Chapter 3 Supply and Demand ©2017 Worth Publishers All Rights Reserved

Outline The Demand Curve for Oil Consumer Surplus What Shifts the Demand Curve? The Supply Curve for Oil Producer Surplus What Shifts the Supply Curve? Takeaway

Introduction Supply, demand, and the idea of equilibrium are the most important tools in economics. They explain how prices are determined. Changes in demand and supply can plunge an economy into recession or set off a boom.

Definition Demand Curve: Quantity Demanded: A function that shows the quantity demanded at different prices. Quantity Demanded: The quantity that buyers are willing and able to buy at a particular price.

Demand Demand for Oil Price Quantity Demanded $55 5 $20 25 $5 50 This table shows demand for oil—the quantities demanded at different prices. The data can be used to construct a demand curve.

Demand Curve Quantity Demanded Price Price of oil per barrel $55 5 $20 25 $5 50 Quantity of oil (MBD)

Reading a Demand Curve A Demand Curve Can Be Read: Horizontally: At a given price, how much are people willing to buy? Vertically: What are people willing to pay for a given quantity?

Reading a Demand Curve Figure 3-2 (3-2): Reading a Demand Curve in Two Different Ways HORIZONTAL: At $20 per barrel, buyers are willing to buy 25m barrels of oil per day.

Reading a Demand Curve Figure 3-2 (3-2): Reading a Demand Curve in Two Different Ways VERTICAL: The maximum price that buyers are willing to pay to purchase 25m barrels per day is $20 per barrel.

Self-Check What quantity is demanded at $15? 10. 50. 75. Answer: b. 50

Self-Check At what price would 100 be demanded? $5. $1. $10. Answer: a. $5

Law of Demand A demand curve is negatively sloped. Show the relation between price and qty demanded The lower the price, the greater the quantity demanded. Demand summarizes how consumers choose to use a good, given: their preferences the possibilities for substitution. NOTE: a demand curve assumes that all other factors (like income, etc) are constant

Law of Demand Consumers will buy more oil at lower prices than at higher prices. When the price is high, consumers will use it only in its most valuable uses.

Law of Demand As the price falls, consumers will also use oil in its less valued uses (heating and rubber duckies).

Law of Demand

Definition Consumer Surplus: Total Consumer Surplus: The consumer’s gain from exchange; difference between the maximum price a consumer is willing to pay for a certain quantity and the market price. Total Consumer Surplus: The area beneath the demand curve and above the price.

Total consumer surplus with a linear demand curve Figure 3-4 (3-4): Total Consumer Surplus Is the Area Beneath the Demand Curve and Above the Price Total consumer surplus with a linear demand curve

Self-Check What is total consumer surplus if market price is $10? $500. $700. $1400. 70 × ($30 – $10) 2 Answer: b. $700 70

Shifting the Demand Curve An increase in demand shifts the demand curve to the right. At each price, people are willing to buy more. At each quantity, people are willing to pay a higher price.

Shifting the Demand Curve Price of oil/barrel An Increase in Demand Willing to pay a higher price for same quantity. $50 Willing to buy more at the same price. $25 New Demand To illustrate the idea that has different values in different uses, we pick three examples of consumers of oil: The president of the United States: It doesn’t really matter what the price of fuel is—Air Force One will fly. Delta Airlines: There are no substitutes for petroleum-based fuel for airlines. Frank, a retired senior citizen: He can choose to stay home or take local bus service. Old Demand 70 140 Quantity of Oil (MBD)

Shifting the Demand Curve Decrease in demand—shifts the demand curve to the left. At each price, people are willing to buy less. At each quantity, people are willing to pay a lower price.

Shifting the Demand Curve Price of oil/barrel A Decrease in Demand Willing to buy less at the same price. $50 Willing to pay a lower price for the same quantity $25 Old Demand To illustrate the idea that has different values in different uses, we pick three types of consumers of oil: The president of the United States: It doesn’t really matter what the price of fuel is—Air Force One will fly. Delta Airlines: There are no substitutes for petroleum-based fuel for airlines. Frank, a retired senior citizen: He can choose to stay home or take local bus service. New Demand 62 74 Quantity of Oil (MBD)

Demand Shifters Factors That Shift Demand: Income Population Price of substitutes Price of complements Expectations Tastes

1. Income Demand Shifters When people get richer, they buy more stuff. When an increase in income increases the demand for a good, it is a normal good. Most goods are normal goods. When an increase in income decreases the demand for a good, it is an inferior good.

Inferior Goods

Self-Check If iPads are a normal good, when incomes increase, the demand curve for iPads will: Shift to the right. Shift to the left. Not change. Answer: a. Higher incomes increase demand for a normal good, shifting the demand curve to the right.

Demand Shifters 2. Population An increase in population will increase demand generally. A shift in subpopulations will change the demand for specific goods and services.

Demand Shifters 3. Prices of Substitutes A substitute is a good that can be consumed instead of another good. A decrease in the price of a substitute will decrease demand for the other good. Examples: Butter vs margarine Coke vs Pepsi Home ownership vs renting

Self-Check If orange juice and apple juice are substitutes, an increase in the price of orange juice will: Increase demand for apple juice. Decrease demand for apple juice. Not affect demand for apple juice. Answer: a. Increase demand for apple juice. A higher price for orange juice will cause some people to substitute the now lower-priced apple juice. This increases the demand for apple juice.

Demand Shifters 4. Prices of Complements Complements are things that go well together. A drop in the price of a complement increases demand for the complementary good. Examples: Smart phones and cell phone service providers Cars and gasoline DVD players and DVD disks

Demand Shifters 5. Expectations 6. Tastes The expectation of a reduction in future supply increases the demand today. 6. Tastes Changes in tastes caused by fads, fashions, and advertising can all increase or decrease demand.

Supply Curve Quantity Supplied Price Price of oil per barrel $55 50 $20 30 $5 10 Quantity of oil (MBD)

Reading a Supply Curve A Supply Curve Can Be Read: Horizontally: At a given price, how much are suppliers willing to sell? Vertically: To produce a given quantity, what price must sellers be paid?

Definition Supply Curve: Quantity Supplied: A function that shows the quantity supplied at different prices. Quantity Supplied: The quantity that sellers are willing and able to sell at a particular price.

Law of Supply Figure 3-9 (3-9): The Supply Curve for Oil Photos: 24Novembers/Shutterstock As the price of oil rises, it becomes profitable to extract from more costly sources. As the price rises, the quantity supplied increases.

Self-Check At what price will producers be willing to supply 50 units? $10. $20. $30. Answer: a. $10

Definition Producer Surplus: Total Producer Surplus: The producer’s gain from exchange, or the difference between the market price and the minimum price at which a producer would be willing to sell a particular quantity. Total Producer Surplus: The area above the supply curve and below the price.

Producer Surplus Figure 3-10 (3-10): Total Producer Surplus Is the Area Above the Supply Curve and Below the Price

Shifting the Supply Curve Increase in Supply—shifts the supply curve to the right. At each price producers are willing to sell more. At each quantity, producers are willing to accept a lower price

Shifting the Supply Curve Price of oil/barrel Increase in supply $60 Old supply New supply 40 Greater quantity supplied at the same price Willing to accept a lower price for the same quantity 18 Quantity of Oil (MBD) 60 80

Shifting the Supply Curve Decrease in supply—shifts the supply curve to the left. At each price sellers will offer less. At each quantity, sellers demand a higher price.

Shifting the Supply Curve Price of oil/barrel Decrease in supply New supply Old supply $50 Higher price required for the same quantity $28 Smaller quantity supplied at the same price Quantity of Oil (MBD) 20 60

Supply Shifters Factors That Shift Supply: Technological innovations and changes in the price of inputs Taxes and subsidies Expectations Entry or exit of producers Changes in opportunity costs

Supply Shifters 1. Technological Innovations Improvements in technology can reduce costs, thus increasing supply. A reduction in input prices also reduces costs and thus has a similar effect. Examples: computers, TVs, cars, etc

Supply Shifters 2. Taxes and Subsidies A tax on output has the same effect as an increase in costs. A subsidy is the reverse of a tax. Figure 3-12 (3-12): A Tax on Industry Output Shifts the Supply Curve Up by the Amount of the Tax

Supply Shifters

Supply Shifters 3. Expectations Suppliers who expect prices to increase will store goods for future sale and sell less today. The expectation of a future price increase therefore decreases current supply. Supply curve shifts to the left.

Supply Shifters 4. Entry or Exit of Producers The entry of new producers increases supply, shifting the curve down and to the right. Figure 3-14 (3-14): Entry Increases Supply

Supply Shifters 5. Changes in Opportunity Costs An increase in opportunity costs shifts the supply curve up and to the left. If the price of wheat increases, the opportunity cost of growing soybeans increases. Some farmers will shift away from producing soybeans and start producing wheat.

Supply Shifters 5. Changes in Opportunity Costs The supply curve for soybeans will shift up and to the left. Figure 3-15 (3-15): Higher (Opportunity) Costs Reduce Supply

Self-Check Suppose a new technology reduces the time it takes to assemble a car. How would this affect the supply of cars? Shift supply to the right. Shift supply to the left. It would have no effect on supply. Answer: a. Producers would be able to supply more cars at the current price, shifting the supply curve to the right.

Are We Ever Going to Run Out of Oil? What does the supply curve concept tell us about this? http://youtu.be/AcWkN4ngR2Y Example: copper vs fiber optics

Takeaway A demand curve shows how customers respond to higher prices by buying less, and to lower prices by buying more. A supply curve shows how producers respond to higher prices by producing more, and to lower prices by producing less. The difference between market price and the maximum a consumer is willing to pay is the consumer’s gain from exchange, or consumer surplus.

Takeaway The difference between market price and the minimum price that a producer is willing to accept is the producer’s gain from exchange, or producer surplus. An increase in demand means that buyers want a greater quantity at the same price or, equivalently, they are willing to pay a higher price for the same quantity.

Takeaway An increase in supply means that sellers are willing to sell a greater quantity at the same price or, equivalently, they are willing to sell a given quantity at a lower price.