(Demand, Supply and Market Equilibrium) Chapter 3 Supply and Demand: In Introduction.

(Demand, Supply and Market Equilibrium)

Chapter 3

Supply and Demand: In Introduction

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Topics

Demand Supply Market Equilibrium

– Tendency to change– Intervention– Comparative study

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Demand

The quantity of a good that buyers wish to buy at each price

Demand curve: a schedule or graph showing demand

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Demand: key points willingness and ability to buy a relationship between quantity demanded

and product price Qd = f (P)

– quantity demanded is a function of price – quantity demanded is determined by price

The law of demand: Qd and P are negatively related

Demand Curve: downward sloping Market demand: the sum of individual

demand

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Key Terms (why downward sloping?)

Substitution effect (of a price change): (willingness to buy)– change in quantity demanded of a good that

results because buyers switch to or from substitutes when the price of the good changes

– Change in Qd when switch to or from substitutes because of P changes

Income effect (of a price change): (ability to buy)– change in quantity demanded of a good that

results because a change in price changes the buyer’s purchasing power

– Change in Qd when purchasing power changes because of P changes

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Key Term (why downward sloping?)

buyer’s reservation price (willingness to pay)– The largest dollar amount the buyer would

be willing to pay for a good– The benefits the buyer expects to receive

(from having it)– The reservation price of the marginal buyer

declines as the quantity of the good bought increases

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The Daily Demand Curve for Pizza in Chicago Figure 3.1, P.64

Exercise 3.1, P.64-Reservation p when Qd=10k-Qd when P=$2.50

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D vs. Qd

D Qd

A relationship between P and Qd

A number at a given P

A curve A point on the curve

Reasons for change: change in factors other than P

Reasons for change: change in P only

Change: a shift of the entire curve

Change: a movement along the curve

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Assumption: Other Things Equal

the other things: factors affecting D

--price of related goods complements vs. substitutes

--income: normal vs. inferior--preference--expectations (prices, income, …)--population--others

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An Increase in the Quantity Demanded versus an Increase in Demand

Figure 3.10, P.73

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Supply:

Quantity of a good that sellers wish to sell at each price

Supply curve: a schedule or graph showing supply

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Supply: Key Points

willingness and ability to sell a relationship between price and quantity

supplied Qs = f (P)

– Quantity supplied is a function of price– quantity supplied is determined by price

The Law of Supply: Qs and P are positively related

Supply Curve: upward sloping Market supply: the sum of individual supply

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Why upward sloping?

Increasin opportunity cost (the low-hanging-fruit principle)

Seller’s reservation price: the smallest dollar amount for which a seller would be willing to sell an additional unit (marginal cost)

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The Daily Supply Curve of Pizza in Chicago

Figure 3.2,P.65

Exercise 3.2-marginal cost when Qd=10k-Qd when P=$3.50

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S vs. Qs

S Qs

A relationship between P and Qs

A number at a given P

A curve A point on the curve

Reasons for change: change in factors other than P

Reasons for change: change in P only

Change: a shift of the entire curve

Change: a movement along the curve

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A decrease in quantity supplied vs. a decrease in supply

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Assumption: Other Things Equal

the other things: factors affecting S

--prices of inputs goods used to produce other goods

--price of related goods goods that use the same resources

--technology--expectations--others

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Market Equilibrium Market:

where the buyers meet the sellers Market Equilibrium:

– when there is no tendency to change (unless caused by external forces)

– When buyers and sellers are satisfied with their respective quantities at the market price

Equilibrium price and equilibrium quantity– Price and quantity when Qd=QsChange in D and impacts on Pe and Qe

Change in S and impacts on Pe and Qe

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Equilibrium Price &Equilibrium Quantity of Pizza in Chicago

Figure 3.3, P.66

Whyno tendency to change?

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Key Terms

Excess supply: (surplus)– Qs > Qd when P>Pe

Excess demand: (shortage)– Qd > Qs when P<Pe

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Excess SupplyFigure 3.4

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Excess DemandFigure 3.5

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What happens when there is excess demand? Excess supply?

Tendency to change (not in equilibrium) until reaching equilibrium

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Graphing Supply and Demand and Finding the Equilibrium Price and Quantity

Figure 3.6

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What if intentionally stay away from market equilibrium?

Government intervention– Price ceiling

• rent control• pizza price control

– Price floor• agricultural products• minimum wage

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Interventions

Interntions: welfare concerns or political interests

Results: inefficiencies in markets

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Price Controls

Legal restrictions on how high or low a market price may go

Price Ceiling: – limiting price (on consumer goods to

protect consumers welfare)– maximum price a seller can charge

Price Floor: – support price (on production factors, e.g.

labor)– minimum price a buyer is required to pay

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Example: Price Ceiling

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The Effects of a Price Ceiling

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Rent ControlsFigure 3.8,P.70

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Price Controls in the Pizza MarketFigure 3.9

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ShortagesInefficiencies

misallocation to consumerswasted resourceslow quality

black markets.

Problems with Price Ceilings

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Example: Price Floor

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The Effects of a Price Floor

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SurplusInefficiencies

misallocation of sales among sellersWasted resourcesInefficiently high quality

Illegal activity

Problems with Price Floors

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Price Controls cause Inefficiency

Consumer surplus Producer surplus Total surplus Deadweight loss

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Recall: Demand--the definition

The quantity of a good or service consumers’ are willing and able to buy at various prices

The maximum price the consumer is willing and able to pay for the next unit of the good or service.

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Two Different Prices

The maximum price

the consumers are willing to pay for

Vs.

The market price

the consumers actually paid for

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Individual consumer surplus the net gain to an individual buyer from the purchase of a good. equal to the difference between the buyer’s willingness to pay and the price paid.

Total consumer surplus the sum of the individual consumer surpluses of all the buyers of a good

Consumer Surplus

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Consumer Surplus

The total consumer surplus generated by purchases of a good at a given price is equal to the area below the demand curve but above that price.

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A Fall in the Market Price Increases Consumer Surplus

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Recall: Supply--the definition

The quantity of a good or service producers are willing and able to sell at various prices

The minimum price the producer is willing and able to accept for providing the next unit of the good or service

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Two Different Prices

The minimum price

the producers are willing to accept

Vs.

The market price

the producers actually get

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Producer Surplus and the Supply Curve

Individual producer surplus the net gain to a seller from selling a good equal to the difference between the price received and the seller’s cost (the minimum price the producer is willing to accept)

Total producer surplus

the sum of the individual producer surpluses of all the sellers of a good

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The total producer surplus from sales of a good at a given price is the area above the supply curve but below that price.

Producer Surplus

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A Rise in Price Increases Producer Surplus

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Putting it together: Total Surplus

the total net gain to consumers and producers from trading in the market

the sum of the producer surplus and the consumer surplus

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Total Surplus