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C H A P T E R3
Supply and DemandSupply and Demand
In this chapter,In this chapter,
look for the answers to these questionlook for the answers to these question
What factors affect buyers demand for goods?
What factors affect sellers supply of goods?
How do supply and demand determine the price ofa ood and the uantit sold?
How do changes in the factors that affect demand
good?
Markets and Competition
A market is a group of buyers and sellers of a
particular product.
compe ve mar e s one w many uyers
and sellers, each has a negligible effect on price.
In a perfectly competitive market:
All goods exactly the same
Buyers & sellers so numerous that no one can
affect market price each is a price taker
2
We assume markets are perfectly competitive.Demand
Demand
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 uantit
demanded of a good falls when the price of the
good rises, other things equal
THE MARKET FORCES OF SUPPLY AND DEMAND 4
The Demand Schedule
Demand schedule:
a table that shows the
r ce
of
lattes
uant t
of lattes
demanderelationship between the
price of a good and the
$0.00 16
1.00 14quantity demanded
Exam le:
2.00 12
3.00 10
Helens demand for lattes. 4.00 8
5.00 6
6.00 4o ce a e en s
preferences obey the
THE MARKET FORCES OF SUPPLY AND DEMAND
.
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Helens Demand Schedule & Curve
Price of
Lattes
r ce
of
lattes
uan y
of lattes
demanded
$5.00
.
$0.00 16
1.00 14
$3.00$4.00 2.00 12
3.00 10
$2.00 4.00 8
5.00 6
$0.00
.
Quantity
6.00 4
THE MARKET FORCES OF SUPPLY AND DEMAND 6
0 5 10 15 of Lattes
Market Demand versus Individual Demand
The quantity demanded in the market is the sum of thquantities demanded by all buyers at each price.
uppose e en an en are e on y wo uyers nthe Latte market. (Qd= quantity demanded)
16
Helens Qd
8
Kens Qd
+ = 24
Market Qd
$0.00
Price
12
14
6
7
+ = 18
+ = 21
2.00
1.00
8 4+
+
=
=
124.00
.
4 2+
+
=
=
66.00
.
The Market Demand Curve for Lattes
P PQd
(Market)
$5.00
.$0.00 24
1.00 21
$3.00
$4.00 2.00 18
3.00 15
$2.004.00 12
5.00 9
$0.00
.
Q
.
THE MARKET FORCES OF SUPPLY AND DEMAND 8
The Market Demand Curve
When the price is $2.00,Catherine will demand 4ice-cream cones.
When the price is $2.00,Nicholas will demand 3ice-cream cones.
e mar et eman at$2.00 will be 7 ice-creamcones.
Price of Ice-Cream Cone
Price of Ice-Cream Cone
Price of Ice-Cream Cone
Catherines Demand Nicholass Demand Market Demand+ =
2 00 2.00. . .
1.00 1.001.00
4 37
8 5
Quantity of Ice-Cream Cones Quantity of Ice-Cream Cones Quantity of Ice-Cream Cones
When the price is $1.00,Catherine will demand 8
When the price is $1.00,Nicholaswill demand5
The market demand at$1.00, will be 13 ice-
2007 Thomson South-W
ice-cream cones.
ice-cream cones. cream cones.
The market demand curve is the horizontal sum of the individual demandcurves!
Movement along the Demand Curve
Change in Quantity Demanded
Movement along the demand curve.
Caused by a change in the price of the
product.
Changes in Quantity Demanded
Price of I ce-Cream
A tax on sellers of icecream cones raises th
Cones price of ice-cream
cones and results in aBmovement a ong t edemand curve.
.
A1.00
0Quantity of I ce-Cream Con84
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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., thin s that
determine buyers demand for a good, otherthan the goods price).
Changes in them shift the Dcurve
THE MARKET FORCES OF SUPPLY AND DEMAND 12
Shifts in the Demand Curve
Price of
Ice-Cream
Increasein demand
Decreasein demand
Demand
Demandcurve, D1
curve, D2
Quantity of
Ice-Cream Cones
,
0
Demand Curve Shifters: # of Buyers
Increase in # of buyers
increases quantity demanded at each price,
shifts Dcurve to the right.
THE MARKET FORCES OF SUPPLY AND DEMAND 14
Demand Curve Shifters: # of Buyers
P Suppose the number
of bu ers increases.
$5.00
. .
Then, at each P,
Qdwill increase
$3.00
$4.00 (by 5 in this example
$2.00
$0.00
.
Q
THE MARKET FORCES OF SUPPLY AND DEMAND
0 5 10 15 20 25 30
Demand Curve Shifters: Income
Demand for a normal good is positively related
to income.
Increase in income causes
increase in uantity demanded at each rice,shifts Dcurve to the right.
related to income. An increase in income shifts
Dcurves for inferior oods to the left.
THE MARKET FORCES OF SUPPLY AND DEMAND 16
Consumer Income Normal Good
Price of Ice-Cream Cone
$3.00
2.50
An increase
in income...
2.00Increasein demand
1.50
1.00
0.50 D2
21 3 4 5 6 7 8 9 10 1211I ce-Crea
Con0
1
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Inferior goods examples
THE MARKET FORCES OF SUPPLY AND DEMAND 18
Consumer Income Inferior GoodPrice of Ice-Cream Cone
.
2.50 An increase
2.00
1.50Decrease
n ncome...
1.00
n eman
0.50
QuantityD1
D2
21 3 4 5 6 7 8 9 10 1211ce- rea
Con0
Demand Curve Shifters: Prices of
Two goods are substitutes if
Related Goods
an increase in the price of one
causes an increase in demand for the other.
Example: pizza and hamburgers.
An increase in the price of pizza
ncreases eman or am urgers,
shifting hamburger demand curve to the right.
Other examples: Coke and Pepsi,
laptops and desktop computers,
THE MARKET FORCES OF SUPPLY AND DEMAND 20
s an mus c own oa s
Demand Curve Shifters: Prices of
Two goods are complements if
Related Good
an increase in the price of one
causes a fall in demand for the other.
Example: computers and software.
If price of computers rises, people buy fewer
computers, an t ere ore ess so tware.
Software demand curve shifts left.
Other examples: college tuition and textbooks,
bagels and cream cheese, eggs and bacon
THE MARKET FORCES OF SUPPLY AND DEMAND
Demand Curve Shifters: Tastes
Anything that causes a shift in tastes towarda
good will increase demand for that good
and shift its Dcurve to the right.
The Atkins diet became popular in the 90s,
caused an increase in demand for e s,
shifted the egg demand curve to the right.
THE MARKET FORCES OF SUPPLY AND DEMAND 22
Demand Curve Shifters: Expectations
Expectations affect consumers buying
decisions.
Examples:
,
their demand for meals at expensive
.
If the economy sours and people worry about
,
autos may fall now.
THE MARKET FORCES OF SUPPLY AND DEMAND
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Summary: Variables That Influence Buyers
Variable A change in this variable
along the Dcurve
o uyers s s e curve
Income shifts the Dcurve
Price ofrelated goods shifts the Dcurve
Tastes shifts the Dcurve
THE MARKET FORCES OF SUPPLY AND DEMAND 24
A C T I V E L E A R N I N GA C T I V E L E A R N I N G 11
eman urveeman urveDraw a demand curve for music downloads.
What happens to it in each of
the following scenarios? Why?
A. The price of iPodsfalls
B. The price of music
downloads falls
C. The price of CDs falls
A C T I V E L E A R N I N GA C T I V E L E A R N I N G 11
. r ce o o s a s. r ce o o s a s
Price ofMusic downloadsMusic downloads
musicdown-loads
complements.
A fall in rice of
complements.
A fall in rice of
P1
iPods shifts the
demand curve for
iPods shifts the
demand curve for
music downloads
to the right.
music downloads
to the right.
Q2 Quantity of
D1D2
Q1
26
music downloads
A C T I V E L E A R N I N GA C T I V E L E A R N I N G 11
. r ce o mus c own oa s a s. r ce o mus c own oa s a s
Price ofThe curve
does not shift.
The curve
does not shift.musicdown-loads
ove own a ong
curve to a point with
lower P hi her Q.
ove own a ong
curve to a point with
lower P hi her Q.P1
, ., .
P2
Quantity of
D1
Q1 Q2music downloads
A C T I V E L E A R N I N GA C T I V E L E A R N I N G 11
. r ce o s a s. r ce o s a s
CDs andCDs andPrice ofmusic downloads
are substitutes.
music downloads
are substitutes.
musicdown-loads
P1
A fall in price of CDs
shifts demand for
A fall in price of CDs
shifts demand for
to the left.to the left.
Q1 Quantity of
D1D2
Q2
28
music downloads
Supply
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Supply
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
su lied of a ood rises when the rice of the
good rises, other things equal
THE MARKET FORCES OF SUPPLY AND DEMAND 30
The Supply Schedule
Supply schedule:
A table that shows the
Price
of
Quantity
of lattes
relationship between the
price of a good and the$0.00 0
1.00 3quant ty supp e .
Exam le:2.00 6
3.00 9
Starbucks supply of lattes.
4.00 12
5.00 15o ce a ar uc s
supply schedule obeys the6.00 18
THE MARKET FORCES OF SUPPLY AND DEMAND
.
Starbucks Supply Schedule & Curve
Price
of
Quantity
of lattesP
$5.00
.
$0.00 0
1.00 3
$3.00
$4.002.00 6
3.00 9
$2.00 4.00 12
5.00 15
$0.00
.6.00 18
Q
THE MARKET FORCES OF SUPPLY AND DEMAND 32
Market Supply versus Individual Supply
e quant ty supp e n t e mar et s t e sum othe quantities supplied by all sellers at each price.
uppose tar uc s an are t e on y twosellers in this market. (Qs= quantity supplied)
0
Starbucks
0
UCC
+ = 0
Market Qs
$0.00
Price
6
3
4
2
+ = 10
+ = 5
2.00
1.00
12 8+
+
=
=
204.00
.
18 12+
+
=
=
306.00
.
The Market Supply Curve
P
P(Market)
$5.00
..
1.00 5
2.00 10
$3.00
$4.00
.
3.00 15
4.00 20
$2.00 5.00 25
6.00 30
$0.00
1.00
Q
THE MARKET FORCES OF SUPPLY AND DEMAND 34
0 5 10 15 20 25 30 35
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Change in Quantity Supplied
Price of Ice-S
Cone
C$3.00
A rise in the priceof ice cream
1.00A
movement alongthe supply curve.
Quantit of
1 5
Ice-Cream
Cones0
Supply Curve Shifters
The supply curve shows how price affects
quantity supplied, other things being equal.
These other things are non-price
determinants of su l .
Changes in them shift the Scurve
THE MARKET FORCES OF SUPPLY AND DEMAND
Shifts in the Supply CurvePrice of
Ice-Cream
Cone
Supply curve, S3Supply
Decreasein supply
curve, S1Supply
curve, S2
Increasein supply
Quantity of
Ice-Cream Cones0
Supply Curve Shifters: Input Prices
Examples of input prices:
wages, prices of raw materials.
A fall in input prices makes production
,
so firms supply a larger quantity at each price,
.
THE MARKET FORCES OF SUPPLY AND DEMAND
Supply Curve Shifters: Input Prices
P Suppose the
$5.00
. .
At each price,
the quantity of
$3.00
$4.00 Lattes supplied
will increase
$2.00
(by 5 in this
example).
$0.00
1.00
Q
THE MARKET FORCES OF SUPPLY AND DEMAND 40
0 5 10 15 20 25 30 35
Supply Curve Shifters: Technology
Technology determines how much inputs are
required to produce a unit of output.
A cost-saving technological improvement has
the same effect as a fall in in ut rices
shifts Scurve to the right.
THE MARKET FORCES OF SUPPLY AND DEMAND
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Supply Curve Shifters: # of Sellers
An increase in the number of sellers increases
e quan y supp e a eac pr ce,
shifts Scurve to the right.
THE MARKET FORCES OF SUPPLY AND DEMAND 42
Supply Curve Shifters: Expectations
Example:
ven s n e e as ea o expec a ons o
higher oil prices.
,
supply now, save some inventory to sell later atthe hi her rice. .
Scurve shifts left.
*n genera , se ers may a us supp y w en e r
expectations of future prices change.*
THE MARKET FORCES OF SUPPLY AND DEMAND
Summary: Variables that Influence Sellers
Variable A change in this variable
Price causes a movementalong the Scurve
Input Prices shifts the Scurve
Technology shifts the Scurve
# of Sellers shifts the Scurve
xpec a ons s s e curve
THE MARKET FORCES OF SUPPLY AND DEMAND 44
A C T I V E L E A R N I N GA C T I V E L E A R N I N G 22
upp y urveupp y urve
Draw a supply curve for tax
return preparation software.
What happens to it in each
A. Retailers cut the price of.
B. A technological advance
produced at lower cost.
C. Professional tax return re arers raise theprice of the services they provide.
A C T I V E L E A R N I N GA C T I V E L E A R N I N G 22
. a n pr ce o ax re urn so ware. a n pr ce o ax re urn so ware
Price of
Scurve does
not shift.
Scurve does
not shift.
tax returnsoftware
S1
Move down
along the curve
Move down
along the curveP1
and lower Q.
and lower Q.P2
Quantity of taxQ1Q2
46
return software
A C T I V E L E A R N I N GA C T I V E L E A R N I N G 22
. a n cos o pro uc ng e so ware. a n cos o pro uc ng e so ware
Price ofcurve s s
to the right:
curve s s
to the right:tax returnsoftware
S1 S2
a eac pr ce,
Qincreases.
a eac pr ce,
Qincreases.P1
Quantity of taxQ1 Q2return software
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A C T I V E L E A R N I N GA C T I V E L E A R N I N G 33
. ro ess ona preparers ra se e r pr ce. ro ess ona preparers ra se e r pr ce
Price of
This shifts the
demand curve for
This shifts the
demand curve for
tax returnsoftware
S1
tax preparation
software, not the
tax preparation
software, not the
..
Quantity of tax
48
return software
Supply and Demand Together
Supply and Demand Together
P
$5.00
$6.00 D Squ r um:
P has reached
$4.00
quantity supplied
equals
$2.00
.quantity demanded
$0.00
$1.00
Q
THE MARKET FORCES OF SUPPLY AND DEMAND 50
0 5 10 15 20 25 30 35
Equilibrium price:
P
e pr ce a equa es quan y supp ewith quantity demanded
D S
$5.00
$6.00 P QD QS
$0 24 0
$4.00 1 21 5
2 18 10
$2.00
.3 15 15
4 12 20
$0.00
$1.00
Q
5 9 25
6 6 30
THE MARKET FORCES OF SUPPLY AND DEMAND
0 5 10 15 20 25 30 35
Equilibrium quantity:
P
e quan y supp e an quan y eman eat the equilibrium price
D S
$5.00
$6.00 P QD QS
$0 24 0
$4.00 1 21 5
2 18 10
$2.00
.3 15 15
4 12 20
$0.00
$1.00
Q
5 9 25
6 6 30
THE MARKET FORCES OF SUPPLY AND DEMAND 52
0 5 10 15 20 25 30 35
Excess demand
THE MARKET FORCES OF SUPPLY AND DEMAND
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Shortage (a.k.a. excess demand):
P
quantity supplied
$5.00
$6.00 D S Example:If P = $1,
$4.00 QD = 21 lattes
and
$2.00
.QS = 5 lattes
resulting in a
$0.00
$1.00
Q
shortage of 16 lattes
Shortage
THE MARKET FORCES OF SUPPLY AND DEMAND 54
0 5 10 15 20 25 30 35
Shortage (a.k.a. excess demand):
P
quantity supplied
$5.00
$6.00 D S ac ng a s or age,sellers raise the price,
$4.00
and QSto rise,
$2.00
. shortage.
$0.00
$1.00
Q
Shortage
THE MARKET FORCES OF SUPPLY AND DEMAND
0 5 10 15 20 25 30 35
Shortage (a.k.a. excess demand):
P
quantity supplied
$5.00
$6.00 D S ac ng a s ortage,sellers raise the price,
$4.00
and QSto rise.
$2.00
. r ces con nue o r seuntil market reachesequilibrium.
$0.00
$1.00
Q
Shortage
THE MARKET FORCES OF SUPPLY AND DEMAND 56
0 5 10 15 20 25 30 35
THE MARKET FORCES OF SUPPLY AND DEMAND
Surplus (a.k.a. excess supply):
P
quantity demanded
$5.00
$6.00 D SSurplus
If P = $5,
$4.00 QD = 9 lattes
$2.00
.
QS = 25 lattes
resultin in a
$0.00
$1.00
Q
surplus of 16 lattes
THE MARKET FORCES OF SUPPLY AND DEMAND 58
0 5 10 15 20 25 30 35
Surplus (a.k.a. excess supply):
P
quantity demanded
$5.00
$6.00 D S ac ng a surp us,sellers try to increasesales b cuttin rice.
Surplus
$4.00
This causesQDto rise and QS to fall
$2.00
.
which reduces thesur lus.
$0.00
$1.00
Q
.
THE MARKET FORCES OF SUPPLY AND DEMAND
0 5 10 15 20 25 30 35
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EXAMPLE 2: A Shift in Supply
P
S S
EVENT: New technologyreduces cost ofroducin h brid cars.
STEP 1:
Scurve shifts
because event affectscost of production.STEP 2: P1
PDcurve does notshift, becausebecause event
reduces cost, D1STEP 3:
is not one of the
factors that affect
makes production
more profitable atQ
Q1 Q2
price to falland quantity to rise.
66
demand. .
EXAMPLE 3: A Shift in Both Supply
P
S S
EVENTS:
price of gas rises AND
P
production costs
STEP 1:
P1Both curves shift.STEP 2:
D1D2
Both shift to the right.
STEP 3:
QQ1 Q2
r ses, u e econ Pis ambiguous:
If demand increases morethan supply, Prises.
EXAMPLE 3: A Shift in Both Supply
P
S S
EVENTS:price of gas rises AND
production costs
STEP 3, cont.P1
PBut if supply
D1D2
than demand,
P falls.Q
Q1 Q2
THE MARKET FORCES OF SUPPLY AND DEMAND 68
What Happens to Price andQuantity When Supply or Demand
Shifts?
A C T I V E L E A R N I N GA C T I V E L E A R N I N G 33
s n supp y an emans n supp y an eman
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 CDs
reduction in the royalties they must pay
for each song they sell.
Event C: Events A and B both occur.
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A C T I V E L E A R N I N GA C T I V E L E A R N I N G 33
. a n pr ce o s. a n pr ce o s
The market for
P
S1
music downloads1. Dcurve shifts
2. Dshifts left P1
P2.
fall.
D1D2
72
Q1Q2
A C T I V E L E A R N I N GA C T I V E L E A R N I N G 33
. a n cos o roya es. a n cos o roya es
The market for
P
S1 S
music downloads1. Scurve shifts
P12. Sshifts right
of sellers costs)
P2
. ,
Qrises.
D1Q
Q1 Q2
A C T I V E L E A R N I N GA C T I V E L E A R N I N G 33
. a n pr ce o s. a n pr ce o s ananfall in cost of royaltiesfall in cost of royalties
STEPS
1. Both curves shift (see parts A & B).
2. Dshifts left, Sshifts right.
3. Punambiguously falls.
The fall in demand reduces Q,
the increase in supply increases Q.
74
TEN PRINCIPLES OF ECONOMIC
2007 Thomson South-Western
CONCLUSION:
One of the Ten Principles from Chapter 1:
ar e s are usua y a goo way
to organize economic activity. In market economies, prices adjust to balance
supply and demand. These equilibrium prices
are the signals that guide economic decisions
and thereby allocate scarce resources.
76