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 Watch/listen to/read the President’s State of the Union address.
 Via email, by the start of class on Wed., Feb. 2, briefly describe the policies he described concerning:

Increasing US jobs

Economic growth

CHAPTER
3
The intense competition among firms selling energy drinks is a striking example of how the market responds to changes in consumer tastes.

CHAPTER
3
Interaction of
Demand & Supply
3.1 The Demand Side of the Market
Discuss the variables that influence demand.
3.2 The Supply Side of the Market
Discuss the variables that influence supply.
3.3 Market Equilibrium: Putting Demand and Supply
Together
Use a graph to illustrate market equilibrium.
3.4 The Effect of Demand and Supply Shifts on
Equilibrium
Use demand and supply graphs to predict changes in prices and quantities

Perfectly Competitive Market A market that meets the conditions of:
1.
Many buyers and sellers,
2.
All firms selling identical products
3.
No barriers to new firms entering the market
4.
Low cost information

3.1 LEARNING OBJECTIVE
Discuss the variables that influence demand.
The Demand Side of the Market
Demand Schedules and Demand Curves:

Demand schedule A table showing the relationship between the price of a product and the quantity of the product demanded.

Quantity demanded The amount of a well defined good or service that a consumer is willing and able to purchase at a given price, during some given time period.

Demand curve A curve that shows the relationship between the price of a well defined product and the quantity of the product demanded, during some given time period.

Market demand The demand by all the consumers of a given good or service.

The Demand Side of the Market:
FIGURE 3-1 A Demand Schedule and Demand Curve
As price changes, consumers change the quantity of energy drinks they are willing to buy. We can show this as a demand schedule in a table or as a demand curve on a graph.
They both show that as the price of energy drinks falls, the quantity demanded rises.
When the price is $3.00, consumers buy 60 million cans/day. When the price drops to $2.50, consumers buy 70 million cans.
Therefore, the demand curve for energy drinks is downward sloping.

The Demand Side of the Market:
 Law of demand The rule that, holding everything else constant, when the price of a product falls, the quantity demanded of the product will increase, and when the price of a product rises, the quantity demanded of the product will decrease.

Deriving the Market Demand
Curve from Individual Demand
Curves
Market demand The demand for a product by all the consumers in a given geographical area.

The Demand Side of the Market:
 Substitution effect The change in the quantity demanded of a good that results from a change in price, making the good more or less expensive relative to other goods that are substitutes.
 Income effect The change in the quantity demanded of a good that results from the effect of a change in the good’s price on consumers’ purchasing power.

The Demand Side of the Market:
 Ceteris paribus (“all else equal”) condition The requirement that when analyzing the relationship between two variables—such as price and quantity demanded— other variables must be held constant.
 A shift of a demand curve is an increase or a decrease in demand. A movement along a demand curve is an increase or a decrease in the quantity demanded.

The Demand Side of the Market:
FIGURE 3-2
Shifting the
Demand Curve
When consumers increase the quantity of a product they want to buy at a given price, the market demand curve shifts to the right, from
D
1 to D
2
.
When consumers decrease the quantity of a product they want to buy at a given price, the demand curve shifts to the left, from D
1 to D
3
.

The Demand Side of the Market:
Many variables other than price can influence market demand.
1.

Normal good A good for which the demand increases as income rises and decreases as income falls.

Inferior good A good for which the demand increases as income falls and decreases as income rises.

Making the
Connection
Are Big Macs an Inferior Good?
Big Macs seem to fit the economic definition of an inferior good because demand increased as income fell. But remember that inferior goods are not necessarily of low quality, they are just goods for which consumers increase their demand as their incomes fall.
McDonald’s restaurants experienced increased sales during
2008 and 2009, despite the recession.

The Demand Side of the Market:
2.

Substitutes Goods and services that can be used for the same purpose.

Complements Goods and services that are used together.
3.
Consumers can be influenced by an advertising campaign for a product. And our tastes can also change because of new interests, new friends, and new decisions over time.

The Demand Side of the Market:
4.
Demographics The characteristics of a population with respect to age, race, and gender.
5.
Consumers choose not only which products to buy but also when to buy them.

Making the
Connection
The Aging of the
Baby Boom Generation
 Older people have a greater D for medical care than do younger people.
 Aging boomers will also have an effect on the housing market.
 What other effects will the aging of the baby boom generation have on the economy?

The Demand Side of the Market:
TABLE 3-1 Variables That Shift Market Demand Curves

The Demand Side of the Market:
TABLE 3-1 Variables That Shift Market Demand Curves

The Demand Side of the Market:
TABLE 3-1 Variables That Shift Market Demand Curves

The Demand Side of the Market:
TABLE 3-1 Variables That Shift Market Demand Curves

The Demand Side of the Market: A Change in Demand versus a Change in Quantity Demanded
FIGURE 3-3 A Change in Demand versus a Change in Quantity Demanded
If the price of energy drinks falls from $3 to
$2.50, the result will be a movement along the D curve from point A to point
B - an increase in quantity demanded from 60 M cans to 70 M cans.
If consumers’ incomes increase, or if another factor changes that makes consumers want more of the product at every price, the D curve will shift to the right—an increase in demand .
In this case, the increase in demand from D
1 to D
2 causes the quantity of energy drinks demanded at a price of $3 to increase from 60
M cans at point A to 80 M cans at point C .

Making the
Connection
Red Bull and the Future
Demand for Energy Drinks
It is important for managers to accurately forecast the demand for their products because it helps them determine how much of a good to produce.
Will Red Bull continue to grow its share of the energy drink market?

3.2 Learning Objective
Discuss the variables that influence supply.
Quantity supplied The amount of a well defined good or service that a firm is willing and able to supply at a given price, within some given time period.

Supply schedule A table that shows the relationship between the price of a well defined product and the quantity of the product supplied, in some given time period.

Supply curve A curve that shows the relationship between the price of a well defined product and the quantity of the product supplied, in some given time period.

The Supply Side of the Market:
FIGURE 3-4 A Supply Schedule and Supply Curve
As the P changes, the makers of
Red Bull, Monster Energy,
Rockstar, and the firms producing energy drinks change the Q they are willing to supply.
We can show this as a supply schedule in a table or as a supply curve on a graph.
They both show that as the P of energy drinks rises, firms will increase the Q they supply.
At a P of $2.50 per can, firms will supply 90 M cans. At a P of
$3, firms will supply 100 M cans.

The Supply Side of the Market:
 Law of supply The rule that, holding everything else constant, increases in price cause increases in the quantity supplied, and decreases in price cause decreases in the quantity supplied.

3 - 7
Deriving the Market
Supply Curve from the
Individual Supply Curves

The Supply Side of the Market:
FIGURE 3-5
Shifting the Supply Curve
When firms increase the Q of a product they want to sell at a given P, the S curve shifts to the right. The shift from S
1 to S
3 represents an increase in supply .
When firms decrease the Q of a product they want to sell at a given P, the supply curve shifts to the left. The shift from S
1 to S
2 represents a decrease in supply .

The Supply Side of the Market:
The following are the most important variables that shift market supply:
1.
Prices of inputs
2.
Technological change/change in productivity
Technological change A positive or negative change in the ability of a firm to produce a given level of output with a given quantity of inputs.
3.
Prices of substitutes in production
4.
Number of firms in the market
5.
Expected future prices & other changes in expectations

The Supply Side of the Market:
TABLE 3-2 Variables That Shift Market Supply Curves

The Supply Side of the Market:
TABLE 3-2 Variables That Shift Market Supply Curves (continued)

The Supply Side of the Market:
TABLE 3-2 Variables That Shift Market Supply Curves (continued)

The Supply Side of the Market:
FIGURE 3-6 Change in Supply v. Change in Quantity Supplied
If the P of energy drinks rises from $2 to $2.50/can, the result will be a movement up the S curve from point A to point B - an increase in quantity supplied by Red Bull, Monster
Energy, Rockstar, and others from 80 M to 90 M cans.
If the P of an input decreases, or another factor changes that makes sellers supply more of the product at every price, the S curve will shift to the right - an increase in supply .
The increase in supply, S
1 to S
2
, causes Q of energy drinks supplied at a P of $2.50 to increase from 90
M cans at point B to 110 M cans at point C .

3.3 Learning Objective
Use a graph to illustrate market equilibrium.
FIGURE 3-7
Market Equilibrium
Where the D curve crosses the S curve determines market equilibrium.
In this case, the D curve for energy drinks crosses the S curve at a P of $2 and a Q of 80 M cans/day.
Only at this point is the Q of energy drinks consumers are willing to buy equal to the Q that
Red Bull, Monster Energy,
Rockstar, and the other firms are willing to sell:
The quantity demanded is equal to the quantity supplied.

Market Equilibrium: Putting D & S Together
 Market equilibrium A situation in which quantity demanded equals quantity supplied.
 Competitive market equilibrium A market equilibrium with many buyers and many sellers.

Market Equilibrium: Putting D & S Together
How Markets Eliminate Surpluses and Shortages
Surplus A situation in which the quantity supplied is greater than the quantity demanded.
Shortage A situation in which the quantity demanded is greater than the quantity supplied.

Market Equilibrium: Putting D & S Together
How Markets Eliminate Surpluses and Shortages
FIGURE 3-8 The Effect of Surpluses and Shortages on the Market Price
When the market P > equilibrium, there will be a surplus . In the figure, a price of $2.50 for energy drinks results in 90 M cans supplied but only 70 M cans demanded, for a surplus of 20 M.
As Red Bull, Monster Energy,
Rockstar, and the others cut the P to dispose of the surplus, the P will fall to the equilibrium of $2.
When the market P < equilibrium, there will be a shortage . P of $1 results in 100 M cans demanded but only 60 M cans supplied, for a shortage of 40 M cans. As consumers who are unable to buy energy drinks offer to pay higher prices, the P will rise to the equilibrium of $2.

Market Equilibrium: Putting D & S Together
Demand and Supply Both Count
Keep in mind that the interaction of demand and supply determines the equilibrium price.
Neither consumers nor firms can dictate what the equilibrium price will be.
No firm can sell anything at any price unless it can find a willing buyer, and no consumer can buy anything at any price without finding a willing seller.

Solved Problem 3-3
Demand and Supply Both Count: A Tale of Two Letters
Both D and S count when determining market P.
The D for Lincoln’s letters is much greater than the D for Booth’s letters, but the S of Booth’s letters is very small.
Historians believe that only 8 letters written by Booth exist today.

Use demand and supply graphs to predict changes in prices and quantities.
3.4 Learning Objective
The Effect of Demand and Supply
Shifts on Equilibrium: Increase in Supply
FIGURE 3-9
The Effect of an Increase in
Supply on Equilibrium
If a firm enters a market, as Coca-
Cola entered the market for energy drinks when it launched
Full Throttle, the equilibrium price will fall, and the equilibrium quantity will rise:
1.
As Coca-Cola enters the market for energy drinks, a larger Q of energy drinks will be supplied at every P, so the market S curve shifts to the right, from S
1 to S
2
, which causes a surplus of cans at the original price, P
1
.
2.
The equilibrium P falls from P 1 to P 2.
3.
The equilibrium Q rises from Q 1 to Q 2.

Making the
Connection
The Falling Price of
LCD Televisions
An increase in S drove the P of a typical large LCD television from $4,000 in fall 2004 to $1,000 at the end of 2008, increasing the quantity demanded worldwide from 8 million to 105 million.

The Effect of Demand and Supply
Shifts on Equilibrium: Increase in Demand
FIGURE 3-10 The Effect of an Increase in Demand on Equilibrium
Increases in income cause equilibrium P & Q to rise:
1.
Because energy drinks are normal , as income grows, the Q demanded increases at every
P, and the market
D curve shifts right, from D
1
D
2
, causing a shortage at the to original price, P
1
.
2.
The equilibrium P rises from P 1 to P 2.
3.
The equilibrium Q rises from Q 1 to Q 2.

The Effect of Demand and Supply
Shifts on Equilibrium:
FIGURE 3-11 Shifts in Demand and Supply over Time
In panel (a), D shifts to the right more than S, and the equilibrium price rises:
1. Demand shifts to the right more than supply.
2. Equilibrium price rises from P
1 to P
2
.
In panel (b), S shifts to the right more than D, and the equilibrium price falls:
1. Supply shifts to the right more than demand.
2. Equilibrium price falls from P
1 to P
2
.

The Effect of Demand and Supply
Shifts on Equilibrium:
TABLE 3-3 How Shifts in Demand and Supply Affect Equilibrium Price (P) and Quantity (Q)
SUPPLY CURVE
UNCHANGED
SUPPLY CURVE
SHIFTS TO THE RIGHT
SUPPLY CURVE
SHIFTS TO THE LEFT
DEMAND CURVE
UNCHANGED
Q unchanged
P unchanged
Q increases
P decreases
Q decreases
P increases
DEMAND CURVE
SHIFTS TO THE RIGHT Q increases
P increases
DEMAND CURVE
SHIFTS TO THE LEFT
Q decreases
P decreases
Q increases
P increases or decreases
Q increases or decreases
P decreases
Q increases or decreases
P increases
Q decreases
P increases or decreases

Solved Problem 3-4
High Demand and Low Prices in the Lobster Market?
Supply and demand for lobster both increase during the summer, but the increase in supply is greater than the increase in demand; therefore, equilibrium price falls.

3.4 Learning Objective
Use demand and supply graphs to predict changes in prices and quantities.
Shifts in a Curve versus Movements along a Curve
Don’t Let This Happen to YOU! Remember: A Change in a Good’s Price
Does Not Cause the Demand or Supply Curve to Shift!
When analyzing markets using D and S curves, remember that when a shift in a D or S curve causes a change in equilibrium P, the change in P does not cause a further shift in D or S.

AN INSIDE
LOOK
>> How Does Advertising Help Red Bull Increase
Demand for Its Energy Drink?
Advertising may cause an increase in the demand for Red Bull.

KEY TERMS
Ceteris paribus (“all else equal”) condition
Competitive market equilibrium
Complements
Demand curve
Demand schedule
Demographics
Income effect
Inferior good
Law of demand
Law of supply
Market demand
Market equilibrium
Normal good
Perfectly competitive market
Quantity demanded
Quantity supplied
Shortage
Substitutes
Substitution effect
Supply curve
Supply schedule
Surplus
Technological change



Review Questions:

Consumer surplus is used as a measure of a consumer’s net benefit from purchasing a good or service. Explain why consumer surplus is a measure of net benefit.

Why would economists use a term like
“deadweight loss” to describe the impact on consumer and producer surplus from a price control?”

Problems and Applications, 3 rd ed., p. 130, 4A.5,
4A.6, 4A.7 & 4A.8; (2 nd ed., p. 134, 4A.5, 4A.6, 4A.7
& 4A.8; 1 st edition: 1-4 on p. 129).