Assignment 2
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chap_2.pptxChapter 2
Market Forces: Demand and Supply
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Chapter Outline
Demand
Factors that change quantity demanded and factors that change demand
The demand function
Consumer surplus
Supply
Factors that change quantity supplied and factors that change supply
The supply function
Producer surplus
Market equilibrium
Price restrictions and market equilibrium
Price ceilings
Price floors
Comparative statics
Changes in demand
Changes in supply
Simultaneous shifts in supply and demand
2-2
Chapter Overview
2
Market demand curve
Illustrates the relationship between the total quantity and price per unit of a good all consumers are willing and able to purchase, holding other variables constant.
Law of demand
The quantity of a good consumers are willing and able to purchase increases (decreases) as the price falls (rises).
2-3
Demand
Demand
3
Market Demand Curve
2-4
Quantity
(thousands per year)
Price ($)
Demand
$40
0
$30
$20
20
40
$10
60
80
Demand
Changing only price leads to changes in quantity demanded.
This type of change is graphically represented by a movement along a given demand curve, holding other factors that impact demand constant.
Changing factors other than price lead to changes in demand.
These types of changes are graphically represented by a shift of the entire demand curve.
2-5
Demand
Changes in Quantity Demanded
Changes in Demand
2-6
Quantity
0
Price
D1
Increase
in
demand
Demand
A
B
D0
D2
Decrease
in
demand
Demand Shifters
Income
Normal good
Inferior good
Prices of related goods
Substitute goods
Complement goods
Advertising and consumer tastes
Informative advertising
Persuasive advertising
Population
Consumer expectations
Other factors
2-7
Demand
Advertising and the Demand for Clothing
2-8
Quantity of
high-style
clothing
0
$50
$40
50,000
Price of
high-style
clothing
D2
60,000
Due to an
increase in
advertising
Demand
D1
The demand function for good X is a mathematical representation describing how many units will be purchased at different prices for good X, different prices of a related good Y, different levels of income, and other factors that affect the demand for good X.
2-9
Demand
The Demand Function
One simple, but useful, representation of a demand function is the linear demand function:
, where:
is the number of units of good X demanded;
is the price of good X;
is the price of a related good Y;
is income;
is the value of any other variable affecting demand.
2-10
Demand
The Linear Demand Function
The signs and magnitude of the coefficients determine the impact of each variable on the number of units of X demanded.
For example:
by the law of demand;
if good Y is a substitute for good X;
if good X is an inferior good.
2-11
Demand
Understanding the Linear Demand Function
Suppose that an economic consultant for X Corp. recently provided the firm’s marketing manager with this estimate of the demand function for the firm’s product:
Question: How many of good X will consumers purchase when per unit, per unit, and ? Are goods X and Y substitutes or complements? Is good X a normal or an inferior good?
Answer:
units. Goods X and Y are substitutes. Good X is an inferior good.
2-12
Demand
The Linear Demand Function in Action
Inverse Demand Function
By setting and and the demand function is
the linear demand function simplifies to
Solving this for in terms of results in
, which is called the inverse demand function. This function is used to construct a market demand curve.
2-13
Demand
Graphing the Inverse Demand Function in Action
2-14
Quantity
Price
$2,020
0
6,060
Demand
Marketing strategies – like value pricing and price discrimination – rely on understanding consumer value for products.
Total consumer value is the sum of the maximum amount a consumer is willing to pay at different quantities.
Total expenditure is the per-unit market price times the number of units consumed.
Consumer surplus is the extra value that consumers derive from a good but do not pay for.
2-15
Consumer Surplus
Demand
Quantity
in liters
Price per
liter
Demand
$5
0
$3
$2
1
2
$1
4
5
2-16
Total Consumer Value:
0.5($5 - $3)x2+(3-0)(2-0) = $8
Expenditures:
$(3-0) x (2-0) = $6
Consumer Surplus:
0.5($5 - $3)x(2-0) = $2
Demand
Market Demand and Consumer Surplus in Action
$4
3
Consumer Surplus
16
Market supply curve
Summarizes the relationship between the total quantity all producers are willing and able to produce at alternative prices, holding other factors affecting supply constant.
Law of supply
As the price of a good rises (falls), the quantity supplied of the good rises (falls), holding other factors affecting supply constant.
2-17
Supply
Supply
Changing only price leads to changes in quantity supplied.
This type of change is graphically represented by a movement along a given supply curve, holding other factors that impact supply constant.
Changing factors other than price lead to changes in supply.
These types of changes are graphically represented by a shift of the entire supply curve.
2-18
Supply
Changes in Quantity Supplied
2-19
Change in Supply in Action
Quantity
Price
S2
0
Decrease
in supply
Supply
A
B
S0
S1
Increase
in supply
Input prices
Technology or government regulation
Number of firms
Entry
Exit
Substitutes in production
Taxes
Excise tax
Ad valorem tax
Producer expectations
2-20
Supply
Supply Shifters
2-21
Change in Supply in Action
Quantity of
gasoline per
week
Price
of
gasoline
0
t = per unit tax of 20¢
Supply
S0
S0+t
t = 20¢
$1.20
$1.00
t
Excise tax
2-22
Change in Supply in Action
Quantity of
backpacks per
week
Price
of
backpacks
0
Supply
S0
S1 = 1.20 x S0
$24
$10
Ad valorem tax
$12
1,100
$20
2,450
The Supply Function
The supply function for good X is a mathematical representation describing how many units will be produced at different prices for X, different prices of inputs W, prices of technologically related goods, and other factors that affect the supply for good X.
2-23
Supply
The Linear Supply Function
One simple, but useful, representation of a supply function is the linear supply function:
, where:
is the number of units of good X produced;
is the price of good X;
is the price of an input;
is price of technologically related goods;
is the value of any other variable affecting supply.
2-24
Supply
The signs and magnitude of the coefficients determine the impact of each variable on the number of units of X produced.
For example:
by the law of supply.
increasing input price.
technology lowers the cost of producing good X.
2-25
Supply
Understanding the Linear Supply Function
Your research department estimates that the supply function for televisions sets is given by:
Question: How many televisions are produced when , per unit, and ?
Answer:
television sets.
2-26
Supply
The Linear Supply Function in Action
Inverse Supply Function
By setting and in
the linear supply function simplifies to
Solving this for in terms of results in
, which is called the inverse supply function. This function is used to construct a market supply curve.
2-27
Supply
The amount producers receive in excess of the amount necessary to induce them to produce the good.
2-28
Supply
Producer Surplus
2-29
Producer Surplus in Action
Quantity
Price
Supply
$400
0
800
Supply
Producer surplus
29
Competitive market equilibrium
Price of a good is determined by the interactions of the market demand and market supply for the good.
A price and quantity such that there is no shortage or surplus in the market.
Forces that drive market demand and market supply are balanced, and there is no pressure on prices or quantities to change.
2-30
Market Equilibrium
Market Equilibrium
2-31
Quantity
Price
Supply
0
Demand
Surplus
Shortage
Market Equilibrium
Market Equilibrium I
Consider a market with demand and supply functions, respectively, as
and
A competitive market equilibrium exists at a price, , such that . That is,
and
units
2-32
Market Equilibrium II
Market Equilibrium
In a competitive market equilibrium, price and quantity freely adjust to the forces of demand and supply.
Sometimes the government restricts how much prices are permitted to rise or fall.
Price ceiling
Price floor
2-33
Price Restrictions and Market Equilibrium
Price Restrictions
2-34
Quantity
Price
Supply
0
Demand
Shortage
Priceceiling
Nonpecuniary price
Lost social welfare
Price Restrictions and Market Equilibrium
Price Ceiling in Action I
Consider a market with demand and supply functions, respectively, as
and
Suppose a $1.50 price ceiling is imposed on the market.
units.
units.
Since a shortage of units exists.
Full economic price of unit is , or . Of this,
$1.50 is the dollar price
$1 is the nonpecuniary price
2-35
Price Restrictions and Market Equilibrium
Price Ceiling in Action II
2-36
Quantity
Price
Supply
0
Demand
Surplus
Pricefloor
Price Restrictions and Market Equilibrium
Price Floor in Action I
Cost of
purchasing
excess supply
Consider a market with demand and supply functions, respectively, as
and
Suppose a $4 price floor is imposed on the market.
units
units
Since a surplus of units exists
The cost to the government of purchasing the surplus is .
2-37
Price Restrictions and Market Equilibrium
Price Floor in Action II
Comparative static analysis
The study of the movement from one equilibrium to another.
Competitive markets, operating free of price restraints, will be analyzed when:
Demand changes;
Supply changes;
Demand and supply simultaneously change.
2-38
Comparative Statics
Comparative Statics
Increase in demand only
Increase equilibrium price
Increase equilibrium quantity
Decrease in demand only
Decrease equilibrium price
Decrease equilibrium quantity
Example of change in demand
Suppose that consumer incomes are projected to increase 2.5% and the number of individuals over 25 years of age will reach an all time high by the end of next year. What is the impact on the rental car market?
2-39
Changes in Demand
Comparative Statics
2-40
Change in Demand in Action
Quantity
(thousands
rented per day)
Price
Supply
0
$45
104
Demand for Rental Cars
Demand1
$49
Demand0
100
Comparative Statics
108
Increase in supply only
Decrease equilibrium price
Increase equilibrium quantity
Decrease in supply only
Increase equilibrium price
Decrease equilibrium quantity
Example of change in supply
Suppose that a bill before Congress would require all employers to provide health care to their workers. What is the impact on retail markets?
2-41
Changes in Supply
Comparative Statics
2-42
Quantity
Price
Supply0
0
Demand
Supply1
Comparative Statics
Change in Supply in Action
Suppose that simultaneously the following events occur:
an earthquake hit Kobe, Japan and decreased the supply of fermented rice used to make sake wine.
the stress caused by the earthquake led many to increase their demand for sake, and other alcoholic beverages.
What is the combined impact on Japan’s sake market?
2-43
Comparative Statics
Simultaneous Shifts in Supply and Demand
2-44
Quantity
Price
Supply0
0
Demand1
Supply1
Demand0
Comparative Statics
Simultaneous Shifts in Supply and Demand in Action
Japan’s Sake Market
Supply2
A
B
C
Demand and supply analysis is useful for
Clarifying the “big picture” (the general impact of a current event on equilibrium prices and quantities).
Organizing an action plan (needed changes in production, inventories, raw materials, human resources, marketing plans, etc.).
2-45
Conclusion
Market Demand Curve
2-46
Quantity
(Millions of Barrels)
Price
(Dollars per Barrel)
Demandoil
$140
0
$100
$60
80
160
$20
240
280
International Oil Market
Demand
Changes in Quantity Demanded
2-47
International Oil Market
Quantity
(Millions of Barrels)
Demandoil
$140
0
$100
$90
80
100
280
Price
(Dollars per Barrel)
Increase in quantity demanded
Demand
Change in Demand
2-48
International Oil Market
Quantity
(Millions of Barrels)
Demandoil1
$140
0
$100
$90
80
100
280
Price
(Dollars per Barrel)
Demandoil2
120
140
Increase in demand
$160
Demand
2-49
Quantity
(Millions of Barrels)
Price
(Dollars per Barrel)
Supplyoil
0
$65
$60
80
90
$20
International Oil Market
Increase in quantity supplied
Supply
Change in Quantity Supplied
2-50
Quantity
(Millions of Barrels)
Price
(Dollars per Barrel)
Supplyoil
$140
0
$100
$60
80
160
$20
240
International Oil Market
Supply
The Market Supply Curve
2-51
Change in Supply in Action
Quantity
(Millions of Barrels)
Price
(Dollars per Barrel)
Supplyoil1
$140
0
$100
180
$20
240
International Oil Market
Supplyoil2
100
160
$50
Decrease in supply
Supply
2-52
Quantity
(Millions of Barrels)
Price
(Dollars per Barrel)
Supplyoil
$140
0
$120
$40
40
Qe = 120
$20
200
280
International Oil Market
Demandoil
Surplus
160 million barrels
Forces of demand and supply
put downward
pressure on price.
Shortage
160 million barrels
Forces of demand and supply
put upward pressure
on price.
Pe = $80
Competitive market equilibrium
Qd(Pe) = Qs(Pe)
Market Equilibrium
Competitive Market Equilibrium I
2-53
Quantity
(Millions of Barrels)
Price
(Dollars per Barrel)
Supplyoil
$140
0
Pf = $120
Pc = $40
40
Qe = 120
$20
200
280
International Oil Market
Demandoil
Shortage
160 million barrels
Pe = $80
Competitive market equilibrium
Qd(Pe) = Qs(Pe)
Priceceiling
Nonpecuniary price
Lost social welfare
Price Restrictions and Market Equilibrium
Price Ceiling in Action I
Increase in demand only
Increase equilibrium price
Increase equilibrium quantity
Decrease in demand only
Decrease equilibrium price
Decrease equilibrium quantity
Example of change in demand
Suppose that worldwide demand for automobiles is projected to decrease by 30% next year. What is the impact on the international crude oil market?
2-54
Changes in Demand
Comparative Statics
2-55
Change in Demand in Action
Quantity
(Millions of Barrels)
Price
(Dollars per Barrel)
Supplyoil
$140
0
Pe2 = $54
Qe1 = 120
$20
280
International Oil Market
Demandoil1
Pe1 = $80
Demandoil2
Qe2 = 68
Comparative Statics
55
Increase in supply only
Decrease equilibrium price
Increase equilibrium quantity
Decrease in supply only
Increase equilibrium price
Decrease equilibrium quantity
Example of change in supply
Suppose that war breaks out in a major oil-producing country in the Middle East. What is the impact on the international crude oil market?
2-56
Changes in Supply
Comparative Statics
2-57
Quantity
(Millions of Barrels)
Price
(Dollars per Barrel)
Supplyoil1
$140
0
Qe1 = 120
$20
280
International Oil Market
Demandoil
Pe1 = $80
Supplyoil2
Pe2 = $100
Qe2 = 80
Comparative Statics
Change in Supply in Action
Suppose that simultaneously the following two events occur:
worldwide demand for automobiles is projected to decrease by 30% next year.
war breaks out in a major oil-producing country in the Middle East.
What is the combined impact on the international crude oil market?
2-58
Comparative Statics
Simultaneous Shifts in Supply and Demand
2-59
Quantity
(Millions of Barrels)
Price
(Dollars per Barrel)
Supplyoil1
$140
Pe2 = $65
Qe2 = 10
Qe1 = 120
$20
280
International Oil Market
Demandoil1
Pe1 = $80
Supplyoil2
Demandoil2
The equilibrium price increases
or decreases depending on the
magnitude of the demand
and supply changes.
Comparative Statics
Simultaneous Shifts in Supply and Demand in Action
