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Copyright ©2011 by Pearson Education, Inc.All rights reserved.

Chapter 3

Demand and Supply

3-2Copyright © 2011 Pearson Education, Inc. All rights reserved.

Introduction

Three decades ago, 45% of U.S. residents were classified as “overweight”. Today, about 67% fall into this category.

One explanation for higher body weights is less exercise; another is that people simply consume more food than in the past.

Determining why individuals eat more requires understanding of how two key variables—price and income—influence desired consumption of an item such as food.


Learning Objectives

• Explain the law of demand• Discuss the difference between money

prices and relative prices• Distinguish between changes in demand

and changes in quantity demanded


Learning Objectives (cont'd)

• Explain the law of supply

• Distinguish between changes in supply and changes in quantity supplied

• Understand how supply and demand interact to determine equilibrium price and quantity


Chapter Outline

• Demand• The Demand Schedule• Shifts in Demand• The Law of Supply• The Supply Schedule• Shifts in Supply• Putting Demand and Supply Together


Did You Know That...

• No new oil refineries have been built in the U.S. since 1976?

• Recently, however, Hyperion, a Dallas-based company, announced its intention to build a new refinery at Elk Pont, South Dakota.

• By using demand and supply you can develop a better understanding of why we sometimes see large increases in the price of gasoline.


Did You Know That… (cont’d)

• Markets

– Arrangements that individuals have for exchanging with one another

– Represent the interaction of buyers and sellers for goods and services

– Markets set the prices we pay and receive.• Automobile market• Health care market• Labor market• Stock market


Demand

• A schedule showing how much of a good or service people will purchase at any price during a specified time period, other things being constant


Demand (cont’d)

• Law of Demand

– Quantity demanded is inversely related to price, holding other factors constant.

• Price Qd

• Price Qd


Demand (cont’d)

• What are we holding constant?

– Income

– Tastes and preferences

– Price of other goods

– Many other factors


Demand (cont’d)

• Relative prices and money prices

– Relative Price• The price of a commodity in terms of

another commodity

– Money Price• Price we observe today in today’s dollars (absolute, or

nominal price)


Table 3-1 Money Price versus Relative Price


E-Commerce Example: Quality-Adjusting the Price of Broadband Service

• In most U.S. areas, broadband Internet service is priced at about $15 per month compared to France, where price is about $36 per month.

• U.S. providers, however, typically offer broadband speeds of less than 0.77 megabit per second compared to 20 megabits per second in France.

• Thus, the U.S. speed-adjusted price is nearly 10 times higher than in France.


The Demand Schedule

• The demand schedule – Table relating prices to quantity demanded

– We must consider • Time dimension• Constant-quality units

• Demand Curve– A graphical representation of the demand schedule

– Negatively sloped line showing inverse relationship between price and quantity demanded, all else equal


Figure 3-1 The Individual Demand Schedule and the Individual Demand Curve, Panel (a)


Figure 3-1 The Individual Demand Schedule and the Individual Demand Curve, Panel (b)


The Demand Schedule (cont’d)

• Individual versus market demand curves

• Market Demand– The demand of all consumers in the

marketplace for a particular good or service

– Summation at each price of the quantity demanded by each individual


Figure 3-2 The Horizontal Summation of Two Demand Curves, Panel (a)


Figure 3-2 The Horizontal Summation of Two Demand Curves, Panels (b), (c), (d)


Figure 3-3 The Market Demand Schedule for Secure Digital Cards, Panel (a)


Figure 3-3 The Market Demand Schedule for Secure Digital Cards, Panel (b)


Shifts in Demand

• Scenario

– Imagine the federal government gives every student registered in a college, university, or technical school in the United States a laptop with a slot for secure digital cards.

• If some factor other than price changes, we can show its effect by moving the entire demand curve, shifting the curve left or right.


Figure 3-4 A Shift in the Demand Curve

Suppose the federal government gives every student a notebook computer

Suppose universities prohibit the use of notebook computers


Determinants of Demand

• Ceteris-Paribus Conditions

– Determinants of the relationship between price and quantity that are unchanged along a curve

– Changes in these factors cause a curve to shift


Normal and Inferior Goods

• Normal Goods– Goods for which demand rises as income rises;

most goods are normal goods

• Inferior Goods– Goods for which demand falls as income rises


Shifts in Demand

• Determinants of demand

– Income

– Tastes and preferences

– The prices of related goods• Substitutes

• Complements


Shifts in Demand (cont'd)

• Substitutes

– Two goods are substitutes when a change in the price of one causes a shift in demand for the other in the same direction as the price change.


Example: Diamonds May Not Really Be Forever

• The day that sellers of diamonds have long dreaded has arrived. Several experts examine three gems.

• The first gem is a real diamond; the second is cubic zirconia; the third is a gem-quality diamond produced in a lab—known as a “synthetic” diamond.

• The jewelry experts pronounce the synthetic gem as the highest quality of the three.

• In what direction do you think the demand curve for real diamonds has shifted as lower-priced synthetic diamonds have become available?



• Complements

– Two goods are complements when a change in the price of one causes an opposite shift in the demand curve for the other.



• Determinants of demand

– Expectations• Future prices

• Income

• Product availability

– Market size (number of buyers)



The Determinants of DemandIncome: Normal Good

D1

Q/Units

D2D3

Price

Decrease in incomedecreases demand

Increase in incomeincreases demand



The Determinants of DemandIncome: Inferior Good

D1

Q/Units

Decrease in incomeincreases demand

Increase in incomedecreases demand

Price

D2D3



The Determinants of DemandTastes and Preferences

D1

Q/Units

Price

Hybrid vehicles• Increase in demand

D2

SUVs• Decrease in demand

D3



The Determinants of DemandPrice of Related Goods: Substitutes

D1

Q/Butter

Butter and Margarine• Price of both = $2/lb• Price of margarine

increases to $3/lb• Demand for butter

increases

D2

Price



The Determinants of DemandPrice of Related Goods: Complements

D1

Q/Speakers

Speakers and Amplifiers• Decrease the relative

price of amplifiers• Demand for speakers

increases

D2D3

Speakers and Amplifiers• Increase the relative

price of amplifiers• Demand for speakers

decreases

Price



The Determinants of DemandExpectations: Income, Future Prices

D1

Q/Units

A higher income or expectations of a higher future price will increase demand

D2D3

A lower income or expectations of a lower future price will decrease demand

Price


The Determinants of DemandMarket Size (Number of Buyers)

D1

Q/Units

Increase in the number of buyers increases demand

D2D3

Decrease in the number of buyers decreases demand

Price




• Changes in demand versus changes in quantity demanded

– A change in one or more of the non-price determinants (income, tastes, etc.) will lead to a change in demand.

• This is a shift of the whole curve.



• Changes in demand versus changes in quantity demanded

– A change in a good’s own price leads to a change in quantity demanded.

• This is a movement along the same curve.– ∆D is not the same as ∆Qd.


Figure 3-5 Movement Along a Given Demand Curve

A change in the price changes the quantity of a good demanded, movement along the curve


The Law of Supply

• Supply

– Schedule showing relationship between price and quantity supplied for a specified time period, other things being equal

– The amount of a product or service that firms are willing to sell at alternative prices


The Law of Supply (cont'd)

• Law of Supply

– The price of a product or service and the quantity supplied are directly related.

• P Qs

• P Qs


The Supply Schedule

• The supply schedule is a table relating prices to quantity supplied at each price.

• Supply Curve– A graphical representation of the

supply schedule

– Positively sloped line showing direct relationship between price and quantity supplied, all else equal


Figure 3-6 The Individual Producer’s Supply Schedule and Supply Curve for Secure Digital Cards, Panel (a)


Figure 3-6 The Individual Producer’s Supply Schedule and Supply Curve for Secure Digital Cards, Panel (b)


Figure 3-7 Horizontal Summation of Supply Curves, Panel (a)


Figure 3-7 Horizontal Summation of Supply Curves, Panels (b), (c), (d)


Figure 3-8 The Market Supply Schedule and the Market Supply Curve for Secure Digital Cards, Panel (a)


Figure 3-8 The Market Supply Schedule and the Market Supply Curve for Secure Digital Cards, Panel (b)


Shifts in Supply

• Scenario

– A new method of manufacturing SD cards significantly reduces the cost of production.

– What will producers of SD cards do?


Figure 3-9 A Shift in the Supply Curve

If some other factor than price changes, the only way we can show its effect is by moving the entire supply curve

If costs decrease, supply increases

If costs increase, supply decreases


S1

Quantity of Flash Memory Pen Drives Supplied (millions of constant-quality units per year)

Pric

e pe

r Fla

sh M

emor

y P

en D

rive

($)

2 4 6 80

1

2

3

4

5

10 12 14

S2

a

cWhen supply increases the quantity supplied will be greater at each price

Figure 3-9 A Shift in the Supply Curve (cont’d)


S1

Quantity of Flash Memory Pen Drives Supplied(millions of constant-quality units per year)

2 4 6 80

1

2

3

4

5

10 12 14

ab

d

c

S2

When supply increases the quantity supplied will be greater at each price

Pric

e pe

r Fla

sh M

emor

y P

en D

rive

($)



Quantity of Flash Memory Pen Drives Supplied(millions of constant-quality units per year)

2 4 6 80

1

2

3

4

5

10 12 14

S1

a

c

S3

b

dWhen supply decreases the quantity supplied will be less at each price

Pric

e pe

r Fla

sh M

emor

y P

en D

rive

($)



Shifts in Supply (cont'd)

• Determinants of supply

– Cost of inputs

– Technology and productivity

– Taxes and subsidies

– Price expectations

– Number of firms in industry



The Determinants of SupplyCost of Inputs

S1

Q/Units

Decrease in cost increases supply

S2Increase in costdecreases supply

S3Price



The Determinants of SupplyTechnology and Productivity

S1

Q/Units

Improvements in technology or increases in productivity increase supply

S2Decreases in productivity decrease supply

S3Price



The Determinants of SupplyTaxes and Subsidies

S1

Q/Units

Decreases in taxes or increases in subsidies increase supply

S2

Increases in taxes or decreases in subsidies decrease supply

S3Price



The Determinants of SupplyPrice Expectations

S1

Q/Units

Expectations of lower future prices increase supply

S2Expectations of higher future prices decrease supply

S3Price



The Determinants of SupplyNumber of Firms in Industry

S1

Q/Units

Increase in the number of firms increases supply

S2Decrease in the number of firms decreases supply

S3Price



• Changes in supply versus changes in quantity supplied

– A change in one or more of the non-price determinants will lead to a change in supply.

• This is a shift of the whole curve.



• Changes in supply versus changes in quantity supplied

– A change in a good’s own price leads to a change in quantity supplied.

• This is a movement along the same curve.– ∆S is not the same as ∆Qs.


International Policy Example: Government Subsidies Generate More Train Traffic in Europe

• Recently, national governments of the European Union decided to shoulder most of the regular expenses associated with maintaining rail track networks, providing a subsidy per kilometer of track traversed by rail freight.

• European rail companies have responded by increasing the amounts of freight transport services they provide.

• Thus, the provision of government subsidies has brought about an increase in the supply of European rail-freight services.


Putting Demand and Supply Together

• Putting demand and supply together

• Equilibrium (Market Clearing) Price– The price that clears the market

– The price at which quantity demanded equals quantity supplied

– The price where the demand curve intersects the supply curve


Figure 3-10 Putting Demand and Supply Together, Panel (a)


Figure 3-10 Putting Demand and Supply Together, Panel (b)


Putting Demandand Supply Together (cont'd)

• Equilibrium

– The situation when quantity supplied equals quantity demanded at a particular price

– There tends to be no movement of the price of the quantity away from this point unless demand or supply changes.

– Equilibrium is a stable point – any point that is not equilibrium is unstable and will not persist.



• Shortages

– The situation when quantity demanded is greater than quantity supplied • Qd > Qs

– Exist at any price below the market clearing price



• Surpluses

–The situation when quantity supplied is greater than quantity demanded•Qd < Qs

–Exist at any price above the market clearing price


Policy Example: Should Shortages in the Ticket Market Be Solved by Scalpers?

• If you’ve ever tried to get tickets to the big game you know all about “shortages.”

• Since the quantity of tickets is fixed, the price can go pretty high.

• Enter the scalper.


Figure 3-11 Shortages of Super Bowl Tickets


Issues and Applications: Why Are People Eating More?

• Being overweight predisposes an individual to ailments such as arthritis, diabetes, heart disease, high blood pressure, respiratory problems, and strokes.

• Yet, about two-thirds of the U.S. population is overweight.

• A more sedentary lifestyle and increased calorie consumption help explain the increase in body mass of the average U.S. resident.

• One of the reasons for the increase in food consumption is the fact that relative food prices have fallen by over 17 percent over the last three decades.


Issues And Applications: Why Are People Eating More? (cont’d)

• One reason people today buy and eat more food is simply because food is cheaper than it used to be.

• Incomes have also risen over the same time span and most food items are normal goods, hence demand for food has risen.

• Without additional exercise, people have been gaining more weight.


Figure 3-12 U.S. Calorie Consumption and the Relative Price of Food, Panel (a)


Figure 3-12 U.S. Calorie Consumption and the Relative Price of Food, Panel (b)


Summary Discussion of Learning Objectives

• The law of demand says that prices and quantity demanded are inversely related.– At a higher price people buy less, at a lower

price people buy more.

• Relative prices must be distinguished from money prices, since people respond to changes in relative prices.


Summary Discussionof Learning Objectives (cont'd)

• A change in quantity demanded versus a change in demand

– A change in quantity demanded is a movement along the same demand curve.

– A change in demand is a shift of the whole demand curve.


Summary Discussion of Learning Objectives (cont'd)

• The law of supply states that price and quantity supplied are directly related.– At a high price firms offer more; at a low price

firms offer less.

• A change in quantity supplied versus a change in supply– A change in quantity supplied is a movement

along the same supply curve.– A change in supply is a shift of the whole

supply curve.


Summary Discussion of Learning Objectives (cont'd)

• Determining market price and equilibrium quantity

– The demand and supply curves intersect at the market clearing, or equilibrium point.

– Surpluses exist if the price of the good is greater than the market price.

– Shortages exist when the price of a good is below the market price.

Documents

3-2 Copyright © 2011 Pearson Education, Inc. All rights reserved.wpscms.pearsoncmg.com/wps/media/objects/6779/6942092/studyn… · Title: Microsoft PowerPoint - MILLER_15_PP_C03.ppt