Chapter 3 Demand and Supply © 2002 South-Western

Economic Principles Individual and Market Demand Market-day, Short-run and Long-run Supply Determination of Equilibrium Price and Quantity

Price Formation Market price is a reflection of people’s willingness to buy and sell.

Measuring Consumer Demand A change in quantity demanded shows: People’s willingness to buy specific quantities of a good or service at specific prices.

Measuring Individual Demand Law of Demand: The inverse relationship between price and quantity demanded.

Measuring Individual Demand Demand Schedule: A schedule which shows the specific quantity of a good or service that people are willing and able to buy at different prices.

Measuring Market Demand Aggregate the demand of many individuals into market demand by: Adding up the quantities purchased by all consumers at given market prices.

Measuring Market Demand If each of the seven dwarfs buys three cups of coffee per week at Snow White’s Café at a price of $1/cup, what is market quantity demanded at a price of $1? 3+3+3+3+3+3+3 = 21.

Measuring Supply Supply Schedule: It is a schedule showing the specific quantity of a good or service that suppliers are willing and able to provide at different prices.

Measuring Supply Market-day supply: A market situation in which the quantity of a good supplied is fixed, regardless of price.

Measuring Supply A supply curve graphs the relationship between price and quantity supplied.

Measuring Supply The supply curve is upward-sloping. Higher prices provide sellers with an incentive to increase quantity supplied.

Measuring Supply If there are three builders in a small town, and if each supplies 4 houses per year at a price of $150,000, what is market quantity supplied at this price? 4 + 4 + 4 = 12.

EXHIBIT 1A INDIVIDUAL DEMAND CURVES FOR FISH

EXHIBIT 1B INDIVIDUAL DEMAND CURVES FOR FISH

EXHIBIT 2 THE MARKET DEMAND CURVE

Exhibit 2: The Market Demand Curve The curve in Exhibit 2 represents: The market demand for fish. It is the sum of all individual demands for fish.

EXHIBIT 3 MARKET-DAY SUPPLY CURVE

Exhibit 3: Market-Day Supply Curve The market-day supply curve for fish is a vertical line because: Fishermen cannot change the quantity they supply, once the day’s catch is in.

EXHIBIT 4 EXCESS DEMAND AND EXCESS SUPPLY

Exhibit 4: Excess Demand and Excess Supply The quantity of fish purchased, when price rises from $5 to $8: Remains at 6,000. The market-day supply curve is a vertical line.

Exhibit 4: Excess Demand and Excess Supply The relationship between quantity demanded and quantity supplied at a price of $8 is: Quantity demanded is 4,500. Quantity supplied is 6,000. Excess supply of 1,500.

Exhibit 4: Excess Demand and Excess Supply The relationship between quantity demanded and quantity supplied at a price of $4 is: Quantity demanded is 6,500. Quantity supplied is 6,000. Excess demand of 500.

Exhibit 4: Excess Demand and Excess Supply The relationship between quantity demanded and quantity supplied at a price of $5 is: They are equal.

Determining Equilibrium Price What is unique about the Equilibrium Price? Quantity demanded is equal to quantity supplied. There is neither an excess supply nor an excess demand. Price gravitates toward the equilibrium price, in well-functioning competitive markets.

EXHIBIT 5 MARKET-DAY, SHORT-RUN, AND LONG-RUN SUPPLY

Exhibit 5: Market-Day, Short-Run, and Long-Run Supply The short-run supply curve slopes upward, while the market-day supply curve is a vertical line because: If price rises, then in the short-run suppliers are able to increase the use of some but not all of the resources they use to produce goods and services.

Exhibit 5: Market-Day, Short-Run, and Long-Run Supply The short-run supply curve slopes upward, while the market-day supply curve is a vertical line because: The short-run suppliers are able to: Make modest increases in quantity supplied if price rises. Make modest decreases in quantity supplied if price falls

Exhibit 5: Market-Day, Short-Run, and Long-Run Supply The short-run supply curve slopes upward, while the market-day supply curve is a vertical line because: This results in a short-run supply curve which is steeply upward-sloping. The quantity supplied is fixed on the market-day supply curve.

Exhibit 5: Market-Day, Short-Run, and Long-Run Supply The long-run supply curve is less steep than the short-run supply curve because: Suppliers are able to change the quantity of all resources they use to produce goods and services during this time interval. A given increase in price will result in a larger increase in quantity supplied in the long run than in the short run.

Change in Demand A change in price will not result in a change in demand. A change in price results in a change in quantity demanded. A change in demand is caused by factors other than a change in the price of that good.

Change in Demand A change in a consumer’s income will result in a change in demand. A change in a consumer’s income will cause the demand curve to shift.

EXHIBIT 6 CHANGE IN DEMAND

Exhibit 6: Change in Demand In Exhibit 6, when the demand curve shifts from D to D’, the equilibrium price and quantity demanded: The equilibrium price rises from $5 to $6. The quantity demanded rises from 6,000 to 6,500.

Exhibit 6: Change in Demand If fish are a normal good and consumer incomes have increased, the demand will shift from D to D’. If a good is normal, then an increase in consumer income will increase demand.

Exhibit 6: Change in Demand In Exhibit 6, when the demand curve shifts from D to D”, the equilibrium price and quantity demanded: The equilibrium price falls from $5 to $4. The quantity demanded falls from 6,000 to 5,500.

Exhibit 6: Change in Demand If fish and beef are substitutes, then a decrease in the price of beef will cause demand to shift from D to D’’. If the price of beef declines: The quantity of beef demanded will increase. The demand curve for fish will shift left.

Changes in Demand What happens to the demand for software when computer hardware and software are complements, and the price of hardware declines: A decline in hardware prices will increase the quantity of hardware demanded. If more hardware is purchased, the result will be more software purchased, since they are complements.

Changes in Demand What happens to the demand for software when computer hardware and software are complements, and the price of hardware declines: The increase in the quantity of software demanded was caused by a factor other than the price of software. The demand for software will increase.

Changes in Demand If consumers anticipate that computer hardware will become considerably cheaper in the coming months, today’s demand for hardware: Today’s demand will decrease (shift to the left). Some consumers will delay their purchase in anticipation of lower future prices.

Changes in Demand The demand for day-old bakery goods if consumer incomes rise, and day-old bakery goods are inferior goods will: The demand for day-old bakery goods will fall as consumer incomes rise. Inferior goods are goods that people consume less of as their incomes rise.

Changes in Demand When students are gone during the summer, the demand for pizza slices on campus: The demand will fall because there will be fewer consumers.

Changes in Demand If the Surgeon General announces that cheeseburgers reduce heart attack risk and prevent premature baldness, this will affect market demand for cheeseburgers: The demand will rise. The news will increase consumer tastes and preferences for cheeseburgers.

Changes in Demand Which of the following are most likely to be consumer substitutes: Peanut butter and jelly. Coke and Pepsi. Cars and gasoline. Telephones and telephone books.

Changes in Demand Which of the following are most likely to be consumer substitutes: Coke and Pepsi.

EXHIBIT 7. DISTINGUISHING CHANGES IN DEMAND EXHIBIT 7 DISTINGUISHING CHANGES IN DEMAND FROM CHANGES IN QUANTITY DEMANDED

Exhibit 7: Distinguishing Changes in Demand from Changes in Quantity Demanded Movement along the demand curve D from a price of $10 to a price of $7 illustrates a change in Quantity demanded.

Exhibit 7: Distinguishing Changes in Demand from Changes in Quantity Demanded In which of the following do we know for certain that a change in demand occurred: i. Price declined and quantity demanded increased. ii. Price remained the same and quantity demanded increased.

Exhibit 7: Distinguishing Changes in Demand from Changes in Quantity Demanded In which of the following do we know for certain that a change in demand occurred: i. Price declined and quantity demanded increased. ii. Price remained the same and quantity demanded increased.

EXHIBIT 8 CHANGE IN SUPPLY

Exhibit 8: Change in Supply When the supply changes from curve S to curve S’, this is an increase in supply.

Exhibit 8: Change in Supply What would cause the equilibrium to shift from point a. to point b. in Exhibit 8? A decrease in supply from S’ to S’’.

Changes in Supply A Change in Supply: A change in quantity supplied of a good or service that is caused by factors other than a change in the price of that good.

Changes in Supply If a labor union successfully negotiates a large pay increase, this will affect the supply curve for the product they make by: Higher wages, like any other increase in resource prices, will cause the supply curve to shift inwards to the left (a decrease in supply).

Changes in Supply If more sellers enter the market, this will affect the market supply curve: An increase in the number of sellers will cause the supply curve to shift outwards to the right (an increase in supply).

Changes in Supply Suppose that farmers who grow soybeans can also grow corn. If the price of soybeans triples, how this will affect the market supply of corn by: This will reduce the market supply of corn, because many corn farmers will switch to growing soybeans.

EXHIBIT 9A INCREASES IN DEMAND AND SUPPLY

EXHIBIT 9B INCREASES IN DEMAND AND SUPPLY

Exhibit 9: Increases in Demand and Supply (panel a) When both demand and supply increase: Equilibrium quantity increases. The effect of an increase in both supply an demand on price depends on the relative size of the increases. If the increase in demand is larger than the increase in supply, then price rises.

EXHIBIT 10A INCREASES IN DEMAND, DECREASES IN SUPPLY

EXHIBIT 10B INCREASES IN DEMAND, DECREASES IN SUPPLY

Exhibit 10: Increases in Demand, Decreases in Supply When demand increases a little and supply decreases a lot: The equilibrium price increases, but equilibrium quantity decreases. This effect is illustrated in Exhibit 10, panel a.

Exhibit 10: Increases in Demand, Decreases in Supply When demand increases a lot and supply decreases a little: The equilibrium price and quantity both increase. This effect is illustrated in Exhibit 10, panel b.

Demand and Supply The equilibrium price of peaches will be affected if the demand for peaches decreases, while at the same time the supply of peaches increases: The equilibrium price of peaches will fall. The relative magnitude of the changes in supply and demand is needed before we can determine how the equilibrium quantity of peaches will change.

Price as a Rationing Mechanism Price rations scarce goods and services in a market: It rations out goods in a market in such a way that only those who have a high willingness-to-pay get them.

EXHIBIT 11A RATIONING FUNCTION OF PRICE

EXHIBIT 11B RATIONING FUNCTION OF PRICE