Chapter 3
Supply and Demand
ECONOMICS: Principles and Applications, 4e
HALL & LIEBERMAN, © 2008 Thomson South-Western
Markets
• Market
– A group of buyers and sellers with the
potential to trade with each other
– Can be defined broadly or narrowly
• Macroeconomics
• Microeconomics
• The economy
– A collection of individual markets
2
Markets
• Macroeconomic Markets
– All capital goods - one market
– All consumer goods - “consumption
goods”
– Overall view of the economy
• Microeconomic Markets
– Narrowly defined
– Models - specific commodities
3
Product and Resource Markets
• Product market
– Goods and services
– Firms – suppliers
– Households – buyers
• Resource market
– Resources
– Firms – buyers
– Households – suppliers
4
Product and Resource Markets
• Figure 1 The Circular Flow Model
Flow of goods and resources
•Resource market
- Households sell resources
- Firms buy resources to
produce goods and services
•Product Market
- Firms sell goods and
services to households
Money flows
- Firms – pay the resource
owners
- Households – receive
income for resources (to buy
goods and services )
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Competition in Markets
• Imperfectly competitive markets
– Buyers/sellers can influence the price
– A few large buyers or sellers
– Product differentiation
• Perfectly competitive markets (or just
competitive markets)
– Buyers/sellers take the market price
– Many small buyers and sellers
– Standardized product
6
Using Supply and Demand
• Supply and demand model
– Designed to explain how prices are
determined in perfectly competitive
markets
• Perfect competition
– Rare in the real world
– Many markets are close to perfect
competition
• To analyze a market, we need both,
Supply and Demand
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How to make a deal
• Single price (most cases)
• Quantity price(buy one get one half
price)
• Two part tariff (membership fee)
• Customer price (Dentist charges
different price according to customers)
• Bargaining price (Vehicle, House)
• Auction price (Antique, Land)
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Demand – Quantity Demanded
• Quantity demanded
• amount of a good
• all buyers in a market would choose to buy
• during a period of time
• given their constraints
– Implies a Choice
• Households choose to buy – considering the
opportunity cost of their decisions
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The Law of Demand
• When the price of a good rises and
everything else remains the same, the
quantity of the good demanded will fall
• Ceteris paribus assumption
• many variables change simultaneously
• understand each variable separately
– we assume “everything else remains the
same”
• understand how demand reacts to price
10
Demand Schedule and Demand Curve
• Demand schedule
– list of different quantities demanded at
different prices, ceteris paribus
• Demand curve
– relationship between the price of a good
and the quantity demanded, ceteris
paribus
11
The Demand Curve
• Each point on the demand curve
– total quantity that buyers would choose
to buy at a specific price
• Graphical depiction of a demand
schedule
• Slopes downward
– Law of Demand
12
The Demand Curve
• Figure 2 The Demand Curve – movement along the demand curve
Price per
Bottle
When the price is $4.00
per bottle, 40,000 bottles
are demanded
$4.00
A
B
2.00
At $2.00 per bottle,
60,000 bottles are
demanded
D
40,000
60,000
Number of Bottles per
Month
13
Movements Along the Demand Curve
• a change in the price of a good causes a
movement along the demand curve,
ceteris paribus.
• In Figure 2
– a fall in price - move rightward along the
demand curve (from A to B)
– a rise in price - move leftward along the
demand curve (from B to A).
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Shifts of the Demand Curve
• a change in any variable that affects
demand—except for the good’s price—
causes the demand curve to shift.
– An increase in quantity at any price
• The demand curve shifts rightward (increase
in demand)
– A decrease in quantity at any price
• The demand curve shifts leftward (decrease
in demand)
15
The Demand Curve
• Figure 3 A Shift of the Demand Curve
An increase in income
shifts the demand curve
for maple syrup from D1 to D2
Price per
Bottle
At each price, more bottles
are demanded after the shift
B
C
$2.00
60,000
D1
D2
80,000
Number of Bottles
per Month
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Change in Quantity Demanded
• “Quantity demanded”
– A particular amount
• buyers would choose to buy at a specific
price
– One point on a demand curve
• Change in quantity demanded
– A movement along a demand curve in
response to a change in price
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Change in Demand
• “Demand”
– Relationship between price and quantity
demanded
– Represented by the entire demand curve
• Change in demand
– Shift of the demand curve
– From changes in something other than
price
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Factors that Shift the Demand Curve
1. Income
– Normal Good
•
People demand more as the income rises
– Inferior Good
•
•
People demand less as the income rises
A rise in income will
– increase the demand for a normal good
– decrease the demand for an inferior
good
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Factors that Shift the Demand Curve
2. Wealth
– Total value of everything you own
minus the total dollar amount you owe
– Measured at a point in time
•
An increase in wealth will
– increase demand (shift rightward) for a
normal good
– decrease demand (shift leftward) for an
inferior good
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Factors that Shift the Demand Curve
3. Prices of Related Goods
• Substitutes
– can be used in place of some other
good
– fulfills more or less the same purpose
•
A rise in the price of a substitute will:
– increase the demand for a good (shift
the demand curve to the right)
21
Factors that Shift the Demand Curve
3. Prices of Related Goods
• Complements
– used together with the good we are
interested in
•
A rise in the price of a complement will
– decrease the demand for a good (shifts
the demand curve to the left)
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Factors that Shift the Demand Curve
4. Population
– An increase in population will
•
•
increase the number of buyers
increase the demand (rightward shift)
5. Expected Price
– An expected rise in price shifts the
demand curve rightward (increase)
– An expected fall in price shifts the
demand curve leftward (decrease)
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Factors that Shift the Demand Curve
6. Tastes/Preferences
– tastes change toward a good
•
demand increases (demand curve shifts
right)
– tastes change away from a good
•
demand decreases (demand curve shifts
left)
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The Demand Curve
• Figure 4 The Demand Curve – A summary
a) Price ↓
Move rightward along
the demand curve
P
P
b) Price ↑
Move leftward along
the demand curve
B
A
P2
P1
B
P2
A
P1
D
D
Q1
Q2
Q
Q2
Q1
Q
25
The Demand Curve
• Figure 4 The Demand Curve – A summary
c) The Demand curve
shifts rightward
P
D2
D1
Income or wealth ↑
Price of substitute↑
Price of complement ↓
Population ↑
Expected price ↑
Tastes shift toward good
Q
26
The Demand Curve
• Figure 4 The Demand Curve – A summary
P
d) The Demand curve
shifts leftward
D1
D2
Income or wealth ↓
Price of substitute ↓
Price of complement ↑
Population ↓
Expected price ↓
Tastes shift away from good
Q
27