Leah Chlsholm

Ch 4
7
Lh

8/31/11
CuLllne
1he MarkeL lorces of Supply and uemand
l lnLroducLlon 1hls chapLer lnLroduces Lhe Lheory of supply and demand how buyers and seller
lnLeracL and behave and how supply and demand deLermlne Lhe economy prlces
A Supply and demand are Lhe forces LhaL make markeL economles work
8 1hey deLermlne Lhe quanLlLy of each good produced and Lhe prlce aL whlch lL ls sold
C Supply and demand refer Lo Lhe behavlor of people as Lhey lnLeracL wlLh one anoLher ln
compeLlLlve markeLs
ll MarkeLs and CompeLlLlon
A WhaL ls a MarkeL?
1A markeL ls a group of buyers and seller of a parLlcular good or servlce 8uyers
deLermlne demand and seller deLermlne supply
2Some markeLs are hlghly organlzed (meeL aL speclflc Llme and place wlLh aucLloneer
seLLlng prlces and sales) buL more ofLen Lhey are less organlzed
3A group of lce cream buyers and seller would form a less organlzed markeL where
each buyer decldes how much lce cream Lo buy from Lhe varlous sellers
8 WhaL ls CompeLlLlon?
1MarkeLs ln Lhe economy are hlgh compeLlLlve Lach buyer knows LhaL Lhere are
several sellers from whlch Lo choose and each seller ls aware LhaL hls producL ls
slmllar Lo LhaL offered by oLher sellers
2As a resulL Lhe prlce and quanLlLy are noL deLermlned by any slngle buyer or seller
buL by all buyers and sellers as Lhey lnLeracL ln Lhe markeLplace
3A compeLlLlve markeL ls one ln whlch Lhere are many buyers and many seller so LhaL
each has a negllglble lmpacL on Lhe markeL prlce
4ln a perfecL compeLlLlve markeL Lhe good offered for sale are all exacLly Lhe same
and Lhe buyer and sellers are so numerous LhaL no slngle buyer or seller has any
lnfluences over Lhe markeL prlce 8uyers and seller are sald Lo be prlce Lakers ln a
perfecLly compeLlLlve markeL because Lhey musL accepL Lhe prlce Lhe markeL
deLermlnes
3When a markeL as only one seller and Lhls seller seLs Lhe prlce lL ls called a
monopoly
6erfecL compeLlLlon and monopoly are exLremes of markeLs
7Assumlng perfecL compeLlLlon ls a useful slmpllflcaLlon and a naLural place Lo sLarL
because Lhey are Lhe easlesL Lo analyze
lll uemand
A 1he uemand Curve 1he 8elaLlonshlp beLween rlce and CuanLlLy uemanded
1CuanLlLy demanded ls Lhe amounL of a good LhaL buyers are wllllng and able Lo
purchase Many Lhlngs deLermlne Lhe quanLlLy demanded buL prlce plays a cenLral
role
2CuanLlLy demanded falls as prlce rlses and rlses as prlce falls so lL ls negaLlvely
relaLed Lo prlce
31he law of demand ls a clalm LhaL oLher Lhlngs equal Lhe quanLlLy demanded of a
good falls when Lhe prlce of Lhe good rlses 1hls ls Lrue for mosL goods ln Lhe
economy
4A demand schedule ls a Lable LhaL shows Lhe relaLlonshlp beLween Lhe prlce of a
good and Lhe quanLlLy demanded lL holds consLanL everyLhlng else LhaL lnfluences
how much consumers of Lhe good wanL Lo buy
31he demand curve ls a graph of Lhe relaLlonshlp beLween Lhe prlce of a good and Lhe
quanLlLy demanded lL ls a downwardsloplng llne
8 MarkeL uemand versus lndlvldual uemand
1MarkeL demand ls Lhe sum of all Lhe lndlvldual demands for a parLlcular good or
servlce We sum lndlvldual demand curves horlzonLally Lo obLaln Lhe markeL demand
curve
2We mosL ofLen work wlLh Lhe markeL demand curve when analyzlng how markeLs
work
31he markeL demand curve show how Lhe LoLal quanLlLy demanded of a good varles
as Lhe prlce of Lhe good varles whlle all oLher facLors LhaL affecL how much
consumers wanL Lo buy are held consLanL
C ShlfLs ln Lhe uemand Curve
1A demand curve need noL be sLable over Llme
2lf someLhlng happens Lo Lhe quanLlLy demanded aL any glven prlce Lhe demand
curve shlfLs
3Any change LhaL lncrease Lhe quanLlLy demanded aL every prlce shlfLs Lhe demand
curve Lo Lhe rlghL and ls called an lncrease ln demand
4Any change LhaL reduces Lhe quanLlLy demanded aL every prlce shlfLs Lhe demand
curve Lo Lhe lefL and ls called a decrease ln demand
31here are many varlables LhaL can shlfL Lhe demand curve When one of Lhese
varlables changes Lhe demand curve shlfLs 1he mosL lmporLanL are
a lncome
l A lower lncome usually means you have less Lo spend ln LoLal lf Lhe
demand for a good falls when lncome falls Lhe good ls called a normal
good A normal good ls a good for whlch an lncrease ln lncome leads Lo an
lncrease ln demand
ll lf Lhe demand for a good rlses when lncome falls Lhe good ls called
lnferlor An lnferlor good ls a food for whlch an lncrease ln lncome leads
Lo a decrease ln demand
b rlces of 8elaLed Coods
l When a fall ln Lhe prlce of one good reduces Lhe demand for anoLher
good Lhe Lwo good are called subsLlLuLes SubsLlLuLes are Lwo good for
whlch an lncrease ln Lhe prlce of one good leads Lo an lncrease ln Lhe
demand for Lhe oLher 1hey are ofLen palrs of goods LhaL are sued ln place
of each oLher
ll When a fall ln prlce of one good ralses Lhe demand for anoLher good Lhe
Lwo goods are complemenLs ComplemenLs are Lwo good for whlch an
lncrease ln prlce of one leads Lo a decrease ln Lhe demand for Lhe oLher
1hey are palrs of good LhaL are used LogeLher
c 1asLes
l 1hls ls Lhe mosL obvlous deLermlnanL ?ou buy more of whaL you llke
d LxpecLaLlons
l LxpecLaLlons of Lhe fuLure may affecL demand for a good or servlce Loday
lf you expecL more money or prlce falls ln fuLure you may spend more or
spend less
e number of 8uyers
l lf anoLher buyer comes up Lhe quanLlLy demanded would be hlgher
6rlce causes a movemenL along Lhe demand curve whlle deLermlnanLs cause a shlfL
because prlce ls measured on an axls whlle Lhese facLors aren'L
lv Supply
A 1he Supply Curve 1he 8elaLlonshlp beLween rlce and CuanLlLy Supplled
11he quanLlLy supplled ls Lhe amounL of a good LhaL seller are wllllng and able Lo sell
When Lhe prlce of a good ls hlgh buslness ls proflLable and quanLlLy supplled ls
large When Lhe prlce ls low Lhe quanLlLy supplled ls low lf a seller shuLs down Lhe
quanLlLy supplled falls Lo zero
2CuanLlLy supplled ls poslLlvely relaLed Lo prlce because quanLlLy supplled rlses as
prlce rlses
31he law of supply ls Lhe clalm LhaL oLher Lhlngs equal Lhe quanLlLy supplled of a
good rlses when Lhe prlce of Lhe good rlses
4A supply schedule ls a Lable LhaL shows Lhe relaLlonshlp beLween Lhe prlce of a good
and Lhe quanLlLy supplled
3A supply curve ls a graph of Lhe relaLlonshlp beLween Lhe prlce of a good and Lhe
quanLlLy supplled 1he supply curve slopes upward because a hlgher prlce means a
greaLer quanLlLy supplled lL shows how much of a good ls offered
8 MarkeL Supply versus lndlvldual Supply
1MarkeL supply ls Lhe sum of Lhe supplles of all sellers
2Sum lndlvldual supply curves horlzonLally Lo obLaln Lhe markeL supply curve
31he markeL supply curve shows how Lhe LoLal quanLlLy supplled varles as Lhe prlce of
Lhe good varles
C ShlfLs ln Lhe Supply Curve
1Any change LhaL ralses quanLlLy supplled aL every prlce shlfLs Lhe supply curve Lo Lhe
rlghL and ls an lncrease ln supply
2Any change LhaL reduces quanLlLy supplled aL every prlce shlfLs Lhe supply curve Lo
Lhe lefL and ls a decrease ln supply
3Some of Lhe mosL lmporLanL varlables LhaL shlfL Lhe supply curve lnclude
a lnpuL rlces
l When Lhe prlce of one or more of Lhe lnpuLs(lngredlenLs machlnes
bulldlngs labor) used Lo make a good rlses produclng Lhe good ls less
proflLable and less ls supplles lf lnpuL prlces rlse subsLanLlally a flrm
mlghL shuL down and supply none
ll Supply of a good ls negaLlvely relaLed Lo Lhe prlce of Lhe lnpuLs used Lo
make lL
b 1echnology
l Machlnes reduce Lhe amounL of labor need Lo produce 8y reduclng flrms'
cosL Lhe advance ln Lechnology ralses Lhe supply of a good
c LxpecLaLlons
l 1he amounL a flrm supplles depends on expecLaLlon of Lhe fuLure lf a flrm
expecLs a prlce Lo rlse ln Lhe fuLure lL wlll puL some of lLs currenL
producLlon lnLo sLorage and supply less Lo Lhe markeL Loday
d number of Sellers
l lf Lhere are fewer sellers supply ln Lhe markeL wlll fall
4rlce causes a movemenL along Lhe supply curve whlle deLermlnanLs cause a shlfL
because prlce ls measured on an axls whlle Lhese facLors aren'L
v Supply and uemand 1ogeLher
A Lqulllbrlum
11he polnL where Lhe markeL supply curve and markeL demand curve lnLersecL ls
called Lhe markeL's equlllbrlum Lqulllbrlum ls a slLuaLlon ln whlch Lhe markeL prlce
has reached Lhe level aL whlch quanLlLy supplles equals quanLlLy demanded
21he prlce aL Lhls lnLersecLlon ls called Lhe equlllbrlum prlce 1he equlllbrlum prlce ls
Lhe prlce LhaL balances quanLlLy supplles and quanLlLy demanded
31he quanLlLy aL Lhls lnLersecLlon ls called Lhe quanLlLy ls called Lhe equlllbrlum
quanLlLy 1he equlllbrlum quanLlLy ls Lhe quanLlLy supplles and Lhe quanLlLy
demanded aL Lhe equlllbrlum prlce
4AL Lhe equlllbrlum prlce Lhe quanLlLy of Lhe good LhaL buyers are wllllng and able Lo
buy exacLly balances Lhe quanLlLy LhaL sellers are wllllng and able Lo sell
3Lqulllbrlum prlce ls someLlmes called Lhe markeLclearlng prlce because aL Lhls prlce
everyone ln Lhe markeL has been saLlsfled 8uyers have boughL all Lhey wanL Lo buy
and sellers have sold all Lhey wanL Lo sell 1hls naLurally moves markeLs Lowards
equlllbrlum of supply and demand
6Surplus ls a slLuaLlon ln whlch quanLlLy supplled ls greaLer Lhan quanLlLy demanded
also called excess supply Suppllers (sellers) are unable Lo sell all Lhey wanL aL Lhe
golng prlce and are lefL wlLh goods Lhey would llke Lo sell buL can'L 1hey respond Lo
Lhls by cuLLlng Lhelr prlces whlch lncrease quanLlLy demanded and decreases
quanLlLy supplled
7A shorLage ls a slLuaLlon ln whlch quanLlLy demanded ls greaLer Lhan quanLlLy
supplled also called excess demand uemanders (buyers) are unable Lo buy all Lhey
wanL Lhe golng prlce WlLh Loo many buyers for Loo few good seller can respond by
ralslng Lhelr prlces wlLhouL loslng sales whlch decreases quanLlLy demanded and
ralses quanLlLy supplled
81he law of supply and demand ls Lhe clalm LhaL Lhe prlce of any good ad[usLs Lo brlng
Lhe quanLlLy supplled and Lhe quanLlLy demanded fro LhaL good lnLo balance 1he
prlce of any good ad[usLs Lo brlng Lhe quanLlLy supplled and quanLlLy demanded for
Lhe good lnLo balance
8 1hree SLeps Lo Analyzlng Changes ln Lqulllbrlum
1Lqulllbrlum deLermlnes Lhe prlce of a good and Lhe amounL of Lhe good purchased
and produced and Lhese depend on Lhe poslLlon of Lhe supply and demands curves
2When some evenL shlfLs one of Lhese curves Lhe equlllbrlum ln Lhe markeL changes
resulLlng ln a new prlce and quanLlLy exchange
31here are Lhree sLeps Lo analyzlng how an evenL affecLs equlllbrlum 1)ueclde
wheLher Lhe evenL shlfLs Lhe supply curve demand curve or boLh curves 2)ueclde
wheLher Lhe curve shlfLs Lo Lhe rlghL or lefL and 3)use Lhe supplyanddemand
dlagram Lo compare Lhe lnlLlal and new equlllbrlum
41he followlng varlous evenLs may affecL markeLs
a A Change ln uemand
l An evenL llke Lhe weaLher may lncrease LasLe for a good causlng a hlgher
demand shlfLlng Lhe demand curve Lo Lhe rlghL buL leavlng Lhe supply
curve unchanged 1he weaLher would lncrease Lhe equlllbrlum quanLlLy
meanlng an lncrease ln Lhe prlce and Lhe quanLlLy sold
b ShlfLs ln Curves versus MovemenLs along Curves
l When Lhe quanLlLy a flrm supplles rlses even Lhough Lhe supply curve
remalns Lhe same Lhere ls an lncrease ln quanLlLy supplled" buL no
change ln supply"
ll Supply refers Lo Lhe poslLlon of Lhe supply curve whlle quanLlLy supplled
refers Lo Lhe amounL suppllers wlsh Lo sell ln Lhe weaLher example
supply doesn'L change because Lhe weaLher does noL alLer flrms' deslre
Lo sell aL any glven prlce buL alLers consumers' deslre Lo buy
lll 1he lncrease ln demand causes Lhe equlllbrlum prlce Lo rlse and when
prlce rlses quanLlLy supplled rlses 1he lncrease ln quanLlLy supplled
represenLs a movemenL along Lhe supply curve
lv A shlfL ln supply curve ls called a change ln supply and a shlfL ln Lhe
demand curve ls a change ln demand
v A movemenL along a supply curve ls a change ln quanLlLy supplled and a
movemenL along a demand curve ls a change ln quanLlLy demanded
c A Change ln Supply
l A change ln Lhe prlce of an lnpuL affecLs Lhe supply curve 8alslng Lhe
cosLs of producLlon reduclng Lhe amounL of a good LhaL flrms produce
and sell 1he demand curve does noL change because Lhe hlgher cosLs of
lnpuLs does noL dlrecLly affecL Lhe amounL of Lhe good households wlsh
Lo buy
ll A shlfL Lo Lhe lefL ln Lhe supply curve ralses Lhe equlllbrlum prlce and
lowers Lhe equlllbrlum quanLlLy As a resulL of lnpuL prlce lncrease Lhe
prlce of Lhe good rlses and Lhe quanLlLy of Lhe good sold falls
d A Change ln 8oLh Supply and uemand
l lf Lhe deslre Lo buy a good lncreases and Lhe amounL of Lhe good LhaL
wanL Lo be sold decreases Lhere ls a shlfL ln boLh Lhe demand and supply
curves ln Lhls case Lhe demand curve shlfLs Lo Lhe rlghL and Lhe supply
curve shlfLs Lo Lhe lefL
ll 1wo posslble ouLcomes are posslble when Lhls happens ln boLh cases
Lhe equlllbrlum prlce rlses
lll When demand lncreases subsLanLlally whlle supply falls [usL a llLLle Lhe
equlllbrlum quanLlLy also rlses 8uL when supply falls subsLanLlally whlle
demand rlses [usL a llLLle Lhe equlllbrlum quanLlLy falls
lv 1he prlce of Lhe good cerLalnly rlses buL Lhe amounL of Lhe good sold
could go elLher way
vl Pow rlces AllocaLe 8esources
A Whenever you go Lo Lhe sLore Lo buy someLhlng you conLrlbuLe Lo demand for LhaL lLem
Whenever you go look for a [ob you conLrlbuLe Lo supply of labor servlces
8 Scarce resources have Lo be allocaLed among compeLlng uses MarkeL economles harness Lhe
forces of supply and demand Lo serve LhaL end
C Supply and demand LogeLher deLermlne Lhe prlces of Lhe economy's dlfferenL goods and
servlces prlces ln Lurn are Lhe slgnals LhaL gulde Lhe allocaLlon of resources
u rlces are Lhe mechanlsm for raLlonlng scarce resources When someLhlng ls llmlLed lL goes
Lo whoever ls wllllng and able Lo pay Lhe prlce 1he prlce ad[usLs unLll Lhe quanLlLy demanded
exacLly balances Lhe quanLlLy supplled
L rlces deLermlne who produces each good and how much ls produced AllocaLlon of workers
depends on [ob declslons and [obs are declded based on prlces 1he prlces of wages ad[usL Lo
ensure LhaL enough people Lake a cerLaln [ob
l rlces are Lhe slgnals LhaL gulde economlc declslons and Lhereby allocaLe scarce resources