Demand and Supply

Demand and Supply

• What is a Market?– The process of freely exchanging goods and

services between buyers and sellers.• Where does the market exist?

– Local Market– National Market– International Market

Demand and Supply

• Voluntary Exchange– A transaction in which a buyer and a seller

exercise their economic freedom by working out their own terms of exchange.

Demand and Supply

• Demand– The amount of a good or service that

consumers are able and willing to buy at various prices during a specified time period.

• Quantity Demanded– The amount of a good or service that a

consumer is willing and able to purchase at a specific price.

Demand and Supply

• Law of Demand– Economic rule stating that the quantity

demanded and price move in opposite directions.

Price PriceQuantity

demandedQuantity

demanded

Demand and Supply

• Real Income Effect– Economic rule stating that individuals cannot

keep buying the same quantity of a product if its price rises while their income stays the same.

Demand and Supply

• Substitution Effect– Economic rule stating that if two items satisfy

the same need and the price of one rises, people will buy the other.

Demand and Supply

• Utility– The ability of any good or service to satisfy

consumer wants.• Marginal Utility

– An additional amount of satisfaction.

Demand and Supply

• Law of Diminishing Marginal Utility– Rule stating that the additional satisfaction a

consumer gets from purchasing one more unit of a product will lessen with each additional unit purchased.

Law of Diminishing Marginal Utility

Episodes of House Satisfaction

1234567

10975321

Law of Diminishing Marginal Utility

Double Cheeseburgersw/ ketchup and pickle only

Satisfaction

1234567

101097630

Demand and Supply

• Demand Schedule– Table showing quantities demanded at

different possible prices.• Demand Curve

– Downward sloping line that shows in graph form the quantities demanded at each possible price.

Demand Schedule

Price Quantity Demanded

$5 10

$4 20

$3 30

$2 40

$1 50

Demand Curve

5 10 15 20 25 30 35 40 45 50 550

1

2

3

4

5

6Price

Quantity

Demand and Supply

• A change in quantity demanded is caused by a change in price and is shown as movement along the demand curve.

Demand Curve

5 10 15 20 25 30 35 40 45 50 550

1

2

3

4

5

6Price

Quantity

Change in quantity demanded

Demand and Supply

• A change in demand is caused by something other than price and is shown as a shift of the entire demand curve.

Demand Shift

5 10 15 20 25 30 35 40 45 50 550

1

2

3

4

5

6Price

Quantity

A Change in demand

Determinants of Demand

• Changes in Population• Changes in Income• Changes in Tastes and Preferences• Substitutes• Complementary Goods

Demand and Supply

• Complementary Good– A product often used with another product

• Camera and Memory Cards• Peanut Butter and Jelly• Golf Balls and Golf Clubs

Demand and Supply

• Elasticity– Consumers’ responsiveness to an increase or

decrease in price of a product.• Price elasticity of demand

– Economic concept that deals with how much demand varies according to changes in price.

• We can determine price elasticity of demand with the following formula:

Price elasticity of demand = (Q2 – Q1) / [ (Q1 + Q2) / 2] (P2 – P1) / [ (P1 + P2 ) / 2]

• If the answer is less than one it is said to be inelastic, and if it is greater than one it is elastic.

Demand and Supply

• Examples:

Insulin• Q1 = 12 injections per week• Q2 = 14 injections per week• P1 = $20.00 per injection• P2 = $10.00 per injection

Orange Juice• Q1 = 1 quart per week• Q2 = 3 quarts per week• P1 = $2.50 per quart• P2 = $2.25 per quart

Demand and Supply

Demand and Supply

• Elastic Demand– Situation in which the rise or fall in a product’s

price greatly affect the amount that people are willing to buy.

Elastic Demand

Demand and Supply

• Inelastic Demand– Situation in which a product’s price change

has little impact on the quantity demanded by consumers.

• Create a demand schedule and demand curve for the following data.

• The demand for corn:– Price range per bushel is $1 - $5– Quantity demanded per bushel is 10, 20, 35,

55, 80

6

5

4

3

2

1

0 10 20 30 40 50 60 70 80 Quantity Demanded (bushels per week)

Pri

ce (

per

bu

shel

)

P Qd

$5

4

3

2

1

10

20

35

55

80

Individual Demand

P

Q

D

The Demand Curve

LO1

The Demand Curve

3-29

• Demand is a consumer based analogy of how market interactions take place.

• Supply, on the other hand, is a producer based analogy of market interacitons.

Demand and Supply

• Supply– The amount of a good or service that

producers are able and willing to sell at various prices during a specified time period.

• Quantity Supplied– The amount of a good or service that a

producer is willing and able to supply at a specific price.

Demand and Supply

• Law of Supply– Economic rule stating that price and quantity

supplied move in the same direction.

Price PriceQuantity supplied

Quantity supplied

Demand and Supply

• Supply Schedule– Table showing quantities supplied at different

possible prices.• Supply Curve

– Upward-sloping line that shows in graph form the quantities supplied at each possible price.

Supply Schedule

Price Quantity Supplied

$1 10

$2 20

$3 30

$4 40

$5 50

Price

Quantity

Supply Curve

5 10 15 20 25 30 35 40 45 50 550

1

2

3

4

5

6

Demand and Supply

• A change in quantity supplied is caused by a change in price and is shown as movement along the supply curve.

Price

Quantity

Supply Curve

5 10 15 20 25 30 35 40 45 50 550

1

2

3

4

5

6

A change in quantity supplied

Demand and Supply

• A change in supply is caused by something other than price and is shown as a shift of the entire supply curve.

Price

Quantity

Supply Curve

5 10 15 20 25 30 35 40 45 50 550

1

2

3

4

5

6

Determinants of Supply

• Price of Inputs• Number of Firms in the Industry• Taxes• Technology

Law of Diminishing Returns

• Economic rule that says as more units of a factor of production are added to other factors of production, after some point total output continues to increase but at a diminishing rate.

Workers Total output

1 2

2 5

3 9

4 14

5 20

6 25

7 29

8 33

9 36

10 38

11 40

• Change in Output• 3• 4• 5• 6• 5• 4• 4• 3• 2• 2

Demand and Supply

• In the real world, demand and supply operate together. As the price of a good goes down, the quantity demanded rises and the quantity supplied falls. As the price goes up, the quantity demanded falls and the quantity supplied rises.

Demand and Supply

• Equilibrium price– The price at which the amount producers are

willing to supply is equal to the amount consumers are willing to buy.

Quantity Demanded Price Quantity Supplied

10 $5 5020 $4 4030 $3 3040 $2 2050 $1 10

5 10 15 20 25 30 35 40 45 50 550

1

2

3

4

5

6Price

Quantity

5 10 15 20 25 30 35 40 45 50 550

1

2

3

4

5

6Price

Quantity

Demand and Supply

• Shortage– Situation in which the quantity demanded is

greater than the quantity supplied at the current price.

• Surplus– Situation in which the quantity supplied is

greater than the quantity demanded at the current price.

5 10 15 20 25 30 35 40 45 50 550

1

2

3

4

5

6Price

Quantity

Surplus

Shortage

Demand and Supply

• Price ceiling– A legal maximum price that may be charged

for a particular good or service.

Government Set Prices

LO5

SP

Q

D

P0

PC

Q0

Shortage

QdQs

ceiling$1,200

800

3-51

Demand and Supply

• Price floor– A legal minimum price below which a good or

service may not be sold.

Government Set Prices

LO5

S

P

Q

D

P0

Pf

Q0

Surplus

QsQd

floor

5.00

$7.25

3-53

Demand and Supply

• Rationing– The distribution of goods and services based

on something other than price.• Black market

– “underground” or illegal market in which goods are traded at prices above their legal maximum prices or in which illegal goods are sold.