Supply and Demand:
An Introduction
MB
MC
MB MC

Supply and Demand:
An Introduction
How do consumers get the goods and
services they want in the right quantities
and qualities?

Some goods and services are allocated by
the market forces of supply and demand
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 3 - Supply and Demand: An Introduction
Slide 2
MB MC

Supply and Demand:
An Introduction
Why do some goods and services have
shortages or surpluses and others do
not?

Some good and supplies services are
regulated by government
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 3 - Supply and Demand: An Introduction
Slide 3
MB MC

What, How, and For Whom?
Central Planning Versus the Market
Three Problems All Economic Systems
Must Address
What should be produced?
 How should it be produced?
 For whom will it be produced?

Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 3 - Supply and Demand: An Introduction
Slide 4
MB MC

What, How, and For Whom?
Central Planning Versus the Market
Centralized Economic Organizations
Agrarian society
 Former Soviet Union
 Cuba
 North Korea
 China
 Bureaucracy

Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 3 - Supply and Demand: An Introduction
Slide 5
MB MC

What, How, and For Whom?
Central Planning Versus the Market
A small number of individuals address:

What
 Establish
production targets for factories and
farms

How
 Plan

how to achieve the goals
For Whom
 Distribute
the goods and services
produced
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 3 - Supply and Demand: An Introduction
Slide 6
MB MC

What, How, and For Whom?
Central Planning Versus the Market
Free-Market or Capitalist Economic
System

Individual choices determine:
 Which
careers to pursue
 Which products to produce or buy
 When to start and shut-down a business
 Who gets what is decided by individual
preferences and purchasing power
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 3 - Supply and Demand: An Introduction
Slide 7
MB MC
Buyers and Sellers In Markets

Market


Consists of all buyers and sellers of a good
or service
What do you think?

What determines the price of pizza,
gasoline, a car wash, or other goods and
services?
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 3 - Supply and Demand: An Introduction
Slide 8
MB MC
Buyers and Sellers In Markets

The Demand Curve

A schedule or graph that tells us the
quantity of a good that buyers wish to buy
at each price
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 3 - Supply and Demand: An Introduction
Slide 9
MB MC
Buyers and Sellers In Markets

A Property of Demand
As price of a good or service goes down
the quantity consumers wish to buy will
increase
 Therefore, the demand curve is downwardsloping

Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 3 - Supply and Demand: An Introduction
Slide 10
MB MC
The Daily Demand
Curve for Pizza in Chicago
Price
($ per slice)
4
3
2
Demand
8
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
12
16
Chapter 3 - Supply and Demand: An Introduction
Quantity
(1000s of slices per day)
Slide 11
MB MC
Buyers and Sellers In Markets

The Demand Curve

Why do buyers purchase a greater quantity
at lower prices and vice-versa?
 The
substitution effect
 The income effect
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 3 - Supply and Demand: An Introduction
Slide 12
MB MC
Buyers and Sellers In Markets

The Substitution Effect

The change in the quantity demanded of a
good that results because buyers switch to
substitutes when the price of the good
changes
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 3 - Supply and Demand: An Introduction
Slide 13
MB MC
Buyers and Sellers In Markets

The Income Effect

The change in the quantity demanded of a
good that results because a change in the
price of a good changes the buyer’s
purchasing power
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 3 - Supply and Demand: An Introduction
Slide 14
MB MC
Buyers and Sellers In Markets

The Cost-Benefit Principle
The reservation price is the benefit the
buyer receives from the good
 The cost of the good is its market price
 If the reservation price (benefit) exceeds
the market price (cost) the consumer will
purchase the good
 At higher prices, benefit will exceed cost
for a smaller quantity than at lower prices

Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 3 - Supply and Demand: An Introduction
Slide 15
MB MC
Buyers and Sellers In Markets
Price
($ per slice)
The buyers reservation price:
The largest dollar amount the
buyer would be willing to pay for
a good
4
3
2
Demand
8
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
12
16
Chapter 3 - Supply and Demand: An Introduction
Quantity
(1000s of slices per day)
Slide 16
MB MC
Buyers and Sellers In Markets
Horizontal Interpretation
Price
($ per slice)
Price determines
quantity demanded
4
3
2
Demand
8
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
12
16
Chapter 3 - Supply and Demand: An Introduction
Slide 17
MB MC
Buyers and Sellers In Markets
Vertical Interpretation
Price
($ per slice)
Quantity measures the
marginal buyer’s
reservation price
4
3
2
Demand
8
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
12
16
Chapter 3 - Supply and Demand: An Introduction
Slide 18
MB MC
Buyers and Sellers In Markets

The Supply Curve

A curve or schedule showing the quantity
of a good that sellers wish to sell at each
price
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 3 - Supply and Demand: An Introduction
Slide 19
MB MC
Buyers and Sellers In Markets

Question

Will the opportunity cost of producing
additional units of pizza increase or
decrease?
 Hint:Low-hanging-fruit
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
principle
Chapter 3 - Supply and Demand: An Introduction
Slide 20
MB MC
Buyers and Sellers In Markets

The Supply Curve

Sellers must receive a higher price to
produce additional units of product to cover
the higher opportunity costs of each
additional unit
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 3 - Supply and Demand: An Introduction
Slide 21
MB MC
The Daily Supply
Curve for Pizza in Chicago
Price
($ per slice)
Supply
4
3
2
8
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
12
16
Chapter 3 - Supply and Demand: An Introduction
Quantity
(1000s of slices per day)
Slide 22
MB MC
The Daily Supply
Curve for Pizza in Chicago
Horizontal Interpretation
Price
($ per slice)
Supply
4
Shows the
quantity produced
for each price
3
2
8
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
12
16
Chapter 3 - Supply and Demand: An Introduction
Quantity
(1000s of slices per day)
Slide 23
MB MC
The Daily Supply
Curve for Pizza in Chicago
Vertical Interpretation
Price
($ per slice)
Supply
4
Shows the marginal
cost (reservation
price) for producing
each additional unit
3
2
8
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
12
16
Chapter 3 - Supply and Demand: An Introduction
Quantity
(1000s of slices per day)
Slide 24
MB MC

The Daily Supply
Curve for Pizza in Chicago
Seller’s Reservation Price

The smallest dollar amount for which a
seller would be willing to sell an additional
unit, generally equal to marginal cost
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 3 - Supply and Demand: An Introduction
Slide 25
MB MC
Market Equilibrium

Equilibrium


A system is in equilibrium when there is no
tendency for it to change
Market Equilibrium

Occurs in a market when all buyers and
sellers are satisfied with their respective
quantities at the market price
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 3 - Supply and Demand: An Introduction
Slide 26
MB MC
The Equilibrium Price and
Quantity of Pizza In Chicago
Price
($ per slice)
Supply
Equilibrium at $3
Quantity Demanded =
Quantity Supplied
4
3
2
Demand
8
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
12
16
Chapter 3 - Supply and Demand: An Introduction
Quantity
(1000s of slices per day)
Slide 27
MB MC
Market Equilibrium

Equilibrium Price and Equilibrium
Quantity

The values of price and quantity for which
quantity supplied and quantity demanded
are equal
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 3 - Supply and Demand: An Introduction
Slide 28
MB MC
Market Equilibrium

What Do You Think?
Would buyers prefer a lower price than the
equilibrium price?
 Would sellers prefer a higher price than the
equilibrium price?

Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 3 - Supply and Demand: An Introduction
Slide 29
MB MC
Excess Supply
Excess supply = 8,000 slices per day
Price
($ per slice)
Supply
4
3
2
Demand
8
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
12
16
Chapter 3 - Supply and Demand: An Introduction
Quantity
(1000s of slices per day)
Slide 30
MB MC
Excess Demand
Price
($ per slice)
Supply
4
Excess demand = 8,000
slices per day
3
2
Demand
8
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
16
Chapter 3 - Supply and Demand: An Introduction
Quantity
(1000s of slices per day)
Slide 31
Points Along the Demand and
Supply Curves of a Pizza Market
MB MC
Demand for pizza
Supply of pizza
Price
($/slice)
Quantity demanded
(1000s of slices/day)
Price
($/slice)
Quantity supplied
(1000s of slices/day)
1
8
1
2
2
6
2
4
3
4
3
6
4
2
4
8
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 3 - Supply and Demand: An Introduction
Slide 32
MB MC
Graphing Supply and Demand and
Finding the Equilibrium Price and Quantity
Price
($per slice)
Supply
5
4
The Equilibrium Price = $2.50
The Equilibrium Quantity = 5
3
2.50
2
1
0
Demand
2
4
6
8
10
Quantity
(1000s of slices per day)
5
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 3 - Supply and Demand: An Introduction
Slide 33
MB MC
Market Equilibrium

What Do You Think?

Is the market equilibrium always an ideal
outcome for all market participants?
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 3 - Supply and Demand: An Introduction
Slide 34
MB MC
An Unregulated Housing Market
Monthly Rent
($/apartment)
Supply
What Do You Think?
Is $1600 more than some
people can afford?
1,600
Demand
2
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 3 - Supply and Demand: An Introduction
Quantity
(Millions of apartments/day)
Slide 35
MB MC
Rent Controls
Monthly Rent
($/apartment)
Supply
2,400
Excess demand = 2 million
apartments per month
1,600
Controlled = 800
Demand
0
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
1
2
3
Chapter 3 - Supply and Demand: An Introduction
Quantity
(Millions of apartments/day)
Slide 36
MB MC
Market Equilibrium

Rent Controls Reconsidered

Other consequences of rent controls
 Maintenance
will decline and housing quality
will fall
 Illegal payments
 Creation of co-ops and conversion to
condominiums
 Reduction in household mobility
 Discrimination
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 3 - Supply and Demand: An Introduction
Slide 37
MB MC
Market Equilibrium

What do you think?

How can we make housing affordable for
poor people without using rent ceilings?
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 3 - Supply and Demand: An Introduction
Slide 38
MB MC
Rent Controls
Monthly Rent
($/apartment)
Supply
1,200
What is the impact of a rent
control set at $1,200/month?
800
Demand
0
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
1
2
3
Chapter 3 - Supply and Demand: An Introduction
Quantity
(Millions of apartments/day)
Slide 39
MB MC
Price Controls
In The Pizza Market
Price
($ per slice)
Supply
4
Excess demand = 8,000 slices per day
3
Price ceiling = 2
Demand
8
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
12
16
Chapter 3 - Supply and Demand: An Introduction
Quantity
(1000s of slices per day)
Slide 40
MB MC
Market Equilibrium

Pizza Price Controls?

Market responses to a pizza price ceiling
 Long
lines
 Preferential treatment to selected customers
 Alternative pricing strategies
 Poorer quality ingredients
 Black-market pizzas
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 3 - Supply and Demand: An Introduction
Slide 41
MB MC

Predicting and Explaining
Changes In Prices and Quantities
Distinguishing Between:

A change in the quantity demanded
A
movement along the demand curve that
occurs in response to a change in price

A change in demand
A
shift of the entire demand curve
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 3 - Supply and Demand: An Introduction
Slide 42
MB MC
An Increase In Quantity
Demanded vs. An Increase In Demand
Price
($/can)
Increase in
quantity
demanded
6
5
4
3
2
1
0
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
D
2
4
6
8
10
12
Quantity
(1000s of cans/day)
Chapter 3 - Supply and Demand: An Introduction
Slide 43
MB MC
An Increase In Quantity
Demanded vs. An Increase In Demand
Price
($/can)
6
D’
D
5
4
Increase in demand
3
2
D’
1
0
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
D
12
Quantity
(1000s of cans/day)
Chapter 3 - Supply and Demand: An Introduction
Slide 44
MB MC

Change in the quantity supplied


Predicting and Explaining
Changes In Prices and Quantities
A movement along the supply curve that
occurs in response to a change in price
Change in supply

A shift of the entire supply curve
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 3 - Supply and Demand: An Introduction
Slide 45
MB MC
An Increase In Quantity
Supplied vs. An Increase In Supplied
Price
($/can)
S
6
5
Increase in
quantity supplied
4
3
2
S
1
0
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
2
4
6
8
10
Quantity
(1000s of cans/day)
Chapter 3 - Supply and Demand: An Introduction
Slide 46
MB MC
An Increase In Quantity
Supplied vs. An Increase In Supplied
Price
($/can)
6
S’
S
5
4
3
Increase in supply
2
1
S’
S
0
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
2
4
6
8
10
Quantity
(1000s of cans/day)
Chapter 3 - Supply and Demand: An Introduction
Slide 47
MB MC
The Effect on the Market for Tennis
Balls of a Decline in Court-Rental Fees
Price
($/ball)
S
1.40
1.00
D’
D
40
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
58
Chapter 3 - Supply and Demand: An Introduction
Quantity
(letters/month)
Slide 48
MB MC

Predicting and Explaining
Changes In Prices and Quantities
Shifts in Demand

Complements
 Two
goods are complements in consumption if
an increase (decrease) in the price of one
cause a decrease (increase) in the demand for
the other
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 3 - Supply and Demand: An Introduction
Slide 49
MB MC
The Effect on the Market for Overnight Letter
Delivery of a Decline in the Price of Internet Access
Price
($/letter)
S
P
P’
D
D’
Q’
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Q
Chapter 3 - Supply and Demand: An Introduction
Quantity
(letters/month)
Slide 50
MB MC

Predicting and Explaining
Changes In Prices and Quantities
Shifts in Demand

Substitutes
 Two
goods are substitutes in consumption if an
increase (decrease) in the price of one causes
an increase (decrease) in the demand for the
other
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 3 - Supply and Demand: An Introduction
Slide 51
MB MC

Predicting and Explaining
Changes In Prices and Quantities
What do you think?

How will a decline in airfares affect intercity bus fares and the price of hotel rooms
in resort communities?
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 3 - Supply and Demand: An Introduction
Slide 52
MB MC

Predicting and Explaining
Changes In Prices and Quantities
Economic Naturalist

When the Federal Government implements
a large pay increase for its employees, why
do rents for apartments near Washington
Metro stations go up relative to rents for
apartments located far away from Metro
stations?
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 3 - Supply and Demand: An Introduction
Slide 53
MB MC
The Effect of a Federal Pay Raise on the Rent for
Conveniently Located Apartments in Washington D.C.
Rent
(dollars per month)
S
P’
P
D
Q
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
D’
Q’
Chapter 3 - Supply and Demand: An Introduction
Conveniently
located apartments
(units per month)
Slide 54
MB MC

Predicting and Explaining
Changes In Prices and Quantities
Shifts in Demand

Changes In Demand
 An
increase (decrease) in the demand for a
good will shift the demand curve to the right
(left)
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 3 - Supply and Demand: An Introduction
Slide 55
MB MC

Predicting and Explaining
Changes In Prices and Quantities
A Change In Income

Normal Good
 One
whose demand increases (decreases)
when the incomes of buyers increase
(decrease)
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 3 - Supply and Demand: An Introduction
Slide 56
MB MC

Predicting and Explaining
Changes In Prices and Quantities
A Change In Income

Inferior Good
 One
whose demand decreases (increases)
when the incomes of buyers increase
(decrease)
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 3 - Supply and Demand: An Introduction
Slide 57
MB MC
The Effect of the Release of Jurassic
Park on the Market for Toy Dinosaurs
D’ = demand after release of movie
Price
S
P’
P
D’
D
Q
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Q’
Chapter 3 - Supply and Demand: An Introduction
Toy Dinosaurs
(units per month)
Slide 58
MB MC
The Effect of a Credible Rumor on
the Market for Apple Macintosh Computers
D’ = demand after rumor of cheaper
model soon to be released
Price
S
P
P’
D’
Q’
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
D
Q
Chapter 3 - Supply and Demand: An Introduction
Apple Computers
(units per month)
Slide 59
MB MC
The Effect of the Increase in
the Population of Potential Buyers
D’ = demand after increase in population
Price
S
P’
P
D
Q
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
D’
Q’
Chapter 3 - Supply and Demand: An Introduction
Housing NY City
(units per month)
Slide 60
MB MC

Predicting and Explaining
Changes In Prices and Quantities
Factors that Shift Demand
Price of complements
 Price of substitutes
 Income
 Preferences
 Population of potential buyers
 Expectations

Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 3 - Supply and Demand: An Introduction
Slide 61
MB MC
The Effect on the Skateboard Market
of an Increase in the Price of Fiberglass
Price
($/skateboard)
S’
S
80
60
D
800 1000
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 3 - Supply and Demand: An Introduction
Quantity
(skateboards/month)
Slide 62
MB MC

Predicting and Explaining
Changes In Prices and Quantities
What Do You Think?

Does the increase in the cost of fiberglass
have any effect on the demand curve for
skateboards?
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 3 - Supply and Demand: An Introduction
Slide 63
MB MC
The Effect on the Market for New Houses
of a Decline in Carpenters’ Wage Rates
Price
($1000/house)
S
S’
120
90
D
40
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
50
Chapter 3 - Supply and Demand: An Introduction
Quantity
(houses/month)
Slide 64
MB MC
The Effect of Technical Change on the Market
for the Term Paper Revisions
Price
($/revision)
S
55
S’
7.50
D
12
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
36
Chapter 3 - Supply and Demand: An Introduction
Quantity
(millions of revisions per year)
Slide 65
MB MC

Predicting and Explaining
Changes In Prices and Quantities
Factors that Shift Supply
Costs of production
 Technology
 Weather
 Number of suppliers
 Expectations

Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 3 - Supply and Demand: An Introduction
Slide 66
MB MC
Four Rules Governing the Effects
of Supply And Demand Shifts
An increase in demand will lead to an increase
in both the equilibrium price and quantity
Price
S
P’
P
D
Q
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
D’
Q’
Chapter 3 - Supply and Demand: An Introduction
Quantity
Slide 67
MB MC
Four Rules Governing the Effects
of Supply And Demand Shifts
A decrease in demand will lead to a decrease
in both the equilibrium price and quantity
Price
S
P
P’
D’
Q’
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
D
Quantity
Q
Chapter 3 - Supply and Demand: An Introduction
Slide 68
MB MC
Four Rules Governing the Effects
of Supply And Demand Shifts
An increase in supply will lead to a
decrease in the equilibrium price
and an increase in the equilibrium quantity
Price
S
S’
P
P’
D
Q
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Q’
Chapter 3 - Supply and Demand: An Introduction
Quantity
Slide 69
MB MC
Four Rules Governing the Effects
of Supply And Demand Shifts
An decrease in supply will lead to
an increase in the equilibrium price
and a decrease in the equilibrium quantity
Price
S’
S
P’
P
D
Q’
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Quantity
Q
Chapter 3 - Supply and Demand: An Introduction
Slide 70
MB MC

Predicting and Explaining
Changes In Prices and Demand
Factors That Cause an Increase
(rightward or upward shift) in Demand
1. A decrease in the price of complements
to the good or service
2. An increase in the price of substitutes for
the good or service
3. An increase in income (for a normal
good)
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 3 - Supply and Demand: An Introduction
Slide 71
MB MC

Predicting and Explaining
Changes In Prices and Demand
Factors That Cause an Increase
(rightward or upward shift) in Demand
4. An increased preference by demanders
for the good or service
5. An increase in the population of potential
buyers
6. An expectation of higher prices in the
future
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 3 - Supply and Demand: An Introduction
Slide 72
MB MC

Predicting and Explaining
Changes In Prices and Demand
Factors That Cause an Increase
(rightward or upward shift) in Supply
1. A decrease in the cost of materials, labor,
or other inputs used in the production of
the good or service
2. An improvement in technology that
reduces the cost of producing the good or
service
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 3 - Supply and Demand: An Introduction
Slide 73
MB MC

Predicting and Explaining
Changes In Prices and Demand
Factors That Cause an Increase
(rightward or upward shift) in Supply
3. An improvement in the weather,
especially for agricultural products
4. An increase in the number of suppliers
5. An expectation of lower prices in the
future
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 3 - Supply and Demand: An Introduction
Slide 74
MB MC
The Effects Of Simultaneous
Shifts In Supply And Demand
The Market for Corn Tortilla Chips
Price
($/bag)
S
S’
P
S’ after reduction in price of
corn harvesting equipment
D’ after discovery that oils are
harmful to people’s health
P’
D
D’
Q’
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Q
Chapter 3 - Supply and Demand: An Introduction
Millions of bags
per month
Slide 75
MB MC
The Effects Of Simultaneous
Shifts In Supply And Demand
The Market for Corn Tortilla Chips
Price
($/bag)
S
S’
P
S’ after reduction in price of
corn harvesting equipment
D’ after discovery that oils are
harmful to people’s health
P’
D’
D
Q Q’
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 3 - Supply and Demand: An Introduction
Millions of bags
per month
Slide 76
MB MC

Predicting and Explaining
Changes In Prices and Demand
Assume
A vitamin found in corn chips helps protect
against cancer and heart diseases
 Swarm of locusts destroys part of the corn
crop


What Do You Think?

What will happen to the equilibrium price
and quantity of corn chips?
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 3 - Supply and Demand: An Introduction
Slide 77
MB MC

Predicting and Explaining
Changes In Prices and Demand
Economic Naturalist

Why do the prices of some goods, like
airline tickets to Europe, go up during the
months of heaviest consumption, while
others, like sweet corn, go down?
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 3 - Supply and Demand: An Introduction
Slide 78
MB MC
Seasonal Variation in Air Travel
High Consumption and Prices Due to High Demand
Price
($/ticket)
S
PS
PW
DS
DW
QW
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
QS
Chapter 3 - Supply and Demand: An Introduction
1000s of
tickets
Slide 79
MB MC
Seasonal Variation in Corn Markets
Price
($/bushel)
High Consumption and Low Prices due to High Supply
SW
SS
PS
PW
D
QW
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
QS
Chapter 3 - Supply and Demand: An Introduction
Millions of
bushels
Slide 80
MB MC
Markets And Social Welfare

What Do You Think?

When are the prices and quantities
determined in market equilibrium socially
optimal, in the sense of maximizing total
economic surplus?
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 3 - Supply and Demand: An Introduction
Slide 81
MB MC
Markets And Social Welfare

Cash On The Table

Assume:
 All

exchange is purely voluntary
If so:
 The
buyer’s reservation price exceeds the
seller’s reservation price and both the buyer
and seller receive an economic surplus
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 3 - Supply and Demand: An Introduction
Slide 82
MB MC
Markets And Social Welfare

Cash On The Table

Buyer’s surplus
 The
difference between the buyer’s reservation
price and the price he or she actually pays
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 3 - Supply and Demand: An Introduction
Slide 83
MB MC
Markets And Social Welfare

Cash On The Table

Seller’s surplus
 The
difference between the price received by
the seller and his or her reservation price
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 3 - Supply and Demand: An Introduction
Slide 84
MB MC
Markets And Social Welfare

Cash On The Table

Total surplus
 The
difference between the buyer’s reservation
price and the seller’s reservation price
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 3 - Supply and Demand: An Introduction
Slide 85
MB MC
Markets And Social Welfare

Cash On The Table

Economic metaphor for unexploited gains
from exchange
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 3 - Supply and Demand: An Introduction
Slide 86
MB MC
Price Controls In The Pizza Market
Price
($ per slice)
Assume:
•Buyer’s reservation P = $4
•Sellers reservation P = $2
•Pizza sells for $3
S
4
•Buyer’s surplus: $4 - $3 = $1
•Seller’s surplus: $3 - $2 = $1
•Total surplus: $4 - $2 = $2
3
2
D
8
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
12
16
Chapter 3 - Supply and Demand: An Introduction
Quantity
(1000s of slices per day)
Slide 87
MB MC
Price Controls In The Pizza Market
Excess demand =
$8,000 slices/day
Price
($ per slice)
Assume price controls = $2
•Quantity supplied falls to 8,000
•Buyer’s reservation price ($4) is
greater than seller’s ($2)
• Both would benefit from
additional production
•There is CASH ON THE TABLE
4
3
2
D
S
8
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
12
16
Chapter 3 - Supply and Demand: An Introduction
Quantity
(1000s of slices per day)
Slide 88
MB MC
Markets And Social Welfare

Smart For One, Dumb For All

Socially optimal quantity
 The
quantity of a good that results in the
maximum possible economic surplus from
producing and consuming the good

The socially optimal quantity occurs when
MC = MB
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 3 - Supply and Demand: An Introduction
Slide 89
MB MC
Markets And Social Welfare

Smart For One, Dumb For All

Economic efficiency occurs when all goods
and services are produced and consumed
at their respective socially optimal levels
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 3 - Supply and Demand: An Introduction
Slide 90
MB MC
Markets And Social Welfare

Smart For One, Dumb For All

The Efficiency Principle
 Maximize
the economic surplus
 Increases the economic pie
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 3 - Supply and Demand: An Introduction
Slide 91
MB MC
Markets And Social Welfare

Smart For One, Dumb For All

When is the market equilibrium efficient?
 When
all cost of producing the good or service
are borne directly by the seller
 When all benefits from the good or service
accrue directly to buyers
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 3 - Supply and Demand: An Introduction
Slide 92
MB MC
Markets And Social Welfare

Smart For One, Dumb For All

Inefficient market equilibrium
 When
some costs of production fall on people
other than those who sell the good or service
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 3 - Supply and Demand: An Introduction
Slide 93
MB MC
Markets And Social Welfare

Example: Pollution
The market is in equilibrium: MC = MB
 MC however underestimates the cost to
society of producing the good
 Therefore, the market produces more than
the efficient amount and there is no
incentive for producers and consumers to
alter their behavior

Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 3 - Supply and Demand: An Introduction
Slide 94
MB MC
Markets And Social Welfare

Smart For One, Dumb For All

Inefficient market equilibrium
 When
some benefits from the good or service
accrue to people who did not buy the good or
service
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 3 - Supply and Demand: An Introduction
Slide 95
MB MC
Markets And Social Welfare

Example: Vaccinations
 The
market is in equilibrium: MC = MB
 MB underestimates the benefits to society of
consuming the vaccinations
 The market produces less than the efficient
amount of vaccinations and there is no
incentive for producers and consumers to alter
their behavior
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 3 - Supply and Demand: An Introduction
Slide 96
MB MC
Markets And Social Welfare

Smart For One, Dumb For All

In these markets
 Buyers
and sellers are behaving rationally
 Market equilibrium exists
 There are no unexploited opportunities for
individuals
 Economic surplus is not maximized
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 3 - Supply and Demand: An Introduction
Slide 97
MB MC
Markets And Social Welfare

The Equilibrium Principle

A market in equilibrium leaves no
unexploited opportunities for individuals,
but may not exploit all gains achievable
through collective action.
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.
Chapter 3 - Supply and Demand: An Introduction
Slide 98
End of
Chapter
MB
MC