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Unit 3 Hints b- How to analyze a supply and demand problem (10 question worksheet approach)

1. What is the starting situation? Most always the starting situation is that the market is in

EQUILIBRIUM with an EQUILBRIUM price and an EQUILBRIUM quantity that is supplied AND

demanded at that price. W e are always interested in what will happen to that price and that quantity

after the situation in the problem happens.

Equilibrium price is the price at which the exact amount that suppliers are willing to sup ply at that price is the SAME as the exact amount that consumers want to buy, at that price. Thus, you arrive at the equilibrium price and equilibrium quantity.

2. What is the change in the situation? The problem will describe some change in the situation. Most often problems will describe a change in the situation that will cause either a SHIFT in the supply curve, or a SHIFT in the demand curve. Normally a problem does not start with a change in

price causing movement ALONG an existing curve. 3. Does it affect Demand or Supply? The problem should make clear if the change in the situation

will cause a change in amount supplied at every price, or a change in the amount demanded at every price. If you look at the situations in the yellow blocks in number 4 below, you should be able to determine if the problem is talking about a change in supply, or a change in demand.

4. Has it caused a movement along the curve, or a shift of the curve? (Movement is caused by a price change and a shift is caused by OTHER factors.) Since the problem did not say there was a

change in the price, there cannot be movement along a curve. There are four possible outcomes, based on the situation in the problem, as it compares to the situations in the yellow blocks below. If the problem is describing a change in factors that affect demand, then one of these two situations

must be happening:

Or….

If the problem is describing a change in factors that affect supply, then one of these two situations

must be happening:

Or….

5. If it is a movement, is it up, or down the curve? There was no mention of price, so there is NO movement along any of the curves. This question does not apply.

Reasons that LESS would be DEMANDED at every price. 1. FEW ER consumers

2. Decreased INCOME 3. Less TASTE for this item 4. Changed EXPECTATIONS

5. Decrease in price of the SUBSTITUTE product

Reasons that MORE would be DEMANDED at every price. 1. MORE consumers

2. Increased INCOME 3. More TASTE for this item 4. Changed EXPECTATIONS

5. Increase in price of the SUBSTITUTE product

Reasons that MORE would be SUPPLIED at every price.

1. More SUPPLIERS 2. Decreased INPUT prices 3. Improved TECHNOLOGY

4. Changed EXPECTATIONS 5. Decrease in price of the RELATED product (gasoline and heating oil)

Reasons that LESS would be SUPPLIED at every price.

1. FEW ER suppliers 2. Increased INPUT prices 3. WORSENING of TECHNOLOGY

4. Changed EXPECTATIONS 5. Increase in price of the RELATED product (gasoline and heating oil)

6. If it is a shift of the curve, did the curve shift to the left, or to the right? If MORE is being demanded at every price, then the demand curve will shift to the RIGHT. If LESS is being demanded

at every price, then the demand curve will shift to the LEFT.

Or….

If MORE is being supplied at every price, then the supply curve will shift to the RIGHT. If LESS is

being supplied at every price, then the supply curve will shift to the LEFT.

Or….

The next step would be to combine the curves by showing the change on the original graph and to

answer question 7.

7. What reaction did this cause in the other curve?

Or….

If demand INCREASES at every price, suppliers will see the price being bid upward, and at the higher price the suppliers will supply more at these higher prices. If demand DECREASES at every

price, suppliers will see prices being bid lower and will supply less at these lower prices.

Or….

If supply INCREASES at every price, consumers will see the price falling, and at the new lower

price, the consumers will demand more. If supply DECREASES at every price, consumers will see the price rising and at the new higher prices consumers will demand less.

8. What is the final change in the equilibrium point?

Demanded

Or….

Supplied

Or…

9. Is the final price higher, or lower?

10. Is the final quantity higher, or lower?

If MORE is demanded at every price, then the final price will be higher and the final quantity will be higher. If LESS is demanded at every price, then the final price will be lower and the final quantity will be lower.

Or…

If MORE is supplied at every price, then the final price will be lower and the f inal quantity will be greater. If LESS is supplied at every price, then the final price will be higher and the final quantity will

be lower.

Or…

11. Answer any other special questions asked in the assigned question.

Using this worksheet approach to analyzing supply and demand problems, one can easily answer questions about such problems as a “babysitting” problem or a “surfboard” problems.

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Let’s try an example of a more complicated problem, similar to the “lobster” problem, or “cocoa beans” problem, with numbers:

Assume that Gizmos (a magical device) are made and sold only in Canada. The following demand and supply schedule is for Gizmos shows how much is demanded at each

price by Canadians and shows how much will be supplied at each price.

Price per Gizmo

Thousands of Gizmos

DEMANDED

by Canadians

Thousands of Gizmos

SUPPLIED

$ 9 1 11

$ 8 2 10

$ 7 3 8

$ 6 4 7

$ 5 6 6

$ 4 7 4

$ 3 8 3

$ 2 9 2

$ 1 11 1

There is a price at which the entire product demanded at that price, exactly equals the amount of product that suppliers are willing to supply, at that price. The price is called the equilibrium price and

the quantity is called the equilibrium quantity. In this example the price is $5 and the quantity both supplied and demanded by the Canadians is six thousand Gizmos. This relationship is shown on the graph below.

Now, suppose that the Gizmo manufacturer is suddenly able to also sell the Gizmos in Japan. The

following chart shows the Japanese demand for Gizmos at each price. Japanese Demand is relatively inelastic, meaning that they demand about the same amount regardless of the price. This would be because they considered the Gizmo to be absolutely essential, like a lifesaving drug, and are willing

to pay nearly any price to get it. Their demand curve is more straight up and down.

Price per Gizmo

Thousands of Gizmos

DEMANDED

by JAPANESE

$ 9 4

$ 8 5

$ 7 5

$ 6 5

$ 5 5

$ 4 5

$ 3 5

$ 2 5

$ 1 6

If we combine the Japanese demand with the Canadian demand, BY ADDING the Japanese and Canadian demand to get a TOTAL demand and compare it to the supply schedule, we get the

following chart.

Price per Gizmo Thousands of Gizmos

DEMANDED by

JAPANESE

Thousands of Gizmos

DEMANDED by

Canadians

Thousands of Gizmos

DEMANDED in

TOTAL

Thousands of Gizmos

SUPPLIED

$ 9 4 1 5 11

$ 8 5 2 7 10

$ 7 5 3 8 8

$ 6 5 4 9 7

$ 5 5 6 11 6

$ 4 5 7 12 4

$ 3 5 8 13 3

$ 2 5 9 14 2

$ 1 6 11 15 1

What happened? W hen we added in the new Japanese demand for Gizmos, the suppliers saw this as a bidding up of the prices and at the higher price the suppliers were willing to supply MORE

Gizmos. W e see that the new COMBINED demand exactly matches the supply at a new equilibrium price of

$7 with a total demand of eight thousand gizmos and a supply at $7 also of eight thousand Gizmos.

W e see that equilibrium price has INCREASED from the original $5 to the new equilibrium price for $7 and the equilibrium quantity that suppliers are willing to supply at $7 is exactly the same as the amount of total demand for Gizmos at $7.

But what happens to the Canadians now that they are forced to pay the new higher price. They still have their original demand schedule and demand curve. At the new higher price of $7, Canadians are

only willing to demand three thousand gizmos , so the Canadian demand dropped from the original six thousand Gizmos to three thousand Gizmos, because the added Japanese demand bid the price up to $7 from the original $5.