Supply and Demand
Demand
  • The ability and willingness to buy specific quantities of a good at alternative prices in a given time period, ceteris paribus.
Market Participants
  1. Maximizing behavior
    • Consumers maximize their satisfaction (utility) given limited resources.
    • Businesses try to maximize profits by using resources efficiently in producing goods.
    • Government maximizes general welfare of society.
  2. Specialization and Exchange
    • The notion that buying and selling goods and services in the market might maximize our well-being originates in two simple observations.
      • Most of us are incapable of producing everything we desire to consume.
      • Even if we could produce all our own goods and service, it would still make sense to specialize.
    • Economic interactions with others are necessitated by two constraints:
      • Inability as individuals to produce all of the goods we need or desire.
      • Limited amounts of time, energy, and resources possessed for producing things we could make for ourselves.
The Circular Flow
  • Four different groups participate in our economy
    1. Consumers
    2. Business firms
    3. Government
    4. Foreigners
  • The Two Markets
    • Factor Markets – Any place where factors of production (e.g., land, labor, capital) are bought and sold.
    • Product Markets – Any place where finished goods and services (products) are bought and sold.
  • The consumer is the final recipient of all goods and services produced.
  • A market exists wherever and whenever an exchange takes place.
  • Dollars and Exchange
    • Nearly every market transaction involves an exchange of dollars for goods or resources.
Individual Demand
  • A demand exists only if someone is willing and able to pay for a good 
  • When people purchase a product there is an opportunity cost.
  • Demand Schedule – a table showing the quantities of a good a consumer is willing and able to buy at alternative prices in a given time period, ceteris paribus.
  • Demand Curve – a curve describing the quantities of a good a consumer is willing and able to buy at alternative prices in a given time period, ceteris paribus.
  • Law of Demand – the quantity of a good demanded in a given time period increases as its price falls, ceteris paribus.
Determinants of Demand
  • The determinants of market demand include:
    • Tastes (desire for this and other goods)
    • Income (of the consumer)
    • Other goods (their availability and price)
    • Expectations (for income, prices, tastes)
    • Number of buyers
    • NOTE:    Determinants of demand are factors that cause the whole curve to shift right or left.  The only thing that will cause a movement along a demand curve is a change in the goods own price.
  • The availability and price of related goods also affect the demand for goods and services.
    • Substitute Goods – goods that substitute for each other; when the price of good x rises, the demand for good y increases
    • Complementary Goods – goods frequently consumed in combination; when the price of good x rises, the demand for good y falls, ceteris paribus.
Shifts in Demand
  • The determinants of demand can and do change
  • A demand curve (schedule) is valid only so long as the underlying determinants of demand remain constant.
  • Shift in Demand – a change in the quantity demanded at any (every) given price.
Movements versus Shifts
  • Movements along a demand curve, referred to as a change in quantity demanded, are a response to price changes for that good.
  • Shifts of the demand curve, referred to as changes in demand, occur when the determinants of demand change.
Market Demand
  • The market demand is determined by the number of potential buyers and their respective tastes, incomes, other goods and expectations.
  • Market Demand – the total quantities of a good or service people are willing and able to buy at alternative prices in a given time period: the sum of individual demands.
  • The Market Demand Curve 
    • Market demand represents the combined demands of all market participants.
    • To determine the total quantity demanded at any given price, we add up the separate demands of the individual consumers.
Supply
  • The ability and willingness to sell (produce) specific quantities of a good at alternative prices in a given time period, ceteris paribus.
Individual Suppliers
  • Law of Supply – The quantity of a good supplied in a given time period increases as its price increases
  • Other factors which affect the individual suppliers willingness and ability to supply a good or service are:
    1. Factor costs are the primary determinant of supply.
    2. Technology also affects the supply through lower costs.
    3. Opportunity cost - next best alternative.
    4. Expectations.
  • Large quantities will be offered for sale at higher prices.
  • Supply curves are upward-sloping to the right.
Market Supply
  • The market supply curve is just a summary of the supply intentions of all producers.
  • Determinants of market supply include:
    1. Factor costs
    2. Technology
    3. Profitability of alternative pursuits
    4. Expectations
    5. The number of sellers.
  • Market supply is an expression of seller’s intentions – an offer to sell – not a statement of actual sales.
Shifts of Supply
  • changes in the quantity supplied are referred to as movements along the supply curve.
  • changes in supply are referred to as shifts in the supply curve.
    • Increase in the supply is a rightward shift.
    • Decrease in the supply is a leftward shift.
Equilibrium
  • Only one price and quantity are compatible with the existing intentions of both the buyers and the sellers.
  • Equilibrium Price – The price at which the quantity of a good demanded in a given time period equals the quantity supplied.
  • Market Clearing 
    1. An equilibrium doesn’t imply that everyone is happy with the prevailing price or quantity.
    2. The equilibrium price is not determined by any single individual.  Rather it is determined by the collective behavior of many buyers and sellers, each acting out his or her own demand or supply schedule.
    3. Although not everyone gets full satisfaction from the market equilibrium, that unique outcome is efficient.
    4. The Invisible Hand
      • The equilibrium price and quantity reflect a compromise between buyers and sellers.  No other compromise yields a quantity demanded that’s exactly equal to the quantity supplied.
      • Adam Smith characterized this market mechanism as “the invisible hand”.
Surplus and Shortage
  • When seller’s asking prices are too high, a market surplus is created.
  • Market Surplus – The amount by which the quantity supplied exceeds the quantity demanded at a given price; excess supply.
  • An Initial Shortage - When seller’s asking prices are too low, a market shortage is created.
  • Market Shortage  - The amount by which the quantity demanded exceeds the quantity supplied at a given price; excess demand.
  • Self-Adjusting Prices
    • Whenever the market price is set above or below the equilibrium price, either a market surplus or a market shortage will emerge.
    • To overcome a surplus or shortage, buyers and sellers will change their behavior.
    • Only at the equilibrium price will no further adjustments be required.
Changes in Equilibrium
  • No equilibrium price is permanent.
  • The equilibrium price will change whenever the supply or demand curve shifts.
  • A Demand Shift – Should the demand curve shift, the result will be a change in equilibrium price and quantity.
  • A Supply Shift – Should the supply curve shift, the result will be a change in equilibrium price and quantity.
  • Changes in supply and demand occur when the determinants of supply and demand change.
Market Outcomes
  • Optimal, Not Perfect
    • Not everyone is happy with market outcomes, but we are given the opportunity to maximize our own satisfaction.
    • Although the outcomes of the marketplace are not perfect, they are often optimal, i.e., the best possible given our incomes and scarce resources.
Changing Yearly Data to Base Year Data:
  • decide on a base year  (in our example below we use 1990 as the base year)
  • convert each year's numbers by using the following formula
        year to convert
       ----------------- x 100 = base year value for the new year
           base year
  • the new values reflects a relative (i.e., percentage) change from the base year
Year
US Exports
in billions
US Imports
in billions
US Exports
1990 base year
US Imports
1990 base year
1990
389
498
100
100
1991
417
491
107
99
1992
440
536
113
108
1993
457
589
117
118
1994
502
669
129
134
1995
576
749
148
150
1996
612
803
157
161
1997
680
876
175
176
1998
670
917
172
184
1999
684
1030
176
207
2000
773
1223
199
246

Visit the Student Online Learning Center for Chapter 3 or our Blackboard class site for extra help with the issues we discussed today.



For Our Next Class...
  • Read chapter 4

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this page is maintained by Reed Fisher
last updated January 7, 2005