Chapter 3
Supply, Demand, and the
Market Process
7 Learning Goals
1) Investigate and describe consumer behavior
2) Distinguish a change in demand from a
change in quantity demanded
3) Investigate and describe firm behavior
4) Distinguish a change in supply from a change
in quantity supplied
5) Build a market model and illustrate how
equilibrium is reached
6) Demonstrate how markets respond to changes
in demand and supply
7) Recognize how prices and the invisible hand
principle create market order
Consumer Choice and
the Law of Demand
The Law of Demand:
The inverse relationship between price
and quantity demanded; when price rises,
quantity demanded falls
Quantity demanded is a number; it’s how
many units of a good you bought
We usually draw a picture of this
relationship
Graph:
Watch content video: Micro Chapter 03demand curve
Today is a great day in economic research. A study of
mine, written jointly with a former colleague, has been
accepted for publication in a leading scholarly journal.
Both he and I are very happy about it. For a professor,
getting recognition for your ideas is always very gratifying
and, in my profession, publication outlets form a clear
hierarchy, with this one near the top. This outlet had
previously published thirteen papers by my ex-colleague,
but none of mine. The marginal utility of the fourteenth
paper published in that journal must be less than the
marginal utility of the first. If we are both rational and
have the same preferences, then I should be much
happier about having this study accepted for publication
than he is.
Q: I have had many scholarly papers published over my
thirty-eight-year career in economics, many of them in
others of the very top scholarly journals in the field.
What’s special about this one?
Why is the demand curve downward
sloping?
Diminishing Marginal Utility
– The marginal benefit you receive from an item falls as
you gain more of the item
– The only way to get you to buy more is to lower the
price
How do consumers react to price
changes?
(1) When the price of one good falls, people
substitute away from relatively more expensive
goods to the relatively cheaper goods
Called the substitution effect
(2) When the price of one good falls, real
consumer income rises so people buy more (it’s
like getting a raise)
Called the income effect
Both of these also cause the demand curve to
be downward sloping
Q3.1 (Potential Multiple Anwer) Consumers buy
less of a good as its price increases because
1.
2.
3.
4.
5.
6.
production costs have risen.
substitute goods are now relatively cheaper.
substitute goods are now relatively more expensive.
the income of consumers has effectively risen.
the income of consumers has effectively decreased.
the higher price will make the good more valuable to
each consumer.
The demand curve represents your
willingness to pay (your maximum
price), not how much you actually
paid
What if the actual price is lower than
your willingness to pay?
In economics, we call this difference
consumer surplus (CS)
Graphically, CS is the area below demand,
out to quantity, and down to price
Graph of CS:
Watch content video: Micro Chapter 03consumer surplus
Q3.2 Which of the following best explains the
source of consumer surplus for good A?
1.
2.
3.
4.
Many consumers pay prices that are greater than the
equilibrium price of good A.
Many consumers would be willing to pay more than the
market price for good A.
Many consumers think the market price of good A is
greater than its cost.
Many consumers think the demand for good A is
elastic.
Changes in Demand
Versus Changes in
Quantity Demanded
Watch video: Hudsucker Proxy
Demand is the relationship
between two variables: price
and quantity demanded
Changes:
(1) When price changes, quantity demanded
changes but demand does NOT change
– This is movement along a demand curve
(2) When something else changes, demand
changes (i.e., the relationship changes)
– This is movement of the entire curve
Typical “something else” changes:
Income
Number of consumers
Prices of related goods (substitutes and
complements)
Expectations
Demographics
Tastes and preferences
Another way to think about the
difference between demand and
quantity demanded
Why is the consumer buying more (or
less)?
If price is the reason, then quantity
demanded changes; move along the
demand curve
If any variable besides price is the reason,
then demand changes; shift the demand
curve
Graphs:
Watch content video: Micro Chapter 03shift vs move along demand
Q3.3 When economists say the demand for a
product has increased, they mean the
1. demand curve has shifted to the right.
2. price of the product has fallen, and
consequently, consumers are buying more of it.
3. cost of producing the product has risen.
4. amount of the product that consumers are
willing to purchase at various prices has
decreased.
Q3.4 When economists say the quantity demanded
of a product has decreased, they mean the
1. demand curve has shifted to the left.
2. demand curve has shifted to the right.
3. price of the product has fallen, and
consequently, consumers are buying more of it.
4. price of the product has risen, and
consequently, consumers are buying less of it.
The price for one good can be
intimately tied to demand for
another good
(1) Substitute goods-used in place of each
other
An increase (decrease) in price for the first
good will increase (decrease) demand for
the second good
(1) Substitute goods
Example: (A)__________, (B)__________
If the price of (A)_________ rose, the
(demand/quantity demanded) of
(A)____________ would (rise/fall) and
consumers would purchase (more/less)
(A)_______________. The
(demand/quantity demanded) for
(B)____________ would (rise/fall), causing
the demand curve to shift (right/left).
Graphs:
Watch content video: Micro Chapter 03substitute goods
(2) Complement goods-usually consumed
at the same time
An increase (decrease) in price for the first
good will decrease (increase) demand for
the second good
(2) Complement goods
Example: (A)__________, (B)__________
If the price of (A)_____________ rose, the
(demand/quantity demanded) of
(A)_____________ would (rise/fall) and
consumers would purchase (more/less)
(A)________________. The
(demand/quantity demanded) for
(B)_____________ would (rise/fall), causing
the demand curve to shift (right/left).
Graphs:
Watch content video: Micro Chapter 03complement goods
Q3.5 If air travel and bus travel are substitutes,
1. an increase in the price of bus travel will
decrease the demand for air travel.
2. a decrease in the price of bus travel will
decrease the demand for air travel.
3. an increase in the price of bus travel will
generally have no effect on the demand for air
travel.
4. an increase in the price of bus travel will shift the
demand curve for air travel to the left.
Q3.6 If coffee and cream are complements, an
increase in the price of coffee will cause
1.
2.
3.
4.
the demand for cream to increase.
the demand for cream to fall.
the demand for coffee to fall.
no change in the demand for cream; only
quantity demanded would be affected.
Producer Choice and the
Law of Supply
Goal: Explain and Predict Firm
Behavior
The Law of Supply:
– The positive relationship between price and
quantity supplied; when price rises, quantity
supplied rises
– Quantity supplied is a number; it’s how many
units of a good you made
Ways to express Law of Supply:
1.
2.
3.
4.
Words (see notes you just wrote)
Table
Math equation
Picture
We usually draw a picture of this
relationship
Graph:
Watch content video: Micro Chapter 03supply curve
Why is the supply curve upward
sloping?
At a higher price, a product is usually more
profitable so a firm has a stronger
incentive to make more.
Q3.7 According to the law of supply,
1. producers are willing to supply larger amounts
of a good as its price increases.
2. a direct relationship exists between the price of
a good and the amount buyers choose to buy.
3. an inverse relationship exists between the price
of a good and the amount buyers wish to buy.
4. an inverse relationship exists between the price
of a good and the amount producers supply.
What if the actual price is higher
than your minimum price?
In economics, we call this difference
producer surplus (PS)
Graphically, PS is the area above supply,
out to quantity, and up to price
Graph of PS:
Watch content video: Micro Chapter 03producer surplus
Watch video: Pretty Woman- consumer
surplus
Changes in Supply
Versus Changes in
Quantity Supplied
Price is not the only factor that
determines how much a firm
makes
Changes:
(1) When price changes, quantity supplied
changes but supply does NOT change
– This is movement along a supply curve
(2) When something else changes, supply
changes (i.e., the relationship changes)
– This is movement of the entire curve
Typical “something else” changes:
Resource prices
Technology
Nature
Political
Taxes
Another way to think about the
difference between supply and quantity
supplied
Why is the firm producing more (or less)?
If price is the reason, then quantity
supplied changes; move along the supply
curve
If any variable besides price is the reason,
then supply changes; shift the supply
curve
Graphs:
Watch content video: Micro Chapter 03shift vs move along supply
Q3.8 When economists say the supply of a product
has increased, they mean the
1. supply curve has shifted to the right.
2. price of the product has risen, and consequently,
suppliers are producing more of it.
3. supply curve has shifted to the left.
4. amount of the product that consumers are willing
to purchase at various prices has increased.
Q3.9 When economists say the quantity supplied of
a product has decreased, they mean the
1. supply curve has shifted to the left.
2. supply curve has shifted to the right.
3. price of the product has risen, and consequently,
suppliers are producing more of it.
4. price of the product has fallen, and consequently,
suppliers are producing less of it.
Even gangsters’ supply curves slope upward. In his
book But He Was Good to His Mother (Jerusalem:
Gefen, 2000), Robert Rockaway reports that an
associate of Big Jack, a New York gangster in the early
twentieth century, stated to police that Big Jack had the
following price list for his services: slash on the cheek
with knife, $1 to $5; shot in leg, $1 to $25; shot in arm,
$5 to $25; throwing a bomb, $5 to $50, murder, $10 to
$100. Clearly, the prices are higher for the more difficult
tasks; and the range of prices for a particular criminal act
probably reflects the ease of access to the target.
Perhaps a shot in the leg costs less than one in the arm
because hitting a person in the leg without causing
further damage is easier than hitting someone in the
arm.
Q: Draw a supply curve for criminal activities. Then
show how it would shift if unemployment were low and
there were many good legitimate jobs. Then show how
the curve would shift if jobs were scarce.
Q3.10 How will an increase in lumber prices
influence the home construction market?
1. The demand for newly constructed homes will
increase.
2. The demand for newly constructed homes will
decrease.
3. The supply of newly constructed homes will
increase.
4. The supply of newly constructed homes will
decrease.
How Market Prices are
Determined: Supply and
Demand Interact
Graph:
Watch content video: Micro Chapter 03supply and demand
Key points:
– (1) Excess supply and excess demand are
NOT unique points
– (2) Equilibrium IS a unique point
Q3.11 On the following graph, how much
is excess supply (surplus)?
1.
2.
3.
4.
5.
150
50
100
125
75
Q3.12 On the following graph, how much
is excess demand (shortage)?
1.
2.
3.
4.
50
75
100
125
How Markets Respond to
Changes in Supply and
Demand
This is called supply and demand
analysis
You don’t have to use graphs but it’s
helpful
Use this 3 step procedure:
– (1) Identify the change
– (2) Determine if Supply or Demand is
affected and how
– (3) Draw and read graph (or reason through
the change)
Only allow one variable to change at
a time.
Example: Part of Doak Campbell Stadium
is destroyed by locusts
– (1) Fewer seats will be available
– (2) Supply is affected, will decrease
– (3) Shift supply left and find new equilibrium
Graph:
Watch content video: Micro Chapter 03decrease supply
There have been stories all over the Web and on
television in the last few weeks about the lowcarbohydrate food craze- people following weight-loss
diets that involve sharp reductions in the intake of
carbohydrates. One story on Yahoo said, “Food
companies rush to take advantage of carbohydrate
crunch.” This is a good description of behavior in a
market where the demand curve has shifted to the right.
The demand shift is due to people’s new belief that these
diets will enable them to lose weight. To meet the shift
in demand- and seeing a chance to make additional
profits- food companies are happy to produce more lowcarbohydrate foods. They are happy to increase the
amount supplied in response to the shift in demand.
Q: What does this change in consumer behavior do to
the equilibrium price of low-carbohydrate foods?
Q3.13 If the demand for a good decreased, what
would be the effect on the equilibrium price and
quantity?
1. Price would increase and quantity would
decrease.
2. Price would decrease and quantity would
decrease.
3. Price would increase and quantity would
increase.
4. Price would decrease and quantity would
increase.
Q3.14 If Georgia experiences a late frost that
damages the peach crop, we should expect the
1. supply curve for peaches to shift to the right
and the price of peaches to fall.
2. supply curve for peaches to shift to the left and
the price of peaches to rise.
3. demand curve for peaches to shift to the left
and the price of peaches to fall.
4. demand curve for peaches to shift to the right
and the price of peaches to rise.
What if supply and demand shift
at the same time?
Suppose supply and demand both
decrease
Watch content video: Micro Chapter 03supply and demand decrease
Q3.15 (Potential Multiple Answer) If there is a
simultaneously an increase in demand and an
increase in supply, we would expect
1. An increase in equilibrium price and an increase
in equilibrium quantity
2. A decrease in equilibrium price and an increase
in equilibrium quantity
3. An increase in equilibrium price and a decrease
in equilibrium quantity
4. A decrease in equilibrium price and a decrease
in equilibrium quantity
Class Activity: Name one good you
purchased recently. Identify at least 5
different people that were involved in that
product so that you could buy it.
Watch video: Friedman-I pencil and price
system
Invisible Hand Principle
Adam Smith- An Inquiry into the Nature
and Causes of the Wealth of Nations
Personal self-interest directed by market
prices is a powerful force promoting
economic progress
“Every individual is continually exerting himself to
find out the most advantageous employment for
whatever [income] he can command. It is his own
advantage, indeed, and not that of the society
which he has in view. But the study of his own
advantage naturally, or rather necessarily, leads
him to prefer that employment which is most
advantageous to society…He intends only his own
gain, and he is in this, as in many other cases, led
by an invisible hand to promote an end which was
not part of his intention. By pursuing his own
interest he frequently promotes that of the society
more effectually than when he really intends to
promote it.”
Q3.16 Which of the following is a major implication
of the invisible hand concept?
1.
2.
3.
4.
When directed by competitive market prices, the actions
of self-interested individuals will tend to promote overall
economic prosperity.
Prosperity cannot be achieved unless the selfish nature
of people can be changed.
Competition is harmful to the health of an economy
because it results in wasteful duplication.
Government-operated firms tend to have higher
efficiency and lower costs than private sector firms.
Question Answers:
Q3.1 = 2 & 5
Q3.2 = 2
Q3.3 = 1
Q3.4 = 4
Q3.5 = 2
Q3.6 = 2
Q3.7 = 1
Q3.8 = 1
Q3.9 = 4
Q3.10 = 4
Q3.11 = 2
Q3.12 = 4
Q3.13 = 2
Q3.14 = 2
Q3.15 = 1 & 2
Q3.16 = 1