Chapter 5 Price: The Role of Supply and Demand © 2001 South-Western College Publishing

2 Law of Demand The quantity purchased of a good or service is inversely related to the price, all other things being equal

3 Quantity Demanded vs. Demand Quantity Demanded: The quantities of a good or service that people will purchase at a specific price over a given period of time. Demand: A schedule of the total quantities of a good or service that purchasers will buy at different prices at a given time

4 Demand 4 Individual demand: –quantity of a good or service that an individual or firm stands ready to buy at various prices at a given time 4Market demand: –sum of the individual demands in the marketplace

5 Demand Schedule/Demand Curve 4 Demand Schedule: –table showing the various quantities of a good or service that will be purchased at various prices 4 Demand Curve: –curve that indicates the number of units of a good or service that consumers will buy at various prices at a given time

6 Demand Curve for Internet Time $ Quantity (millions of hours) Price per Hour D

7 Changes in Demand 4 Change in Quantity Demanded: –Movement along the demand curve that occurs because the price of the product has changed 4 Change in Demand: –Change in the amounts of the product that would be purchased at the same given prices; a shift in the entire demand curve

8 Quantity (millions of hours) Demand Curves for Internet Time $ Price per Hour D D2D2 D1D1

9 Supply 4 Supply: The total quantities of a good or service that sellers stand ready to sell at different prices at a given time 4 Individual Supply: Quantities offered for sale at various prices at a given time by an individual seller 4 Market Supply: Sum of the individual supply schedules in the marketplace

10 Supply 4 Supply Schedule: Table showing the various quantities of a good or service that sellers will offer at various prices at a given time 4 Supply Curve: Line showing the number of units of a good or service that will be offered for sale at different prices at a given time

11 Law of Supply The quantity offered by sellers of a good or service is directly related to price, all things being equal.

12 Changes in Supply 4 Change in the Quantity Supplied: Movement along the supply curve that occurs because the price of the product has changed 4 Change in Supply: A change in the amount of the product that would be offered for sale at the same given price; a shift of the entire supply curve

13 Quantity (millions of hours) Supply Curves for Internet Time $ Price per Hour S S2S2 S1S1

14 Determinants of Supply 4 Changes in the cost of resources 4 Technology 4 Expectations of future prices 4 Prices of related products

15 Equilibrium Price The price at which the quantity demanded equals the quantity supplied

16 Quantity (millions of hours) Demand, Supply, and Market Price for Internet Time $ Price per Hour Supply Demand E

17 Quantity (millions of hours) Surplus, Shortage, and Equilibrium for Internet Time $ Price per Hour Supply Demand E Surplus Shortage

18 Alternate Supply and Demand Positions D D1D1 S P Q/t P D S S1S1 Demand Increases (D becomes D 1 ) Demand Decreases (D 1 becomes D) Supply Increases (S becomes S 1 ) Supply Decreases (S 1 becomes S)

19 Price Ceiling Government mandated maximum price that can be charged for a good or a service

20 Effects of a Price Ceiling on Rental Housing ,000 30,000 40,000 Shortage D S E Monthly Price ($) Quantity (housing units)

21 Price Floor Government mandated minimum price that can be charged for a good or a service

22 Effects of a Price Floor on Wheat , , ,000 Surplus D S Price per bushel ($) Quantity (bushels)

23 Price Elasticity of Demand Measure of the sensitivity or responsiveness of quantity demanded to a change in price –Formula method –Total revenue method

24 D 2 Quantity/Time Demand Curve Showing Different Elasticities $ ,600 2,000 2,400 Price D D D 1

25 Formula Method

26 Unit Elastic Demand Demand that exists when a percentage change in price causes an equal percentage change in quantity demanded – has an elasticity coefficient equal to 1.0

27 Elastic Demand Demand that exists when a percentage change in price causes a greater percentage change in quantity demanded –has an elastic coefficient greater than 1.0

28 Inelastic Demand Demand that exists when a percentage change in price causes a smaller percentage change in quantity demanded –has an elasticity coefficient less than 1.0

29 Total Revenue Method 4 If price changes and total revenue is constant, unit elasticity of demand exists 4 If price changes and total revenue moves in the opposite direction, demand is elastic 4 If price changes and total revenue moves in the same direction, demand is inelastic

30 Characteristics Affecting Price Elasticity of Demand Trend Toward Elastic Demand 4 Luxuries 4 Large expenditures 4 Durable goods 4 Substitute goods 4 Multiple uses Trend Toward Inelastic Demand 4 Necessities 4 Small expenditures 4 Perishable goods 4 Complementary goods 4 Limited uses

31 D1D1 Three Demand Curves Showing Different Elasticities P PP Q/t D2D2 D3D3 (a) (b)(c) Perfectly Elastic Perfectly Inelastic Perfectly Unit Elastic

32 Quantity/Time Demand Curve Showing Different Elasticities $ Price Elastic demand Unit Elastic Inelastic demand

33 Other Types of Elasticity 4 Cross elasticity of demand 4 Income elasticity of demand 4 Price elasticity of supply

34 Cross Elasticity of Demand Measure of the responsiveness of the quantity demanded of one product as a result of a change in the price of another product

35 Income Elasticity of Demand Measure of the responsiveness of the quantity demanded to a change in income

36 Price Elasticity of Supply Measure of the responsiveness of the quantity supplied to a change in price

37 Time and Elasticity of Supply - Intermediate P1P2P1P2 Q Q/t D1D1 S D P

38 Time and Elasticity of Supply - Short Run P2PP2P Q Q 2 Q/t D1D1 S D P

39 Time and Elasticity of Supply - Long Run P3PP3P Q Q 3 Q/t D1D1 S D P

40 Effects of a Tax on Cigarettes D S Price per Pack ($) D S Quantity (millions of packs) Quantity (millions of packs) S + $ S + $1 e e R R Price per Pack ($)