Supply and Demand

Market Interactions

•Groups of Market Participants

– Consumers

– Business firms

– Governments

– Foreigners

Market Interactions

The Two Markets

•Factor Market

– Any place where factors of production are bought and sold.

•Product Market

– Any place where finished goods and services (products) are bought and sold.

Product Market

•Consumers buy and producers sell in the product market.

•Imports and exports are also a part of the product market.

Locating Markets

•A market is anywhere an economic exchange occurs.

•A market exists wherever and whenever an exchange takes place.

Supply and Demand

•The two sides of each market transaction are called supply and demand.

Supply and Demand

•Supply

Supply and Demand

•Demand

Individual Demand

•How much someone is willing to pay for something is determined by his income and the opportunity cost.

Demand Schedule

•A table showing the quantities of a good a consumer is willing and able to buy at alternative prices in a given time period, ceteris paribus.

Demand Schedule

•Demand is an expression of buyer intentions, of a willingness to buy, not a statement of actual purchases.

Demand Curve

•A curve describing the quantities of a good a consumer is willing and able to buy at alternative prices in a given time period, ceteris paribus.

Demand Curve

•The demand curve does not state actual purchases, rather only what consumers are willing and able to purchase.

Individual Demand

Law of Demand

•The quantity of a good demanded in a given time period increases as its price falls, ceteris paribus.

Determinants of Demand

•Tastes (desire for this and other goods)

•Income (of the consumer)

•Other goods (their availability and price)

•Expectations (for income, prices, tastes)

•Number of buyers

Ceteris Paribus

•The assumption of nothing else changing.

– Focus on one or two forces at a time and assume nothing else changes.

Ceteris Paribus

•Allows us to focus on the relationship between quantity demanded and price.

Shift in Demand

•A change in the quantity demanded at any given price.

Shift in Demand

•The demand schedule and curve remain unchanged only so long as the underlying determinants of demand remain constant.

Shift in Demand

•Changes in any of the determinants of demand will cause the demand curve to shift.

A Shift in Demand

Movement vs. Shifts

•Movements along a demand curve are a response to price changes for that good.

Movement vs. Shifts

•Shifts of the demand curve occur only when the determinants of demand change.

Movement vs. Shifts

•Changes in quantity demanded

Market Demand

•The total quantities of a good or service people are willing and able to buy at alternative prices in a given time period.

•The sum of individual demands.

Market Demand

•Market demand is determined by the number of potential buyers and their respective tastes, incomes, other goods, and expectations.

The Market Demand Curve

•A picture of the total quantities demanded by all consumers within a market at different price levels.

The Market Demand Schedule

Construction of the Market Demand Curve

The Use of Demand Curves

•Show how much consumers will spend at different price levels.

•Predict the amount to produce at a given price.

•Determine the price that will result in desired output levels.

Supply

•Supply interacts with demand to determine the price that will be charged.

Market Supply

•The total quantities of a good that sellers are willing and able to sell at alternative prices in a given time period, ceteris paribus.

Market Supply

•Market supply is an expression of sellers’ intentions, of the ability and willingness to sell, not a statement of actual sales.

Determinants of Supply

•Technology

•Factor costs

•Other goods

•Taxes and subsidies

•Expectations

•Number of sellers

Law of Supply

•The quantity of a good supplied in a given time period increases as its price increases, ceteris paribus.

•Larger quantities will be offered at higher prices.

The Market Supply Curve

Shifts in Supply

•Changes in a quantity supplied

– Movement along a given supply curve.

•Changes in supply

– Shifts due to some change in a determinant of supply.

Equilibrium

•Only one price and quantity are compatible with the existing intentions of both buyers and sellers.

Equilibrium Price

•The price at which the quantity of a good demanded in a given time period equals the quantity supplied.

Equilibrium Price

Equilibrium Price

•The equilibrium price occurs at the intersection of the supply and demand curves.

Equilibrium Price

Market Clearing

•Collective actions of sellers and buyers create an equilibrium price.

•The equilibrium price and quantity reflect a compromise between buyers and sellers.

Market Clearing

•No other compromise yields a quantity demanded that is exactly equal to the quantity supplied.

Surplus and Shortage

•Either a market surplus or a market shortage will emerge whenever the market price is set above or below the equilibrium.

Market Shortage

•The amount by which quantity demanded exceeds the quantity supplied at a given price.

Market Shortage

•Occurs when the selling price is lower than equilibrium price.

Market Shortage

Market Surplus

•The amount by which quantity supplied exceeds quantity demanded at a given price.

Market Surplus

•Occurs when the selling price is higher than equilibrium price.

Market Surplus

Surplus and Shortage

•Businesses often discover the equilibrium price through trial and error.

Changes in Equilibrium

•Equilibrium price and quantity changes whenever supply or demand curve shifts.

•Happens when the determinants of supply or demand change.

A New Equilibrium

Disequilibrium Pricing

•Price Ceiling

– Upper limit imposed on the price of a good or service.

•Price Floor

– Lower limit imposed on the price of a good or service.

Price Ceiling

•Price ceilings have three predictable effects:

– Increases quantity demanded.

– Decreases quantity supplied.

– Creates a market shortage.

Price Ceiling

•Rent control on housing is an example of a price ceiling.

Price Ceilings Create Shortages

Price Floors

•Price floors has three predictable effects:

– Increases quantity supplied.

– Decreases quantity demanded.

– Creates a market surplus.

Price Floors

•Minimum wages and price supports for agriculture are examples of price floors.

Price Floors

•A government imposed price floor can create a wrong mix of output, an increased tax burden, and an altered distribution of income.

Price Floors Create Surplus

Market Mechanism

•The use of market prices and sales to signal desired outputs (or resource allocations).

What, How, For Whom

•The market mechanism helps resolve the basic economic questions.

What, How, For Whom

•What to produce — whatever consumers are willing to buy from suppliers.

What, How, For Whom

•How goods are produced — profit-seeking firms seek to produce goods at lowest cost using the lowest priced resources.

What, How, For Whom

•For whom to produce — only those buyers willing and able to pay the market price receive the good.

Optimal, Not Perfect

•Market outcomes are optimal, not perfect.

Optimal, Not Perfect

•Optimal outcomes are the best possible, given the level and distribution of incomes and scarce resources.

Optimal, Not Perfect

•We expect the choices made in the marketplace to be the best possible choices for each participant.

Supply and Demand

•End of Chapter 3