Supply and Demand
3
Slides By: Solina Lindahl
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Overview
After studying this chapter you should be
able to describe:
• the nature and purposes of markets.
• the nature of demand, demand curves, and the
law of demand.
• the determinants of demand.
• the difference between a change in demand and
a change in quantity demanded.
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Overview
After studying this chapter you should be
able to describe (cont.):
• the nature of supply, supply curves, and the law of
supply.
• the determinants of supply.
• the difference between a change in supply and a
change in quantity supplied.
• market equilibrium price and output.
• and predict how price and output will change
given changes to supply and demand in the
market.
• impacts of government intervention in markets.3- 3
Food for Thought….
Some good blogs and other sites to get the juices flowing:
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Markets
• Models of supply and demand are
the foundation of economic theory.
• Market: institution that brings
buyers and sellers together
• Examples: lemonade stand, eBay, NY
Stock Exchange
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The Price System
• Prices send signals in free-market
economies:
• To buyers
• What to buy? How much?
• To sellers
• What to sell? How much? What method of
production to use?
• The Price System: market economies use
prices to allocate resources, goods and
services.
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Demand
Demand: the maximum amount of a
product that buyers are willing and
able to purchase over some time
period at various prices (ceteris
paribus)
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The Demand Curve
$100
Price ($)
$80
$60
$40
Price
Quantity
$100
0
80
5
60
10
40
15
20
20
$20
D
5
10
15
20
Quantity (computer games)
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Law of Demand
• Law of Demand: Holding all other
relevant factors constant, price
and quantity demanded are
negatively related
• Consumer incomes can afford more
goods when prices are lower.
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Market Demand Curves
• Market demand: horizontal summation of
all individual demand curves
• Horizontal summation: Market demand and
supply curves are found by adding together
how many units of the product will be
purchased/supplied at each price.
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Market Demand Curve
Betty’s Demand
+
Curve
Abe’s Demand
Curve
=
Market Demand
Curve
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Determinants of Demand
• In drawing a demand curve, we
hold other factors constant: these
are called Determinants of Demand
• Tastes and Preferences
• Income
• Prices of related goods
• Number of buyers
• Future expectations
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Tastes and Preferences
• Demand will increase for products
that “come into fashion” (and vice
versa)
• Examples:
• Soymilk, organic produce, “fair trade”
coffee, skinny pants, acai berries
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Income
• Normal goods: demand increases
as incomes rise.
• Inferior goods: demand decreases
as incomes rise.
• Examples of inferior goods:
• Bus travel, fast food
• Other?
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Prices of Related Goods
• Substitute goods are those used in
place of one another (depending
on their relative prices)
• Examples:
• Margarine brands
An increase in
the price of
Brand A will
increase the
demand for
Brand B
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Prices of Related Goods
• Complement goods are those
typically consumed together
• Examples:
Gas price
increases are
bad for SUV
sales
• Gas and SUVs
• If the price of a complement
decreases, the demand for the
original good increases
• (and vice versa)
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The Number of Buyers
• As more consumers enter a
market, demand increases
As average life spans are
extended, demand for
pharmaceuticals
increases.
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3
Future Expectations
• A change in consumers’
expectations about:
• Future Prices
• A good’s availability
• Their own incomes
• Will affect demand curves
2009: gun sales increased as NRA members
worried that Obama would enact tougher gun
control laws
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18
Changes in Demand
• A “change in demand” is NOT the
same as a “change in quantity
demanded.”
• A change in demand: Occurs when
one or more of the determinants of
demand changes, shown as a shift in
the entire demand curve.
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Changes in Demand vs. Changes in
Quantity Demanded
Change in Demand
Change in Quantity Demanded
D1
Price ($)
80
Price ($)
80
40
D0
D0
20
40
Quantity (computer games)
20
40
Quantity (computer games)
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Who’s Who
Alfred Marshall (1842-1924)
• Father of modern Supply and Demand
• Was J.M. Keynes’ teacher
• Developed key ideas:
• Price elasticity of demand
• Consumer and producer surplus
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Supply
Supply: the maximum amount of a
product that producers are willing
and able to sell over some time
period at various prices (ceteris
paribus)
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22
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The Supply Curve
S
$100
Price ($)
$80
$60
Price
Quantity
$20
10
40
20
60
30
80
40
100
50
$40
$20
10
20
30
40
Quantity (computer games)
50
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Law of Supply
• Price and Quantity Supplied are
positively related
• Producers want to maximize their profits
so usually offer more for sale when prices
rise
• e.g., production of corn increases as
ethanol demand pushes prices for corn
higher (and thus profits!)
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Market Supply Curves
• Market supply: horizontal summation
of all individual supply curves
• e.g., if there are 100 producers of
doghouses,
• each of whom makes 5 doghouses when
P=$50,
• then market supply = 500
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Determinants of Supply
• In drawing a supply curve, we hold
other factors constant:
• Production Technology
• Costs of Resources
• Prices of Other Commodities
• Future Expectations
• Number of Sellers
• Taxes and Subsidies
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Production Technology
Supply will increase for products when
technology improves
• Examples: Computers, gaming systems, laser
hair removal, flat screen TVs.
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Costs of Resources
Example: if corn prices decrease, the supply of
corn tortillas increases
Supply will increase if the costs of
resources used decrease (and vice
versa)
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Prices of Other Commodities
Producers have the ability to
produce other goods
An increase in the profitability of
small cars will decrease the supply
of SUVs
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29
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Future Expectations
A change in producers’ expectations
about profitability will affect supply
curves
Windmill production increases as
producers expect sales and
profitability to increase.
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Number of Sellers
• As more producers
enter a market,
supply increases
(and vice versa)
As more firms
enter the solar
installation
market, the
number of solar
installations
available for sale
increases
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Taxes and Subsidies
Taxes and subsidies affect profits and
therefore supply.
A 10% yacht tax reduced the supply of
yachts 53% in the early 1990s.
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Cotton Supply
When the U.S. decreases its cotton subsidies,
U.S. cotton supply decreases
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Changes in Supply
• A “change in supply” is NOT the same
as a “change in quantity supplied.”
• A change in supply: Occurs when one
or more of the determinants of supply
changes, shown as a shift in the entire
supply curve.
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Changes in Supply vs. Changes in
Quantity Supplied
Change in Supply
Change in Quantity Supplied
S0
S0
S1
80
Price ($)
Price ($)
80
40
20
40
Quantity (computer games)
20
40
Quantity (computer games)
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Market Equilibrium
• Equilibrium: When Qs=Qd at a certain
price
• Equilibrium price: the price that results
when Qs=Qd
• Equilibrium Quantity: the output that
results where Supply = Demand
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How Markets Find Equilibrium When
Price Is Too High
P
At P = $5.00:
Energy Drinks
S
.
$5.00
.
4.00
3.00
Surplus forces
producers to drop
price….Price will
fall, people will buy
more and Qd = Qs
2.00
1.00
D
0
5
10
15
20
25
Q
At a price of $5.00, a SURPLUS of 10 energy drinks exists
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How Markets Find Equilibrium When
Price Is Too Low
P
Energy Drinks
At P = $3.00:
S
$5.00
4.00
.
3.00
.
Shortage allows
producers to raise
price….Price will
rise, people will buy
less and Qd = Qs
2.00
1.00
D
0
Q
5
10
15
20
25
At a price of $3.00, a SHORTAGE of 10 energy drinks exists
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How Markets Find Equilibrium
When Price is Too High
P
Energy Drinks
At P = $5.00:
S
.
$5.00
Qs = 25, Qd = 15
.
4.00
Price will fall to
equilibrium ($4.00)
and Qd will rise to 20,
Qs will fall to 20 and
3.00
Qd = Qs
2.00
1.00
D
Q
0
5
10
15
20
25
At a price of $5.00, a SURPLUS of 10 energy drinks (25-15) exists… suppliers are
left with stock on the shelves, so they take action to get the surplus sold and raise
revenue.
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How Markets Find Equilibrium
When Price is Too Low
P
Energy Drinks
At P = $3.00:
S
Qs = 15, Qd = 25
$5.00
Price will rise to
equilibrium ($4.00):
Qd will fall to 20, Qs
will rise to 20 and
4.00
.
3.00
.
Q d = Qs
2.00
1.00
D
Q
0
5
10
15
20
25
At a price of $3.00, a SHORTAGE of 10 energy drinks (25-15) exists… buyers
compete with each other for purchases, so sellers see their chance to raise price
and revenue
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Equilibrium and Shifts of the
Demand Curve
Price of
energy
drinks
An increase in
demand
S
Causes the
equilibrium to
change to a
P1
higher P and Q
P0
D0
Q0
Q1
D1
Quantity of energy
drinks
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Equilibrium and Shifts of the
Demand Curve
Price of
energy
drinks
A decrease in
demand
S
Causes the
equilibrium to
change to a
P0
lower P and Q
P1
D01
Q1
Q0
Quantity of energy
drinks
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Equilibrium and Shifts of the
Supply Curve
Price of
energy
drinks
An increase in
supply
SS10
P0
Causes the
equilibrium to
change to a
lower P and
higher Q
P1
D0
Q0
Q1
Quantity of energy
drinks
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Equilibrium and Shifts of the
Supply Curve
Price of
energy
drinks
A decrease in
supply
SS0 1
P1
Causes the
equilibrium to
change to a
higher P and
lower Q
P0
D0
Q1
Q0
Quantity of energy
drinks
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When Both Curves Shift
Predicting the outcome is more tricky, but can be
done if you know which curves shifts further.
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Review of Shifts
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Price Ceilings
Price
S0
Pe
Pc
D0
Shortage
Q3
A price ceiling is a
government-set
maximum price that
can be charged for a
product or service.
Price ceilings lead to
shortages.
Q4
Quantity
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Price Floors
Surplus
S0
Price
P1
Pe
A price floor is a
government-set
minimum price that
can be charged for a
product or service.
Price floors lead to
surpluses.
D0
Q1
Q2
Quantity
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Key Concepts
•
•
•
•
•
•
•
•
•
•
•
•
•
Markets
Price System
Demand
Law of Demand
Demand Curve
Horizontal summation
Determinants of Demand
Normal good
Inferior good
Substitute goods
Complementary goods
Change in Demand
Change in quantity
Demanded
•
•
•
•
•
•
•
•
•
•
•
•
•
Supply
Law of Supply
Supply curve
Determinants of Supply
Change in Supply
Change in quantity
Supplied
Equilibrium
Equilibrium price
Equilibrium quantity
Surplus
Shortage
Price ceiling
Price floor
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Which of the following is NOT a
determinant of demand for orange juice?
a. Level of consumer incomes
b. Price of apple juice, a substitute good
c. Medical research that reports new benefits
from drinking orange juice
d. Level of government subsidies to orange
farmers
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Which of the following will cause an
increase in the demand for autos?
a. Price of car tires increase because of a
Malaysian rubber shortage
b. Concrete steel reinforcing rods are replaced by
aluminum along the Atlantic coast to prevent
rusting
c. Gasoline prices drop by 50% when OPEC
nations increase production
d. McDonald’s increases its hamburger production
in response to consumer trends
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If the cost of wood falls, what
will happen in the violin
market?
a. Equilibrium Price and Quantity
both fall
b. Equilibrium Price and Quantity
both rise
c. Equilibrium Price falls and
Quantity rises
d. Equilibrium Price rises and
Quantity falls
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If garden gnomes regain
widespread popularity,
what will happen?
a. Equilibrium Price and Quantity
both fall
b. Equilibrium Price and Quantity
both rise
c. Equilibrium Price falls and
Quantity rises
d. Equilibrium Price rises and
Quantity falls
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If the price of MP3s drops
substantially, what happens
in the market for CDs?
a. Equilibrium Price and
Quantity both fall
b. Equilibrium Price and
Quantity both rise
c. Equilibrium Price falls and
Quantity rises
d. Equilibrium Price rises and
Quantity falls
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