1 of 46 Chapter Outline and Learning Objectives CHAPTER 3 3.1The Demand Side of the Market 3.2The Supply Side of the Market 3.3Market Equilibrium: Putting Demand and Supply Together 3.4The Effect of Demand and Supply Shifts on Equilibrium Where Prices Come From: The Interaction of Demand and Supply

2 of 46 Demand for tablet computers How many tablets do consumers want to buy? Affected by price of the tablets Affected by other factors, including prices of other goods Supply of tablet computers How many tablets are producers willing to sell? Affected by price of the tablets Affected by other factors, including prices of other goods What determines the price of a tablet computer?

3 of 46 Discuss the variables that influence demand. 3.1 LEARNING OBJECTIVE The Demand Side of the Market

4 of 46 Demand Schedule: Table showing how many of a product will be purchased at various prices. Demand Curve: Graphical representation of demand schedule. Price on y-axis. Quantity demanded on x-axis. Figure 3.1 Demand

5 of 46 Law of Demand: As price changes, quantity demanded changes in opposite direction, ceteris paribus. Implication: Demand curve slopes downward Ceteris Paribus: Latin phrase meaning “all else equal” Figure 3.1 Demand

6 of 46 Figure 3.2 A change in something other than price that affects demand causes the entire demand curve to shift. A shift to the right (D 1 to D 2 ) is an increase in demand. A shift to the left (D 1 to D 3 ) is a decrease in demand. Changes in demand

7 of 46 Figure 3.2 As the demand curve shifts, the quantity demanded is likely to change, even if the price doesn’t change. The quantity demanded changes at every possible price. P1P1 Q 3 Q 1 Q 2 Changes in demand

8 of 46 Income of consumers Increase in income increases demand if product is normal, decreases demand if product is inferior. Price of related goods Increase in price of related good increases demand if products are substitutes, decreases demand if products are complements Tastes and preferences Population and demographics Expected future prices What would cause a change in demand?

9 of 46 Normal goods: Goods for which the demand increases as income rises, and decreases as income falls Examples: Clothing Restaurant meals Vacations Inferior goods: Goods for which the demand decreases as income rises, and increases as income falls Examples: Second-hand clothing Ramen noodles Are tablet computers normal or inferior goods? Probably normal Effect of increase in income, if good is normal Effect of increase in income, if good is inferior Changes in demand: consumer incomes

10 of 46 Substitutes: Goods and services that can be used for the same purpose Examples: Big Mac and Whopper Ford F-150 and Dodge Ram Jeans and Khakis Complements: Goods and services that are consumed together Examples: Big Mac and McDonald’s fries Hot dogs and hot dog buns Left shoes and right shoes Effect on demand for Big Macs, if price of Whopper increases Effect on demand for Big Macs, if price of McDonald’s fries increases Changes in demand: Price of related goods

11 of 46 If consumers’ tastes or preferences change, they may buy more or less of the product Example: If consumers become more concerned about eating healthily, they might decrease their demand for fast food Effect on demand for fast food, if consumers want to eat healthy Increases in the number of people buying something will increase the amount demanded Example:An increase in the elderly population increases the demand for medical care Effect on demand for medical care, as the population ages Changes in demand: Tastes and preferences Changes in demand: Population and demographics

12 of 46 Consumers decide which products to buy and when to buy them. Future products are substitutes for current products An expected increase in the price tomorrow increases demand today. An expected decrease in the price tomorrow decreases demand today. Example: If you found out the price of gasoline would go up tomorrow, you would increase your demand today. Effect on today’s gasoline demand, if price will rise tomorrow Changes in demand: Expected future prices

13 of 46 Apple’s policy on speculation about future products Making the Connection Apple strongly discourages its employees from speculating about when a new model will appear. Why? Suppose a customer learns that a new iPad model will be available next month. The new model is a potential substitute for the current model The price of the current model will likely fall next month Both effects decrease current demand (bad for Apple!)

14 of 46 Figure 3.3 A change in the price of the product being examined causes a movement along the demand curve. This is a change in quantity demanded. Any other change affecting demand causes the entire demand curve to shift. This is a change in demand. Change in demand vs. change in quantity demanded

15 of 46 Discuss the variables that influence supply. 3.2 LEARNING OBJECTIVE The Supply Side of the Market

16 of 46 Figure 3.4 Supply Schedule: Table showing how many of a product will be available for purchase at various prices. Supply Curve: Graphical representation of supply schedule. Price on y-axis. Quantity demanded on x-axis. Supply schedule and supply curve

17 of 46 Figure 3.4 Law of Supply: As price changes, quantity supplied changes in the same direction, ceteris paribus. Implication: supply curve slopes upward Law of supply

18 of 46 Figure 3.5 A change in something other than price that affects supply causes the entire supply curve to shift. A shift to the right (S 1 to S 3 ) is an increase in supply. A shift to the left (S 1 to S 2 ) is a decrease in supply. Changes in supply

19 of 46 Figure 3.5 As the supply curve shifts, the quantity supplied is likely to change, even if the price doesn’t change. The quantity supplied changes at every possible price. P1P1 Q 2 Q 1 Q 3 Changes in supply

20 of 46 Price of inputs Technological change Prices of substitutes in production Number of firms in the market Expected future prices What would cause a change in supply?

21 of 46 Inputs are things used in the production of a good or service. Examples of inputs for tablet computers: Computer processor Plastic housing Labor An increase in the price of an input decreases the profitability of selling the good, causing a decrease in supply. A decrease in the price of an input increases the profitability of selling the good, causing an increase in supply. Effect of an increase in the price of input goods Effect of a decrease in the price of input goods Changes in supply: Price of inputs

22 of 46 A firm may experience a positive or negative change in its ability to produce output given a fixed amount of inputs. Examples: A new, more productive variety of wheat would increase the supply of wheat. Governmental restrictions on land use for agriculture might decrease the supply of wheat. Changes raise or lower firms’ costs, hence their supply of the good. Effect of a positive change in technology Effect of a negative change in technology Changes in supply: Technological change

23 of 46 Many firms can produce and sell more than one product. Example: An Illinois farmer can plant corn or soybeans. If the price of soybeans rises, he will plant (supply) less corn. Effect on the supply of corn, of an increase in the price of soybeans Effect of a increase in the number of firms More firms in the market will result in more product available at a given price (greater supply). Fewer firms → supply decreases. Changes in supply: Prices of substitutes in production Changes in supply: Number of firms in the market

24 of 46 If a firm anticipates the price of its product will be higher in the future, it might decrease its supply today in order to increase it in the future. What types of products could be “stored” like this? Non-perishable products Effect of an increase in future expected price of a good Changes in supply: Expected future prices

25 of 46 Figure 3.6 A change in the price of the product being examined causes a movement along the supply curve. This is a change in quantity supplied. Any other change affecting supply causes the entire supply curve to shift. This is a change in supply. Change in supply vs. change in quantity supplied

26 of 46 Use a graph to illustrate market equilibrium. 3.3 LEARNING OBJECTIVE Market Equilibrium: Putting Demand and Supply Together

27 of 46 Figure 3.8 If the price of a tablet is $600, consumers want to buy 4 million per month, while producers want to sell 6 million. This gives a surplus of 2 million tablets. Prediction: sellers will compete amongst themselves, driving the price down. Surplus

28 of 46 If the price of a tablet is $300, consumers want to buy 7 million per month, while producers want to sell 3 million. This gives a shortage of 4 million tablets. Prediction: sellers will realize they can increase the price and still sell as many tablets, so the price will rise. Shortage Figure 3.8

29 of 46 At a price of $500, consumers want to buy 5 million tablets, and producers want to sell 5 million. There is no reason for the price to change. Equilibrium price: $500 Equilibrium quantity: 5 million per month Figure 3.7 Market equilibrium

30 of 46 Price is determined by the interaction of buyers and sellers. Neither group can dictate price in a competitive market (i.e. one with many buyers and sellers). However changes in supply and/or demand will affect the price and quantity traded. Who determines price, buyers or sellers?

31 of 46 Use demand and supply graphs to predict changes in prices and quantities. 3.4 LEARNING OBJECTIVE The Effect of Demand and Supply Shifts on Equilibrium

32 of 46 Predictions about price and quantity in model require us to know supply and demand curves. Typically, we know price and quantity, but do not know the curves that generate them. The power of the supply and demand model is in its ability to predict directional changes in price and quantity traded. Usefulness of the supply and demand model

33 of 46 Toshiba enters the tablet computer market, introducing the Thrive. More tablets are available at any given price – an increase in supply from S 1 to S 2. Equilibrium price falls from P 1 to P 2. Equilibrium quantity rises from Q 1 to Q 2. The effect of shifts in supply on equilibrium Figure 3.9

34 of 46 Figure 3.9 The effect of shifts in supply on equilibrium By how much will price fall? By how much will quantity rise? We cannot say, without knowing more information. For now, we can only predict that price will fall and quantity traded will rise.

35 of 46 Figure 3.10 Consumer incomes increase. What happens to equilibrium in the tablet market? Tablets are normal goods, so as income rises, demand rises (D 1 to D 2 ). Equilibrium price rises (P 1 to P 2 ). Equilibrium quantity rises (Q 1 to Q 2 ). The effect of shifts in demand on equilibrium

36 of 46 Table 3.3 Supply Curve Unchanged Supply Curve Shifts to the Right Supply Curve Shifts to the Left Demand Curve Unchanged Q unchanged P unchanged Q ↑ P ↓ Q ↓ P ↑ Demand Curve Shifts to the RightQ ↑ P ↑ Demand Curve Shifts to the Left Q ↓ P ↓ Effects of shifts in demand and supply

37 of 46 The Falling Price of Blu-ray Players Making the Connection From 2006 to 2010, the price of Blu-ray players fell from almost $1000 to about $120, while the number of Blu-ray players traded increased dramatically. What best explains this change? A: Increase in demand B: Decrease in demand C: Increase in supply D: Decrease in supply Can you show this change on a supply-and-demand diagram?

38 of 46 The Falling Price of Blu-ray Players Making the Connection Supply increased as additional firms started manufacturing Blu- ray players and input costs fell.

39 of 46 Suppose supply and demand both increase. What does our model predict? S↑  ( P↓ and Q↑ ) D↑  ( P↑ and Q↑ ) So we can be sure equilibrium quantity will rise; but the effect on equilibrium price is not clear. Effect on price depends on how far each curve moves. In this graph, demand moves more than supply. Simultaneous shifts in supply and demand

40 of 46 Suppose supply and demand both increase. What does our model predict? S↑  ( P↓ and Q↑ ) D↑  ( P↑ and Q↑ ) So we can be sure equilibrium quantity will rise; but the effect on equilibrium price is not clear. Effect on price depends on how far each curve moves. In this graph, supply moves more than demand. Simultaneous shifts in supply and demand

41 of 46 Supply Curve Unchanged Supply Curve Shifts to the Right Supply Curve Shifts to the Left Demand Curve Unchanged Q unchanged P unchanged Q ↑ P ↓ Q ↓ P ↑ Demand Curve Shifts to the Right Q ↑ P ↑ Q ↑ P effect uncertain Q effect uncertain P ↑ Demand Curve Shifts to the Left Q ↓ P ↓ Q effect uncertain P ↓ Q ↓ P effect uncertain Effects of shifts in demand and supply

42 of 46 Over time, it is common for both supply and demand to shift. The stronger of the two effects will determine the overall change in price and quantity. In the Blu-ray example, demand for Blu-ray players increased from 2006 to But the supply effect was stronger. How can we tell? Because we know the price fell; if the demand effect were stronger, the price would have risen. Supply and demand shifts over time

43 of 46 Terminology: movement along the curve (caused by price change) vs. shifting the curve (caused by other changes). Not moving curves far enough to be able to illustrate a change. Exaggerating curve shifts is okay. Incompletely labeling diagrams. Use your arrows! Common misconceptions to avoid

44 of 46 Shifting a curve, then shifting another curve due to the resulting price change. The price change does not cause a further shift in demand or supply. Being certain of both price and quantity changes when both demand and supply curves move. Only one of these effects will be certain. Common misconceptions to avoid