Markets: Supply and Demand

Markets

• Market : A group of buyers and sellers of a certain good or service

• Competitive Market : Many buyers and many sellers so each has small if any impact on the price

• Role of Price: information -“price signal”

• Perfectly Competitive Market: many buyers and sellers – none have any influence over the market price

• Everybody is a price taker

• Monopoly : only one seller, so sets the price• Monopsony : only one buyer, so sets the price

• Other markets: somewhere between these extremes

Demand

• Quantity demanded–Amount of a good buyers are willing and

able to purchase at a certain price • Law of demand–Other things equal (ceteris paribus) when

the price of the good rises the quantity demanded of a good falls

• Demand Schedule/Curve : one a table, the other a graph– Both represent the relationship between price and

quantity demanded

• Individual Demand : Demand of a single individual

• We will focus on linear demand curves:– A simplifying assumption

Price of Coffee Quantity Demanded (cups)

$0.00 6

$0.50 5

$1.00 4

$1.50 3

$2.00 2

$2.50 1

$3.00 0

1 2 3 4 5 6

$1.00

$2.00

$3.00

Price

Quantity

Sara’s Demand Schedule and Demand Curve

Note: we say price affects quantity – Q=f(P) but price is on “y” axis – comes from historical perspective and fish markets – Marshal?

• Market Demand : Sum of all individuals’ demand in that market

• Market Demand Curve : Sum up individual demand curves horizontally

Price of Coffee Sara David Market

$0.00 6 12 18

$0.50 5 10 15

$1.00 4 8 12

$1.50 3 6 9

$2.00 2 4 6

$2.50 1 2 3

$3.00 0 0 0

Market Demand Schedule

$1.00

$2.00

$3.00

Price

$1.00

$2.00

$3.00

Price

$1.00

$2.00

$3.00

Price

6 18124 128

Market Demand Curve Creation

Sara’s Demand

David’s Demand

Market Demand

More on Demand Curves• Shifts in Demand– Increased Demand• Anything that increases the quantity demanded at all

prices• Curve shifts to the right

– Decreased Demand• Anything that decreases the quantity demanded at all

prices• Curve shifts to the left

• Note: Difference between change in quantity demanded and shift in demand

P

Q

Increased Demand

Decreased Demand

Change in quantity demanded

Change in Demand vs Change in Quantity Demanded

Change in Demand

• What things shift demand (change demand)– Income– Price of related goods– Tastes– Expectations– Number of buyers

On Effect of Income

• Normal Good: – When income goes up demand goes up– When income goes down demand goes down

• Inferior Good:– When income goes up demand goes down– When income goes down demand goes up

On Effect of Related Goods

• Substitutes (need 2 goods):– An increase in the price of one leads to an

increase in demand for the other– A decrease in the price of one leads to an decrease

in demand for the other• Compliments (need 2 goods):– An increase in the price of one leads to an

decrease in demand for the other– A decrease in the price of one leads to an

increase in demand for the other

• Tastes: Like it more, increase demand

• Expectations: What you think might happen in the future (income, price changes) can affect current demand

• Number of buyers: more buyers, increase demand

Remember The Difference

• Change in price – Change in quantity demanded (movement along demand curve)

• Change in all others (income, tastes, price of other goods, etc.) – Change in demand (shift in demand curve)

Example Reducing Soda Consumption

• Tax sugar – will increase the price– Leads to a movement along the demand curve

• Education On Healthy Diet – will change tastes– Lead to a shift in the demand curve

P

Q

P’

Q’

P’’

Q’’

Tax

Q’’’

Movement along demand due to change in price

Shift in demand due to change in tastes

Supply

• Quantity Supplied:– Amount of the good that suppliers are willing and

able to supply at a specific price

• Law of Supply:– All other things being equal, if price goes up

quantity supplied will go up

• Supply Schedule/Curve : one a table, the other a graph– Both represent the relationship between price and

quantity supplied

• Individual Supply : Supply of a single individual/firm (seller)

• We will focus on linear supply curves:– A simplifying assumption

Price of Coffee Quantity Supplied (cups)

$0.00 0

$0.50 1

$1.00 2

$1.50 3

$2.00 4

$2.50 5

$3.00 6

1 2 3 4 5 6

$1.00

$2.00

$3.00

Price

Quantity

Starbuck’s Supply Schedule and Supply Curve

• Market Supply : Sum of all suppliers individual supply in that market

• Market Supply Curve : Sum up individual supply curves horizontally

Price of Coffee Starbucks Seattle’s Best Market

$0.00 0 0 0

$0.50 1 2 3

$1.00 2 4 6

$1.50 3 6 9

$2.00 4 8 12

$2.50 5 10 15

$3.00 6 12 18

Market Supply Schedule

$1.00

$2.00

$3.00

Price

$1.00

$2.00

$3.00

Price

$1.00

$2.00

$3.00

Price

6 18122 64

Market Supply Curve Creation (sort of)

Starbuck’s Supply

Seattle’s Supply

MarketSupply

More on Supply Curves• Shifts in Supply– Increased Supply• Anything that increases the quantity supplied at all

prices• Curve shifts to the right

– Decreased Supply• Anything that decreases the quantity supplied at all

prices• Curve shifts to the left

• Note: Difference between change in quantity supplied and change in supply

P

Q

Increased Supply

Decreased Supply

Change in quantity supplied

Change in Supply vs Change in Quantity Supplied

Change in Supply

• What things shift supply curve (change supply)– Price of inputs: input prices go up, supply goes

down– Technology: better tech., increase in supply– Expectations: beliefs about future can affect

current supply– Number of sellers: more sellers increases supply

• Again remember difference between change in supply (shift of curve) and change in quantity supplied (movement on curve)

Equilibrium

• Market equilibrium: when markets “clear”, quantity demanded = quantity supplied

• Equilibrium price: the price at which the market clears

• Equilibrium quantity: the amount of the good bought/sold at the equilibrium

P

Q

$1.50

9

Equilibrium

Equilibrium Price

Equilibrium Quantity

Market Demand Market Supply

Equilibrium Between Demand and Supply

Out of Equilibrium

• Surplus: excess supply – Quantity supplied > quantity demanded– Downward pressure on price to clear market

• Shortage: excess demand– Quantity demanded > quantity supplied– Upward pressure on price to clear market

• Note difference between shortage and scarcity

Surplus

Price higher than eq. price

QuantityDemanded

QuantitySupplied

P

Q

Price lower than eq. price

Shortage

QuantityDemanded

QuantitySupplied

SupplySupply

Demand

Demand

Shortage and Surplus

Excess Supply Excess Demand

Changes to Equilibrium

• Analyzing Changes in the market after some “shock” or change

• 1st is supply changed, is demand changed• How is it changed• Graphically make the change and determine

new equilibrium• Beware of drawing conclusion based on scale

Example: Study finds eating ice-cream increases students GPAWhat happens? – Demand increases, quantity supplied increases

P’’

P’

Q’’Q’

Original Eq.

New Eq.

DemandIncreases

Quantity Supplied Increases

Price increased in mktQuantity increased in mkt

Example: Study finds eating ice-cream increases students GPA and price of sugar goes upWhat happens? – Demand increases, Supply Decreases

P’’

P’

Q’’Q’

Original Eq.

New Eq.

DemandIncreases Supply Decreases

Price increased in mktQuantity increased in mkt

But: b/c of scale

Example: Study finds eating ice-cream increases students GPA and price of sugar goes upWhat happens? – Demand increases, Supply Decreases

P’’

P’

Q’’ Q’

Original Eq.

New Eq.

DemandIncreases

Supply Decreases

Price increased in mktQuantity decreased in mkt

But: b/c of scale

• So in analyzing market changes be careful of possible ambiguous answers

• If supply and demand both change do their changes have the same qualitative effect on price/quantity

• If the same then effect is known• If different the effect depends on which is

larger