I.
Learning objectives
A.
What demand is and what affects it.
B.
What supply is and what affects it.
C.
How supply and demand together determine market equilibrium.
D.
How changes in supply and demand affect equilibrium prices and
quantities.
E.
What government-set prices are and how they can cause product
surpluses and shortages.
II.
Markets
A. A market is an
institution or mechanism that brings together buyers (demanders) and
sellers (suppliers) of particular goods and services.
B. Competitive
markets have:
1. a
large number of independent buyers and sellers.
2.
prices that are “discovered” through the interaction of
buyers and sellers. No individual can dictate the
market price.
III.
Demand

A. Demand is a
schedule that shows the various amounts of a product that consumers
are willing and able to buy at each specific price in a series of
possible prices during a specified time period.
1. Example of
demand schedule for corn is Figure 3.1.
2. The schedule
shows how much buyers are willing and able to purchase at five
possible prices.
3. The market price
depends on demand and supply.
4. To be
meaningful, the demand schedule must have a period of time
associated with it.
B. Law of demand is
a fundamental characteristic of demand behavior.
1. Other things
being equal, as price increases, the corresponding quantity demanded
falls.
2. Restated, there
is an inverse relationship between price and quantity demanded.
3. Note the
“other-things-equal” assumption refers to consumer income and
tastes, prices of related goods, and other things besides the price
of the product being discussed.
4. Explanation of
the law of demand:
a. Diminishing
marginal utility: The decrease in added satisfaction that results
as one consumes additional units of a good or service, i.e., the
second “Big Mac” yields less extra satisfaction (or utility) than
the first.
b. Income effect: A
lower price increases the purchasing power of money income enabling
the consumer to buy more at lower price (or less at a higher price)
without having to reduce consumption of other goods.
c. Substitution
effect: A lower price gives an incentive to substitute the
lower-priced good for now relatively higher-priced goods.
C. The demand
curve:
1. Illustrates the
inverse relationship between price and quantity (see corn example,
Figure 3.1).
2. The downward
slope indicates lower quantity (horizontal axis) at higher price
(vertical axis, higher quantity at lower price, reflecting the Law
of Demand.
D. Individual vs.
market demand:
1. Transition from
an individual to a market demand schedule is accomplished by summing
individual quantities at various price levels.
2. Market curve is
horizontal sum of individual curves (see corn example, Tables 3.1,
3.2 and Figure 3.2).
E. Changes in
Non Price Determinants cause changes in
demand.
A change in any of
the demand determinants causes a change in demand and a shift in the
demand curve. An increase in demand involves a rightward shift, and a
decrease in demand involves a leftward shift.
1.
Tastes—-favorable change leads to increase in demand; unfavorable
change to decrease.
2. Number of
buyers—more buyers lead to an increase in demand; fewer buyers lead
to a decrease.
3. Income—more
leads to an increase in demand; less leads to decrease in demand for
normal goods. (The rare case of goods whose demand varies inversely
with income is called inferior goods).
4. Prices of
related goods also affect demand.
a. Substitute goods (those that can be used in place of each
other): The price of the substitute good and demand for the other
good are directly related. If the price of Coke rises (because of a
supply decrease), demand for Pepsi should increase.
b. Complementary goods (those that are used together like tennis
balls and rackets): When goods are complements, there is an inverse
relationship between the price of one and the demand for the other.
5. Consumer
expectations—consumer views about future prices and income can shift
demand.
6. A summary of
what can cause an increase in demand:
a. Favorable change
in consumer tastes.
b. Increase in the
number of buyers.
c. Rising income if
product is a normal good.
d. Falling incomes
if product is an inferior good.
e. Increase in the
price of a substitute good.
f. Decrease in the
price of a complementary good.
g. Consumers expect
higher prices or incomes in the future.
3. A summary of
what can cause a decrease in demand:
a. Unfavorable
change in consumer tastes,
b. Decrease in
number of buyers,
c. Falling income
if product is a normal good,
d. Rising income if
product is an inferior good,
e. Decrease in
price of a substitute good,
f. Increase in
price of a complementary good,
g. Consumers’
expectations of lower prices or incomes in the future.

G. Review the
distinction between a change in quantity demanded caused by price
change and a change in demand caused by change in determinants.
IV.
Supply

A. Supply is a schedule
that shows amounts of a product a producer is willing and able to
produce and sell at each specific price in a series of possible prices
during a specified time period.
1. A supply schedule
portrays this such as the corn example in Figure 3.4.
2. Schedule shows what
quantities will be offered at various prices or what price will be
required to induce various quantities to be offered.
B. Law of supply:
1. Producers will
produce and sell more of their product at a high price than at a low
price.
2. Restated: There is a
direct relationship between price and quantity supplied.
3. Explanation: Given
product costs, a higher price means greater profits and thus an
incentive to increase the quantity supplied.
4. Beyond some
production quantity producers usually encounter increasing costs per
added unit of output.
C. The supply curve:
1. The graph of supply
schedule appears in Figure 3.5, which graphs data from Table 3.4.
2. It shows a direct
relationship in an upward sloping curve.
D. Non
Price Determinants of
supply:
A change in any of
the supply determinants causes a change in supply and a shift in the
supply curve. An increase in supply involves a rightward shift, and a
decrease in supply involves a leftward shift.
1. Resource prices—a
rise in resource prices will cause a decrease in supply or leftward
shift in supply curve; a decrease in resource prices will cause an
increase in supply or rightward shift in the supply curve.
2. Technology—a
technological improvement means more efficient production and lower
costs, so an increase in supply, or rightward shift in the curve
results.
3. Prices of related
goods—if price of substitute production good rises, producers might
shift production toward the higher priced good, causing a decrease in
supply of the original good.
4.
Producer expectations—expectations about the future price of
a product can cause producers to increase or decrease
current supply.
5. Number of
sellers—generally, the larger the number of sellers the greater the
supply.
6.
Taxes and subsidies—a business tax is treated as a cost, so
decreases supply; a subsidy lowers cost of production, so
increases supply.

E. Review the
distinction between a change in quantity supplied due to price changes
and a change or shift in supply due to change in determinants of supply.
V.
Supply and Demand: Market Equilibrium
A. Review the text
example, Table 3.6, which combines data from supply and demand schedules
for corn.
Thousands
of
bushels
demanded |
Price
per
bushel |
Thousand
of
bushels
supplied |
Surplus (+)
or
shortage (-) |
|
|
85
80
75
70
65
60 |
$3.40
3.70
4.00
4.30
4.60
4.90 |
72
73
75
77
79
81 |
_____
_____
_____
_____
_____
_____ |
B. Find
the point where quantity supplied equals the quantity demanded, and note this equilibrium price and quantity. Emphasize the correct
terminology!
1. At prices above this
equilibrium, note that there is an excess quantity or surplus.
2. At prices below this
equilibrium, note that there is an excess quantity demanded or shortage.
C. Market clearing or
market price is another name for equilibrium price.
D. Graphically, note
that the equilibrium price and quantity are where the supply and demand
curves intersect (See Figure 3.6). This is an IMPORTANT point is to recognize and remember. Note that it is NOT correct to say
supply equals demand!

E. Rationing function
of prices is the ability of competitive forces of supply and demand to
establish a price where buying and selling decisions are coordinated.
(Key Question 8)
CONSIDER THIS …
Ticket Scalping: A Bum Rap!
- “Scalping” refers to the
practice of reselling tickets at a
higher-than-original price, which happens often
with athletic and artistic events. Is this
“ripping off” justified?
- Ticket re-sales are voluntary—both buyer and seller must feel
that they gain or they would not agree to the transaction.
- “Scalping” market simply redistributes assets (tickets) from
those who value them less than money to those who value them more than
the money they’re willing to pay.
- Sponsors may be injured, but if that is the case, they should
have priced the tickets higher.
- Spectators are not damaged, according to economic theory,
because those who want to go the most are getting the tickets.
- Conclusion: Both seller and buyer benefit and event sponsors
are the only ones who may lose, but that is due to their own error in
pricing and they would have lost from this error whether or not the
scalping took place.
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G. Efficient allocation – productive and allocative efficiency
1. Competitive markets generate
productive efficiency –
the production of any particular good in the least costly way. Sellers
that don’t achieve the least-cost combination of inputs will be
unprofitable and have difficulty competing in the market.
2. The competitive process also generates
allocative
efficiency – producing the combination of goods and services most
valued by society.
3. Allocative efficiency requires that there be productive
efficiency. Productive efficiency can occur without allocative
efficiency. Goods can be produced in the least costly method without
being the most wanted by society.
4. Allocative and productive efficiency occur at the equilibrium
price and quantity in a competitive market. Resources are neither over-
nor underallocated based on society’s wants.
VI.
Changes in Supply and Demand, and Equilibrium
A. Changing demand with
supply held constant:
1. Increase in demand
will have effect of increasing equilibrium price and quantity
(Figure 3.7a).
2. Decrease in demand
will have effect of decreasing equilibrium price and quantity
(Figure 3.7b).
B. Changing supply with
demand held constant:
1. Increase in supply
will have effect of decreasing equilibrium price and increasing quantity
(Fig 3.7c).
2. Decrease in supply
will have effect of increasing equilibrium price and decreasing quantity
(Fig 3.7d).
C. Complex cases—when
both supply and demand shift (see Table 3.7):
1. If supply increases
and demand decreases, price declines, but new equilibrium quantity
depends on relative sizes of shifts in demand and supply.
2. If supply decreases
and demand increases, price rises, but new equilibrium quantity depends
again on relative sizes of shifts in demand and supply.
3. If supply and demand
change in the same direction (both increase or both decrease), the
change in equilibrium quantity will be in the direction of the shift but
the change in equilibrium price now depends on the relative shifts in
demand and supply.
CONSIDER THIS …
Salsa and Coffee Beans
- Demand is an inverse
relationship between price and quantity
demanded, other things equal (unchanged).
Supply is a direct relationship showing the
relationship between price and quantity
supplied, other things equal (unchanged).
It can appear that these rules have been
violated over time, when tracking the price
and the quantity sold of a product such as
salsa or coffee.
- Many factors
other than price determine the outcome.
- If neither the
buyers nor the sellers have changed, the equilibrium price will remain
the same.
- The most important
distinction to make is to determine if a change has occurred because of
something that has affected the buyers or something that is influencing
the sellers.
- A change in any of
the determinants of demand will shift the demand curve and cause a
change in quantity supplied. (See Figure 3.7 a & b)
- A change in any of
the determinants of supply will shift the supply curve and cause a
change in the quantity demanded. (See Figure 3.7 c & d)
- Confusion
results if “other things” (determinants) change and one does not take
this into account. For example, sometimes more is demanded at
higher prices because incomes rise, but if that fact is ignored,
the law of demand seems to be violated. If income changes,
however, there is a shift or increase in demand that could cause more to
be purchased at a higher price. In this example, “other things” did
not remain constant.
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VII. Application: Government-Set Prices (Ceilings and Floors)
A.
Government-set prices prevent the market from reaching the
equilibrium price and quantity.
B.
Price ceilings

1. The maximum legal price a seller may charge, typically placed below
equilibrium.
2.
Shortages result as quantity demanded exceeds quantity supplied
(Figure 3.8)
3. Alternative methods of rationing must emerge to take the
places of the price mechanism. These may be formal
(rationing coupons) or informal (lines at the pump).
4. Black markets may emerge to satisfy the unmet
consumer demand.Another example: Rent controls in large cities – intended to keep
housing affordable but resulting in housing shortages.
C. Price floors

1. The minimum legal price a seller may charge, typically placed above
equilibrium.
2. Surpluses result as quantity supplied exceeds quantity demanded
(Figure 3.9).
3. Resources are overallocated to the production of wheat and
consumers pay higher than efficient prices for wheat-based goods.
4. Another example: Minimum wage
Note: The federal minimum wage, for example, will be
below equilibrium in some labor
markets (large cities). In that case the price floor has no effect.
VIII. LAST WORD: A Market for Human Organs?
A. Organ transplants
have become increasingly common, but not everyone who needs a transplant
can get one. In 2005, there were 89,000 Americans on the waiting list.
It is estimated that there are 4000 deaths per year in the U.S. because
not enough organs are available.
B. Why shortages?
1. No market exists for
human organs.
2. The demand curve for
human organs would resemble others in that a greater quantity would be
demanded at low prices than at higher prices.
3. Donated organs that
are rationed by a waiting list have a zero price. The existing supply
is perfectly inelastic and is the fixed quantity offered by willing
donors.
4. There is a shortage
of human organs because at a zero price the quantity demanded exceeds
the quantity supplied.
C. Using a market.
1. A market for human
organs would increase the incentive to donate organs. The higher the
expected price of an organ, the greater would be the number of people
willing to have their organs sold at death.
2. The shortage of
organs would be eliminated, and the number of organs available for
transplanting would rise.
D. Objections.
1. The first is a moral
objection that turning human organs into commodities commercializes
human beings and diminishes the special nature of human life.
2. An analytical
critique based on the elasticity of supply, suggests that the likely
increase in the actual number of usable organs for transplants would not
be great.
3. A health‑cost
concern suggests that a market for body organs would greatly increase
the cost of health care.
E. Prohibitions on a human organ market have been rise to
a worldwide, $1 billion-per-year illegal market. There is concern that
those willing to participate in an illegal market such as this may also
be willing to take extreme measures to solicit organs from unwilling
donors.
F. Supporters of legalizing the market for organs argue
that it would increase the supply of legal organs, drive down the price
of organs, and reduce the harvesting of organs from unwilling sellers
(the lower price would make it less profitable).
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