Chapter 3:
Supply & Demand
Price ($)
Supply
P*
Demand
Q*
Quantity (Units)
1
Value, Prices, & Markets
• Prices communicate information about the
value of a good or service.
• Prices arise from the interaction of supply
and demand in a market economy.
• Supply and Demand, and thus prices,
coordinate the production and distribution
of goods and services in the economy.
2
Competitive Markets
• Definition: A competitive market is a
market in which there are many buyers and
sellers of the same good or service.
• A completely competitive market is one
where no one individual or firm can make
a noticeable impact on the price.
• Think about monopoly or oligopoly.
3
Supply & Demand
• Supply & Demand: A simple model that
describes how competitive markets work,
and how prices are determined.
• The Elements of the Model:
– Supply and Demand Curves
– What Factors Cause the Curves to Shift
– Equilibrium Price and Changes in Equilibrium
4
Other Things Equal
• When analyzing the relationship between
the price and quantity demanded other
variables must be kept constant.
• Ceteris paribus (“all else equal”)
5
The Demand Schedule
• The Demand Schedule is a Table which shows
how much consumers will want to buy at each
price.
Price
($ per ticket)
Quantity
demanded
(tickets)
350
5,000
300
6,000
250
8,000
200
11,000
150
15,000
100
20,000
6
The Demand Curve
• The Demand Curve is a Graph of the Demand
Schedule which shows how much consumers will
want to buy at each price.
7
The LAW of DEMAND
• The Law of Demand says that a higher price for a
good, other things constant, means people will
demand a smaller quantity of the good.
8
Individual vs. Market Demand
For each price level sum the
“individual quantity demanded”
to get the “market quantity
demanded” at that price level.
9
Individual vs. Market Demand
For each price level sum the
“individual quantity demanded”
to get the “market quantity
demanded” at that price level.
10
“Demand” vs. “Quantity Demanded”
• When we talk about “Demand” we are talking
about the ENTIRE DEMAND schedule or curve.
• When we talk about “Quantity Demanded” we
are talking about a SPECIFIC POINT on the
demand curve – the quantity on the demand
curve at SPECIFIC PRICE.
11
“Movement Along” vs. “Shift”
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.
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the demand curve
12
“Movement Along” vs. “Shift”
Causes of a
“Movement Along”
Causes of a “Shift”
Change in Price
Changes in the Prices of Other Goods
Changes in Incomes
Changes in Tastes & Preferences
Changes in Expectations
13
Shifts in Demand
• A change in quantity demanded at any given
price represents a shift in the demand curve.
A decrease
 an
“increasein
demand
means
in
demand”,
a leftward
means
a shift of
the demand
rightward
shift of
curve.
the
demand
Price
Decrease
Increase
D3
D1
D2
Quantity14
Change in Prices of Other Goods
• Substitutes: Two goods are substitutes if a fall in
the price of one of the goods makes consumers
less willing to buy the other good. Ex.: muffins
and donuts.
• Complements: Two goods are complements if a
fall in the price of one good makes people more
willing to buy the other good. Ex: PB&J,
Computers/Monitors
15
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.
• Inferior Goods: When a rise in income decreases
the demand for a good, it is an inferior good. Ex:
instant noodles.
16
Changes in Tastes or Expectations
• Tastes & Preferences are constantly changing
with Fads, Fashions, Needs and Wants.
Can you think of any examples?
• Expectations: Consumers choose not only which
products to buy but also when to buy them.
17
Shifts in Demand
• Suppose Tom Brady announces retirement and that the next
game is his last game! What happens at the next game?
18
Check Understanding Question A
What would be the effect of a sharp increase in the
price of squash balls on the demand for squash
racquets? Why?
If the price of a
compliment good
rises, then demand
decreases for the
good in question and
the demand curve
shifts left.
Price
Decrease
D2
D1
Quantity
19
Check Understanding Question B
What would be the effect of a sharp increase in the
price of Pepsi on the demand for Coke? Why?
If the price of a
substitute good
rises, then demand
increases for the
good in question and
the demand curve
shifts right.
Price
Increase
D1
D2
Quantity
20
Check Understanding Question C
As Larissa’s income goes up, she buys less instant
noodles. What kind of a good is instant noodles for
Larissa?
Goods for which
demand decreases if
your income rises
are called inferior
goods. In this case,
instant noodles are
an inferior good.
Price
Decrease
D2
D1
Quantity
21
Check Understanding Question D
Following David Beckham and Sting, more men start to
follow the fashion of wearing skirts. What would the effect
of this change in tastes be on the demand for skirts?
Price
If tastes change in
favor of a certain
good, then demand
increases for the
good.
Increase
D1
D2
Quantity
22
Supply
• Producers or Firms must make a decision about
how much of a good or service to sell in the
market place.
• Quantity Supplied: The actual amount of a good
or service that people are willing to sell at some
specific price.
23
The Supply Schedule
• The Supply Schedule is a Table which shows how
much of good or service will be supplied at
different prices.
Supply Schedule for Tickets
Price
($ per ticket)
Quantity Supplied
(tickets)
350
8,800
300
8,500
250
8,000
200
7,000
150
5,000
100
2,000
24
The Supply Curve
• The Supply Curve is a Graph of the Supply
Schedule which shows how much sellers will
want to sell at each price.
25
•Law of supply holding everything
else constant, increases in price
cause increases in the quantity
supplied, and decreases in price
cause decreases in the quantity
supplied.
26
Individual vs. Market Supply
Price (DVD’s) Firm 1
Firm 2
Market Supply
A
$0.50
2
0
2
B
$1.00
3
1
4
C
$1.50
4
2
6
D
$2.00
5
3
8
27
“Supply” vs. “Quantity Supplied”
• When we talk about “Supply” we are talking
about the ENTIRE SUPPLY schedule or curve.
• When we talk about “Quantity Supplied” we are
talking about a SPECIFIC POINT on the supply
curve – the quantity on the supply curve at a
SPECIFIC PRICE.
28
“Movement Along” vs. “Shift”
Causes of a
“Movement Along”
Causes of a Supply “Shift”
Change in Price
Changes in Input Prices
Changes in Technology
Changes in Expectations
29
“Movement Along” vs. “Shift”
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.
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supply
curve
30
Shifts in Supply
• A change in quantity supplied at any given price
represents a shift in the supply curve.
A decrease
 an
“increasein
supply
means a
in
supply”,
leftwardashift of
means
the supplyshift
curve.
rightward
of
the supply curve.
Price
S3
S1
S2
Decrease
Increase
Quantity31
Change in Input Prices
• Why might input prices matter?
• If the price of inputs rises, your costs go up,
therefore you want to supply fewer goods at each
price – supply decreases (shifts left)
• If the price of inputs falls, your costs go down,
therefore you are willing to supply more goods at
each price – supply increases (shifts right)
32
Changes in Technology
• A change in technology doesn’t necessarily mean
just changes in electronics. Changes in
technology can simply be changes in how things
are done.
• If a change in technology improves the
production of a good (higher productivity or
efficiency) then costs fall.
• Producers are willing to supply more at every
price – supply increases (shifts right)
33
Changes in Expectations
• Expectations: Producer expectations about
future events such as changes in costs or prices
can cause supply to shift.
• If you believe the price of your good will be
higher in the future, you supply less today, thus
supply decreases.
• If you believe the price of your good will be lower
in the future, you supply more today, thus supply
increases.
34
Shifts in Supply (for scalpers)
• Suppose Brady announces retirement and that
the next game is his last game! Supply shifts left
since scalpers have a harder time getting tickets.
35
Check Understanding Question A
More homeowners put their houses up for sale
during a real estate boom that has caused house
prices to rise. Is this a shift or movement along…?
Price
S1
A change in prices
results in a
movement along the
curve
Quantity
36
Check Understanding Question B
Strawberry farmers open temporary roadside
stands during harvest season even though prices
are usually lower at that time.
Price
S1
S2
Increase
Quantity
Farmer’s have much
more supply during
harvest season.
They need to sell
them before they go
bad. Increased
supply reduces the
prices.
37
Supply, Demand and Equilibrium
Competitive Market Equilibrium:
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 (a.k.a 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.
38
Equilibrium for Football Tickets
Equilibrium
Price = $250
Equilibrium Quantity
= 8,000 Tickets
39
Why does the market price fall if it is above the
equilibrium price?
Let’s say the market
price of $350 is above
the equilibrium price of
$250
This creates a
surplus
This surplus will push
the price down until it
reaches the equilibrium
price of $250.
40
Surplus
There is a surplus of
a good when the
quantity supplied
exceeds the quantity
demanded.
Surpluses occur
when the price is
above its
equilibrium level.
41
Why does the market price rise if it is below the
equilibrium price?
Let’s say the market
price of $150 is below
the equilibrium price of
$250.
This creates a
shortage.
This shortage will
push the price up until it
reaches the equilibrium
price of $250.
42
Shortage
There is a shortage of
a good when the
quantity demanded
exceeds the quantity
supplied.
Shortages occur when
the price is below its
equilibrium level.
43
Markets are never in equilibrium but they
always tend to the equilibrium
• Demand and Supply both matter because
neither consumers or firms dictate equilibrium
price.
• Firm cannot sell anything at any price unless it
can find a willing buyer.
• A consumer cannot buy anything at any price
without finding a willing seller.
44
What happens when the demand curve shifts?
Coffee and tea are substitutes: if the price of tea rises (falls),
the demand for coffee will increase (decrease). But how does
the price of tea affect the market for coffee?
When
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45
What happens when the supply curve shifts?
Technological innovation: Engineers learned how to put
microscopic electronic components onto a silicon chip;
allowing ever more components to be put on each chip.
Surplus
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46
Simultaneous Shifts in Supply and Demand
What happens when the both supply and demand
curves shift simultaneously?
The increase
There
is a in
simultaneous
demand
is
rightwardlarger
relatively
shift of
the demand
than
the decrease
curve
and
in
supply,
leftward
so the
shift
of the supplyprice
equilibrium
curve.and the
rises
equilibrium
quantity increases.
47
Simultaneous Shifts in Supply and Demand
Another Scenario
The decrease
There
is a
in
simultaneous
supply
is relatively
rightward
larger
than shift
the of
the demand
increase
in curve
and leftward
demand,
so the
shift
of the supply
equilibrium
price
curve.and the
rises
equilibrium quantity
decreases.
48
The Effect of Demand and Supply Shifts
on Equilibrium
How Shifts in Demand and Supply Affect
Equilibrium Price (P) and Quantity (Q)
SUPPLY CURVE
UNCHANGED
SUPPLY CURVE
SHIFTS TO THE RIGHT
SUPPLY CURVE
SHIFTS TO THE LEFT
Q unchanged
P unchanged
Q increases
P decreases
Q decreases
P increases
DEMAND CURVE
SHIFTS TO THE RIGHT Q increases
P increases
Q increases
P increases or
decreases
Q increases or
decreases
P increases
DEMAND CURVE
SHIFTS TO THE LEFT
Q increases or
decreases
P decreases
Q decreases
P decreases or
increases
DEMAND CURVE
UNCHANGED
Q decreases
P decreases
49