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TM 4-2Copyright © 1998 Addison Wesley Longman, Inc.
Learning Objectives
• Distinguish between a money price and a relative price
• Explain the main influences on demand
• Explain the main influences on supply
• Explain how prices and quantities bought and sold are determined by demand and supply
TM 4-3Copyright © 1998 Addison Wesley Longman, Inc.
Learning Objectives (cont.)
• Explain why some prices fall, some rise, and some fluctuate
• Use demand and supply to make predictions about price changes
TM 4-4Copyright © 1998 Addison Wesley Longman, Inc.
Learning Objectives
• Distinguish between a money price and a relative price
• Explain the main influences on demand
• Explain the main influences on supply
• Explain how prices and quantities bought and sold are determined by demand and supply
TM 4-5Copyright © 1998 Addison Wesley Longman, Inc.
Price and Opportunity Cost
Price is the number of monetary units (euros, dollars, leva, yens, etc.) that must be given up in exchange for an item — this is referred to as the money price.
The ratio of one price to another is referred to as the relative price.
Relative prices are opportunity costs.
TM 4-6Copyright © 1998 Addison Wesley Longman, Inc.
Price and Opportunity Cost
• Relative Prices
• price index
• Supply and demand determines relative prices.
• “Price falling” means the price falls relative to the average price of other goods and services.
TM 4-8Copyright © 1998 Addison Wesley Longman, Inc.
Learning Objectives
• Distinguish between a money price and a relative price
• Explain the main influences on demand
• Explain the main influences on supply
• Explain how prices and quantities bought and sold are determined by demand and supply
TM 4-9Copyright © 1998 Addison Wesley Longman, Inc.
Demand
If a person demands something, they:
• Want it.
• Can afford it.
• Have made a definite plan to buy it.
Wants are the unlimited desires or wishes that people have for goods and services.
TM 4-10Copyright © 1998 Addison Wesley Longman, Inc.
Demand
The quantity demanded of a good or service is the amount that consumers plan to buy during a given time period at a particular price.
TM 4-11Copyright © 1998 Addison Wesley Longman, Inc.
Demand
What determines buying plans?
• The price of the good
• The prices of related goods
• Expected future prices
• Income
• Population
• Preferences
TM 4-12Copyright © 1998 Addison Wesley Longman, Inc.
Demand
The Law of Demand
Other things remaining the same, the higher the price of a good, the smaller is the quantity demanded.
Reasons for the Law of Demand
• Substitution Effect
• Income Effect
TM 4-13Copyright © 1998 Addison Wesley Longman, Inc.
Demand
Demand Curve and Demand Schedule
Demand curves show the relationship between the quantity demanded of a good and its price (ceteris paribus).
Demand schedules list the quantities demanded at each different price (ceteris paribus).
TM 4-14Copyright © 1998 Addison Wesley Longman, Inc.
Demand
a 1 9
b 2 6
c 3 4
d 4 3
e 5 2
Price Quantity(dollars per CD) (millions of CD’s per week)
TM 4-15Copyright © 1998 Addison Wesley Longman, Inc.
Demand
0 2 4 6 8 10
1
2
3
4
5
6
e
d
c
b
a
Quantity (millions of CD’s per week)
Pri
ce (
dolla
r pe
r C
D)
Demand for CDs
TM 4-16Copyright © 1998 Addison Wesley Longman, Inc.
Demand
A Change in Demand
When any factor that influences buying plans other than the price of the good changes, there is a change in demand.
• An increase in demand causes the demand curve to shift rightward.
• A decrease in demand causes the demand curve to shift leftward.
TM 4-17Copyright © 1998 Addison Wesley Longman, Inc.
A Change in Demand
Price of Related Goods
• Substitutes - goods used in the place of another good
• Complements - goods used in conjunction with another good
What Happens to Demand if the price of a substitute good increases? A complement?
TM 4-18Copyright © 1998 Addison Wesley Longman, Inc.
A Change in Demand
Expected Future Prices
• If the price of a good is expected to rise in the future, people buy more of the good now.
• If the price of a good is expected to fall in the future, people buy less of the good now.
TM 4-19Copyright © 1998 Addison Wesley Longman, Inc.
A Change in Demand
Income
• Normal Goods — demand increases as income increases
• Inferior Goods (lower quality) — demand decreases as income increases
TM 4-20Copyright © 1998 Addison Wesley Longman, Inc.
A Change in Demand
Population
• Size and age structure
Preferences
• Attitudes toward goods and services
TM 4-21Copyright © 1998 Addison Wesley Longman, Inc.
Original demand schedule New demand schedule
Walkman $200 Walkman $50
Price Quantity Quantity(dollarsper CD)
(millions of CD’s per week)
a 1 9
Price(dollarsper CD)
(millions of CDsper week)
b 2 6
c 3 4
d 4 3
e 5 2
Assume the original price of Walkmans is $200. The demand schedule showsthe Price-Quantity relationship for CDs.
TM 4-22Copyright © 1998 Addison Wesley Longman, Inc.
Original demand schedule New demand schedule
Walkman $200 Walkman $50
Price Quantity Quantity(dollarsper CD)
(millions of CDsper week)
a 1 9
Price(dollarsper CD)
(millions of CDsper week)
b 2 6
c 3 4
d 4 3
e 5 2
a' 1 13
b' 2
c' 3
d' 4
e' 5
10
8
7
6
TM 4-23Copyright © 1998 Addison Wesley Longman, Inc.
Demand
0 2 4 6 8 10 12 14
1
2
3
4
5
6
Quantity (millions of CDs per week)
Pri
ce (
dolla
r pe
r C
D) e
d
c
b
aDemand for CDs(Walkman $200)
e'
d'
c'
b'
a'
Demand for CDs(Walkman $50)
TM 4-24Copyright © 1998 Addison Wesley Longman, Inc.
The Demand for Tapes
The Law of Demand
The quantity of CDs demanded
Decreases if:
The price of a CD rises.
Increases if:
The price of a CD falls.
TM 4-25Copyright © 1998 Addison Wesley Longman, Inc.
The Demand for CDs
Changes In Demand
The demand for CDs
Decreases if:
• The price of a substitute falls.
• The price of a complement rises.
• Income falls (a CD is a normal good).
• The population decreases.
• The price of a CD is expected to fall in the future.
TM 4-26Copyright © 1998 Addison Wesley Longman, Inc.
The Demand for CDsChanges In Demand
The demand for CDsIncreases if:
• The price of a substitute rises.
• The price of a complement falls.
• Income rises (a CD is a normal good).
• The population increases.
• The price of a CD is expected to rise in the future.
TM 4-27Copyright © 1998 Addison Wesley Longman, Inc.
A Change in the Quantity Demanded Versus a Change in Demand
A movement along a demand curve, which results from a change in price, shows a change in the quantity demanded.
If some other influence on buyers’ plans changes, holding price constant, there is a change in demand.
TM 4-28Copyright © 1998 Addison Wesley Longman, Inc.
A Change in the Quantity Demanded Versus a Change in Demand
Quantity
Pri
ce
D1
D2
Decrease inquantitydemanded
Increase inquantitydemanded
D0
Increase in
demand
Decrease in demand
TM 4-29Copyright © 1998 Addison Wesley Longman, Inc.
Learning Objectives
• Distinguish between a money price and a relative price
• Explain the main influences on demand
• Explain the main influences on supply
• Explain how prices and quantities bought and sold are determined by demand and supply
TM 4-30Copyright © 1998 Addison Wesley Longman, Inc.
Supply
If a firm supplies a good or service, the firm
• Has the resources and technology to produce it.
• Can profit from producing it.
• Has made a definite plan to produce it and sell it.
TM 4-31Copyright © 1998 Addison Wesley Longman, Inc.
Supply
The quantity supplied of a good or service is the amount that producers plan to sell during a given time period at a particular price.
TM 4-32Copyright © 1998 Addison Wesley Longman, Inc.
Supply
What determines selling plans?
• The price of the good.
• The prices of resources used to produce the good.
• The prices of related goods produced.
• Expected future prices.
• The number of suppliers.
• Technology.
TM 4-33Copyright © 1998 Addison Wesley Longman, Inc.
Supply
The Law of Supply
Other things remaining the same, the higher the price of a good, the greater is the quantity supplied.
TM 4-34Copyright © 1998 Addison Wesley Longman, Inc.
Supply
Supply Curve and Supply Schedule
Supply curves show the relationship between the quantity supplied of a good and its price (ceteris paribus).
Supply schedules list the quantities supplied at each different price (ceteris paribus).
TM 4-35Copyright © 1998 Addison Wesley Longman, Inc.
Supply
a 1 0
b 2 3
c 3 4
d 4 5
e 5 6
Price Quantity (dollars per CD) (millions of CDs per week)
TM 4-36Copyright © 1998 Addison Wesley Longman, Inc.
Supply
0 2 4 6 8 10
1
2
3
4
5
6
Quantity (millions of CDs per week)
Pri
ce (
dolla
r pe
r C
D)
Supply of CDs
a
b
c
d
e
TM 4-37Copyright © 1998 Addison Wesley Longman, Inc.
Supply
A Change in Supply
When any factor that influences selling plans other than the price of the good changes, there is a change in supply.
• An increase in supply causes the supply to shift rightward.
• A decrease in supply causes the supply curve to shift leftward.
TM 4-38Copyright © 1998 Addison Wesley Longman, Inc.
A Change in Supply
• Price of Productive Resources
• Price of Related Goods Produced
• Substitutes in Production
• Complements in Production
• Expected Future Prices
TM 4-39Copyright © 1998 Addison Wesley Longman, Inc.
A Change in Supply
• The Number of Suppliers
• Technology
TM 4-40Copyright © 1998 Addison Wesley Longman, Inc.
Supply
Original supply schedule New supply schedule
Old technology New technology
Price Quantity Quantity(dollarsper CD)
(millions of CDsper week)
a 1 0
Price(dollarsper CD)
(millions of CDsper week)
b 2 3
c 3 4
d 4 5
e 5 6
a' 1 3
b' 2
c' 3
d' 4
e' 5
6
8
10
12
TM 4-41Copyright © 1998 Addison Wesley Longman, Inc.
Supply
Quantity (millions of CDs per week)
Pri
ce (
dolla
r pe
r C
D)
0 2 4 6 8 10 12 14
1
2
3
4
5
6
a
e
d
c
bSupply of CDs(new technology)
a'
b'
c'
d'
e'
Supply of CDs(old technology)
TM 4-42Copyright © 1998 Addison Wesley Longman, Inc.
The Supply of Tapes
The Law of Supply
The quantity of CDs supplied
Decreases if:
The price of a CD falls.
Increases if:
The price of a CD rises.
TM 4-43Copyright © 1998 Addison Wesley Longman, Inc.
The Supply of Tapes
Changes In Supply
The supply of CDs
Decreases if:
• The price of a resource used to produce CDs rises.
• The number of CD producers decreases.
• The price of a substitute in production rises.
TM 4-44Copyright © 1998 Addison Wesley Longman, Inc.
The Supply of CDs
Changes In Supply
The supply of CDs (cont.)
Decreases if:
• The price of a complement in production falls.
• The price of a CD is expected to rise in the future.
TM 4-45Copyright © 1998 Addison Wesley Longman, Inc.
The Supply of CDS
Changes In Supply
The supply of CDs
Increases if:
• The price of a resource used to produce CDs falls.
• More efficient technologies for producing CDs are discovered.
• The number of CD producers increases.
TM 4-46Copyright © 1998 Addison Wesley Longman, Inc.
The Supply of CDs
Changes In Supply
The supply of CDs (cont.)
Increases if:
• The price of a substitute in production falls.
• The price of a complement in production rises.
• The price of a CD is expected to fall in the future.
TM 4-47Copyright © 1998 Addison Wesley Longman, Inc.
A Change in the Quantity Supplied Versus a Change in Supply
A movement along a supply curve, which results from a change in price, shows a change in the quantity supplied.
If some other influence on sellers’ plans changes, holding price constant, there is a change in supply.
TM 4-48Copyright © 1998 Addison Wesley Longman, Inc.
A Change in the Quantity Supplied Versus a Change in Supply
Quantity
Pri
ce S0S0 S1S2
Increase in
supply supply
Decrease in
Increase inquantitysupplied
Decrease inquantitysupplied
TM 4-49Copyright © 1998 Addison Wesley Longman, Inc.
Learning Objectives
• Distinguish between a money price and a relative price
• Explain the main influences on demand
• Explain the main influences on supply
• Explain how prices and quantities bought and sold are determined by demand and supply
TM 4-50Copyright © 1998 Addison Wesley Longman, Inc.
Market Equilibrium
Equilibrium in a market occurs when the price balances the plans of buyers and sellers.
Equilibrium price is the price at which quantity demanded equals quantity supplied.
Equilibrium quantity is the quantity bought and sold at the equilibrium price.
TM 4-51Copyright © 1998 Addison Wesley Longman, Inc.
Market Equilibrium
Price as a Regulator
• If the price is too low, quantity demanded exceeds quantity supplied.
• If the price is too high, quantity supplied exceeds quantity demanded.
TM 4-52Copyright © 1998 Addison Wesley Longman, Inc.
Market Equilibrium
Quantity Quantity Shortage(–)Price demanded supplied or surplus(+)(dollars
per CD) (millions of CDS per week)
1 9 0
2 6 3
3 4 4
4 3 5
5 2 6
TM 4-53Copyright © 1998 Addison Wesley Longman, Inc.
Market Equilibrium
Quantity Quantity Shortage(–)Price demanded supplied or surplus(+)(dollars
per CD) (millions of CDs per week)
1 9 0 -9
2 6 3 -3
3 4 4 0
4 3 5 +2
5 2 6 +4
TM 4-54Copyright © 1998 Addison Wesley Longman, Inc.
Market Equilibrium
0 2 4 6 8 10
1
2
3
4
5
6
Quantity (millions of CDs per week)
Pri
ce (
dolla
r pe
r C
D)
Supply of CDs
Demand for CDs
Equilibrium
Shortage of 3 million CDs at $2 a CD
Surplus of2 million CDsat $4 a CD
TM 4-55Copyright © 1998 Addison Wesley Longman, Inc.
Market Equilibrium
Price Adjustments
• A shortage forces the price up.
• A surplus forces the price down.
Such price changes are mutually beneficial to both buyers and sellers.
TM 4-56Copyright © 1998 Addison Wesley Longman, Inc.
Learning Objectives (cont.)
• Explain why some prices fall, some rise, and some fluctuate
• Use demand and supply to make predictions about price changes
TM 4-57Copyright © 1998 Addison Wesley Longman, Inc.
Predicting Changes in Price and Quantity
A Change in Demand
What would happen to the price and quantity of CDs if the price of a Walkman falls from $200 to $50?
TM 4-58Copyright © 1998 Addison Wesley Longman, Inc.
The Effects of a Change in Demand
Quantity demanded Price (millions of CDs per week)(dollars Quantity suppliedper CD ) Walkman $200 Walkman $50 (millions of CDs per week)
1 9 0
2 6 3
3 4 4
4 3 5
5 2 6
TM 4-59Copyright © 1998 Addison Wesley Longman, Inc.
Quantity demanded Price (millions of CDs per week)(dollars Quantity suppliedper CD ) Walkman $200 Walkman $50 (millions of CDs per week)
1 9 13 0
2 6 10 3
3 4 8 4
4 3 7 5
5 2 6 6
The Effects of a Change in Demand
TM 4-60Copyright © 1998 Addison Wesley Longman, Inc.
The Effects of a Change in Demand
Quantity (millions of CDs per week)
0 2 4 6 8 10 12 14
1
2
3
4
5
6P
rice
(do
llar
per
CD
) Supply of CDs
Demand for tapes(Walkman $50)
Demand for tapes(Walkman $200)
TM 4-61Copyright © 1998 Addison Wesley Longman, Inc.
A Change in Demand
Prediction
• When demand increases, both the price and quantity increase.
• When demand decreases, both the price and quantity decrease.
TM 4-62Copyright © 1998 Addison Wesley Longman, Inc.
Predicting Changes in Price and Quantity
A Change in Supply
What would happen to the price and quantity of CDs if a new cost-saving production technology was developed?
TM 4-63Copyright © 1998 Addison Wesley Longman, Inc.
The Effects of a Change in Supply
Quantity supplied Price (millions of CDs per week)
(dollars Quantity demanded old newper CD ) (millions of CDs per week) technology technology
1 9 0
2 6 3
3 4 4
4 3 5
5 2 6
TM 4-64Copyright © 1998 Addison Wesley Longman, Inc.
The Effects of a Change in Supply
Quantity supplied Price (millions of CDs per week)
(dollars Quantity demanded old newper CD ) (millions of CDs per week) technology technology
1 9 0 3
2 6 3 6
3 4 4 8
4 3 5 10
5 2 6 12
TM 4-65Copyright © 1998 Addison Wesley Longman, Inc.
The Effects of a Change in Supply
Quantity (millions of CDs per week)0 2 4 6 8 10 12 14
1
2
3
4
5
6P
rice
(do
llar
per
CD
) Supply of CDs(old technology)
Demand for CDs
Supply of CDs(new technology)
TM 4-66Copyright © 1998 Addison Wesley Longman, Inc.
A Change in Supply
Prediction
• When supply increases, the quantity increases and the price falls.
• When demand decreases, the quantity decreases and the price falls
TM 4-67Copyright © 1998 Addison Wesley Longman, Inc.
Predicting Changes in Price and Quantity
A Change in Both Demand and Supply
What would happen if both demand and supply change together?
TM 4-68Copyright © 1998 Addison Wesley Longman, Inc.
Original Quantities New Quantities (millions of CDs per week) (millions of CDs per week)
Price Quantity Quantity Quantity Quantity (dollars demanded supplied demanded suppliedper CD ) Walkman old Walkman new
$200 technology $50 technology
1 9 0
2 6 3
3 4 4
4 3 5
5 2 6
The Effects of an Increase in Both Demand and Supply
TM 4-69Copyright © 1998 Addison Wesley Longman, Inc.
The Effects of an Increase in Both Demand and Supply
Original Quantities New Quantities (millions of CDs per week) (millions of CDs per week)
Price Quantity Quantity Quantity Quantity (dollars demanded supplied demanded suppliedper tape ) Walkman old Walkman new
$200 technology $50 technology
1 9 0 13 3
2 6 3 10 6
3 4 4 8 8
4 3 5 7 10
5 2 6 6 12
TM 4-70Copyright © 1998 Addison Wesley Longman, Inc.
Demand for CDs(Walkman $50)
The Effects of an Increase in Both Demand and Supply
Quantity (millions of CDs per week)0 2 4 6 8 10 12 14
1
2
3
4
5
6
Pri
ce (
dolla
r pe
r C
D)
Supply of CDs(new technology)
Demand for CDs(Walkman $200)
Supply of CDs(old technology)
TM 4-71Copyright © 1998 Addison Wesley Longman, Inc.
A Change in Both Demand and Supply
Prediction
• When both demand and supply increase, the quantity increases and the price decreases, or remains constant.
• When both demand and supply decreases, the quantity decreases and the price increases, decreases, or remains constant.
TM 4-72Copyright © 1998 Addison Wesley Longman, Inc.
The Effects of an Decrease in Demand and an Increase in Supply
Original Quantities New Quantities (millions of CDs per week) (millions of CDs per week)
Price Quantity Quantity Quantity Quantity (dollars demanded supplied demanded suppliedper CD) MP3 player old MP3 player new
$400 technology $200 technology
1 13 0
2 10 3
3 8 4
4 7 5
5 6 6
TM 4-73Copyright © 1998 Addison Wesley Longman, Inc.
The Effects of an Decrease in Demand and an Increase in Supply
Original Quantities New Quantities (millions of tapes per week) (millions of tapes per week)
Price Quantity Quantity Quantity Quantity (dollars demanded supplied demanded suppliedper CD ) MP3 player old MP3 player new
$400 technology $200 technology
1 13 0 9 3
2 10 3 6 6
3 8 4 4 8
4 7 5 3 10
5 6 6 2 12
TM 4-74Copyright © 1998 Addison Wesley Longman, Inc.
Demand for CDs(MP3 player $400)
The Effects of an Decrease in Demand and an Increase in Supply
Quantity (millions of CDs per week)0 2 4 6 8 10 12 14
1
2
3
4
5
6
Pri
ce (
dolla
r pe
r C
D)
Supply of CDs(new technology)
Demand for CDs(MP3 player $200)
Supply of CDs(old technology)
TM 4-75Copyright © 1998 Addison Wesley Longman, Inc.
The Effects of an Decrease in Demand and an Increase in Supply
Prediction
• When demand decreases and supply increases, the price falls and the quantity increases, decreases, or remains constant.
• When demand increases and supply decreases, the price rises and the quantity increases, decreases, or remains constant.
TM 4-76Copyright © 1998 Addison Wesley Longman, Inc.
Market EQUILIBRIUM
Supply
Quantity supplied (Qs)
Pri
ce (
p)
Demand
P*
Q*
Marketequilibrium
0
TM 4-77Copyright © 1998 Addison Wesley Longman, Inc.
7
SP
Qo
$5
4
3
2
1
2 4 6 8 10 12 14 16
D
surplus
Market SURPLUS