Chapter 4

Supply and Demand

– An Initial Look

The free enterprise system is absolutely too important to be left

to the voluntary action of the marketplace.RICHARD KELLY

The Invisible Hand

• Invisible hand– Adam Smith

– People pursue own self-interests

– “Led by an invisible hand”

– Promote wellbeing of community

2

Demand and Quantity Demanded

• Quantity demanded– Number of units

– Consumers• Willing• Can afford to buy

– Specified period of time

3

Demand and Quantity Demanded

• Quantity demanded– Depends on price

– Also depends on • Population size• Consumer incomes• Tastes• Prices of other products

4

Demand and Quantity Demanded

• Demand schedule - Table– Period of time

– Quantity demanded changes• As price changes• All other determinants – constant

• All other determinants constant– As price rises

• Quantity demanded falls

– As price falls• Quantity demanded rises 5

Demand schedule for beef

Table 1

6

Price per pound Quantity demanded Label in Figure 1

$7.50 45 A

7.40 50 B

7.30 55 C

7.20 60 E

7.10 65 F

7.00 70 G

6.90 75 H

Demand and Quantity Demanded

• Demand curve– Graphical depiction of demand schedule

– Quantity demanded – changes• Price – changes

– Period of time

– All other determinants – constant

7

Demand curve for beef

Figure 1

8

D

D6.90

7.00

7.10

7.20

7.30

Pric

e pe

r P

ound

$7.50

7.40

45 50 550 60 65

Quantity Demanded in Millions of Pounds per Year

70 75

G

A

B

C

E

F

H

Demand and Quantity Demanded

• Change in price– Movement along demand curve

• Change in other determinants– Shifts entire demand curve

– Consumers - buy more (any & all prices) • Demand curve – shifts right/outward

– Consumers – buy less (any & all prices)• Demand curve – shifts left/inward

9

Movement along versus shift of a demand curve

Figure 2

10

D0

D0

7.10

$7.30

Pric

e pe

r P

ound

0 Quantity Demanded in Millions of Pounds per Year

C

F

D1

D1

Demand and Quantity Demanded

• Consumer income - increase– Demand – increase

• Outward shift

• Population – increase– Demand – increase

• Outward shift

• Consumer preferences – in favor– Demand – increase

• Outward shift

11

Shifts of the demand curve

Figure 3

12

(a)

Pric

e

Quantity demanded

D0

D0

D1

D1

(b)

Pric

e

Quantity

D0

D0

D2

D2S

S

E

M

Demand and Quantity Demanded

• Prices & availability of related goods– Price of substitutes – increase

• Demand – increase– Shift right

– Price of complements – increase• Demand – decrease

– Shift left

13

Supply and Quantity Supplied

• Quantity supplied– Number of units

– Sellers - want to sell

– Specified period of time

• All other determinants constant– As price rises

• Quantity supplied rises

– As price falls• Quantity supplied falls

14

Supply and Quantity Supplied

• Supply schedule - Table– Period of time

– Quantity supplied changes• As price changes• All other determinants – constant

15

Supply schedule for beef

Table 2

16

Price per pound Quantity supplied Label in Figure 4

$7.50 90 a

7.40 80 b

7.30 70 c

7.20 60 e

7.10 50 f

7.00 40 g

6.90 30 h

Supply and Quantity Supplied

• Supply curve– Graphical depiction of supply schedule

– Quantity supplied – changes• Price – changes

– Period of time

– All other determinants – constant

17

Supply curve for beef

Figure 4

18

S

S

6.90

7.00

7.10

7.20

7.30

Pric

e pe

r P

ound

$7.50

7.40

30 40 500 60 70

Quantity Supplied in Millions of Pounds per Year

80 90

a

b

e

f

h

g

c

Supply and Quantity Supplied

• Change in price– Movement along supply curve

• Change in other determinants– Shifts entire supply curve

• Size of industry• Technological progress• Prices of inputs• Prices of related outputs

19

Movement along versus shift of a supply curve

Figure 5

20

S0

S0

7.10

$7.30

Pric

e pe

r P

ound

0 Quantity Supplied in Millions of Pounds per Year

c

f

S1

S1

Supply and Quantity Supplied

• Size of industry– Increase

• New firms - enter• Existing firms - expand

– Supply – increase• Outward shift

• Technological progress– Reduces costs

– Supply – increase• Outward shift 21

Shifts of the supply curve

Figure 6

22

(a)

Pric

e

Quantity

(b)

Pric

e

Quantity

D

DS0

S0

S1

S1

S0

S0

S2

S2

V

EU

Supply and Quantity Supplied

• Prices of inputs – increase– Supply – decrease

• Inward shift

• Prices of related outputs - change– Supply – shift

23

Supply and Demand Equilibrium

• Supply-demand diagram– Graph: Supply & Demand curves

– Determines• Equilibrium price• Equilibrium quantity

• Shortage– Excess quantity demanded

• Over quantity supplied

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Supply and Demand Equilibrium

• Surplus– Excess quantity supplied

• Over quantity demanded

• Equilibrium– No inherent forces that produce change

• Equilibrium change– “Outside events”

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Determination of equilibrium price & quantity of beef

Table 3

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Priceper pound

QuantityDemanded

QuantitySupplied

Surplus orShortage

PriceDirection

$7.50 45 90 Surplus Fall

7.40 50 80 Surplus Fall

7.30 55 70 Surplus Fall

7.20 60 60 Neither Unchanged

7.10 65 50 Shortage Rise

7.00 70 40 Shortage Rise

6.90 75 30 Shortage Rise

Demand curve for beef

Figure 7

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6.90

7.00

7.10

7.20

7.30

Pric

e pe

r P

ound

$7.50

7.40

30 40 500 60 70

Quantity in Millions of Pounds per Year

80 90

S

Sa

g

D

D

G

A

E

Supply and Demand Equilibrium

• Law of Supply and Demand– Free market

– Forces: supply & demand• Push the price - equilibrium level

– Quantity supplied = quantity demanded

– May be disobeyed• Long term

– Shortages– Surpluses– Prices - fail to move toward equilibrium

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Demand shifts & supply-demand equilibrium

• Demand curve - shift outward / right– Supply curve – no change

– Equilibrium price – rise

– Equilibrium quantity – rise

• Demand curve - shift inward / left– Supply curve – no change

– Equilibrium price – fall

– Equilibrium quantity – fall

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The effects of shifts of the demand curve

Figure 8

30(a)

D0

D0 S

S

Quantity

Pric

e pe

r po

und

7.20

60 70 75

D1

D1

T$7.30

(b)

D0

D0 S

S

Quantity

Pric

e pe

r po

und

$7.20

605045

E

D2

D2

M7.10

LRE

Supply shifts & supply-demand equilibrium

• Supply curve - shift outward / right– Demand curve – no change

– Equilibrium price – fall

– Equilibrium quantity – rise

• Supply curve - shift inward / left– Demand curve – no change

– Equilibrium price – rise

– Equilibrium quantity – fall

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The effects of shifts of the supply curve

Figure 9

32(a)

D

D S0

S0

Quantity

Pric

e pe

r po

und

$7.20

60 65 78

7.10

(b)

S1

S1

J

D

DS0

S0

Quantity

Pric

e pe

r po

und

7.20

605037.5

E

$7.40

S2

S2

U

V

I

E

Application: Who really pays that tax?

• New tax on product: 10 cents gasoline tax per gallon– Firms

• Decrease supply• Pay part of tax

– Consumers• Pay part of tax

• What if consumers have an inelastic demand for gasoline?

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Who pays for a new tax on products?

Figure 10

34

D

DS0

S0

Millions of gallons per year

Pric

e pe

r ga

llon

$2.64

2.60

2.54

S1

S1

50

Q1

30

Q2

E1

M

E0

The Market Fights Back

• Battling the invisible hand• Legally imposed constraints on prices

– Price ceilings• Legal maximum• Equilibrium price – above it

– Price floors• Legal minimum• Equilibrium price – below it

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Price Ceilings

• Keep price – below free-market level• Consequences

– ShortageShortage – persistent• Quantity demanded > quantity supplied

– Illegal or “black” market

– Black market prices – higher

– Portion of revenues – illicit supplier

– Investment – dries up

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Case study: Rent controls in New-York city

• Rent control– To protect consumers

– Long run - worse off

– Shortage – long waiting list, high search cost

– Poor maintenance

– Black market – bribes

– Only some benefit, and they defend the rent control

37

Supply-demand diagram for rental housing

Figure 11

38

D

D S

S

Ren

t pe

r m

onth

1,200

$2,000

32.5

Millions of dwellings rented per month

3.5

EMarket rent

Rent ceiling

C

B

Price Floors

• Keep price – above free-market level• Symptoms

– SurplusSurplus

– Problem of disposal for regulated goods

– Motivate sellers provide disguised and unwanted discounts

– Overinvestment in industry

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Case study: Farm price supports; Sugar prices

• Farm price supports– Introduced 1933 - “temporary”

– Prices – inflated

– Surplus – unsellable• Purchases by government

• Taxpayer pays– Higher prices

– Taxes

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Case study: Farm price supports; Sugar prices

• Sugar industry– Producers

• Low-interest loans

• Enforced price floor– Limit domestic production

– Limit foreign imports

– Supply curve – left shift

• Industry – benefits• Consumers – pay

41

Supporting the price of sugar

Figure 12

42

Pric

e

Quantity

D

D S0

S0

S1

S1

25¢

50¢

Summary

• Movement along the D or S curve vs. shift of the whole curve

• Supply meets demand → equilibrium• Price control is a bad idea

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