© 2006 mcgraw-hill ryerson limited. all rights reserved.1 chapter 4: supply and demand prepared by:...

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© 2006 McGraw-Hill Ryerson Li mited. All rights reserved. 1 Chapter 4: Supply and Demand Prepared by: Kevin Richter, Douglas College Charlene Richter, British Columbia Institute of Technology

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© 2006 McGraw-Hill Ryerson Limited. All rights reserved.

1

Chapter 4:Supply and Demand

Prepared by:Kevin Richter, Douglas CollegeCharlene Richter, British Columbia Institute of Technology

© 2006 McGraw-Hill Ryerson Limited. All rights reserved.

2

Chapter Objectives

1. Explain the law of demand and what it implies. a. Distinguish a change in demand from a

change in quantity demanded. b. Draw a demand curve from a demand table. c. Derive the market demand curve.

© 2006 McGraw-Hill Ryerson Limited. All rights reserved.

3

Chapter Objectives

2. Explain the law of supply and what it implies. a. Distinguish a change in supply from a change

in quantity supplied. b. Draw a supply curve from a supply table. c. Derive the market supply curve.

3. Explain how prices adjust to achieve an equilibrium between demand and supply. a. Explain the concept of equilibrium.

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4

Chapter Objectives

4. Show the effects of a shift in demand or supply on the equilibrium price and quantity using real-world events. a. Be able to determine if an observed change in

price and quantity is due to a change in demand or supply.

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5

Demand

Demand means the willingness and capacity to pay.

Prices are the tools by which the market coordinates individual desires.

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6

Law of Demand

Law of demand – there is an inverse relationship between price and quantity demanded.

As price falls, quantity demanded rises, other things constant.

As price rises, quantity demanded falls, other things constant.

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7

Law of Demand

What accounts for the law of demand?

People tend to substitute away from goods whose price has gone up.

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8

Demand Curve

The demand curve is the graphic representation of the law of demand.

It represents the maximum price consumers will pay for an additional unit of the good.

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9

Demand Curve

The demand curve slopes downward and to the right.

As the price goes up, the quantity demanded goes down.

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10

D

Pri

ce (

per

uni

t)

0

Quantity demanded (per unit of time)

PA

QA

A

Sample Demand Curve

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11

Other Things Constant

Other things constant means that all other factors that affect quantity demanded are assumed to remain constant, whether they actually remain constant or not.

Tastes, prices of other goods, even the weather, may affect demand.

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12

Demand refers to a schedule of quantities of a good that will be bought per unit of time at various prices, other things constant.

Graphically, it refers to the entire demand curve.

Change in Demand versus Change in Quantity Demanded

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13

Quantity demanded refers to a specific amount that will be demanded per unit of time at a specific price.

Graphically, it refers to a specific point on the demand curve.

Change in Demand versus Change in Quantity Demanded

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14

A movement along a demand curve happens when there is a change in price.

We move from one point to another point on the demand curve.

Change in Demand versus Change in Quantity Demanded

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15

Changes in price

cause changes in quantity demanded

represented by a movement along a demand curve.

Change in Demand versus Change in Quantity Demanded

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16

Change in Quantity Demanded

D1

Change in quantity demanded(a movement along the curve)

B

0

Pri

ce (

per

uni

t)

Quantity demanded (per unit of time)100

$2

$1

200

A

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17

A shift in demand happens when anything other than price changes.

The entire demand curve moves to the left or right.

Change in Demand versus Change in Quantity Demanded

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18

D0

D1

Change in DemandP

rice

(pe

r u

nit)

Quantity demanded (per unit of time)100

$2

$1

200

B A

Change in demand(a shift of the curve)

250

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19

Shift Factors of Demand

Shift factors of demand are factors that cause shifts in the demand curve: Society's income. The prices of other goods. Tastes. Expectations. Population.

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20

Income

An increase in income may increase or decrease the demand for a good:

An increase in income will increase demand for normal goods.

An increase in income will decrease demand for inferior goods.

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21

Price of Other Goods

When the price of a substitute good falls, demand falls for the good whose price has not changed.

When the price of a complement good falls, demand rises for the good whose price has not changed.

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22

Tastes

A change in taste will change demand with no change in price.

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23

Expectations

If you expect your income to rise, you may consume more now.

If you expect prices to fall in the future, you may delay purchases today.

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24

Population

An increase in population will increase demand at every price.

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25

Demand Table The demand table assumes:

The Law of Demand. (As price rises, quantity demanded declines.)

A specific time dimension.

Products are identical in shape, size, quality, etc.

Everything else is held constant.

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26

From Demand Table to Demand Curve You plot each point in the demand table on a

graph and connect the points to create the demand curve.

The demand curve graphically conveys the same information that is on the demand table.

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27

From Demand Table to Demand Curve The curve represents the maximum price that

you will pay for various quantities of a good – you will happily pay less.

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28

Price

per

cas

sette

s (in

dol

lars

)

A Demand Curve

Quantity of cassettes demanded (per week)1 2 3 4 5 6 7 8 9 10 11 12

13

$6.00

5.00

4.00

3.00

2.00

1.00 .50

0

3.50E

D

C

BA

From Demand Table to Demand Curve

Price per cassette

ABCDE

A Demand Table

Cassette rentals demanded per

week

$0.50 1.002.003.004.00

98642

Demand for cassettes

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29

Individual and Market Demand Curves A market demand curve is the horizontal sum

of all individual demand curves.

This is determined by adding the individual demand curves of all the demanders.

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30

Individual and Market Demand Curves Sellers estimate total market demand for their

product which becomes a smooth and downward sloping curve.

From Individual Demandsto a Market Demand Curve

(1)Price per cassette

$.0.501.001.502.002.503.003.504.00

(2)Marie’s demand

(3)Pierre’s demand

(2)Cathy’s demand

(3)Market demand

98765432

65432100

11000000

16141197532

ABCDEFGH Pierre Marie

D

A

C

EF

G

Quantity of cassettes demanded per week2

$4.00

3.50

3.00

2.50

2.00

1.50

1.00

0.50

0Pr

ice p

er c

asse

tte (i

n do

llars

)

4 6 8 10 12 14 16

B

Market demand

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.

Cathy

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32

Law of Demand

Regarding the market demand curve,

At lower prices, existing demanders buy more.

At lower prices, new demanders enter the market.

The market demand curve is flatter than the individual demand curves.

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33

Supply

Individuals control the factors of production – inputs necessary to produce goods.

Factors of production are the resources or inputs necessary to produce goods or services.

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34

Supply

The supply of produced goods involves:

An analysis of the supply of the factors of production by households to firms.

An analysis of how firms transform those factors of production into usable goods and services.

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35

Law of Supply

There is a direct relationship between price and quantity supplied.

As price rises, quantity supplied rises, other things constant.

As price falls, quantity supplied falls, other things constant.

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36

Supply Curve

The supply curve is the graphic representation of the law of supply.

It provides the minimum price the producer requires to produce an additional unit of output.

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37

Supply Curve

The supply curve slopes upward to the right, and tells us that the quantity supplied varies directly – in the same direction – with the price.

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38

S

A

Quantity supplied (per unit of time)

0

Pric

e (p

er u

nit)

PA

QA

Sample Supply Curve

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39

Supply refers to a schedule of quantities a seller is willing to sell per unit of time at various prices, other things constant.

Graphically, it refers to the entire supply curve.

Change in Supply Versus Change in Quantity Supplied

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40

Quantity supplied refers to a specific amount that will be supplied at a specific price.

Graphically, it refers to a specific point on the supply curve.

Change in Supply Versus Change in Quantity Supplied

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41

Changes in price

cause changes in quantity supplied

represented by a movement along a supply curve.

Change in Supply Versus Change in Quantity Supplied

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42

A movement along a supply curve – happens when there is a change in price.

Change in Supply Versus Change in Quantity Supplied

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43

Change in quantity supplied (a movement along the curve)

Change in Quantity Supplied

Pric

e (p

er u

nit)

Quantity supplied (per unit of time)

S0

$25

A

1,250 1,500

B

$15

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44

A shift in supply happens when anything other than price changes.

The entire supply curve moves to the left or right.

Change in Supply Versus Change in Quantity Supplied

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45

Shift in supply – the graphic representation of the effect of a change in a factor other than price on supply.

Change in Supply Versus Change in Quantity Supplied

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46

Shift in Supply

Pric

e (p

er u

nit)

Quantity supplied (per unit of time)

S0

Shift in Supply(a shift of the curve)

S1

$15A B

1,250 1,500

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47

Shift Factors of Supply

Other factors besides price affect how much will be supplied:

Prices of inputs used in the production of a good.

Technology.

Suppliers’ expectations.

Taxes and subsidies.

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48

Price of Inputs

When costs rise, profits decrease, so there is less incentive to supply.

If costs rise substantially, the firm may even shut down.

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49

Technology

Advances in technology reduce the cost of production, and there is a greater incentive to supply.

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50

Expectations

If suppliers expect prices to rise in the future, they may store today's supply to reap higher profits later.

If they expect prices to fall in the future, suppliers may sell off more of their inventories today.

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51

Taxes and Subsidies

When taxes go up, costs increase, and profits fall, reducing the incentive to produce.

When government subsidies go up, costs fall, and profits rise, giving suppliers the incentive to increase output.

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52

Supply Table

Each supplier follows the law of supply.

When price rises, each supplies more, or at least as much as they did at a lower price.

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53

From Supply Table to Supply Curve To derive a supply curve from a supply table,

you plot each point in the supply table on a graph and connect the points.

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54

From Supply Table to Supply Curve The supply curve represents the set of

minimum prices an individual seller will accept for various quantities of a good.

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55

From Supply Table to Supply Curve Competing suppliers’ entry into the market

places a limit on the price any supplier can charge.

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56

Individual and Market Supply Curves The market supply curve is derived by

horizontally adding the individual supply curves of each supplier.

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57

From Individual Supplies to a Market Supply

Quantities Supplied

ABCDEFGHI

(1)Price

(per cassette)

(2) Ann's Supply

(5)MarketSupply

(4)Charlie'sSupply

$0.000.501.001.502.002.503.003.504.00

012345678

001234555

000000022

013579

111415

(3)Barry's Supply

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58

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16

From Individual Supplies to a Market Supply

Pric

e pe

r ca

sset

te

Charlie Barry Ann

Quantity of cassettes supplied (per week)

$4.00

3.50

3.00

2.50

2.00

1.50

1.00

0.50

0

I

H

G

F

E

D

C

BA

Market Supply

CA

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59

Equilibrium

Equilibrium is a concept in which opposing dynamic forces cancel each other out.

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60

Equilibrium

In a free market, the forces of supply and demand interact to determine equilibrium quantity and equilibrium price.

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61

Equilibrium

Equilibrium price – the price toward which the invisible hand drives the market.

Equilibrium quantity – the amount bought and sold at the equilibrium price.

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62

What Equilibrium Isn’t

Equilibrium isn’t a state of the world, it is a characteristic of the model used to look at the world.

Equilibrium isn’t inherently good or bad, it is simply a state in which dynamic pressures offset each other.

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63

What Equilibrium Isn’t

Equilibrium means that the upward pressure on price is exactly offset by the downward pressure on price.

When the market is not in equilibrium, you get either excess supply or excess demand, and a tendency for price to change.

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64

Excess Supply

Excess supply – a situation where the quantity supplied is greater than quantity demanded.

Prices tend to fall.

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65

Excess Demand

Excess demand – a situation where the quantity demanded is greater than quantity supplied

Prices tend to rise.

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66

B

A

Marriage of Supply and Demand

Pric

e pe

r ca

sset

te (

in d

olla

rs) $5.00

4.00

3.50

3.00

2.50

2.00

1.50

1.00

S

D

Quantity of cassettes supplied and demanded (per week)

Excess demand

1 2 3 4 5 6 7 8 9 10 11 12

Excess supply

E

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67

Interaction of Supply and Demand When price is $3.50 each, quantity supplied

equals 7 and quantity demanded equals 3.

The excess supply of 4 pushes price down.

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68

Interaction of Supply and Demand When price is $1.50 each, quantity supplied

equals 3 and quantity demanded equals 7.

The excess demand of 4 pushes price up.

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69

Interaction of Supply and Demand When price is $2.50 each, quantity supplied

equals 5 and quantity demanded equals 5.

There is no excess supply or excess demand, so price will not rise or fall.

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70

Price Adjusts

The greater the difference between quantity supplied and quantity demanded, the more pressure there is for prices to rise or fall.

When quantity demanded equals quantity supplied, prices have no tendency to change.

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71

Power of Supply and Demand

Changes in either supply or demand will change equilibrium price and quantity.

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72

Six Real World Examples

Supply and demand can shed light on a variety of real-world events: Brazil freeze. Financial assets and the baby boomers. Twenty percent excise tax. Rice in Indonesia. Farm labourers. Christmas toys.

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73

Sugar Shock in Brazil

The crop-damaging freeze shifted the supply curve to the left.

At the original price, quantity demanded exceeded quantity supplied.

Price rose until the quantity demanded equaled the quantity supplied.

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74

A

Shift in Supply

Pric

e

Quantity

P1

P0

0 QeQS QD

D0

S1

S0C

Excess demandB

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75

Baby Boomers and Financial Assets Demographic changes among baby boomers

moved the demand curve for financial assets to the right.

At the original price, quantity demanded exceeded quantity supplied.

Price rose until the quantity demanded equaled the quantity supplied.

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76

Increase in Demand

An increase in demand creates excess demand at the original equilibrium price.

The excess demand pushes price upward until a new higher equilibrium price and quantity are reached.

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77

Baby Boomers and Financial Assets

S

(f)

D0

P1

QeQ0

P0

D1

QD

Price

Quantity

Excessdemand

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78

Baby Boomers and the Housing Market The same phenomenon occurred in the

surging demand for housing among this group during the 1980s.

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79

Excise Tax

Korean Government imposed a 20 percent luxury tax on imported golf clubs.

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80

Excise Tax

A 20 percent tax levied on suppliers shifts the supply curve to the left.

After the tax is imposed, the quantity of imported clubs demanded drops.

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81

Excise Tax

S0

D0

P1

Q1

P0

Q0

S1

(e)

Price

Quantity

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82

Rice in Indonesia

Drought, pestilence, and the financial crisis shift the supply curve to the left.

The steep demand curve means that the quantity demanded does not change much with changes in price.

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83

Rice in Indonesia

Responding to high prices, the government imported rice and distributed it to the market, causing the supply curve to shift to the right.

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84

Rice in Indonesia

S0

Demand

P1

Q1

P2

Q2

P0

Q0

S1 S2

Price

Quantity

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85

Farm Labourers

The compressed harvesting season increased the demand and increased border patrols decreased supply of labour.

Demand shifted to the right and supply shifted to the left.

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86

Farm Labourers

At the original price, the quantity of workers demanded exceeded the quantity supplied.

Price rises until the quantity demanded equals the quantity supplied.

The effect on the number of labourers hired depended on the relative size of the supply shift.

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87

Farm Labourers

S0

D0

P1

S1

D1P0

Qe

Price

Quantity

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88

Christmas Toys

A Christmas craze for Furbies shifts demand to the right.

A shortage ensued along with a black market.

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89

Christmas Toys

Finally the supplier produced more, shifting the supply curve to the right, causing the price to drop.

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90

Christmas Toys

P1

P0

QS0

S0

D0

S1

D1

QD0 QD1

Price

Quantity

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91

Effects of Shifts of Demand and Supply on Price and Quantity

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92

Supply and Demand

End of Chapter 4