Chapter 3 ©2010  Worth Publishers Supply and Demand Slides created by Dr. Amy Scott

WAKE UP AND DON’T SMELL THE COFFEE Who decided to raise the prices of coffee beans? Nobody: prices went up because of events outside anyone’s control.  The main cause of rising bean prices was a significant decline in the supply of coffee beans from the world’s two leading coffee exporters: Brazil and Vietnam.  In this chapter, we lay out the pieces that make up the supply and demand model,, and show how this model can be used to understand how many markets behave.

Chapter Objectives 1.Competitive Market 2.Supply and demand model A.Demand curve B.The difference between movements along a curve and shifts of a curve C.Supply curve D.Equilibrium price and quantity as determined by supply and demand curves E.Shortage or surplus and how price moves the market back to equilibrium F.New equilibrium after shifts of the curves

Competitive Market  A competitive market is:  Has many buyers and sellers  Offers same good or service  No individual’s actions have a noticeable effect on the price at which the good or service is sold.  In other words: no one party can influence price  Behavior of this type of market is well described by Supply and Demand

Supply and Demand Model  The supply and demand model is a model of how a competitive market works.  It has five key elements:  Demand curve  Supply curve  Demand and supply curve shifts  Market equilibrium  Changes in the market equilibrium

Demand Curve  A demand curve is the graphical representation of the demand schedule;  it shows how much of a good or service consumers want to buy at any given price.  Law of Demand: A higher a price for a good, other things equal, leads people to demand smaller quantities of that good.

Demand Schedule  A demand schedule shows how much of a good or service consumers will want to buy at different prices Price of coffee beans (per pound) Quantity of coffee beans demanded (billions of pounds) $2.00 Demand Schedule for Coffee Beans

Demand Curve A demand curve is the graphical representation of the demand schedule; it shows how much of a good or service consumers want to buy at any given price $ Price of coffee bean (per gallon) Quantity of coffee beans (billions of pounds) Demand curve, D As price rises, the quantity demanded falls

An Increase in Demand  An increase in the population and other factors generate an increase in demand – a rise in the quantity demanded at any given price.  This is represented by the two demand schedules - one showing demand in 2002, before the rise in population, the other showing demand in 2009, after the rise in population in 2002in 2009 $ Price of coffee beans (per pound) Quantity of coffee beans demanded (billions of pounds) Demand Schedules for Coffee Beans

A shift of the demand curve is a change in the quantity demanded at any given price, represented by the change of the original demand curve to a new position, denoted by a new demand curve. Increase in population  more coffee drinkers Price of coffee beans (per gallon) $ D 1 D 2 Demand curve in 2009 Demand curve in 2002 Quantity of coffee beans (billions of pounds) An Increase in Demand

Movement Along the Demand Curve $ D 1 D 2 AC B A shift of the demand curve… … is not the same thing as a movement along the demand curve Price of coffee beans (per gallon) Quantity of coffee beans (billions of pounds) A movement along the demand curve is a change in the quantity demanded of a good that is the result of a change in that good’s price.

Shifts of the Demand Curve A “decrease in demand”, means a leftward shift of the demand curve: at any given price, consumers demand a smaller quantity than before. (D1  D3) Price Quantity D 3 D 1 D 2 Increase in demand Decrease in demand An “increase in demand” means a rightward shift of the demand curve: at any given price, consumers demand a larger quantity than before. (D1  D2)

Demand versus Quantity Demanded  A shift of the demand curve is a change in the quantity demanded at any given price, represented by the change of the original demand curve to a new position, denoted by a new demand curve.  A movement along the demand curve is a change in the quantity demanded of a good that is the result of a change in that good’s price.

What Causes a Demand Curve to Shift? 1.Changes in the Prices of Related Goods A. Substitutes: Two goods are substitutes if a fall in the price of one of the goods makes consumers less willing to buy the other good. Ex., Coke vs. Pepsi B. Complements: Two goods are complements if a fall in the price of one good makes people more willing to buy the other good. Ex., Hot dogs and Hot Dog buns

What Causes a Demand Curve to Shift? 2. Changes in Income A. Normal Goods: When a rise in income increases the demand for a good – that good is a normal good. B. Inferior Goods: When a rise in income decreases the demand for a good, it is an inferior good. 3. Changes in Tastes 4. Changes in Expectations 5. Changes in number of consumers

Individual Demand Curve and the Market Demand Curve The market demand curve is the horizontal sum of the individual demand curves of all consumers in that market. D Darla D Dino $ D Market (a) Darla’s Individual Demand Curve (b) Dino’s Individual Demand Curve (c) Market Demand Curve Price of coffee beans (per pound) Quantity of coffee beans (pounds)

Supply Curve  A supply curve is the graphical representation of the supply schedule;  it shows how much of a good or service producers are willing to sell at any given price.  Law of Supply: A higher price for a good, other things equal, the greater the quantities of that good is produced.

Supply Schedule A supply schedule shows how much of a good or service would be supplied at different prices. Supply Schedule for Coffee Beans Price of coffee beans (per pound) Quantity of coffee beans supplied (billions of pounds) $

Supply Curve Quantity of coffee beans (billions of pounds) Price of coffee beans (per pound) $ As price rises, the quantity supplied rises. A supply curve shows graphically how much of a good or service people are willing to sell at any given price. Supply curve, S

An Increase in Supply  The entry of Vietnam into the coffee bean business generated an increase in supply—a rise in the quantity supplied at any given price.  This event is represented by the two supply schedules—one showing supply before Vietnam’s entry, the other showing supply after Vietnam came in. Supply Schedule for Coffee Beans Price of coffee beans (per pound) Quantity of beans supplied (billions of pounds) Before entryAfter entry $

An Increase in Supply A shift of the supply curve is a change in the quantity supplied of a good at any given price. Vietnam enters coffee bean business  more coffee producers $ S 1 S 2 Price of coffee beans (per pound) Quantity of coffee beans (billions of pounds) … is not the same thing as a shift of the supply curve A movement along the supply curve…

Movement Along the Supply Curve Versus Shift of the Supply Curve A movement along the supply curve is a change in the quantity supplied of a good that is the result of a change in that good’s price $ S 1 S 2 A C B Price of coffee beans (per pound) Quantity of coffee beans (billions of pounds) … is not the same thing as a shift of the supply curve A movement along the supply curve…

Any “increase in supply” means a rightward shift of the supply curve: at any given price, there is an increase in the quantity supplied. (S1  S2) Shifts of the Supply Curve S 3 S 1 S 2 Price Quantity Decrease in supply Increase in supply Any “decrease in supply” means a leftward shift of the supply curve: at any given price, there is a decrease in the quantity supplied. (S1  S3)

1.Changes in input prices An input is a good that is used to produce another good. 2.Changes in the prices of related goods and services 3.Changes in technology 4.Changes in expectations 5.Changes in the number of producers What Causes a Supply Curve to Shift?

Individual Supply Curve and the Market Supply Curve The market supply curve is the horizontal sum of the individual supply curves of all firms in that market. S Figueroa S Bien Pho $ S Market (a) Mr. Figueroa’s Individual Supply Curve (b) Mr. Bien Pho’s Individual Supply Curve (c) Market Supply Curve Price of coffee beans (per pound) Quantity of coffee beans (pounds)

Supply, Demand and Equilibrium  Equilibrium in a competitive market is when quantity demanded = quantity supplied  The price at which this takes place is the equilibrium price (a.k.a. market-clearing price):  Every buyer finds a seller and vice versa.  The quantity of the good bought and sold at that price is the equilibrium quantity.

Market equilibrium occurs at point E, where the supply curve and the demand curve intersect. Price of coffee beans (per pound) Quantity of coffee beans (billions of pounds) $ Supply Demand E EquilibriumEquilibrium price Equilibrium quantity Market Equilibrium

Surplus and Shortage  Surplus of a good is when quantity supplied > quantity demanded. Surpluses occur when the price is above its equilibrium level.  Shortage of a good is when quantity demanded > quantity supplied Shortages occur when the price is below its equilibrium level.

There is a surplus of a good when the quantity supplied exceeds the quantity demanded. Surpluses occur when the price is above its equilibrium level $ Supply Demand E Surplus Quantity demanded Quantity supplied Price of coffee beans (per pound) Quantity of coffee beans (billions of pounds) Surplus

$ Supply Demand E Shortage Quantity demanded Quantity supplied Price of coffee beans (per pound) Quantity of coffee beans (billions of pounds) There is a shortage of a good when the quantity demanded exceeds the quantity supplied. Shortages occur when the price is below its equilibrium level. Shortage

Equilibrium and Shifts of the Demand Curve Q 2 Q 1 P 2 P 1 D 2 Supply D 1 E 2 E 1 Price of coffee beans Quantity of coffee beans Price rises Quantity rises An increase in demand… … leads to a movement along the supply curve due to a higher equilibrium price and higher equilibrium quantity

Equilibrium and Shifts of the Supply Curve P 2 P 1 Q 1 Q 2 Demand E 1 S 1 S 2 E 2 Price of coffee beans Quantity of coffee beans Price rises Quantity falls A decrease in supply… … leads to a movement along the demand curve due to a higher equilibrium price and lower equilibrium quantity

Simultaneous Shifts of Supply and Demand Two opposing forces determining the equilibrium quantity. The increase in demand dominates the decrease in supply. Quantity of coffee Q 2 Q 1 P 2 P 1 S 2 D 2 D 1 S 1 E 1 E 2 ( a) One possible outcome: Price Rises, Quantity Rises Price of coffee Small decrease in supply Large increase in demand New equilibrium depends on the magnitude of the shifts

Simultaneous Shifts of Supply and Demand Two opposing forces determining the equilibrium quantity. Q 1 Q 2 P 2 P 1 S 2 D 2 D 1 S 1 E 1 E 2 (b) Another Possibility Outcome: Price Rises, Quantity Falls Price of coffee Quantity of coffee Large decrease in supply Small increase in demand

Simultaneous Shifts of Supply and Demand We can make the following predictions about the outcome when the supply and demand curves shift simultaneously: Simultaneous Shifts of Supply and Demand Supply IncreasesSupply Decreases Demand Increases Price: ambiguous Quantity: up Price: up Quantity: ambiguous Demand Decreases Price: down Quantity: ambiguous Price: ambiguous Quantity: down

1.The supply and demand model illustrates how a competitive market works. 2.The demand schedule shows the quantity demanded at each price and is represented graphically by a demand curve. The law of demand says that demand curves slope downward. 3.A movement along the demand curve occurs when a price change leads to a change in the quantity demanded. When economists talk of increasing or decreasing demand, they mean shifts of the demand curve—a change in the quantity demanded at any given price. 1 of 4 Summary

4.There are five main factors that shift the demand curve: 1. A change in the prices of related goods or services 2. A change in income 3. A change in tastes 4. A change in expectations 5. A change in the number of consumers 5.The market demand curve for a good or service is the horizontal sum of the individual demand curves of all consumers in the market. 6.The supply schedule shows the quantity supplied at each price and is represented graphically by a supply curve. Supply curves usually slope upward. 2 of 4 Summary

7. A movement along the supply curve occurs when a price change leads to a change in the quantity supplied. When economists discuss increasing or decreasing supply, they mean shifts of the supply curve—a change in the quantity supplied at any given price. 8. There are five main factors that shift the supply curve: A change in input prices A change in the prices of related goods and services A change in technology A change in expectations A change in the number of producers 9. The market supply curve for a good or service is the horizontal sum of the individual supply curves of all producers in the market. 3 of 4 Summary

10.The supply and demand model is based on the principle that the price in a market moves to its equilibrium price, (market- clearing price), the price at which the quantity demanded = quantity supplied. This quantity is the equilibrium quantity. When the price is above its market-clearing level, there is a surplus that pushes the price down. When the price is below its market-clearing level, there is a shortage that pushes the price up. 11.An increase in demand increases both the equilibrium price and the equilibrium quantity; a decrease in demand has the opposite effect. An increase in supply reduces the equilibrium price and increases the equilibrium quantity; a decrease in supply has the opposite effect. 12.Shifts of the demand curve and the supply curve can happen simultaneously. 4 of 4 Summary