Chapter 2: Demand, Supply, and Market Equilibrium

Chapter 2: Demand, Supply, and Market Equilibrium

Demand and Supply (-) (+,-) (+,-) (+) (+) (+) (+) (-) (-) (+) (-) (+)

Demand vs. Quantity Demanded • Quantity demanded (Qd) • Amount of a good or service consumers are willing & able to purchase at a given price Dr. Chen’s notes: If someone asks, “Do you have demand on apple?” I believe your answer is “Yes.” You are supposed to have enough money to buy. Another immediate question follows, “How many pounds will you buy?” We cannot determine the exact quantity demanded without knowing the price per pound. See the difference b/w demand and quantity demanded? Demand is like a schedule or a plan to purchase (consume) the product at varied prices; quantity demanded is an exact amount at a given price. Therefore, your answer might be “Give me 5 pounds if the price is $1/lb.” Your quantity demanded (Qd) is 5 lbs associated with the price (P)=$1/lb.

General Demand Function • Six variables that influence Qd • Price of good or service (P) • Incomes of consumers (M) • Prices of related goods & services (PR) • Expected future price of product (Pe) • Number of consumers in market (N) • General demand function

General Demand Function • b, c, d, e, f, & g are slope parameters • Measure effect on Qdof changing one of the variables while holding the others constant • Sign of parameter shows how variable is related to Qd • Positive sign indicates direct relationship • Negative sign indicates inverse relationship Dr. Chen’s notes: How to measure  (consumer taste)? In reality, economists use “advertising expenditures” as a feasible measure for consumer tastes. The more ads expenditures; the stronger demand on the product.

e = Qd/is positive General Demand Function Inverse for complements P b = Qd/P is negative Inverse c = Qd/Mis positive Direct for normal goods M c = Qd/Mis negative Inverse for inferior goods d = Qd/PRis positive Direct for substitutes PR d = Qd/PRis negative Direct Pe f = Qd/Peis positive Direct N g = Qd/Nis positive Direct

Direct Demand Function • The direct demand function, or simply demand, shows how quantity demanded, Qd, is related to product price, P, when all other variables are held constant. P is the indep. variable and Qd,is dep. variable. • Qd = f(P) • Law of Demand • Qdincreases when P falls & Qddecreases when P rises, all else constant • Qd /P must be negative Dr. Chen’s notes: When the price drops, people purchase more quantity to substitute the satisfaction from consuming the other relatively expensive goods.

A Demand Curve (Figure 2.1)

Graphing Demand Curves • Change in quantity demanded • Occurs when price changes • Movement along demand curve • Change in demand • Occurs when one of the other variables, or determinants of demand, changes • Demand curve shifts rightward or leftward Dr. Chen’s notes: Again, did you see the difference b/w demand and quantity demanded? When all the other factors (determinants) remain, price change only causes quantity demanded change. The demand function remains the same. However, when one of the other determinants changes (income, taste,…etc), the whole demand curve will shift; that is the demand function will change. Check the next slide to see the shifts.

Shifts in Demand (Figure 2.2) Dr. Chen’s notes: A rightward shift means demand increase. Why? Given the same price ($80), the new demand consumes at 800 units, more than 600 of the old demand.

Supply vs. Quantity Supplied • Quantity supplied (Qs) • Amount of a good or service offered for sale at a given price Dr. Chen’s notes: Similar to demand, supply is a schedule to sell (produce) the product at varied prices; quantity supplied is an exact amount at a given price. When you study supply, consider it as a cost schedule. In the next few slides, you will review the determinants of supply curve. Do not mix them with those for demand!

Supply • Six variables that influence Qs • Price of good or service (P) • Input prices (PI ) • Prices of goods related in production (Pr) • Technological advances (T) • Expected future price of product (Pe) • Number of firms producing product (F) • General supply function

General Supply Function • k, l, m, n, r, & s are slope parameters • Measure effect on Qsof changing one of the variables while holding the others constant • Sign of parameter shows how variable is related to Qs • Positive sign indicates direct relationship • Negative sign indicates inverse relationship Dr. Chen’s notes: In economics, technology improvement (T) means cost reduction. The same resources can be used to produce more quantity of output; that is, unit cost declines. The supply curve increases (down shift or right shift) when technology improvement occurs.

General Supply Function Direct for complements P k = Qs/P is positive Direct PI l = Qs/PIis negative Inverse m = Qs/Pris negative Inverse for substitutes Pr m = Qs/Pris positive T n = Qs/Tis positive Direct Pe r = Qs/Peis negative Inverse F s = Qs/Fis positive Direct

Direct Supply Function • The direct supply function, or simply supply, shows how quantity supplied, Qs, is related to product price, P, when all other variables are held constant • Qs = f(P) • There is No Law of Supply!! • Not every firm has supply schedule, especially for firms acting as price makers (searcher). Dr. Chen’s notes: The positive (direct) relationship b/w P and Qs is confirmed only when “price determines quantity supplied” in a competitive market. A higher market price will attract competitive firms to produce more. However, for firms with market power, such as OPEC, cutting output (Qs) will lift up price (P ). We will talk about it more later.

Graphing Supply Curves • Change in quantity supplied • Occurs when price changes • Movement along supply curve • Change in supply • Occurs when one of the other variables, or determinants of supply, changes • Supply curve shifts rightward or leftward Dr. Chen’s notes: Similar to Slide #8 of demand change. Please check the next slide to see the shifts of supply curve.

Shifts in Supply (Figure 2.4)

Market Equilibrium • Equilibrium price & quantity are determined by the intersection of demand & supply curves • At the point of intersection, Qd = Qs • Consumers and producers trade at the “market-clearing” price P* • Both consumers (buyers) and producers (sellers) are satisfied (i.e. no incentive to move) at the equilibrium Dr. Chen’s notes: What is equilibrium? Nobody moves. In the end of most Hollywood action movies, the bad guy puts gun at the hostage’s head and asks the hero (or heroin) to put down weapon, right? In general, if nothing “pops up”, they will hold still for a while. That’s equilibrium.

Market Equilibrium (Figure 2.5) Dr. Chen’s notes: Qd = Qs=800 ; P* = $60

Disequilibrium • Occurs when Qd ≠ Qs • Excess demand (shortage) • Exists when quantity demanded exceeds quantity supplied (Qd Qs): sellers will ask for a higher price (a move) • Excess supply (surplus) • Exists when quantity supplied exceeds quantity demanded (Qs Qd): buyers will ask for a lower price (a move) Dr. Chen’s notes: In the graph of previous slide, if the price is not equal to $60, either buyers or sellers will have incentive to move.

Measuring the Value of Market Exchange • Consumer surplus (C.S.) • Difference between the economic value of a good (willing-to-pay price) & the market price (Area of Auv) • Producer surplus (P.S.) • Difference between the market price & the minimum price producers would accept to supply (Area of Awv) • Social surplus (welfare) • Sum of consumer & producer surplus (Auw) Dr. Chen’s notes: How a freely trade market benefits? C.S. measures the invisible “savings” for consumers (i.e. the market price is lower than what they are willing to pay) and P.S. measures the additional “profit” for producers (i.e. the market price is higher than their opportunity costs of production). All in the above are welfare analysis in economics.

Measuring the Value of Market Exchange (Figure 2.6)

Changes in Market Equilibrium • Qualitative forecast • Predicts only the direction in which an economic variable will move (no need for detailed information of functions; graph analysis) • Quantitative forecast • Predicts both the direction and the magnitude of the change in an economic variable (functions are required) Dr. Chen’s notes: The basic quantitative forecast of equilibrium change is like: Demand function: QD = 102P Supply function: QS = 3P What are the equilibrium price and equilibrium quantity? If the supply function changes to QS = 3P 5 (supply decrease), what will be the new equilibrium price and quantity?

Demand Shifts (Supply Constant)(Figure 2.7) Dr. Chen’s notes: Please go over textbook pp. 65~74 to learn the details for both graph analysis and basic quantitative calculation.

Supply Shifts (Demand Constant)(Figure 2.8)

S S’ S’’ B • P’ • C P’’ D’ D Q’ Q’’ Simultaneous Shifts: (D, S) P A • P Q Q Price may rise or fall; Quantity rises

S S’ S’’ B • P’ • C P’’ D’ D Q’ Q’’ Simultaneous Shifts: (D, S) P A • P Q Q Price falls; Quantity may rise or fall

S’’ S • S’ C P’’ B • P’ D’ D Q’ Q’’ Simultaneous Shifts: (D, S) P A • P Q Q Price rises; Quantity may rise or fall

S’’ S S’ • C P’’ • B P’ D’ D Q’’ Q’ Simultaneous Shifts: (D, S) P A • P Q Q Price may rise or fall; Quantity falls

Ceiling & Floor Prices • Ceiling price (e.g. rent control) • Maximum price government permits sellers to charge for a good or service • When ceiling price is below equilibrium, a shortage occurs; when ceiling price is above equilibrium, nothing happens. • Floor price (e.g. minimum wage) • Minimum price government permits sellers to charge for a good or service • When floor price is above equilibrium, a surplus occurs; when floor price is below equilibrium, nothing happens. Dr. Chen’s notes: An effective ceiling (floor) price must be below (above) the market equil price.

Sx 3 2 2 1 Dx 62 50 50 84 22 32 Panel B – Floor price Ceiling & Floor Prices (Figure 2.12) Px Px Price (dollars) Price (dollars) Sx Dx Qx Qx Quantity Quantity Panel A – Ceiling price

Chapter 2: Demand, Supply, and Market Equilibrium