© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien CHAPTER 3: Where Prices Come From:The Interaction of Demand and Supply 1 of 34 The Demand Side of the Market The Law of Demand The Law of Demand: Holding everything else constant (ceteris paribus), when the price of a product falls, the quantity demanded of the product will increase, and when the price of a product rises, the quantity demanded of the product will decrease. What Explains the Law of Demand? Substitution effect: The change in the quantity demanded of a good that results from a change in price making the good more or less expensive relative to other goods that are substitutes. Income effect: The change in the quantity demanded of a good that results from the effect of a change in the good’s price on consumer purchasing power.

© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien CHAPTER 3: Where Prices Come From:The Interaction of Demand and Supply 2 of 34 The Demand Side of the Market The Demand of an Individual Buyer Quantity demanded: The quantity of a good or service that a consumer is willing to purchase at a given price. Plotting a Price-Quantity Combination on a Graph At a price of $125 per printer, Kate, the purchasing manager for the Prudential Insurance Company, will be willing to buy 5 printers in the next month.

© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien CHAPTER 3: Where Prices Come From:The Interaction of Demand and Supply 3 of 34 The Demand Side of the Market Demand schedule: A table showing the relationship between the price of a product and the quantity of the product demanded. Demand curve: A curve that shows the relationship between the price of a product and the quantity of the product demanded. Demand Schedules and Demand Curves

© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien CHAPTER 3: Where Prices Come From:The Interaction of Demand and Supply 4 of 34 The Demand Side of the Market Individual Demand and Market Demand Market demand: The demand for a product by all the consumers in a given geographical area. Deriving the Market Demand Curve from Individual Demand Curves

© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien CHAPTER 3: Where Prices Come From:The Interaction of Demand and Supply 5 of 34 The Demand Side of the Market  Price of related goods Substitutes Goods and services that can be used for the same purpose. Complements Goods that are used together.  Income Normal good A good for which the demand increases as income rises and decreases as income falls. Inferior good A good for which the demand increases as income falls, and decreases as income rises.  Tastes  Population and demographics Demographics The characteristics of a population with respect to age, race, and gender.  Expected future prices Variables That Shift Market Demand Shifting the Demand Curve

© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien CHAPTER 3: Where Prices Come From:The Interaction of Demand and Supply 6 of 34 The Demand Side of the Market Variables That Shift Market Demand Variables That Shift Market Demand Curves

© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien CHAPTER 3: Where Prices Come From:The Interaction of Demand and Supply 7 of 34 The Demand Side of the Market Variables That Shift Market Demand Variables That Shift Market Demand Curves

© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien CHAPTER 3: Where Prices Come From:The Interaction of Demand and Supply 8 of 34 The Demand Side of the Market A Change in Demand versus a Change in Quantity Demanded A Change in Demand versus a Change in the Quantity Demanded

© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien CHAPTER 3: Where Prices Come From:The Interaction of Demand and Supply As Sandi’s income rises, her demand for popcorn rises. As Mark’s income falls, his demand for prepaid telephone cards rises. What kinds of goods are popcorn and telephone cards for the people who demand each? Popcorn is a normal good for Sandi. Prepaid telephone cards are an inferior good for Mark. Self Test

© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien CHAPTER 3: Where Prices Come From:The Interaction of Demand and Supply Give an example that illustrates how to derive a market demand curve. Suppose only two people, Bob and Alice, have a demand for good X. At a price of $7, Bob buys 10 units and Alice buys 3 units; at a price of $6, Bob buys 12 units and Alice buys 5 units. One point on the market demand curve represents a price of $7 and a quantity demanded of 13 units; another point represents $6 and 17 units. A market demand curve is derived by adding the quantities demanded at each price. Self Test

© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien CHAPTER 3: Where Prices Come From:The Interaction of Demand and Supply What factors can change demand? What factors can change quantity demanded? A change in income, preferences, prices of related goods, number of buyers, and expectations of future price can change demand. A change in the price of the good changes the quantity demanded of the good. For example, a change in income can change the demand for oranges, but only a change in the price of oranges can directly change the quantity demanded of oranges. Self Test

© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien CHAPTER 3: Where Prices Come From:The Interaction of Demand and Supply 12 of 34 The Supply Side of the Market The Law of Supply Law of supply: Holding everything else constant, increases in price cause increases in the quantity supplied, and decreases in price cause decreases in the quantity supplied.

© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien CHAPTER 3: Where Prices Come From:The Interaction of Demand and Supply 13 of 34 The Supply Side of the Market Quantity supplied: The quantity of a good or service that a firm is willing to supply at a given price. Supply schedule: A table that shows the relationship between the price of a product and the quantity of the product supplied. Supply curve: A curve that shows the relationship between the price of a product and the quantity of the product demanded. Supply Schedules and Supply Curves

© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien CHAPTER 3: Where Prices Come From:The Interaction of Demand and Supply 14 of 34 The Supply Side of the Market Hewlett-Packard’s Supply Schedule and Supply Curve

© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien CHAPTER 3: Where Prices Come From:The Interaction of Demand and Supply 15 of 34 The Supply Side of the Market Individual Supply and Market Supply Deriving the Market Supply Curve from the Individual Supply Curves

© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien CHAPTER 3: Where Prices Come From:The Interaction of Demand and Supply 16 of 34 The Supply Side of the Market  Price of inputs  Technological change A positive or negative change in the ability of a firm to produce a given level of output with a given amount of inputs.  Expected future prices  Number of firms in the market Variables That Shift Supply Shifting the Supply Curve

© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien CHAPTER 3: Where Prices Come From:The Interaction of Demand and Supply 17 of 34 The Supply Side of the Market Variables That Shift Supply Variables That Shift Market Supply Curves

© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien CHAPTER 3: Where Prices Come From:The Interaction of Demand and Supply 18 of 34 The Supply Side of the Market Variables That Shift Supply Variables That Shift Market Supply Curves

© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien CHAPTER 3: Where Prices Come From:The Interaction of Demand and Supply 19 of 34 The Difference between a Change in Supply versus a Change in the Quantity Supplied The Supply Side of the Market A Change in Supply versus a Change in Quantity Supplied

© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien CHAPTER 3: Where Prices Come From:The Interaction of Demand and Supply What happens to the supply curve if each of the following occurs? a. There is a decrease in the number of sellers. b. A per-unit tax is placed on the production of a good. c. The price of a relevant resource falls. a. The supply curve shifts to the left. b. The supply curve shifts to the left. c. The supply curve shifts to the right. Self Test

© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien CHAPTER 3: Where Prices Come From:The Interaction of Demand and Supply “If the price of apples rises, the supply of apples will rise.” True or false? Explain your answer. False. If the price of apples rises, the quantity supplied of apples will rise—not the supply of apples. We are talking about a movement from one point on a supply curve to a point higher up on the supply curve and not about a shift in the supply curve. Self Test

© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien CHAPTER 3: Where Prices Come From:The Interaction of Demand and Supply 22 of 34 Market Equilibrium: Putting Demand and Supply Together Market equilibrium: A situation where quantity demanded equals quantity supplied. Competitive market equilibrium: A market equilibrium with many buyers and many sellers. Market Equilibrium

© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien CHAPTER 3: Where Prices Come From:The Interaction of Demand and Supply 23 of 34 The Effect of Shifts in Supply on Equilibrium The Effect of a Decrease in Supply on Equilibrium The Effect of Demand and Supply Shifts on Equilibrium

© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien CHAPTER 3: Where Prices Come From:The Interaction of Demand and Supply 24 of 34 The Effect of Shifts in Demand on Equilibrium The Effect of an Increase in Demand on Equilibrium The Effect of Demand and Supply Shifts on Equilibrium

© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien CHAPTER 3: Where Prices Come From:The Interaction of Demand and Supply 25 of 34 The Effect of Shifts in Demand and Supply over Time Shifts in Demand and Supply over Time The Effect of Demand and Supply Shifts on Equilibrium

© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien CHAPTER 3: Where Prices Come From:The Interaction of Demand and Supply 26 of 34 The Effect of Shifts in Demand and Supply over Time The Demand for Chicken Has Increased More Than the Supply The Effect of Demand and Supply Shifts on Equilibrium

© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien CHAPTER 3: Where Prices Come From:The Interaction of Demand and Supply The price of a given-quality personal computer is lower today than it was five years ago. Is this necessarily the result of a lower demand for computers? Explain your answer. No. It could be the result of a higher supply of computers. Either a decrease in demand or an increase in supply will lower price. Self Test

© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien CHAPTER 3: Where Prices Come From:The Interaction of Demand and Supply What is the effect on equilibrium price and quantity of the following? a)A decrease in demand that is greater than the increase in supply Lower price and quantity b)An increase in supply Lower price and higher quantity c)A decrease in supply that is greater than the increase in demand Higher price and lower quantity d)A decrease in demand Lower price and quantity Self Test

© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien CHAPTER 3: Where Prices Come From:The Interaction of Demand and Supply 29 of 34 Market Equilibrium: Putting Demand and Supply Together How Markets Eliminate Surpluses and Shortages Surplus: A situation in which the quantity supplied is greater than the quantity demanded. Shortage: A situation in which the quantity demanded is greater than the quantity supplied. The Effect of Surpluses and Shortages on the Market Price

© 2007 Prentice Hall Business Publishing; Essentials of Economics, R. Glenn Hubbard, Anthony Patrick O’Brien CHAPTER 3: Where Prices Come From:The Interaction of Demand and Supply 30 of 34 Price Controls Price ceiling: A legally determined maximum price that sellers may charge. Price floor: A legally determined minimum price that sellers may receive.