Supply, Demand and Market Equilibrium

By: Thomas Gruca - University of Iowa Mark Pelzer - Kirkwood Community College

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Demand: Raw data

Name Quantity Maximum price willing to pay

Mary Bob Jane Ed Alice

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1

1 1 1 1 1

4 1 5 3 2

Demand Schedule
Price 5 4 3 2 1
1

Quantity 1 1 1 1 1

Total Quantity Demanded 1 2 3 4 5

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Demand Curve
6 5 4

Price

3 2 1 0 1 2 3 Quantity demanded 4

D
5

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Demand: Definition
Relationship between price and quantity demanded at a given price

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Demand Curve
6 5 4

Price

3 2 1 0 1 2 3 Quantity demanded 4 5

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Demand Curve
6 5 4

Price

3 2 1 0 1 2 3 Quantity demanded 4 5

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Change in quantity demanded due to change in price 6

5 4

Price

3 2 1 0 1 2 3 4 5

II D

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Quantity demanded

Shifts in the Demand Curve

income related goods tastes number of consumers expectations of future prices

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Demand curve shifts to the right

6 5 4
Price

3 2 1 0 1 2 3 Quantity demanded 4 5
D

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Demand curve shifts to the left

6 5 4

Price

3 2 1 0 1 2 3 Quantity demanded 4 5

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Demand for an intangible good

For example, a promise exchanged for money Value of the promise depends on future events Examples
loans insurance
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Demand for an intangible good

Application: a futures contract
value based on a future event possible events
price of a bushel of wheat in October Microsoft stock price on 3rd Friday of June value of the Euro in $ on February 1st price of oil on April 21st

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Assignment
Political futures contract
pays $1 if Bradley is the Democratic nominee for 2000 pays $0 otherwise

Price that someone is willing to pay is based on their own prediction of a particular outcome Assignment: graphing a real demand curve
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Graph of Bradley demand data

0.4 0.35 0.3 0.25
Price

0.2 0.15 0.1 0.05 0 0 5 10 15 20 25 30 35 40 Quantity Demanded

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The effect of NBA party on demand for Bradley contracts

0.4 0.35 0.3 0.25 0.2 0.15 0.1 0.05 0 0
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Price

10

15

20

25

30

35

40

Quantity Demanded

Supply: Raw data

Company Name Quantity Minimum price willing to accept

ADC SSW QWE YYJ AQD

1

1 1 1 1 1

3 2 5 1 4

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Supply Schedule
Price 1 2 3 4
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1

Quantity 1 1 1 1 1

Total Quantity Supplied 1 2 3 4 5

Supply Curve
6 5 4

Price

3 2 1 0 1 2 3 4 5

Quantity supplied
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Supply: Definition
Relationship between price and quantity supplied at a given price

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Supply Curve
6 5 4

Price

3 2 1 0 1

Quantity supplied
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Change in quantity supplied due to a change in price 6

S
5

II
4

Price

3 2 1 0 1

Quantity supplied
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Shifts in the Supply Curve

prices of relevant resources technology taxes number of sellers expectations of future prices

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Supply curve shifts to the right

6 5 4

Price

3 2 1 0 1 2 3 4 5

Quantity supplied
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Supply curve shifts to the left

6 5 4

Price

3 2 1 0 1 2 3 4 5

Quantity supplied
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Supply for an intangible good

Simplified insurance example Why would anyone supply car insurance? Seller expects that you will not have an accident during the next year If you do, they pay the bills. If not, they still keep the premium (price of policy) Prices depend on how likely there will be a claim
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Political Futures Contract

Recall our example political futures contract People holding this contract get $1 if Bradley is the Democratic nominee for 2000 and $0 otherwise They may be willing to sell if they are not 100% sure that Bradley will be the nominee Assignment 4: graphing a real supply curve
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Graph of Bradley supply data

0.6 0.5 0.4

Price

0.3

0.2

0.1

0 0 5 10 15 20 25 30 35 Quantity supplied

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Effect of internet taxes on supply of Bradley contracts

0.6 0.5

0.4
Price

0.3

0.2

0.1

0 0 5 10 15 20 25 30 35 Quantity supplied
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A Market
6 5 4

Price

3 2 1 0 1 2 3 4 5

Quantity
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Surplus
6 5 4

Surplus

Price

3 2 1 0 1 2 Qd 3 4 Qs 5

Quantity

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Market adjustment to surplus

6 5 4

Surplus

Price

3 2 1 0 1 2 Qd 3 4 Qs 5

Quantity

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Shortage
6 5 4

Price

3 2 1 0 1 2 Qs 3 4 Qd 5

Shortage

Quantity

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Market adjustment to shortage

6 5 4

Price

3 2 1

D Shortage
1 2 Qd 3 4 Qs 5

Quantity

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Equilibrium
6

Price

5 4

Eq.P

3 2 1 0 1 2 3 Eq.Q 4 5

Quantity
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Government interventions: Price controls

The government sets a maximum price
Example: the price of basic commodities in many countries (milk, flour, bread, rice) what happens to the availability of this good?

The government sets a minimum price for wages

Example: minimum wage what happens to the supply of labor?
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Equilibrium in the Bradley market

Bradley Nomination Market (6/99-9/99) 0.6
S

0.5 0.4

Price

0.3 0.2 0.1 0 0 10 20 Quantity 30 40

D

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Supply and demand information available in a real market

Exchanges that already have occurred

S
Offers to sell (ask price)

Price

Market price (observed)

Offers to buy (bid price)

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Quantity

Supply and demand information available in a real market

Price
S
Best Ask Last Trade Best Bid Note: Eq.Q. is equilibrium quantity

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Eq.Q

Eq.Q +1

Quantity

Iowa Electronic Market

The market for Bradley contracts is run by the Iowa Electronic Market
real $, real time futures market run by the Tippie Business School at the University of Iowa web site: www.biz.uiowa.edu/iem

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IEM Prices: 12/10/99

Market Quotes: DCONV00
(2000 Democratic National Convention Market) Quotes current as of 15:45:05 CST, Friday, December 10, 1999.

Symbol

Bid

Ask

Last

Low

High Average

BRADLEY 0.310 0.324 0.311 0.311 0.323 0.314 GORE 0.682 0.694 0.682 0.681 0.698 0.682 DCROF 0.002 0.003 0.002 0.002 0.002 0.002 DCROF is a contract for candidates other than Gore and Bradley
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Assignment 7
Choose one of the current markets running at the IEM
Read the prospectus to make sure you understand how the contracts work Using various news sources, try to determine what events will affect prices in the IEM for two-weeks Using your understanding of supply and demand, predict how prices should change Determine if your predictions were correct and reconcile any discrepancies
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How do bid,ask prices happen?

The bid and ask prices you see on the IEM trading screen are offers to buy and sell posted by traders in the market. Other information available includes:
last traded price volume of trades historical prices
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How do you get contracts to sell?

There are two ways to buy contracts
Buy a bundle of contracts from the market
each market has a set of contracts only one will pay $1, all others pay 0$ keep the contracts that you think will pay off and sell the others

Buy from another trader

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How do you make $ in the IEM markets?

Buy and hold those contracts which eventually pay $1 Buy contracts at a low price and sell them when the prices rise Sell one of each contract when sum of all bid prices is greater than $1 (Why?)

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