The Basics of Supply and Demand
Introduction
What are supply and demand?
What is the market mechanism?
What are the effects of changes in market equilibrium?
What are elasticities of supply and demand? ©2005 Pearson
Chapter 2
2
Topics to Be Discussed
How do short-run and long-run elasticities differ?
How do we understand and predict the effects of changing market conditions?
What are the effects of government intervention – price controls?
©2005 Pearson
Chapter 2
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Supply and Demand
Supply and demand analysis can:
1.
2.
3.
Help us understand and predict how real world economic conditions affect market price and production
Analyze the impact of government price controls, minimum wages, price supports, and production incentives on the economy
Determine how taxes, subsidies, tariffs and import quotas affect consumers and producers ©2005 Pearson
Chapter 2
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Supply and Demand
The Supply Curve
The relationship between the quantity of a good that producers are willing to sell and the price of the good
Measures quantity on the x-axis and price on the y-axis
Q S Q S(P)
©2005 Pearson
Chapter 2
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The Supply Curve
S
Price
($ per unit)
The Supply Curve,
Graphically Depicted
P2
The supply curve slopes upward, demonstrating that at higher prices firms will increase output
P1
Q1
©2005 Pearson
Q2
Quantity
Chapter 2
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The Supply Curve
Other Variables Affecting Supply
Costs of Production
Labor
Capital
Raw
Materials
Lower costs of production allow a firm to produce more at each price and vice versa
©2005 Pearson
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Change in Supply
The cost of raw materials falls
P
Produced Q1 at P1 and Q0 at P2
Now produce Q2 at P1 and Q1 at P2
P1
Supply curve shifts right to S’
P2
S
Q0
©2005 Pearson
Chapter 2
Q1
Q2
S’
Q
8
The Supply Curve
Change in Quantity Supplied
Movement along the curve caused by a change in price
Change in Supply
Shift of the curve caused by a change in something other than the price of the good
Change
©2005 Pearson
in costs of production
Chapter 2
9
Supply and Demand
The Demand Curve
The relationship between the quantity of a good that consumers are willing to buy and the price of the good
Measures quantity on the x-axis and price on the y-axis
Q D Q D(P)
©2005 Pearson
Chapter 2
10
The Demand Curve
Price
($ per unit)
The demand curve slopes downward, demonstrating that consumers are willing to buy more at a lower price as the product becomes relatively cheaper.
P2
P1
D
Q1
©2005 Pearson
Q2
Quantity
Chapter 2
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The Demand Curve
Other Variables Affecting Demand
Income
Increases
in income allow consumers to purchase more at all prices
Consumer Tastes
Price of Related Goods
Substitutes
Complements
©2005 Pearson
Chapter 2
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Change in Demand
Income Increases
P
Purchased Q0, at P2
P2
and Q1 at P1
Now purchased Q1 at
P2 and Q2 at P1
Same for all prices
Demand curve shifts right
D
D’
P1
Q0
©2005 Pearson
Chapter 2
Q1
Q2
Q
13
The Demand Curve
Changes in quantity demanded
Movements along the demand curve caused by a change in price
Changes in demand
A shift of the entire demand curve caused by something other than price
Income
Preferences
©2005 Pearson
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The Market Mechanism
The market mechanism is the tendency in a free market for price to change until the market clears
Markets clear when quantity demanded equals quantity supplied at the prevailing price Market clearing price – price at which markets clear
©2005 Pearson
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The Market Mechanism
S
Price
($ per unit)
The curves intersect at equilibrium, or marketclearing, price.
Quantity demanded equals quantity supplied at P0
P0
D
Q0
©2005 Pearson
Quantity
Chapter 2
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The Market Mechanism
In equilibrium
There is no shortage or excess demand
There is no surplus or excess supply
Quantity supplied equals quantity demanded
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