# The Foundations of Microeconomics

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1 The Foundations of Microeconomics D I A N N A D A S I L V A - G L A S G O W D E P A R T M E N T O F E C O N O M I C S U N I V E R S I T Y O F G U Y A N A S E P T E M B E R 1 4,

2 Lecture 3... INTRODUCTION TO THE SUPPLY AND DEMAND MODELS

3 Demand Demand means the willingness and capacity to pay. Prices are the tools by which the market coordinates individual desires.

4 Demand vs. Quantity Demanded Demand is the amount of a product that people are willing and able to purchase at each possible price during a given period of time. The quantity demand is the amount of a product that people are willing and able to purchase at one, specific price.

5 The Law of Demand Law of demand there is an inverse relationship between price and quantity demanded. Quantity demanded rises as price falls, other things constant. Quantity demanded falls as prices rise, other things constant.

6 Demand Schedule A demand schedule is a table showing the likely number of purchases based on a series of arbitrarily chosen prices

7 The Law of Demand What accounts for the law of demand? The Demand Curve Why do buyers purchase a greater quantity at lower prices and vice-versa? The Substitution Effect The change in the quantity demanded of a good that results because buyers switch to substitutes when the price of the good changes The Income Effect The change in the quantity demanded of a good that results because a change in the price of a good changes the buyer s purchasing power

8 The Demand Curve The demand curve is the graphic representation of the law of demand. The demand curve slopes downward and to the right. As the price goes up, the quantity demanded goes down.

9 Price (per unit) A Sample Demand Curve P A A 0 Q A D Quantity demanded (per unit of time)

10 An Increase In Quantity Demanded vs. An Increase In Demand Price (\$/can) 6 5 Increase in quantity demanded D 12 Quantity (1000s of cans/day) Chapter 3 - Supply and Demand: An Introduction SLIDE 10

11 Price per DVDs (in dollars) From a Demand Table to a Demand Curve A Demand Table \$6.00 A Demand Curve A B C D E Price per cassette \$ DVD rentals demanded per week E D G C F Quantity of DVDs demanded (per week) B Demand for DVDs A

12 Demand Schedule and Demand Curve for DVDs

13 Individual and Market Demand Curves A market demand curve is the horizontal sum of all individual demand curves. This is determined by adding the individual demand curves of all the demanders.

14 Price per cassette (in dollars) From Individual Demands to a Market Demand Curve \$ G F E D C B A Cathy Bruce Alice Market demand Quantity of cassettes demanded per week McGraw-Hill/Irwin 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.

15 Aggregation of Demand (I)

16 Aggregation of Demand (II)

17 Price per Orange First Buyer (Mark) Quantity Demanded Second Buyer (Clifford) Third Buyer (Simone) Total Quantity Demanded per week \$ = = = = = 221

18 Shifts in Demand Versus Movements Along a Demand Curve Demand refers to a schedule of quantities of a good that will be bought per unit of time at various prices, other things constant. Graphically, it refers to the entire demand curve. Quantity demanded refers to a specific amount that will be demand per unit of time at a specific price. Graphically, it refers to a specific point on the demand curve.

19 Shifts in Demand Versus Movements Along a Demand Curve A movement along a demand curve is the graphical representation of the effect of a change in price on the quantity demanded.

20 Price (per unit) Change in Quantity Demanded \$2 B Change in quantity demanded (a movement along the curve) \$1 A 0 D Quantity demanded (per unit of time)

21 Shifts in Demand Versus Movements Along a Demand Curve A shift in demand is the graphical representation of the effect of anything other than price on demand.

22 An Increase In Quantity Demanded vs. An Increase In Demand Price (\$/can) 6 D D Increase in demand D 12 D Quantity (1000s of cans/day) Chapter 3 - Supply and Demand: An Introduction SLIDE 22

23 Price (per unit) Shift in Demand \$2 Change in demand (a shift of the curve) \$1 B A D 0 D Quantity demanded (per unit of time)

24 Determinants of Demand Income Number of buyers Tastes Prices of related goods (substitutes and complements) Expectations

25 Income Normal VERSUS inferior goods.

26 Income Normal Goods One whose demand increases (decreases) when the incomes of buyers increase (decrease) Higher income = higher demand Lower income = lower demand

27 Income Inferior Goods One whose demand decreases (increases) when the incomes of buyers increase (decrease) Higher income = lower demand Lower income = higher demand

28 Price of related goods A change in the price of a related good may either increase or decrease the demand for a product, depending on whether the related good is a substitute or a compliment. CHAPTER 3 - SUPPLY AND DEMAND: AN INTRODUCTION Slide 28

29 Complements Price of related goods Complementary goods are goods that are used together and are usually demanded together. If the price of gasoline falls and as a result you drive your car more often, the extra driving increases your demand for motor oil. Thus gas and motor oil are jointly demanded; they are complements. When two products are complements the price of one and the demand of the other good move in the opposite directions. CHAPTER 3 - SUPPLY AND DEMAND: AN INTRODUCTION Slide 29

30 The Effect of the Release of Jurassic Park on the Market for Toy Dinosaurs D = demand after release of movie Price S P P Q Q D D Toy Dinosaurs (units per month) Chapter 3 - Supply and Demand: An Introduction SLIDE 30

31 Price of related goods Substitutes Two goods are substitutes in consumption if an increase (decrease) in the price of one causes an increase (decrease) in the demand for the other. Beef and chicken are examples of substitute goods. When the price of beef rises, consumers buy less beef and increase the demand for chicken. Conversely, as the price of beef falls, consumers buy more of beef and decrease their demand for chicken. When two products are substitutes of each other the price of one and the demand for the other move in the same direction CHAPTER 3 - SUPPLY AND DEMAND: AN INTRODUCTION Slide 31

32 The Effect on the Market for Chicken of a decline in the price of fish Price (\$) S P P D Q Q D Quantity (letters/month) Chapter 3 - Supply and Demand: An Introduction SLIDE 32

33 Tastes and preferences A favorable change in consumer taste (preference) for the product- a change that makes the product more desirable means that more of it will be demanded at each price. Demand will increase and the demand curve will shift to the right. An unfavorable change in consumer preference will decrease demand and shift the demand curve to the left.

34 Expectations If you expect your income to rise, you may consume more now. If you expect prices to fall in the future, you may put off purchases today.

35 Shifts in Demand Complements Two goods are complements in consumption if an increase (decrease) in the price of one cause a decrease (increase) in the demand for the other Chapter 3 - Supply and Demand: An Introduction SLIDE 35

36 Shifts in Demand Substitutes Two goods are substitutes in consumption if an increase (decrease) in the price of one causes an increase (decrease) in the demand for the other Chapter 3 - Supply and Demand: An Introduction SLIDE 36

37 The Effect of the Increase in the Population of Potential Buyers Price D = demand after increase in population S P P Q Q D D Housing NY City (units per month) Chapter 3 - Supply and Demand: An Introduction SLIDE 37

38 NUMBER OF BUYERS: an increase in the number of buyers in a market increases demand and therefore shifts the demand curve to the right. likewise a decrease in the number of buyers will decrease demand and thus shift the demand curve to the left. Price Increase in demand D 1 Decrease D in Demand D 2 Quantity Demanded

39 Supply Supply refers to a schedule of quantities a seller is willing to sell per unit of time at various prices, other things constant.

40 Law of Supply Law of Supply As the price of a product rises, producers will be willing to supply more. The height of the supply curve at any quantity shows the minimum price necessary to induce producers to supply that next unit to market. The height of the supply curve at any quantity also shows the opportunity cost of producing the next unit of the good.

41 The Law of Supply The law of supply is accounted for by two factors: When prices rise, firms substitute production of one good for another. Assuming firms costs are constant, a higher price means higher profits.

42 The Supply Curve The supply curve is the graphic representation of the law of supply. The supply curve slopes upward to the right. The slope tells us that the quantity supplied varies directly in the same direction with the price.

43 Price (per unit) A Sample Supply Curve S P A A 0 Q A Quantity supplied (per unit of time)

44 Supply Curve DVDs

45 Individual and Market Supply Curves The market supply curve is derived by horizontally adding the individual supply curves of each supplier.

46 From Individual Supplies to a Market Supply Quantities Supplied A B C D E F G H I (1) Price (per DVD) (2) Ann's Supply (5) Market Supply (4) Charlie's Supply \$ (3) Barry's Supply

47 Aggregation of Supply (I)

48 Aggregation of Supply (II)

49 Shifts in Supply Versus Movements Along a Supply Curve Quantity supplied refers to a specific amount that will be supplied at a specific price.

50 Shifts in Supply Versus Movements Along a Supply Curve Changes in price causes changes in quantity supplied represented by a movement along a supply curve.

51 Price (per unit) Change in Quantity Supplied S 0 B \$15 A Change in quantity supplied (a movement along the curve) 1,250 1,500 Quantity supplied (per unit of time)

52 Shifts in Supply Versus Movements Along a Supply Curve Shift in supply the graphic representation of the effect of a change in a factor other than price on supply.

53 Price (per unit) Shift in Supply S 0 S 1 \$15 A B Shift in Supply (a shift of the curve) 1,250 1,500 Quantity supplied (per unit of time)

54 Shift Factors of Supply Other factors besides price affect how much will be supplied: Prices of inputs used in the production of a good. Cost of production Weather Technology Suppliers expectations. Taxes and subsidies.

55 Factors that Shift Supply Resource Prices Prices of Related Goods and Services Supply Technology And Productivity Number Of Producers Expectations Of Producers

56 Price of Inputs (Resource Prices) When costs go up, profits go down, so that the incentive to supply also goes down vice versa.

57 Decrease in Supply

58 Increase in Supply

59 Technology Advances in technology reduce the number of inputs needed to produce a given supply of goods. Costs go down, profits go up, leading to increased supply.

60 Price (\$/can) 6 S S Increase in supply 2 1 S S Quantity (1000s of cans/day) Chapter 3 - Supply and Demand: An Introduction SLIDE 60

61 Expectations If suppliers expect prices to rise in the future, they may store today's supply to reap higher profits later, vice versa.

62 Decrease in Supply

63 Increase in Supply

64 Number of Suppliers As more people decide to supply a good the market supply increases (Rightward Shift), vice versa.

65 Price of Related Goods or Services The opportunity cost of producing and selling any good is the forgone opportunity to produce another good. If the price of alternate good changes then the opportunity cost of producing changes too! Example Mc Don selling Hamburgers vs. Salads.

66 The Effect on the Market for Tennis Balls of a Decline in Court-Rental Fees Price (\$/ball) S D D Quantity (letters/month) Chapter 3 - Supply and Demand: An Introduction SLIDE 66

67 Taxes and Subsidies When taxes go up, costs go up, and profits go down, leading suppliers to reduce output. When government subsidies go up, costs go down, and profits go up, leading suppliers to increase output.

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