• many people reply supply equals demand • this statement summarizes a simple, yet powerful model Supply and demand model • most widely-used economic model • testable like all good theo
Trang 1Chapter 2
Supply and Demand
Key issues
• demand
• supply
• market equilibrium
• shocking the equilibrium
• effects of government interventions
• when to use supply and demand model
Today's questions
1 What is the effect of a ban on foreign imports of
rice into Japan on the supply of rice to the
Japanese market?
2 What is the effect of a price control (ceiling)?
3 What is the effect of instituting usury laws?
4 Could the Immigration Reform and Control Act
create a labor shortage for farmers?
5 Will the mad cow crisis lower beef prices in the
United States?
What is the most important thing you know about economics?
• many people reply
supply equals demand
• this statement summarizes a simple, yet powerful model
Supply and demand model
• most widely-used economic model
• testable (like all good theories)
• describes how consumers and suppliers
interact in a market to determine quantity of
a good sold and its price
To use supply and demand model
• you need to determine
• buyers' behavior
• sellers' behavior
• how they interact
• know where to use the model:
in competitive markets
Trang 2Quantity demanded
is the amount of a good or service that
consumers want to buy at a given price,
holding constant other factors that affect
demand
What determines demand?
• tastes
• price of this good
• prices of other goods
• income
• information (cholesterol)
• government actions
• other factors: nicotine,
Demand curve
• shows quantity demanded—largest quantity that
consumers are willing to buy—at each price,
holding constant other factors that affect purchases
• note: quantity demanded of a good or service can
exceed quantity sold (or vice versa)
• strange demand curve convention: price is on the
vertical axis
Figure 2.1 Demand Curve for Canadian Processed Pork
p , $ per kg
200 220
Demand curve for pork, D1
Q, Million kg of pork per year
0 2.30 3.30 4.30 14.30
Effect of price changes
• movement along the demand curve
• demand curve is a concise summary of the
answer to the question:
what happens to the quantity demanded as the
price changes, holding all other factors
constant?
Law of demand
• demand curves slope down
• ⇒a drop in price results in an increase in quantity demanded (holding other factors constant)
• one of the most important empirical finding
in economics
Trang 3Demand effects of other factors
• change in any factor other than the price of
the good causes a shift of the demand curve
(not a movement along the demand curve)
• this shift of the demand curve is a trick to
avoid drawing 3D diagrams
Effect on pork demand of a rise
in price of beef
• beef is a substitute for pork
• at a given price of pork, a rise in the price of beef causes some people to switch from beef to pork
Figure 2.2 A Shift of the Pork Demand Curve
p, $ per kg
220 176
Effect of a 60¢ increase in the price of beef
D1
D2
232
Q, Million kg of pork per year
0
3.30
Summary
• change in the price of a good causes a
movement along a demand curve
• change in any other factor besides the price causes a shift of the demand curve
Variable definitions
• Q = quantity of pork demanded (million kg
per year)
• p = price of pork ($ per kg)
• p b= price of beef ($ per kg)
• p c= price of chicken ($ per kg)
• Y = income of consumers (thousand $)
Demand function
• general function
Q = D(p, p b , p c , Y)
• specific (linear) pork demand function
Trang 4Hold other factors constant
• D1(Figure 2.1) holds p b , p c , and Y at their
typical values:
Y = $12.5 thousand
• Q = 171 – 20p + 20p b + 3p c + 2Y
= 171 – 20p + (20 x 4) + (3 x 3 1/3) + (2 x 12.5)
= 286 – 20p
p , $ per kg
200 220
Demand curve for pork, D1
Q, Million kg of pork per year
0 2.30 3.30 4.30 14.30
Plotting demand function:
Intercept
• Q = 286 – 20p
• constant term, 286, is the quantity
demanded if price is zero
• Q = 286 - (20 x 0) = 286
Plotting demand function: Slope
• Q = 286 – 20p
• number on price, 20, is rate at which quantity changes as price changes
∆Q = Q 2 - Q 1 = D(p 2 ) – D(p 1 )
= (286 – 20p 2 ) - (286 – 20p 1 )
= -20(p 2 – p 1) = -20 ∆p
Slope of pork demand curve
• ∆p/∆Q = [the "rise"]/[the "run"]
= [$1 per kg]/[-20 million kg per year]
= -$0.05 per million kg per year
• negative sign is consistent with Law of
Demand
Calculus
• Q = 286 – 20p
• differentiate:
20
dQ
Trang 5Summing demand curves
• total demand is sum of demand for all consumers
• suppose there are 2 consumers with demand
curves:
Q1= D1(p)
Q2= D2(p)
• total quantity demanded = horizontal sum of
quantity each consumer demands at each given
price:
Q = Q1+ Q2= D1(p) + D2(p)
p, $ per ton
50
Q, Tons of peaches per 10,000 people per year
0
275
183
Total demand
Demand for canned peaches Demand for fruit cocktail
Q c = 18 Q = 22
Q f= 4
Quantity supplied
is the amount of a good or service that firms
want to sell at a given price, holding
constant other factors that affect supply
Supply is a function of
• price
• costs of production
• government rules and regulations
• technology…
Supply curve
• increase in price of pork causes a movement
along the supply curve (holding fixed other
variables that affect supply)
• supply curve is a concise summary of
answer to the question:
what happens to the quantity supplied as
the price changes holding all other factors
constant?
Figure 2.3 Supply Curve of Canadian Processed Pork
p, $ per kg
220 176
Supply curve, S1
300
Q, Million kg of pork per year
0 3.30 5.30
Trang 6Effect of price on supply
• supply curve for pork is upward sloping
• thus, increase in the price of pork ⇒
movement along the supply curve, resulting
in larger quantity of pork supplied
There is no "Law of Supply"
market supply curve may be upward sloping, vertical, horizontal, or downward sloping
Supply effects of other variables
shift in a variable other than price of pork
causes the entire supply curve to shift
Figure 2.4 A Shift of Pork Supply Curve
p , $ per kg
205 176
Effect of a 25¢ increase in the price of hogs
S1
S2
220
Q, Million kg of pork per year
0 3.30
Summary
• change in price of pork causes a movement
along the supply curve
• when costs, government rules, or other
variables that affect supply change, the
supply curve shifts
General supply function
Q = S(p, ph),
Q = the quantity of processed pork supplied
(million kg per year)
p = price of processed pork ($ per kg)
Trang 7Specific linear pork supply
function
holding p h fixed at its average value of
$1.50 per the supply function is
Q = 88 + 40p
Movement along the supply
curve
• supply function:
Q = 88 + 40p
• if price of processed pork increases by
∆p = p2- p1
• then
∆Q = 40∆p
Calculus
• Q = 88 + 44p
• differentiate:
44
dQ
Summing supply curves
total supply curve
• horizontal summation of individual supply curves
• shows total quantity produced by all suppliers at each possible price
Total Supply: The Sum of Domestic and Foreign Supply
p , Price
per ton
p, Price
per ton
p, Price
per ton
Q
d*
S d
Q
f* Q* = Q
d * + Q
f*
Q
d, Tons per year Q
f, Tons per year Q, Tons per year
(a) Japanese Domestic Supply (b) Foreign Supply (c) Total Supply
S (no ban)
S f(no ban)
Solved problem
• What is the effect of a ban on foreign imports of rice into Japan on the supply curve of rice to the Japanese market?
• (suppose that domestic and foreign supply curves of rice in Japan are linear, upward sloping curves with the same intercept and different slopes)
Trang 8Restatement of problem
• in most of our problems we are asked to
determine how a change in a variable or
policy affects one or more variables
• what changes: foreign rice may no longer
be imported
• which affects foreign supply and total
Japanese supply curve
Answer
1 show what the ban does to the foreign supply: ban
lies on the vertical axis
2 compare the new and original foreign supply curves: at prices above the price where foreign
supplier originally supplied quantity, the new foreign supply curve lies to left of original one
Answer (continued)
3 show what happens to new total supply: new total
supply curve is the horizontal sum of the Japanese
supply curve, S d , and foreign supply curve, S f
Thus, new total supply curve is identical to
domestic supply curve
4 compare new and original total supply curves: at
any price above the price where any quantity was
originally supplied by foreign suppliers, the new
total supply curve lies to the left of the original
one
Figure 2.5 Total Supply: The Sum of Domestic and Foreign Supply
p , Price
per ton
p, Price
per ton
p, Price
per ton
Q
d*
S d S f(ban)
Q
f* Q = Q
d* Q* = Q
d * + Q
f*
Q
d, Tons per year Q
f, Tons per year Q, Tons per year
(a) Japanese Domestic Supply (b) Foreign Supply (c) Total Supply
S (ban) S (no ban)
S f(no ban)
Quota
next figure shows the effect of a (nonzero)
quota on the supply curve of rice
p, Price
per ton
p, Price
per ton
p, Price
per ton
S d
Q, Tons per year
(a) U.S Domestic Supply (b) Foreign Supply (c) Total Supply
S
S
Q d Q f Q
d, Tons per year Q
f, Tons per year
Q d* Q f*
S f
S f
Q d *+ Q f*
Q d * + Q f
Q d + Q f
Trang 9Supply and demand: Market
equilibrium
• supply and demand curves determine
market price and quantity
• unless price is set so that consumers want to
buy exactly as much as suppliers want to
sell, some party will be frustrated
• when neither buyers nor sellers are
disappointed, market is in equilibrium: no
one wants to change his or her behavior
Equilibrium
• equilibrium price: price where
• consumers can buy as much as they want
• sellers can sell as much as they want
• equilibrium quantity:quantity bought and
sold at the equilibrium price
Figure 2.6 Pork Market Equilibrium
p , $ per kg
220 176
D
S e
233 246
194 207
Q, Million kg of pork per year
0
3.95
3.30
2.65
Excess supply = 39
Excess demand = 39
Determine equilibrium price
• find price, p, that equates equilibrium demand and
quantity:
286 - 88 = 40p + 20p
198 = 60p 3.30 = p
Determine equilibrium quantity
• substitute equilibrium price, p = $3.30, into
demand function or supply function to
determine equilibrium quantity:
• Q d= 286 – (20 x 3.30)
= 88 + (40 x 3.30) = Q s
= 220 = Q
Invisible hand
at nonequilibrium price, consumers or firms change their behavior (market forces) driving price to equilibrium level
Trang 10Market forces drive market to
equilibrium
• at prices < equilibrium level: excess demand
(amount by which quantity demanded
exceeds quantity supplied at the specified
price)
• at price > equilibrium level: excess supply
• equilibrium price is market clearing price:
no excess demand or excess supply
p , $ per kg
220 176
D
S e
233 246
194 207
Q, Million kg of pork per year
0
3.95 3.30 2.65
Excess supply = 39
Excess demand = 39
Shocking the equilibrium
• once an equilibrium is achieved, it can
persist indefinitely because no one applies
pressure to change the price
• equilibrium changes only if
• demand curve shifts
• supply curve shifts
• government intervenes
Figure 2.7a Effects of a Shift of the Pork Demand Curve
D1
D2
S
176
Q, Million kg of pork per year
Excess demand = 12
3.30
e 2
e1
p, $ per kg
(a) Effect of a 60¢ Increase in the Price of Beef
Figure 2.7b Effects of a Shift of the Pork Demand Curve
S1
1
e 2
D
p, $ per kg
(b) Effect of a 25¢ Increase in the Price of Hogs
176
S 2
Government policies
• ceiling price
• price controls
• usury laws
• rent control
• floor price: minimum wage
• quotas (restriction on supply)
• taxes and tariffs (tax on imports only)
Trang 11Zimbabwe price controls
• October 2001 during a presidential campaign,
Zimbabwe’s government imposed price controls
on many basic commodities
• foods (about a third of citizens’ daily consumption)
• soap
• cement
• controls led to shortages
• thriving black or parallel market developed
• black market prices 2 to 3 x controlled prices
Zimbabwe: Cement
• cement manufacturers stopped accepting new orders when price controls were imposed
• dealers quickly shifted existing supplies to the parallel market
• lack of cement crippled the construction industry
• by May 2002, the government nearly doubled control price of cement in an effort to induce firms
to resume selling cement
Zimbabwe: Food
• sugar is significantly cheaper than in surrounding
regions
• smuggling to other countries
• Zimbabwe suffered from sugar shortage
• supermarkets have no maize-meal, sugar, and
cooking oil on many days
• bakers scaled back operation they have only half
as much flour as before controls
• because of shortages, many people may starve
Solved problem: Minimum wage
• What is the effect of a minimum wage on a labor market?
• restatement:
• what changes is that government sets a minimum wage, w*, that must be paid
• affects equilibrium wage, equilibrium hours
worked
Minimum Wage
w, wage
H s H
H d
Minimum wage
D S
H, Hours worked
Excess supply: Unemployment
w
e
w*
Supply need not equal demand
does not necessarily equal quantity demanded
• quantity supplied = amount firms want to sell at a
given price, holding constant other factors that affect supply
• quantity demanded = amount consumers want to
buy at a given price, holding constant other factors
Trang 12Permanent excess demand or
supply
quantity demanded and quantity supplied at
a given price need not equal actual quantity
that is bought and sold:
• can get persistent excess demand (price
ceiling)
• can get persistent excess supply (price
floor)
Supply equals demand
if someone insists that "demand must equal supply," they must be defining demand and supply as the actual quantities sold
• we define quantities supplied and demanded
in terms of peoples' wants
• thus, statement that "supply equals demand"
is a theory, not merely a definition
When to use supply and demand
model
• many buyers and sellers
• firms sell identical goods
• firms are price takers
• no uncertainty: everyone has full
information about price and quality of
goods
• low transaction costs: buyers and sellers can
trade easily
When supply and demand model
is inappropriate
• only a few sellers (auto manufacturers)
• buyers and sellers are uncertain about the market equilibrium (concert music business)
• consumers know much less than sellers about quality or price (used cars)
• high transaction costs (art work)
Use supply and demand model in
• agricultural markets
• financial
• labor
• construction
• services
• wholesale
• retail
1 Demand curve summary
• demand curve: relationship between quantity demanded and price, fixing other factors
• Law of Demand: demand curves slope down
• change in price causes a movement along the demand curve
• change in income, tastes, or another factor other
than price, causes a shift of the demand curve
• total demand curve = horizontal sum of individuals’ demand curves
Trang 132 Supply curves
• supply curve: relationship between quantity
supplied and price, holding constant other factors
• market supply curve need not slope up but
frequently does
• change in price causes a movement along the
supply curve
• shift in the price of an input or government
regulations cause a shift of the supply curve
• total supply curve = horizontal sum of individual
firms’ supply curves
3 Market equilibrium
• intersection of demand and supply curves determines market equilibrium price and quantity
• market force drive the price and quantity to the equilibrium levels if they are initially too low or too high
4 Shocks
change in an underlying factor other than
price that causes a shift of the supply curve
or the demand curve, alters the equilibrium
5 Effects of government
intervention
government policies, such as price controls, can cause the quantity supplied to be greater
or less than the quantity demanded, so that there are persistent shortages or excesses
6 When to use supply and
demand model
• supply and demand model is applicable
only in competitive markets
• competitive markets: homogeneous goods,
many buyers and sellers (price takers)