Chapter 4 Demand, Supply, and Market Equilibrium

Market competition

Market is a group of buyers and sellers of a particular good or services. Competitive market is the market in which there are so many buyers and sellers that each has negligible impact on market price. Perfectly competitive: same goods; numerous buyers and sellers; price-takers; Sellers can sell as much as he wants.
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Demand in Product Markets

Quantity demanded is the amount (number of units) of a product that a buyer (consumer, household) are willing and able to buy in a given time period.

The most important relationship in individual markets is that between market price and quantity demanded.
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Price and Quantity Demanded: The Law of Demand

The law of demand states that there is a negative, or inverse, relationship between price and the quantity of a good demanded and its price.

This means that demand curves slope downward.

From Individual Demand to Market Demand

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 demand is 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.

From Individual Demand to Market Demand

Assuming there are only two individuals in the market, market demand is derived as follows:

Demand in Product/Output Markets

Quantity demanded is also affected by other factors:

The income available to the household. The households accumulated wealth. The prices of other products (substitutes and complements). The households tastes and preferences. The number of consumers. The households expectations about future income, wealth, and prices.

Changes in Quantity Demanded Versus Changes in Demand

We use the ceteris paribus or all else equal device, to examine the relationship between the quantity demanded of a good per period of time and the price of that good, while holding income, wealth, other prices, tastes, and expectations constant. Changes in price affect the quantity demanded per period. Changes in income, wealth, other prices, tastes, or expectations shift demand curve.

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A Change in Demand Vs. a Change in Quantity Demanded

To summarize: Change in price of a good or service leads to Change in quantity demanded (Movement along the curve).

Change in income, preferences, or prices of other goods or services leads to Change in demand (Shift of curve).

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The Impact of a Change in Income

Higher income decreases the demand for an inferior good Higher income increases the demand for a normal good

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Income & Household Demand

Normal Goods are goods for which demand goes up when income is higher and for which demand goes down when income is lower. Inferior Goods are goods for which demand falls when income rises.

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Price of other Goods & Demand

Substitutes are 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 are goods that go together; a decrease in the price of one results in an increase in demand for the other, and vice versa.
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The Impact of a Change in the Price of Related Goods

Demand for complement good (ketchup) shifts left

Price of hamburger rises Quantity of hamburger demanded per month falls

Demand for substitute good (chicken) shifts right

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Test yourself

Quantity of toasters demanded per year

# of toasters demanded (millions) 7.0 6.5

Price of a toaster (Dollars) 12 14

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6.2
6.0

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5.8

Plot the demand curve. How each of the following tend to shift the demand curve for toasters? 1. consumer incomes rise by 20%. 2. the price of the bread falls by 10% 3. the price of electricity increases by 5% 4. medical report indicate that toaster prevents heart disease. 5. the cost of producing a toaster increases by 10%.
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Supply in Product/Output Markets

Quantity supplied of any good or service is the amount that sellers are willing and able to sell. Supply decisions depend on profit potential. Profit = Revenues - Costs.

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The Law of Supply

A supply curve is a graph illustrating how much of a product a firm will supply per period of time at different prices.
CLARENCE BROWN'S SUPPLY SCHEDULE FOR ICECREAMS
QUANTITY SUPPLIED (THOUSANDS OF SCOOPS PER WEEK) 0 10 20 30 45 45

PRICE (PER SCOOP) $ 1.50 1.75 2.25 3.00 4.00 5.00

Price of icecream per scoop ($)

6 5 4 3 2 1 0

Thousands of scoops of icecream produced per week

10

20

30

40

50

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The Law of Supply

The law of supply states that there is a positive relationship between price and quantity of a good supplied. This means that supply curves typically have a positive slope.

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Individual Supply to Market Supply

As with market demand, market supply is the horizontal summation of individual firms supply curves.

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Shift of Supply Versus Movement Along a Supply Curve

A higher price causes higher quantity supplied, and a move along the supply curve.
A change in determinants of supply other than price causes an increase in supply, or a shift of the entire supply curve, from SA to SB.
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Other Determinants of Supply

The cost of producing the good, which in turn depends on:

The price of required inputs (material, labor, capital, and land), The technologies that can be used to produce the product.

Expectations regarding future prices.

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Market Equilibrium

Equilibrium is quantity supplied equal to quantity demanded.

At any price level other than P0, such as P1, quantity supplied does not equal quantity demanded.
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Market Equilibrium

Market equilibrium is the condition that exists when quantity supplied and quantity demanded are equal. At equilibrium, there is no tendency for the market price to change.

The actions of buyers and sellers naturally move markets toward the equilibrium of demand and supply.
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Market Equilibrium
Excess demand, or shortage, is the condition that exists when quantity demanded exceeds quantity supplied at the current price. When quantity demanded exceeds quantity supplied, price tends to rise until equilibrium is restored.

Excess supply, or surplus, is the condition that exists when quantity supplied exceeds quantity demanded at the current price.
When quantity supplied exceeds quantity demanded, price tends to fall until equilibrium is restored.

Law of demand and supply: The price of any good adjusts to bring the Quantity supplied and quantity demanded for that good into balance.

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Changes in Equilibrium (ice cream)

Ex1: During one summer the weather is very hot. Ex2: Many people moved out of town during a economic downturn.

Higher demand leads to higher equilibrium price and higher equilibrium quantity.

Lower demand leads to lower price and lower quantity exchanged.

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Changes in Equilibrium (ice cream)

Ex3: A hurricane destroys the sugarcane crop and drives up the price of sugar. Ex4: Price of sugar drops.

Lower

supply leads to higher price and lower quantity exchanged.

Higher

supply leads to lower equilibrium price and higher equilibrium quantity. 30

Relative Magnitudes of Change

Ex5: During one summer, the weather is very hot, at the same time the sugar price is also lower compared to last year.

When supply and demand both increase, quantity will increase, but price may go up or down.
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Test Yourself

Suppose that the quantity of toasters supplied per year depends on the price of a toaster, as follows:
Price (Dollars) 12 14 16 18 20 Quantity demanded (Millions) 7.0 6.5 6.2 6.0 5.8 Quantity supplied (Millions) 4.0 5.0 5.5 6.0 6.3

Q1: Plot the supply curve for tasters. Q2: If the price is $14, will there be excess demand of toasters? Q3: What is the equilibrium price for toaster? Equilibrium quantity?
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