© 2007 Thomson South-Western Unit II: The Price Discovery Mechanism

© 2007 Thomson South-Western

Unit II: The Price Discovery Mechanism


Consumer Activity

• This requires full class participation• All you need to do is raise your hand

• I will be polling the class on their willingness to pay for a certain good or service

• We all will copy the data down in our notes…



• A market is a group of buyers and sellers of a particular good or service.

What Is a Market?

Apple Store: I-Phone 4 Launch


Competitive Markets

• A market in which there are many buyers and sellers so that no individual has an impact on the market price.


Market’s in 100% Perfect Competition• Products are the same

• Numerous buyers and sellers so that each has no influence over price

• Firms are price takers


Demand and supply in a market

Buyers determine demand.

Sellers determine supply


Demand!!!!


Demand• Shows the amount people are

willing to buy at every price


Quantity Demanded

• The amount of a good that buyers are able and willing to purchase at a specific price.

• You want the good, and you can afford it


Would this factor into your quantity demanded?


The Law of Demand

• When a good’s price is lower, consumers will buy more of it. When the price is higher, consumers will buy less of it.


The Demand Curve: The Relationship between Price and Quantity Demanded

• Demand Schedule • The demand schedule is a table that

shows the relationship between the price of the good and the quantity demanded.


Catherine’s Demand Schedule


The Demand Curve: The Relationship between Price and Quantity Demanded

• Demand Curve • The demand curve is a graph of the

relationship between the price of a good and the quantity demanded.


Catherine’s Demand Schedule


Figure 1 Catherine’s Demand Schedule and Demand Curve

Price ofIce-Cream Cone

0

2.50

2.00

1.50

1.00

0.50

1 2 3 4 5 6 7 8 9 10 11 Quantity ofIce-Cream Cones

$3.00

12

1. A decrease in price ...

2. ... increases quantity of cones demanded.


Market Demand versus Individual Demand• Market demand refers to the sum

of all individual demands for a particular good or service.


Brain Busta! Can you draw the market demand curve for ice-cream cones?


The Market Demand Curve

Price of Ice-Cream Cone



2.00 2.00 2.00

4 3 7

1.00 1.001.00

8 5 13

Quantity of Ice-Cream Cones Quantity of Ice-Cream Cones Quantity of Ice-Cream Cones

Catherine’s Demand Nicholas’s Demand Market Demand+ =

When the price is $2.00, Catherine will demand 4 ice-cream cones.

When the price is $2.00, Nicholas will demand 3 ice-cream cones.

The market demand at $2.00 will be 7 ice-cream cones.

When the price is $1.00, Catherine will demand 8 ice-cream cones.

When the price is $1.00, Nicholas will demand 5 ice-cream cones.

The market demand at $1.00, will be 13 ice-cream cones.

The market demand curve is the horizontal sum of the individual demand curves!


Shifts in the Demand Curve

0


First know this!!

• Quantity Demanded and Demand are two different things!

• Quantity Demanded is referring to the amount of demand at a give price

• Demand refers to the actual curve itself• Let’s take a look…


0

D

Price of Ice-Cream Cones

Quantity of Ice-Cream Cones

A $1 tax on sellers of ice-cream cones raises the price of ice-cream

cones. What will happen to the quantity

demanded?

A

B

8

1.00

$2.00

4

Changes in Quantity Demanded


Does a change in the price of goods shift the demand curve?

NO!!!


Shifts in the Demand Curve• This is called a “change in Demand”

• A shift in the demand curve, either to the left or right.

• Caused by a change in a quantity at every price other than a change in the price of the good/service.

• “Only 2 people would buy a dog for $200. Now, because something changed other than price, 10 people would buy a dog for $200.”

Day 1 Day 2 Day 3

If a Jimmy John’s cookie was $1, 2

people would buy one.

A new study has proven eating Jimmy

John’s cookies makes you 20% more intelligent

After the study was released, now 20 people would buy the cookie for $1


Figure 3 Shifts in the Demand Curve

Price ofIce-Cream

Cone

Quantity ofIce-Cream Cones

Increasein demand

Decreasein demand

Demand curve, D3

Demandcurve, D1

Demandcurve, D2

0


What causes a shift in the Demand Curve

• Anything that changes Qd other than a price change of the good/service• Consumer income

• Prices of related goods

• Tastes & Advertisements

• Expectations

• Number of buyers


Normal Goods vs Inferior Goods

Normal Goods

• a good that consumers demand more of when their income increases

Inferior Goods

• A good that consumers demand less of when their incomes increase

• Since you make more money, you can afford something better.


Normal or Inferior Good?


1,8001,500

1,200

900

600

300

21 3 4 5 6 7 8 9 10 1211

Price of Crappy Televisions

Quantity of Crappy

Televisions0

Decreasein demand

An increase in income...

D1D2

Consumer Income Inferior Good



$3.002.50

2.001.501.00

0.50

21 3 4 5 6 7 8 9 10 1211

Price of Apples

Quantity of Apples

0

Increasein demand


D1

D2

Consumer Income Normal Good



1,8001,500

1,200

900

600

300

21 3 4 5 6 7 8 9 10 1211

Price of Crappy Car

Quantity of Crappy Car

0

Decreasein demand


D1D2

Consumer Income Inferior Good


Shifts in the Demand Curve

• Prices of Related Goods• When a fall in the price of one good

reduces the demand for another good, the two goods are called substitutes.

• When a fall in the price of one good increases the demand for another good, the two goods are called complements.


Substitute Example


If price goes up in…


You may purchase the cheaper alternative…


$3.002.50

2.001.501.00

0.50

21 3 4 5 6 7 8 9 10 1211

Price of Totino’s

Quantity of

Totino’s0

Increasein demand

D1

D2


Complement Example

If price goes down ???


$3.002.50

2.001.501.00

0.50

21 3 4 5 6 7 8 9 10 1211

Price of Mustard

Quantity of

Mustard0

Increasein demand

D1

D2


Consumer Expectations

• Expectations about the future

• What if someone told you a bike would be on sale in a week, which way would the demand curve shift on that day you found out about the impending sale?



Amount of Buyers

• An increase in population causes an increase in demand for most goods


Consumer Tastes and Advertising

• Fads affect demand



Advertisements

• Good advertisements can increase demand





Table 1 Variables That Influence Buyers

52

SUPPLY


Quantity Supplied• The amount of a good sellers are

willing and able to sell

Flu Shot


Law of Supply

When Price

Increases

Quantity Supplied Increases


Ben’s Supply Schedule

No-Friends Rabbit No-Friends Rabbit


The Supply Curve: The Relationship between Price and Quantity Supplied

• Supply Curve• The supply curve is the graph of the relationship

between the price of a good and the quantity supplied.


Figure 5 Ben’s Supply Schedule and Supply Curve

Price ofNo-Friends

Rabbit

0

2.50

2.00

1.50

1.00

1 2 3 4 5 6 7 8 9 10 11 Quantity ofNo-Friends Rabbit

$3.00

12

0.50

1. Anincrease in price ...

2. ... increases quantity of cones supplied.


Market Supply versus Individual Supply

• Market supply refers to the sum of all individual supplies for all sellers of a particular good or service.

• Graphically, individual supply curves are summed horizontally to obtain the market supply curve.


Figure 7 Shifts in the Supply Curve

Price ofIce-Cream

Cone


0

Supply curve, S3

curve, Supply

S1Supply

curve, S2


First know this!!!

• Quantity Supplied and Supply are two different things!

• Quantity Supplied is referring to the amount of supply at a given price

• Supply refers to the actual curve itself• Let’s take a look…


1 5


Quantity of Ice-Cream Cones0

S

1.00A

C$3.00 A rise in the price

of ice cream cones results in a movement along the supply curve.

Change in Quantity Supplied


Shifts in the Supply Curve

• Change in Supply• A shift in the supply curve, either to the left or right.

• Caused by a change in a quantity at every price

other than a change in the price of the good/service.

January May June-July

At $3 each, I will put 5 mini

American flags on my store shelf

The 4th of July holiday is

approaching

At $3 each, I will put 100 mini

American flags on my store shelf


Figure 7 Shifts in the Supply Curve

Price ofIce-Cream

Cone


0

Increasein supply

Decreasein supply

Supply curve, S3

curve, Supply

S1Supply

curve, S2


Shifts in the Supply Curve

• Input prices

• Technology

• Expectations

• Number of sellers

• Government


Input Costs

• Any change of an input cost (production costs) will affect supply


Lets say you produce these…


What would happen to supply if the price of steel went up?

Supply of buses

would decrease


Technology Example


Early 1900’s Assembly Line


Today’s Assembly Line


Technology and Supply

• If technology increases, supply increases (shift to the right)


Government’s Influence on Supply

• Subsidy–Government payment that supports

a business market–Increases supply/shift to the right


True Subsidy Story• Tax authorities in the Netherlands agreed

to provide an education subsidy to a Dutch woman who was studying and training to be a witch. The woman’s attendance at the 13-weekend witchery program, which cost $3,003, was ruled a legitimate tax-deductible schooling expense by government officials. Students in the program reportedly learned to cast spells, prepare herbs and potions, and to use crystal balls while generally using magic as “a force for good.”


Other Examples

• Expectations– If you expect the price of an input cost to rise

in the future, than you current supply will increase and shift to the right

• Number of Sellers– If a new hospital in Plainfield opens, the

following supply will increase and shift to the right: doctors, hospital beds, MRI machines, vaccinations, etc…


Table 2: Variables That Influence Sellers


Market Equilibrium


Market Equilibrium

• Market for a good is stable

• Price and quantity is exactly what both buyers and sellers are willing to give up

• Quantity supplied = Quantity demanded

Equilibrium?


SUPPLY AND DEMAND TOGETHER

• Equilibrium Price– The price that balances quantity supplied and

quantity demanded.

• Equilibrium Quantity– The quantity supplied and the quantity

demanded at the equilibrium price.

• Both are found where supply and demand intersect


At $2.00, the quantity demanded is equal to the quantity supplied!

SUPPLY AND DEMAND TOGETHERDemand Schedule

Supply Schedule


Figure 8 The Equilibrium of Supply and Demand

Price ofIce-Cream

Cone

0 1 2 3 4 5 6 7 8 9 10 11 12Quantity of Ice-Cream Cones

13

Equilibriumquantity

Equilibrium price Equilibrium

Supply

Demand

$2.00



Disequilibrium

• When quantity supplied is NOT equal to quantity demanded in the market


Two Types of Disequilibrium

• Shortage (excess demand)– When quantity demanded is more than

quantity supplied– Price is below equilibrium price


Figure 9 Markets Not in Equilibrium

Price ofIce-Cream

Cone

0 Quantity ofIce-Cream

Cones

Supply

Demand

(b) Excess Demand

Quantitysupplied

Quantitydemanded

1.50

10

$2.00

74

Shortage


Two Types of Disequilibrium

• Shortage (excess demand)– When quantity demanded is more than

quantity supplied– Price is below equilibrium price

• Surplus (excess supply)– When quantity supplied is more than quantity

demanded– Price is above equilibrium price


Figure 9 Markets Not in Equilibrium

Price ofIce-Cream

Cone

0

Supply

Demand

(a) Excess Supply

Quantitydemanded

Quantitysupplied

Surplus

Quantity ofIce-Cream

Cones

4

$2.50

10

2.00

7


Disequilibrium: Changes in demand and/or supply


Table 3: Three Steps for Analyzing Changes in Equilibrium


Figure 10 How an Increase in Demand Affects the Equilibrium

Price ofIce-Cream

Cone

0 Quantity of Ice-Cream Cones

Supply

Initialequilibrium

D

D

3. . . . and a higherquantity sold.

2. . . . resultingin a higherprice . . .

1. Hot weather increasesthe demand for ice cream . . .

2.00

7

New equilibrium$2.50

10


Figure 11 How a Decrease in Supply Affects the Equilibrium

Price ofIce-Cream

Cone

0 Quantity of Ice-Cream Cones

Demand

Newequilibrium

Initial equilibrium

S1

S2

2. . . . resultingin a higherprice of icecream . . .

1. An increase in theprice of sugar reducesthe supply of ice cream. . .

3. . . . and a lowerquantity sold.

2.00

7

$2.50

4


Last one….

What happens to the equilibrium price and equilibrium quantity if BOTH supply and demand increase?


Table 4: What Happens to Price and Quantity When Supply or Demand Shifts?

Summary


• Economists use the model of supply and demand to analyze competitive markets.

• In a competitive market, there are many buyers and sellers, each of whom has little or no influence on the market price.

Summary


• The demand curve shows how the quantity of a good depends upon the price.– According to the law of demand, as the price of a good

falls, the quantity demanded rises. Therefore, the demand curve slopes downward.

– In addition to price, other determinants of how much consumers want to buy include income, the prices of complements and substitutes, tastes, expectations, and the number of buyers.

– If one of these factors changes, the demand curve shifts.

Summary


• The supply curve shows how the quantity of a good supplied depends upon the price.– According to the law of supply, as the price of a good rises,

the quantity supplied rises. Therefore, the supply curve slopes upward.

– In addition to price, other determinants of how much producers want to sell include input prices, technology, expectations, and the number of sellers.

– If one of these factors changes, the supply curve shifts.

Summary


• Market equilibrium is determined by the intersection of the supply and demand curves.

• At the equilibrium price, the quantity demanded equals the quantity supplied.

• The behavior of buyers and sellers naturally drives markets toward their equilibrium.

Summary


• To analyze how any event influences a market, we use the supply-and-demand diagram to examine how the event affects the equilibrium price and quantity.

• In market economics, prices are the signals that guide economic decisions and thereby allocate resources.


Supply or Demand Activity• On a separate sheet of blank paper, please

do the following:– Write a specific market at the top (Shoes for

example)– Write a scenario that will affect that market

(Adidas spends 50 million dollars on a new advertisement campaign).

– MAKE IT UNIQUE (take your time thinking)– Pass the paper behind you (group at the end…

walk to the front)


Partner Activity

• Read your market and the scenario.

• Determine if the scenario would have an impact on supply or demand.

• Then, graph and provide a written description of the market change


Bringing it Back

• Each group will read their market and scenario they received. – Every student must write the market and

scenario they hear in their notes

• Each group will then explain the affect the scenario had on their demand.– Every student must write the effect in their

notes.

Documents

© 2007 Thomson South-Western Unit II: The Price Discovery Mechanism