The Demand and Supply Curve
Economic Model
• Objectives:
– Understand the demand curve
– Understand the supply curve
– What happens when supply and demand meet
and what causes an increase or decrease in one or
the other?
Can of Coke
• How much are you willing to pay for an ice
cold can of Coca Cola, that I will allow you to
drink in class?
• Let´s graph the result
Can of Coke
• 100 soles?
• 20 soles?
• 12 soles?
• 8 soles?
•
5 soles?
Whatt do we have? Go to next slide
50 centimos?
The Demand Curve
• As the price increases (goes up) the quantity
demanded decreases (goes down) = MOVEMENT
ALONG THE CURVE
• However, some things can actually move the
curve, examples:
– Changes in income (how much they people get paid)
– Changes in consumer preference
– Competitor prices
Movement (increase or decrease) of
the demand curve
Practice:
• In which direction (right = increase or
left = decrease) does the demand curve move
in the following situations:
– People get a pay rise (or in our example, your
parents give you more money to bring to school)
– A competitor decreases its prices
Movement (Increase or decrease) of
the demand curve
– You have a very successful advertisement on TV
– The government increases income taxes
– Ther product is found to be harmful to your health
The Supply Curve
• How much you would have to be paid (in
soles, by other students) to be make a
Mother´s Day Card that you will make yourself
(to sell to other students for their moms)
• For each card, 250 soles, 40 soles, 20 soles,
8 soles, 4 soles, 1 sol
What do we have? Go to next slide
The Supply Curve
• As the price increases, supply increases =
MOVEMENT ALONG THE CURVE
• However, some things can actually move the
supply curve to the right (= increase) or
to the left (= decrease)
–
–
–
–
Raw materials become cheaper
New machinery
Labor costs go up
Energy costs increase
TODAY´S CLASS – 4.1 & 4.2
• Objective: Solidify our knowledge of Demand
and Supply Curve Economic model
• And……teach the absent students about the
model…..Students absent last week will be
tutored by classmates, and will take a 10
minute quiz at the end of the class
Review
REVIEW
Putting the Demand and Supply
Curves Together
• We drew a demand curve
• We drew a supply curve
• When we put them together we have a model
for a MARKET FOR A PARTICULAR GOOD OR
SERVICE, WHERE BUYERS (DEMAND) AND
SELLERS (SUPPLY) MEET
Demand and Supply Curves meet
• The point of equilibrium, where
the two curves meet, or market
clearing price (point A) is where the
quantity demanded equals the quantity
supplied at a certain price
Now, how do the four different
possibilities look?
1. Increase in demand - DEMAND CURVE
SHIFTS TO THE THE RIGHT
INCREASE IN INCOME, DECREASE IN TAXES, INCREASE IN THE PRICE OF
FANTA, ESPECIALLY HOT WEATHER
• END UP AT EQUILIBRIUM POINT B, with a
higher price and a higher quantity
demanded
Decrease in Demand
2. Decrease in demand - DEMAND CURVE
SHIFTS TO THE LEFT
INCREASE IN TAXES, DECREASE IN INCOME, A NEW JOB THAT PAYS LESSS,
DECREASE IN PRICE OF COMPETITORS PRODUCT (FANTA), COLD WEATHER ALL SUMMER
C
END UP AT EQUILIBRIUM POINT , with
a lower price and lower quantity
demanded
Increase in Supply
• 3. Increase in supply - SUPPLY CURVE
SHIFTS TO THE RIGHT
RAW MATERIALS TO MAKE THE MOTHERS DAY CARD ARE CHEAPER,
YOU GET SOME NEW SCISSORS OR MARKERS OR TAKE AN ART CLASS ANY OF WHICH MAKE YOU ABLE TO MAKE THE CARDS QUICKER, YOUR
TEACHERS GIVE YOU EXTRA TIME TO MAKE THE CARDS IN CLASS, FOR COKE COULD BE A NEW DISCOVERY THAT MAKES THE PROCESSS TO MAKE
COKE CHEAPER, OR THE TAXES THEY HAVE TO PAY TO THE GOVERNMENT DECREASE, OR THEIR WORKERS BECOME MORE EFFICIENT IN MAKING
COKE
• END UP AT EQUILIBRIUM POINT E, with a
higher price and lower quantity demanded
Decrease in Supply
Decrease in supply – SUPPLY CURVE SHIFTS TO
THE LEFT
THE COST OF THE RAW MATERIALS INCREASE, YOUR SCISSORS BREAK AND YOU HAVE TO USE OLD
SCISSORS OR BAD MARKERS, OR YOUR TEACHERS DONT GIVE YOU ANY TIME TO MAKE THE CARDS IN CLASS. FOR COKE, COULD
BE INCREASE IN THE TAXES THEY HAVE TO PAY, OR THEIR MACHINERY BREAKS, OR THEIR EMPLOYEES SAY THEY WANT TO BE PAID
MORE MONEY..
F
END UP AT EQUILIBRIUM POINT , with a
lower price and lower quantity demanded
4.2 Group Project Results
• Diego´s group
- 3 GHMs, 3 extra points
• Carlos Siles´ group - 2 GHMs, 2 extra points
• Santiago´s group - 1 GHM, 1 extra point
• too few groups (one less than planned)
• confusion on students´ names (had to change
groups)
• confusion on what was required
• poor exam results for the group project, etc…
4.1 and 4.2 - ANSWER KEY AND
WIKISPACES
• Answer key being handed out today
• Powerpoint is on wikispaces
• Please be ready for any exam question, and ask
the teacher if you need help
• We will have two exams later this term
(2 assessments)
Important Macroeconomic Lecture –
5 Interrelated Topics
• Interest rates and Inflation (closely linked)
• Unemployment
• the Business Cycle
• Leading and Lagging Indicators
The Party is going fine
Level of Economic Activity =
amount of spending by businesses and
people, and how many people are employed and
spending their earnings on goods and services
Rate of Inflation
Amount of Borrowing
by businesses
and consumers
Level of
Interest Rates
Danger! Things still ok, but may be partying too
much
Level of Economic Activity =
amount of spending by businesses and
people, and how many people are employed and
spending their earnings on goods and services
Rate of Inflation
Amount of Borrowing
by businesses
and consumers
Level of
Interest Rates
Uh oh, we partied too much - Recession
UNEMPLOYMENT GOES UP
Level of Economic Activity
TOO HIGH
CAUSING ECONOMIC ACTIVITY
TO START TO REVERSE (RECESSION IN WORST CASE)
Inflation is TOO HIGH
SO THE Amount of Borrowing
DECREASES
Interest Rates
GO UP TOO MUCH
Interest Rates
• It is the cost of money, it is what you pay to the bank or
another person who lends you money
• You are the borrower and get a loan, and you must
pay the money back to the lender (the bank)
• The terms of your loan (how many years is the loan for,
and the interest rate) will be put in a contract called a
promissary note, which says that you promise to pay
the money back to the lender
Why do you have to pay interest?
• Any bank or company or person that has money can do
something themself with it and earn money
• Money is a tool that allows us to make more money
(like buying a business that then become profitable and
lets you earn more money than you had before)
• So if you are going to use their money instead of letting
them use their own YOU OF COURSE HAVE TO PAY
THEM FOR USING YOUR MONEY
Interest rates
• So borrowing money is like RENTING money,
like if you rent a house in Asia (Perú) for the
summer, you pay rent because the owner of
the house could either:
• A) spend the summer there themself
• B) Let a friend of family member stay there
• B) rent it out to someone else and collect rent
Next Definition - Inflation
• Inflation – is the rate of increase in the prices of
goods and services in an economy (each country
takes a basket of approximately 30 goods and
services)
• Every country has its own inflation rate,
calculated monthly and annually
• In the rare case that prices are going DOWN, it is
called deflation
Goods and Services included in the US inflation rate
(called the Consumer Price Index)
• RECREATION (televisions, cable television, pets
and pet products, sports equipment, admissions)
• EDUCATION AND COMMUNICATION (college
tuition, postage, telephone services, computer
software and accessories)
• OTHER GOODS AND SERVICES (tobacco and
smoking products, haircuts and other personal
services, funeral expenses)
Goods and Services included in the US inflation rate
(called the Consumer Price Index)
• FOOD AND BEVERAGES (breakfast cereal, milk, coffee, chicken,
wine, full service meals and snacks)
• HOUSING (rent of primary residence, owners' equivalent rent,
fuel oil, bedroom furniture);
• APPAREL (men's shirts and sweaters, women's dresses, jewelry)
• TRANSPORTATION (new vehicles, airline fares, gasoline, motor
vehicle insurance)
• MEDICAL CARE (prescription drugs and medical supplies,
physicians' services, eyeglasses and eye care, hospital services)
Inflation
Question: If the inflation rate in 2011 was 3.2%
and the inflation rate in 2012 was 2.4%, in 2012
did prices:
A) go down in 2012
B) go up at a lesser rate in 2012 than in 2011
C) go up at a faster rate in 2012 than 2011
Answer
B) go up at a lesser rate in 2012 than in 2011
Now rising at 2.4% instead of 3.2%
What determines interest rates?
1) The amount of time you have the
money
The longer the amount of time, the
higher the interest rate because there
is more of a chance that something
could go wrong and you cannot pay
back the money
Interest rates – Length of time
• Company A borrows for 1 year
Interest rate might be 6%
• Company A borrows for 20 years
Interest rate might be 10%
What determines interest rates?
2) The general level of interest rates in an
economy, which are determined by the
inflation rate
If there is high inflation, you are losing
purchasing power of your money, so you
demand to be paid a higher interest rate so as
protect you from that loss in purchasing power
Lost Purchasing Power?
• It means that your money is losing its value
(called lost purchasing power)
• If the inflation rate is 2%, your same $1.00 has to
worth $1.02 to buy the same amoung of things
one year later
• That is why your salary must go up by at least the
same amount as the rate of inflation, or you are
worse off
And lost purchasing power affects the
lenders - Why?
• SO THEY DON´T GET PAID
BACK WITH LESS MONEY
THAN THEY LENT
Example
• Jan 2014 - borrow $10.00
• 2014 inflation rate = 8%
• December 2014, pay back the $10 to the
bank, you are only paying the bank about
$9.20
What determines the interest rates?
3) The riskiness of making the loan (who
the borrower is)
For example, Microsoft is a less risky
company to make a loan to than a small
Venezuelan company that has not been
profitable (has been losing money)
More on Inflation
• A high inflation rate is very bad for an
economy (hurts growth)
• Deflation can also be bad
• Leaving us with the fact that there is an ideal
rate of inflation, not too high, not too low,
around 2 to 3%
Inflation can be caused two ways
1) Demand pull - the economy is growing too
fast (so the demand curve keeps shifting up to
the right for all products), increasing prices
2) Cost Push - an event that makes the price of
some important goods in the economy go up
(and supply curve of many products shifts to
the left)
Example of Cost Push Inflation
If there were a war in the middle east
between Iraq and Iran, the price of oil would
go way up, and it would affect the inflation
rate of almost all countries
Inflation
• Inflation in LEDC´s is almost always higher
than inflation in MEDC´s
• The MEDC´s have more mature economies
and there is less growth and/or fluctuation in
the economy, leading the lower, more stable
inflation rates
Inflation rates
• LEDCs - 5.5% average
• MEDCs - 2.2% average
• http://www.tradingeconomics.com/countrylist/inflation-rate
Inflation – is it good for anyone?
• It is only good for people that
have investments, like in real
estate (a home or building)
AND NOTE -- There are goods that are
have limited supply, and they will be
immune to inflation
The 1913 Liberty nickle (5 cents in USA) is worth
$3 million dollars because there are so few of
the coins that exist
Why is an increase in inflation bad?
• It makes interest rates go
up (lenders need to charge
higher rates to protect
themselves from inflation)
Why is an increase in interest
rates bad?
• If interest rates rise too much, businesses
stop borrowing money for projects and
expanding (which is what leads to the growth
in an economy), and consumers stop
borrowing also
• That makes the economy grow at a slower
rate, or, when interest rates become really
high, it causes a recession
It causes a recession in the worst case!
• A recession is a DECLINE in
economic activity for at least six
months (two consecutive 3month quarters)
Recession
• A recession causes people to lose jobs and
have hard times
So why do you think deflation is also bad?
• Think about a company that
would like to charge more for its
product in 2014 than it is
charging in 2013 to make more
profit……..
ANSWER
• If there is deflation, then the company
will have a hard time increasing its prices
• And will make less money, and that can
affect many companies and the whole
economy
ANSWER
• And if many companies are not
making as much money then
they cannot emply as many
people and we have higher
unemployment