• Sellers will not supply more than 2 units

• For 2 units, some buyers are willing to pay more than $5

• Buyers will raise their bids against one another, raising the price

• At higher prices, sellers are willing to supply more!

• Continues until equilibrium, no pressure for change, qs=qd

• Buyers will not buy more than 2 units

• For 2 units, some sellers are willing to accept less than $8

• Sellers will lower their asking prices against one another, lowering the price

• At lower prices, buyers are willing to buy more!

• Continues until equilibrium, no pressure for change, qs=qd

• Supply function and demand function relate quantity (supplied or demanded) to price only

  • Describes how buyers/sellers respond to changes in market price

• Certainly there are many other factors that influence how much a buyer or seller will purchase at a particular price!

  • income, preferences, prices of other goods, expectations, etc.

• A supply or demand function (or graph) requires "ceterus paribus" (all else equal)

• A consumer's quantity demanded (of good x), qDx is a function of their demand for good x, which depends on current market prices and their income

qDx=D(m,px,py)

1. Income effects (ΔqDxΔm): how qDx changes with changes in income
2. Cross-price effects (ΔqDxΔpy): how qDx changes with changes in prices of other goods (e.g. y)
3. (Own) Price effects (ΔqDxΔpx): how qDx changes with changes in price (of x)

• A change in one of the "determinants of demand" (or "shifters") will shift the demand curve

  • Change in income m
  • Change in price of other goods py (substitutes or complements)
  • Change in preferences or expectations about good x (show up in utility function)
  • Change in number of buyers in market

• Shows up in (inverse) demand function by a change in the intercept (choke price)!

• See my Visualizing Demand Shifters

See Class 1.9 for a reminder.

• Consider our demand function: qD=10−p

• If the market price (p) changes (perhaps because supply changes), that results in a change in quantity demanded (qD)

  • We move along the existing demand curve

• Ceterus paribus has not been violated

• Consider our demand function: qD=10−p

• If the something other than price changes (income, preferences, price of a complement, etc), that results in a change in demand

  • We need to draw a new demand curve (or demand function)

qD=12−p

• Ceterus paribus has been violated

• There is a big difference between a change in "quantity demanded" and a change in "demand"!

• More individuals want to buy more of the good at every price

• Entire demand curve shifts to the right

• More individuals want to buy more of the good at every price

• Entire demand curve shifts to the right

• At the original market price, a shortage! (qD>qS)

• More individuals want to buy more of the good at every price

• Entire demand curve shifts to the right

• At the original market price, a shortage! (qD>qS)

• Some buyers willing to pay more at this quantity

• More individuals want to buy more of the good at every price

• Entire demand curve shifts to the right

• At the original market price, a shortage! (qD>qS)

• Some buyers willing to pay more at this quantity

• Buyers raise bids, inducing sellers to sell more

• Reach new equilibrium with:

  • higher market-clearing price
  • larger market-clearing quantity exchanged

• Fewer individuals want to buy less of the good at every price

• Entire demand curve shifts to the left

• Fewer individuals want to buy less of the good at every price

• Entire demand curve shifts to the left

• At the original market price, a surplus! (qD<qS)

• Fewer individuals want to buy less of the good at every price

• Entire demand curve shifts to the left

• At the original market price, a surplus! (qD<qS)

• Some sellers willing to accept less at this quantity

• Fewer individuals want to buy less of the good at every price

• Entire demand curve shifts to the left

• At the original market price, a surplus! (qD<qS)

• Some sellers willing to accept less at this quantity

• Sellers lower asks, inducing buyers to buy more

• Reach new equilibrium with:

  • lower market-clearing price
  • smaller market-clearing quantity exchanged

• More individuals want to sell more of the good at every price

• Entire supply curve shifts to the right

• More individuals want to sell more of the good at every price

• Entire supply curve shifts to the right

• At the original market price, a surplus! (qD<qS)

• More individuals want to sell more of the good at every price

• Entire supply curve shifts to the right

• At the original market price, a surplus! (qD<qS)

• Some sellers willing to accept less at this quantity

• More individuals want to sell more of the good at every price

• Entire supply curve shifts to the right

• At the original market price, a surplus! (qD<qS)

• Some sellers willing to accept less at this quantity

• Sellers lower asks, inducing buyers to buy more

• Reach new equilibrium with:

  • lower market-clearing price
  • larger market-clearing quantity exchanged

• Fewer individuals want to sell less of the good at every price

• Entire supply curve shifts to the left

• Fewer individuals want to sell less of the good at every price

• Entire supply curve shifts to the left

• At the original market price, a shortage! (qD>qS)

• Fewer individuals want to sell less of the good at every price

• Entire supply curve shifts to the left

• At the original market price, a shortage! (qD>qS)

• Some buyers willing to pay more at this quantity

• Fewer individuals want to sell less of the good at every price

• Entire supply curve shifts to the left

• At the original market price, a shortage! (qD>qS)

• Some buyers willing to pay more at this quantity

• Buyers raise bids, inducing sellers to sell more

• Reach new equilibrium with:

  • higher market-clearing price
  • smaller market-clearing quantity exchanged

• Markets allocate resources based on individuals' reservation prices:

  • maximum willingness to pay (as a buyer)
  • minimum willingness to accept (as a seller)

• Goods flow to those who value them the highest and away from those who value them the lowest

• It might look like it, but competition in markets is NOT between buyers vs. sellers!

• In markets: buyers compete with other buyers and sellers compete with other sellers

• Buyers want to pay the lowest price to buy a good

• But they face competition from other buyers over the same scarce goods

• Buyers attempt to raise their bids above others' reservation prices to obtain the goods

• Sellers want to get the highest price for a good they sell

• But they face competition from other sellers over the same potential customers

• Sellers attempt to lower their asking prices below others' reservation prices to sell their goods

• Supply and demand set the market-clearing price for all units exchanged (bought and sold)

• Demand function measures how much you would hypothetically be willing to pay for various quantities

  • "reservation price"

• You often actually pay (the market-clearing price, p∗) a lot less than your reservation price

• The difference is consumer surplus

CS=WTP−p∗

CS=12bhCS=12(5−0)($10−$5)CS=$12.50

• An increase in market price reduces consumer surplus

CS′=12bhCS′=12(3−0)($10−$7)CS′=$4.50

• An decrease in market price increases consumer surplus

CS′=12bhCS′=12(7−0)($10−$3)CS′=$24.50

• A relatively inelastic demand curve generates more consumer surplus

CS=12bhCS=12(5−0)($10−$5)CS=$12.50

• A relatively inelastic demand curve generates more consumer surplus

CS=12bhCS=12(5−0)($10−$5)CS=$12.50

• A relatively elastic demand curve generates less consumer surplus

CS=12bhCS=12(5−0)($7−$5)CS=$5.00

• Supply function measures how much you would hypothetically be willing to accept to sell various quantities

  • "reservation price"

• You often actually receive (the market-clearing price, p∗) a lot more than your reservation price

• The difference is producer surplus

PS=p∗−WTA

PS=12bhPS=12(5−0)($5−$0)PS=$12.50

• An increase in market price increses producer surplus

PS′=12bhPS′=12(7−0)($7−$0)PS′=$24.50

• An decrease in market price decreases producer surplus

PS′=12bhPS′=12(3−0)($3−$0)PS′=$4.50

• A relatively inelastic supply curve generates more producer surplus

PS=12bhPS=12(5−0)($5−$0)PS=$12.50

• A relatively inelastic supply curve generates more producer surplus

PS=12bhPS=12(5−0)($5−$0)PS=$12.50

• A relatively elastic supply curve generates less producer surplus

PS=12bhPS=12(5−0)($5−$3)PS=$5.00

• The more elastic curve at p∗ generates less surplus

  • More options, easier to change choices, less benefit from any one particular exchange

• The less elastic curve at p∗ generates more surplus

  • Fewer options, harder to change choices, more benefit from any one particular exchange

• This is important for policies such as price controls, taxes, etc.

• A good visual rule of thumb:

• Compare distance between choke price and p∗ for each curve

• Bigger distance ⟹ less elastic in equilibrium (and vice versa)

  • ⟹ more surplus