Chapter4TheMarketForcesofSupplyandDemandCHAPTER4THEMARKETFORCESOFSUPPLYANDDEMANDInthischapter,lookfortheanswerstothesequestions:Whatfactorsaffectsellers’supplyofgoods?Howdosupplyanddemanddeterminethepriceofagoodandthequantitysold?Howdochangesinthefactorsthataffectdemandorsupplyaffectthemarketpriceandquantityofagood?Howdomarketsallocateresources?CHAPTER4THEMARKETFORCESOFSUPPLYANDDEMANDSupplyThequantitysuppliedofanygoodistheamountthatsellersarewillingandabletosell.Lawofsupply:theclaimthatthequantitysuppliedofagoodriseswhenthepriceofthegoodrises,otherthingsequal0CHAPTER4THEMARKETFORCESOFSUPPLYANDDEMANDTheSupplyScheduleSupplyschedule:

Atablethatshowstherelationshipbetweenthepriceofagoodandthequantitysupplied.Example:

Starbucks’supplyoflattes.NoticethatStarbucks’supplyscheduleobeysthe

LawofSupply.0CHAPTER4THEMARKETFORCESOFSUPPLYANDDEMANDStarbucks’SupplySchedule&CurvePQ0MarketSupplyversusIndividualSupplyThequantitysuppliedinthemarketisthesumofthequantitiessuppliedbyallsellersateachprice.SupposeStarbucksandJittersaretheonlytwosellersinthismarket.(Qs=quantitysupplied)1815129630Starbucks121086420Jitters++++====30252015+=10+=5+=0MarketQs

$0.006.005.004.003.002.001.00Price0CHAPTER4THEMARKETFORCESOFSUPPLYANDDEMANDPQTheMarketSupplyCurve0CHAPTER4THEMARKETFORCESOFSUPPLYANDDEMANDSupplyCurveShiftersThesupplycurveshowshowpriceaffectsquantitysupplied,otherthingsbeingequal.These“otherthings”arenon-pricedeterminantsofsupply.ChangesinthemshifttheScurve…0CHAPTER4THEMARKETFORCESOFSUPPLYANDDEMANDSupplyCurveShifters:inputpricesExamplesofinputprices:

wages,pricesofrawmaterials.Afallininputpricesmakesproduction

moreprofitableateachoutputprice,

sofirmssupplyalargerquantityateachprice,

andtheScurveshiftstotheright.0CHAPTER4THEMARKETFORCESOFSUPPLYANDDEMANDPQSupposethepriceofmilkfalls.Ateachprice,thequantityof

Lattessupplied

willincrease

(by5inthisexample).SupplyCurveShifters:inputprices0CHAPTER4THEMARKETFORCESOFSUPPLYANDDEMANDSupplyCurveShifters:technologyTechnologydetermineshowmuchinputsarerequiredtoproduceaunitofoutput.Acost-savingtechnologicalimprovementhasthesameeffectasafallininputprices,

shiftsScurvetotheright.0CHAPTER4THEMARKETFORCESOFSUPPLYANDDEMANDSupplyCurveShifters:#ofsellers

Anincreaseinthenumberofsellersincreasesthequantitysuppliedateachprice, shiftsScurvetotheright.0CHAPTER4THEMARKETFORCESOFSUPPLYANDDEMANDSupplyCurveShifters:expectations

Example:EventsintheMiddleEastleadtoexpectationsofhigheroilprices.Inresponse,ownersofTexasoilfieldsreducesupplynow,savesomeinventorytoselllateratthehigherprice.Scurveshiftsleft.Ingeneral,sellersmayadjustsupply*whentheirexpectationsoffuturepriceschange.

(*Ifgoodnotperishable.)0CHAPTER4THEMARKETFORCESOFSUPPLYANDDEMANDSummary:VariablesThatAffectSupplyVariable Achangeinthisvariable…Price …causesamovement

alongtheScurveInputprices …shiftstheScurveTechnology …shiftstheScurveNo.ofsellers …shiftstheScurveExpectations …shiftstheScurve0A

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Supplycurve14Drawasupplycurvefortax

returnpreparationsoftware.

Whathappenstoitineach

ofthefollowingscenarios?0A.

Retailerscutthepriceof

thesoftware.B.

Atechnologicaladvance

allowsthesoftwaretobe

producedatlowercost.C.

Professionaltaxreturnpreparersraisethepriceoftheservicestheyprovide.A

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A.fallinpriceoftaxreturnsoftware15Scurvedoes

notshift.Movedown

alongthecurve

toalowerP

andlowerQ.PriceoftaxreturnsoftwareQuantityoftaxreturnsoftwareS1P1Q1Q2P2A

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B.fallincostofproducingthesoftware16Scurveshiftstotheright:ateachprice,

Qincreases.PriceoftaxreturnsoftwareQuantityoftaxreturnsoftwareS1P1Q1S2Q2A

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C.professionalpreparersraisetheirprice17Thisshiftsthedemandcurvefortaxpreparationsoftware,notthesupplycurve.PriceoftaxreturnsoftwareQuantityoftaxreturnsoftwareS1CHAPTER4THEMARKETFORCESOFSUPPLYANDDEMANDPQSupplyandDemandTogetherDSEquilibrium:

Phasreached

thelevelwhere

quantitysuppliedequals

quantitydemanded0CHAPTER4THEMARKETFORCESOFSUPPLYANDDEMANDDSPQEquilibriumprice:Thepricethatequatesquantitysuppliedwithquantitydemanded0CHAPTER4THEMARKETFORCESOFSUPPLYANDDEMANDDSPQEquilibriumquantity:Thequantitysuppliedandquantitydemandedattheequilibriumprice0CHAPTER4THEMARKETFORCESOFSUPPLYANDDEMANDPQDSSurplus:whenquantitysuppliedisgreaterthanquantitydemandedSurplusExample:

IfP=$5,then

QD=9lattesand

QS=25lattesresultinginasurplusof16lattes0CHAPTER4THEMARKETFORCESOFSUPPLYANDDEMANDPQDSSurplus:whenquantitysuppliedisgreaterthanquantitydemandedFacingasurplus,

sellerstrytoincreasesalesbycuttingprice.Thiscauses

QDtoriseSurplus…whichreducesthesurplus.andQStofall…0CHAPTER4THEMARKETFORCESOFSUPPLYANDDEMANDPQDSSurplus:whenquantitysuppliedisgreaterthanquantitydemandedFacingasurplus,

sellerstrytoincreasesalesbycuttingprice.Thiscauses

QDtoriseandQStofall.SurplusPricescontinuetofalluntilmarketreachesequilibrium.0CHAPTER4THEMARKETFORCESOFSUPPLYANDDEMANDPQDSShortage:whenquantitydemandedisgreaterthanquantitysuppliedExample:

IfP=$1,then

QD=21lattesand

QS=5lattesresultingina

shortageof16lattesShortage0CHAPTER4THEMARKETFORCESOFSUPPLYANDDEMANDPQDSShortage:whenquantitydemandedisgreaterthanquantitysuppliedFacingashortage,

sellersraisetheprice,causingQDtofall…whichreducestheshortage.andQStorise,Shortage0CHAPTER4THEMARKETFORCESOFSUPPLYANDDEMANDPQDSShortage:whenquantitydemandedisgreaterthanquantitysuppliedFacingashortage,

sellersraisetheprice,causingQDtofallandQStorise.ShortagePricescontinuetoriseuntilmarketreachesequilibrium.0CHAPTER4THEMARKETFORCESOFSUPPLYANDDEMANDThreeStepstoAnalyzingChangesinEq’mTodeterminetheeffectsofanyevent,1. DecidewhethereventshiftsScurve,

Dcurve,orboth.2. Decideinwhichdirectioncurveshifts.3. Usesupply-demanddiagramtosee

howtheshiftchangeseq’mPandQ.CHAPTER4THEMARKETFORCESOFSUPPLYANDDEMANDEXAMPLE:

TheMarketforHybridCars

PQD1S1P1Q1priceofhybridcarsquantityof

hybridcarsCHAPTER4THEMARKETFORCESOFSUPPLYANDDEMANDSTEP1:Dcurveshifts

becausepriceofgasaffectsdemandforhybrids.Scurvedoesnotshift,becausepriceofgasdoesnotaffectcostofproducinghybrids.STEP2:Dshiftsright

becausehighgaspricemakeshybridsmoreattractiverelativetoothercars.EXAMPLE1:

AChangeinDemand

EVENTTOBE

ANALYZED:

Increaseinpriceofgas.PQD1S1P1Q1D2P2Q2STEP3:Theshiftcausesanincreaseinprice

andquantityofhybridcars.CHAPTER4THEMARKETFORCESOFSUPPLYANDDEMANDEXAMPLE1:

AChangeinDemand

PQD1S1P1Q1D2P2Q2Notice:

WhenPrises,producerssupply

alargerquantity

ofhybrids,eventhoughtheScurvehasnotshifted.Alwaysbecarefultodistinguishb/washiftinacurveandamovementalongthecurve.TermsforShiftvs.MovementAlongCurveChangeinsupply:ashiftintheScurveoccurswhenanon-pricedeterminantofsupplychanges(liketechnologyorcosts)Changeinthequantitysupplied:

amovementalongafixedScurveoccurswhenPchangesChangeindemand:ashiftintheDcurveoccurswhenanon-pricedeterminantofdemandchanges(likeincomeor#ofbuyers)Changeinthequantitydemanded:

amovementalongafixedDcurveoccurswhenPchangesCHAPTER4THEMARKETFORCESOFSUPPLYANDDEMANDSTEP1:Scurveshifts

becauseeventaffectscostofproduction.Dcurvedoesnotshift,becauseproductiontechnologyisnotoneofthefactorsthataffectdemand.STEP2:Sshiftsright

becauseeventreducescost,

makesproductionmoreprofitableatanygivenprice.EXAMPLE2:

AChangeinSupply

PQD1S1P1Q1S2P2Q2EVENT:Newtechnologyreducescostofproducinghybridcars.STEP3:Theshiftcausespricetofall

andquantitytorise.CHAPTER4THEMARKETFORCESOFSUPPLYANDDEMANDEXAMPLE3:

AChangeinBothSupply

andDemandPQD1S1P1Q1S2D2P2Q2EVENTS:

priceofgasrisesAND

newtechnologyreducesproductioncostsSTEP1:Bothcurvesshift.STEP2:Bothshifttotheright.STEP3:Qrises,buteffect

onPisambiguous:Ifdemandincreasesmorethansupply,Prises.CHAPTER4THEMARKETFORCESOFSUPPLYANDDEMANDEXAMPLE3:

AChangeinBothSupply

andDemandSTEP3,cont.PQD1S1P1Q1S2D2P2Q2EVENTS:

priceofgasrisesAND

newtechnologyreducesproductioncostsButifsupplyincreasesmorethandemand,

Pfalls.A

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Changesinsupplyanddemand35Usethethree-stepmethodtoanalyzetheeffectsofeacheventontheequilibriumpriceandquantityofmusicdownloads.EventA: AfallinthepriceofcompactdiscsEventB: Sellersofmusicdownloadsnegotiateareductionintheroyaltiestheymustpayforeachsongtheysell.EventC: EventsAandBbothoccur.2. DshiftsleftA

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A.fallinpriceofCDs36PQD1S1P1Q1D2ThemarketformusicdownloadsP2Q21. Dcurveshifts3. PandQbothfall.STEPSA

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B.fallincostof

royalties37PQD1S1P1Q1S2ThemarketformusicdownloadsQ2P21. Scurveshifts2. Sshiftsright3. Pfalls,

Qrises.STEPS(royaltiesarepartofsellers’costs)A

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C.fallinpriceofCDs

ANDfallincostofroyalties38STEPS1. Bothcurvesshift(seepartsA&B).2. Dshiftsleft,Sshiftsright.3. Punambiguouslyfalls. EffectonQisambiguous:

ThefallindemandreducesQ,

theincreaseinsupplyincreasesQ.CHAPTER4THEMARKETFORCESOFSUPPLYANDDEMANDCONCLUSION:

HowPricesAllocateResourcesOneoftheTenPrinciplesfromChapter1:Marketsareusuallyagoodway

toorganizeeconomicactivity.Inmarketeconomies,pricesadjusttobalancesupplyanddemand.Theseequilibriumpricesarethesignalsthatguideeconomicdecisionsandtherebyallocatescarceresources.CHAPTER4THEMARKETFORCESOFSUPPLYANDDEMANDCHAPTERSUMMARYAcompetitivemarkethasmanybuyersandsellers,eachofwhomhaslittleornoinfluence

onthemarketprice.Economistsusethesupplyanddemandmodeltoanalyzecompetitivemarkets.Thedownward-slopingdemandcurvereflectstheLawofDemand,whichstatesthatthequantitybuyersdemandofagooddependsnegativelyonthegood’sprice.CHAPTER4THEMARKETFORCESOFSUPPLYANDDEMANDCHAPTERSUMMARYBesidesprice,demanddependsonbuyers’incomes,