Fernando&YvonnQuijanoPreparedby:©2008PrenticeHallBusinessPublishing•Microeconomics•Pindyck/Rubinfeld,7e.TheBasicsofSupplyandDemand2CHAPTERChapter2SupplyandDemand2of53©2008PrenticeHallBusinessPublishing•Microeconomics•Pindyck/Rubinfeld,7e.CHAPTER2OUTLINE2.1SupplyandDemand2.2TheMarketMechanism2.3ChangesinMarketEquilibrium2.4ElasticitiesofSupplyandDemand2.5Short-RunversusLong-RunElasticities2.6UnderstandingandPredictingtheEffectsofChangingMarketConditions2.7EffectsofGovernmentIntervention—PriceControlsChapter2SupplyandDemand3of53©2008PrenticeHallBusinessPublishing•Microeconomics•Pindyck/Rubinfeld,7e.TheBasicsofSupplyandDemand•Understandingandpredictinghowchangingworldeconomicconditionsaffectmarketpriceandproduction•Evaluatingtheimpactofgovernmentpricecontrols,minimumwages,pricesupports,andproductionincentives•Determininghowtaxes,subsidies,tariffs,andimportquotasaffectconsumersandproducersSupply-demandanalysisisafundamentalandpowerfultoolthatcanbeappliedtoawidevarietyofinterestingandimportantproblems.Tonameafew:Chapter2SupplyandDemand4of53©2008PrenticeHallBusinessPublishing•Microeconomics•Pindyck/Rubinfeld,7e.SUPPLYANDDEMAND2.1TheSupplyCurve●supplycurveRelationshipbetweenthequantityofagoodthatproducersarewillingtosellandthepriceofthegood.TheSupplyCurveThesupplycurve,labeledSinthefigure,showshowthequantityofagoodofferedforsalechangesasthepriceofthegoodchanges.Thesupplycurveisupwardsloping:Thehighertheprice,themorefirmsareableandwillingtoproduceandsell.Ifproductioncostsfall,firmscanproducethesamequantityatalowerpriceoralargerquantityatthesameprice.Thesupplycurvethenshiftstotheright(fromStoS’).Figure2.1Chapter2SupplyandDemand5of53©2008PrenticeHallBusinessPublishing•Microeconomics•Pindyck/Rubinfeld,7e.SUPPLYANDDEMAND2.1TheSupplyCurveThesupplycurveisthusarelationshipbetweenthequantitysuppliedandtheprice.Wecanwritethisrelationshipasanequation:QS=QS(P)OtherVariablesThatAffectSupplyThequantitythatproducersarewillingtoselldependsnotonlyonthepricetheyreceivebutalsoontheirproductioncosts,includingwages,interestcharges,andthecostsofrawmaterials.Whenproductioncostsdecrease,outputincreasesnomatterwhatthemarketpricehappenstobe.Theentiresupplycurvethusshiftstotheright.Economistsoftenusethephrasechangeinsupplytorefertoshiftsinthesupplycurve,whilereservingthephrasechangeinthequantitysuppliedtoapplytomovementsalongthesupplycurve.Chapter2SupplyandDemand6of53©2008PrenticeHallBusinessPublishing•Microeconomics•Pindyck/Rubinfeld,7e.SUPPLYANDDEMAND2.1TheDemandCurveWecanwritethisrelationshipbetweenquantitydemandedandpriceasanequation:QD=QD(P)●demandcurveRelationshipbetweenthequantityofagoodthatconsumersarewillingtobuyandthepriceofthegood.Chapter2SupplyandDemand7of53©2008PrenticeHallBusinessPublishing•Microeconomics•Pindyck/Rubinfeld,7e.TheDemandCurveThedemandcurve,labeledD,showshowthequantityofagooddemandedbyconsumersdependsonitsprice.Thedemandcurveisdownwardsloping;holdingotherthingsequal,consumerswillwanttopurchasemoreofagoodasitspricegoesdown.Thequantitydemandedmayalsodependonothervariables,suchasincome,theweather,andthepricesofothergoods.Formostproducts,thequantitydemandedincreaseswhenincomerises.Ahigherincomelevelshiftsthedemandcurvetotheright(fromDtoD’).SUPPLYANDDEMAND2.1Figure2.2TheDemandCurveChapter2SupplyandDemand8of53©2008PrenticeHallBusinessPublishing•Microeconomics•Pindyck/Rubinfeld,7e.SUPPLYANDDEMAND2.1TheDemandCurveShiftingtheDemandCurveIfthemarketpricewereheldconstant,wewouldexpecttoseeanincreaseinthequantitydemandedasaresultofconsumers’higherincomes.Becausethisincreasewouldoccurnomatterwhatthemarketprice,theresultwouldbeashifttotherightoftheentiredemandcurve.ShiftingtheDemandCurve●substitutesTwogoodsforwhichanincreaseinthepriceofoneleadstoanincreaseinthequantitydemandedoftheother.●complementsTwogoodsforwhichanincreaseinthepriceofoneleadstoadecreaseinthequantitydemandedoftheother.Chapter2SupplyandDemand9of53©2008PrenticeHallBusinessPublishing•Microeconomics•Pindyck/Rubinfeld,7e.THEMARKETMECHANISM2.2SupplyandDemandThemarketclearsatpriceP0andquantityQ0.AtthehigherpriceP1,asurplusdevelops,sopricefalls.AtthelowerpriceP2,thereisashortage,sopriceisbidup.Figure2.3Chapter2SupplyandDemand10of53©2008PrenticeHallBusinessPublishing•Microeconomics•Pindyck/Rubinfeld,7e.THEMARKETMECHANISM2.2Equilibrium●equilibrium(ormarketclearing)pricePricethatequatesthequantitysuppliedtothequantitydemanded.●marketmechanismTendencyinafreemarketforpricetochangeuntilthemarketclears.●surplusSituationinwhichthequantitysuppliedexceedsthequantitydemanded.●shortageSituationinwhichthequantitydemandedexceedsthequantitysupplied.Chapter2SupplyandDemand11of53©2008PrenticeHallBusinessPublishing•Microeconomics•Pindyck/Rubinfeld,7e.THEMARKETMECHANISM2.2WhenCanWeUsetheSupply-DemandModel?Weareassumingthatatanygivenprice,agivenquantitywillbeproducedandsold.Thisassumptionmakessenseonlyifamarketisatleastroughlycompetitive.Bythiswemeanthatbothsellersandbuyersshouldhavelittlemarketpower—i.e.,littleabilityindividuallytoaffectthemarketprice.Supposethatsupplywerecontrolledbyas