Supply and DemandSupply and DemandSupply and DemandSupply and Demand

Chapter 4Chapter 4

Demand• Buyers or Consumers are sometimes

called demanders.• Consumers are said to “demand”

products in the market place.• Demand refers to the consumption

behavior of buyers in the market.• Demand also means the willingness to

pay of consumers at various prices and quantities.

Demand• Prices are the tools by which the

market coordinates individual desires.

The Law of Demand• Quantity demanded rises as price falls,

other things held constant (such as income or the prices of competitive products).

• Quantity demanded falls as prices rise, other things constant.

• Therefore, there is an inverse or negative relationship between price and quantity demanded.

The Law of Demand• What accounts for the law of

demand?• People tend to substitute for goods whose price has gone up

The Demand Curve• The demand curve is the graphic

representation of the law of demand.

• The demand curve slopes downward and to the right.

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

The Demand Curve• The slope tells us that quantity demanded

varies indirectly—in the opposite direction—with price.

• The slope of the demand curve is negative because the relationship between price and quantity is inverse.

• A simple equation of demand in slope-intercept form is

Qd = a - mP

Slope is negative

Assumption :Other Things Constant

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

• These factors may include changing tastes, prices of other goods, the income of the buyers, even the weather.

D

Pri

ce (

per

uni

t)

0

Quantity demanded (per unit of time)

PA

QA

A

A Sample Demand Curve

Shifts in Demand Versus

Movements Along a Demand Curve

• 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, “demand” refers to the entire demand curve.

Shifts in Demand Versus

Movements Along a Demand Curve

• 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.

Shifts in Demand Versus

Movements Along a Demand Curve

• A movement along a demand curve is the graphical representation of the effect of a change in price on the quantity demanded.

Shifts in Demand Versus

Movements Along a Demand Curve

• A shift in demand is the graphical representation of the effect of anything other than price on demand.• The original curve will move to the

right or to the left.

Change in Quantity Demanded

0D1

Change in quantity demanded(a movement along the curve)

B

Pri

ce (

per

uni

t)

Quantity demanded (per unit of time)100

$2

$1

200

A

D0

Shift in DemandP

rice

(pe

r u

nit)

Quantity demanded (per unit of time)100

$2

$1

200

A

D1

Change in demand(a shift of the curve – in this case a decrease in demand)

250

B

Shift Factors of Demand

• Shift factors of demand are those that cause shifts in the demand curve to the right or left.

Shift Factors of Demand

• Shift factors of demand include—but are not limited—to the following:– Society's income

– The prices of other goods– Tastes– Expectations

Shift Factors of Demand

• A rise in income will increase demand for goods.

• When the prices of substitute goods fall, you will consume less of the good whose price has not changed.

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

Shift Factors of Demand

• 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.

The Demand Table• The demand table assumes all the

following:– 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.– The schedule assumes that everything else is

held constant.

From a Demand Table to a Demand Curve

• Plot each point in the demand table on a graph and connect the points to derive the demand curve.

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

• The curve represents the maximum price that you will for various quantities of a good—you will happily pay less.

Price

per

cas

sette

(in

dolla

rs)

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

BFA

From a Demand Table to a 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

Individual and Market Demand Goods

• A market demand curve is the horizontal sum of all individual demand curves.

• The market demand curve is determined by adding the individual demand curves of all the demanders.

Individual and Market Demand Goods

• Real world sellers do not add up individual demand curves.

• They estimate total market demand for their product which becomes smooth and downward sloping curve.

Individual and Market Demand Goods

• The demand curve is downward sloping for the following reasons:

– At lower prices, existing demanders buy more.

– At lower prices, new demanders enter the market.

From Individual Demands

to a Market

(1)Price per cassette

$.0.501.001.502.002.503.003.504.00

(2)Alice’s

demand

(3)Bruce’s demand

(2)Cathy’s demand

(3)Market demand

98765432

65432100

11000000

16141197532

ABCDEFGH

Quantity of cassettes demanded per week2

Cathy Bruce Alice

D

A

C

EF

G$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

Supply• Individuals control the factors of

production.– Factors of production are the

resources or inputs, necessary to produce goods or services.

• Individuals supply factors of production to intermediaries or firms.

Supply• The analysis of the supply of

produced goods has two parts:

– An analysis of the supply of the factors of production to firms.

– An analysis of why firms transform those factors of production into final goods and services.

The Law of Supply• Quantity supplied rises as price

rises, other things constant.• Quantity supplied falls as price

falls, other things constant.• Thus, there is a direct or positive

relationship between price and quantity supplied.

The Law of Supply• The law of supply is accounted for by

two factors:

– When prices of their product rise, firms arrange their activities to supply more of the good to the market, substituting production of that good for the production of other goods.

– Assuming firms' costs are constant, a higher price means higher profits.

– Or, assuming firms’ costs rise as production increases, they must raise price to cover their cost increase.

The Supply Curve• The supply curve is the graphic

representation of the law of supply.• The supply curve slopes upward to the

right.• The slope tells us that the quantity

supplied varies directly—in the same direction—with the price.

• A simple equation of supple isQs = a + mP

Slope is positive

Quantity supplied (per unit of time)

0

S

A

Pric

e (p

er u

nit)

PA

QA

A Sample Supply Curve

Shifts in Supply Versus

Movements Along a Supply Curve

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

Shifts in Supply Versus

Movements Along a Supply Curve

• If the amount supplied is affected by anything other than a change in price, there will be a shift in supply.

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

Shifts in Supply Versus

Movements Along a Supply Curve

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

Shifts in Supply Versus

Movements Along a Supply Curve

• Changes in price causes changes in quantity supplied represented by a movement along a supply curve.

Shift in SupplyP

rice

(per

uni

t)

Quantity supplied (per unit of time)

S0

Shift in Supply(a shift of the curve – in this case an increase in supply)

S1

$15A B

1,250 1,500

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

$15A

1,250 1,500

B

Shift Factors of Supply• Shift factors of supply are those

factors that cause shifts in the entire supply curve to the left or right.

Shift Factors of Supply• The following are shift factors of

supply:– Changes in the prices of inputs used in the production of a good

– Changes in technology– Changes in suppliers' expectations– Changes in taxes and subsidies

Shift Factors of Supply• Changes in the prices of inputs

used in the production of a good.

– If costs go up, then profits go down, and the incentive to supply also goes down.

– If costs go up substantially, the firm may even shut down.

Shift Factors of Supply• Technology makes costs go down,

profits go up, thus the incentive to supply also goes up.

– This is especially true when technology replaces labor.

Shift Factors of Supply• If they expect prices to rise in the

future, suppliers may store today's production for an expected windfall later.• If they expect prices to fall in the

future, suppliers may sell off more of their inventories today.

Shift Factors of Supply• If taxes go up, costs also go up,

and profits go down, leading suppliers to reduce output.

• If government subsidies go up, costs go down, and profits go up, leading suppliers to increase output.

From a Supply Table to a 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.

• The supply curve represents the set of minimum prices an individual seller will accept for various quantities of a good.

• Competing suppliers’ entry into the market places a limit on the price any supplier can charge.

From a Supply Table to a Supply Curve

• Competing suppliers’ entry into the market places a limit on the price any supplier can charge.

Individual and Market Supply Curves

• The market supply curve is derived by horizontally adding the individual supply curves of each supplier.

From Individual Supplies to a Market

Supply

Quantities Supplied

ABCDEFGHI

(1)Price

(in dollars)

(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

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

From Individual Supplies to a Market

SupplyP

rice

per

cass

ette

(in

dol

lars

)

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

The Dynamic Laws of Supply and Demand

• Supply and demand come together to determine equilibrium quantity and equilibrium price.

Excess Supply and

Excess Demand

• Excess supply – prices tend to fall if quantity supplied is greater than quantity demanded.

• Excess demand – prices tend to rise if quantity demanded is greater than quantity supplied.

Price Adjusts• The larger the difference between

quantity demanded and quantity supplied, the greater the pressure for prices to rise (if there is excess demand) or fall (if there is excess supply.

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

A

The 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)

C

Excess demand

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

Excess supply

Excess supply

BE

Market Equilibrium• Equilibrium is a concept in which

opposing dynamic forces pushing cancel each other out.

• In supply and demand analysis, equilibrium means that the upward pressure on price is exactly offset by the downward pressure on price.

Equilibrium• Equilibrium price is the price

toward which the invisible hand drives the market.

• Equilibrium quantity is the amount bought and sold at the equilibrium price.

Equilibrium is not…• A state of the world—it is a

characteristic of the static model we use to examine the world.

• Neither good or bad—but simply a state in which dynamic pressures offset each other.

• Equilibrium exists at a particular moment in time.

Desirable Characteristics of Supply/Demand

Equilibrium

• Consumer surplus – the distance between the demand curve and the price the demander pays is net benefit to consumers.

Desirable Characteristics of Supply/Demand

Equilibrium

• Producer surplus – if a producer receives more than the price he would be willing to sell it for, he receives a net benefit.

Desirable Characteristics of Supply/Demand

Equilibrium

• What's good about equilibrium is that it makes the combination of consumer and producer surplus as large as it can be.

Desirable Characteristics of Supply/Demand

Equilibrium

• Markets allow trade, thereby leading to an increase in the combination of consumer and producer surplus.

Consumer and Producer Surplus

Pric

e

Supply

Demand

Quantity

0

$10987654321

10987654321

Producer Surplus

Consumer Surplus

Lost Surplus

Supply and DemandSupply and DemandSupply and DemandSupply and Demand

End of Chapter 4End of Chapter 4