Transcript for:
Overview of Market Models and Economics

enjoy it hey friends welcome back in this video we're going to develop a model of a market okay now this is important because economics is the study of how we use resources and in our society most resources are allocated by markets the rest of the resource is not allocated by markets are allocated by the government okay so a model of a market has to keep in mind what a market is now a market can take on lots of different forms it can be somewhere formal like a store that you walk into it can be somewhere less formal like a street corner or it could be somewhere that's virtual like uh you know an internet Market that you might access using your smartphone or something like that okay so a market can take on lots of different forms at its heart a market is simply the arrangement or institution by which buyers and sellers come together so all of these different markets basically just involve buyers and sellers getting together and so our model of a market just needs to incorporate these two uh players if you will the buyers and the sellers now our model is called the supply and demand model the demanders are the buyers and the suppliers are the sellers we're going to have some relatively strict assumptions about this model that we're going to build here namely that it has many buyers and sellers that the firms are selling identical products basically and that it's easy for new firms to enter the industry now these are relatively strict assumptions however if you loosen them up a little bit the results don't change very much so still quite a useful model for us in our efforts here all right so once we have uh once we build a model we'll see that a model of a market can help us understand important things about markets like how the price is determined and how many units will be produced Okay so um think about the model the market for bottled water for example right the demand for premium bottled water um is sort of related to questions like this how many bottles do consumers want to buy right so demand is all about the the purchasers so uh essentially we're wondering how many bottles do the consumers want that's what the demand is about now that's affected by the price of the water but also uh lots of other factors including prices of other Goods right there are lots of things that you could buy instead of water that would quench your thirst for example right now the supply of bottled water basically we're trying to ask this answer this question how many bottles are producers willing to sell of course this is very much affected by the price of bottled water if the price goes up firms want to sell more because they're making more money and that's the whole objective of the firm right there are lots of other factors that go into how many bottles the producers are willing to sell including the prices of other Goods things that the supplier could produce instead of water also things like how much does it cost to bottle the water stuff like that right so our model of a market is going to try to take into account these two groups the buyers and the sellers the demand and the supply if you will okay what we're going to do is start by handling these two groups separately once we understand the different things that affect the demanders or the buyers and we understand how to model those things graphically then we will do the same thing for the supply side once we have the demand and the supply size kind of figured out in terms of their incentives the things that motivate them and how to model it graphically then we will put supply and demand together to see how their interactions determine those important outcomes like what the price will be and how many units will be sold so here we are starting with the demand side of the market okay so this is just basically all about the buyers now we know that there are a lot of things that affect the buyers probably the most important thing that affects buyers is the price of the water itself now there are many many other things that affect buyers too so we're going to have to try to understand those other factors and incorporate them but for now just think about the price and how consumers would respond to different prices I think most of us are comfortable with the idea that lower prices make consumers happier right in other words when the price Falls consumers want to buy more and when the price Rises consumers want to buy less well that's what's captured here in this chart here we'll call this a demand schedule notice the left column we have prices the right you have the quantity that would be demanded okay so and you can see there's the price Falls the quantity demanded increases now what we've done here on the right is graph that all right so we've put prices on the vertical axis and we put quantity on the horizontal axis we have put our numbers uh the prices we're considering and the quantities that we believe would would be demanded those prices uh on our axes and we have plotted points right each of these dots along the line represents one of these sort of price quantity combinations on our demand schedule right here's uh the the first says that when the price is 250 the quantity Amanda will be three and that's what this first dot right here says at a price of 250 the quantity demanded is three so this is called a demand curve it plots the relationship between the market price and the quantity that would be demanded definitely the most important thing about this demand curve is that it is downward sloping um it and it's that negative slope that captures that relationship that we know is true that when the price Falls the quantity demanded increases and vice versa so when the price Rises the quantity demanded decreases that is what's captured in the slope of this demand curve all right so I hope that makes sense to you now when we draw a demand curve like this one we can only do so and actually when we State this relationship here between price and quantity demanded we can only state this relationship if we hold everything else constant so what does that mean well this is called the ceteris paribus assumption it's Latin for all else equal and it's a requirement anytime you're analyzing or stating the relationship between two variables like price and quantity demanded they have to hold other variables constant okay so let me give you an example what I mean by that right here say say we're considering going from a price of 250 down to two dollars we know from our chart over here that that'll increase the quantity of water that is demanded and so that and that seems reasonable right price goes down people want more okay non-rocket science there but um that's only true if you hold other things that are also important constant for example what if it turned out that bottled water in plastic bottles actually causes massive health problems if that piece of information came out then less water would be demanded even if the price fell from 250 to two dollars probably less water would be demanded because well now people are realizing that stuff is bad for you right so my point here is you can only make this statement about the relationship between price and quantity demanded namely that more units will be sold if the price Falls if you hold other variables constant and that's what the senator is paribus assumption says we have to do right it's the requirement that we're analyzing the relationship between two variables other variables must be held constant now you've actually probably made this assumption anytime you're talking about the relationship between two variables and if you consider the variables height and weight in people now generally speaking it's pretty safe to say that the taller someone is the heavier they are right but that's actually only true if you hold other variables constant like for example body type right if you say okay for a given body type the taller someone is the more they weigh now that's reasonable you cannot just say that the taller someone is the more they weigh right because we all know people that are tall and skinny and short and heavy right so the relationship between height and weight that you think you know and you're comfortable with is really only true ceteris paribus holding all else equal so that's an important thing to keep in mind when you're trying to articulate the relationship between two variables and that's something we'll actually do a fair amount in this class so we'll come back to the ceteris paribus assumption but it's important thing to talk about when we're here articulating this relationship between these two variables price and quantity demanded okay now the quantity demanded of course is what you see here in the right column of this demand schedule table that we have here right it's the amount of the good or service that people are willing and able to buy at given prices okay so that's the quantity demanded it only changes when the price of the good changes and we model that by sliding along the demand curve now what we see in the slope of this demand curve this downward slope is this relationship that we know exists right when the price goes down the quantity demanded increases and vice versa and actually that understanding of the relationship between the quantity that would be demanded and the price of the good is so fundamental and so critical to our understanding of markets that it is called the law of demand right that's my scary important voice right the law of demand okay so a law this is kind of the ultimate academic title that can be given to an idea there are other ways there are theorems you know there are um there are lemmas there are lots of different ways to State ideas but a law this is kind of the ultimate I think law of gravity or Kepler's laws of motion if you done any astronomy right so law of demand is a big deal and uh and so basically it just says what we know is true that holding everything else constant there's your Setters paribus assumption when the price Falls the quantity demand will increase and when the price Rises the quantity demand will decrease that seems pretty good that law of demand is here in the slope of this demand curve all right so um listen we know that the law of demand is true from our intuition of course when the price goes down the coin in a minute it increases but here we've called this thing a law and we need to substantiate our law with something a little bit more solid than it's true because I know it's true or because I feel it's true right so what we're looking for here is a little bit more depth um about explaining why this is true like why is it that when the price goes down people want more well there are two explanations for law of demand called the substitution and the income effect essentially the substitution effect assumes that for the particular good there are multiple things that could satisfy the need like if you're thirsty certainly there are many different uh Goods that could substitute for water in your effort to you know quench your thirst okay so the idea here is the reason that when the price Falls people want more of a good is that consumers substitute toward a good whose price has fallen right the substitution effect is the change in quantity demanded resulting from a change in a Goods price making it more or less expensive relative to other Goods that are substitutes okay so the reason that more people demand water when the price Falls is because some people who were consuming say orange juice or soda or beer or whatever will shift into water now that the price has fallen that is the substitution effect right and conversely when the price of water rises people will buy less water because they will substitute away from water into the good whose price is now um you know relatively lower hasn't gone up anyway okay so that's the substitution effect the other uh reason that when the price goes down the quantity demanded will increase is the income effect okay listen here's the deal money income if you well money in general it's only worth what you can buy with it right I mean if you were locked on a desert island with 10 million dollars in cash in a briefcase that wouldn't do anything for you because you can't spend the money right so money is only good for what you can spend it on and when the price Falls your money goes further right we say that you've had an increase in your purchasing power if the number of dollars you have buys you more stuff because the price of that stuff has fallen it's like getting more income when the price Falls because your money goes further or you can buy more stuff but actually not getting any more income right it's just that the dollars you have go further it's called the income effect because it's like getting more income or when price rise when prices increase it's like having less income okay so that's just uh you know these are our two main explanations for the law of demand all right okay so the law of demand does a great job at explaining the relationship between the market price and the quantity that would be sold but remember there are many things other than the price of the good that affect how many units people want in other words the quantity sold or or purchased right and many things besides price that affect consumers so we need to think about some of those other variables now we've made this demand curve as the relationship between price and quantity demanded but how do we incorporate into this model here that we're building changes in things other than price that might affect consumers right we know that this demand curve and the law of demand is is true holding everything else constant but what if those other things aren't held constant right how do we incorporate changes in variables other than price into our model all right well the way we're going to do that is by moving the entire demand curve to the right or or to the left so um let me just kind of draw a demand curve here in the upper left corner I guess that's the upper right corner isn't it and um we can think about how this works a little bit more okay so here is a demand curve that is downward sloping right looks something like this now we're going to be moving these demand this demand curve to the right or to the left in response to changes in variables other than the price of the good itself so to see when we might do that try to think about a demand curve out here to the right of our first demand curve I'll call it demand curve 2. and think about what it means sort of graphically to shift to the right from D1 to D2 so basically what I what I want you to see here is something like this right what this rightward shifted curve shows is that even if the price of the goods stays exactly the same more of the good is demanded for some reason that's what a rightward shift shows right say we start up here at the P1 whatever that is and originally we're kind of at this spot on the demand curve a rightward shifted curve shows that even if the price stays constant at P1 that something else has changed so that now more of the good is demanded right and notice that this is true no matter what the price happens to be we could have started down here at P2 and then at this point along the original demand curve right a right word shifted demand curve says basically that even if the price stays exactly the same here at P2 something else changed so that now more of the good is demanded all right so this is what we're looking for with a rightward shift in demand basically something other than the price has changed that makes it so that more of the good would be purchased for some reason that's what a rightward shift says and that's called an increase in demand now there are lots of things that could cause this like for example an increase in income okay for most goods for what we call normal Goods we'll talk about that in a minute but say say income increases even if the price is high at P1 and stays there right if income increases probably more people are going to want the product even if the price of the good doesn't change at all but that's true also if the price happened to be low down here at P2 right if we're stuck here at P2 and income increased even without any change in in the price more of the good would be demanded right so that's what this rightward shifted demand curve shows that something other than price changed so that more of the good would be demanded an increase in income will do this an increase in the price of the substitute good will do this now substitutes are Goods that can be used for the same purpose so if the price of a substitute good Rises then people are going to shift away from that good and into this good right so the demand for a good will increase if the price of a substitute good Rises there are lots of things that could cause um you know more of the good to be demanded other than price and we're going to handle that by shifting this whole demand curve to the right remember this means that something besides price has changed making the good more attractive there are lots of things that could could cause that shift I just went over two of them now keep in mind this demand curve could shift to the left also and the interpretation is analogous a leftward shifted demand curve shows that that even if the price doesn't change something else changed making the good less attractive right originally imagine we were originally here at um let's see I'm just going to erase this a little bit here something like that okay so imagine that we were originally here at P1 out here on the second demand curve D2 if um if something changes that makes the good less attractive and the price itself doesn't move you know fewer less of the good is going to be demanded and that's what this leftward shift shows right so maybe income decreases if the price doesn't change or prices here at P1 and income decreases well less of the good is going to be demanded so we're going to move to the left right and this is true no matter what the price is if income decreases say we originally started here at P2 if income decreases less of the good is going to be demanded and so we have a movement like this right a leftward shift in the demand curve says that something other than price changed making the good less attractive and that's called a decrease in demand lots of things could do this right a decrease in the price of a substitute good all right people well what people buying this good originally whatever says bottled water whatever will shift into the good whose price has fallen for example all right so my point here friends is there are lots of things other than the price of the good that will affect how many units consumers want and we're going to incorporate those changes into our model by Shifting the demand curve to the right or to the left depending on whether or not the change that made the good more or less attractive to Consumers all right so uh that is the deal okay so I hope that makes sense to you we will uh definitely be able to incorporate and get lots of practice with this stuff as we go right so just try to remember right if something changes other than price that makes the good more attractive we move the curve to the right if something other than price change that makes it good less attractive we move it to the left now if it's the price itself that does change then we move along the demand curve that's called a change in quantity demanded right but we're moving the whole curve right or left in response to a change in any variable other than price that's a change in demand now don't get these terms confused a change in demand versus change in quantity demanded they sound very similar but they mean different things the tests for this class are word questions and so you have to be on top of small differences in wording like this because it's the difference between choosing the right and the wrong answer so um so we'll get lots of um practice with this now there are lots of different things that affect market demand right and when we talk about demand we mean the whole demand curve a change in demand um is the shifting of this entire curve so demand is this entire price quantity relationship now there are lots of different things that affect demand these are things other than price that affect consumers I talked about income prices of related Goods like substitutes but they're also complements Goods that are consumed together and then there are lots of other factors too tastes population demographics expected future prices we'll talk about each of these but we should note that this is a very incomplete list there are probably hundreds of things that we could put on this list of things other than price that affect consumers like the quality of the good the health information that exists about the good right I mean there was a time when people didn't know cigarettes caused cancer for example right that piece of information uh had a significant effect on market demand for cigarettes but notice it's not even on this list it's kind of buried in tastes here if you want um you know cigarettes causing cancer decrease people's taste for the product okay that seems reasonable but um you know you could put a lot of other things on this list that's my point maybe hundreds of things right so uh but we'll consider these five now the main thing I really want you to be able to do is yeah you're going to have to know some definitions and work with these five things that shift demand but I really want you to think about the intuition behind oops Bond how this works right that a shift into a change in demand yeah is caused by a change in any variable other than price and that when a change happens that would make the good more attractive we move the curve to the right and when a change happens it makes a good less attractive we move the curve to the left and that's true as long as the change is something other than the price of the good if it's the price of the good we move along the curve now that intuition will get you as far as you need to go with these five variables but it'll also allow you to handle any of the hundreds of real or variables that aren't on this list but do nonetheless influence market demand so you know the understanding intuitively what it means to have the curve shifting right and left is really critical so with regard to income there are a couple of caveats here now for most goods for what we call normal Goods demand increases as income Rises all right and that makes sense right as people have more money they typically want more stuff that's the whole point of getting more money is so you can afford more stuff right and so when income increases generally speaking demand for products Rises that's true for most things for normal Goods that is true but there are goods for which it's not true where you might actually buy less of the good if your income increased think about that for a minute is there anything in your life that you would buy less of if you made more money right well listen when I was in college I had a lot of Top Ramen the lowest price I ever got them for was 10 cents a piece I got 10 for a dollar and so I was eating my I was feeding myself for 10 cents a meal my girlfriend's dog I crunched it out because I was an econ major uh was eating for 40 cents a meal so the dog was eating for four times the cost per meal as I was eating and it was at that point friends that I made some adjustments to my diet so anyway um I do not eat much uh Ramen anymore because I ate too much as college students and so I made more money I shifted away from ramen noodles and so for me those are that's an inferior good there's nothing like super inferior about this like uh like you know Subway actually Subway Subway restaurants actually do really well during recessions it's because people go there because it's it's relatively cheap food there's nothing wrong with Subway right um but it's an inferior good because you know the demand increases when When people's income Falls um so this term inferior is a little sounds a little bit derogatory but it's not meant that way it's just that there's something going on there if consumers want less of the product if they make more money but anyway with regard to changes in income this is something that you have to be aware of you're going to get questions from me about um how does the change in income affect the demand for a product it'll say in the setup of the question if the good is normal or inferior but you have to keep in mind that this is a really important difference and that it totally affects your answer for normal good income will increase if income increases the demand shifts to the right but for an inferior good an increase in income shifts the demand to the left all right so that's just something you got to be aware of all right so um that's good I think this is just a visual description here's an increase in income for a normal good this is an increase in income for an inferior good all right now with regard to changes in prices of related Goods there are two types of relations that we're interested in here substitutes and compliments I've mentioned substitutes already a little bit substitutes are Goods that can be used for the same purpose complements are Goods that are typically consumed together like peanut butter and jelly or um you know hamburgers and hamburger buns or whatever substitutes these are Goods that can be used for the same purpose like if you're hungry you can get a Big Mac or a Whopper if you need a truck you could get a Ford F-150 or a Dodge Ram sorry that adds a really deep manly voice for the ram so I tried to go there but it didn't work for me anyway so these are the two relationships you gotta be aware of and um you know I think the thing to do is come back to that sort of intuitive meaning of what it is to have the supply curve shifting to the right or to the left right or sorry the demand curve so here's the demand curve that's a terrible demand curve sorry about that I have no artistic talent and it's really sad because this job kind of requires me to draw stuff sometimes anyway so a rightward shifted demand curve says that something other than price changed that makes the good more attractive so even if we started here at P1 and we stay at P1 our rightward shift says something else changed to make the good more attractive now this is also true if we had been down here at a lower price right something else changed so that even if the price stays exactly the same with P2 now more of the good is demanded for some reason so that rightward chef says the good has become more attractive a leftward shift says it has become less attractive now with that interpretation in mind you know you can just kind of intuitively push your way through some of these examples right what do you think happens to the demand for Big Mac if the price of the Whopper Rises the price of the Whopper Rising make the Big Mac more or less attractive well probably more attractive some people who buy the Whopper normally going to switch into the Big Mac if the Whopper gets more expensive and so the demand for the Big Mac will shift to the right right now um what about compliments here right Big Macs and McDonald's fries okay so these are compliments people typically buy these together now um if the Big Mac goes up in price people probably not going to buy the Big Mac anymore or not as much right that's just the law of demand but that's going to affect the demand for fries also people are buying less Big Macs that means less fries and so if the price of the Big Mac goes up then um the demand for fries goes down now the opposite is true too if the Big Mac big you know goes on sale then people are going to buy more Big Macs they're going to buy more fries so the demand for a good will increase if the price of a compliment Falls all right so it's kind of how substitutes and complements work all right here's kind of a picture of some of that stuff that I just went over right now when we talk about the tastes for a good right remember we've we're going through these five variables that shift market demand we've done income you have to worry about the normal and and inferior Goods we've done prices of related Goods okay so you got to worry about compliments and substitutes now uh we're on to our third which is tastes we'll also do population demographics and expected future prices okay now tastes um you know the tastes are just kind of overall consumer preference for a good um typically we think about advertising as changing the tastes for a good a 30 second ad during the Super Bowl for example is really really expensive the only reason that firms are willing to pay millions of dollars for a 30 second ad is because they know that it'll increase the demand for their product and um you know increase their profits by more than the cost of the ad itself right otherwise they wouldn't pay for the ad to be no point um so taste can change for a lot of different reasons you think about uh health information as changing the taste for a good also but I kind of think it think of it as something separate but you know maybe now it doesn't really matter uh anyway uh taste can change for a good if the good becomes more popular the curve shifts to the right it becomes less popular shifts to the left simple as that right now demographics are statistics that describe populations so demographers are people that study populations and they will break down a population across a lot of different statistics demographics if you will right so for example a demographer breakdown of population with respect to uh race um religious affiliation political affiliation gender age eye color what kind of clothes they like I mean as much information as they can get we can break down a population so demographics describe these popular relations how they change and the truth is that populations change all the time in the United States there are two big demographic shifts happening we're getting older and less white that is what's happening and uh this is relevant because um as groups grow or Shrink in size so too does demand for products favored by those groups right we're seeing a significant increase in people in their 80s right now right because we have serious advancements in health care that are helping people live longer now so what that means is the number of 80 year olds that exist is growing and so the demand for products favored by people in their 80s is Shifting to the right as there are more customers right something other than price changing may think of making a good more attractive well more customers will do that okay now finally um expectations about future prices look the deal is that consumers like low prices and so they look at um you know what they think the prices are going to be in the future and that affects their willingness to buy today for example if prices are supposed to be higher in the future that makes today's prices look more attractive so demand today will increase if folks think the price will be higher in the future lower prices in the future make prices today look worse right and so demand today will decrease if people think prices will be lower in the future as people wait for those lower prices right if I told you the price of gas was going to Triple today you'd probably go out and you know fill a gas tank up if you if you have a car or if you're really into it go buy a gas truck right fill that thing up and sell the gas tomorrow when it's cheap or when it's more expensive something like that right so listen these are definitely five different things that we've gone through that can shift the demand curve around to the right or to the left there's some definitions you need to know in there but big picture the intuition is really the most important thing a rightward shifted curve shows that more of the good is demanded for some reason other than the price of the good decreasing all right so um have you ever been to an Apple store trying to get those people to talk to you about what's happening with future products they are pretty tight-lipped that crew and the reason is because people in the Apple Store know that new models are substitutes for the current model and that people will wait for the new model to come out and so if they talk about new stuff coming out it's bad for existing sales people will wait until the next product comes out and also um they think prices for the current model will be lower in the future because they know when the new one comes out the price of the old one Falls so this is this is one really good reason why the people in the Apple Store will not tell you anything about new products even though sometimes they know stuff they do all right now um in this section we've gone over a lot of terminology that sounds similar the most problematic for students is the these two terms uh change in demand versus a change in quantity demanded these two things sound really similar but they mean different things and you have to be able to distinguish between terms like this that sound familiar I mean we have we've had others too we had the substitution effect and we had substitute Goods right those two things sound similar but they mean really different things that you have to know these differences friends you got to have this terminology down so change in demand versus change in quantity demand is probably the most important one it comes up a lot and the answers to the questions that you're going to be assessed on right now these questions are word questions hence the definitions and the differences between words really matters so change in demand versus change in quantity demanded a change in quantity demanded is caused by a change in the price of the good remember when we first developed a demand curve that we considered some different prices we thought about how the quantity demanded might change and you know at a price of like 250 for example we saw that there were three and then when the price Falls to two dollars we said we'd get four these were millions of water bottles sold right something like that so this is the first time we saw the the term quantity demanded this is quantity demanded right here and quantity demanded is changing right here from three to four now the only thing that causes a change in quantity demanded is a change in the price of the good itself it was this relationship that we plotted to create our first demand curve right so when we use the term a change in quantity demanded this is what we're talking about it's caused by a change in price and is shown by movement along the curve like so right now since then we've been dealing with a change in demand which is where the whole curve is Shifting lots of things caused that right we went through five of them income price of related Goods taste population demographics inspected future prices but in reality there are probably hundreds of things that cause the demand to change only one thing causes a change in quantity demanded of movement along the curve and that's the price of the good everything else causes a change in demand which is the whole curve shifting to the right or to the left okay so hope that makes some sense to you now if you're pondering a career as an economist one of the things you might be able to get a job doing is forecasting demands right companies pay economists and consulting firms and a lot of them have in-house folks that do this but they pay them to sort of predict how much of the good they're going to be able to sell that's called forecasting demand you can see why this would be really important to uh to companies they want to know how much should I produce right no firm wants to over produce and have a bunch of money tied up in inventory and no firm wants to under produce either and leave money on the table right so try to get it right and to get it right they have folks that forecast the demand you could do this so what do you have to know to forecast the demand what kind of you want to start with last year's demand and then make some adjustments to it think well how did incomes change right are we in a recession have income's fallen or we're in an expansion where it comes arising or things flat right you want to know how incomes change um what you know how has the availability of substitutes changed have consumers tastes change right have we done some great advertising have our competitors just destroyed us with ads what has happened right how have consumer demographics changed you got to try to factor in everything that you know about the demand for a product and um use that information to forecast the demand for next year of course there's lots of room to be wrong but this is an important job and uh you can get paid good money for doing it so I hope that makes some sense friends so that is the demand side of the market let's have a look here at the supply side the supply side of our Market model is where we will handle everything that affects the sellers the buyers in the market are handled with the demand side and the demand curve the sellers are here with the supply side and what you'll see in a minute the supply curve now when we talk about Supply generally we're thinking about how many units would be produced now there are lots of different things that affect how many units we'd be produced the price of the product is probably the most important but there are many others like the cost of producing it right and how many other firms exist in the industry and what people think of the price in the future and lots of other factors too but we will start of all these different things that affect these sellers we will start by thinking about the uh the price of the output itself so we're turning to our water bottle example here is a supply schedule this table right in the left column we have prices and in the right column we have the quantities that would be supplied now what you see here is that as the price Falls the quantity supplied decreases right and this makes sense because as the price Falls it's harder for firms to profit and when firms aren't profiting as much they don't want to produce as much and so when the price Falls the quantity supplied decreases um and when the price Rises the quantity supplied increases if you put price on the vertical axis in quantity on the horizontal axis as we did when we developed the demand curve and we plot the points here in this relationship between price and quantity um what you'll see is you get this upward sloping supply curve right notice what happens is we move along the supply curve here the price is rising and the quantity supplied is increasing and we move down the curve the price is falling and the quantity supplied is decreasing right this table that we have developed here that describes this relationship is called a supply schedule the line that's plotted based on those points that's called the supply curve all right now what you can see here in this upward slope of the supply curve is that fundamental intuition that when the price Rises it's easier for firms to profit and so the quantity supplied will increase as existing firms boost production and maybe even new firms enter the industry and as the price Falls the quantity Supply decreases because it's harder to make a buck and fewer firms are interested in participating in the market as the price Falls and it becomes more difficult to profit right and so in this uh in this fundamental relationship that you see here in this upward sloping supply curve is the law that's my big scary voice again of Supply right this is the rule that holding everything else constant ceteris paribus right an increase in the price will increase the quantity supplied and vice versa decrease in the price decreases the quantity supplied so this friends is how we handle the way that the market price affects the quantity that would be supplied but as we know there are lots of other things besides the price that affect the quantity that would be supplied and we will consider those now the way we will introduce those other things besides the price that affect the quantity supplied is going to be to move the supply curve around to the right and to the left just like we did with the demand curve all right so I think an important part of this is understanding what it actually means sort of mathematically or intuitively to have this curve shifting to the right uh or or to the left okay so here is a supply curve all right there's a price here's quantity supply all right so think for a minute what it means to have a curve out here to the right one well there are a few ways to see it I think probably the cleanest is to note that this right work shifted supply curve says that doesn't matter what the price is could be up here P1 a nice high price when we have a curve shifted to the right what it tells us is that if the price stayed exactly the same like started here at P1 and continued to bp1 that a regular shifted curve says even at that same price if the price stayed exactly the same more units would be supplied for some reason and this rightward shifted curve shows that this is true no matter what the price is if we started down here at P2 we originally at this spot on the supply curve a rightward shifted curve shows us that even if the price stays exactly the same something else has changed so that more of the good would be supplied so generally speaking this is going to be something that increases the profitability of this particular item makes this item look better than Alternatives that the firms could think about producing or it may just be an increase in the number of firms that exist but basically a rightward shifted supply curve says something other than the price has changed makes it so more of the good will be produced and a leftward shift says the opposite the leftward shift shows us that even if the price stayed the same less of the good would be supplied for some reason lots of different things could cause this but ultimately when you've got the whole curve moving around shifting to the left and to the right something other than the price has changed making it so more or less of the good will be produced for a right word and leftward shift respectively so that's what's going on with this curve shifting to the right or to the left something other than the price has changed making the good more or less attractive to produce all right so it's really similar to what we had on the demand side where the curve shifts around when more something other than price causes a situation where more or less of the good would be consumed right so anyway this is what it means for the supply curve to shift around there are lots of different things besides price that affect how many units will be produced we're going to handle all those things by Shifting the curve to the right or to the left there are some definitions that you have to know and we'll go over those but the main thing is the intuition you're going to be given changes on both for both demand and supply and I'm going to ask you to model those changes what you're going to have to do is figure out based on the change you're given first of all would this affect the supply or the demand curve and once you figure out whether it affects the buyers or the sellers primarily then you say okay well will this make it so more Market activity would take place or less and for both curves if it's more Market activity you shift the curve to the right if it's less Market activity you shift it to the left so we'll get some practice doing that but ultimately that's where we're going with this you're going to have to actually ship these things around um here in in due time all right so um you know as I mentioned this this supply curve shifts around and these denote and and you know basically articulate changes that are in some variable other than the price of the good itself so there are many things that could move this supply curve around we will consider only five okay this is a really incomplete list but it's a list of the important ones and because it's incomplete that's why I think understanding the intuition behind what makes the supply curve shift to the right to left is important if you understand that intuition that more production means a right work shift and less production means a leftward chip then you could handle these five variables in any of the other variables that we could put on this list all right so we will consider these separately but let's talk about them briefly so prices of inputs inputs are anything that the firm needs to produce output so this could be raw materials workers land machines um that sort of thing okay now technological change technology is a sort of a problematic word for students in this course a lot of sense because it has such a common usage right but in economics technology means something specific all right technology is the process that firms use to convert inputs into outputs so you can kind of think about a firm as the subtle economists do sometimes we think about a firm as kind of a black box okay this is the firm all right and what the firm does every firm is it buys inputs and once it has obtained the inputs whatever the firm needs to produce the output the inside the firm the technology is applied right so whatever process the firm uses um to convert the inputs and the outputs whatever process is used is actually applied and after the technology is implied to the inputs The Firm sells sells the output every firm works this way all right so technology is the process the firm uses to convert the inputs and the outputs and generally speaking the technology just gets better because technology is a process right we don't generally forget processes now there are some times when technology might decline because a process is made illegal for example some companies in the past have used part of their technological process has been to just be able to dispose of their waste for free back in the day chemical manufacturers could just dump the waste from their chemical production into rivers but nowadays we have the Clean Water Act and that's illegal so the government forced firms to dispose of their waste in a more responsible way and it increased costs for the firms and you could model that by something that makes firms uh worse off and therefore leftward shift in Supply now prices of substitutes in production there are a lot of goods that firms could produce right think about the number of goods that Coca-Cola could produce they have a lot of different drinks that they make substitutes in production are Goods that can be produced using similar inputs so Coca-Cola has a lot of goods like this that could produce Coke they could produce Diet Coke and the price of coke affects the amount of supply of Diet Coke say for some reason the price of coke went through the roof and Coca-Cola could barely keep up with demand for that product well then they would probably end up producing less Diet Coke in order to supply more of the coke whose price has risen right anyway number of firms in the market that toast certainly affects how much is available for sale and expected future prices right firms want to sell when the price is higher so if they think price is going to be lower in the future then they want to sell more today if they think price is going to be higher in the future well they might uh hold back on production today to try to get tomorrow's higher prices so we'll talk about each of these specifically but that's just a brief run through right so as I mentioned inputs are anything used in the production of a good or service remember that a rightward shifted curve says that something has changed making it so more of the good would be supplied and a leftward shifts is something other than price has changed making so less of the good would be supplied all right so inputs are things that the firm has to buy so if the price of inputs goes up it's bad for firms it's harder for them to produce produce so that's a leftward shift if the price of inputs Falls it makes producing the good itself easier more profitable so Supply increases that's pretty much it so technological change is the process that firms use to convert inputs into outputs and essentially if the process gets better that means that firms can produce more output with the inputs they have or conversely could produce a given amount of input sorry of output with fewer inputs all right so um generally speaking technology just gets better and so that's going to be a rightward shift as it gets easier for firms to profit now of course technology could get worse if the government restricts some um you know production process and that could make Supply shift to the left as well all right so prices of related Goods um we talked about we've talked briefly about substitutes in production um you also have there are also some compliments in production and the prices of these things affect one another for example substitutes in production these are Goods that the firms can produce using similar inputs so the classic example in the United States is Quorum soybeans Now farmers produce corn and soybeans and each year they decide what they want to produce right corn and soybeans are not like an orchard where you're stuck with the specific type of tree for decades right corn and soybeans typically the fields are burned at the end of the year so at the beginning of the Season Farmers have to decide well what's it going to be this year corn or soybeans of course if the price of uh one of those two goods goes up then the farmers want to produce that good and it means the supply of the other good is going to decrease right for example if soybeans goes up in price then uh The Firm then the farmer will want to supply soybeans and that means he'll plant less corn so the price of a substitute in production Rises the supply of a given good will decrease and vice versa now sometimes the two products are produced together complements in production if you will like producing beef and leather right they both come from cows so if the price of beef goes up then there's going to be more leather supplied and so it's as simple as that friends so hopefully that makes some sense to you now a number of firms and expected future prices basically if there are more firms there will be more production so rightward shift and vice versa if firms think the price is going to be higher in the future then they want to pull back today in order to produce more in the future perhaps it's easiest to think of this example with an oil producing company a company that has rights to drill for oil in a certain area wants to drill that oil out when the price is high right if the price is low they don't want to pump that oil out once the oil is out it's gone so when the price is lower they cut back on production and when the price is higher they increase production um and of course what determines whether or not today's price is higher or lower is the firm's expectation of future prices if firms think price will be higher in the future cut back today if firms think they'll be lower in the future then produce more today all right so that's these are all different reasons and well a few of them anyway that the supply curve can shift to the right or to the left there are some definitions to know here but the key thing is to understand that a rightward shift means more production will take place and the leftward shift means less production will take place and that's valid for any thing that affects firms other than the price of the good itself the price of the good itself changes you move along the curve that's a change in quantity supplied if the price if anything other than the price changes the whole thing shifts and that's a change in Supply and that's what's here on this diagram you'll recall we had something similar at the end of our demand section A lot of this terminology sounds similar so you got to keep this stuff straight change in Supply versus change in quantity supplied those terms sound similar they mean different things there's a lot of stuff like that in this course I mean think about the word substitutes we saw substitutes in production we've seen substitute Goods that consumers choose between and we've also seen the substitution effect right so you have to have this terminology dialed in you're going to get word questions on the exams and um you know you got to know what the words mean to have a shot so heads up on these definitions that sound similar probably the most important one is the change in Supply versus change in quantity supplied or change in demand versus change in quantity demanded so I have slides dedicated to those okay so when we use the term a change in quantity supplied remember where we first encountered that um that term okay what we were doing was thinking about how the quantity supplied might change in response to different prices right now uh in the market for bottled water what we saw was that for some different prices that when the price Rises the quantity supplied increases and we could plot these points here's price here's quantity supplied and create a supply curve something like this right so when we talk about a change in quantity supplied this is what we're talking about quantity supplied changes only when the price of the good itself changes and we model that by creating different points along a supply curve right so when we use the term a change in quantity supplied it's caused only by the price of the good changing and is a movement along the supply curve anything other than the price of the good changes we say Supply is changing and the whole curve shifts to the rider to the left so that's the key difference in terminology quantity supplied only changes in responsive change in price it's movement along the Curve Supply changes in response to change in anything other than the price of the good itself and is modeled by movement of the entire curve so you got to have that stuff down okay now that we have created a supply curve and created a demand curve we now have these tools that we can use to represent the buyers and the sellers in a market right we've thought about lots of different variables that affect the buyers and the sellers and we know how to model changes in those variables using the supply and demand curves if the price of the good itself changes we move along the supplier demand curves if anything other than the price of the good changes we move the entire supplier demand curve to the rider to the left depending on whether more or less activity is expected respectively all right so let's try to put the buyers and the sellers together we in fact know that they interact with each other in markets and what we're trying to do here is build a model of a market so consider for a minute how we develop these these curves right we thought about some different prices there's an e in there and we thought first about how the quantity demanded would change and then about how the quantity supplied would change and we thought about these prices um something like this right I'll leave that last one off or maybe I want down here 50 cents okay and we said well the quantity demanded that that uh D that increases as the price Falls right so we're like three four five six seven and the quantity supplied that actually uh decreases as the price Falls firms prefer the higher prices so we had numbers that look like this now uh the market equilibrium by definition is where quantity supplied equals quantity demanded notice that there is only one price where the quantity supplied equals the quantity demanded and it's here at a buck fifty right so we say that a buck 50 is the equilibrium price and that five is the equilibrium quantity all right now if we graph these if we if we were to graph these remember what happens here here's here we have price here we have quantity here's the supply curve here's the demand curve and this point right here that is the equilibrium that is where the quantity supplied equals the quantity demanded it's five units and where the price must be a buck 50. now uh the reality is that this equilibrium this point here this is our expected outcome in the market and uh you'll see why in a minute but basically it's because if the price is anything other than the equilibrium a surplus or a shortage will emerge putting pressure on the market to move towards that equilibrium all right so here's a prettier graph than the one I just drew but it is nonetheless the same thing right we put these supply and demand curves together this point where their cross is the equilibrium and it is denoted by an equilibrium price a buck 50 equilibrium quantity of five right now as I mentioned the equilibrium is the expected outcome which is to say that if the supply curve accurately uh depicts the preferences of Sellers and if this demand curve accurately uh depicts the preferences of the buyers then we think this will occur this equilibrium specifically that means that five units 5 million I guess in this situation will sell at a price of a buck fifty now the reason we think this is the expected outcome is because if it's not the current outcome there will be pressure pushing us towards that outcome for example imagine if the price was two dollars notice that if the price was two dollars that the quantity supplied which is here is 6 million and the quantity demanded here is 4 million so we have a situation where you have six million being produced and only 4 million being uh desired and that's a surplus friends we have more units being produced than what we'll sell and you can quantify it right we have a surplus here of two million units because we're supplying six and only demanding four all right and so what do you think happens to the price if there are these Surplus units that are existing that are not selling all right of course the firms have to lower the price in order to sell those units and that's what happens anytime there's a surplus this Surplus will put downward pressure on the price towards the equilibrium so if the price is above the equilibrium Surplus emerges putting downward pressure on the price now what if the price is below the equilibrium well say for example the price was 50 cents notice that down here at a price of 50 cents that consumers want to buy a lot of water seven million bottles of water down here is what the quantity demanded is you can tell because that's where the price of 50 cents crosses the demand curve now at this price of 50 cents the supply curve tells us that only 3 million units will be supplied at a price of 50 cents and so we have a shortage right you'll always get a shortage if the quantity demanded exceeds the quantity supplied and in this case we have a 4 million unit shortage right consumers want 7 million firms are only willing to supply three so this four million bottle shortage and what do you think happens to the price if there's a shortage right there's upward pressure isn't there um for a lot of reasons right firms know that there's a shortage because there's a line out the door when they open every morning and they sell product immediately right so firms may try to take advantage and increase the price consumers may even bid against each other but either way at a price of 50 cents the shortage emerge is putting upward pressure on the price so that's why we say the equilibrium price this equilibrium this is the expected outcome because if it's not the current outcome well then the price is either above or below and if it's above there's a surplus putting downward pressure and if it's below there's a shortage putting upward pressure in the end pressure will lead to a situation where the market Finds Its equilibrium now equilibrium if you look it up in the dictionary it's like the fifth definition it says at rest and it's because at that point there is no pressure on the price to move any direction at the equilibrium the quantity supplied equals the quantity demanded there is no shortage there is no Surplus and therefore there is no pressure for the price to go anywhere all right so one key thing to keep in mind here is that both supply and demand matter nobody dictates the price in a competitive market right one with with many buyers and sellers the price is determined by both parties and um and the price can be found at the equilibrium here right where these curves cross here is our equilibrium length but one thing we know friends is that listen this equilibrium might be found here at the uh where these curves cross but we know these curves move around right we studied several different variables that shift the demand curve and several that shift the supply curve so what you're going to have to be able to do is make predictions about changes in the market equilibrium price and quantity based on changes in the variables that we discussed this is the main thing you're going to have to do with this chunk of knowledge is make predictions about the change in the equilibrium and just to give you a little foreshadowing basically what you're going to have to do is start with a picture that looks like this one here and then get a change right I'm going to give you some change and you have to figure out which curve is Shifting and in which direction and then draw the shift all right so this is here's your this is your kind of three-step approach for predicting changes in the equilibrium answer these questions which curve is affected which direction does it move and then starting from this picture here draw the shift draw the shift and note uh changes in price and quantity okay so for example say this Mark of water bottles right and um and the price of plastic increases okay this is a totally reasonable question what will happen to the price and quantity in this market if the price of plastic water bottles goes up and this is the market for water bottles right well the first thing which curve is going to be effective right now between the buyers and the sellers who do you think is primarily affected by the price of plastic water bottles going up and it's the suppliers the suppliers are the ones that have to buy the plastic water bottles in order to produce their product the demanders they'll be affected eventually down the road after this after the sellers try to pass off some of the costs onto the demanders but um you know if the price of water bottles goes if the price of plastic bottles goes up that's something that affects the sellers all right so supply curve which direction remember a leftward chef says it's bad for the firms less activity is going to take place a rightward shift says something has made life better for the firms well the firm's costs are going up that's bad for them right so in the market for water bottles if the price of plastic bottle plastic bottles Rises the supply curve will shift to the left Chris now we have one and two done now you just draw the shift so I'm going to draw a new supply curve right here to the left and look at the new equilibrium it's right here notice that the price is higher and the quantity is lower right so what happened in the market for water bottles well the price went up and the quantity went down when the price of plastic bottles increased right so you're gonna have to do stuff like this here's a good three-step approach that I I recommend using all right so um let's have a look at the at the rest of the stuff as I said uh the main thing you're going to have to do is make predictions about the pricing quantity um and notice that in this example right I can't really tell you based on the information I have how big the price increases or how big the quantity decrease was um I can tell you about the direction that these shifts move in but I can't really talk about the size of the shifts without a lot more information information that we're not going to have in this class all right so um here's another type of change you might have to analyze right what happens to the equilibrium in the market for whatever the good is this is sort of the normal question when a certain change occurs right the change here is suppose income increases all right we're going to assume that bottled water is a normal good those inferior good the answer would be different but assuming that bottled water is a normal good and income increases well you just got to use your three-step approach which curve would be affected if income increases once the demand curve right consumers are the ones who get income and then which direction does it move well an increase in income for normal good is going to make it so the good will be more likely to be purchased right it's gonna be a right work shift in demand and then you just look at the at the new equilibrium and compared to the old one right the new equilibrium where D2 crosses the supply curve has a higher price and quantity so that's the answer what happens to the equilibrium well the price and quantity go up if income increases and we're talking about the market for premium bottled water all right so um here's another example right what happens to the equilibrium if what happens here well PepsiCo enters the market it's just a big bottle drink manufacturer they're going to enter the market and try to sell water so that can affect the market supply or market demand while Supply primarily right yeah it'll affect the consumers you know in in the end but the primary effect is on the market supply Pepsi is entering that means more water is going to be sold and so it's the supply curve shifting to the right and so you draw the new curve and note the equilibrium the new equilibrium is where S2 crosses the demand curve price down quantity up right that is that's the answer okay now you might want to know how much by how much will the price Fall by how much will the quantity rise and we don't know um unfortunately right all we can predict are the directions not the magnitudes of the changes now um when you've got just one curve moving it's relatively straightforward to figure this stuff out just go through that steep that three-step approach that I mentioned um you know draw start with your supply and demand diagram figure out which curve shifts in which direction and then just draw the shift and look at where the new equilibrium is and compared to the old one pretty simple when you've got just one curve moving this table right here represents all of the possibilities and what we have in here are the situation where you have only one curve moving those are all filled out here now the reality of course is that you can have both supply and demand shifting at the same time and it and it happens all the time in the market so you got to be able to handle something like that so here's an example right orange juice sales fell by more than 15 percent okay so that means the quantity has declined um without any information you know without any other change we would think that if less is selling um you know the price is probably going to be lower because well that's what firms do and they don't sell as much they try to lower the price but the reality is that in this time period the price actually went up so what we have is a situation where the sales declined but the price actually Rose right so we we have this situation here where the quantity decreased and uh the price increased now there are ways that could happen with only one curve shifting around namely if you have if you were originally here at this equilibrium and what we're seeing is that the quantity went down and the price went up that could happen if um if Supply was decreasing right price up quantity down all right but think about this quote here people are shifting to a low calorie natural product all right so if that's true how would we capture that in our uh supply and demand model right people are shifting to low calorie natural products this is the demand changing isn't it so some Deutsche Bank analyst claims that um demand ha it has decreased here and that may very well be the case but in our picture the only way we could get what we've observed is if it's the supply that's decreasing okay hmm well look if demand is decreasing and we know that that's true well you would expect that that would cause a decrease in the price right here's here's the two curves if it was just demand decreasing you'd have something like this and notice here's the original equilibrium here's the new equilibrium that the price has fallen right so if this Deutsche Bank analyst is correct and people are shifting to low calorie product demand should shift left decreasing the price but we know that the price actually went up okay so there's a couple things happening here let's believe the Deutsche Bank analyst that demand is decreasing but in order to get what we actually saw then a decline in quantity and an increase in price there must be something else happening here okay so um there is something happening there's a disease in the Citrus crop right and that has reduced the Supply right now here's a diagram of what's happened here you've got demand shifting to the left for the Deutsche Bank analyst reason um and um all else equal that would cause the price to fall but we what we know is the price increased and so you've got this big shift in Supply happening here because of the diseases in the citrus trees right so a big decrease in Supply and the small decrease in demand will result in the price actually Rising right the decline in demand would cause the price to fall the decline in Supply would cause the price to rise when both of these two things happen at the same time if the price has in fact risen it must be because the decrease in Supply outweighed the effect of the decrease in Supply in demand okay so I hope that makes some sense to you so you're going to have to make predictions about changes in Market equilibria according to changes in certain variables now for our purposes you're basically very rarely going to know the size of the shifts relative to another in this particular example we were able to tease out the fact that it must be true that the supply shift was bigger because there was a decrease in demand decrease in demand would cause the prices to fall but the price actually went up that was our clue that something else is going on and it turns out the you know problem with the citrus trees is that is the culprit right okay so coming back to our water bottle example here now um as income Rises kind of two things are going to happen um demand will increase right people with more money like ritzy or water but then over time you've got to imagine that new firms will also enter the industry so over time we would expect both supply and demand to increase in the market for premium bottled water right but how much will the supply and demand change that we don't know right and if you have both curves shifting to the right you could have lots of different possibilities right it could be like this picture shows that the demand shift is bigger than the supply shift and therefore prices go up all right um or you know well let me avoid that for a minute um so think about these two things happening separately right if you just had um the supply curve increasing right if you just have Supply increasing then that decreases the price if you just have demand increasing that increases the price here's our original price here's demand increasing we have a new price up here right so if you have these two things happening separately you really don't know what's going to happen in price unless you know about the size of these shifts relative to one another if just the supply increases price Falls if just demand increased prices rise what happens if both of these things happen at the same time well they could cancel each other out perfectly if the size of the shifts are identical but that's probably not going to happen right it's likely that one of the shifts is bigger than the other and we don't know which one is bigger than the other until after they take place and we actually observe what happened to the price but if you have both curves shifting to the right you don't really know what happens to price you can definitely say that the quantity will increase right because both of these shifts individually cause the quantity to increase so for sure the quantity is going to rise but the price we don't know and the reality is that whenever you have both curves shifting it's going to be something like this you'll know for sure about one of the variables either price or quantity but the other variable you just won't know about because you won't really know the size of the shifts relative to each other ultimately you're going to have to make these predictions though so here's a prettier picture than the one I just drew this is a drawing where the demand shift is bigger than the supply shift um causing the price to rise here is a picture of the supply shift being bigger than the demand shift causing the price to fall right so we're not going to know what actually happens to price until after these changes take place and we can observe the market if we're sitting here trying to predict what's going to happen we don't know what the truth is with regard to price quantity will certainly increase but price we don't know so here is that table flushed out a little bit further right if we have both curves shifting to the right we can definitely say Quantity increases but the price it could increase decrease or be unchanged here are the four scenarios where you've got both curve shifting ultimately you're going to be able to say something about one of the variables but the other variable you won't know about so um one last little sort of common misconception to clean up before we get into some examples is this this suppose that a supply that the supply increases all right we know that that will make um the price go down and the quantity go up and it's tempting to think that because the price is going to go down there's going to be an increase in demand but that's not true remember that when the price decreases it's a change in quantity demanded movement along the demand curve right not a change in demand so basically um you know more units will end up being consumed but that's an increase in quantity demanded caused by the price falling right remember that the demand curve already describes how much of the goods consumers want to buy at any given price so when the price Falls that's already described by the current demand curve the whole curve is not going to shift all right okay so um let's maybe um do some examples okay so here are some examples that I made up for you regarding the market for lemonade okay so um lemonade needs uh to make lemonade you need lemons sugar water and uh that's just I guess a piece of information you need to do this question properly all right so remember when you have um you know these changes and and you're trying to predict what happens in the market and by that I mean when I say what happens in the market what I'm really looking for here are what happens to the equilibrium Price p star and the equilibrium quantity Q star okay now remember we have a three-step approach all right step one which curve is affected right you got to answer these questions step two which direction does it shift and then step three is to draw the shift draw the shift and compare new equilibrium to old one so let's do our three-step approach here right so for question one the price of lemons increases all right which curve is going to be affected Supply or demand well price of lemons it's going to affect the firms right the lemonade producers okay so we're going to have Supply shifting and which direction will it shift right well press of lemons goes up firms have to pay for lemon so that's bad for them it's going to be a leftward shift okay so it's going to be the supply curve shifting left and then we're going to draw that shift here's our original equilibrium right here here's our new supply curve supply curve number two look at our look at our look at our new equilibrium now right notice that the price is higher and the quantity is uh lower right so that's the answer to part one here is that the price went up pretty pretty one up and quantity went down okay so that's how we handled part one now um what about what about uh number two here number two said number two says income increases and lemonade is a normal good so which curve is affected when income changes it's the demand curve right because the consumers are the ones who get income and is income increasing going to result in more lemonade or less lemonade being purchased well it's a normal good so that tells you with more income you're going to have more demand so for number two here we should have the demand curve shifting to the right and once you know you've got the demand curve shifting to the right you just draw that it's our original equilibrium here's the demand curve shifting to the right look at our new equilibrium up here right looks like the price is higher and the quantity is higher also so we've done this so number two that's going to result in price up quantity up okay good so how's this feeling so far friends pretty pretty reasonable just follow your three-step approach here apply the definitions and and where where we need to be um so we get to numbers five and six here okay so uh number three says um priceable I made a substitute in production Rises okay so substitutes in production price of a substitute production is that going to affect the supply or demand curve well you got to know what a substitute in production is first of all right these definitions are critical so substitute production is a good that can be produced with similar inputs right so the price of limeade goes up so we're thinking firms could produce either lemonade or limeade sure that sounds reasonable now if the price of limeade goes up how does that affect the market for lemonade well listen this is about this is all about production right substitutes in production this has to do with the supply curve right and here's the thing right if the price of limeade goes up lemonade producers might switch to producing limeade because that's going to be more profitable right so the price of limeade goes up then the supply of lemonade goes down as firms switch to the thing whose price is increased right so um so we've got the supply curve shifting and it's going to shift for lemonade to the left because the firms would prefer to produce the limeade so we've got Supply shifting to the left you just draw it here's our original equilibrium here's our new equilibrium called it S2 here is our new point where they crossed right price goes up quantity goes down and that's the answer price up quantity down okay so I hope this is making good sense to you let's have a look at the fourth one here price of vodka a complement Rises okay so complements are um this is a complement in consumption right so the idea here is that some consumers buy vodka and they drink it with their lemonade probably lemonade is something they mix in right um so the price of vodka goes up what the heck does that mean well um some people who buy lemonade and vodka together because the price of vodka goes up they're going to buy less vodka and because they're not buying as much vodka they don't need as much lemonade right so price of vodka going up is going to change the demand for lemonade and it's going to decrease it right so we just need demand shifting to the left so we just draw our picture here's our original equilibrium we need demand shifting to the left so something like this here's D2 and look at our new equilibrium looks like the price has fallen and the quantity has fallen as well and so that's the answer price down quantity down all right all right so that seems reasonable what about number five here evil Scooby-Doo music uh well this is hard because now we have two changes occurring simultaneously you've got one and two both occurring the price of lemons increases and income increases okay so what we have to do is try to predict what happens when both of these curves are are changing and as we saw when you have two curves shifting we'll be able to say something about one of the variables but the other variable we won't be sure about now there are kind of two approaches to doing these problems where you got both curve shifting my preferred approach I think it's just a little bit cleaner is to imagine that the changes are not happening simultaneously imagine they happen separately and then try to mash them together so if just one occurs we know that the we know that the price goes up and the quantity goes down if just two occurs we know that the price goes up and the quantity goes up now if they both occur simultaneously what do we think happens here well the price definitely goes up right because if just one occurs the price goes up if just two occurs the price goes up so if they both occur the price is definitely going to go up now the quantity that's the one we don't know about if just one occurs the quantity goes down if just two occurs the quantity goes up what happens if they both occur well they could uh cancel each other out perfectly but that would be only if the size of the shifts and the curves was identical we don't know how big the size of the shifts are and so we don't know actually if shift one is bigger than shift two or vice versa so we can't say what happens to quantity here so the answer for our purposes for a number five is that price is definitely going to go up but quantity we don't know about now if you uh so that's kind of my Approach for when you have two shifts happening simultaneously imagine they happen separately and try to match the effects together you'll be able to see one variable for sure we know what happens and the other variable will be ambiguous now if you want to draw these curves you can do that but keep in mind that you don't know how big the size of the shifts are relative to one another so you probably want to draw the shifts to be roughly the same size now if just one occurs we've got Supply decreasing so there's oh that's terrible but I'll work with that there's Supply decreasing um and we've got um income increasing here too right so um let's see here uh what do I want here I want income increasing so there's D2 it's D1 we have this rightward shift so here's our originally equilibrium here's our new equilibrium something like that right look you can definitely tell the price went up for sure the price went up but the quantity we don't know about right tried to draw these chips roughly the same size so that the effects on quantity would cancel each other out like they did here but if I drawn the supply shift to be bigger Well we'd see a decrease in quantity if I'd run the demand shift together we'd see a net increase in quantity but since we don't know about the size of the shifts we don't know about that particular variable in this case all right so what if number six occurs finally just wrapping things up here you've got three and four occurring simultaneously and just three occurs you've got um the supply decreasing and so price up quantity down if just four occurs you've got the demand decreasing so price down quantity down if you mash these two to together certainly the quantity is going to go down right because both of them independently because the quantity to go down the price is the one we don't know about right the price if just three occurs the price goes up if just four occurs the price goes down so we don't know about that when you try to match these two together price we don't know quantity goes down so that's the answer if you want to do the picture drawing approach that's no problem just try to make the shifts the same size and you'll be able to see which variable is ambiguous so we've got Supply decreasing something like that here's our original equilibrium and we've got demand um decreasing as well okay so here's demand decreasing as well oh that's just terrible so here is where S2 and D2 cross this is our new equilibrium and you can see the price we don't know what the heck happened there we don't know but quantity we were originally here and now we're here so quantity has definitely Fallen which is exactly what we said would happen all right so hope this stuff makes sense to you friends I will see you in the uh in the worksheet video all right thanks for watching it Kern's production All rights reserved