Economics 101Chapter06

8/11/2019 Economics 101Chapter06

1/13

Objectives for Chapter 6 Supply and Equilibrium

At the end of chapter 6, you will be able to:

1. Define theLaw of Supply

2. Differentiate Between the Causes of a Movement Alongthe Supply Curve and a Shiftin Supply

. !a"e and #$plain the Four Factorsthat will cause the Supply of a %iven &roduct to Shift to the 'eft (or to the )i*ht+.

. #$plain equilibrium- #$plain how the euilibriu" price and uantity are deter"ined-

/. 0f the price is above euilibriu", e$plain what will result- 0f the price is below euilibriu",e$plain what will result-

6. #$plain what will happen to the price and the uantity in each of the followin* cases (as wellas why this will happen+: a. there is an increase in de"and or a decrease in de"and b. there is an increase in supply or a decrease in supply

. #$plain what will happen to the price and the uantity in each of the followin* cases, as wellas why it will happen:

a. both de"and and supply increase c. de"and increases and supply decreases b. both de"and and supply decrease d. de"and decreases and supply increases

1


2/13

Chapter 6 Supply And Equilibrium (latest revision ay 2336+

!" Supply

0n Chapter /, we focused e$clusively on the behaviors of buyers. But buyers are only half ofthe "ar4et. 5e "ust also consider the behaviors of sellers. Discussin* sellers is so"ewhateasier because we can safely assume that sellers have only one motivation# toma$imi%e theirprofits. Sellers will be "otivated to do "ore of anythin* that increases profits and less ofanythin* that decreases profits. Theirtotalprofits are calculated as the difference betweentheir total revenues and their total costs of production.

'et us be*in with thetotal revenues, the "oney ta4en in fro" sellin* the product. otalrevenues are calculated as theprice of the product times the quantity sold. So, if we sell 133units of the product at 713 each, our total revenues eual 71,333. 0f we sell 133 units at 723, ourtotal revenues eual 72,333. Since we *ain "ore revenues if the price is 723 than if it is 713, we

would li4ely want to sell "ore units of the product. So we can conclude that as the price of theproduct rises (falls), the quantity supplied rises (falls). We call this statement the law of

supply. (%o bac4 and co"pare this state"ent with the law of de"and.+ o illustrate the law ofsupply, you would e$pect that "ore and "ore ho"es would be built after 188/ when the pricesof ho"es be*an risin* *reatly. his is indeed what has occurred. 9ou would e$pect electricpower producers to produce "ore electricity after the prices doubled in the su""er of 2333. Andyou would e$pect that "ore and "ore people would want to beco"e en*ineers and scientistswhen the prices paid for these people (called the wa*es+ rose. A*ain, indeed, this is what hasoccurred. (Does it "a4e any sense that when the tic4et prices char*ed for baseball and football*a"es rose, aor 'ea*ue Baseball chan*ed fro" 1/ *a"es to 162 *a"es per year and the!ational ;ootball 'ea*ue chan*ed fro" 12 *a"es to 16 *a"es per year-+

5e can illustrate the law of supply with a supply schedulefor ho"es.

Price of Homes Quantity Supplied 1 $300,000 3000 2 $350,000 4000

3 $400,000 5000

4 $450,000 60005 $500,000 70006 $550,000 80007 $600,000 9000

8 $650,000 10000

9 $700,000 1100013 $750,000 1200011 $800,000 1300012 $850,000 14000

he schedule shows that, as the price char*ed for ho"es rises, sellers wish to sell "ore ho"es.5e can also plot this in the *raph below. his *raph depicts the law of supply as an

2


3/13

up&ard'sloping line. !otice that the line does not be*in at the ori*in. here is so"e price /3,333 per ho"e. his tells us the uantity supplied, whichrises fro" 1,333 ho"es to 1,333 ho"es.+5e shiftthe line if anythin* else chan*es. 'et usnow consider the factors that cause shifts in supply, called the determinants of supply. hereare fourdeter"inants of supply.

(eterminants of Supply

(1+ he *oal of a co"pany, as stated above, is to "a$i"i=e profits, calculated as the differencebetween the total revenues and the total costs of production. So, one of the deter"inants ofsupply "ust be the totalcosts of production. s costs of production rise, profits fall, andtherefore the quantity supplied falls (shifts to the left). !onversely, as costs of production fall,

the profits rise, and the quantity supplied rises (shifts to the right)" Costs include the costs ofnatural resources such as wood used in buildin* a ho"e, the costs of labor (wa*es and benefits+,interest rates, ta$es, and the costs of the capital *oods. 5e will consider the" "any ti"esthrou*hout the course.

(2+ 5hen we considered de"and, one of the deter"inants was population (the nu"ber ofbuyers+. he sa"e is true for supply. ?ne of the deter"inants of supply is the number of sellersof the product. Whenthe number of sellers increases, the supply increases (shifts to the


4/13

right). When the number of sellers falls, the supply decreases (shifts to the left). 0n thiscourse, we will see that a "aor reason for the increase in the nu"ber of sellers of "any productshas been the openin* of international trade @ a topic that will be discussed several ti"es.

(+ 5hen we considered de"and, one of the deter"inants was the price of a substitute *ood.

A*ain, the sa"e is true for supply. 0n this case, the substitute is a substitute for the seller


5/13

&rice of o"es

Supply2

Supply1

3 uantity of o"es&rice of o"es

Supply1

Supply2

3 uantity of o"es

*est +our ,nderstanding

Consider an oran*e *rove. 0n each of the followin* cases, state whether there is a "ove"ent alon* thesupply curve of oran*es, a shift in the supply curve of to the ri*ht, or a shift in the supply curve to the left: 1. the wa*es paid to hired wor4ers rises 2. the nu"ber of oran*e *rowers rises . the price paid by consu"ers for avocados rises . the price paid by consu"ers for oran*es rises

/. oran*e *rowers e$pect the price of oran*es to rise *reatly soon

-" Equilibrium

!ow, we can ta4e the two sides of the "ar4et, de"and and supply, and put the" to*ether.his will allow us to deter"ine the uantity produced and the price of the product. 0n the *raphon the followin* pa*e, the de"and curve and the supply curve have been superi"posed on eachother. hey reflect the de"and and supply schedules that we had before.

/

S,../+ S01F*S /EF* 1F

(1+ costs of production rise(1+ the nu"ber of sellers falls(2+ the price of adifferent

product produced by thesa"e seller rises

(+ sellers e$pect the price torise

S,../+ S01F*S 21)0*

1F#

(1+ costs of production fall(2+ the nu"ber of sellers

rises(+ the price of a different

product produced by thesa"e seller falls

(+ sellers e$pect the price tofall


6/13

&rice uantity De"anded uantity Supplied7>/3,333 3 1,3337>33,333 1333 1,3337/3,333 2333 12,333733,333 333 11,33376/3,333 333 13,333

7633,333 /333 8,3337//3,333 6333 >,3337/33,333 333 ,3337/3,333 >333 6,333

733,333 8333 /,333 7/3,333 13333 ,333 733,333 11333 ,333

Assu"e that, for whatever reason, the price is 7>33,333 per ho"e. he de"and curve tells usthat buyers wish to buy 1,333 ho"es (point 1+. he supply curve tells us sellers wish to sell1,333 ho"es (point 1+. 5e have a proble". here are 12,333 ho"es that sellers wish to sell

that no one wishes to buy (1,333 < 1,333+. his is called a surplus. %raphs "ay see" abstractbut surpluses are not. A seller 4nows there is a surplus by the fact that *oods for sale are notsellin*. )esale ho"es *o on sale and sit for "onths and "onths without any buyer "a4in* anoffer. !ew ho"es have the E%rand ?penin*E fla*s out for "onths and even years. #ventually,sellers fi*ure out that they "ust lo&er the price. As the price falls, buyers will buy "ore (a"ove"ent alon* the de"and curve+. Sellers "ay even choose to sell less at the lower price,ta4in* ho"es off the "ar4et (a "ove"ent alon* the supply curve+. he surplus beco"es s"allerand s"aller until it disappears. !ow assu"e that the price be*ins at 733,333 per ho"e. he de"and curve tells us thatbuyers wish to buy 11,333 ho"es (point +. he supply curve tells us that sellers wish to sell,333 ho"es (point 11+. 5e have a proble". All ,333 ho"es for sale will sell uic4ly and"any "ore buyers will co"e see4in* to buy. 5e call this a shortage. A shorta*e is also easy toreco*ni=e. ;ifty ho"es *o on sale for a "ini"u" price. A wee4 before orders are to be ta4en,about /33 peopleline up to spend a wee4 in line. 0t is easy for sellers to reali=e that there was ashorta*e. he "ini"u" price obviously was too low.

6


7/13

As a result, sellers raise the price. he hi*her price will cause buyers to buy less ("ove alon*the de"and curve+. 0t "ay also induce sellers to sell "ore ho"es ("ove alon* the supply curve+.he shorta*e beco"es s"aller and s"aller until it disappears. At the price of 7/33,333 (point +, there is no surplus. here is also no shorta*e. Sellers want

to sell ,333 ho"es. his is e$actly what buyers want to buy. here is no reason to either lowerto raise the price. 5e call 7/33,333 the equilibrium price. 5e call ,333 ho"es theequilibrium quantity. he de"and and the supply are eual. All forces affectin* the price oruantity are in balance there is no tendency to chan*e. 5e started our analysis by as4in* whatdeter"ined the uantity produced and the price of the product. 5e now 4now that the uantityproduced will be ,333 ho"es and the price will be 7/33,333 per ho"e. he price and theuantity of ho"es will stay at these levels until so"ethin* happens to chan*e the".


he followin* are de"and and supply schedules for co"puters:0f the &rice is: he uantity De"anded is: and he uantity Supplied is: 71333 /33 133 712/3 33 233 71/33 33 33 71/3 233 33 72333 133 /33

he euilibriu" price is 7 and the euilibriu" uantity is. 0f the price were 72333, there would be a (shorta*e or surplus-+ eual to co"puters.


8/13

3" Changes in Equilibrium

Case !: Assu"e that we be*in with a "ar4et for ho"es in euilibriu". hen, so"ethin*chan*es. 'et us assu"e that income rises. ow do we analy=e this case-

Does inco"e affect de"and or supply- he answer, as we saw in the last chapter, is demand.5ill there be a shift or "ove"ent alon* de"and- he answer is shift, because the chan*e iscaused by so"ethin* other than the price. 0s the shift ri*ht or left- he de"and will increase,which is a shift to the right. he data below are repeated.1f the price is# *he quantity demanded is# *he quantity supplied is

1ncome 4 578777 1ncome 4 5!778777

7>/3,333 3 2333 1333 7>33,333 1333 333 1333 7/3,333 2333 333 12333 733,333 333 /333 11333 76/3,333 333 6333 13333 7633,333 /333 333 8333

7//3,333 6333 >333 >333 7/33,333 333 8333 333 7/3,333 >333 13333 6333 733,333 8333 11333 /333 7/3,333 13333 12333 333 733,333 11333 1333 333

>


9/13

he de"and shifts fro" the blue line to the yellow line. Fust loo4in* at the data and at the *raphtells us that there will be a new euilibriu" price and uantity. *he equilibrium price &ill riseto 578777 and the equilibrium quantity &ill rise to 98777 homes. 5ith the aid of thenu"bers and the *raph, we can e$plain what occurs. Buyers wish to buy "ore ho"es (8333+ atthe price of 7/33,333 per ho"e because they have "ore inco"e. But there are no "ore ho"es to

buy (333+. his causes a shorta*e to result (a shorta*e of 2333 ho"es+. )eco*ni=in* theshorta*e, sellers will raise the price (fro" 7/33,333 to 7//3,333+. As the price rises, sellers willdesire to sell "ore ho"es (fro" 333 ho"es to >333 ho"es+. And buyers will buy fewer ho"es(fro" 8333 ho"es bac4 to >333 ho"es+. he shorta*e will be eli"inated.

Case -: A*ain, assu"e that there is a "ar4et for ho"es that be*ins in euilibriu". 0n this case,the chan*e that occurs is an increase in the price of &ood. ow do we analy=e this case-

Since wood is used to build ho"es, this is an increase in a cost of production. Do costs ofproduction affect the de"and or the supply- he answer, as shown earlier in this chapter, issupply. 5ill there be a shift in or "ove"ent alon* the supply- he answer is a shift, since the

cause is so"ethin* other than the price of the product. 5ill the shift be ri*ht or left- Since costsare increasin*, supply &ill decrease ''' a shift to the left.

1f the price is# quantity demanded is# quantity supplied is# ne& quantity supplied is#

7>/3,333 3 1333 12333 7>33,333 1333 1333 11333 7/3,333 2333 12333 13333 733,333 333 11333 8333 76/3,333 333 13333 >333

7633,333 /333 8333 333 7//3,333 6333 >333 6333 7/33,333 333 333 /333

7/3,333 >333 6333 333 733,333 8333 /333 333 7/3,333 13333 333 2333 733,333 11333 333 1333

8


10/13

he supply curve shifts fro" the red line to the yellow line. ;ro" loo4in* at the nu"bers and the*raph, you can see that the price of homes &ill rise to 578777 &hile the quantity of homes&ill fall to 68777. 5ith the aid of the nu"bers and the *raph, we can e$plain what occurs. As

costs rise, sellin* ho"es beco"es less profitable. Sellers wish to sell less (shift fro" redtoyellow


11/13

price of ho"es rise. So the price of ho"es will definitely rise. =ut &e cannot say definitively&hat &ill happen to the quantity of homes. By itself, an increase in the de"and for ho"eswill "a4e the uantity of ho"es rise. By itself, a decrease in the supply of ho"es will "a4e theuantity of ho"es fall. 0f both happen si"ultaneously, we cannot 4now what will happen to theuantity of ho"es unless we 4now which of the two shifts is *reater. ?n the *raph below, the

uantity bou*ht and sold stayed the sa"e at ,333. But this is a pure coincidence of the way the*raph was drawn.


1. Assu"e that the "ar4et for auto"obiles be*ins in euilibriu". Draw the de"and and supply curvesfor auto"obiles in the *raph below. 'abel all a$es and curves. Show the euilibriu" price and uantity. hen, the price of gasoline rises. a4e the appropriate chan*e on the *raph on the ne$t pa*e. Showthe new euilibriu". 5hen the new euilibriu" is reached, the price will have (risen or fallen-+ and theuantity will have (risen or fallen-+ &rice

3 uantity

11


12/13

2. Assu"e that the "ar4et for oran*es be*ins in euilibriu". Draw the de"and and supply curves fororan*es in the *raph below. 'abel all a$es and curves. Show the euilibriu" price and uantity. hen, there is an increase in the price of &ater gro&ers must pay. 5ater, of course, is needed to*row oran*es. a4e the appropriate chan*e on the *raph. Show the new euilibriu". 5hen the new euilibriu" is reached, the price will have (risen or fallen-+ and the

uantity will have (risen or fallen-+ &rice

uantity

. Do the sa"e type of analysis for an increase in rents char*ed on apart"ents.. he product is ho"es.Gse your own *raph.. Do the sa"e type of analysis for an increase in interest rates paid to borrow "oney to buy ho"es.Gse your own *raph./. Do the sa"e type of analysis if the nu"ber of ho"ebuilders is reduced as so"e co"panies *o out of

business. Gse your own *raph.

>" Summary

his chapter first e$a"ined the behavior of sellers. 0t started with the fact that sellers respondto chan*es in the price of the product. 5hen the price of the product rises, the uantity suppliedrises. And when the price of the product falls, the uantity supplied falls. his is called theLawof Supply. he chapter also e$plained thefour determinants of supply. (1+ As costs ofproduction rise (fall+, the supply of a product falls (rises+. (2+ As the nu"ber of sellers rises(falls+, the supply rises (falls+. (+ As the price of a different product also produced by the sellerrises (falls+, the supply of the product in uestion falls (rises+. And finally (+, as sellers e$pectthe price to rise (fall+ in the future, the supply of the product on the "ar4et today falls (rises+. 0n the second part, this chapter illustrated how "ar4ets reach an equilibrium price and anequilibrium quantity. 5hen there are shortages, the price will rise until the shorta*es areeli"inated. 5hen there are surpluses, the price will fall until the surpluses are eli"inated. 5hen

so"ethin* occurs to chan*e either the de"and for the product or the supply of the product, theeuilibriu" is disturbed te"porarily. owever, a new and different euilibriu" price anduantity will occur. ;ro" this analysis of the response to a chan*e in either the de"and for orthe supply of a product, we can learn "uch about two "ar4ets that are of *reat i"portance @ theforei*n e$chan*e "ar4et and the stoc4 "ar4et. hese are the topics of the ne$t chapter.

12


13/13

.ractice ?ui% for Chapter 6

1. he la& of supplystates that, other thin*s bein* unchan*ed,a. as the price rises, the uantity supplied rises c. as the supply rises, the price fallsb. as the price rises, the uantity supplied falls d. as the de"and rises, the supply falls

;or uestions 2, , , /, and 6, answer (a+ if there is a "ove"ent alon* the supply curve, (b+ if the supply curveshifts to the left, and (c+ if the supply curve shifts to the ri*ht.

2. he product is electricity and there is an increase in the price of electricity.. he product is auto"obiles and there is a technical chan*e "a4in* auto"obile wor4ers "ore productive.. he product is fast food and there is an increase in the "ini"u" wa*e paid to fast food wor4ers./. he product is shares of stoc4. Stoc4holders believe that the price of the stoc4 will fall soon.6. he product is co"puter operatin* syste"s and there is an increase in the nu"ber of co"panies producin* co"puter operatin* syste"s.

. Gsin* the nu"bers below, what is the equilibrium price- &rice De"and Supply 71 13 6

72 8 7 > > 7 8 a. 1 b. 2 c. d.

>. 0f the price is belo& equilibrium,a. uantity de"anded euals uantity supplied c. there are surplusesb. there are shorta*es d. supply "ust shift to the ri*ht

8. Assu"e that a "ar4et be*ins in euilibriu". hen, there is an increase in buyers@ incomes. 5hen the neweuilibriu" is reached:

a. the price and the uantity will both have risenb. the price and the uantity will both have fallen

c. the price will have risen and the uantity will have fallend. the price will have fallen and the uantity will have risen

13. Assu"e that a "ar4et be*ins in euilibriu". hen, there is an increase in a cost of production.5hen thenew euilibriu" is reached:

a. the price and the uantity will both have risen c. the price will have risen and the uantity will have fallenb. the price and the uantity will both have fallen d. the price will have fallen and the uantity will have risen

Answers: 1. A 2. A . C . B /. C 6. C . C >. B 8. A 13. C

1

Economics 101Chapter06

Documents

Transcript of Economics 101Chapter06