ch03-110629184923-phpapp02 (1).ppt

© 2002 Prentice Hall Business Publishing
© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e
Principles of Economics, 6/e Karl Case, Ray Fair
Karl Case, Ray Fair
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Prepare d by: Fe rnand o Q uij
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Prepare d by: Fe rnand o Q uij
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and Yvonn Q uij
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and Yvonn Q uij
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Demand, Supply, and
Demand, Supply, and
Market Equilibrium
Market Equilibrium

© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
The Basic Decision-Making Units
The Basic Decision-Making Units
• A
A firm
firm is an organization that transforms
is an organization that transforms
resources (inputs) into products (outputs).
resources (inputs) into products (outputs).
Firms are the primary producing units in a
Firms are the primary producing units in a
market economy.
market economy.
• An
An entrepreneur
entrepreneur is a person who organizes,
is a person who organizes,
manages, and assumes the risks of a firm,
manages, and assumes the risks of a firm,
taking a new idea or a new product and
taking a new idea or a new product and
turning it into a successful business.
turning it into a successful business.
• Households
Households are the consuming units in an
are the consuming units in an
economy.
economy.

The Circular Flow of Economic Activity
The Circular Flow of Economic Activity
• The
The circular flow of
circular flow of
economic activity
economic activity shows
shows
the connections between
the connections between
firms and households in
firms and households in
input and output markets.
input and output markets.

Input Markets and Output Markets
Input Markets and Output Markets
• Output, or product,
Output, or product,
markets
markets are the markets
are the markets
in which goods and
in which goods and
services are exchanged.
services are exchanged.
• Input markets
Input markets are the
are the
markets in which
markets in which
resources—labor, capital,
resources—labor, capital,
and land—used to
and land—used to
produce products, are
produce products, are
exchanged.
exchanged.
• Payments flow in the opposite
Payments flow in the opposite
direction as the physical flow of
direction as the physical flow of
resources, goods, and services
resources, goods, and services
(counterclockwise).
(counterclockwise).

Input Markets
Input Markets
Input markets include:
Input markets include:
• The
The labor market
labor market, in which households supply
, in which households supply
work for wages to firms that demand labor.
work for wages to firms that demand labor.
• The
The capital market
capital market, in which households supply
their savings, for interest or for claims to future
their savings, for interest or for claims to future
profits, to firms that demand funds to buy capital
profits, to firms that demand funds to buy capital
goods.
goods.
• The
The land market
land market, in which households supply
land or other real property in exchange for rent.
land or other real property in exchange for rent.

Determinants of Household Demand
Determinants of Household Demand
• The
The price of the product
price of the product in question.
in question.
• The
The income
income available to the household.
available to the household.
• The household’s amount of
The household’s amount of accumulated wealth
accumulated wealth.
.
• The
The prices of related products
prices of related products available to the
available to the
household.
household.
• The household’s
The household’s tastes and preferences
tastes and preferences.
.
• The household’s
The household’s expectations
expectations about future
about future
income, wealth, and prices.
income, wealth, and prices.
A household’s decision about the quantity of a particular
A household’s decision about the quantity of a particular
output to demand depends on:
output to demand depends on:

Quantity Demanded
Quantity Demanded
• Quantity demanded
Quantity demanded is the amount
is the amount
(number of units) of a product that a
(number of units) of a product that a
household would buy in a given time
household would buy in a given time
period if it could buy all it wanted at
period if it could buy all it wanted at
the current market price.
the current market price.

Demand in Output Markets
Demand in Output Markets
• A
A demand schedule
demand schedule
is a table showing
is a table showing
how much of a given
how much of a given
product a household
product a household
would be willing to
would be willing to
buy at different prices.
• Demand curves are
Demand curves are
usually derived from
usually derived from
demand schedules.
demand schedules.
PRICE
(PER
CALL)
QUANTITY
DEMANDED
(CALLS PER
MONTH)
$ 0 30
0.50 25
3.50 7
7.00 3
10.00 1
15.00 0
ANNA'S DEMAND
SCHEDULE FOR
TELEPHONE CALLS

The Demand Curve
The Demand Curve
• The
The demand curve
demand curve is
is
a graph illustrating
a graph illustrating
how much of a given
how much of a given
product a household
product a household
would be willing to
would be willing to
PRICE
(PER
CALL)
QUANTITY
DEMANDED
(CALLS PER
MONTH)
$ 0 30
0.50 25
3.50 7
7.00 3
10.00 1
15.00 0
ANNA'S DEMAND
SCHEDULE FOR
TELEPHONE CALLS

The Law of Demand
The Law of Demand
• The
The law of demand
law of demand
states that there is a
negative, or inverse,
negative, or inverse,
relationship between
relationship between
price and the quantity
price and the quantity
of a good demanded
of a good demanded
and its price.
and its price.
• This means that
This means that
demand curves slope
demand curves slope
downward.
downward.

Other Properties of Demand Curves
Other Properties of Demand Curves
• Demand curves intersect
Demand curves intersect
the quantity (
the quantity (X
X)-axis, as a
)-axis, as a
result of time limitations and
result of time limitations and
diminishing marginal utility.
diminishing marginal utility.
• Demand curves intersect
Demand curves intersect
the (
the (Y
Y)-axis, as a result of
)-axis, as a result of
limited incomes and wealth.
limited incomes and wealth.

Income and Wealth
Income and Wealth
• Income
Income is the sum of all households
is the sum of all households
wages, salaries, profits, interest
wages, salaries, profits, interest
payments, rents, and other forms of
payments, rents, and other forms of
earnings in a given period of time. It is
earnings in a given period of time. It is
a
a flow
flow measure.
measure.
• Wealth
Wealth, or
, or net worth
net worth, is the total value
, is the total value
of what a household owns minus what
of what a household owns minus what
it owes
it owes.
. It is a
It is a stock
stock measure.
measure.

Related Goods and Services
• Normal Goods
Normal Goods are goods for which
are goods for which
demand goes up when income is
demand goes up when income is
higher and for which demand goes
higher and for which demand goes
down when income is lower.
down when income is lower.
• Inferior Goods are goods for which
demand falls when income rises.

• Substitutes
Substitutes are goods that can serve as
are goods that can serve as
replacements for one another; when the
replacements for one another; when the
price of one increases, demand for the
price of one increases, demand for the
other goes up.
other goes up. Perfect substitutes
Perfect substitutes are
are
identical products.
identical products.
• Complements are goods that “go
together”; a decrease in the price of one
results in an increase in demand for the
other, and vice versa.

Shift of Demand Versus Movement Along a
Shift of Demand Versus Movement Along a
Demand Curve
Demand Curve
• A change in
A change in demand
demand is
is
not the same as a change
not the same as a change
in
in quantity demanded
quantity demanded.
.
• In this example, a higher
In this example, a higher
price causes lower
price causes lower
quantity demanded
quantity demanded.
.
• Changes in determinants
Changes in determinants
of demand, other than
of demand, other than
price, cause a change in
price, cause a change in
demand
demand, or a
, or a shift
shift of the
of the
entire demand curve, from
entire demand curve, from
D
DA
A to
to D
DB
B.
.

• When demand shifts to
the right, demand
increases. This causes
quantity demanded to be
greater than it was prior to
the shift, for each and
every price level.
A Change in Demand Versus a Change in
Quantity Demanded
Quantity Demanded

Quantity Demanded
Quantity Demanded
To summarize:
Change in price of a good or service
leads to
Change in quantity demanded
(Movement along the curve).
Change in income, preferences, or
prices of other goods or services
leads to
Change in demand
(Shift of curve).

The Impact of a Change in Income
The Impact of a Change in Income
• Higher income
decreases the demand
for an inferior good
• Higher income
increases the demand
for a normal good

The Impact of a Change in the Price
The Impact of a Change in the Price
of Related Goods
of Related Goods
• Price of hamburger rises
• Demand for complement good
(ketchup) shifts left
• Demand for substitute good (chicken)
shifts right
• Quantity of hamburger
demanded falls

From Household to Market Demand
From Household to Market Demand
• Demand for a good or service can be
Demand for a good or service can be
defined for an
defined for an individual household
individual household, or
, or
for a group of households that make up a
for a group of households that make up a
market
market.
.
• Market demand
Market demand is the sum of all the
is the sum of all the
quantities of a good or service demanded
quantities of a good or service demanded
per period by all the households buying in
per period by all the households buying in
the market for that good or service.
the market for that good or service.

From Household Demand to Market
From Household Demand to Market
Demand
Demand
• Assuming there are only two households in the
Assuming there are only two households in the
market, market demand is derived as follows:
market, market demand is derived as follows:

Supply in Output Markets
Supply in Output Markets
• A
A supply schedule
supply schedule is a table
is a table
showing how much of a product
showing how much of a product
firms will supply at different
firms will supply at different
prices.
prices.
• Quantity supplied
Quantity supplied represents the
represents the
number of units of a product that
number of units of a product that
a firm would be willing and able to
a firm would be willing and able to
offer for sale at a particular price
offer for sale at a particular price
during a given time period.
during a given time period.
PRICE
(PER
BUSHEL)
QUANTITY
SUPPLIED
(THOUSANDS
OF BUSHELS
PER YEAR)
$ 2 0
1.75 10
2.25 20
3.00 30
4.00 45
5.00 45
CLARENCE BROWN'S
SUPPLY SCHEDULE
FOR SOYBEANS

The Supply Curve and
The Supply Curve and
the Supply Schedule
the Supply Schedule
• A
A supply curve
supply curve is a graph illustrating how much
is a graph illustrating how much
of a product a firm will supply at different prices.
of a product a firm will supply at different prices.
0
1
2
3
4
5
6
0 10 20 30 40 50
Thousands of bushels of soybeans
produced per year
Price
of
soybeans
per
bushel
($)
PRICE
(PER
BUSHEL)
QUANTITY
SUPPLIED
(THOUSANDS
OF BUSHELS
PER YEAR)
$ 2 0
1.75 10
2.25 20
3.00 30
4.00 45
5.00 45
CLARENCE BROWN'S
SUPPLY SCHEDULE
FOR SOYBEANS

The Law of Supply
The Law of Supply
• The
The law of supply
law of supply
positive relationship
positive relationship
between price and
between price and
quantity of a good
quantity of a good
supplied.
supplied.
• This means that
This means that
supply curves
supply curves
typically have a
typically have a
positive slope.
positive slope.
0
1
2
3
4
5
6
0 10 20 30 40 50
Thousands of bushels of soybeans
produced per year
Price
of
soybeans
per
bushel
($)

Determinants of Supply
Determinants of Supply
• The
The price
price of the good or service.
of the good or service.
• The
The cost
cost of producing the good, which in
of producing the good, which in
turn depends on:
turn depends on:
• The
The price of required inputs
price of required inputs (labor,
(labor,
capital, and land),
capital, and land),
• The
The technologies
technologies that can be used to
that can be used to
produce the product,
produce the product,
• The
The prices of related products.
prices of related products.

A Change in Supply Versus
a Change in Quantity Supplied
• A change in
A change in supply
supply is
is
not the same as a
not the same as a
change in
change in quantity
quantity
supplied
supplied.
.
• In this example, a higher
In this example, a higher
price causes
price causes higher
higher
quantity supplied
quantity supplied, and
, and
a
a move along
move along the
the
demand curve.
demand curve.
• In this example, changes in determinants of supply, other
In this example, changes in determinants of supply, other
than price, cause an
than price, cause an increase in supply
increase in supply, or a
, or a shift
shift of the
of the
entire supply curve, from
entire supply curve, from S
SA
A to
to S
SB
B.
.

• When supply shifts
to the right, supply
increases. This
causes quantity
supplied to be
greater than it was
prior to the shift, for
each and every price
level.

To summarize:
Change in price of a good or service
leads to
Change in quantity supplied
(Movement along the curve).
Change in costs, input prices, technology, or prices of
related goods and services
leads to
Change in supply
(Shift of curve).

From Individual Supply
From Individual Supply
to Market Supply
to Market Supply
• The supply of a good or service can be defined
The supply of a good or service can be defined
for an individual firm, or for a group of firms that
for an individual firm, or for a group of firms that
make up a market or an industry.
make up a market or an industry.
• Market supply
Market supply is the sum of all the quantities of
is the sum of all the quantities of
a good or service supplied per period by all the
a good or service supplied per period by all the
firms selling in the market for that good or
firms selling in the market for that good or
service.
service.

Market Supply
Market Supply
• As with market demand, market supply is the
horizontal summation of individual firms’ supply
curves.

Market Equilibrium
Market Equilibrium
• The operation of the market
The operation of the market
depends on the interaction
depends on the interaction
between buyers and sellers.
between buyers and sellers.
• An
An equilibrium
equilibrium is the condition
is the condition
that exists when quantity supplied
that exists when quantity supplied
and quantity demanded are equal.
and quantity demanded are equal.
• At equilibrium, there is no tendency
At equilibrium, there is no tendency
for the market price to change.
for the market price to change.

Market Equilibrium
Market Equilibrium
• Only in equilibrium is
Only in equilibrium is
quantity supplied
quantity supplied
equal to quantity
equal to quantity
demanded.
demanded.
• At any price level
At any price level
other than
other than P
P0
0, the
, the
wishes of buyers
wishes of buyers
and sellers do not
and sellers do not
coincide.
coincide.

Market Disequilibria
• Excess demand
Excess demand, or
, or
shortage, is the condition
shortage, is the condition
that exists when quantity
demanded exceeds
demanded exceeds
quantity supplied at the
quantity supplied at the
current price.
current price.
• When quantity demanded
When quantity demanded
exceeds quantity
exceeds quantity
supplied, price tends to
supplied, price tends to
rise until equilibrium is
rise until equilibrium is
restored.
restored.

• Excess supply
Excess supply, or
, or
surplus, is the condition
surplus, is the condition
supplied exceeds quantity
supplied exceeds quantity
demanded at the current
demanded at the current
price.
price.
• When quantity supplied
When quantity supplied
exceeds quantity
exceeds quantity
demanded, price tends to
demanded, price tends to
fall until equilibrium is
fall until equilibrium is
restored.
restored.

Increases in Demand and Supply
Increases in Demand and Supply
• Higher demand
Higher demand leads to
leads to
higher equilibrium price and
higher equilibrium price and
higher equilibrium quantity.
• Higher supply
Higher supply leads to
leads to
lower equilibrium price and
lower equilibrium price and

Decreases in Demand and Supply
Decreases in Demand and Supply
• Lower demand
Lower demand leads to
leads to
lower price and lower
lower price and lower
quantity exchanged.
quantity exchanged.
• Lower supply
Lower supply leads to
leads to
higher price and lower
higher price and lower
quantity exchanged.
quantity exchanged.

Relative Magnitudes of Change
• The relative magnitudes of change in supply and
The relative magnitudes of change in supply and
demand determine the outcome of market equilibrium.
demand determine the outcome of market equilibrium.

• When supply and demand both increase, quantity
When supply and demand both increase, quantity
will increase, but price may go up or down.
will increase, but price may go up or down.

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