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Chapter 3
The Supply and Demand Model
IntroductionIntroduction
• The supply and demand model can explain the following: Why are ticket scalpers for Final Four seats (or any
sold-out sporting event) able to sell tickets for as much as $5000?
Why do gasoline prices go up or down very easily?
Why do rose prices rise significantly on Valentine’s Day?
DemandDemand
• Demand Demand – a relationship between price and the quantity demanded, all other things equal.
• Price – Price – the amount of money or other goods that one must pay to obtain a particular good.
• Quantity Demanded – the quantity of a good that people want to buy at a given price during a specific time period.
DemandDemand
Demand Schedule: Demand Schedule: a tabular representation of demand. The information it contains describes the quantity of a good that a buyer is willing to purchase at different prices.
The Demand CurveThe Demand Curve
Demand Curve: Demand Curve: a graph of demand showing the downward-sloping relationship between price and quantity demanded.
Figure 1: The Demand
Curve
The Law of DemandThe Law of Demand
• Law of Demand: Law of Demand: the tendency for the quantity demanded of a good to decline as its price rises.
• Note: Note: For a demand curve to be consistent with the Law of Demand, the demand curve must be downward sloping.
A lower price
Leads to a higher quantity demanded
The Law of DemandThe Law of Demand
According to the law of demand, a lower price will result in an increase in the quantity of the good that consumers are willing to buy, holding all else constant.
Figure 1: The Figure 1: The Demand CurveDemand Curve
Shifts in DemandShifts in Demand
Changes in the following can cause the demand cause the demand curve to shiftcurve to shift to the left or to the right:Consumers’ PreferencesConsumers’ InformationConsumers’ IncomeNumber of Consumers in the MarketConsumers’ Expectations of Future PricesPrices of Closely Related Goods
a)a) Substitutes Substitutes b)b) ComplementsComplements
Figure 2: A Shift in the Demand CurveFigure 2: A Shift in the Demand Curve
Figure 2: A Shift in the Demand CurveFigure 2: A Shift in the Demand Curve
Consumers’ PreferencesConsumers’ Preferences
Changes in consumers’ preferences or tastes for a product (relative to another productrelative to another product) will change the amount of they purchase at a given price.
Example: • After September 11, 2001, more consumers
were afraid to fly, resulting in a decrease in the demand for air travel. The demand for gasoline increased, as people chose to drive more to different destinations.
Consumers’ InformationConsumers’ Information
New information New information available to consumers can result in a change in the quantity that consumers buy of a good, even though the price does not change. Examples:Examples:
a) Car owners bought fewer Firestone tires once they learned of the mass recall of Firestone tires.
b) Demand for Krispy Kreme doughnuts declined when people got information that eating fewer carbohydrates can facilitate weight loss (e.g., as in the Atkins diet).
Normal Goods Normal Goods –– goods for which demand increases when the consumers’ income rises and decreases when consumers’ income falls.
Examples: Examples: a) Jewelry b) Luxury cars
Consumers’ IncomesConsumers’ Incomes
Inferior Goods Inferior Goods – goods for which demand decreases when the consumers’ income risesand increases when consumers’ income falls.
Examples:Examples:a) Instant noodlesb) Bus tickets
Consumers’ IncomesConsumers’ Incomes
Number of ConsumersNumber of Consumersin the Marketin the Market
More consumers More consumers in the market will likely resultresult in a larger demandlarger demand for the good or service, while fewer consumers will likely result in a smaller demand for the good or service.
Example: Example: The demand for electricity in your city
increases as the population increases.
Consumers’ Expectations Consumers’ Expectations of Future Pricesof Future Prices
Expectations of higher future prices will increase demand now. Expectations of lower future prices will decrease demand now.
Example: Example: Expectations of higher prices of gasoline in
the future tend to make individuals fill up now.
Substitute Substitute – a good that has many of the same characteristics as and can be used in place of another good.
Examples: Examples: a) Coke is a substitute for Pepsi.b) Riding a car is a substitute for taking the bus. c) Downloading music is a substitute for buying
music CDs.
Prices of Closely Related GoodsPrices of Closely Related Goods
ComplementComplement – a good that is consumed or used together with another good.
Examples: Examples: a) Gasoline is a complement to SUVs.b) Cream is a complement to coffee.
Prices of Closely Related GoodsPrices of Closely Related Goods
Prices of Closely Related GoodsPrices of Closely Related Goods
If two goods are complements, then an increase in the price of one good will result in a decrease in the demand for the other good.
If two goods are substitutes, then an increase in the price of one good will result in an increase in the demand for the other good.
Figure 3: Shifts of versus MovementsFigure 3: Shifts of versus MovementsAlong the Demand CurveAlong the Demand Curve
SupplySupply
• Supply – a relationship between price and the quantity supplied, all other things equal.
• Quantity Supplied Quantity Supplied – the quantity of a good that sellers want to sell at a given price during a specific time period.
SupplySupply
Supply ScheduleSupply Schedule: a tabular representationof the supply curve.
The Supply CurveThe Supply Curve
Supply CurveSupply Curve: the graph of supply showing the upward relationship between price and quantity supplied.
Figure 4: Figure 4: The Supply CurveThe Supply Curve
Law of Supply Law of Supply – the tendency for the quantity supplied of a good in a market to increase as its price rises.
The Law of SupplyThe Law of Supply
A higher price
Leads to a higher quantity supplied
The Law of SupplyThe Law of Supply
According to the law According to the law of supply, a higher of supply, a higher price will result in price will result in an increase in the an increase in the quantity of the good quantity of the good that sellers are that sellers are willing to sell, willing to sell, holding all else holding all else constant. constant.
Figure 4: Figure 4:
The Supply CurveThe Supply Curve
Shifts in SupplyShifts in Supply
Changes Changes in the following can cause the supply cause the supply curve to shiftcurve to shift to the left or to the right:
a)a) TechnologyTechnologyb)b) Weather conditionsWeather conditionsc)c) Prices of inputs used in productionPrices of inputs used in productiond)d) Number of firms in the marketNumber of firms in the markete)e) Expected future selling priceExpected future selling pricef)f) Government taxes, subsidies, and Government taxes, subsidies, and
regulationsregulations
TechnologyTechnology
Anything that changes the amount that a firm can produce with a given amount of inputs can be considered a change in technology. Improvements in technology will correspond to an increase in supply.
Example: Example: Innovations that decrease the time it takes to
produce cars
Weather ConditionsWeather Conditions
Droughts, earthquakes, and hurricanes affect how much of certain goods can be produced.
Examples: Examples: a) An unusually cold winter in 2006 decreased
citrus production in California.b) Hurricanes Katrina and Rita decreased oil
production in Louisiana and Texas.
More expensive inputs (raw materials, land, and capital) increase the cost of production of goods and services, and may force the firm to sell less at a given price.
Example:Example:Higher steel prices in 2002 decreased the
production of household appliances.
The Price of Inputs Used in ProductionThe Price of Inputs Used in Production
The Number of Firms in the MarketThe Number of Firms in the Market
If the number of firms in the market increases, the supply curve shifts to the right. If the number of firms in the market decreases, the supply curve shifts to the left.
Expectations of lower selling prices in the future will increase the supply today as firms decide to sell less in the future when prices are lower. Similarly, expectations of higher selling prices in the future will decrease the supply today as firms decide to sell more in the future when prices are higher.
Expectations of Future PricesExpectations of Future Prices
An increases in taxes (payments by firms to the government) or a decrease in subsidies (payment by the government to firms) will decrease supply. A decrease in taxes or an increase in the subsidies will increase supply.
Government Taxes, Subsidies,Government Taxes, Subsidies,and Regulationsand Regulations
Government Taxes, Subsidies,Government Taxes, Subsidies,and Regulationsand Regulations
Regulations Regulations – government policies or rules that control the firm’s behavior. These regulations can affect the firm’s cost of production and thereby affect supply.
Example: Example: • Government requirements that food vendors
pass sanitary inspection will reduce the number of vendors and decrease supply.
Movement Along the Supply Curve Movement Along the Supply Curve – occurs when a change in the quantity supplied of a good is brought along by a change in its price.
A Shift in the Supply Curve A Shift in the Supply Curve – occurs when a change is brought along by any source other than the price.
Shifts versus MovementShifts versus Movement
Figure 6: Shifts of versus MovementsFigure 6: Shifts of versus Movements
Figure 7: Figure 7: Overview ofOverview ofSupply and Supply and
DemandDemand
Market EquilibriumMarket Equilibrium
Shortage (excess demand) Shortage (excess demand) – a situation in which the quantity demanded is greater than the quantity supplied. This occurs when the price in the market is below the equilibrium price.
Surplus (excess supply) Surplus (excess supply) – a situation in which the quantity supplied is greater than the quantity demanded. This occurs when the current price in the market is above the equilibrium price.
Market EquilibriumMarket Equilibrium
Equilibrium Price Equilibrium Price – the price at which the quantity that sellers are willing to sell equals the quantity that consumers are willing to purchase.
Equilibrium Quantity Equilibrium Quantity – the quantity traded at the equilibrium price.
Market Equilibrium Market Equilibrium –– the situation where the price equals the equilibrium price and the quantity traded equals the equilibrium quantity.
Finding the Equilibrium with a Finding the Equilibrium with a Supply and Demand DiagramSupply and Demand Diagram
If the price is below the equilibrium, a shortage occurs, causing the price to increase until the price reaches equilibrium.
If the price is above the equilibrium, a surplus occurs, causing the price to decrease until the price reaches equilibrium.
Figure 8: Figure 8: Equilibrium Price and Equilibrium QuantityEquilibrium Price and Equilibrium Quantity
Figure 8: Figure 8: Equilibrium Price and Equilibrium QuantityEquilibrium Price and Equilibrium Quantity
Effects of an Increase in DemandEffects of an Increase in Demand
An increase in An increase in demand will shift demand will shift the demand curve the demand curve to the right, to the right, resulting in a resulting in a higher equilibrium higher equilibrium price and quantity.price and quantity.
Figure 9(a): Effects of a Shift in DemandFigure 9(a): Effects of a Shift in Demand
Effects of a Decrease in DemandEffects of a Decrease in Demand
A decrease in A decrease in demand will shift demand will shift the demand curve the demand curve to the left, resulting to the left, resulting in a lower in a lower equilibrium price equilibrium price and quantity.and quantity.
Figure 9(b): Effects of a Shift in DemandFigure 9(b): Effects of a Shift in Demand
Effects of an Increase in SupplyEffects of an Increase in Supply
An increase in An increase in supply will shift the supply will shift the supply curve to the supply curve to the right, resulting in a right, resulting in a lower equilibrium lower equilibrium price and a higher price and a higher equilibrium equilibrium quantity.quantity.
Figure 10(a): Effects of a Shift in SupplyFigure 10(a): Effects of a Shift in Supply
Effects of a Decrease in SupplyEffects of a Decrease in Supply
A decrease in supply A decrease in supply will shift the supply will shift the supply curve to the left, curve to the left, resulting in a higher resulting in a higher equilibrium price and equilibrium price and a lower equilibrium a lower equilibrium quantity.quantity.
Figure 10(b): Effects of a Shift in SupplyFigure 10(b): Effects of a Shift in Supply
Using Using Supply and Demand Supply and Demand
to to Analyze Real-World IssuesAnalyze Real-World Issues
Figure 11: Figure 11: Combined Effect of a Simultaneous Increase in Combined Effect of a Simultaneous Increase in
Demand and Decrease in Supply of GasolineDemand and Decrease in Supply of Gasoline
Figure 12: Figure 12: Predicted Effects of Energy PolicyPredicted Effects of Energy Policy
Key TermsKey Terms
• demanddemand• priceprice• quantity demandedquantity demanded• demand scheduledemand schedule• law of demandlaw of demand• demand curvedemand curve• normal goodnormal good• inferior goodinferior good• substitutesubstitute• complementcomplement• supplysupply
• quantity suppliedquantity supplied• supply schedulesupply schedule• law of supplylaw of supply• supply curvesupply curve• shortage (excess shortage (excess
demand)demand)• surplus (excess supply)surplus (excess supply)• equilibrium priceequilibrium price• equilibrium quantityequilibrium quantity• market equilibriummarket equilibrium
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