Unit 2: Supply, Demand,
and Consumer Choice
Can they
see me?
Demand
DEMAND
What is Demand?
Demand is the different quantities of goods that
consumers are willing and able to buy at different
prices.
What is the Law of Demand?
INVERSE relationship between price and
quantity demanded
Why does the Law of Demand occur?
1. The Substitution effect
2. The Income effect
3. The Law of Diminishing Marginal Utility
What Causes a Shift in Demand?
5 Determinates of Demand (SHIFTERS) :
1. Tastes and Preferences
2. Number of Consumers
3. Price of Related Goods
4. Income
5. Future Expectations
Changes in PRICE don’t shift
the curve.
Prices of Related Goods
Substitutes
P _____Demand for Other _____
P _____Demand for Other _____
Compliments
P _____Demand for Other _____
P _____Demand for Other _____
Income
Normal
Income _____Demand _____
Income _____Demand _____
Inferior
Income _____Demand _____
Income _____Demand _____
Other things equal, if the price of a key resource used to
produce product X falls, the:
A)supply curve of X will shift to the right.
B)demand curve of X will shift to the right.
C)supply curve of X will shift to the left.
D)demand curve of X will shift to the right.
E)both the supply and demand of X will increase
If Z is an inferior good, a decrease in income will shift the:
A)supply curve for Z to the left.
B)supply curve for Z to the right.
C)demand curve for Z to the left.
D)demand curve for Z to the right
E) there is no shift since this only changes price
Supply
Supply
What is supply?
Supply is the different quantities of a good that sellers
are willing and able to sell (produce) at different prices.
What is the Law of Supply?
There is a DIRECT (or positive) relationship between
price and quantity supplied.
Shifters
• Prices/Availability of inputs (resources)
• Number of Sellers
• Technology
• Government Action: Taxes & Subsidies
• Opportunity Cost of Alternative Production
• Expectations of Future Profit
Price
Controls
Draw an effective Price Floor and Price Ceiling
What are the results?
Price of Corn
P
S
$5
4
3
2
1
o
D
2
4
6
78
10 12 14 16
Quantity of Corn
Q
Price of Corn
P
$5
Surplus
S
Floor
4
3
2
Ceiling
Shortage
1
o
D
2
4
6
78
10 12 14 16
Quantity of Corn
Q
At price $20, there would be a surplus of…
A)100 B) 150
C) 200
D) 50
E) 0
What would be the effect of a price floor at $60
A) It would be ineffective
E) A shortage of 100
B) A shortage of 50
D) A surplus of 100
C) Quantity demanded would increase
Excise Taxes
Taxes on producers
Practice
FRQ #1
Double Shifts
• Demand for sports cars fell at the same time as
production technology improved.
• What happens to P and Q?
If TWO curves shift at the same
time, EITHER price or quantity
will be indeterminate.
Which of the following statements is correct?
A)If demand increases and supply decreases,
equilibrium price will fall.
B)If the demand and the supply both fall at the same
time, quantity will be indeterminate
C)If demand decreases and supply increases,
equilibrium price will rise.
D) If supply increases and demand decreases,
equilibrium price will fall.
E) If supply falls and demand remains constant,
equilibrium price will fall.
How does the S&D graph show consumer
and producer’s surplus?
P
$10
8
Consumer’s Surplus = Buyers Maximum - Price
Producer’s Surplus = Price- Sellers Minimum
S
7
6
5
4
3
2
D
6 7 8 9 10 11 12 13
Q
Practice
FRQ #2
Elasticity
Inelastic Demand
INelastic = Insensitive to a
change in price.
•If price increases, quantity
20%
demanded will fall a little
•If price decreases, quantity
demanded increases a little.
In other words, people will
continue to buy it.
General Characteristics of INelastic Goods:
• Few Substitutes
• Necessities
• Small portion of income
• Required now, rather than later
5%
Elastic Demand
Elastic = Sensitive to a change
in price.
•If price increases, quantity
demanded will fall a lot
•If price decreases, quantity
demanded increases a lot.
In other words, the amount
people buy is sensitive to price.
General Characteristics of Elastic Goods:
• Many Substitutes
• Luxuries
• Large portion of income
• Plenty of time to decide
Perfectly and Unit Elastic
Perfectly INELASTIC
Unit Elastic (45 degrees)
Total Revenue Test
Use elasticity to show how changes in price
will affect total revenue (TR).
Elastic Demand• Price _____ causes TR to _____
• Price _____ causes TR to _____
Inelastic Demand
• Price _____ causes TR to _____
• Price _____ causes TR to _____
Unit Elastic• Price _____causes TR to ______
Practice
FRQ #3
Consumer Choice
UTILITY MAXIMIZING COMBINATION
$ 10 income
Unit of
product
First
Product A:
Price = $1
Marginal
Marginal utility per
utility,
dollar
utils
(MU/price)
10
--
Product B:
Price = $2
Marginal
Marginal utility per
utility,
dollar
utils
(MU/price)
24
--
To maximize utility, how should
the $10 income be allocated?
UTILITY MAXIMIZING COMBINATION
$ 10 income
Unit of
product
First
Product A:
Price = $1
Marginal
Marginal utility per
utility,
dollar
utils
(MU/price)
10
10
Product B:
Price = $2
Marginal
Marginal utility per
utility,
dollar
utils
(MU/price)
24
12
Examine the
marginal utilities per dollar
UTILITY MAXIMIZING COMBINATION
$ 10 income
Unit of
product
Product A:
Price = $1
Marginal
Marginal utility per
utility,
dollar
utils
(MU/price)
First
10
Second 8
Third
7
Fourth 6
Fifth
5
Sixth
4
Seventh 3
10
8
7
6
5
4
3
Product B:
Price = $2
Marginal
Marginal utility per
utility,
dollar
utils
(MU/price)
24
20
18
16
12
6
4
12
10
9
8
6
3
2
UTILITY MAXIMIZING COMBINATION
$ 10 income
Unit of
product
Product A:
Price = $1
Marginal
Marginal utility per
utility,
dollar
utils
(MU/price)
First
10
Second 8
Third
7
Fourth 6
Fifth
5
Sixth
4
Seventh 3
10
8
7
6
5
4
3
Product B:
Price = $2
Marginal
Marginal utility per
utility,
dollar
utils
(MU/price)
24
20
18
16
12
6
4
12
10
9
8
6
3
2
UTILITY MAXIMIZING COMBINATION
$ 10 income
Unit of
product
Product A:
Price = $1
Marginal
Marginal utility per
utility,
dollar
utils
(MU/price)
First
10
Second 8
Third
7
Fourth 6
Fifth
5
Sixth
4
Seventh 3
10
8
7
6
5
4
3
Product B:
Price = $2
Marginal
Marginal utility per
utility,
dollar
utils
(MU/price)
24
20
18
16
12
6
4
12
10
9
8
6
3
2
UTILITY MAXIMIZING COMBINATION
$ 10 income
Unit of
product
Product A:
Price = $1
Marginal
Marginal utility per
utility,
dollar
utils
(MU/price)
First
10
Second 8
Third
7
Fourth 6
Fifth
5
Sixth
4
Seventh 3
10
8
7
6
5
4
3
Product B:
Price = $2
Marginal
Marginal utility per
utility,
dollar
utils
(MU/price)
24
20
18
16
12
6
4
12
10
9
8
6
3
2
UTILITY MAXIMIZING COMBINATION
$ 10 income
Unit of
product
Product A:
Price = $1
Marginal
Marginal utility per
utility,
dollar
utils
(MU/price)
First
10
Second 8
Third
7
Fourth 6
Fifth
5
Sixth
4
Seventh 3
10
8
7
6
5
4
3
Product B:
Price = $2
Marginal
Marginal utility per
utility,
dollar
utils
(MU/price)
24
20
18
16
12
6
4
12
10
9
8
6
3
2
UTILITY MAXIMIZING COMBINATION
$ 10 income
Unit of
product
Product A:
Price = $1
Marginal
Marginal utility per
utility,
dollar
utils
(MU/price)
First
10
Second 8
Third
7
Fourth 6
Fifth
5
Sixth
4
Seventh 3
10
8
7
6
5
4
3
Product B:
Price = $2
Marginal
Marginal utility per
utility,
dollar
utils
(MU/price)
24
20
18
16
12
6
4
12
10
9
8
6
3
2
UTILITY MAXIMIZING COMBINATION
$ 10 income
Unit of
product
Product A:
Price = $1
Marginal
Marginal utility per
utility,
dollar
utils
(MU/price)
First
10
Second 8
Third
7
Fourth 6
Fifth
5
Sixth
4
Seventh 3
10
8
7
6
5
4
3
Product B:
Price = $2
Marginal
Marginal utility per
utility,
dollar
utils
(MU/price)
24
20
18
16
12
6
4
12
10
9
8
6
3
2
UTILITY MAXIMIZING COMBINATION
$ 10 income
Unit of
product
Product A:
Price = $1
Marginal
Marginal utility per
utility,
dollar
utils
(MU/price)
First
10
10
Second 8
8
Third
7
7
Utility maximizing
Fourth 6
6
combination is 2 of Product A
Fifth
5 B 5
and
4 of product
Sixth
4
4
Seventh 3
3
Product B:
Price = $2
Marginal
Marginal utility per
utility,
dollar
utils
(MU/price)
24
20
18
16
12
6
4
12
10
9
8
6
3
2
UTILITY MAXIMIZING COMBINATION
$ 10 income
Unit of
product
First
Product A:
Price = $1
Marginal
Marginal utility per
utility,
dollar
utils
(MU/price)
10
10
Product B:
Price = $2
Marginal
Marginal utility per
utility,
dollar
utils
(MU/price)
24
12
Utility Maximizing Rule
The consumer’s money should be spent so that the
marginal utility per dollar of each goods equal each
other.
MUx = MUy
Px
Py
Practice
FRQ #4
UNIT 1 KEY CONCEPT
Absolute and
Comparative Advantage
Output Questions:
OOO=
Output: Other goes Over
Input Questions:
IOU=
Input: Other goes Under