class: center, middle, inverse, title-slide # 3.1 — The Supply and Demand Model ## ECON 306 · Microeconomic Analysis · Fall 2020 ### Ryan Safner
Assistant Professor of Economics
safner@hood.edu
ryansafner/microF20
microF20.classes.ryansafner.com
--- class: inverse, center, middle # Equilibrium --- # Recall: 2 Major Models of Economics as a “Science” .pull-left[ ## Optimization - Agents have .hi[objectives] they value - Agents face .hi[constraints] - Make .hi[tradeoffs] to maximize objectives within constraints .center[ ![](../images/optimize.jpeg) ] ] -- .pull-right[ ## Equilibrium - Agents .hi[compete] with others over **scarce** resources - Agents .hi[adjust] behaviors based on prices - .hi[Stable outcomes] when adjustments stop .center[ ![](../images/equilibriumbalance.png) ] ] --- # Recall: Optimization and Equilibrium .pull-left[ - If people can *learn* and *change* their behavior, they will always switch to a higher-valued option - If there are no alternatives that are better, people are at an *optimum* - If everyone is at an optimum, the system is in *equilibrium* ] .pull-right[ .center[ ![:scale 70%](https://www.dropbox.com/s/wp97bsk0yni31k9/incentive2.jpg?raw=1) ![:scale 70%](https://www.dropbox.com/s/j7xenkgo3p71vke/equilibriumbalance.png?raw=1) ] ] --- # Equilibrium Analysis: Questions to Answer .pull-left[ - Where do prices come from? - How do they change? - How consumers and producers to respond to changes? ] .pull-right[ .center[ ![](https://www.dropbox.com/s/7l05ucw4hfwlsyc/economics1.jpg?raw=1) ] ] --- # Equilibrium Analysis .pull-left[ - An .hi[equilibrium] is an allocation of resources such that no individual has an incentive to alter their behavior - In markets: .hi-purple["market-clearing"] prices where quantity supplied equals quantity demanded ] .pull-right[ .center[ ![:scale 70%](https://www.dropbox.com/s/j7xenkgo3p71vke/equilibriumbalance.png?raw=1) ] ] --- # *Partial* Equilibrium Analysis .pull-left[ - We will only look at .hi-purple["*partial* equilibrium"] in a single market - Changes in *one* market often affect *other* markets, affecting the .hi-purple["*general* equilibrium"] - e.g. a change in the price of corn will affect the market for wheat, soybeans, flax, cereal, sugar, candy, ethanol, gasoline, automobiles, etc... - think of all of the *complements*, *substitutes*, upstream and downstream goods in production... - General equilibrium is too complicated for undergraduate courses... ] .pull-right[ .center[ ![:scale 70%](https://www.dropbox.com/s/j7xenkgo3p71vke/equilibriumbalance.png?raw=1) ] ] --- class: inverse, center, middle # Recall: Demand --- # Demand Function .pull-left[ - .hi[Demand function] relates quantity to price .content-box-green[ .green[**Example**]: `$$q=10-p$$` ] - Not graphable (wrong axes)! ] .pull-right[ <img src="3.1-slides_files/figure-html/unnamed-chunk-1-1.png" width="504" /> ] --- # Inverse Demand Function .pull-left[ - .hi[*Inverse* demand function] relates price to quantity - Take demand function and solve for `\(p\)` .content-box-green[ .green[**Example**]: `$$p=10-q$$` ] - Graphable (price on vertical axis)! ] --- # Inverse Demand Function .pull-left[ - .hi[*Inverse* demand function] relates price to quantity - Take demand function and solve for `\(p\)` .content-box-green[ .green[**Example**]: `$$p=10-q$$` ] - Vertical intercept (.hi-purple["Choke price"]): price where `\\(q_D=0\\)` ($10), just high enough to discourage *any* purchases ] .pull-right[ <img src="3.1-slides_files/figure-html/unnamed-chunk-2-1.png" width="504" /> ] --- # Inverse Demand Function .pull-left[ - Read two ways: - Horizontally: at any given price, how many units person wants to buy - Vertically: at any given quantity, the .hi[maximum willingness to pay (WTP)] for that quantity - This way will be very useful later ] .pull-right[ <img src="3.1-slides_files/figure-html/unnamed-chunk-3-1.png" width="504" /> ] --- class: inverse, center, middle # Recall: Supply --- # Supply Function .pull-left[ - .hi[Supply function] relates quantity to price .content-box-green[ .green[**Example**]: `$$q=2p-4$$` ] - Not graphable (wrong axes)! ] .pull-right[ <img src="3.1-slides_files/figure-html/unnamed-chunk-4-1.png" width="504" /> ] --- # Inverse Supply Function .pull-left[ - .hi[*Inverse* supply function] relates price to quantity - Take supply function, solve for `\(p\)` .content-box-green[ .green[**Example**]: `$$p=2+0.5q$$` ] - Graphable (price on vertical axis)! ] -- .pull-right[ <img src="3.1-slides_files/figure-html/unnamed-chunk-5-1.png" width="504" /> ] --- # Inverse Supply Function .pull-left[ .content-box-green[ .green[**Example**]: `$$p=2+0.5q$$` ] - Slope: 0.5 - Vertical intercept called the .hi["Choke price"]: price where `\\(q_S=0\\)` ($2), just low enough to discourage *any* sales ] .pull-right[ <img src="3.1-slides_files/figure-html/unnamed-chunk-6-1.png" width="504" /> ] --- # Inverse Supply Function .pull-left[ - Read two ways: - Horizontally: at any given price, how many units firm wants to sell - Vertically: at any given quantity, the .hi[minimum willingness to accept (WTA)] for that quantity ] .pull-right[ <img src="3.1-slides_files/figure-html/unnamed-chunk-7-1.png" width="504" /> ] --- class: inverse, center, middle # Market Equilibrium --- # Market Equilibrium .pull-left[ - Market-clearing (equilibrium) price `\((p^*)\)`: $6.00 - Market-clearing (equilibrium) quantity exchanged `\((q^*)\)`: 4 ] .pull-right[ <img src="3.1-slides_files/figure-html/unnamed-chunk-8-1.png" width="504" /> ] --- class: inverse, center, middle # Why Markets Tend to Equilibrate --- # Excess Demand I .pull-left[ .content-box-green[ .smallest[ .green[**Example**]: Consider *any* price below $6, such as $5: - `\(\color{blue}{Q_d=5} \quad \color{red}{Q_s=2}\)` - `\(\color{blue}{Q_d}>\color{red}{Q_s}\)`: .hi[excess demand] - A .hi[shortage] of 3 units ] ] ] .pull-right[ <img src="3.1-slides_files/figure-html/unnamed-chunk-9-1.png" width="504" /> ] --- # Excess Demand II .pull-left[ .content-box-green[ .smallest[ .green[**Example**]: Consider *any* price below $6, such as $5: - `\(\color{blue}{Q_d=5} \quad \color{red}{Q_s=2}\)` - `\(\color{blue}{Q_d}>\color{red}{Q_s}\)`: .hi[excess demand] - A .hi[shortage] of 3 units ] ] .smallest[ - Sellers will not supply more than 2 units - For 2 units, some buyers are willing to pay more than $5 ] ] .pull-right[ <img src="3.1-slides_files/figure-html/unnamed-chunk-10-1.png" width="504" /> ] --- # Excess Demand III .pull-left[ .content-box-green[ .smallest[ .green[**Example**]: Consider *any* price below $6, such as $5: - `\(\color{blue}{Q_d=5} \quad \color{red}{Q_s=2}\)` - `\(\color{blue}{Q_d}>\color{red}{Q_s}\)`: .hi[excess demand] - A .hi[shortage] of 3 units ] ] .smallest[ - Buyers will **raise their bids** against one another, raising the price - At higher prices, sellers willing to sell more! - Until .hi-purple[equilibrium], no pressure for change, `\(\color{blue}{Q_d}=\color{red}{Q_s}\)` ] ] .pull-right[ <img src="3.1-slides_files/figure-html/unnamed-chunk-11-1.png" width="504" /> ] --- # Excess Supply I .pull-left[ .content-box-green[ .smallest[ .green[**Example**]: Consider *any* price above $6, such as $7: - `\(\color{blue}{Q_d=2} \quad \color{red}{Q_s=8}\)` - `\(\color{blue}{Q_d}<\color{red}{Q_s}\)`: .hi[excess supply] - A .hi[surplus] of 6 units ] ] ] .pull-right[ <img src="3.1-slides_files/figure-html/unnamed-chunk-12-1.png" width="504" /> ] --- # Excess Supply II .pull-left[ .content-box-green[ .smallest[ .green[**Example**]: Consider *any* price above $6, such as $7: - `\(\color{blue}{Q_d=2} \quad \color{red}{Q_s=8}\)` - `\(\color{blue}{Q_d}<\color{red}{Q_s}\)`: .hi[excess supply] - A .hi[surplus] of 6 units ] ] .smallest[ - Buyers will not buy more than 2 units - For 2 units, some sellers willing to accept less than $8 ] ] .pull-right[ <img src="3.1-slides_files/figure-html/unnamed-chunk-13-1.png" width="504" /> ] --- # Excess Supply III .pull-left[ .content-box-green[ .smallest[ .green[**Example**]: Consider *any* price above $6, such as $7: - `\(\color{blue}{Q_d=2} \quad \color{red}{Q_s=8}\)` - `\(\color{blue}{Q_d}<\color{red}{Q_s}\)`: .hi[excess supply] - A .hi[surplus] of 6 units ] ] .smallest[ - Sellers will **lower their asking prices** against one another, lowering the price - At lower prices, buyers willing to buy more! - Until .hi-purple[equilibrium], no pressure for change, `\(\color{blue}{Q_d}=\color{red}{Q_s}\)` ] ] .pull-right[ <img src="3.1-slides_files/figure-html/unnamed-chunk-14-1.png" width="504" /> ] --- # Why Markets Tend to Equilibrate .center[ ![:scale 60%](https://www.dropbox.com/s/60q8uepk12z3zv4/kiviqauction.png?raw=1) ] --- class: inverse, center, middle # Comparative Statics --- # Ceterus Paribus I .pull-left[ .smallest[ - 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 .hi["ceterus paribus"] (all else equal) ] ] .pull-right[ .center[ ![:scale 75%](https://www.dropbox.com/s/pnyb4kyxum5no25/ceterusparibus.png?raw=1) ] ] --- # Recall (for example), Demand I .pull-left[ .smallest[ - A consumer's .hi[demand] (for good x) depends on current prices & income: `$$q_x^D = q_x^D(m, p_x, p_y)$$` - How does **demand for x** change? 1. .hi-purple[Income effects] `\(\left(\frac{\Delta q_x^D}{\Delta m}\right)\)`: how `\(q_x^D\)` changes with changes in income 2. .hi-purple[Cross-price effects] `\(\left(\frac{\Delta q_x^D}{\Delta p_y}\right)\)`: how `\(q_x^D\)` changes with changes in prices of *other* goods (e.g. `\(y)\)` 3. .hi-purple[(Own) Price effects] `\(\left(\frac{\Delta q_x^D}{\Delta p_x}\right)\)`: how `\(q_x^D\)` changes with changes in price (of `\(x)\)` ] ] .pull-right[ .center[ ![](https://www.dropbox.com/s/nw0v6bsho0ab4zq/choices.jpg?raw=1) ] ] .source[See [Class 1.7](/class/1.7-class) for a reminder.] --- # Recall (for example), Demand II .pull-left[ .smallest[ - A change in one of the .hi-purple["determinants of demand"] will **shift** demand curve! - Change in **income** `\\(m\\)` - Change in **price of other goods** `\\(p_y\\)` (substitutes or complements) - Change in **preferences** or **expectations** about good `\\(x\\)` - Change in **number of buyers** - Shows up in (inverse) demand function by a **change in intercept (choke price)**! - Again, see my [Visualizing Demand Shifters](https://ryansafner.shinyapps.io/Demand/) ] .source[See [Class 1.8](/class/1.8-class) for a reminder.] ] .pull-right[ <img src="3.1-slides_files/figure-html/unnamed-chunk-15-1.png" width="504" /> ] --- # Ceterus Paribus II .pull-left[ - Consider our demand function: `$$q_D=10-p$$` - If the **market price `\((p)\)` changes** (perhaps because supply changes), that results in a **change in _quantity demanded_ `\((q_D)\)`** - We move *along* the existing demand curve - *Ceterus paribus* has not been violated ] .pull-right[ .center[ ![:scale 75%](https://www.dropbox.com/s/pnyb4kyxum5no25/ceterusparibus.png?raw=1) ] ] --- # Ceterus Paribus III .pull-left[ - Consider our demand function: `$$q_D=10-p$$` - 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) `$$q_D=12-p$$` - *Ceterus paribus* has been violated ] .pull-right[ .center[ ![:scale 75%](https://www.dropbox.com/s/pnyb4kyxum5no25/ceterusparibus.png?raw=1) ] ] --- # Ceterus Paribus IV .pull-left[ - .hi-purple[There is a big difference between a change in "quantity demanded" and a change in "demand"!] ] -- .pull-right[ .center[ ![:scale 75%](https://www.dropbox.com/s/urfaj6q5xgx4nhp/quantitydemandedvsdemand.jpg?raw=1) ] ] --- # Increase in Demand .pull-left[ ] .pull-right[ <img src="3.1-slides_files/figure-html/unnamed-chunk-16-1.png" width="504" /> ] --- # Increase in Demand .pull-left[ .smallest[ - More individuals want to buy more of the good at *every* price - Entire demand curve shifts to the *right* ] ] .pull-right[ <img src="3.1-slides_files/figure-html/unnamed-chunk-17-1.png" width="504" /> ] --- # Increase in Demand .pull-left[ .smallest[ - 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!** `\((q_D > q_S)\)` ] ] .pull-right[ <img src="3.1-slides_files/figure-html/unnamed-chunk-18-1.png" width="504" /> ] --- # Increase in Demand .pull-left[ .smallest[ - 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!** `\((q_D > q_S)\)` - Some buyers willing to pay more at this quantity ] ] .pull-right[ <img src="3.1-slides_files/figure-html/unnamed-chunk-19-1.png" width="504" /> ] --- # Increase in Demand .pull-left[ .smallest[ - 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!** `\((q_D > q_S)\)` - 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** ] ] .pull-right[ <img src="3.1-slides_files/figure-html/unnamed-chunk-20-1.png" width="504" /> ] --- # Decrease in Demand .pull-left[ ] .pull-right[ <img src="3.1-slides_files/figure-html/unnamed-chunk-21-1.png" width="504" /> ] --- # Decrease in Demand .pull-left[ .smallest[ - Fewer individuals want to buy less of the good at *every* price - Entire demand curve shifts to the *left* ] ] .pull-right[ <img src="3.1-slides_files/figure-html/unnamed-chunk-22-1.png" width="504" /> ] --- # Decrease in Demand .pull-left[ .smallest[ - 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!** `\((q_D < q_S)\)` ] ] .pull-right[ <img src="3.1-slides_files/figure-html/unnamed-chunk-23-1.png" width="504" /> ] --- # Decrease in Demand .pull-left[ .smallest[ - 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!** `\((q_D < q_S)\)` - Some sellers willing to accept less at this quantity ] ] .pull-right[ <img src="3.1-slides_files/figure-html/unnamed-chunk-24-1.png" width="504" /> ] --- # Decrease in Demand .pull-left[ .smallest[ - 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!** `\((q_D < q_S)\)` - 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** ] ] .pull-right[ <img src="3.1-slides_files/figure-html/unnamed-chunk-25-1.png" width="504" /> ] --- # Increase in Supply .pull-left[ ] .pull-right[ <img src="3.1-slides_files/figure-html/unnamed-chunk-26-1.png" width="504" /> ] --- # Increase in Supply .pull-left[ .smallest[ - More individuals want to sell more of the good at *every* price - Entire supply curve shifts to the *right* ] ] .pull-right[ <img src="3.1-slides_files/figure-html/unnamed-chunk-27-1.png" width="504" /> ] --- # Increase in Supply .pull-left[ .smallest[ - 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!** `\((q_D < q_S)\)` ] ] .pull-right[ <img src="3.1-slides_files/figure-html/unnamed-chunk-28-1.png" width="504" /> ] --- # Increase in Supply .pull-left[ .smallest[ - 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!** `\((q_D < q_S)\)` - Some sellers willing to accept less at this quantity ] ] .pull-right[ <img src="3.1-slides_files/figure-html/unnamed-chunk-29-1.png" width="504" /> ] --- # Increase in Supply .pull-left[ .smallest[ - 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!** `\((q_D < q_S)\)` - 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** ] ] .pull-right[ <img src="3.1-slides_files/figure-html/unnamed-chunk-30-1.png" width="504" /> ] --- # Decrease in Supply .pull-left[ ] .pull-right[ <img src="3.1-slides_files/figure-html/unnamed-chunk-31-1.png" width="504" /> ] --- # Decrease in Supply .pull-left[ .smallest[ - Fewer individuals want to sell less of the good at *every* price - Entire supply curve shifts to the *left* ] ] .pull-right[ <img src="3.1-slides_files/figure-html/unnamed-chunk-32-1.png" width="504" /> ] --- # Decrease in Supply .pull-left[ .smallest[ - 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!** `\((q_D > q_S)\)` ] ] .pull-right[ <img src="3.1-slides_files/figure-html/unnamed-chunk-33-1.png" width="504" /> ] --- # Decrease in Supply .pull-left[ .smallest[ - 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!** `\((q_D > q_S)\)` - Some buyers willing to pay more at this quantity ] ] .pull-right[ <img src="3.1-slides_files/figure-html/unnamed-chunk-34-1.png" width="504" /> ] --- # Decrease in Supply .pull-left[ .smallest[ - 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!** `\((q_D > q_S)\)` - 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** ] ] .pull-right[ <img src="3.1-slides_files/figure-html/unnamed-chunk-35-1.png" width="504" /> ] --- # Equilibrium Tendencies .pull-left[ .center[ ![:scale 60%](https://www.dropbox.com/s/60q8uepk12z3zv4/kiviqauction.png?raw=1) ![:scale 35%](https://www.dropbox.com/s/hu6jcwr05idub6v/equilibriumball.png?raw=1) ] ] .pull-right[ - Equilibrium is a *tendency* we can *predict* with our models - Buyers and sellers raise and lower their bids and asks to adjust to competition from other buyers and sellers, moving the market price - *Ceterus paribus*, market prices will settle on an equilibrium given existing conditions - But conditions are always changing (and so are prices)! ]