Chapter 3
Supply and Demand
MODERN PRINCIPLES OF ECONOMICS
Third Edition
Outline
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The Demand Curve for Oil
Consumer Surplus
What Shifts the Demand Curve?
The Supply Curve for Oil
Producer Surplus
What Shifts the Supply Curve?
2
Definition
Demand Curve:
A function that shows the quantity
demanded at different prices.
Quantity Demanded:
The quantity that buyers are willing
and able to buy at a particular price.
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Demand
Demand for Oil
Price
Quantity
Demanded
$55
5
$20
25
$5
50
Demand
•
•
Quantity
Demanded
This table shows demand for oil - the quantities
demanded at different prices.
The data can be used to construct a demand curve.
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Demand Curve
Price
Priceofofoil
oil
per
perbarrel
barrel
Price
Quantity
Demanded
$55
5
$20
25
$5
50
Quantity of
oil (MBD)
5
Reading a Demand Curve
A Demand Curve Can Be Read:
 Horizontally: At a given price, how much are
people willing to buy?
 Vertically: What are people willing to pay for
a given quantity?
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Reading a Demand Curve
HORIZONTAL: At $20 per barrel, buyers are willing to buy
25m barrels of oil per day.
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Reading a Demand Curve
VERTICAL: The maximum price that buyers are willing to
pay to purchase 25m barrels per day is $20 per barrel.
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Self-Check
What quantity is demanded at $15?
a. 10.
b. 50.
c. 75.
$15
Answer: b. 50
9
Self-Check
At what price would 100 be demanded?
a. $5.
b. $1.
c. $10.
$5
Answer: a. $5
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Law of Demand
 A demand curve is negatively sloped.
 The lower the price, the greater the quantity
demanded.
 Demand summarizes how consumers choose to
use a good, given their preferences and the
possibilities for substitution.
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Law of Demand
 For example, when the price of oil is high,
consumers will use it only in its most valuable
uses (e.g., gasoline and jet fuel).
 As the price falls, consumers will also use oil in
its less valued uses (heating and rubber
duckies).
 Consumers will buy more oil at lower prices than
at higher prices.
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Definition
Consumer Surplus:
The consumer’s gain from exchange,
or the difference between the
maximum price a consumer is willing
to pay for a certain quantity and the
market price.
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Definition
Total Consumer Surplus:
The area beneath the demand curve and
above the price.
Consumer Surplus:
The consumer’s gain from exchange, or the
difference between the maximum price a
consumer is willing to pay for a certain
quantity and the market price.
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Consumer Surplus
Total consumer surplus with a linear demand curve
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Self-Check
What is total consumer surplus if market
price is $10?
a. $500.
b. $700.
c. $1400.
70 x ($30-$10)
2
Answer: b. $700
70
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Shifting the Demand Curve
 An increase in demand shifts the demand
curve to the right.
• At the same price, people are willing to buy
more.
• At the same quantity, people are willing to pay
a higher price.
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Shifting the Demand Curve
Price of
oil/barrel
An Increase in Demand
Willing to pay a higher
price for same quantity.
$50
Willing to buy more
at the same price.
$25
New Demand
Old Demand
0
70
140
Quantity of Oil
(MBD)
18
Shifting the Demand Curve
 Decrease in demand – shifts the demand
curve to the left.
• At the same price, people are willing to buy
less.
• At the same quantity, people are willing to pay
a lower price.
19
Shifting the Demand Curve
Price of
oil/barrel
A Decrease in Demand
Willing to buy less
at the same price.
$50
Willing to pay a lower price
for the same quantity
$25
Old Demand
New Demand
0
62
74
Quantity of Oil
(MBD)
20
Demand Shifters
Factors That Shift Demand:
1.
2.
3.
4.
5.
6.
Income
Population
Price of substitutes
Price of complements
Expectations
Tastes
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Demand Shifters
1. Income
 When people get richer, they buy more stuff.
 When an increase in income increases the
demand for a good, it is a normal good.
 Most goods are normal goods.
 When an increase in income decreases the
demand for a good, it is an inferior good.
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Self-Check
If iPads are a normal good, when incomes
increase, the demand curve for iPads will:
a. Shift to the right.
b. Shift to the left.
c. Not change.
Answer: a
Higher incomes increase demand for a normal
good, shifting the demand curve to the right.
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Demand Shifters
2. Population
 An increase in population will increase
demand generally.
 A shift in subpopulations will change the
demand for specific goods and services.
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Demand Shifters
3. Prices of Substitutes
 A substitute is a good that can be consumed
instead of another good.
 A decrease in the price of a substitute will
decrease demand for the other good.
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Self-Check
If orange juice and apple juice are substitutes,
an increase in the price of orange juice will:
a. Increase demand for apple juice.
b. Decrease demand for apple juice.
c. Not affect demand for apple juice.
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Self-Check
If orange juice and apple juice are substitutes,
an increase in the price of orange juice will:
Answer: a – increase demand for apple juice.
A higher price for orange juice will cause some
people to substitute the now lower-priced apple
juice. This increases the demand for apple juice.
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Demand Shifters
4. Prices of Complements
 Complements are things that go well together.
 A drop in the price of a complement increases
demand for the complementary good.
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Demand Shifters
5. Expectations
 The expectation of a reduction in future supply
increases the demand today.
6. Tastes
 Changes in tastes caused by fads, fashions,
and advertising can all increase or decrease
demand.
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Supply Curve
Price of oil per barrel
Price
Quantity
Supplied
$55
50
$20
30
$5
10
Quantity of oil (MBD)
30
Reading a Supply Curve
A Supply Curve Can Be Read:
 Horizontally: At a given price, how much are
suppliers willing to sell?
 Vertically: To produce a given quantity, what
price must sellers be paid?
31
Definition
Supply Curve:
A function that shows the quantity
supplied at different prices.
Quantity Supplied:
The quantity that sellers are willing
and able to sell at a particular price.
32
Law of Supply
Top photo: Dan Lamont/Corbis Bottom: Bettmann/Corbis
 As the price of oil rises, it becomes profitable to
extract from more costly sources.
 As the price rises, the quantity supplied increases.
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Self-Check
At what price will producers be willing to
supply 50 units?
a. $10.
b. $20.
c. $30.
Answer: a - $10
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Definition
Producer Surplus:
The producer’s gain from exchange,
or the difference between the market
price and the minimum price at which
a producer would be willing to sell a
particular quantity.
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Definition
Total Producer Surplus:
The area above the supply curve
and below the price.
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Producer Surplus
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Shifting the Supply Curve
 Increase in Supply - shifts the supply
curve to the right.
• At the same price producers are willing to
sell more.
• At the same quantity, producers are willing
to accept a lower price
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Shifting the Supply Curve
Price of
oil/barrel
Increase in supply
$60
Old supply
New supply
Greater quantity
supplied at the
same price
40
Willing to accept
a lower price for
the same quantity
18
0
60
80
Quantity of Oil
(MBD)
39
Shifting the Supply Curve
 Decrease in supply – shifts the supply
curve to the left.
• At the same price sellers will offer less.
• At the same quantity, sellers demand a
higher price.
40
Shifting the Supply Curve
Price of
oil/barrel
Decrease in supply
New supply
Old supply
$50
Higher price required
for the same quantity
$28
Smaller quantity supplied
at the same price
20
60
Quantity of Oil
(MBD)
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Supply Shifters
Factors That Shift Supply:
1. Technological innovations and changes in
the price of inputs
2. Taxes and subsidies
3. Expectations
4. Entry or exit of producers
5. Changes in opportunity costs
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Supply Shifters
1. Technological Innovations
 Improvements in technology can reduce
costs, thus increasing supply.
 A reduction in input prices also reduces costs
and thus has a similar effect.
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Supply Shifters
2. Taxes and Subsidies
 A tax on output has the same effect as an increase
in costs.
 A subsidy is the reverse of a tax.
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Supply Shifters
3. Expectations
 Suppliers who expect prices to increase will
store goods for future sale and sell less today.
 The expectation of a future price increase
therefore decreases current supply.
 Supply curve shifts to the left.
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Supply Shifters
4. Entry or Exit of Producers
 The entry of new producers increases supply,
shifting the curve down and to the right.
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Supply Shifters
5. Changes in Opportunity Costs
 An increase in opportunity costs shifts the
supply curve up and to the left.
 If the price of wheat increases, the opportunity
cost of growing soybeans increases.
 Some farmers will shift away from producing
soybeans and start producing wheat.
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Supply Shifters
5. Changes in Opportunity Costs
 The supply curve for soybeans will shift up
and to the left.
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Self-Check
Suppose a new technology reduces the time it
takes to assemble a car. How would this affect
the supply of cars?
a. Shift supply to the right.
b. Shift supply to the left.
c. It would have no effect on supply.
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Self-Check
Suppose a new technology reduces the time it
takes to assemble a car. How would this affect
the supply of cars?
Answer: a – producers would be able to
supply more cars at the current price, shifting
the supply curve to the right.
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Takeaway
 A demand curve shows how customers
respond to higher prices by buying less, and to
lower prices by buying more.
 A supply curve shows how producers respond
to higher prices by producing more, and to
lower prices by producing less.
 The difference between market price and the
maximum a consumer is willing to pay is the
consumer’s gain from exchange or consumer
surplus.
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Takeaway
 The difference between market price and
the minimum price which a producer is
willing to accept is the producer’s gain from
exchange, or producer surplus.
 An increase in demand means that buyers
want a greater quantity at the same price or,
equivalently, they are willing to pay a higher
price for the same quantity.
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Takeaway
 An increase in supply means that sellers
are willing to sell a greater quantity at the
same price or, equivalently, they are willing
to sell a given quantity at a lower price.
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Sources
"Coffee with Cream and Sugar (6703560771)" by TheCulinaryGeek from Chicago,
USA - Coffee with Cream and SugarUploaded by the wub. Licensed under CC BY
2.0 via Wikimedia Commons http://commons.wikimedia.org/wiki/File:Coffee_with_Cream_and_Sugar_(67035
60771).jpg#mediaviewer/File:Coffee_with_Cream_and_Sugar_(6703560771).jpg
"Oh Henry bar". Via Wikimedia Commons http://commons.wikimedia.org/wiki/File:Oh_Henry_bar.jpg#mediaviewer/File:Oh
_Henry_bar.jpg
"Kinderchocolate" by Thegreenj - Own work. Licensed under CC BY-SA 3.0 via
Wikimedia Commons http://commons.wikimedia.org/wiki/File:Kinderchocolate.jpg#mediaviewer/File:K
inderchocolate.jpg
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