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CHAPTER 3Demand, Supply

and Market Equilibrium

MarketsAn institution or mechanism that brings together buyers and sellers of particular goods and services.

This chapter focuses on competitive markets.

What is a competitive market?

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A schedule or a curve that shows the various amounts consumers are willing and able to purchase at each of a series of possible prices, during. some specified period of time

Demand

Demand Schedule for DVDs

Price(dollars/dvd)

Quantity(millions of dvds/week)

ABCDE

12345

96432

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Ceteris paribus, as price falls, the quantity demanded rises (& vice-versa)

Explanation of law of demand: 1. diminishing marginal utility2. income effect3. substitution effect

Law of Demand

Individual versus Market demand

The market demand us the horizontal sum of individual demand curve.

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Market Demand Schedule for DVDs

Quantity demanded (millions/week)

Total quantity demanded/week

Price(dollars/dvd)

Buyer 1 Buyer 2

Buyer 3

ABCDE

12345

85321

96432

75432

24161185

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A change in one or more of the determinants of demand results in a shift in the demand curve

Changes in Demand

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Changes in any of these determinants will cause a change in demand:

tastes (preferences)number of buyersincomeprices of related goodsexpectations

let’s examine these more closely…

Changes in Demand

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Changes in Tastes (preferences)positive change shifts D curve rightmore will be demanded at each price

PPAA

QQAA

DD DD′′

Changes in Demand

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Changes in Number of Buyers:decrease will shift curve left

PPAA

QQAA

D’D’ DD

Changes in Demand

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Changes in Money Incomes:when income increasesdemand for NORMAL goods increasesdemand for INFERIOR goods decreases

Changes in Demand

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Changes in Prices of Related Goods:when two products are SUBSTITUTES, price of

one & demand for the other move in the same direction

when two products are COMPLEMENTS, price of one & demand for the other move in opposite directions

when products are unrelatedno effect

Changes in Demand

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Changes in Consumer Expectations:about future prices or incomes

Changes in Demand

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when price of the product changes, there is a movement along the demand curve…this is called a change in quantity demanded.

when any other determinant of demand changes, there is a shift in the demand curve… this is called a change in demand.

Change in Quantity Demanded

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A schedule or a curve showing the amounts that producers are willing and able to make available for sale at each of a series of possible prices, during some specified period of time.

Supply

Supply Schedule for DVDs

Price(dollars/dvd)

Quantity(millions of dvds/week)

ABCDE

12345

05101316

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Ceteris paribus, as price rises, the quantity supplied rises (& vice-versa)

why?price is revenue to suppliershigher price necessary to induce higher supply,

to cover higher costs of production

Law of Supply

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Changes in any of these determinants will cause the supply curve to shift:

factor pricestechnologytaxes & subsidiesprices of other goodsproducer expectationsnumber of sellers

let’s examine these more closely…

Determinants of Supply

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A change in quantity supplied is a movement from one point to another on a fixed supply curve

A change in supply is a shift of the entire curve

priceprice

quantityquantity

SS

Increase in QIncrease in QSS

Decrease in QDecrease in QSS

NOT NOT supply!supply!NOT NOT

supply!supply!

Changes in Quantity Supplied

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Equilibrium price will be established where the supply decisions of producers and the demand decisions of buyers are mutually consistent

Market Equilibrium

Market Supply & Demand for DVDs Price(dollars/dvd)

Quantity demanded(millions of dvds/week)

Quantity supplied(millions of dvds/week)

Shortage (-) or surplus (+)(millions of dvds/week)

12345

24161185

05

101316

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Equilibrium price & quantity

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Equilibrium price (market clearing price) is the price in a competitive market at which the quantity demanded is equal to the quantity supplied.

There is neither a shortage nor a surplus at this price.

Equilibrium quantity is the quantity demanded & supplied at the equilibrium price in a competitive market.

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What is the rationing function of prices?

Efficient allocation

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Efficient allocation of society’s resources occur in a competitive market at equilibrium.

Efficient allocation means:1.Productive efficiency2.Allocative efficiency

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when both supply and demand change, the effect is a combination of the individual effects

if both demand and supply shift, one of either price or quantity cannot be predicted–the result is indeterminate

Complex Cases

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Change in supply

Change in demand

Effect on equilibrium price

Effect on equilibrium quantity

Increase Decrease Decrease Indeterminate

Decrease Increase Increase Indeterminate

Increase Increase Indeterminate Increase

Decrease Decrease Indeterminate Decrease

Table 3-3Complex Cases

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Price Ceilings: A legally established maximum price for a good or service.

3.4 Applications: Government Set Prices

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Rationing ProblemBlack Markets

Price Ceilings and Shortages

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Price Floor: A legally established price above an equilibrium price

Government Set Prices: Price Floors

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Additional consequences• Distort resource allocation• Cause shortages or surpluses• Produce negative side effects

Price Floors and Surplus

Mathematics of Market Equilibrium

P = 100 - 0.5 Qd

P = 5 + 0.5 Qs

Calculate the equilibrium quantity & price Step 1: Set the right hand side of both equations to

equal on another & solve for Q* (Q*= Qd = Qs in equilibrium)

Step 2: Substitute Q* into either equation & solve for P* (P*=P in equilibrium)

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Homework questions

Study questions are end of chapter: 3,6,7, 8, 9,13, 14, 17

The key will be posted on my website.

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