4 Demand and Supply AnalysisDemand and Supply Analysis

What factors affect buyers’ demand for goods?

What factors affect sellers’ supply of goods?

How do supply and demand determine the price of a good and the quantity sold?

How do changes in demand or supply affect the market price and quantity of a good?

What are the effects of price controls?

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Demand

Demand comes from the behavior of buyers.

The quantity demanded of any good is the amount of the good that buyers are willing and able to purchase.

Law of demand: the claim that the quantity demanded of a good falls when the price of the good rises, other things equal

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The Demand Schedule

Demand schedule: A table that shows the relationship between the price of a good and the quantity demanded.

Example: The demand for lattes.

Notice that the Law of Demand holds.

P Qd

(hundreds)

$0.00 24

1.00 21

2.00 18

3.00 15

4.00 12

5.00 9

6.00 6

4

$0.00

$1.00

$2.00

$3.00

$4.00

$5.00

$6.00

0 5 10 15 20 25

P

Q(100s)

The Market Demand Curve

P Qd

(hundreds)

$0.00 24

1.00 21

2.00 18

3.00 15

4.00 12

5.00 9

6.00 6

D

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Demand Curve Shifters

The demand curve shows how price affects quantity demanded, other things being equal.

These “other things” are non-price determinants of demand (i.e., things that determine buyers’ demand for a good, other than the good’s price).

Changes in them shift the D curve…

What are these non-price determinants?

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Summary: Variables ThatAffect Demand

Variable A change in this variable…

Price …causes a movement along the D curve

# of buyers …shifts the D curve

Income …shifts the D curve

Price ofrelated goods …shifts the D curve

Tastes …shifts the D curve

Expectations …shifts the D curve

AA CC TT II VV E LE L EE AA RR NN II NN G G 11: : Demand curveDemand curve

A. The price of iPods falls

B. The price of music downloads falls

C. The price of compact discs falls

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Draw a demand curve for music downloads. What happens to it in each of the following scenarios? Why?

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Supply

Supply comes from the behavior of sellers.

The quantity supplied of any good is the amount that sellers are willing and able to sell.

Law of supply: the claim that the quantity supplied of a good rises when the price of the good rises, other things equal

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The Supply Schedule

Supply schedule: A table that shows the relationship between the price of a good and the quantity supplied.

Example: The supply of lattes.

Notice that the supply schedule obeys the Law of Supply.

P QS (hundreds)

$0.00 0

1.00 5

2.00 10

3.00 15

4.00 20

5.00 25

6.00 30

10

$0.00

$1.00

$2.00

$3.00

$4.00

$5.00

$6.00

0 5 10 15 20 25 30 35

P

Q(100s)

The Market Supply Curve

P QS (hundreds)

$0.00 0

1.00 5

2.00 10

3.00 15

4.00 20

5.00 25

6.00 30

S

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Supply Curve Shifters

The supply curve shows how price affects quantity supplied, other things being equal.

These “other things” are non-price determinants of supply.

Changes in them shift the S curve…

What are these non-price determinants?

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Summary: Variables ThatAffect Supply

Variable A change in this variable…

Price …causes a movement along the S curve

Input prices …shifts the S curve

Technology …shifts the S curve

Prices of alternativegoods …shifts the S curve

# of sellers …shifts the S curve

Expectations …shifts the S curve

AA CC TT II VV E LE L EE AA RR NN II NN G 2G 2: : Supply curveSupply curve

13

Draw a supply curve for tax return preparation software. What happens to it in each of the following scenarios?

A. Retailers cut the price of the software.

B. A technological advance allows the software to be produced at lower cost.

C. Professional tax return preparers raise the price of the services they provide.

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$0.00

$1.00

$2.00

$3.00

$4.00

$5.00

$6.00

0 5 10 15 20 25 30 35

P

Q(100s)

Supply and Demand Together

D S Equilibrium: P has reached the level where quantity supplied equals quantity demanded

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Three Steps to Analyzing Changesin Equilibrium

1. Decide whether event shifts S curve, D curve, or both.

2. Decide in which direction curve shifts.

3. Use supply-demand diagram to see how the shift changes eq’m P and Q.

1. Decide whether event shifts S curve, D curve, or both.

2. Decide in which direction curve shifts.

3. Use supply-demand diagram to see how the shift changes eq’m P and Q.

To determine the effects of any event,

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EXAMPLE: The Market for Hybrid Cars

P

Q

D1

S1

P1

Q1

price of hybrid cars

quantity of hybrid cars

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STEP 1:

D curve shifts because price of gas affects demand for hybrids.

S curve does not shift, because price of gas does not affect cost of producing hybrids.

STEP 2:

D shifts rightbecause high gas price makes hybrids more attractive relative to other cars.

EXAMPLE 1: A Change in Demand

EVENT TO BE ANALYZED: Increase in price of gas.

P

Q

D1

S1

P1

Q1

D2

P2

Q2

STEP 3:

The shift causes an increase in price and quantity of hybrid cars.

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EXAMPLE 1: A Change in Demand

P

Q

D1

S1

P1

Q1

D2

P2

Q2

Notice: When P rises, producers supply a larger quantity of hybrids, even though the S curve has not shifted.

Always be careful Always be careful to distinguish b/w to distinguish b/w a shift in a curve a shift in a curve and a movement and a movement along the curve. along the curve.

Shift in Curve vs. Movement along Curve

Change in supply: a shift in the S curve• occurs when a non-price determinant of supply

changes (like technology or costs)

Change in the quantity supplied: a movement along a fixed S curve • occurs when P changes

Change in demand: a shift in the D curve• occurs when a non-price determinant of

demand changes (like income or # of buyers)

Change in the quantity demanded: a movement along a fixed D curve• occurs when P changes

AA CC TT II VV E LE L EE AA RR NN II NN G G 33: : Changes in supply and demandChanges in supply and demand

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Use the three-step method to analyze the effects of each event on the equilibrium price and quantity of music downloads.

Event A: A fall in the price of compact discs

Event B: Sellers of music downloads negotiate a reduction in the royalties they must pay for each song they sell.

Event C: Events A and B both occur.

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Government Policies That Alter the Private Market

Outcome Price controls

• Price ceiling: a legal maximum on the price of a good or service. Example: rent control.

• Price floor: a legal minimum on the price of a good or service. Example: minimum wage.

We will use the supply/demand model to see We will use the supply/demand model to see how each policy affects the market outcome how each policy affects the market outcome

(the price buyers pay, the price sellers receive, (the price buyers pay, the price sellers receive, and equilibrium quantity).and equilibrium quantity).

We will use the supply/demand model to see We will use the supply/demand model to see how each policy affects the market outcome how each policy affects the market outcome

(the price buyers pay, the price sellers receive, (the price buyers pay, the price sellers receive, and equilibrium quantity).and equilibrium quantity).

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AA CC TT II VV E LE L EE AA RR NN II NN G G 44: : Price floors Price floors & ceilings & ceilings

22

40

50

60

70

80

90

100

110

120

130

140

50 60 70 80 90 100 110 120 130Q

PS

0

The market for hotel rooms

D

Determine theeffects of:

A. a $90 price ceiling

B. a $90 price floor

C. a $120 price floor

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Evaluating Price Controls

Prices are the signals that guide the allocation of society’s resources. This allocation is altered when policymakers restrict prices.

Price controls are often intended to help the poor, but they often hurt more than help them:

• The minimum wage can cause job losses.

• Rent control can reduce the quantity and quality of affordable housing.