Chapter 3 - Markets. In this chapter you will learn: Characteristics of a competitive market, how to construct a demand curve, shift in vs. a movement along the demand curve, how to construct a supply curve, shift in supply vs. movement along supply curve, how demand and supply interact to bring markets to equilibrium, how changes in supply and demand influence equilibrium price and quantity.
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Chapter 3
Markets
© 2014 by McGraw‐Hill Education 2
What will you learn in this chapter?
• Characteristics of a competitive market
• How to construct a demand curve
• Shift in vs. a movement along the demand curve
• How to construct a supply curve
• Shift in supply vs. movement along supply curve
• How demand and supply interact to bring markets
to equilibrium
• How changes in supply and demand influence
equilibrium price and quantity
Markets
• A marketrefers to the buyers and sellers who trade a
particular good or service
–Markets can be located locally, globally, or even virtually
• One special class of markets is the competitive market.
• Four characteristics of perfectly competitive markets
• In this chapter, markets are assumed to be perfectly
competitive
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Demand
for a product.
particular good or service that buyers are
willing and able to purchase at a given price.
• The law of demand states that the lower the
price, the higher the quantity demanded, all
other things equal.
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Cell phones
(millions)
Price
($)
30
90 120 150 180 210 240 270
60
180
140 160
120 100 80 60 40 20
The demand schedule
• A demand schedule
displays the quantities
demanded at various
prices
• This demand schedule
provides the quantity of
cellphones demanded at
specific prices
• Notice that as price falls,
the quantity demanded
increases
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Cell phones
(millions)
Price
($)
30
90 120 150 180 210 240 270
60
180
140 160
120 100 80 60 40 20
The demand curve
Quantity of cell phones (millions)
30 60 90 120 150 180 210 240 270
1. As the price decreases…
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220
Price ($)
2. …the quantity demand increases.
The demand curve illustrates the relationship between the quantity demanded and the
price of the good, holding all of the other non‐price determinants constant.
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Active Learning: Constructing demand
Use the following demand schedule to construct the demand curve.
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140 160 180 200 220 240 260 280 300 P
Q
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Changes in demand
determinants changes?
–If positive influence, demand increases
–If negative influence, demand decreases
Preferences Number of buyers
Incomes Expectations
Price of related goods
• When demand increases, the demand curve shifts
to the right
• When demand decreases, the demand curve shifts
to the left
Shifting the demand curve
0
40
80
120
160
200
240
Quantity of cell phones (millions)
Price ($)
D A
D B
D C
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Shifts versus movements
There is an important difference between a shift in the demand
curveand a movement along the demand curve
If the price decreases, then quantity demanded increases and there is a movement along the demand curve.
If a non‐price determinant changes,
then the demand curve shifts with
changes in the quantity demanded
at every price.
Quantity of cell phones (millions)
0
40
80
120
160
200
240
60 120 180 240
Price ($)
DB DA DC
D
Quantity of cell phones (millions)
0 40 80 120 160 200 240
60 120 180 240
Price ($)
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Active Learning: Shifts vs. movements
Indicate whether a shift or movement occurs in
the market for cellphones when each of the
following determinants changes.
–Advertising causes individuals to prefer cellphones
over home phones
–Cellphones go on sale
–Cellphone calling plans become more expensive
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Supply
a product.
• The quantity supplied is the amount of a
particular good that producers are willing and
able to purchase at a given price.
• The law of supply states that the higher the
price, the higher the quantity supplied, all
other things equal.
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Cell phones
(millions)
Price
($)
270
210 180 150 120 90 60 30
240
180
140 160
120 100 80 60 40 20
The supply schedule
• A supply schedule
displays the
quantities supplied at
various prices
• This supply schedule
provides the quantity
of cellphones
supplied at specific
prices
• Notice that as price
increases, the
quantity supplied
increases
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Cell phones
(millions)
Price
($)
270
210 180 150 120 90 60 30
240
180
140 160
120 100 80 60 40 20
The supply curve
2 quantity supplied increases…
0
20
40
60
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100
120
140
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180
200
30 60 90 120 150 180 210 240 270
Price ($)
Quantity of cell phones (millions)
1 As price increases…
Active Learning: Constructing supply
Use the following supply schedule to construct the supply curve
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140 160 180 200 220 240 260 280 300 P
Q
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Changes in supply
determinants of supply are:
determinants changes?
–If positive influence, supply increases
–If negative influence, supply decreases
Technology Number of producers
Price of Inputs Expectations
Price of related goods
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• When supply increases, the supply curve shifts to the right
• When supply decreases, the supply curve shifts to the left
Shifting the supply curve
0
40
80
120
160
200
240
Quantity of cell phones (millions)
Price ($)
S A
S C
S B
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Shifts versus movements
There is an important difference between a shift in the supply
curveand a movement along the supply curve
If a non‐price determinant changes,
then the supply curve shifts with
changes in the quantity supplied at
every price.
If the price decreases, then quantity supplied decreases and there is a movement along the supply curve.
Quantity of cell phones (millions)
0
40
80
120
160
200
240
60 120 180 240 300
Price ($)
S C
S A
S B
Quantity of cell phones (millions)
0 40 80 120 160 200 240
60 120 180 240 300
Price ($)
SA
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Active Learning: Shifts vs. movements
in the market for cellphones when each of the
following determinants change.
–A new Chinese cellphone manufacturer enters the
market
–Producers expect cellphones prices to rise
–The price of calling over the Internet (e.g. Skype)
decreases
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Market equilibrium
• The equilibrium is where
the supply curve intersects the demand curve
–At this point,consumers are willing to buy exactly what producers are willing to sell
• The equilibrium price is
$100
• The equilibrium quantity
is 150 M
Quantity of cell phones (millions)
0
200
Price ($)
S
D
50
100
150
Active Learning: Finding equilibrium
1) Graph the supply and demand curve and find the equilibrium.
2) Circle the market equilibrium price and quantity in the schedule.
0 1 2 3 4 5 6 7 8
P
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Disequilibrium
• What happens when the market is not in
equilibrium?
• If the market price is not equal to the equilibrium
price, then quantity demanded is not equal to
quantity supplied
–If the price is too high, excess supplyoccurs and there
is a surplusof the good or service
• A lower price alleviates the surplus.
–If the price is too low, excess demand occurs and there
is a shortageof the good or service
• A higher price alleviates the shortage.
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A surplus
• A surplus provides incentives for the price to decrease.
• As the price decreases…
1) The quantity supplied
decreases
2) The quantity demanded increases
• The price continues to decrease until QS = QD = Q*
40
80
160
120
200
300
Price ($)
Quantity of cell phones (millions)
S
D
Surplus
(excess supply)
Price is too high
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A shortage
• A shortage provides incentives for the price to increase.
• As the price increases…
1) The quantity supplied
increases
2) The quantity demanded
decreases
• The price continues to increase until QS = QD = Q*
S
D
Quantity of cell phones (millions)
0
40
80
160
120
200
Price ($)
Shortage
(excess demand)
Price is
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Active Learning: Excess supply
1) Find the quantity demanded and quantity supplied at a price of $3.
2) Quantify the excess supply (surplus).
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Active Learning: Excess demand
1) Find the quantity demanded and quantity supplied at a price of $1.
2) Quantify the excess demand (shortage).
Changes in market equilibrium
• The equilibrium price and quantity are determined by the
intersection of the demand and supply curves
• If a non‐price factor changes, this affects the market
equilibrium
• To determine the effect on market equilibrium, there are
three questions that must be answered:
– Does the change affect demand? If so, how?
– Does the change affect supply? If so, how?
– What happens to equilibrium price and quantity?
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Shifts in demand
Suppose the price of land‐line service suddenly
skyrockets.
D 2
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120
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180
200
0 30 60 90 120 150 180 210 240 270 300
Quantity of cell phones (millions)
Price ($)
D 1
S 2
• Market for cellphones isin equilibrium
• More expensive substitute causesthe demand to increase
• The demand curve shifts right
• The market equilibrium changes
– Equilibrium price increases.
– Equilibrium quantity increases.
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Active Learning: Equilibrium effects from
shifts in demand
Suppose the demand curve shifts outward by 60 units. Update
the demand schedule and find the new equilibrium price and
quantity
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S 2
Shifts in supply
• Market for cellphones is
initially in equilibrium
• Increased technology causes
the supply to increase
• The supply curve shifts right
• The market equilibrium changes
– Equilibrium price decreases.
– Equilibrium quantity
increases.
Suppose there is a breakthrough in battery technology
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200
0 30 60 90 120 150 180 210 240 270 300
Quantity of cell phones (millions)
Price ($)
D 1
S 1
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Active Learning: Equilibrium effects from
shifts in supply
D
S P
Q
P*
Q*
Ice Cream Market
Suppose the cost of sugar, an input for making ice cream,
increases. Identify whether supply, demand, or both shift(s)
and the new equilibrium price and quantity for ice cream
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Shifts in demand or supply
When either demand or supply changes, there is
an unambiguous effect on equilibrium price and
quantity.
Curve Change Price change Quantity change
Supply Decrease
Supply Increase
Demand Decrease
Demand Increase
Shifts in both demand and supply
• It is possible for non‐price factors that influence both
demand and supply at the same time
• This leads to shifts in both demand and supply
• The new equilibrium occurs at the new intersection
• Suppose that landline phone service prices increase
and an input price to make cellphones decreases
–Demandincreases
–Supply increases
• What happens to equilibrium price and quantity?
–It depends on whether the demand or supply curve shifts
out more
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Shifts in both demand and supply
New equilibrium
– Quantity increases.
– Price increases.
Conclusion: Quantity increases.
Price may increase or decrease (ambiguous).
New equilibrium
– Quantity increases.
– Price decreases.
Quantity of cell phones (millions)
0
60
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100
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120
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200
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160
30 60 90 120 150 180 210 240 270 300
Price ($)
(A) Demand increases more
S 1
D 2
S 2
E 1 E 2
D 1
(B) Supply increases more
Quantity of cell phones (millions)
0
60
20
100 80 120 140 200
160
30 60 90 120 150 180 210 240 270
Price ($)
S 1
S 2
E E
D
D 2
1 2
1
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Shifts in demand and supply
When both supply and demand shift and the
magnitudes of change are unknown, the effect
on either price or quantity is known, but not
both.
Supply change Demand change Price change Quantity change
Decrease Decrease
Decrease Increase
Increase Increase
Increase Decrease
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Summary
who trade.
–A competitive market exists if a large number of
buyers and sellers trade standardized goods and
services
–Modeled using supply and demand
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Summary
willingness to pay for a given quantity.
–The demand curve has a negative slope
shifts to the left or the right.
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Summary
that they must receive to sell a given quantity.
–The supply curve has a positive slope
to the left or the right.
Summary
when quantity supplied equals quantity
demanded. At this point:
–Producerssell all they desire at the equilibrium price
–Consumersbuy all they desire at the equilibrium price
• If the market price is not equal to the equilibrium
price, then a surplus or shortage exists, and the
price adjusts until quantity demanded is equal to
quantity supplied
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Summary
effect on equilibrium price and quantity can be
evaluated by:
–Determining whether supply, demand, or both are
affected
–Determining the direction supply, demand, or both
shift(s)
–Comparing the new equilibrium to the initial
equilibrium to identify the effect on price and
quantity