Unit 2 - Supply and Demand
The Law of Demand
Buyers of a product will purchase more of
the product if its price is lower and vice
versa, assuming all other
things remain
constant (ceteris
paribus).
Unit 2 - Supply and Demand
Two Reasons Why Buyers Buy More at
Lower Prices and Less at Higher Prices
 The Substitution Effect
 The Income Effect
Unit 2 - Supply and Demand
Substitution Effect
When the price of a product decreases,
ceteris paribus, the product becomes
cheaper. It is, therefore, more attractive
relative to other products (and vice versa).
Unit 2 - Supply and Demand
Income Effect
When the price of a product decreases,
ceteris paribus, consumers have more
relative income. They can, therefore,
purchase additional products (and vice
versa).
Unit 2 - Supply and Demand
One Buyer
How much gasoline
would you purchase at
the following prices
(gallons per month)?
Price Per
Gallon
Quantity
Demanded
$2.50
50
$3.00
45
$3.50
42
$4.00
35
$4.50
20
$5.00
10
Price in Dollars
Per Gallon
5.00
4.50
4.00
3.50
3.00
2.50
D
One Individual’s Demand Curve
Quantity
Demanded
Unit 2 - Supply and Demand Micro
Why Do You Purchase 10 instead of 11
Gallons of Gasoline When You Visit the
Gas Station?
Unit 2 - Supply and Demand Micro
Marginal Utility
Marginal utility is the increase in
satisfaction (as measured in “utils”) per
additional item consumed.
Unit 2 - Supply and Demand Micro
The Law of Diminishing Marginal Utility
As consumers purchase more of a
product, the value (satisfaction) of
additional items purchased declines.
Unit 2 - Supply and Demand
Several Buyers
(the Market)
Price
$2.50
$3.00
How much
gasoline would
you purchase at
the following
prices
(gallons/month)?
$3.50
$4.00
$4.50
$5.00
Q1
Q2
Q3
Q4
Total
buyer 1
buyer 2
buyer 3
buyer 4
market
Price in Dollars
Per Gallon
5.00
4.50
4.00
3.50
3.00
2.50
D
Market Demand Curve
Quantity
Demanded
Unit 2 - Supply and Demand
The Demand Curve
A change in the price is a movement along
the demand curve. This is called a change
in “quantity demanded”.
Price
$4
Individual product demand
curves always extend from the
upper left to the lower right.
They are downward sloping.
A
B
$1.75
Demand Curve
60
80
Quantity Demanded
Unit 2 - Supply and Demand
The Law of Supply
Producers supply more of a product at
higher than at lower prices, ceteris paribus
(and vice versa).
Unit 2 - Supply and Demand
One Supplier
If you had a small oil
well in your backyard
and it took you some
effort to get the oil out,
and you were able to
sell the oil, how much
gasoline would you
supply if you could sell
the oil at the following
prices in the market
(gallons per month)?
Price Per
Gallon
$2.50
$3.00
$3.50
$4.00
$4.50
$5.00
Quantity
Supplied
Price in Dollars
Per Gallon
S
5.00
4.50
4.00
3.50
3.00
2.50
Individual Supply Curve
Quantity
Supplied
Unit 2 - Supply and Demand
Several Suppliers
If you had a small oil well in
your backyard and it took
you some effort to get the
oil out, and you were able
to sell the oil, how much
gasoline would you supply
at the following prices
(gallons per month)?
Price
$2.50
$3.00
$3.50
$4.00
$4.50
$5.00
Q1
Q2
Q3
Q4
Total
seller 1
seller 2
seller 3
seller 4
market
Price in Dollars
Per Gallon
S
5.00
4.50
4.00
3.50
3.00
2.50
Market Supply Curve
Quantity
Supplied
Unit 2 - Supply and Demand
The Supply Curve
A change in the price is a movement along
the supply curve from point A to point B.
This is called a change in “ _______.”
Price
Supply Curve
B
$4.50
A supply curve is
upward sloping.
A
$2
30
90
Quantity Supplied
Unit 2 - Supply and Demand

Reasons why producers produce more at
higher prices
The Substitution Effect
When the market price increases, other competing
products will become less profitable and less
attractive to produce (and vice versa).

The Income Effect
When the price increases, the product earns more
money (income) and the supplier has more incentive
to produce (and vice versa).
Unit 2 - Supply and Demand
Equilibrium Price and Quantity
In a free market the equilibrium price and
quantity occur where the supply and
demand curves intersect.
Price
S
$3
D
50
Quantity
Rent
The Case of Rent Control
S
$1,800
$1,000
D
700
900
Quantity
Demanded
Price
of Labor
The Minimum Wage
SL
$7.50
$6.00
DL
900 1,000 1,100
Minimum Wage
Quantity
Demanded
of Labor
Price
of Labor
Minimum Wage – New York Example
SL
$10.00
$8.50
$7.50
DL
900 1,000 1,100
Quantity
Demanded
of Labor
Unit 2 - Supply and Demand
Demand Determinants
The following changes will shift the demand
curve to the right or to the left.
 A change in real incomes or wealth (normal and inferior
products).
 A change in tastes or preferences.
 A change in the prices of related products (substitute and
complementary products).
 A change in the expectation of the product’s future price or
buyers’ future incomes.
 A change in the number of buyers (population).
Unit 2 - Supply and Demand
Equilibrium Price and Quantity
When demand increases, the
demand curve shifts to the right.
Price
S
$4
$3
D2
D1
50
70 Quantity
Equilibrium
price increases,
and equilibrium
quantity
increases.
Unit 2 - Supply and Demand
The Effect of a Change in Demand on
Equilibrium Price and Quantity
In the short run, when demand increases
1. the equilibrium price increases, and
2. the equilibrium quantity increases.
In the short run, when demand decreases
1. the equilibrium price decreases, and
2. The equilibrium quantity decreases
Unit 2 - Supply and Demand
Supply Determinants
The following changes will shift the supply
curve to the right or to the left.
 An advance in technology.
 A change in input prices.
 A change in taxes, subsidies, or regulations.
 A change in the number of firms selling the
product.
Unit 2 - Supply and Demand
Equilibrium Price and Quantity
When supply increases, the
supply curve shifts to the right.
Equilibrium
price decreases,
S1
S2 and equilibrium
quantity
increases.
Price
$3
$2
D
50
60
Quantity
Unit 2 - Supply and Demand
The Effect of a Change in Supply on
Equilibrium Price and Quantity
When supply increases (a rightward shift of the
supply curve)
1. The equilibrium price decreases, and
2. The equilibrium quantity increases.
When supply decreases (a leftward shift of the
supply curve)
1. The equilibrium price increases, and
2. The equilibrium quantity decreases.
Unit 2 - Supply and Demand
Changes in Demand and Supply –
Example 1
What happens to the equilibrium price and quantity
of an Ipod (a normal product) when simultaneously:


Buyers’ incomes rise,
and
Technology to make the
Ipods improves?
What happens to the price and quantity
bought/sold of Ipods if incomes rise and
technology advances?
1.
2.
3.
4.
Price down; quantity up
Price same; quantity up
Price up; quantity up
Price down; quantity
down
5. None of the above
Unit 2 - Supply and Demand
Changes in Demand and Supply –
Example 1 Answer
 An increase in incomes will increase demand
(price and quantity increase).
 An advance in technology will increase supply
(price decreases and quantity increases).
The combined effect is that price change is
indeterminate and equilibrium quantity
increases.
Unit 2 - Supply and Demand
Changes in Demand and Supply – Example 2
What happens to the equilibrium price and
quantity of paper towels when simultaneously
Buyers expect the future
price of paper towels
to be significantly higher
in the near future.
The government
taxes the production of
paper towels.
Determine price and quantity of paper towels
when future price is expected to rise and
production tax rises
1. Pe increases; Qe
decreases
2. Pe increases; Qe change
is unknown
3. Pe decreases; Qe
decreases
4. Pe increases; Qe
increases
5. Pe is unknown; Qe
decreases
6. none
Unit 2 - Supply and Demand

Changes in Demand and Supply Example 2 Answer

The expectation of a higher future price increases the
current demand for the product (price and quantity
increase).
The imposition of a government tax reduces the
supply (price increases and quantity decreases).

The combined effect is that the equilibrium
quantity change is unknown (indeterminate)
and the equilibrium price increases.
Unit 2 - Supply and Demand
Consumer Surplus
is the difference in what consumers are
willing to pay for the price of the product
and what they are actually paying for it
in the market.
Price
Consumer
Surplus
S
$8
$7
$6
$5
D
90 100 110 120
Quantity
Demanded
Per Day
Unit 2 - Supply and Demand
Producer Surplus
is the difference in what suppliers are
willing to sell the product for and what
they are actually receiving for it in the
market.
Price
S
Producer
Surplus
$5
$4
$3
$2
D
90 100 110 120
Quantity
Demanded
Per Day
Unit 2 - Supply and Demand
The Free Market Economy
Free market economy = capitalist economy =
laissez-faire economy = price system
In a free market economy prices of goods
and services, wages, interest rates, foreign
exchange values, etc., are determined by
supply and demand
Unit 2 - Supply and Demand
The Free Market Economy
Should all prices, including wages, be
determined by supply and demand?
Celebrities receive millions of dollars per year in compensation
Baltimore Sun photo by Ezra Shaw.
Unit 2 - Supply and Demand
The Free Market Economy and
Externalities
Do prices reflect their true market value?
Businesses that pollute:
1.
2.
3.
4.
Should be fined by the
government and the
revenue should be
used to help clean the
environment
Should be forced to
go out of business
Should be allowed to
operate just like any
other business
No opinion/other
Organizations that provide products that have
positive externalities:
1.
2.
3.
4.
Should be
subsidized by the
government
Should be fully
funded by the
government
Should operate just
like any other
organization
No opinion/other
Unit 2 - Supply and Demand
Prices of Manufactured Products
Manufactured products are abundantly
available and are produced in competitive
industries. Examples include computers,
cell phones, CDs, and bicycles.
Prices of manufactured goods equal the cost of
production plus a reasonable profit. Prices are rarely
excessive, especially in the long run.
Unit 2 - Supply and Demand
Prices of Limited-Supply Products
Examples of limited-supply
products include land, office
space, labor, Super Bowl
tickets, and products sold
by monopolies.
Prices of limited-supply products can be excessive,
even in the long run.