1. Supply and Demand 4 Teach a parrot the terms supply and demand and you’ve got an economist. — Thomas Carlyle CHAPTER 4 Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

2. Supply and Demand 4 Chapter Goals State the law of demand and draw a demand curve from a demand table State the law of supply and draw a supply curve from a supply table Distinguish shifts in demand from movements along a demand curve Explain the importance of substitution to the laws of supply and demand 4-2

3. Supply and Demand 4 Chapter Goals Distinguish shifts in supply from movements along a supply curve Show the effect of a shift in demand and supply on equilibrium price and quantity Explain how the law of demand and the law of supply interact to bring about equilibrium State the limitations of demand and supply analysis 4-3

4. Supply and Demand 4 Demand The law of demand states that the quantity of a good demanded is inversely related to the good’s price As prices change, people change how much they’re willing to buy In other words, other things equal, Quantity demanded rises as price falls Quantity demanded falls as price rises The law of demand is based on the fact that when prices for a good rise, people substitute away from that good to other goods 4-4

5. Supply and Demand 4 The Demand Curve A demand curve is the graphic representation of the relationship between price and quantity demanded Demand P Q The demand curve is downward sloping As price increases, quantity demanded decreases P0P0 Q1Q1 P1P1 Q0Q0 4-5

6. Supply and Demand 4 Shifts in Demand versus Movements Along a Demand Curve Quantity demanded refers to a specific amount that will be demanded per unit of time at a specific price, other things constant Refers to a specific point on the demand curve A change in price changes quantity demanded A change in price causes a change in quantity demanded A change in price causes a movement along the demand curve 4-6

7. Supply and Demand 4 Shifts in Demand versus Movements Along a Demand Curve Demand refers to a schedule of quantities of a good that will be bought per unit of time at various prices, other things constant Refers to the entire demand curve Demand tells us how much will be bought at various prices A change in anything other than price that affects the demand curve changes the entire demand curve A change in the entire demand curve is a shift in demand 4-7

8. Supply and Demand 4 Shifts in Demand versus Movements Along a Demand Curve Demand P Q A change in price causes a movement along the demand curve $1 100 $2 200 Movement along a demand curve B A 4-8

9. Supply and Demand 4 Shifts in Demand versus Movements Along a Demand Curve Demand 0 P Q A change in a shift factor causes a shift in demand $1 150200 Shift in demand BA Demand 1 4-9

10. Supply and Demand 4 Shift Factors in Demand Important demand shift factors include: 1.Society’s income 2.The prices of other goods 3.Tastes 4.Expectations 5.Taxes and subsidies to consumers 4-10

11. Supply and Demand 4 Application: Demand Shift Demand 1 P Q Demand would shift out to the right because your income increased What happens to demand for CDs if you won $1 million in the lottery? Demand 0 4-11

12. Supply and Demand 4 From a Demand Table to a Demand Curve Demand for DVDs P Q $3.00 10 $4.00 2 B A $2.00 $1.00 Price per DVD DVD rentals demanded per week A $0.509 B $1.008 C $2.006 D $3.004 E $4.002 864 C D E 4-12

13. Supply and Demand 4 Individual and Market Demand Curves Price per DVD Alice’s demand + Bruce’s demand + Carmen’s demand = Market demand $1.0085114 $2.006309 $3.004105 $4.002002 4-13

14. Supply and Demand 4 Individual and Market Demand Curves Market demand for DVDs P Q $3.00 10 $4.00 2 $2.00 $1.00 864 11 1213 14 Market demand curve for DVDs per week ALICEBRUCECARMEN The market demand curve is the summation of all individual demand curves 4-14

15. Supply and Demand 4 Supply The law of supply states that the quantity of a good supplied is directly related to the good’s price The law of supply occurs because: When prices rise, firms substitute production of one good for another Assuming firm’s costs are constant, a higher price means higher profit In other words, other things equal, Quantity supplied rises as price rises Quantity supplied falls as price falls 4-15

16. Supply and Demand 4 The Supply Curve A supply curve is the graphic representation of the relationship between price and quantity supplied Supply P Q The supply curve is upward sloping As price increases, quantity supplied increases P0P0 Q1Q1 P1P1 Q0Q0 4-16

17. Supply and Demand 4 Shifts in Supply versus Movements Along a Supply Curve Quantity supplied refers to a specific amount that will be supplied per unit of time at a specific price, other things constant Refers to a specific point on the supply curve A change in price changes quantity supplied A change in price causes a change in quantity supplied A change in price causes a movement along the supply curve 4-17

18. Supply and Demand 4 Shifts in Supply versus Movements Along a Supply Curve Supply refers to a schedule of quantities of a good a seller is willing to sell per unit of time at various prices, other things constant Refers to the entire supply curve Supply tells us how much will be sold at various prices A change in anything other than price that affects the supply curve changes the entire supply curve A change in the entire supply curve is a shift in supply 4-18

19. Supply and Demand 4 Shifts in Supply versus Movements Along a Supply Curve A change in price causes a movement along the supply curve Movement along a supply curve Supply P Q $50 4.6 $80 4.1 4-19

20. Supply and Demand 4 Shifts in Supply versus Movements Along a Supply Curve A change in a shift factor causes a shift in supply Shift in Supply S0S0 P Q S1S1 4-20

21. Supply and Demand 4 Shift Factors in Supply Important supply shift factors include: 1.Price of inputs 2.Technology 3.Expectations 4.Taxes and subsidies 4-21

22. Supply and Demand 4 Individual and Market Supply Curves Price per DVD Ann’s Supply + Barry’s supply + Charlie’s supply = Market supply $1.002103 $2.004307 $3.0065011 $4.0085215 4-22

23. Supply and Demand 4 Individual and Market Demand Curves P Q $3.00 10 $4.00 2 $2.00 $1.00 864 11 1213 14 Market supply curve for DVDs per week The market supply curve is the summation of all individual supply curves BARRY ANN 15 Market supply for DVDs CHARLIE 4-23

24. Supply and Demand 4 The Interaction of Supply and Demand Equilibrium is a concept in which opposing dynamic forces cancel each other out Equilibrium quantity is the amount bought and sold at equilibrium price Equilibrium price is the price toward which the invisible hand drives the market In the free market, the forces of supply and demand interact to determine: 4-24

25. Supply and Demand 4 The Interaction of Supply and Demand If there is an excess supply (a surplus), quantity supplied is greater than quantity demanded Prices adjust and tend to rise when there is excess demand and fall when there is excess supply to reach an equilibrium If there is an excess demand (a shortage), quantity demanded is greater than quantity supplied 4-25

26. Supply and Demand 4 The Interaction of Supply and Demand Supply P Q P0P0 P1P1 Demand Excess demand causes upward pressure on price Excess supply Excess supply causes downward pressure on price Excess demand P*P* 4-26

27. Supply and Demand 4 Shifts in Supply and Demand Shifts in either supply or demand change equilibrium price An increase in demand or a decrease in supply Creates excess demand at the original equilibrium price Excess demand increases price until a new higher equilibrium prince is reached A decrease in demand or an increase in supply Creates excess supply at the original equilibrium price Excess supply decreases price until a new lower equilibrium price is reached 4-27

28. Supply and Demand 4 Application: A decrease in supply A decrease in supply generates excess demand. Price will increase until a new, higher, equilibrium price is reached D0D0 Q S1S1 Q1Q1 P1P1 S0S0 P P0P0 Q0Q0 Excess demand 4-28

29. Supply and Demand 4 Application: A decrease in demand P0P0 D1D1 Q1Q1 P1P1 S0S0 D0D0 P Q Q0Q0 Excess supply A decrease in demand generates excess supply. Price will decrease until a new, lower, equilibrium price is reached 4-29

30. Supply and Demand 4 Limitations of Supply and Demand Analysis Sometimes supply and demand are interconnected The other things held constant assumption is not likely to hold when the goods represent a large percentage of the entire economy The fallacy of composition is the false assumption that what is true for a part will also be true for the whole 4-30

31. Supply and Demand 4 Chapter Summary The law of demand states that the quantity demanded rises as price falls, other things constant The laws of demand and supply hold true because people can substitute The law of supply states that the quantity supplied rises as price rises, other things constant A change in quantity demanded (supplied), caused by only a change in the good’s own price, is a movement along the demand (supply) curve A change in demand (supply) is a shift of the entire demand (supply) curve 4-31

32. Supply and Demand 4 Chapter Summary Factors that affect supply and demand other than price are called shift factors Important supply shift factors include price of inputs, technology, expectations, and taxes and subsidies Important demand shift factors include society’s income, the price of other goods, tastes, expectations, and taxes and subsidies to consumers A market demand (supply) curve is the horizontal sum of all individual demand (supply) curves When quantity demanded equals quantity supplied at equilibrium, prices have no tendency to change 4-32

33. Supply and Demand 4 Chapter Summary When quantity demanded is greater than quantity supplied, prices tend to rise When quantity supplied is greater than quantity demanded, prices tend to fall When the demand curve shifts to the right (left), equilibrium price rises (declines) and equilibrium quantity rises (falls) When the supply curve shifts to the right (left), equilibrium price decline (rises) and equilibrium quantity rises (falls) 4-33

34. Supply and Demand 4 Preview of Chapter 5: Using Supply and Demand Explain real-world events using supply and demand Explain the effects of excise taxes and tariffs Discuss how exchange rates are determined Explain the effect of a third-party-payer system Demonstrate the effect of a price ceiling and price floor 4-34