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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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