Chapter 3
Supply and Demand
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
3-1
Chapter Objectives
• Define and explain demand in a product
or service market
• Define and explain supply
• Determine the equilibrium point in the
market for a specific good, given data on
supply and demand at different price
levels
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
3-2
Chapter Objectives
• Understand what causes shifts in demand
and supply
• Understand how price ceilings cause
shortages
• Understand how price floors cause
surpluses
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
3-3
Demand
• The schedule of quantities of a
good or service that people are
willing and able to buy at
different prices
– Sometimes a schedule is also called
a table
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
3-4
Hypothetical Daily Demand for Coach Seats on Roundtrip Weekly Flights Between Denver and Chicago
Table 1
$500
Price
QD
$500
1,000
400
450
3,000
350
400
7,000
300
350
12,000
250
300
19,000
200
250
30,000
150
200
45,000
100
150
57,000
100
67,000
450
D
50
10
20 30 40 50 60
Quantity (in thousands)
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
70
3-5
Hypothetical Daily Demand for Coach Seats on Roundtrip Weekly Flights Between Denver and Chicago
Table 1
$500
Price
QD
$500
1,000
400
450
3,000
350
400
7,000
300
350
12,000
250
300
19,000
200
250
30,000
150
200
45,000
100
150
57,000
100
67,000
450
D
50
10
20 30 40 50 60
Quantity (in thousands)
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
70
3-6
Hypothetical Daily Demand for Coach Seats on Roundtrip Weekly Flights Between Denver and Chicago
Table 1
$500
Price
QD
$500
1,000
400
450
3,000
350
400
7,000
300
350
12,000
250
300
19,000
200
250
30,000
150
200
45,000
100
150
57,000
100
67,000
450
D
50
10
20 30 40 50 60
Quantity (in thousands)
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
70
3-7
Hypothetical Daily Demand for Coach Seats on Roundtrip Weekly Flights Between Denver and Chicago
Table 1
$500
Price
QD
$500
1,000
400
450
3,000
350
400
7,000
300
350
12,000
250
300
19,000
200
250
30,000
150
200
45,000
100
150
57,000
100
67,000
450
D
50
10
20 30 40 50 60
Quantity (in thousands)
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
70
3-8
Hypothetical Daily Demand for Coach Seats on Roundtrip Weekly Flights Between Denver and Chicago
Table 1
$500
Price
QD
$500
1,000
400
450
3,000
350
400
7,000
300
350
12,000
250
300
19,000
200
250
30,000
150
200
45,000
100
150
57,000
100
67,000
450
D
50
10
20 30 40 50 60
Quantity (in thousands)
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
70
3-9
Hypothetical Daily Demand for Coach Seats on Roundtrip Weekly Flights Between Denver and Chicago
Table 1
$500
Price
QD
$500
1,000
400
450
3,000
350
400
7,000
300
350
12,000
250
300
19,000
200
250
30,000
150
200
45,000
100
150
57,000
100
67,000
450
D
50
10
20 30 40 50 60
Quantity (in thousands)
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
70
3-10
Hypothetical Daily Demand for Coach Seats on Roundtrip Weekly Flights Between Denver and Chicago
Table 1
$500
Price
QD
$500
1,000
400
450
3,000
350
400
7,000
300
350
12,000
250
300
19,000
200
250
30,000
150
200
45,000
100
150
57,000
100
67,000
450
D
50
10
20 30 40 50 60
Quantity (in thousands)
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
70
3-11
Hypothetical Daily Demand for Coach Seats on Roundtrip Weekly Flights Between Denver and Chicago
Table 1
$500
Price
QD
$500
1,000
400
450
3,000
350
400
7,000
300
350
12,000
250
300
19,000
200
250
30,000
150
200
45,000
100
150
57,000
100
67,000
450
D
50
10
20 30 40 50 60
Quantity (in thousands)
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
70
3-12
Hypothetical Daily Demand for Coach Seats on Roundtrip Weekly Flights Between Denver and Chicago
Table 1
$500
Price
QD
$500
1,000
400
450
3,000
350
400
7,000
300
350
12,000
250
300
19,000
200
250
30,000
150
200
45,000
100
150
57,000
100
67,000
450
D
50
10
20 30 40 50 60
Quantity (in thousands)
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
70
3-13
Hypothetical Daily Demand for Coach Seats on Roundtrip Weekly Flights Between Denver and Chicago
Table 1
$500
Price
QD
$500
1,000
400
450
3,000
350
400
7,000
300
350
12,000
250
300
19,000
200
250
30,000
150
200
45,000
100
150
57,000
100
67,000
450
D
50
10
20 30 40 50 60
Quantity (in thousands)
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
70
3-14
Table 1 is the Demand
Schedule
Table 1
Figure 1 is the Graph of the
Demand Schedule
Figure 1
$500
Price
QD
$500
1,000
400
450
3,000
350
400
7,000
300
350
12,000
250
300
19,000
200
250
30,000
150
200
45,000
100
150
57,000
100
67,000
450
50
The line is the
Demand Curve
10
20 30 40 50 60
Quantity (in thousands)
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
D
70
3-15
Quantity Demanded is a point
on the Demand Curve
Price and Quantity Demanded
are inversely related
Table 1
Figure 1
$500
Price
QD
$500
1,000
400
450
3,000
350
400
7,000
300
350
12,000
250
300
19,000
200
250
30,000
150
200
45,000
100
150
57,000
100
67,000
450
D
50
10
20 30 40 50 60
Quantity (in thousands)
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
70
3-16
Remember, Demand is the
entire schedule or the entire
curve
Table 1
Quantity Demanded is a point
on the Demand Curve
Figure 1
$500
Price
QD
$500
1,000
400
450
3,000
350
400
7,000
300
350
12,000
250
300
19,000
200
250
30,000
150
200
45,000
100
150
57,000
100
67,000
450
D
50
10
20 30 40 50 60
Quantity (in thousands)
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
70
3-17
Supply
• Is the “schedule” of quantities of a
good or service that people are
willing to sell at different prices
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
3-18
Supply is the entire schedule
or the entire curve
Price
$500
$450
$400
$350
$300
$250
$200
$150
$100
QS
62,000
59,000
54,000
48,000
40,000
30,000
16,000
7,000
2,000
S
$500
450
400
350
300
250
200
150
100
50
10
20 30 40 50 60
Quantity (in thousands)
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70
3-19
Quantity Supplied is a point on
the curve
Price
$500
$450
$400
$350
$300
$250
$200
$150
$100
QS
62,000
59,000
54,000
48,000
40,000
30,000
16,000
7,000
2,000
S
$500
450
400
350
300
250
200
150
100
50
10
20 30 40 50 60
Quantity (in thousands)
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
70
3-20
Demand and Supply Curves
Price
$500
$450
$400
$350
$300
$250
$200
$150
$100
QS
62,000
59,000
54,000
48,000
40,000
30,000
16,000
7,000
2,000
QD
1,000
3,000
7,000
12,000
19,000
30,000
45,000
57,000
67,000
S
$500
450
400
350
300
250
200
150
D
100
50
10
Equilibrium price
is the price where
QD = QS
20 30 40 50
60
Quantity (in thousands)
70
We can find equilibrium price
and quantity by seeing where the
supply and demand curves cross
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
3-21
Demand and Supply Curves
Surpluses and Shortages
Price
$500
$450
$400
$350
$300
$250
$200
$150
$100
QS
62,000
59,000
54,000
48,000
40,000
30,000
16,000
7,000
2,000
QD
1,000
3,000
7,000
12,000
19,000
30,000
45,000
57,000
67,000
S
$500
450
54,000-7,000 = 47,000
400
350
300
250
200
150
D
100
50
10
Equilibrium price = EP
Market price = MP
20 30 40 50
60
Quantity (in thousands)
70
MP > EP there is a surplus
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
3-22
Demand and Supply Curves
Surpluses and Shortages
Price
$500
$450
$400
$350
$300
$250
$200
$150
$100
QS
62,000
59,000
54,000
48,000
40,000
30,000
16,000
7,000
2,000
QD
1,000
3,000
7,000
12,000
19,000
30,000
45,000
57,000
67,000
S
$500
450
54,000-7,000 = 47,000
400
350
300
250
200
150
D
100
50
10
Equilibrium price = EP
Market price = MP
20 30 40 50
60
Quantity (in thousands)
70
A surplus would force sellers to
lower their prices. Eventually,
prices would fall back to the
equilibrium price
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
3-23
Demand and Supply Curves
Surpluses and Shortages
Price
$500
$450
$400
$350
$300
$250
$200
$150
$100
QS
62,000
59,000
54,000
48,000
40,000
30,000
16,000
7,000
2,000
QD
1,000
3,000
7,000
12,000
19,000
30,000
45,000
57,000
67,000
S
$500
450
400
350
300
250
200
150
100
57,000-7,000 = 50,000
50
10
Equilibrium price = EP
Market price = MP
D
20 30 40 50
60
Quantity (in thousands)
70
MP < EP here is a shortage
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
3-24
Demand and Supply Curves
Surpluses and Shortages
Price
$500
$450
$400
$350
$300
$250
$200
$150
$100
QS
62,000
59,000
54,000
48,000
40,000
30,000
16,000
7,000
2,000
QD
1,000
3,000
7,000
12,000
19,000
30,000
45,000
57,000
67,000
S
$500
450
400
350
300
250
200
150
100
57,000-7,000 = 50,000
50
10
Equilibrium price = EP
Market price = MP
D
20 30 40 50
60
Quantity (in thousands)
70
A shortage would allow sellers to raise
their prices. As prices increased people
would buy less. Eventually, prices
would move back to the equilibrium
price
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
3-25
Demand and Supply Curves
Surpluses and Shortages
Price
$500
$450
$400
$350
$300
$250
$200
$150
$100
QS
62,000
59,000
54,000
48,000
40,000
30,000
16,000
7,000
2,000
QD
1,000
3,000
7,000
12,000
19,000
30,000
45,000
57,000
67,000
S
$500
450
400
350
300
250
200
150
D
100
50
10
20 30 40 50
60
Quantity (in thousands)
70
We can see that the forces of demand
and supply work together to establish an
equilibrium price at which there are no
shortages or surpluses
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
3-26
The schedule changes from QD1 to QD2
Table 4
Price
QD1
S
$500
QD2
450
$500 1,000
12,000
400
450 3,000
15,000
350
400 7,000
21,000
300
250
350 12,000
30,000
300 19,000
40,000
150
250
30,000
55,000
100
200 45,000
63,000
50
150 57,000
75,000
100
88,000
67,000
200
D1
D2
10
20 30 40 50 60
Quantity (in thousands)
70
The demand curve shifts to the right from D1 to D2
This is an increase in demand
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3-27
The schedule changes from QD2 to QD1
Table 4
Price
QD1
S
$500
QD2
450
$500 1,000
12,000
400
450 3,000
15,000
350
400 7,000
21,000
300
250
350 12,000
30,000
300 19,000
40,000
150
250
30,000
55,000
100
200 45,000
63,000
50
150 57,000
75,000
100
88,000
67,000
200
D1
D2
10
20 30 40 50 60
Quantity (in thousands)
70
The demand curve shifts to the left from D2 to D1
This is a decrease in demand
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3-28
Shifts in Supply and Demand
If the schedule changes the
Supply curve shifts
Price
500
S
S
450
400
350
300
250
200
Supply decreases . . . the
curve shifts to the left
150
100
50
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Companies, Inc. All rights reserved.
D
10 20 30 40 50 60 70
Quantity (in thousands) 3-29
Shifts in Supply and Demand
If the schedule changes the
Supply curve shifts
Price
500
S
S
450
400
350
300
250
200
150
Supply increases . . . the
curve shifts to the right
Copyright 2008 by The McGraw-Hill
Companies, Inc. All rights reserved.
100
50
D
10 20 30 40 50 60 70
Quantity (in thousands)
3-30
Shifts in Supply and Demand
If the Supply curve is S1
what is the equilibrium price
and quantity?
Price
500
S2
S1
450
400
350
300
250
The equilibrium price is
approximately 262 or 263
200
150
The equilibrium quantity is
approximately 35,000
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Companies, Inc. All rights reserved.
100
50
D
10 20 30 40 50 60 70
Quantity (in thousands)
3-31
Shifts in Supply and Demand
If the Supply curve changes
to S2 what is the new
equilibrium price and
quantity?
Price
500
S2
S1
450
400
350
300
250
The new equilibrium price
is approximately 325
200
150
The new equilibrium
quantity is approximately
26,000
Copyright 2008 by The McGraw-Hill
Companies, Inc. All rights reserved.
100
50
D
10 20 30 40 50 60 70
Quantity (in thousands) 3-32
Shifts in Supply and Demand
Is a shift from S1 to S2 an
increase or decrease in
Supply?
Price
500
S2
S1
450
400
350
300
250
A decrease
200
150
100
50
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Companies, Inc. All rights reserved.
D
10 20 30 40 50 60 70
Quantity (in thousands)
3-33
Price Floors and Ceilings
The price can go no lower
than the floor.
25
S
20
The surplus is the amount
by which the quantity
supplied is greater than the
quantity demanded
Surplus
15
Price
floor
10
5
D
A price floor creates a
permanent surplus
10
20
30
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40
50
60
70
Quantity
3-34
Price Floors and Ceilings
The price can go no higher
than the ceiling.
S
40
The shortage is the amount
by which the quantity
demanded is greater than
the quantity supplied
30
20
Pric e ceiling
Shortage
10
A price ceiling creates a
permanent shortage
D
10
20
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30
40
50
60
70
80
Quantity
3-35
Applications of Supply and
Demand
• Interest rates are set by
– Supply and demand
• Wage rates are set by
– Supply and demand
• Rents are determined by
– Supply and demand
• The prices of nearly all goods are determined by
– Supply and demand
• The prices of nearly all services are determined
by
– Supply and demand
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
3-36
Hypothetical Demand for and Supply of Loanable Funds
S
20
18
16
14
12
10
8
6
4
2
D
100 200 300 400 500 600 700 800 900 1,000 1,100
Quantity of loanable f unds (in billions of dollars)
We can see that $600 billion is lent (or borrowed) at an interest rate
of 6 percent
What would happen if the supply of loanable funds increased?
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
3-37
Hypothetical Demand for and Supply of Loanable Funds
S1
20
S2
18
16
14
12
10
8
6
4
2
D
200
400
600
800
1,000
Quantity of loanable f unds (in billions of dollars)
The interest rate would decrease to 4 percent and the amount of
money borrowed would increase to $800 billion
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
3-38
Hypothetical Demand for and Supply of Loanable Funds
S
20
18
16
14
12
10
8
6
D2
4
2
D1
200
400
600
800
1,000
Quantity of loanable f unds (in billions of dollars)
If the demand for loanable funds rises to D2 the interest rate would
rise to 9 percent and the amount of money borrowed would rise to
$700 billion
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
3-39
Last Word
• Government sometimes interferes with the free
operation of the markets by
– Imposing prices floors and price ceilings
– This creates the problems of shortages and surpluses
• The government may also ensure the smooth operation
of the markets by protecting property rights,
guaranteeing enforcement of legal contracts, and
issuing a supply of money that buyers and sellers
readily accept
– Property rights are essential to a free and
prosperous nation
• While governmental interference with the market
system can have adverse affects, the government does
have a substantial supportive role to play in a market
economy.
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
3-40
Current Issue: High Gas Prices
• Hurricane Katrina
–
–
–
–
–
–
Temporarily shut down off shore wells
Briefly put 10% of our refineries out of commission
Result – a sudden drop in oil supply
The government took a “hands” off approach
Gasoline prices rose sharply – duh?
People could buy all they wanted at sharply
increased prices with no wait at the pumps
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
3-41
The Alternative to High Gas Prices
In 1970 and 1979
• Middle east countries curtailed oil shipments to
the United States
• Resulted in reduced oil supply
• Government’s solution – restrict purchases and
hold down prices
• The result – long gas lines in many parts of the
country
• People paid less but waited much longer to
purchase gas at moderately higher prices
(sometimes one to two hours)
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
3-42
Summation
Gasoline Supply Decreases
• Short Run
– Prices Rise
– Many people cut back on their driving
• Long Run
– People buy more gas efficient cars
– Higher prices encourage greater exploration
for oil
– Higher prices encourage the development of
alternative energy sources
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
3-43
Summation
Government Restricts Purchases and Holds
Down Price Increases
• Short Run
– Prices may rise moderately
– People cut back on their driving very little if
any
– Significant waits at the gas pumps occur
• Long Run
– People have little incentive to buy more gas
efficient cars
– Lower prices discourage greater exploration
for oil
– Higher prices discourage the development of
alternative energy sources
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
3-44
Closing Comments
• Most economists probably believe price ceilings do
more harm than good in the long run
• Most people probably think in the short run and want
government to do something about higher prices
• Government probably is inclined to get involved
• Corporate greed probably can and will influence
government actions
• The result . . . who knows? But past history indicates it
probably won’t be good for the consumer
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
3-45