Chapter 3 Demand and Supply. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-2...

Chapter 3

Demand and Supply

Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-2

Introduction

They are small, thin and lightweight…

Some are not aware of their existence, while others allocate a lot of time and effort in obtaining them.

What are they? They are sports trading cards.

Most can be purchased for a few dollars or less, but many cost much more—up to thousands of dollars each!

In this chapter you will learn why the prices of different sports trading cards can vary so widely.


Learning Objectives

• Explain the law of demand

• Discuss the difference between money prices and relative prices

• Distinguish between changes in demand and changes in quantity demanded


Learning Objectives (cont'd)

• Explain the law of supply

• Distinguish between changes in supply and changes in quantity supplied

• Understand how supply and demand interact to determine equilibrium price and quantity


Chapter Outline

• The Law of Demand

• The Demand Schedule

• Shifts in Demand

• The Law of Supply

• The Supply Schedule

• Shifts in Supply

• Putting Demand and Supply Together


Did You Know That...

• The average price of an apartment-sized condominium has often exceeded the average price of a standalone house?

• The relative physical size of items does not determine the prices at which people exchange them for?

• By using demand and supply you can develop a better understanding of why relative size of an item typically has little to do with the price at which it sells?


Markets

• Markets

Arrangements that individuals have for exchanging with one another

Represent the interaction of buyers and sellers for goods and services

Markets set the prices we pay and receive. Automobile market Health care market Labor market Stock market


The Law of Demand

• Demand

A schedule showing how much of a good or service people will purchase at any price during a specified time period, other things being constant


The Law of Demand

• Law of Demand

Quantity demanded is inversely related to price, holding other factors constant.

Price Qd

Price Qd


The Law of Demand (cont'd)

• What are we holding constant?

Income

Tastes and preferences

Price of other goods

Many other factors


Relative Prices versus Money Prices

• Relative prices and money prices

Relative PriceThe price of a commodity in terms of

another commodity

Money PricePrice we observe today in today’s dollars

(absolute, or nominal price)


Table 3-1 Money Price versus Relative Price


The Demand Schedule

• The demand schedule Table relating prices to quantity demanded

We must consider Time dimension Constant-quality units

• Demand Curve A graphical representation of the demand schedule

Negatively sloped line showing inverse relationship between price and quantity demanded, all else equal


Figure 3-1 The Individual Demand Schedule and the Individual Demand Curve, Panel (a)


Figure 3-1 The Individual Demand Schedule and the Individual Demand Curve, Panel (b)


E-Commerce Example: Why RFID Tags Are Catching On Fast

• An RFID tag contains a tiny microchip and a radio antenna that emits a signal for tracking items.

• The price of an RFID tag has gone from 30 cents down to 15 cents, and is expected to go even lower, closer to 5 cents.

• Why do you think the European Central Bank is contemplating putting RFID tags in smaller denomination euro notes?


The Demand Schedule

• Individual versus market demand curves

• Market Demand The demand of all consumers in the

marketplace for a particular good or service

Summation at each price of the quantity demanded by each individual


Figure 3-2 The Horizontal Summation of Two Demand Curves, Panel (a)


Figure 3-2 The Horizontal Summation of Two Demand Curves, Panels (b), (c), (d)


Figure 3-3 The Market Demand Schedule for Flash Memory Pen Drives, Panel (a)


Figure 3-3 The Market Demand Schedule for Flash Memory Pen Drives, Panel (b)


Shifts in Demand

• Scenario

Imagine the federal government gives every student registered in a college, university, or technical school in the United States a notebook computer.

If some factor other than price changes, we can show its effect by moving the entire demand curve, shifting the curve left or right.


Figure 3-4 A Shift in the Demand Curve

Suppose the federal government gives every student a notebook computer

Suppose universities prohibit the use of notebook computers


Determinants of Demand

• Ceteris-Paribus Conditions

Determinants of the relationship between price and quantity that are unchanged along a curve

Changes in these factors cause a curve to shift


Normal and Inferior Goods

• Normal Goods Goods for which demand rises as income

rises, most goods are normal goods

• Inferior Goods Goods for which demand falls as

income rises


Shifts in Demand

• Determinants of demand

Income

Tastes and preferences

The prices of related goodsSubstitutes

Complements


Shifts in Demand (cont'd)

• Substitutes

Two goods are substitutes when a change in the price of one causes a shift in demand for the other in the same direction as the price change.


Example: Kids Give Barbie Dolls and Legos the Boot

• Barbie dolls and Lego building blocks were among the most popular toys for many years.

• Since the early 2000s, annual purchases of such toys have fallen by as much as 25%.

• At the same time, prices of substitute forms of entertainment, such as video games and computer software, have declined.

• In what direction do you think the demand curve for toys has shifted as the prices of substitute forms of entertainment have declined?



• Complements

Two goods are complements when a change in the price of one causes an opposite shift in the demand curve for the other.



• Determinants of demand

ExpectationsFuture prices

Income

Product availability

Market size (number of buyers)



The Determinants of DemandIncome: Normal Good

D1

Q/Units

D2D3

Price

Decrease in incomedecreases demand

Increase in incomeincreases demand



The Determinants of DemandIncome: Inferior Good

D1

Q/Units

Decrease in incomeincreases demand

Increase in incomedecreases demand

Price

D2D3



The Determinants of DemandTastes and Preferences

D1

Q/Units

Price

Hybrid vehicles• Increase in demand

D2

SUVs• Decrease in demand

D3



The Determinants of DemandPrice of Related Goods: Substitutes

D1

Q/Butter

Butter and Margarine• Price of both = $2/lb• Price of margarine

increases to $3/lb• Demand for butter

increases

D2

Price



The Determinants of DemandPrice of Related Goods: Complements

D1

Q/Speakers

Speakers and Amplifiers• Decrease the relative

price of amplifiers• Demand for speakers

increases

D2D3

Speakers and Amplifiers• Increase the relative

price of amplifiers• Demand for speakers

decreases

Price



The Determinants of DemandExpectations: Income, Future Prices

D1

Q/Units

A higher income or expectations of a higher future price will increase demand

D2D3

A lower income or expectations of a lower future price will decrease demand

Price


The Determinants of DemandMarket Size (Number of Buyers)

D1

Q/Units

Increase in the number of buyers increases demand

D2D3

Decrease in the number of buyers decreases demand

Price




• Changes in demand versus changes in quantity demanded

A change in one or more of the non-price determinants (income, tastes, etc.) will lead to a change in demand.

This is a shift of the whole curve.



• Changes in demand versus changes in quantity demanded

A change in a good’s own price leads to a change in quantity demanded.

This is a movement along the same curve. ∆D is not the same as ∆Qd.


Figure 3-5 Movement Along a Given Demand Curve

A change in the price changes the quantity of a good demanded, movement along the curve


The Law of Supply

• Supply

Schedule showing relationship between price and quantity supplied for a specified time period, other things being equal

The amount of a product or service that firms are willing to sell at alternative prices


The Law of Supply (cont'd)

• Law of Supply

The price of a product or service and the quantity supplied are directly related.

P Qs

P Qs


The Supply Schedule

• The supply schedule is a table relating prices to quantity supplied at each price.

• Supply Curve A graphical representation of the

supply schedule

Positively sloped line showing direct relationship between price and quantity supplied, all else equal


Figure 3-6 The Individual Producer’s Supply Schedule and Supply Curve for Flash Memory Pen Drives, Panel (a)


Figure 3-6 The Individual Producer’s Supply Schedule and Supply Curve for Flash Memory Pen Drives, Panel (b)


Figure 3-7 Horizontal Summation of Supply Curves, Panel (a)


Figure 3-7 Horizontal Summation of Supply Curves, Panels (b), (c), (d)


Figure 3-8 The Market Supply Schedule and the Market Supply Curve for Flash Memory Pen Drives, Panel (a)


Figure 3-8 The Market Supply Schedule and the Market Supply Curve for Flash Memory Pen Drives, Panel (b)


Shifts in Supply

• Scenario

A new method of manufacturing flash memory pen drives reduces the cost of production dramatically.


Figure 3-9 A Shift in the Supply Curve

If some other factor than price changes, the only way we can show its effect is by moving the entire supply curve

If costs decrease, supply increases

If costs increase, supply decreases


Figure 3-9 A Shift in the Supply Curve (cont'd)

S1

Quantity of Flash Memory Pen Drives Supplied (millions of constant-quality units per year)

Pric

e pe

r F

lash

Mem

ory

Pen

Driv

e ($

)

2 4 6 80

1

2

3

4

5

10 12 14

S2

a

cWhen supply increases the quantity supplied will be greater at each price



S1

Quantity of Flash Memory Pen Drives Supplied(millions of constant-quality units per year)

2 4 6 80

1

2

3

4

5

10 12 14

a

b

d

c

S2

When supply increases the quantity supplied will be greater at each price

Pric

e pe

r F

lash

Mem

ory

Pen

Driv

e ($

)



Quantity of Flash Memory Pen Drives Supplied(millions of constant-quality units per year)

2 4 6 80

1

2

3

4

5

10 12 14

S1

a

c

S3

b

dWhen supply decreases the quantity supplied will be less at each price

Pric

e pe

r F

lash

Mem

ory

Pen

Driv

e ($

)


Shifts in Supply (cont'd)

• Determinants of supply

Cost of inputs

Technology and productivity

Taxes and subsidies

Price expectations

Number of firms in industry



The Determinants of SupplyCost of Inputs

S1

Q/Units

Decrease in cost increases supply

S2Increase in costdecreases supply

S3

Price



The Determinants of SupplyTechnology and Productivity

S1

Q/Units

Improvements in technology or increases in productivity increase supply

S2

Decreases in productivity decrease supply

S3

Price



The Determinants of SupplyTaxes and Subsidies

S1

Q/Units

Decreases in taxes or increases in subsidies increase supply

S2

Increases in taxes or decreases in subsidies decrease supply

S3

Price


Policy Example: Import Restrictions Reduce the Supply of Cement

• U.S. cement manufacturers produce more than 80 million metric tons of cement per year.

• The rest of the cement supplied—15 to 20 million metric tons—is imported, much of it from Mexico.

• During the 1990s the U.S. government began imposing an import duty on Mexican cement.

• The continuation of this tariff during the 2000s caused Mexican producers to limit sales to the United States at any given price, reducing the U.S. supply of cement.



The Determinants of SupplyPrice Expectations

S1

Q/Units

Expectations of lower future prices increase supply

S2Expectations of higher future prices decrease supply

S3

Price



The Determinants of SupplyNumber of Firms in Industry

S1

Q/Units

Increase in the number of firms increases supply

S2Decrease in the number of firms decreases supply

S3

Price



• Changes in supply versus changes in quantity supplied

A change in one or more of the non-price determinants will lead to a change in supply.

This is a shift of the whole curve.



• Changes in supply versus changes in quantity supplied

A change in a good’s own price leads to a change in quantity supplied.

This is a movement along the same curve. ∆S is not the same as ∆Qs.


Putting Demand and Supply Together

• Putting demand and supply together

• Equilibrium (Market Clearing) Price The price that clears the market

The price at which quantity demanded equals quantity supplied

The price where the demand curve intersects the supply curve


Figure 3-10 Putting Demand and Supply Together, Panel (a)


Figure 3-10 Putting Demand and Supply Together, Panel (b)


Putting Demandand Supply Together (cont'd)

• Equilibrium

The situation when quantity supplied equals quantity demanded at a particular price



• Shortages

The situation when quantity demanded is greater than quantity supplied Qd > Qs

Exist at any price below the market clearing price



• Surpluses

The situation when quantity supplied is greater than quantity demandedQd < Qs

Exist at any price above the market clearing price


Policy Example: Should Shortages in the Ticket Market Be Solved by Scalpers?

• If you’ve ever tried to get tickets to the big game you know all about “shortages.”

• Since the quantity of tickets is fixed, the price can go pretty high.

• Enter the scalper.


Figure 3-11 Shortages of Super Bowl Tickets


Issues and Applications: The Market Clearing Prices of Baseball Cards

• Various companies, such as Topps and Upper Deck, print sports trading cards that provide photos and stats on pro athletes.

• Why are some of the market clearing prices so high?

• The answer has to do with demand and supply. (A relatively low supply helps explain the relatively high market clearing price.)

• You can buy a “Shoeless” Joe Jackson card for up to $9,000!


Table 3-2 Baseball Cards with the Highest Market Clearing Prices


Summary Discussion of Learning Objectives

• The law of demand says that prices and quantity demanded are inversely related. At a higher price people buy less, at a

lower price people buy more.

• Relative prices must be distinguished from money prices, since people respond to changes in relative prices.


Summary Discussionof Learning Objectives (cont'd)

• A change in quantity demanded versus a change in demand

A change in quantity demanded is a movement along the same demand curve.

A change in demand is a shift of the whole demand curve.


Summary Discussion of Learning Objectives (cont'd)

• The law of supply states that price and quantity supplied are directly related. At a high price firms offer more; at a low price

firms offer less.

• A change in quantity supplied versus a change in supply A change in quantity supplied is a movement

along the same supply curve. A change in supply is a shift of the whole

supply curve.


Summary Discussion of Learning Objectives (cont'd)

• Determining market price and equilibrium quantity

The demand and supply curves intersect at the market clearing, or equilibrium point.

Surpluses exist if the price of the good is greater than the market price.

Shortages exist when the price of a good is below the market price.

End of Chapter 3

Demand and Supply

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Chapter 3 Demand and Supply. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-2...

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