Chapter 3 Supply and Demand

Outline The Demand Curve for Oil Consumer Surplus What Shifts the Demand Curve? The Supply Curve for Oil Producer Surplus What Shifts the Supply Curve?

Definition Demand Curve: Quantity Demanded: A function that shows the quantity demanded at different prices. Quantity Demanded: The quantity that buyers are willing and able to buy at a particular price.

Demand Demand for Oil Price Quantity Demanded $55 5 $20 25 $5 50 This table shows demand for oil - the quantities demanded at different prices. The data can be used to construct a demand curve.

Demand Curve Quantity Demanded Price Price of oil per barrel $55 5 $20 25 $5 50 Quantity of oil (MBD)

Tyler Cowen and Alex Tabarrok Figure 3-3 (3-3): The Demand for Oil Depends on the Value of Oil in Different Uses (Top photo: ssuaphotos/Shutterstock) (Bottom: Lew Robertson/Corbis) Tyler Cowen and Alex Tabarrok Modern Principles: Macroeconomics, Third Edition / Modern Principles of Economics, Third Edition Copyright © 2015 by Worth Publishers

Reading a Demand Curve A Demand Curve Can Be Read: Horizontally: At a given price, how much are people willing to buy? Vertically: What are people willing to pay for a given quantity?

Reading a Demand Curve Figure 3-2 (3-2): Reading a Demand Curve in Two Different Ways (LEFT) HORIZONTAL: At $20 per barrel, buyers are willing to buy 25m barrels of oil per day.

Reading a Demand Curve Figure 3-2 (3-2): Reading a Demand Curve in Two Different Ways (RIGHT) VERTICAL: The maximum price that buyers are willing to pay to purchase 25m barrels per day is $20 per barrel.

Self-Check What quantity is demanded at $15? 10. 50. 75. Answer: b. 50

Self-Check At what price would 100 be demanded? $5. $1. $10. Answer: a. $5

Law of Demand A demand curve is negatively sloped. The lower the price, the greater the quantity demanded. Demand summarizes how consumers choose to use a good, given their preferences and the possibilities for substitution.

Law of Demand .

Law of Demand For example, when the price of oil is high, consumers will use it only in its most valuable uses (e.g., gasoline and jet fuel). As the price falls, consumers will also use oil in its less valued uses (heating and rubber duckies). Consumers will buy more oil at lower prices than at higher prices.

Definition Consumer Surplus: The consumer’s gain from exchange, or the difference between the maximum price a consumer is willing to pay for a certain quantity and the market price.

Definition Total Consumer Surplus: Consumer Surplus: The area beneath the demand curve and above the price. Consumer Surplus: The consumer’s gain from exchange, or the difference between the maximum price a consumer is willing to pay for a certain quantity and the market price.

Total consumer surplus with a linear demand curve Figure 3-4 (3-4): Total Consumer Surplus Is the Area Beneath the Demand Curve and Above the Price Total consumer surplus with a linear demand curve

Self-Check What is total consumer surplus if market price is $10? $500. $700. $1400. 70 x ($30-$10) 2 Answer: b. $700 70

Shifting the Demand Curve An increase in demand shifts the demand curve to the right. At the same price, people are willing to buy more. At the same quantity, people are willing to pay a higher price.

Shifting the Demand Curve Price of oil/barrel An Increase in Demand Willing to pay a higher price for same quantity. $50 Willing to buy more at the same price. $25 New Demand To illustrate the idea that has different values in different uses, we pick three types of consumers of oil: The president of the U.S. – It doesn’t really matter what the price of fuel is. Air force one will fly. Delta airlines – there are no substitutes for petroleum based fuel for airlines. Frank who is a retired senior citizen – He can choose to stay home or take local bus service. Old Demand 70 140 Quantity of Oil (MBD)

Shifting the Demand Curve Decrease in demand – shifts the demand curve to the left. At the same price, people are willing to buy less. At the same quantity, people are willing to pay a lower price.

Shifting the Demand Curve Price of oil/barrel A Decrease in Demand Willing to buy less at the same price. $50 Willing to pay a lower price for the same quantity $25 Old Demand To illustrate the idea that has different values in different uses, we pick three types of consumers of oil: The president of the U.S. – It doesn’t really matter what the price of fuel is. Air force one will fly. Delta airlines – there are no substitutes for petroleum based fuel for airlines. Frank who is a retired senior citizen – He can choose to stay home or take local bus service. New Demand 62 74 Quantity of Oil (MBD)

Demand Shifters Factors That Shift Demand: Income Population Price of substitutes Price of complements Expectations Tastes

Demand Shifters 1. Income When people get richer, they buy more stuff. When an increase in income increases the demand for a good, it is a normal good. Most goods are normal goods. When an increase in income decreases the demand for a good, it is an inferior good.

Inferior Goods

Self-Check If iPads are a normal good, when incomes increase, the demand curve for iPads will: Shift to the right. Shift to the left. Not change. Answer: a Higher incomes increase demand for a normal good, shifting the demand curve to the right.

Demand Shifters 2. Population An increase in population will increase demand generally. A shift in subpopulations will change the demand for specific goods and services.

Demand Shifters 3. Prices of Substitutes A substitute is a good that can be consumed instead of another good. A decrease in the price of a substitute will decrease demand for the other good.

Self-Check If orange juice and apple juice are substitutes, an increase in the price of orange juice will: Increase demand for apple juice. Decrease demand for apple juice. Not affect demand for apple juice.

Self-Check If orange juice and apple juice are substitutes, an increase in the price of orange juice will: Answer: a – increase demand for apple juice. A higher price for orange juice will cause some people to substitute the now lower-priced apple juice. This increases the demand for apple juice.

Demand Shifters 4. Prices of Complements Complements are things that go well together. A drop in the price of a complement increases demand for the complementary good.

Demand Shifters 5. Expectations 6. Tastes The expectation of a reduction in future supply increases the demand today. 6. Tastes Changes in tastes caused by fads, fashions, and advertising can all increase or decrease demand.

Supply Curve Quantity Supplied Price Price of oil per barrel $55 50 $20 30 $5 10 Quantity of oil (MBD)

Reading a Supply Curve A Supply Curve Can Be Read: Horizontally: At a given price, how much are suppliers willing to sell? Vertically: To produce a given quantity, what price must sellers be paid?

Definition Supply Curve: Quantity Supplied: A function that shows the quantity supplied at different prices. Quantity Supplied: The quantity that sellers are willing and able to sell at a particular price.

Law of Supply Figure 3-9 (3-9): The Supply Curve for Oil Top photo: Dan Lamont/Corbis Bottom: Bettmann/Corbis As the price of oil rises, it becomes profitable to extract from more costly sources. As the price rises, the quantity supplied increases.

Self-Check At what price will producers be willing to supply 50 units? $10. $20. $30. Answer: a - $10

Definition Producer Surplus: The producer’s gain from exchange, or the difference between the market price and the minimum price at which a producer would be willing to sell a particular quantity.

Definition Total Producer Surplus: The area above the supply curve and below the price.

Producer Surplus Figure 3-10 (3-10): Total Producer Surplus Is the Area Above the Supply Curve and Below the Price

Shifting the Supply Curve Increase in Supply - shifts the supply curve to the right. At the same price producers are willing to sell more. At the same quantity, producers are willing to accept a lower price

Shifting the Supply Curve Price of oil/barrel Increase in supply $60 Old supply New supply 40 Greater quantity supplied at the same price Willing to accept a lower price for the same quantity 18 Quantity of Oil (MBD) 60 80

Shifting the Supply Curve Decrease in supply – shifts the supply curve to the left. At the same price sellers will offer less. At the same quantity, sellers demand a higher price.

Shifting the Supply Curve Price of oil/barrel Decrease in supply New supply Old supply $50 Higher price required for the same quantity $28 Smaller quantity supplied at the same price Quantity of Oil (MBD) 20 60

Supply Shifters Factors That Shift Supply: Technological innovations and changes in the price of inputs Taxes and subsidies Expectations Entry or exit of producers Changes in opportunity costs

Supply Shifters 1. Technological Innovations Improvements in technology can reduce costs, thus increasing supply. A reduction in input prices also reduces costs and thus has a similar effect. Examples: computers, TVs, cars, etc

Supply Shifters 2. Taxes and Subsidies A tax on output has the same effect as an increase in costs. A subsidy is the reverse of a tax. Figure 3-12 (3-12): A Tax on Industry Output Shifts the Supply Curve Up by the Amount of the Tax

Supply Shifters Figure 3-12 (3-12): A Tax on Industry Output Shifts the Supply Curve Up by the Amount of the Tax

Supply Shifters 3. Expectations Suppliers who expect prices to increase will store goods for future sale and sell less today. The expectation of a future price increase therefore decreases current supply. Supply curve shifts to the left.

Supply Shifters 3. Expectations A change in producers’ expectations about profitability will affect supply curves Windmill production increases as producers expect sales and profitability to increase.

Supply Shifters 4. Entry or Exit of Producers The entry of new producers increases supply, shifting the curve down and to the right. Figure 3-14 (3-14): Entry Increases Supply

Supply Shifters 5. Changes in Opportunity Costs An increase in opportunity costs shifts the supply curve up and to the left. If the price of wheat increases, the opportunity cost of growing soybeans increases. Some farmers will shift away from producing soybeans and start producing wheat.

Supply Shifters 5. Changes in Opportunity Costs The supply curve for soybeans will shift up and to the left. Figure 3-15 (3-15): Higher (Opportunity) Costs Reduce Supply

Self-Check Suppose a new technology reduces the time it takes to assemble a car. How would this affect the supply of cars? Shift supply to the right. Shift supply to the left. It would have no effect on supply.

Self-Check Suppose a new technology reduces the time it takes to assemble a car. How would this affect the supply of cars? Answer: a – producers would be able to supply more cars at the current price, shifting the supply curve to the right.

Takeaway A demand curve shows how customers respond to higher prices by buying less, and to lower prices by buying more. A supply curve shows how producers respond to higher prices by producing more, and to lower prices by producing less. The difference between market price and the maximum a consumer is willing to pay is the consumer’s gain from exchange or consumer surplus.

Takeaway The difference between market price and the minimum price which a producer is willing to accept is the producer’s gain from exchange, or producer surplus. An increase in demand means that buyers want a greater quantity at the same price or, equivalently, they are willing to pay a higher price for the same quantity.

Takeaway An increase in supply means that sellers are willing to sell a greater quantity at the same price or, equivalently, they are willing to sell a given quantity at a lower price.

Sources "Coffee with Cream and Sugar (6703560771)" by TheCulinaryGeek from Chicago, USA - Coffee with Cream and SugarUploaded by the wub. Licensed under CC BY 2.0 via Wikimedia Commons - http://commons.wikimedia.org/wiki/File:Coffee_with_Cream_and_Sugar_(6703560771).jpg#mediaviewer/File:Coffee_with_Cream_and_Sugar_(6703560771).jpg "Oh Henry bar". Via Wikimedia Commons - http://commons.wikimedia.org/wiki/File:Oh_Henry_bar.jpg#mediaviewer/File:Oh_Henry_bar.jpg "Kinderchocolate" by Thegreenj - Own work. Licensed under CC BY-SA 3.0 via Wikimedia Commons - http://commons.wikimedia.org/wiki/File:Kinderchocolate.jpg#mediaviewer/File:Kinderchocolate.jpg