1 1 lesson overview ba 210 lesson i.4 demand and supply chapter 3 demand and supply what is a demand...

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Lesson OverviewLesson Overview

BA 210 Lesson I.4 Demand and Supply

Chapter 3 Demand and SupplyChapter 3 Demand and SupplyWhat is a demand curve?What is a demand curve?Movements along a demand curve verses shiftsMovements along a demand curve verses shiftsWhat causes demand shifts?What causes demand shifts?Substitution and income effectsSubstitution and income effectsWhat is a supply curve?What is a supply curve?Movements along a supply curve verses shiftsMovements along a supply curve verses shiftsWhat causes supply shifts?What causes supply shifts?What is a competitive market?What is a competitive market?Competitive market equilibriumCompetitive market equilibriumPrice moving to equilibriumPrice moving to equilibriumControversy: Government BailoutsControversy: Government BailoutsSummarySummaryReview QuestionsReview Questions

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• When there are many competing buyers of the same commodity, buyers cannot bargain over the price.

• A demand schedule for a commodity shows how much of a good buyers will want to buy at different prices.

7.1

7.5

8.1

8.9

10.0

11.5

14.2

Price of coffee beans (per

pound)

Quantity of coffee beans demanded

(billions of pounds)

1.75

1.50

1.25

1.00

0.75

0.50

$2.00

Demand Schedule for Coffee Beans

What is a demand curve? What is a demand curve?

3 3

A A demand curve demand curve is a graph of the is a graph of the demand schedule; it shows how much demand schedule; it shows how much of a good consumers want to buy at of a good consumers want to buy at any given price and, alternatively, it any given price and, alternatively, it shows how much a consumer is shows how much a consumer is willing to pay for each unit of a good.willing to pay for each unit of a good.

(The curve below is interpolated from (The curve below is interpolated from 7 demand points.)7 demand points.)

70 9 11 1513 17

$2.00

1.75

1.50

1.25

1.00

0.75

0.50

Price of coffee

bean (per gallon)

Quantity of coffee beans (billions of

pounds)

Demand curve, D

As price rises, the quantity

demanded falls


What is a demand curve? What is a demand curve?

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• An increase in the An increase in the population and other population and other factors generate an factors generate an increase in demand – increase in demand – a rise in the quantity a rise in the quantity demanded at any given demanded at any given price. price.

• This is represented by the This is represented by the two demand schedules – two demand schedules – one showing demand in one showing demand in 2004, before the rise in 2004, before the rise in population, the other population, the other showing demand in 2008, showing demand in 2008, after the rise in population.after the rise in population.

Demand Schedules for Coffee Beans

Price of coffee beans (per pound)

Quantity of coffee beans demanded (billions of

pounds)

in 2004 in 2008

$2.00 7.1 8.5

$1.75 7.5 9.0

$1.50 8.1 9.7

$1.25 8.9 10.7

$1.00 10.0 12.0

$0.75 11.5 13.8

$0.50 14.2 17.0

Movements along a demand curve verses shiftsMovements along a demand curve verses shifts

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A shift of the demand curve is a change in the quantity demanded at any given price, represented by the change of the original demand curve to a new position, denoted by a new demand curve.

Price of

coffee beans (per

gallon)

70 9 11 1513 17

$2.00

1.75

1.50

1.25

1.00

0.75

0.50 D1 D2

Demand curve in

2008

Demand curve in

2004


pounds)



6 6

7 8.1 9.70 10 1513 17

$2.00

1.75

1.50

1.25

1.00

0.75

0.50 D1 D2

A C

B

A shift of the demand curve…

… is not the same thing as a movement along

the demand curve


gallon)


pounds)

A movement along the demand curve is a change in the quantity demanded of a good that is the result of a change in that good’s price.



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Read demand horizontally. A “decrease in demand”, means a leftward shift of the demand curve: at any given price, consumers demand a smaller quantity than before. (D1D3)

Price

Quantity

D3

D1

D2

Increase in demand

Decrease in demand



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What causes demand shifts?What causes demand shifts?

• Changes in IncomeChanges in Income Normal Goods: When a rise in income increases the Normal Goods: When a rise in income increases the

demand for a good - the demand for a good - the normalnormal case - we say that the case - we say that the good is a normal good. Rich people eat lobster. good is a normal good. Rich people eat lobster. Other Other normal goods?normal goods?

Inferior Goods: When a rise in income decreases the Inferior Goods: When a rise in income decreases the demand for a good, it is an demand for a good, it is an inferiorinferior good. Poor people good. Poor people eat Raman Noodles. eat Raman Noodles. Other inferior goods?Other inferior goods?

• Changes in TastesChanges in Tastes

• Changes in ExpectationsChanges in Expectations


What causes demand shifts?

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Demand Shifts from Changes in the Prices of Other Goods

When the price of Good X changes, the demand for Good Y responds in two steps:

The Substitution Effect:

• Substitutes: Goods X and Y are substitutes if an increase in the price of one of the goods makes consumers more willing to buy the other good.

• Complements: Goods X and Y are complements if an increase in the price of one good makes people less willing to buy the other good.

The Income Effect: An increase in the price of Good X decreases each consumer’s power to purchase goods. That decrease in purchasing power has the same effect as a decrease in income:

• People are less willing to buy good Y if good Y is a normal good.

• People are more willing to buy good Y if good Y is an inferior good.


Substitution and Income Effects

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Changes in the Prices of Other Goods

For example, when the price of gas increases, the demand for cars decreases in two steps:

The Substitution Effect: Gas and cars are complements because they are consumed together, so an increase in the price of gas makes people less willing to buy cars, meaning the demand for cars decreases.

The Income Effect: An increase in the price of gas decreases each consumer’s power to purchase goods. Since cars are a normal good (rich households have more cars than poor households), that decrease in purchasing power makes people less willing to buy cars, meaning the demand for cars decreases further.



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Changes in the Prices of Other Goods

The Gross Effect is the substitution effect plus the income effect. When the price of Good X changes, the demand for Good Y responds with the gross effect:

Substitutes: Goods X and Y are gross substitutes if an increase in the price of one of the goods makes consumers more willing to buy the other good.

Complements: Goods X and Y are gross complements if an increase in the price of one good makes people less willing to buy the other good.

(When Paul Krugman says “substitutes”, he really means gross substitutes because there is both a substitution effect and an income effect when prices change. Likewise, when Paul Krugman says “complements”, he means gross complements.)



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Sometimes gross substitution is the same as substitutionSometimes gross substitution is the same as substitution

For example, when the price of apples increases, the demand for For example, when the price of apples increases, the demand for oranges responds in two steps:oranges responds in two steps: The Substitution Effect: Apples and oranges are The Substitution Effect: Apples and oranges are substitutessubstitutes

because they are consumed as alternatives, so an increase because they are consumed as alternatives, so an increase in the price of apples makes people more willing to buy in the price of apples makes people more willing to buy oranges, meaning the demand for oranges increases.oranges, meaning the demand for oranges increases.

The Income Effect: An increase in the price of apples The Income Effect: An increase in the price of apples decreases consumers’ power to purchase goods, but that decreases consumers’ power to purchase goods, but that decrease is small since consumers do not spend much on decrease is small since consumers do not spend much on apples. apples.

Apples and oranges are thus “gross substitutes” and Apples and oranges are thus “gross substitutes” and “substitutes”.“substitutes”.



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Sometimes gross substitution is different than substitutionSometimes gross substitution is different than substitution

For example, when tuition at Pepperdine increases, the demand For example, when tuition at Pepperdine increases, the demand for oranges responds in two steps:for oranges responds in two steps: The Substitution Effect: Pepperdine and oranges are not The Substitution Effect: Pepperdine and oranges are not

significantly significantly substitutes nor complementssubstitutes nor complements because they are because they are not significantly consumed together or as alternatives.not significantly consumed together or as alternatives.

The Income Effect: An increase in tuition at Pepperdine The Income Effect: An increase in tuition at Pepperdine decreases consumers’ power to purchase goods. Since decreases consumers’ power to purchase goods. Since oranges are a oranges are a normalnormal good (rich households buy more good (rich households buy more oranges than poor households), that decrease in purchasing oranges than poor households), that decrease in purchasing power makes people less willing to buy oranges, meaning power makes people less willing to buy oranges, meaning the demand for oranges decrease.the demand for oranges decrease.

Apples and oranges are thus “gross complements” but not Apples and oranges are thus “gross complements” but not “complements”.“complements”.



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• When there are many competing sellers of the same commodity, sellers cannot bargain over the price.

• A supply schedule shows how much of a good would be supplied at different prices.

• Alternatively, a supply schedule shows the minimum price it would take per unit for suppliers to supply a particular quantity of a good.

Supply Schedule for Coffee Beans

Price of coffee beans(per pound)

Quantity ofcoffee beans

supplied(billions of pounds)

$2.00 11.6

1.75 11.5

1.50 11.2

1.25 10.7

1.00 10.0

0.75 9.1

0.50 8.0

What is a supply curve?What is a supply curve?

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Quantity of coffee beans (billions of pounds)


70 9 11 1513 17

$2.00

1.75

1.50

1.25

1.00

0.75

0.50

As price rises, the quantity supplied rises.

A supply curve graphs A supply curve graphs how much of a good how much of a good people are willing to people are willing to sell at any given price. sell at any given price. (The curve below is (The curve below is interpolated from 7 interpolated from 7 supply points.)supply points.)

Supply curve, S


What is a supply curve?What is a supply curve?

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• The entry of Vietnam into the coffee bean business generated an increase in supply—a rise in the quantity supplied at any given price.

• This event is represented by the two supply schedules—one showing supply before Vietnam’s entry, the other showing supply after Vietnam came in.

Supply Schedule for Coffee Beans

Price of coffee beans

(per pound)

Quantity of beans supplied

(billions of pounds)

Before entry After entry

$2.00 11.6 13.9

$1.75 11.5 13.8

$1.50 11.2 13.4

$1.25 10.7 12.8

$1.00 10.0 12.0

$0.75 9.1 10.9

$0.50 8.0 9.6

Movements along a supply curve verses shiftsMovements along a supply curve verses shifts

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A shift of the supply curve is a change in the quantity supplied of a good at any given price.

70 9 11 13 15 17

$2.00

1.75

1.50

1.25

1.00

0.75

0.50

S1

S2


pound)


… is not the same thing as a

shift of the supply curve

A movement along the supply

curve…



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A movement along the supply curve is a change in the quantity supplied of a good that is the result of a change in that good’s price.

70 10 11.2 12 15 17

$2.00

1.75

1.50

1.25

1.00

0.75

0.50

S1S2

AC

B


pound)


… is not the same thing as a shift of the supply curve

A movement along the supply

curve…



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Read supply horizontally.

Any “increase in supply” means a rightward shift of the supply curve: at any given price, there is an increase in the quantity supplied.

(S1 S2)

S3

S1

S2

Price

Quantity

Decrease in supply

Increase in supply



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• Changes in input prices An input is a good that is used to produce another good.

• Changes in the prices of related goods that could have been sold

• Changes in technology

• Changes in expectations about future prices

• Changes in the number of producers


What causes supply shifts?What causes supply shifts?

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• A competitive market: Many competing buyers and sellers Same commodity (physical good or service)

• The demand and supply model explains a competitive market.

• Five key elements: Demand curve Supply curve Demand and supply curve shifts Market equilibrium Changes in the market equilibrium


What is a competitive market? What is a competitive market?

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The market demand curve is the horizontal sum of the individual demand curves of all consumers in that market.

DDarla DDino

0 0 10 203020 0

$2

1

$2

1

$2

1

30 40 50

DMarket

(a) Darla’s Individual

Demand Curve

(b) Dino’s Individual Demand Curve

(c) Market Demand Curve

Price of coffee

beans (per pound)

Price of coffee

beans (per pound)

Price of coffee

beans (per pound)

Quantity of coffee beans (pounds)




Competitive market equilibrium Competitive market equilibrium

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The market supply curve is the horizontal sum of the individual supply curves of all firms in that market.

SFigueroa SBien Pho

1 2 31 22 31 4 500 0

$2

1

$2

1

$2

1

SMarket

(a) Mr. Figueroa’s

Individual Supply Curve

(b) Mr. Bien Pho’s Individual

Supply Curve

(c) Market Supply Curve

Price of coffee

beans (per pound)

Price of coffee

beans (per pound)

Price of coffee

beans (per pound)






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• Equilibrium in a competitive market: when the quantity demanded of a good equals the quantity supplied of that good.

• The price at which this takes place is the equilibrium price, or market-clearing price):

Every buyer finds a seller and vice versa.

The quantity of the good bought and sold at that price is the equilibrium quantity.



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Market equilibrium occurs at point E, where the supply curve and the demand curve intersect.



70 10 1513 17

$2.00

1.75

1.50

1.25

1.00

0.75

0.50

Supply

Demand

E EquilibriumEquilibrium price

Equilibrium quantity



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If the price were higher than in a competitive equilibrium, there is a surplus of a good when the quantity supplied exceeds the quantity demanded. Suppliers then decrease price from $1.50 to compete for buyers.

70 10 1513 17

$2.00

1.75

1.50

1.25

1.00

0.75

0.50

Supply

Demand

8.1 11.2

E

Surplus

Quantity demande

d

Quantity

supplied




Price moving to equilibrium Price moving to equilibrium

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70 10 1513 17

$2.00

1.75

1.50

1.25

1.00

0.75

0.50

Supply

Demand

9.1 11.5

E

Shortage

Quantity demande

d

Quantity

supplied


pound)


If the price were higher than in a competitive equilibrium, there is a shortage of a good when the quantity demanded exceeds the quantity supplied. Suppliers then increase price from $0.75 to increase profit.



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Q2Q

1

P2

P1

D2

Supply

D1

E2

E1


Quantity of coffee beans

Price rises

Quantity rises

An increase in demand…

… leads to a movement along the supply curve

due to a higher equilibrium price and

higher equilibrium quantity



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P2

P1

Q1

Q2

Demand

E1

S1

S2

E2


Quantity of coffee beans

Price rises

Quantity falls

A decrease in supply…

… leads to a movement along the demand curve


lower equilibrium quantity



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Two opposing forces determining the equilibrium quantity.

The increase in demand dominates the decrease in supply.

Quantity of coffeeQ2Q

1

P2

P1

S2

D2D

1

S1

E1

E2

Simultaneous demand and supply shifts. One possible outcome: Price Rises, Quantity Rises

Small decrease in supply

Large increase in demand



Price of coffee

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Simultaneous demand and supply shifts. Another possible outcome: Price Rises, Quantity Falls

Q1

Q2

P2

P1

S2

D2

D1

S1

E1

E2

Price of coffee

Quantity of coffee

Large decrease in supply

Small increase in demand



Two opposing forces determining the equilibrium quantity.

The increase in demand is dominated by the decrease in supply.

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Controversy: Government BailoutsControversy: Government Bailouts

BA 210 Lesson I.3 Trade


33 33BA 210 Lesson I.3 Trade

A bailout is an act of giving capital to a company in danger of failing in an attempt to save it from bankruptcy, insolvency, or total liquidation and ruin. A bailout could be seen as a necessity in order to prevent greater, socioeconomic failures: For example, the US government assumes transportation to be the backbone of America's general economic fluency, which maintains the nation's geopolitical power. As such, it is the policy of the US government to protect the biggest American companies responsible for transportation—airliners, petrol companies, etc—from failure through subsidies and low-interest loans. These companies, among others, are deemed “too big to fail” because their goods and services are considered by the government to be constant universal necessities in maintaining the nation's welfare and often, indirectly, its security.



Question: Consider the policy of the US government to protect American airlines from failure through subsidies and low-interest loans.

What would happen to the largest American airlines (Southwest, American, Delta, United, U.S. Airways, Northwest, Continental, …) if they are all currently failing to make profits and if the US government changed its policy and did nothing? Would the entire industry fail?



Answer: Eventually, without profits, airlines would start dropping out of the industry (though bankruptcy, insolvency, or total liquidation). But as some airlines drop out, the total supply of air travel decreases, which raises price. And as prices raise, profits raise. This process would increase until airlines no longer fail to make sufficient profits to stay in business.

In particular, the entire industry does not fail without government bailouts.


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P2

P1

Q1

Q2

Demand

E1

S1

S2

E2

Price of air travel

Quantity of air travel

Price rises

Quantity falls

A decrease in supply…

… leads to a movement along the demand curve


lower equilibrium quantity



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SummarySummary

1.1. A demand schedule exists when there are many competing A demand schedule exists when there are many competing buyers of the same commodity. buyers of the same commodity. The demand schedule shows The demand schedule shows the quantity demanded at each price and is represented the quantity demanded at each price and is represented graphically by a demand curve. The law of demand says that graphically by a demand curve. The law of demand says that demand curves slope downward.demand curves slope downward.

2.2. A movement along the demand curve occurs when a price A movement along the demand curve occurs when a price change leads to a change in the quantity demanded. When change leads to a change in the quantity demanded. When economists talk of increasing or decreasing demand, they economists talk of increasing or decreasing demand, they mean shifts of the demand curve—a change in the quantity mean shifts of the demand curve—a change in the quantity demanded at any given price. demanded at any given price.


SummarySummary

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SummarySummary

3.3. There are five main factors that shift the demand curve:There are five main factors that shift the demand curve:• A change in the prices of related goodsA change in the prices of related goods• A change in incomeA change in income• A change in tastesA change in tastes• A change in expectationsA change in expectations• A change in the number of consumersA change in the number of consumers

4.4. A supply schedule exists when there are many competing A supply schedule exists when there are many competing sellers of the same commodity. sellers of the same commodity. The supply schedule shows The supply schedule shows the quantity supplied at each price and is represented the quantity supplied at each price and is represented graphically by a supply curve. Supply curves usually slope graphically by a supply curve. Supply curves usually slope upward.upward.


SummarySummary

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SummarySummary

5. A movement along the supply curve occurs when a price change leads to a change in the quantity supplied. When economists talk of increasing or decreasing supply, they mean shifts of the supply curve—a change in the quantity supplied at any given price.

6. There are five main factors that shift the supply curve:• A change in input prices• A change in the prices of related goods and services• A change in technology• A change in expectations• A change in the number of producers


SummarySummary

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SummarySummary

7.7. The The supply and demand model supply and demand model illustrates how a competitive illustrates how a competitive market works.market works.

8.8. The market demand curve The market demand curve for a good or service is the for a good or service is the horizontal sum of the individual demand curves of all horizontal sum of the individual demand curves of all consumers in the market.consumers in the market.

9.9. The market supply curve The market supply curve for a good or service is the for a good or service is the horizontal sum of the individual supply curves of all horizontal sum of the individual supply curves of all producers in the market.producers in the market.


SummarySummary

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SummarySummary

10. An increase in demand increases both the equilibrium price and the equilibrium quantity; a decrease in demand has the opposite effect. An increase in supply reduces the equilibrium price and increases the equilibrium quantity; a decrease in supply has the opposite effect.

11. Shifts of the demand curve and the supply curve can happen simultaneously.


SummarySummary

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Review QuestionsReview Questions


Review QuestionsReview Questions You should try to answer some of the following questions You should try to answer some of the following questions before the next class. before the next class. You will not turn in your answers, but students may request You will not turn in your answers, but students may request to discuss their answers to begin the next class. to discuss their answers to begin the next class. Your upcoming Exam 1 and cumulative Final Exam will Your upcoming Exam 1 and cumulative Final Exam will contain some similar questions, so you should eventually contain some similar questions, so you should eventually consider every review question before taking your exams.consider every review question before taking your exams.

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Review QuestionsReview Questions


Follow the linkFollow the linkhttp://faculty.pepperdine.edu/jburke2/ba210/PowerP1/Set3Answers.pdffor review questions for Lesson I.4 that practices these skills: for review questions for Lesson I.4 that practices these skills: Describe when demand or supply increases (shifts right) or decreases (shifts Describe when demand or supply increases (shifts right) or decreases (shifts left).left). Identify a competitive equilibrium of demand and supply.Identify a competitive equilibrium of demand and supply.Describe the equilibrium shifts when demand or supply increases or Describe the equilibrium shifts when demand or supply increases or decreases.decreases.Describe how prices or gross substitutes or gross complements shift Describe how prices or gross substitutes or gross complements shift demand.demand. Describe how input costs or production costs shift supply.Describe how input costs or production costs shift supply. Aggregate individual demand into market demand.Aggregate individual demand into market demand. Describe how effective price ceilings cause shortages.Describe how effective price ceilings cause shortages.Compute some special demand curves and some special supply curves from Compute some special demand curves and some special supply curves from verbal descriptions.verbal descriptions.

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End of Lesson I.4End of Lesson I.4

BA 210 Introduction to BA 210 Introduction to MicroeconomicsMicroeconomics


1 1 lesson overview ba 210 lesson i.4 demand and supply chapter 3 demand and supply what is a demand...

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