2.1A Supply and Demand Model

Transcription

1 2.1A Supply and Demand Model

2 What are competitive markets? Competitive Markets: Bring together the decentralized decisions of buyers and sellers Decentralized Decisions of Buyers: Drive them to try to get the lowest possible price for the goods they want Decentralized Decisions of Sellers: Drive them to try to get the highest possible price for the goods they are selling When these decisions come together competitive markets yield: Best possible price for the product Produced at the lowest possible cost Most efficient allocation of resources

3 What are competitive markets? Competitive Markets: Bring together the decentralized decisions of buyers and sellers Decentralized Decisions of Buyers: Drive them to try to get the lowest possible price for the goods they want Decentralized Decisions of Sellers: Drive them to try to get the highest possible price for the goods they are selling When these decisions come together competitive markets yield: Best possible price for the product Produced at the lowest possible cost Most efficient allocation of resources

4 What are competitive markets? Fundamental Assumptions of Supply + Demand Model: 1. Operating under Perfect Competition Lots of buyers and sellers Goods sold are identical No cost to entering or leaving the market 2. Equal access to information 3. Externalities do not exist No single economic agent can unilaterally exert any price control

7 What is Demand? Demand comes from the buyer of a good/service Each buyer is trying to get the lowest price possible for the good/service that they want Quantity Demanded: Amount of the good buyers want to buy at each price point

8 What is Demand? Demand Schedule: gives the quantity demanded at each price Price Quantity Demanded $5 13 $6 12 $7 10

9 What is Demand? From the demand schedule, we can determine the demand curve Price $7 $6 $ Demand Q demanded Demand Curve: Relationship between price of the good and amount people want to buy of the good (quantity demanded) Law of Demand: As price of a good declines, people want to buy more of it

10 Changes in Demand Movement along the demand curve: Price of the good has changed but there is no change in the willingness of buyers to buy the good Price changes move to a new point on the demand curve (from A to B) Price $7 A $5 B Demand Q demanded

11 Changes in Demand Shift in the demand curve: Some factor has changed that directly impacts buyers willingness to buy the good Demand curve shifts at each price point there is now a new quantity demanded Price $7 A B D.1 D Q demanded

12 Factors that Shift Demand 1. Change in Income Normal Goods Sally just received a raise at work. She now buys Starbuck s lattes on her way to work. Price of lattes $4.50 A B 0 1 Q demanded Inferior Goods After receiving her raise, Sally no longer buys coffee at the gas station on her way to work. D.1 D.2

13 Factors that Shift Demand 2. Change in Price of Related Goods Compliments: Goods that are consumed together If the price of hot dogs increases, people will demand (or buy) less hot dog buns Price of Good A increases: Demand for Good B decreases Price of Good A decreases: Demand for Good B increases Price of Hot Dog Buns $1.50 B A 5 6 D.1 D.2 Q demanded

14 Factors that Shift Demand 2. Change in Price of Related Goods Substitutes: Goods that can be consumed in the place of another good If the price of hot dogs increases, people will demand (or buy) more hamburgers Price of Good A increases: Demand for Good B increases Price of Good A decreases: Demand for Good B decreases Price of Hamburgers $4.00 A B 7 8 Q demanded

15 Factors that Shift Demand 3. Change in Tastes and Preferences As it gets colder out in the winter months, people prefer to buy sweaters and jackets. Demand for sweaters increases. 4. Change in Number of Buyers As laptops become more popular and easy to use, more people buy them. Demand for laptops increases. 5. Change in Future Expectations Future Price of the Good: If people expect discounted prices due to retailers holiday sales, they will wait to buy the goods Future Income: If a college student secures a job that he will start in a few months, he will feel more confident buying an expensive suit today.

16 What is Supply? Supply comes from the seller of a good/service Each seller is trying to get the highest price possible for the good/service that they produce Quantity Supplied: Amount of the good sellers are willing to sell at each price point

17 What is Supply? Supply Schedule: gives the quantity supplied at each price Price Quantity Supplied $5 10 $6 12 $7 13

18 What is Supply? From the supply schedule, we can determine the supply curve Price Supply $7 $6 $ Q supplied Supply Curve: Relationship between price of the good and amount firms are willing to sell of the good (quantity supplied) Law of Supply: As price of a good increases, people want to sell more of it

19 Changes in Supply Movement along the supply curve: Price of the good has changed but there is no change in the cost of production or willingness to sell by the firm Price changes move to a new point on the supply curve (from A to B) Price Supply $7 B $5 A Q supplied

20 Changes in Supply Shift in the supply curve: Some factor has changed that directly impacts sellers willingness to sell/produce the good (or) their cost of production Supply curve shifts at each price point there is now a new quantity supplied Price S.1 S.2 $7 A B Q supplied

21 Factors that Shift Supply 1. Change in Price of Inputs If the price of wood increases, the cost of producing tables would increase. Supply would decrease at each price point. Price of Tables S.2 S.1 $100 B A Q supplied

22 Factors that Shift Supply 2. Change in Production Technology The replacement of workers with robots in car production. Supply increases at each price point. 3. Change in Number of Sellers More sellers means more production at each price point. Supply increases. 4. Change In Future Expectations Future Price of the Good: Expect price to rise in the future produce/sell more then Future Price of Inputs: Expect inputs to be more expensive produce/sell more today

23 Key Takeaway Demand is determined by the buyers of a good. Buyer always want to get the lowest price they can! Hence, demand is downward sloping Supply is determined by the sellers of the good. Sellers always want to get the highest price they can! Hence, supply is upward sloping Certain factors affect each of the curves and cause them to shift. The shifts come from an underlying change to the willingness to buy or willingness to sell.

24 2.1B Supply, Demand and Market Equilibrium

25 Market Equilibrium Price Supply P* Q* Demand Quantity

26 Market Equilibrium Price P P* SURPLUS Supply Qd Qs Demand Quantity

27 Market Equilibrium Price Supply P* P SHORTAGE Qd Qs Demand Quantity

28 Test your Understanding Consider the market for oranges. Draw out the supply and demand curves based on the following supply and demand schedule: Price QD QS $ $ $ $ $ $ Draw out the supply and demand curves based on this information. Where is the equilibrium price and quantity? 2. Suppose there is an exceptionally cold winter in Florida with frosts ruining many groves. What happens to this market? Illustrate and explain. 3. What happens if the price of apples falls? Illustrate and explain. 4. What if both scenarios happen simultaneously?

29 Test your Understanding 1. Draw out the supply and demand curves based on this information. Where is the equilibrium price and quantity? Price Supply $3 A 30 Demand Quantity

30 Test your Understanding 2. Suppose there is an exceptionally cold winter in Florida with frosts ruining many groves. What happens to this market? Illustrate. Price $4 B S.2 S.1 $3 A Demand Quantity

31 Test your Understanding 3. What happens if the price of apples falls? Illustrate and explain. Price S.1 $3 $2 B A D.2 D.1 Quantity

32 Test your Understanding 4. What if both scenarios happen simultaneously? Ambiguous change in equilibrium price Price $3 C B B' A S.2 S.1 D D.1 Quantity Definite decrease in equilibrium quantity

33 Simultaneous Shifts in Both Curves SIMULTANEOUS SHIFTS Supply Increases Demand Increases Ambiguous Effect on Price Quantity Increases Price A S.1 B S.2 In the market for sweaters: - Winter is coming and it s going to be a cold one! (Increase in Demand) - Wool becomes cheaper (Increase in Supply) Q.1 Q.2 D.1 D.2 Quantity

34 Simultaneous Shifts in Both Curves SIMULTANEOUS SHIFTS Supply Decreases Demand Increases Price increases Ambiguous Effect on Quantity Price P.2 P.1 B A S.2 S.1 In the market for coffee: - FDA says coffee can help people stay healthy (Increase in Demand) - A drought in Ecuador destroys the coffee crops (Decrease in Supply) D.2 D.1 Quantity

35 Simultaneous Shifts in Both Curves SIMULTANEOUS SHIFTS Supply Decreases Demand Decreases Ambiguous Effect on Price Quantity Decreases In the market for snowboards: - Skiing gear is now cheaper than snowboarding gear (Decrease in Demand) - A few major producers of snowboards decide to shift their business focus to other products (Decrease in Supply) Price B Q.2 A Q.1 S.2 S.1 D.1 D.2 Quantity

36 Simultaneous Shifts in Both Curves SIMULTANEOUS SHIFTS Supply Increases Demand Decreases Price decreases Ambiguous Effect on Quantity In the market for electric cars: - Gas prices fall, people prefer to keep their old cars (Decrease in Demand) - Innovations in production make it cheaper for companies to make electric cars (Increase in Supply) Price P.1 P.2 A S.1 S.2 B D.1 D.2 Quantity

37 Key Takeaway Market Equilibrium brings together the decentralized decisions of buyers and sellers Because each agent is looking out for their own best interest we get the optimal results in the model Shifts in the S or D curve must come from a change in one of the factors that change either willingness to sell or willingness to buy S-D Graph is critical in helping us find equilibrium and analyze/understand changes in the market.

38 Principles of Microeconomics Module 2.1 (C ) Price Controls 63

39 In this video, we will discuss what happens when the government imposes a price control in a market. We will see how this distorts the equilibrium outcomes in the supply and demand model 64

40 Price Controls In economics, we argue: Best possible outcomes occur with no gov t interference Yields most efficient allocation of resources When policies to control the price interfere in the market, they create distortions These distortions cause: Shortages Surpluses 65

41 What are Price Controls? Price controls Setting a price maximum (price ceiling) or price minimum (price floor) in a given market Non-binding price control: the equilibrium is not distorted and the market outcomes are efficient Binding price control: the equilibrium cannot be reached and the market outcomes are inefficient (shortage or surplus) 66

44 Test your Understanding Consider two labor markers where a lawyer s wage rate is approximately $100/hr and a housecleaner s wage rate is approximately $8/hr. The government decides to impose a minimum wage law of $12/hr. 1. What impact does this have on the market for lawyers? Draw out the supply and demand model. 2. What impact does this have on the market for housecleaners? Draw out the supply and demand model. 69

45 Minimum Wage Laws Market for Lawyers Market for Housecleaners P $100 S Market Equilibrium P S $8 Market Equilibrium D D Q Q 70

46 Minimum Wage Laws Market for Lawyers Market for Housecleaners P S P S $100 Price Floor Min. Wage $12 $12 $8 Price Floor Min. Wage D D Q Q 71

47 Minimum Wage Laws Market for Lawyers Market for Housecleaners P S P S $100 Price Floor Min. Wage $12 $12 $8 Price Floor Min. Wage D D Qd = Qs Q Qd Qs Q 72

48 Minimum Wage Laws Market for Lawyers Market for Housecleaners P S P S $100 Price Floor Min. Wage $12 $12 $8 Price Floor Min. Wage D D Qd = Qs Q Qd Qs Q Qd = Qs: No effect of the market for lawyers 73

49 Minimum Wage Laws Market for Lawyers Market for Housecleaners P S P S $100 Price Floor Min. Wage $12 $12 $8 Price Floor Min. Wage D D Qd = Qs Q Qd Qs Q Qd < Qs: At $12: Surplus of Housecleaners 74

50 Key Takeaways Government policies can cause distortions in the market for goods and services by preventing supply and demand to reach equilibrium These distortions create Shortages Surpluses Mismatch between prices for buyers and sellers Policies are put in place many times due to the social benefits outweighing the economic costs 75

51 Price Elasticity of Demand and Supply Principles of Microeconomics Module 2.2 (A)

52 Ways that Demand and Supply Change Changes in demand and supply come from: Movement along the curve some factor changes that does not directly affect the willingness of buyer to pay or seller to sell Shift in the curve some factor changes that directly affects the willingness of buyer to pay or seller to sell

53 Price Elasticity Price Elasticity of Demand: By how much does Qd respond to a price change? Movement along the demand curve from A to B Responsiveness of quantity demanded to price change

54 Price Elasticity Price Elasticity of Supply: By how much does Qs respond to a price change? Movement along the supply curve from A to B Responsiveness of quantity supplied to price change

55 Midpoint Method for Price Elasticity

56 Elasticity of Curves P Pa Pb Elastic Demand A B Any change in price yields a large response/adjustment in quantity demanded: - Luxury goods: designer jeans à not a necessity - Gourmet foods: $15/lb cheese à many substitutes - Kit Kat bars à many substitutes Qa Qb Q

57 Elasticity of Curves P Pa Inelastic Demand A Change in price yields a small response/adjustment in quantity demanded: Pb Qa B Qb Q - Medicine - Food - Peak railroad tickets

58 Elasticity of Curves Change in price yields a large response/adjustment in quantity supplied: P Pb Elastic Supply B Firm operating below capacity Any change in price the firm will quickly adjust production Pa A Qa Qb Q

59 Elasticity of Curves Change in price yields a small response/adjustment in quantity supplied: P Inelastic Supply Agriculture in the short term can t immediately produce more Pb Pa A B Nuclear power Qa Qb Q

60 Price Elasticity of Demand and Supply Principles of Microeconomics Module 2.2 (B)

61 Price Elasticity of Demand Suppose a grocery store owner is deciding to increase the price of smoked salmon by 10% from $11.00 to $ The quantity of smoke salmon he can sell falls from 40 units to 25 units. What is the price elasticity of demand for smoked salmon? Is it elastic or inelastic? Can you calculate the change in the grocer s revenue if he increases the price of smoked salmon? (Total Revenue = Price x Quantity)

62 Price Elasticity of Demand

65 Price Elasticity of Demand Now what if the same grocery store owner is deciding to increase the price of bread by 10% from $3.00 to $3.30, the quantity of bread he can sell falls from 100 units to 98 units. What is the price elasticity of demand for bread? Is it elastic or inelastic? Can you calculate the change in the grocer s revenue if he increases the price of bread? (Total Revenue = Price x Quantity)

69 Price Elasticity of Supply Now suppose that this grocer observes that his neighborhood is changing, and many new people are moving in. The number of buyers is increasing. As a result, the price of his goods, on average increases from $5 to $7 and the quantity of grocery goods supplied increases from 1000 to What is the price elasticity of supply?

70 Price Elasticity of Supply Now suppose that this grocer observes that his neighborhood is changing, and many new people are moving in. The number of buyers is increasing. As a result, the price of his goods, on average increases from $5 to $7 and the quantity of grocery goods supplied increases from 1000 to 1250.

71 Price Elasticity of Demand and Supply Principles of Microeconomics Module 2.2 (C)

72 Income Elasticity of Demand By how much does Qd respond to a change in income?

73 Income Elasticity Consider the popular brand of craft beer: Magic Hat and suppose the average income of a 23 yearold is $45,000. The 23 year-old consumes on average 5 Magic Hats a month. When his income rises to $50,000, he consumes 9 Magic Hats per month. What is his income elasticity of demand? Is this a normal good or an inferior good?

74 Income Elasticity Consider the popular brand of craft beer: Magic Hat and suppose the average income of a 23 year-old is $45,000. The 23 year-old consumes on average 5 Magic Hats a month. When his income rises to $50,000, he consumes 9 Magic Hats per month.

75 Cross Price Elasticity of Demand By how much does Qd respond to a change in the price of a related good?

76 Cross Price Elasticity Consider, once again, the market for beer. When the price of pretzels moves from $4 to $3, the consumption of beer increases from 100 units to 120 units. 1. What is the cross price elasticity of demand for beer when the price of pretzels rises? 2. How are these markets related?

77 Cross Price Elasticity Consider, once again, the market for beer. When the price of pretzels moves from $4 to $3, the consumption of beer increases from 100 units to 120 units.

78 Key Takeaways Understanding elasticity allows us to quantify the changes in demand and supply. Provides an additional analysis to understand how responsiveness quantity demanded and quantity supplied are to price changes, income changes and changes in prices of related goods.

79 Principles of Microeconomics Module 2.3 Consumer Surplus and Producer Surplus 100

80 Welfare Economics How the allocation of resources and market outcomes affect economic well-being Reaching equilibrium: maximizes welfare (in most cases) Welfare Economics: Consumer Surplus, Producer Surplus and Total Surplus 101

81 Consumer Surplus Willingness to pay price actually paid Every buyer has a maximum price they are willing to pay for every good At lower prices, his consumer surplus is larger he is better off because not paying his full maximum price 102

82 Consumer Surplus Willingness to pay price actually paid Every buyer has a maximum price they are willing to pay for every good At lower prices, his consumer surplus is larger he is better off because not paying his full maximum price 103

83 Consumer Surplus Consider what you would pay for a bottle of water at a summer concert P $2.50 CS If the price of water is actually $2.50 per bottle, would you buy the water? If your max price is $5 then yes! Your consumer surplus is $2.50 If your max price is $2 then no Q What happens if the price falls to $70 per day? If your max price is $100: Your consumer surplus rises to $30 If yous max price is $85 now you buy the tickets and have positive consumer surplus of $15 104

84 Consumer Surplus Consider what you would pay for a bottle of water at a summer concert P $2.50 CS If the price of water is actually $2.50 per bottle, would you buy the water? If your max price is $5 then yes! Your consumer surplus is $2.50 If your max price is $2 then no $1.50 NEW CS Q What happens if the price falls to $1.50 per day? If your max price is $5: Your consumer surplus rises to $3.50 If your max price is $2 now you buy the water and have positive consumer surplus of $1 105

85 Producer Surplus Price actually received willingness to sell Every seller faces a minimum value they are willing to accept to sell their goods This reflects the cost of production At higher prices, his producer surplus is larger he is better off from selling his goods above cost 106

86 Producer Surplus Price actually received willingness to sell Every seller faces a minimum value they are willing to accept to sell their goods This reflects the cost of production At higher prices, his producer surplus is larger he is better off from selling his goods above cost 107

87 Producer Surplus Consider independent food and beverage vendors at the summer music festival, each with the following willingness to sell a bottle of water: Willingness to sell Vendor A $3.00 Vendor B $2.75 Vendor C $

88 Producer Surplus P If the price of a bottle of water is $2.25, how many vendors will sell water? Only vendor C P.S. will be $0.25 $2.25 PS Q What happens if the price rises to $3.50 per bottle? All vendors will sell water PS Vendor A: $0.50 PS Vendor B: $0.75 PS Vendor C: $

89 Producer Surplus P $3.50 $2.25 New PS PS Q If the price of a bottle of water is $2.25, how many vendors will sell water? Only vendor C P.S. will be $0.25 What happens if the price rises to $3.50 per bottle? All vendors will sell water PS Vendor A: $0.50 PS Vendor B: $0.75 PS Vendor C: $

90 Total Economic Surplus Combines consumer surplus and producer surplus Total Surplus = Value to Buyers Cost to Sellers 111

91 Total Surplus and Free Market Outcomes GOODS WILL BE ALLOCATED TO: Buyers who value them most highly, as measured by their willingness to pay. P $2.75 CS PS Sellers who can produce them at the lowest cost. Q The free market yields an equilibrium quantity and price that maximizes both consumer and producer surplus 112

92 Total Surplus and Free Market Outcomes GOODS WILL BE ALLOCATED TO: Buyers who value them most highly, as measured by their willingness to pay. P $2.75 CS PS Sellers who can produce them at the lowest cost. Q The free market yields an equilibrium quantity and price that maximizes both consumer and producer surplus 113

93 Key Takeaways Welfare Economics is the analysis of the economic well-being of producers and consumers Assume that market outcomes lead to maximized total surplus 114

94 Principles of Microeconomics Module 2.4 Taxation 115

95 Taxes in the Supply and Demand Model Taxes cause: Price paid by buyer > Price received by seller Insert wedge in the Supply and Demand model Tax wedge creates deadweight loss: Loss of total surplus or economic well-being as a result of the policy 116

96 Sales Taxes P PB TAX PS Taxes insert a wedge between the price paid by buyers (Pb) and price received by sellers (Ps) Regardless of who pays the tax (sellers or buyers) both share the tax burden Qt Qe Q Tax = Pb Ps Tax revenue = Tax*Qt Tax burden (buyer) = Pb Pe Tax burden (seller) = Pe - Ps 117

97 Sales Taxes P PB TAX PS Taxes insert a wedge between the price paid by buyers (Pb) and price received by sellers (Ps) Regardless of who pays the tax (sellers or buyers) both share the tax burden Qt Qe Q Tax = Pb Ps Tax revenue = Tax*Qt Tax burden (buyer) = Pb Pe Tax burden (seller) = Pe - Ps 118

98 Sales Taxes P Taxes insert a wedge between the price paid by buyers (Pb) and price received by sellers (Ps) PB PS TAX REVENUE Regardless of who pays the tax (sellers or buyers) both share the tax burden Qt Qe Q Tax = Pb Ps Tax revenue = Tax*Qt Tax burden (buyer) = Pb Pe Tax burden (seller) = Pe - Ps 119

99 Understanding Taxes Consider the market for socks, where the equilibrium price of socks is $5 per pair and the equilibrium quantity is 300. The government imposes a $1 tax on the market to be paid by the seller, causing a fall in the quantity sold to 200. What happens when the tax is imposed? Draw out the supply and demand model showing the market before the tax and after the tax 120

100 Understanding Taxes P S Pe = $5 Qe = 300 D Q 121

101 Understanding Taxes P S Pb = $5.50 Tax: Pb Ps $1 Pe = $5 Pb = $4.50 Qt = 200 Qe = 300 D Q 122

102 Understanding Taxes P S Tax: Pb Ps $1 Pb = $5.50 Pe = $5 Tax Revenue = Tax*Qt $1 * 200 = $200 Pb = $4.50 Qt = 200 Qe = 300 D Q 123

103 How do taxes affect Market Participants? Analyze the following before tax vs. after tax is imposed: Consumer Surplus Producer Surplus Total Surplus Government Revenue How does the tax change economic welfare? 124

104 Consumer Surplus BEFORE TAXES AFTER TAXES P S P S Pe Consumer Surplus Pb Pe Consumer Surplus Ps Qe D Q Qt Qe D Q 125

105 Producer Surplus P BEFORE TAXES S P AFTER TAXES S Pb Pe Pe Producer Surplus Ps Producer Surplus Qe D Q Qt Qe D Q 126

106 Government Tax Revenue P BEFORE TAXES S P AFTER TAXES S Pb Pe Producer Surplus Pe Gov t Tax Revenue Ps Qe D Q Qt Qe D Q 127

107 Deadweight Loss P BEFORE TAXES S P AFTER TAXES S Pb Pe Producer Surplus Pe DWL Ps Qe D Q Qt Qe D Q 128

108 Elasticity and the Tax Burden 129

109 Key Takeaways We can think of taxation in the context of supply and demand model in terms of How it affects prices and quantities How it affects economic well-being via welfare economics Since taxes cause distortions in the market (tax wedge) they yield inefficient market outcomes Why do we have them? Derive some benefits from government revenue. 130