chapter 3 supply and demand intertwined mcgraw-hill/irwincopyright © 2009 by the mcgraw-hill...
TRANSCRIPT
Chapter 3
Supply and Demand
Intertwined
McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All Rights Reserved.
3-2
Learning Objectives
• How do supply and demand determine prices?
• What is equilibrium?• What is surplus?• What is shortage?• What is the effect of a change in demand?• What is the effect of a change in supply?
3-3
$P
.45
Quantity of Apples
Demand
When Supply and Demand Intersect
Supply
Quantity supplied at
0.45
Quantity demanded at
0.45
12,000
At $0.45:• Consumers want 12,000
apples.• Firms want to produce
12,000 apples.• Quantity demanded
= Quantity supplied.• Supply and demand
intersect.
= Equilibrium
3-4
$P
.70
Quantity of Apples
Demand
Surplus
Supply
Quantity supplied at
0.70
Quantity demanded at
0.70
10,000 14,600
At $0.70:• Consumers want 10,000
apples.• Firms want to produce
14,600 apples.• Quantity supplied
> quantity demanded
= Surplus. • Price will fall.
3-5
$P
.25
Quantity of Apples
Demand
Shortage
Supply
Quantity supplied at
0.25
Quantity demanded at
0.25
9,000 15,000
At $0.25:• Firms want to produce
9,000 apples.• Consumers want 15,000
apples.• Quantity supplied
< quantity demanded
= Shortage. • Price will rise.
3-6
Equilibrium
• A market at equilibrium is stable unless disturbed by shift of supply or demand curves.
• A market not at equilibrium moves towards equilibrium with change in price.
3-7
Equilibrium
Demand Supply
Price
Quantity
Price above equilibrium = Surplus.Fall in price
Price below equilibrium = Shortage.Rise in price
Equilibrium quantity sold
Equilibrium
Equilibrium price
3-8
Do You Know?
• When does a surplus arise?When price is above equilibrium where quantity supplied exceeds quantity demanded.
• When does a shortage arise?When price is below equilibrium where quantity demanded exceeds quantity supplied.
3-9
Quantity
Demand
Moving Towards New Equilibrium
An increase in supply:• A new equilibrium at a
lower price and a higher quantity.
Old Supply
Price
New Supply
Old equilibrium
New equilibrium
3-10
Quantity
Old Demand
Moving Towards New Equilibrium
An increase in demand:
• A new equilibrium at a lower price and a higher quantity.
Price
SupplyOld
equilibrium
New equilibrium
New Demand
3-11
Quantity
Demand
Moving Towards New Equilibrium
A decrease in supply:• A new equilibrium at a
higher price and a lower quantity.
New Supply
Price
Old Supply
New equilibrium
Old equilibrium
3-12
Quantity
New Demand
Moving Towards New Equilibrium
A decrease in demand:
• A new equilibrium at a higher price and a lower quantity.
Price
SupplyNew
equilibrium
Old equilibrium
Old Demand
3-13
Market Forces in a Fictional Tale
In anticipation of the blockade…• Increase in demand for food and hence its price.• Smuggler transports food rather than luxury
goods.
After the blockade…• With higher food prices, the smuggler is willing
to take the risk of shipping food.
After government control over food prices…• No incentive for the smuggler to ship food.
3-14
Invisible Hand
• Invisible hand of the market pushes self-interested people to act for the good of society.
“It is not from the benevolence of the butcher, the brewer or the baker, that we expect our dinner, but from their regard to their own interest.”
3-15
Quantity of fish
Demandbefore
Markets in Times of Crisis
• Pets destroy wheat crop.
• Increase in demand for a substitute, i.e. fish.
• Increase in price of fish.
• Fishermen catch more fish.
Price
SupplyOld
equilibrium
New equilibrium
Demandafter
$7
$4
600 800
3-16
Quantity of oil
Demand
Markets in Times of Crisis
• War in the Middle East reduces supply of oil.
• Price of oil rises.• Higher price causes
people to use less oil. • Market offers the best
solution among all the alternatives.
Supply after
$Price
Supply before
New equilibrium
Old equilibrium
150
70
3-17
Markets in Times of Crisis
Hurricane damage affects the supply and demand for bottled water.
• Decrease in supply• Increase in demand
How will it affect new equilibrium price?
How will it affect new equilibrium quantity?
Only one can be determined, the other is ambiguous.
3-18
Hurricane DamageIncrease in demand
> Decrease in supply.• Higher price• Higher quantity
Increase in demand < Decrease in supply.• Higher price• Lower quantity
Price Price
Quantity of bottled water Quantity of bottled water
Demand before Demand
before
Demand after
Demand after
Supplyafter
Supplyafter
Supplybefore
Supplybefore
3-19
Markets in Times of Crisis
Price gouging:
• Increase in price as a result of market reaction to increase in demand or decrease in supply.
• It provides incentive to firms to sell more.
• It provides incentive to consumers to conserve the good short in supply.
3-20
Quantity
Diamonds vs. Water
Why do markets place higher value on diamonds than on precious water?
• Water is in much greater supply than diamonds.
Price
Water Supply
Water demand
Diamond supply
Diamond demand
Diamond Equilibrium
Water Equilibrium
3-21
Diamonds vs. Water
• A good’s price is influenced by its marginal value to consumers.
• Marginal value = additional benefit received from the last unit of the good consumed.
• Consumers receive less marginal value from a good the more they have of it.
• At the equilibrium in market for water, so much water is consumed that marginal value is very low.
3-22
Quantity of developable land
Demand
Government passes anti-development law:
• Decrease in supply of developable land.
• Higher price and lower quantity of traded developable land.
Supplyafter
Price
Supplybefore
New Equilibrium
Old Equilibrium
Market for Developable Land
3-23
Quantity of newly built homes sold
Demand
Increase in price of developable land increases cost of production.
• Decrease in supply of newly built homes.
• Higher price and lower quantity sold of newly built homes.
New Supply
Price
Old Supply
New Equilibrium after higher land prices
Old Equilibrium
before higher land prices
Market for Newly Built Homes
3-24
Quantity sold of previously built homes
Old Demand
• Newly built and previously occupied homes are substitutes.
Higher price of newly built homes:
• Increase in demand for previously occupied homes
• Higher price and higher quantity sold of previously occupied homes
Price
Supply
New Equilibrium
before higher prices of new
homes
Old Equilibrium
before higher prices of new
homes
Market for Previously Occupied Homes
New Demand
3-25
Do You Know?
• Do markets move to new equilibrium instantaneously?No. It takes time. How long depends on the type of market. It can be from a few seconds to a few months.
• What are some examples of forces that disturb market equilibrium?Any changes that effect demand or supply disturb market equilibrium, e.g., change in input prices, future expectations, change in price of substitutes, innovations.
3-26
Do You Know?
• What is Adam Smith’s Invisible Hand?Market forces guide self-interested people as if by an invisible hand to act for the good of society.
• How does marginal value relate to the price of water?A good’s price is influenced by its marginal value to consumers. The marginal value of water is very low since lots of water is consumed.
3-27
Summary
• Equilibrium = When quantity demanded meets quantity supplied.
• Surplus = When quantity supplied exceeds quantity demanded.
• Shortage = When quantity demanded exceeds quantity supplied.
• A market not at equilibrium moves towards equilibrium with change in price.
3-28
Summary
• A good’s price is determined by intersection of demand and supply.
• A change in demand or supply shifts the market to a new equilibrium.
• Market forces offer the best solution to any changes in the society.
3-29
Coming Up
By how much does quantity change when there is a change in
price?