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7.30
7.30 55 70 Surplus Fall
E
7.20 7.20 60 60 Neither Unchanged
7.10 65 50 Shortage Rise
7.10
7.00 70 40 Shortage Rise
g G
7.00 6.90 75 30 Shortage Rise
6.90
S D
0 30 40 50 60 70 80 90
Quantity
in Millions of Pounds per Year




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Licensed to:

Chapter 4 65
Supply and Demand: An Initial Look



A shortage is an excess of
Thus, quantity demanded will exceed quantity supplied. There will be a shortage
quantity demanded over
equal to 70 minus 40, or 30 million pounds. Price will thus be driven up by unsatisfied
quantity supplied. When
demand. Alternatively, at a higher price, such as $7.50 per pound, quantity supplied
there is a shortage, buyers
will be 90 million pounds (point a) and quantity demanded will be only 45 million cannot purchase the quan-
(point A). Quantity supplied will exceed quantity demanded”creating a surplus tities they desire at the cur-
equal to 90 minus 45, or 45 million pounds. The unsold output can then be expected rent price.
to push the price down.
A surplus is an excess of
Because $7.20 is the only price in this graph at which quantity supplied and quantity
quantity supplied over
demanded are equal, we say that $7.20 per pound is the equilibrium price (or the “market quantity demanded. When
clearing” price) in this market. Similarly, 60 million pounds per year is the equilibrium there is a surplus, sellers
quantity of beef. The term equilibrium merits a little explanation, because it arises so fre- cannot sell the quantities
quently in economic analysis. they desire to supply at the
current price.
An equilibrium is a situation in which there are no inherent forces that produce change.
Think, for example, of a pendulum resting at its center point. If no outside force (such as a An equilibrium is a situa-
person™s hand) comes to push it, the pendulum will remain exactly where it is; it is there- tion in which there are no
fore in equilibrium. inherent forces that pro-
If you give the pendulum a shove, however, its equilibrium will be disturbed and it duce change. Changes away
from an equilibrium posi-
will start to move. When it reaches the top of its arc, the pendulum will, for an instant, be
tion will occur only as a re-
at rest again. This point is not an equilibrium position, for the force of gravity will pull the
sult of “outside events” that
pendulum downward. Thereafter, gravity and friction will govern its motion from side to
disturb the status quo.
side. Eventually, the pendulum will return to its original position. The fact that the pen-
dulum tends to return to its original position is described by saying that this position is
a stable equilibrium. That position is also the only equilibrium position of the pendulum.
At any other point, inherent forces will cause the pendulum to move.
The concept of equilibrium in economics is similar and can be illustrated by our
supply-and-demand example. Why is no price other than $7.20 an equilibrium price in
Table 3 or Figure 7? What forces will change any other price?
Consider first a low price such as $7.00, at which quantity demanded (70 million
pounds) exceeds quantity supplied (40 million pounds). If the price were this low, many
frustrated customers would be unable to purchase the quantities they desired. In their
scramble for the available supply of beef, some would offer to pay more. As customers
sought to outbid one another, the market price would be forced up. Thus, a price below
the equilibrium price cannot persist in a free market because a shortage sets in motion
powerful economic forces that push the price upward.
Similar forces operate in the opposite direction if the market price exceeds the equilib-
rium price. If, for example, the price should somehow reach $7.50, Table 3 tells us that
quantity supplied (90 million pounds) would far exceed the quantity demanded (45 million
pounds). Producers would be unable to sell their desired quantities of beef at the prevail-
ing price, and some would undercut their competitors by reducing price. Such competi-
tive price cutting would continue as long as the surplus remained”that is, as long as
quantity supplied exceeded quantity demanded. Thus, a price above the equilibrium
price cannot persist indefinitely.
We are left with a clear conclusion. The price of $7.20 per pound and the quantity of
60 million pounds per year constitute the only price-quantity combination that does not
sow the seeds of its own destruction. It is thus the only equilibrium for this market. Any
lower price must rise, and any higher price must fall. It is as if natural economic forces
place a magnet at point E that attracts the market, just as gravity attracts a pendulum.
The pendulum analogy is worth pursuing further. Most pendulums are more fre-
quently in motion than at rest. However, unless they are repeatedly buffeted by outside
forces (which, of course, is exactly what happens to economic equilibria in reality), pen-
dulums gradually return to their resting points. The same is true of price and quantity
in a free market. They are moved about by shifts in the supply and demand curves that
we have already described. As a consequence, markets are not always in equilibrium.
But, if nothing interferes with them, experience shows that they normally move toward
equilibrium.




Copyright 2009 Cengage Learning, Inc. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part.
Licensed to:
Part 1
66 Getting Acquainted with Economics



The Law of Supply and Demand
The law of supply and
demand states that in a
In a free market, the forces of supply and demand generally push the price toward its
free market the forces of
supply and demand gener- equilibrium level, the price at which quantity supplied and quantity demanded are
ally push the price toward equal. Like most economic “laws,” some markets will occasionally disobey the law of
the level at which quantity supply and demand. Markets sometimes display shortages or surpluses for long periods
supplied and quantity de-
of time. Prices sometimes fail to move toward equilibrium. But the “law” is a fair gener-
manded are equal.
alization that is right far more often than it is wrong.




EFFECTS OF DEMAND SHIFTS ON SUPPLY-DEMAND EQUILIBRIUM
Figure 3 showed how developments other than changes in price”such as increases in con-
sumer income”can shift the demand curve. We saw that a rise in income, for example, will
shift the demand curve to the right, meaning that at any given price, consumers”with
their increased purchasing power”will buy more of the good than before. This, in turn,
will move the equilibrium point, changing both market price and quantity sold.
This market adjustment is shown in Figure 8(a). It adds a supply curve to Figure 3(a) so
that we can see what happens to the supply-demand equilibrium. In the example in the
graph, the quantity demanded at the old equilibrium price of $7.20 increases from 60 mil-
lion pounds per year (point E on the demand curve D0D0) to 75 million pounds per year
(point R on the demand curve D1D1). We know that $7.20 is no longer the equilibrium
price, because at this price quantity demanded (75 million pounds) exceeds quantity sup-
plied (60 million pounds). To restore equilibrium, the price must rise. The new equili-
brium occurs at point T, the intersection point of the supply curve and the shifted demand
curve, where the price is $7.30 per pound and both quantities demanded and supplied are
70 million pounds per year. This example illustrates a general result, which is true when
the supply curve slopes upward:
Any influence that makes the demand curve shift outward to the right, and does not af-
F I GU R E 8 fect an upward-sloped supply curve, will raise the equilibrium price and the equilibrium
quantity.5
The Effects of Shifts of
the Demand Curve



D1

S
D0 D0 S
D2
Price per Pound




Price per Pound




T
$7.30
E
E R
7.20 $7.20
L M
7.10

D1
D0
D0 S
S D2
60 7075 45 50 60
Quantity Quantity
(a) (b)


NOTE: Quantity is in millions of pounds per year.


For example, when incomes rise rapidly, in many developing countries the demand curves for a variety of con-
5

sumer goods shift rapidly outward to the right. In Japan, for example, the demand for used Levi™s jeans and
Nike running shoes from the United States skyrocketed in the early 1990s as status-conscious Japanese con-
sumers searched for outlets for their then-rising incomes.




Copyright 2009 Cengage Learning, Inc. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part.
Licensed to:

Chapter 4 67
Supply and Demand: An Initial Look




The Ups and Downs of Milk Consumption
The following excerpt from a U.S Department of Agriculture publi- in 1970. These changes are consistent with increased public con-
cation discusses some of the things that have affected the con- cern about cholesterol, saturated fat, and calories. However, de-
sumption of milk in the last century. cline in per capita consumption of fluid milk also may be attrib-
uted to competition from other beverages, especially carbonated
In 1909, Americans consumed a total of 34 gallons of fluid milk
soft drinks and bottled water, a smaller percentage of children
per person”27 gallons of whole milk and 7 gallons of milks
and adolescents in the U.S., and a more ethnically diverse popu-
lower in fat than whole milk, mostly buttermilk. . . . Fluid milk
lation whose diet does not normally include milk.
consumption shot up from 34 gallons per person in 1941 to a
peak of 45 gallons per person in 1945. War production lifted SOURCE: Judy Putnam and Jane Allshouse, “Trends in U.S. Per Capita Consumption
of Dairy Products, 1909 to 2001,” Amber Waves: The Economics of Food, Farming,
Americans™ incomes but curbed civilian production and the goods
Natural Resources and Rural America, June 2003, U.S. Department of Agriculture,
consumers could buy. Many food items were rationed, including
available at http://www.usda.gov.
meats, butter and sugar. Milk was not rationed, and consumption
soared. Since 1945, however, milk consumption has fallen
Americans are switching to lower fat milks
steadily, reaching a record low of just under 23 gallons per per-
40 Whole milk
son in 2001 (the latest year for which data are available). Steep



Gallons per person
30
declines in consumption of whole milk and buttermilk far out- Other lower fat milks
20
paced an increase in other lower fat milks. By 2001, Americans
were consuming less than 8 gallons per person of whole milk, 10 Buttermilk

compared with nearly 41 gallons in 1945 and 25 gallons in 0
1909 1916 1923 1930 1937 1944 1951 1958 1965 1972 1979 1986 1993 2000

1970. In contrast, per capita consumption of total lower fat milks Lower fat milks include: buttermilk (1.5 percent fat), plain and flavored reduced fat milk (2 percent fat), low-fat milk
(1 percent fat), nonfat milk, and yogurt made from these milks (except frozen yogurt).
was 15 gallons in 2001, up from 4 gallons in 1945 and 6 gallons




Everything works in reverse if consumer incomes fall. Figure 8(b) depicts a leftward
(inward) shift of the demand curve that results from a decline in consumer incomes. For
example, the quantity demanded at the previous equilibrium price ($7.20) falls from
60 million pounds (point E) to 45 million pounds (point L on the demand curve D2D2). The
initial price is now too high and must fall. The new equilibrium will eventually be estab-
lished at point M, where the price is $7.10 and both quantity demanded and quantity sup-
plied are 50 million pounds. In general:
Any influence that shifts the demand curve inward to the left, and that does not affect
the supply curve, will lower both the equilibrium price and the equilibrium quantity.




SUPPLY SHIFTS AND SUPPLY-DEMAND EQUILIBRIUM
A story precisely analogous to that of the effects of a demand shift on equilibrium price and
quantity applies to supply shifts. Figure 6 described the effects on the supply curve of beef if
the number of farms increases. Figure 9(a) now adds a demand curve to the supply curves of
Figure 6 so that we can see the supply-demand equilibrium. Notice that at the initial price of
$7.20, the quantity supplied after the shift is 780 million pounds (point I on the supply curve
S1S1), which is 30 percent more than the original quantity demanded of 600 million pounds
(point E on the supply curve S0S0). We can see from the graph that the price of $7.20 is too
high to be the equilibrium price; the price must fall. The new equilibrium point is J, where
the price is $7.10 per pound and the quantity is 650 million pounds per year. In general:
Any change that shifts the supply curve outward to the right, and does not affect the de-
mand curve, will lower the equilibrium price and raise the equilibrium quantity.

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