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ECO100: Introductory Economics Supply, Demand & Equilibrium Robert Gazzale, PhD Department of Economics University of Toronto [email protected] Gazzale (University of Toronto) ECO100: Supply, Demand & Equilibrium 1 / 36

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Page 1: ECO100: Introductory Economics Supply, Demand & Equilibrium · ECO100: Introductory Economics Supply, Demand & Equilibrium Robert Gazzale, PhD Department of Economics University of

ECO100: Introductory EconomicsSupply, Demand & Equilibrium

Robert Gazzale, PhD

Department of EconomicsUniversity of Toronto

[email protected]

Gazzale (University of Toronto) ECO100: Supply, Demand & Equilibrium 1 / 36

Page 2: ECO100: Introductory Economics Supply, Demand & Equilibrium · ECO100: Introductory Economics Supply, Demand & Equilibrium Robert Gazzale, PhD Department of Economics University of

background

(perfectly) competitive market: the assumptions

Each seller’s good is exactly the same as any other seller’sEach buyer is small relative to the entire market

Any 1 buyer can buy as much as he wants at the market pricewithout affecting the market priceImplication for buyer:

Each seller is small relative to the entire marketAny 1 seller can sell as much as she wants at the market pricewithout affecting the market priceImplication for seller:

Gazzale (University of Toronto) ECO100: Supply, Demand & Equilibrium 2 / 36

Page 3: ECO100: Introductory Economics Supply, Demand & Equilibrium · ECO100: Introductory Economics Supply, Demand & Equilibrium Robert Gazzale, PhD Department of Economics University of

demand

So, how much coffee gets demanded?in a particular “market”, over a particular time frame . . .

1 Current price of coffee2 Prices of related goods3 Expected prices in future time frames4 Income5 Number of consumers in “market”6 Tastes and preferences

Let’s hold 2-6 constant (for now) and look only at the relationship be-tween price and quantity . . .

Gazzale (University of Toronto) ECO100: Supply, Demand & Equilibrium 3 / 36

Page 4: ECO100: Introductory Economics Supply, Demand & Equilibrium · ECO100: Introductory Economics Supply, Demand & Equilibrium Robert Gazzale, PhD Department of Economics University of

demand

insight from Observo, master of the bleeding obvious

the unobjectionable(?) insight

As the price of something decreases, the quantity demanded of thatsomething increases

Why?

Gazzale (University of Toronto) ECO100: Supply, Demand & Equilibrium 4 / 36

Page 5: ECO100: Introductory Economics Supply, Demand & Equilibrium · ECO100: Introductory Economics Supply, Demand & Equilibrium Robert Gazzale, PhD Department of Economics University of

demand

demand: a graph & its interpretationfrom previous notes: Marginal Willingness to Pay = MWTP = Item Value - Implicit Cost

$ (Price)

5

3

4

2

1

Quantity2 3 41

Gazzale (University of Toronto) ECO100: Supply, Demand & Equilibrium 5 / 36

Page 6: ECO100: Introductory Economics Supply, Demand & Equilibrium · ECO100: Introductory Economics Supply, Demand & Equilibrium Robert Gazzale, PhD Department of Economics University of

demand

two ways of characterizing the P,Qd relationshipFirst way: Qd as a function of P. Example: Qd (P) = 22− 4P

Gazzale (University of Toronto) ECO100: Supply, Demand & Equilibrium 6 / 36

Page 7: ECO100: Introductory Economics Supply, Demand & Equilibrium · ECO100: Introductory Economics Supply, Demand & Equilibrium Robert Gazzale, PhD Department of Economics University of

demand

Graphically characterizing the P,Qd relationshipQd(P) = 22− 4P

24

Price/$

5

3

4

2

1

1 3 5 72 4 6

910 20

19 3029 Quantity

Gazzale (University of Toronto) ECO100: Supply, Demand & Equilibrium 7 / 36

Page 8: ECO100: Introductory Economics Supply, Demand & Equilibrium · ECO100: Introductory Economics Supply, Demand & Equilibrium Robert Gazzale, PhD Department of Economics University of

demand

market demand curve: summary

Relationship between market price (P) and market quantitydemanded (Qd), everything else constant

We are not saying any particular (P) is going to happen . . .

Reasonably assumed to be a negative relationship: “Law ofDemand”2 interpretations for

(Q̂, P̂

), a point on the curve

1 If a price (P̂) does happen, what is quantity demanded? Q̂2 At what price are exactly Q̂ units demanded? P̂

2 caveats:

Gazzale (University of Toronto) ECO100: Supply, Demand & Equilibrium 8 / 36

Page 9: ECO100: Introductory Economics Supply, Demand & Equilibrium · ECO100: Introductory Economics Supply, Demand & Equilibrium Robert Gazzale, PhD Department of Economics University of

demand shifts in demand

So, how much coffee gets demanded?in a particular “market”, over a particular time frame . . .

1 Current price of coffee2 Prices of related goods3 Expected prices in future time frames4 Income5 Number of consumers in “market”6 Tastes and preferences

For each item in 2-6, how does a particular change affect therelationship between P and Q?

Gazzale (University of Toronto) ECO100: Supply, Demand & Equilibrium 9 / 36

Page 10: ECO100: Introductory Economics Supply, Demand & Equilibrium · ECO100: Introductory Economics Supply, Demand & Equilibrium Robert Gazzale, PhD Department of Economics University of

demand shifts in demand

a trick question

Is D2 a shift up of D0 or a shift out (right) of D0?

Gazzale (University of Toronto) ECO100: Supply, Demand & Equilibrium 10 / 36

Page 11: ECO100: Introductory Economics Supply, Demand & Equilibrium · ECO100: Introductory Economics Supply, Demand & Equilibrium Robert Gazzale, PhD Department of Economics University of

demand shifts in demand

shifts in demandup/out versus in/down

Gazzale (University of Toronto) ECO100: Supply, Demand & Equilibrium 11 / 36

Page 12: ECO100: Introductory Economics Supply, Demand & Equilibrium · ECO100: Introductory Economics Supply, Demand & Equilibrium Robert Gazzale, PhD Department of Economics University of

demand shifts in demand

changes in the price of related goodsconsider ↑ Prelated

ComplementsIf more value from A if B consumed as well, then A and B arecomplements

SubstitutesIf A and C are substitutes, then A and C are substitutes

Gazzale (University of Toronto) ECO100: Supply, Demand & Equilibrium 12 / 36

Page 13: ECO100: Introductory Economics Supply, Demand & Equilibrium · ECO100: Introductory Economics Supply, Demand & Equilibrium Robert Gazzale, PhD Department of Economics University of

demand shifts in demand

expected future pricesconsider ↑ Ptomorrow

For those items where “buying today” and “buying tomorrow” aresubstitutes . . .

Difference between a pound of coffee beans and a cup of coffee.

Gazzale (University of Toronto) ECO100: Supply, Demand & Equilibrium 13 / 36

Page 14: ECO100: Introductory Economics Supply, Demand & Equilibrium · ECO100: Introductory Economics Supply, Demand & Equilibrium Robert Gazzale, PhD Department of Economics University of

demand shifts in demand

changes in income (or wealth)consider ↑ income

Normal GoodIncome and demand move in same direction (positively related)

Inferior GoodIncome and demand move in opposite direction

Gazzale (University of Toronto) ECO100: Supply, Demand & Equilibrium 14 / 36

Page 15: ECO100: Introductory Economics Supply, Demand & Equilibrium · ECO100: Introductory Economics Supply, Demand & Equilibrium Robert Gazzale, PhD Department of Economics University of

demand shifts in demand

changes in number of consumers in marketconsider ↑ number of consumers

Straightforward . . .

. . . but be careful: number in market versus number who purchasebecause of price change

Gazzale (University of Toronto) ECO100: Supply, Demand & Equilibrium 15 / 36

Page 16: ECO100: Introductory Economics Supply, Demand & Equilibrium · ECO100: Introductory Economics Supply, Demand & Equilibrium Robert Gazzale, PhD Department of Economics University of

demand shifts in demand

individual demands into market demandQ(P) = 10− P and Q(P) = 15− 3P/2

Gazzale (University of Toronto) ECO100: Supply, Demand & Equilibrium 16 / 36

Page 17: ECO100: Introductory Economics Supply, Demand & Equilibrium · ECO100: Introductory Economics Supply, Demand & Equilibrium Robert Gazzale, PhD Department of Economics University of

demand shifts in demand

a note on demand semantics

Change in quantity demanded: movement along the curveOnly changes in price move us along demand curve

Change in demand: shift of the curveA (relevant) change in anything but price shifts the curve

Gazzale (University of Toronto) ECO100: Supply, Demand & Equilibrium 17 / 36

Page 18: ECO100: Introductory Economics Supply, Demand & Equilibrium · ECO100: Introductory Economics Supply, Demand & Equilibrium Robert Gazzale, PhD Department of Economics University of

supply

insight from Observo, master of the bleeding obvious

another unobjectionable(?) insight

As the price of something increases, the quantity supplied (i.e., offeredfor sale) of that something increases

Why?

Gazzale (University of Toronto) ECO100: Supply, Demand & Equilibrium 18 / 36

Page 19: ECO100: Introductory Economics Supply, Demand & Equilibrium · ECO100: Introductory Economics Supply, Demand & Equilibrium Robert Gazzale, PhD Department of Economics University of

supply

supply: a graph & its interpretation

$ (Price)

5

3

4

2

1

Quantity2 3 41

Gazzale (University of Toronto) ECO100: Supply, Demand & Equilibrium 19 / 36

Page 20: ECO100: Introductory Economics Supply, Demand & Equilibrium · ECO100: Introductory Economics Supply, Demand & Equilibrium Robert Gazzale, PhD Department of Economics University of

supply

two ways of characterizing the P,Qs relationshipFirst way: Qs as a function of P. Example: Qs(P) = 24P − 48

Gazzale (University of Toronto) ECO100: Supply, Demand & Equilibrium 20 / 36

Page 21: ECO100: Introductory Economics Supply, Demand & Equilibrium · ECO100: Introductory Economics Supply, Demand & Equilibrium Robert Gazzale, PhD Department of Economics University of

supply

graphically characterizing the P,Qs relationshipQs(P) = 24P − 48

24

Price/$

5

3

4

2

1

1 3 5 72 4 6

910 20

19 3029 Quantity

Gazzale (University of Toronto) ECO100: Supply, Demand & Equilibrium 21 / 36

Page 22: ECO100: Introductory Economics Supply, Demand & Equilibrium · ECO100: Introductory Economics Supply, Demand & Equilibrium Robert Gazzale, PhD Department of Economics University of

supply

market supply curve: summary

Relationship between market price (P) and market quantitysupplied (Qs), everything else constant

We are not saying any particular (P) is going to happen . . .

Reasonably assumed to be positive relationship: “Law of Supply”

2 interpretations for(

Q̂, P̂)

, a point on the curve

1 If a price (P̂) does happen, what is quantity supplied? Q̂2 At what price are exactly Q̂ units supplied? P̂

Gazzale (University of Toronto) ECO100: Supply, Demand & Equilibrium 22 / 36

Page 23: ECO100: Introductory Economics Supply, Demand & Equilibrium · ECO100: Introductory Economics Supply, Demand & Equilibrium Robert Gazzale, PhD Department of Economics University of

supply shifts in supply

shifts in supply

1 Input Prices: ↑ Pinputs ⇒ S0 →2 Technology: ↑ Technology ⇒ S0 →

The curious case of weather

3 Expectations: ↑ Pnext period ⇒ S0 →4 # of sellers: ↑ # Sellers ⇒ S0 →Gazzale (University of Toronto) ECO100: Supply, Demand & Equilibrium 23 / 36

Page 24: ECO100: Introductory Economics Supply, Demand & Equilibrium · ECO100: Introductory Economics Supply, Demand & Equilibrium Robert Gazzale, PhD Department of Economics University of

supply shifts in supply

a note on supply semantics

Change in quantity supplied: movement along the curveOnly changes in price move us along supply curve

Change in supply: shift of the curveA (relevant) change in anything but price shifts the curve

Gazzale (University of Toronto) ECO100: Supply, Demand & Equilibrium 24 / 36

Page 25: ECO100: Introductory Economics Supply, Demand & Equilibrium · ECO100: Introductory Economics Supply, Demand & Equilibrium Robert Gazzale, PhD Department of Economics University of

equilibrium

what we want our model to provide: a predictiongiven assumptions about market, what is expected outcome

Equilibrium, loosely: Stability.Ideally there is some force moving from disequilibrium toequilibrium.Market clearing condition: when the quantity supplied equalsthe quantity demanded

Intersection of Supply and Demand Curves

Algebraically: 2 unknowns, need 2 equations

Solve for price (P∗) : Qs(P∗) = Qd(P∗) (1)

Find quantity (Q∗) : Q∗ = Qd(P∗)(= Qs(P∗)) (2)

Gazzale (University of Toronto) ECO100: Supply, Demand & Equilibrium 25 / 36

Page 26: ECO100: Introductory Economics Supply, Demand & Equilibrium · ECO100: Introductory Economics Supply, Demand & Equilibrium Robert Gazzale, PhD Department of Economics University of

equilibrium

equilibrium in (perfectly) competitive markets: exampleQd(P) = 22− 4P; Qs(P) = 24P − 48

24

Price/$

5

3

4

2

1

1 3 5 72 4 6

910 20

19 3029 Quantity

Gazzale (University of Toronto) ECO100: Supply, Demand & Equilibrium 26 / 36

Page 27: ECO100: Introductory Economics Supply, Demand & Equilibrium · ECO100: Introductory Economics Supply, Demand & Equilibrium Robert Gazzale, PhD Department of Economics University of

equilibrium

what we want our model to provide: a predictiongiven assumptions about market, what is expected outcome

Equilibrium, loosely: Stability.Ideally there is some force moving from disequilibrium toequilibrium.Market clearing condition: when the quantity supplied equalsthe quantity demanded

Intersection of Supply and Demand Curves

Algebraically: 2 unknowns, need 2 equations

Solve for price (P∗) : Qs(P∗) = Qd(P∗) (1)

Find quantity (Q∗) : Q∗ = Qd(P∗)(= Qs(P∗)) (2)

Gazzale (University of Toronto) ECO100: Supply, Demand & Equilibrium 27 / 36

Page 28: ECO100: Introductory Economics Supply, Demand & Equilibrium · ECO100: Introductory Economics Supply, Demand & Equilibrium Robert Gazzale, PhD Department of Economics University of

equilibrium

equilibrium in perfectly competitive markets: exampleQd(P) = 22− 4P; Qs(P) = 24P − 48

Gazzale (University of Toronto) ECO100: Supply, Demand & Equilibrium 28 / 36

Page 29: ECO100: Introductory Economics Supply, Demand & Equilibrium · ECO100: Introductory Economics Supply, Demand & Equilibrium Robert Gazzale, PhD Department of Economics University of

equilibrium changes in equilibrium

effects of shifts in supply and demand

After a shift in one or both curves, need to find new equilibriumLet’s do some examples . . .

Gazzale (University of Toronto) ECO100: Supply, Demand & Equilibrium 29 / 36

Page 30: ECO100: Introductory Economics Supply, Demand & Equilibrium · ECO100: Introductory Economics Supply, Demand & Equilibrium Robert Gazzale, PhD Department of Economics University of

equilibrium changes in equilibrium

example: shift up/out of demand curvee.g., increase in the price of a substitute

Gazzale (University of Toronto) ECO100: Supply, Demand & Equilibrium 30 / 36

Page 31: ECO100: Introductory Economics Supply, Demand & Equilibrium · ECO100: Introductory Economics Supply, Demand & Equilibrium Robert Gazzale, PhD Department of Economics University of

equilibrium changes in equilibrium

example: shift down/out of supply curvee.g., improvement in technology

Gazzale (University of Toronto) ECO100: Supply, Demand & Equilibrium 31 / 36

Page 32: ECO100: Introductory Economics Supply, Demand & Equilibrium · ECO100: Introductory Economics Supply, Demand & Equilibrium Robert Gazzale, PhD Department of Economics University of

equilibrium changes in equilibrium

shifting both curves

If both curves shift1 We know the direction of change of either P or Q2 The direction of change in the other outcome is ambiguous

Proof by example:Shift Up/Out of Demand CurveShift Down/Out of Supply Curve

Gazzale (University of Toronto) ECO100: Supply, Demand & Equilibrium 32 / 36

Page 33: ECO100: Introductory Economics Supply, Demand & Equilibrium · ECO100: Introductory Economics Supply, Demand & Equilibrium Robert Gazzale, PhD Department of Economics University of

equilibrium changes in equilibrium

shifting both curves: an exampleshift up/out of demand curve; shift down/out of supply curve

Which is consistent with evolution of personal computer market (atleast before tablets)?

Gazzale (University of Toronto) ECO100: Supply, Demand & Equilibrium 33 / 36

Page 34: ECO100: Introductory Economics Supply, Demand & Equilibrium · ECO100: Introductory Economics Supply, Demand & Equilibrium Robert Gazzale, PhD Department of Economics University of

equilibrium changes in equilibrium

summary

The 2 interpretations of supply and demand curvesScarce resources are often allocated by marketsWe started with one type of market: perfectly competitive

Made some very strong assumptionEquilibrium as a prediction of what is going to happen

Positive Claim: The decentralized, perfectly competitive marketfinds the price P∗ that equilibrates supply and demand

Price as a signal of value and scarcity

Gazzale (University of Toronto) ECO100: Supply, Demand & Equilibrium 34 / 36

Page 35: ECO100: Introductory Economics Supply, Demand & Equilibrium · ECO100: Introductory Economics Supply, Demand & Equilibrium Robert Gazzale, PhD Department of Economics University of

equilibrium changes in equilibrium

a real-world exampleempirical facts (U.S. Office of National Drug Control Policy)

1990 U.S. Marijuana Purchases: $15 billion2000 U.S. Marijuana Purchases: $10.5 billion (inflation adjusted)Increased consumption from 1990 to 2000Implication: Price decreased: Price decrease relatively larger thanquantity increase

The Questions1 If we limit ourselves to shifting one curve, what shift is consistent

with ↑ Q, ↓ P?2 What does ↓↓ P, ↑ Q tell us about steepness of curves?

Gazzale (University of Toronto) ECO100: Supply, Demand & Equilibrium 35 / 36

Page 36: ECO100: Introductory Economics Supply, Demand & Equilibrium · ECO100: Introductory Economics Supply, Demand & Equilibrium Robert Gazzale, PhD Department of Economics University of

equilibrium changes in equilibrium

the U.S. marijuana market, graphically

Gazzale (University of Toronto) ECO100: Supply, Demand & Equilibrium 36 / 36