Understanding Economics

Understanding Economics 4th edition by Mark Lovewell, Khoa Nguyen and Brennan Thompson

Understanding Economics

Demand and Supply

1Learning ObjectivesAfter this chapter, you will be able to:understand complementors, competitors and the different meanings of industrycomprehend the nature of demand, changes in quantity demanded, changes in demand, and the factors that affect demandunderstand the nature of supply, changes in quantity supplied, changes in supply, and the factors that affect supplyexplain how markets reach equilibrium the point at which demand and supply meetThe Business MapOrganization Set of processes and network of transactionsSuppliers ----Organization----Customers

Suppliers are indirect competitors and collaborators to the organization andCustomers are potential competitors and collaboratorsCompetitors/collaborators or complementorsCompetitors rivals (compete for resources and/or customers)Complementors join forces and work togetherCan competitors be complementors at the same time?What does the term industry mean?A collection of firms producing similar products (North American Industrial Classification System)

What about business/economics?Degree of substitutability (in consumption) among products: A good book and a movie

What Is Demand?Demand is a relationship between a products price and quantity demanded at some given time period, other factors held constant. Demand is shown using a schedule or curve.The law of demand states that price and quantity demanded are inversely related.Market demand is the sum of quantities demanded by all consumers in a market.61Any item you are willing to buy must provide you with some benefitsMB= benefit from additional unit of itemDiminishing marginal benefit each unit provides less benefit than the one before itPrice you are willing to pay should decrease with quantity purchasedThe Demand CurveFigure 2.1, page 330135791113Quantity Demanded(kg per month)Your Demand Curve for StrawberriesYour Demand Schedulefor StrawberriesQuantity Demanded(kg per month)Pointon graphPrice($ per kg)$2.502.001.50 9 711Price ($ per kg)0.501.001.502.002.50D b a c a b c83Deriving Market DemandFigure 2.2, page 3501234567Quantity Demanded (kg per month)Friends Demand Curve for StrawberriesIndividual and Market DemandSchedules for StrawberriesYou

(D0)Price

($ per kg)$2.502.001.50

123234357Price ($ per kg)0.501.001.502.002.50Friend

(D1)Market

(Dm)(kg per month)01234567Quantity Demanded (kg per month)Market Demand Curve for StrawberriesPrice ($ per kg)0.501.001.502.002.5001234567Quantity Demanded (kg per month)Your Demand Curve for StrawberriesPrice ($ per kg)0.501.001.502.002.50D0D1Dm93What is Price?Could be absolute, relative, balance or total

Absolute = Price of Product x (Px)Could be real, specific or categorical

Real = Px/IP (IP= index of prices of all productsSpecific = Px/Py (Py refers to price of product y)Categorical = Px/IPCat (IPCat = index of prices of products in a category)Relative PriceBalance & TotalBalance = PPC/PRPPPC = price paid by customersPRP = price received by producersBalance may be expressed as PPC-PRP

Total = Px + TCTC = transaction costsChanges in Demand (a)Changes in demand:are shown by shifts in the demand curveare caused by changes in demand factors

132Changes in Demand (b)Figure 2.3, page 360135791113Quantity Demanded(millions of kg per year)Market Demand Curve for StrawberriesMarket Demand Schedulefor StrawberriesQuantity Demanded(millions of kg)Price($ per kg)$2.502.001.5057 911 7 991113Price ($ per kg)0.501.001.502.002.50D0D1D2(D2)(D0)(D1)143Demand Factors (a)Demand factors include the following:The number of buyers (an increase causes a rightward demand shift)IncomeFor normal products, an increase causes a rightward demand shift.For inferior products, an increase causes a leftward demand shift.154Demand Factors (b)Prices of other productsFor substitute products, a rise in the other products price causes a rightward demand shift.For complementary products, a rise in the other products price causes a leftward demand shift.Consumer preferencesConsumer expectations165Changes in Quantity Demanded (a)Changes in quantity demanded:are shown by movements along demand curveare caused by price changesChanges in Quantity Demanded (b)Figure 2.4, page 38050006000Quantity Demanded (pairs of skis)Change in Quantity DemandedPrice ($ per pair of skis)0.501.001.502.0005000Quantity Demanded (pairs of skis)Change in DemandPrice ($ per pair of skis)0.501.001.502.00abD0D0D1183What Is Supply?Supply:is a relationship between a products price and quantity suppliedis shown using a schedule or curveThe law of supply states there is a direct relationship between price and quantity supplied.196The Supply CurveFigure 2.5, page 40Market Supply Schedulefor StrawberriesQuantity Supplied(millions of kg)Pointson graphPrice($ per kg)$1.502.002.50 9 513 e d fMarket Supply Curve for StrawberriesS f e d0135791113Quantity Supplied(millions of kg per year)Price ($ per kg)0.501.001.502.002.50203Changes in Supply (a)Changes in supply:are shown by shifts in the supply curveare caused by changes in supply factors217Changes in Supply (b)Figure 2.6, page 41Market Supply Schedulefor StrawberriesQuantity Supplied(millions of kg)Price($ per kg)$2.502.001.5011 7 9 111315 35 7S0S1S2Market Supply Curve for Strawberries0135791113Quantity Supplied(millions of kg per year)Price ($ per kg)0.501.001.502.002.5015 (S2) (S0) (S1)223Supply Factors (a)Supply factors include the following factors:Number of producers (an increase causes a rightward supply shift)Resource prices (an increase causes a leftward supply shift)State of technology (an improvement causes a rightward supply shift)Prices of related products (an increase causes a leftward supply shift)239Supply Factors (b)Changes in nature (an improvement causes a rightward shift for some products)Producer expectations (an expectation of lower prices in the future causes an immediate rightward supply shift)

Changes in Quantity Supplied (a)Changes in quantity supplied:are shown by movements along the supply curveare caused by price changesChanges in Quantity Supplied (b)Figure 2.7, page 43012Quantity Supplied(millions of kg per year)Change in Quantity SuppliedPrice ($ per kg)20406080100120Change in Supply012Quantity Supplied(millions of kg per year)Price ($ per kg)20406080100120S0S1S0ba263Market Equilibrium (a)When a product is in surplus:there is excess supplyprice is pushed downWhen a product is in shortage:there is excess demandprice is pushed up2710Market Equilibrium (b)Figure 2.8, page 440135791113Quantity(millions of kg per year)Market Demand and Supply Curvesfor StrawberriesPrice ($ per kg)1.001.502.002.503.00SD15$3.00513+8 2.50711+4 2.00990 1.50117-4 1.00135-8Market Demand and Supply Schedules for StrawberriesPrice($ per kg)Quantities(millions of kg) DSSurplus (+)or Shortage (-)(millions of kg)SurplusShortagebbaaeMarket EquilibriumBalancing supply and demandQxS = Qxd Steady-state

PriceQuantitySD5612Shortage12 - 6 = 66If price is too low7PriceQuantitySD914Surplus14 - 6 = 8688If price is too high7Changes in Equilibrium (a)A rightward demand shift pushes up both equilibrium price and quantity.A leftward demand shift pushes down both equilibrium price and quantity.A rightward supply shift pushes equilibrium price down and equilibrium quantity up.A leftward supply shift pushes equilibrium price up and equilibrium quantity down.3212Demand Changes and EquilibriumFigure 2.9, page 460135791113Quantity(millions of kg per year)Market Demand and Supply Curves for StrawberriesPrice ($ per kg)1.001.502.002.503.00SD015 a$3.002.502.001.501.00Market Demand and SupplySchedules for Strawberries

Price Quantities (D0) (D1)(S)($ per kg.) (millions of kg)D1 bshortage 5 7 911139 11 1315171311 97 517Supply Changes and EquilibriumFigure 2.10, page 470135791113Quantity(millions of kg per year)Market Demand and Supply Curves for StrawberriesPrice ($ per kg)1.001.502.002.503.00S0D015$3.002.502.001.501.00Market Demand and SupplySchedules for Strawberries

Price Quantities($ per kg) (millions of kg) 5 7 9111313 11 9751715 1311 917S1ab(D0) (S0)(S1)SurplusChanges in Equilibrium (b)A simultaneous rightward shift in demand and supply raises equilibrium quantity, but the effect on equilibrium price depends on the relative sizes of the two shifts.if demand shifts rightward more than supply, then price rises if supply shifts rightward more than demand, then price falls

3512Effects of Increases in Demand and SupplyFigure 2.11 page 480135791113Quantity(millions of kg per year)Market Demand and Supply Curves for StrawberriesPrice ($ per kg)1.001.502.002.503.00D015 a$3.002.502.001.501.00Market Demand and SupplySchedules for Strawberries

Price Quantities (D0) (D1) ( S0) (S1) ($ per kg.) (millions of kg)D1 b 5 7 911139 11 1315171311 97 5171715 1311 9S0S136Changes in Equilibrium (c)A simultaneous rightward shift in demand and leftward shift in supply raises equilibrium price, but the effect on equilibrium quantity depends on the relative sizes of the two shifts.if supply shifts leftward more than demand shifts rightward, then quantity fallsif demand shifts rightward more than supply shifts leftward, then quantity rises

3712Effects of a Demand Increase and Supply DecreaseFigure 2.12 page 490135791113Quantity(millions of kg per year)Market Demand and Supply Curves for StrawberriesPrice ($ per kg)1.001.502.002.503.00D015 a$3.002.502.001.501.00Market Demand and SupplySchedules for Strawberries

Price Quantities (D0) (D1) ( S0) (S1) ($ per kg.) (millions of kg)D1 b 5 7 911137 9 1113151311 97 517119 75 3S0S1Spoilt for ChoiceWilliam Stanley Jevons:assumed measurable utilityoutlined the law of diminishing marginal utility, which states that a consumers marginal utility declines as more of a product is consumedshowed how this law can be illustrated using the downward-sloping marginal utility graph for a given consumer and product, based on that consumers total utility graph

3913Spoilt for Choice (b)Figure A, page 5401234Cups of CappuccinoTotal UtilityConsumers Total and MarginalUtility From CappuccinoQuantityConsumed(cups)012340(a)12(b)20(c)24(d)26(e)Utility (utils)48121620TotalUtility(utils)MarginalUtility(utils)12(f)8(g)4(h) 2(i)242801234Cups of CappuccinoMarginal UtilityUtility (utils)481216abcdefghi403The Utility-Maximizing RuleJevons devised the utility-maximizing rulethis rule states a consumer should reach the same marginal utility per dollar for all products consumedin mathematical terms:MU1P1MU2P2=Spoilt for Choice (c)Figure B, page 561284201234Cups of Cappuccino(price = $1)QuantityMarginalUtility(MU1)

(utils)MarginalUtilityper $(MU1/P1=MU1/$1)(utils per $)12842Cappuccinos01234Cups of CappuccinoMarginal UtilityPer $ (utils)481216128401234Danish Pastries(price = $2)QuantityMarginalUtility(MU2)

(utils)MarginalUtilityper $(MU2/P2=MU2/$2)(utils per $)864201234PastriesDanish PastriesMarginal UtilityPer $ (utils)4812423