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Demand and Supply
Principles of MicroeconomicsProfessor Dalton
ECON 202 – Fall 2013Boise State University
Markets
Market : any institution, mechanism, or arrangement which facilitates voluntary cooperation among individuals.
A market is a group of buyers and sellers of a particular good or service.• Buyers determine demand.• Sellers determine supply.
The Concept of Demand
Demand
refers to theoffers of buyers to purchase
a good or service.
Determinants of Demand
1. Market Price2. Consumer Income3. Prices of Related Goods4. Tastes5. Expectations6. Taxes on/subsidies to consumers7. Number of Consumers (demographic
changes)
“Ceteris Paribus “
All the relevant variables (e.g., determinants of demand) are held constant, except the one(s) being studied at the time.
The ceteris paribus proviso is a constraint on theorizing, not an aspect of the real world. It focuses attention on one aspect of change so that the analysis does not become confused (or confusing).
Price
Quantity/time
Demand Curve
The Demand Curve
shows the maximum quantity that consumers are willing to purchase at any given price, or the maximum price that consumers are willing to pay for any given quantity.
D
At P1, Q1 is the maximum quantity that will be purchased
At Q0, P0 is the maximum price that consumers will pay
P1
P0
Q1 Q0
Price
Quantity/time
The Law of Demand
The Law of Demand
The quantity demanded of a good or service is an inverse function of the good or service’s own-price, ceteris paribus.
D
As the price of a good falls...
…the quantity demanded of the good increases
P1
P0
Q1 Q0
Price
Quantity/time
Non-Price Determinantsof Demand
A demand curve shows the inverse relationship between price and quantity demanded. The magnitude of non-price determinants determine “where” the demand curve lies in price/quantity space. D1
D2D0
Price
Quantity/time
Non-Price Determinantsof Demand
Changes in all non-price determinants of demand shift the demand curve to either the left or right, depending on the change.
D1D2D0
Demand Curve shifts right --Increase in Demand
Demand Curve shifts left --Decrease in Demand
Change in Demand
Increase in Demand an increase in the maximum quantity consumers
will purchase at a given price, or an increase in the price consumers will pay for any given quantity.
Decrease in Demand a decrease in the maximum quantity consumers
will purchase at a given price, or a decrease in the price consumers will pay for any given quantity.
Quantity Demandedv. Demand
Change in Quantity DemandedA movement along a demand curve;
caused only by a change in a good’s own-price.
Change in DemandA shift in the entire demand curve, either
right or left, caused by a change in a non-price determinant of demand.
Change in Quantity Demanded
Price
Quantity/time
$2.00
7
$1.00
13
Demand
Change in Demand
Price
Quantity/time
$2.00
7
D1
D2
15
Changes in Non-Price Determinants of Demand
2. Consumer Income3. Prices of Related Goods4. Tastes5. Expectations6. Taxes on/subsidies to consumers7. Number of Consumers
Change in Consumer Income
Consumer IncomeNormal goods and Inferior goods
For normal goods: An increase in income will increase demand; and a decrease in income will decrease demand. Demand moves in the same direction as changes in income.
For inferior goods: An increase in income will decrease demand; and a decrease in income will increase demand. Demand moves in the opposite direction as changes in income.
Change inPrice of Related Goods
Prices of Related GoodsSubstitutes and Complements
For substitutes: An increase in the price of a substi-tute increases demand; a decrease in the price of a substitute decreases demand. Demand moves in the same direction as changes in substitute good prices.
For complements: An increase in the price of a com-plement decreases demand; a decrease in the price of a complement increases demand. Demand moves in the opposite direction as changes in complementary good prices.
Change in Tastes
Tastes An increase in the taste (or preference)
for a good will increase demand; a decrease in the taste (or preference) for a good will decrease demand. Demand moves in the same direction as changes in tastes (preferences).
Change in Expectations
ExpectationsPrice and Income
An expectation that price will rise in the future will increase demand now, and vice versa. Demand moves in the same direction as changes in expectations of future price. (storable v. non-storable goods)
An expectation that income will rise in the future will increase demand now, and vice versa. Demand moves in the same direction as changes in expectations of future income. (normal v. inferior goods)
Change in Taxes/Subsidies
Taxes and subsidies Taxies levied on consumers increase the cost
of goods to consumers. Demand moves in the opposite direction as changes in taxes on consumers (increase in tax reduces demand).
Subsidies provided to consumers decrease the cost of goods to consumers. Demand moves in the same direction as changes in subsidies to consumers (increase in subsidy increases demand).
Change in Number of Consumers
Number of Consumers An increase in the number of consumers
for a good will increase demand; a decrease in the number of consumers for a good will decrease demand. Demand moves in the same direction as changes in the number of consumers.
From Individual Demandsto Market Demand
Cathy Bruce Alice
D
A
C
E
F
G
X per week2
$4.00
3.50
3.00
2.50
2.00
1.50
1.00
0.50
0
Price
per
uni
t of X
(in
dol
lars
)
4 6 8 10 12 14 16
B
Market demand
The Concept of Supply
Supply
refers to theoffers of sellers to sell
a good or service.
Determinants of Supply
1. Market Price2. Input Prices3. Technology4. Expectations5. Taxes on/subsidies to sellers6. Number of Sellers
Price
Quantity/time
Supply Curve
The Supply Curve
shows the maximum quantity that sellers are willing to sell at any given price, or the minimum price that sellers are willing to receive for any given quantity.
SAt P1, Q1 is the maximum quantity that will be offered for sale
At Q0, P0 is the minimum price that sellers will accept
P1
P0
Q1Q0
Price
Quantity/time
The Law of Supply
The Law of Supply
The quantity supplied of a good or service is a positive function of the good or service’s own-price, ceteris paribus.
SAs the price of a good rises...
…the quantity supplied of the good increases
P1
P0
Q0 Q1
Price
Quantity/time
Non-Price Determinantsof Supply
A supply curve shows the positive relationship between price and quantity supplied. The magnitude of non-price determinants determine “where” the supply curve lies in price/quantity space.
S1 S2S0
Price
Quantity/time
Non-Price Determinantsof Supply
Changes in all non-price determinants of supply shift the Supply curve to either the left or right, depending on the change.
S1 S2S0
Supply Curve shifts right --Increase in Supply
Supply Curve shifts left --Decrease in Supply
Change in Supply
Increase in Supply an increase in the maximum quantity sellers will
offer to sell at a given price, or a decrease in the minimum price sellers will accept for any given quantity.
Decrease in Supply a decrease in the maximum quantity sellers will offer
to sell at a given price, or an increase in the minimum price sellers will accept for any given quantity.
Quantity Suppliedv. Supply
Change in Quantity SuppliedA movement along a Supply curve;
caused only by a change in a good’s own-price.
Change in SupplyA shift in the entire Supply curve, either
right or left, caused by a change in a non-price determinant of Supply.
Change in Quantity Supplied
Price
Quantity/time
$2.00
7
$1.00
13
Supply
Change in Supply
Price
Quantity/time
$2.00
7
S1 S2
15
Changes in Non-Price Determinants of Supply
2. Input Prices3. Technology4. Expectations5. Taxes on/subsidies to sellers6. Number of Sellers
Change in Input Prices
Input Prices An increase in an input price increases
costs and at given market price for output reduces profits, decreasing the incentive to supply, and vice versa. Supply moves in the opposite direction as changes in input price.
Change in Technology
Technology Advances in technology reduce costs and
at given market price for output increases profits, increasing the incentive to supply, and vice versa. Supply moves in the same direction as changes in technology.
Change in Expectations
ExpectationsFuture output price and future input price
An expectation that output price will rise in the future will decrease supply now, and vice versa. Supply moves in the opposite direction as changes in expectations of future output price. (storable v. non-storable goods; production v. supply)
An expectation that input prices will rise in the future will increase production now, but may not affect supply. (storable v. non-storable goods; production v. supply)
Change in Taxes/Subsidies
Taxes and subsidies Taxies levied on sellers reduce the price
received. Supply moves in the opposite direction as changes in taxes on sellers (increase in tax reduces supply).
Subsidies provided to sellers increase the price received. Supply moves in the same direction as changes in subsides to sellers (increase in subsidy increases supply).
Change in Number of Sellers
Number of Sellers An increase in the number of sellers of a
good will increase supply; a decrease in the number of sellers of a good will decrease supply. Supply moves in the same direction as changes in the number of sellers.
From Individual Supplies to Market Supply
Pric
e pe
r D
VD
Charlie Barry Ann
Quantity of DVDs supplied (per week)
$4.00
3.50
3.00
2.50
2.00
1.50
1.00
0.50
0
I
H
G
F
E
D
C
BA
Market Supply
CA
P
Q/t
S
Demand and Supply Putting It Together
Suppose sellers expect a price of Pe to exist in the market this time period.
D
Pe
Q0
PDThen they supply Q0 units.But when they arrive at market, buyers bid the price up to PD.
Since the demand price is greater than the supply price, suppliers increase output.
P
Q/t
S
Demand and Supply Putting It Together
Suppose sellers expect a price of Pe to exist in the market this time period.
D
Pe
Q1
PX
Then they supply Q1 units.But when they arrive at market, buyers bid the price down to PX.
Since the demand price is less than the supply price, suppliers decrease output.
P
Q/t
S
Equilibrium
Only when the quantity of output is such that the maximum price buyers are willing to pay is equal to the minimum price that sellers are willing to receive is there no change in behavior. D
P*
Q*Equilibrium occurs!!!!!
Equilibrium
Equilibrium Price The price at which the supply and demand
curves intersect. Quantity Supplied and Quantity Demanded are equal at this price.
Equilibrium Quantity The quantity at which the supply and
demand curves intersect. Demand Price and Supply Price are equal at this quantity.
Equilibrium
Equilibrium occurs when…(1) At the current quantity, the demand
price equals the supply price; or,(2) At the current price, the quantity
demanded equals the quantity supplied; or,
(3) The plans of all participants in the market have been fulfilled at the current price.
The Nature of Equilibrium
In a free market, the forces of supply and demand interact to push actual market price and quantity toward equilibrium price and quantity.
Equilibrium isn’t necessarily a state of the world; but rather is a characteristic of our reasoning about markets.
Disequilibrium
Excess Supply (Surplus)Price is above equilibrium price, therefore
producers are unable to sell all they want at the going price.
Excess Demand (Shortage)Price is below equilibrium price, therefore
consumers are unable to buy all they want at the going price.
P
Q/t
S
Disequilibrium
If price is above the equilibrium price...
D
PH
QSQD
Excess Supply
…then QS > QD.An excess supply (surplus) of the good occurs.
Excess supply creates competition among sellers, lowering price.
P
Q/t
S
Disequilibrium
If price is below the equilibrium price...
D
PL
QS QD
Excess Demand
…then QD > QS.An excess demand (shortage) for the good occurs.
Excess demand creates competition among buyers, raising price.
Disequilibrium
Disequilibrium occurs when…(1) At the current quantity, the demand price
differs from the supply price; or,(2) At the current price, the quantity
demanded differs from the quantity supplied; or,
(3) The plans of all participants in the market have not been fulfilled (at least some participants’ plans have been frustrated).
P
Q/t
S
The Gains from Trade
At the equilibrium:P*, Q*.
D
P*
Q*
Consumer surplus equals…
Producer surplus equals…
The total gains from trade (economic surplus) equals…
CS
PS
Total surplus
P
Q/t
S
The Gains from Trade
If output is smaller…
D
P*
Q*
The total gains from trade (economic surplus) are smaller…
e.g., at Q’
Q’
The foregone gains from trade equal…
Total surplus
P
Q/t
S
The Gains from Trade
If output is larger…
D
P*
Q*
The total gains from trade (economic surplus) are also smaller…
e.g., at Q’’
Q’’
Because the additional units are valued less than the foregone output elsewhere…
Total surplus
P
Q/t
S
The Gains from Trade
At the equilibrium:
P*, Q*… the gains from trade are maximized.
No other output level, given the conditions of demand and supply will create greater social value!
D
P*
Q*
CS
PS
Total surplus
Comparative Statics: Analyzing Changes in
Equilibrium
Determine if event shifts supply curve, the demand curve, or both.
Determine if curve(s) shift to left or right.
Determine how shift affects equilibrium price and quantity.
P
Q/t
S
Comparative Statics
Begin in equilibrium at P*, Q*.
D
P*
Q*
Increase in price of substitute occurs...
D1
Excess Demand
P**
Q**
Demand increases...
…creating an excess demand at P*...
…and buyers bid up price.As price rises, QS increases and QD decreases, until...… a new equilibrium occurs at a higher price and higher quantity.
P
Q/t
S
Comparative Statics
Begin in equilibrium at P*, Q*.
D
P*
Q*
Decrease in price of inputs occurs... S1
Excess Supply
P**
Q**
Supply increases...
…creating an excess supply at P*...
…and sellers bid down price.As price falls, QS decreases and QD increases, until...… a new equilibrium occurs at a lower price and higher quantity.
Comparative Statics:Summary
Market Change Change Pe Change Qe
Increase D
Decrease D
Increase S
Decrease S
Increase D and Increase S
Decrease D and Decrease S
Increase D and Decrease S
Decrease D and Increase S
Increase Increase
Decrease Decrease
Decrease Increase
Increase Decrease
? Increase
? Decrease
Increase ?
Decrease ?
Real-World Supply and Demand Applications
Supply and demand can be used to evaluate real-world events and the policies of government.• Examples of real world markets and
price determination• Impact of specific real world events• Impact of government policies
The Price of a Foreign Currency
The market for foreign currencies is called the foreign exchange (forex) market.
The exchange rate – the price of one currency in terms of another currency.• People demand currencies of other countries
to buy those countries’ goods and assets.• A currency is just another good.• The determination of exchange rate is the
same as the determination of price.
The Price of a Foreign Currency
The euro is the currency used by the 12 members of the European Union.• Belgium, Germany, Greece, Spain, France,
Ireland, Italy, Luxembourg, Netherlands, Austria, Portugal, Finland
The euro was first introduced on January 1, 1999, and Euro notes and coins entered circulation on January 1, 2002.• (From Jan. 1, 1999 to December 31, 2001, the
euro was an accounting currency with a fixed exchange rate among national currencies.)
The Price of a Foreign Currency
When first introduced in January of 1999 the price of a euro in US dollars was $1.17. Over the next two years the price of a euro fell to about $0.90.
From a low in June 2001, the euro has rebounded to a price of around $1.34 in December of 2004.
The Price of a Foreign Currency
Dollar Price of Euro
0.000
0.200
0.400
0.600
0.800
1.000
1.200
1.400
1.600
Time
$/E
uro
The Price of a Foreign Currency
Changes in the price of one currency in terms of another are primarily driven by international trade requirements.
To buy a BMW, I need to exchange dollars for euros (because German workers want to be paid in euros, not dollars).
Importers usually do this at the wholesale stage, rather than consumers at the retail stage.
The Price of a Foreign Currency
Typically then, the price of euros will rise with a greater demand for European Union assets/goods by Americans relative to European Union demand for U.S. assets/goods.
The price of euros will fall with a greater demand by Europeans for American assets/goods relative to American demand for European assets/goods.
The Price of a Foreign Currency
From 1999 to mid-2001, Europeans increased their demand for dollars (supply of euros) as the US stock market rose; simultaneously Americans exited European stock markets, decreasing the supply of dollars (demand for euros).
The supply of euros rose and the demand for euros fell, driving the dollar price of euros down.
Euro Market
P1
Q0
D1
D0
S0
S1
P2
Dollar Price of Euros
Quantity of Euros
The Price of a Foreign Currency
From mid-2001, except for a brief rally in late 2001 and early 2002, the American stock market fell to a bottom in mid 2003; at the same time, American demand for foreign goods relative to foreign demand for American goods accelerated.
Europeans decreased their demand for dollars (supply of euros) as the US stock market fell; simultaneously Americans re-entered European stock markets and demanded greater quantities of foreign goods, increasing the supply of dollars (demand for euros).
The supply of euros fell and demand for euros rose, driving the dollar price of euros up.
Euro Market
P2
Q0
D0
D1
S1
S0
P1
Dollar Price of Euros
Quantity of Euros
