Chapter 3 - Demand and Supply1 Learning Objectives Explain the law of demand Distinguish between...

Chapter 3 - Demand and Supply 1

Learning Objectives Explain the law of demand Distinguish between changes in demand and

changes in quantity demanded

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


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

What are we holding constant?

– Income

– Tastes and preferences

– Price of other goods

– Many other factors


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


The Individual Demand Schedule and the Individual Demand Curve


The Individual Demand Schedule and the Individual Demand Curve


The Demand ScheduleIndividual 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


The Horizontal Summation of Two Demand Curves


The Horizontal Summation of Two Demand Curves


The Market Demand Schedule for Flash Memory Pen Drives


The Market Demand Schedule for Flash Memory Pen Drives


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.


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 goods

• Substitutes

• Complements


Shifts in Demand

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.


Shifts in Demand

Complements

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


Shifts in Demand

Determinants of demand

– Expectations

• Future prices

• Income

• Product availability

– Market size (number of buyers)


Shifts in DemandThe Determinants of Demand

Income: Normal Good

D1

Q/Units

D2D3

Price

Decrease in incomedecreases demand

Increase in incomeincreases demand



Income: Inferior Good

D1

Q/Units

Decrease in incomeincreases demand

Increase in incomedecreases demand

Price

D2D3



Tastes and Preferences

D1

Q/Units

Price

Hybrid vehicles• Increase in demand

D2

SUVs• Decrease in demand

D3



Price 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



Price 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



Expectations: 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

Shifts in Demand


Shifts in Demand

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.


Shifts in Demand

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.


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

Law of Supply

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

• P Qs

• P Qs


The Supply ScheduleThe 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


The Individual Producer’s Supply Schedule and Supply Curve for Flash

Memory Pen Drives


The Individual Producer’s Supply Schedule and Supply Curve for Flash

Memory Pen Drives


Horizontal Summation of Supply Curves


Horizontal Summation of Supply Curves


The Market Supply Schedule and the Market Supply Curve for Flash Memory

Pen Drives


The Market Supply Schedule and the Market Supply Curve for Flash Memory

Pen Drives


Shifts in Supply

Scenario

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


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



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

Determinants of supply

– Cost of inputs

– Technology and productivity

– Taxes and subsidies

– Price expectations

– Number of firms in industry


Shifts in SupplyThe Determinants of Supply

Cost of Inputs

S1

Q/Units

Decrease in cost increases supply

S2Increase in costdecreases supply

S3

Price


Shifts in SupplyThe 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



Taxes 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



Price Expectations

S1

Q/Units

Expectations of lower future prices increase supply

S2Expectations of higher future prices decrease supply

S3

Price


Shifts in SupplyThe 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


Shifts in Supply

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.


Shifts in Supply

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






Putting Demandand Supply Together

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 demanded

• Qd < 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 a big

game you know all about “shortages.”

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

Enter the scalper.


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.)


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.


Summary Discussionof Learning Objectives

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.



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.



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.

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Chapter 3 - Demand and Supply1 Learning Objectives Explain the law of demand Distinguish between...

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