Lectures following Rüdiger Dornbusch’ works (3)
DEMAND, SUPPLY, AND THE MARKET
(DEMAND FOR AND SUPPLY OF FISH
DEMAND, SUPPLY, PRICE – model data)
It is important to make the distinction between demand and quantity demanded and between supply and quantity supplied even though it is not common in everyday language. In everyday language we would say that the demand for football tickets exceeded the supply, so some people couldn’ get in. Not so, the economist would say. Rather, the quantity demanded at the price that was set for the tickets exceeded the quantity supplied. At a higher price the quantity demanded might have been much smaller, and the stadium half empty. There is no change in demand between the two situations even though the quantity demanded changes as the price rises.
The reason for emphasizing the distinction between demand and quantity demanded (and between supply and quantity supplied) is that in economics much of the focus is on finding prices that will balance the quantity demanded with the quantity supplied. To find this balance, it is necessary to allow the price to change. Noting the distinction between supply and demand and the quantities supplied and demanded at particular prices drives home the lesson that prices guide the allocation of resources.
Consider now the demand side. Suppose fish were free. Most households would choose a diet with plenty of fish and relatively little meat or poultry. The quantity demanded of fish would be high. But it would not be unlimited. Nobody would want to eat only fish or have huge amounts of fish lying around the house, possibly spoiling. Table 3-1 accordingly shows that with a zero price, the quantity demanded is 50 million pounds.
Suppose next that the price was $1 per pound. The table shows that the quantity demanded would be lower: only 40 million pounds. Other foods find a larger place in the diet as fish becomes more expensive and households want to purchase less fish, consuming it perhaps only 4 days per week. The table shows that at progressively higher prices of fish, there is an increasing substitution toward other foods. The quantity of fish demanded falls off rapidly; it is down to 10 million pounds at a $4 price and all the way down to zero at $5, where even the most fish-enthusiastic household eliminates fish entirely from the menu. Table 3-1 exhibits the pattern of demand: The lower the price, the higher the quantity demanded of a part cular comnodity.
On the supply side, as the third column of Table 3-1 shows, the opposite holds true. The quantity supplied increases as the price increases. On the supply side we have to ask what persuades people to devote labor and machinery (such as boats and ships) to catching and marketing fish rather than doing something else with their time and equipment. The higher the price at which fish can be sold, the more resources will be used in fishing and the more fish will be of fered for sale. As the price of fish rises, fishermen use their boats more intensively, and new fishermen come into the market. Also, it becomes profitable for sellers of fish to expand their supply by importing fish from other parts of the country and even from other countries.
Accordingly, Table 3-1 shows the quantity supplied rising as the price increases. At a price of zero there will be no fish offered for sale; indeed, the price has to rise above $1 per pound before any fish appears on the market. At $2 per pound there is already some quantity supplied, and the quantity supplied increases further as the price rises. The third column shows supply behavior: The higher the price, the higher the quantity supplied of a particular commodity.
The Market and the Equilibrium Price
In talking about a market, we need to specify not only what is traded in the market but also what area the market covers and the length of time being considered. To be concrete, we will talk about the market for fish in Chicago and about the weekly supply and demand. We will want to know what determines the price of fish and the quantity sold per week.
Consider now supply in relation to demand, and look at Table 3-1. At low prices the quantity demanded exceeds the quantity supplied, and at high prices the quantity supplied exceeds the quantity demanded. At an intermediate price the quantity demanded and the quantity supplied are equal; in other words, there is a price that equates demand and supply. That price is the equilibrium price.
The equilibrium price is the price at which the quantity demanded and the quantity supplied are equal.
Table 3-1 shows that the equilibrium price is $3 per pound. It is only at that price that the quantity buyers want to buy is equal to the amount sellers want to sell. At any price below $3, the quantity demanded is greater than the quantity supplied, and so there is an unsatisfied demand, or a shortage, or excess demand. If the price somehow fell below $3, sellers would want to sell less than the amount demanders would want to buy. Fish would be sold out before everyone who wanted some could buy it. If the price were above $3, however, sellers would want to sell more than the amount buyers would want to buy, and at the end of the day the sellers would be left with un#sold fish. In this situation there is ezcess supply, or a surplus. Only at a price of $3 do the quantities supplied and demanded match; as it is put alternatively, only at the $3 price does the market clear.
Corresponding to the equilibrium price of $3 is an equilibrium quantity, in this case 20 million pounds. That is the amount bought and sold when the market is in equilibrium-when the quantity supplied equals the quantity demanded.
Will the price in fact be $3, and if so, how does the price get there? The price will, indeed, tend toward the equilibrium price because if it is not at the equilibrium level, there is reason for it to change. Suppose that sellers set the price at $5 and correspondingly brought 40 million pounds of fish to market. At a $5 price they would face a zero quantity demanded and therefore find themselves with more fish than they know what to do with. Their reaction would be to lower the price. If the price were below $3-say, at $2-sellers would want to sell only 10 million pounds. Buyers would want 30 million pounds. The sellers would be overwhelmed in the rush for the small quantity of fish. They would react by raising the price and trying to obtain more fish to meet the demand. Only at the price of $3, with the quantities demanded and supplied equal (at 20 million pounds), are there no forces tending to change the price. For that reason we expect the actual price to be close to the equilibrium price.
Of course, on any particular day it is quite possible that the quantity demanded and the quantity supplied are not exactly equal and that the price is not equal to the equilibrium price.
Perhaps there is a sudden increase in the demand for fish and suppliers do not adjust prices quickly enough. In this case they sell out. Or perhaps the weather keeps customers away, and some fish goes unsold. But in each case there is an incentive for the price to change and to move toward the equilibrium price. Thus on the average we expect the price to be at about the equilibrium level.
We have talked about the fish market as if the sellers of fish set the price. But the actual arrangements about who sets the price in any market differ. In some markets there is an auctioneer-an individual who calls out prices until the quantity available for sale is sold. Auctioneers may be found in wholesale markets for fish, in many agricultural markets, or at auctions of household objects or used cars. In other markets prices are set by a process of haggling. The particular methods differ enormously, but in most cases we can think that the price is set so as to equate the quantity supplied and the quantity demanded.1
To summarize the essential points of this and the previous section:
1 Demand is the quantity of a good buyers want to buy at each price. The lower the price, the greater the quantity demanded.
2 Supply is the quantity of a good sellers want to sell at each price. The higher the price, the larger the quantity supplied.
3 The market clears, or is in equilibrium, when the price is at the level at which the quantity demanded and the quantity supplied are equal.
‘ Veteran economists often say that price eduates supply and demand rather than that it equates quantity supplied and quantity demanded. This should be thought of as a way of saving words. But it is not strictly accurate and should not be said until you have been practicing economics for at least 8 years.
4 If the price is not at the equilibrium level, it will tend in a free market to move toward it. On the average, therefore, the price will be at the equilibrium level.
3 DEMAND AND SUPPLY CURVES AND THE EOUILIBRIUM PRICE
Table 3-1 shows demand and supply conditions in the fish market and allows us to find the equilibrium price and quantity. For further applications we introduce another way of looking at supply and demand, namely, supply and demand curves. (Curves will be shown on special pages.)
We start by drawing the demand curve in Figure 3-1. Prices corresponding to the first column of Table 3-1 are measured on the vertical axis. Quantities, in millions of pounds per week, are measured on the horizontal axis. From Table 3-1, the quantity demanded at a price of $1 is 40 (million pounds). We show this with point A, at which the price is $1 and the quantity is 40. Consider next a price of $4 and the corresponding quantity demanded of 10. This is shown with point B. Clearly we can continue plotting all the prices and the corresponding levels of demand. This is done in Figure 3-l, where we have connected the points to show the demand cuţve.
The demand curve or demand schedule shows the quantity demanded at each price.
Supply conditions are similarly shown by the supply curve or supply schedule.
The supply curve shows the quantity that would be supplied at each price. The points corresponding to the third column of Table 3-1 are shown in Figure 3-2 (for example, price = $4, and quantity supplied = 30 million pounds). Again, the points have been connected.
The demand and supply curves can be combined in the same diagram:
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