Econ homework -Opportunity Costs and Scarcity

Supply and Demand 1/17/19 –

1/22/19

Preclass Music: eBay by Weird Al Yankovic

Previously

• “Scarcity” refers to the limited nature of society's resources.

• The production possibilities frontier (PPF)

is an illustration of the goods and services

an economy is capable of producing.

• Trade is generally mutually beneficial for

both parties involved.

Big Questions

1. What are the fundamentals of markets?

2. What determines demand?

3. What determines supply?

4. How can we model shifts in markets using the

supply-demand model?

• What factors

affect the price of

gasoline?

Here’s a question for you…

Fundamentals of Markets—1

• Firms

– Supply goods (or services)

• Consumers

– Purchase goods supplied by firms

• Exchange happens

– Through prices established in markets

– Supply or demand factors can change the

market price

• Market – Place where buyers and sellers meet

• Doesn’t have to be a physical place

Fundamentals of Markets—2

Fundamentals of Markets—3

• Market economy

– Resources are allocated

among households and

firms with little or no

government

interference.

– Producers and

consumers are

motivated by self-

interest.

• Characteristics of a competitive market:

– Many buyers and sellers

– The goods sold by each vendor are similar

– Bottom Line: No one individual has any

influence over the price

Competitive Markets

• Imperfect market

– Buyer or seller has an influence on the price

• Market power

– The firm’s ability to influence price

• Monopoly

– A single company that supplies the entire market

for a good or service

Imperfect Markets

Method for learning the

supply-demand model

• Start with demand

• Move on to supply

• Bring supply and demand together in

one model

• Analyze the equilibrium of the model

• Look at effects of external changes

on the equilibrium

Demand—1

• Quantity demanded

– The amount of a good buyers are willing and

able to produce at the current price

• Law of demand

– All else equal, there is an inverse relationship

between price and quantity demanded

• If price , quantity demanded 

• If price , quantity demanded 

“Law” of demand – why?

• Who likes pizza?

• What if you ate a piece of

pizza today? How good

would it taste?

• What if you ate a piece

every hour for the next 12

hours?

• The law of demand is really

the law of diminishing value

Demand—2

• Demand schedule

– Table showing the relationship between price

and quantity demanded

• Demand curve

– Graph of the relationship between price and

quantity demanded

Demand Schedule

Ryan’s Demand Schedule

for Salmon

Price of

Salmon

(per pound)

Pounds of

Salmon

Demanded

$20.00 0

$17.50 1

$15.00 2

$12.50 3

$10.00 4

$ 7.50 5

$ 5.00 6

$ 2.50 7

$ 0.00 8

Higher price Lower quantity

demanded

Lower price Higher quantity

demanded

Demand Curve

Market Demand—1

• Market demand

– Horizontal sum of all individual quantities

demanded by each buyer in the market at

each price

Market Demand—2

Price of

Salmon Ryan’s Demand

Melissa’s

Demand Market Demand

$20.00 0 0 0

$17.50 1 0 1

$15.00 2 1 3

$12.50 3 1 4

$10.00 4 2 6

$ 7.50 5 2 7

$ 5.00 6 3 9

$ 2.50 7 3 10

$ 0.00 8 4 12

+ =

Changes in Quantity Demanded

versus Changes in Demand

• Change in quantity demanded

– Movement along a demand curve

– Caused by a change in the price of the good

• Change in demand

– Shift of the demand curve

• Entire demand curve will shift to the left or right

– Caused by changes in nonprice factors

What happens if…..?

P

Q (Oreos)

D

Event:

The price of

Oreos falls to

$2.00 per

pack?

$3

$2

4 5

A

B

What happens if…?

P

Q (movie tickets)

D

Event:

The price of

movie tickets

increases to

$20?

$20

$15

2 3

B

A

Changes in Demand

Factors that Shift Demand—1

1. Changes in income

• Normal good

– Good we buy more of when we get more

income

• Inferior good

– Good we buy less of when we get more

income

Factors that Shift Demand—2

2. Price of related goods

• Complements

– Two goods used together

• Substitutes

– Goods that can be used in place of each other

Prices of Related Goods

• Event: Price of peanut butter increases

P

Peanut butter:

Movement along

the demand curve

$4

$3

2 4

A

B

D

Q

P

Jelly:

A shift in demand

Q

D1D2

Factors that Shift Demand—3

3. Changes in Tastes and Preferences

• A good may become more fashionable or may go

out of style

• A good may come into or go out of season

Factors that Shift Demand—4

4. Price expectations

– Our consumption today may depend on what

we think the price may be tomorrow

5. Number of buyers

– More individual buyers means more market

demand

6. Taxes

– Excise taxes raise the cost to consumers

7.New information about quality

– E.g. dangers, health, breakage

What happens if…?

P

Q (Big Macs)

D1D2

Event:

The price of a

Burger King

Whopper falls

What happens if…?

P

Q (fancy dinners)

D1 D2

Event:

Your financial

aid is increased

What happens if…?

P

Q (ramen noodles)

D1D2

Event:

Your financial

aid is

increased

What happens if…?

P

Q (pizza)

D1 D2

Event:

The price of

Coke falls

What happens if…?

P

Q (oranges)

D1 D2

Event:

Doctors discover

that oranges

reduce gray hair

Assume Pepsi operates in a

reasonably competitive market

(could be questioned).

• The following three questions

are considering the market for

the same good:

PEPSI

• We are considering:

– Change in quantity demanded

(movement)

– Change in demand (shift)

Assume you like Pepsi and

your income increases.

A. The demand for Pepsi decreases.

B. The quantity demanded of Pepsi increases.

C. The demand for Pepsi increases.

D. The quantity demanded of Pepsi decreases.

Assume the price of Pepsi

decreases

.

A. The demand for Pepsi increases.

B. The demand for Pepsi decreases.

C. The quantity demanded of Pepsi decreases.

D. The quantity demanded of Pepsi increases

Assume the price of Coke

decreases.

A. The demand for Pepsi increases.

B. The demand for Pepsi decreases.

C. The quantity demanded of Pepsi increases.

D. The quantity demanded of Pepsi decreases.

What would you answer?

• Suppose the price of good X increases.

In terms of demand, what is the result?

A. The demand for X increases.

B. The demand for X decreases.

C. The quantity demanded of X increases.

D. The quantity demanded of X decreases.

What would you answer?

• Suppose goods X and Y are substitutes

for each other. If the price of good Y

increases, what is the result in the

market for good X?

A. The demand for X increases.

B. The demand for X decreases.

C. The quantity demanded of X increases.

D. The quantity demanded of X decreases.

Economics in The Hudsucker

Proxy

• The Hudsucker Proxy (1994)

– Watch for changes in price. Which price

changes are an illustration of a movement

along a demand curve, and which are the result

of demand increase?

Supply—1

• Quantity supplied

– The amount of the good or service that

producers are willing and able to sell at the

current price

• Supply in a competitive market

– All else equal, there is a direct relationship

between price and quantity supplied

• If price , quantity supplied 

• If price , quantity supplied 

Supply—2

• Supply schedule

– Table showing the relationship between price

and quantity supplied

• Supply curve

– Graph of the relationship between price and

quantity supplied

Supply—3

Pure Food Fish’s Supply Schedule

Price of Salmon

(per pound)

Pounds of

Salmon Supplied

$20.00 800

$17.50 700

$15.00 600

$12.50 500

$10.00 400

$ 7.50 300

$ 5.00 200

$ 2.50 100

$ 0.00 0

Higher price Higher quantity

supplied

Lower price Lower quantity

supplied

Small group discussion: What

determines supply?

• Remember that “supply” is only for

competitive markets (many sellers of

a relatively homogeneous product)

Market Supply—1

• Market supply

– Horizontal sum of all individual quantities

supplied by each seller in the market at each

price

Market Supply—2

Price of

Salmon

Pure Food Fish’s

Supply

City Fish’s

Supply

Market

Supply

$20.00 800 200 1000

$17.50 700 175 875

$15.00 600 150 750

$12.50 500 125 625

$10.00 400 100 500

$ 7.50 300 75 375

$ 5.00 200 50 250

$ 2.50 100 25 125

$ 0.00 0 0 0

+ =

Changes in Quantity Supplied

versus Changes in Supply

• Change in quantity supplied

– Movement along a supply curve

– Caused by a change in the price of the good

• Change in supply

– Shift in the supply curve • Entire supply curve will shift to the left or right

– Caused by a change in nonprice factors

First Starbucks opened in Seattle’s

Pike Place Market in 1971

Changes in Supply

Factors that Shift Supply—1

1. The cost of inputs

• Inputs

– Resources used in the production

process

2. Changes in technology

• Technology

– Knowledge that producers have about

how to produce a product

Factors that Shift Supply—2

3. Taxes and subsidies

• Tax

– Tax paid by producer  added cost of production

• Subsidy

– “Opposite” of a tax; government pays sellers to produce goods

• Reduces the cost of production

Factors that Shift Supply—3

4. Number of sellers

– More individual sellers means more market

supply

5. Price expectations

– Higher price expected tomorrow? If so, delay

sales until future if possible

What do you think?

• Assume the price of cheese decreases. What

will happen to supply of pizza?

A. The supply of pizza increases.

B. The supply of pizza decreases.

C. The quantity supplied of pizza increases.

D. The quantity supplied of pizza decreases.

What do you think?

• Which of the following will

cause the supply curve for

oranges to shift to the left?

A. The government begins subsidizing orange

growers.

B. A study is released showing oranges improve

eyesight.

C. An ice storm strikes Florida.

D. A new orange juice commercial airs on TV.

Bringing Supply and Demand

Together

• How is the price of a good

determined?

– By supply and demand colliding in

markets

• Nature of a competitive equilibrium

(1)

– The market price of any good will adjust

to bring the quantity supplied and quantity

demanded into balance

Supply and Demand—1

• Equilibrium price

– The price at which quantity supplied is equal to

quantity demanded

– The price that “clears the market”

• Equilibrium quantity

– The quantity at which quantity demanded is equal to

quantity supplied

Shortages and Surpluses—1

• Shortage

– Occurs when QD > QS

– Occurs at any price below equilibrium

• Price will rise over time toward equilibrium unless

there are some barriers

• Why does price rise over time with a

shortage?

– Consumers will “outbid” other consumers with low valuations of the product

Shortages and Surpluses—2

• Surplus

– Occurs when QS > QD

– Occurs at any price above equilibrium

• Price will fall over time toward equilibrium (this is

where many sellers becomes especially important)

• Why does price fall over time with a

surplus?

– Firms will lower prices to get rid of mounting

inventories

Supply and Demand—2

In terms of supply and

demand schedules

Another possibility

Principles of Economics, Second Edition

Copyright © 2018 W. W. Norton & Company

Price (per seat) Quantity demanded in

year 1

Quantity demanded In

year 2

Quantity supplied

$25 75,000 60,000 45,000

$30 60,000 55,000 45,000

$35 45,000 50,000 45,000

$40 30,000 45,000 45,000

$45 15,000 40,000 45,000

Economics in Pawn Stars

• Pawn Stars (History Channel)

– Bartering is a great way to see the

forces of supply and demand at work.

Steps in analyzing effect of

shifts on equilibrium P and Q

1. Decide which curve is shifting?

2. Is the curve shifting up (more at all

prices/right) or down (less at all

prices/left)?

3. Add shift onto the supply/demand

schedule or graph

4. Analyze the resulting equilibrium

REMEMBER: The S-D model’s purpose

is to analyze equilibria. Don’t presume!

What do you think?

• Suppose there is a shortage in the market for

avocados. Assuming a competitive and

unrestrained market, what happens over time?

A. The price of avocados will fall, and the shortage

will worsen.

B. The price of avocados will rise, and the market

will eventually reach equilibrium.

C. The price of avocados will rise, and a large

surplus will be created.

D. Producers will stop growing avocados.

Graphs of Shifts—1

Change Illustration Impact on Equilibrium

Price and Quantity

Demand increases

Due to increased

income, changes in

tastes, lower price of

complements, etc.

The demand curve shifts

to the right. As a result,

the equilibrium price and

equilibrium quantity

increase.

Supply increases

Due to technological

improvements, lower

costs, lower taxes, etc.

The supply curve shifts

to the right. As a result,

the equilibrium price

declines and the

equilibrium quantity

increases.

Graphs of Shifts—2

Change Illustration Impact on Price and

Quantity

Demand decreases

Due to decreased

income, changes in

tastes, higher price of

complements, etc.

The demand curve shifts

to the left. As a result,

the equilibrium price and

equilibrium quantity

decrease.

Supply decreases

Due to increased

costs, increased taxes,

etc.

The supply curve shifts

to the left. As a result,

the equilibrium price

increases and the

equilibrium quantity

decreases.

Just remember…….

• Supply and demand is only for roughly competitive markets.

• If there is just one or two buyers, what does the demand curve look like?

• If there is only one seller, what does supply look like?

Just remember…….

• Supply and demand is only for roughly competitive markets.

• If there is just one or two buyers, what does the demand curve look like?

• If there is only one seller, what does supply look like?

Answer

Whatever they want the quantity demand and quantity supplied to look like.

Demand and supply are just one point if markets are truly uncompetitive

Conclusions

• If you take away just one thing from this course,

it will probably be supply and demand

– Powerful tool for explaining market changes

• In competitive markets, supply and demand

allow prices to adjust toward equilibrium

– The model predicts no surpluses or shortages

• Shift in supply and demand due to exogenous

changes change equilibrium price and quantity

– Trick is figuring out which curve is shifting in which

direction!