The Law of Demand Law of Demand: the inverse ( or negative) relationship between the price of a good and the quantity consumers are willing to purchase, other things held constant (ceteris paribus). As the price of a good rises, consumers buy less.
The Law of Demand The demand curve allows you to find the quantity demanded by a buyer at different selling prices by moving along the curve
The Substitution Effect of aPrice Change What explains this “Law of Demand?” Lower Price= Greater Amount Consumer… Why? Substitution effect: The consumer will substitute a cheaper good for a more expensive good.
The Income Effect of a PriceChange IncomeEffect: A fall in the price of the good increases the consumers purchasing power. The consumer can now buy more with NO change in their income level.
The Demand Schedule andDemand Curve Demand: a curve or schedule showing the various quantities of a product consumers are willing to purchase at possible prices during a specific period of time, other things held constant. Demand is the quantity consumers are both willing and able to buy at each possible price.
Market Demand ScheduleA demand schedule is simply a table listing the various quantities of something consumers are willing to purchase prices Example of the demand schedule
Example of a Market Schedule Demand of Hula Hoops Price (in Dollars) Quantity Demanded (Hula Hoops) $10.00 0 8.00 10 6.00 20 4.00 30 2.00 40
The Demand Curve Using theSchedule The demand curve is the plots of this table Example of demand curve using the demand schedule
Demand Curve of Hula HoopsPrice of the Hula Hoops(measu red indollars) Quantity Demanded of Hula Hoops
Market Demand The transition from the individual to the market demand curve is done by totaling or summing the individual demand schedules (this is known as the horizontal summation of demand). Example of horizontal summation
Market Demand of HulaHoops Themarket demand of hula hoops, is the horizontal summation of the two individuals demand for hula hoops (i.e. the summation of quantity demanded at each individual price).
Market Demand of Hula Hoops Price(measured in dollars) Quantity Demanded of Hula Hoops
Changes in demand vs. changesin quantity demandedA movement along the curve- CHANGES IN PRICE ONLY Changes in quantity demanded Example of movement
Movement along the Curve A movement from $8 to $6 represents an increase in quantity demanded A movement from $8 to $10 represents an decrease in quantity demanded
The distinction between changes in QuantityDemanded and Changes in Demand Remember that price and quantity variables in our model are subject to the ceteris paribus assumption (other things held constant). IT IS VERY IMPORTANT TO REMEMBER THE FOLLOWING: If you are dealing with price of the item it is a movement along the curve, a change in quantity demanded not DEMAND, NO SHIFT!!!!!!
Shifts of the Demand Curve: 1) Changes in consumer income Normal goods Inferior goods 2) Changes in the price of a related good Substitutes Complements 3) Changes in expectations- prices, income, or availability of goods. 4) Changes in the number of consumers in the market 5) Changes in consumer tastes and preferences
Examples Income Normal goods: direct relationship Inferior goods: inverse relationship
Changes in Demand Most of us would consider steak to be a normal good. Since, steak is a more expensive meat as income increases then more consumption of steak should occur. Thus, when consumer income increases, the demand for steak increases.
Inferior Goods However, we could argue that Ramon Noodles would be an inferior good, meaning as income increases then the demand for Ramon Noodles would decline. Thus, when income increases, then the demand of Ramon Noodles will decrease. This would be a leftward shift of the demand curve
Examples Related goods Substitute good: if the price of the substitutable good decreases, then demand decreases for the good of interest Complementary good: if the price of the complement good increases, then demand decreases for the good of interest.
Substitute goods Let’s assume that Pepsi and Coke are substitute goods for one another. If the price of Pepsi increases, then what happens to the demand of Coke? The demand for Coke will increase, because now consumers will substitute Coke for Pepsi
Graph of Coke Price(measured in dollars) D2 D1 Quantity Demanded of Coke (in millions)
Complementary Goods Complementary goods are goods that we buy together, I think it is safe to say that peanut butter and jelly are bought together. Thus, what would happen to the demand of jelly, if the price of peanut butter increased? The demand for jelly would decrease. This is a leftward shift of the demand curve
Supply Supply indicates how much producers are willing and able to offer for sale per period at each possible price, other things held constant.
Law of Supply There is a direct (positive) relationship between the price of a good or service and the amount of it that suppliers are willing to produce. Example of the supply curve When price increases, then the amount supplied will increase. Why are sellers willing to sell more at a higher price? Does this make sense?
Market Supply Again,it is the horizontal summation of the quantity produced by the sellers Example of Horizontal Summation
Changes in Supply VS.Changes in Quantity Supplies Increase or decrease in the price of the good is a movement along the curve This is a change in “quantity supplied” Example here
Shifts of the Supply Curve1) Changes in Technology2) Changes in the Prices of Relevant resources Inputs into production.3) Changes in the Price of Alternative Goods Other goods that the producer could produce3) Changes in Producer Expectations4) Changes in the Number of Producers
MarketsA market is any arrangement in which buyers and sellers interact to determine the price and quantity of goods and services exchanged. Markets reduce transaction costs
Market Equilibrium The market is where the buyers and sellers come together Equilibrium is no conflict between demand and supply Quantity supplied= Quantity demand Example of the equilibrium This is the theory of how the price system operates and it is the cornerstone of microeconomic analysis
Equilibrium in the Pizza Market (a) Market schedules Millions of pizzas per Week Price per Quantity Quantity Surplus or pizza Demanded Supplied Shortage Effect on Price $15 8 28 Surplus of 20 Falls 12 14 24 Surplus of 10 Falls 9 20 20 Equilibrium Remains the same 6 26 16 Shortage of 10 Rises 3 32 12 Shortage of 20 Rises
Equilibrium in the Pizza Market (b) Market curves S Market equilibrium occurs at:$15 Surplus Price where QD=QS; Point c 12 Above the equilibrium price:Price per pizza QS>QD; 9 c Surplus; Downward pressure on P 6 Below the equilibrium price: 3 Shortage D QD>QS; Shortage; Upward pressure on P 0 14 16 20 24 26 Millions of pizzas per week
Economic Efficiency When a market reaches equilibrium, all the gains from trade between the buyer and seller have been fully realized and Economic efficiency is met
Prices and Market order Prices communicate information to decision makers Prices coordinate the actions of the market participants Prices motivate economic players
Invisible Hand Principle The tendency of market forces to channel the actions of self-interest individuals into activities that promote the general betterment of society The key to economic progress
What is this all about Price System?? What is that?
Shifts of the Demand Curve Increase in demand Rightward shift of D curve Shortage; Upward pressure on P QD decreases; Qs increase New equilibrium: Increase in P and Q Decrease in demand Surplus; Downward pressure on P New equilibrium: Decrease in P and Q
Exhibit 6Effects of an Increase in Demand S Increase in demand: Rightward shift to D’ $12 g At P=$9: QD>QS; shortagePrice per pizza c Upward pressure on P 9 QD decreases QS increases D’ New equilibrium g Higher P D Higher Q 0 20 24 30 Millions of pizzas per week
Shifts in the Supply Curve Increase in supply Rightward shift of S curve Surplus; Downward pressure on P QD increases; QS decreases New equilibrium: P decreases; Q increases Decrease in supply New equilibrium: P increase; Q decreases
Effects of an Increase in Supply S Increase in supply: Rightward shift to S’ Price per pizza S’ At P=$9: QS>QD; surplus c $9 Downward pressure on P QD increases QS decreases 6 dExhibit 7 New equilibrium d Higher Q D Lower P 0 20 26 30 Millions of pizzas per week
Simultaneous Shifts ofD and S curves Both S and D increase; Q increases D shifts more: P increases S shifts more: P decreases Both S and D decrease: Q decreases D shifts more: P decreases S Shifts more: P increases
Exhibit 8Indeterminate Effect of an Increase in BothDemand and Supply (a) Shift of D dominates (b) Shift of S dominates S S Price Price S’ S’’p’ b a ap p D’ p’’ c D’’ D D 0 Q Q’ 0 Q Q’’ Units per period Units per period
Disequilibrium Surplus Downward pressure on P Shortage Upward pressure on P Disequilibrium Temporary, or Result of government intervention Price floors Price ceilings
Disequilibrium Price Floors Set above equilibrium P Minimum selling P Surplus Distort markets Reduce economic welfare
Disequilibrium Price Ceilings Set below the equilibrium P Maximum selling P Shortage Distort markets Reduce economic welfare
Exhibit 11Price Floors and Price Ceilings (a) Price floor for milk (b) Price ceiling for rent S S SurplusPrice per gallon Monthly rental price$2.50 $1,000 1.90 600 Shortage D D 0 14 19 24 0 40 50 60 Millions of gallons per month Thousands of rental units per month No effect if price floor is No effect if price ceiling is set at or below equilibrium P set at or above equilibrium P