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1. Supply and Demand Keyissues •demand •supply •marketequilibrium •shockingtheequilibrium •effectsofgovernmentinterventions •whentousesupplyanddemandmodel Today'squestions Whatistheeffectofabanonforeignimportsof riceintoJapanonthesupplyofricetothe Japanese market? Whatistheeffectofapricecontrol(ceiling)? Whatistheeffectofinstitutingusurylaws? CouldtheImmigrationReformandControlAct createalaborshortageforfarmers? Willthemadcowcrisislowerbeefpricesinthe UnitedStates? 1. 2. 3. 4. 5. 1
2. Whatisthemostimportantthing youknowabouteconomics? •manypeoplereply supplyequalsdemand •thisstatementsummarizesasimple,yet powerfulmodel Supplyanddemandmodel •mostwidely-usedeconomicmodel •testable(likeallgoodtheories) •describeshowconsumersandsuppliers interactinamarkettodeterminequantityof a goodsoldanditsprice Tousesupplyanddemandmodel • youneedtodetermine •buyers'behavior •sellers'behavior •how they interact •knowwheretousethemodel: incompetitivemarkets 2
3. Quantitydemanded istheamountofagoodorservicethat consumerswanttobuyatagivenprice, holdingconstantotherfactorsthataffect demand Whatdeterminesdemand? • • • • • • • tastes priceofthisgood pricesofothergoods income information(cholesterol) governmentactions otherfactors:nicotine,... Demand curve • showsquantitydemanded—largestquantitythat consumersarewillingtobuy—ateachprice, holdingconstantotherfactorsthataffectpurchases note:quantitydemandedofagoodorservicecan exceedquantitysold(orviceversa) strangedemandcurveconvention:priceisonthe verticalaxis • • 3
4. Figure2.1DemandCurveforCanadianProcessedPork p,$perkg Demandcurveforpork, D1 14.30 4.30 3.30 2.30 0 200220 240 286 Q,Millionkgofporkperyear Effectofpricechanges •movementalongthedemandcurve •demandcurveisaconcisesummaryofthe answertothequestion: whathappenstothequantitydemandedasthe pricechanges,holdingallotherfactors constant? Lawofdemand •demandcurvesslopedown a dropinpriceresultsinanincreasein quantitydemanded(holdingotherfactors constant) • •oneofthemostimportantempiricalfinding ineconomics 4
5. Demandeffectsofotherfactors •changeinanyfactorotherthanthepriceof thegoodcausesashiftofthedemandcurve (notamovementalongthedemandcurve) •thisshiftofthedemandcurveisa trickto avoiddrawing3Ddiagrams Effectonporkdemandof arise inpriceofbeef •beefisasubstituteforpork •atagivenpriceofpork,ariseinthepriceof beefcausessomepeopletoswitchfrom beeftopork Figure2.2 AShiftofthePorkDemandCurve Effectofa60¢increaseinthe priceofbeef p,$perkg 3.30 D D1 D2 220 232 0 176 Q,Millionkgofporkperyear 5
6. Summary • changeinthepriceofagoodcausesa movementalonga demandcurve • changeinanyother factorbesidestheprice causesashiftofthedemandcurve Variabledefinitions • Q=quantityofporkdemanded(millionkg peryear) p=price ofpork($perkg) pb=price ofbeef($perkg) pc=priceofchicken($perkg) Y=incomeofconsumers(thousand$) • • • • Demandfunction • generalfunction Q=D(p,pb,pc,Y) specific(linear)porkdemandfunction Q=171-20p+20pb+3pc+2Y • 6
7. Holdotherfactorsconstant •D1(Figure2.1) holdspb,pc,andYattheir typicalvalues: pb=$4perkg pc =$31/3perkg Y=$12.5thousand •Q=171–20p+20pb+3pc+2Y =171–20p+(20x4)+(3x31/3)+(2x12.5) =286–20p Figure2.1DemandCurveforCanadianProcessedPork p,$perkg Demandcurveforpork, D1 14.30 4.30 3.30 2.30 0 200220 240 286 Q,Millionkgofporkperyear Plottingdemandfunction: Intercept •Q=286–20p •constantterm, 286,isthequantity demandedifpriceiszero •Q=286-(20x0)=286 •D1hitsquantityaxisat286(price= 0) 7
8. Plottingdemandfunction:Slope •Q=286–20p •numberonprice,20,israte atwhich quantitychangesaspricechanges Q=Q2-Q1 =D(p2)–D(p1) =(286–20p2)-(286–20p1) =-20(p2 –p1)=-20 p • p=$1 Q=-20 p=-20millionkgperyear Slopeofporkdemandcurve • p/ Q=[the"rise"]/[the"run"] =[$1perkg]/[-20millionkgperyear] =-$0.05permillionkgperyear •negativesignisconsistentwithLawof Demand Calculus •Q=286–20p •differentiate: dQ dp 20 8
9. Summingdemandcurves • totaldemandissumofdemandforallconsumers • supposethereare2consumerswithdemand curves: Q1 =D1(p) Q2 =D2(p) • totalquantitydemanded=horizontalsumof quantityeachconsumerdemandsateachgiven price: Q=Q1 +Q2 =D1(p)+D2(p) Application AggregatingtheDemandforClingPeaches p,$ perton 275 183 Demandfor fruit Totaldemand Demandforcannedpeaches cocktail 0 Q=4 Q=18 Q=22 50 f c Q,Tonsofpeachesper10,000peopleperyear Quantitysupplied istheamountofa goodorservicethatfirms wanttosellatagivenprice,holding constantotherfactorsthataffectsupply 9
10. Supplyisafunctionof • • • • price costsofproduction governmentrulesandregulations technology… Supplycurve increaseinpriceofporkcausesa movement alongthesupplycurve(holdingfixedother variablesthat affectsupply) supplycurveisaconcisesummaryof answertothequestion: whathappenstothequantitysuppliedas thepricechangesholdingall otherfactors constant? • • Figure2.3 SupplyCurveofCanadianProcessedPork p, $perkg 5.30 Supplycurve,S1 3.30 0 176 220 300 Q,Millionkgofporkperyear 10
11. Effectof priceonsupply •supplycurveforporkisupwardsloping •thus,increaseinthepriceofpork movementalongthesupplycurve,resulting inlargerquantityofporksupplied Thereisno"LawofSupply" marketsupplycurvemaybeupward sloping,vertical,horizontal,ordownward sloping Supplyeffectsof othervariables shiftinavariableotherthanpriceofpork causestheentiresupplycurvetoshift 11
12. Figure2.4 AShiftofPorkSupplyCurve p,$perkg Effect ofa25¢increase inthepriceofhogs S2 S1 3.30 0 176 205 220 Q,Millionkgofporkperyear Summary •changeinpriceofporkcausesa movement alongthesupplycurve •whencosts,governmentrules,orother variablesthat affectsupplychange,the supplycurveshifts Generalsupplyfunction Q=S(p,ph), Q=thequantityofprocessedporksupplied (millionkgperyear) p=priceofprocessedpork($perkg) ph=priceofahog($perkg) 12
13. Specificlinearporksupply function Q=178+40p-60ph, holdingph fixedatits averagevalueof $1.50perthesupplyfunctionis Q=88+40p Movementalongthesupply curve •supplyfunction: Q=88+40p •ifpriceofprocessedporkincreasesby p=p2-p1 •then Q=40 p Calculus •Q=88+44p •differentiate: dQ dp 44 13
14. Summingsupplycurves totalsupplycurve • horizontalsummationofindividualsupply curves •showstotalquantityproducedbyall suppliersateachpossibleprice TotalSupply:TheSumofDomesticandForeignSupply (a)JapaneseDomesticSupply (b)ForeignSupply (c)TotalSupply p,Price ce on rice ton p,Pri Sd pert p,P Sf(noban) per S(noban perton ) p* p* p* p p p Q*=Q*+Q* d f Q,Tonsperyear Q* d Q* f Q,Tonsperyear f Q ,Tonsperyear d Solvedproblem Whatistheeffectofabanon foreign importsofriceintoJapanon thesupply curveofricetotheJapanesemarket? • •(supposethat domesticandforeignsupply curvesofriceinJapanarelinear,upward slopingcurveswiththesameinterceptand differentslopes) 14
15. Restatementofproblem •inmostofourproblemsweareaskedto determinehowachangeinavariableor policyaffectsoneormorevariables •whatchanges:foreignricemaynolonger beimported •whichaffectsforeignsupplyandtotal Japanesesupplycurve Answer 1.showwhatthebandoestotheforeignsupply:ban preventsimports newforeignsupplycurve,Sf, liesontheverticalaxis 2.comparethenewandoriginalforeignsupply curves:atpricesabovethepricewhereforeign supplieroriginallysuppliedquantity,thenew foreignsupplycurveliestoleftoforiginalone Answer(continued) 3.showwhathappenstonewtotalsupply:newtotal supplycurveisthehorizontalsumoftheJapanese supplycurve,Sd,andforeignsupplycurve,Sf. Thus,newtotalsupplycurveisidenticalto domesticsupplycurve 4.comparenewandoriginaltotalsupplycurves:at anypriceabovethepricewhereanyquantitywas originallysuppliedbyforeignsuppliers,thenew totalsupplycurveliestotheleftoftheoriginal one 15
16. Figure2.5 TotalSupply:TheSumofDomesticandForeignSupply (a)JapaneseDomesticSupply (b)ForeignSupply (c)TotalSupply p,Price ce on rice ton p,Pri Sd pert p,P Sf(ban) Sf(noban) per S(ban) S(noban perton ) p* p* p* p p p Q=Q* Q*=Q*+Q* d d f Q,Tonsperyear Q* d Q* f Q,Tonsperyear f Q ,Tonsperyear d Quota nextfigureshowstheeffectofa (nonzero) quotaon thesupplycurveofrice (a)U.S.DomesticSupply (b)ForeignSupply (c)TotalSupply rice ton p,Price perton ice ton p,Pr per Sd Sf p,P per S S Sf p* p* p* p p p Q Q* Q Q* Q +Q Q*+Q Q*+Q* d f d f d f Q,Tonsperyear d d Q ,Tonsperyear d f f Q,Tonsperyear f 16
17. Supplyanddemand:Market equilibrium supplyanddemandcurvesdetermine marketpriceandquantity unlesspriceissetsothatconsumerswantto buyexactlyasmuchassupplierswantto sell,somepartywillbefrustrated whenneitherbuyersnorsellersare disappointed,marketisinequilibrium:no onewantstochangehisorherbehavior • • • Equilibrium • equilibriumprice:pricewhere •consumerscanbuyasmuchastheywant •sellerscansellasmuchastheywant • equilibriumquantity:quantityboughtand sold attheequilibriumprice Figure2.6 PorkMarketEquilibrium Excess p,$perkg Excess supply=39 S D 3.95 e 3.30 2.65 Exce ssdemand =39 194 207 220 233 246 0 176 Q,Millionkgofporkperyear 17
18. Determineequilibriumprice • findprice,p,thatequatesequilibriumdemandand supplyquantity:Qd =Qs =Q,equilibrium quantity: • Qd =286-20p (demandfunction) • Qs=88+40p (supplyfunction) • Qd =286-20p=88+40p=Qs 286-88=40p+20p 198=60p 3.30=p Determineequilibriumquantity •substituteequilibriumprice,p=$3.30,into demand functionorsupplyfunctionto determineequilibriumquantity: •Qd=286–(20x3.30) =88+(40x3.30) =Qs =220=Q Invisiblehand atnonequilibriumprice,consumersorfirms changetheirbehavior(marketforces) drivingpricetoequilibriumlevel 18
19. Marketforcesdrivemarketto equilibrium •atprices<equilibriumlevel:excessdemand (amountbywhichquantitydemanded exceedsquantitysuppliedatthespecified price) •atprice>equilibriumlevel:excesssupply •equilibriumpriceismarketclearingprice: no excessdemandorexcesssupply Figure2.6 PorkMarketEquilibrium Excess p,$perkg Excess supply =39 S D 3.95 e 3.30 2.65 Exce ssdemand =39 194 207 220 233 246 0 176 Q,Millionkgofporkperyear Shockingtheequilibrium •onceanequilibriumisachieved,it can persistindefinitelybecausenooneapplies pressuretochangetheprice •equilibriumchangesonlyif •demandcurveshifts •supplycurveshifts •governmentintervenes 19
20. Figure2.7a EffectsofaShiftofthePorkDemandCurve (a)Effectofa60¢IncreaseinthePriceofBeef e2 p,$perkg S 3.50 3.30 e D2 D 1 1 0 176 220 228 232 Excessdemand=12 Q,Millionkgofporkperyear Figure2.7b EffectsofaShiftofthePorkDemandCurve (b)Effectofa25¢IncreaseinthePriceofHogs p,$perkg S2 S1 e2 3.55 3.30 e D 1 0 176 205 215 220 Excessdemand=15 Q,Millionkgofporkperyear Governmentpolicies •ceilingprice •pricecontrols •usurylaws •rentcontrol •floorprice:minimumwage •quotas(restrictiononsupply) •taxesandtariffs(taxonimportsonly) 20
21. Zimbabwepricecontrols October2001duringapresidential campaign, Zimbabwe’sgovernmentimposedpricecontrols onmanybasiccommodities • foods(aboutathirdofcitizens’dailyconsumption) • soap • cement controlsledtoshortages thrivingblackorparallelmarketdeveloped blackmarketprices2to3xcontrolledprices • • • • Zimbabwe:Cement cementmanufacturers stoppedacceptingnew orderswhenpricecontrolswereimposed dealersquicklyshiftedexistingsuppliestothe parallelmarket lackofcementcrippledtheconstructionindustry byMay2002,thegovernment nearlydoubled controlpriceofcementinanefforttoinducefirms toresumesellingcement • • • • Zimbabwe:Food sugarissignificantlycheaperthaninsurrounding regions • smugglingtoothercountries • Zimbabwesufferedfromsugarshortage supermarketshavenomaize-meal,sugar,and cookingoilonmanydays bakersscaledbackoperation--theyhaveonlyhalf asmuchflourasbeforecontrols becauseofshortages,manypeoplemaystarve • • • • 21
22. Solvedproblem:Minimumwage •Whatistheeffectofa minimumwageona labormarket? •restatement: •whatchangesisthatgovernment setsa minimumwage,w*,thatmustbepaid •affectsequilibrium wage,equilibrium hours worked MinimumWage w,wage S Minimum wage w* e D w Hd Hs H,Hoursworked H Excess supply: Unemployment Supplyneednotequaldemand • priceceilingsorpricefloors quantitysupplied doesnotnecessarilyequalquantitydemanded • quantitysupplied=amountfirmswanttosellata givenprice,holdingconstantotherfactorsthat affectsupply • quantitydemanded =amountconsumerswantto buyatagivenprice,holdingconstantotherfactors 22
23. Permanentexcessdemandor supply quantitydemandedand quantitysuppliedat agivenpriceneednotequalactualquantity thatisboughtandsold: cangetpersistentexcessdemand(price ceiling) cangetpersistentexcesssupply(price floor) • • Supplyequalsdemand ifsomeoneinsiststhat"demandmustequal supply,"theymustbedefiningdemandand supplyastheactualquantitiessold wedefinequantitiessuppliedanddemanded intermsofpeoples'wants thus,statementthat"supplyequalsdemand" isa theory,notmerelya definition • • Whentousesupplyanddemand model •manybuyersandsellers •firmssellidenticalgoods •firmsarepricetakers •nouncertainty:everyonehasfull informationaboutprice andqualityof goods •lowtransactioncosts:buyersandsellerscan tradeeasily 23
24. Whensupplyanddemandmodel isinappropriate •onlyafewsellers(automanufacturers) •buyersandsellersareuncertainaboutthe marketequilibrium(concertmusic business) •consumersknowmuchlessthansellers aboutqualityorprice(usedcars) •hightransactioncosts(artwork) Usesupplyanddemandmodelin • • • • • • • agriculturalmarkets financial labor construction services wholesale retail 1Demandcurvesummary demandcurve:relationshipbetweenquantity demandedandprice,fixingotherfactors LawofDemand:demandcurvesslopedown changeinpricecausesamovementalongthe demandcurve changeinincome,tastes,oranotherfactorother thanprice,causesashiftofthedemandcurve totaldemandcurve=horizontalsumof individuals’demandcurves • • • • • 24
25. 2 Supplycurves supplycurve:relationshipbetweenquantity suppliedandprice,holdingconstantotherfactors marketsupplycurveneednotslopeupbut frequentlydoes changeinpricecausesamovementalongthe supplycurve shiftinthepriceofaninputorgovernment regulationscauseashiftofthesupplycurve totalsupplycurve=horizontalsumofindividual firms’supplycurves • • • • • 3 Marketequilibrium intersectionofdemandandsupplycurves determinesmarketequilibriumpriceand quantity marketforcedrivethepriceandquantityto theequilibriumlevelsiftheyareinitially toolowortoohigh • • 4 Shocks changeinanunderlyingfactorotherthan pricethatcausesashiftofthesupplycurve orthedemandcurve,alterstheequilibrium 25
26. 5 Effectsofgovernment intervention governmentpolicies,suchaspricecontrols, cancausethequantitysuppliedtobe greater orlessthanthequantitydemanded,sothat therearepersistentshortagesorexcesses 6Whentousesupplyand demandmodel •supplyanddemandmodelisapplicable onlyincompetitivemarkets •competitivemarkets:homogeneousgoods, manybuyersandsellers(pricetakers) 26