AP Macroeconomics
MR. Graham
Unit Two
Supply and Demand
Module 5:
Supply and Demand:
Introduction and Demand
2
Competitive Market
• A market in which there are many buyers and
sellers of the same good or service.
• No individual’s actions have a noticeable effect
on the price at which a good or service is sold.
• When a market is competitive, its behavior is
well described by supply and demand model.
3
Supply and Demand Model
• There are five key elements in this model:
•
The demand curve
•
The supply curve
•
The set of factors that cause the demand curve to shift
and the set of factors that cause the supply curve to
shift
•
The market equilibrium, which includes the equilibrium
price and equilibrium quantity.
•
The way the market equilibrium changes when the
supply curve or demand curve shifts
4
“Demand” Defined
• A schedule of quantities of goods or services
that will be purchased at various prices, during a
specified time period, other things being
constant (“ceteris paribus”).
The Demand Schedule and
the Demand Curve
Law of Demand
• Law of Demand
– A negative, or inverse, relationship between
the price of any good or service and the
quantity demanded, holding other factors
constant (ceteris paribus)
–When the price of a good goes up, people buy
less of it, other things being equal.
–When the price of a good goes down, people
buy more of it, other things being equal.
“Quantity Demanded” vs. “Demand”
• A change in a
good’s price leads
to a change in
quantity demanded
(movement along
the demand curve)
“Quantity Demanded” vs. “Demand”
• Whenever there is a change in a ceteris paribus
condition, there will be a change in demand
– A shift of the entire
demand curve
– The only thing that
can cause the entire
curve to move is a
change in determinant
other than price
“Quantity Demanded” vs. “Demand”
“Quantity Demanded” vs. “Demand”
Let us review by using viewing
“Quantity Demanded and Demand”
from Reffonomics.
Determinants of Demand (8)
1. Number of consumers
2. Income: Normal Goods
3. Tastes and preferences
4. Income: Inferior Goods
5. The prices of related goods: Substitutes
6. The prices of related goods: Complements
7. Expectations: Future Prices
8. Expectations: Future Income
Shifts in Demand (cont'd)
The Determinants of Demand
Market Size (Number of Consumers)
Price
Increase in the
number of consumers
increases demand
Decrease in the
number of consumers
decreases demand
D3
D1
D2
Q/Units
Determinants of Demand (8)
1. Number of consumers
2. Income: Normal Goods
3. Tastes and preferences
4. Income: Inferior Goods
5. The prices of related goods: Substitutes
6. The prices of related goods: Complements
7. Expectations: Future Prices
8. Expectations: Future Income
Normal and Inferior Goods
• Normal Goods
– Goods for which demand rises as income rises;
most goods are normal goods
– As Y , then demand for normal goods 
• In economics, the letter “Y” stands for income
Shifts in Demand (cont'd)
The Determinants of Demand
Income: Normal Good
Price
Increase in income
increases demand
Decrease in income
decreases demand
D3
D1
D2
Q/Units
Determinants of Demand (8)
1. Number of consumers
2. Income: Normal Goods
3. Tastes and preferences
4. Income: Inferior Goods
5. The prices of related goods: Substitutes
6. The prices of related goods: Complements
7. Expectations: Future Prices
8. Expectations: Future Income
Shifts in Demand (cont'd)
The Determinants of Demand
Tastes and Preferences
Price
Hybrid vehicles
• Increase in demand
SUVs
• Decrease in demand
D3
D1
D2
Q/Units
Determinants of Demand (8)
1. Number of consumers
2. Income: Normal Goods
3. Tastes and preferences
4. Income: Inferior Goods
5. The prices of related goods: Substitutes
6. The prices of related goods: Complements
7. Expectations: Future Prices
8. Expectations: Future Income
Normal and Inferior Goods
• Inferior Goods
– Goods for which demand falls as income rises
– As Y , then demand for inferior goods 
Shifts in Demand (cont'd)
The Determinants of Demand
Income: Inferior Good
Price
Decrease in income
increases demand
Increase in income
decreases demand
D3
D1
D2
Q/Units
Determinants of Demand (8)
1. Number of consumers
2. Income: Normal Goods
3. Tastes and preferences
4. Income: Inferior Goods
5. The prices of related goods: Substitutes
6. The prices of related goods: Complements
7. Expectations: Future Prices
8. Expectations: Future Income
Shifts in Demand (cont'd)
• Substitutes
– Two goods are substitutes when a change in the
price of one causes a shift in demand for the other in
the same direction as the price change
– There are millions of products that have substitutes:
• Soap (Ivory v. Dove)
• Pizza (Pizza Hut v. Dominos)
• Cola (Coke v. Pepsi)
Shifts in Demand (cont'd)
The Determinants of Demand
Price of Related Goods: Substitutes
Price
Butter and Margarine
• Price of both = $2/lb
• Price of margarine
increases to $3/lb
• Demand for butter
increases
D1
D2
Q/Butter
Determinants of Demand (8)
1. Number of consumers
2. Income: Normal Goods
3. Tastes and preferences
4. Income: Inferior Goods
5. The prices of related goods: Substitutes
6. The prices of related goods: Complements
7. Expectations: Future Prices
8. Expectations: Future Income
Shifts in Demand (cont'd)
• Complements
– Two goods are complements when a change in
the price of one causes an opposite shift in the
demand curve for the other
– There are millions of products that complement
each other:
• Soap and Shampoo
• Toothbrush and Toothpaste
• Shoes and Socks
• Peanut Butter and Jelly
Shifts in Demand (cont'd)
The Determinants of Demand
Price of Related Goods: Complements
Price
Speakers and Amplifiers
• Decrease the relative
price of amplifiers
• Demand for speakers
increases
Speakers and Amplifiers
• Increase the relative
price of amplifiers
• Demand for speakers
decreases
D3
D1
D2
Q/Speakers
Determinants of Demand (8)
1. Number of consumers
2. Income: Normal Goods
3. Tastes and preferences
4. Income: Inferior Goods
5. The prices of related goods: Substitutes
6. The prices of related goods: Complements
7. Expectations: Future Prices
8. Expectations: Future Income
Shifts in Demand (cont'd)
The Determinants of Demand
Expectations: Future Prices
Price
Expectations of a higher future
price will increase demand
Expectations of a lower future
price will decrease demand
D3
D1
D2
Q/Units
Determinants of Demand (8)
1. Number of consumers
2. Income: Normal Goods
3. Tastes and preferences
4. Income: Inferior Goods
5. The prices of related goods: Substitutes
6. The prices of related goods: Complements
7. Expectations: Future Prices
8. Expectations: Income
Shifts in Demand (cont'd)
The Determinants of Demand
Expectations: Income
Price
A higher income will increase
demand
A lower income will decrease
demand
D3
D1
D2
Q/Units
Shifts in Demand
Let us review by using viewing the
“Demand Interactive Chart”
from Reffonomics.
Module 6:
Supply and Demand:
Supply and Equilibrium
34
“Supply” Defined
• A schedule of quantities of goods or services
that will be supplied at various prices, during a
specified time period, other things being
constant (“ceteris paribus”)
The Supply Schedule and
the Supply Curve
The Law of Supply
• Law of Supply
– The higher the price of a good, the more of
that good sellers will make available over a
specified time period, other things equal
• At higher prices, a larger quantity will generally
be supplied than at lower prices, all other things
held constant.
• At lower prices, a smaller quantity will generally
be supplied than at higher prices, all other things
held constant.
“Quantity Supplied” vs. “Supply”
What is the difference between
Quantity Supplied and Supply?
“Quantity Supplied” vs. “Supply”
• A change in a
good’s own price
leads to a change in
quantity supplied.
“Quantity Supplied” vs. “Supply”
• Whenever there is a change in a ceteris paribus
condition, there will be a change in supply
– A shift of the entire
supply curve to the
right or to the left
– The only thing that can
cause the entire curve
to move is a change in
a determinant other
than the good’s own
price
Determinants of Supply (6)
1. Number of suppliers
2. Cost of inputs
3. Physical availability of resources
4. Technology and productivity (in long run)
5. Taxes and subsidies
6. Price expectations
Shifts in Supply (cont'd)
The Determinants of Supply
Number of Suppliers
Price
Decrease in the
number of firms
decreases supply
S3
S1
S2
Increase in the
number of firms
increases supply
Q/Units
Determinants of Supply (6)
1. Number of suppliers
2. Cost of inputs
3. Physical availability of resources
4. Technology and productivity (in long run)
5. Taxes and subsidies
6. Price expectations
Shifts in Supply (cont'd)
The Determinants of Supply
Cost of Inputs
Price
Increase in cost
decreases supply
S3
S1
S2
Decrease in cost
increases supply
Q/Units
Determinants of Supply (6)
1. Number of suppliers
2. Cost of inputs
3. Physical availability of resources
4. Technology and productivity (in long run)
5. Taxes and subsidies
6. Price expectations
Shifts in Supply (cont'd)
The Determinants of Supply
Physical Availability of Resources
Price
S3
S1
S2
Generally unavailable
resources decrease supply
Existence or discovery of new deposits
of resources increases supply
Q/Units
Determinants of Supply (6)
1. Number of suppliers
2. Cost of inputs
3. Physical availability of resources
4. Technology and productivity (in long run)
5. Taxes and subsidies
6. Price expectations
Shifts in Supply (cont'd)
The Determinants of Supply
Technology and Productivity
Price
S3
S1
S2
Decreases in productivity
decrease supply
Improvements in technology or
increases in productivity
increase supply
Q/Units
Determinants of Supply (6)
1. Number of suppliers
2. Cost of inputs
3. Physical availability of resources
4. Technology and productivity (in long run)
5. Taxes and subsidies
6. Price expectations
Shifts in Supply (cont'd)
The Determinants of Supply
Taxes and Subsidies
Price
S3
S1
S2
Increases in taxes or
decreases in subsidies
decrease supply
Decreases in taxes or
increases in subsidies
increase supply
Q/Units
Determinants of Supply (6)
1. Number of suppliers
2. Cost of inputs
3. Physical availability of resources
4. Technology and productivity (in long run)
5. Taxes and subsidies
6. Price expectations
Shifts in Supply (cont'd)
The Determinants of Supply
Price Expectations
Price
Expectations of higher
future prices decrease
supply
S3
S1
S2
Expectations of lower
future prices increase
supply
Q/Units
Determinants of Supply
Shifts in Supply
Let us review by using viewing the
Khan Academy lesson on
Factors Affecting Supply
and the
“Supply Interactive Chart”
from Reffonomics.
Putting Demand
and Supply Together
 Equilibrium Price
(a.k.a. “Market Clearing Price”)
 The price that clears
the market
 The price at which
quantity demanded
equals quantity supplied
 The price where the
demand curve intersects
the supply curve
Market Equilibrium
Market Equilibrium
 Equilibrium is a stable point – any point that is
not equilibrium is unstable and will not persist:
1. Why does the market price fall if it is above the
equilibrium price?
2. Why does the market price rise if it is below the
equilibrium price?
Market Equilibrium—Surplus
 Surplus—The situation when quantity supplied
is greater than quantity demanded
Market Equilibrium—Shortage
 Shortage—The situation when quantity
demanded is greater than quantity supplied
Do Now.
• “Thousands in Mexico City
protest rising food prices.” So
read a recent headline in the New
York Times. Specifically, the
demonstrators were protesting a
sharp rise in the price of tortillas,
a staple food of Mexico’s poor,
which had gone from 25 cents a
pound to between 35 and 45
cents a pound in just a few
months.
• Why were tortilla prices soaring?
Module 7:
Supply and Demand:
Changes in Supply and Demand
61
What Happens When the
Demand Curve Shifts
Determinants of Demand (8)
• Number of consumers
• Income: Normal Goods
• Income: Inferior Goods
• Tastes and preferences
• The prices of related goods: Substitutes
• The prices of related goods: Complements
• Expectations: Future Prices
• Expectations: Future Income
What Happens When the
Demand Curve Shifts
What Happens When the
Demand Curve Shifts
• Increases in demand
increase equilibrium price and quantity
• Decreases in demand
decrease equilibrium price and quantity
What Happens When the
Supply Curve Shifts
Determinants of Supply (6)
• Number of suppliers
• Cost of inputs
• Physical availability of resources
• Technology and productivity (in long run)
• Taxes and subsidies
• Price expectations
What Happens When the
Supply Curve Shifts
What Happens When the
Supply Curve Shifts
• Increases in supply
decrease equilibrium price and
increase equilibrium quantity
• Decreases in supply
increase equilibrium price and
decrease equilibrium quantity
Simultaneous Changes in
Demand and Supply
• If both the supply and demand curves
shift simultaneously, the outcome is
indeterminate for either equilibrium
price or equilibrium quantity
• The resulting effect depends upon how
much each curve shifts
Simultaneous Changes in
Demand and Supply
• When the curves move in same direction:
– Increases in supply and demand
increase equilibrium quantity and
change in equilibrium price is ambiguous
– Decreases in supply and demand
decrease equilibrium quantity and
change in equilibrium price is ambiguous
– Let’s check for ourselves…
Simultaneous Changes in
Demand and Supply
• When the curves move in opposite directions:
– Increases in demand and decreases in supply
increase equilibrium price and
change in equilibrium quantity is ambiguous
– Decreases in demand and increases in supply
decrease equilibrium price and
change in equilibrium quantity is ambiguous
– Let’s check for ourselves…
Simultaneous Changes in
Demand and Supply
Changes in Supply and Demand
Let us finally review by viewing
the Khan Academy lesson on
Changes in Equilibrium
Module 8:
Supply and Demand:
Price Controls (Ceilings and Floors)
73
Why Governments Control Prices
• Markets move to the level at which the quantity
supplied equals the quantity demanded.
• But this equilibrium price does not necessarily
please either buyers or sellers
– Buyers would like to pay less money for what they
buy (e.g. rent in New York City)
– Sellers would like to get more money for what they
sell (e.g. labor wage rates)
2-74
How Governments Control Prices
• There is often a strong political demand for
governments to intervene in markets
• “Price Controls”
– Government-mandated minimum or maximum
– Price Ceiling: A legal maximum price
– Price Floor: A legal minimum price
Modeling a Price Ceiling
Modeling a Price Ceiling
A price ceiling that is set below the
market clearing price creates a shortage.
Problems with Price Ceilings
1. Inefficient Allocation to Consumers
– People who want the good badly and are
willing to pay a high price don’t get it.
– People who care relatively little about the
good and are only willing to pay a relatively
low price do get it.
Problems with Price Ceilings
2. Wasted Resources
– People expend money, effort, and time to
cope with the shortages caused by the price
ceiling (e.g. looking for homes).
Problems with Price Ceilings
3. Inefficiently Low Quality
– Sellers offer low quality goods at a low price
even though buyers would prefer a higher
quality at a higher price
Problems with Price Ceilings
4. Black Markets
– Market in which goods or services are
bought and sold illegally—either because it
is illegal to sell them at all or because the
prices charged are legally prohibited by a
price ceiling
Problems with Price Ceilings
5. Controls Discourage Construction
– With a 16% vacancy rate and no controls,
Dallas recently built 11,000 new rental units
– With a 1.6% vacancy rate and controls, San
Francisco recently built 2,000 new rental units
So Why Are There Price Ceilings
1. Benefit some influential buyers of a good.
2. Governments do not understand or ignore
supply and demand analysis!
Modeling a Price Floor
Modeling a Price Floor
A price floor that is set above the
market clearing price creates a surplus.
Problems with Price Floors
1. Inefficiently Low Quantity
– Because a price floor raises the price of a
good to consumers, it reduces the quantity
demanded of that good below the market
equilibrium quantity.
Problems with Price Floors
2. Inefficient Allocation of Sales
Among Sellers
– Those who would be willing to sell the good
at the lowest price are not always those
who manage to sell it.
Problems with Price Floors
3. Wasted Resources
– Create surplus production that is sold at a
discount or destroyed (e.g. government
purchases of unwanted agriculture)
– Also expend money, effort, and time to
cope with the shortages caused by the price
floor (e.g. looking for jobs).
Problems with Price Floors
4. Inefficiently High Quality
– Sellers offer high quality goods at a high
price even though buyers would prefer a
lower quality at a lower price
(e.g. airlines before deregulation of 1970s)
Problems with Price Floors
5. Illegal Activity
– “Black Labor”—working off the books
and/or bribing government inspectors
So Why Are There Price Floors?
1. Benefit some influential sellers of a good.
2. Governments do not understand or ignore
supply and demand analysis!
The Effect of Minimum Wages
• Minimum Wage
– A price floor, legislated by government,
setting the lowest hourly wage rate that
firms may legally pay their workers
The Effect of Minimum Wages
Economics USA
• http://www.learner.org/series/econusa/unit0
5/
Do Now.
Respond to the following:
•
Thousands of people in the United
States are on a waiting list to receive
a kidney. Every day, over a dozen
people on this waiting list die.
Kidneys must be donated, and cannot
be sold. In other words, there is a
price ceiling of zero on kidneys.
Economists believe this is the reason
for the severe kidney shortage.
Would there be more kidneys (and
fewer deaths) if people were allowed
to sell their kidney? Price ceilings
cause black markets to develop to
help alleviate the shortage.
• http://www.criticalcommon
s.org/Members/economicst
ube/clips/svukidneybrighter.
wmv
Module 9:
Supply and Demand:
Quanity Controls
96
Quantity Controls
• Government Prohibitions and Licensing
Requirements
– Some commodities cannot be purchased at
all legally; others require a license
• Import Quota
– Supply restriction that prohibits the
importation of more than a specified
quantity of a particular good
Quantity Controls
Quantity Controls
The Cost of Quantity Controls
• Inefficiency
– Buyer willing to buy good at a price seller
willing to accept, but it doesn’t happen
(e.g. “deadweight loss”)
• Demand price exceeds supply price.
• Buyers and sellers both experience a loss
– Encourages illegal activity
2-100