Supply and Demand
Value and Cost
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Value – what the buyer thinks the product is
worth
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Cost – what the seller must pay to produce and
market the product
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Both terms include opportunity cost (what could
I do instead?)
Price
n
Offering price – the seller tags a good at a
dollar amount at which he wants to sell
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Actual price – the agreed upon dollar amount the
buyer will pay the seller
Deal? … or No Deal?
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Buyer’s value > price…
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… and price > seller’s cost? DEAL!
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Buyer’s value < price? NO DEAL!
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Price < seller’s cost? NO DEAL!
What Sets the (actual) Price?
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The interaction of:
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buyers’ behavior (law of demand) and
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sellers’ behavior (law of supply).
Demand
n
The willingness
and ability of buyers to purchase different quantities of a good at different
prices during a specific time period.
Demand
n
For any good:
n
as price (P) rises, the quantity demanded (Qd)
falls.
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as the price (P) falls, the quantity demanded
(Qd) rises.
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P and Qd are inversely related.
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The demand curve is downward sloping.
Law of Demand (add diagram)
P rise
Q fall
P fall
Q rise
Schedule Graph
P Q
10
2
6 6
3 11
1 14
Demand and Quantity Demanded: The Difference
n
When the word is used alone, demand is the
behavior pattern of buyers. It is an attitude.
n
In contrast, quantity demanded is an amount.
There is one particular Qd for each P.
Why does the Demand Curve Slope Downward?
n
Two reasons:
n
At higher prices, your current income can’t buy
as much.
n
Diminishing Marginal Utility: the next one you
buy is not as useful to you (MB is lower) as the first one, so it has to be at
a lower price (MC is lower) for you to buy it.
Major Factors that Set Demand Behavior
n
Income
n
Preferences
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Number of Buyers
Major Factors that Set Demand Behavior
n
If any of these factors change, demand behavior
changes.
n
A demand behavior change is shown by shifting
the demand curve.
n
Increase in demand: shift the curve to the
right.
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Decrease in demand: shift the curve left.
Shifting Demand
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Demand increases (shift right) when:
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income increases
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preferences increase
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number of buyers increase
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Qd increases for each possible P
Shifting Demand
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Demand decreases (shift left) when:
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income decreases
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preferences decrease
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number of buyers decrease
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Qd decreases for each possible P
Does A Changing Price Shift the Demand Curve?
n
A change in the price DOES NOT shift the demand
curve.
n
However:
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raise the price and quantity demanded falls.
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lower the price and quantity demanded rises.
Change in Demand and Change in Quantity Demanded (diagram)
Supply
n
The willingness
and ability of sellers to produce and offer to sell different quantities of a
good at different prices during a specific time period.
Supply
n
For any good:
n
as price (P) rises, the quantity supplied (Qs)
rises.
n
as the price (P) falls, the quantity supplied
(Qs) falls.
n
P and Qs are directly related.
n
The supply curve is upward sloping.
Law of Supply (add diagram)
P rise
Q rise
P falls
Q falls
Schedule Graph
P Q
10 12
6 8
3 4
1
1
Supply and Quantity Supplied: The Difference
n
When the word is used alone, supply is the
behavior pattern of sellers. It is an attitude.
n
In contrast, quantity supplied is an amount.
There is a particular Qs for each P.
Change in Supply and a Change in Quantity Supplied (add diagram)
Major Factors that Set Supply Behavior
n
Business Costs
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Resource costs
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Taxes
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Regulatory costs
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Technology
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Number of Sellers
Major Factors that Set Supply Behavior
n
If any of these factors change, supply behavior
changes.
n
This type of change is shown by shifting the
supply curve.
n
Increase in supply: shift the curve to the
right.
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Decrease in supply: shift the curve left.
Shifting Supply
n
Supply increases (shift right) when:
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costs decrease
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new technology in implemented
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number of sellers increase
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Qs increases for each possible P
Shifting Supply
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Supply decreases (shift left) when:
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costs increase
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obsolescence sets in
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number of sellers decrease
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Qs decreases for each possible P
Does a Changing Price Shift the Supply Curve?
n
A change in the price DOES NOT shift the supply
curve.
n
However:
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raise the price and quantity supplied rises.
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lower the price and quantity supplied falls.
Making a Market
A market is an interaction of buyers and
sellers.
n
Buyer behavior
(the
demand curve) and seller behavior (the supply curve) intersect.
Making a Market
n
Three possibilities exist:
n
Surplus (supply exceeds demand)
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Qs > Qd
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Equilibrium (supply equals demand)
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Qs = Qd
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Shortage (demand exceeds supply)
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Qs < Qd
Surplus (diagram)
n
Supply exceeds demand.
n
Price is too high, so Qs is large and Qd is
small. (Qs>Qd)
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Unhappy sellers lower prices.
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Qs decreases and Qd increases
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Until Qs = Qd
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Equilibrium is reached
Surplus
n
Price is too
high.
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Quantity supplied
(Qs) exceeds quantity demanded (Qd).
n
Qs > Qd
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Price will fall
to Pe.
Shortage (diagram)
n
Demand exceeds supply.
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Price is too low, so Qd is large and Qs is
small. (Qd>Qs)
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Unhappy buyers bid up prices.
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Qs increases and Qd decreases
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Until Qs = Qd
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Equilibrium is reached
Shortage
n
Price is too low.
n
Quantity demanded
(Qd) exceeds quantity supplied (Qs)
n
Qd > Qs
n
Price will rise
to Pe.
Equilibrium (diagram)
n
Price is neither too high nor too low.
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Supply equals demand
n
Qs = Qd
n
Prices will not rise or fall until either demand
behavior or supply behavior changes.
Equilibrium
n
No shortage.
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No surplus.
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Qd = Qs = Qe.
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The price will
not rise or fall until there is a shift
in demand or in supply.
Increasing Demand
n
Demand curve shifts right.
n
Equilibrium is upset.
n
At the old equilibrium price, a shortage is
created.
n
The shortage triggers rising prices.
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New equilibrium is reached at a higher price and
a larger quantity.
Demand increases (diagram)
n
Demand
shifts right.
n
Old equilibrium
is upset: Shortage.
n
A new
equilibrium is established.
n
Price rises from
P1 to P2.
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Quantity rises
from Q1 to Q2
Decreasing Demand
n
Demand curve shifts left.
n
Equilibrium is upset.
n
At the old equilibrium price, a surplus is
created.
n
The surplus triggers falling prices.
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New equilibrium is reached at a lower price and
a smaller quantity.
Demand decreases (diagram)
n
Demand shifts
left.
n
Old equilibrium
is upset: Surplus.
n
A new
equilibrium is established.
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Price falls from
P1 to P2.
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Quantity falls
from Q1 to Q2
Increasing Supply
n
Supply curve shifts right.
n
Equilibrium is upset.
n
At the old equilibrium price, a surplus is
created.
n
The surplus triggers falling prices.
n
New equilibrium is reached at a lower price and
a larger quantity.
Supply increases (diagram)
n
Supply shifts
right.
n
Old equilibrium
is upset: Surplus.
n
A new
equilibrium is established.
n
Price falls from
P1 to P2.
n
Quantity rises
from Q1 to Q2.
Decreasing Supply
n
Supply curve shifts left.
n
Equilibrium is upset.
n
At the old equilibrium price, a shortage is
created.
n
The shortage triggers rising prices.
n
New equilibrium is reached at a higher price and
a smaller quantity.
Supply decreases (diagram)
n
Supply shifts
left.
n
Old equilibrium
is upset: Shortage.
n
A new
equilibrium is established.
n
Price rises from
P1 to P2.
n
Quantity falls
from Q1 to Q2.
When do prices change?
n
Prices change only when a market is in disequilibrium
n
Shortage? Price rises
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Surplus? Price falls
n
A shift in either demand or supply causes the
price to change, BUT….
n
A price change does NOT cause
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the demand curve to shift, or
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the supply curve to shift
Another Look at Market Equilibrium (diagram)
n
For each buyer,
the demand curve shows his valuation of a good (his MB).
n
His MC is the
price.
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For each seller,
the supply curve shows is production costs (his MC).
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His MB is the
price.
Consumer Surplus
n
This is how much better off buyers are having
bought the good.
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= MB – P
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= the area below the demand curve and above the
equilibrium price.
Consumer Surplus (diagram)
Producer Surplus
n
This is how much better off sellers are having
sold the good.
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= P - MC
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= the area below the equilibrium price and above
the supply curve.
Producer Surplus (diagram)
Betterment of Society
n
Three groups in society:
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Buyers – better off by consumer surplus
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Sellers – better off by producer surplus
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Everyone else – neither better nor worse off
n
Total society betterment due to trade equals
consumer surplus plus producer surplus.
Society is Better Off (diagram)
Price Controls
n
Government intervenes in a market to restrict
the movement of price.
n
Affected market cannot reach equilibrium.
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Two kinds:
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Price Ceiling
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Price Floor
Price Ceiling
n
Government mandated a maximum price below
equilibrium.
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Purpose: to help low income buyers
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Consequence: permanent shortage
Price ceiling (diagram)
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Government sets a maximum legal price
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P < Pe
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Persistent shortage
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Qd – Qs
Price Floor
n
Government mandated a minimum price above
equilibrium.
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Purpose: to help low income sellers
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Consequence: permanent surplus
Price floor (diagram)
n
Government sets a minimum legal price
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P > Pe
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Persistent surplus
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Qs – Qd
Activity
n
Government has set a price ceiling on
apartments.
n
This generates a shortage.
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What rationing device should be used?
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First come first served
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Draw numbers
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Favoritism
Consequences
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Price floors and price ceilings:
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Both cause fewer wants and needs to be satisfied
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Both cause a waste of resources
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Neither do much good for the intended group
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Black markets develop
Black market
n
Illegal buying and selling
n
Despite the legislation, demand and supply
behaviors still exist