1 Slides prepared by Bruno Fullone, George Brown College © 2010 McGraw-Hill Ryerson Limited CHAPTER 3 Demand, Supply and Market Equilibrium PART 1: AN INTRODUCTION TO ECONOMICS AND THE ECONOMY
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1
Slides prepared by Bruno Fullone, George Brown College
© 2010 McGraw-Hill Ryerson Limited
CHAPTER 3 Demand, Supply and Market Equilibrium
PART 1: AN INTRODUCTION TO ECONOMICS AND THE ECONOMY
2
• Learning objective 3.1: What demand is and what affects it
• Learning objective 3.2: What supply is and what affects it
• Learning objective 3.3: How demand and supply together determine market equilibrium
• Learning objective 3.4: What government-set prices are and how they can cause surpluses and shortages
In this Chapter You Will Learn:
3 LO3.1
• A schedule or a curve that shows the various amounts consumers are willing and able to purchase at each of a series of possible prices, during some specified period of time
3.1 Demand
4 LO3.1
Demand
Figure 3-1
0
1
2
3
4
5
6
0 20 40 60 80 100
quantity
pri
ce
Quantity Demanded
Price
per
bushel
Quantity
demand
ed per
week
$5 10
4 20
3 35
2 55
1 80
Demand
Demand: An Individual Buyer’s Demand for Corn
5 LO3.1
Demand
Figure 3-1
0
1
2
3
4
5
6
0 20 40 60 80 100
quantity
pri
ce
Price
per
bushel
Quantity
demanded
per week
$5 10
4 20
3 35
2 55
1 80
Demand
6 LO3.1
Demand
Figure 3-1
0
1
2
3
4
5
6
0 20 40 60 80 100
quantity
pri
ce
Price
per
bushel
Quantity
demanded
per week
$5 10
4 20
3 35
2 55
1 80
Demand
7 LO3.1
Demand
Figure 3-1
0
1
2
3
4
5
6
0 20 40 60 80 100
quantity
pri
ce
Price
per
bushel
Quantity
demanded
per week
$5 10
4 20
3 35
2 55
1 80
Demand
8 LO3.1
Demand
Figure 3-1
0
1
2
3
4
5
6
0 20 40 60 80 100
quantity
pri
ce
Price
per bushel
Quantity
demande
d per
week
$5 10
4 20
3 35
2 55
1 80
Demand
9 LO3.1
• All else equal, as price falls, the quantity demanded rises (& vice-versa)
• Supported by:
– diminishing marginal utility
– income effect
– substitution effect
Law of Demand
10 LO3.1
price QD–Joe QD–Jen QD–
market
$5 10 12 22
$4 20 23 43
$3 35 39 74
$2 55 60 115
$1 80 87 167
+ =
Market Demand – Two Buyers
Copyright © 2007 McGraw-Hill Ryerson Ltd. Chapter 3 11
Individual Demand 1
$0
$1
$2
$3
$4
$5
0 20 40 60 80
quantity
pri
ce
Individual Demand 2
$0
$1
$2
$3
$4
$5
0 20 40 60 80
quantity
pri
ce
Market Demand
$0
$1
$2
$3
$4
$5
0 50 100 150
quantity
pri
ce
35 39
74
12 LO3.1
• A change in one or more of the determinants of demand changes, there is a shift in the demand curve
Changes in Demand
LO 3.1 13
Demand Shifters are Changes in:
• tastes (preferences)
• number of buyers
• income
• prices of related goods
• expectations
let’s examine these more closely…
Changes in Demand
LO 3.1 14
Changes in Tastes (preferences)
• positive change shifts D curve right
• more will be demanded at each price
PA
QA
D D′
Changes in Demand
LO 3.1 15
Changes in Number of Buyers:
• decrease will shift curve left
PA
QA
D’ D
Changes in Demand
LO 3.1 16
Changes in Money Incomes:
• when income increases
demand for NORMAL goods increases
demand for INFERIOR goods decreases
Changes in Demand
LO3.1 17
Changes in Prices of Related Goods:
• when two products are SUBSTITUTES, price of one & demand for the other move in the same direction
Changes in Demand
LO3.1 18
Changes in Prices of Related Goods:
• when two products are COMPLEMENTS, price of one & demand for the other move in opposite directions
Changes in Demand
LO3.1 19
Changes in Prices of Related Goods:
• when products are unrelatedno effect
Changes in Consumer Expectations:
• about future prices or incomes
Changes in Demand
LO3.1 20
• when any other determinant of demand changes, there is a shift in the demand curve
• when price of the product changes, there is a movement along the demand curve
Change in Quantity Demand
LO3.1 21
• change in price
change in quantity demanded
PA
QA
D
Q1 Q2
P2
P1
movement along the curve
Movement Along Demand Curve
LO3.2 22
• A schedule or a curve showing the amounts that producers are willing and able to make available for sale at each of a series of possible prices, during some specified period of time
3.2 Supply
Individual Supply 6
5
4
3
2
1
0
Quantity Supplied (bushels per week)
Pri
ce (
pe
r b
ush
el)
P Qs
$5
4
3
2
1
60
50
35
20
5
P
Q
S1
10 20 30 40 50 60 70
LO23 24
• All else being constant, as price rises, the quantity supplied rises (& vice-versa)
• why?
– price is revenue to suppliers
– higher price necessary to induce higher supply, to cover higher costs of production
Law of Supply
25 LO3.2
Price Qs -
One
Firm
200
Firms
In
Market
Qs-
Market
$5 60 x 200 12,000
$4 50 x 200 10,000
$3 35 x 200 7,000
$2 20 x 200 4,000
$1 5 x 200 1,000
The Market Supply Curve
LO 3.2 26
Individual Firm Supply
0
1
2
3
4
5
6
0 10 20 30 40 50 60
quantity
pri
ce
LO 3.2 27
Market Supply
0
1
2
3
4
5
6
0 5000 10000
quantity
pri
ce
LO 3.2 28
Supply Shifters are Changes in: • factor prices • technology • taxes & subsidies • prices of other goods • producer expectations • number of sellers
let’s examine these more closely…
Determinants of Supply
LO3.2 29
Changes in Factor Prices:
• decrease will increase supply & shift curve right
• more will be supplied at each price PA
S
QA
Changes in Supply
LO3.2 30
Changes in Taxes & Subsidies:
• increases in taxes will reduce supply
PA S
QA
Changes in Supply
LO3.2 31
Changes in Technology:
• new technology will decrease costs & increase supply
PA S
QA
Changes in Supply
LO23 32
Changes in Prices of Other Goods:
• higher prices of substitutes in production will reduce supply
PA S
QA
Changes in Supply
LO3.2 33
Changes in Producer Expectations:
• of the future price of a product
• difficult to generalize
Changes in Number of Sellers:
• as the number of sellers increases, so does supply
Changes in Supply
LO3.2 34
• A change in supply is a shift of the entire curve
• A change in quantity supplied is a movement from one point to another on a fixed supply curve
price
quantity
S
Increase in QS
Decrease in QS
NOT supply!
Changes in Quantity Supplied
LO 3.3 35
• Equilibrium price will be established where the supply decisions of producers and the demand decisions of buyers are mutually consistent
• Surpluses drive prices down
• Shortages drive prices up
Let’s look at the process of adjustment to equilibrium graphically
3.3 Market Equilibrium
LO3.3 36
Figure 3-6
0
1
2
3
4
5
6
0 2 4 6 8 10 12 14 16 18
Bushels of corn (thousands per week)
Pri
ce
(p
er
bu
sh
el)
6000-bushel surplus
S
D
$4 is not the equilibrium
price
Equilibrium Price and Quantity
LO 3.3 37
Figure 3-6
0
1
2
3
4
5
6
0 2 4 6 8 10 12 14 16 18
Bushels of corn (thousands per week)
Pri
ce
(p
er
bu
sh
el)
7000-bushel shortage
S
D
$2 is not the equilibrium
price
Equilibrium Price and Quantity
LO3.3 38
Figure 3-6
0
1
2
3
4
5
6
0 2 4 6 8 10 12 14 16 18
Bushels of corn (thousands per week)
Pri
ce
(p
er
bu
sh
el)
QD=QS D
S $3 is the
equilibrium price
Equilibrium Price and Quantity
LO 3.3 39
• Rationing Function of Prices
– combination of freely made individual decisions results in market-clearing price
• Efficient Allocation
– Productive Efficiency
– Allocative Efficiency
Equilibrium Price and Quantity
LO 3.3 40
• Changes in demand or supply will affect the equilibrium price and quantity
Changes in Supply, Demand and Equilibrium
LO 3.3 41
An increase in demand will cause:
•a shortage at the original price p1
D1 D2 P
Q
p1
q1 q3
S
Increase in Demand
LO 3.3 42
•Consumers will bid price up to p2
•QS will increase, QD will decrease •new equilibrium reached at p2, q2
D1 D2 P
Q
p1
q1
S
p2
q2
price has increased from p1 to p2,
quantity traded has increased from q1 to q2
NOT an increase in
supply
q3
Increase in Demand
LO 3.3 43
A decrease in demand will cause:
•a surplus at the original price p1
D2 D1 P
Q
p1
q1 q3
S
Decrease in Demand
LO 3.3 44
•Producers will drop price to p2
•QS will decrease, QD will increase •new equilibrium will be reached at p2, q2
D2 D1 P
Q
p1
q1 q3
S
q2
p2
price has decreased from p1 to p2,
quantity traded has decreased from q1 to
q2
NOT a decrease in
supply
Decrease in Demand
LO 3.3 45
An increase in supply will cause:
•a surplus at the original price p1
S1
S2
P
Q
D
q1
p1
q3
Increase in Supply
LO 3.3 46
•Producers will drop price to p2
•QD will increase, QS will decrease •A new equilibrium will be reached at p2, q2
S1
S2
P
Q
D
q1
p1
q3 q2
p2
price has decreased from p1 to p2,
quantity traded has increased from q1 to
q2
Increase in Supply
LO 3.3 47
A decrease in supply will cause:
•a shortage at the original price p1
S2
S1
P
Q
D
q3
p1
q1
Decrease in Supply
LO 3.3 48
•Consumers will bid price up to p2
•QS will increase, QD will decrease •A new equilibrium will be reached at p2, q2
S2
S1
P
Q
D
q3
p1
q1
p2
q2
price has increased from p1 to p2,
quantity traded has decreased from q1
to q2
Decrease in Supply
LO 3.3 49
• when both supply and demand change, the effect is a combination of the individual effects
• if both demand and supply shift, one of either price or quantity cannot be predicted–the result is indeterminate
Complex Cases
LO 3.3 50
Change in
supply
Change in
demand
Effect on
equilibrium
price
Effect on
equilibrium
quantity
Increase Decrease Decrease Indeterminate
Decrease Increase Increase Indeterminate
Increase Increase Indeterminate Increase
Decrease Decrease Indeterminate Decrease
Table 3-3 Complex Cases
• Price Ceilings: A legally established maximum price for a good or service.
• Which can graphically be shown ….
LO 3.4 51
3.4 Applications: Government Set Prices
LO 3.4 52
D
D S
S
P0
The result of imposing a legal price
ceiling is a....
P
Q
Figure 3-8
Qd Qs
SHORTAGE
Q
Price Ceilings and Shortages
LO 3.4 53
• Rationing Problem
• Black Markets
• Credit Card Interest Ceilings
Price Ceilings and Shortages
LO 3.4 54
• Price Floor: A legally established price above an equilibrium price
• Which can graphically be shown as ….
Government Set Prices: Price Floors
LO 3.4 55
D
D S
S
$3.00 P0 The result of imposing a legal price floor is a....
P
Q
Figure 3-9
Q0
SURPLUS
Qs Qd
$4.00 P1
Price Floors and Surplus
LO 3.4 56
• Additional consequences
• Distort resource allocation
• Cause shortages or surpluses
• Produce negative side effects
Price Floors and Surplus
The Last Word: A Market for Human Organs
• Waiting list for transplants
• Demand for organs
• Supply of organs—two possibilities
• Market eliminates shortage
• Moral objections
• Legalize and regulate?
57 Chapter 3
The Last Word: A Market for Human Organs P
Q
S2 S1
D1
P1
P0 Q1 Q2 Q3
Supply of Organs
At Price P1 the Shortage is Reduced By Q1 – Q2
Demand for Organs
58 Chapter 3
Chapter 3 59
3.1 Demand
3.2 Supply
3.3 Supply & Demand: Market Equilibrium
3.4 Application: Government-set Prices
Chapter 3 Summary
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