Ch03:demand, supply, and market equilibrium
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Ch03:demand, supply, and market equilibrium

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Ch03:demand, supply, and market equilibrium

Ch03:demand, supply, and market equilibrium

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Ch03:demand, supply, and market equilibrium Presentation Transcript

  • 1. CHAPTERCHAPTER 3Prepared by: Fernando QuijanoPrepared by: Fernando Quijanoand Yvonn Quijanoand Yvonn Quijano© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairDemand, Supply,and Market Equilibrium
  • 2. CHAPTER3:CHAPTER3:2 of© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairFirms and Households:The Basic Decision-Making Units• A firm is an organization thattransforms resources (inputs) intoproducts (outputs). Firms are theprimary producing units in a marketeconomy.• An entrepreneur is a person whoorganizes, manages, and assumes therisks of a firm, taking a new idea or anew product and turning it into asuccessful business.• Households are the consuming units inan economy.
  • 3. CHAPTER3:CHAPTER3:3 of© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairInput Markets and Output Markets:The Circular Flow• The circular flow ofeconomic activityshows how firmsand householdsinteract in input andoutput markets.
  • 4. CHAPTER3:CHAPTER3:4 of© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairInput Markets and Output Markets:The Circular Flow• Product or outputmarkets are the marketsin which goods andservices are exchanged.• Input markets are themarkets in whichresources—labor,capital, and land—usedto produce products, areexchanged.
  • 5. CHAPTER3:CHAPTER3:5 of© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairInput Markets and Output Markets:The Circular Flow• Goods and services flowGoods and services flowclockwise. Firms provideclockwise. Firms providegoods and services;goods and services;households supply laborhouseholds supply laborservices.services.• Payments (usually money)Payments (usually money)flow in the oppositeflow in the oppositedirection (counterclockwise)direction (counterclockwise)as the flow of laboras the flow of laborservices, goods, andservices, goods, andservices.services.
  • 6. CHAPTER3:CHAPTER3:6 of© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairInput Markets and Output Markets:The Circular Flow• Input or factor markets are themarkets in which the resources usedto produce products are exchanged.They include:• The labor market, in whichhouseholds supply work for wagesto firms that demand labor.
  • 7. CHAPTER3:CHAPTER3:7 of© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairInput Markets and Output Markets:The Circular Flow• Input or factor markets are themarkets in which the resources usedto produce products are exchanged.They include:• The capital market, in whichhouseholds supply their savings,for interest or for claims to futureprofits, to firms that demand fundsto buy capital goods.
  • 8. CHAPTER3:CHAPTER3:8 of© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairInput Markets and Output Markets:The Circular Flow• Input or factor markets are themarkets in which the resources usedto produce products are exchanged.They include:• The land market, in whichhouseholds supply land or otherreal property in exchange for rent.
  • 9. CHAPTER3:CHAPTER3:9 of© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairInput Markets and Output Markets:The Circular Flow• Inputs into the productionprocess are also calledfactors of production.
  • 10. CHAPTER3:CHAPTER3:10© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairDemand in Product/Output Markets• The price of the product inquestion.• The income available to thehousehold.• A household’s decision about thequantity of a particular output todemand depends on:
  • 11. CHAPTER3:CHAPTER3:11© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairDemand in Product/Output Markets• The household’s amount ofaccumulated wealth.• The prices of other products(substitutes and complements)available to the household.• A household’s decision about thequantity of a particular output todemand depends on:
  • 12. CHAPTER3:CHAPTER3:12© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairDemand in Product/Output Markets• The household’s tastes andpreferences.• The household’s expectationsabout future income, wealth, andprices.• A household’s decision about thequantity of a particular output todemand depends on:
  • 13. CHAPTER3:CHAPTER3:13© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairDemand in Product/Output Markets• Quantity demanded is theamount (number of units) of aproduct that a household wouldbuy in a given time period if itcould buy all it wanted at thecurrent market price.
  • 14. CHAPTER3:CHAPTER3:14© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairChanges in Quantity DemandedVersus Changes in Demand• The most importantrelationship in individualmarkets is that betweenmarket price and quantitydemanded.
  • 15. CHAPTER3:CHAPTER3:15© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairChanges in Quantity DemandedVersus Changes in Demand• We use the ceteris paribus or “allelse equal” device, to examine therelationship between the quantitydemanded of a good per period oftime and the price of that good, whileholding income, wealth, other prices,tastes, and expectations constant.
  • 16. CHAPTER3:CHAPTER3:16© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairChanges in Quantity DemandedVersus Changes in Demand• Changes in price affect thequantity demanded per period.• Changes in income, wealth,other prices, tastes, orexpectations affect demand.
  • 17. CHAPTER3:CHAPTER3:17© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairPrice and Quantity Demanded:The Law of Demand• A demand scheduleis a table showinghow much of a givenproduct a householdwould be willing tobuy at different prices.• Demand curves areusually derived fromdemand schedules.PRICE(PER CALL)QUANTITYDEMANDED(CALLS PERMONTH)$ 0 300.50 253.50 77.00 310.00 115.00 0ANNAS DEMANDSCHEDULE FORTELEPHONE CALLS
  • 18. CHAPTER3:CHAPTER3:18© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairPrice and Quantity Demanded:The Law of Demand• The demand curve isa graph illustratinghow much of a givenproduct a householdwould be willing to buyat different prices.PRICE(PERCALL)QUANTITYDEMANDED(CALLS PERMONTH)$ 0 300.50 253.50 77.00 310.00 115.00 0ANNAS DEMANDSCHEDULE FORTELEPHONE CALLS
  • 19. CHAPTER3:CHAPTER3:19© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairPrice and Quantity Demanded:The Law of Demand• The law of demandstates that there is anegative, or inverse,relationship betweenprice and the quantityof a good demandedand its price.• This means thatdemand curves slopedownward.
  • 20. CHAPTER3:CHAPTER3:20© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairOther Determinantsof Household Demand• Income is the sum of all householdswages, salaries, profits, interestpayments, rents, and other forms ofearnings in a given period of time. Itis a flow measure.• Wealth, or net worth, is the totalvalue of what a household ownsminus what it owes. It is a stockmeasure.
  • 21. CHAPTER3:CHAPTER3:21© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairOther Determinantsof Household Demand• Normal Goods are goods for whichdemand goes up when income ishigher and for which demand goesdown when income is lower.• Inferior Goods are goods for whichdemand falls when income rises.
  • 22. CHAPTER3:CHAPTER3:22© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairOther Determinantsof Household Demand• Substitutes are goods thatcan serve as replacements forone another; when the price ofone increases, demand for theother goes up.• Perfect substitutes areidentical products.
  • 23. CHAPTER3:CHAPTER3:23© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairOther Determinantsof Household Demand• Complements are goods that“go together”; a decrease inthe price of one results in anincrease in demand for theother, and vice versa.
  • 24. CHAPTER3:CHAPTER3:24© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairShift of Demand VersusMovement Along a Demand Curve• A change in demand is notthe same as a change inquantity demanded.• A higher price causes lowerquantity demanded and amove along the demandcurve DA.• Changes in determinants ofdemand, other than price,cause a change in demand,or a shift of the entiredemand curve, from DA to DB.
  • 25. CHAPTER3:CHAPTER3:25© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairA Change in Demand Versusa Change in Quantity DemandedTo summarize:Change in price of a good or serviceleads toChange in quantity demanded(Movement along the curve).Change in income, preferences, orprices of other goods or servicesleads toChange in demand(Shift of curve).
  • 26. CHAPTER3:CHAPTER3:26© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairThe Impact of a Change in Income• Higher incomedecreases the demandfor an inferior good• Higher incomeincreases the demandfor a normal good
  • 27. CHAPTER3:CHAPTER3:27© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairThe Impact of a Changein the Price of Related Goods• Price of hamburger rises• Demand forcomplementgood(ketchup)shifts left• Demand forsubstitutegood(chicken)shifts right• Quantity of hamburgerdemanded per month falls
  • 28. CHAPTER3:CHAPTER3:28© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairFrom HouseholdDemand to Market Demand• Demand for a good or service can bedefined for an individualhousehold, or for a group ofhouseholds that make up a market.• Market demand is the sum of all thequantities of a good or servicedemanded per period by all thehouseholds buying in the market forthat good or service.
  • 29. CHAPTER3:CHAPTER3:29© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairFrom HouseholdDemand to Market Demand• Assuming there are only two households in themarket, market demand is derived as follows:
  • 30. CHAPTER3:CHAPTER3:30© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairSupply in Product/Output Markets• Supply decisions dependon profit potential.• Profit is the differencebetween revenues andcosts.
  • 31. CHAPTER3:CHAPTER3:31© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray Fair• A supply schedule is atable showing how muchof a product firms willsupply at different prices.• Quantity suppliedrepresents the number ofunits of a product that afirm would be willing andable to offer for sale at aparticular price during agiven time period.PRICE(PERBUSHEL)QUANTITYSUPPLIED(THOUSANDSOF BUSHELSPER YEAR)$ 2 01.75 102.25 203.00 304.00 455.00 45CLARENCE BROWNSSUPPLY SCHEDULEFOR SOYBEANSSupply in Product/Output Markets
  • 32. CHAPTER3:CHAPTER3:32© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairPrice and Quantity Supplied:The Law of Supply• AA supply curvesupply curve is a graph illustrating howis a graph illustrating howmuch of a product a firm will supply permuch of a product a firm will supply perperiod of time at different prices.period of time at different prices.01234560 10 20 30 40 50Thousands of bushels of soybeansproduced per yearPriceofsoybeansperbushel($)PRICE(PERBUSHEL)QUANTITYSUPPLIED(THOUSANDSOF BUSHELSPER YEAR)$ 2 01.75 102.25 203.00 304.00 455.00 45CLARENCE BROWNSSUPPLY SCHEDULEFOR SOYBEANS
  • 33. CHAPTER3:CHAPTER3:33© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairPrice and Quantity Supplied:The Law of Supply• The law of supplystates that there is apositive relationshipbetween price andquantity of a goodsupplied.• This means thatsupply curves typicallyhave a positive slope.01234560 10 20 30 40 50Thousands of bushels of soybeansproduced per yearPriceofsoybeansperbushel($)
  • 34. CHAPTER3:CHAPTER3:34© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairOther Determinants of Supply• The price of the good or service.• The cost of producing the good,which in turn depends on:• The price of required inputs(labor, capital, and land),• The technologies that can beused to produce the product,• The prices of related products.
  • 35. CHAPTER3:CHAPTER3:35© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray Fair• A higher price causesA higher price causeshigher quantityhigher quantitysuppliedsupplied, and a, and amove alongmove along thethedemand curve.demand curve.• A change in determinantsA change in determinantsof supply other than priceof supply other than pricecauses ancauses an increase inincrease insupplysupply, or a, or a shiftshift of theof theentire supply curve, fromentire supply curve, fromSSAA toto SSBB..Shift of Supply VersusMovement Along a Supply Curve
  • 36. CHAPTER3:CHAPTER3:36© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray Fair• In this example, since thefactor affecting supply is notthe price of soybeans but atechnological change insoybean production, there isa shift of the supply curverather than a movementalong the supply curve.• The technological advance means thatmore output can be supplied for at anygiven price level.Shift of Supply Curve for SoybeansFollowing Development of a New Seed Strain
  • 37. CHAPTER3:CHAPTER3:37© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairTo summarize:Change in price of a good or serviceleads toChange in quantity supplied(Movement along the curve).Change in costs, input prices, technology, or prices ofrelated goods and servicesleads toChange in supply(Shift of curve).Shift of Supply VersusMovement Along a Supply Curve
  • 38. CHAPTER3:CHAPTER3:38© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairFrom IndividualSupply to Market Supply• The supply of a good or service canbe defined for an individual firm, orfor a group of firms that make up amarket or an industry.• Market supply is the sum of all thequantities of a good or servicesupplied per period by all the firmsselling in the market for that good orservice.
  • 39. CHAPTER3:CHAPTER3:39© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairFrom IndividualSupply to Market Supply• As with market demand, marketsupply is the horizontal summationof individual firms’ supply curves.
  • 40. CHAPTER3:CHAPTER3:40© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairMarket Equilibrium• Market equilibrium isthe condition that existswhen quantity suppliedand quantity demandedare equal.• At equilibrium, there is notendency for the marketprice to change.
  • 41. CHAPTER3:CHAPTER3:41© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairMarket Equilibrium• Only in equilibrium isquantity suppliedequal to quantitydemanded.• At any price levelAt any price levelother thanother than PP00, such as, such asPP11, quantity supplied, quantity supplieddoes not equaldoes not equalquantity demanded.quantity demanded.
  • 42. CHAPTER3:CHAPTER3:42© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairExcess Demand• Excess demand, orshortage, is the conditionthat exists when quantitydemanded exceedsquantity supplied at thecurrent price.• When quantity demandedexceeds quantity supplied,price tends to rise untilequilibrium is restored.
  • 43. CHAPTER3:CHAPTER3:43© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairExcess Supply• Excess supply, or surplus,is the condition that existswhen quantity suppliedexceeds quantity demandedat the current price.• When quantity suppliedexceeds quantity demanded,price tends to fall untilequilibrium is restored.
  • 44. CHAPTER3:CHAPTER3:44© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairChanges in Equilibrium• Higher demand leads tohigher equilibrium price andhigher equilibrium quantity.• Higher supply leads tolower equilibrium price andhigher equilibrium quantity.
  • 45. CHAPTER3:CHAPTER3:45© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairChanges in Equilibrium• Lower demand leads tolower price and lowerquantity exchanged.• Lower supply leads tohigher price and lowerquantity exchanged.
  • 46. CHAPTER3:CHAPTER3:46© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairRelative Magnitudes of Change• The relative magnitudes of change in supply and demanddetermine the outcome of market equilibrium.
  • 47. CHAPTER3:CHAPTER3:47© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairRelative Magnitudes of Change• When supply and demand both increase, quantityWhen supply and demand both increase, quantitywill increase, but price may go up or down.will increase, but price may go up or down.
  • 48. CHAPTER3:CHAPTER3:48© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairReview Terms and Conceptscapital marketcapital marketcomplements, complementary goodscomplements, complementary goodsdemand curvedemand curvedemand scheduledemand scheduleentrepreneurentrepreneurequilibriumequilibriumexcess demand or shortageexcess demand or shortageexcess supply or surplusexcess supply or surplusfactors of productionfactors of productionfirmfirmhouseholdshouseholdsperfect substitutesperfect substitutesproduct or output marketsproduct or output marketsprofitprofitquantity demandedquantity demandedquantity suppliedquantity suppliedshift of a demand curveshift of a demand curvesubstitutessubstitutessupply curvesupply curvesupply schedulesupply schedulewealth or net worthwealth or net worthincomeincomeinferior goodsinferior goodsinput or factor marketsinput or factor marketslabor marketlabor marketland marketland marketlaw of demandlaw of demandlaw of supplylaw of supplymarket demandmarket demandmarket supplymarket supplymovement along amovement along ademand curvedemand curvenormal goodsnormal goods