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Demand and Supply

NHM 373

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+Questions

n Seasonal goods n Why do crabs become cheaper during the crab season, while

vacation rentals become more expensive during the vacation season?

n What are other seasonal goods and how do their prices vary by season?

n Why do some bars charge customers for water but give them peanuts for free?

n Why does a mobile phone sell for only $39.99, while a spare battery for that same phone sells for $59.99?

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+Market

n A place where a good or service is bought and sold n Can be a virtual place

n Demand curve n horizontal interpretation

n Mathematical relationship that tells how many units of the good buyers wish to purchase at various possible prices, holding all else constant

n vertical interpretation

n Mathematical relationship that tells how much ($) the consumers are willing to pay for another unit at a given quantity of the good

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+Example: Demand Curve for Lobsters

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n Supply curve n horizontal interpretation

n Mathematical relationship that tells how many units of the good sellers wish to offer at various possible prices, holding all else constant

n vertical interpretation

n Mathematical relationship that tells marginal cost of delivering an additional unit at a given quantity of the good

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+Example: Supply Curve for Lobsters

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+Law of Demand and Law of Supply nLaw of Demand n Inverse relationship between price and the quantity

demanded n Downward sloping demand curve n Price increases quantity demanded decreases n Price decreases quantity demanded increases

n Other things being equal, consumers will buy less of a good at a high price than at a low price.

nLaw of Supply n Upward-sloping supply curve n Price increases quantity supplied increases n Price decreases quantity supplied decreases

n Other things being equal, the quantity supplied rises as the price of a product rises.

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+Market Equilibrium

nMarket equilibrium is obtained where the supply and demand curves intersect. nEquilibrium price is where

QDemanded = Qsupplied nThis price is also called market clearing price.

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+Example: Equilibrium in the Lobster Market

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+The Algebra of Supply and Demand

n Suppose: n Supply: P = 2 + 3QS n Demand: P = 10 QD

n Since the equilibrium is where QS= QD , we dont need the subscripts.

P = 2 + 3Q* P = 10 Q* Therefore, 2 + 3Q* = 10 Q* Q* = 2 Plug this back into one of the two equations and get P* = 8

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+What if somebody (like government or monopolist) sets the price elsewhere?

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Surplus

Shortage

+Excess supply and excess demand

If the price is set above the market equilibrium: Short run Excess Supply (or

Surplus) The quantity supplied

will exceed the quantity demanded.

n Long run n Sellers will compete for buyers by

offering better rates. n Price will fall until it meets the

equilibrium price.

nIf the price is set below the market equilibrium: Short run n Excess Demand (or

Shortage) n The quantity

demanded will exceed the quantity supplied

n Long run n Buyers will compete for products by

increasing their bids. n Price will fall rise until it meets the

equilibrium price.

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n At a price of $4 in this hypothetical lobster market, how much excess demand for lobsters will there be?

n How much excess supply will there be at a price of $20?

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+Attractive properties of equilibrium

n If price and quantity take anything other than the equilibrium, it will always be possible to reallocate so as to make at least some people better off without harming others.

n Example n Suppose that the price of a lobster is $4. Only 2000 lobsters will be

supplied. n A dissatisfied consumer were to offer $5 for a lobster. n Sellers will gladly supply more lobsters. n Sellers are made better off because they can sell MORE at HIGHER

price. n Since at Q=2000 the value of a lobster to consumers is $8, consumers

are still better off by paying $5 and buy more. (consumers get $8-$5=$3 benefit per lobster consumed.)

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+Government Price Controls

n Price ceiling n A legal maximum on the price at which a good can be sold

n Price floor n A legal minimum on the price at which a good can be sold

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+Price Ceilings

nWhy? nHold inflation in check nKeep the purchase of a certain item within the

reach of low-income consumers

nIf the price ceiling is set below the equilibrium price, the quantity demanded exceeds the quantity supplied. nShortage

nExample: Rent Control

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+Price Ceilings (Rent Control )

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+Price Floors

nWhy? n Increase (or guarantee) the incomes of those who sell the

item

nIf the price floor is set above the equilibrium price, the quantity supplied exceeds the quantity demanded. n Surplus

nExample: n agricultural price support n minimum wage

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+Price Floors (Agricultural Price Support)

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+Minimum Wage and Unemployment

n Economic theory predicts that raising minimum wage will cause unemployment among low-skilled workers.

n There is ongoing debate on minimum wage and teen unemployment. What do you think?

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+Exercise

n The demand for apartments is P=1200-QD while the supply is P=QS units.

nWhat would the equilibrium price be? n (Find P that satisfies QD=QS)

nThe government imposes rent control at P=$300/month. How many apartment units would be in shortage under the rent control? n (Find QD-QS at P=300)

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+Determinant of Supply and Demand

n Determinants of demand n Income n Taste n Prices of substitutes and complements n Expectations n Population

n Determinants of supply n Technology n Factor prices n Number of suppliers n Expectations n Weather

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+Factors that Shift Demand Curves

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+Factors that Shift Supply Curves

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+Market Analysis

nTo analyze how any event influences a market, we use the supply-and-demand diagram to examine how the event affects the equilibrium price and quantity. nFirst, we decide whether the event shifts supply

or demand (or both) nSecond, we decide which direction the curve

shifts nThird, we compare the new equilibrium with the

old equilibrium

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+Four Simple Rules

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+Four Simple Rules, contd

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+ Using diagrams, show what changes in price and quantity would be expected in the following markets under the scenarios given:

n As petroleum reserves decrease, it becomes more difficult to find and recover crude oil. What will happen in the crude oil market?

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+ Using diagrams, show what changes in price and quantity would be expected in the following markets under the scenarios given:

n Worries about air safety cause travelers to shy away from air travel. What will happen in:

n Air travel market?

n Rail travel market?

n Hotel rooms in Hawaii?

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+ Using diagrams, show what changes in price and quantity would be expected in the following markets under the scenarios given:

n A genetically engineered hormone enables large milk producers to cut production costs. What will happen to milk price and quantity at the equilibrium?

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q How will a decline in airfare affect intercity bus fares? q Hint: Flying and riding intercity buses are substitutes.

q How will the increase in pay for federal employees affect the rent for conveniently located apartments in Washington DC area? q Hint: Conveniently located homes are normal goods.

qWhat will happen to the equilibrium price and quantity of new houses if the wage rate of carpenters falls? q Hint: Carpenters are inputs to building new houses.

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