Introduction to Macroeconomics Chapter 3. Private Markets and Prices: Laws of Supply and Demand.

Introduction to Macroeconomics

Chapter 3. Private Markets and Prices:

Laws of Supply and Demand

Chapter 3. Laws of Supply & Demand

• Microeconomic Supply and Demand– Demand curve– Supply curve

• Supply - Demand Equilibrium– Equilibrium– Disequilibrium– Shifts in demand and supply curves

Law of Demand

• As the price of a product declines relative to the price of all other goods, the quantity demanded will increase, ceteris paribus.

• The demand curve, a graphic representation of the Law of Demand, slopes downward to the right

Demand Curve

0

10

20

30

40

50

0 10 20 30 40 50 60

Quantity Demanded

Pro

du

ct

Pri

ce

As price declinesthe quantity demanded increases

Demand

Demand CurveCeteris Paribus Assumption

Everything else that can affect demand is unchanged:

• Prices of all other goods

• Income

• Tastes

Law of Supply

• As the price of a product declines relative to the price of all other goods, the quantity supplied will decline, ceteris paribus.

• The supply curve, a graphic representation of the Law of Supply, slopes upward to the right

Supply Curve

0

10

20

30

40

50

0 10 20 30 40 50 60

Quantity Supplied

Pro

du

ct

Pri

ce

As price increasesthe quantity supplied increases Supply

Supply CurveCeteris Paribus Assumption

Everything else that can affect supply is unchanged:

• Prices of all inputs– labor, raw materials, cost of capital

• Prices of all other goods

• Technology

• Environment (e.g., weather)

Supply - Demand Equilibrium

0

10

20

30

40

50

0 10 20 30 40 50 60

Quantity

Pro

du

ct P

rice

Equilibrium

Supply

Demand

Price at which quantity supplied equals the quantity demanded

Disequilibrium

• Price above the equilibrium level– quantity demanded < quantity supplied– surplus– price floor: price prevented from

dropping to equilibrium level

• Price below the equilibrium level– quantity demanded > quantity supplied– shortage– price ceiling: price prevented from

rising to equilibrium level

Price Floor

0

10

20

30

40

50

0 10 20 30 40 50 60

Quantity

Pro

du

ct P

rice

SupplyDemand

PriceFloor

Quantity Demanded Quantity Supplied<Surplus

Price Ceiling

0

10

20

30

40

50

0 10 20 30 40 50 60

Quantity

Pro

du

ct P

rice

SupplyDemand

PriceCeiling

Quantity Supplied Quantity Demanded<Shortage

Demand vs Quantity Demanded

• “Quantity Demanded” refers to a point on the demand curve. A “Change in Quantity Demanded” refers to a movement along a stable demand curve

• “Demand” refers to the entire curve. A “Change in Demand” refers to a shift in the demand curve.

Change in Quantity Demanded

0

10

20

30

40

50

0 10 20 30 40 50 60

Quantity Demanded

Pro

du

ct

Pri

ce As price declines

the quantity demanded increases

Demand

A change in priceresults in a movement along a demand curve

Change in Demand

0

10

20

30

40

50

0 10 20 30 40 50 60

Quantity

Pro

du

ct P

rice

Increase in Demand:Demand Curve Shifts Right

A change in anything except pricethat affects the quantity demanded

results in a shift of the demand curvve

Demand Curve Shifters

A change in any variable listed under the Ceteris Paribus assumptions

Change in Variable

Demand Curve Shift

Income See following slide on Normal and Inferior Goods

Tastes Increase in Preference

Right

Prices of Other Goods

See following slide on Complements and Substitutes

Normal and Inferior Goods

Demand curve will shift with change in income

• Normal Good - as income increase, demand for the good also increases (demand curve shifts right)

• Inferior Good - as income increase, demand for the good decreases (demand curve shifts left)

Complements and Substituesin Demand

Demand curve will shift with change in price of related goods

• Complements in Demand - demand decreases as price of complement increases– big cars and gasoline

• Substitutes in Demand- demand increases as price of substitute increases– butter and margerine

Supply vs Quantity Supplied

• “Quantity Supplied” refers to a point on the supply curve. A “Change in Quantity Supplied” refers to a movement along a stable supply curve.

• “Supply” refers to the entire curve. A “Change in Supply” refers to a shift in the supply curve.

Change in Quantity Supplied

0

10

20

30

40

50

0 10 20 30 40 50 60

Quantity

Pro

du

ct

Pri

ce

A change in priceresults in a movement along a supply curve

As price declines the quantity supplied decreases

Supply

Change in Supply

0

10

20

30

40

50

0 10 20 30 40 50 60

Quantity

Pro

du

ct

Pri

ce Increase in Supply:

Supply Curve Shifts Right

A change in anything except pricethat affects the quantity supplied

results in a shift of the supply curvve

Supply Curve Shifters

A change in any variable listed under the Ceteris Paribus assumptions

Change in Variable

Supply Curve Shift

Price of Inputs Increase Left

Technology Improvement Right

Weather Hurricane Left

Prices of Other Goods

See next slide on complements and substitutes

Complements and Substitues in Supply

Supply curve will shift with change in price of related goods in the production process

• Complements in Supply - supply increases as price of the complement increases– beef and leather

• Substitutes in Supply - supply decreases as price of the substitute increases– wheat and rye

Supply Curve Shift and Equilibrium

0

10

20

30

40

50

0 10 20 30 40 50 60

Quantity

Pro

du

ct

Pri

ce

Supply CurveShifts RightDemand

Increase inQuantity

Decrease inPrice