Lecture 4: Demand, Supply and Equilibrium

Required Text: Chapter 2

Law of Demand

When price of a good goes up, people buy less of that good Leads to downward sloping demand curve

Price ($/cup)

Quantity Demanded (cups)

0.50 5

0.75 4

1.00 3

1.25 2

1.50 1

Demand versus Quantity Demanded

Quantity Demanded Amount of a good consumed at a given price Change in price means a change in quantity

demanded Movement along the demand curve

Demand A family of numbers that lists the quantity

demanded corresponding to each possible price Demand Schedule Demand Curve

Demand Schedule and Demand Curve

Demand Schedule - Refers to the demand table that shows quantity demanded at each price

Demand Curve - Graph illustrating demand - Graphical representation of the demand schedule Price on the vertical axis Quantity demanded on the horizontal axis

Demand Equation Qd = (price, income, tastes and preferences,

expectations, and prices of other goods)

Changes in Demand

Price change does not lead to change in demand Change in anything other than price lead to demand changes

- Entire curve shifts Income Price of related goods

Substitutes Complements

Taste (preference) Sales Tax Number of consumers

Shifting Demand

Fall in Demand Decision made by demanders to buy a smaller

quantity at each given price Leftward shift of demand curve

Rise in Demand Decision made by demanders to a buy a larger

quantity at each given price Rightward shift of demand curve

Sales Tax Example

Sales Tax – A tax imposed on consumers Paid directly to the government Does not affect the price Consumers pay “Price plus sales tax”

Less desirable to buy the taxed good or service at every given price

Demand shifts downward and to the left

Effect of a Sales Tax on Demand

A new law requires $0.25 sales tax per cup of coffee

Price ($/cup)

Quantity (cups) before Tax

Quantity (cups) after tax

0.50 5 4

0.75 4 3

1.00 3 2

1.25 2 1

1.50 1 0

Shape of the Demand Curve

Steeply-sloped demand curve Large change in price leads to small change in

quantity demanded

Flat demand curve Small change in price leads to large change in

the quantity demanded

Important to producers of goods and services

Econometrics

Statistical techniques used by economist to resolve questions about slopes of various demand curves

Based on direct observations in marketplace Ex. Demand for murder Ex. Demand for reckless driving

Wide scope of economics Allows for other investigations as well

Market (Aggregate) Demand

Aggregate quantity of a good demanded by all consumers in a community (market) at each given price

The aggregate or market demand is obtained by the horizontal summation of all individual consumer’s demand curves.

Similar to the individual demand curve - Slopes downward

Market (Aggregate) Demand

Suppose, there are 10,000 SB coffee consumers in Lubbock Each individual consumer’s demand for SB coffee is the same

Price ($/cup)

Ind. Quantity (cups)

Ag. Quantity (cups)

0.50 5 50,000

0.75 4 40,000

1.00 3 30,000

1.25 2 20,000

1.50 1 10,000

Law of Supply

When the price of a good goes up, the quantity supplied goes up Leads to a upward sloping supply curve

Price ($) Quantity (cups)

0.25 0

0.50 100

0.75 200

1.00 300

1.25 400

1.50 500

Supply versus Quantity Supplied

Quantity Supplied Amount of a good that suppliers will provide at a given

price Changes if the price changes

Movement along the curve

Supply Family of numbers giving the quantities supplied at each

price Change in anything other than price changes supply

Shifts the entire curve

Changes in Supply

Supply Equation Qs = (price, expectations, input prices, prices of other

goods, technological change, number of producers)

Rise in Supply Increase in quantities that supplier will provide at each price Rightward shift of supply

Fall in Supply Decrease in quantities that supplier will provide at each price Leftward shift of supply

Changes in Supply

Price change does not lead to change in supply Factors that lead to supply changes - Entire curve shifts

Production costs Improvement in production technology Change in the wage rate

Changes in the Prices of other goods (subs. or comps.)

Excise Tax Number of Producers

Excise Tax Example

The government imposes a tax on producers Producers pay the tax directly to the

government Price does not change, but the cost

Less desirable to produce the taxed good or service at every given price

Supply shifts to the left and upward

Effect of an Excise Tax on Supply

An excise tax of $0.25 per cup of coffee

Price ($/cup)

Quantity Supplied before tax

Quantity Supplied after tax

0.25 0 0

0.50 100 0

0.75 200 100

1.00 300 200

1.25 400 300

1.50 500 400

Market (Aggregate) Supply

Aggregate quantity of a good supplied by all producers in a community (market) at each given price

The aggregate or market supply is obtained by the horizontal summation of all individual producer’s supply curves.

Similar to the individual producer’s supply curve – Market supply curve slopes upward

Market (Aggregate) Supply

Suppose, there are 10 SB coffee sellers in Lubbock Each individual seller’s supply for SB coffee is the same

Price ($/cup)

Ind. Quantity (cups)

Ag. Quantity (cups)

0.50 1,000 10,000

0.75 2,000 20,000

1.00 3,000 30,000

1.25 4,000 40,000

1.50 5,000 50,000

Market Equilibrium

Actual price and Quantity determined by interactions between demanders (consumers) and suppliers (sellers) Demanders cannot purchase more than

suppliers willing to sell Suppliers cannot sell more than demanders

willing to buy

Equilibrium Point

Point where the market demand and supply curves intersect Price at which quantity demanded equals

quantity supplied

Demanders and suppliers are satisfied Able to behave as one wants to, taking market

prices as given

Market Equilibrium for SB Coffee

Equilibrium price – $1.00 per cup Equilibrium quantity – 30,000 cups per day

Price ($/cup)

Ag. Quantity Demanded

Ag. Quantity Supplied

0.50 50,000 10,000

0.75 40,000 20,000

1.00 30,000 30,000

1.25 20,000 40,000

1.50 10,000 50,000

Changes in the Equilibrium Point

The only way that anything can affect the equilibrium price and quantity is by causing a shift in either the supply curve or the demand curve Never look at price and quantity Look at the effect of the change has on demand curve

and/or supply curve

The factors that shifts the demand and supply curves affect the equilibrium price and quantity

The Effects of Supply and Demand Shifts

Landsburg, Price Theory and Applications, 7th edition

Effect of Sales Tax

Sales tax of x¢ per item causes equilibrium price to fall by some amount less than x¢ per item

Price to suppliers not same as price to demanders (price plus sales tax)

Effect of Excise Tax

Excise tax of x¢ per item causes the equilibrium price to rise by some amount less than x¢ per item

Price to suppliers (price minus excise tax) not same as price to demanders

Comparing Two Taxes Economic Incidence – the division of a tax burden

according to who actually pays the tax

Legal Incidence – the division of a tax burden according to who is required under the law to pay the tax

The economic incidence of a tax independent of its legal incidence

Ex. Social Security tax

A Sales Tax versus an Excise Tax

Landsburg, Price Theory and Applications, 7th edition

Aggregated Effects of a Demand Curve Shift (for example change in income)

Price

Q

SD D’

P0

P1

Q0 Q1

Firm’s response to increased demand

What steps could a firm manager take to react to a shift in the demand curve to the right for an agricultural/food product?

For a competitive (atomistic) firm manager Knowledge of the increase in demand is first seen by a noticed increase

in price received. Usual reaction is to increase output.

Other firm managers see that above normal profits are being earned and enter the market thus putting some upward pressure on input costs.

The increased production lower prices to an equilibrium price (where price = average cost) that is somewhat higher than the initial price.

Firm’s response to increased demand …

For the firm in monopolistic competition the firm manager (remember the firm is a price maker)

would first be aware of the increase in demand by an increase in sales or product orders.

The firm’s reaction would be to increase output and/or increase price.

Seeing the above normal profits, other firms would enter and increase the supply.

The firm would experience a weakened demand for its product with the resulting equilibrium price a little higher that the initial price.

This higher price is due to the increased average costs.

Firm’s response to increased demand

For the oligopolistic firm manager The increase in demand would be recognized by an

increase in sales/orders. Reaction would be to increase output and price. Entry is possible, but more difficult. With entry, demand would weaken. The resulting price

is not predictable.

Impacts of Large Decline in Demand in Alternative Market Models

Situations Atomistic Monopolist Competition

Oligopoly

First indication

Price falls Orders/Sales decline

Orders/Sales decline

First Reaction

Cut output Cut output, change promotion

Cut output, change promotion

Long run Many firms exit

A few firms exit Possibly an exit

Impact of Exits

Price raises Increase sales Increase sales

Domestic Demand vs. Export Demand

Consideration of demand for the farm commodity must consider total demand where total demand equals domestic demand plus export demand.

Domestic food demand is fairly stable with little change from year to year. However, droughts and other disasters that occur in foreign countries can create large swings in foreign demand from year to year.

Question What can be the major result of these often-unexpected shifts in

foreign demand?

Agricultural/Food Sector Trends

Moving from atomistic markets towards monopolistic competition:

How: creating differentiation: regional (California fruit), branding (Dole, green giant, Del Monte)

Why: more alternative marketing strategies For example rice, bananas, tomatoes, lettuce, beef?