DEMAND

SUPPLY

EQUILIBRIUM


Supply & demand are relationships between the price of something and the quantity of the same thing.

(For example, we could talk about the relationship between the price of hamburgers and the quantity of hamburgers.)



DEMAND
DEMAND

(For example, the demand for pizzas is the relationship between the price of pizzas and the quantity of pizzas demanded at every possible price.)


A DEMAND SCHEDULE

For example:
PRICE OF HAMBURGERS QUANTITY OF HAMBURGERS DEMANDED
$5.00 1
$4.00 2
$3.00 3
$2.00 4
$1.00 5


A DEMAND CURVE



















For example, plot the points in the above table on a graph.

(Note: It is traditional in economics to place price on the vertical axis and quantity on the horizontal axis.)


WHY DO DEMAND CURVES SLOPE DOWNWARD?

There is usually an inverse relationship between the price of something and the quantity demanded of that thing.

Why?

Economists suggest this inverse relationship is due to:

(1) income effects

and

(2) substitution effects.


Income effects - As the price of something decreases, our real income (i.e., purchasing power) increases. One of the things we might do with our increased purchasing power is buy more of this product.


Hamburger Example of Income Effects

Suppose you have $4 in your pocket. If you go to McDonald's and find that Big Macs cost $2.50, then you might buy one Big Mac for lunch.

With that same $4 in your pocket, suppose you go to McDonald's and find Big Macs on sale for 99 cents. You might buy 2 Big Macs for lunch.

In both of these cases, your monetary income is the same ($4). You have more real income (purchasing power) in the second case, however.


Substitution effects - As the price of something decreases, some consumers (who would not have purchased this product at the higher price) will buy this product as a substitute for something else.


Hamburger Example of Substitution Effects

Suppose you go to McDonald's for lunch. On the way there, you are thinking you might enjoy their chicken sandwich today.

When you arrive at the restaurant, you are pleasantly surprised to find that Big Macs are on sale for 99 cents. The chicken sandwich is not on sale and costs $2.49.



Thus, when the price of Big Macs decreases, one of the reasons the quantity demanded increases is that some consumers will substitute away from other products (e.g., chicken sandwiches) and buy the cheaper Big Macs.


Thus, the inverse relationship between price and quantity demanded is due to

(1) income effects, and

(2) substitution effects.


SHIFTS IN DEMAND

A change in demand means that the demand curve has shifted. At every possible price, there is (probably) a different quantity demanded (than before the shift).

The demand for a particular good may shift because of changes in:


DEMAND vs. QUANTITY DEMANDED

It is extremely important to understand the difference between "demand" and "quantity demanded."

This is the one of the biggest points of confusion among introductory economics students.


DEMAND

QUANTITY DEMANDED


"AN INCREASE IN DEMAND" versus "AN INCREASE IN QUANTITY DEMANDED" (in the market for pizza).

With an INCREASE IN DEMAND (for pizza)

An INCREASE IN DEMAND might be caused by:

An Illustration of an Increase in Demand
























With an INCREASE IN QUANTITY DEMANDED (for pizza)

An INCREASE IN QUANTITY DEMANDED (for pizza) is caused by:

An Illustration of an Increase in Quantity Demanded

























REMEMBER: A demand curve tells you how much the quantity of pizza demanded changes when the price of pizza changes.



SUPPLY

SUPPLY

(For example, the supply of pizzas is the relationship between the price of pizzas and the quantity of pizzas supplied at every possible price.)




A SUPPLY SCHEDULE

For example:
PRICE OF HAMBURGERS QUANTITY OF HAMBURGERS SUPPLIED
$5.00 5
$4.00 4
$3.00 3
$2.00 2
$1.00 1


A SUPPLY CURVE

For example, plot the points in the above table on a graph.

(Note: It is traditional in economics to place price on the vertical axis and quantity on the horizontal axis.)






















sUPply curves slopes UPward

There is usually a direct relationship between the price of something and the quantity supplied of that thing.


LABOR SUPPLY EXAMPLE

Suppose I need some help with projects around the house (e.g., yard work). Would you be willing to help me this weekend if I offer you $3 per hour? What if I offer $5 per hour? Would you say "yes" if I pay you $10 per hour? What about $20 per hour? What if I pay $50 per hour?

When I ask a room full of people these questions, as the amount I pay increases, the number of people willing to help me increases.

This is an example of a supply curve for labor. As the price of labor (the amount I am willing to pay you) increases, the number of people willing to work for me also increases.



SHIFTS IN SUPPLY

A change in supply means that the supply curve has shifted. At every possible price, there is (probably) a different quantity supplied (than before the shift).

The supply for a particular good may shift because of changes in:


SUPPLY vs. QUANTITY SUPPLIED

It is extremely important to understand the difference between "supply" and "quantity supplied."

This is one of the biggest points of confusion among introductory economics students.


SUPPLY

QUANTITY SUPPLIED


"AN INCREASE IN SUPPLY" versus "AN INCREASE IN QUANTITY SUPPLIED" (in the market for pizza).

With an INCREASE IN SUPPLY (of pizza)

An INCREASE IN SUPPLY of pizza might be caused by:





An Illustration of an Increase in Supply
























With an INCREASE IN QUANTITY SUPPLIED (of pizza)

An INCREASE IN QUANTITY SUPPLIED (of pizza) is caused by:

An Illustration of an Increase in Quantity Supplied





















REMEMBER: A supply curve tells you how much the quantity of pizza supplied changes when the price of pizza changes.



EQUILIBRIUM

In a market, prices are determined by the interaction of supply and demand. We can represent the supply and demand for a good or service by drawing supply and demand curves.

If we draw these curves on the same graph, the intersection of the supply & demand curves represents the equilibrium point.

The equilibrium point represents the price at which the quantity supplied and the quantity demanded are equal.

It is important because it is efficient.

At the equilibrium price, suppliers want to produce and sell the same quantity which demanders (i.e., consumers) wish to buy at that price.



An Illustration of Equilibrium
























PRICES ABOVE EQUILIBRIUM

At any market price above the equilibrium, the quantity which producers wish to supply (represented by the horizontal distance between the vertical axis and the supply curve at that price) is larger than the quantity which consumers demand (represented by the horizontal distance between the vertical axis and the demand curve).

At prices above the equilibrium, there is a surplus of the product. The quantity supplied exceeds the quantity demanded.

This is not a situation we would expect to be maintained very long. Since some sellers are unable to find buyers for all of their product at current prices, the price of the product will tend to fall and a smaller quantity of the product will be produced. (This represents a move down the supply curve toward the origin.)

When stores at the mall have things which do not sell as quickly as expected, they put them on sale, don't they?

As the price falls in this market, there is an increase in the quantity of this product which is demanded. (This represents a movement down the demand curve.)

At any price above equilibrium, there is pressure for the market price to fall (because the quantity supplied exceeds the quantity demanded). This pressure continues until the market price reaches equilibrium.

An Illustration of How Prices Above Equilibrium Create a Surplus
























PRICES BELOW EQUILIBRIUM

At any market price below the equilibrium, the quantity which consumers demand (represented by the horizontal distance between the vertical axis and the demand curve) is greater than the quantity which producers wish to supply (represented by the horizontal distance between the vertical axis and the supply curve at that price).

At prices below the equilibrium, there is a shortage of the product. The quantity demanded exceeds the quantity supplied.

This is not a situation we would expect to be maintained very long. Since some buyers are unable to find a seller of the product at current prices, the price of the product will tend to rise and a larger quantity of the product will be produced. (This represents a movement up the supply curve.)

(If I am unable to hire enough people to help me with yard work if I pay only $3 an hour, I have to pay a higher price. If I offer $10 an hour, more people are likely to be willing to work.)

As the price rises in this market, there is an increase in the quantity of this product which is supplied. (This represents a movement up the supply curve.) There also is a decrease in the quantity demanded. (This represents a movement up the demand curve.)

At any price below equilibrium, there is pressure for the market price to rise (because the quantity demanded exceeds the quantity supplied). This pressure continues until the market price reaches equilibrium.

An Illustration of How Prices Below Equilibrium Create a Shortage























In equilibrium,

If a market is not in equilibrium, market forces are pushing it toward equilibrium.


HOW SHIFTS IN DEMAND AFFECT THE MARKET EQUILIBRIUM

Market prices move up and down because of changes in the supply and demand for the particular product.



BEEF MARKET EXAMPLE

To illustrate this on the demand side, let's examine the market for beef.

Suppose a report on national television suggests that eating beef is bad for your health.

Would this affect the market price for beef?

The report suggesting beef may be harmful causes the demand for beef to decrease.

This means the DEMAND CURVE shifts left. No matter what the price of beef is, people want less of it.

If nothing else changes, what has happened to the equilibrium price of beef?



Since the supply curve has not shifted and the demand curve has shifted left, the new intersection occurs at a lower price and smaller quantity than the initial equilibrium point.

The published report caused the equilibrium price and quantity of beef to fall.

(This was the basis of a lawsuit filed by representatives of the beef industry against talk show host Oprah Winfrey in 1997.)




HOW SHIFTS IN SUPPLY AFFECT THE MARKET EQUILIBRIUM

Market prices move up and down because of changes in the supply and demand for the particular product.



ORANGE JUICE MARKET EXAMPLE

To illustrate this on the supply side, let's examine the market for orange juice.

Most of the oranges grown is Florida are used to make orange juice.

Suppose a series of hurricanes hit Florida and destroy a large portion of the orange groves.

What affect will this have on equilibrium in the orange juice market?

Because orange groves have been destroyed, the supply of orange juice has decreased.

The supply curve has shifted left.

At every possible price, less orange juice is produced than before the orange groves were destroyed.





Since the demand curve has not shifted, the new equilibrium occurs at a higher market price and a smaller quantity of orange juice.


Economists use supply and demand analysis to examine most issues which affect the economy.

For example, we can use the supply & demand framework to examine minimum wage laws, agricultural price supports, and rent controls.



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