mcgraw-hill/irwin copyright 2006 by the mcgraw-hill companies, inc. all rights reserved. demand and...
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McGraw-Hill/Irwin Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
DEMAND DEMAND AND AND
SUPPLYSUPPLY
Chapter 4Chapter 4
McGraw-Hill/Irwin Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
4-2
Today’s lecture will:Today’s lecture will:• Introduce the law of demand and draw a
demand curve.
• Explain the importance of substitution in the laws of supply and demand.
• Distinguish between a change in demand (shift in the curve) and a change in quantity demanded (movement along the demand curve).
• Explain the law of supply and construct a supply curve.
McGraw-Hill/Irwin Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
4-3
Today’s lecture will:Today’s lecture will:
• Distinguish between a change in supply (shift in the curve) and a change in quantity supplied (movement along the supply curve).
• Explain how the laws of supply and demand interact to bring about equilibrium.
• Show the effect of shifts in demand and supply on equilibrium price and quantity.
• Explore the limitations of demand and supply analysis.
McGraw-Hill/Irwin Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
4-4
The Law of Demand The Law of Demand
• Law of demand – there is an inverse relationship between price and quantity demanded.
• Other things equal: Quantity demanded rises as price falls Quantity demanded falls as price rises
• Law of demand is based on the fact that people substitute for goods whose price increases.
McGraw-Hill/Irwin Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
4-5
The Demand CurveThe Demand Curve
• The demand curve is the graphic representation of the law of demand.
• The demand curve slopes downward and to the right.
• As price goes up, the quantity demanded goes down.
D
Pri
ce
(pe
r u
nit
)
0
Quantity demanded (per unit of time)
PA
QA
A
B
QB
PB
McGraw-Hill/Irwin Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
4-6
Other Things ConstantOther Things Constant
• Other things constant places a limitation on the application of the law of demand.
• All other factors, such as changing tastes, prices of other goods, income, and even the weather, are assumed to remain constant, whether they actually remain constant or not.
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4-7
Quantity Demanded Quantity Demanded Versus DemandVersus Demand
• Quantity demanded refers to a specific amount that will be demanded per unit of time at a specific price.
• Quantity demanded refers to a specific point on the demand curve.
• A change in quantity demanded, caused only by a change in the price of the good itself, is shown by a movement along a demand curve.
McGraw-Hill/Irwin Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
4-8
Quantity Demanded Quantity Demanded Versus DemandVersus Demand
• Demand refers to a schedule of quantities of a good that will be bought per unit of time at various prices, other things constant.
• It refers to the entire demand curve.
• A change in demand, caused by anything other than the good’s own price, is shown by a shift in the demand curve.
McGraw-Hill/Irwin Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
4-9
B
100
$2
Quantity Demanded Quantity Demanded Versus DemandVersus Demand
D1
Change in quantity demanded
0
Pri
ce
(pe
r 5
0 m
iles
)
Quantity demanded (per unit of time)
$1
200
AP
ric
e (p
er
50
mile
s)
Quantity demanded (per unit of time)
D0
D1
$2
$1
100
BA
Change in demand
200
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4-10
Shift Factors of DemandShift Factors of Demand
• Shift factors of demand are factors that cause changes in demand (shifts in the demand curve).
• Society’s Income An increase in income will increase
demand for normal goods. An increase in income will decrease
demand for inferior goods.
McGraw-Hill/Irwin Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
4-11
Shift Factors of DemandShift Factors of Demand
• Prices 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.
• Tastes A change in taste will change demand with
no change in price.
McGraw-Hill/Irwin Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
4-12
Shift Factors of DemandShift Factors of Demand
• Expectations If you expect your income to rise, you
may consume more now. If you expect prices to fall in the future,
you may put off purchases today.
• Taxes and Subsidies Taxes increase the cost of goods,
thereby reducing demand. Subsidies have an opposite effect.
McGraw-Hill/Irwin Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
4-13
The Demand TableThe Demand Table
• The demand table assumes: As price rises, quantity demanded
declines. Quantity demanded has a specific time
dimension to it. All the products involved are identical in
shape, size, quality, etc. Everything else is constant.
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4-14
From a Demand Table From a Demand Table to a Demand Curveto a Demand Curve
Pri
ce p
er D
VD
s (i
n d
oll
ars) A Demand Curve
Quantity of DVDs demanded (per week)
1 2 3 4 5 6 7 8 9 101112
13
$6.00
5.00
4.00
3.00
2.00
1.00 .50
0
3.50
E
D
C
BFA
A Demand Table
ABCDE
$0.50 1.002.003.004.00
98642
Price per cassette
DVD rentals demanded per
week
Demand for DVDs
G
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4-15
Individual and Market Individual and Market Demand CurvesDemand Curves
Price per cassette
$.0.501.001.502.002.503.003.504.00
Alice’s demand
Market demand
98765432
65432100
11000000
16141197532
ABCDEFGH Cathy BruceAlice
D
A
C
EF
G
Quantity of cassettes demanded per week
2
$4.00
3.50
3.00
2.50
2.00
1.50
1.00
0.50
0
Pri
ce p
er c
asse
tte
(in
do
llars
)
4 6 8 10 12 14 16
B
+ Bruce’s demand
Cathy’s demand
+ + =
McGraw-Hill/Irwin Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
4-16
The Law of SupplyThe Law of Supply• There is a direct relationship between price and
quantity supplied.
• Other things constant: Quantity supplied rises as price rises. Quantity supplied falls as price falls.
• The law of supply occurs because: When prices rise, firms substitute production of one
good for another. Assuming firms’ costs are constant, a higher price
means higher profits.
McGraw-Hill/Irwin Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
4-17
The Supply CurveThe Supply Curve
• The supply curve is the graphic representation of the law of supply.
• The supply curve slopes upward to the right because quantity supplied varies directly with price.
• As price increases, the quantity supplied increases. Quantity supplied
(per unit of time)
0
Pri
ce
(pe
r u
nit
) S
APA
QA
BPB
QB
McGraw-Hill/Irwin Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
4-18
Quantity Supplied Versus SupplyQuantity Supplied Versus Supply
• Quantity supplied refers to a specific amount that will be supplied at a specific price.
• Quantity supplied refers to a specific point on the supply curve.
• A change in quantity supplied, caused only by a change in the price of the good itself, is shown by a movement along the supply curve.
McGraw-Hill/Irwin Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
4-19
Quantity Supplied Versus SupplyQuantity Supplied Versus Supply
• Supply refers to a schedule of quantities a seller is willing to sell per unit of time at various prices, other things constant.
• Supply refers to the whole supply curve.
• A change in supply, caused by anything other than the good’s price, is shown by a shift in the supply curve.
McGraw-Hill/Irwin Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
4-20
Quantity Supplied Versus SupplyQuantity Supplied Versus Supply
Pri
ce
(pe
r b
arr
el)
Barrels per year (millions)
S0Change in Supply S1
$15A B
1700 1800
Change in quantity supplied
Pri
ce
(pe
r b
arr
el)
Barrels per year (millions)
S0
$15A
1700 1900
B$36
McGraw-Hill/Irwin Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
4-21
Shift Factors of SupplyShift Factors of Supply
• Shift factors of supply are factors that cause changes in supply (shifts in the supply curve).
• Price of Inputs When costs go up, profits go down, so that the
incentive to supply also goes down.
• Technology Advances in technology reduce the number of inputs
needed to produce a given supply of goods, decreasing costs, increasing profits, leading to increased supply.
McGraw-Hill/Irwin Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
4-22
Shift Factors of SupplyShift Factors of Supply
• Expectations If suppliers expect prices to rise in the
future, they may store today’s supply to sell later, decreasing supply now.
• Taxes and Subsidies When taxes increase, costs go up, and
profits go down, causing a decrease in supply.
When subsidies increase, costs decrease, and profits increase, leading to an increase in supply.
McGraw-Hill/Irwin Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
4-23
Individual and Market SupplyIndividual and Market Supply
Price (per DVD)
ABCDEFGHI
$0.000.501.001.502.002.503.003.504.00
012345678
001234555
000000022
013579
111415
AnnMarket
supplyCharlieBarry+ + =
Quantity of DVDs supplied (per week)
$4.00
3.50
3.00
2.50
2.00
1.50
1.00
0.50
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
Charlie Barry Ann
0
IH
G
F
E
D
C
BA
Market Supply
CA
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4-24
EquilibriumEquilibrium
• Equilibrium is a concept in which opposing forces cancel each other out.
• In a free market, the forces of supply and demand interact to determine: Equilibrium price – the price toward which
the invisible hand drives the market. Equilibrium quantity – the amount bought
and sold at the equilibrium price.
McGraw-Hill/Irwin Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
4-25
EquilibriumEquilibrium
• When the market is not in equilibrium, there is either excess demand or excess supply.
• Excess supply – a surplus, the quantity supplied is greater than the quantity demanded, and prices fall.
• Excess demand – a shortage, the quantity demanded is greater than the quantity supplied, and prices rise.
• When quantity demanded equals quantity supplied, prices have no tendency to change.
McGraw-Hill/Irwin Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
4-26
EquilibriumEquilibrium
Price
(per DVD)QS QD
Surplus(+)
Shortage (-)
$3.50 7 3 +4
$2.50 5 5 0
$1.50 3 7 -4
A
Pri
ce p
er D
VD
$5.00
4.00
3.50
3.00
2.50
2.00
1.50
1.00
S
D
Quantity of DVDs supplied and demanded (per week)
C
Excess demand
1 2 3 4 5 6
Excess supply
E
7 8
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4-27
Shifts in Supply and DemandShifts in Supply and Demand
• Shifts in either supply or demand change equilibrium price.
• An increase in demand or a decrease in supply: Creates excess demand at the original
equilibrium price. Excess demand increases price until a
new higher equilibrium price and quantity are reached.
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4-28
Increase in DemandIncrease in DemandP
rice
(p
er D
VD
s)
A
S0
Quantity of DVDs (per week)
$2.50
2.25
0 98 10
D0 D1
B Excess demand
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4-29
B Excess demandA
Pri
ce (
per
DV
Ds)
Quantity of DVDs (per week)
$2.50
2.25
0 98 10
D0
S0C
S1
Decrease in SupplyDecrease in Supply
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4-30
Limitations of Supply and Limitations of Supply and Demand AnalysisDemand Analysis
• Sometimes supply and demand are interconnected.
• The other things constant assumption is likely not to hold when the goods represent a large percentage of the entire economy.
• The fallacy of composition is the false assumption that what is true for a part will also be true for the whole.
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4-31
SummarySummary
• The law of demand states that the quantity demanded rises as price falls, other things constant.
• The law of supply states that the quantity supplied rises as price rises, other things constant.
• The laws of demand and supply hold true because people can substitute.
McGraw-Hill/Irwin Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
4-32
SummarySummary
• A change in quantity demanded (supplied), caused only by a change in the good’s own price, is a movement along the demand (supply) curve.
• A change in demand (supply) is a shift of the entire demand (supply) curve.
• Factors that affect supply and demand other than price are called shift factors.
McGraw-Hill/Irwin Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
4-33
SummarySummary
Shift Factors of Demand Shift Factors of Supply
Income Price of Inputs
Prices of Other Goods Technology
Tastes Expectations
ExpectationsTaxes and Subsidies on
Producers
Taxes and Subsidies on Consumers
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4-34
SummarySummary
• A market demand (supply) curve is the horizontal sum of all individual demand (supply) curves.
• When quantity demanded equals quantity supplied at equilibrium, prices have no tendency to change.
• When quantity demanded > quantity supplied, prices tend to rise.
• When quantity supplied > quantity demanded, prices tend to fall.
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4-35
SummarySummary
• When the demand curve shifts to the right (left), equilibrium price rises (declines) and equilibrium quantity rises (falls).
• When the supply curve shifts to the right (left), equilibrium price declines (rises) and equilibrium quantity rises (falls).
McGraw-Hill/Irwin Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved.
4-36
Given the following demand and supply of pizza:
Price Quantity Quantityper Pizza Supplied Demanded
$8 200 60 7 150 80 6 100 100 5 50 120 4 0 140 Review Question 4-1 What is the equilibrium price and quantity?
Review Question 4-2 If the price is $7, is there a shortage or surplus?How much is the shortage or surplus? Explain how the market will return to equilibrium.
Equilibrium price is $6 and equilibrium quantity is 100 pizzas.
At a price of $7, there is a surplus of 150 - 80 = 70 pizzas. Producerswill reduce the price in order to sell the surplus. As price decreases,quantity demanded increases until the surplus is eliminated at the equilibrium price of $6.