1 chapter 3 market supply and demand ©2002 south-western college publishing key concepts key...

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Chapter 3 Market Supply and Demand

©2002 South-Western College Publishing

• Key Concepts• Summary• Practice Quiz• Internet Exercises

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What is thelaw of demand?

The principle that there is an inverse relationship between the price of a good and the quantity buyers are willing to purchase in a defined time period, ceteris paribus

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What does “ceteris paribus” mean?

All else remains the same

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What is a demand curve?

Depicts the relationship between price and quantity demanded

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$20

$15

$10

$5

4 8 12 16

A

B

C

D

Individual’s Demand Curve for Compact Discs

Demand Curve

P

Q

7

A $20 4

B $15 6

C $10 10

D $5 16

Point Price Quantity demanded per compact disk (per year)

Individuals Buyer’s Demand Schedule for Compact Discs

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Why do demand curves have a negative slope?At a higher price consumers will buy fewer units, and at a lower price they will buy more units

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What is ademand schedule?

Shows the specific quantity of a good or service that people are willing and able to buy at different prices

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What ismarket demand?The summation of the individual demand schedules

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IMPORTANT - KNOW THE DIFFERENCE BETWEEN A CHANGE IN THE QUANTITY DEMANDED AND A CHANGE IN DEMAND

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When price changes, what happens?

The curve does not shift - there is a change in

the quantity demanded

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Decrease in Price

Increase in Quantity

Demanded

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$20

$15

$10

$5

1 2 3 4

P

Q5 6 7 8 9

Fred’s Demand Curve

D1

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$20

$15

$10

$5

1 2 3 4

P

Q5 6 7 8 9

Mary’s Demand Curve

D2

14

$20

$15

$10

$5

3 4 5 6

P

Q7 8 9 1011

Market Demand Curve

D3

12

15

12

$20

$15

$10

$5

1 2 3 4

P

Q5 6 7 8 9

Fred’s Demand Curve

D1

13

$20

$15

$10

$5

1 2 3 4

P

Q5 6 7 8 9

Mary’s Demand Curve

D2

14

$20

$15

$10

$5

3 4 5 6

P

Q7 8 9 1011

Market Demand Curve

D3

12

16

$25 1 + 0 = 1

$20 2 1 3

$15 3 3 6

$10 4 5 9

$5 5 7 12

Price Fred Mary Total Demanded

Market Demand Schedule for Compact Discs

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$20

$15

$10

$5

10 20 30 40

AB

A change in price causes a change in the quantity

demanded

D

P

Q50

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When something changes other than

price, what happens?The whole curve

shifts,there is a change in demand

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$20

$15

$10

$5

10 20 30 40

D1

D2

P

50

A

When the ceteris paribus assumption is relaxed, the whole curve can shift

Q

B

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Change innonprice

determinant

Increase in demand

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What can cause a shift in a demand curve?• Tastes and preferences• Number of buyers in the market• Income• Expectations of consumers• Prices of related goods

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Price increases

Upward movement along the

demand curve

Decrease in quantity

demanded

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Price decreases

Downward movement along the

demand curve

Increase in quantity

demanded

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Nonprice determinant

Leftward or rightward shift in

the demand curve

Decrease or increase in

demand

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What is a normal good?

Any good for which there is a direct relationship between changes in income and its demand curve

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What is aninferior good?

Any good for which there is an inverse relationship between changes in income and its demand curve

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What aresubstitute goods?

Goods that compete with one another for consumer purchases

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What happens when the price increases for

a good that has a substitute?

The demand curve for the substitute good increases

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What happens when the price decreases for

a good that has a substitute?

The demand curve for the substitute good decreases

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What does a direct relationship

between price and quantity mean?

The two move in the same direction

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What are complementary goods?

Goods that are jointly consumed with another good

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What happens when the price increases for

a good that has a complement?

The demand curve for the substitute good decreases

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What happens when the price decreases for

a good that has a complement?

The demand curve for the substitute good increases

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What does an inverse relationship between

price & quantity mean? It means that the two move in opposite directions

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What is thelaw of supply?

The principle that there is a direct relationship between the price of a good and the quantity sellers are willing to offer for sale in a defined time period, ceteris paribus

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Why do supply curves have a positive slope?

Only at a higher price will it be profitable for sellers to incur the higher opportunity cost associated with supplying a larger quantity

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$20

$15

$10

$5

10 20 30 40

A

BC

Supply CurveA company’s Supply Curve for Compact Discs

P

Q

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A $20 40

B 10 30

C 6 20

Point Price Quantity

An Individual Seller’s Supply for Compact Discs

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$25

$20

$15

$10

10

P

Q15 20

Super Sound Supply Curve

S1

25

40

$25

$20

$15

$10

20

P

Q25 30

High Vibes Supply Curve

S2

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What is a market?Any arrangement in which buyers and sellers interact to determine the price and quantity of goods and services exchanged

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What is market supply?

The horizontal summation of all the quantities supplied at various prices that might prevail in the market

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$25

$20

$15

$10

40

P

Q45 55

Market Supply Curve

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S total

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$25 25 + 35 = 60

$20 20 30 50

$15 15 25 40

$10 10 20 30

$5 5 15 20

Price Super Sound High Vibes Total

Market Supply Schedule for Compact Discs

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IMPORTANT - KNOW THE DIFFERENCE BETWEEN A CHANGE IN THE QUANTITY SUPPLIED AND A CHANGE IN SUPPLY

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When price changes, what happens?

The curve does not shift - there is a change in the quantity supplied

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$20

$15

$10

$5

10 20 30 40

A

BC

Supply CurveA change in price causes a change

in the quantity supplied

P

Q

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Increase in Price

Increase in Quantity Supplied

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When something changes other than

price, what happens?The whole curve shifts -

there is a change in supply

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$20

$15

$10

$5

10 20 30 40

S1S2

When the ceteris paribus assumption is relaxed, the

whole curve can shiftP

Q

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Change innonprice

determinant

Increase in supply

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What can cause a shift in a supply curve?

1. Number of sellers in the market2. Technology3. Resource prices4. Taxes and subsidies5. Expectations of producers6. Prices of other goods the firm

could produce

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$120

$90

$60

$30

1,000 2,000 3,000 4,000

D

S

The Supply & Demand for Tennis ShoesP

Q

Surplus

Shortage

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What is an equilibrium?

A market condition that occurs at any price for which the quantity demanded and the quantity supplied are equal

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What is the price system?

A mechanism that uses the forces of supply and demand to create an equilibrium through rising and falling prices

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Key Concepts

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Key Concepts

• What is the law of demand?• What is a demand curve?• Why do demand curves have a negative slope?• When price changes, what happens?• When something changes other than price, what

happens?• What can cause a shift in a demand curve?

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Key Concepts cont.

• What is the law of supply?• Why do supply curves have a positive slope?• When price changes, what happens?• When something changes other than price, wha

t happens?• What can cause a shift in a supply curve?• What is a market?• What is an equilibrium?

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Summary

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The law of demand states there is an inverse relationship between the price and the quantity demanded, ceteris paribus. A market demand curve is the horizontal summation of individual demand curves.

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$20

$15

$10

$5

4 8 12 16

A

B

C

D

Individual’s Demand Curve for Compact Discs

Demand Curve

P

Q

7

A $20 4

B $15 6

C $10 10

D $5 16

Point Price Quantity demanded per compact disk (per year)

Individuals Buyer’s Demand Schedule for Compact Discs

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A change in quantity demanded is a movement along a stationary demand curve caused by a change in price. When any of the nonprice determinants of demand changes, the demand curve responds by shifting. An increase in demand (rightward shift) or a decrease in demand (leftward shift) is caused by a change in one of the nonprice determinants.

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$20

$15

$10

$5

10 20 30 40

D1

D2

P

50

A

When the ceteris paribus assumption is relaxed, the whole curve can shift

Q

B

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Nonprice determinants of demand:

a. the number of buyers,

b. tastes and preferences.

c. income (normal and inferior).

d. expectations of future p;rice and income changes, and

e. prices of related goods (substitutes and complements)

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The law of supply states there is a direst relationship between the price and the quantity supplied, ceteris paribus. The market supply curve is the horizontal summation of individual supply curves.

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A change in quantity supplied is a movement along a stationary supply curve caused by a change in price. When any of the nonprice determinants of supply changes, the supply curve responds by shifting. An increase in supply (rightward shift) or a decrease in supply (leftward shift) is caused by a change in one of the nonprice determinants.

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$20

$15

$10

$5

10 20 30 40

A

BC

Supply CurveA company’s Supply Curve for Compact Discs

P

Q

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$20

$15

$10

$5

10 20 30 40

S1S2

When the ceteris paribus assumption is relaxed, the whole

curve can shift

P

Q

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Nonprice determinants of supply:a. the number of sellers.b. technologyc. resource prices. d. taxes and subsidies.e. expectations of future price changes, f. prices of other goods.

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A surplus or shortage exists at any price where the quantity demanded and the quantity supplied are not equal. When the price of a good is greater than the equilibrium price, there is an excess quantity supplied called a surplus. When the price is less than the equilibrium price, there is an excess quantity demanded called a shortage.

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Equilibrium is the unique price and quantity established at the intersection of the supply and the demand curves. Only at equilibrium does quantity demanded equal quantity supplied.

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$120

$90

$60

$30

1,000 2,000 3,000 4,000

D

S

The Supply & Demand for Tennis ShoesP

Q

Surplus

Shortage

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The price system is the supply and demand mechanism that establishes equilibrium through the ability of prices to rise or fall.

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Chapter 3 Quiz

©2002 South-Western College Publishing

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1. If the demand curve for good X is downward-sloping, this means that an increase in the price will result ina. an increase in the demand for good X.b. a decrease in the demand for good X.c. no change in the quantity demanded

for good X.d. a larger quantity demanded for good X.e. a smaller quantity demanded for good

X.E. When price changes there is a

opposite change in the quantity demanded as measured on the horizontal axis.

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2. The law of demand states that the quantity demanded of a good changes, other things being equal, whena. the price of the good changes.b. consumer income changes.c. the prices of other goods change.d. a change occurs in the quantities of

other goods purchased.

A. A “change in demand” means that the whole curve shifts, but a “change in the quantity demanded” means that there is movement along a stationary curve.

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3. Which of the following is the result of a decrease in the price tea, other things being equal?a. A leftward shift in the demand

curve for tea.b. A downward movement along the

demand curve for tea.c. A rightward shift in the demand

curve for tea.d. An upward movement along the

demand curve for tea.B. Because demand curves have a

negative slope, as the price declines, the quantity demanded will increase.

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4. Which of the following will cause a movement along the demand curve for X?a. A change in the price of a close

substitute.b. A change in the price of good X.c. A change in consumer tastes and

preferences for good X.d. A change in consumer income.

B. Movement along a given demand curve always occurs when the price changes, if anything other than price changes, then the whole curve will shift.

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5. Assuming that beef and pork are substitutes, a decrease in the price of pork will cause the demand curve for beef toa. shift to the left as consumers

switch from pork to beef.b. shift to the right as consumers

switch from port to beef.c. remain unchanged, since beef and

pork are sold in separate markets.d. none of the above.

A. With a decrease in the price of pork people will want to buy more pork; because beef and pork are substitutes, they will buy less at possible prices for beef.

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6. Assuming that coffee and tea are substitutes, a decrease in the price of coffee, other things being equal, results in a (an)a. downward movement along the

demand curve for tea.b. leftward shift in the demand curve for

tea.c. upward movement along the demand

curve for tea.d. rightward shift in the demand curve for

tea.B. With a decrease in the price of coffee

people will want to buy more coffee; because coffee and tea are substitutes, they will buy less at possible prices for tea.

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7. Assuming steak and potatoes are complements, a decrease in the price of steak willa. decrease the demand for steak.b. increase the demand for steak.c. increase the demand for potatoes.d. decrease the demand for potatoes.

C. With a decrease in the price of steak people will want to buy more steak; because steak and potatoes are complements, they will buy more potatoes as well.

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8. Assuming that steak is a normal good, a decrease in consumer income, other things being equal, willa. cause a downward movement along

the demand curve for steak.b. shift the demand curve for steak to

the left.c. cause an upward movement along

the demand curve for steak.d. shift the demand curve for steak to

the right.B. Normal goods are goods that people

will buy more of as their incomes increase and less of as their income decreases.

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9. An increase in consumer income, other things being equal, willa. shift the supply curve for a normal

good to the right.b. cause an upward movement along

the demand curve for an inferior good.

c. shift the demand curve for an inferior good to the left.

d. cause a downward movement along the supply curve for a normal good.

C. Inferior goods are goods that people will buy less of at possible prices as their income increases.

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B. A shift to the right of a supply curve along a stationary demand curve will result in a lower price as illustrated on the next page.

10. Yesterday, seller A supplied 400 units of a good X at $10 per unit. Today, seller A supplies the same quantity of units at $5 per unit. Based on this evidence, seller A has experienced a (an)a. decrease in supply.b. increase in supply.c. increase in the quantity supplied.d. decrease in the quantity supplied.e. increase in demand.

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$20

$15

$10

$5

10 20 30 40

S1S2

When the ceteris paribus assumption is relaxed, the

whole curve can shiftP

Q

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11. An improvement technology causes a (an)a. leftward shift of the supply curve.b. upward movement along the supply

curve.c. firm to supply a larger quantity at any

given price.d. downward movement along the

supply curve.C. When price changes, the supply curve

itself does not change, but when other things change, the whole curve will shift. A change in technology is an example of what can cause the supply curve to shift.

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12. Suppose auto workers receive a substantial wage increase. Other things being equal, the price of autos will rise because of a (an)a. increase in the demand for autos.b. rightward shift of the supply curve for

autos.c. leftward shift of the supply curve for

autos.d. reduction in the demand for autos.

C. A change in costs for a business is a factor that will shift the supply curve. If costs go up, as in the case of having to pay higher wages, the supplier has less of an ability to supply cars.

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13. Assuming that soybeans and tobacco can both be grown on the same land, an increase in the price of tobacco, other things being equal, causes a (an)a. upward movement along the supply

curve for soybeans.b. downward movement along the supply

curve for soybeans.c. rightward shift in the supply for

soybeans.d. leftward shift in the supply for soybeans.

D. With an increase in the price of tobacco farmers will want to grow more tobacco to take advantage of the higher price. Farmers will therefore plant soybeans on land they used to use for tobacco.

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14. If Qd = quantity demanded and Qs = quantity supplied at a given price, a shortage in the market results when

a. Qs is greater than Qd.

b. Qs equals Qd.

c. Qs is less than or equal to Qd.

d. Qs is greater than or equal to Qd. D. When there are more units of

something being demanded than being supplied, a shortage will result.

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15. Assume that the equilibrium price for a good is $10. If the market price is $5, a a. shortage will cause the price to remain

at $5.b. surplus will cause the price to remain at

$5.c. shortage will cause the price to rise

toward $10.d. surplus will cause the price to rise

toward $10.C. When the price of a good is below the

market price, there are more units being supplied than being demanded. The result is a shortage and consumers will bid the price up toward the equilibrium price.

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100 200 300 400

D

SSupply & Demand ExhibitP

Q

$2.00

$1.50

$1.00

$.50

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16. In the market shown in the previous graph, the equilibrium price and quantity of good X area. $0.50, 200.b. $1.50, 300c. $2.00, 100d. $1.00, 200

D. The equilibrium price and equilibrium quantity are at the point where the quantity demanded equals the quantity supplied. This is the price toward which the economy tends.

Previous graph

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17. In the previous graph, at a price of $2.00, the market for good X will experience a a. shortage of 150 units.b. surplus of 100 units.c. shortage of 100 units.d. surplus of 200 units.

D. At a price of $2.00 the quantity demanded is 100 and the quantity supplied is 300; 300 units minus 100 equals 200 units.

Previous graph

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18. In the previous graph, if the price of good X moves from $1.00 to $2.00, the new market condition will put a. upward pressure on price.b. no pressure on price to change.c. downward pressure on price.d. upward pressure on price.

C. Anytime the price is above the equilibrium price a surplus will result. Suppliers will therefore lower price to get rid of the surplus.

Previous graph

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END