Supply and Demand: An Introduction

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What, How, and For Whom? Central Planning Versus the Market

Three Problems All Economic Systems Must Address

What should be produced?  How should it be produced?  For whom will it be produced?


Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved.

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What, How, and For Whom? Central Planning Versus the Market

Centralized Economic Organizations

Former Soviet Union  Cuba


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What, How, and For Whom? Central Planning Versus the Market

A small number of individuals address:



What
 Establish

production targets for factories and

farms


How
 Plan

how to achieve the goals the goods and services

For Whom
 Distribute

produced

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What, How, and For Whom? Central Planning Versus the Market

Free-Market or Capitalist Economic System



Individual choices determine:

 Which

careers to pursue  Which products to produce or buy  When to start and shut-down a business  Who gets what is decided by individual preferences and purchasing power

Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved.

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Buyers and Sellers In Markets Market



Consists of all buyers and sellers of a good or service What determines the price of pizza, gasoline, a car wash, or other goods and services?

What do you think?



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Buyers and Sellers In Markets The Demand Curve



A schedule or graph that tells us the quantity of a good that buyers wish to buy at each price

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Points Along the Demand Curve of a Pizza Market

Demand for pizza

Price ($/slice) 2 3 4 Quantity demanded (1000s of slices/day) 16 12 8

Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved.

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Buyers and Sellers In Markets A Property of Demand



As price of a good or service goes down the quantity consumers wish to buy will increase, other things remaining the same Therefore, the demand curve is downwardsloping

Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved.

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The Daily Demand Curve for Pizza in Chicago

Price ($ per slice)

4 3 2

Demand

12

16

Quantity (1000s of slices per day)

Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved.

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Buyers and Sellers In Markets The Demand Curve



Why do buyers purchase a greater quantity at lower prices and vice-versa?

 The

substitution effect  The income effect

Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved.

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Buyers and Sellers In Markets The Substitution Effect



The change in the quantity demanded of a good that results because buyers switch to substitutes when the price of the good changes

Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved.

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Buyers and Sellers In Markets The Income Effect



The change in the quantity demanded of a good that results because a change in the price of a good changes the buyers purchasing power

Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved.

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Buyers and Sellers In Markets The Supply Curve



A curve or schedule showing the quantity of a good that sellers wish to sell at each price

Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved.

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Points Along the Supply Curve of a Pizza Market

Supply of pizza
Price ($/slice) Quantity supplied (1000s of slices/day)

2 3 4

8 12 16

Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved.

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The Daily Supply Curve for Pizza in Chicago

Price ($ per slice)

Supply

4 3 2

12

16

Quantity (1000s of slices per day)

Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved.

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Market Equilibrium

Equilibrium


A system is in equilibrium when there is no tendency for it to change Occurs in a market when all buyers and sellers are satisfied with their respective quantities at the market price

Market Equilibrium


Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved.

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Points Along the Demand and Supply Curves of a Pizza Market

Demand for pizza Supply of pizza
Price ($/slice) 2 3 4 Quantity supplied (1000s of slices/day) 8 12 16

Price ($/slice) 2 3 4

Quantity demanded (1000s of slices/day) 16 12 8

Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved.

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The Equilibrium Price and Quantity of Pizza In Chicago

Price ($ per slice)

Supply

4 3 2

Equilibrium at $3 Quantity Demanded = Quantity Supplied

Demand
Quantity (1000s of slices per day)

12

16

Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved.

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Market Equilibrium

Equilibrium Price and Equilibrium Quantity



The values of price and quantity for which quantity supplied and quantity demanded are equal

Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved.

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Market Equilibrium

What Do You Think?

Would buyers prefer a lower price than the equilibrium price?  Would sellers prefer a higher price than the equilibrium price?


Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved.

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Excess Supply
Excess supply = 8,000 slices per day
Price ($ per slice)

Supply

4 3 2

Demand
Quantity (1000s of slices per day)

12

16

Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved.

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Excess Demand
Price ($ per slice)

Supply

4 3 2 Excess demand = 8,000 slices per day

Demand
Quantity (1000s of slices per day)

16

Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved.

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Graphing Supply and Demand and Finding the Equilibrium Price and Quantity

Price ($per slice) 5 4 3 2.50 2 1

Supply

The Equilibrium Price = $2.50 The Equilibrium Quantity = 5

Demand
2 4 5 6 8 10
Quantity (1000s of slices per day)

Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved.

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Market Equilibrium

What Do You Think?



Is the market equilibrium always an ideal outcome for all market participants?

Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved.

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An Unregulated Housing Market

Monthly Rent ($/apartment)

Supply

1,600

What Do You Think? Is $1600 more than some people can afford?

Demand

Quantity (Millions of apartments/day)

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Rent Controls
Monthly Rent ($/apartment)

Supply

2,400

1,600

Excess demand = 2 million apartments per month

Controlled = 800

Demand
Quantity (Millions of apartments/day)

Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved.

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Market Equilibrium

Rent Controls Reconsidered



Other consequences of rent controls

 Maintenance

will decline and housing quality

will fall  Illegal payments  Reduction in household mobility  Discrimination

Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved.

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Market Equilibrium

What do you think?



How can we make housing affordable for poor people without using rent ceilings?

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Rent Controls
Monthly Rent ($/apartment)

Supply

1,200 What is the impact of a rent control set at $1,200/month?

800

Demand
Quantity (Millions of apartments/day)

Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved.

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Price Controls In The Pizza Market

Price ($ per slice)

Supply

4
Excess demand = 8,000 slices per day

3 Price ceiling = 2

Demand
Quantity (1000s of slices per day)

12

16

Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved.

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Market Equilibrium

Pizza Price Controls?



Market responses to a pizza price ceiling

 Long

lines  Preferential treatment to selected customers  Alternative pricing strategies  Poorer quality ingredients  Black-market pizzas

Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved.

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Predicting and Explaining Changes In Prices and Quantities

Distinguishing Between:


A change in the quantity demanded

A

movement along the demand curve that occurs in response to a change in price shift of the entire demand curve

A change in demand
A

Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved.

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An Increase In Quantity Demanded vs. An Increase In Demand

Price ($/can)

6 5 4 3 2 1

Increase in quantity demanded

D
2 4 6 8 10 12
Quantity (1000s of cans/day)

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An Increase In Quantity Demanded vs. An Increase In Demand

Price ($/can)

6 5 4

Increase in demand
3 2 1

D D
12
Quantity (1000s of cans/day)

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Predicting and Explaining Changes In Prices and Quantities

Change in the quantity supplied



A movement along the supply curve that occurs in response to a change in price A shift of the entire supply curve

Change in supply


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An Increase In Quantity Supplied vs. An Increase In Supplied

Price ($/can)

6 5 4 3 2

S
Increase in quantity supplied

S
1
Quantity (1000s of cans/day)

10

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An Increase In Quantity Supplied vs. An Increase In Supplied

Price ($/can)

6 5 4 3 2 1

Increase in supply

S
0 2 4

S
6 8 10

Quantity (1000s of cans/day)

Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved.

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The Effect on the Market for Tennis Balls of a Decline in Court-Rental Fees
Price ($/ball)

1.40 1.00

D D
40 58
Quantity (letters/month)

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Predicting and Explaining Changes In Prices and Quantities

Shifts in Demand


Complements
 Two

goods are complements in consumption if an increase (decrease) in the price of one cause a decrease (increase) in the demand for the other

Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved.

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Predicting and Explaining Changes In Prices and Quantities

Shifts in Demand


Substitutes
 Two

goods are substitutes in consumption if an increase (decrease) in the price of one causes an increase (decrease) in the demand for the other

Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved.

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Predicting and Explaining Changes In Prices and Quantities

Shifts in Demand


Changes In Demand
 An

increase (decrease) in the demand for a good will shift the demand curve to the right (left)

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Predicting and Explaining Changes In Prices and Quantities

A Change In Income


Normal Good
 One

whose demand increases (decreases) when the incomes of buyers increase (decrease)

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Predicting and Explaining Changes In Prices and Quantities

A Change In Income


Inferior Good
 One

whose demand decreases (increases) when the incomes of buyers increase (decrease)

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The Effect of a Credible Rumor on the Market for Apple Macintosh Computers
D = demand after rumor of cheaper model soon to be released Price

P P D
Apple Computers (units per month)

D Q Q

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The Effect of the Increase in the Population of Potential Buyers

D = demand after increase in population Price

P P D
Housing NY City (units per month)

D Q Q

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Predicting and Explaining Changes In Prices and Quantities

Factors that Shift Demand

Price of complements  Price of substitutes  Income  Preferences  Population of potential buyers  Expectations


Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved.

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The Effect on the Market for New Houses of a Decline in Carpenters Wage Rates

Price ($1000/house)

S S

120 90

D
40 50
Quantity (houses/month)

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Predicting and Explaining Changes In Prices and Quantities

Factors that Shift Supply

Costs of production  Technology  Weather  Number of suppliers  Expectations  Price of related goods


Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved.

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Predicting and Explaining Changes In Prices and Demand Factors That Cause an Increase (rightward or upward shift) in Demand

1. A decrease in the price of complements to the good or service 2. An increase in the price of substitutes for the good or service 3. An increase in income (for a normal good)

Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved.

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Predicting and Explaining Changes In Prices and Demand Factors That Cause an Increase (rightward or upward shift) in Demand

4. An increased preference by demanders for the good or service 5. An increase in the population of potential buyers 6. An expectation of higher prices in the future

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Predicting and Explaining Changes In Prices and Demand

Factors That Cause an Increase (rightward or upward shift) in Supply

1. A decrease in the cost of materials, labor, or other inputs used in the production of the good or service 2. An improvement in technology that reduces the cost of producing the good or service 3. Price of other goods alternate goods and joint products

Copyright c 2007 by The McGraw-Hill Companies, Inc. All rights reserved.

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End of Chapter
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