Bringing Supply and Demand Together
5 c h a p t e r
Enough has been said for now about demand and supply separately. Bearing in mind our discussion of the “fuzzy” nature of many real-world markets, we now bring the market supply and demand together.
EQUILIBRIUM PRICE AND QUANTITY
The market equilibrium is found at the point at which the market supply and market demand curve intersect. The price at the intersection of the market demand curve and the market supply curve is called the equilibrium price, and the quantity is called the
equilibrium quantity. At the equilibrium price, the amount that buyers are willing and able to buy is exactly equal to the amount that sellers are willing and able to produce. The equilibrium market solution is best understood with the help of a simple graph. Let’s return to the coffee example we used in our earlier discussions of supply and demand. Exhibit 1 combines the market demand curve for coffee with the market supply curve. At $3 per pound, buyers are willing to buy 5,000 pounds of coffee and sellers are willing to supply 5,000 pounds of coffee. Neither may be “happy” about the price because the buyers would like a lower price and the sellers would like a higher price. But both buyers and sellers are able to carry out their purchase and sales plans at that $3 price. At any other price, either suppliers or demanders would be unable to trade as much as they would like.
SHORTAGES AND SURPLUSES
What happens when the market price is not equal to the equilibrium price? Suppose the market price is above the equilibrium price, as seen in Exhibit 2(a). At $4 per pound, the quantity of coffee demanded would be 3,000 pounds, but the quantity supplied would be 7,000 pounds. At that price, a
surplus, or excess quantity supplied, would exist.
That is, at this price, growers would be willing to sell more coffee than demanders would be willing to buy. To get rid of the unwanted surplus, frustrated suppliers would cut their price and cut back on production. And as price falls, consumers would buy more, ultimately eliminating the unsold surplus and returning the market to the equilibrium level.
What would happen if the market price of coffee were below the equilibrium price? As seen in Exhibit 2(b), at $2 per pound, the yearly quantity demanded of 8,000 pounds would be greater than the 3,000 pounds that producers would be willing to supply at that low price. So at $2 per pound, a shortage or excess quantity demanded would exist of 5,000 pounds. Because of the coffee shortage, frustrated buyers would be forced to compete for the existing supply, bidding up the price. The rising price would have two effects: (1) Producers would be willing to increase the quantity supplied, and (2) the higher price would decrease the quantity demanded. Together, these two effects would ultimately eliminate the shortage, returning the market to the equilibrium.
Market Equilibrium Price and Quantity
s e c t i o n
5.1
_ What is the equilibrium price?
_ What is the equilibrium quantity?
_ What is a shortage?
_ What is a surplus?
86 CHAPTER FIVE | Bringing Supply and Demand Together
Supply Demand 0 Equilibrium
Price of Coffee (per pound) Quantity of Coffee (thousands of pounds)
2 4 6 8 10 1 3 5 7 9 Equilibrium Quantity Equilibrium Price $5 4 3 2 1
Market Equilibrium
SECTION 5.1
EXHIBIT 1
The equilibrium is found at the intersection of the market supply and demand curves. The equilibrium price is $3 per pound, and the equilibrium quantity is 5,000 pounds of coffee. At the equilibrium quantity, the quantity demanded equals the quantity supplied.
Market Equilibrium Price and Quantity 87
Supply 4000 Pound Surplus Demand 0
Price of Coffee(per pound) Quantity of Coffee (thousands of pounds) a. Excess Quantity Supplied
3 5 7 Quantity Demanded Quantity Supplied $5 4 3 2 1 Demand 0
Price of Coffee(per pound) Quantity of Coffee (thousands of pounds) b. Excess Quantity Demanded
8 3 5 Quantity Demanded $5 4 3 2 1 5000 Pound Shortage Supply Quantity Supplied
Markets in Temporary Disequilibrium SECTION 5.1
EXHIBIT 2
In (a), the market price is above the equilibrium price. At this price, $4, the quantity supplied (7,000 pounds) exceeds the quantity demanded (3,000 pounds), and there is a surplus of 4,000 pounds. To get rid of the unwanted surplus, suppliers cut their prices. As prices fall, consumers buy more, eliminating the surplus and moving the market back to equilibrium. In (b), the market price is below the equilibrium price.
At this price, $2, the quantity demanded (8,000 pounds) exceeds the quantity supplied (3,000 pounds), and there is a shortage of 5,000 pounds. The many frustrated buyers compete for the existing supply, offering to buy more and driving the price up toward the equilibrium level. Therefore, with both shortages and surpluses, market prices tend to pull the market back to the equilibrium level.
Imagine that you own a butcher shop. Recently, you have noticed that at about noon, you run out of your daily supply of chicken. Puzzling over your predicament, you hypothesize that you are charging less than the equilibrium price for your chicken. Should you raise the price of your chicken? Explain using a simple graph.
If the price you are charging is below the equilibrium price (PE), you can draw a horizontal line from that price straight across Exhibit 3 and see where it intersects the supply and demand curves. The point where this horizontal line intersects the demand curve indicates how much chicken consumers are willing to buy at the below-equilibrium price (P1). Likewise, the intersection of this horizontal line with the supply curve indicates how much chicken producers are willing to supply at P1. From this, it is clear that a shortage (or excess quantity demanded) exists, because consumers want more chicken (QD) than producers are will to supply (QS) at this relatively low price. This excess quantity demanded results in competition among buyers, which will push prices up and reduce or eliminate the shortage. That is, it would make sense to raise your price on chicken. As the price moves up toward the equilibrium price, consumers will be willing to purchase less (some will substitute fish, steak, and ground round), and producers will have an incentive to supply more chicken.
SHORTAGES
USING WHAT YOU'VE LEARNED
A Q
PE
QS QD
P1
Supply Demand
Price of Chicken Quantity of Chicken
0 Shortage
EXHIBIT 3
88 CHAPTER FIVE | Bringing Supply and Demand Together
TEMPE, Ariz.—You can’t help but admire the power and influence of the Super Bowl. What else can close down Miami’s freeways for hours on a Sunday afternoon for a parade of VIP limos? What else can cause a sacred Indian burial ground to be plowed up, without resistance, for a glitzy football theme park lasting just one week? Stronger than a sovereign nation, the National Football League rules in most situations. But the free market is the one force that eludes the NFL offense, despite its determined efforts.
The Super Bowl is a high-demand, limited-supply event.
This year, in Tempe, there are some 80,000 seats for the 30th playing of football’s crowning moment. The NFL has done such a good marketing job that half of the United States wants to attend.
Yet the league has no intention of allowing them in. Market control is the NFL goal.
For the first 29 Super Bowls, ticket prices for all stadium seats were the same regardless of location. So much for the market! This year’s game has differential prices ($200, $250, and $350), “to more adequately reflect differences in seat quality,” a league spokesman says. But with present market prices ranging from $1,000 to $3,000, the NFL has not priced to what the market will bear. Even with the NFL in charge, scalping is inevitable. So many want seats, and some who receive official tickets are willing to sell them. Each year hundreds of ticket scalpers from across the United States descend on the host city a week before the game to trade from temporary command posts in motel rooms.
Scalpers always appear at the stadium even when the probability of arrest is high.
Rather than ramming ahead into the force of the market, the NFL should try a reverse. Scalpers should be allowed to operate license-free at one location on game day. Phoenix pioneered such an ordinance for the 1995 NBA All-Star Game, and the results have overwhelmingly benefited the customers.
Search costs are minimized. Prices are lower. The nuisance effects of congested street corners, aggressive sellers, and fights are gone. Counterfeit tickets are almost nonexistent. The common area will simply make shopping easier for those rabid fans who are willing to pay what it takes to achieve a once-in-a-lifetime dream.
The NFL, alas, has no plans for a reverse. League rules prohibit anyone affiliated with the NFL from scalping Super Bowl tickets. Also, the host city is required to have an antiscalping ordinance enforced at the event.
The Super Bowl’s status as the top sporting event in the United States means that the vast majority of tickets never reach the open market. Yet the human spirit coupled with market forces still emerges as fans and scalpers search for each other. Just outside the stadium, within the shadow of the mighty NFL, they will meet. Neither ordinances nor screening can stop them. Even the NFL can’t sack the laws of supply and demand.
SOURCE: Stephen Happel and Marianne Jennings, “Just the Ticket for Super Bowl Fans,” The Wall Street Journal, January 25, 1996, p. A-22. Wall Street Journal, eastern edition (staff-produced copy only) by Stephen Happel and Marianne Jennings. Copyright 1996 by Dow Jones & Co., Inc. Reproduced with permission of Dow Jones & Co., Inc. in the format Textbook via Copyright Clearance Center.
JUST THE TICKET FOR SUPER BOWL FANS
In The NEWS
Price per Ticket Quantity of Super Bowl Tickets
EXHIBIT 4
At the face value for Super Bowl tickets (P1), there is a shortage.
That is, at P1, the quantity demanded (QD) is greater than the quantity supplied (QS).
© Ron Vesely Photogpraphy
When one of the many determinants of demand or supply changes, the demand and supply curves will shift leading to changes in the equilibrium price and equilibrium quantity. We first consider a change in demand.
A CHANGE IN DEMAND
A shift in the demand curve—caused by a change in the price of a related good (substitutes or complements), income, the number of buyers, tastes, or expectations—results in a change in both equilibrium price and equilibrium quantity. But how and why does this happen? This result can be most clearly explained through the use of an example.
Gasoline prices are typically higher in the summer than in the winter because more people travel during the summer months than during the winter months. Therefore, the demand for gasoline increases during the summer, shifting the demand curve to the right as seen in Exhibit 1. The rightward shift of the demand curve results in an increase in both equilibrium price and quantity,
ceteris paribus.
A CHANGE IN SUPPLY
Like a shift in demand, a shift in the supply curve will also influence both equilibrium price and equilibrium quantity, assuming that demand for the product has not changed. For example, why are strawberries less expensive in summer than in
Changes in Equilibrium Price and Quantity 89
Changes in Equilibrium Price and Quantity
5.2
_ What happens to equilibrium price and quantity when the demand curve shifts?
_ What happens to equilibrium price and quantity when the supply curve shifts?
_ What happens when both supply and demand shift in the same time period?
_ What is an indeterminate solution?
1. The intersection of the supply and demand curve shows the equilibrium price and equilibrium quantity in a market.
2. A surplus is a situation where quantity supplied exceeds quantity demanded.
3. A shortage is a situation where quantity demanded exceeds quantity supplied.
4. Shortages and surpluses set in motion actions by many buyers and sellers that will move the market toward the equilibrium price and quantity unless otherwise prevented.
1. How does the intersection of supply and demand indicate the equilibrium price and quantity in a market?
2. What can cause a change in the supply and demand equilibrium?
3. What must be true about the price charged for a shortage to occur?
4. What must be true about the price charged for a surplus to occur?
5. Why do market forces tend to eliminate both shortages and surpluses?
6. If tea prices were above their equilibrium level, what force would tend to push tea prices down? If tea prices were below their equilibrium level, what force would tend to push tea prices up?
s e c t i o n c h e c k
© 1999 Wiley Miller/Distributed by the Washington Post Writers Group
winter? Assuming that consumers’ tastes and income are fairly constant throughout the year, the answer lies on the supply side of the market. The supply of strawberries is higher during the summer because strawberries are in season. As shown in Exhibit 2, this increase in supply of strawberries during the summer shifts the supply curve to the right, resulting in a lower equilibrium price (from PWINTER
to PSUMMER) and a greater equilibrium quantity (from QWINTER to QSUMMER).
CHANGES IN BOTH SUPPLY AND DEMAND
We have discussed that, as part of the continual adjustment process that occurs in the marketplace, supply and demand can each shift in response to
90 CHAPTER FIVE | Bringing Supply and Demand Together
PSUMMER
QWINTER QSUMMER
PWINTER
Supply DSUMMER
Price of Gasoline Quantity of Gasoline
0 DWINTER
Summer Equilibrium Winter Equilibrium
Higher Gasoline Prices in the Summer
SECTION 5.2
The demand for gasoline is generally higher in the summer than in the winter. The increase in demand during the summer means a higher price and a greater quantity, ceteris paribus.
Demand Price of Strawberries Quantity of Strawberries
0 Winter Equilibrium Summer Equilibrium SWINTER
SSUMMER
Why Are Strawberries Less Expensive in the Summer Than in Winter?
In the summer, the supply of fresh strawberries is greater, leading to a lower equilibrium price and a greater equilibrium quantity, ceteris paribus.
many different factors, with the market then adjusting toward the new equilibrium. We have, so far, only considered what happens when just one such change occurs at a time. In these cases, we learned that the results of the adjustments in supply and demand on the equilibrium price and quantity are predictable. However, very often supply and demand will both shift in the same time period. Can we predict what will happen to equilibrium prices and equilibrium quantities in these situations?
As you will see, when supply and demand move at the same time, we can predict the change in one
Changes in Equilibrium Price and Quantity 91
In ski resorts like Aspen, hotel prices are higher in January and February (in season, when there are more skiers) than in May (out of season, when there are fewer skiers). Why is this the case?
In the (likely) event that supply is not altered significantly, demand is chiefly responsible for the higher prices in the prime skiing months. In Exhibit 3, we see that the demand is higher in season (February) than out of season (May). For example, at the Hotel Jerome in Aspen, the price of a Deluxe King room is $560 in February and $230 in May.
To see a complete list of seasonal rates, go to http://www.
hoteljerome.com/room.html.
CHANGE IN DEMAND
QMAY QFEBRUARY
Supply DFEBRUARY
PFEBRUARY
DMAY
PMAY
Price of Aspen Rentals Quantity of Aspen Rentals
0 In Season Equilibrium Out of Season Equilibrium
© Photolink/PhotoDisc/Getty One Images ©1997 Thaves. Reprinted with permission fromCartoonist Group.
variable (price or quantity), but we are unable to predict the direction of the effect on the other variable with any certainty. The change in the second variable, then, is said to be indeterminate, because it cannot be determined without additional information about the size of the relative shifts in supply and demand. This concept will become clearer to you as we work through the following example.
An Increase in Supply and a Decrease in Demand
When considering the scenario of supply and demand moving at the same time, it might help you to break it down into its individual parts. As you learned in the last section, an increase in supply (a rightward shift in the supply curve) results in a decrease in the equilibrium price and an increase in the equilibrium quantity. A decrease in demand (a leftward movement of the demand curve), on the other hand, results in a decrease in both the equilibrium price and the equilibrium quantity. These shifts are shown in Exhibit 4(a). Taken together, then, these changes will clearly result in a decrease in the equilibrium price, because both the increase in supply and the decrease in demand work to push this price down. This drop in equilibrium price (from P1 to
P2) is shown in the movement from E1 to E2.
The effect of these changes on equilibrium price is clear, but how does the equilibrium quantity change? The impact on equilibrium quantity is indeterminate because the increase in supply increases the equilibrium quantity and the decrease in demand decreases it. In this scenario, the change in the equilibrium quantity will vary depending on the rel-
92 CHAPTER FIVE | Bringing Supply and Demand Together
The ice is starting to melt on California orange and lemon trees, and growers are cautiously optimistic that the worst of a freeze that has hobbled the state’s citrus industry is over.
Early morning temperatures Saturday hovered around 30 degrees in central California after a week in which they bottomed out at a fruit-killing 21 degrees.
With industry officials considering the region’s $90 million lemon crop a total loss, the challenge comes in finding salvageable fruit hanging among oranges that are frozen through, their juice sacs burst.
Growers were banking on a slow warm-up to allow some table oranges to heal and save them from a profitless season.
“I think everyone is still holding out hope that some fruit will be good,” said Terry Barker, who believes he lost almost his entire crop of navel oranges in Woodlake.
“Some guys just shut off their (wind) machines and gave up,” Barker said Saturday after getting his first full night’s sleep in several days.
But “you’ll find people in farming are basically optimists.
You hate to lose a crop, you really do. You plan on it. You realize these things happen and you just have to go on.” The past week’s low temperatures are expected to seriously hurt California’s $1.5 billion citrus industry, of which $853 million last year came from the oranges and lemons that have borne the brunt of the freeze.
California grows about 80 percent of the nation’s fresh oranges that are used for eating.
The state’s industry needed two years to recover from a 1990 freeze that destroyed nearly 90 percent of the citrus crop.
Eighty-five packinghouses were shut down, leading to 12,000 layoffs. The state estimates at least $591 million in damage this year to oranges, lemons, and tangerines, although farmers said Saturday that they expected to rebound next year.
Hundreds of workers have already been laid off by a handful of packinghouses. A trickle-down effect may well hit harvesters and truckers.
“There’s going to be obviously a boatload of people out of work, that’s for sure,” said Shann Blue, director of grower services for California Citrus Mutual, a trade group.
In “a lot of these small cities in the San Joaquin Valley, revenue is driven by the citrus industry,” he said. “They’re going to feel it, from car dealers to restaurants, if their money comes from people in the citrus business.”
SOURCE: Associated Press, December 27, 1998.
BAD WEATHER PUTS THE SQUEEZE ON ORANGE CROP
CONSIDER THIS:
The unfavorable weather conditions caused a reduction in supply. A decrease in supply, ceteris paribus, will lead to a higher price and a reduction in the quantity sold.
© T. O’Keefe/Photolink/PhotoDisc/Getty One Images
ative changes in supply and demand. If, as show...
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