Economics THIRD EDITION By John B Taylor Stanford University Copyright © 2001 by H Chapter The Supply and Demand Model Copyright © 2001 by H Overview The supply and demand model is fundamental to economics Supply and demand are discussed as representing the interests of sellers and buyers, respectively Next, supply and demand curves are shown Shifts of the curves compared to movements along the curves are discussed The model is then used to show the determination of price The causes of shortages and surpluses are explained Finally, market interference is discussed within the issues of price ceiling and price floors Copyright © 2001 by H Teaching Objectives Develop the demand curve Differentiate between changes in demand and changes in quantity demanded Develop the supply curve Differentiate between changes in supply and changes in quantity supplied List the factors that shift the supply curve Show how the interaction of supply and demand determines the equilibrium price Copyright © 2001 by H Teaching Objectives (Cont.) Use supply and demand analysis to explain things students are interested in Show how price controls interfere with the market and create surpluses or shortages Discuss how shifts in the demand and/or the supply curve will change the equilibrium price Shift curves simultaneously Again, the "shifts" versus "movements along" distinction is very important but difficult for some students Copyright © 2001 by H Demand 1a Demand is a relation between the price of a good or service and the quantity of that good or service consumers are willing to buy at that price per unit of time, ceteris paribus Demand curves relate price and quantity demanded Copyright © 2001 by H Demand 1b The law of demand states that price and quantity demanded are negatively related Price is the independent variable and quantity demanded is the dependent variable Price determines quantity Copyright © 2001 by H Figure 3.1 The Demand Curve Copyright © 2001 by H Demand 1c Demand is shown graphically by the demand curve – see Figure 3.1 We relate the negative slope to the inverse relationship in the law of demand 1d Price affects quantity because changes in price create an incentive to substitute Copyright © 2001 by H Shifts in the Demand Curve 1e Demand curves shift around, indicating changes in other variables A shift is called a change in demand See Figure 3.2 1e.1 The main determinants of demand are consumer preferences, information, income, price expectations, population, and the prices of related goods Copyright © 2001 by H 10 Figure 3.5 A Shift in the Supply Curve Copyright © 2001 by H 18 Shifts versus Movements • 2e Figure 3.6 to shows the difference between movements along the supply curve and shifts in it • Movements are due to changes in non-price determinants of supply while movements are due to price changes (variable on the vertical axis) Copyright © 2001 by H 19 Figure 3.6 Shifts versus Movements Along the Supply Curve Copyright © 2001 by H 20 Figure 3.7 Overview of Supply and Demand Copyright © 2001 by H 21 Market Equilibrium: Combining Supply and Demand • 3a The model of supply and demand is used to explain the determination of market price Use Table 3.3 and Figure 3.7 3b Price adjusts to differences in quantity demanded and quantity supplied A shortage indicates a willingness on the part of consumers to pay sellers higher prices A surplus indicates a willingness on the part of sellers to lower prices 3c Price reaches equilibrium when quantity demanded equals quantity supplied, ceteris paribus Copyright © 2001 by H 22 Figure 3.8 Equilibrium Price and Equilibrium Quantity Copyright © 2001 by H 23 Equilibrium Note: Price adjustment represents movements along the curves and not shifts of the curves 3d Shifts in the demand and/or the supply curve may result in a price adjustment Figures 3.8 and 3.9 will be useful Copyright © 2001 by H 24 Using the Supply and Demand Model: A Case Study • 4a Figures 3.11, 3.12, and 3.13 show the effects of shifts in the demand and supply of peanuts on the price of peanuts This example shows the confusion between movements along the demand curve and shifts in the demand curve See Figure 3.10 Copyright © 2001 by H 25 Figure 3.9 Effects of a Shift in Demand Copyright © 2001 by H 26 Figure 3.10 Effects of a Shift in Supply Copyright © 2001 by H 27 Interference with Market Prices • 5a One form of government interference with the market process is the use of price controls Price ceilings keep prices from rising, whereas price floors keep prices from falling 5b Price ceilings are always associated with shortages because the ceiling keeps the price from rising to equilibrium Thus, the quantity demanded always exceeds the quantity supplied Rent controls are a classic example Black markets usually develop Use Figure 3.14 5c Price floors are associated with surpluses Use Figure 3.15 Governments must purchase the surplus to support the price Copyright © 2001 by H 28 Figure 3.11 Peanut Production in the United States Copyright © 2001 by H 29 Figure 3.12 Supply and Demand for Peanuts Copyright © 2001 by H 30 Figure 3.13 Effects of a Drought in the Southeast Copyright © 2001 by H 31 Figure 3.14 Predicted Effects of an Increase in the Peanut Quota Copyright © 2001 by H 32 ... Supply and Demand Model Copyright © 2001 by H Overview The supply and demand model is fundamental to economics Supply and demand are discussed as representing the interests of sellers and buyers, respectively