L03
Where Price Come From: The Interaction of Supply
and Demand
Motivation
How are things priced?
 Ipod vs… Netbook


ANS:
Supply and Demand
Demand – Think Consumer
 Supply – Think Producer

Demand
Definition: The relationship between price and
quantity demanded, all else held constant.
•Example: Demand for Sports Teams
Price
(Ticket
Price)
•What happens to quantity
demanded as price rises?
•ANS:
•What happens when Price Falls?
•ANS:
Demand
•What causes movement
along a demand curve?
•ANS
Quantity (Attendance)
Demand Curve
Demand Schedule
Price
$0.00
0.50
1.00
1.50
2.00
2.50
3.00
Price
$3.00
2.50
2.00
Quantity
12
10
8
6
4
2
0
1.50
1.00
0.50
0 1
2 3 4 5 6 7 8 9 10 11 12
Quantity
Demand Definitions
◦Demand schedule A table showing the relationship
between the price and quantity demanded of a
product.
◦Demand curve A curve that shows the relationship
between the price and quantity demanded of a
product.
◦Quantity demanded The amount of a good or
service that a consumer is willing and able to purchase
at a given price.
Price
Demand

Obtain a demand curve by
holding all other variables
constant, and changing the price
only.
 This is called
Movement
Along a
Demand
Curve Or a
change in
$3.0
$2.7
Quantity
Demanded
20
25
Quantity
Price
Demand Shifters


If something changes other than price, what
happens to the demand curve?
It shifts!
Increase in demand
(Shift to the Right)
Y1
Notice, X2 > X1
Notice, X3 < X1
Decrease in demand
Shift to the Left
X3
X1
X2
Quantity
Demand Shifters

5 most important
1.
2.
3.
4.
5.
Consumer Income
Prices of Related Goods
Tastes
Population and Demographics
Expected Future Prices
Demand Shifters

5 most important
1. Consumer Income – Goes Up


Normal Good – When Income goes up, demand for a
good increases (shifts to the right)
Inferior Good – When Income goes up, demand for a
good decreases (shifts to the left)
2.
Prices of Related Goods
3.
Tastes
4.
Population and Demographics
5.
Expected Future Prices
Demand Shifters
Price at Amazon
Price at Amazon
Demand for
MP3s at
Amazon.com
Q MP3s

Q MP3s
5 most important
2. Prices of Related Goods
Substitutes – Goods that can be used for the same
purpose


When the price of MP3s on Walmart.com goes down, what
happens to the demand for MP3s on Amazon.com?

ANS:_____________________________.

When the price of MP3s on Walmart.com goes up, what
happens to the demand for MP3s on Amazon.com?

ANS:________________________________
Demand Shifters
Price of iPods
Price of iPods
Demand for
iPods

Quantity of iPods
Quantity of iPods
5 most important
2. Prices of Related Goods
Complements: Goods and services that are used
together





What happens to the demand for iPods when the price on iTunes
goes down?
ANS:_______________________________________
What happens to the demand for iPods when the price on iTunes
goes up?
ANS:______________________________________
Demand Shifters

5 most important
3. Tastes
What will happen to the demand for South Beach Diet
books when all of the sudden people change their tastes
towards the South Beach Diet?


ANS:__________________________________
What will happen to the demand for Crocs when
everyone begins to think they are not so neat?


ANS:__________________________________
Demand Shifters

5 most important
4. Population and Demographics
5. Expected Future Prices
What happens to demand for gas in the current time
period if you expect the price to go up in the future?


ANS
What happens to the demand for MP3s in the current
period if you expect prices to be slashed in the future?


ANS:
Demand “D” “D”ownward sloping

Why is Demand downward sloping?
◦ Substitution Effect – When the price of
something goes up, consumers substitute less
expensive forms goods.
◦ Income Effect – When the price of something
goes up, consumers have less purchasing
power.
Supply – Think like A Producer

Estimate the Supply of ….
Law of Supply
Definition: The relationship between price and quantity
supplied, all else equal
Price of
Ice-Cream
Cone
ANS: _______________
What happens to
Quantity Supplied as price
increases?
$3.00
S
C
A
1.00
0
What Causes
Movement along
the supply
Curve?
ANS: ________
1
5
Quantity of
Ice-Cream
Cones
Price Supply
of IceCream
Cone
$3.00
2.50
2.00
1.50
1.00
Curve
Supply Schedule
Price
$0.00
0.50
1.00
1.50
2.00
2.50
3.00
Quantity
0
0
1
2
3
4
5
0.50
0
1 2 3 4 5 6 7 8 9 10 11 12
Quantity of
Ice-Cream
Cones
Change in Supply
S3
Price
S1
S2
Y1
Decrease in
Supply
0
X3
Increase in
Supply
X1
X2
Quantity
A SHIFT UP IS NOT AN INCREASE IN
S3
SUPPLY!
Price
S1
Y1
Decrease in
Supply
0
X3
X1
Quantity
Market Equilibrium
Price
S
Equilibrium:
When quantity
Supplied
Equals
Quantity
Demanded
QD=QS
PE
D
QE
Quantity
Supply and Demand Together
Demand Schedule
Price
$0.00
0.50
1.00
1.50
2.00
2.50
3.00
Quantity
19
16
13
10
7
4
1
Supply Schedule
Price
$0.00
0.50
1.00
1.50
2.00
2.50
3.00
What is the equilibrium Price and
Quantity?
Quantity
0
0
1
4
7
10
13
Supply Shifters
1. Increase in the price of Inputs
2. Technological Advancement
3. Increase in the price of a substitute in PRODUCTION
•
Consider market for regular iPods, What happens to the supply of
iPods when the price of the Touch goes up?
4. Number of Firms in the market increases
5. Expected Future Prices
•
If you expect future prices to go up, are you interested in
selling more or less now?
•
Less!
Disequilibrium in the Market: Excess Supply
P
P*
PE
S
Surplus or excess supply
QD
at
P*

c
a
QS at P*

b


D
Qd QE Qs

Q


At P*, QS > QD
Excess supply puts
downward pressure
on the price. i.e.
producers having
sales
As the price falls,
QD rises
(a to b, law of
demand)
and QS falls
(c to b, law of supply)
to bring the market
to equilibrium.
Disequilibrium in the Market: Excess Demand
S
P
b
PE
QS at P*
*
P
a
c
QD at P*
Shortage or excess demand
QE
D
Q
At P*, QD > QS
 Excess demand puts
upward pressure on
the price.
 As the price rises,
 QD falls
 (a to b, law of
demand)
 and QS rises
 (c to b, law of supply)
to bring the market
to equilibrium.

What Happens when Price is too
low?
Price allocates goods and services in a
Market Economy
 What happens when Price is too low?
 Example: Black Friday

The Effects of Shifts on Equilibrium
SUPPLY CURVE
UNCHANGED
DEMAND CURVE
UNCHANGED
Q unchanged
P unchanged
DEMAND CURVE
SHIFTS TO THE RIGHT Q increases
P increases
DEMAND CURVE
SHIFTS TO THE LEFT
SUPPLY CURVE
SHIFTS TO THE RIGHT
SUPPLY CURVE
SHIFTS TO THE LEFT
The Effects of Shifts on Equilibrium
So
P
PE1
PEo
Do
QEo QE1
D1
Q
•Demand
increases (shift to
the right)
•What happens
to supply?
•ANS:____
•What Happens
to Quantity
Supplied?
•ANS:____
•What happens
to Equilibrium
Price? Quantity?
•ANS:____
The Effects of Shifts on Equilibrium
SUPPLY CURVE
UNCHANGED
DEMAND CURVE
UNCHANGED
Q unchanged
P unchanged
SUPPLY CURVE
SHIFTS TO THE RIGHT
SUPPLY CURVE
SHIFTS TO THE LEFT
2
5
DEMAND CURVE
SHIFTS TO THE RIGHT Q increases
P increases
3
6
DEMAND CURVE
SHIFTS TO THE LEFT
4
7
1
The Effects of Shifts on Equilibrium
So
S1
P
S2
PE1
PEo
PE2
Do
QEo QE1
QE2
D1
Q
•ANS:____
•Table entry: Q increases, P increases or decreases
•Demand and
Supply increase
(shift to the
right)
•What happens
to Equilibrium
Price and
Quantity using S1
and D1?
•ANS:____
•What Happens
to Equilibrium P
and Q using S2
and D1?
The Effects of Shifts on Equilibrium
SUPPLY CURVE
UNCHANGED
DEMAND CURVE
UNCHANGED
Q unchanged
P unchanged
SUPPLY CURVE
SHIFTS TO THE RIGHT
SUPPLY CURVE
SHIFTS TO THE LEFT
2
5
DEMAND CURVE
SHIFTS TO THE RIGHT Q increases
P increases
3
6
DEMAND CURVE
SHIFTS TO THE LEFT
4
7
1