Chapter 3: Demand, Supply, and Market Prices

1. Chapter 3 Demand (D), Supply (S), and Market Prices

2. Econ Quote of the Day Teach a parrot the terms ‘supply and demand’ and you’ve got an economist. - Thomas Carlyle

3. Chapter 3 Objectives: Upon completion of this lecture, you should understand and be able to answer these key questions: • What are the basic decision-making units in the economy? • What are the relationships between these basic units? How does a circular flow diagram illustrate these relationships? • What do we mean by ‘quantity demanded?’ What influences quantity demanded on the part of households? • What is the demand schedule for a product? What are the main features of a demand curve? What is the law of demand and how is it illustrated by demand curves? • What can change the demand for a product? How does the demand curve react to changes in demand? What do we mean by normal goods? Inferior goods? Complementary goods? Substitute goods? • What is the law of supply? What influences the quantity supplied of a good? What are the features of a supply curve? How do supply curves illustrate the law of supply? What factors can cause the supply of a product to change and how are these changes reflected in the supply curve? • What is the equilibrium price for a product? What do we mean by a shortage? A surplus? • How do changes in the supply or demand for a product affect its equilibrium price and quantity?

4. Key Concepts • Circular flow model and markets • Demand (D) a. D schedule, D curve, movement along D curve, law of D b. Factors affecting D, shift of D curve c. Individual and market D d. Types of goods (normal, inferior, substitutes, complements) • Supply (S) a. S schedule, S curve, movement along S curve, law of S b. Factors affecting S, shift of S curve c. Individual and market S • Market interaction of S&D • Disequilibrium (excess demand, excess supply) • Equilibrium & equilibrium changes (due to shifts in D and/or S)

5. Some S & D Managerial Implications 1. Understand how P’s are determined in order to anticipate P changes and capitalize with strategies related to: - buying - selling - producing - managing inventories - staffing - contracting 2. Understand how consumers and producers are likely to respond or be motivated by P changes (i.e. how economic activities are coordinated) in order to anticipate and capitalize on those expected responses.

6. D Schedule = a table showing the quantities (physical amount or units) of an item a buyer (or buyers) are willing to buy at different prices, ceteris paribus

7. D Curve = a graph of a D schedule, normally with price (P) units on the vertical axis. P D Q

8. On a typical day, literally millions of hamburgers are purchased by individuals in the U.S. What factors influence the willingness and ability of these consumers to buy hamburgers?

9. Law of D • D curves are downward sloping • ΔP and ΔQd are in ‘opposite’ directions

10. Quote of the Day • “In this world, there are two ways to get rich: #1. Produce something valuable and sell it to others. #2. Steal from those who are successful at pursuing the first strategy.” N. Gregory Mankiw Fortune (June 12, 2000)

11. Factors That Affect D for X 1. PX = P of that product (or item) (note ΔP could be caused by Δ supply) 2. P and/or availability of another item (e.g. Y) a. Substitutes (PY   D for X) b. Complements (PY   D for X) 3. Income (I) a. Inferior (I  D for X) b. Normal (I  D for X) 4. Type of Item a. Luxury b. Necessity

12. Factors That Affect D for X • Buyer concerns or expectations • Safety • Health • Cost • Advertising • Tastes and preferences • No. of buyers or alternative uses • Govt. policy (e.g. tax) • Seasonality • Interest rates • Profitability of an input – derived demand

13. Graphical Impacts of D (for X) Factor s • ΔPX movement along the D curve for X (often called “Δ in quantity demanded”) • Δ any other factor  shift of the D curve for X (called “Δ in demand”) Shift to right   D

14. Change in “Quantity Demanded” of X(Due to ΔPX = ΔP of THAT product) PX A to B: Increase in quantitydemanded A 10 B 6 D0 Q 4 7

15. Change in “Demand” for X(Due to Δ other than ΔP of THAT product) D0 to D1: Increase in Demand PX 6 D1 D0 Q 7 13

16. S Schedule = a table showing the quantities (physical amount or units) of an item a seller (or sellers) are willing to sell at different prices, ceteris paribus.

17. S Curve = a graph of a S schedule, normally with price (P) units on the vertical axis. P S Q

18. Law of S • S curves are upward sloping • ΔP and ΔQS are in the “same” direction

19. In a typical year recently, U.S. farmers produce 9-11 billion bushels of corn. What factors influence the willingness and ability of these producers to produce corn?

20. Factors that Affect S of X • PX = P of that product or item (note ΔP could be caused ΔD) • P or profitability of an alternative production item (e.g. Y) (PY  S of X) • P or cost of an input (e.g. Z) (PZ  S of X) • Taxes • Interest rates

21. Factors that Affect S of X • Gov’t policies/regulations • Technology • Producer expectations • Weather • Number of producers

22. Graphical Impacts of S (of X) Factor Δs • ΔPX movement along the S curve for X (Often called ‘Δ quantity supplied”) • Δ any other factor  shift of the S curve for X (often called “Δ in supply”) Shift to right  S

23. Change in “Quantity Supplied” of X (Due to ΔP = ΔP of THAT product) PX S0 B 20 A 10 Q 5 10

24. Change in Supply of X(Due to Δ other thanΔP of THAT product) PX S0 S1 8 6 Q 7 5

25. Equilibrium Price = Price for which QD = QS P (P=0+.01Q) 3.00 S 2.00* ← equilibrium point (P=4-.01Q) 1.00 D 100 200* 300

26. In markets, people pursue their own self interests by responding to price incentives. • Adam Smith (Wealth of Nations, 1776) noted it’s almost as if individuals are being led by an ‘invisible hand’, and this self-regulating behavior actually promotes the best interests of society as a whole.

27. Equilibrium Changes Over Time P P P S1 S2 S3 D2 D1 D3 Q Q Q T1 T2 T3

28. Solving for Equilibrium P Mathematically • Set S equation for P = D equation for P, and solve for equilibrium Q • Plug equilibrium Q back into either the S equation or the D equation and solve for equilibrium P Example: S equation: P = 0 + .01Q D equation: P = 4 - .01Q • 1) .01Q = 4 - .01Q  .02Q = 4  Q = 200 • 2) P = 4 - .01Q  P = 4 - .01(200)  P = 2.00

29. Q. What happens if a market price is either above or below the equilibrium value?

30. Disequilibrium price Prices for Qd≠ QS P (P=0+.01Q) Excess S 3.00 S 2.00 (P=4-.01Q) Excess D 1.00 D Q 100 200 300

31. Equilibrium Changes

32. Graph of Equilibrium Change, Case #1 (DX)  Shift of D curve for X to right caused by ΔD factor other than ΔPX causes ΔPX which causes ΔQS (movement along S curve) PX S1 P2 P1 D2 D1 QX

33. Graph of Equilibrium ChangeCase #4 (SX) Shift of S curve of X to left caused by ΔS factor other than ΔPX causes ΔPX which causes ΔQd (movement along D curve) PX S2 S1 P2 P1 D1 QX

34. Graph of Equilibrium ChangeCase #6 (DX, SX) PX S2 S1 P2 P1 D2 D1 QX