L03 Where Price Come From: The Interaction of Supply

and Demand

Motivation

How are things priced?

Ipod vs… Netbook

ANS:

Supply and Demand

Demand – Think Consumer

Supply – Think Producer

Demand Definition: The relationship between price and

quantity demanded, all else held constant. •Example: Demand for Sports Teams

•What happens to quantity

demanded as price rises?

•ANS: •What happens when Price Falls?

•ANS:

Quantity (Attendance)

Price

(Ticket

Price)

Demand

•What causes movement

along a demand curve?

•ANS

Demand Curve

$3.00

2.50

2.00

1.50

1.00

0.50

2 1 3 4 5 6 7 8 9 10 12 11

Price

Quantity 0

Price Quantity$0.00 120.50 101.00 81.50 62.00 42.50 23.00 0

Demand Schedule

Demand Definitions

◦Demand schedule A table showing the relationship

between the price and quantity demanded of a

product.

◦Demand curve A curve that shows the relationship

between the price and quantity demanded of a

product.

◦Quantity demanded The amount of a good or

service that a consumer is willing and able to purchase

at a given price.

Demand Obtain a demand curve by

holding all other variables

constant, and changing the price

only.

Pri

ce

Quantity 25

$2.7

$3.0

20

This is called

Movement

Along a

Demand

Curve Or a

change in

Quantity Demanded

Demand Shifters If something changes other than price, what

happens to the demand curve?

It shifts! Pri

ce

Quantity

Increase in demand

(Shift to the Right)

Decrease in demand

Shift to the Left

Y1

X1 X2

Notice, X2 > X1

X3

Notice, X3 < X1

Demand Shifters

5 most important

1. Consumer Income

2. Prices of Related Goods

3. Tastes

4. Population and Demographics

5. Expected Future Prices

Demand Shifters

5 most important

1. Consumer Income – Goes Up

Normal Good – When Income goes up, demand for a

good increases (shifts to the right)

Inferior Good – When Income goes up, demand for a

good decreases (shifts to the left)

2. Prices of Related Goods

3. Tastes

4. Population and Demographics

5. Expected Future Prices

Demand Shifters

5 most important

2. Prices of Related Goods

Substitutes – Goods that can be used for the same

purpose

When the price of MP3s on Walmart.com goes down, what

happens to the demand for MP3s on Amazon.com?

ANS:_____________________________.

When the price of MP3s on Walmart.com goes up, what

happens to the demand for MP3s on Amazon.com?

ANS:________________________________

Demand for

MP3s at

Amazon.com

Price at Amazon Price at Amazon

Q MP3s

Q MP3s

Demand Shifters

5 most important

2. Prices of Related Goods

Complements: Goods and services that are used

together

What happens to the demand for iPods when the price on iTunes

goes down?

ANS:_______________________________________

What happens to the demand for iPods when the price on iTunes

goes up?

ANS:______________________________________

Demand for

iPods

Quantity of iPods

Price of iPods

Price of iPods

Quantity of iPods

Demand Shifters

5 most important

3. Tastes

What will happen to the demand for South Beach Diet

books when all of the sudden people change their tastes

towards the South Beach Diet?

ANS:__________________________________

What will happen to the demand for Crocs when

everyone begins to think they are not so neat?

ANS:__________________________________

Demand Shifters

5 most important

4. Population and Demographics

5. Expected Future Prices

What happens to demand for gas in the current time

period if you expect the price to go up in the future?

ANS

What happens to the demand for MP3s in the current

period if you expect prices to be slashed in the future?

ANS:

Demand “D” “D”ownward sloping

Why is Demand downward sloping?

◦ Substitution Effect – When the price of

something goes up, consumers substitute less

expensive forms goods.

◦ Income Effect – When the price of something

goes up, consumers have less purchasing

power.

Supply – Think like A Producer

Estimate the Supply of ….

Law of Supply Definition: The relationship between price and quantity

supplied, all else equal

1 5

Price of Ice-Cream Cone

Quantity of Ice-Cream Cones

0

S

1.00 A

C $3.00

What happens to

Quantity Supplied as price

increases?

ANS: _______________

What Causes

Movement along

the supply

Curve?

ANS: ________

Supply Curve

$3.00

2.50

2.00

1.50

1.00

0.50

2 1 3 4 5 6 7 8 9 10 12 11

Price

of Ice-

Cream

Cone

Quantity of

Ice-Cream

Cones

0

Price Quantity

$0.00 0

0.50 0

1.00 1

1.50 2

2.00 3

2.50 4

3.00 5

Supply Schedule

Increase in Supply

Change in Supply

Price

Quantity

0

S1 S2

S3

Decrease in Supply

Y1

X1 X2 X3

A SHIFT UP IS NOT AN INCREASE IN

SUPPLY!

Price

Quantity

0

S1

S3

Decrease in Supply

Y1

X1 X3

Market Equilibrium

Price

Quantity

S

D

PE

QE

QD=QS

Equilibrium:

When quantity

Supplied

Equals

Quantity

Demanded

Supply and Demand Together

Price Quantity

$0.00 0

0.50 0

1.00 1

1.50 4

2.00 7

2.50 10

3.00 13

Price Quantity

$0.00 19

0.50 16

1.00 13

1.50 10

2.00 7

2.50 4

3.00 1

Demand Schedule Supply Schedule

What is the equilibrium Price and

Quantity?

Supply Shifters

1. Increase in the price of Inputs

2. Technological Advancement

3. Increase in the price of a substitute in PRODUCTION

• Consider market for regular iPods, What happens to the supply of

iPods when the price of the Touch goes up?

4. Number of Firms in the market increases

5. Expected Future Prices

• If you expect future prices to go up, are you interested in

selling more or less now?

• Less!

Disequilibrium in the Market: Excess Supply

At P*, QS > QD

Excess supply puts downward pressure on the price. i.e. producers having sales

As the price falls,

QD rises

(a to b, law of demand)

and QS falls

(c to b, law of supply) to bring the market to equilibrium.

P

Q

S

D

PE

QE

P* QS at P*

QD at P*

Surplus or excess supply

a

b

c

Qd Qs

Disequilibrium in the Market: Excess Demand

At P*, QD > QS

Excess demand puts

upward pressure on

the price.

As the price rises,

QD falls

(a to b, law of

demand)

and QS rises

(c to b, law of supply)

to bring the market

to equilibrium.

P

Q

S

D

PE

QE

P* QS at P*

QD at P*

Shortage or excess demand

c

b

a

What Happens when Price is too

low? Price allocates goods and services in a

Market Economy

What happens when Price is too low?

Example: Black Friday

The Effects of Shifts on Equilibrium

SUPPLY CURVE

UNCHANGED

SUPPLY CURVE

SHIFTS TO THE RIGHT

SUPPLY CURVE

SHIFTS TO THE LEFT

DEMAND CURVE

UNCHANGED

Q unchanged

P unchanged

DEMAND CURVE

SHIFTS TO THE RIGHT

Q increases

P increases

DEMAND CURVE

SHIFTS TO THE LEFT

P

Q

So

D1

PE1

QE1

PEo

Do

QEo

•Demand

increases (shift to

the right)

•What happens

to supply?

•ANS:____

•What Happens

to Quantity

Supplied?

•ANS:____

•What happens

to Equilibrium

Price? Quantity?

•ANS:____

The Effects of Shifts on Equilibrium

The Effects of Shifts on Equilibrium

SUPPLY CURVE

UNCHANGED

SUPPLY CURVE

SHIFTS TO THE RIGHT

SUPPLY CURVE

SHIFTS TO THE LEFT

DEMAND CURVE

UNCHANGED

Q unchanged

P unchanged 2 5

DEMAND CURVE

SHIFTS TO THE RIGHT

Q increases

P increases 3 6

DEMAND CURVE

SHIFTS TO THE LEFT 1 4 7

P

Q

So

D1

PE1

QE1

PEo

Do

QEo

•Demand and

Supply increase

(shift to the

right)

•What happens

to Equilibrium

Price and

Quantity using S1

and D1?

•ANS:____

•What Happens

to Equilibrium P

and Q using S2

and D1?

The Effects of Shifts on Equilibrium

S1

S2

PE2

QE2

•ANS:____

•Table entry: Q increases, P increases or decreases

The Effects of Shifts on Equilibrium

SUPPLY CURVE

UNCHANGED

SUPPLY CURVE

SHIFTS TO THE RIGHT

SUPPLY CURVE

SHIFTS TO THE LEFT

DEMAND CURVE

UNCHANGED

Q unchanged

P unchanged 2 5

DEMAND CURVE

SHIFTS TO THE RIGHT

Q increases

P increases 3 6

DEMAND CURVE

SHIFTS TO THE LEFT 1 4 7