Supply And Demand

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Supply And Demand

  1. 1. Demand <ul><li>If, for the next week, I was selling grades for this course, how much would you be willing and able to pay for a 7? Explain why you’d pay this much. </li></ul><ul><li>Answer this question seriously. </li></ul>09/02/09
  2. 2. Demand Schedule <ul><li>At each price, how many people would demand a 7? </li></ul><ul><li>What if you heard tha Swine Flu was getting worse and school might get cancelled? </li></ul><ul><li>What if there was a rumor that I might be lowering the prices? </li></ul>09/02/09 Demand for a 7 Price (per 7 ) Quantity Demanded
  3. 3. Demand Curve 09/02/09 Price Quantity (Grades of 7) Demand for a 7 Price (per 7 ) Quantity Demanded
  4. 4. Demand Schedules and Demand Curves <ul><li>Demand schedule </li></ul><ul><ul><li>A demand schedule is a table that depicts quantity demanded at every price, all else equal </li></ul></ul><ul><li>Demand curve </li></ul><ul><ul><li>A demand curve shows the relationship between the price and quantity demanded, all else equal </li></ul></ul>09/02/09 Antu Panini Murshid--Principles of Macroeconomics
  5. 5. Demand <ul><li>Desires or wants </li></ul><ul><ul><li>Desire refers to people's willingness to own a good </li></ul></ul><ul><li>Demand </li></ul><ul><ul><li>Demand is the amount of a good that consumers are willing and able to buy at various prices </li></ul></ul>09/02/09 Antu Panini Murshid--Principles of Macroeconomics
  6. 6. Determinants of Demand <ul><li>Price </li></ul><ul><li>Consumers’ income </li></ul><ul><li>Tastes and preferences </li></ul><ul><li>Expectations about future prices </li></ul><ul><li>Prices of related goods ( substitutes and complements ) </li></ul><ul><li>Number of consumers </li></ul>09/02/09 Antu Panini Murshid--Principles of Macroeconomics
  7. 7. Demand <ul><li>Read back through your article, and answer the following questions: </li></ul><ul><li>How does the article relate to demand? </li></ul><ul><li>What has caused a change in demand ? </li></ul>09/02/09
  8. 8. The Law of Demand <ul><li>How do higher prices affect the amount of a good you are willing and able to buy? </li></ul><ul><li>The law of demand </li></ul><ul><ul><li>All else equal, the quantity demanded is negatively related to price </li></ul></ul><ul><ul><li>Prices ↑ quantity demanded ↓ </li></ul></ul><ul><ul><li>Prices ↓ quantity demanded ↑ </li></ul></ul>09/02/09 Antu Panini Murshid--Principles of Macroeconomics
  9. 9. The Demand for Shoes <ul><li>Demand schedule for shoes </li></ul>Demand for Shoes Price (per pair ) Quantity (pairs) $100 2,000 80 4,000 60 6,000 40 8,000 20 10,000
  10. 10. The Demand for Shoes <ul><li>Demand Curve </li></ul><ul><li>for shoes </li></ul>Quantity (pairs of shoes) Price 20 40 60 80 100 2,000 4,000 6,000 8,000 10,000 D Demand for Shoes Price (per pair ) Quantity (pairs) $100 2,000 80 4,000 60 6,000 40 8,000 20 10,000
  11. 11. Price Changes: Movement Along the Demand Curve <ul><li>A change in price will lead to a movement along the demand curve </li></ul><ul><li>A price induced change in demand is referred to as a change in quantity demanded </li></ul>09/02/09 Antu Panini Murshid--Principles of Macroeconomics
  12. 12. Graphing a Movement along the Demand Curve <ul><li>Suppose that the price of shoes is $80 per pair… </li></ul><ul><ul><li>What is the quantity demanded at this price? </li></ul></ul><ul><ul><li>We are at point A </li></ul></ul><ul><li>What would happen if the price were to decrease to $40? </li></ul><ul><ul><li>Quantity demanded would increase to 8,000 </li></ul></ul><ul><ul><li>This is illustrated by a movement to point B </li></ul></ul>Quantity (pairs of shoes) Price 20 40 60 80 100 2,000 4,000 6,000 8,000 10,000 A B D
  13. 13. Shifts in Demand <ul><li>Any factor other than price that results in a change in demand, will cause a shift in the demand curve </li></ul><ul><li>Examples: </li></ul><ul><ul><li>An increase in income will shift the demand curve for a normal good to the right </li></ul></ul>09/02/09 Antu Panini Murshid--Principles of Macroeconomics
  14. 14. Graphing a Shift in the Demand Curve <ul><li>Suppose initially price of shoes is 80 and quantity demanded is 4,000 </li></ul><ul><li>What happens if income increases? </li></ul><ul><ul><li>If shoes are a normal good, demand will increase </li></ul></ul><ul><ul><li>Suppose at $80, quantity demanded increases to 8000 (point B) </li></ul></ul><ul><ul><li>The demand curve will shift to the right </li></ul></ul>Quantity (pairs of shoes) Price 20 40 60 80 100 2,000 4,000 6,000 8,000 10,000 A B D 1 D 2
  15. 15. The Goal of Advertising <ul><li>Consider the following demand curve for shoes </li></ul><ul><li>Suppose currently the price of shoes is $80 a pair </li></ul><ul><li>This implies that quantity demanded is 4,000 pairs </li></ul><ul><li>We are therefore at point A on the demand curve </li></ul>D 1 A Quantity (pairs of shoes) Price 20 40 60 80 100 2,000 4,000 6,000 8,000 10,000
  16. 16. The Goal of Advertising <ul><li>Suppose an ad campaign raises the demand for shoes </li></ul><ul><li>Suppose that at $80 a pair, the demand for shoes is now 6,000 pairs… </li></ul><ul><li>… moving us to point B </li></ul><ul><li>… and shifting the demand curve to the right </li></ul>D 1 A B D 2 Quantity (pairs of shoes) Price 20 40 60 80 100 2,000 4,000 6,000 8,000 10,000
  17. 17. Income: Normal and Inferior Goods <ul><li>How does income affect demand? </li></ul><ul><ul><li>An increase in income increases ability to buy </li></ul></ul><ul><li>Normal goods </li></ul><ul><ul><li>For normal goods an increase in income leads to an increase in demand </li></ul></ul><ul><li>Inferior goods </li></ul><ul><ul><li>For inferior goods an increase in income leads to a decrease in demand </li></ul></ul>09/02/09 Antu Panini Murshid--Principles of Macroeconomics
  18. 18. Tastes and Preferences <ul><li>Changes in tastes and preferences will affect demand, as they affect consumers’ desires to purchase goods and services </li></ul>09/02/09 Antu Panini Murshid--Principles of Macroeconomics
  19. 19. Future Expectations <ul><li>An expectation that future prices will increase may lead to an increase in current demand </li></ul><ul><li>An expectation that future prices will decrease may lead to a decrease in demand today as consumers’ postpone consumption till later </li></ul>09/02/09 Antu Panini Murshid--Principles of Macroeconomics
  20. 20. Substitutes and Complements <ul><li>Substitutes </li></ul><ul><ul><li>Similar products which can be substituted for one another </li></ul></ul><ul><ul><li>Butter and margarine </li></ul></ul><ul><li>Complements </li></ul><ul><ul><li>Products that complement each other and are often purchased in conjunction with each other </li></ul></ul><ul><ul><li>CDs and CD players </li></ul></ul>09/02/09 Antu Panini Murshid--Principles of Macroeconomics
  21. 21. Income & Substitution Effects <ul><li>Income effect </li></ul><ul><ul><li>Lower prices increase your ability to buy more </li></ul></ul><ul><li>Substitution effect </li></ul><ul><ul><li>Lower prices increase your willingness to buy more as you substitute away from more expensive alternatives </li></ul></ul>09/02/09 Antu Panini Murshid--Principles of Macroeconomics
  22. 22. Supply <ul><li>Supply </li></ul><ul><ul><li>Supply is the amount of a good that producers are willing and able to offer for sale at various price </li></ul></ul>09/02/09 Antu Panini Murshid--Principles of Macroeconomics
  23. 23. Determinants of Supply <ul><li>Price </li></ul><ul><li>Resource prices </li></ul><ul><li>Technology </li></ul><ul><li>Number of producers </li></ul>09/02/09 Antu Panini Murshid--Principles of Macroeconomics
  24. 24. The Law of Supply <ul><li>The law of supply </li></ul><ul><ul><li>All else equal, the quantity supplied is positively related to price </li></ul></ul><ul><ul><li>Prices ↑ quantity supplied ↑ </li></ul></ul><ul><ul><li>Prices ↓ quantity supplied ↓ </li></ul></ul>09/02/09 Antu Panini Murshid--Principles of Macroeconomics
  25. 25. Rising Per-Unit Costs <ul><li>Why does the supply curve slope upward? </li></ul><ul><ul><li>Costs per unit tend to increase with output </li></ul></ul><ul><ul><ul><li>Firms have to pay overtime for workers </li></ul></ul></ul><ul><ul><ul><li>Production bottlenecks could slow production and raise costs </li></ul></ul></ul><ul><ul><ul><li>Greater depreciation of capital equipment </li></ul></ul></ul><ul><ul><li>Higher prices allow sellers to cover these higher costs of production </li></ul></ul>09/02/09 Antu Panini Murshid--Principles of Macroeconomics
  26. 26. Technology and Costs of Production <ul><li>Resource prices </li></ul><ul><ul><li>An increase in resource prices implies an increases in firms’ costs, which implies a decrease in supply, unless prices increase also to accommodate the increase in costs </li></ul></ul><ul><li>Technological advances </li></ul><ul><ul><li>Improvements in technology allow firms to produce more using the same resources </li></ul></ul><ul><ul><li>Technological advances therefore reduce the costs of production </li></ul></ul>09/02/09 Antu Panini Murshid--Principles of Macroeconomics
  27. 27. Supply Schedules and Supply Curves <ul><li>Supply schedule </li></ul><ul><ul><li>A supply schedule is a table that depicts quantity supplied at every price, all else equal </li></ul></ul><ul><li>Supply curve </li></ul><ul><ul><li>A supply curve shows the relationship between the price and quantity demanded, all else equal </li></ul></ul>09/02/09 Antu Panini Murshid--Principles of Macroeconomics
  28. 28. The Supply of Shoes <ul><li>Supply schedule for shoes </li></ul>Supply of Shoes Price (per pair) Quantity (pairs) $100 10,000 80 8,000 60 6,000 40 4,000 20 2,000
  29. 29. The Supply of Shoes Quantity (pairs of shoes) Price 20 40 60 80 100 2,000 4,000 6,000 8,000 10,000 S Supply of Shoes Price (per pair) Quantity (pairs) $100 10,000 80 8,000 60 6,000 40 4,000 20 2,000
  30. 30. Price Changes: Movements Along the Supply Curve <ul><li>A change in price will lead to a movement along the supply curve </li></ul><ul><li>A price induced change in supply is referred to as a change in quantity supplied </li></ul>09/02/09 Antu Panini Murshid--Principles of Macroeconomics
  31. 31. Graphing a Movement along the Demand Curve <ul><li>Suppose that initially price is 40 </li></ul><ul><li>At a price of 40, quantity supplied is 4,000 </li></ul><ul><ul><li>We are therefore at point A </li></ul></ul><ul><li>What happens when price increases to 80? </li></ul><ul><ul><li>Quantity supplied increases to 8,000 and we move to point B </li></ul></ul>A B Quantity (pairs of shoes) Price 20 40 60 80 100 2,000 4,000 6,000 8,000 10,000 S
  32. 32. Shifts in Supply <ul><li>Any factor other than price that results in a change in supply, will cause a shift in the supply curve </li></ul><ul><li>Examples: </li></ul><ul><ul><li>A decrease in production costs will shift the supply curve to the right </li></ul></ul><ul><ul><li>A quantity tax will shift the supply curve to the left </li></ul></ul>09/02/09 Antu Panini Murshid--Principles of Macroeconomics
  33. 33. The Effect of a Tax on Supply S 1 <ul><li>Suppose initially price of shoes is $40 a pair and the quantity supplied is 4,000 (Point A) </li></ul><ul><li>What happens if the government places a quantity tax of $20 per shoe? </li></ul><ul><li>With a quantity tax of $20, the government will receive $20 for each pair of shoes sold, while the seller will receive $40-$20=$20 for each pair of shoes sold </li></ul>A Quantity (pairs of shoes) Price 20 40 60 80 100 2,000 4,000 6,000 8,000 10,000 Tax= $20
  34. 34. The Effect of a Tax on Supply S 1 <ul><li>But prior to the tax, at $20, the seller would be willing to supply 2,000 pairs of shoes only </li></ul><ul><li>After the tax, even though the price is $40, since the seller is receiving only $20 for each pair of shoes, he will only be willing to supply 2,000 pairs </li></ul><ul><li>We move to point C… </li></ul><ul><li>… and supply shifts left </li></ul>C Quantity (pairs of shoes) Price 20 40 60 80 100 2,000 4,000 6,000 8,000 10,000 B A S 2 Tax= $20
  35. 35. What Price and What Quantity? <ul><li>The demand curve shows the quantity demanded at various prices </li></ul><ul><li>The supply curve shows the quantity supplied at various prices </li></ul><ul><li>But which of these prices will prevail in the market? </li></ul><ul><li>What quantity will actually end up being sold? </li></ul>09/02/09 Antu Panini Murshid--Principles of Macroeconomics
  36. 36. Equilibrium Price and Quantity in the Market for Shoes <ul><li>Let us consider the market for shoes… </li></ul><ul><li>What happens at a price of $20? </li></ul><ul><li>Quantity demanded is 10,000… </li></ul><ul><li>Quantity supplied is 2,000… </li></ul><ul><li>Hence there is an excess demand (a shortage) of 8,000 </li></ul>Price (per pair) Quantity Demanded (pairs) Quantity Supplied (pairs) Excess (pairs) $100 2,000 10,000 + 8,000 80 4,000 8,000 + 4,000 60 6,000 6,000 0 40 8,000 4,000 - 4,000 20 10,000 2,000 - 8,000
  37. 37. Equilibrium Price and Quantity in the Market for Shoes <ul><li>What happens when price is $100? </li></ul><ul><li>Quantity demanded is 2,000… </li></ul><ul><li>Quantity supplied is 10,000… </li></ul><ul><li>Hence there is an excess supply of 8,000 </li></ul>Price (per pair) Quantity Demanded (pairs) Quantity Supplied (pairs) Excess (pairs) $100 2,000 10,000 + 8,000 80 4,000 8,000 + 4,000 60 6,000 6,000 0 40 8,000 4,000 - 4,000 20 10,000 2,000 - 8,000
  38. 38. Equilibrium Price and Quantity in the Market for Shoes <ul><li>Now consider a price of $60? </li></ul><ul><li>Quantity demanded is 6,000… </li></ul><ul><li>Quantity supplied is 6,000… </li></ul><ul><li>Hence quantity demanded is equal to quantity supplied </li></ul><ul><li>The market clears </li></ul>Price (per pair) Quantity Demanded (pairs) Quantity Supplied (pairs) Excess (pairs) $100 2,000 10,000 + 8,000 80 4,000 8,000 + 4,000 60 6,000 6,000 0 40 8,000 4,000 - 4,000 20 10,000 2,000 - 8,000
  39. 39. Equilibrium Price and Quantity <ul><li>The equilibrium price , is the price at which quantity demanded equals quantity supplied </li></ul><ul><li>The equilibrium quantity is the quantity demanded and supplied at the equilibrium price </li></ul>09/02/09 Antu Panini Murshid--Principles of Macroeconomics
  40. 40. Stability of Equilibrium <ul><li>What ensures that the market will converge to equilibrium? </li></ul><ul><li>Consider a price of $20… </li></ul><ul><li>At a price of $20, there is a shortage of 8,000 </li></ul><ul><li>Firms respond by raising prices... </li></ul><ul><li>As prices rise, the quantity demanded falls and the quantity supplied rises… </li></ul><ul><li>Until the shortage is eliminated </li></ul>100 Quantity (pairs of shoes) Price 20 40 60 80 2,000 4,000 6,000 8,000 10,000 D S Equilibrium shortage
  41. 41. Stability of Equilibrium <ul><li>Now consider a price of $100… </li></ul><ul><li>At a price of $100, there is a surplus of 8,000 </li></ul><ul><li>Faced with unsold stock, firms respond by lowering prices </li></ul><ul><li>As prices fall, the quantity demanded rises and the quantity supplied falls... </li></ul><ul><li>Until the surplus is eliminated </li></ul>100 Quantity (pairs of shoes) Price 20 40 60 80 2,000 4,000 6,000 8,000 10,000 D S Equilibrium surplus
  42. 42. Price of Oranges and Airline Tickets in the Summer <ul><li>In the summer… </li></ul><ul><ul><li>… the prices of oranges go down and the quantity sold increases </li></ul></ul><ul><ul><li>… the prices of airline tickets go up and the quantity sold increases </li></ul></ul><ul><li>How can you use supply and demand analysis to explain this apparent paradox? </li></ul>09/02/09 Antu Panini Murshid--Principles of Macroeconomics
  43. 43. Applications <ul><li>Markets for oranges and airline tickets </li></ul><ul><li>Oil price shock </li></ul><ul><li>Price stabilization—buffer stock </li></ul>09/02/09 Antu Panini Murshid--Principles of Macroeconomics
  44. 44. Market for Oranges and the Market for Airline Tickets <ul><li>In the summer… </li></ul><ul><ul><li>… the price of oranges falls while the quantity supplied also rises </li></ul></ul><ul><ul><li>… the price of airline tickets rise but the quantity supplied also rises </li></ul></ul><ul><ul><li>Explain this apparent paradox </li></ul></ul>09/02/09 Antu Panini Murshid--Principles of Macroeconomics
  45. 45. Market for Oranges in the Summer <ul><li>Suppose that the equilibrium price for oranges is P 1 * and the equilibrium quantity is Q 1 * </li></ul><ul><li>In the summer weather conditions are favorable for growing oranges... </li></ul><ul><li>So the supply curve shifts to the right </li></ul><ul><li>Equilibrium price falls and quantity rises </li></ul>S 2 D Market for Oranges S 1 P 2 * Q 2 * P 1 * Q 1 * Quantity (oranges) Price
  46. 46. Market for Airline Tickets <ul><li>Suppose that the equilibrium price for airline tickets is P 1 * and the equilibrium quantity is Q 1 * </li></ul><ul><li>In the summer the demand for airline tickets increases </li></ul><ul><li>Demand curve shifts right </li></ul><ul><li>Equilibrium price and quantity rise </li></ul>S Market for Airline Tickets D 1 P 1 * Q 1 * D 2 P 2 * Q 2 * Quantity (airline tickets) Price
  47. 47. Aggregate Supply and Aggregate Demand <ul><li>Consider the supply and demand for all goods and services produced in an economy— aggregate supply and aggregate demand </li></ul><ul><li>Price in this case is some measure of the average price level </li></ul><ul><li>Quantity is the total output in an economy </li></ul><ul><li>Suppose that the aggregate supply curve is upward sloping and the aggregate demand curve is downward sloping </li></ul>09/02/09 Antu Panini Murshid--Principles of Macroeconomics
  48. 48. OPEC 1973: AS-AD Analysis <ul><li>In 1973 OPEC raised oil prices. The result was higher inflation and higher unemployment in many countries </li></ul><ul><li>Explain using aggregate supply and aggregate demand analysis </li></ul>09/02/09 Antu Panini Murshid--Principles of Macroeconomics
  49. 49. OPEC 1973: AS-AD Analysis <ul><li>Consider the pre-oil shock equilibrium first (low inflation and high output)…. </li></ul><ul><li>After the hike in oil prices (cost shock) aggregate supply shifted to the left… </li></ul><ul><li>… the price level rose and output fell </li></ul>Output Price level AS 1 AD Aggregate Supply and Aggregate Demand AS 2 P 1 * Y 1 * P 2 * Y 2 *
  50. 50. Government Intervention <ul><li>Sometimes the government intervenes in the market to influence price </li></ul><ul><li>For instance, the government could use a price support, which is a legally established minimum price above the equilibrium price </li></ul><ul><ul><li>An example of a price support is an agricultural subsidy </li></ul></ul><ul><li>Alternatively the government could use a price ceiling </li></ul><ul><ul><li>An example of a price ceiling is rent control </li></ul></ul>09/02/09 Antu Panini Murshid--Principles of Macroeconomics
  51. 51. Price Stabilization Using Buffer Stock Schemes <ul><li>The price and supply of agricultural products can fluctuate considerably </li></ul><ul><li>A negative shock to supply (adverse weather) can cause a sharp price increase… </li></ul><ul><li>And a positive shock could cause a sharp price decrease </li></ul><ul><li>A buffer stock scheme works to stabilize prices of agricultural products </li></ul>S 1 D Market for Wheat S 2 Price increases S 3 Price decreases P* Q* Q L * P H * P L * Q H * Quantity (wheat) Price
  52. 52. Price Stabilization Using Buffer Stock Schemes <ul><li>First the government sets a minimum price above the equilibrium </li></ul><ul><li>This leads to an excess supply (surplus) of wheat </li></ul><ul><li>The government buys this surplus (at price P H ) which it then stockpiles </li></ul><ul><li>Effectively this amounts to shifting the demand curve to the right </li></ul>S 1 D Market for Wheat P* Q* P H * D+D G Quantity (wheat) Price
  53. 53. Price Stabilization Using Buffer Stock Schemes <ul><li>Now suppose that there is a negative shock to supply </li></ul><ul><li>Price should rise to P HH </li></ul><ul><li>The government uses its reserve of wheat to raise supply and stabilize price at P H </li></ul>S 1 D Market for Wheat S 2 S 3 P* Q* P H * D+D G P HH * Quantity (wheat) Price
  54. 54. Summary <ul><li>Can you name some determinants of demand? </li></ul><ul><li>What is the relationship between price and quantity demanded </li></ul><ul><li>What causes a shift in the demand curve and what causes a movement along the demand curve? </li></ul>09/02/09 Antu Panini Murshid--Principles of Macroeconomics Price Quantity D D D
  55. 55. Summary <ul><li>What are determinants of supply? </li></ul><ul><li>What is the law of supply? </li></ul><ul><li>Why does a supply curve slope upward? </li></ul><ul><li>Do you know the difference between shifts in supply and movements along supply </li></ul>09/02/09 Antu Panini Murshid--Principles of Macroeconomics Price Quantity S S S
  56. 56. Summary <ul><li>What is the equilibrium or market clearing price and quantity </li></ul><ul><li>Do you understand why this equilibrium is stable? </li></ul>09/02/09 Antu Panini Murshid--Principles of Macroeconomics Price Quantity S D D’ S’

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