Chapter 3 Supply and Demand

1. Chapter 3Supply and Demand

2. Chapter Outline • Market demand • Market supply • Market equilibrium • Comparative statics analysis • Supply, demand, and price

3. Learning Objectives • Define supply, demand, and equilibrium price • List and provide specific examples of the non-price determinants of supply and demand • Distinguish between the short-run rationing function and long-run guiding function of price • Illustrate how the concepts of supply and demand can be used in management decisions about price and allocations of resources. • Use supply and demand diagrams to determine price in the short and long run

4. Market Demand • The demand for a good or service is defined as: • Quantities of a good or service that people are ready, willing and able to buy at various prices within some given time period. (Other factors besides price held constant.)

5. Market Demand • “Ready” implies that consumers are prepared to buy a good or service both because they are: • Willing: Consumers have a preference for it. • Able: Consumers have the income to support this preference.

6. Market Demand Market demand is the sum of all the individual demands. • Individuals may have distinct demand curves, and they sum to the overall demand in the market. Example: demand for pizza

7. Market Demand There is an inverse relationship between price and the quantity demanded of a good or service. This is called the Law of Demand. Thus, the demand curve is downward sloping.

8. Market Demand • Graphical Representation of Demand • Algebraic Representation of Demand Qd=700-100P

9. Market Demand • Changes in price result in changes in the quantity demanded • This is shown as movement along the demand curve. • Changes in non-price factors result in changes in demand • This is shown as a shift in the demand curve.

10. Market Demand

11. Market Demand • Non-price determinants of demand-result is a shift in the demand curve. • tastes and preferences • income • prices of related products • future expectations • number of buyers

12. Market Supply • The supply of a good or service is defined as quantities that people are ready to sell at various prices within some given time period (Other factors besides price held constant)

13. Market Supply • Changes in price result in changes in the quantity supplied • shown as movement along the supply curve • Changes in non-price determinants result in changes in supply • shown as a shift in the supply curve

14. Market Supply

15. Market Supply • Non-price determinants of supply-results in a shift in the supply curve. • costs and technology • prices of other goods or services offered by the seller • future expectations • number of sellers • weather conditions

16. Market Equilibrium • Equilibrium price: the price that equates the quantity demanded with the quantity supplied • Equilibrium quantity: the amount that people are willing to buy and sellers are willing to offer at the equilibrium price level

17. Market Equilibrium • Shortage: a market situation in which the quantity demanded exceeds the quantity supplied • shortage occurs at a price below the equilibrium level • Surplus: a market situation in which the quantity supplied exceeds the quantity demanded • surplus occurs at a price above the equilibrium level

18. Market Equilibrium

19. Comparative Statics Analysis • Comparative statics is a form of sensitivity (or what-if) analysis • Commonly used method in economic analysis

20. Comparative Statics Analysis • Process of comparative statics analysis: • state all the assumptions needed to construct the model • begin by assuming that the model is in equilibrium • introduce a change in the model, so a condition of disequilibrium is created • find the new point of equilibrium • compare the new equilibrium point with the original one

21. Comparative Statics Analysis Step 1 • assume all factors except the price of pizza are constant • buyers’ demand and sellers’ supply are represented by lines shown

22. Comparative Statics Analysis Step 2 • begin the analysis in equilibrium as shown by Q1 and P1

23. Comparative Statics Analysis Step 3 • assume that a new study shows pizza to be the most nutritious of all fast foods • consumers increase their demand for pizza as a result

24. Comparative Statics Analysis Step 4 • the shift in demand results in a new equilibrium price (P2) • and a new equilibrium quantity (Q2)

25. Comparative Statics Analysis Step 5 • comparing the new equilibrium point with the original one, we see that both equilibrium price and quantity have increased

26. Comparative Statics Analysis • The short run is the period of time in which: • sellers already in the market respond to a change in equilibrium price by adjusting variable inputs • buyers already in the market respond to changes in equilibrium price by adjusting the quantity demanded for the good or service

27. Comparative Statics Analysis • Short run changes show the rationing function of price • The rationing function of price is the change in market price to eliminate the imbalance between quantities supplied and demanded.

28. Comparative Static Analysis:Short-run • an increase in demand causes equilibrium price and quantity to rise

29. Comparative Static Analysis: Short-run • a decrease in demand causes equilibrium price and quantity to fall

30. Comparative Static Analysis: Short-run • an increase in supply causes equilibrium price to fall and equilibrium quantity to rise

31. Comparative Static Analysis: Short-run • a decrease in supply causes equilibrium price to rise and equilibrium quantity to fall

32. Comparative Static Analysis:Long-run • The long run is the period of time in which: • new sellers may enter a market • existing sellers may exit from a market • existing sellers may adjust fixed factors of production • buyers may react to a change in equilibrium price by changing their tastes and preferences

33. Comparative Static Analysis:Long-run • Long run changes show the allocating function of price • The guiding or allocating function of price is the movement of resources into or out of markets in response to a change in the equilibrium price.

34. Comparative Static Analysis:Long-run • initial change: decrease in demand from D1 to D2 • result: reduction in equilibrium price and quantity (to P2, Q2) • follow-on adjustment: • movement of resources out of the market • leftward shift in the supply curve to S2 • equilibrium price and quantity (to P3, Q3)

35. initial change: increase in demand from D1 to D2 result: increase in equilibrium price and quantity (to P2, Q2) follow-on adjustment: movement of resources into the market rightward shift in the supply curve to S2 equilibrium price and quantity (to P3, Q3) Long-run Analysis

36. Summary: Short-Run and Long-Run Changes in the Market

37. Supply, Demand, and Price • In the extreme case, the forces of supply and demand are the sole determinants of the market price, not any single firm. • this type of market is ‘perfect competition’ • In many cases, individual firms can exert market power over price because of their: • dominant size • ability to differentiate their product through advertising, brand name, features, or services

38. Supply, Demand, and Price • Discussion of changes in the computer industry • Makers of PCs, notebooks and jump drives are facing slower growth in the demand for their products as technology is changing. • What impact do you think cloud computing will have on the demand for stand-alone applications such as Microsoft Office or storage devices for computers?

39. Global Application What are the implications of rising demand for oil among developing counties?

40. Global Application

41. Global Application

42. Summary • The law of demand states that, other factors held constant, the quantity demanded is inversely related to price. • The law of supply states that, other factors held constant, the quantity supplied is directly related to price. • Non-price factors may shift the curves. • Price serves a short-run rationing function and a long-run guiding function in the marketplace.