Lecture 02Lecture 02

Demand, Supply and Demand, Supply and Market EquilibriumMarket Equilibrium

The Basic Decision-Making The Basic Decision-Making Units in the Economy:Units in the Economy:

Firms and Households

Firms and HouseholdsFirms and Households

A firmfirm is an organization that transforms resources into products Firms are the primary producing units in a market economy.

HouseholdsHouseholds are the consuming units in an economy.

The EntrepreneurThe Entrepreneur

The entrepreneurentrepreneur is the person who organizes, manages, and assumes the risks of a firm, taking a new idea or a new product and turning it into a successful business.

MarketsMarkets

Product or outputProduct or output markets are the markets in which goods and services are exchanged.

Input or FactorInput or Factor markets are the markets in which resources used to produce products are exchanged.

Product Factor

Labor MarketsLabor Markets

Labor marketsLabor markets are the input markets in which households supply work for wages to firms that demand labor.

Capital MarketsCapital Markets

Capital marketsCapital markets are the input markets in which households supply their savings, for interest or for claims to future profits, to firms that demand funds in order to buy capital goods.

Land MarketsLand Markets

Land marketsLand markets are the input markets in which households supply land or other real property in exchange for rent.

The Circular FlowThe Circular Flow

A circular flow diagramcircular flow diagram describes the interaction of firms and households in markets for outputs and inputs.

The Circular FlowThe Circular Flow

FirmsHouseholds

Output Markets

(Goods &Services)

Supply Demand

Input Markets:Labor (wages)

Capital (interest)Land (rent)

SupplyDemand

Demand in the Product MarketsDemand in the Product Markets

A household’s decision about what quantity of a product to demand depends on a number of factors...

The quantity demandedquantity demanded represents the amount of a product that a household buy in a given time period at the current market price.

Determinants of Household Determinants of Household Demand:Demand:

PRICEPRICE of the product INCOMEINCOME available Amount of accumulated WEALTHWEALTH PRICES OF RELATED PRODUCTSPRICES OF RELATED PRODUCTS TASTESTASTES and PREFERENCESPREFERENCES EXPECTATIONSEXPECTATIONS with respect to future

income, wealth, and prices

The Demand ScheduleThe Demand Schedule

A demand scheduledemand schedule is a table or chart showing how much of a given product a household would be willing to buy at different prices.

The Demand CurveThe Demand Curve

The demand curvedemand curve is a graph illustrating how much of a given product a household would be willing to buy at different prices.Demand curves are usually derived from demand schedules.

The Demand CurveThe Demand Curve

D

P

Q0

Anna’s Demand Schedule for Anna’s Demand Schedule for Telephone Calls - Telephone Calls - (Table 4.1)(Table 4.1)

Price (per call)$ 0

.50

3.50

7.00

10.00

15.00

Quantity Demanded(calls per month)

30

25

7

3

1

0

Anna’s Demand Curve -Anna’s Demand Curve - (Figure 4.2)

$15.00

30

$10.00

$7.50

$3.50

$ .50

257310 Quantity demanded

Price

The Law of DemandThe Law of Demand

There is a negative, or inverse, relationship between the quantity of a good demanded and its price.

This means that demand curves typically have a negative slope.

Other Determinants of Household Other Determinants of Household Demand:Demand:

1) Income and Wealth IncomeIncome: The total of all earnings received by a household in a given period of time WealthWealth: The total value of what a household owns less what it owes

Income as a Determinant of Income as a Determinant of DemandDemand

Normal Goods: Goods for which demand goes up when income is higher and for which demand goes down when income is lower

Inferior Goods: Goods for which demand falls when income rises.

Prices of Other Goods and Services Prices of Other Goods and Services as Determinants of Demandas Determinants of Demand

Substitutes: Goods that can serve as replacements for one another; when the price of one increases, demand for the other goes up - Perfect substitutes are identical products.

Complements: Goods that ‘go together’; when the price of one increases, demand for the other goes down.

Other Determinants of Other Determinants of Household Demand:Household Demand:

Tastes and Preferences - These are quite subjective and tend to change over time.

Expectations - With respect to future income, wealth, prices, and availability.

Changes in Quantity Demanded Changes in Quantity Demanded vs. Changes in Demand:vs. Changes in Demand:

Changes in quantity demandedquantity demanded imply movement along a demand curve. Changes in demanddemand imply a shift in the entire demand curve.

Important Distinction!!

Anna’s Demand for Telephone Calls - A Anna’s Demand for Telephone Calls - A Change in Quantity DemandedChange in Quantity Demanded

$15.00

30

$10.00

$7.50

$3.50

$ .50

257310Quantity demanded

Price

D

Change in quantity demanded from 3 to 7 caused by a change in price from $7.50 to $3.50

Anna’s Demand for Telephone Calls - A Anna’s Demand for Telephone Calls - A Change in DemandChange in Demand

$15.00

30

$10.00

$7.50

$3.50

$ .50

257310Quantity demanded

D1D2

Change in demand caused by a change in a demand factor other than price

Changes in DemandChanges in Demand- Income Changes -- Income Changes -

Income RisesP

Q

P

QDemand for inferior good

shifts leftDemand for normal good

shifts right

D1 D1D2

D2

Changes in DemandChanges in Demand- Prices of Related Goods -- Prices of Related Goods -

Price of hamburger rises

P

QP

D1D2 Q

P

D1

D2

Quantity of hamburger

demanded falls

Demand for complement good (catsup) shifts left

Demand for substitute good (chicken) shifts right

Q

From Household to Market From Household to Market DemandDemand

Demand for a good or service can be defined for an individual household, or for a group of households that make up a

market.

Market DemandMarket Demand- Defined -- Defined -

Market demandMarket demand may be defined as the sum of all the quantities of a good or service demanded per period by all the households buying in the market for that good or service.

Deriving Deriving market demand from market demand from the individual demand the individual demand

curves:curves:

DA

P

04 8 Qd

30$1.50

$3.50 DB

Qd

0

P

$1.50

$3.50DC

94 Qd

0

Price

$3.50

$1.50

208 Qd

Market Demand

Supply in Output Supply in Output MarketsMarkets

A firm’s decision about what quantity of a product to supply depends on a number of factors...

Quantity SuppliedQuantity Supplied

The quantity suppliedquantity supplied represents the number of units of a product that a firm would be willing and able to offer for sale at a particular price during a given time period

Factors Determining Factors Determining Firm Supply:Firm Supply:

PRICE of the product COST of producing the product - Prices of required inputs

- Technologies used to produce the product

PRICES of RELATED products

The Law of SupplyThe Law of Supply

There is a positivepositive, or directdirect, relationship between the quantity of a good supplied and its price.This means that supply curves typically have a positive slope.

The Supply Schedule and The Supply Schedule and Supply CurveSupply Curve

A supply schedulesupply schedule is a table, or chart, showing how much of a product firms will supply at different prices.A supply curvesupply curve is the graphical representation of a supply schedule.

Clarence Brown’s Soybean Clarence Brown’s Soybean Supply ScheduleSupply Schedule Price

per bushel

$ 1.50

1.75

2.25

3.00

4.00

Bushels

per year

0

10,000

20,000

30,000

45,000

Clarence Brown’s Soybean Clarence Brown’s Soybean Supply CurveSupply Curve

$4.00

30

$3.00

$2.25

$1.75$1.50

4020100

Quantity demanded (1,000s)

PriceS

50

Changes in Quantity Changes in Quantity Supplied vs. Changes in Supplied vs. Changes in

Supply:Supply:

Changes in quantity supplied imply movement along a supply curve. Changes in supply imply a shift in the entire supply curve.

IMPORTANT DISTINCTION !

A Change in the Quantity A Change in the Quantity Supplied of Clarence Brown’s Supplied of Clarence Brown’s

SoybeansSoybeans$4.00

30

$3.00

$2.25

$1.75$1.50

4020100

Quantity demanded (1,000s)

50

Change in quantity supplied from 10 to 20 caused by a change in price from $1.75 to $2.25

SP

A Shift in Clarence Brown’s A Shift in Clarence Brown’s Soybean SupplySoybean Supply

Price$4.00

30

$3.00

$2.25

$1.75$1.50

4020100

S1

50

S2

Quantity demanded (1,000s)

Change in supply caused by a change in a supply factor other than price

Changes in Quantity Changes in Quantity Supplied vs. Changes in Supplied vs. Changes in

Supply:Supply:

Q

PS S1 S2

P

Q An increase in the quantity supplied

An increase in supply

From Individual Firm to From Individual Firm to Market SupplyMarket Supply

The supply of a good or service can be defined for an individual individual firmfirm, or for a group of firms that make up a marketmarket or an industryindustry.

Market SupplyMarket SupplyThe sum of all the quantities of a good or service supplied per period by all the firms selling in the market for that good or service.As with market demand, market supply is the horizontal summation of the individual firms’ supply curves.

From Individual Firm to From Individual Firm to Market SupplyMarket Supply

Q Q

P PSASB

10,000 30,000 5,000 10,000

3.00 3.00

1.751.75

Firm A’s supply Firm B’s supply

Q

P SA+B

25,000 65,000

1.75

3.00

Market Supply Curve

Market EquilibriumMarket Equilibrium

The operation of the market depends on the interaction between suppliers and demanders.

Market EquilibriumMarket Equilibrium

An equilibriumequilibrium is the condition that exists when quantity supplied is equal to quantity demanded.

At equilibrium, there is no tendency for the market price to change.

Market EquilibriumMarket Equilibrium

P

Q

PE

QE

E

S

D

The market for soybeans The market for soybeans in equilibrium:in equilibrium:

0 Bushels of soybeans (1,000s)

D

S

$2.50

35

P

Excess DemandExcess Demand

Excess DemandExcess Demand is the condition that exists when quantity demanded exceeds quantity supplied at the current price.

At a price of $1.75 there At a price of $1.75 there is is Excess DemandExcess Demand in the in the

Soybean Market:Soybean Market:

0

D

S

$2.50

3525 50

$1.75

Q

P

Excess SupplyExcess Supply

Excess supplyExcess supply is the condition that exists when quantity supplied exceeds quantity demanded at the current price.

At a price of $3.00 there At a price of $3.00 there is is Excess Supply Excess Supply in the in the

Soybean Market:Soybean Market:

0

D

S

$2.50

3522 40

$3.00

Q

P

Changes in EquilibriumChanges in Equilibrium- Demand Shifts/Supply is Constant -- Demand Shifts/Supply is Constant -

D1D2

S

Q

P

Q1 Q2

P2

P1

D2

SP

QQ 2 Q1

P1

P2

Increase in Demand Decrease in Demand

D1

Changes in EquilibriumChanges in Equilibrium- Supply Shifts/Demand is Constant -- Supply Shifts/Demand is Constant -

DD

S1

Q

P

Q1 Q2

P2

P1

S1P

QQ 2 Q1

P1

P2

Increase in Supply Decrease in Supply

S2

S2

Changes in EquilibriumChanges in Equilibrium- - Supply & Demand both Increase (or Decrease) -Supply & Demand both Increase (or Decrease) -

D1

S1

Q

P

Q1 Q2

P

?

Increase in Demand & Supply

Decrease in Demand & Supply

S2

D2

D2

S2

Q

P

Q2 Q1

S1

D1

P

?

Changes in EquilibriumChanges in Equilibrium- Demand & Supply Move Opposite -- Demand & Supply Move Opposite -

D1

S1

Q

P

Q -?

Demand Increases & Supply Decreases

Demand Decreases & Supply Increases

S2

D2

D2

S2

Q

P

Q -?

S1

D1P1

P2

P1

P2

Review Terms & ConceptsReview Terms & Concepts

Capital Market Complements Demand curve Demand schedule Entrepreneur Equilibrium Excess demand Excess supply

Factors of production Firm Households Income Inferior goods Input markets labor market land market

Review Terms & ConceptsReview Terms & Concepts(continued)(continued)

Law of demand Law of supply Market demand Market supply Movement along a curve Normal goods Perfect substitutes Product markets

Profit Quantity demanded Quantity supplied Shift of a curve Substitutes Supply curve Supply schedule Wealth or net worth