Lesson Overview
Chapter 3 Demand and Supply
What is a demand curve?
Movements along a demand curve verses shifts
What causes demand shifts?
Substitution and income effects
What is a supply curve?
Movements along a supply curve verses shifts
What causes supply shifts?
What is a competitive market?
Competitive market equilibrium
Price moving to equilibrium
Controversy: Government Bailouts
Summary
Review Questions
BA 210 Lesson I.4 Demand and Supply
1
What is a demand curve?
• When there are many
competing buyers of the
same commodity, buyers
cannot bargain over the
price.
• A demand schedule for a
commodity shows how much
of a good buyers will want to
buy at different prices.
Demand Schedule for Coffee Beans
Price of coffee
beans (per
pound)
Quantity of coffee
beans demanded
(billions of pounds)
$2.00
7.1
1.75
7.5
1.50
8.1
1.25
8.9
1.00
10.0
0.75
11.5
0.50
14.2
2
What is a demand curve?
Price of
coffee bean
(per gallon)
A demand curve is a graph of the
demand schedule; it shows how much
of a good consumers want to buy at
any given price and, alternatively, it
shows how much a consumer is
willing to pay for each unit of a good.
(The curve below is interpolated from
7 demand points.)
$2.00
1.75
1.50
1.25
1.00
0.75
0.50
0
As price rises,
the quantity
demanded falls
7
9
Demand
curve, D
11
13
15
17
Quantity of coffee beans
(billions of pounds)
BA 210 Lesson I.4 Demand and Supply
3
Movements along a demand curve verses shifts
• An increase in the
population and other
factors generate an
increase in demand –
a rise in the quantity
demanded at any given
price.
• This is represented by the
two demand schedules –
one showing demand in
2004, before the rise in
population, the other
showing demand in 2008,
after the rise in population.
Demand Schedules for Coffee Beans
Price of
coffee beans
(per pound)
Quantity of coffee beans
demanded (billions of
pounds)
in 2004
in 2008
$2.00
7.1
8.5
$1.75
7.5
9.0
$1.50
8.1
9.7
$1.25
8.9
10.7
$1.00
10.0
12.0
$0.75
11.5
13.8
$0.50
14.2
17.0
4
Movements along a demand curve verses shifts
A shift of the
demand curve is
a change in the
quantity
demanded at any
given price,
represented by
the change of
the original
demand curve to
a new position,
denoted by a
new demand
curve.
$2.00
1.75
Price of
coffee 1.50
beans
(per
1.25
gallon)
1.00
Demand curve
in 2008
0.75
0.50
0
Demand curve
in 2004
7
9
D
11
13
1
15
D
2
17
Quantity of coffee beans
(billions of pounds)
BA 210 Lesson I.4 Demand and Supply
5
Movements along a demand curve verses shifts
A movement along the demand
curve is a change in the quantity
demanded of a good that is the
result of a change in that good’s
price.
A shift of the
demand curve…
$2.00
Price of
coffee
beans
(per
gallon)
1.75
A
1.50
… is not the same thing
as a movement along
the demand curve
C
1.25
B
1.00
0.75
0.50
0
D
7
8.1
9.7
10
13
1
15
D
2
17
Quantity of coffee
beans (billions of
pounds)
BA 210 Lesson I.4 Demand and Supply
6
Movements along a demand curve verses shifts
Price
Increase in
demand
Read demand horizontally. A
“decrease in demand”, means
a leftward shift of the demand
curve: at any given price,
consumers demand a smaller
quantity than before.
(D1D3)
Decrease in
demand
D
3
D
1
D
2
Quantity
BA 210 Lesson I.4 Demand and Supply
7
What causes demand shifts?
What causes demand shifts?
• Changes in Income
 Normal Goods: When a rise in income increases the
demand for a good - the normal case - we say that the
good is a normal good. Rich people eat lobster. Other
normal goods?
 Inferior Goods: When a rise in income decreases the
demand for a good, it is an inferior good. Poor people
eat Raman Noodles. Other inferior goods?
• Changes in Tastes
• Changes in Expectations
BA 210 Lesson I.4 Demand and Supply
8
Substitution and Income Effects
Demand Shifts from Changes in the Prices of Other Goods
When the price of Good X changes, the demand for Good Y responds in two
steps:

The Substitution Effect:
• Substitutes: Goods X and Y are substitutes if an increase in the
price of one of the goods makes consumers more willing to buy the
other good.
• Complements: Goods X and Y are complements if an increase in
the price of one good makes people less willing to buy the other
good.

The Income Effect: An increase in the price of Good X decreases each
consumer’s power to purchase goods. That decrease in purchasing
power has the same effect as a decrease in income:
• People are less willing to buy good Y if good Y is a normal good.
• People are more willing to buy good Y if good Y is an inferior
good.
BA 210 Lesson I.4 Demand and Supply
9
Substitution and Income Effects
Changes in the Prices of Other Goods
For example, when the price of gas increases, the demand for cars
decreases in two steps:
 The Substitution Effect: Gas and cars are complements
because they are consumed together, so an increase in the
price of gas makes people less willing to buy cars, meaning
the demand for cars decreases.
 The Income Effect: An increase in the price of gas
decreases each consumer’s power to purchase goods. Since
cars are a normal good (rich households have more cars
than poor households), that decrease in purchasing power
makes people less willing to buy cars, meaning the demand
for cars decreases further.
BA 210 Lesson I.4 Demand and Supply
10
Substitution and Income Effects
Changes in the Prices of Other Goods
The Gross Effect is the substitution effect plus the income effect.
When the price of Good X changes, the demand for Good Y
responds with the gross effect:
 Substitutes: Goods X and Y are gross substitutes if an
increase in the price of one of the goods makes consumers
more willing to buy the other good.
 Complements: Goods X and Y are gross complements if an
increase in the price of one good makes people less willing
to buy the other good.
(When Paul Krugman says “substitutes”, he really means gross
substitutes because there is both a substitution effect and an
income effect when prices change. Likewise, when Paul
Krugman says “complements”, he means gross complements.)
BA 210 Lesson I.4 Demand and Supply
11
Substitution and Income Effects
Sometimes gross substitution is the same as substitution
For example, when the price of apples increases, the demand for
oranges responds in two steps:
 The Substitution Effect: Apples and oranges are substitutes
because they are consumed as alternatives, so an increase
in the price of apples makes people more willing to buy
oranges, meaning the demand for oranges increases.
 The Income Effect: An increase in the price of apples
decreases consumers’ power to purchase goods, but that
decrease is small since consumers do not spend much on
apples.
 Apples and oranges are thus “gross substitutes” and
“substitutes”.
BA 210 Lesson I.4 Demand and Supply
12
Substitution and Income Effects
Sometimes gross substitution is different than substitution
For example, when tuition at Pepperdine increases, the demand
for oranges responds in two steps:
 The Substitution Effect: Pepperdine and oranges are not
significantly substitutes nor complements because they are
not significantly consumed together or as alternatives.
 The Income Effect: An increase in tuition at Pepperdine
decreases consumers’ power to purchase goods. Since
oranges are a normal good (rich households buy more
oranges than poor households), that decrease in purchasing
power makes people less willing to buy oranges, meaning
the demand for oranges decrease.
 Apples and oranges are thus “gross complements” but not
“complements”.
BA 210 Lesson I.4 Demand and Supply
13
What is a supply curve?
• When there are many
competing sellers of the
same commodity, sellers
cannot bargain over the
price.
• A supply schedule shows
how much of a good
would be supplied at
different prices.
• Alternatively, a supply
schedule shows the
minimum price it would
take per unit for suppliers
to supply a particular
quantity of a good.
Supply Schedule for Coffee Beans
Price of
coffee beans
(per pound)
Quantity of
coffee beans
supplied
(billions of
pounds)
$2.00
11.6
1.75
11.5
1.50
11.2
1.25
10.7
1.00
10.0
0.75
9.1
0.50
8.0
14
What is a supply curve?
Price of coffee
beans (per pound)
A supply curve graphs
how much of a good
people are willing to
sell at any given price.
(The curve below is
interpolated from 7
supply points.)
Supply
curve, S
$2.00
1.75
1.50
As price rises, the
quantity supplied rises.
1.25
1.00
0.75
0.50
0
7
9
11
13
15
17
Quantity of coffee beans (billions of pounds)
BA 210 Lesson I.4 Demand and Supply
15
Movements along a supply curve verses shifts
Supply Schedule for Coffee Beans
• The entry of Vietnam
into the coffee bean
Quantity of beans supplied
Price of
business generated an coffee beans
(billions of pounds)
increase in supply—a
(per pound) Before entry After entry
rise in the quantity
$2.00
11.6
13.9
supplied at any given
price.
$1.75
11.5
13.8
• This event is
$1.50
11.2
13.4
represented by the two
$1.25
10.7
12.8
supply schedules—one
$1.00
10.0
12.0
showing supply before
$0.75
9.1
10.9
Vietnam’s entry, the
other showing supply
$0.50
8.0
9.6
after Vietnam came in.
16
Movements along a supply curve verses shifts
Price of coffee
beans (per
pound)
S
$2.00
S
1
2
A movement
along the supply
curve…
1.75
1.50
1.25
1.00
… is not the
same thing as a
shift of the
supply curve
0.75
0.50
0
7
9
11
13
15
17
Quantity of coffee beans (billions of pounds)
A shift of the supply curve is a change in the quantity supplied of a good at
any given price.
BA 210 Lesson I.4 Demand and Supply
17
Movements along a supply curve verses shifts
Price of coffee
beans (per
pound)
$2.00
A movement
along the supply
curve…
1.75
S
2
S
1
1.50
B
1.25
A
1.00
C
… is not the
same thing as
a shift of the
supply curve
0.75
0.50
0
7
10 11.2
12
15
17
Quantity of coffee beans (billions of pounds)
A movement along the supply curve is a change in the quantity supplied of a
good that is the result of a change in that good’s price.
BA 210 Lesson I.4 Demand and Supply
18
Movements along a supply curve verses shifts
Price
S
3
S
1
S
2
Increase in
supply
Decrease in
supply
Read supply horizontally.
Any “increase in supply”
means a rightward shift
of the supply curve: at
any given price, there is
an increase in the
quantity supplied.
(S1 S2)
Quantity
BA 210 Lesson I.4 Demand and Supply
19
What causes supply shifts?
• Changes in input prices
 An input is a good that is used to produce another good.
• Changes in the prices of related goods that could have been
sold
• Changes in technology
• Changes in expectations about future prices
• Changes in the number of producers
BA 210 Lesson I.4 Demand and Supply
20
What is a competitive market?
• A competitive market:
 Many competing buyers and sellers
 Same commodity (physical good or service)
• The demand and supply model explains a competitive market.
• Five key elements:
 Demand curve
 Supply curve
 Demand and supply curve shifts
 Market equilibrium
 Changes in the market equilibrium
BA 210 Lesson I.4 Demand and Supply
21
Competitive market equilibrium
The market demand curve is the horizontal sum of the individual
demand curves of all consumers in that market.
(a)
Darla’s Individual
Demand Curve
(c)
Market Demand Curve
(b)
Dino’s Individual
Demand Curve
Price of
coffee
beans (per
pound)
Price of
coffee
beans (per
pound)
$2
Price of
coffee
beans (per
pound)
$2
$2
DMarket
1
1
1
DDarla
0
20
30
DDino
0
Quantity of coffee beans
(pounds)
10
20
Quantity of coffee beans
(pounds)
BA 210 Lesson I.4 Demand and Supply
0
30
40
50
Quantity of coffee beans
(pounds)
22
Competitive market equilibrium
The market supply curve is the horizontal sum of the individual
supply curves of all firms in that market.
Price of
coffee
beans (per
pound)
(a)
Mr. Figueroa’s
Individual Supply
Curve
Price of
coffee
beans (per
pound)
SFigueroa
$2
0
SBien Pho
$2
1
Price of
coffee
beans (per
pound)
1
1
2
3
0
Quantity of coffee beans
(pounds)
(c)
Market Supply Curve
(b)
Mr. Bien Pho’s Individual
Supply Curve
SMarket
$2
1
1
2
Quantity of coffee beans
(pounds)
BA 210 Lesson I.4 Demand and Supply
0
1
2
3
4
5
Quantity of coffee beans
(pounds)
23
Competitive market equilibrium
• Equilibrium in a competitive market: when the quantity
demanded of a good equals the quantity supplied of that good.
• The price at which this takes place is the equilibrium price, or
market-clearing price):

Every buyer finds a seller and vice versa.

The quantity of the good bought and sold at that price is the
equilibrium quantity.
BA 210 Lesson I.4 Demand and Supply
24
Competitive market equilibrium
Price of
coffee beans
(per pound)
Supply
$2.00
1.75
Market equilibrium
occurs at point E, where
the supply curve and the
demand curve intersect.
1.50
1.25
Equilibrium
price
E
1.00
Equilibrium
0.75
0.50
0
Demand
7
10
Equilibrium
quantity
13
15
17
Quantity of coffee beans
(billions of pounds)
BA 210 Lesson I.4 Demand and Supply
25
Price moving to equilibrium
Price of coffee
beans (per pound)
If the price were higher
than in a competitive
equilibrium, there is a
surplus of a good when the
quantity supplied exceeds
the quantity demanded.
Suppliers then decrease
price from $1.50 to
compete for buyers.
Supply
$2.00
1.75
Surplus
1.50
1.25
E
1.00
0.75
0.50
0
Demand
7
8.1
Quantity
demanded
10
11.2
Quantity
supplied
13
15
17
Quantity of coffee beans
(billions of pounds)
BA 210 Lesson I.4 Demand and Supply
26
Price moving to equilibrium
Price of coffee
beans (per
pound)
Supply
$2.00
1.75
1.50
1.25
E
1.00
0.75
Shortage
0.50
0
If the price were higher
than in a competitive
equilibrium, there is a
shortage of a good when
the quantity demanded
exceeds the quantity
supplied. Suppliers then
increase price from $0.75
to increase profit.
7
9.1
10
Quantity
supplied
11.5
Quantity
demanded
Demand
13
15
17
Quantity of coffee beans
(billions of pounds)
BA 210 Lesson I.4 Demand and Supply
27
Price moving to equilibrium
Price of coffee
beans
An increase in
demand…
E
P
Price
rises
… leads to a movement
along the supply curve
due to a higher
equilibrium price and
higher equilibrium
quantity
2
2
E
P
Supply
1
1
D
D
Q
1
Q
2
1
2
Quantity of coffee beans
Quantity rises
BA 210 Lesson I.4 Demand and Supply
28
Price moving to equilibrium
Price of coffee
beans
S
2
P
S
1
E
2
2
… leads to a movement
along the demand curve
due to a higher
equilibrium price and
lower equilibrium
quantity
Price
rises
P
A decrease
in supply…
E1
1
Demand
Q
2
Q
1
Quantity of coffee beans
Quantity falls
BA 210 Lesson I.4 Demand and Supply
29
Price moving to equilibrium
Simultaneous demand and supply shifts.
One possible outcome: Price Rises, Quantity Rises
Small decrease
in supply
Price of
coffee
E
P
2
S
2
1
1
D
D
1
Two opposing forces
determining the
equilibrium quantity.
The increase in
demand dominates
the decrease in
supply.
2
E
P
S
2
1
Large increase
in demand
Q
1
Q2
BA 210 Lesson I.4 Demand and Supply
Quantity of coffee
30
Price moving to equilibrium
Simultaneous demand and supply shifts.
Another possible outcome: Price Rises, Quantity Falls
Large decrease
in supply
Price of
coffee
S
2
S
E
P
2
2
E
P
1
Small increase
in demand
1
1
D
D
Q
2
Q
1
Two opposing forces
determining the
equilibrium quantity.
The increase in
demand is dominated
by the decrease in
supply.
2
1
Quantity of coffee
BA 210 Lesson I.4 Demand and Supply
31
Controversy: Government Bailouts
Controversy: Government Bailouts
BA 210 Lesson I.3 Trade
32
Controversy: Government Bailouts
A bailout is an act of giving capital to a company in danger of
failing in an attempt to save it from bankruptcy, insolvency, or
total liquidation and ruin. A bailout could be seen as a necessity
in order to prevent greater, socioeconomic failures: For example,
the US government assumes transportation to be the backbone of
America's general economic fluency, which maintains the nation's
geopolitical power. As such, it is the policy of the US government
to protect the biggest American companies responsible for
transportation—airliners, petrol companies, etc—from failure
through subsidies and low-interest loans. These companies,
among others, are deemed “too big to fail” because their goods
and services are considered by the government to be constant
universal necessities in maintaining the nation's welfare and
often, indirectly, its security.
BA 210 Lesson I.3 Trade
33
Controversy: Government Bailouts
Question: Consider the policy of the US government to protect
American airlines from failure through subsidies and low-interest
loans.
What would happen to the largest American airlines (Southwest,
American, Delta, United, U.S. Airways, Northwest, Continental,
…) if they are all currently failing to make profits and if the US
government changed its policy and did nothing? Would the entire
industry fail?
BA 210 Lesson I.3 Trade
34
Controversy: Government Bailouts
Answer: Eventually, without profits, airlines would start dropping
out of the industry (though bankruptcy, insolvency, or total
liquidation). But as some airlines drop out, the total supply of air
travel decreases, which raises price. And as prices raise, profits
raise. This process would increase until airlines no longer fail to
make sufficient profits to stay in business.
In particular, the entire industry does not fail without government
bailouts.
BA 210 Lesson I.3 Trade
35
Controversy: Government Bailouts
Price of air
travel
S
2
P
S
1
E
2
2
… leads to a movement
along the demand curve
due to a higher
equilibrium price and
lower equilibrium
quantity
Price
rises
P
A decrease
in supply…
E1
1
Demand
Q
2
Q
1
Quantity of air travel
Quantity falls
BA 210 Lesson I.4 Demand and Supply
36
Summary
Summary
1. A demand schedule exists when there are many competing
buyers of the same commodity. The demand schedule shows
the quantity demanded at each price and is represented
graphically by a demand curve. The law of demand says that
demand curves slope downward.
2. A movement along the demand curve occurs when a price
change leads to a change in the quantity demanded. When
economists talk of increasing or decreasing demand, they
mean shifts of the demand curve—a change in the quantity
demanded at any given price.
BA 210 Lesson I.4 Demand and Supply
37
Summary
Summary
3. There are five main factors that shift the demand curve:
•
A change in the prices of related goods
•
A change in income
•
A change in tastes
•
A change in expectations
•
A change in the number of consumers
4. A supply schedule exists when there are many competing
sellers of the same commodity. The supply schedule shows
the quantity supplied at each price and is represented
graphically by a supply curve. Supply curves usually slope
upward.
BA 210 Lesson I.4 Demand and Supply
38
Summary
Summary
5. A movement along the supply curve occurs when a price
change leads to a change in the quantity supplied. When
economists talk of increasing or decreasing supply, they mean
shifts of the supply curve—a change in the quantity supplied
at any given price.
6. There are five main factors that shift the supply curve:
•
A change in input prices
•
A change in the prices of related goods and services
•
A change in technology
•
A change in expectations
•
A change in the number of producers
BA 210 Lesson I.4 Demand and Supply
39
Summary
Summary
7. The supply and demand model illustrates how a competitive
market works.
8. The market demand curve for a good or service is the
horizontal sum of the individual demand curves of all
consumers in the market.
9. The market supply curve for a good or service is the
horizontal sum of the individual supply curves of all
producers in the market.
BA 210 Lesson I.4 Demand and Supply
40
Summary
Summary
10. An increase in demand increases both the equilibrium price
and the equilibrium quantity; a decrease in demand has the
opposite effect. An increase in supply reduces the
equilibrium price and increases the equilibrium quantity; a
decrease in supply has the opposite effect.
11. Shifts of the demand curve and the supply curve can happen
simultaneously.
BA 210 Lesson I.4 Demand and Supply
41
Review Questions
Review Questions
 You should try to answer some of the following questions
before the next class.
 You will not turn in your answers, but students may request
to discuss their answers to begin the next class.
 Your upcoming Exam 1 and cumulative Final Exam will
contain some similar questions, so you should eventually
consider every review question before taking your exams.
BA 210 Lesson I.4 Demand and Supply
42
Review Questions
Follow the link
http://faculty.pepperdine.edu/jburke2/ba210/PowerP1/Set3Answers.pdf
for review questions for Lesson I.4 that practices these skills:
 Describe when demand or supply increases (shifts right) or decreases (shifts
left).
 Identify a competitive equilibrium of demand and supply.
 Describe the equilibrium shifts when demand or supply increases or
decreases.
 Describe how prices or gross substitutes or gross complements shift demand.
 Describe how input costs or production costs shift supply.
 Aggregate individual demand into market demand.
 Describe how effective price ceilings cause shortages.
 Compute some special demand curves and some special supply curves from
verbal descriptions.
BA 210 Lesson I.4 Demand and Supply
43
BA 210
Introduction to Microeconomics
End of Lesson I.4
BA 210 Lesson I.4 Demand and Supply
44