chapter 3 demand, supply and the market ©mcgraw-hill education, 2014
TRANSCRIPT
CHAPTER 3Demand, supply and the
market
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• Market: a set of arrangements by which buyers and sellers are in contact to exchange goods or services
• Demand: the quantity of a good buyers wish to purchase at each conceivable price
• Supply: the quantity of a good sellers wish to sell at each conceivable price
• Equilibrium price: price at which quantity supplied = quantity demanded.
Key concepts in the study of markets
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Quantity
Pric
e
S
The supply curve shows the relation between price and quantity demanded
holding other things constant
Other things include:
• Technology• Input costs• Government regulations•Business expectations
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Market equilibrium
Quantity
Pric
e
Market equilibrium is at E0 where quantity demanded equals quantity supplied . The equilibrium price is P0 and quantity Q0
S
E0P0
Q0
D
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Behind the demand curve
•It is important to distinguish between movements (or shifts) in the demand curve and movements along the demand curve.
•Movements along the demand curve result from changes in the price of the good itself.
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Movements along the demand curve
AP0
Q0 Quantity
Price
D
BP1
Q1
• A movement along the demand curve from A to B occurs when price falls
• Here all other determinants of demand remain constant.
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Behind the demand curve
• Movements (or shifts) in the demand curves are caused by
Changes in the price of related goods –either substitutes or complements
Changes in consumer incomesChanges in tastesExpectations over future price changes.
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Income changes and demand
• The influence of changes in income on demand depends on whether the good is
a normal good or
an inferior good.
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B
AC
F
Q2 Q3
Movements of or shifts in the demand curve
P0
Q0 Q1 Quantity
Price
P1
• A movement (or shift) of
the demand curve from D0
to D1leads to an increase in
demand at each and every price
• e.g., at P0 quantity
demanded increases from
Q0 to Q2: at P1 quantity
demanded increases from
Q1 to Q3
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E0
Q0
P0
A shift in demand
E1
Price
Quantity
If the price of a substitute good decreases, thenless will be demanded ateach price.
D0
D0
The demand curve shiftsfrom D0D0 to D1D1.
D1
D1
Q1
P1
If price stayed at P0 the resultant glut would put downward pressure on the price.Demand would rise and supply fall until equilibrium is restored at E1.
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Behind the supply curve (1)
• It is important to distinguish between movements (or shifts) in the supply curve and movements along the supply curve.
• Movements along the supply curve result from changes in the price of the good itself.
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Behind the supply curve (2)
• Movements (or shifts) in the supply curves are caused by
Changes in technologyChanges in input costsChanges in government regulationsBusiness expectations
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A shift in supply
D
Q0
P0 E0
Price
Quantity
Suppose safety regulations are tightened, increasing producers’ costs
S0
S0
The supply curve shifts to S1S1
If price stayed at P0, then there would be excess demand andupward pressure on price.
Q1
P1
E2
Demand would fall and supply increase until market equilibrium is restored.
S1
D
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Consumer and producer surplus(1)
•The difference between what a consumer is willing to pay for a good and the price actually paid is a measure of the consumer’s surplus.•Total consumer surplus in a market is the sum of all the surpluses enjoyed by all consumers.
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Consumer and producer surplus (2)
•The difference between the price at which a firm would be willing to supply a good and the price actually received by the firm is a measure of its producer surplus.•Total producer surplus in a market is the sum of all the surpluses enjoyed by all producers.
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Consumer and producer surplus (3)
Quantity
Pric
e
P *
Q*
Consumer surplus
Producer surplus
For a single consumer, the consumer surplus is the difference between the maximum price that she is willing to pay for a given amount of a good or service and the price she actually pays.
The producer surplus for sellers is the amount that sellers benefit by selling at a market price that is higher than they would be willing to sell for.
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Consumer and producer surplus and the gains from trade
•The economic surplus in a market (sum of consumer and producer surplus) is a measure of the benefits firms and consumers derive from trade.•It is maximized at the equilibrium price.•Only at this price are all the benefits from exchange exhausted.
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What, how and for whom• The market:
– decides how much of a good should be produced
• by finding the price at which the quantity demanded equals the quantity supplied
– tells us for whom the goods are produced
• those consumers willing to pay the equilibrium price
– determines what goods are being produced
• there may be goods for which no consumer is prepared to pay a price at which firms would be willing to supply
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excess demand
QS Q0 QD Quantity
Free markets and price controls: a market in disequilibrium
Price
P0
S
P1
E
A B
P2
S • Suppose a disastrous harvest moves the supply curve to SS.
• The resulting market clearing or equilibrium
price is P0.
• Government may try to protect the poor, setting a
price ceiling at P1.
• The result is excess demand.
RATIONING is needed to cope with the resulting excess demand.
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Free markets and price controls: a market in disequilibrium
•Minimum wages are an example of a price floor and can result in unemployment.•Rent caps are an example of a price ceiling and can result in shortages in rental markets.
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Exploring the mathematics of demand and supply (1)
The demand equation: QD
=a - bP (1)
where QD denotes the quantity demanded, P the price while a and b are two positive constants.
The supply equation:
QS =c + dP (2)
where QS s the quantity supplied, while c and d are two constants. We assume that the constant d is positive.
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Exploring the mathematics of demand and supply (2)
Market equilibrium is where quantity demanded equals quantity supplied:
QD = QS
)(
)(
)(
*
db
caP
cadbP
cabPdP
P* is the equilibrium price that equates quantity demanded and quantity supplied.
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Uncovering demand and supply curves
• It is important to understand that demand and supply curves are not physical objects that can be seen or touched.
• Rather they are relationships revealed through the appropriate use of statistical analyses undertaken by skilled econometricians.
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Uncovering supply and demand
• We cannot plot ex ante demand curves and supply curves
• So we use historical data and the supposition that the observed values are equilibrium ones
• Since other things are often not constant, careful use of statistical techniques is required to isolate the parameters of a demand or supply curve.
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Concluding comments (1)• Demand is the quantity that buyers wish
to buy at each price.• Supply is the quantity of a good sellers
wish to sell at each price.• The market clears, or is in equilibrium,
when the price equates the quantity supplied and the quantity demanded, and there are no shortages or surpluses.
• An increase in the price of a substitute good (or decrease in the price of a complementary good) will raise the quantity demanded at each price.
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Concluding comments (2)
• The consumer surplus is measured by the area below the market demand and above the equilibrium price.
• The producer surplus is measured by the area above the market supply and below the equilibrium price.
• To be effective, a price ceiling must be imposed below the free market equilibrium price.
• An effective price floor must be imposed above the free market equilibrium price.
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