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Supply and Demand:
An Introduction
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
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Market Coordination
How do consumers get the goods and services
they want in the right quantities and
qualities?
Some goods and services are allocated by the
market forces of supply and demand
Why do some goods and services have
shortages or surpluses and others do not?
Some goods and services are regulated by
government
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
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Questions
All economies must answer the
following questions:
What should be produced?
How should it be produced?
For whom will it be produced?
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
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Central Planning
Agrarian society
Former Soviet Union
Cuba, North Korea
China
Bureaucracy
A small number of of individuals address
these concerns:
Establish production targets for factories and
farms
Plan how to achieve the goals
Distribute the goods and services produced
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
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Market Forces
Free market
Capitalist economies
Individuals decide for themselves
Which careers to pursue
Which products to produce or buy
When to start businesses
Who gets what is decided by individual
preferences and purchasing power
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
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Markets
A market for any good consists of all
buyers and sellers of that good
Includes individuals who either do sell or
might sell
Includes individuals who either do buy or
might buy
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
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Prices
Why are some goods cheap and others
expensive?
Through most of history, individuals had
no idea
Most thought that it was because of the
cost of production
Others thought only of the value people
received from consumption
Answer: both are important
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
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Supply Curve
Shows the total quantity of a good or service
that sellers wish to sell at each price
On a graph
In a schedule
Positive relationship
As price rises, a higher quantity can be sold
because more opportunity costs can be covered
Application of the “low-hanging fruit principle”
Reflects the rising marginal costs of producing
additional units
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
Fig. 4.1
Daily Supply Curve of Hamburgers
in Greenwich Village
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
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Demand Curve
Shows the total quantity of a good or service
that buyers wish to buy at each price
On a graph
In a schedule
Negative relationship
As price rises, consumers want fewer items
People switch to substitutes
People cannot afford as much
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
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Fig. 4.2
Daily Demand Curve for Hamburgers
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
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Market Equilibrium
When all buyers and sellers are satisfied with
their respective quantities at the market price
There is a stable, balanced, unchanging situation
The supply and demand curves intersect
This results in the equilibrium price
The price the good sells for
This results in the equilibrium quantity
The quantity that will be sold
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
Fig. 4.3
The Equilibrium Price and Quantity of
Hamburgers in Greenwich Village
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
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Disequilibrium
Excess supply
Surplus
Price is higher than equilibrium price
Sellers are dissatisfied
Excess demand
Shortage
Price is lower than equilibrium price
Buyers are dissatisfied
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
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Fig. 4.4
Excess Supply
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
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Fig. 4.5
Excess Demand
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
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Free Markets and
Equilibrium
Free markets have an automatic
tendency to eliminate excess supply and
excess demand
Surplus leads producers to decrease the
price
Shortage leads producers to increase the
price
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
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Legislation and Markets
Market equilibrium does not mean that
everyone has what they want
E.G. a poor person may not be able to afford the
item at the equilibrium price
Legislators protect consumers by using
price ceilings
A maximum allowable price specified by law
Price signal is too low, so consumers want too much
e.g. rent controls, limits on the price of gasoline
Result in shortages
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
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Legislation and Markets
Legislators protect producers by using
price floors
A minimum allowable price specified by law
For example, price supports, minimum wage
Price signal is too high, so consumers don’t
want as much
Result in surpluses
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
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Fig. 4.6
An Unregulated Housing Market
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
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Fig. 4.7
Rent Controls
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
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Economists and the Poor
Economists realize there are more
effective ways of helping the poor than
violating the free market system
Using rent controls or price ceilings
results in inefficiency for everyone
Using a direct income transfer to the
poor is a more efficient way to help
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
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Fig. 4.8
Price Controls in the Hamburger Market
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
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Markets and Social Welfare
Social optimal quantity of a good
The quantity that results in the maximum
possible economic surplus
The socially optimal quantity will occur
where the marginal cost equals the
marginal benefit
Economic efficiency
Occurs when all goods and services are
produced and consumed at their respective
socially optimal levels
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
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Markets and Efficiency
Efficiency Principle
Efficiency is an important social goal
Everyone can have a larger slice of a larger pie
Equilibrium Principle
A market in equilibrium leaves no unexploited
opportunities for individuals
No “cash on the table” remains
All opportunities for profit have been exploited
Efficiency occurs when
the market-demand curve captures all the
marginal benefits of the good
the market-supply curve captures all the
marginal costs of the good
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
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Terminology
If the good’s price changes, you have a
“change in quantity demanded”
A movement along the demand curve
“change in quantity supplied”
A movement along the supply curve
If something else changes, you have a
“change in demand”
A shift of the entire demand curve
change in supply”
A shift of the entire supply curve
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
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Fig. 4.9
An Increase in the Quantity Demanded
Versus an Increase in Demand
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
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Shifts in Supply
Favorable changes to the producer shift
supply curve rightward
lower equilibrium price
higher equilibrium quantity
Unfavorable changes to the producer
shift supply leftward
higher equilibrium price
lower equilibrium quantity
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
Fig. 4.10
The Effect on the Skateboard Market
of an Increase in the Price of
Fiberglass
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
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Shifts in Supply
Changes in the Cost of Production
Changes in Technology
Changes in Weather
Changes in Expectations
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
Fig. 4.11
The Effect on the Market for New
Houses of a Decline in Carpenters’
Wage Rates
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
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Fig. 4.12
The Effect of Technical Change on the
Market for Manuscript Revisions
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
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Shifts in Demand
Complements
Substitutes
Income
Preferences
Demand curve shifts rightward
higher equilibrium price
higher equilibrium quantity
Demand curve shifts leftward
lower equilibrium price
lower equilibrium quantity
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
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Fig. 4.13
The Effect on the Market for Tennis Balls
of a Decline in Court Rental Fees
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
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Complements
Goods that are more valuable when
used in combination--e.g. tennis balls
and tennis courts
Two goods are complements in
consumption if an increase in the price
of one causes a leftward shift in the
demand curve for the other
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
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Substitutes
Goods that replace each other--e.g.
email messages and overnight letters
Two goods are substitutes in
consumption if an increase in the price
of one causes a rightward shift in the
demand curve for the other
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
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Fig. 4.14
Effect on the Market for Overnight
Letter Delivery of a Decline in the Price
of Internet Access
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
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Income
Normal good
One whose demand curve shifts right
when the incomes of buyers increase
Inferior good
One whose demand curves shifts left when
the incomes of buyers increase
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
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Fig. 4.15
The Effect of a Federal Pay Raise on the
Rent for Conveniently Located
Apartments
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
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Simultaneous Shifts
If, at the same time,
Demand decreases and Supply increases
Demand shifts left
Lower price, lower quantity
Supply shifts right
Lower price, higher quantity
We can predict that price will fall
But, what happens to quantity?
We must know the magnitude of the shifts
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
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Fig. 4.16
Four Rules Governing the Effects of
Supply and Demand Shifts
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
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Fig. 4.17
The Effects of Simultaneous Shifts in
Supply and Demand
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.
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Fig. 4.18
Seasonal Variation in the Air Travel and
Corn Markets
Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.