© OnlineTexts.com p. 1 Chapter 3 Supply and Demand

© OnlineTexts.com p. 2 The Law of Demand The law of demand holds that other things equal, as the price of a good or service rises, its quantity demanded falls. –The reverse is also true: as the price of a good or service falls, its quantity demanded increases. The law of demand holds that other things equal, as the price of a good or service rises, its quantity demanded falls. –The reverse is also true: as the price of a good or service falls, its quantity demanded increases.

© OnlineTexts.com p. 3 Demand Curve The demand curve has a negative slope, consistent with the law of demand.

© OnlineTexts.com p. 4 The Law of Supply The law of supply holds that other things equal, as the price of a good rises, its quantity supplied will rise, and vice versa. Why do producers produce more output when prices rise? –They seek higher profits –They can cover higher marginal costs of production The law of supply holds that other things equal, as the price of a good rises, its quantity supplied will rise, and vice versa. Why do producers produce more output when prices rise? –They seek higher profits –They can cover higher marginal costs of production

© OnlineTexts.com p. 5 Supply Curve The supply curve has a positive slope, consistent with the law of supply.

© OnlineTexts.com p. 6 Equilibrium In economics, an equilibrium is a situation in which: –there is no inherent tendency to change, –quantity demanded equals quantity supplied, and –the market just clears. Explain - In economics, an equilibrium is a situation in which: –there is no inherent tendency to change, –quantity demanded equals quantity supplied, and –the market just clears. Explain -

© OnlineTexts.com p. 7 Equilibrium Equilibrium occurs at a price of $3 and a quantity of 30 units.

© OnlineTexts.com p. 8 Shortages and Surpluses A shortage occurs when quantity demanded exceeds quantity supplied. Draw and Label –A shortage implies the market price is too low. A surplus occurs when quantity supplied exceeds quantity demanded. Draw and Label –A surplus implies the market price is too high. A shortage occurs when quantity demanded exceeds quantity supplied. Draw and Label –A shortage implies the market price is too low. A surplus occurs when quantity supplied exceeds quantity demanded. Draw and Label –A surplus implies the market price is too high.

 The “Invisible Hand” - the market forces of S + D will push the price up or down to equilibrium Explain the “Invisible Hand” -  The “Invisible Hand” - the market forces of S + D will push the price up or down to equilibrium Explain the “Invisible Hand” - © OnlineTexts.com p. 9

© OnlineTexts.com p. 10 Shift vs. Movement in the Demand Curve A change in any variable other than price that influences quantity demanded produces a shift in the demand curve or a change in demand. If the Price changes – then it is just a movement along the curve = change in QD Know the difference : Change in QD vs. Change in D A change in any variable other than price that influences quantity demanded produces a shift in the demand curve or a change in demand. If the Price changes – then it is just a movement along the curve = change in QD Know the difference : Change in QD vs. Change in D

Factors that shift the demand curve include: –Change in consumer incomes (normal / inferior) –Population change (# of buyers) –Consumer preferences (Taste) –Prices of related goods: Substitutes: goods consumed in place of one another Complements: goods consumed jointly Factors that shift the demand curve include: –Change in consumer incomes (normal / inferior) –Population change (# of buyers) –Consumer preferences (Taste) –Prices of related goods: Substitutes: goods consumed in place of one another Complements: goods consumed jointly © OnlineTexts.com p. 11

© OnlineTexts.com p. 12 Shift in the Demand Curve This demand curve has shifted to the right. Quantity demanded is now higher at any given price.

© OnlineTexts.com p. 13 Equilibrium After a Demand Shift The shift in the demand curve moves the market equilibrium from point A to point B, resulting in a higher price and higher quantity. **Careful: What Came First? The Chicken or the Egg? Many people will get confused after the shift in D. They see a higher price and increase in Q and then ask…”why are we buying more if the P went up?”…....but need to understand that the Price was a result of a change in the Demand and not the other way.

Practice with Demand If income increases and the good is “normal”…. If income increases and the good is “inferior”…. If income decreases and the good is “normal”… If income decreases and the good is “inferior”… If income increases and the good is “normal”…. If income increases and the good is “inferior”…. If income decreases and the good is “normal”… If income decreases and the good is “inferior”… © OnlineTexts.com p. 14

Practice with Demand If the number of buyers increases….. If the number of buyers decreases….. If consumers tastes change in favor of a good…. If consumers tastes change away from a good… If the number of buyers increases….. If the number of buyers decreases….. If consumers tastes change in favor of a good…. If consumers tastes change away from a good… © OnlineTexts.com p. 15

Practice with Demand If Price of good x increases – what happens to good y (substitute) If Price of good x decreases – what happens to good y (substitute) If Price of good x increases – what happens to good y (complement) If the price of good x decreases – what happens to good y (complement) If Price of good x increases – what happens to good y (substitute) If Price of good x decreases – what happens to good y (substitute) If Price of good x increases – what happens to good y (complement) If the price of good x decreases – what happens to good y (complement) © OnlineTexts.com p. 16

© OnlineTexts.com p. 17 Shift vs. Movement in the Supply Curve A change in any variable other than price that influences quantity supplied produces a shift in the supply curve or a change in supply. If the Price changes – then it is just a movement along the curve = change in QS Know the difference : Change in QS vs. Change in S A change in any variable other than price that influences quantity supplied produces a shift in the supply curve or a change in supply. If the Price changes – then it is just a movement along the curve = change in QS Know the difference : Change in QS vs. Change in S

Factors that shift the supply curve include: –Change in input costs –Increase in technology (or increase in # of resources) (or destruction) –Change in size of the industry (# of sellers) Factors that shift the supply curve include: –Change in input costs –Increase in technology (or increase in # of resources) (or destruction) –Change in size of the industry (# of sellers) © OnlineTexts.com p. 18

© OnlineTexts.com p. 19 Shift in the Supply Curve For an given price, quantity supplied is now lower than before.

© OnlineTexts.com p. 20 Equilibrium After a Supply Shift The shift in the supply curve moves the market equilibrium from point A to point B, resulting in a higher price and lower quantity. **Careful: What Came First? The Chicken or the Egg? Many people will get confused after the shift in S. They see a higher price and decrease in Q and then ask…”why are we selling less more if the P went up?”…....but need to understand that the Price was a result of a change in the Supply and not the other way.

Practice with Supply If input prices rise……. If input prices fall….. If there is new technology ….or increase in amount of resources …… If there is natural disaster or the depletion of a resource…. If input prices rise……. If input prices fall….. If there is new technology ….or increase in amount of resources …… If there is natural disaster or the depletion of a resource…. © OnlineTexts.com p. 21

Practice with Supply If the number of sellers increase …. If the number of sellers decrease…. If the number of sellers increase …. If the number of sellers decrease…. © OnlineTexts.com p. 22

© OnlineTexts.com p. 23 Price Ceilings & Floors A price ceiling is a legal maximum that can be charged for a good. –Results in a shortage of a product (Binding) –Common examples include apartment rentals and credit cards interest rates. A price floor is a legal minimum that can be charged for a good. –Results in a surplus of a product (Binding) –Common examples include soybeans, milk, minimum wage A price ceiling is a legal maximum that can be charged for a good. –Results in a shortage of a product (Binding) –Common examples include apartment rentals and credit cards interest rates. A price floor is a legal minimum that can be charged for a good. –Results in a surplus of a product (Binding) –Common examples include soybeans, milk, minimum wage

© OnlineTexts.com p. 24 Price Ceiling A price ceiling is set at $2 resulting in a shortage of 20 units. Binding vs. Non Binding

© OnlineTexts.com p. 25 Price Floor A price floor is set at $4 resulting in a surplus of 20 units. Binding vs. Non Binding 5 Why set a Price floor if sellers now sell less ? Look at total revenue