Micro-Unit 2 - Supply and Demand.pdf

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Supply and Demand

Unit

!

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Price & Quan,ty Determina,on

§  The demand curve

displays the

rela,onship between the price and the

quan,ty demanded of a good at a given period.

§  The graph shows

Nijel would purchase 6 avocados at $0.25 each and 3 avocados at $0.95 each.

Section!

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Demand Curves

§  An individual's demand curve for a good indicates the

addi,onal beneﬁt or "marginal u,lity" (measured in dollars) received from each incremental unit of the

good.

§  Nijel values the ﬁrst

avocado at $1.50, the second at $1.20, the

third at $0.95, & so on. §  A line drawn through

these points creates a

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Demand Schedules

§  The same informa,on

is represented on a

chart, which is known as a demand schedule. §  No,ce that Nijel

receives less and less addi,onal beneﬁt -‐ his marginal u,lity

decrease -‐ as he

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The Law of Diminishing Marginal U,lity

§  Nijel's ﬁrst avocado goes toward his greatest

need, perhaps extreme hunger

§  As he consumes more avocados, he becomes

less hungry, so each addi,onal avocado goes toward a lesser need.

§  The decreasing sa,sfac,on gained from each

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Law of Demand

§  The law of diminishing marginal u,lity correlates to

the law of demand, which states that as the price of a good increases, the quan,ty of that good

demanded by customers falls.

§  Similarly, as the price falls, the quan,ty demanded

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Inverse Rela,onship Between Price and

Quan,ty

§  Nijel would buy 3 avocados

at a price of 75₵ because each avocado is worth

more than that to him, but each subsequent avocado is worth less to him.

§  But as the price drops to

35₵, he will two buy more.

§  This explains the inverse

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Market Demand Curve

§  The market demand curve is reached by adding up

all the individual demanders for a good.

§  For simplicity, assume Nijel and Mary are the only

two purchasers of avocados in the market (say they live on a tropical island).

§  The following graphs indicate each individual

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Market Demand Curves

§  At each price, the demand curves of the two consumers combine to

form one curve.

§  At $1.50, Nijel buys one avocado and Mary buys zero, so the market

value is one.

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Manipula,ng Demand

§  It is important to dis,nguish between a change in

the quan,ty demanded (demand along a demand

curve) and a change in demand (a shi) in the demand curve).

§  Changes in price cause movement along the

demand curve, while changes in demand shi) the curve.

§  A demand curve maps out the value of a unit of

good to the consumer.

§  A shi_ in demand results from any change that

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Determinants of Demand

Anything other than changing price can shi_ the

demand curve:

§  Change in consumer tastes or preferences (successful

adver,sing campaigns or health reports) §  Change in the number of buyers

§  Change in the prices of complementary and subs,tute

goods

–  Subs,tute goods (Buying Pepsi instead of Coke)

–  Complements (increase in gasoline reduces demand for large

trucks)

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Determinants of Demand

§  Change in consumer income

–  “Normal goods" (normal goods are purchased more o_en

when income is raised, i.e. buying more steak)

–  “Inferior goods" (inferior goods are purchased more o_en

when income is lowered, i.e. subs,tu,ng hot dogs for steak)

§  Change in consumer expecta,ons

–  Future income (expected lay-‐oﬀs cause less spending or

passing board exam means expected salary increase leading to increased spending = consump8on smoothing)

–  Future prices

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Determinants of Demand

§  Changes in taxes or subsidies (higher or lower)

§  Changes in regula,ons that promote use

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Supply and Demand Model

§ 

Standard supply and demand model assumes

a perfectly compe,,ve market = many small

ﬁrms selling the same product can enter or

leave the market without cost.

§ 

(In imperfect compe,,on, a monopolists

actually has no supply curve.)

Section!

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Supply Curves

§  The supply curve for a perfectly compe,,ve ﬁrm

and the corresponding supply schedule show the

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Law of Supply

§

 

The

law of supply

says that as the price

increases, the quan,ty of a good supplied in a

given period will increase, other things being

equal.

§ 

At a price of $0.25 someone might be willing to

give up his least valuable ,me to grow 100

avocados as a hobby.

§

 

At $0.50 apiece, someone might be willing to

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Why Supply Costs Increase

§  Increasing produc,on may create ini,al eﬃciencies

may come about, eventually the addi,onal cost of producing another unit – the marginal cost – will increase.

§  The opportunity cost of ,me will increase as more

valuable alterna,ves are sacriﬁced to produce more avocados.

§  As produc,on increases may need to hire best and

cheapest inputs (avocado pickers, tractors, land) and then resort to inferior inputs – leads to necessarily

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The Market Supply Curve

§  The market supply curve indicated the total

quan,,es of a good that suppliers are willing and able to provide at various prices during a given

period of ,me.

§  Just as the market demand curve adds all consumers

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Total Market Supply

§  If Avocados Unlimited is willing to produce 350 avocados for $1 each,

and Always Avocados is willing to produce 450 at $1 each (assuming these are the only two producers), then the market supply is 350 + 450 = 800 at a price of $1.

§  The market supply curve reﬂects the marginal cost (MC) of producing

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Changes in Supply and Quan,ty Supplied

§  Changes in quan,ty supplied or price of goods

supplied results in a change along the supply curve.

§  Changes in supply (a shi_ in the supply curve to the

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Determinants of Supply

Factors that shi_ the supply curve:

§ 

Change in resource prices or input prices

§ 

Change in technology

§ 

Change in taxes and subsidies

§ 

Change in the prices of other goods

§ 

Change in producer expecta,ons

§ 

Change in the number of suppliers

Section!

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Determinants of Supply in Short

§ 

Any factor that

increases

the cost of

produc,on

decreases

supply.

§ 

Any factor that

decreases

the cost of

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Finding the Equilibrium

§  The demand curve and supply curve for a par,cular

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The Equilibrium Point

§  The point of intersec,on between the two curves is

called the equilibrium point.

§  It is only at the equilibrium price of $1500 that the

quan,ty of computers demanded equals the quan,ty supplied (900).

§  For that reason

the equilibrium

price is also called the market

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Returning to Equilibrium

§  A surplus would lead sellers to lower their prices un,l

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Returning to Equilibrium

§  A surplus would lead sellers to lower their prices un,l

equilibrium is reached.

§  A shortage would cause computer sellers to raise

their prices un,l equilibrium is reached.

§  Economic theory

predicts that in the long run the

market price and quan,ty will equal the equilibrium

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Marginal U,lity & the Law of Demand

§  Total U,lity = The aggregate level of sa,sfac,on or fulﬁllment that

a consumer receives through the consump,on of a speciﬁc good or service.

All consumers want to get the highest possible level of total u,lity for the money they spend.

§  Marginal U,lity = The addi,onal sa,sfac,on a consumer gains

from consuming one more unit of a good or service.

Marginal u,lity is an important economic concept because

economists use it to determine how much of an item a consumer will buy.

–  Posi,ve marginal u,lity is when the consump,on of an addi,onal item increases the total u,lity.

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Alloca,ng Budget Based on

Marginal U,lity

§ 

A condi,on called

consumer equilibrium

exists

when the following equality holds true:

(MU/Price)

_Shirt

= (MU/price)

_Steak

§ 

The condi,on of consumer equilibrium can

also be expressed as:

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Responsiveness of Quan,ty

Demanded to Price Changes

Elas,c and Inelas,c Demand Curves

§

 

If the quan,ty demanded is sensi,ve to a

change in price, economists would say the

demand for such goods is

elas5c

.

–  Example: Tacos

§

 

If the quan,ty demanded is rela,vely

insensi,ve to a change in price, the demand for

such goods is

inelas5c

.

–  Example: Gasoline

Section!

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Quali,es That Aﬀect Elas,city

of Demand

§ 

Subs,tutability

§ 

Propor,on of income spent on product

§ 

Luxury or necessity

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Price Elas,city of Demand

§  Price Elas,city of Demand = A measure of the responsiveness of

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Excise Tax

§ 

Excise tax

is a tax levied on a par,cular good

or service.

§ 

This tax typically is a

per-‐unit tax

, meaning

that the seller must give the government a

set amount of money for each unit sold.

§ 

This tax is an extra cost that the seller will try

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Who Really Pays Tax?

§ 

O_en the person who actually pays the

government does not bear the burden of the

tax. The person who bears the burden of the

tax is said to bear the

incidence

of the tax.

§ 

Taxpayers will shi_ the incidence of a tax

whenever possible.

§ 

The incidence of a tax can be shi_ed only

when the taxpayer can get a higher price for

something he or she sells or a lower price for

something he or she buys.

Section!

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Who Really Pays Tax?

§ 

If the taxpayer is able to raise the price of

something he or she sells, the tax is shi_ed

forward. If the taxpayer is able to lower the

price of something he or she buys, the tax is

shi_ed backward.

§ 

How much of the incidence of a tax can be

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Tax Incidence & Elas,city of Demand

The more inelas,c the demand for a good, the more incidence of an excise tax can be shi_ed to the

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Tax Incidence & Elas,city of Demand

The more elas,c the demand for a good, the less

incidence of an excise tax can be shi_ed to the

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A Classroom Market for Crude Oil

Sample Buy Card

Section!

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Price Ceilings and Floors

§  A Price Ceiling is a government regula,on that places an

upper limit on the price at which a par,cular good or service or factor of produc,on may be traded.

–  Results in a shortage

–  Rent Ceiling

–  A Black Market

§  A Price Floor is a government regula,on that places a

lower limit on the price at which a par,cular good, service or factor of produc,on may be traded.

–  Results in a surplus

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A.  What is the

quan,ty demanded and supplied of

Greebes at the

equilibrium price? Why?

B.  What is the

quan,ty demanded if the government mandates a $2

price ceiling? Why?

C.  What is the

quan,ty supplied at a price ceiling of

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D.  With the price

ceiling, what is the shortage of

Greebes?

E.  If people want to

buy more

Greebes, who will get the Greebes?

F.  Why do we call a

price that is lower than equilibrium a

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G.  What would

happen if all goods and

services were

free? Who would produce the

goods and services?

H.  What would

happen to inventories?

What would be the long-‐run

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A.  What is the

quan,ty

demanded and

quan,ty supplied at the equilibrium price? Why?

B.  What is the

quan,ty

demanded if there is a price

ﬂoor of $5? Why?

C.  What is the

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D.  At a price ﬂoor of

$5, what is the surplus of

Greebes?

E.  If people want to

sell more

Greebes than

consumers want to buy, who will get the surplus?

F.  Why is this call a

price ﬂoor? In

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Review

1. Who gains and who looses under a price

ceiling?

2. Who gains and who looses under a price

ﬂoor?

3. How does consumer surplus and producer

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Property Rights, Market Failure,

and Deadweight Loss

§  Property Rights are legally established ,tles to the

ownership, use, and disposal of factors of produc,on and goods and services that are enforceable in the

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Property Rights, Market Failure,

and Deadweight Loss

§  Marginal private beneﬁt (MPB) is the beneﬁt from an

addi,onal unit of a good or service that the consumer of that good or service receives.

§  Marginal external beneﬁt (MEB) is the beneﬁt from an

addi,onal unit of a good or service that people other than the consumer of that good or service enjoy.

§  Marginal social beneﬁt (MSB) is the marginal beneﬁt

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Property Rights, Market Failure,

and Deadweight Loss

§  Marginal private cost (MPC) is the cost of producing an

addi,onal unit of a good or service that is borne by the producer of that good or service.

§  Marginal external cost (MEC) is the cost of producing an

addi,onal unit of a good or service that falls on people other than the producer.

§  Marginal social cost (MSC) the marginal cost incurred by

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Property Rights, Market Failure,

and Deadweight Loss

§  Externali,es are:

–  the costs or beneﬁts that arise from produc,on and that

falls on someone other than the producer;

–  or costs or beneﬁts that arise from consump,on and that

fall on someone other than the consumer.

§  Market Failure is when the quan,ty produced in the

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1. Why is there more liter along a country

highway than in someone’s front yard?

2. Why would a homeowner generally take

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The Eﬀect of Pollu,on

1.  How much paper is

produced when there is no

pollu,on?

2.  What is the price of

a unit of paper in the absence of

pollu,on?

3.  Why does the MPC

curve lie below the MSC curve when the paper

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The Eﬀect of Pollu,on

4.  How much paper is

produced when the paper companies

dump their waste products into the river?

5.  What is the price of

a unit of paper when there is pollu,on?

6.  How does society

feel about the

quan,ty produced by the pollu,ng

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Deadweight Loss of a Price Ceiling

1.  What is the market

price of a gallon of gasoline?

2.  What is the

equilibrium quan,ty?

3.  What is the value of

consumer surplus?

producer surplus?

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Deadweight Loss of a Price Ceiling

6.  Assume the

government sets a

price ceiling of $4.50 in the market. What will be the quan,ty

demanded and the quan,ty supplied?

7.  What area of the graph

shows the deadweight loss of the price