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Supply and Demand

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Slides By: Solina Lindahl

OverviewOverview

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After studying this chapter you should be able to describe:

• the nature and purposes of markets.• the nature of demand, demand curves, and the

law of demand.• the determinants of demand.• the difference between a change in demand and

a change in quantity demanded.

OverviewOverview

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After studying this chapter you should be able to describe (cont.):

• the nature of supply, supply curves, and the law of supply.

• the determinants of supply.• the difference between a change in supply and a

change in quantity supplied.• market equilibrium price and output.• and predict how price and output will change given

changes to supply and demand in the market.• impacts of government intervention in markets.

Some good blogs and other sites to get the juices flowing:

Food for Thought….Food for Thought….

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MarketsMarkets

• Models of supply and demand are the foundation of economic theory.

• Market: institution that brings buyers and sellers together• Examples: lemonade stand, eBay, NY

Stock Exchange

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The Price SystemThe Price System• Prices send signals in free-market

economies:• To buyers

• What to buy? How much?

• To sellers• What to sell? How much? What method of

production to use?

• The Price System: market economies use prices to allocate resources, goods and services.

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DemandDemand

Demand: the maximum amount of a product that buyers are willing and able to purchase over some time period at various prices (ceteris paribus)

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The Demand CurveThe Demand Curve

Price Quantity

$100 0

80 5

60 10

40 15

20 20

$100

$80

$60

$40

$20

5 10 15 20

Pri

ce (

$)

D

Quantity (computer games)

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Law of DemandLaw of Demand

• Law of Demand: Holding all other relevant factors constant, price and quantity demanded are negatively related• Consumer incomes can afford more

goods when prices are lower.

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Market Demand CurvesMarket Demand Curves• Market demand: horizontal summation of

all individual demand curves

• Horizontal summation: Market demand and supply curves are found by adding together how many units of the product will be purchased/supplied at each price.

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Market Demand CurveMarket Demand CurveBetty’s Demand Curve

Abe’s Demand Curve+

Market Demand Curve=

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Determinants of DemandDeterminants of Demand• In drawing a demand curve, we hold other factors

constant: these are called Determinants of Demand• Tastes and Preferences• Income• Prices of related goods• Number of buyers• Future expectations

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Tastes and PreferencesTastes and Preferences

• Demand will increase for products that “come into fashion” (and vice versa)• Examples:

• Soymilk, organic produce, “fair trade” coffee, skinny pants, acai berries

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IncomeIncome

• Normal goods: demand increases as incomes rise.

• Inferior goods: demand decreases as incomes rise.• Examples of inferior goods:

• Bus travel, fast food• Other?

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Prices of Related GoodsPrices of Related Goods

• Substitute goods are those used in place of one another (depending on their relative prices)• Examples:

• Margarine brands

An increase in the price of Brand A will increase the demand for Brand B

An increase in the price of Brand A will increase the demand for Brand B

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Prices of Related GoodsPrices of Related Goods• Complement goods are those

typically consumed together• Examples:

• Gas and SUVs

• If the price of a complement decreases, the demand for the original good increases• (and vice versa)

Gas price increases are bad for SUV sales

Gas price increases are bad for SUV sales

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The Number of BuyersThe Number of Buyers

• As more consumers enter a market, demand increases

As average life spans are extended, demand for

pharmaceuticals increases.

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Future ExpectationsFuture Expectations

• A change in consumers’ expectations about:• Future Prices• A good’s availability• Their own incomes

• Will affect demand curves

2009: gun sales increased as NRA members worried that Obama would enact tougher gun

control laws

2009: gun sales increased as NRA members worried that Obama would enact tougher gun

control laws

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Changes in DemandChanges in Demand• A “change in demand” is NOT the

same as a“change in quantity demanded.”

• A change in demand: Occurs when one or more of the determinants of demand changes, shown as a shift in the entire demand curve.

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Changes in Demand vs. Changes in Changes in Demand vs. Changes in Quantity DemandedQuantity Demanded

Quantity (computer games)Quantity (computer games)

Pri

ce (

$)

Pri

ce (

$)

Change in Demand Change in Quantity Demanded

D0

D1

80

40

20 40

D0

80

20 40

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Who’s WhoWho’s Who

Alfred Marshall (1842-1924)

• Father of modern Supply and Demand

• Was J.M. Keynes’ teacher

• Developed key ideas:• Price elasticity of demand

• Consumer and producer surplus

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SupplySupply

Supply: the maximum amount of a product that producers are willing and able to sell over some time period at various prices (ceteris paribus)

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The Supply CurveThe Supply Curve$100

$80

$60

$40

$20

10 20 30 40

Pri

ce (

$)

Quantity (computer games)50

S

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Law of SupplyLaw of Supply

• Price and Quantity Supplied are positively related• Producers want to maximize their profits

so usually offer more for sale when prices rise

• e.g., production of corn increases as ethanol demand pushes prices for corn higher (and thus profits!)

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Market Supply CurvesMarket Supply Curves• Market supply: horizontal summation

of all individual supply curves• e.g., if there are 100 producers of

doghouses,

• each of whom makes 5 doghouses when P=$50,

• then market supply = 500

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Determinants of SupplyDeterminants of Supply• In drawing a supply curve, we hold other

factors constant:• Production Technology• Costs of Resources• Prices of Other Commodities• Future Expectations• Number of Sellers• Taxes and Subsidies

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Production TechnologyProduction Technology

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Costs of ResourcesCosts of Resources

Supply will increase if the costs of resources used decrease (and vice versa)

Example: if corn prices decrease, the supply of corn tortillas increases

Example: if corn prices decrease, the supply of corn tortillas increases

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Prices of Other CommoditiesPrices of Other Commodities

Producers have the ability to produce other goods

An increase in the profitability of small cars will decrease the supply of SUVs

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Future ExpectationsFuture Expectations

A change in producers’ expectations about profitability will affect supply curves

Windmill production increases as producers expect sales and profitability to increase.

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Number of SellersNumber of Sellers• As more producers

enter a market, supply increases (and vice versa)

As more firms enter the solar installation market, the number of solar installations available for sale increases

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Taxes and SubsidiesTaxes and Subsidies

Taxes and subsidies affect profits and therefore supply.

A 10% yacht tax reduced the supply of yachts 53% in the early 1990s. 3- 32

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Cotton SupplyCotton Supply

When the U.S. decreases its cotton subsidies, U.S. cotton supply decreases

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Changes in SupplyChanges in Supply• A “change in supply” is NOT the same

as a“change in quantity supplied.”

• A change in supply: Occurs when one or more of the determinants of supply changes, shown as a shift in the entire supply curve.

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Changes in Supply vs. Changes in Quantity Changes in Supply vs. Changes in Quantity SuppliedSupplied

Quantity (computer games)Quantity (computer games)

Pri

ce (

$)

Pri

ce (

$)

Change in Supply Change in Quantity SuppliedS0

S1

40

20

S0

80

40

80

4020

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Market EquilibriumMarket Equilibrium• Equilibrium: When Qs=Qd at a certain

price

• Equilibrium price: the price that results when Qs=Qd

• Equilibrium Quantity: the output that results where Supply = Demand

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At a price of $5.00, a SURPLUS of 10 energy drinks exists

How Markets Find Equilibrium When Price Is Too How Markets Find Equilibrium When Price Is Too HighHigh

$5.00

4.00

3.00

2.00

1.00

0

5 10 15 20 25

Q

S

P

D

Energy Drinks

..

At P = $5.00:

Surplus forces producers to drop price….Price will fall, people will buy more and Qd = Qs

At P = $5.00:

Surplus forces producers to drop price….Price will fall, people will buy more and Qd = Qs

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How Markets Find Equilibrium When Price Is Too How Markets Find Equilibrium When Price Is Too LowLow

$5.00

4.00

3.00

2.00

1.00

0

5 10 15 20 25

Q

S

P

D

..

At P = $3.00:

Shortage allows producers to raise price….Price will rise, people will buy less and Qd = Qs

At P = $3.00:

Shortage allows producers to raise price….Price will rise, people will buy less and Qd = Qs

At a price of $3.00, a SHORTAGE of 10 energy drinks exists

Energy Drinks

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How Markets Find Equilibrium How Markets Find Equilibrium When Price is Too HighWhen Price is Too High

$5.00

4.00

3.00

2.00

1.00

0

5 10 15 20 25

Q

S

P

D

Energy Drinks

..

At P = $5.00:

Qs = 25, Qd = 15Qs = 25, Qd = 15

At P = $5.00:

Qs = 25, Qd = 15Qs = 25, Qd = 15

Price will fall to equilibrium ($4.00) and Qd will rise to 20, Qs will fall to 20 and

Qd = QsQd = Qs

Price will fall to equilibrium ($4.00) and Qd will rise to 20, Qs will fall to 20 and

Qd = QsQd = Qs

At a price of $5.00, a SURPLUS of 10 energy drinks (25-15) exists… suppliers are left with stock on the shelves, so they take action to get the surplus sold and raise revenue.

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How Markets Find Equilibrium How Markets Find Equilibrium When Price is Too LowWhen Price is Too Low

Price will rise to equilibrium ($4.00): Qd will fall to 20, Qs will rise to 20 and

QQdd = Q = Qss

Price will rise to equilibrium ($4.00): Qd will fall to 20, Qs will rise to 20 and

QQdd = Q = Qss

$5.00

4.00

3.00

2.00

1.00

05 10 15 20 25

Q

S

P

D

..

At P = $3.00:

QQss = 15, Q = 15, Qdd = 25 = 25

At P = $3.00:

QQss = 15, Q = 15, Qdd = 25 = 25

At a price of $3.00, a SHORTAGE of 10 energy drinks (25-15) exists… buyers compete with each other for purchases, so sellers see their chance to raise price and revenue

Energy Drinks

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D1

Equilibrium and Shifts of the Equilibrium and Shifts of the Demand CurveDemand Curve

Q0

P0

S

D0

Price of energy drinks

Quantity of energy drinks

Q1

P1

Causes the equilibrium to change to a higher P and Qhigher P and Q

Causes the equilibrium to change to a higher P and Qhigher P and Q

An increase in demandAn increase in demand

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D0

Equilibrium and Shifts of the Equilibrium and Shifts of the Demand CurveDemand Curve

S

Price of energy drinks

Quantity of energy drinks

Q0

P0

D1

Q1

P1

Causes the equilibrium to change to a lower P and Qlower P and Q

Causes the equilibrium to change to a lower P and Qlower P and Q

A decrease in demandA decrease in demand

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S1

D0

Equilibrium and Shifts of the Equilibrium and Shifts of the Supply CurveSupply Curve

S0

Price of energy drinks

Quantity of energy drinks

Q0

P0

Q1

P1

Causes the equilibrium to change to a lower P and higher Q

Causes the equilibrium to change to a lower P and higher Q

An increase in supplyAn increase in supply

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S1

D0

Equilibrium and Shifts of the Equilibrium and Shifts of the Supply CurveSupply Curve

S0

Price of energy drinks

Quantity of energy drinks

Q0

P0

Q1

P1

Causes the equilibrium to change to a higher P and lower Q

Causes the equilibrium to change to a higher P and lower Q

A decrease in supplyA decrease in supply

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Predicting the outcome is more tricky, but can be done if you know which curves shifts further.

When Both Curves ShiftWhen Both Curves Shift

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Review of ShiftsReview of Shifts

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Price CeilingsPrice CeilingsP

rice

Quantity

S0

D0

Pe

Pc

Shortage

A price ceiling is a government-set maximum price that can be charged for a product or service.Price ceilings lead to shortages.

Q4Q3

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Price FloorsPrice FloorsP

rice

Quantity

S0

D0

Pe

P1

Q1 Q2

Surplus

A price floor is a government-set minimum price that can be charged for a product or service.Price floors lead to surpluses.

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Key ConceptsKey Concepts

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Which of the following is NOT a determinant of demand for orange juice?

a. Level of consumer incomes

b. Price of apple juice, a substitute good

c. Medical research that reports new benefits from drinking orange juice

d. Level of government subsidies to orange farmers

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Which of the following will cause an increase in the demand for autos?

a. Price of car tires increase because of a Malaysian rubber shortage

b. Concrete steel reinforcing rods are replaced by aluminum along the Atlantic coast to prevent rusting

c. Gasoline prices drop by 50% when OPEC nations increase production

d. McDonald’s increases its hamburger production in response to consumer trends

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If the cost of wood falls, what will happen in the violin market?

a. Equilibrium Price and Quantity both fall

b. Equilibrium Price and Quantity both rise

c. Equilibrium Price falls and Quantity rises

d. Equilibrium Price rises and Quantity falls

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If garden gnomes regain widespread popularity, what will happen?

a. Equilibrium Price and Quantity both fall

b. Equilibrium Price and Quantity both rise

c. Equilibrium Price falls and Quantity rises

d. Equilibrium Price rises and Quantity falls

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If the price of MP3s drops substantially, what happens in the market for CDs?a. Equilibrium Price and

Quantity both fall

b. Equilibrium Price and Quantity both rise

c. Equilibrium Price falls and Quantity rises

d. Equilibrium Price rises and Quantity falls