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Chapter 3

Demand and Supply

Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-2

Introduction

Over the past 30 years, college tuition and fees have increased significantly. Annual tuition that would have been about $2,000 in the 1980s is now at a level of around $20,000.

Textbook prices have experienced a sizable increase as well. Students now typically pay $1,000 a year for books, compared to an annual expense of about $200 in the 1980s.

In this chapter you will learn what has caused these prices to rise.


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

• 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 ...

• After truck freight-hauling prices jumped in the early 2010s, rail shipments of freight containers rose by more than 10 percent?

• Higher truck-transportation prices induced many companies to choose rail transportation as a substitute.

• By using demand and supply, you can develop a better understanding of why sometimes we observe large increases in the purchase of items such as rail freight services.


Did You Know That … (cont’d)

• Market

– All of the arrangements that individuals have for exchanging with one another

– Examples of markets:• Automobile market• Health-care market• Market for high-speed internet access

– One of the most important activities in these markets in the determination of prices.


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


Demand (cont’d)

• Law of Demand– A negative, or inverse, relationship between the

price of any good or service and the quantity demanded, holding other factors constant (ceteris paribus)

• When the price of a good goes up, people buy less of it, other things being equal.

• When the price of a good goes down, people buy more of it, other things being equal.


Demand (cont’d)

• What are we holding constant?

– Income

– Tastes and preferences

– Price of other goods

– Many other factors


Demand (cont’d)

• Relative prices and money prices

– Relative Price• The price of a commodity in terms of

another commodity

– Money Price• Price we observe today in today’s dollars (absolute, or

nominal price)


Table 3-1 Money Price versus Relative Price


Example: Why Sales of Electric Cars are Stuck in Low Gear

• Prices of electric autos exceed prices of hybrid versions by at least 30 percent and prices of gasoline powered versions by 50 percent.

• The quality-adjusted prices of electric cars are even higher when we take into account the limited range of distance over which they can operate.

• Beyond a distance of roughly 250 miles, the batteries in electric cars cease to function.

• This limitation in their usefulness helps explain why sales of electric cars remain a small portion of the overall automobile market.


The Demand Schedule

• Demand schedule – Table relating prices to quantities demanded

– We must also consider: • Time dimension (e.g., per year)• Constant-quality units


The Demand Schedule (cont’d)

• Demand Curve– A graphical representation of the demand

schedule

– Negatively sloped line showing the inverse relationship between the price and the quantity demanded (other things being 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)


The Demand Schedule (cont’d)

• 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 Magneto Optical Disks, Panel (a)


Figure 3-3 The Market Demand Schedule for Magneto Optical Disks, Panel (b)


Shifts in Demand

• Scenario

– Imagine the government gives every registered college student in the United States a magneto optical disk drive.

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

• In this case, there will be an increase in the number of MO disks demanded at each and every possible price.


Figure 3-4 A Shift in the Demand Curve


Shifts in Demand (cont’d)

• 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 Goods– Goods for which demand rises as income rises;

most goods are normal goods

• Inferior Goods– Goods for which demand falls as income rises


Example: Lower Incomes Boost the Demand for Reconditioned Cellphones

• U.S. residents who have been out of work or who are classified as discouraged workers are earning much lower incomes than they did a few years ago.

• Many of these people have purchased reconditioned cellphones, a cheaper alternative to a new phone.

• This allows us to identify reconditioned cellphones as an inferior good.



• Determinants of demand

– Income

– Tastes and preferences

– The prices of related goods• Substitutes

• 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



• Complements

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


Example: Why Fewer Wine Bottles Have Natural Cork Stoppers

• Cork bottle stoppers have traditionally been used for wine bottles because wine can “breathe” air through the porous cell structure of natural cork.

• Since the early 2000s, prices of natural cork bottle stoppers have risen above prices of plastic stoppers, and this translates into higher prices for wine in cork-furnished bottles.

• In response, consumers have purchased more wine bottled with plastic stoppers.



• Determinants of demand

– Expectations• Future prices

• Income

• Product availability

– Market size (number of buyers)


Policy Example: An Expected Uranium Price Implosion Cuts Uranium Demand

• Following the 2011 earthquake and tsunami in Japan, many countries announced plans to decrease their reliance on nuclear power as a source of energy.

• This led to an expectation of lower uranium prices in the future.

• As a consequence, purchases of uranium were delayed, and the uranium price dropped immediately.



• Changes in demand versus changes in quantity demanded– Whenever there is a change in a ceteris paribus

condition, there will be a change in demand• A shift of the entire demand curve to the right or to the

left• The only thing that can cause the entire curve to move

is a change in a determinant other than the good’s own price



• Changes in demand versus changes in quantity demanded– A change in a good’s own price leads to a

change in quantity demanded (a single point on a demand curve) for any given demand curve

• A movement along the same demand curve


Figure 3-5: Movement Along a Given Demand 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 higher the price of a good, the more of that

good sellers will make available over a specified time period, other things being equal

• At higher prices, a larger quantity will generally be supplied than at lower prices, all other things held constant.

• At lower prices, a smaller quantity will generally be supplied than at higher prices, all other things held constant.


Example: Steel Producers Reduce Production When the Price of Steel Falls

• When the market price of steel declined from $660 per ton to below $625 per ton, steel manufacturers responded by cutting back on production.

• This is consistent with the upward-sloping supply curve of steel.


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 (curve) showing the direct relationship between price and quantity supplied, all else being equal


Figure 3-6 The Individual Producer’s Supply Schedule and Supply Curve for Magnetic Optical Disks, Panel (a)


Figure 3-6 The Individual Producer’s Supply Schedule and Supply Curve for Magnetic Optical Disks, 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 Magnetic Optical Disks, Panel (a)


Figure 3-8 The Market Supply Schedule and the Market Supply Curve for Magnetic Optical Disks, Panel (b)


Shifts in Supply

• Scenario

– A new method of manufacturing magnetic optical disks significantly reduces the cost of production.

– Producers of MO disks will supply more product at any given price.


Example: Cotton Price Movements Squeeze and Stretch Clothing Supply

• Between 2009 and 2010, the price of cotton increased by 55 percent.– Clothing manufacturers responded by reducing

the number of cotton garments supplied at any given price.

• During 2011, cotton prices decreased.– In response, there was an increase in the supply

of cotton clothes.


Figure 3-9 Shifts in the Supply Curve


Shifts in Supply (cont'd)

• Determinants of supply

– Cost of inputs

– Technology and productivity

– Taxes and subsidies

– Price expectations

– Number of firms in industry


What If . . . politicians oppose a higher gasoline price yet favor higher fuel taxes?

• A decrease in the market supply of gasoline results in higher prices.

– Members of Congress may then complain that gas prices are “too high”.

– Yet, these same elected officials may favor higher fuel taxes.

– A tax imposed on gasoline has the same effect as a decrease in supply.


Example: How Deadly Southern Twisters Pummeled U.S. Poultry Supply

• Between April 26 and April 28 of 2011, there were 278 tornadoes in the U.S.

• Many of the twisters hit Alabama, where poultry farmers typically supply about 12 percent of the national poultry market.

• Damage to chicken-processing plants resulted in a decrease in the number of firms supplying the market.



• Changes in supply versus changes in quantity supplied– Whenever there is a change in a ceteris paribus

condition, there will be a change in supply• A shift of the entire supply curve to the right or to the

left• The only thing that can cause the entire curve to move

is a change in a determinant other than the good’s own price



• Changes in supply versus changes in quantity supplied– A change in a good’s own price leads to a

change in quantity supplied (a single point on a supply curve) for any given supply curve

• A movement along the same supply curve


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

– There tends to be no movement of the price of the quantity away from this point unless demand or supply changes

– Equilibrium is a stable point – any point that is not equilibrium is unstable and will not persist



• The equilibrium price

– The price toward which the market price will automatically tend to gravitate,

– There is no outcome better than this price for both consumers and producers



• Shortages

– The situation when quantity demanded is greater than quantity supplied

– Exist at any price below the market clearing price

– Shortages and scarcity are not the same thing


Example: Production Breakdowns Create a Shortage of a Life-Saving Drug

• Each year, 20,000 new cases of acute lymphoblastic leukemia are diagnosed.

– Cytarabine is the drug commonly used to treat this disease.

• Recently, all of the firms manufacturing this drug experienced problems that slowed or halted production of the drug.

• A shortage of cytarabine resulted, and the drug was rationed by medical professionals who judged the urgency of need in various individuals.



• Surpluses

– The situation when quantity supplied is greater than quantity demanded

– 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


You Are There … Why the Casket Industry Is on Life Support

• The CEO of a casket manufacturer described his industry as one that isn’t growing.

• Falling prices for a substitute good, cremations, are the primary reason.

• The typical price for a traditional casket burial exceeds $7,200. This compares to $1,300 for the average price of a cremation service.

• This decreasing price of a lower-priced substitute has caused a decline of the demand for caskets.


Issues & Applications: Your Higher Education Bills Really Are Increasing

• What explains the higher prices that students are paying for a college education, as compared to prices 30 years ago?

• The figure on the following slide displays an index measure of three variables from 1978 to 2010:– 1) U.S. college tuition and fees– 2) U.S. educational books and supplies– 3) The level of consumer prices overall


Issues & Applications: Your Higher Education Bills Really Are Increasing (cont’d)

Figure 3-12 Indexes of Prices for Higher-Education-Related Items and All Goods and Services since 1978


Issues & Applications: Your Higher Education Bills Really Are Increasing (cont’d)

• The figure on the preceding slide shows that the money prices of tuition and textbooks have increased substantially since 1978.

• The relative prices of these goods have increased as well.

• Compared to 1978:– Relative tuition has tripled– Relative textbook prices have doubled

• The equilibrium prices of these goods and services have increased over the past four decades.


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– Firms offer more at a higher price; firms offer

less at a lower price

• 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

Date post:	14-Sep-2014
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