Chapter 3 Supply and Demand 3-1 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter Objectives Define and explain demand in a product or service market Define and explain supply Determine the equilibrium point in the market for a specific good, given data on supply and demand at different price levels 3-2 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter Objectives Understand what causes shifts in demand and supply Understand how price ceilings cause shortages Understand how price floors cause surpluses 3-3 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

The schedule of quantities of a good or service that people are willing and able to buy at different prices –Sometimes a schedule is also called a table Demand Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. 3-4

Hypothetical Daily Demand for Coach Seats on Round- Trip Weekly Flights between Denver and Chicago Table 1 Price QD $500 1, , , , , , , , , Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

Hypothetical Daily Demand for Coach Seats on Round- Trip Weekly Flights between Denver and Chicago Table 1 Price QD $500 1, , , , , , , , , Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

Hypothetical Daily Demand for Coach Seats on Round- Trip Weekly Flights between Denver and Chicago Table 1 Price QD $500 1, , , , , , , , , Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

Hypothetical Daily Demand for Coach Seats on Round- Trip Weekly Flights between Denver and Chicago Table 1 Price QD $500 1, , , , , , , , , Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

Hypothetical Daily Demand for Coach Seats on Round- Trip Weekly Flights between Denver and Chicago Table 1 Price QD $500 1, , , , , , , , , Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

Hypothetical Daily Demand for Coach Seats on Round- Trip Weekly Flights between Denver and Chicago Table 1 Price QD $500 1, , , , , , , , , Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

Hypothetical Daily Demand for Coach Seats on Round- Trip Weekly Flights between Denver and Chicago Table 1 Price QD $500 1, , , , , , , , , Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

Hypothetical Daily Demand for Coach Seats on Round- Trip Weekly Flights between Denver and Chicago Table 1 Price QD $500 1, , , , , , , , , Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

Hypothetical Daily Demand for Coach Seats on Round- Trip Weekly Flights between Denver and Chicago Table 1 Price QD $500 1, , , , , , , , , Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

Hypothetical Daily Demand for Coach Seats on Round- Trip Weekly Flights between Denver and Chicago Table 1 Price QD $500 1, , , , , , , , , Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

Hypothetical Daily Demand for Coach Seats on Round- trip Weekly Flights between Denver and Chicago Table 1 Price QD $500 1, , , , , , , , , Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

Table 1 Price QD $500 1, , , , , , , , , Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. Table 1 is the Demand Schedule Figure 1 is the Graph of the Demand Schedule Figure 1 The line is the Demand Curve

Table 1 Price QD $500 1, , , , , , , , , Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. Figure 1 Price and Quantity Demanded are inversely related Quantity Demanded is a point on the Demand Curve

Table 1 Price QD $500 1, , , , , , , , , Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. Figure 1 Remember, Demand is the entire schedule or the entire curve Quantity Demanded is a point on the Demand Curve

Supply Is the “schedule” of quantities of a good or service that people are willing to sell at various prices 3-19 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3-20 Price QS $500 62,000 $450 59,000 $400 54,000 $350 48,000 $300 40,000 $250 30,000 $200 16,000 $150 7,000 $100 2,000 Supply is the entire schedule or the entire curve

Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved Price QS $500 62,000 $450 59,000 $400 54,000 $350 48,000 $300 40,000 $250 30,000 $200 16,000 $150 7,000 $100 2,000 Quantity Supplied is a point on the curve

Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved Price QS QD $500 62,000 1,000 $450 59,000 3,000 $400 54,000 7,000 $350 48,000 12,000 $300 40,000 19,000 $250 30,000 30,000 $200 16,000 45,000 $150 7,000 57,000 $100 2,000 67,000 Demand and Supply Curves Equilibrium price is the price where QD = QS We can find equilibrium price and quantity by seeing where the supply and demand curves cross

Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved Price QS QD $500 62,000 1,000 $450 59,000 3,000 $400 54,000 7,000 $350 48,000 12,000 $300 40,000 19,000 $250 30,000 30,000 $200 16,000 45,000 $150 7,000 57,000 $100 2,000 67,000 Demand and Supply Curves Equilibrium price = EP Market price = MP MP > EP there is a surplus Surpluses and Shortages 54,000-7,000 = 44,000

Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved Price QS QD $500 62,000 1,000 $450 59,000 3,000 $400 54,000 7,000 $350 48,000 12,000 $300 40,000 19,000 $250 30,000 30,000 $200 16,000 45,000 $150 7,000 57,000 $100 2,000 67,000 Demand and Supply Curves Equilibrium price = EP Market price = MP Surpluses and Shortages 54,000-7,000 = 44,000 A surplus would force sellers to lower their prices. Eventually, prices would fall back to the equilibrium price

Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved Price QS QD $500 62,000 1,000 $450 59,000 3,000 $400 54,000 7,000 $350 48,000 12,000 $300 40,000 19,000 $250 30,000 30,000 $200 16,000 45,000 $150 7,000 57,000 $100 2,000 67,000 Demand and Supply Curves Equilibrium price = EP Market price = MP Surpluses and Shortages 57,000-7,000 = 44,000 MP < EP here is a shortage

Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved Price QS QD $500 62,000 1,000 $450 59,000 3,000 $400 54,000 7,000 $350 48,000 12,000 $300 40,000 19,000 $250 30,000 30,000 $200 16,000 45,000 $150 7,000 57,000 $100 2,000 67,000 Demand and Supply Curves Equilibrium price = EP Market price = MP Surpluses and Shortages 57,000-7,000 = 44,000 A shortage would allow sellers to raise their prices. As prices increased people would buy less. Eventually, prices would move back to the equilibrium price

Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved Price QS QD $500 62,000 1,000 $450 59,000 3,000 $400 54,000 7,000 $350 48,000 12,000 $300 40,000 19,000 $250 30,000 30,000 $200 16,000 45,000 $150 7,000 57,000 $100 2,000 67,000 Demand and Supply Curves Surpluses and Shortages We can see that the forces of demand and supply work together to establish an equilibrium price at which there are no shortages or surpluses

Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved Table 4 Price QD 1 QD 2 $500 1,000 12, ,000 15, ,000 21, ,000 30, ,000 40, ,000 55, ,000 63, ,000 75, ,000 88,000 The schedule changes from QD1 to QD2 The demand curve shifts to the right from D 1 to D 2 This is an increase in demand

Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved Table 4 Price QD 1 QD 2 $500 1,000 12, ,000 15, ,000 21, ,000 30, ,000 40, ,000 55, ,000 63, ,000 75, ,000 88,000 The schedule changes from QD2 to QD1 The demand curve shifts to the left from D 2 to D 1 This is a decrease in demand

Price Quantity (in thousands) S D Shifts in Supply and Demand If the schedule changes the Supply curve shifts Supply decreases... the curve shifts to the left S 3-30 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

Price Quantity (in thousands) S D Shifts in Supply and Demand If the schedule changes the Supply curve shifts Supply increases... the curve shifts to the right S Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. 3-31

Price Quantity (in thousands) S1S1 D Shifts in Supply and Demand If the Supply curve is S 1 what is the equilibrium price and quantity? The equilibrium price is approximately 262 or 263 S2S2 The equilibrium quantity is approximately 35, Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

Price Quantity (in thousands) S1S1 D Shifts in Supply and Demand If the Supply curve changes to S 2 what is the new equilibrium price and quantity? The new equilibrium price is approximately 325 S2S2 The new equilibrium quantity is approximately 26, Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

Price Quantity (in thousands) S1S1 D Shifts in Supply and Demand Is a shift from S 1 to S 2 an increase or decrease in Supply? A decrease S2S2 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. 3-34

3-35 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. Price Floors and Ceilings The price can go no lower than the floor. A price floor creates a permanent surplus The surplus is the amount by which the quantity supplied is greater than the quantity demanded

3-36 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. Price Floors and Ceilings The price can go no higher than the ceiling. A price ceiling creates a permanent shortage The shortage is the amount by which the quantity demanded is greater than the quantity supplied

Applications of Supply and Demand Interest rates are set by –Supply and demand Wage rates are set by –Supply and demand Rents are determined by –Supply and demand Prices of nearly all goods are determined by –Supply and demand Prices of nearly all services are determined by –Supply and demand 3-37 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

3-38 Hypothetical Demand for and Supply of Loanable Funds We can see that $600 billion is lent (or borrowed) at an interest rate of 6% What would happen if the supply of loanable funds increased?

Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved Hypothetical Demand for and Supply of Loanable Funds The interest rate would decrease to 4% and the amount of money borrowed would increase to $800 billion

Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved Hypothetical Demand for and Supply of Loanable Funds If the demand for loanable funds rises to D 2 the interest rate would rise to 9% and the amount of money borrowed would rise to $700 billion

Price Mechanism ( The Forces of Supply & Demand) Operates an automatic guidance system –Sometimes this is called the “invisible hand” –Efficiently allocates the limited means of production toward the satisfaction of human wants –Provides consumers with an endless stream of goods and services In a sense, the price system has failed poor people –Many are working 50 or 60 hours a week, but they are still poor 3-41 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.