Demand and Supply
CHAPTER
4
EYE ONS
Demand
Law of Demand
Demand curve
Law of Market Forces
Demand Schedule
Law of Supply
Quantity demanded
Minimum wage law
Change in demand
Change in quantity demanded
Shortage/excess demand
Supply
Supply curve
Supply schedule
Quantity supplied
Change in supply
Change in quantity supplied
Shortage/excess supply
Equilibrium price
Equilibrium quantity
Market equilibrium
Inferior Good
Normal Good
Price ceiling/cap
Price floor
Complement
Complement in production
Substitute
Substitute in production
Using Demand and Supply
The demand and supply model
is going to be a big part of the rest of your life!
1. You will use it again and again during your economics course.
• D/S model is one of the major economic tools
• Having a firm grasp of it will bring an immediate payoff.
2. You better appreciation how your economic world works
• By understanding the laws of D/S
• By being aware of how prices adjust to balance the two
opposing forces
Example: When you hear someone complaining about a price hike
and blaming it on someone’s greed  think about
•The law of market forces and how demand and supply determine price
•You will know how supply and demand influence the price of clothing,
music, food, and many other items that you purchase
COMPETITIVE MARKETS
What is
a market?
In this chapter, we study a competitive market that has so
many buyers and so many sellers that no individual buyer
or seller can influence the price.
CHAPTER 4
Demand
• Law of Demand
• # price = $ Qty Demanded
• Quantity Demanded:
• Amount willing and able to BUY during a specific
period at a specific price
• Per unit of time (2 bottles a day)
• Demand
• Relationship between Qty Demanded and Price
• List of quantities at different prices
• Portrayed as 1) schedule or 2) curve
DEMAND – Schedule and Curve
CHAPTER 4
Changes in Demand
• Change in Quantity Demanded:
• Price change of given good results in a change in buying habits
• Change in Demand
• Any Influence Other than Price results in a change in buying habits
1. Price of related goods
In Consumption
• Substitute good – a good that can be consumed in the
place of another good
Apples &
oranges
• # price of substitute good = $ Qty Dem for that good
• # price of substitute good = # Demand for other good
• Complement good – a good that can be consumed with
another good
Ice cream &
choc syrup
• # price of complement good = $ Qty Dem for that good
• # price of complement good = $ Demand for other good
CHAPTER 4
Changes in Demand
• Change in Quantity Demanded:
• Price change of given good results in a change in buying habits
• Change in Demand
• Any Influence Other than Price results in a change in buying habits
2. Income
• Normal good : # income = # demand
• Inferior good : # income = $ demand
BMWs or
Ramon Noodles
3. Expectations
• Expected future prices #
• Expected future income #
= ‘buy it now’ = #demand
= ‘take a vacation’
CHAPTER 4
Changes in Demand
• Change in Quantity Demanded:
• Price change of given good results in a change in buying habits
• Change in Demand
• Any Influence Other than Price results in a change in buying habits
4. Number of Buyers
• # # of buyers = # demand
5. Preferences
(Demand # for one item and $ for another item)
• Better information: ‘Smoking’ # demand for cigarettes and $
demand for nicotine patches
• Introduction of new good: Introduction of MP3’s
$ demand for CD’s, #demand for internet service
CHAPTER 4
Changes in Demand
A Change in the Demand for Roses
In a normal
month, the
price is $40 a
bouquet and
6 million
bouquets are
sold.
Valentine’s Day
in February the
demand for
roses increases
and the demand
curve shifts
rightward.
In February, the equilibrium price rises and
the equilibrium quantity increases.
CHAPTER 4
Supply
• Law of Supply
• # price = # Qty Supplied
• Quantity Supplied:
• Amount willing and able to SELL during a specific
period of time at a specific price
• Per unit of time (2 bottles a day)
• Supply
• Relationship between Qty Supplied and Price
• List of quantities at different prices
• Portrayed as 1) schedule or 2) curve
SUPPLY – Schedule and Curve
CHAPTER 4
Changes in Supply
• Change in Quantity Supplied:
• Price change of given good results in a change in selling plans
• Change in Supply
• Any Influence Other than price results in a change in selling plans
1. Price of related goods
SUV
&
Truck
In Production
• Substitute good – a good that can be produced in the place of
another good
• # price of substitute good = # Qty Supplied for that good
• # price of substitute good = $ Supply for other good
• Complement good – a good that can be produced with
another good
Cream &
Skim milk
• # price of complement good = # Qty Supplied for that
good
• # price of complement good = # Supply for other good
CHAPTER 4
Changes in Supply
• Change in Quantity Supplied:
• Price change of given good results in a change in
selling plans
• Change in Supply
• Any Influence Other than price results in a change in
selling plans
Steel
Crisis
2. Prices of resources and other inputs
• # price of resource = $ supply
3. Expectations
Orange Juice
Frost kills FL oranges
• Expected future prices # = $ supply
‘suppliers stock up now to get future high prices’
CHAPTER 4
Changes in Supply
• Change in Quantity Supplied:
• Price changes result in a change in Selling plans
• Change in Supply
• Any Other Influence results in a change in selling plans
4. Number of Sellers
• # # of sellers= # supply
5. Productivity – Output per unit of Input
• Technological Change: $cost
• Improvements = # productivity and #supply
• Natural Events: #cost
• hurricanes =$ productivity and $ supply
CHAPTER 4
Changes in Supply
A Change in the Supply of Flat Panel TVs
A few years ago,
the price of a 42inch flat panel TV
was $6,000.
Advances in
technology have
lowered the cost
of production
and the supply
increased.
The equilibrium
price decreased.
The equilibrium
quantity increased.
The quantity
demanded increased.
CHAPTER 4
Market Equilibrium
• Equilibrium is when  Qty Demanded = Qty Supplied
CHAPTER 4
Market Equilibrium
• Equilibrium is when  Qty Demanded = Qty Supplied
Shortage = excess demand
Surplus = Excess supply
Shortage =
Price rises
Until
market is in
equilibrium
Surplus =
Price falls
CHAPTER 4
Effects of Changes in Demand
• When equilibrium is disturbed, the market immediately begins to adjust
(short-term) and eventually arrives at a NEW equilibrium (long-term)
MARKET EQUILIBRIUM
Effects of Change in Demand … in action
Event: A new zero-calorie sports drink is invented.
To work out the effects on the market for bottled water:
1. Does the event change demand or supply?
•
The new drink is a substitute for bottled water, so the
demand for bottled water changes
2. Does the event Increase or Decrease demand or supply?
•
The demand for bottled water decreases, the demand
curve shifts leftward.
3. What are the new equilibrium price and quantity and how have
they changed (increase or decrease)?
•
What are the new equilibrium price and equilibrium
quantity and how have they changed?
MARKET EQUILIBRIUM – Bottled Water Market
Figure 4.7(b) shows the
outcome.
1. A decrease in demand
shifts the demand curve
leftward.
2. At $1.00 a bottle, there is a
surplus, so the price falls.
3. Quantity supplied
decreases along the
supply curve.
4. Equilibrium quantity
decreases.
MARKET EQUILIBRIUM
When demand changes:
• The supply curve does not shift.
• But there is a change in the quantity supplied.
• Equilibrium price and equilibrium quantity change
in the same direction as the change in demand.
CHAPTER 4
Effects of Changes in Supply
• When equilibrium is disturbed, the market immediately begins to adjust
(short-term) and eventually arrives at a NEW equilibrium (long-term)
MARKET EQUILIBRIUM
Effects of Change in Demand … in action
Event: Drought dries up some springs in the United
States.
To work out the effects on the market for bottled water:
1. Does the event change demand or supply?
•
Drought changes the supply of bottled water.
2. Does the event Increase or Decrease demand or supply?
•
The supply of bottled water decreases, the supply curve
shifts leftward.
3. What are the new equilibrium price and quantity and how have
they changed (increase or decrease)?
•
What are the new equilibrium price and equilibrium
quantity and how have they changed?
MARKET EQUILIBRIUM – Bottled Water Market
Figure 4.8(b) shows the
outcome.
1. A decrease in supply
shifts the supply curve
leftward.
2. At $1.00 a bottle, there
is a shortage, so the
price rises.
3. Quantity demanded
decreases along the
demand curve.
4. Equilibrium quantity
decreases.
MARKET EQUILIBRIUM
When supply changes:
• The demand curve does not shift.
• But there is a change in the quantity demanded.
• Equilibrium price changes in the same direction
as the change in supply.
• Equilibrium quantity changes in the opposite
direction to the change in supply.
CHAPTER 4
Changes in Both Demand and Supply
• We cannot say what happens to PRICE or QUANTITY
without knowing the MAGNITUDE of the changes
When two events occur at the same time,
work out how each event influences the market:
1. Does each event change demand or supply?
2. Does either event increase or decrease demand or
increase or decrease supply?
3. What are the new equilibrium price and equilibrium
quantity and how have they changed?
CHAPTER 4
Changes in Both Demand and Supply
CHAPTER 4
Changes in Both Demand and Supply
CHAPTER 4
Changes in Both Demand and Supply
CHAPTER 4
Changes in Both Demand and Supply
CHAPTER 4
Changes in Both Demand and Supply
SUPPLY CURVE
UNCHANGED
SUPPLY CURVE
SHIFTS TO THE RIGHT
SUPPLY CURVE
SHIFTS TO THE LEFT
Q unchanged
P unchanged
Q increases
P decreases
Q decreases
P increases
DEMAND CURVE
SHIFTS TO THE RIGHT Q increases
P increases
Q increases
P increases or
decreases
Q increases or
decreases
P increases
DEMAND CURVE
SHIFTS TO THE LEFT
Q increases or
decreases
P decreases
Q decreases
P increases or
decreases
DEMAND CURVE
UNCHANGED
Q decreases
P decreases
CHAPTER 4
Price Rigidities
• What happens if the Price does NOT adjust
THREE COMMON REASONS WHY PRICE DOES NOT ADJUST
• Price Floor – lowest LEGAL price to trade or sell a good,
service or factor of production
• Price Ceiling – highest LEGAL price to trade or sell a
good, service or factor of production
• Sticky Price – buyer and seller agree on price for a fixed
period or seller infrequently changes price in given market
CHAPTER 4
Price Rigidities – Price Floor
• What happens if the Price does NOT adjust
Minimum
Wage
Price Floor [minimum wage]
• Price Floor set ABOVE the
equilibrium point DOES effect
the market
• Price Floor set BELOW the
equilibrium point DOES NOT
effect the market
• Don’t forget to quantify the
effects
• Surplus of 4000 workers
CHAPTER 4
Price Rigidities – Price Ceiling
• What happens if the Price does NOT adjust
Rent Control
College
Tuition
Price Ceiling [parking spaces]
• Price Floor set ABOVE the
equilibrium point DOES NOT
effect the market
• Price Floor set BELOW the
equilibrium point DOES effect
the market
• Don’t forget to quantify the
effects
• Shortage of 2000 parking
spaces
CHAPTER 4
Price Rigidities – Sticky Prices
• Sticky Price = Buyer and Seller AGREE on a price for a
PERIOD of time
• Long-term contracts
• Labor unions
• Interest rates
• Commodity trade
• Prices DO adjust but, NOT quick enough to avoid shortages
and surpluses
The Federal Minimum Wage
The federal government’s Fair Labor Standards Act sets the
minimum wage, but most states set their own minimum wage
rate at a higher level than the federal minimum.
The minimum wage creates unemployment.
But how much unemployment does it create?
Until recently, most economists believed that a 10 percent
increase in the minimum wage rate decreased teenage
employment by between 1 and 3 percent.
The Federal Minimum Wage
David Card and Alan Kruger claim that a rise in the minimum
wage rate increases the employment rate of low-income
workers.
They suggest three reasons:
1. Workers become more conscientious and productive.
2. Worker are less likely to quit, so costly labor turnover
is reduced.
3. Managers make a firm’s operations more efficient.
The Federal Minimum Wage
But most economists are skeptical about these ideas.
They suggest:
1. With labor more productive and lower turnover costs,
firms would willingly pay a wage equal to the minimum
wage.
2. Firms anticipate a rise in the minimum wage, so they
cut the number of workers ahead of the rise in the
minimum wage. Unemployment does not increase
after a rise in minimum wage rate.
3. Looking at employment misses the effect on the supply
of labor—a higher minimum wage increases the supply
as people drop out of high school to look for work.
CHAPTER 4
Analyzing the News
When Wal-Mart slashes prices or enters a new market the
company has the same impact as an increase in supply as
shown above. A new market participant of that size forces
competitors to emulate and lower prices. However, profit
margins get competed away to the point where the least
efficient eventually go out of business.
Summary: Key Points in the Article
Giant retailer Wal-Mart upended the market
for flat-panel televisions last November
when it made the decision to drop price
below the $1,000 mark for the 42-inch
screens. The impact on Wal-Mart was
minimal since the stores quickly sold
inventories and replenished with a flood of
new flat panels from new factories.
However the impact on the company’s
competitors was dramatic.
Circuit City Stores, Tweeter Home
Entertainment Group, and CompUSA have
all been forced to close stores and lay off
employees as the companies price-matched
Wal-Mart’s televisions. While Wal-Mart’s
move did catch some off guard, many
analysts pointed out the similar impact on
grocery store chains when Wal-Mart entered
the grocery business. Others noted that
several toy chains entered bankruptcy
largely due to Wal-Mart’s fierce price
cutting.
Wal-Mart maintains that consumers benefit
due to lower prices. Wal-Mart’s competitors
hope that at least a few customers will
continue to want their televisions installed
and might prefer a wider selection.
CHAPTER 4
Analyzing the News
A number of factors other than a change in price
have impacted the potential supply of oil. These all
culminate in a decrease in oil supply, or expected
decrease, and subsequent increase in the price of
oil.
Summary: Key Points in the Article
The price of oil topped $72 a barrel on the
heels of news that eight foreign oil
workers were kidnapped from a Nigerian
oil drilling rig. Iran’s uncertain nuclear
future also created additional uncertainty
about the political stability of another oil
rich region. Recent Nigerian militant
violence includes blowing up oil pipelines
and other acts of violence designed to
disrupt the country’s oil production.
To date, the Nigerian violence has resulted
in the shut-in of 500,000 barrels of oil per
day at a time when global production only
exceeds consumption by about two
million barrels of oil per day. Gasoline
futures surged as well due to a production
slowdown resulting from a Texas refinery
that sustained lightning-related fire
damage and subsequent disruption in
output.
Elsewhere, OPEC decided to leave its
output quotas unchanged. Growth in
global oil demand slowed a little but
remains strong with U.S. gasoline demand
up about one per cent over the same
period last year.
CHAPTER 4
Analyzing the News
Note that both the supply and demand shifts would
result in a higher cocoa price taken in isolation.
Since all three factors have hit this market
simultaneously, it is not surprising that prices have
risen as rapidly and are substantial increases.
Summary: Key Points in the Article
Cocoa futures are riding high due to drought,
political unrest, and changing consumer
tastes. Two major factors have combined to
restrict the supply of cocoa; a drought in
Western Africa and civil unrest in the Ivory
Coast. The Ivory Coast is the planet’s biggest
producer of cocoa. The result is a 5.5% drop
in the production of cocoa over the previous
year. Cocoa prices have responded
accordingly and are near a three year high
with prices increasing by 44% since
November 2005.
The demand side is also affecting prices.
Consumer tastes have shifted toward darker
chocolates and dark chocolate requires more
cocoa to manufacture. The change in
preference is driven partially by health
reasons. Dark chocolates are higher in
antioxidants and considered to be healthier
than other chocolates. Some studies link dark
chocolate consumption to lower blood
pressure. Since dark chocolates are also
higher margin products, manufacturers have
been happy to oblige. However, the
combined effect of the supply and demand
factors is a certain recipe for higher cocoa
prices.
CHAPTER 4
Analyzing the News
Gold prices are being pushed by investor demand
for gold increasing while at the same time jewelry
demand for gold is falling. The net impact, coupled
with net supply changes due to lower mining
production and higher scrap production, has settled
prices above the $900 mark. However, gold traders
are having difficulty forecasting direction and the
ultimate settling price.
Summary: Key Points in the
Article
The rising price of gold as a
jewelry input has pushed many
consumers to postpone jewelry
purchases. The result is that
gold traders are becoming more
cautious about the current price
level until it is determined how
much of the current $900 price
is the result of inflation hedging
and how much is derived from
jewelry demand. Meanwhile
global output fell about 1
percent last year as production
costs increased.
Many traders indicate that
jewelers have evaporated from
the gold market. Meanwhile
many jewelry items are being
melted down and returned to
the market as scrap to take
advantage of the current high
prices. Much of the demand
appears to be investor driven as
stocks tumble and interest rates
fall.
CHAPTER 4
Analyzing the News
Note that at price P there are more toys demanded
than there are toys supplied. This shortage,
particularly in game consoles, can be best visualized
by the fact that some consumers are buying game
consoles at store prices and selling them on Ebay
for a large profit. The Ebay price would be
equivalent to the price at equilibrium point A.
Summary: Key Points in the Article
Production problems, coupled with
higher than expected consumer demand,
are contributing to shortages of certain
toys this holiday season. Many of the
Chinese factories are experiencing labor
shortages as high-tech job creation
causes many Chinese to move off of the
assembly line. Power outages have also
contributed to lower productivity in the
manufacturing regions of southern
China. Unfortunately these problems
came at the wrong time and have limited
supplies of numbers of toys including
Sony’s PlayStation 3.
In addition to the supply problems,
consumer demand was underestimated.
Last year’s sales data were extrapolated
to this year and many retailers placed
very conservative orders. The limited
supply and underestimated demand has
created a real shortage of some toys. The
result is a hot secondary market on Ebay
for many toys such as the PlayStation 3
and Mattel’s TMX Elmo. The Elmo
retails for $40 but is fetching $65 on
Ebay.