Chapter 17. Demand, Supply, and Equilibrium

Chapter 17Demand, Supply, and EquilibriumCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.17-1Chapter ObjectivesIndividual and market demandChanges in demandIndividual and market supplyChanges in supplyGraphing supply and demand curvesFinding equilibrium price and quantityCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.17-2Demand DefinedDemand is the schedule of quantities of a good or service that people will purchase at different pricesThe law of demand: when the price of a good is lowered, more of it is demanded; When it is raised, less is demandedCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.17-3Individual and Market DemandThe law of demand holds for both individuals and marketsIndividual demand is the schedule of quantities that a person would purchase at different pricesMarket demand is the schedule of quantities that everyone in the market would buy at different pricesCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.17-4Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.17-5Table 1 Hypothetical Individual Demand and Market Demand Schedules 0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 612182430QuantityPrice Quantity demanded by VenusPrice QD$30 0 25 2 20 3 15 3 10 4 5 5Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.17-6Table 1 Hypothetical Individual Demand and Market Demand Schedules 0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 612182430QuantityPrice Quantity demanded by MartinaPrice QD$30 1 25 1 20 2 15 3 10 5 5 6Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.17-7Table 1 Hypothetical Individual Demand and Market Demand Schedules 0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 612182430QuantityPrice Quantity demanded by SerenaPrice QD$30 2 25 3 20 5 15 6 10 7 5 7Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.17-8Table 1 Hypothetical Individual Demand and Market Demand Schedules 0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 612182430QuantityPrice Quantity demanded by LindsayPrice QD$30 1 25 3 20 4 15 6 10 7 5 8Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.17-9 0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 612182430QuantityPricePrice Venus Martina Serena Lindsay Total $30 0 1 2 1 4 Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.17-10 0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 612182430QuantityPricePrice Venus Martina Serena Lindsay Total $30 0 1 2 1 4 $25 2 1 3 3 9 Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.17-11 0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 612182430QuantityPricePrice Venus Martina Serena Lindsay Total $30 0 1 2 1 4 $25 2 1 3 3 9 $20 3 2 5 4 14 Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.17-12 0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 612182430QuantityPricePrice Venus Martina Serena Lindsay Total $30 0 1 2 1 4 $25 2 1 3 3 9 $20 3 2 5 4 14 $15 3 3 6 6 18Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.17-13 0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 612182430QuantityPricePrice Venus Martina Serena Lindsay Total $30 0 1 2 1 4 $25 2 1 3 3 9 $20 3 2 5 4 14 $15 3 3 6 6 18 $10 4 5 7 7 23Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.17-14 0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 612182430QuantityPricePrice Venus Martina Serena Lindsay Total $30 0 1 2 1 4 $25 2 1 3 3 9 $20 3 2 5 4 14 $15 3 3 6 6 18 $10 4 5 7 7 23 $ 5 5 6 7 8 26Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.17-15 0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 612182430QuantityPricePrice Venus Martina Serena Lindsay Total $30 0 1 2 1 4 $25 2 1 3 3 9 $20 3 2 5 4 14 $15 3 3 6 6 18 $10 4 5 7 7 23 $ 5 5 6 7 8 26Market Demand17-16Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.What Is the Market?The market is where people buy and sellLocal marketsGasoline, groceriesRegionalAutomobilesNational or internationalComputersChanges in DemandPrice QD(1) QD(2) $30 4 5 $25 9 11 $20 14 18 $15 18 28 $10 23 38 $ 5 26 50 A change in demand would be a change in the schedule17-17Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.An Increase in DemandPrice QD(1) QD(2) $30 4 5 $25 9 11 $20 14 18 $15 18 28 $10 23 38 $ 5 26 50 An increase in demand is an increase in the quantity people are willing to purchase at all prices17-18Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.The demand curve shifts to the rightAn Increase in DemandPrice QD(1) QD(2) $30 4 5 $25 9 11 $20 14 18 $15 18 28 $10 23 38 $ 5 26 50 A decrease in demand means people are willing to purchase less at all prices17-19Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.The demand curve shifts to the leftChanges in DemandD2D1ABC17-20Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Move from point A to point BA change in quantity demandedA and B are on the same line, therefore, they are on the same schedule. If they are on the same schedule, there can be no change in demand Changes in DemandD2D1ABC17-21Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Move from point A to point BA change in quantity demandedMovement from A to B is simply a change in quantity demanded in response to a change in price Changes in DemandEGI17-22Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Move from point F to point GAn increase in demandThere is an increase in demand because people are willing to buy more at all prices on G’s curve which is to the right of F’s curveHFChanges in DemandEGI17-23Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Move from point G to point HA decrease in demandThere is a decrease in demand because people are willing to buy less at all prices on H’s curve which is to the left of G’s curveHFChanges in DemandEGI17-24Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Move from point H to point IA change in quantity in demandedAs long as we remain on the same curve, there is no change in demandHFChanges in DemandLGJ17-25Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Move from point J to point KA change in quantity in demandedAs long as we remain on the same curve, there is no change in demandNKMChanges in DemandLGJ17-26Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Move from point K to point LAn increase in demandFrom K to L is an increase in demand because L’s demand curve is entirely to the right of K’s curve NKMChanges in DemandLGJ17-27Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Move from point L to point MA decrease in demandFrom L to M is a decrease in demand because M’s demand curve is entirely to the left of L’s curve NKMChanges in DemandLGJ17-28Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Move from point M to point NA change in demandWe don’t know on which of an infinite number of possible demand curves N is situated, therefore, the most we can say is that there is a change in demandNKM17-29Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.What Causes Changes in Demand?Changes in incomeChanges in the price of related goods and servicesChanges in taste and preferencesChanges in price expectationsChanges in population17-30Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Changes in IncomeThe demand for NORMAL goods varies directly with incomeWhen income goes up people buy more therefore demand goes upThe demand for INFERIOR goods varies inversely with incomeWhen income goes up people buy less, therefore demand goes down17-31Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Changes in the Price of Related Goods and ServicesGoods and services are related in two waysThey can be used as a substitute for the otherHot dogs and hamburgers; Tuna and salmonThey can complement the otherVideos & VCRs; Gasoline & cars, tires 17-32Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Prices of Substitute GoodsDirectly relatedIf the price of hamburgers goes upThe price of hot dogs would also go upAs the price of hamburgers goes up people will buy less hamburgers and more hot dogs. This increases the demand for hot dogs . . . thus increasing the price of hot dogs 17-33Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.17-34Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Prices of Complementary GoodsInversely relatedPrices of weenies go up . . . the price of hot dog buns goes downThe price of weenies goes up . . . people buy less weenies. If people buy less weenies, they will also buy less hot dog bunsThis decreases the demand for hot dog buns and lowers the price of hotdog buns17-35Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.17-36Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Changes in Taste and PreferencesTaste and preferences tend to change over timeSmaller cars and less fattening foodsPreferring designer clothing and brand name sneakersFewer people are smoking (has been helped by a campaign to reduce smoking)17-37Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Changes in Price ExpectationsIf people expect the price of something to rise, they rush out to stock up before it doesThis increases the demand If people expect the price of something to fall, they will hold off buying it This decreases the demand17-38Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Changes in PopulationAs the nation’s population increases, the demand for particular goods and services increaseGeneral growth increases the demand for food, housing, autos, etc.The changing age distribution affects demandNext three decades there will be a higher demand for retirement homes, nursing homes, wheel chairs, bifocal glasses, etc.17-39Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Supply DefinedSupply is a schedule of quantities of a good or service that people are willing to sell at various pricesAs prices rise, people are willing to sell moreThus, there is a positive or direct relationship between price and quantityPrice rises . . . quantity supplied risesPrices declines . . . quantity supplied declines17-40Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Individual and Market SupplyHypothetical supply of American Cars, 2001 (in thousands) Daimler Japanese Price GM Ford Chrysler Owned Firms Total$20,000 5311 2356 1245 535 9,447 18,000 4617 1984 991 384 7,976 16,000 4002 1584 762 270 6,618 14,000 3623 1216 601 208 5,648 12,000 3190 996 491 181 4,858 17-41Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Hypothetical Supply of American Cars, 2001Changes in Supply17-42Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.A change in quantity suppliedChanges in Supply17-43Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.An increase in supplyChanges in Supply17-44Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.A change in supplyChanges in Supply17-45Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.A change in quantity suppliedChanges in Supply17-56Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.17-45An increase in supplyChanges in Supply17-47Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.A change in quantity suppliedChanges in Supply17-48Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.A decrease in supplyChanges in Supply17-49Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.A change in supply17-50Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.17-51Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.17-52Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.17-53Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.17-54Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.17-55Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.17-56Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Graphing the Demand and Supply Curves17-57Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Hypothetical Demand Schedule Price Quantity Demanded(QD) $10 1 $ 9 2 $ 8 4 $ 7 7 $ 6 12 Graphing the Demand and Supply Curves17-58Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Hypothetical Supply Schedule Price Quantity Supplied (QS) $10 14 $ 9 12 $ 8 9 $ 7 5 $ 6 1 Graphing the Demand and Supply Curves17-59Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Hypothetical Demand and Supply Schedules Price QD QS $10 1 14 $ 9 2 12 $ 8 4 9 $ 7 7 5 $ 6 12 1 The equilibrium point is where the demand and supply curves crossGraphing the Demand and Supply Curves17-60Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Hypothetical Demand and Supply Schedules Price QD QS $10 1 14 $ 9 2 12 $ 8 4 9 $ 7 7 5 $ 6 12 1 Equilibrium quantity is 6Equilibrium price is about $7.20Graphing the Demand and Supply Curves17-61Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Above equilibrium price there are surplusesPricePrice always tends toward equilibrium. If price is above equilibrium, sellers will lower prices until the price declines to the equilibrium pricePricePriceGraphing the Demand and Supply Curves17-62Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Below equilibrium price there are shortagesPricePrice always tends toward equilibrium. If price is below equilibrium, buyers will bid prices up until the price rises to the equilibrium pricePricePriceFinding Equilibrium Price and Quantity17-63Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.If we draw our graphs accurately, we can usually find equilibrium price and quantity in a couple of seconds, especially if we’ve used graph paper. But sometime we need to do further analysis to find really accurate equilibrium prices and quantitiesPrice Quantity Demanded Quantity Supplied $15 2 19 $14 4 17 $13 7 12 $12 12 6 $11 20 3 Hypothetical Demand and Supply ScheduleHow much is the equilibrium price?Finding Equilibrium Price and Quantity17-64Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Price Quantity Demanded Quantity Supplied $15 2 19 $14 4 17 $13 7 12 $12 12 6 $11 20 3 Hypothetical Demand and Supply ScheduleHow much is the equilibrium price?First we add a “Units apart” columnFinding Equilibrium Price and Quantity17-65Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Price Quantity Demanded Units Apart Quantity Supplied $15 2 17 19 $14 4 13 17 $13 7 5 12 $12 12 6 6 $11 20 17 3 Hypothetical Demand and Supply ScheduleHow much is the equilibrium price?First we add a “Units apart” columnEquilibrium price is closer to $13 than to $12Finding Equilibrium Price and Quantity17-66Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Price Quantity Demanded Units Apart Quantity Supplied $15 2 17 19 $14 4 13 17 $13 7 5 12 $12 12 6 6 $11 20 17 3 Hypothetical Demand and Supply ScheduleHow much is the equilibrium price?First we add a “Units apart” columnEquilibrium price is a little closer to $13 than to $12Therefore, equilibrium price has to be something greater than $12.50 and less than $1317-67Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Price Quantity Demanded Units Apart Quantity Supplied $15 2 17 19 $14 4 13 17 $13 7 5 12 $12 12 6 6 $11 20 17 3 Hypothetical Demand and Supply ScheduleHow much is the equilibrium quantity?Equilibrium quantity demanded is closer to 7 than 12. The midpoint between 12 and 7 is 9.5. Therefore, we know the equilibrium quantity demanded must be something less than 9.5 Equilibrium quantity supplied is closer to 12 than 6. The midpoint between 12 and 6 is 9. Therefore, we know the equilibrium quantity supplied is something more than 9.0The equilibrium quantity has to be between 9.0 and 9.5. Anything between 9.1 and 9.4 would be acceptable. I would split the difference and say 9.2 or 9.317-68Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Graph of the Previous Demand and Supply ScheduleRemember, equilibrium price has to be something greater than $12.50 and less than $13$12.60 plus or minus .05 is about the best you can do17-69Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Graph of the Previous Demand and Supply Schedule$12.60 plus or minus .05 is about the best you can doRemember, the equilibrium quantity has to be between 9.0 and 9.5. Anything between 9.1 and 9.4 would be acceptable. I would split the difference and say 9.2 or 9.3In this instance, this technique proved useful.Is This Type of Analysis Necessary?It isn’t when you’ve got an equilibrium price or quantity that is clearly closer to one figure than to anotherYou will be able to spot this when you draw your graphBut when the demand and supply curves cross about halfway between two figures, then you will need to go back to the original schedule to figure out more precisely where the equilibrium point lies17-70Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.