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Chapter 3
Supply and Demand
Intertwined
McGraw-Hill/Irwin Copyright 2009 by The McGraw-Hill Companies, Inc !ll
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3-2
Learning Objectives
!w d! supply and demand determineprices"
#hat is e$uilibrium"
#hat is surplus"
#hat is sh!rtage"
#hat is the e%%ect !% a change in demand"
#hat is the e%%ect !% a change in supply"
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3-3
&'
()*
+uantity !% ,pples
Demand
#hen Supply and Demand Intersect
Supply
+uantitysupplied at
()*
+uantitydemanded at
()*
.2/
,t &()*0
C!nsumers want .2/apples(
1irms want t! pr!duce.2/ apples(
+uantity demanded
+uantity supplied(
Supply and demandintersect(
$uilibrium
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3-)
&'
(4
+uantity !% ,pples
Demand
Surplus
Supply
+uantitysupplied at
(4
+uantitydemanded at
(4
./ .)/5
,t &(40
C!nsumers want ./apples(
1irms want t! pr!duce.)/5 apples(
+uantity supplied
6 $uantity demanded
Surplus( 'rice will %all(
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3-*
&'
(2*
+uantity !% ,pples
Demand
Sh!rtage
Supply
+uantitysupplied at
(2*
+uantitydemanded at
(2*
7/ .*/
,t &(2*0
1irms want t! pr!duce7/ apples(
C!nsumers want .*/apples(
+uantity supplied
8 $uantity demanded
Sh!rtage(
'rice will rise(
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3-5
$uilibrium
, mar9et at e$uilibrium is stable unlessdisturbed by shi%t !% supply !r demandcurves(
, mar9et n!t at e$uilibrium m!ves t!wardse$uilibrium with change in price(
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3-4
$uilibrium
Demand Supply
'rice
+uantity
'rice ab!vee$uilibrium
Surplus(1all in price
'rice bel!we$uilibrium Sh!rtage(:ise in price
$uilibrium$uantity s!ld
$uilibrium
$uilibrium
price
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3-;
D!
#hen price is ab!ve e$uilibrium where$uantity supplied e>ceeds $uantitydemanded(
#hen d!es a sh!rtage arise"
#hen price is bel!w e$uilibrium where$uantity demanded e>ceeds $uantitysupplied(
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3-7
+uantity
Demand
?!ving @!wards Aew $uilibrium
,n increase in supply0
, new e$uilibrium at al!wer price and a
higher $uantity(
OldSupply
'rice
AewSupply
Olde$uilibrium
Aewe$uilibrium
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3-.
+uantity
OldDemand
?!ving @!wards Aew $uilibrium
,n increase indemand0
, new e$uilibrium at a
l!wer price and ahigher $uantity(
'rice
Supply
Olde$uilibrium
Aewe$uilibrium
AewDemand
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3-..
+uantity
Demand
?!ving @!wards Aew $uilibrium
, decrease in supply0
, new e$uilibrium at ahigher price and a
l!wer $uantity(
AewSupply
'rice
OldSupply
Aewe$uilibrium
Olde$uilibrium
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3-.2
+uantity
AewDemand
?!ving @!wards Aew $uilibrium
, decrease indemand0
, new e$uilibrium at a
higher price and al!wer $uantity(
'rice
Supply
Aewe$uilibrium
Olde$uilibrium
OldDemand
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3-.3
?ar9et 1!rces in a 1icti!nal @ale
In anticipati!n !% the bl!c9adeB
Increase in demand %!r %!!d and hence its price(
Smuggler transp!rts %!!d rather than lu>ury
g!!ds(
,%ter the bl!c9adeB
#ith higher %!!d prices/ the smuggler is willing
t! ta9e the ris9 !% shipping %!!d(,%ter g!vernment c!ntr!l !ver %!!d pricesB
A! incentive %!r the smuggler t! ship %!!d(
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3-.)
Invisible and
Invisible hand!% the mar9et pushessel%-interested pe!ple t! act %!r theg!!d !% s!ciety(
It is not from the benevolence of thebutcher, the brewer or the baker, that
we expect our dinner, but from their
regard to their own interest.
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3-.*
+uantity !% %ish
Demandbe%!re
?ar9ets in @imes !% Crisis
'ets destr!y wheatcr!p(
Increase in demand
%!r a substitute/ i(e(%ish(
Increase in price !%%ish(
1ishermen catchm!re %ish(
'rice
SupplyOld
e$uilibrium
Aewe$uilibrium
Demanda%ter
&4
&)
5 ;
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3-.5
+uantity !% !il
Demand
?ar9ets in @imes !% Crisis
#ar in the ?iddleast reduces supply!% !il(
'rice !% !il rises( igher price causes
pe!ple t! use less !il(
?ar9et !%%ers the bests!luti!n am!ng all thealternatives(
Supplya%ter
&'rice
Supplybe%!re
Aewe$uilibrium
Olde$uilibrium
.*
4
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3-.4
?ar9ets in @imes !% Crisis
urricane damage a%%ects the supply anddemand %!r b!ttled water(
Decrease in supply
Increase in demand
!w will it a%%ect new e$uilibrium price"
!w will it a%%ect new e$uilibrium $uantity"Only !ne can be determined/ the !ther isambigu!us(
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3-.;
urricane DamageIncrease in demand
6 Decrease in supply( igher price igher$uantity
Increase in demand
8 Decrease in supply( igher price L!wer$uantity
'rice 'rice
+uantity !% b!ttled water +uantity !% b!ttled water
Demandbe%!re Demand
be%!re
Demanda%ter
Demanda%ter
Supplya%ter
Supplya%ter
Supplybe%!re
Supplybe%!re
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3-.7
?ar9ets in @imes !% Crisis
'rice g!uging0
Increase in price as a result !% mar9etreacti!n t! increase in demand !rdecrease in supply(
It pr!vides incentive t! %irms t! sell m!re(
It pr!vides incentive t! c!nsumers t!c!nserve the g!!d sh!rt in supply(
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3-2
+uantity
Diam!nds vs( #ater
#hy d! mar9etsplace higher value !ndiam!nds than !n
preci!us water"
#ater is in muchgreater supply thandiam!nds(
'rice
#aterSupply
#aterdemand
Diam!ndsupply
Diam!nddemand
Diam!nd$uilibrium
#ater
$uilibrium
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3-2.
Diam!nds vs( #ater
, g!!dEs price is in%luenced by its marginal valuet! c!nsumers(
?arginal value additi!nal bene%it received %r!m
the last unit !% the g!!d c!nsumed( C!nsumers receive less marginal value %r!m a
g!!d the m!re they have !% it(
,t the e$uilibrium in mar9et %!r water/ s! muchwater is c!nsumed that marginal value is veryl!w(
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3-23
+uantity !% newly built h!mes s!ld
Demand
Increase in price !%devel!pable landincreases c!st !%
pr!ducti!n( Decrease in supply !%
newly built h!mes(
igher price andl!wer $uantity s!ld !%newly built h!mes(
AewSupply
'rice
OldSupply
Aew$uilibriuma%ter higherland prices
Old$uilibrium
be%!re higherland prices
?ar9et %!r Aewly Guilt !mes
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+uantity s!ld !% previ!usly built h!mes
Old Demand
Aewly built andprevi!usly !ccupiedh!mes are substitutes(
igher price !% newly builth!mes0
Increase in demand %!rprevi!usly !ccupiedh!mes
igher price and higher$uantity s!ld !% previ!usly!ccupied h!mes
'rice
Supply
Aew$uilibrium
be%!re higherprices !% new
h!mes
Old$uilibrium
be%!re higherprices !% new
h!mes
?ar9et %!r 'revi!usly Occupied !mes
Aew
Demand
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3-2*
D!
#hat are s!me e>amples !% %!rces that disturbmar9et e$uilibrium"
,ny changes that e%%ect demand !r supplydisturb mar9et e$uilibrium/ e(g(/ change in inputprices/ %uture e>pectati!ns/ change in price !%substitutes/ inn!vati!ns(
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D!
?ar9et%!rces guidesel%-interested pe!ple as i%by an invisible handt! act %!r the g!!d !%
s!ciety(
!w d!es marginal value relate t! the price !%water"
, g!!dEs price is in%luenced by its marginal valuet! c!nsumers( @he marginal value !% water isvery l!w since l!ts !% water is c!nsumed(
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Summary
$uilibrium #hen $uantity demandedmeets $uantity supplied(
Surplus #hen $uantity suppliede>ceeds $uantity demanded(
Sh!rtage #hen $uantity demandede>ceeds $uantity supplied(
, mar9et n!t at e$uilibrium m!ves t!wardse$uilibrium with change in price(
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Summary
, g!!dEs price is determined byintersecti!n !% demand and supply(
, change in demand !r supply shi%ts themar9et t! a new e$uilibrium(
?ar9et %!rces !%%er the best s!luti!n t! anychanges in the s!ciety(
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C!ming Hp
Gy h!w much d!es $uantitychange when there is a change in
price"