ECON202 Chapter 4 Notes CHENG

What happens when the market is not in equilibrium?

• Laws of Supply and Demand –

o Why do we need to understand these in the market?

▪ Helps determine market price of a product

▪ Helps determine the quantity of products needed in the market

o Markets – the environment in which a buyer and seller interact in the exchange of  goods, services, and payments

▪ Competitive markets – environment where multiple buyers and sellers  interact; results in the buyers/sellers having little to no impact on market  price

• Perfectly competitive markets – makes market analysis simple; they  don’t really exist in reality, but it serves as a benchmark/baseline Don't forget about the age old question of What is the role of the tangent line?

when we’re evaluating more complicated market scenarios;  

How does the market overcome shortages and surpluses?

characterized by the following features:

o Homogenous goods – goods in each category are the exact  

same (e.g. a laptop is simply a laptop; there’s no MacBooks,  

no Microsoft Studio…there are just..laptops)

o Price takers – buyers and sellers have no influence on the  

market price of a good

o Law of Demand (LOD) – states that, when all other variables remain constant, the  quantity of a good decreases when its price increases; there is a negative  relationship between price and quantity demanded (downward sloping curve)  • NOTE: In some instances, the demand curve CAN slope upward,  

meaning that people will buy more when the price goes up. (e.g.  

In markets, prices move toward equilibrium because of what?

wealthy people might buy a luxury car that’s super expensive  

because it’s a status symbol)

▪ Quantity Demanded (QD) – the amount of a good that buyers are willing  and able to purchase If you want to learn more check out In the human variation, what is heritability?

▪ Market Demand Curves – can be determined when there are multiple  consumer’s being analyzed

• Example: Helen buys 8 lattes when they’re priced at $4 a piece, and  Ken buys 4 lattes at $4 a piece; when the lattes are $5, Helen buys 6  

and Ken buys 3. Market demand curve is determined by adding the  

quantities of Helen and Ken’s lattes that they bought at the different  

price levels. So two of the points on the curve would be (4, 12) and  

(5, 9)

▪ Change in Quantity Demanded vs. Change in Demand

• Change in QD – due to a change in the good’s price; curve itself  does NOT shift, only the point on the curve shifts from one  position to another Don't forget about the age old question of Who is henry the 8th?

• Change in Demand – due to a change in ANY factors (“other  things”), excluding the good’s price; entire curve shifts from one  location on the graph to another (left or right of its original position) Don't forget about the age old question of Why do most polar covalent bonds involve nitrogen or oxygen?

o Demand shifters – the “other things” that can affect the  position of the demand curve; there are 5 demand shifters we  should be aware of:

▪ Number of buyers – when there are more buyers  

present, there is an increase in demand, which shifts  

the demand curve to the right (e.g. during football  

season, there are more fans in town to buy Ole Miss  

related goods)

▪ Levels of income –

• When income increases, demand increases for  

normal goods like new cars (demand curve  If you want to learn more check out What is the painting bronzino's venus, cupid, folly, and time mannerism, about 1546, all about?

shifts to the right)

• When income increases, demand decreases  

for inferior goods like public transit (demand  

curve shifts to the left)  

▪ Prices of related goods – We also discuss several other topics like How is the consumer price index (cpi) calculated?

• Substitutes (e.g. Coke and Pepsi) – if the price  

of one substitute increases, the demand for  

the OTHER substitute increases (curve for  

good 2 shifts to the right)

• Complements (e.g. smartphones and apps) – if  

the price of a good increases, the demand for  

its complement goods decreases (curve for  

complement good shifts to the left)

▪ Tastes – when a consumer’s taste for certain products  

changes,  

▪ Expectations – sometimes there are events that allow  

consumers to make predictions about price changes  

(e.g. iPhone 7 comes out in September, so we assume  

the price of iPhone 6s will go down in September)

o Law of Supply (LOS) – states that, when other factors are held constant, the  quantity of a good supplied increases when the price of a good increases (sellers want to sell more when they’re selling their goods at a higher price); there  is a positive relationship between price and quantity supplied (upward sloping curve)

▪ Quantity Supplied (QS) – the amount of a good that sellers are willing and  able to sell

▪ Change in Quantity Supplied vs. Change in Supply

• Like quantity demanded, when there is a change in the quantity  supplied, there will only be a move ALONG the curve; the curve  itself will not shift

• When there is a change in supply, it is due to factors other than the  price of the good and the entire curve can shift left or right

o Supply shifters – the “other things” that can affect the  

position of the supply curve; there are 4 supply shifters we  

should be aware of:

▪ Number of sellers – when there is an increasing  

number of sellers in a market (regardless of price)  

they will sell more, so the supply curve will shift to the

right

▪ Input prices – an increase in input prices (cost of  

materials/labor to make a product) is less profitable for  

the seller, so supply decreases; supply curve shifts to  

the left

▪ Technology – advanced technology often makes  

production easier and more profitable for sellers,  

therefore supply increases and the supply curve shifts  

to the right

▪ Expectations  

o Combining Supply and Demand  

▪ Market Equilibrium – when sellers produce exactly as many goods as  the buyers will purchase; QS = QD 

• Market Equilibrium Price/Market Clearing Price (P*) – the price of  a good when QS and QD are equal; basically the perfect price that  benefits sellers and suppliers equally

• Market Equilibrium Quantity (Q*) – the quantity of goods that are  supplied at that perfect price

• P* and Q* are located at the intersection of the demand and  supply curves

o Example: Market research has revealed the following  

information about the market for chocolate bars: the demand  schedule/curve can be represented by the equation Qd =  

1600 – 300P; the supply schedule/curve can be represented  by the equation Qs = 1400 + 700P. What are market  

equilibrium price and quantity?

▪ Set each equation equal to one another and solve for P

(price). Then substitute this value of P into one of the  

individual equations to determine Q (quantity).  

▪ What happens when the market is not in equilibrium?  

• Surplus – excess supply; occurs when quantity supplied is greater  than quantity demanded; on a supply/demand graph, a surplus is  any points above the intersection

o To determine the surplus on the supply/demand graph, take  the higher quantity and subtract it from the lower quantity.  

• Shortage – excess demand; occurs when quantity supplied is less  than quantity demanded; on a supply/demand graph, a shortage is  any points below the intersection  

o To determine the shortage, take the higher quantity and  subtract it from the lower quantity.  

• How does the market overcome shortages and surpluses?  o The market will cure itself with adjustments in price. If there is  a surplus of goods, sellers will lower the price, so people  will buy more. If there is a shortage of goods, the seller will  raise the price so less people are interested in the good.  Rational people rely on self-interest, which will eliminate  any surpluses or shortages.  

o This concept is referred to as the market mechanism, which  is driven by the law of demand and the law of supply.

▪ The market mechanism only applies to a market  

economy, and has no effect in a centrally-planned  

economy, where the government has control over the  

production of goods and the land they’re produced  

on.

▪ Shifts in Supply and Demand – the factors of supply and demand  determine the equilibrium price and quantity. As these factors shift, the  equilibrium price and quantity will also change.  

• If the demand decreases, for example a particular style of  sunglasses becomes less popular, (i.e., a change a tastes and  preferences), the quantity demanded at each price has  

decreased. At the current price there is now a surplus in the  market and pressure for the price to decrease. The new equilibrium  will be at a lower price and lower quantity. Note that the supply  curve does not shift but a lower quantity is supplied due to a  decrease in the price.

• If the demand curve shifts right, there is a greater quantity  demanded at each price, the newly created shortage at the  original price will drive the market to a higher equilibrium price  and quantity. As the demand curve shifts the change in the  equilibrium price and quantity will be in the same direction, i.e.,  both will increase.

• If the supply curve shifts left, say due to an increase in the price of  

the resources used to make the product, there is a lower quantity  supplied at each price. The result will be an increase in the market  equilibrium price but a decrease in the market equilibrium  quantity. The increase in price, causes a movement along the  demand curve to a lower equilibrium quantity demanded.

• A rightward shift in the supply curve, say from a new production  technology, leads to a lower equilibrium price and a greater  

quantity. Note that as the supply curve shifts, the change in the  

equilibrium price and quantity will be in opposite directions.

Chapter 4 Homework Questions:

1. Which of the following statements is correct? …Buyers determine demand, and  sellers determine supply.  

2. For a market for a good or service to exist, there must be a …group of buyers and  sellers.  

3. A competitive market is a market in which…no individual buyer or seller has any  significant impact on the market price.

4. If a seller in a competitive market chooses to charge more than the going price,  then…buyers will make purchases from other sellers.

5. In competitive markets, which of the following is NOT correct? …Some sellers can set  prices.  

6. A movement upward and to the left along a demand curve is called a(n)…decrease in  quantity demanded.

7. When the price of a good or service changes, …there is a movement along a given  demand curve.

8. The movement from point A to point B on the graph shows…an increase in quantity  demanded.

9. When we move along a given demand curve, …all non-price determinants of demand  are held constant.  

10.When quantity demanded decreases at every possible price, the demand curve has …shifted to the left.  

11.The market demand curve…represents the sum of the quantities demanded by all  the buyers at each price of the good.  

12.To obtain the market demand curve for a product, sum the individual demand  curves…(not sure on this one, but it’s not diagonally or vertically, lol)  

13.If Consumer A and Consumer B are the only consumers in a market, then the market  quantity demanded when the price is $6 is…12 units.  

14.The shift from D to D’ is called…a decrease in demand.

15.If the demand curve shifts from D to D’, then…(not sure on this one either ☹)  

16.The movement from D to D’ could be caused by…a decrease in the price of a  substitute.  

17.The movement from D’ to D could be caused by…(idk, sorry.)

18.The movement from D’ to D in the market for potato chips could be caused by a(n) 19.Which of the following changes would NOT shift the demand curve for a good or  service? …a change in the price of the good or service.

20.Soup is an inferior good if the demand…for soup falls when income rises.  

21.Suppose that a decrease in the price of good X results in fewer units of good Y being  demanded. This implies that X and Y are…substitute goods.  

22.If toast and butter are complements, then which of the following would increase the  demand for toast? …a decrease in the price of butter.

23.Suppose scientists provide evidence that chocolate pudding increases the bad  cholesterol levels of those who eat it. We would expect to see…a decrease in the  demand for chocolate pudding.  

24.Ford Motor Company announces that next month it will offer $3000 rebates on new  Mustangs. As a result of this information, today’s demand curve for Mustangs…shifts  to the left.  

25.A movement along the supply curve might be caused by a change in…the price of the  good or service that is being supplied.  

26.A supply curve slopes upward because…an increase in price gives producers an  incentive to supply a larger quantity.  

27.When quantity supplied decreases at every possible price, we know that the supply  curve has…shifted to the left.  

28.Which of the following changes would not shift the supply curve for a good or service? …a change in the price of the good or service.

29.In a market, to find the total amount of supplied at a particular price, we must…sum  the quantities that individual firms are willing and able to supply at that price.  

30.A market supply curve shows…the total quantity supplied at all possible prices. 31.Which supply schedules obey the laws of supply? …Firm B’s and Firm D’s only.

32.If these are the only four sellers in the market, then the market quantity supplied at a  price of $4 is…30 units.

33.Workers at a bicycle assembly plant currently earn the mandatory minimum wage. If  the federal government increases the minimum wage by $1 per hour, then it is likely  that the…supply of bicycles will shift to the left.  

34.An improvement in production technology will…decrease a firm’s costs and increase  its supply.  

35.If suppliers expect the price of their product to fall in the future, then they  will…increase supply now.

36.A decrease in the number of sellers in the market causes…the supply curve to shift to  the left.

37.The shift from S to S’ could be caused by a(n)…improvement in production  technology.  

38.The shift from S to S’ in the market for peaches could be caused by a(n)…decrease in  the labor costs of the workers who pick peaches.

39.The shift from S’ to S in the market for chocolate cake could be caused by  a(n)…decrease in the number of commercial bakers.  

40.At the equilibrium price, the quantity of the good that buyers are willing and able to  buy…exactly equals the quantity that sellers are willing and able to sell.

41.If the demand can be represented by the equation QD = 2400-200P and supply can be  represented by the equation QS = 2000+200P, what are the equilibrium price and  quantity? …P=1; Q=2200

42.In markets, prices move toward equilibrium because of…the actions of buyers and  sellers.  

43.When the price of a good is higher than the equilibrium price, …sellers desire to  produce and sell more than buyers wish to purchase.  

44.When a surplus exists in a market, sellers…lower price, which increases quantity  demanded and decreases quantity supplied until the surplus disappears.

45.Suppose roses are currently selling for $20 per dozen, but the equilibrium price of  roses is $30 per dozen. We would expect a…shortage to exist and the market price  of roses to increase.

46.The law of supply and demand asserts that…the price of a good will eventually rise in  response to an excess demand for that good.  

47.If there is currently a shortage of 20 units of the good, then the law of …supply and  demand predicts that the price will rise by $2 to eliminate the shortage.  

48.The equilibrium price and quantity, respectively, are…$6 and 30 units. 49.If the price were $8, a…surplus of 25 units would exist, and price would tend to fall.

50.If the price were $4, a…shortage of 25 units would exist, and price would tend to  rise.

51.Which of the following events must cause equilibrium quantity to fall? …demand and  supply both decrease.

52.If the demand for a product decreases, then we would expect equilibrium price…and  equilibrium quantity to both decrease.  

53.Suppose that demand for a good increases and, at the same time, supply of the good  decreases. What would happen in the market for the good? …Equilibrium price would  increase, but the impact on equilibrium quantity would be ambiguous.

54.If scientists discover that steamed milk, which is used to make lattes, prevents heart  attacks, what would happen to the equilibrium price and quantity of lattes? …both the  equilibrium price and quantity would increase.  

55.What would happen to the equilibrium price and quantity of peanut butter if the price  of peanuts goes up, the price of jelly falls, fewer firms decide to produce peanut  butter, and health officials announced that eating peanut butter was good for you? …price will rise and the effect on quantity is ambiguous.  

56.All else equal, an increase in the income of buyers who consider turkey to be an  inferior good would cause a move from…DA to DB.  

57.All else equal, in increase in the number of turkey sellers would cause a move from …y  to x.