Demand and Supply Introduction to Economics

TM 4-2 Copyright © 1998 Addison Wesley Longman, Inc. Learning Objectives Distinguish between a money price and a relative price Explain the main influences on demand Explain the main influences on supply Explain how prices and quantities bought and sold are determined by demand and supply

TM 4-3 Copyright © 1998 Addison Wesley Longman, Inc. Learning Objectives (cont.) Explain why some prices fall, some rise, and some fluctuate Use demand and supply to make predictions about price changes

TM 4-4 Copyright © 1998 Addison Wesley Longman, Inc. Learning Objectives Distinguish between a money price and a relative price Explain the main influences on demand Explain the main influences on supply Explain how prices and quantities bought and sold are determined by demand and supply

TM 4-5 Copyright © 1998 Addison Wesley Longman, Inc. Price and Opportunity Cost Price is the number of monetary units (euros, dollars, leva, yens, etc.) that must be given up in exchange for an item — this is referred to as the money price. The ratio of one price to another is referred to as the relative price. Relative prices are opportunity costs.

TM 4-6 Copyright © 1998 Addison Wesley Longman, Inc. Price and Opportunity Cost Relative Prices price index Supply and demand determines relative prices. “Price falling” means the price falls relative to the average price of other goods and services.

TM 4-7 Copyright © 1998 Addison Wesley Longman, Inc. The Price of Wheat

TM 4-8 Copyright © 1998 Addison Wesley Longman, Inc. Learning Objectives Distinguish between a money price and a relative price Explain the main influences on demand Explain the main influences on supply Explain how prices and quantities bought and sold are determined by demand and supply

TM 4-9 Copyright © 1998 Addison Wesley Longman, Inc. Demand If a person demands something, they: Want it. Can afford it. Have made a definite plan to buy it. Wants are the unlimited desires or wishes that people have for goods and services.

TM 4-10 Copyright © 1998 Addison Wesley Longman, Inc. Demand The quantity demanded of a good or service is the amount that consumers plan to buy during a given time period at a particular price.

TM 4-11 Copyright © 1998 Addison Wesley Longman, Inc. Demand What determines buying plans? The price of the good The prices of related goods Expected future prices Income Population Preferences

TM 4-12 Copyright © 1998 Addison Wesley Longman, Inc. Demand The Law of Demand Other things remaining the same, the higher the price of a good, the smaller is the quantity demanded. Reasons for the Law of Demand Substitution Effect Income Effect

TM 4-13 Copyright © 1998 Addison Wesley Longman, Inc. Demand Demand Curve and Demand Schedule Demand curves show the relationship between the quantity demanded of a good and its price (ceteris paribus). Demand schedules list the quantities demanded at each different price (ceteris paribus).

TM 4-14 Copyright © 1998 Addison Wesley Longman, Inc. Demand a19 a19 b26 b26 c34 c34 d43 d43 e52 e52 PriceQuantity (dollars per CD)(millions of CD’s per week)

TM 4-15 Copyright © 1998 Addison Wesley Longman, Inc. Demand e d c b a Quantity (millions of CD’s per week) Price (dollar per CD) Demand for CDs

TM 4-16 Copyright © 1998 Addison Wesley Longman, Inc. Demand A Change in Demand When any factor that influences buying plans other than the price of the good changes, there is a change in demand. An increase in demand causes the demand curve to shift rightward. A decrease in demand causes the demand curve to shift leftward.

TM 4-17 Copyright © 1998 Addison Wesley Longman, Inc. A Change in Demand Price of Related Goods Substitutes - goods used in the place of another good Complements - goods used in conjunction with another good What Happens to Demand if the price of a substitute good increases? A complement?

TM 4-18 Copyright © 1998 Addison Wesley Longman, Inc. A Change in Demand Expected Future Prices If the price of a good is expected to rise in the future, people buy more of the good now. If the price of a good is expected to fall in the future, people buy less of the good now.

TM 4-19 Copyright © 1998 Addison Wesley Longman, Inc. A Change in Demand Income Normal Goods — demand increases as income increases Inferior Goods (lower quality) — demand decreases as income increases

TM 4-20 Copyright © 1998 Addison Wesley Longman, Inc. A Change in Demand Population Size and age structure Preferences Attitudes toward goods and services

TM 4-21 Copyright © 1998 Addison Wesley Longman, Inc. Original demand schedule New demand schedule Walkman $200Walkman $50 Price Quantity (dollars per CD) (millions of CD’s per week) a1 9 Price (dollars per CD) (millions of CDs per week) b2 6 c3 4 d4 3 e5 2 Assume the original price of Walkmans is $200. The demand schedule shows the Price-Quantity relationship for CDs.

TM 4-22 Copyright © 1998 Addison Wesley Longman, Inc. Original demand schedule New demand schedule Walkman $200Walkman $50 Price Quantity (dollars per CD) (millions of CDs per week) a1 9 Price (dollars per CD) (millions of CDs per week) b2 6 c3 4 d4 3 e5 2 a' 1 13 b' 2 c' 3 d' 4 e'

TM 4-23 Copyright © 1998 Addison Wesley Longman, Inc. Demand Quantity (millions of CDs per week) Price (dollar per CD) e d c b a Demand for CDs (Walkman $200) e' d' c' b' a' Demand for CDs (Walkman $50)

TM 4-24 Copyright © 1998 Addison Wesley Longman, Inc. The Demand for Tapes The Law of Demand The quantity of CDs demanded Decreases if: The price of a CD rises. Increases if: The price of a CD falls.

TM 4-25 Copyright © 1998 Addison Wesley Longman, Inc. The Demand for CDs Changes In Demand The demand for CDs Decreases if: The price of a substitute falls. The price of a complement rises. Income falls (a CD is a normal good). The population decreases. The price of a CD is expected to fall in the future.

TM 4-26 Copyright © 1998 Addison Wesley Longman, Inc. The Demand for CDs Changes In Demand The demand for CDs Increases if: The price of a substitute rises. The price of a complement falls. Income rises (a CD is a normal good). The population increases. The price of a CD is expected to rise in the future.

TM 4-27 Copyright © 1998 Addison Wesley Longman, Inc. A Change in the Quantity Demanded Versus a Change in Demand A movement along a demand curve, which results from a change in price, shows a change in the quantity demanded. If some other influence on buyers’ plans changes, holding price constant, there is a change in demand.

TM 4-28 Copyright © 1998 Addison Wesley Longman, Inc. A Change in the Quantity Demanded Versus a Change in Demand Quantity Price D1D1 D2D2 Decrease in quantity demanded Increase in quantity demanded D0D0 Increase in demand Decrease in demand

TM 4-29 Copyright © 1998 Addison Wesley Longman, Inc. Learning Objectives Distinguish between a money price and a relative price Explain the main influences on demand Explain the main influences on supply Explain how prices and quantities bought and sold are determined by demand and supply

TM 4-30 Copyright © 1998 Addison Wesley Longman, Inc. Supply If a firm supplies a good or service, the firm Has the resources and technology to produce it. Can profit from producing it. Has made a definite plan to produce it and sell it.

TM 4-31 Copyright © 1998 Addison Wesley Longman, Inc. Supply The quantity supplied of a good or service is the amount that producers plan to sell during a given time period at a particular price.

TM 4-32 Copyright © 1998 Addison Wesley Longman, Inc. Supply What determines selling plans? The price of the good. The prices of resources used to produce the good. The prices of related goods produced. Expected future prices. The number of suppliers. Technology.

TM 4-33 Copyright © 1998 Addison Wesley Longman, Inc. Supply The Law of Supply Other things remaining the same, the higher the price of a good, the greater is the quantity supplied.

TM 4-34 Copyright © 1998 Addison Wesley Longman, Inc. Supply Supply Curve and Supply Schedule Supply curves show the relationship between the quantity supplied of a good and its price (ceteris paribus). Supply schedules list the quantities supplied at each different price (ceteris paribus).

TM 4-35 Copyright © 1998 Addison Wesley Longman, Inc. Supply a10a10 b23b23 c34c34 d45d45 e56e56 PriceQuantity (dollars per CD) (millions of CDs per week)

TM 4-36 Copyright © 1998 Addison Wesley Longman, Inc. Supply Quantity (millions of CDs per week) Price (dollar per CD) Supply of CDs a b c de

TM 4-37 Copyright © 1998 Addison Wesley Longman, Inc. Supply A Change in Supply When any factor that influences selling plans other than the price of the good changes, there is a change in supply. An increase in supply causes the supply to shift rightward. A decrease in supply causes the supply curve to shift leftward.

TM 4-38 Copyright © 1998 Addison Wesley Longman, Inc. A Change in Supply Price of Productive Resources Price of Related Goods Produced Substitutes in Production Complements in Production Expected Future Prices

TM 4-39 Copyright © 1998 Addison Wesley Longman, Inc. A Change in Supply The Number of Suppliers Technology

TM 4-40 Copyright © 1998 Addison Wesley Longman, Inc. Supply Original supply scheduleNew supply schedule Old technology New technology Price Quantity (dollars per CD) (millions of CDs per week) a1 0 Price (dollars per CD) (millions of CDs per week) b2 3 c3 4 d4 5 e5 6 a' 1 3 b' 2 c' 3 d' 4 e'

TM 4-41 Copyright © 1998 Addison Wesley Longman, Inc. Supply Quantity (millions of CDs per week) Price (dollar per CD) a e d c b Supply of CDs (new technology) a' b' c' d' e' Supply of CDs (old technology)

TM 4-42 Copyright © 1998 Addison Wesley Longman, Inc. The Supply of Tapes The Law of Supply The quantity of CDs supplied Decreases if: The price of a CD falls. Increases if: The price of a CD rises.

TM 4-43 Copyright © 1998 Addison Wesley Longman, Inc. The Supply of Tapes Changes In Supply The supply of CDs Decreases if: The price of a resource used to produce CDs rises. The number of CD producers decreases. The price of a substitute in production rises.

TM 4-44 Copyright © 1998 Addison Wesley Longman, Inc. The Supply of CDs Changes In Supply The supply of CDs (cont.) Decreases if: The price of a complement in production falls. The price of a CD is expected to rise in the future.

TM 4-45 Copyright © 1998 Addison Wesley Longman, Inc. The Supply of CDS Changes In Supply The supply of CDs Increases if: The price of a resource used to produce CDs falls. More efficient technologies for producing CDs are discovered. The number of CD producers increases.

TM 4-46 Copyright © 1998 Addison Wesley Longman, Inc. The Supply of CDs Changes In Supply The supply of CDs (cont.) Increases if: The price of a substitute in production falls. The price of a complement in production rises. The price of a CD is expected to fall in the future.

TM 4-47 Copyright © 1998 Addison Wesley Longman, Inc. A Change in the Quantity Supplied Versus a Change in Supply A movement along a supply curve, which results from a change in price, shows a change in the quantity supplied. If some other influence on sellers’ plans changes, holding price constant, there is a change in supply.

TM 4-48 Copyright © 1998 Addison Wesley Longman, Inc. A Change in the Quantity Supplied Versus a Change in Supply Quantity Price S0S0 S0S0 S1S1 S2S2 Increase in supply Decrease in Increase in quantity supplied Decrease in quantity supplied

TM 4-49 Copyright © 1998 Addison Wesley Longman, Inc. Learning Objectives Distinguish between a money price and a relative price Explain the main influences on demand Explain the main influences on supply Explain how prices and quantities bought and sold are determined by demand and supply

TM 4-50 Copyright © 1998 Addison Wesley Longman, Inc. Market Equilibrium Equilibrium in a market occurs when the price balances the plans of buyers and sellers. Equilibrium price is the price at which quantity demanded equals quantity supplied. Equilibrium quantity is the quantity bought and sold at the equilibrium price.

TM 4-51 Copyright © 1998 Addison Wesley Longman, Inc. Market Equilibrium Price as a Regulator If the price is too low, quantity demanded exceeds quantity supplied. If the price is too high, quantity supplied exceeds quantity demanded.

TM 4-52 Copyright © 1998 Addison Wesley Longman, Inc. Market Equilibrium Quantity Quantity Shortage(–) Price demanded supplied or surplus(+) (dollars per CD) (millions of CDS per week)

TM 4-53 Copyright © 1998 Addison Wesley Longman, Inc. Market Equilibrium Quantity Quantity Shortage(–) Price demanded supplied or surplus(+) (dollars per CD) (millions of CDs per week)

TM 4-54 Copyright © 1998 Addison Wesley Longman, Inc. Market Equilibrium Quantity (millions of CDs per week) Price (dollar per CD) Supply of CDs Demand for CDs Equilibrium Shortage of 3 million CDs at $2 a CD Surplus of 2 million CDs at $4 a CD

TM 4-55 Copyright © 1998 Addison Wesley Longman, Inc. Market Equilibrium Price Adjustments A shortage forces the price up. A surplus forces the price down. Such price changes are mutually beneficial to both buyers and sellers.

TM 4-56 Copyright © 1998 Addison Wesley Longman, Inc. Learning Objectives (cont.) Explain why some prices fall, some rise, and some fluctuate Use demand and supply to make predictions about price changes

TM 4-57 Copyright © 1998 Addison Wesley Longman, Inc. Predicting Changes in Price and Quantity A Change in Demand What would happen to the price and quantity of CDs if the price of a Walkman falls from $200 to $50?

TM 4-58 Copyright © 1998 Addison Wesley Longman, Inc. The Effects of a Change in Demand Quantity demanded Price (millions of CDs per week) (dollars Quantity supplied per CD ) Walkman $200 Walkman $50 (millions of CDs per week)

TM 4-59 Copyright © 1998 Addison Wesley Longman, Inc. Quantity demanded Price (millions of CDs per week) (dollars Quantity supplied per CD ) Walkman $200 Walkman $50 (millions of CDs per week) The Effects of a Change in Demand

TM 4-60 Copyright © 1998 Addison Wesley Longman, Inc. The Effects of a Change in Demand Quantity (millions of CDs per week) Price (dollar per CD) Supply of CDs Demand for tapes (Walkman $50) Demand for tapes (Walkman $200)

TM 4-61 Copyright © 1998 Addison Wesley Longman, Inc. A Change in Demand Prediction When demand increases, both the price and quantity increase. When demand decreases, both the price and quantity decrease.

TM 4-62 Copyright © 1998 Addison Wesley Longman, Inc. Predicting Changes in Price and Quantity A Change in Supply What would happen to the price and quantity of CDs if a new cost-saving production technology was developed?

TM 4-63 Copyright © 1998 Addison Wesley Longman, Inc. The Effects of a Change in Supply Quantity supplied Price (millions of CDs per week) (dollars Quantity demanded old new per CD ) (millions of CDs per week) technology technology

TM 4-64 Copyright © 1998 Addison Wesley Longman, Inc. The Effects of a Change in Supply Quantity supplied Price (millions of CDs per week) (dollars Quantity demanded old new per CD ) (millions of CDs per week) technology technology

TM 4-65 Copyright © 1998 Addison Wesley Longman, Inc. The Effects of a Change in Supply Quantity (millions of CDs per week) Price (dollar per CD) Supply of CDs (old technology) Demand for CDs Supply of CDs (new technology)

TM 4-66 Copyright © 1998 Addison Wesley Longman, Inc. A Change in Supply Prediction When supply increases, the quantity increases and the price falls. When demand decreases, the quantity decreases and the price falls

TM 4-67 Copyright © 1998 Addison Wesley Longman, Inc. Predicting Changes in Price and Quantity A Change in Both Demand and Supply What would happen if both demand and supply change together?

TM 4-68 Copyright © 1998 Addison Wesley Longman, Inc. Original Quantities New Quantities (millions of CDs per week) (millions of CDs per week) Price Quantity Quantity Quantity Quantity (dollars demanded supplied demanded supplied per CD ) Walkman old Walkman new $200 technology $50 technology The Effects of an Increase in Both Demand and Supply

TM 4-69 Copyright © 1998 Addison Wesley Longman, Inc. The Effects of an Increase in Both Demand and Supply Original Quantities New Quantities (millions of CDs per week) (millions of CDs per week) Price Quantity Quantity Quantity Quantity (dollars demanded supplied demanded supplied per tape ) Walkman old Walkman new $200 technology $50 technology

TM 4-70 Copyright © 1998 Addison Wesley Longman, Inc. Demand for CDs (Walkman $50) The Effects of an Increase in Both Demand and Supply Quantity (millions of CDs per week) Price (dollar per CD) Supply of CDs (new technology) Demand for CDs (Walkman $200) Supply of CDs (old technology)

TM 4-71 Copyright © 1998 Addison Wesley Longman, Inc. A Change in Both Demand and Supply Prediction When both demand and supply increase, the quantity increases and the price decreases, or remains constant. When both demand and supply decreases, the quantity decreases and the price increases, decreases, or remains constant.

TM 4-72 Copyright © 1998 Addison Wesley Longman, Inc. The Effects of an Decrease in Demand and an Increase in Supply Original Quantities New Quantities (millions of CDs per week) (millions of CDs per week) Price Quantity Quantity Quantity Quantity (dollars demanded supplied demanded supplied per CD) MP3 player old MP3 player new $400 technology $200 technology

TM 4-73 Copyright © 1998 Addison Wesley Longman, Inc. The Effects of an Decrease in Demand and an Increase in Supply Original Quantities New Quantities (millions of tapes per week) (millions of tapes per week) Price Quantity Quantity Quantity Quantity (dollars demanded supplied demanded supplied per CD ) MP3 player old MP3 player new $400 technology $200 technology

TM 4-74 Copyright © 1998 Addison Wesley Longman, Inc. Demand for CDs (MP3 player $400) The Effects of an Decrease in Demand and an Increase in Supply Quantity (millions of CDs per week) Price (dollar per CD) Supply of CDs (new technology) Demand for CDs (MP3 player $200) Supply of CDs (old technology)

TM 4-75 Copyright © 1998 Addison Wesley Longman, Inc. The Effects of an Decrease in Demand and an Increase in Supply Prediction When demand decreases and supply increases, the price falls and the quantity increases, decreases, or remains constant. When demand increases and supply decreases, the price rises and the quantity increases, decreases, or remains constant.

TM 4-76 Copyright © 1998 Addison Wesley Longman, Inc. Market EQUILIBRIUM Supply Quantity supplied (Q s ) Price (p) Demand P* Q* Market equilibrium 0

TM 4-77 Copyright © 1998 Addison Wesley Longman, Inc. 7 S P Q o $ D surplus Market SURPLUS

TM 4-78 Copyright © 1998 Addison Wesley Longman, Inc S P Q o $ D Corn deficit Market DEFICIT