1. Chapter 3 Demand and Supply

2. Slide 3-2 Introduction Newly-minted Ph.D. economists have faced a difficult job market for academic positions in recent years. This is because two factors have simultaneously increased the supply of economics instructors and decreased the demand for their services.

3. Slide 3-3 Learning Objectives Explain the law of demand Discuss the difference between money prices and relative prices Distinguish between a change in demand and a change in quantity demanded

4. Slide 3-4 Learning Objectives 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

5. Slide 3-5 The Law of Demand The Demand Schedule Shifts in Demand Chapter Outline

6. Slide 3-6 Chapter Outline The Law of Supply The Supply Schedule Shifts in Supply Putting Demand and Supply Together

7. Slide 3-7 Did You Know That... Even though overall prices trend steadily upwards, some prices hold steady or decline? The average price of a desktop personal computer has fallen by almost 50 percent? Demand and supply can explain most of relative price changes?

8. Slide 3-8 Markets –Arrangements that individuals have for exchanging with one another –Represent the interaction of buyers and sellers

9. Slide 3-9 Markets –Markets for gasoline –Markets for labor –Stock market –Market for Super Bowl tickets –Compact disk market

10. Slide 3-10 Markets –Markets set the prices we pay and receive

11. Slide 3-11 The Law of Demand Demand –Quantities of specific goods or services that individuals, taken singly or as a group, will purchase at various possible prices, other things being constant

12. Slide 3-12 The Law of Demand Law of Demand –Quantity demanded is inversely related to price, all things equal

13. Slide 3-13 The Law of Demand What are we holding constant? –Income –Price of other goods –Many other factors

14. Slide 3-14 The Law of Demand Relative prices versus 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, nominal price)

15. Slide 3-15 Money Price versus Relative Price Money PriceRelative Price Price Last YearPrice This YearPrice Last YearPrice This Year DVDs$20$28 Videocassettes$10$16 $20 $10 = 2.0 $10 $20 = 0.5 $28 $16 = 1.75 $16 = 0.57 $28 Table 3-1

16. Slide 3-16 Example: Price per Constant-Quality Unit Many products, for which you pay one price, contain many features. The right to return an item for a refund may be one feature that is included in the price. Some retailers now are finding ways to unbundle these various features, by offering consumers the option of paying extra if they wish to use them.

17. Slide 3-17 The Demand Schedule The demand schedule is a table relating prices to quantity demanded. We must consider: –The time dimension –Constant-quality units

18. Slide 3-18 The Individual Demand Schedule Figure 3-1, Panel (a)

19. Slide 3-19 The Individual Demand Curve Figure 3-1, Panel (b)

20. Slide 3-20 The Horizontal Summation of Two Demand Schedules Figure 3-2, Panel (a)

21. Slide 3-21 The Horizontal Summation of Two Demand Schedules Figure 3-2, Panels (b), (c), (d)

22. Slide 3-22 The Market Demand Schedule for Rewritable CD’s Figure 3-3, Panel (a)

23. Slide 3-23 The Market Demand Curve for Rewritable CD’s Figure 3-3, Panel (b)

24. Slide 3-24 Policy Example: Preventing Traffic Jams Expressways in Japan are subject to tolls. Increased toll rates in recent years have resulted in lower traffic volume.

25. Slide 3-25 Shifts in Demand Scenario –The federal government gives every student registered in college a rewritable CD drive to use with a personal computer.

26. Slide 3-26 A Shift in the Demand Curve D1D1 Quantity of Rewritable CDs Demanded (millions of constant-quality units per year) Price per Rewritable CD ($) 24680 1 2 3 4 5 101214 Suppose the federal government gives every student a rewritable CD drive. D2D2 Increase in Demand Figure 3-4

27. Slide 3-27 A Shift in the Demand Curve D1D1 Quantity of Rewritable CDs Demanded (millions of constant-quality units per year) Price per Rewritable CD ($) 24680 1 2 3 4 5 101214 D2D2 D3D3 Suppose universities prohibit the use of personal computers. Decrease in Demand Figure 3-4

28. Slide 3-28 A Shift in the Demand Curve D1D1 Quantity of Rewritable CDs Demanded (millions of constant-quality units per year) Price per Rewritable CD ($) 24680 1 2 3 4 5 101214 D2D2 When demand increases the quantity demanded will be greater at each price a c b d Figure 3-4

29. Slide 3-29 Shifts in Demand Determinants of demand –Income –Tastes and preferences –The price of related goods Complements Substitutes

30. Slide 3-30 Shifts in Demand Determinants of demand –Expectations Future prices Income Product availability –Market size (number of buyers)

31. Slide 3-31 Shifts in Demand The Determinants of Demand Income: Normal Good D1D1 Q/Units D2D2 D3D3 Price Decrease in income decreases demand Increase in income increases demand

32. Slide 3-32 Shifts in Demand The Determinants of Demand Income: Inferior Good D1D1 Q/Units Decrease in income increases demand Increase in income decreases demand Price D2D2 D3D3

33. Slide 3-33 Shifts in Demand The Determinants of Demand Income: Tastes and Preferences D1D1 Q/Units Price Sport Utility Vehicle Increase in demand D2D2 Smoking Decrease in demand D3D3

34. Slide 3-34 Shifts in Demand The Determinants of Demand Price of Related Goods: Substitutes D1D1 Q/Butter Butter and Margarine Price of both = $2/lb. Price of margarine increases to $3/lb. Demand for butter increases D2D2 Price

35. Slide 3-35 Shifts in Demand The Determinants of Demand Price of Related Goods: Complements D1D1 Q/Speakers Speakers and Amplifiers Decrease the relative price of amplifiers Demand for speakers increases D2D2 D3D3 Speakers and Amplifiers Increase the relative price of amplifiers Demand for speakers decreases Price

36. Slide 3-36 Shifts in Demand The Determinants of Demand Expectations D1D1 Q/Units A higher income or expectations of a higher future price will increase demand D2D2 D3D3 A lower income or expectations of a lower future price will decrease demand Price

37. Slide 3-37 Shifts in Demand The Determinants of Demand Population D1D1 Q/Units Increase in the population increases demand D2D2 D3D3 Decrease in population decreases demand Price

38. Slide 3-38 Shifts in Demand Changes in demand versus changes in quantity demanded –A change in one or more of the non-price determinants (income, tastes, etc.) will lead to a change in demand. –This is a shift of the whole curve.

39. Slide 3-39 Shifts in Demand Changes in demand versus changes in quantity demanded –A change in a good’s own price leads to a change in quantity demanded. –This is a movement along the same curve.

40. Slide 3-40 Movement Along a Given Demand Curve Quantity of Rewritable CDs Demanded (millions of constant-quality units per year) Price of Rewritable CDs($) 24680 1 2 3 4 5 1012 Figure 3-5

41. Slide 3-41 A change in the price changes the quantity of a good demanded Movement Along a Given Demand Curve Quantity of Rewritable CDs Demanded (millions of constant-quality units per year) Price of Rewritable CDs($) 24680 1 2 3 4 5 1012 D Figure 3-5

42. Slide 3-42 D A change in the price changes the quantity of a good demanded Movement Along a Given Demand Curve Quantity of Rewritable CDs Demanded (millions of constant-quality units per year) Price of Rewritable CDs($) 24680 1 2 3 4 5 1012 Figure 3-5

43. Slide 3-43 Movement Along a Given Demand Curve Quantity of Rewritable CDs Demanded (millions of constant-quality units per year) Price of Rewritable CDs($) 24680 1 2 3 4 5 1012 D Figure 3-5 A change in the price changes the quantity of a good demanded

44. Slide 3-44 Example: Higher Honey Prices Honey prices more than doubled between 2000 and 2003. Many food manufacturers switched to other flavorings as a substitute. This shows that an increase in the price of honey led to an increase in the demand for a substitute good.

45. Slide 3-45 The Law of Supply Supply –The amount of a product or service that firms are willing to sell at alternative prices

46. Slide 3-46 The Law of Supply Law of Supply –The price of a product or service and the quantity supplied are directly related

47. Slide 3-47 The Supply Schedule The supply schedule is a table relating prices to quantity supplied.

48. Slide 3-48 The Individual Producer’s Supply Schedule Figure 3-6, Panel (a)

49. Slide 3-49 The Individual Producer’s Supply Curve Figure 3-6, Panel (b)

50. Slide 3-50 Horizontal Summation of Supply Curves Figure 3-7, Panel (a)

51. Slide 3-51 Horizontal Summation of Supply Curves Figure 3-7, Panels (b), (c), (d)

52. Slide 3-52 The Market Supply Schedule for Rewritable CDs Figure 3-8, Panel (a)

53. Slide 3-53 The Market Supply Curve for Rewritable CDs Figure 3-8, Panel (b)

54. Slide 3-54 Shifts in Supply Scenario –A new method of manufacturing rewritable CDs reduces the cost of production by 50 percent.

55. Slide 3-55 A Shift in the Supply Curve If some other factor than price changes, the only way we can show its effect is by moving the entire supply curve Quantity of Rewritable CDs Demanded (millions of constant-quality units per year) Price per Rewritable CD ($) 24680 1 2 3 4 5 101214 S1S1 Figure 3-9

56. Slide 3-56 A Shift in the Supply Curve If costs decrease, supply increases Quantity of Rewritable CDs Demanded (millions of constant-quality units per year) Price per Rewritable CD ($) 24680 1 2 3 4 5 101214 S2S2 S1S1 Figure 3-9

57. Slide 3-57 A Shift in the Supply Curve If costs increase, supply decreases Quantity of Rewritable CDs Demanded (millions of constant-quality units per year) Price per Rewritable CD ($) 24680 1 2 3 4 5 101214 S3S3 S2S2 S1S1 Figure 3-9

58. Slide 3-58 A Shift in the Supply Curve Quantity of Rewritable CDs Demanded (millions of constant-quality units per year) Price per Rewritable CD ($) 24680 1 2 3 4 5 101214 S1S1 When supply increases the quantity supplied will be greater at each price Figure 3-9

59. Slide 3-59 A Shift in the Supply Curve S1S1 Quantity of Rewritable CDs Demanded (millions of constant-quality units per year) Price per Rewritable CD ($) 24680 1 2 3 4 5 101214 S2S2 a c When supply increases the quantity supplied will be greater at each price Figure 3-9

60. Slide 3-60 A Shift in the Supply Curve S1S1 Quantity of Rewritable CDs Demanded (millions of constant-quality units per year) Price per Rewritable CD ($) 24680 1 2 3 4 5 101214 a b d c S2S2 When supply increases the quantity supplied will be greater at each price Figure 3-9

61. Slide 3-61 A Shift in the Supply Curve Quantity of Rewritable CDs Demanded (millions of constant-quality units per year) Price per Rewritable CD ($) 24680 1 2 3 4 5 101214 S1S1 a c S3S3 b d When supply decreases the quantity supplied will be less at each price Figure 3-9

62. Slide 3-62 Policy Example: The Supply of New Housing Environmental regulations in California add to the costs of new housing construction. These higher costs serve to reduce the supply of new housing.

63. Slide 3-63 Shifts in Supply Determinants of supply –Cost of inputs –Technology and productivity –Taxes and subsidies –Price expectations –Number of firms in industry

64. Slide 3-64 Shifts in Supply The Determinants of Supply Cost of Inputs S1S1 Q/Units Decrease in cost increases supply S2S2 Increase in cost decreases supply S3S3 Price

65. Slide 3-65 Shifts in Supply The Determinants of Supply Technology and Productivity S1S1 Q/Units Improvements in technology or increases in productivity increase supply S2S2 Decreases in productivity decrease supply S3S3 Price

66. Slide 3-66 Shifts in Supply The Determinants of Supply Taxes and Subsidies S1S1 Q/Units Decreases in taxes or increases in subsidies increase supply S2S2 Increases in taxes or decreases in subsidies decrease supply S3S3 Price

67. Slide 3-67 Shifts in Supply The Determinants of Supply Price Expectations S1S1 Q/Units Expectations of lower future prices increase supply S2S2 Expectations of higher future prices decrease supply S3S3 Price

68. Slide 3-68 Shifts in Supply The Determinants of Supply Number of Firms in Industry S1S1 Q/Units Increase in the number of firms increases supply S2S2 Decrease in the number of firms decreases supply S3S3 Price

69. Slide 3-69 Shifts in Supply Changes in supply versus changes in quantity supplied –A change in one or more of the non-price determinants will lead to a change in supply. –This is a shift of the whole curve.

70. Slide 3-70 Shifts in Supply Changes in supply versus changes in quantity supplied –A change in a good’s own price leads to a change in quantity supplied. –This is a movement along the same curve.

71. Slide 3-71 Putting Demand and Supply Together Figure 3-10, Panel (a)

72. Slide 3-72 Putting Demand and Supply Together Quantity of Rewritable CDs (millions of constant-quality units per year) Price per Rewritable CD($) 24680 1 2 3 4 5 1012 S D AB Excess quantity demanded at price $1 Shortage At P = $1: Q s (A) = 2 < Q d (B) = 10 All prices below $3 Q d > Q s Price will be pushed up Figure 3-10, Panel (b)

73. Slide 3-73 Putting Demand and Supply Together Quantity of Rewritable CDs (millions of constant-quality units per year) Price per Rewritable CD($) 24680 1 2 3 4 5 1012 S D D Excess quantity supplied at price $5 Surplus At P = $5: Q d (D) = 2 < Q s (C) = 10 All prices above $3 Q d < Q s Price will be pushed down Figure 3-10, Panel (b)

74. Slide 3-74 Putting Demand and Supply Together Quantity of Rewritable CDs (millions of constant-quality units per year) Price per Rewritable CD($) 24680 1 2 3 4 5 1012 S D D Excess quantity supplied at price $5 AB Excess quantity demanded at price $1 Equilibrium Market clearing, or equilibrium price E Figure 3-10, Panel (b)

75. Slide 3-75 Putting Demand and Supply Together Equilibrium –The situation when quantity supplied equals quantity demanded at a particular price

76. Slide 3-76 Putting Demand and Supply Together Shortages –The situation when quantity demanded is greater than quantity supplied –Exists at any price below the equilibrium price –Is not the same as scarcity

77. Slide 3-77 Putting Demand and Supply Together Surpluses –The situation when quantity supplied is greater than quantity demanded –Exists at any price above the equilibrium price

78. Slide 3-78 Figure 3-11 Should Shortages in the Ticket Market Be Solved by Scalpers? Quantity of Super Bowl Tickets Price per Ticket Q1Q1 Q2Q2 P1P1 P2P2 S D Excess quantity demanded (shortage at price P 1 )

79. Slide 3-79 Example: Rail Transport Prices and Logjams A recent increase in the amount of grains ready for market led to a shortage of freight space on trains used for shipping. In response, freight rates rose. Both the quantity of grain to be shipped declined a bit, and the amount of rail cars available rose, eliminating the shortage.

80. Slide 3-80 More students have pursued academic careers in economics, increasing the supply of instructors. The demand for all college professors has declined, as private colleges have lost endowment income and state universities have experienced funding cutbacks. The simultaneous increase in supply and decrease in demand has lowered salaries for economics instructors. Issues and Applications: Your Economics Instructor’s Salary May Be Lagging

81. Slide 3-81 Issues and Applications: Your Economics Instructor’s Salary May Be Lagging Figure 3-12

82. Slide 3-82 Summary Discussion of Learning Objectives The law of demand says that prices and quantity demanded are inversely related. Relative prices must be distinguished from money, since people respond to changes in relative prices.

83. Slide 3-83 Summary Discussion of Learning Objectives 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 The law of supply states that price and quantity supplied are directly related.

84. Slide 3-84 Summary Discussion of Learning Objectives 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

85. Slide 3-85 Summary Discussion of Learning Objectives Determining market price and equilibrium quantity –The demand and supply curves intersect at the equilibrium point. –Shortages exist when the price of a good is below the market price. –Surpluses exist if the price of the good is greater than the market price.

86. End of Chapter 3 Demand and Supply