Copyright © 2012 by McGraw-Hill Ryerson Limited. All rights reserved. Understanding Economics 6 th edition by Mark Lovewell

Chapter 2 Demand and Supply Copyright © 2012 by McGraw-Hill Ryerson Limited. All rights reserved.

Learning Objectives After this chapter, you will be able to: 1. comprehend the nature of demand, changes in quantity demanded, changes in demand, and the factors that affect demand 2. understand the nature of supply, changes in quantity supplied, changes in supply, and the factors that affect supply 3. explain how markets reach equilibrium – the point at which demand and supply meet Copyright © 2012 by McGraw-Hill Ryerson Limited. All rights reserved.

What Is Demand? o Demand is a relationship between a product’s price and quantity demanded. Demand is shown using a schedule or curve. The law of demand states that price and quantity demanded are inversely related. Market demand is the sum of quantities demanded by all consumers in a market. Copyright © 2012 by McGraw-Hill Ryerson Limited. All rights reserved.

The Demand Curve Figure 2.1, page 34 Copyright © 2012 by McGraw-Hill Ryerson Limited. All rights reserved Quantity Demanded (kg per month) Your Demand Curve for Strawberries Your Demand Schedule for Strawberries Quantity Demanded (kg per month) Point on graph Price ($ per kg) $ Price ($ per kg) D b a c a b c

Deriving Market Demand Figure 2.2, page 36 Copyright © 2012 by McGraw-Hill Ryerson Limited. All rights reserved Quantity Demanded (kg per month) Friend’s Demand Curve for Strawberries Individual and Market Demand Schedules for Strawberries You (D 0 ) Price ($ per kg) $ Price ($ per kg) Friend (D 1 ) Market (D m ) (kg per month) Quantity Demanded (kg per month) Market Demand Curve for Strawberries Price ($ per kg) Quantity Demanded (kg per month) Your Demand Curve for Strawberries Price ($ per kg) D0D0 D1D1 DmDm

Changes in Demand (a) Changes in demand: are shown by shifts in the demand curve are caused by changes in demand factors Copyright © 2012 by McGraw-Hill Ryerson Limited. All rights reserved.

Changes in Demand (b) Figure 2.3, page 37 Copyright © 2012 by McGraw-Hill Ryerson Limited. All rights reserved Quantity Demanded (millions of kg per year) Market Demand Curve for Strawberries Market Demand Schedule for Strawberries Quantity Demanded (millions of kg) Price ($ per kg) $ Price ($ per kg) D0D0 D1D1 D2D2 (D 2 )(D 0 )(D 1 )

Demand Factors (a) Demand factors include the following: The number of buyers (an increase causes a rightward demand shift) Income For normal products, an increase causes a rightward demand shift. For inferior products, an increase causes a leftward demand shift. Copyright © 2012 by McGraw-Hill Ryerson Limited. All rights reserved.

Demand Factors (b) Prices of other products For substitute products, a rise in the other product’s price causes a rightward demand shift. For complementary products, a rise in the other product’s price causes a leftward demand shift. Consumer preferences Consumer expectations Copyright © 2012 by McGraw-Hill Ryerson Limited. All rights reserved.

Changes in Quantity Demanded (a) Changes in quantity demanded: are shown by movements along demand curve are caused by price changes Copyright © 2012 by McGraw-Hill Ryerson Limited. All rights reserved.

Changes in Quantity Demanded (b) Figure 2.4, page 39 Copyright © 2012 by McGraw-Hill Ryerson Limited. All rights reserved Quantity Demanded (pairs of skis) Change in Quantity Demanded Price ($ per pair of skis) Quantity Demanded (pairs of skis) Change in Demand Price ($ per pair of skis) a b D0D0 D0D0 D1D1

What Is Supply? Supply: is a relationship between a product’s price and quantity supplied is shown using a schedule or curve The law of supply states there is a direct relationship between price and quantity supplied. Copyright © 2012 by McGraw-Hill Ryerson Limited. All rights reserved.

The Supply Curve Figure 2.5, page 41 Copyright © 2012 by McGraw-Hill Ryerson Limited. All rights reserved. Market Supply Schedule for Strawberries Quantity Supplied (millions of kg) Points on graph Price ($ per kg) $ e f d Market Supply Curve for Strawberries S f e d Quantity Supplied (millions of kg per year) Price ($ per kg)

Changes in Supply (a) Changes in supply: are shown by shifts in the supply curve are caused by changes in supply factors Copyright © 2012 by McGraw-Hill Ryerson Limited. All rights reserved.

Changes in Supply (b) Figure 2.6, page 42 Copyright © 2012 by McGraw-Hill Ryerson Limited. All rights reserved. Market Supply Schedule for Strawberries Quantity Supplied (millions of kg) Price ($ per kg) $ S0S0 S1S1 S2S2 Market Supply Curve for Strawberries Quantity Supplied (millions of kg per year) Price ($ per kg) (S 2 ) (S 0 ) (S 1 )

Supply Factors (a) Supply factors include the following: Number of producers (an increase causes a rightward supply shift) Resource prices (an increase causes a leftward supply shift) State of technology (an improvement causes a rightward supply shift) Prices of related products (an increase causes a leftward supply shift) Copyright © 2012 by McGraw-Hill Ryerson Limited. All rights reserved.

Supply Factors (b) Changes in nature (for some products, an improvement causes a rightward supply shift) Producer expectations (an expectation of lower prices in the future causes an immediate rightward supply shift) Copyright © 2012 by McGraw-Hill Ryerson Limited. All rights reserved.

Changes in Quantity Supplied (a) Changes in quantity supplied: are shown by movements along the supply curve are caused by price changes Copyright © 2012 by McGraw-Hill Ryerson Limited. All rights reserved.

Changes in Quantity Supplied (b) Figure 2.7, page 44 Copyright © 2012 by McGraw-Hill Ryerson Limited. All rights reserved Quantity Supplied (millions of kg per year) Change in Quantity Supplied Price ($ per kg) Change in Supply Quantity Supplied (millions of kg per year) Price ($ per kg) S0S0 S1S1 S0S0 b a

Market Equilibrium (a) When a product is in surplus: there is excess supply price is pushed down When a product is in shortage: there is excess demand price is pushed up Copyright © 2012 by McGraw-Hill Ryerson Limited. All rights reserved.

Market Equilibrium (b) Figure 2.8, page 46 Copyright © 2012 by McGraw-Hill Ryerson Limited. All rights reserved Quantity (millions of kg per year) Market Demand and Supply Curves for Strawberries Price ($ per kg) S D 15 Market Demand and Supply Schedules for Strawberries Price ($ per kg) Quantities (millions of kg) DS Surplus (+) or Shortage (-) (millions of kg) Surplus Shortage b b aa e $

Changes in Equilibrium (a) A rightward demand shift pushes up both equilibrium price and quantity. A leftward demand shift pushes down both equilibrium price and quantity. A rightward supply shift pushes equilibrium price down and equilibrium quantity up. A leftward supply shift pushes equilibrium price up and equilibrium quantity down. Copyright © 2012 by McGraw-Hill Ryerson Limited. All rights reserved.

Demand Changes and Equilibrium Figure 2.9, page 47 Copyright © 2012 by McGraw-Hill Ryerson Limited. All rights reserved Quantity (millions of kg per year) Market Demand and Supply Curves for Strawberries Price ($ per kg) S D0D0 15 a $ Market Demand and Supply Schedules for Strawberries Price Quantities (D 0 ) (D 1 )(S) ($ per kg.) (millions of kg) D1D1 b shortage

Supply Changes and Equilibrium Figure 2.10, page 48 Copyright © 2012 by McGraw-Hill Ryerson Limited. All rights reserved Quantity (millions of kg per year) Market Demand and Supply Curves for Strawberries Price ($ per kg) S0S0 D0D0 15 $ Market Demand and Supply Schedules for Strawberries Price Quantities ($ per kg) (millions of kg) S1S1 a b (D 0 ) (S 0 )(S 1 ) Surplus

Changes in Equilibrium (b) A simultaneous rightward shift in demand and supply raises equilibrium quantity, but the effect on equilibrium price depends on the relative sizes of the two shifts. if demand shifts rightward more than supply, then price rises if supply shifts rightward more than demand, then price falls Copyright © 2012 by McGraw-Hill Ryerson Limited. All rights reserved.

Effects of Increases in Demand and Supply Figure 2.11 page 49 Copyright © 2012 by McGraw-Hill Ryerson Limited. All rights reserved Quantity (millions of kg per year) Market Demand and Supply Curves for Strawberries Price ($ per kg) D0D0 15 a $ Market Demand and Supply Schedules for Strawberries Price Quantities (D 0 ) (D 1 ) ( S 0 ) (S 1 ) ($ per kg.) (millions of kg) D1D1 b S0S0 S1S1

Changes in Equilibrium (c) A simultaneous rightward shift in demand and leftward shift in supply raises equilibrium price, but the effect on equilibrium quantity depends on the relative sizes of the two shifts. if supply shifts leftward more than demand shifts rightward, then quantity falls ( greater decrease in supply than increase in demand) if demand shifts rightward more than supply shifts leftward, then quantity rises (greater increase in demand than decrease in supply) Copyright © 2012 by McGraw-Hill Ryerson Limited. All rights reserved.

Effects of a Demand Increase and Supply Decrease Figure 2.12 page 50 Copyright © 2012 by McGraw-Hill Ryerson Limited. All rights reserved Quantity (millions of kg per year) Market Demand and Supply Curves for Strawberries Price ($ per kg) D0D0 15 a $ Market Demand and Supply Schedules for Strawberries Price Quantities (D 0 ) (D 1 ) ( S 0 ) (S 1 ) ($ per kg.) (millions of kg) D1D1 b S0S0 S1S1

Spoilt for Choice William Stanley Jevons: assumed measurable utility outlined the law of diminishing marginal utility, which states that a consumer’s marginal utility declines as more of a product is consumed showed how this law can be illustrated using the downward-sloping marginal utility graph for a given consumer and product, based on that consumer’s total utility graph Copyright © 2012 by McGraw-Hill Ryerson Limited. All rights reserved.

Spoilt for Choice (b) Figure A, page 57 Copyright © 2012 by McGraw-Hill Ryerson Limited. All rights reserved Cups of Cappuccino Total Utility Consumer’s Total and Marginal Utility From Cappuccino Quantity Consumed (cups) (a) 12(b) 20(c) 24(d) 26(e) Utility (utils) Total Utility (utils) Marginal Utility (utils) 12(f) 8(g) 4(h) 2(i) Cups of Cappuccino Marginal Utility Utility (utils) a b c d e f g h i

The Utility-Maximizing Rule Jevons devised the utility-maximizing rule this rule states a consumer should reach the same marginal utility per dollar for all products consumed in mathematical terms: Copyright © 2012 by McGraw-Hill Ryerson Limited. All rights reserved. MU 1 P1P1 MU 2 P2P2 =

Spoilt for Choice (c) Figure B, page 58 Copyright © 2012 by McGraw-Hill Ryerson Limited. All rights reserved Cups of Cappuccino (price = $1) QuantityMarginal Utility (MU 1 ) (utils) Marginal Utility per $ (MU 1 /P 1 =MU 1 /$1) (utils per $) Cappuccinos Cups of Cappuccino Marginal Utility Per $ (utils) Danish Pastries (price = $2) QuantityMarginal Utility (MU 2 ) (utils) Marginal Utility per $ (MU 2 /P 2 =MU 2 /$2) (utils per $) Pastries Danish Pastries Marginal Utility Per $ (utils)

Through the Ranks (OLC) Indifference Curves Using indifference curves, consumer preferences can be shown without the need to assume measurable utility. An individual consumer must merely rank his/her options for various bundles of two products in order of preference. A consumer may prefer one bundle to another, or be indifferent between the two. Copyright © 2012 by McGraw-Hill Ryerson Limited. All rights reserved.

Through the Ranks (OLC) An Indifference Curve (a) An indifference curve shows all bundles of two goods to which a particular consumer is indifferent. The curve is downward-sloping because, for any point on the curve, all points to the northeast provide more utility and all points to the southwest provide less utility. Copyright © 2012 by McGraw-Hill Ryerson Limited. All rights reserved.

Through the Ranks (OLC) An Indifference Curve (b) Copyright © 2012 by McGraw-Hill Ryerson Limited. All rights reserved. Hamburgers Alice’s Indifference Curve Alice’s Indifference Schedule Milkshakes Hamburgers Point on Graph Milkshakes I0I0 b a c a c 112 d d b At each point on the curve, Alice derives the same level of utility.

Through the Ranks (OLC) The Marginal Rate of Substitution The absolute value of an indifference curve’s slope is the marginal rate of substitution (MRS). An indifference curve is convex, since the curve’s MRS diminishes as more of the product on the horizontal axis (hamburgers), and less on the vertical axis (milkshakes) is consumed. Copyright © 2012 by McGraw-Hill Ryerson Limited. All rights reserved.

Through the Ranks (OLC) Diminishing Marginal Rate of Substitution The diminishing marginal rate of substitution occurs because, as hamburger consumption rises, more hamburgers must be gained to make the consumer willing to sacrifice another milkshake. Copyright © 2012 by McGraw-Hill Ryerson Limited. All rights reserved.

Through the Ranks (OLC) A Map of Indifference Curves (a) A map of indifference curves can be drawn for an individual consumer, with each indifference curve further to the northeast representing a higher level of utility Copyright © 2012 by McGraw-Hill Ryerson Limited. All rights reserved.

Through the Ranks (OLC) A Map of Indifference Curves (b) Copyright © 2012 by McGraw-Hill Ryerson Limited. All rights reserved. Hamburgers A Map of Indifference Curves Milkshakes I0I I1I1 I2I2 Each curve shows points that give different levels of utility for Alice.

Through the Ranks (OLC) The Budget Line (a) A consumer’s budget line: is drawn based on the assumption that all the consumer’s budget is spent on hamburgers and milkshakes has a vertical intercept equal to the consumer’s budget divided by the price of milkshakes has a horizontal intercept equal to the consumer’s budget divided by the price of hamburgers Copyright © 2012 by McGraw-Hill Ryerson Limited. All rights reserved.

Through the Ranks (OLC) The Budget Line (b) has a slope whose absolute value equals the ratio of the two prices (the price of hamburgers divided by the price of milkshakes) divides the graph into an attainable region southwest of the line, and an unattainable region northeast of the line Copyright © 2012 by McGraw-Hill Ryerson Limited. All rights reserved.

Through the Ranks (OLC) The Budget Line (c) Copyright © 2012 by McGraw-Hill Ryerson Limited. All rights reserved. Hamburgers Alice’s Budget Line Alice’s Budget Schedule Milkshakes Hamburgers Milkshakes The budget curve shows all those points Alice can reach with her limited budget. $15/$3 $15/$

Through the Ranks (OLC) The Utility-Maximizing Point (a) The consumer maximizes utility by reaching the highest possible indifference curve on the budget line. This utility-maximizing point occurs on the indifference curve that just touches the budget line at a single point. Copyright © 2012 by McGraw-Hill Ryerson Limited. All rights reserved.

Through the Ranks (OLC) The Utility-Maximizing Point (b) Copyright © 2012 by McGraw-Hill Ryerson Limited. All rights reserved. Hamburgers Milkshakes I0I Alice’s greatest achievable utility is on the indifference curve which touches her budget line at a single point b (4, 3)

Through the Ranks (OLC) Deriving a Demand Curve (a) The consumer’s demand curve for hamburgers can be found by tracing out the results of a change in the price of hamburgers given a constant money budget and price for milkshakes. Copyright © 2012 by McGraw-Hill Ryerson Limited. All rights reserved.

Through the Ranks (OLC) Deriving a Demand Curve (b) Copyright © 2012 by McGraw-Hill Ryerson Limited. All rights reserved. Hamburgers Milkshakes I1I A decline in the price of hamburgers from $1.50 to $1 causes Alice’s quantity demanded to rise from 4 to 6, as shown by her demand curve, D b Quantity (hamburgers per week) Price ($ per hamburger) D e (6,3) I0I0

Chapter 2 The End Copyright © 2012 by McGraw-Hill Ryerson Limited. All rights reserved.