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Supply And Demand

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