V Market (who, what, how)

V Supply and demand is an economic model

Designed to explain how prices are determined
in certain types of markets
V What you will learn in this chapter
How the model of supply and demand works
and how to use it
1. The law of demand
2. The law of supply
3. The determination of market equilibrium
4. Factors shifting demand or supply curves

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V On economics, a market is not a place but rather
a group of buyers and sellers with the potential
to trade with each other
Market is defined not by its location but by its
participants
First step in an economic analysis is to define and
characterize the market or collection of markets to
analyze
V Economists think of the economy as a
collection of individual markets

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V Defining the market often requires economists
to group things together
Aggregation is the combining of a group of distinct
things into a single whole
V Markets can be defined broadly or narrowly,
depending on our purpose
How broadly or narrowly markets are defined is one
of the most important differences between
Macroeconomics and Microeconomics

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V aoods and services are aggregated to the
[
[levels
Macro models lump all consumer goods into the
single category ¦consumption goods
Macro models will also analyze all capital goods as
one market
Macroeconomists take an overall view of the
economy without getting bogged down in details

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V Markets are defined narrowly
Focus on models that define much more specific
commodities
V Always involves some aggregation
But stops it reaches the highest level of generality
that macroeconomics investigates

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V Buyers and sellers in a market can be
Households
Business firms
aovernment agencies
All three can be both buyers and sellers in the same
market, but are not always
V For purposes of simplification this text will
usually follow these guidelines
On markets for consumer goods, we0ll view
business firms as the only sellers, and households
as only buyers
On most of our discussions, we0ll be leaving out
the ¦middleman
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V On imperfectly competitive markets, individual buyers
or sellers can influence the price of the product
V On perfectly competitive markets (or just competitive
markets), each buyer and seller takes the market price
as a given
V What makes some markets imperfectly competitive
and others perfectly competitive?
Perfectly competitive markets have many small buyers and
sellers
Each is a small part of the market, and the product is standardized
Omperfectly competitive markets have just a few large buyers
and sellers
Œr else the product of each seller is unique in some way

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V Supply and demand model is designed to
explain how   
 in  


   markets
Perfect competition is rare but many markets come
reasonably close
Perfect competition is a matter of degree rather than
an all or nothing characteristic

V Supply and demand is one of the most versatile

and widely used models in the economist0s tool
kit

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V ×

0 quantity demanded of a good
Specific amount household would choose to buy
over some time period, given
A particular price that must be paid for the good
All other constraints on the household
 
 quantity demanded (or quantity
demanded) is the specific amount of a good
that all buyers in the market would choose to
buy over some time period, given
A particular price they must pay for the good
All other constraints on households

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V Omplies a choice
How much households would like to buy when they take into
account the opportunity cost of their decisions?
V Os hypothetical
Makes no assumptions about availability of the good
How much would households want to buy, at a specific price,
given real-world limits on their spending power?
V Stresses price
Price of the good is one variable among many that influences
quantity demanded
We0ll assume that all other influences on demand are held
constant, so we can explore the relationship between price and
quantity demanded

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V The price of a good rises and everything else
remains the same, the quantity of the good
demanded will fall
The words, ¦everything else remains the same are
important
On the real world many variables change
simultaneously
However, in order to understand the economy we must
first understand each variable separately
Thus we assume that, ¦everything else remains the
same, in order to understand how demand reacts to
price

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V Demand schedule
A list showing the quantity of a good that consumers
would choose to purchase at different prices, with all
other variables held constant
V Demand V.S. Quantities demanded
- demand is the entire relationship between
price and quantity
- quantities demanded are specific amount of
goods buyers want to buy

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V The market demand curve (or just demand
curve) shows the relationship between the
price of a good and the quantity demanded ,
holding constant all other variables that
influence demand
Each point on the curve shows the total buyers
would choose to buy at a specific price
V Law of demand tells us that demand curves
virtually always slope downward

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V Move along the demand curve
From a change in the 
 of the good we
analyze
V On maple syrup example, Figure 1
A fall in price would cause a movement to the right along the
demand curve (point A to B)
V See figure 3(a)

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V Shift of demand curve
a change in other things than price of the good
causes a shift in the demand curve itself, for example,
income
V On Figure 2
Demand curve has shifted to the right of the old
curve (from Figure 1) as income has risen
A change in any variable that affects demandr
except for the good0s pricercauses the demand
curve to shift

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V Language is important when discussing
demand
¦Quantity demanded means
A particular amount that buyers would choose to buy at a
specific price
Ot is a number represented by a 

  on a demand
curve
When a change in the price of a good moves us along a
demand curve, it is a change in quantity demand
The term demand means
The entire relationship between price and quantity
demandedrand represented by the   
  
When something other than price changes, causing the entire
demand curve to shift, it is a change in demand
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V An increase in income has effect of shifting
demand for normal goods to the right
However, a rise in income shifts demand for inferior
goods to the left
V A rise in income will increase the demand for a
normal good, and decrease the demand for an
inferior good
V Normal good and inferior good are defined by
the relation between demand and income

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V Dour wealthrat any point in timeris the total
value of everything you own minus the total
dollar amount you owe
- Example
V An increase in wealth will
Oncrease demand (shift the curve rightward) for a
normal good
Decrease demand (shift the curve leftward) for an
inferior good

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V Substitutergood that can be used in place of
some other good and that fulfills more or less
the same purpose
Example
A rise in the price of a substitute increases the
demand for a good, shifting the demand curve to the
right
V Complementrused together with the good we
are interested in
Example
A rise in the price of a complement decreases the
demand for a good, shifting the demand curve to the
left
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V Population
As the population increases in an area
Number of buyers will ordinarily increase
Demand for a good will increase
V Expected Price
An expectation that price will rise (fall) in the future shifts the
current demand curve rightward (leftward)
V Tastes
Combination of all the personal factors that go into determining
how a buyer feels about a good
When tastes change toward a good, demand increases, and the
demand curve shifts to the right
When tastes change away from a good, demand decreases, and
the demand curve shifts to the left

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V O 
(depends on good0s nature: normal or
inferior)
V W
[(depends on good0s nature)
V G    (positively related)
V G 


  (negatively related)
V G
  (positively related)
V À   (positively related)
V ` (positively related)

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V A firm0s R  
 of a good is the
specific amount its managers would choose to
sell over some time period, given
A particular price for the good
All other constraints on the firm
 
 quantity supplied (or quantity
supplied) is the specific amount of a good that
all sellers in the market would choose to sell
over some time period, given
A particular price for the good
All other constraints on firms

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V Omplies a choice
Quantity that gives firms the highest possible profits when they
take account of the constraints presented to them by the real
world
V Os hypothetical
Does not make assumptions about firms0 ability to sell the good
How much would firms0 managers want to sell, given the price
of the good and all other constraints they must consider?
V Stresses price
The price of the good is just one variable among many that
influences quantity supplied
We0ll assume that all other influences on supply are held
constant, so we can explore the relationship between price and
quantity supplied

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V States that when the price of a good rises and
everything else remains the same, the quantity
of the good supplied will rise
The words, ¦everything else remains the same are
important
On the real world many variables change
simultaneously
However, in order to understand the economy we must
first understand each variable separately
We assume ¦everything else remains the same in order
to understand how supply reacts to price

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V Supply schedulershows quantities of a good
or service firms would choose to produce and
sell at different prices, with all other variables
held constant
V Supply curvergraphical depiction of a supply
schedule
Shows quantity of a good or service supplied at
various prices, with all other variables held constant

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V A change in the price of a good causes a
movement along the supply curve
On Figure 4
A rise (fall) in price would cause a rightward (leftward)
movement along the supply curve
V A drop in transportation costs will cause a shift
in the supply curve itself
On Figure 5
Supply curve has shifted to the right of the old curve (from
Figure 4) as transportation costs have dropped
A change in any variable that affects supplyrexcept for the
good0s pricercauses the supply curve to shift

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V Onput prices
A fall (rise) in the price of an input causes an
increase (decrease) in supply, shifting the supply
curve to the right (left)
V Price of Related aoods
When the price of an alternate good rises (falls),
the supply curve for the good in question shifts
leftward (rightward)
V Technology
Cost-saving technological advances increase the
supply of a good, shifting the supply curve to the
right
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V Number of Firms
An increase (decrease) in the number of sellersr
with no other changesrshifts the supply curve to
the right (left)
V Expected Price
An expectation of a future price increase (decrease)
shifts the current supply curve to the left (right)

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V Changes in weather
Favorable weather
Oncreases crop yields
Causes a rightward shift of the supply curve for that crop
Xnfavorable weather
Destroys crops
Shrinks yields
Shifts the supply curve leftward
V Œther unfavorable natural events may effect all
firms in an area
Causing a leftward shift in the supply curve

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V The short list of shift-variables for supply that
we have discussed is far from exhaustive
V On some cases, even the threat of such events
can cause serious effects on production
V Basic principle is always the same
Anything that makes sellers want to sell more or less
of a good at any given price will shift supply curve

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V When a market is in equilibrium
Both price of good and quantity bought and sold
have settled into  
The equilibrium price and equilibrium quantity are
values for price and quantity in the market but, once
achieved, will remain constant
Xnless and until supply curve or demand curve shifts
V The equilibrium price and equilibrium quantity
can be found on the vertical and horizontal
axes, respectively
At point where supply and demand curves cross

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V Excess demand
At a given price, the excess of quantity demanded
over quantity supplied
V Price of the good will rise as buyers compete
with each other to get more of the good than is
available

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V Excess Supply
At a given price, the excess of quantity supplied over
quantity demanded
V Price of the good will fall as sellers compete
with each other to sell more of the good than
buyers want

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V Suppose that demand is given by the
equation , where is quantity

÷
demanded, P is — the´price
G of the good. Supply is
given by where is quantity
supplied.


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V What is the

equilibrium price and quantity?

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V Oncome rises, causing an increase in demand
Rightward shift in the demand curve causes
rightward movement along the supply curve
Equilibrium price and equilibrium quantity both rise
V Shift of one curve causes a movement along the
other curve to new equilibrium point

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V An ice storm causes a decrease in supply
Weather is a shift variable for supply curve
Any change that shifts the supply curve leftward in a
market will increase the equilibrium price
ù And decrease the equilibrium quantity in that market

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V Why did Oraq0s invasion of Kuwait cause the
price of oil to rise?
Ommediately after the invasion, Xnited States led a
worldwide embargo on oil from both Oraq and
Kuwait
A significant decrease in the oil industry0s
productive capacity caused a shift in the supply
curve to the left
Price of oil increased

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V Why did the price of natural gas rise as well?
Œil is a substitute for natural gas
Rise in the price of a substitute increases demand for
a good
Rise in price of oil caused demand curve for natural
gas to shift to the right
Thus, the price of natural gas rose

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V When just one curve shifts (and we know the
direction of the shift) we can determine the
direction that both equilibrium price and
quantity will move
V When both curves shift (and we know the
direction of the shifts) we can determine the
direction for either price or quantityrbut not
both
Direction of the other will depend on which curve
shifts by more

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V Key Step 1rCharacterize the Market
Decide which market or markets best suit problem
being analyzed and identify decision makers (buyers
and sellers) who interact there
V Key Step 2rFind the Equilibrium
Describe conditions necessary for equilibrium in the
market, and a method for determining that
equilibrium
V Key Step 3rWhat Happens When Things
Change
Explore how events or government polices change
market equilibrium

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V Example: problem 4, 
 
 
 

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chapter 3 in textbook.
V Demand & Supply º á O
Diagram
V Equilibrium P & Q O @ë O—

V Why $1000 can not be O@ @@ O^

equilibrium?
V Effects from a tornado O— Oè Oè
destroying some
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apartments.
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V Through the study of the chapter, you will be able to
V Characterize a market.
V Xse a demand schedule and a demand curve to demonstrate
the law of demand.
V Explain the difference between a [
 
 (shift of the
curve) and a [
 R  
  (movement along the
curve).
V List the factors that will lead to a change in demand, and give
examples of each.
V Similar analysis for supply side.
V Explain how equilibrium price and quantity are determined
in a competitive market.
V Explain what will happen in a competitive market after a shift
in the supply curve, the demand curve, or both.
V Describe the three steps economists take to answer almost
any question about the economy.

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