Microeconomics
Supply, Demand, and Price
Standard
• SSEMI2- The student will explain how the Law of
Demand, the Law of Supply, prices, and profits work to
determine production and distribution in a market
economy.
– Define the Law of Supply and the Law of Demand.
– Describe the role of buyers and sellers in determining market
clearing price
– Illustrate on a graph how supply and demand determine
equilibrium price and quantity.
– Explain how prices serve as incentives in a market economy
• Essential Question: How does quantity demanded and
price impact each other?
Quick Review
• 3 Economic Questions
– What to produce?
– How much to produce?
– Who gets what?
Supply and Demand Overview
• In a market system the interaction of
buyers and sellers determines the prices
of most goods as well as what quantity of
a good will be produced
• Buyers demand goods
• Sellers supply goods
• Interactions between the groups lead to an
agreement on prices and quantity traded
Demand
• Demand- the desire to own something
and the ability to pay for it
• The Law of Demand- Consumers buy
more a good when its price decreases and
less when its price increases
Demand Schedule
Demand Schedule- a table that lists the quantity of a good a
person will buy at each different price
Market Demand Schedule- a table that lists the quantity of a
good all consumers in a market will buy at each different price;
allows business owners to predict sales at several different price
levels
Individual Demand Schedule
Market Demand Schedule
Price of a slice of
pizza
Quantity
demanded per
day
Price of a slice of
pizza
Quantity
demanded per
day
$.50
5
$.50
300
$1.00
4
$1.00
250
$1.50
3
$1.50
200
$2.00
2
$2.00
150
$2.50
1
$2.50
100
$3.00
0
$3.00
50
Demand Graph
• Demand Curve- a graphic representation
of a demand schedule
– Vertical Axis- labeled with the lowest
possible prices at the bottom and the highest
at the top
– Horizontal Axis- lowest quantity at the left
and highest quantity at the right
Demand Curve
• Demand curves only show the relationship
between the price of the good and the
quantity purchased; they assume ceteris
paribus- Latin phrase that means all other
things are held constant
• Demand curves on the graph slopes
downward to the right; as price decreases,
demand increases
Demand Curve
Price per slice (in dollars)
This illustrates our
market demand
schedule for pizzas
from earlier.
Market Demand Curve
3.00
2.50
2.00
1.50
1.00
.50
Demand
0
0
50
100 150 200 250 300 350
Slices of pizza per day
Shifts of the Demand Curve
• Changes in Demand
– A demand curve is accurate as long as there are
no changes other than price that could affect the
consumer’s decision
– When ceteris paribus is dropped and other
factors change the entire demand curve shifts
• Increase in demand- the curve shifts right
• Decrease in demand- the curve shifts left
– A shift if the demand curve means that at every
price consumers buy a different quantity than
before
What Changes Demand?
• A change in price does NOT cause the
demand curve to shift- price changes are
already built in
What Changes Demand?
• Recall the definition
– Taste (desire)
– Income (ability to pay)
– Complimentary Items
– Substitutes
– Expectations
Taste
• As we grow up, hear
information, learn
more etc our opinions
and feelings change
• The way we want,
desire, feel or like
something is TASTE
Income
• Due to our salary, pay
checks, job
opportunities we have
more or less money
to spend.
• This change in
Income changes our
ability to buy
Complimentary Goods
• These items go
together.
• For example if the
cost of peanut butter
goes way down, we
desire more jelly. (if
cost goes up we will
desire less jelly)
Substitutes
• These items can be
exchanged for the other.
• If the cost of peanut
butter goes way up, we
may buy more pizza for
lunch. Pizza can be
exchanged for PB and J
sandwiches.
Expectations
• What people anticipate will occur in the
future
What Changes Demand?
• Remember TICS changes demand!!
– Taste (desire)
– Income (ability to pay)
– Complimentary Items
– Substitutes
– Expectations
Elasticity of Demand
• Elasticity of Demand- a measure of how
consumers react to a change in price
– Inelastic- the demand for a good you will
keep buying despite a price increase
– Elastic- describes that demand is sensitive to
a change in price
Calculating Elasticity
• Remember that the law of demand says
that whenever there is an increase in price,
there will be a decrease in demand
• Price range helps to determine the
elasticity of a price
– Demand for a good at one price may be
elastic but at another price the same good
might be inelastic
Calculating Elasticity
Elasticity is calculated by using the following formula:
Elasticity of Demand= percentage change in demand of a
good
percentage change in the price of the
good
Percentage Change= Original number-New Number
Original Number
X 100
Results may be negative, but all negatives are dropped.
Values of Elasticity
• If the elasticity of demand for a good is
less than 1, demand is inelastic
• If elasticity is greater than 1, demand is
elastic
• If elasticity is equal to 1, demand is unitary
elastic
Elasticity
• If the price of a pizza
goes up from $1 to
$1.50, and the
quantity of the pizza
fell from 4 to 3.
• The change in price is
____
• The change in
quantity demanded is
___
• Is the price of pizza
elastic or inelastic?
Factors Affecting Elasticity
• Availability of substitutes- Lack of
substitutes makes a good’s demand
inelastic; substitutes makes a good’s
demand elastic
• Relative importance- how much of your
budget you spend on a good will
determine its elasticity
• Necessities versus luxuries
Change Over Time
• Consumers often take time to respond to
price changes- demand is inelastic for the
short term
• Demand for a good becomes elastic as
consumer find substitutes
Elasticity and Total Revenue
• Total revenue is defined as the amount of
money the company receives by selling its
goods
• If a good is elastic, an increase in price may
cause a firm’s total revenue to go down
• If a good is inelastic, an increase in price will
make up for lower sales
Elasticity and Pricing Policies
• Firms use elasticity of a good to figure out
whether or not it would be helpful or
harmful to their revenue to raise the price
of a good.
Total Revenue and Price
• If Price Increases & total revenue
increases= inelastic
• If Price decrease & total revenue
decreases= inelastic
• If Price increases & total revenue
decreases= elastic
• If Price decreases & total revenue
increases= elastic
Are the Following Elastic or
Inelastic?
•
•
•
•
•
Salt
New Cars
Pork Chops
European Vacation
Insulin
• Insulin at one of four
drug stores in a
shopping mall
• Gasoline purchased
on day after a 20%
price increase
• Gasoline purchased
one year after a 20%
price increase
Supply
• Supply- the amount of goods available; used by
economists to refer to the relationship between
price and quantity supplied
• Law of Supply- tendency of suppliers to offer
more of a good at a higher price; the higher the
price the larger the quantity produced
• Quantity Supplied- the amount a supplier is
willing and able to supply at a certain price
Supply Continued
• As the price of a good rises, existing firms
will produce more in order to earn
additional revenue
– New firms have an incentive to enter the
market to earn a profit for themselves
– If the price falls, some firms produce less and
others might drop out of the market
Higher Production
• If a firm is earning a profit then an increase
in price- ceteris paribus- will increase the
firms profits
The Supply Schedule
• Supply Schedule- a chart that lists how
much of a good a supplier will offer at
different prices
• Market Supply Schedule- a chart that
lists how much of a good all suppliers will
offer at different prices
• Like demand schedules a change in price
is built in the schedule
The Supply Graph
• Supply Curve- a graph of the quantity
supplied of a good at different prices
– Vertical- price
– Horizontal- quantity of the good supplied
– Rises from left to right
• Market Supply Curve- a graph of the
quantity supplied of a good by all suppliers
at different prices
Supply Curve
Market Supply Curve
Supply
3.00
Price (in dollars)
2.50
2.00
1.50
1.00
.50
0
0
500
1000 1500 2000 2500 3000 3500
Output (slices per day)
What Changes Supply?
• Recall The Definition
•
•
•
•
•
•
Sellers
Technology
Regulations
Input Costs
Productivity
Expectations
Sellers
• Depending on the
circumstance
there are
sometimes more
or less sellers
based on
competition or
product
availability
Technology
• This changes the
manner in which
we make our
products
• This deals with
efficiency
Regulations
• Regulation- a
government intervention
in a market that affects
the production of a good
• Subsidy- a government
payment that supports a
business or market
• Excise Tax- a tax on the
production or sale of a
good (ex. Tax on
cigarettes)
Input Costs
• This involves the changes that effect the
materials, fixed cost and other variable
costs it takes to produce the product.
Productivity
• This changes the
manner in which
we make our
products
• This deals with
efficiency
• And often focuses
on the people and
training
Expectations
• What is going to
happen…how do
businesses prepare
for it?
• Ex. Christmas
Production
This is why you need to remember
•
•
•
•
•
•
Sellers
Technology
Regulations
Input Costs
Productivity
Expectations
Supply and Elasticity
• Elasticity of Supply– a measure of the
way quantity supplied reacts to a change
in price
– If elasticity is greater than 1, supply is elasticsupply is sensitive to change in price
– If elasticity is less than 1, supply is inelastic
– If elasticity is equal to 1, supply is unitary
elastic
What affects elasticity of supply?
• Time
– In the short run, a firm cannot easily change
its output level, so supply is inelastic.
– In the long run, firms are more flexible, so
supply can become more elastic
The point at which quantity demanded and
quantity supplied come together is known as
equilibrium (market clearing price).
Finding Equilibrium
Equilibrium Point
Combined Supply and Demand Schedule
$3.50
$2.50
$2.00
Equilibrium
Price
$1.50
$1.00
$.50
Supply
0
50
a
Equilibrium
Quantity
Price per slice
$3.00
Demand
100 150 200 250 300
Slices of pizza per day
Price of
a slice
of pizza
Quantity
demanded
Quantity
supplied
$ .50
300
100
$1.00
250
150
$1.50
200
200
$2.00
150
250
$2.50
100
300
$3.00
50
350
350
Result
Shortage from
excess demand
Equilibrium
Surplus from
excess supply
Combining Supply and Demand
• At Equilibrium the market for a good is
stable
• The Equilibrium Price and Quantity can be
found where quantity supplied equals
quantity demanded or where the two
curves cross.
Disequilibrium
• Disequilibrium- describes any price or quantity
not at equilibrium; when quantity supplied is not
equal to quantity demanded in a market
– Excess Demand- when quantity demanded is more
than quantity supplied
• Sellers will raise their prices
– Excess Supply- when quantity supplied is more than
quantity demanded
• Sellers will lower their prices
• Interactions between buyers and sellers will always push the
market back towards equilibrium.
Government Intervention
• Price Ceiling- a maximum price that can
be legally charged for a good or service
– Rent Control- a price control placed on rent
(has occurred in New York City)
• What do you think are the problems with rent
control?
Government Regulation
• Price Floor- a minimum price for a good
or service
– Minimum Wage- minimum price that an
employer can pay a worker for an hour of
labor
• Minimum Wage can cause a surplus of labor
Shifts in Supply
• Understanding a Shift
– Since markets tend to move toward equilibrium, a
change in supply will set market forces in motion that
lead the market to a new equilibrium price and
quantity sold.
• Excess Supply
– A surplus is a situation in which quantity supplied is
greater than quantity demanded. If a surplus occurs,
producers reduce prices to sell their products. This
creates a new market equilibrium.
• A Fall in Supply
– The exact opposite will occur when supply is
decreased. As supply decreases, producers will raise
prices and demand will decrease.
Shifts in Demand
• Excess Demand
– A shortage is a situation in which quantity
demanded is greater than quantity supplied.
• Search Costs
– Search costs are the financial and opportunity
costs consumers pay when searching for a
good or service.
• A Fall in Demand
– When demand falls, suppliers respond by
cutting prices, and a new market equilibrium
is found.
Analyzing Shifts in Supply and Demand
Graph A: A Change in Supply
Graph B: A Change in Demand
$800
$60
a
b
Supply
$50
Original
supply
$40
c
Price
Price
$600
$400
c
$30
a
b
$20
$200
New
supply
Demand
New
demand
Original
demand
$10
0
1
2
3
Output (in millions)
4
5
0
100
200
300
400
500
600
Output (in thousands)
700
800
• Graph A shows how the market finds a new
equilibrium when there is an increase in
supply.
• Graph B shows how the market finds a new
equilibrium when there is an increase in
demand.
900
Prices in a Free Market
• Prices help move land, labor, and capital
into the hands of producers and finished
goods into the hands of buyers.
The Advantages of Prices
• Price as incentive
– Prices are a signal that tell a consumer or
producer how to adjust
• Prices as signals
– Low Price- buyers purchase more; sellers
make less
– High Price- buyers purchase less; sellers
make more
The Advantages of Prices
• Flexibility
– Prices can be easily increased to solve the
problem of excess demand
– Prices can be easily decreased to solve the
problem of excess supply
– Supply Shock- a sudden shortage of a good
• Rationing- a system of allocating scarce goods
and services using criteria other than price
• Raising prices is the quickest way to solve excess
demand
A Wide Choice of Goods
• A benefit of a market-based economy is
the diversity of goods and services
consumers can buy
• Market economy allows price to allocate
resources efficiently
• In a market economy there are incentives
to raise prices in return for profit
Wealth of Nations
• Wealth of Nations- Written by Adam Smith
in 1776
– Businesses prosper by finding out what
people want and then providing it
Market Problems
• Imperfect Competition- there are not
enough producers of a good to drive
prices down
• Spillover Costs- costs of production that
affect people who have no control over
how much of a good is produced
• Imperfect Information