demand and supply. the power of trade voluntary versus involuntary exchange an intuitive approach to...

Demand and Supply

The Power of Trade

• Voluntary versus involuntary exchange

• An intuitive approach to gains in trade

• Using an economic model to demonstrate the gains from trade

Voluntary Exchange

• All parties to a voluntary exchange must be made better off

• Allow for specialization and division of labor

• Increase interdependence

• Promote cooperation rather than conflict

An intuitive Approach to Gains From Trade

• Self-sufficiency – Pros: independence– Cons: loss of efficiency, variety in consumption

and production

• Trade with Yakima?

• Trade with other states?

• Trade with other nations?

History of Trade

• Tribal to feudal times

• Adam Smith (1776) and David Ricardo (1817)

• The costs of not trading (e.g. lamb example)

• Distribution impacts: consumers win but some producers and workers lose

• The cost of protectionism

Markets: The power of Demand and Supply

• Competitive Markets– identical or homogeneous goods– many sellers and buyers– perfect Information– free entry and exit

• Non-Competitive Markets– Monopoly – one seller– Oligopoly – few sellers– Monopolistically Competitive – differentiated products

Demand• The demand curve

– Price and the quantity demanded• Rational behavior

– Utility maximization MB=MC – Boxes example

– Law of Demand – as the price of a product falls, ceteris paribus (all other things equal), the quantity demanded of the good will rise

• Law of Diminishing Marginal Utility – Jelly bean example• Income and substitution effects

– Substitution effect – consumers will substitute the now relatively cheaper good for other now relatively more expensive goods

– Income effect – a decrease in any price, ceteris paribus, increases the purchasing power of the consumer’s income leading. Therefore, consumer will purchase more of a normal good.

• Demand schedule – is a table of the various prices and the quantities that a consumer will demand at those prices.

• Individual demand curve – is a graph relating price and quantity demanded for a consumer.

• Market demand curve – is a graph reflecting the sum of individual consumer demands in a market.

Catherine’s Demand Schedule

Figure 1 Catherine’s Demand Schedule and Demand Curve

Copyright © 2004 South-Western

Price ofIce-Cream Cone

0

2.50

2.00

1.50

1.00

0.50

1 2 3 4 5 6 7 8 9 10 11 Quantity ofIce-Cream Cones

$3.00

12

1. A decrease in price ...

2. ... increases quantity of cones demanded.

• The demand function – lists all of the determinants of demand and includes:– Price of the Good - law of demand– Price of related goods

• Complements – as the Pc goes up QD of the good goes down• Substitutes - as the Ps goes up QD of the good goes up

– Income – normal vs. inferior goods– Number of Buyers– Tastes– Expectations – future prices, shortages, other conditions

• QD =F ( P(-), PR (Pc(-), Ps(+)) ,I (normal (+), inferior(-)), N(+), T(+), E)

• Movement along and shifts of the demand curve– Movement – only change in the price of the

good– Shifts – changes in any determinant but the

prices of the good– Curve versus function– Schedules– Graphs

Figure 3 Shifts in the Demand Curve

Copyright©2003 Southwestern/Thomson Learning

Price ofIce-Cream

Cone

Quantity ofIce-Cream Cones

Increasein demand

Decreasein demand

Demand curve, D3

Demandcurve, D1

Demandcurve, D2

0

Supply

• Price and the quantity supplied– Rational behavior an the profit motive– Law of diminishing returns

• Supply schedule

• Individual supply curve

• Market supply curve

Ben’s Supply Schedule

Figure 5 Ben’s Supply Schedule and Supply Curve


Price ofIce-Cream

Cone

0

2.50

2.00

1.50

1.00

1 2 3 4 5 6 7 8 9 10 11 Quantity ofIce-Cream Cones

$3.00

12

0.50

1. Anincrease in price ...

2. ... increases quantity of cones supplied.

• The supply function– Price of the Good– Input prices– technology– number of sellers– expectations

• QS =F ( P, I, N, E, T)

Figure 7 Shifts in the Supply Curve


Price ofIce-Cream

Cone

Quantity ofIce-Cream Cones

0

Increasein supply

Decreasein supply

Supply curve, S3

curve, Supply

S1Supply

curve, S2

Market Equilibrium• Equilibrium price and quantity = market clearing price

and quantity• Disequilibrium prices and quantities

– Shortage– Surplus

• Comparative static analysis: changes in equilibrium prices and quantities

• Shifts in curves versus movement along revisited• Changes in demand and supply

Figure 8 The Equilibrium of Supply and Demand


Price ofIce-Cream

Cone

0 1 2 3 4 5 6 7 8 9 10 11 12Quantity of Ice-Cream Cones

13

Equilibriumquantity

Equilibrium price Equilibrium

Supply

Demand

$2.00

Figure 9 Markets Not in Equilibrium


Price ofIce-Cream

Cone

0

Supply

Demand

(a) Excess Supply

Quantitydemanded

Quantitysupplied

Surplus

Quantity ofIce-Cream

Cones

4

$2.50

10

2.00

7

Figure 8 The Equilibrium of Supply and Demand


Price ofIce-Cream

Cone

0 1 2 3 4 5 6 7 8 9 10 11 12Quantity of Ice-Cream Cones

13

Equilibriumquantity

Equilibrium price Equilibrium

Supply

Demand

$2.00



Price ofIce-Cream

Cone

0

Supply

Demand

(a) Excess Supply

Quantitydemanded

Quantitysupplied

Surplus

Quantity ofIce-Cream

Cones

4

$2.50

10

2.00

7



Price ofIce-Cream

Cone

0 Quantity ofIce-Cream

Cones

Supply

Demand

(b) Excess Demand

Quantitysupplied

Quantitydemanded

1.50

10

$2.00

74

Shortage

Figure 10 How an Increase in Demand Affects the Equilibrium


Price ofIce-Cream

Cone

0 Quantity of Ice-Cream Cones

Supply

Initialequilibrium

D

D

3. . . . and a higherquantity sold.

2. . . . resultingin a higherprice . . .

1. Hot weather increasesthe demand for ice cream . . .

2.00

7

New equilibrium$2.50

10

Figure 11 How a Decrease in Supply Affects the Equilibrium


Price ofIce-Cream

Cone

0 Quantity of Ice-Cream Cones

Demand

Newequilibrium

Initial equilibrium

S1

S2

2. . . . resultingin a higherprice of icecream . . .

1. An increase in theprice of sugar reducesthe supply of ice cream. . .

3. . . . and a lowerquantity sold.

2.00

7

$2.50

4

The Invisible Hand• Economic Agents are motivated by self-interest

– consumers by utility maximization

– Producers by profit maximization

• Market prices as signals for resource allocation and coordinate consumer and producer behavior

• Market or the Price System and Efficiency

Demand and Supply Applications

• Market for Water

• Market for Gas

• Shortages and Surplus

• Price Controls– Price ceilings– Price floors

demand and supply. the power of trade voluntary versus involuntary exchange an intuitive approach to...

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