1. SUPPLY AND DEMAND: HOW MARKETS WORK

2. Demand, Supply and Equilibrium

3. MARKETS AND COMPETITION
Buyers determine demand.
Sellers determine supply 4

4. Demand and the Price Effect

5. DEMAND
Demand is the amount of a good that buyers are willing and able to purchase at different prices at a particular time.
The Law of Demand or the price effect of demand:
The law of demand states that the quantity demanded of a good falls when the price of the good rises 8

6. SUPPLY
Supply is the amount of a good that sellers are willing and able to sell.
Law of Supply
The law of supply states that the quantity supplied of a good rises when the price of the good rises.
Sellers are motivated by high prices
A high price covers the higher production cost + still allows sellers to make a profit 25

7. It lists the quantities demanded at various prices
The Demand Schedule
The demand schedule is a table that shows the relationship between the price of the good and the quantity demanded.
It lists the quantities demanded at various prices
The information can be plotted on a graph with price as the y axis and quantity as the x axis 17

8. Catherine’s Demand Schedule17

9. The Demand Curve: The Relationship between Price and Quantity Demanded
The demand curve is a graph of the relationship between the price of a good and the quantity demanded.
Information from the demand schedule is plotted on a graph
A demand curve always demonstrates the Law of Demand, as the price goes up, consumers will demand less 17

10. Figure 1 Catherine’s Demand Schedule and Demand Curve
Price of
Ice-Cream Cone
$3.00
2.50
1. A decrease
in price
...
2.00
1.50
1.00
0.50 1 2 3 4 5 6 7 8 9 10 11 12
Quantity of 2.
...
increases quantity
of cones demanded.
Ice-Cream Cones
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11. The Price Effect or Law of Demand
The inclination of people to buy less of something at higher prices than they would buy at lower prices.
4 Factors which explain why price effects demand:
1. Buying power – the quantity of goods & services a person can buy with a given amount of money.
2. Diminishing personal value – people value items more or less and will adjust their demand for the items if the price goes up or down significantly

12. The Price Effect or Law of Demand
3. Diminishing marginal utility – the point reached when an additional unit of a product consumed is less satisfying than the one before (lower price to increase sales; “buy 1 get one free” offers)
4. Substitutes – goods or services that can replace another good or service
(Our willingness to choose the substitute depends on the price of the product.)

13. Market Demand versus Individual Demand
Market demand is the total quantity of a good or service people are willing and able to buy at alternative prices in a given time period.
Each consumer’s individual demand for a good or service and combines it into an overall demand schedule and curve.
Market demand is affected by the number of buyers and their tastes, incomes, other goods, and expectations.

14. Demand is elastic if a rise in price results in a large drop in demand
Price Elasticity of Demand – a measure of the impact prices have on quantity demanded
Demand is elastic if a rise in price results in a large drop in demand
Demand is inelastic if a rise in price results in a relatively small or no drop in demand

15. Elastic Demand
Elastic demand – when a small change in price causes a relatively large change or “stretch” in the amount demanded (demand will decrease if the price increases)
Items with elastic demand :
Cereal
Pizza
Soft drinks
Fast food
Anything with a lot of substitutes; not necessities

16. Inelastic Demand
Inelastic demand – when a price change causes only a small change in the amount demanded
Items with inelastic demand are usually necessities (are not a big part of your budget ) or scarce items such as:
Milk
Salt
Gasoline
Bread
Insulin

17. Price Elasticity of Demand Factors
Availability of substitutes – when substitutes are plentiful, demand is more elastic
% of your budget – a product’s price tends to be more elastic if it is a larger portion of your household budget (autos, electronics, etc.)
Time – The longer people have to adjust to a price increase, the more likely demand will become elastic (gasoline prices over time)

18. Shifts in the Demand Curve
Change in Quantity Demanded
Movement along the demand curve.
Caused by a change in the price of the product.
Movement to the left or right indicates a shift in demand 19

19. Changes in Quantity Demanded
Price of Ice-Cream Cones
A tax that raises the price of ice-cream cones results in a movement along the demand curve. B
$2.00 A
1.00 D 4 8
Quantity of Ice-Cream Cones

20. Factors cause demand to change (or shift)
A change in income - if incomes rise, people have more money to spend
Prices or availability of substitututes - goods that can serve as replacements for one another; when the price of one increases, demand for the other goes up.
Prices or Availability of Complementary goods - goods that “go together”; a decrease in the price of one results in an increase in demand for the other, and vice versa.

21. Factors cause demand to change (or shift)
Change in the weather or season – seasons/weather impact demand for products (gasoline in the summer, Coca Cola, etc.)
Change in the number of buyers – the size of the market affects demand
Changes in styles, tastes & habits - if more fashionable or popular an item is the greater the demand
Changes in expectations - consumers sometimes predict that the price or availability of a product is likely to change in the future

22. Shifts in the Demand Curve
Change in Demand
A shift in the demand curve, either to the left or right.
Caused by any change that alters the quantity demanded at every price.
Increase in demand causes the new demand curve to shift to the right
Decrease in demand causes the new demand curve to shift to the left 19

23. Figure 3 Shifts in the Demand Curve
Price of
Ice-Cream
Cone
Increase
in demand
Decrease
in demand
Demand
curve, D 2
Demand
curve, D 1
Demand curve, D 3
Quantity of
Ice-Cream Cones
Copyright©2003 Southwestern/Thomson Learning

24. Change in Consumer Income
Price of Ice-Cream Cone
$3.00
An increase in income...
2.50
Increase
in demand
2.00
1.50
1.00
0.50 D2 D1
Quantity of Ice-Cream Cones 1 2 3 4 5 6 7 8 9 10 11 12

25. A Decrease in Consumer Income
Price of Ice-Cream Cone
$3.00
2.50
An decrease in income...
2.00
Decrease
in demand
1.50
1.00
0.50 D2 D1
Quantity of Ice-Cream Cones 1 2 3 4 5 6 7 8 9 10 11 12

26. Shifts in the Demand Curve
Prices of Substitutes & Complements
When a fall in the price of one good reduces the demand for another good, the two goods are called substitutes.
When a fall in the price of one good increases the demand for another good, the two goods are called complements.

27. Table 1 Variables That Influence Buyers
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28. SUPPLY
Supply is the amount of a good that sellers are willing and able to sell.
Law of Supply
The law of supply states that the quantity supplied of a good rises when the price of the good rises.
Sellers are motivated by high prices
A high price covers the higher production cost + still allows sellers to make a profit 25

29. The Supply Curve: The Relationship between Price and Quantity Supplied
Supply Schedule
The supply schedule is a table that shows the relationship between the price of the good and the quantity supplied. 29

30. Ben’s Supply Schedule 29

31. The Supply Curve: The Relationship between Price and Quantity Supplied
The supply curve is the graph of the relationship between the price of a good and the quantity supplied.
A supply curve always demonstrates the Law of Supply - as the price goes up, the amount supplied also will increase 29

32. Figure 5 Ben’s Supply Schedule and Supply Curve
Price of
Ice-Cream
Cone
$3.00
2.50
1. An
increase
in price
...
2.00
1.50
1.00
0.50 1 2 3 4 5 6 7 8 9 10 11 12
Quantity of
Ice-Cream Cones 2.
...
increases quantity of cones supplied.
Copyright©2003 Southwestern/Thomson Learning

33. Market Supply versus Individual Supply
Market supply refers to the sum of all individual supplies for all sellers of a particular good or service.
Graphically, individual supply curves are summed horizontally to obtain the market supply curve.

34. Factors Which Cause A Change in Supply
Changes in the marginal cost of production:
The price of resources (labor, capital, and land),
The technologies that can be used to produce the product
Changes in the # of producers:
When new businesses enter a market, supply will increase (price goes down)
Change in expectations: producers may decrease supply today if they expect higher prices later

35. Price Elasticity of Supply
If price increases & this causes a large increase (or stretch) in the amount supplied, the price effect is significant and supply is elastic. (chicken, products which can be made quickly & inexpensively)
Other products have inelastic supplies: a change in price has much less influence on the quantity supplied (gold, diamonds, gasoline, electricity, etc.,); even if the price goes up, supply does not increase

36. Price Elasticity of Supply
If sellers produce more because the price of an item has increased, supply is elastic
If sellers can’t produce more because the price of an item has increased, supply is inelastic

37. Shifts in the Supply Curve
Change in Quantity Supplied
Movement along the supply curve.
Caused by a change in anything that alters the quantity supplied at each price. 30

38. Change in Quantity Supplied
Price of Ice-Cream Cone S C
$3.00
A rise in the price of ice cream cones results in a movement along the supply curve. A
1.00
Quantity of Ice-Cream Cones 1 5 30

39. Shifts in the Supply Curve
Change in Supply
A shift in the supply curve, either to the left or right.
Caused by a change in a determinant other than price. 30

40. Figure 7 Shifts in the Supply Curve
Price of
Supply curve, S 3
Ice-Cream
curve,
Supply S 1
Cone
Supply
curve, S 2
Decrease
in supply
Increase
in supply
Quantity of
Ice-Cream Cones
Copyright©2003 Southwestern/Thomson Learning

41. Table 2 Variables That Influence Sellers
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42. SUPPLY AND DEMAND TOGETHER
Equilibrium refers to a situation in which the price has reached the level where quantity supplied equals quantity demanded.
The market is balanced, or cleared at this price
Demand and supply are equal 36

43. SUPPLY AND DEMAND TOGETHER
Equilibrium Price
The price that balances quantity supplied and quantity demanded.
On a graph, it is the price at which the supply and demand curves intersect.
Equilibrium Quantity
The quantity supplied and the quantity demanded at the equilibrium price.
On a graph it is the quantity at which the supply and demand curves intersect. 36

44. SUPPLY AND DEMAND TOGETHER
Demand Schedule
Supply Schedule
At $2.00, the quantity demanded is equal to the quantity supplied! 36

45. Figure 8 The Equilibrium of Supply and Demand
Price of
Ice-Cream
Cone
Supply
Demand
Equilibrium
Equilibrium price
$2.00
Equilibrium
quantity 1 2 3 4 5 6 7 8 9 10 11 12 13
Quantity of Ice-Cream Cones
Copyright©2003 Southwestern/Thomson Learning

46. Figure 9 Markets Not in Equilibrium
(a) Excess Supply
Price of
Ice-Cream
Supply
Cone
Surplus
Demand
$2.50 10 4
2.00 7
Quantity of
Quantity
demanded
Quantity
supplied
Ice-Cream
Cones
Copyright©2003 Southwestern/Thomson Learning

47. Equilibrium Surplus Occurs at any price above the equilibrium price
There is excess supply or a surplus.
Suppliers will lower the price to increase sales, thereby moving toward equilibrium.

48. Equilibrium Shortage Occurs at any price below the equilibrium price
Quantity demanded > the quantity supplied.
There is excess demand or a shortage.
Suppliers will raise the price due to too many buyers chasing too few goods, thereby moving toward equilibrium.

49. Figure 9 Markets Not in Equilibrium
(b) Excess Demand
Price of
Ice-Cream
Supply
Cone
Demand
$2.00 7
1.50 10 4
Shortage
Quantity of
Quantity
supplied
Quantity
demanded
Ice-Cream
Cones
Copyright©2003 Southwestern/Thomson Learning

50. Law of supply and demand
Equilibrium
Law of supply and demand
The claim that the price of any good adjusts to bring the quantity supplied and the quantity demanded for that good into balance.

51. The functions of prices in a market system
Prices send signals to both buyers and sellers in a market
Prices ration – scarce goods are bought by the consumers who are willing to pay the highest price for them
Prices motivate – prices provide incentives for people to produce goods & services

52. Figure 10 How an Increase in Demand Affects the Equilibrium
Price of
Ice-Cream
1. Hot weather increases
the demand for ice cream . . .
Cone D D
Supply
New equilibrium
$2.50 10
resulting
in a higher
price . . .
2.00 7
Initial
equilibrium
Quantity of 3.
. . .
and a higher
quantity sold.
Ice-Cream Cones
Copyright©2003 Southwestern/Thomson Learning

53. Figure 11 How a Decrease in Supply Affects the Equilibrium
Price of
1. An increase in the
price of sugar reduces
the supply of ice cream. . .
Ice-Cream
Cone S2 S1
Demand
New
equilibrium
$2.50 4
resulting
in a higher
price of ice
cream . . .
Initial equilibrium
2.00 7
Quantity of 3.
. . .
and a lower
quantity sold.
Ice-Cream Cones
Copyright©2003 Southwestern/Thomson Learning

54. Table 4 What Happens to Price and Quantity When Supply or Demand Shifts?
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55. Summary
The demand curve shows how the quantity of a good depends upon the price.
According to the law of demand, as the price of a good falls, the quantity demanded rises. Therefore, the demand curve slopes downward.
In addition to price, other determinants of how much consumers want to buy include income, the prices of complements and substitutes, tastes, expectations, and the number of buyers.
If one of these factors changes, the demand curve shifts.

56. Summary
The supply curve shows how the quantity of a good supplied depends upon the price.
According to the law of supply, as the price of a good rises, the quantity supplied rises. Therefore, the supply curve slopes upward.
In addition to price, other determinants of how much producers want to sell include input prices, technology, expectations, and the number of sellers.
If one of these factors changes, the supply curve shifts.

57. Summary
Market equilibrium is determined by the intersection of the supply and demand curves.
At the equilibrium price, the quantity demanded equals the quantity supplied.
The behavior of buyers and sellers naturally drives markets toward their equilibrium.