The Market Forces of Supply and Demand Ratna K. Shrestha Chapter 4.

The Market Forces of Supply and Demand

Ratna K. Shrestha

Chapter 4

Overview

Market and Competition Demand Supply Equilibrium Price and Resource Allocation

Supply and Demand

Supply and Demand are the forces that make market economies work!Supply is determined by the producers.Demand is determined by the consumers.

Modern microeconomics is about supply, demand, and market equilibrium.

Markets and Competition

The terms supply and demand refer to the behavior of people. . .

. . .as they interact with one another in markets.

Market: any institution, mechanism, or arrangement which facilitates exchange of

goods and services.

A market is a group of buyers and sellers of a particular good or service.

– A market for cars.– A market for computers.– A market for legal services.

What is Market?

Market Type: A Competitive Market

A Competitive Market is a market: with many buyers and sellers selling/buying

homogeneous Products.Where no single consumer or a firm can

influence the price. Total demand and supply determine the price.

Where firms can enter or exit freely.in which a narrow “range of prices” are

established that buyers and sellers.

e.g. steel and agricultural product markets.

Other Types of Market

Monopoly:– One Seller, controls price. e.g. BC Hydro,

Shaw Cable, ICBC, Microsoft. Oligopoly:

– Few Sellers, not aggressive competition Monopolistic Competition:

– Many Sellers, differentiated products– e.g. auto, computer, restaurants.– Honda Civic is different from Toyota Corolla.

Spectrum of Market Structure

PureCompetition

PureMonopoly

ImperfectCompetition

Four Types of Market Structure

Monopoly Oligopoly Monopolistic Competition

Perfect Competition

• Tap water

• Cable TV

• Tennis balls

• Crude oil

•Hockey Skates

• Novels, CD

• Movies

• Wheat

• Milk

Number of Firms?

Type of Products?

Many firms

One firm Few

firms Differentiated products

Identical products

The Concept of Demand. . .

Quantity Demanded refers to the amount (quantity) of a good that buyers are willing to purchase at various prices for a given period.

P

Q

Individual Demand ScheduleCathy’s Demand: Ice Cream Cones

Price Per Cone

(P)

Daily Quantity

(Q)

$3.00 0 $2.50 2 $2.00 4 $1.50 6

Individual Demand CurveCathy’s Demand: Ice Cream Cones

P$/Cone

Q # Cones Per Day

$2.50

$2.00

$1.50

2 4 6

(P)QQ DD

Demand Equation:

Market Demand Schedule

Market demand is the sum of all individualdemands at each possible price.

Assume the ice cream market has two buyers as follows:

Price Per Cone Cathy Nick Mkt Demand $0.00 12 + 7 = 19 $0.50 10 + 6 = 16 $1.00 8 + 5 = 13 $1.50 6 + 4 = 10 $2.00 4 + 3 = 7

Market Demand CurveAll Buyers

P$/Cone

Q # Cones Per Day

$2.00

$1.50

$1.00

7 10 13

Determinants of Demand

What factors determine how much ice cream you will buy?

Product’s Own Price

Consumer IncomePrices of Related GoodsTastesExpectationsNumber of Consumers

Determinant of Demand: Product’s Own Price

Law of Demand:

There exists an inverse relationship between Price and

Quantity Demanded.

P

Q

As P

Q

Ceteris Paribus . . .

...implies that all the relevant variables (e.g. determinants of demand) are held constant, except the one(s) being studied at the time.

Change in Quantity Demanded vs. Change in Demand

Change in Quantity DemandedMovement along the demand curve is caused by a change in the Price of the product.

Change in Demand (Shift)

A shift in the demand curve, either to the left or right is caused by changes in Non-Price Factors.

Changes in Quantity Demanded

Price

Quantity

$2.00

7

D

Changes in Quantity Demanded

Price

Quantity

$2.00

7

$1.00

13

D

Changes in Quantity Demanded

Price

Quantity

$2.00

7

$1.00

13

Caused by a changein Price

D

Change (Shift) in Demand

Price

Quantity

$2.00

7

D

(Shift) Change in Demand

Price

$2.00

7 Quantity10

DD’

(Shift) Change in Demand

Price

$2.00

7 Quantity10

Caused byNon-PriceFactors:Income,Tastes...

DD’

Determinant of Demand: Income

As income increases the demand for a normal good will increase.

Examples? Why the demand

curve shifts?

P

Q

Determinant of Demand: Income

As income increases the demand for an inferior good will decrease.

Examples? In Japan, Ashahi

Brewery did well during recession. What is the possible implication of this?

P

Q

Examples??

Melbourne newspaper reports that local book retailers are faring better this Christmas than last. So the income elasticity seems to be helping out here. Possibly books are inferior goods.

Determinant of Demand: Prices of Related Goods

When the fall in price of one good reduces the demand for another good (shift of demand curve to the left), the two goods are substitutes.

Examples?

Determinant of Demand: Prices of Related Goods

When the fall in price of one good increases the demand for another good (shift of demand curve to the right), the two goods are complements.

Examples?

Quick Quiz!

List the determinants of the demand for pizza.

Give an example of a demand schedule for pizza.

Give an example of something that would shift the demand curve.

The Concept of Supply. . .

Quantity Supplied refers to the amount of a good that sellers are willing to make available for sale at alternative prices for a given period.

The minimum price a seller is willing to accept for a product is its cost of production.

Individual Supply ScheduleBen’s Store: Ice Cream Cones

Price Per Cone (P)

Daily Quantity (Q)

$3.00 5

$2.50 4

$2.00 3

$1.50 2

P

Q # Cones Per Day

$2.50

$2.00

$1.50

2 3 4

Individual Supply CurveBen’s Store: Ice Cream Cones

(P)QQ SS

Supply Equation:

Market Supply Schedule

Market supply is the sum of all individualsupplies at each possible price.

Assume the ice cream market has twofirms as follows:

Price Cone Ben’s Jerry’s IceMart Market Supply $0.00 0 + 0 = 0 $0.50 0 + 0 = 0 $1.00 1 + 0 = 1 $1.50 2 + 2 = 4 $2.00 3 + 4 = 7

P

Q # Cones Per Day

$2.00

$1.50

$1.00

1 4 7

Market Supply CurveAll Sellers

S

Determinants of Supply

Product’s Own Price

Other Factors:Input Prices (cost of production)TechnologyExpectations Number of Producers

Determinant of Supply: Market Price

Law of Supply

There exists a direct (positive) relationship between Price and Quantity Supplied.

P

Q

Change in Quantity Supplied vs. Change in Supply

Change in Quantity Supplied Movement along the supply curve. Caused by a change in the Price of the

product. Change in Supply (Shift)

A shift in the supply curve, either to the left or right.

Caused by changes in Non-Price Factors

Changes in Quantity Supplied

Price

Quantity

$2.00

3

S

Changes in Quantity Supplied

Price

Quantity

$2.00

3

$1.00

1

S

Changes in Quantity Supplied

Price

Quantity

$2.00

3

$1.00

1

Caused bya change in Price

S

Change in Supply

Price

Quantity

$2.00

3

S

Change in Supply (Shift)

Price

Quantity

$2.00

3 6

Caused byNon-PriceFactors:Technology,Input Prices

S S’

Quick Quiz!

List the determinants of the supply for pizza.

Give an example of a supply schedule for pizza.

Give an example of something that would shift the supply curve.

Supply and Demand Together

Equilibrium Price

The price at which the supply and demand curve intersect.

Equilibrium Quantity

The quantity at which the supply and demand curve intersect; that is, Quantity Supplied and Quantity Demanded are equal.

Forces of Demand and Supply At RestMarket Equilibrium

Price

Quantity

$2.00

7

S

D

Equilibrium is a state in which there is no tendency to change. This occurs when everyone is doing the best he or she can.

Is there Equilibrium in this Picture?

Actions of buyers and sellers that move toward equilibrium.

Excess Supply

Price is above equilibrium price, therefore producers are unable to sell all they want at the going price.

Excess Demand

Price is below equilibrium price, therefore consumers are unable to buy all they want at the going price.

Actions of buyers and sellers that move toward equilibrium.

Price

Quantity

$2.50

$2.00

4 10

S

D

7

Actions of buyers and sellers that move toward equilibrium.

Price

Quantity

$2.50

$2.00

4 10

Excess Supply = 6 cones

7

S

D

Actions of buyers and sellers that move toward equilibrium.

Price

Quantity

$2.00

$1.50

4 7 10

S

D

Actions of buyers and sellers that move toward equilibrium.

Price

Quantity

$2.00

$1.50

4 7 10

ExcessDemand=6 cones

SD

Comparative Statics: Analyzing Changes in Equilibrium

Determine if an event shifts supply curve, the demand curve, or both.

Determine if curve(s) shift to left or right. Determine how the shift affects equilibrium

price and quantity. Example Event: Heat Wave

Product: Ice Cream Cones

Heat Wave Affects Buyers (Demand)

Price

Quantity

P1

Q1

S

D

Heat Wave Will Cause:Rightward Shift in Demand

Price

Quantity

P1

Q1

P2

Q2

S

D

D’

An Increase in Demand: Demand Shifts Right

Price

Quantity

P1

Q1

P2

Q2

Both P and Q increase.

D

D’

S

D’S’

Changes In Market Equilibrium

When Income Increases & at the same time raw material prices fall– Quantity

increases– If the shift in D is

greater than the shift in S, price increases

P

Q

S

P2

Q2

D

P1

Q1

Shifts in Supply and Demand

When supply and demand shift simultaneously, the impact on the equilibrium price and quantity is determined by:

1. The relative size and direction of the change

2. The shape or slope of the supply and demand models

Market for a College Education

Q (millions enrolled))

P(annual cost

in 1970dollars)

D1970

S1970

S2002

D2002

$3,917

13.2

$2,530

8.6

S2002

D2002

D1900

S1900 S1950

D1950

Long-Run Path of Priceand Consumption

Copper Market Equilibrium

Quantity

Price

Concluding Thoughts. . .

Market economies harness the forces of supply and demand. . .

Supply and Demand together determine the prices of the economy’s different goods and services. . .

Prices in turn are the signals that guide the allocation of resources.

BC Cranberry Case Study

After the discovery of beneficial health effect of Cranberry in 1996 (Harvard Study), BC cranberry farmers expected its demand and hence price to go up. But to their dismay, the price fell instead.

Analyze what might have caused this unexpected result??

Practice Numerical Problems

1. Given

(i) QD = 50 – 3P; QS = 10 + 2P

Draw S and D curves. Find equilibrium P and Q.

(ii) QD = 50 – 3P + I

Draw D curve for I = 10. Show the effect of increase in I from $10 to

$25.