2. Why did the price of coffee soar in 2010 and 2011?

3. 4
Demand and Supply
CHAPTER CHECKLIST
When you have completed your study of this chapter, you will be able to
1 Distinguish between quantity demanded and demand, and explain what determines demand.
2 Distinguish between quantity supplied and supply, and explain what determines supply.
3 Explain how demand and supply determine price and quantity in a market, and explain the effects of changes in demand and supply.
Notes and teaching tips: 4, 6, 7, 8, 26, 29, 37, 50, 51, 55, 57, 58, and 60.
To view a full-screen figure during a class, click the red “expand” button.
To return to the previous slide, click the red “shrink” button.
To advance to the next slide, click anywhere on the full screen figure.
To enhance your lecture, check out the Lecture Launchers, Land Mines, and Class Activities in the Instructor’s Manual.

4. COMPETITIVE MARKETS
A market is any arrangement that brings buyers and sellers together.
A market might be a physical place or a group of buyers and sellers spread around the world who never meet.
Launch your first lecture on demand and supply by using a story made famous by Milton Friedman. Ask the class if someone has a regular pencil. Have a student hold up the pencil and ask the class to think about how that pencil got into this student’s hand: someone grew and harvested a tree, someone made the graphite center, someone grew the rubber that made the eraser, someone made the brass eraser holder, someone made the yellow paint, and someone assembled all these bits. Shippers, wholesalers, and a retailer all played a part in getting that pencil to your student’s hand. Emphasize that no one told anyone that this student wanted a pencil. Markets did all this work. Use this example of the power of the market to segue into the study of demand and supply.

5. COMPETITIVE MARKETS
In this chapter, we study a competitive market that has so many buyers and so many sellers that no individual buyer or seller can influence the price.

6. 4.1 DEMAND
Quantity demanded is the amount of a good, service, or resource that people are willing and able to buy during a specified period at a specified price.
The quantity demanded is an amount per unit of time. For example, the amount per day or per month.
Don’t dive right in by drawing a demand-supply graph on the board.
Tease the ideas out of the students with one of these exercises:
Quick exercise to generate demand curve: Pick a good (say a slice of pizza) and propose that a person would be willing to buy one slice at a price of $4. Now pick a student and ask the student if you reduced the price to $3 a slice, how much pizza would he or she be willing to buy. Next ask the same student how much he or she would buy at $2 per slice and then ask about $1 a slice. It is helpful for you to pick the initial price and quantity so the student has a starting point for the subsequent choices. You are then guaranteed an easy-to-graph relationship between price and quantity. Do this same experiment for one or two more students. Use the data provided by your volunteer students by collecting the demand schedule on the board. Graph the resulting demand curve, explicitly labeling the axes. Make the point that as the price of a slice falls the students are willing to buy more slices, and that as the price of a slice rises the students are willing to buy fewer slices. Then inform the students that they have just “discovered” the law of demand! Finally, use the demand curve by moving between several points on the curve. Emphasize that these “movements along the demand curve” are a change in the quantity demanded and are the result of changes in the price of a slice of pizza.

7. Law of Demand 4.1 DEMAND Other things remaining the same,
If the price of the good rises, the quantity demanded of that good decreases.
If the price of the good falls, the quantity demanded of that good increases.
Experiment to generate demand curve (needs about 30 minutes): Of the hundreds of classroom experiments that are available today, very few are worth the time they take to conduct. The classic demand-revealing experiment is one of the most productive and worthwhile ones. Bring to class 2 bottles of ice-cold, ready-to-drink, Coke or bottled water or sports drink. (If your class is very large, bring 6 bottles). Tell the students that you have these drinks and ask them to indicate if they would like one. Most hands will go up and you are now ready to make two points:
(i) The students have just revealed a want but not a demand.
(ii) You don’t have enough bottles to satisfy their wants, so you need an allocation mechanism. Ask the students to suggest some allocation mechanisms. You might get suggestions such as: give them to the oldest, the youngest, the tallest, the shortest, the first-to-the-front-of-the-class. For each one, point out the difficulty/inefficiency/inequity.
If no one suggests selling them to the highest bidder, tell the class that you are indeed going to do just that. Tell them that this auction is real.
The winner will get the drink and will pay. Ask for a show of hands of those who have some cash and can afford to buy a drink. Explain that these indicate an ability to buy but not a definite plan to buy. Begin the auction. Appoint a student to count hands (more than one for a big class) and appoint another student to keep a spreadsheet (see the Parkin Website for a sample that you can download).
[continued on next slide note]

8. Demand Schedule and Demand Curve
Demand is the relationship between the quantity demanded and the price of a good when all other influences on buying plans remain the same.
Demand is illustrated by a demand schedule and a demand curve.
Begin at a low price: say 10¢ a bottle and count the number willing to buy. Raise the price in 10¢ increments and keep tally of the number who are willing to buy at each price.
When the number willing to buy equals the number of bottles you have for sale, do the transactions. (If you make a profit, and you might do so, tell the students that the profit, small though it is, will go the department fund for undergraduate activities—and deliver on that promise.)
Now use the data to make a demand curve for Coke (or other drink) in your classroom today. Emphasize the law of demand. Also emphasize that every demand curve relates to a market for the good (as defined by geography or some other spatial dimension) and for a given time period. Now that you have a demand curve, you can do some thought experiments that will shift it.
Ask:
How would this demand curve have been different if the temperature in the classroom was 10 degrees higher/lower?
How would this demand curve have been different if half the class was sick and absent today?
How would this demand curve have been different if there was a Coke machine right in the classroom?
(Save your demand data for later. We’ll make some suggestions for its further use in Chapter 5 on the elasticity of demand.)

9. 4.1 DEMAND
Demand schedule is a list of the quantities demanded at each different price when all the other influences on buying plans remain the same.
Demand curve is a graph of the relationship between the quantity demanded of a good and its price when all other influences on buying plans remain the same.

10. 4.1 DEMAND

11. Individual Demand and Market Demand
Market demand is the sum of the demands of all the buyers in a market.
The market demand curve is the horizontal sum of the demand curves of all buyers in the market.

12. 4.1 DEMAND

13. Changes in Demand 4.1 DEMAND
Change in demand is a change in the quantity that people plan to buy when any influence other than the price of the good changes.
A change in demand means that there is a new demand schedule and a new demand curve.

14. 4.1 DEMAND Figure 4.3 shows changes in demand.
1. When demand decreases, the demand curve shifts leftward from D0 to D1.
2. When demand increases, the demand curve shifts rightward from D0 to D2.

15. The main influences on buying plans that change demand are
Prices of related goods
Expected future prices
Income
Expected future income and credit
Number of buyers
Preferences

16. 4.1 DEMAND Prices of Related Goods
A substitute is a good that can be consumed in place of another good.
For example, apples and oranges are substitutes.
The demand for a good increases, if the price of one of its substitutes rises.
The demand for a good decreases, if the price of one of its substitutes falls.

17. 4.1 DEMAND A complement is a good that is consumed with another good.
For example, ice cream and fudge sauce are complements.
The demand for a good increases, if the price of
one of its complements falls.
The demand for a good decreases, if the price of
one of its complements rises.

18. 4.1 DEMAND Expected Future Prices
A rise in the expected future price of a good increases the current demand for that good.
A fall in the expected future price of a good decreases current demand for that good.
For example, if the price of a computer is expected to fall next month, the demand for computers today decreases.

19. 4.1 DEMAND
Income
A normal good is a good for which the demand increases if income increases and demand decreases if income decreases.
An inferior good is a good for which the demand decreases if income increases and demand increases if income decreases.

20. 4.1 DEMAND Expected Future Income and Credit
When income is expected to increase in the future, or when credit is easy to get and the cost of borrowing is low, the demand for some goods increases.
When income is expected to decrease in the future, or when credit is hard to get and the cost of borrowing is high, the demand for some goods decreases.
Changes in expected future income and the availability and cost of credit has the greatest effect on the demand for big ticket items such as homes and cars.

21. 4.1 DEMAND Number of Buyers
The greater the number of buyers in a market, the larger is the demand for any good.
Preferences
When preferences change, the demand for one item increases and the demand for another item (or items) decreases.
Preferences change when:
People become better informed.
New goods become available.

22. Change in Quantity Demanded Versus Change in Demand
A change in the quantity demanded is a change in the quantity of a good that people plan to buy that results from a change in the price of the good.
A change in demand is a change in the quantity that people plan to buy when any influence other than the price of the good changes.

23. 4.1 DEMAND Figure 4.4 illustrates and summarizes the distinction.
When you draw a shift of the demand, be careful to draw the arrows in the horizontal direction. Follow the text by always describing shifts of demand and supply curves as “rightward” or “leftward.” Do not say that the curves shift “up” or “down” or “inward” or “outward.”

24. The Law of Supply 4.2 SUPPLY
Quantity supplied is the amount of a good, service, or resource that people are willing and able to sell during a specified period at a specified price.
The Law of Supply
Other things remaining the same,
If the price of a good rises, the quantity supplied of that good increases.
If the price of a good falls, the quantity supplied of that good decreases.

25. Supply Schedule and Supply Curve
Supply is the relationship between the quantity supplied of a good and the price of the good when all other influences on selling plans remain the same.
Supply is illustrated by a supply schedule and a supply curve.
Estimating the supply of Coke (or bottled water) in the classroom. It is best to do this next classroom activity on a different day from the demand experiment.) Tell the students that you would like a Coke (or other drink) that is available from a machine somewhere near the classroom and you want someone to get it for you. You are going to continue teaching while the student is out of the room and you will be giving hints about what is on the next test.
Ask the students to raise their hand if they are willing to fetch one can of Coke if you pay, say $5.00. Write down the number. Lower the price you’re willing to pay in $1 increments until the number of students willing to fetch you the drink begins to decrease. Keep track of the numbers. Then lower the price you’re willing to pay in 25¢ increments until you get close to only having one student willing to fetch you the drink. Keep track of the numbers. Lower the price in smaller increments if necessary until just one student is willing to fetch you a drink. Now use the data to make a supply curve for Coke (or other drink) in your classroom today. Emphasize the law of supply. Emphasize that every supply curve relates to a market for the good (as defined by geography or some other spatial dimension) and for a given time period.
Now that you have a supply curve, you can do some thought experiments that will shift it. Ask:
How would this supply curve have been different if the coke machine was a mile away?
How would this supply curve have been different if half the class was sick and absent today?
How would this supply curve have been different if there was a Coke machine right in the classroom?
How would this supply curve have been different if the temperature in the classroom was 10 degrees higher/lower?

26. 4.2 SUPPLY
A supply schedule is a list of the quantities supplied at each different price when all other influences on selling plans remain the same.
A supply curve is a graph of the relationship between the quantity supplied and the price of the good when all other influences on selling plans remain the same.

27. 4.2 SUPPLY

28. Individual Supply and Market Supply
Market supply is the sum of the supplies of all sellers in a market.
The market supply curve is the horizontal sum of the supply curves of all the sellers in the market.

29. 4.2 SUPPLY

30. Changes in Supply 4.2 SUPPLY
A change in supply is a change in the quantity that suppliers plan to sell when any influence on selling plans other than the price of the good changes.
A change in supply means that there is a new supply schedule and a new supply curve.

31. 4.2 SUPPLY 4.2 SUPPLY Figure 4.7 shows changes in supply.
1. When supply decreases, the supply curve shifts leftward from S0 to S1.
2. When supply increases, the supply curve shifts rightward from S0 to S2.
When you draw a shift of the supply curve, again be careful to draw the arrows in the horizontal direction. Follow the text by always describing shifts of supply curves as “rightward” or “leftward.” Do not say that the curves shift “up” or “down.” This description of a shift is especially confusing for the supply curve. A rightward shift of the supply curve makes it look as if the curve is moving lower. Students who do not think in terms of “rightward” and “leftward” believe this shift reflects a decrease in supply, which is wrong. Get the student to always go left and right and draw the shift arrows too.

32. 4.2 SUPPLY The main influences on selling plans that change supply are
Prices of related goods
Prices of resources and other inputs
Expected future prices
Number of sellers
Productivity

33. 4.2 SUPPLY Prices of Related Goods
A change in the price of one good can bring a change in the supply of another good.
A substitute in production is a good that can be produced in place of another good.
For example, a truck and an SUV are substitutes in production in an auto factory.
The supply of a good increases if the price of one of its substitutes in production falls.
The supply a good decreases if the price of one of its substitutes in production rises.

34. 4.2 SUPPLY
A complement in production is a good that is produced along with another good.
For example, cream is a complement in production of skim milk in a dairy.
The supply of a good increases if the price of one of its complements in production rises.
The supply a good decreases if the price of one of its complements in production falls.

35. 4.2 SUPPLY Prices of Resources and Other Inputs
Resource and input prices influence the cost of production. And the more it costs to produce a good, the smaller is the quantity supplied of that good.
Expected Future Prices
Expectations about future prices influence supply.
Expectations of future prices of resources also influence supply.

36. 4.2 SUPPLY Number of Sellers
The greater the number of sellers in a market, the larger is supply.
Productivity
Productivity is output per unit of input.
An increase in productivity lowers costs and increases supply. For example, an advance in technology increases supply.
A decrease in productivity raises costs and decreases supply. For example, a severe hurricane decreases supply.

37. Change in Quantity Supplied Versus Change in Supply
A change in quantity supplied is a change in the quantity of a good that suppliers plan to sell that results from a change in the price of the good.
A change in supply is a change in the quantity that suppliers plan to sell when any influence on selling plans other than the price of the good changes.

38. 4.2 SUPPLY
Figure 4.8 illustrates and summarizes the distinction.

39. 4.3 MARKET EQUILIBRIUM
Market equilibrium occurs when the quantity demanded equals the quantity supplied.
At market equilibrium, buyers’ and sellers’ plans are consistent.
Equilibrium price is the price at which the quantity demanded equals the quantity supplied.
Equilibrium quantity is the quantity bought and sold at the equilibrium price.

40. 4.3 MARKET EQUILIBRIUM Figure 4.9 shows the equilibrium price and
equilibrium quantity.
1. Market equilibrium at the intersection of the demand curve and the supply curve.
2. The equilibrium price is $1 a bottle.
3. The equilibrium quantity is 10 million bottles a day.

41. Price: A Market’s Automatic Regulator
4.3 MARKET EQUILIBRIUM
Price: A Market’s Automatic Regulator
Law of market forces
When there is a shortage, the price rises.
When there is a surplus, the price falls.
Shortage is the quantity demanded exceeds the quantity supplied.
Surplus is the quantity supplied exceeds the quantity demanded.
The law of market forces is important, so you want your students to grasp why prices are driven to the equilibrium. You can choose a good, like concert tickets to the hottest band. Draw a demand-supply graph with a reasonable equilibrium price and quantity. Ask the students what would happen if the concert promoter decided to charge only $10 a ticket. Would students line up before dawn to buy them? Yes! Explain that this is a case of excess demand. Ask them what could the promoter do to get the crowds to go away? Hopefully they will answer, “Raise ticket prices!” Show them how the market pressures the price to rise to the equilibrium price and use the graph to show how the promoter and students move up their respective supply and demand curves. You can do the same thing for excess supply. Let the promoter try to sell tickets for $1,000 each. Again, move down along the supply and demand curves as the market pressures the price to fall.

42. 4.3 MARKET EQUILIBRIUM Figure 4.10(a) market achieves equilibrium.
At $1.50 a bottle:
1. Quantity supplied is 11 million bottles.
2. Quantity demanded is 9 million bottles.
The magic of market equilibrium and the forces that bring it about and keep the market there need to be demonstrated with the basic diagram, with intuition, and, if you’ve got the time, with hard evidence in the form of further class activity. If you did the demand experiment, you might want to begin with that and explain that in the classroom market, the supply was fixed (so there was vertical supply curve) at the quantity of bottles that you brought to class. The equilibrium occurred where the market demand curve (demand by the students) intersected your supply curve. Then, if you did the supply experiment, you can explain that in that classroom market, demand was fixed (so there was a vertical demand curve) at the quantity that you had decided to buy. The equilibrium occurred where the market supply curve (supply by the students) intersected your demand curve. Point out that the trades you made in your classroom economy made buyers and sellers better off. If you want to devote a class to equilibrium and the gains from trade in a market, you might want to run a double oral auction. There are lots of descriptions of these and one of the best is at Charlie Holt’s
3. There is a surplus of 2 million bottles.
4. Price falls until the surplus is eliminated and the market is in equilibrium.

43. 4.3 MARKET EQUILIBRIUM Figure 4.10(b) market achieves equilibrium.
At 75 cents a bottle:
1. Quantity demanded is 11 million bottles.
2. Quantity supplied is 9 million bottles.
3. There is a shortage of 2 million bottles.
4. Price rises until the shortage is eliminated and the market is in equilibrium.

44. Predicting Price Changes: Three Questions
4.3 MARKET EQUILIBRIUM
Predicting Price Changes: Three Questions
We can work out the effects of an event by answering:
Does the event change demand or supply?
Does the event increase or decrease demand or supply—shift the demand curve or the supply curve rightward or leftward?
What are the new equilibrium price and equilibrium quantity and how have they changed?
The whole chapter builds up to using the demand/supply model to predict changes in the equilibrium price and quantity.
Students are too ready to guess the consequences of events that change either demand, or supply or both. They must be encouraged to work out the answer and draw the diagram.
Encourage the students to break all exercises about the effects of events in a market into three questions:
Question 1 Does the event change demand, supply, both, or neither?
Question 2 Does the event increase or decrease demand or supply—shift the demand curve or the supply curve rightward or leftward?
Question 3 What are the new equilibrium price and equilibrium quantity and how have they changed?
Proceed in five steps:
Step 1 Draw a demand-supply graph and label the axes with the price and quantity of the good or service in question.
Step 2 Think about the event or events and answer Question 1: does it change demand, supply, both or neither.
Step 3 Think about the event or events and answer Question 2: what is the direction of change?
Step 4 Draw the new demand curve and supply curve on the diagram.
Step 5 Look at the diagram and answer Question 3: how have the price and quantity changed?
Walk the students through the steps and have one or two students work some examples in front of the class.

45. Effects of Changes in Demand
4.3 MARKET EQUILIBRIUM
Effects of Changes in Demand
Event: A new study says that tap water is unsafe.
In the market for bottled water:
With tap water unsafe, demand for bottled water changes.
The demand for bottled water increases, the demand curve shifts rightward.
What are the new equilibrium price and equilibrium quantity and how have they changed?

46. 4.3 MARKET EQUILIBRIUM Figure 4.11(a) illustrates the outcome.
1. An increase in demand shifts the demand curve rightward.
2. At $1.00 a bottle, there is a shortage, so the price rises.
Tell students that they will do much better on the exam if they DRAW the demand-supply graph to answer a question.
Show them how much easier it is to see the effects of a change in demand or a change in supply or both on the equilibrium price and equilibrium quantity if they draw the graph.
3. The quantity supplied increases along the supply curve.
4. Equilibrium quantity increases.

47. 4.3 MARKET EQUILIBRIUM
Event: A new zero-calorie sports drink is invented.
In the market for bottled water:
The new drink is a substitute for bottled water, so the demand for bottled water changes
The demand for bottled water decreases, the demand curve shifts leftward.
What are the new equilibrium price and equilibrium quantity and how have they changed?

48. 4.3 MARKET EQUILIBRIUM Figure 4.11(b) shows the outcome.
1. A decrease in demand shifts the demand curve leftward.
2. At $1.00 a bottle, there is a surplus, so the price falls.
Now emphasize the distinction between a change in supply and a change in the quantity supplied.
3. Quantity supplied decreases along the supply curve.
4. Equilibrium quantity decreases.

49. 4.3 MARKET EQUILIBRIUM When demand changes:
The supply curve does not shift.
But there is a change in the quantity supplied.
Equilibrium price and equilibrium quantity change in the same direction as the change in demand.

50. Effects of Changes in Supply
4.3 MARKET EQUILIBRIUM
Effects of Changes in Supply
Event: European water bottlers buy springs and open plants in the United States.
In the market for bottled water:
With more suppliers of bottled water, supply changes.
The supply of bottled water increases, the supply curve shifts rightward.
What are the new equilibrium price and equilibrium quantity and how have they changed?

51. 4.3 MARKET EQUILIBRIUM Figure 4.12(a) shows the outcome.
1. An increase in supply shifts the supply curve rightward.
2. At $1 a bottle, there is a surplus, so the price falls.
3. Quantity demanded increases along the demand curve.
4. Equilibrium quantity increases.

52. 4.3 MARKET EQUILIBRIUM
Event: Drought dries up some springs in the United States.
In the market for bottled water:
Drought changes the supply of bottled water.
The supply of bottled water decreases, the supply curve shifts leftward.
What are the new equilibrium price and equilibrium quantity and how have they changed?

53. 4.3 MARKET EQUILIBRIUM Figure 4.12(b) shows the outcome.
1. A decrease in supply shifts the supply curve leftward.
2. At $1.00 a bottle, there is a shortage, so the price rises.
3. Quantity demanded decreases along the demand curve.
4. Equilibrium quantity decreases.

54. 4.3 MARKET EQUILIBRIUM When supply changes:
The demand curve does not shift.
But there is a change in the quantity demanded.
Equilibrium price changes in the opposite direction as the change in supply.
Equilibrium quantity changes in the same direction to the change in supply.

55. Changes in Both Demand and Supply
4.3 MARKET EQUILIBRIUM
Changes in Both Demand and Supply
When two events occur at the same time, work out how
each event influences the market:
Does each event change demand or supply?
Does either event increase or decrease demand or increase or decrease supply?
What are the new equilibrium price and equilibrium quantity and how have they changed?

56. 4.3 MARKET EQUILIBRIUM The figure shows the effects of an increase in
both demand and supply.
An increase in demand shifts the demand curve rightward; an increase in supply shifts the supply curve rightward.
1. Equilibrium quantity increases.
2. Equilibrium price might rise or fall.

57. 4.3 MARKET EQUILIBRIUM Increase in Both Demand and Supply
Increases the equilibrium quantity.
The change in the equilibrium price is ambiguous because the:
Increase in demand raises the price.
Increase in supply lowers the price.

58. 4.3 MARKET EQUILIBRIUM This figure shows the effects of a decrease in
both demand and supply.
A decrease in demand shifts the demand curve leftward; a decrease in supply shifts the supply curve leftward.
1. Equilibrium quantity decreases.
2. Equilibrium price might rise or fall.

59. 4.3 MARKET EQUILIBRIUM Decrease in Both Demand and Supply
Decreases the equilibrium quantity.
The change in the equilibrium price is ambiguous because the:
Decrease in demand lowers the price
Decrease in supply raises the price.

60. 4.3 MARKET EQUILIBRIUM The figure shows the effects
of an increase in demand
and a decrease in supply.
An increase in demand shifts
the demand curve rightward;
a decrease in supply shifts
the supply curve leftward.
1. Equilibrium price rises.
2. Equilibrium quantity might increase, decrease, or not change.

61. 4.3 MARKET EQUILIBRIUM Increase in Demand and Decrease in Supply
Raises the equilibrium price.
The change in the equilibrium quantity is ambiguous because the:
Increase in demand increases the quantity.
Decrease in supply decreases the quantity.

62. 4.3 MARKET EQUILIBRIUM This figure shows the effects
of a decrease in demand
and an increase in supply.
A decrease in demand shifts
the demand curve leftward;
an increase in supply shifts
the supply curve rightward.
1. Equilibrium price falls.
2. Equilibrium quantity might increase, decrease, or not change.

63. 4.3 MARKET EQUILIBRIUM Decrease in Demand and Increase in Supply
Lowers the equilibrium price.
The change in the equilibrium quantity is ambiguous because the:
Decrease in demand decreases the quantity.
Increase in supply increases the quantity.

64. Why Did the Price of Coffee Soar in 2010 and 2011?
In January 2009, the price of coffee was $1.25 a pound (point A).
By May 2011, it had risen to $3.00 a pound (point B).
1. Why did the price of coffee soar?

65. Why Did the Price of Coffee Soar in 2010 and 2011?
The market for coffee answers this question.
2. Heavy rain decreased the supply of coffee. The supply curve shifted leftward.
3. The price rose to $3 a pound.
4. The quantity demanded decreased to million pounds.