Chapter 3: Demand and Supply

Demand vs. Quantity Demanded Demand is the amount of a product that people are willing to purchase at each possible price during a given period of time. The quantity demanded is the amount of a product that people are willing and able to purchase at one, specific price. Prices are the tools by which the market coordinates individual desires. Eg 100 PCs for $10??

3.1 The Law of Demand Law of demand – there is an inverse relationship between price and quantity demanded. –Quantity demanded rises as price falls, other things constant. –Quantity demanded falls as prices rise, other things constant. Eg. Drop PC price

The Law of Demand What accounts for the law of demand? –People tend to substitute for goods whose price has gone up eg. butter and margarine –Relative price: the price of one product in terms of another product eg. If hot fudge sundaes are $2 while CDs are $14, then a CD costs 7 sundaes

The Law of Demand What accounts for the law of demand? –Money price: the actual amount paid for product

The Demand Table The demand table assumes all the following: –As price rises, quantity demanded declines. –Quantity demanded has a specific time dimension to it. –All the products involved are identical in shape, size, quality, etc.

The Demand Table The demand table assumes all the following: –The schedule assumes that everything else is held constant.

From a Demand Table to a Demand Curve You plot each point in the demand table on a graph and connect the points to derive the demand curve.

The Demand Curve The demand curve is the graphic representation of the law of demand. The demand curve slopes downward and to the right. As the price goes up, the quantity demanded goes down.

D Price (per unit) 0 Quantity demanded (per unit of time) PAPA QAQA A A Sample Individual Demand Curve

Price per DVDs (in dollars) A Demand Curve Quantity of DVDs demanded (per week) $ E D C BF A From a Demand Table to a Demand Curve Price per cassette ABCDEABCDE A Demand Table DVD rentals demanded per week $ Demand for DVDs G

Other Things Constant Other things constant places a limitation on the application of the law of demand. –All other factors that affect quantity demanded are assumed to remain constant, whether they actually remain constant or not. ie. Ceteris Paribas

Individual versus Market Demand Curves A market demand curve is the (horizontal) sum of all individual demand curves. –This is determined by adding the individual demand curves of all the demanders. Eg everyone’s demand for chocolate bars

Individual and Market Demand Curves Market: all of the arrangements between buyers and sellers to exchange a product for money, goods etc.

From Individual Demands to a Market Demand Curve (1) Price per cassette $ (2) Alice’s demand (3) Bruce’s demand (2) Cathy’s demand (3) Market demand ABCDEFGHABCDEFGH Cathy Bruce Alice D A C E F G Quantity of cassettes demanded per week 2 $ Price per cassette (in dollars) B Market demand

Demand refers to a schedule of quantities of a good that will be bought per unit of time at various prices, other things constant. Graphically, it refers to the entire demand curve. 3.2 Shifts in Demand

A shift in demand is the graphical representation of the effect of anything other than price on demand. Shifts in Demand

D0D0 D1D1 Shift in Demand Price (per unit) Quantity demanded (per unit of time) 100 $2 $1 200 B A Change in demand (a shift of the curve) 250

Determinants of Demand Tastes Income Inferior and Normal Goods Income Inferior and Normal Goods Number of buyers Expectations Prices of related goods Substitutes and Compliments Prices of related goods Substitutes and Compliments

Income An increase in income will increase demand for normal goods. Eg. cars An increase in income will decrease demand for inferior goods. Eg. beans

Price of Other Goods When the price of a substitute good falls, demand falls for the good whose price has not changed. When the price of a complement good falls, demand rises for the good whose price has not changed.

Tastes A change in taste will change demand with no change in price.

Expectations If you expect your income to rise, you may consume more now. If you expect prices to fall in the future, you may put off purchases today.

Taxes and Subsidies Taxes levied on consumers increase the cost of goods to consumers, thereby reducing demand. Subsidies have an opposite effect.

Quantity demanded refers to a specific amount that will be demand per unit of time at a specific price. Graphically, it refers to a specific point on the demand curve. Changes in Demand versus Movements Along a Demand Curve

A movement along a demand curve is the graphical representation of the effect of a change in price on the quantity demanded. Changes in Demand versus Movements Along a Demand Curve

Change in Quantity Demanded D1D1 Change in quantity demanded (a movement along the curve) B 0 Price (per unit) Quantity demanded (per unit of time) 100 $2 $1 200 A

Changes in Demand and Quantity Demanded Change in Quantity Demanded - movement along the same demand curve in response to a price change. Change in Demand - shift in entire demand curve in response to a change in a determinant of demand (a ceteris paribus variable)

3.3 The Law of Supply There is a direct relationship between price and quantity supplied. –Quantity supplied rises as price rises, other things constant. –Quantity supplied falls as price falls, other things constant. –Supply: amount of a product the firm is willing to sell at various prices

Law of Supply –As the price of a product rises, producers will be willing to supply more. –The height of the supply curve at any quantity shows the minimum price necessary to induce producers to supply that next unit to market.

The Law of Supply The law of supply is accounted for by two factors: –When prices rise, firms substitute production of one good for another. –Assuming firms’ costs are constant, a higher price means higher profits.

The Supply Curve The supply curve is the graphic representation of the law of supply. The supply curve slopes upward to the right. The slope tells us that the quantity supplied varies directly – in the same direction – with the price.

S A Quantity supplied (per unit of time) 0 Price (per unit) PAPA QAQA A Sample Supply Curve

Individual and Market Supply Curves The market supply curve is derived by horizontally adding the individual supply curves of each supplier.

From Individual Supplies to a Market Supply Quantities Supplied ABCDEFGHIABCDEFGHI (1) Price (per DVD) (2) Ann's Supply (5) Market Supply (4) Charlie's Supply $ (3) Barry's Supply

From Individual Supplies to a Market Supply Price per DVD CharlieBarry Ann Quantity of DVDs supplied (per week) $ I H G F E D C B A Market Supply CACA

3.4 Shifts in Supply Supply refers to a schedule of quantities a seller is willing to sell per unit of time at various prices, other things constant.

If the amount supplied is affected by anything other than a change in price, there will be a shift in supply. Shifts in Supply

Shift in supply – the graphic representation of the effect of a change in a factor other than price on supply. Shifts in Supply

Shift in Supply Price (per unit) Quantity supplied (per unit of time) S0S0 Shift in Supply (a shift of the curve) S1S1 $15 AB 1,2501,500

Shift Factors of Supply Other factors besides price affect how much will be supplied: –Prices of inputs used in the production of a good. –Technology. –Suppliers’ expectations. –Taxes and subsidies.

Factors that Shift Supply Supply Resource Prices Technology And Productivity Expectations Of Producers Number Of Producers Prices of Related Goods and Services

Price of Inputs (Resource Prices) When costs go up, profits go down, so that the incentive to supply also goes down.

Technology Advances in technology reduce the number of inputs needed to produce a given supply of goods. Costs go down, profits go up, leading to increased supply.

Expectations If suppliers expect prices to rise in the future, they may store today's supply to reap higher profits later.

Number of Suppliers As more people decide to supply a good the market supply increases (Rightward Shift).

Taxes and Subsidies When taxes go up, costs go up, and profits go down, leading suppliers to reduce output. When government subsidies go up, costs go down, and profits go up, leading suppliers to increase output.

Decrease in Supply Change in supply (a shift of the curve) Price (per unit) Quantity supplied (per unit of time) S0S0 $15 1,2501,500 S1S1

Increase in Supply Change in supply (a shift of the curve) Price (per unit) Quantity supplied (per unit of time) S1S1 $15 1,2501,500 S0S0

Change in quantity supplied (a movement along the curve) Change in Quantity Supplied Price (per unit) Quantity supplied (per unit of time) S0S0 $15 A 1,2501,500 B

Changes in price cause changes in quantity supplied represented by a movement along a supply curve. Changes in anything else eg income, taxes, subsidies etc...results in shifts in supply curve Shifts in Supply Versus Movements Along a Supply Curve

3.5 Putting Supply and Demand Together Equilibrium is a concept in which opposing dynamic forces cancel each other out.

Equilibrium In a free market, the forces of supply and demand interact to determine equilibrium quantity and equilibrium price.

Equilibrium Equilibrium price – the price toward which the invisible hand drives the market. Equilibrium quantity – the amount bought and sold at the equilibrium price.

What Equilibrium Isn’t Equilibrium isn’t a state of the world, it is a characteristic of a model. Equilibrium isn’t inherently good or bad, it is simply a state in which dynamic pressures offset each other.

What Equilibrium Isn’t When the market is not in equilibrium, you get either excess supply or excess demand, and a tendency for price to change.

The Graphical Interaction of Supply and Demand

A Price per DVD $ S D Quantity of DVDs supplied and demanded C Excess demand Excess supply E

The Graphical Interaction of Supply and Demand When price is $3.50 each, quantity supplied equals 7 and quantity demanded equals 3. The excess supply of 4 pushes price down.

The Graphical Interaction of Supply and Demand When price is $1.50 each, quantity supplied equals 3 and quantity demanded equals 7. The excess demand of 4 pushes price up.

The Graphical Interaction of Supply and Demand When price is $2.50 each, quantity supplied equals 5 and quantity demanded equals 5. There is no excess supply or excess demand, so price will not rise or fall.

Equilibrium (Graph)

Excess Supply Excess supply – a surplus, the quantity supplied is greater than quantity demanded Prices tend to fall.

Excess Demand Excess demand – a shortage, the quantity demanded is greater than quantity supplied Prices tend to rise.

Price Adjusts The greater the difference between quantity supplied and quantity demanded, the more pressure there is for prices to rise or fall.

Price Adjusts Equilibrium price: when quantity demanded equals quantity supplied, prices have no tendency to change.

3.6 Shifts in Supply and Demand Shifts in either supply or demand change equilibrium price and quantity.

Increase in Demand An increase in demand creates excess demand at the original equilibrium price. The excess demand pushes price upward until a new higher price and quantity are reached.

Price (per DVDs) A S0S0 Quantity of DVDs (per week) $ Excess demand D1D1 Increase in Demand D0D0 B

The Effects of a Shift of the Demand Curve

Decrease in Supply A decrease in supply creates excess demand at the original equilibrium price. The excess demand pushes price upward until a new higher price and lower quantity are reached.

A Decrease in Supply Price (per DVDs) Quantity of DVDs (per week) $ D0D0 S1S1 S0S0 C B Excess demand

Price (per DVDs) A S0S0 Quantity of DVDs (per week) $ D1D1 Increase in Demand and Supply D0D0 B S1S1

A Decrease in Supply and Increase in Demand Price (per DVDs) Quantity of DVDs (per week) $ D0D0 S1S1 S0S0 B D1D1

A Price Floor

Rent Controls