1. The Market Forces of Supply and Demand Chapter 4 Copyright © 2001 by Harcourt, Inc. All rights reserved. Requests for permission to make copies of any part of the work should be mailed to: Permissions Department, Harcourt College Publishers, 6277 Sea Harbor Drive, Orlando, Florida 32887-6777.

2. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Market Type: A Competitive Market A competitive market is a market...  with many buyers and sellers.  that is not controlled by any one person.  in which a narrow range of prices are established that buyers and sellers act upon.

3. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Competition: Perfect and Otherwise u Products are the same u Numerous buyers and sellers so that each has no influence over price u Buyers and Sellers are price takers Perfect Competition

4. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Competition: Perfect and Otherwise u Monopoly u One seller, and seller controls price u Oligopoly u Few sellers u Not always aggressive competition

5. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Competition: Perfect and Otherwise u Monopolistic Competition u Many sellers u Slightly differentiated products u Each seller may set price for its own product

6. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Markets u A market is a group of buyers and sellers of a particular good or service. u The terms supply and demand refer to the behavior of people... as they interact with one another in markets.

7. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Markets u Buyers determine demand. u Sellers determine supply.

8. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. The Market Forces of Supply and Demand u Supply and demand are the two words that economists use most often. u Supply and demand are the forces that make market economies work. u Modern microeconomics is about supply, demand, and market equilibrium.

9. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Demand is the amount of a good that buyers are willing and able to purchase.

10. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Law of Demand The law of demand states that there is an inverse relationship between price and quantity demanded. As prices rise, demand falls and as prices fall, demand rises

11. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Law of Demand There are two reasons that explain the Law of Demand Income Effect ä As prices drop, consumers “real” income (purchasing power) increases. They can buy more with each dollar.

12. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Law of Demand n Substitution Effect äAs the price of a good increases consumers will choose to purchase (substitute) another less expensive good

13. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Demand Schedule The demand schedule is a table that shows the relationship between the price of the good and the quantity demanded.

14. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Demand Schedule

15. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Demand Curve The demand curve is a graph relating price to quantity demanded.

16. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Demand Curve $3.00 2.50 2.00 1.50 1.00 0.50 213456789101211 Price of Ice-Cream Cone Quantity of Ice-Cream Cones 0

17. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Ceteris Paribus Ceteris paribus is a Latin phrase that means all variables other than the ones being studied are assumed to be constant. Literally, ceteris paribus means “other things being equal.” The demand curve slopes downward because, ceteris paribus, lower prices imply a greater quantity demanded!

18. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Determinants of Demand u Market price u Consumer income u Prices of related goods u Tastes u Expectations u Number of buyers

19. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Change in Quantity Demanded versus Change in Demand

20. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Change in Quantity Demanded versus Change in Demand Change in Quantity Demanded u Movement along the demand curve. u Caused by a change in the price of the product.

21. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Changes in Quantity Demanded 0 D1D1 Price of Cigarettes per Pack Number of Cigarettes Smoked per Day A tax that raises the price of cigarettes results in a movement along the demand curve. A C 20 2.00 $4.00 12

22. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Change in Quantity Demanded versus Change in Demand Change in Demand u A shift in the demand curve, either to the left or right. u Caused by a change in a determinant other than the price.

23. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Changes in Demand 0 D1D1 Price of Ice-Cream Cone Quantity of Ice-Cream Cones D3D3 D2D2 Increase in demand Decrease in demand

24. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Consumer Income u As income increases the demand for a normal good will increase. u As income increases the demand for an inferior good will decrease.

25. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Consumer Income Normal Good $3.00 2.50 2.00 1.50 1.00 0.50 213456789101211 Price of Ice-Cream Cone Quantity of Ice-Cream Cones 0 Increase in demand An increase in income... D1D1 D2D2

26. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Consumer Income Inferior Good $3.00 2.50 2.00 1.50 1.00 0.50 213456789101211 Price of Ice-Cream Cone Quantity of Ice-Cream Cones 0 Decrease in demand An increase in income... D1D1 D2D2

27. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Prices of Related Goods Substitutes & Complements u Pairs of goods that are used in place of each other are called substitutes. uHot dogs and hamburgers u Pairs of goods that are used together are called complements. uGasoline and automobiles

28. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Market Demand u Market demand refers to the sum of all individual demands for a particular good or service. u Graphically, individual demand curves are summed horizontally to obtain the market demand curve.

29. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Supply Quantity supplied is the amount of a good that sellers are willing and able to sell.

30. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Law of Supply The law of supply states that there is a direct (positive) relationship between price and quantity supplied. As prices rises producers are more willing and able to supply more.

31. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Supply Schedule The supply schedule is a table that shows the relationship between the price of the good and the quantity supplied.

32. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Supply Schedule

33. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Supply Curve The supply curve is the upward- sloping line relating price to quantity supplied.

34. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Supply Curve $3.00 2.50 2.00 1.50 1.00 0.50 213456789101211 Price of Ice-Cream Cone Quantity of Ice-Cream Cones 0

35. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Determinants of Supply u Market price u Input prices u Technology u Expectations u Number of producers

36. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Change in Quantity Supplied versus Change in Supply Change in Quantity Supplied u Movement along the supply curve. u Caused by a change in the market price of the product.

37. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Change in Quantity Supplied 1 5 Price of Ice-Cream Cone Quantity of Ice-Cream Cones 0 S 1.00 A C $3.00 A rise in the price of ice cream cones results in a movement along the supply curve.

38. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Change in Quantity Supplied versus Change in Supply Change in Supply u A shift in the supply curve, either to the left or right. u Caused by a change in a determinant other than price.

39. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Change in Supply Price of Ice-Cream Cone Quantity of Ice-Cream Cones 0 S1S1 S2S2 S3S3 Increase in Supply Decrease in Supply

40. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Change in Quantity Supplied versus Change in Supply

41. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Government Intervention n Subsidies äGovernment may provide tax breaks or direct monetary support to a particular business or industry to increase or ensure continued production

42. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. n Taxes äTaxes add to the cost of production and decrease a business’s ability and willingness to produce Types of business taxes include income tax (corporate and personal), capital gains taxes, property taxes, sales taxes, and excise taxes.

43. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. n Regulations äRegulations add to the cost of production and reduce businesses’ willingness and ability to produce. Government may require more safety features, pollution control devices, minimum wage.

44. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Market Supply u Market supply refers to the sum of all individual supplies for all sellers of a particular good or service. u Graphically, individual supply curves are summed horizontally to obtain the market supply curve.

45. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Supply and Demand Together Equilibrium Price u The price that balances supply and demand. On a graph, it is the price at which the supply and demand curves intersect. Equilibrium Quantity  The quantity that balances supply and demand. On a graph it is the quantity at which the supply and demand curves intersect.

46. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Supply and Demand Together Demand ScheduleSupply Schedule At $2.00, the quantity demanded is equal to the quantity supplied!

47. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Supply Demand Price of Ice-Cream Cone Quantity of Ice-Cream Cones Equilibrium of Supply and Demand 2134567891012110 $3.00 2.50 2.00 1.50 1.00 0.50 Equilibrium

48. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Price of Ice-Cream Cone Quantity of Ice-Cream Cones 2134567891012110 $3.00 2.50 2.00 1.50 1.00 0.50 Supply Demand Surplus Excess Supply

49. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Surplus When the price is above the equilibrium price, the quantity supplied exceeds the quantity demanded. There is excess supply or a surplus. Suppliers will lower the price to increase sales, thereby moving toward equilibrium.

50. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Excess Demand Quantity of Ice-Cream Cones Price of Ice-Cream Cone $2.00 0123 4 5678910111213 Supply Demand $1.50 Shortage

51. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Shortage When the price is below the equilibrium price, the quantity demanded exceeds the quantity supplied. There is excess demand or a shortage. Suppliers will raise the price due to too many buyers chasing too few goods, thereby moving toward equilibrium.

52. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Three Steps To Analyzing Changes in Equilibrium u Decide whether the event shifts the supply or demand curve (or both). u Decide whether the curve(s) shift(s) to the left or to the right. u Examine how the shift affects equilibrium price and quantity.

53. How an Increase in Demand Affects the Equilibrium Price of Ice-Cream Cone 2.00 0 7 Quantity of Ice-Cream Cones Supply Initial equilibrium D1D1 1. Hot weather increases the demand for ice cream... D2D2 2....resulting in a higher price... $2.50 10 3....and a higher quantity sold. New equilibrium Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.

54. Shifts in Curves versus Movements along Curves u A shift in the supply curve is called a change in supply. u A movement along a fixed supply curve is called a change in quantity supplied. u A shift in the demand curve is called a change in demand. u A movement along a fixed demand curve is called a change in quantity demanded.

55. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. S2S2 How a Decrease in Supply Affects the Equilibrium Price of Ice-Cream Cone 2.00 012347891112 Quantity of Ice-Cream Cones 13 Demand Initial equilibrium S1S1 10 1. An earthquake reduces the supply of ice cream... New equilibrium 2....resulting in a higher price... $2.50 3....and a lower quantity sold.

56. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. What Happens to Price and Quantity When Supply or Demand Shifts?

57. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Summary u Economists use the model of supply and demand to analyze competitive markets. u The demand curve shows how the quantity of a good depends upon the price.

58. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Summary u According to the law of demand, as the price of a good rises, the quantity demanded falls. u In addition to price, other determinants of quantity demanded include income, tastes, expectations, and the prices of complements and substitutes.

59. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Summary u The supply curve shows how the quantity of a good supplied depends upon the price. u According to the law of supply, as the price of a good rises, the quantity supplied rises.

60. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Summary u In addition to price, other determinants of quantity supplied include input prices, technology, and expectations. u Market equilibrium is determined by the intersection of the supply and demand curves.

61. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Summary u Supply and demand together determine the prices of the economy’s goods and services. u In market economies, prices are the signals that guide the allocation of resources.

62. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Graphical Review

63. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. How an Increase in Demand Affects the Equilibrium Price of Ice-Cream Cone 2.00 0 710 Quantity of Ice-Cream Cones Supply Initial equilibrium D1D1

64. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. How an Increase in Demand Affects the Equilibrium Price of Ice-Cream Cone 2.00 0 710 Quantity of Ice-Cream Cones Supply Initial equilibrium D1D1 1. Hot weather increases the demand for ice cream...

65. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. How an Increase in Demand Affects the Equilibrium Price of Ice-Cream Cone 2.00 0 710 Quantity of Ice-Cream Cones Supply Initial equilibrium D1D1 1. Hot weather increases the demand for ice cream... D2D2 New equilibrium $2.50

66. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. How an Increase in Demand Affects the Equilibrium Price of Ice-Cream Cone 2.00 0 710 Quantity of Ice-Cream Cones Supply Initial equilibrium D1D1 1. Hot weather increases the demand for ice cream... D2D2 New equilibrium 2....resulting in a higher price... $2.50

67. How an Increase in Demand Affects the Equilibrium Price of Ice-Cream Cone 2.00 0 710 Quantity of Ice-Cream Cones Supply Initial equilibrium D1D1 1. Hot weather increases the demand for ice cream... D2D2 New equilibrium 2....resulting in a higher price... $2.50 3....and a higher quantity sold. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.

68. How an Increase in Demand Affects the Equilibrium Price of Ice-Cream Cone 2.00 0 710 Quantity of Ice-Cream Cones Supply Initial equilibrium D1D1 1. Hot weather increases the demand for ice cream... D2D2 New equilibrium 2....resulting in a higher price... $2.50 3....and a higher quantity sold. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.

69. How a Decrease in Supply Affects the Equilibrium Price of Ice-Cream Cone 2.00 01234567891112 Quantity of Ice-Cream Cones 13 Demand Initial equilibrium S1S1 10

70. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. How a Decrease in Supply Affects the Equilibrium Price of Ice-Cream Cone 2.00 01234567891112 Quantity of Ice-Cream Cones 13 Demand Initial equilibrium S1S1 10 1. An earthquake reduces the supply of ice cream...

71. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. How a Decrease in Supply Affects the Equilibrium Price of Ice-Cream Cone 2.00 01234567891112 Quantity of Ice-Cream Cones 13 Demand Initial equilibrium S1S1 10 1. An earthquake reduces the supply of ice cream...

72. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. How a Decrease in Supply Affects the Equilibrium Price of Ice-Cream Cone 2.00 01234567891112 Quantity of Ice-Cream Cones 13 Demand Initial equilibrium S1S1 10 1. An earthquake reduces the supply of ice cream... New equilibrium $2.50

73. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. How a Decrease in Supply Affects the Equilibrium Price of Ice-Cream Cone 2.00 01234567891112 Quantity of Ice-Cream Cones 13 Demand Initial equilibrium S1S1 10 1. An earthquake reduces the supply of ice cream... New equilibrium $2.50 2....resulting in a higher price...

74. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. How a Decrease in Supply Affects the Equilibrium Price of Ice-Cream Cone 2.00 012347891112 Quantity of Ice-Cream Cones 13 Demand Initial equilibrium S1S1 10 1. An earthquake reduces the supply of ice cream... New equilibrium $2.50 2....resulting in a higher price... 3....and a lower quantity sold.