EWMBA201a: Introduction to Supply and Demand

Professor Wolfram EWMBA201a - Fall 2006 Page 2

Economic units come in two classes.

Buyers– Consumers: finished goods

and services.

– Firms: raw materials, labor, intermediate goods.

Sellers– Firms: finished goods.

– Workers: skilled and unskilled labor.

– Resource owners: land, raw materials.

MARKET: A collection of economic units resulting in the possibility of exchange.

- Can be a physical location: NYSE floor, Fulton Street

Fish market.

- Can be a related set of transaction that are not in the same

geographical location: Berkeley housing market, labor market for IT

professionals.

Professor Wolfram EWMBA201a - Fall 2006 Page 3

Demand, the buyer side of the market

Demand: the quantities of a good or service that people are willing to buy at various prices within some given time period, other factors besides price held constant.

• Willing to buy: a consumer would both like to (i.e., has the taste for it) and is able to (i.e., have sufficient income to pay for it) buy the good.

• Time period: especially for non-durables, the amount I’m willing to buy depends on the time period.

• Other factors: the focus of demand is on the relationship between price and quantity.

A demand curve describes the relationship between the price and the quantity customers are ready to purchase at that price.

Professor Wolfram EWMBA201a - Fall 2006 Page 4

A demand curve example

How do buyers respond to a change in price?

– Lower price buyers willing to purchase more.

– Higher price buyers willing to purchase less.

Price (per slice) Quantity

demanded

$6.00 0

$4.50 1000

$3.00 5000

$1.50 6000

$0 7000

The daily demand for pizza in Berkeley:

Professor Wolfram EWMBA201a - Fall 2006 Page 5

The demand for pizza in Berkeley graphically

Quantity

Pric

e

$6

$3

0

$4.5

$1.5

1000 5000 6000 7000

Professor Wolfram EWMBA201a - Fall 2006 Page 6

Demand versus quantity demanded

Quantity

Pric

e

0

Quantity

Pric

e

0

$1.5

6000

Demand

Quantity demanded

“Demand” describes the entire curve.

“Quantity demanded” describes a particular point, corresponding to a particular price.

Professor Wolfram EWMBA201a - Fall 2006 Page 7

What, other than price, drives demand?

P

Q

Demand Curve B

Demand Curve A

- TASTES (e.g. advertising)

- PRICES OF RELATED

PRODUCTS (substitutes and

complements)

-INCOME

-DEMOGRAPHICS

Professor Wolfram EWMBA201a - Fall 2006 Page 8

A supply curve summarizes the supply side of the market.

Supply: the quantities of a good or service that firms are willing to sell at various prices within some given time period, other factors besides price held constant.

• This definition is identical to the definition of demand, except that we’ve substituted the word “sell” for the word “buy.”

A supply curve describes the relationship between the price and the quantity firms are willing to supply at that price.

Professor Wolfram EWMBA201a - Fall 2006 Page 9

A supply curve example

How do firms respond to a change in price?

– Lower price firms willing to supply less.

– Higher price firms willing to supply more.

Price (per slice) Quantity

supplied

$6.00 7000

$4.50 6000

$3.00 5000

$1.50 1000

$0 0

The daily supply of pizza in Berkeley:

Professor Wolfram EWMBA201a - Fall 2006 Page 10

The supply of pizza in Berkeley graphically

Quantity

Pric

e

$6

$3

0

$4.5

$1.5

1000 5000 6000 7000

Professor Wolfram EWMBA201a - Fall 2006 Page 11

Demand and supply on the same graph

Quantity

Pric

e

$6

$3

0

$4.5

$1.5

1000 5000 6000 7000

S

D

Professor Wolfram EWMBA201a - Fall 2006 Page 12

What happens if the price is $4.50?

Quantity

Pric

e

$6

$3

0

$4.5

$1.5

1000 5000 6000 7000

D

S

Professor Wolfram EWMBA201a - Fall 2006 Page 13

What happens if the price is $4.50?

Quantity

Pric

e

$6

$3

0

$4.5

$1.5

1000 5000 6000 7000

D

S

QSQD

Professor Wolfram EWMBA201a - Fall 2006 Page 14

What happens if the price is $4.50?

Quantity

Pric

e

$6

$3

0

$4.5

$1.5

1000 5000 6000 7000

D

S

QSQD

Surplus

Professor Wolfram EWMBA201a - Fall 2006 Page 15

What happens if the price is $4.50?

Quantity

Pric

e

$6

$3

0

$4.5

$1.5

1000 5000 6000 7000

D

S

QSQD

Surplus

Professor Wolfram EWMBA201a - Fall 2006 Page 16

What happens if the price is $1.50?

Quantity

Pric

e

$6

$3

0

$4.5

$1.5

1000 5000 6000 7000

D

S

Professor Wolfram EWMBA201a - Fall 2006 Page 17

What happens if the price is $1.50?

Quantity

Pric

e

$6

$3

0

$4.5

$1.5

1000 5000 6000 7000

D

S

QS QD

Shortage

Professor Wolfram EWMBA201a - Fall 2006 Page 18

What happens if the price is $1.50?

Quantity

Pric

e

$6

$3

0

$4.5

$1.5

1000 5000 6000 7000

D

S

QS QD

Shortage

Professor Wolfram EWMBA201a - Fall 2006 Page 19

What happens if the price is $3.00?

Quantity

Pric

e

$6

$3

0

$4.5

$1.5

1000 5000 6000 7000

D

S

Professor Wolfram EWMBA201a - Fall 2006 Page 20

The market mechanism

If the market price is above the equilibrium price (P>P*), there will be a surplus until:

• producers tend to lower their prices, and

• quantity demanded tends to expand.

If the market price is below the equilibrium price (P<P*), there will be a shortage until:

• producers tend to raise their prices, and

• quantity demanded tends to contract.

At the market clearing price (P = P*),, there is no tendency for the price to change and the market is in equilibrium.

• Consumers can buy all they want, given the price.

• Firms can sell all they want, given the price.

Professor Wolfram EWMBA201a - Fall 2006 Page 21

Supply versus quantity supplied

Quantity

Pric

e

0

Quantity

Pric

e

0

$1.5

6000

Supply

Quantity supplied

“Supply” describes the entire curve.

“Quantity supplied” describes a particular point, corresponding to a particular price.

Professor Wolfram EWMBA201a - Fall 2006 Page 22

What, other than price, drives supply?

P

Q

Supply Curve B

Supply Curve A

- PRICE OF INPUTS (both

substitutes and complements)

- TECHNOLOGY