# 1 Ch. 3: Supply and Demand: Theory James R. Russell, Ph.D., Professor of Economics & Management, Oral Roberts University ©2005 Thomson Business & Professional.

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1 Ch. 3: Supply and Demand: Theory James R. Russell, Ph.D., Professor of Economics & Management, Oral Roberts University ©2005 Thomson Business & Professional Publishing, A Division of Thomson Learning

2 Demand Demand: (1) the willingness and ability of buyers to purchase different quantities of a good (2) at different prices (3) during a specific period of time. Demand: (1) the willingness and ability of buyers to purchase different quantities of a good (2) at different prices (3) during a specific period of time. Law of Demand: as the price of a good rises, quantity demanded of that good falls, as the price of a good falls, quantity demanded of that good rises, ceteris paribus. Law of Demand: as the price of a good rises, quantity demanded of that good falls, as the price of a good falls, quantity demanded of that good rises, ceteris paribus.

3 Four Ways to Represent The Law Of Demand In Words: “As price rises, quantity demanded falls” In Words: “As price rises, quantity demanded falls” In Symbols: P  Q d  In Symbols: P  Q d  In a Demand Schedule In a Demand Schedule As a Demand Curve As a Demand Curve

4 Exhibit 1: Demand Schedule and Demand Curve

5 Prices Absolute Price: the price of a good in money terms. Absolute Price: the price of a good in money terms. Relative Price: the price of a good in terms of another good. Relative Price: the price of a good in terms of another good.

6 Why Quantity Demanded Goes Down As Price Goes Up 1. People substitute lower-priced goods for higher-priced goods. 2. The Law of Diminishing Marginal Utility: for a given time period, the marginal (additional) utility or satisfaction gained by consuming equal successive units of a good will decline as the amount consumed increases.

7 Exhibit 2: Deriving a Market Demand Schedule and a Market Demand Curve

8 Change in Quantity Demanded versus a Change in Demand Change in Quantity Demanded: a movement from one point to another point on the same demand curve caused by a change in the price of the good. Change in Quantity Demanded: a movement from one point to another point on the same demand curve caused by a change in the price of the good. Change in Demand: a shift in the demand curve Change in Demand: a shift in the demand curve –Increase in demand: a shift to the right –Decrease in demand: as shift to the left

9 Exhibit 3: Shifts in the Demand Curve

10 Causes of Change in the Demand Curve Income Income Preferences Preferences Prices of Related Goods Prices of Related Goods Number of Buyers Number of Buyers Expectations of Future Price Expectations of Future Price

11 Income Induced Changes in Demand Normal Good: a good the demand for which rises (falls) as income rises (falls). Normal Good: a good the demand for which rises (falls) as income rises (falls). Inferior Good: a good the demand for which rises (falls) as income falls (rises). Inferior Good: a good the demand for which rises (falls) as income falls (rises). Neutral Good: a good the demand for which does not change as income rises or falls. Neutral Good: a good the demand for which does not change as income rises or falls.

12 Preferences and Related Goods Preferences: affect the amount of a good they are willing to buy at a particular price (Ex: favorite food, favorite author) Preferences: affect the amount of a good they are willing to buy at a particular price (Ex: favorite food, favorite author) Substitutes: the demand for product X increases as the price for substitute Y increases, and the demand for product X falls as the price for Y falls, (Ex:Coke and Pepsi). Substitutes: the demand for product X increases as the price for substitute Y increases, and the demand for product X falls as the price for Y falls, (Ex:Coke and Pepsi). Complements: the price of product A falls as the demand for product B rises, and the price of product A rises as the demand for product B falls, (Ex: Ketchup and Hot Dog Buns). Complements: the price of product A falls as the demand for product B rises, and the price of product A rises as the demand for product B falls, (Ex: Ketchup and Hot Dog Buns).

13 Exhibit 4: Substitutes and Complements

14 Number of Buyers and Expectation of Future Price Number of Buyers: More Buyers, More Demand; Fewer Buyers, Less Demand. Number of Buyers: More Buyers, More Demand; Fewer Buyers, Less Demand. Price Expectations: Price Expectations: –Expect higher price tomorrow, buy more today, increase in demand. –Expect lower price tomorrow, buy less today, decrease in demand.

15 Exhibit 5: A Change in Demand versus a Change in Quantity Demanded

16 Self-Test As Sandi’s income rises, her demand for popcorn rises. As Mark’s income falls, his demand for prepaid telephone cards rises. What kinds of goods are popcorn and telephone cards for the people who demand each? As Sandi’s income rises, her demand for popcorn rises. As Mark’s income falls, his demand for prepaid telephone cards rises. What kinds of goods are popcorn and telephone cards for the people who demand each? Why are demand curves downward sloping? Why are demand curves downward sloping? Give an example that illustrates how to derive a market demand curve. Give an example that illustrates how to derive a market demand curve. What factors can change demand? What factors can change quantity demanded? What factors can change demand? What factors can change quantity demanded?

17 Supply Supply: The (1) willingness and ability of sellers to produce and offer to sell different quantities of a good (2) at different prices (3) during a specific period of time. Supply: The (1) willingness and ability of sellers to produce and offer to sell different quantities of a good (2) at different prices (3) during a specific period of time. Law of Supply: As the price of a good rises, the quantity supplied of the good rises; and as the price of a good falls, the quantity supplied of the good falls. Law of Supply: As the price of a good rises, the quantity supplied of the good rises; and as the price of a good falls, the quantity supplied of the good falls.

18 Exhibit 6: A Supply Curve

19 Exhibit 7: Supply Curves When There is No Time to Produce More or No More Can Be Produced

20 Why Most Supply Curves Slope Upwards? Most supply curves slope upward because costs rise when more of a good is produced.

21 Market Supply Curve Market Supply Curve: represents the price-quantity combinations for all sellers of a particular good. Market Supply Curve: represents the price-quantity combinations for all sellers of a particular good. Individual supply Curve: represents the price-quantity combinations for a single seller Individual supply Curve: represents the price-quantity combinations for a single seller

22 Exhibit 8: Deriving a Market Supply Schedule and a Market Supply Curve

23 Factors Which Can Shift the Supply Curve Prices of Relevant Resources Prices of Relevant Resources Technology Technology Number of Sellers Number of Sellers Expectations of Future Price Expectations of Future Price Taxes and Subsidies Taxes and Subsidies Government Restrictions Government Restrictions

24 Changes in Quantity Supplied versus Changes in Supply Changes in Quantity Supplied: a movement along the supply curve. Changes in Quantity Supplied: a movement along the supply curve. Changes in Supply: a shift in the supply curve. Changes in Supply: a shift in the supply curve. –Increase in supply: a shift to the right. –Decrease in supply: a shift to the left.

25 Exhibit 10: A Change in Supply versus a Change in Quantity Supplied

26 Self-Test What would the supply curve of houses in your city look like in the next 10 hours? In three months? What would the supply curve of houses in your city look like in the next 10 hours? In three months? What happens to the supply curve if each of the following occurs? What happens to the supply curve if each of the following occurs? –There is a decrease in the number of sellers. –A per-unit tax is placed on the production of a good. –The price of a relevant resource falls. “If the price of apples rises, the supply of apples will rise.” True or false? Explain. “If the price of apples rises, the supply of apples will rise.” True or false? Explain.

27 Exhibit 11: Supply and Demand at Work at an Auction

28 Market Language If quantity supplied is greater than the quantity demanded, the good has a surplus or excess supply. If quantity supplied is greater than the quantity demanded, the good has a surplus or excess supply. If quantity demanded is greater than quantity supplied, a shortage or excess demand exists. If quantity demanded is greater than quantity supplied, a shortage or excess demand exists. The price at which quantity demanded equals quantity supplied is the equilibrium price, or the market-clearing price. The price at which quantity demanded equals quantity supplied is the equilibrium price, or the market-clearing price.

29 More Market Language Equilibrium Quantity: the quantity that corresponds to the equilibrium price. Equilibrium Quantity: the quantity that corresponds to the equilibrium price. Disequilibrium Price: any price at which quantity demanded is not equal to quantity supplied. Disequilibrium Price: any price at which quantity demanded is not equal to quantity supplied. Disequilibrium: a market that is exhibiting either a surplus or a shortage is in disequilibrium. Disequilibrium: a market that is exhibiting either a surplus or a shortage is in disequilibrium. Equilibrium. A market in which quantity demanded equals quantity supplied is in equilibrium. Equilibrium. A market in which quantity demanded equals quantity supplied is in equilibrium.

30 Exhibit 12: Moving to Equilibrium

31 Exhibit 13: A Summary Exhibit of a Market (Supply and Demand)

32 Exhibit 14: Moving to Equilibrium in Terms of Maximum and Minimum Prices

33 Equilibrium In Terms of Consumers’ and Producers’ Surplus Consumers’ Surplus: the difference between the maximum price a buyer would be willing and able to pay for a good or service and the price actually paid. Consumers’ Surplus: the difference between the maximum price a buyer would be willing and able to pay for a good or service and the price actually paid. Producers’ Surplus: the difference between the price sellers receive for a good and the minimum or lowest price they would have sold the good. Producers’ Surplus: the difference between the price sellers receive for a good and the minimum or lowest price they would have sold the good. Total Surplus = Consumers’ Surplus + Producers’ Surplus Total Surplus = Consumers’ Surplus + Producers’ Surplus

34 Exhibit 15: Consumers’ and Producers’ Surplus

35 Exhibit 16: Equilibrium, Consumers’ Surplus, and Producers’ Surplus

36 Exhibit 17: Equilibrium Price and Quantity Effects of Supply Curve Shifts and Demand Curve Shifts

37 What Can Change Equilibrium Price and Quantity? Demand rises and supply is constant: Equilibrium price rises, Equilibrium quantity rises. Demand rises and supply is constant: Equilibrium price rises, Equilibrium quantity rises. Demand falls, supply is constant: Equilibrium price falls, Equilibrium quantity falls. Demand falls, supply is constant: Equilibrium price falls, Equilibrium quantity falls. Supply rises, demand is constant: Equilibrium price falls, Equilibrium quantity rises. Supply rises, demand is constant: Equilibrium price falls, Equilibrium quantity rises. Supply falls, demand is constant: Equilibrium price rises, Equilibrium quantity falls. Supply falls, demand is constant: Equilibrium price rises, Equilibrium quantity falls.

38 What Can Change Equilibrium Price and Quantity? Demand rises and supply falls by an equal amount: Equilibrium rises, Equilibrium quantity is constant. Demand rises and supply falls by an equal amount: Equilibrium rises, Equilibrium quantity is constant. Demand falls and supply rises by an equal amount: Equilibrium price falls, Equilibrium quantity is constant. Demand falls and supply rises by an equal amount: Equilibrium price falls, Equilibrium quantity is constant. Demand rises by a greater amount than supply falls: Equilibrium price and quantity rise. Demand rises by a greater amount than supply falls: Equilibrium price and quantity rise. Demand rises by a lesser amount than supply falls: Equilibrium price rises, Equilibrium quantity falls. Demand rises by a lesser amount than supply falls: Equilibrium price rises, Equilibrium quantity falls.

39 Self-Test When a person goes to the grocery store to buy food, there is no auctioneer calling out prices for bread, milk, and other items. Therefore, supply and demand cannot be operative. Do you agree or disagree? Explain. When a person goes to the grocery store to buy food, there is no auctioneer calling out prices for bread, milk, and other items. Therefore, supply and demand cannot be operative. Do you agree or disagree? Explain. The price of a given quality personal computer is lower today than it was five years ago. Is this necessarily the result of a lower demand for computers? Explain. The price of a given quality personal computer is lower today than it was five years ago. Is this necessarily the result of a lower demand for computers? Explain. If the price paid is \$40 and consumers’ surplus is \$6, then what is the maximum buying price? If the minimum selling price is \$30 and producers’ surplus is \$4, then what is the price received by the seller? If the price paid is \$40 and consumers’ surplus is \$6, then what is the maximum buying price? If the minimum selling price is \$30 and producers’ surplus is \$4, then what is the price received by the seller?

40 Self-Test What is the effect on equilibrium price and quantity of the following: What is the effect on equilibrium price and quantity of the following: –A decrease in demand that is greater than the increase in supply –An increase in supply –A decrease in supply that is greater than the increase in demand –A decrease in demand At equilibrium quantity, what is the relationship between “maximum buying price” and the “minimum selling price?” At equilibrium quantity, what is the relationship between “maximum buying price” and the “minimum selling price?”

41 Price Controls (Price Ceiling) Price Ceiling: a government mandated maximum price above which legal trades cannot be made. Price Ceiling: a government mandated maximum price above which legal trades cannot be made. Price Ceilings may cause: Price Ceilings may cause: 1) Shortages 2) Fewer Exchanges 3) Non-price Rationing Devices 4) Buying and Selling at a Prohibited Price 5) Tie in Sales

42 Exhibit 18: A Price Ceiling

43 Price Controls (Price Floor) Price Floor: a government mandated minimum price below which legal trades cannot be made. Price Floor: a government mandated minimum price below which legal trades cannot be made. Price floors can cause: Price floors can cause: –Surpluses –Fewer Exchanges.

44 Exhibit 19: A Price Floor

45 Self-Test Do buyers prefer lower prices to higher prices? Do buyers prefer lower prices to higher prices? When there are long-lasting shortages, there are long lines of people waiting to buy goods. It follows that the shortages cause the long lines.” Do you agree or disagree? Explain you answer. When there are long-lasting shortages, there are long lines of people waiting to buy goods. It follows that the shortages cause the long lines.” Do you agree or disagree? Explain you answer. Who might argue for a Price Ceiling? A Price Floor? Who might argue for a Price Ceiling? A Price Floor?

46 Coming Up (Ch. 4): Supply and Demand: Practice

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