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R. Larry Reynolds 1997

Fall 97 Principles of Microeconomics slide 1

Demand and Supply

Markets as allocative mechanism require: nonattenuated property rights
[exclusive, enforceable, transferable]

voluntary transactions Markets include all potential buyers and sellers behavior of buyers is represented by demand
[benefits side of model]

behavior of sellers is represented by supply

[cost side of model]
Fall 97 Principles of Microeconomics slide 2

Markets, Supply and Demand

markets include all potential buyers and sellers
geographic boundaries of market markets defined by nature of product and characteristics of buyers conditions of entry into market markets, competition and substitutes
Fall 97 Principles of Microeconomics slide 3

Demand
Definition: A schedule of the quantities of a good that buyers are willing and able to purchase at each possible price during a period of time, ceteris paribus. [all other things held constant] Demand can also be perceived as a schedule of the maximum prices buyers are willing and able to pay for each unit of a good.
Fall 97 Principles of Microeconomics slide 4

Demand Function
Is the functional relationship between the price of the good and the quantity of that good purchased in a given time period [UT], income, other prices and preferences being held constant. A change in income, prices of other goods or preferences will alter [shift] the demand function.
Fall 97 Principles of Microeconomics slide 5

Quantity demanded
A change in the price of the good under consideration will change the quantity demanded. Q = f (P, holding M, Pr , preferences constant); where: M = income Pr = prices of related goods P causes a change in X [ Q], this is a change in quantity demanded

Fall 97

Principles of Microeconomics

slide 6

Change in demand
If M, Pr, or preferences change, the demand function [relationship between P and Q] will change. These are sometimes called demand shifters Be sure to understand difference between a change in demand and a change in quantity demanded
change in demand --- shift of the function change in quantity demanded --- move on the function

Fall 97

Principles of Microeconomics

slide 7

Law of Demand
Theory and empirical evidence suggest that the relationship between Price and Quantity is an inverse or negative relationship At higher prices, quantity purchased is smaller, or at lower prices the quantity purchased is greater.
Fall 97 Principles of Microeconomics slide 8

An example of hot chocolate:

There is a coffee cart in the building that primarily serves the individuals who work in the building. The market is defined to some extent by the geography of the building. Individuals who buy the hot chocolate rarely come from other buildings to purchase a cup. During the time period [UT]under consideration [8:00-9:00am on a week day ] the incomes and preferences of buyers are unlikely to change. The prices of coffee, lattes, etc. can be controlled by the vendor and the price of soft drinks from the machines remains constant. The number of workers in the building remain at a constant level. Under these circumstances, we observe the number of cups of hot chocolate [H] sold each morning as the price [P] is changed. From these observations the demand relationship is estimated.

Fall 97

Principles of Microeconomics

slide 9

Cups of Hot Chocolat e [H] purchased each day bet ween 8 -9 am

price per cup A B C D E F G H 0 $ .5 0 $ .75 cups purchased 20 . 15 .

The demand relationship can be demonstrated as a table:

$ 1. 0 0 [+.75] $ 1. 25 $ 1. 5 0 $ 1. 75 $ 2 .00

P>0

Demand is a schedule of quantities that will be 12 . 5 purchased at a schedule Q<0 of prices during a given 10 . [-7.5] time period, cet. par.
7 .5 5 . 2 .5 0

As the price is increased, the quantity purchased decreases.

This demand relationship can be expressed as an equation: P = 2 - .1Q or Q = 20 - 10P: [Q = f (P, . . .) but we graph P on
the Y axis and Q on the X axis.]
Fall 97 Principles of Microeconomics slide 10

The demand relationship can be expressed as a table (previous slide) or an equation [either P = 2 - .1Q or Q = 20 - 10P] The data from the table or equation can be graphed:

PRICE

2.25 2.00 1.75 1.50 1.25 1.00 .75

P = $2, Then Q = 0

..
4 6

P = $1.75, then Q = 2.5 P = $1.50, then Q = 5 P = $1.25, Q = 7.5

..
8

.50
.25 2

..

P = $1, then Q = 10 P = 0, then Q = 20 Demand

22 24

QUANTITY The demand function can be represented as a table, {CUPS/UT}

10 12 14

16 18 20

an equation or a graph.
Fall 97

Principles of Microeconomics

slide 11

The demand equation P = 2 - .1Q was graphed

A change in quantity demanded is a movement on the demand function caused by a change in the independent variable [ price].

PRICE

2.25 2.00 1.75 1.50 1.25 1.00 .75 .50 .25

P from $1.50 to $1 causes Q from 5 to 10 units

.
2

.
8

A change in quantity demanded is a move from point A to B on the demand function caused by a change in the price!

Demand [P = 2 - .1Q]
QUANTITY
4 5 6 10 12 14 16 18 20 22 24
Principles of Microeconomics {CUPS/ UT} slide 12

Fall 97

A change in any of the parameters (income, price of related goods, preferences, population of buyers, etc.) will cause a shift of the demand function. In this example, the intercepts have changed, the slope has remained constant

The demand equation P = 2 - .1Q was graphed

PRICE

2.50 2.25 2.00 1.75 1.50 1.25 1.00 .75

ad

an increase in demand D [ P = 2.5 - .1Q]

ec re ase in d
4 6

.50
.25 2

em a
8

nd
10 12 14

Demand [P = 2 - .1Q]
16 18 20 22 24

D`` [P`` = 1.5 - .1Q] of Microeconomics Fall 97 Principles

QUANTITY
{CUPS/UT} slide 13

PRICE

2.50 2.25 2.00 1.75 1.50 1.25 1.00 .75 .50 .25

buyers are more responsive to P P` = 2- .048076923Q

buyers a decrease in the are less slope responsive an increase in Demand [P = 2 - .1Q] the slope to P P = 2 - .25Q
2 4 6 8 10 12 14 16 18 20 22 24

QUANTITY
{CUPS/UT}

A change in the parameters [income, Pr, preferences, population, etc.] might alter the relationship by changing the slope A change in demand refers to a movement or shift of the entire demand function
Fall 97 Principles of Microeconomics slide 14

PRICE

2.50 2.25 2.00 1.75 1.50 1.25 1.00 .75 .50

An increase in demand
increase

results in a larger quantity being purchased at each price

D2

[an increase in demand]

.25
2 4 6

Demand [P = 2 - .1Q]
Q = 7.5
8 10 12 14 16 18 20 22 24

{CUPS/UT} In this case, an increase in demand results in an increase in the amount that will be purchased at a price of $1.25. At this price the Quantity purchased increases from 7.5 to 18. An increase in demand!

QUANTITY

Fall 97

Principles of Microeconomics

slide 15

PRICE

2.50 2.25 2.00 1.75 1.50 1.25 1.00 .75 .50 .25

Effect of a change in the price of a substitute

D em the and fo r pric e of steak chic incre as ken incr es wh e eas es n

in dec fo th re r e as s t de e ea m k an d
2 4 6 8

D2
10 12 14

Demand [P = 2 - .1Q]
16 18 20 22 24

If the price of a substitute, like chicken, increases buyers will buy more steak at each price of steak

QUANTITY
[steak /UT]

If the price of chicken decreases, the buyers will want less steak at each possible price of steak; the demand for steak decreases!

Fall 97

Principles of Microeconomics

slide 16

Complementary goods
Two goods may be complimentary, i.e. the two goods are used together. [tennis rackets and tennis balls or CDs and CD Players] An increase in the price of CDs will tend to reduce the demand [shift the demand function to the left] for CD Players

PCDs
P2 P1

As the price of CDs increases from P1 to P2, the quantity of CDs decreases from Y1 to Y. Ppl

Pplayers

As people buy fewer CDs, the demand for CD players decreases. At the same price, Ppl , the demand is reduced from Dto D.

Dcd
Y Y1 CDs/UT X

Dplayer

Dplayer

Fall 97

Principles of Microeconomics

X1 CD Players per UT slide 17

Compliments and Substitutes

Substitutes: if the price of a substitute increases, the demand for the good increases. if the price of a substitute decreases, the demand for the good decreases. Compliments: if the price of a compliment increases, the demand for the good decreases. if the price of a compliment decreases, the demand for the good increases.
Fall 97 Principles of Microeconomics slide 18

Demand Summary
Law of Demand holds that usually as the price of a good increases, individuals will buy less of it. The nature of this relationship is influenced by a variety of other variables; income, preferences, prices of related goods, and other circumstances as these circumstances change, the demand relationship changes or shifts.
Fall 97 Principles of Microeconomics slide 19

Demand Summary

[cont. . . ]

A change in demand means the relationship between price and quantity was altered by a change in some other variable [a demand shifter] The demand shifts. A change in quantity demanded is a change in the quantity bought that was caused by a change in the price of the good. There is a movement on the demand function.

Fall 97

Principles of Microeconomics

slide 20

Supply
Supply is defined as a schedule of quantities of a good that will be produced and offered for sale at a schedule of prices during a given time [UT], ceteris paribus. Generally, producers are willing to offer greater quantities of a good for sale at higher prices; a positive relationship between price and quantity supplied.
Fall 97 Principles of Microeconomics slide 21

Supply Schedule

Observation A B C D E
F

Price
$1 $2 $3 $4

Quantity Supplied
6 10 14 18

The information can be represented on a graph by plotting each price quantity combination.

$5

22

P
$5 $4 $3 $2 $1
2 4

Both the graph and the table represent a supply relationship: Q = 2 + 4P

A supply schedule can be displayed as a table.

Fall 97

.
6 8

. .
10 12 14

y ppl su

.
Q

Principles of Microeconomics

slide 22

Change in Quantity Supplied

A change in the price of the good causes a change in the quantity supplied. The change in the price of the good causes a movement on the supply function, not a change or shift of the supply function.
Fall 97 Principles of Microeconomics slide 23

Supply Schedule

Observation A B C D E
F

Price
$1 $1 $2

Quantity Supplied
6

$3 $3 $4

10 P CAUSES 14 18

A change in the price causes a change in the quantity supplied. This can be represented by a Q movement on the supply function in the graph

$5

22

This is a change in quantity supplied. Not to be confused with a change in supply!

P from $1 to $3

P
$5 $4 $3 $2 $1 P causes the quantity supplied to increase from 6 to 14.

ply sup
2 4 6 8 10 12 14 16

Fall 97

Principles of Microeconomics

slide 24

Q /ut

Change in Supply
A change in supply [like a change in demand] refers to a change in the relationship between the price and quantity supplied. A change in supply is caused by a change in any variable, other than price, that influences supply A change in supply can be represented by a shift of the supply function on a graph
Fall 97 Principles of Microeconomics slide 25

Change in Supply [cont. . . ]

There are many factors that infuence the willingness of producers to supply a good.
technology prices of inputs returns in alternative choices taxes, expectations, weather, number of sellers, . . . Qs = fs (P, Pinputs, technology, . . .)

Fall 97

Principles of Microeconomics

slide 26

Change in Supply [cont. . . ]

Qs = fs (P, Pinputs, technology, number of sellers, taxes, . . .) A change in the price [P] causes a change in quantity supplied; a change in any other variable causes a change in supply

Fall 97

Principles of Microeconomics

slide 27

Given the supply schedule, An increase in the prices of inputs would make it more expensive to produce each unit of output, therefore, the supply decreases

Supply Schedule

Observation A B C D E

Price
$1 $2 $3 $4

Quantity Supplied

46 10 8 12 14 16 18
22 20

P
$5 $4 $3 $2 $1

$5

a shift to the left is a decrease in supply

ne

l pp su w

n fu y

n tio c
in

ase e ncr i an ply sup

16

ply sup The development of a new

Q

The decreased quantity at each price shifts the supply curve to the left!

10

12 14

technology that reduces the cost of production will shift the supply function to the right
slide 28

Fall 97

Principles of Microeconomics

Equilibrium
Equilibrium: 1. a state of rest or balance due to the equal action of opposing forces. 2. equal balance between any powers, influences, [Websters
Encyclopedic Unabridged Dictionary of the English Language]

In a market an equilibrium is said to exist when the forces of supply [sellers] and demand [buyers] are in balance: the actions of sellers and buyers are coordinated. The quantity supplied equals the quantity demanded!

Fall 97

Principles of Microeconomics

slide 29

[Price]

100 90 80 $70 70 60 50 40 30 20 10
10 20 30 40 50 60

Su

pl p

y
Given a demand function [which
represents the behavior or choices of buyers, and a supply function that represents the behavior of De m sellers,

Px

an d

60

70

80

90 100 110 120 130

Where the quantity that people want to buy is equal to the quantity that the producers want to sell, there is an equilibrium quantity. The price that coordinates the preferences of the buyers and sellers is the equilibrium price. At the equilibrium price of $70, the quantity supplied is equal to the quantity demanded.
Fall 97 Principles of Microeconomics slide 30

Qx/ UT

When the price is greater than the equilibrium price, the amount that sellers want to sell at that price [quantity supplied] exceeds the amount that buyers are willing to purchase [quantity demanded] at that price. The price is too high.
At a Price of $90 the quantity supplied is 80, the quantity demanded is 35

[Price]

100

surplus = 45

90 $90

Su

pl y p

60 50 40 30 20 10
10 Fall 97 20 3035 40

equilibrium quantity

80 $70 70

Px

equilibrium price

At $90 there is a surplus of 45 units [80-35=45]

De ma n
70 80 80 90 100 110 120 130 slide 31

50 60

60

Principles of Microeconomics

Qx/ UT

[Price]

100

surplus = 45
lower price

90 $90

80 $70 70 60 50 40 30 20 10
10

.
60

pl up S

Px

Quantity demanded increases

Suppliers have more to sell than buyers will purchase at a price of $90. To get rid of these unsold units [inventory], the Quantity sellers lower supplied decreases the price. D

At a price of $90 a surplus of 45 units exists

em

an d

20

3035 40

50 60

70

80 80

90

100 110 120 130

As the price of the good is reduced, the quantity supplied decreases. The quantity demanded increases as the price falls. As the price moves toward equilibrium, quantity supplied and quantity demanded are brought into equilibrium.
Fall 97 Principles of Microeconomics

Qx/ UT

slide 32

[Price]

100 90 80 $70 70 60 50 40 30 $30 20 10

As a result of market forces the market moves to

equilibrium

price rises quantity supplied increases

10 15 20 30 40

.
60 60

y pl p Su At a price below equilibrium the the quantity demanded exceeds the quantity supplied.
At a price of $30 the quantity demanded is 110. The quantity supplied is 15.

Px

quantity demanded decreases shortage = 95

50 70 80

De ma

nd

90 100 110 120 130 110

Qx/ UT

Since the buyers cannot obtain all they want at a price of $30, some buyers will offer to pay more. Some buyers will not pay the higher price, they buy less so the quantity demanded decreases. At the higher price the quantity supplied increases

At a price of $30 the quantity demanded exceeds the quantity supplied by 95 units [110 - 15 = 95]. This is a shortage.

..

Fall 97

Principles of Microeconomics

slide 33

[Price]

100 90 $89 80 $70 70 60 50 40 30 20 10

demand increases price rises

Su

pl p

Px

in equilibrium at Px = $70

The market for good X is

equilibrium quantity increases

De ma nd

D2

10 20 30 40 50 60 70 80 90 100 110 120 130 60 80

An increase in the price of a substitute [good Y] causes the demand for good X to increase. As a result of the increased demand, market forces push Px up.
Fall 97

Qx/ UT

The increase in the demand for good X results in an increase in both the equilibrium price and quantity. Identify other factors that could increase demand!
slide 34

Principles of Microeconomics

[Price]

100 90 80 70 60

Su Given a demand function,

an equilibrium is defined. A decrease in demand, establishes a new equilibrium at a lower price and quantity.

pl p

Px

$70
40 30 20 10

$50.89 50

D1

De ma nd
A change in the price of the good does not change demand! It changes the quantity demanded.
slide 35

10 20 30 39.2 50 60 70 80 90 100 110 120 130 40 60

Demand might be reduced by: a decrease in the price of a substitute, an increase in the price of a compliment, a change in income, a change in the number of buyers or their preferences, or, . . .
. Fall 97 Principles of Microeconomics

Qx/ UT

[Price]

100 90 80 $70 70

Su
supply increases

pl p

S2

Px

price falls 60
50 $50 40 30 20 10

De ma nd
10 20 30 40 50 60 70 80 90 100 110 120 130 60 86

Given an equilibrium condition in a market,

Qx/ UT

an increase in supply will increase the equilibrium quantity and decrease equilibrium P.
Fall 97

Quantity increases

Identify 1. 2. 3. 4.

factors that increase supply: fall in price of inputs improved technology increase in number of sellers fall in return in alternative uses of inputs 5. or, . . .
slide 36

Principles of Microeconomics

A decrease in supply causes the equilibrium price to increase and equilibrium quantity to decrease. What forces might cause the

Px
$90 90
80 70 60 50 40 30 20 10 100 price rises

$70

supply to decrease? 1. an increase in the prices of inputs S1 2. increase in returns from ly alternative actions pp decrease in supply 3. problems in technology Su [regulations, . . . ] 4. decrease in number of sellers or producers

quantity decreases

De m
10 20 30 40 50 60 70 80 90 100 110 120 130 60 35

an d

Qx/ UT
slide 37

Fall 97

Principles of Microeconomics

P100 x
$70
60 50 40 30 20 10 90 80 70

demand increases price might go up or down or stay the same

and decrease price

pl up S

y
and increase price

S2 If both supply and

demand decrease, the P will be indeterminate and the equilibrium Q will decrease.

+ P

increase

- P

supply increases

results in increase a market force in results to aincrease Q market force to increase Q

D2
De ma nd

10 20 30 40

When demand and supply both shift, the resultant effect on either equilibrium price or quantity will be indeterminate.

50 60 70 80 90 100 110 120 130 60 100

Qx/ UT

Both the increase in demand and supply increase quantity; equilibrium Q increases. The increase in demand pushes price up. The increase in supply pushes price down. The change in price may be positive or negative, it depends on the magnitude of the shifts in and slopes of demand and supply.
Fall 97 Principles of Microeconomics slide 38

A decrease in supply tends to increase P and reduce Q. An increase in demand tends to increase both P and Q. Result is that Price will rise, Quantity may increase, decrease or stay the same depending on the magnitudes of the shifts and slopes of supply and demand. In this example, Price the price $105 increases to 100 $105.

S1
pushes price up

90 When supply 80 increases and $70 70

to push price up

pl decrease in supply up S

demand decreases, the price will fall but the change in Q will be indeterminate!

60 50 40 30 20 10 reducesand increase quantity Q

an increase in demand tends

D2
De m an d

10 20 3035 49 60 70 80 90 100 110 120 40 50 60

Fall 97

the quantity decreases to 49

Principles of Microeconomics

Qx/ UT
slide 39

Supply and Demand Analysis

Supply and demand is a simplistic model that provides insights into the effects of events that are related to a specific market. Whether an event will tend to cause the price of a good to increase or decrease is of importance to decision makers. To estimate the magnitude of price and quantity changes more sophisticated models are needed.

Fall 97

Principles of Microeconomics

slide 40