Econ Week 3: Supply and Demand
The supply curve
a graph illustrating how much of a product a firm will supply at different prices -upwards sloping, increase in price, increase in incentives, increase in supply b/c producers want to produce more (low hanging fruit principle) horizontal interpretation: price determines the quantity to be supplied vertical interpretation: quantity determines the seller's reservation price (marginal cost) of producing the marginal unit
Suppliers (#of) (shifter of supply)
-entry or exit of sellers -as producers/sellers enter and exit the market, the overall supply changes -if 10 producers and 2 go out of business, supply is going to shift to the left (you don't know if remaining companies have resources to replace the 2 other ones but you DO KNOW that the supply has decreased if there are two fewer produces) -don't assume that other companies will produce more to cover the sellers that left
Resolving a Market Surplus
-price is too high -QS > QD, a surplus -buyer and seller behaviors kick in (sellers lower the price, so the buyers buy more fixing the surplus) -Sellers have an incentive to decrease the price in order to sell more -as price decrease, the quantity offered for sale decreases along the supply curve and the quantity demanded increases along the demand curve -price will fall to equilibrium price, Pe.
Resolving a Market Shortage
-price is too low -QS < QD, a shortage -buyer and seller behaviors kick in (sellers raise the price, so the buyers buy less fixing the shortage) - Sellers have an incentive to increase the price in order to sell more -price will rise to equilibrium price, Pe. -free market always fixes itself by moving back into equilibrium
Demand (buyer's/product market)
Demand and Demand Schedule
Demand Curve and the Cost Benefit Principle
Buyers value goods differently - The buyer's reservation price is the highest price an individual is willing to pay for a good - It represents the buyer's marginal benefit from the good - The market price is what the buyer must pay for the good - buyer's marginal cost. - Assuming buyers differ in their reservation prices, at higher prices, fewer consumers will pass the cost-benefit test and so few will buy. The Cost-Benefit Principle says buy if: - Reservation Price (MB) > Market Price (MC).
Adam Smith's Invisible Hand
a metaphor for the idea that beneficial social and economic outcomes may arise from entirely self-serving actions of individuals, none of whom intends to bring about such socially beneficial outcomes.
positive externality
beneficial side effect that affects an uninvolved third party - Vaccinations - Private MB less than social MB. - Too little is produced. Economic surplus will increase if production and consumption is increased.
A "Smart for One, Dumb for All" situation occurs when
individuals, when acting rationally, fail to take advantage of all opportunities for social benefit.
Double Shifts in Supply and Demand
shifts to both the demand and supply curve -one of the answers, quantity or price, will be ambiguous, while the other increases or decreases
negative externality
the harm, cost, or inconvenience suffered by a third party because of actions by others - Cigarette smoke - Private MC less than social MC. - Too much is produced. Economic surplus will increase if production and consumption is reduced.
buyers and sellers in the market
- Buyers and sellers have different motivations - Buyers want to benefit from consuming the good - Sellers want to make a profit from producing and selling the good - Buyers don't know the seller's private information. - Sellers don't know the buyer's private information.
consequences of rent controls (price ceilings)
- Excess demand / persistent shortages - Long waiting lists - rationing must be imposed on consumers - Controls reduce quantity supplied - landlords convert apt. buildings to office spaces - Illegal markets develop - Prices charged in the illegal market are typically higher than those that would be charged in the free market to pay for illegally marketing the goods - Substantial portion of the illegal price goes to pay the middlemen rather than the actual producers. - Investment in the industry dries up. - Favoritism, corruption, discrimination - Renters are forced to rent worthless furniture at exorbitant prices
Externalities
- In the face of externalities people make optimal choices for themselves but they turn out to be sub-optimal for the group as a whole (Smart for One Dumb for All) -positive and negative
capitalist market system In a capitalist market system who performs the three coordination task of what, how and for whom to produce?
- No one in particular. Consumer demands and Production costs, allocate resources automatically, anonymously, and efficiently through a system of prices and markets. It need not be "equitable" (fair), but it will be (under ideal conditions) economically efficient.
Every society answers 3 basic questions:
- Output Selection: What to Produce - which goods to produce; how much of each to produce? - Production Planning: How to produce - which technology; which resources (inputs) to use? - Distribution: For whom to produce - how to distribute the output; on the basis of need or income (ability to pay)?
centrally planned economies
- The coordination tasks are performed typically by a central planning authority which decides on how, how much and for whom to produce. (Cuba, N. Korea, China) - All economic decisions of income allocations are based on need rather than on resource ownership or contribution to production. problems: Planners cannot carry out the coordination tasks of the economy due to - lack of necessary data; - computational complications arising from interdependence between sectors.
The King of Prussia owns all apple orchards in his country. He deliberately sets the price of apples above the market equilibrium price. What can we conclude?
- The market for apples is demand constrained. - There will be an excess supply on the market.
cash on the table
- an economic metaphor for existence of unexploited gains from exchange as happens when markets are out of equilibrium.
Efficiency occurs when
- the socially optimal quantity of goods and services is being produced. - the economic surplus is maximized. - Society's marginal benefits are equated to society's marginal costs.
The Impact of a Change in Income (I)(shifter of demand)
-changes in income not only affect a person's ability to demand goods but also affect the types of goods that are demanded -make more income, demand more; make less income, demand less (types of goods you buy also change) -inferior goods and normal goods
Taste of Buyers (T)(shifter of demand)
-How we view the product -if view changes, demand is going to change (if you think a product is cool, demand curve will shift to the right) -influenced by advertising, news reports (coffee prolongs your life, drink more coffee so demand increases), trends, etc.
Shift of Demand Versus Movement Along a Demand Curve
-a change in demand is not the same as change in quantity demanded -in this example, a higher price causes lower quantity demanded. -changes in determinants of demand, other than price, cause a change in demand, or a shift of the entire demand curve, from Da to Db -write D1 and D2, no arrows
The Demand Curve
-a graph illustrating how much of a given product a household would be willing to buy at different prices -any shift in prices would result in a movement in the demand curve from one point to another -price: y axis -quantity demanded: x axis -must use equivalent units (by 1s, by 2s, or by 10s, or by 1000s) -demand curves uses the market demand including all consumers Horizontal interpretation: Price determines quantity demanded Vertical interpretation: Quantity determines the buyer's reservation price (marginal benefit) for the marginal unit.
Technology (shifter of supply)
-a technological innovation ALWAYS increases efficiency and lower production cost and increase supply (supply curve shifts to the right)
Change in Supply (delta S)
-a willingness and ability to increase quantity supplied at all price levels -a shift to the right means increase in supply -a shift to the left shows a decrease in supply -any event that causes the supply curve to shift, reflects a change in quantity supplied at any given price
efficiency principle
-allocation that results in the maximization the total surplus (TS= CS + PS). Both consumers and producers can not increase their wellbeing without making each other worse off -have to be at equilibrium to achieve efficiency (creating a price that benefits producer and consumer) -free markets allocate and create maximum efficiency -a competitive free market maximizes total surplus and achieves allocative efficiency/socially optimal quantity (when producing in terms of the need of your economy) - Socially optimal quantity occurs when MC (to society) = MB (to society) - important social goal bc it maximizes the economic surplus and when the economic pie gets larger, each individual economic agent can potentially have a greater share - markets achieve efficiency when all the costs of producing the good fall directly on the sellers and the benefits from the good accrue directly to the buyer
Substitution Effect
-as the price of a good falls, the consumer substitutes that good in place of other goods whose prices have not changed -always going to buy the cheaper of two substitutes -at a higher price, people are going to buy the other good, so QD of the more expensive good decreases while the QD of the substitute increases
Price determination
-can determine price and quantity in the market by using supply and demand -supply represents producers -demand represents consumers
A change in supply vs. a change in QS
-change in price of a good or service leads to change in QS (movement along the curve) -change in costs, input prices, technology, or prices of related goods and services leads to change in supply (shift of curve)
Price floor
-equilibrium price is too low for producers so gov raises price to protect producers and keep them in the market -government imposes a minimum price greater than Pe. -generally on essential items that have a very low market equilibrium price (ex: agricultural price supports, minimum wage) -this generates a surplus (Qs > Qd) (increase price, QS will increase bc producers can earn more money, QD will decrease because price is raised) -the market mechanism cannot clear the market -a permanent surplus exists -lost gains from trade (deadweight loss) -misallocation of resources (overinvestment in the industry; inefficient businesses will enter) -sellers offer discounts in disguise (wasteful increases in quality) -problem of disposal
shortage
-excess demand (QS < QD) -when the price is below the equilibrium, QD increases but QS decreases -when price decreases, move down the demand curve, so QD increases -when price decreases, move down supply curve, so QS decreases -consumers want to buy more, producers don't want to produce as much b/c there's less of an incentive to produce more -shortage is difference between the QD and QS -the market is supply constrained as Qs < Qd
surplus
-excess supply (QD < QS) -when the price is above the equilibrium, QD decreases but QS increases -if price increased, move up the demand curve, so QD decreases -if price increases, move up the demand curve, so QS increases -surplus is difference between QS and QD -market is demand constrained as Qd < Qs
inferior goods (shifter of demand)
-goods you buy when you have less money -higher income decreases the demand for an inferior good bc that's all you can afford
normal goods (shifter of demand)
-goods you prefer to have when you have more money -higher income increases the demand for a normal good bc you can afford more expensive stuff now
Price Ceiling
-government imposes a maximum price less than Pe to make the market more accessible to the every day person (more affordable) (rent can not go above that price) -price ceiling must be BELOW the market price/equilibrium to be effective, can NOT be above market price -Generally on essential items that have a very high market equilibrium price (ex: housing -> rent control) -this generates a shortage (Qd > Qs) -this market mechanism cannot clear the market -a permanent shortage exists ex: rent controls in NYC -if the goal is to combat expensive housing, the government has to correct the problem by putting a lower price in place, as that will actually help renters. -when price ceiling decrease the market price, you are going to move down your demand curve (the incentives for land owners decrease and can convert the apartments into other buildings and decrease quantity supplied)
Gov't Influence: Taxes and Subsidies (shifter of supply)
-government provides regulations -a tax on output raises costs and decreases supply (taxes always decreases supply unless they cut taxes for producers (doesn't matter if they cut income taxes it has to affect the producers (corporate tax) to affect the supply curve) -a subsidy (gives company or industry money) on production lowers costs and increase supply (gov is giving pharmaceutical companies to produce vaccine so increases supply) -regulations, producers have to do x, y, z which slows them down for a while and decrease their supply
Expectations of Future Prices (E) (shifter of demand)
-graphing current demand that will depend on what you think will happen in the future -the expectation of a higher (lower) price for a good in the future increases (decreases) current demand for the good -consumers will adjust their current spending in anticipation of the direction of future prices in order to obtain the lowest possible price -if gas price was going to increase over the weekend, the demand for gas now would increase b.c you don't want to pay more -can only use expectations for FUTURE PRICES (not that you would live longer if you drank coffee)
Increase in DEMAND and Supply
-higher demand leads to higher equilibrium price and higher equilibrium quantity -Change in Delta D (curve shifts to the right) and change in Delta QS (supply curve didn't move, but there was a movement along the supply curve(increase in QS))
Increase in Demand and SUPPLY
-higher supply leads to lower equilibrium price and higher equilibrium quantity -change in Delta S (curve shifts to the right) and change in Delta QD (demand curve didn't move, but there was a movement along the demand curve (increase in QD) )
Input Costs and Availability (shifter of supply)
-input is a factor of production -talks about production cost and availability of materials -a decrease in the price of an input (materials) increases profits and encourages more supply -a supply shock (there is a sudden shortage) will increase input prices, raise production costs, and decrease supply -positive supply shock means discovery of new resources which would lower production costs and increases supply
Decrease in DEMAND and supply
-lower demand leads to lower equilibrium price and lower equilibrium quantity -Change in Delta D (curve shifts to the left) and change in Delta QS (supply curve didn't move, but there was a movement along the supply curve (decrease in QS))
Decrease in demand and SUPPLY
-lower supply leads to higher equilibrium price and lower equilibrium quantity -Change in Delta S (curve shifts to the left) and change in Delta QD (demand curve didn't move, but there was a movement along the supply curve (decrease in QD)
Determinants of Supply
-non price conditions that influence a seller's willingness and ability to supply a good (QS changes at every price level) T- Technology I- Input Costs and Availability G- Gov't Influence: Taxes and Subsidies E- Expectation of Future Prices R-Related Good's Prices S- Suppliers (# of) An favorable change in climate (esp. for agricultural goods) (rice supply with abundant monsoon rains) a change in PRICE doesn't shift the curve, it only causes a movement along the curve
Determinants of Demand
-non-price conditions that influence a consumer's willingness and ability to demand a good (QD changes at every price level) T- taste and preferences R- related goods (complementary products and substitutes) I- income of buyers B- buyers (# of) E- expectations of future prices a change in the PRICE doesn't shift the curve, it only causes a movement along the curve
Buyers (# of) (B) (shifter of demand)
-number of potential buyers for your good -as the population of an economy changes, the number of buyers of a particular good also changes -if there's a baby boom, there's an increase in demand for diapers -if gov going to raises the smoking age to 25, the demand curve shifts to the left
How are prices related to equilibrium? incentive principle
-prices are signals that tell a consumer or producer how to adjust. (behave) - Prices provide incentives to economic agents to act in their self-interest. - Buyers maximize their total net benefits - pleasure (utility) from consumption minus the expenditure. - Sellers maximize their total net benefits - profits (revenues minus cost) from producing and selling good and services. -Increasing the price for the cronut would make consumers reconsider how much they want it (decrease in QD, so no more shortage) free market fixed on its own -market will always tell if it is at equilibrium, because if the price was too cheap, there would be a shortage and if the price was too expensive, there would be a surplus -price changes can move the market toward equilibrium and solve shortages and surpluses -good thing about a free market is that producers can adjust the price to equilibrium - signal that balances the dual forces of the value buyers derive from the good (buyer's marginal benefit) and the cost to produce one more unit of the good (seller's marginal cost)
Disequilibrium
-quantity demanded does not equal quantity supplied -shortage and surplus -know if at equilibrium because market will tell you (people will buy less or buy more causing a shortage or surplus if not at equilibrium)
Related Good's Prices (shifter of supply)
-related goods use the same inputs (inputs: flour, sugar, eggs; related goods: vanilla cupcake and chocolate cupcakes) -producers will always put more inputs into goods that yield a higher profit -Honda produces 10 Civis and 10 CRVs using steel, cloth, tires, etc -If SUVs become more popular, and more expensive, Honda will shift production to more SUVs (supply shifts right bc they yield a higher product) and less Civics (supply shifts left bc yield a lower product) -talking price of RELATED GOODS not the price of INPUTS
Supply
-represents the number of units of a product that a firm would be willing and able to offer fo sale at a particular price during a given time period -price goes up, incentive goes up, so producers make more goods (supply) -must have resources to produce that good -what is worth your time and effort? -schedule lists quantities supplied at various prices
Expectation of Future Prices (shifter of supply)
-sellers will adjust their current supply in anticipation of the direction of future prices in order to obtain the highest possible price -the expectation of a higher price for a good in the future decreases current supply of the good (if they can store the good) and vice versa -if hear price of oil will increase in the future, don't want to sell supply now bc you won't make extra money so you store supply for now and release it later on but because you're storing it now so the supply decreases
The Law of Demand
-states that there is a negative, or inverse, relationship between price and the quantity of a good demanded and its price -A change in the price (delta P) of a good will result in a change in the quantity demanded (delta QD) -movement along the demand curve when price changes b/c QD changes - increase P, decrease QD -decrease P, increase QD
labor curve (minimum wage)
-supply: workers-demand: employers -x-axis: wage -y-axis: labor -unregulated, labor will be very cheap -government regulates wage to protect the worker (raise minimum wage) but then quantity demanded of workers will decrease bc they are more expensive but they will increase the supply of workers who weren't usually on the labor force -QS of labor increases, QD of labor decreases -a lot more workers than jobs, so surplus and more people can't find jobs -more unemployed people, more people competing for job so there will be an increase in quality (inefficiently high quality of workers), raise min wage ends up hurting teenagers bc employers would choose the older worker when really it doesn't matter
Demand Schedule
-table that shows the quantities of a good/service that a person will purchase at each price
The Law of Diminishing Marginal Utility
-tells us that the marginal utility of a good declines as more of it is consumed over a given time period -the more we consume of something, the less satisfaction we will get from each additional unit of it -consumers will pay according to the utility they receive. They will pay more when the utility is high and less when the utility is low.-The greater the number of uses the higher the price elasticity of demand and vice-versa. -value of second unit is not the same as the first unit because you lose utility for the second unit so you would not be willing to pay the same amount for it
Producer's Surplus
-the difference between the price the seller received and the cost of producing the good -market price minus the seller's reservation price -the profit-PS= Price - Production Cost (profit seller would receive if they sold the good) -if producers aren't efficient enough to sell at the market price, then they don't have any producer surplus
Consumer surplus
-the difference between what consumers are willing to pay (buyer's max) and what they actually pay (price) -buyer's reservation price minus the market price -what consumers get from the exchange is consumer surplus -if they highly value a product and willing to pay but market price is lower, then they benefit b/c they were willing to pay more -if a person's maximum price is less than the market price, he or she will not buy and will gain no consumer surplus (if not willing to buy, no consumer surplus because not willing to exchange)
Change in demand (delta D)
-the entire demand shifts and a new demand curve is created. There is a change in QD at every price (rather than just one price) -A shift to the right means increase in demand -a shift to the left ("left is less) shows a decrease in demand
equilibrium on market graph
-the forces of supply and demand work to establish a price at which QD is equal to QS -no tendency to change P or Q -where supply and demand meet -market equilibrium: price that works for both consumers and producers in the market -this is where quantity demanded is equal to quantity supplied
Putting a market together
-the interaction of buyers and sellers makes a market -so putting demand curve and supply curve on a graph represents a market b/c buyers and sellers interact -equilibrium -no shortage exists -no surplus exists
The Law of Supply
-the law of supply states that there is a positive relationship between price and quantity of a good supplied -a change in price (delta P) leads to a change in quantity supplied (delta QS) (decrease (increase) in P, decrease (increase) QS) (incentive increase when price increases) -a higher price causes higher quantity supplied, and a movement along the demand curve - Supply is characterized by the principle of increasing OC - low-hanging-fruit principle. - As quantity supplied rises so does the OC. - Cost benefit Principle says: sell if: Market Price (MB) > Opp. Cost (MC) of supplying the good (seller's reservation price) - Sellers differ in their OC. At higher prices, more sellers pass the cost-benefit test and so more sellers will supply the good.
Relative Magnitudes of Change
-the relative magnitudes of change in supply and demand determine the outcome of market equilibrium Increase S > Decrease D -> Increase Q, Decrease P Increase S < Decrease D -> Decrease Q, Decrease P Increase S > Increase D -> Increase Q, Decrease P Increase S < Increase D -> Increase Q, Increase P
Income Effect
-when price changes, buying power changes NOT when income changes -as price of a good decrease, the consumer's purchasing power increases (because you can buy more), causing a change in quantity demanded for the good -a drop (rise) in price increases (decreases) purchasing power
When the price Macbooks fall, people buy fewer Windows-based laptop PCs. Which of the following statements is/are true? Check all that apply. A. The above describes a movement along the demand curve for Macbooks. B. The above implies a movement along the demand curve for PCs. C. Macbooks and PCs are substitutes in consumption. D. Ceteris paribus, the price of PCs will rise in equilibrium. E. The above describes a leftward shift in the demand curve for PCs.
A. The above describes a movement along the demand curve for Macbooks. C. Macbooks and PCs are substitutes in consumption. E. The above describes a leftward shift in the demand curve for PCs.
At what level of output is the marginal cost greater than the marginal benefit?
Another way of understanding value to a consumer is to think of it as the amount of benefit that will be gained from consuming the good. - The marginal benefit (the value) is also represented by the demand curve, and the marginal cost, the price producers must have if they are going to produce one more unit of a good, is represented by the supply curve. - At a level of output of 150 on the graph, the marginal benefit is about a $1.00 and the marginal cost is about $1.15. Thus, it costs more to produce than its value to consumers.
Consider a downward sloping demand curve drawn with prices measured on the horizontal axis and quantities on the vertical axis. Which of the following is the correct horizontal interpretation of the graph?
For a given quantity, the horizontal distance measures the maximum amount the buyer is willing to pay for one extra unit of the good.
In the US all car owners must carry a minimum liability insurance on the car. Suppose a new law mandates an increase in the required levels of insurance. Which of the following statements is true?
It will lead to an decrease in the demand for cars.
An Arizona student claims to have spotted a UFO over the desert outside of Tucson. How will this claim affect the supply (not the quantity supplied) of binoculars in Tucson stores?
Supply will not change. The demand for binoculars is likely to increase, leading to an increase in price and quantity supplied (but no change in supply).
What would be the initial change in the market for beer if a city suddenly restricted the number of bar licenses they permitted? (Note: A bar requires a licenses to operate.)
Supply would decrease and at current prices, there would be a shortage - The reduced number of licenses would reduce the number of sellers of beer, leading to a decrease in supply. Since demand has remained constant and supply has decreased, quantity supplied is smaller than quantity demanded and there is a shortage.
total surplus
Total surplus = buyer's surplus + seller's surplus - Total surplus is buyer's reservation price - seller's reservation price - No cash on the table when surplus is maximized No opportunity to gain from additional sales or purchases
What is the law of demand a result of?
The law of demand is the result of three separate behavior patterns that overlap: 1. The Income effect 2. The substitution effect 3. The Law of Diminishing Marginal Utility -these cause the demand curve's slope to go downward (why when QD is high, price is low and vice versa)
The economic significance of successful ticket scalping (scalpers sell tickets at higher than official prices) at baseball games is that:
There is an excess demand for tickets and ticket prices should be raised
Suppose you notice that more and more people are driving gas-guzzling cars. Since you drive an economy car, their increased demand for gas:
causes the price you pay for gas to increase.
The Impact of a Change in the Price of Related Goods (R)(shifter of demand)
complementary good- the use of one increase the use of the other (ex: hamburger and ketchup; price of hamburger increases and quantity demanded falls which causes the demand for complement good (ketchup) to shift to the left; price of ketchup did NOT change but its complement product did change which caused its demand curve to change since few hamburgers are being eaten so the demand will fall for ketchup, shift curve for KETCHUP not HAMBURGER) substitutes- demand for substitute good shifts opposite of the other good (ex: demand for chicken will increase and shift to the right when the price of hamburgers rise causing people to eat less hamburgers and demand more chicken because it is the cheaper substitute) GRAPHING THE GOODS WHOSE PRICES DIDN'T CHANGE (NON-PRICE CONDITIONS) BUT WERE AFFECTED BY THE CHANGE IN MARKET OF A RELATED GOOD
Consumer and Producer Surplus
concepts that are used to compare the actual market price of a product to the price that consumers/producers are willing to pay for that product -how much do consumers and producers benefit from an exchange?
giffen goods
goods that are exceptions to the law of demand where at very low prices, with consumers on low incomes and dependent upon the good for survival, as price rises, then so does demand - All inferior goods must be giffen goods. However, all giffen goods are not necessarily inferior goods.
Smart for One, Dumb for All
principle that indicates that pursuing selfish interests sometimes conflicts with social welfare - Externalities create situations that are smart for one but dumb for all - Here individual actors behave rationally - However, there are unexploited gains from society's point of view. - Individual action cannot exploit all opportunities, but collective action maybe able to.
Demand
the ability and willingness to buy a good or service -to demand something you have to be able to afford and want to buy the good
Suppose the local slaughterhouse gives off an unpleasant stench. The quantity of meat produced would then be _______ because not all of the _______ are accounted for in the marketplace.
too high; costs
