c h a p t e r three © 2007 Prentice Hall Business Publishing; Essentials of Economics R. Glenn Hubbard, Anthony Patrick O’Brien Prepared by: Fernando & Yvonn Quijano Where Prices Come From: The Interaction of Demand and Supply

© 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 28 After studying this chapter, you should be able to: Discuss the variables that influence demand. Discuss the variables that influence supply. Use a graph to illustrate market equilibrium. Use demand and supply graphs to predict changes in prices and quantities. Carly Fiorina How Hewlett-Packard Manages the Demand for Printers LEARNING OBJECTIVES … Because of the importance of printers to Hewlett-Packard, the company devotes significant resources to monitoring and forecasting consumer demand

© 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 28 The Demand Side of the Market The Demand of an Individual Buyer LEARNING OBJECTIVE 1 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 4 of 28 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 Kate’s Demand Schedule and 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 5 of 28 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 6 of 28 The Demand Side of the Market The Law of Demand The Law of Demand Holding everything else constant, when the price of a product falls, the quantity demanded of the product will increases, 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 7 of 28 The Demand Side of the Market Total Substitution Income Effect Effect Effect

© 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 28 The Demand Side of the Market Type Substitution Income Total Good Effect Effect Effect Normal Inferior Giffen Giffen good is the only exception to the law of demand. Price of Good X increases

© 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 9 of 28 The Demand Side of the Market Holding Everything Else Constant: The Ceteris Paribus Condition Ceteris paribus (“all else equal”) The requirement that when analyzing the relationship between two variables—such as price and quantity demanded—other variables must be held constant.

© 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 10 of 28 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 11 of 28 The Demand Side of the Market Variables That Shift Market Demand Variables That Shift Market Demand Curves 3 - 1

© 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 28 The Demand Side of the Market Variables That Shift Market Demand Variables That Shift Market Demand Curves (continued)

© 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 28 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 14 of 28 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. LEARNING OBJECTIVE 2 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 15 of 28 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 16 of 28 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 17 of 28 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 18 of 28 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.  Prices of substitutes in production  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 19 of 28 The Supply Side of the Market Variables That Shift Supply Variables That Shift Market Supply Curves 3 - 2

© 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 20 of 28 The Supply Side of the Market Variables That Shift Supply Variables That Shift Market Supply Curves (continued)

© 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 21 of 28 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 3 - 9

© 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 28 Market Equilibrium: Putting Demand and Supply Together LEARNING OBJECTIVE 3 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 28 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 24 of 28 LEARNING OBJECTIVE 4 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 25 of 28 The Falling Price of Large Flat-Screen Televisions Corning’s breakthrough spurred the manufacture of LCD televisions in Taiwan, South Korea, and Japan, and an eventual decline in 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 26 of 28 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 27 of 28 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 28 of 28 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