CHAPTER 2:

DEMAND, SUPPLY, MARKET EQUILIBRIUM

I.MARKET.

  1. Defined: A market is a formal or informal arrangement in which people exchange goods, services, or productive resources.

1)Formal (organized)

2)Informal (unorganized)

  1. Competitive Markets

1)Defined: Many buyers and sellers of a relatively homogenous product.

2)Examples:

  • Markets for agricultural products
  • Stocks
  • Bonds
  • Precious Metals
  • Foreign currencies

II.DEMAND SIDE OF MARKET.

  1. Generalized Demand function

1)Defined: Shows the relationship between quantity demanded and product price, as well as the five other independent variables that affect quantity demanded.

2)Qd = (P, M, PR, , Pe, N) where:

Qd = Quantity demanded of a good or service.

P = Price of the good or service.

M = Consumer’s income (generally per capita).

PR= Price of related products.

= Taste patterns of consumers.

Pe= Expected price of the good in some future period.

N = Number of consumers in the market.

  1. Generalized demand function in linear form

1)Qd = a + bP + cM + dPR + e+ fPe + gN

2)Parameters

a)Intercept Parameter: Shows the value of Qd when all other variables are 0.

b)Slope Parameters: Measure the effect on Qd of changing one of the independent variables while holding the rest of the independent variables constant.

c)For example:

b = ceteris paribus or b = .

d)Expected signs of parameters: Table 2.1

  1. Demand function (ordinary demand function)

1)Qd = (P) “ceteris paribus”

2)To derive the demand function from a generalized demand function, the other five independent variables in the generalized demand function must have fixed values.

3) Hypothetical Example:

Qd = (P,M',P'R)

Qd = 1800 - 20P + .6M - 50 PR

Qd =1800 - 20P + .6(20,000) - 50(250)

Qd =1800- 20P + 12000 – 12500

Qd =1300 - 20P

Interpretation of Intercept Parameter:

The amount of the good that the consumer will demand if the price is 0.

4)Points to note.

a)Law of demand.

b)Demand schedule: Table 2.2

c)Demand curve: Figure 2.1

5) Inverse Demand Function

P = (Qd)

P = 65 – 1/20 Qd

6) Determinants of Demand

a. M = Consumer’s income

1. Normal Good

2. Inferior Good

b. PR = Price of related goods

1. Complements

2. Substitutes

c. = Consumer Tastes

d. Pe = Expected price in future

e. N = Number of consumers in the

market

(Figure 2.2: Demand shifts)

7) Summary of Demand Shifts and signs of slope

parameters. (Table 2.4)

8) Change in Demand vs. Change in Quantity

Demanded.

III. SUPPLY SIDE OF THE MARKET
  1. Generalized supply function.

1)Defined:Shows the relationship between quantity supplied and product price, as well as the other five independent variables that affect supply.

2)Qs = (P, Pi, Pr, T, Pe, F)

Where:

Qs= Quantity supplied of a good or service

P = Price of the good.

PI = Price of the inputs used to produce the good.

Pr= Price of goods related in production.

T = Level of available technology

Pe= Expectations of producers concerning future price of the product

F = Number of firms producing the good, or productive capacity.

  1. Generalized supply function in linear form

1)Qs = h + kP +lPi + mPr + nT + rPe + sF

2)Parameters

a)Intercept Parameter:Shows the value of Qs when all of the independent variables have a value of 0.

b)Slope Parameters:Measure the affect on Qsof changing one of the independent variables while holding the rest of the independent variables constant. k, l, m, n, r and s are slope parameters.

For example: k = Ceteris Parabus

k =

c) Expected signs of Parameter (Table 2.5)

  1. Supply function (ordinary supply function)

1)Qs = f (P), “ceteris parabus”

2)To derive the supply function from a generalized supply function, the other five independent variables in the generalized supply function must have fixed values.

Hypothetical Example:

Qs = f(P,P'I,F')

Qs = 50 + 10P - 8Pi + 5F

Qs = 50 + 10P - 8(50) + 5(90)

Qs = 100 + 10P

3)Points to note:

a)Relationship between Qs and P is direct.

b)A point on the supply schedule indicates the maximum amount of a good or service that will be offered at a specific price, or the supply price, the minimum amount necessary to induce producers to voluntarily offer a given amount for sale.

c)Supply schedule: Table2.6

d)Supply curve: Figure 2.3

4) Inverse Supply Function

P = f (Qs)

P = -10 +1/10 Q

5) Determinants of supply

a. Pi = Price of inputs

b. Pr = Price of goods related in production

c. T = State of technology

d. Pe = Expected Price

e. F = Number of firms in industry

(Figure 2.4 Supply Shifts)

6) Summary of Sign Shifts and Slope

Parameters. (Table 2.8)

7)Change in Supply vs. Change in Quantity Supplied.

IV. MARKET EQUILIBRIUM
  1. Intuitive explanation

1)Equilibrium: General Definition

2)Equilibrium price Qd = Qs,

a. Only stable price in the market.

b. Actual price equilibrium price

Shortage & upward pressure on price.

c. Actual price equilibrium price

Surplus & downward pressure on price.

  1. Equilibrium from table: (Table 2.9)
  1. Equilibrium from graph: (Figure 2.5)

Equilibrium algebraically:

Qd = 1300 - 20P

Qs = 100 + 10P

1300 - 20P = 100 + 10P

30P = 1200

P = $40

Qd = 1300 - 20(40) = 500

Qs = 100 + 10(40) = 500

E. Changes in Equilibrium

1)Qualitative Forecast: A forecast that predicts only the direction in which an economic variable will change.
Example:
Technical Questions 14 & 15

2)Quantitative Forecast: A forecast that predicts both the direction and magnitude in which an economic variable will change.
Example:
13d and 13e

V.PRICE CEILINGS & PRICE FLOORS

A.Price ceiling: The maximum legal price that the government permits sellers to charge for a good when this price is below equilibrium, a shortage occurs.

1)Figure 2.11 a (A shortage occurs)

2)Examples of Price ceilings

B.Price floor: The minimum legal price that the government permits sellers to charge for a good when this price is above equilibrium a surplus occurs.

1) Figure 2.11 b (A surplus occurs)

2) Examples of Price Floors

Chapter 2 Assignment

Technical Problems: 1, 2, 6, 7, 9, 10, 11, 13, 14, 15

Applied Problems: 1, 2, 11