Chap004 Demand & Supply

Micro232 2004 - jafgac

Supply and DemandSupply and Demand

Chapter 4

Micro232 2004 JAFGAC

Laugher CurveLaugher Curve

Q. What do you get when you cross the Godfather with an economist?

A. An offer you can't understand.


DemandDemand Demand means the willingness and

capacity to pay. Prices are the tools by which the market

coordinates individual desires.


The Law of DemandThe Law of Demand Law of demand – there is an inverse

relationship between price and quantity demanded. Quantity demanded rises as price falls,

other things constant. Quantity demanded falls as prices rise,

other things constant.


The Law of DemandThe Law of Demand What accounts for the law of demand?

People tend to substitute for goods whose price has gone up.


The Demand CurveThe Demand Curve The demand curve is the graphic

representation of the law of demand. The demand curve slopes downward and

to the right. As the price goes up, the quantity

demanded goes down.


D

Pric

e (p

er u

nit)

0Quantity demanded (per unit of time)

PA

QA

A

A Sample Demand CurveA Sample Demand Curve


Other Things ConstantOther Things Constant Other things constant places a limitation

on the application of the law of demand. All other factors that affect quantity

demanded are assumed to remain constant, whether they actually remain constant or not.


Other Things ConstantOther Things Constant Other things constant places a limitation

on the application of the law of demand. These factors may include changing

tastes, prices of other goods, income, even the weather.


Demand refers to a schedule of quantities of a good that will be bought per unit of time at various prices, other things constant.Graphically, it refers to the entire demand curve.

Shifts in Demand Versus Shifts in Demand Versus Movements Along a Movements Along a Demand CurveDemand Curve


Quantity demanded refers to a specific amount that will be demand per unit of time at a specific price.

Graphically, it refers to a specific point on the demand curve.



A movement along a demand curve is the graphical representation of the effect of a change in price on the quantity demanded.



A shift in demand is the graphical representation of the effect of anything other than price on demand.



Change in Quantity Change in Quantity DemandedDemanded

D1

Change in quantity demanded(a movement along the curve)

B

0

Pric

e (p

er u

nit)

Quantity demanded (per unit of time)100

$2

$1

200

A


D0

D1

Shift in DemandShift in DemandP

rice

(per

uni

t)

Quantity demanded (per unit of time)100

$2

$1

200

B A

Change in demand(a shift of the curve)

250


Shift Factors of DemandShift Factors of Demand Shift factors of demand are factors that

cause shifts in the demand curve: Society's income. The prices of other goods. Tastes. Expectations. Taxes on subsidies to consumers.


IncomeIncome An increase in income will increase

demand for normal goods. An increase in income will decrease

demand for inferior goods.


Price of Other GoodsPrice of Other Goods When the price of a substitute good falls,

demand falls for the good whose price has not changed.

When the price of a complement good falls, demand rises for the good whose price has not changed.


TastesTastes A change in taste will change demand with

no change in price.


ExpectationsExpectations If you expect your income to rise, you may

consume more now. If you expect prices to fall in the future, you

may put off purchases today.


Taxes and SubsidiesTaxes and Subsidies Taxes levied on consumers increase the

cost of goods to consumers, thereby reducing demand.

Subsidies have an opposite effect.


The Demand TableThe Demand Table The demand table assumes all the

following: As price rises, quantity demanded

declines. Quantity demanded has a specific time

dimension to it. All the products involved are identical in

shape, size, quality, etc.


The Demand TableThe Demand Table The demand table assumes all the

following: The schedule assumes that everything

else is held constant.


From a Demand Table to From a Demand Table to a Demand Curvea Demand Curve You plot each point in the demand table on

a graph and connect the points to derive the demand curve.


From a Demand Table to From a Demand Table to a Demand Curvea Demand Curve The demand curve graphically conveys the

same information that is on the demand table.


From a Demand Table to From a Demand Table to a Demand Curvea Demand Curve The curve represents the maximum price

that you will pay for various quantities of a good – you will happily pay less.


Price

per

DVD

s (in

dol

lars

)

A Demand Curve

Quantity of DVDs demanded (per week)1 2 3 4 5 6 7 8 9 10 11 12

13

$6.00

5.00

4.00

3.00

2.00

1.00 .50

0

3.50E

D

C

BFA

From a Demand Table to From a Demand Table to a Demand Curvea Demand Curve

Price per cassette

ABCDE

A Demand Table

DVD rentals demanded per

week

$0.50 1.002.003.004.00

98642

Demand for DVDs

G


Individual and Market Individual and Market Demand CurvesDemand Curves A market demand curve is the horizontal

sum of all individual demand curves. This is determined by adding the

individual demand curves of all the demanders.


Individual and Market Individual and Market Demand CurvesDemand Curves Sellers estimate total market demand for

their product which becomes smooth and downward sloping curve.

From Individual DemandsFrom Individual Demandsto a Market Demand to a Market Demand CurveCurve

(1)Price per cassette

$.0.501.001.502.002.503.003.504.00

(2)Alice’s

demand

(3)Bruce’s demand

(2)Cathy’s demand

(3)Market demand

98765432

65432100

11000000

16141197532

ABCDEFGH Cathy Bruce Alice

D

A

C

EF

G

Quantity of cassettes demanded per week2

$4.00

3.50

3.00

2.50

2.00

1.50

1.00

0.50

0Pr

ice p

er c

asse

tte (i

n do

llars

)

4 6 8 10 12 14 16

B

Market demand

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.


The Law of DemandThe Law of Demand The demand curve is downward sloping for

the following reasons: At lower prices, existing demanders buy

more. At lower prices, new demanders enter

the market.


SupplySupply Individuals control the factors of production

– inputs, or resources, necessary to produce goods.

Individuals supply factors of production to intermediaries or firms.


SupplySupply The analysis of the supply of produced

goods has two parts: An analysis of the supply of the

factors of production to households and firms.

An analysis of why firms transform those factors of production into usable goods and services.


The Law of SupplyThe Law of Supply There is a direct relationship between price

and quantity supplied. Quantity supplied rises as price rises,

other things constant. Quantity supplied falls as price falls,

other things constant.


The Law of SupplyThe Law of Supply The law of supply is accounted for by two

factors: When prices rise, firms substitute

production of one good for another. Assuming firms’ costs are constant, a

higher price means higher profits.


The Supply CurveThe Supply Curve The supply curve is the graphic

representation of the law of supply. The supply curve slopes upward to the

right. The slope tells us that the quantity

supplied varies directly – in the same direction – with the price.


S

A

Quantity supplied (per unit of time)

0

Pric

e (p

er u

nit)

PA

QA

A Sample Supply CurveA Sample Supply Curve


Shifts in Supply Versus Shifts in Supply Versus Movements Along a Movements Along a Supply CurveSupply Curve Supply refers to a schedule of quantities a

seller is willing to sell per unit of time at various prices, other things constant.


Quantity supplied refers to a specific amount that will be supplied at a specific price.

Shifts in Supply Versus Shifts in Supply Versus Movements Along a Movements Along a Supply CurveSupply Curve


Changes in price causes changes in quantity supplied represented by a movement along a supply curve.



A movement along a supply curve – the graphic representation of the effect of a change in price on the quantity supplied.



If the amount supplied is affected by anything other than a change in price, there will be a shift in supply.



Shift in supply – the graphic representation of the effect of a change in a factor other than price on supply.



Shift in SupplyShift in SupplyP

rice

(per

uni

t)


S0

Shift in Supply(a shift of the curve)

S1

$15 A B

1,250 1,500


Change in quantity supplied (a movement along the curve)

Change in Quantity Change in Quantity Supplied Supplied

Pric

e (p

er u

nit)


S0

$15 A

1,250 1,500

B


Shift Factors of SupplyShift Factors of Supply Other factors besides price affect how

much will be supplied: Prices of inputs used in the production of

a good. Technology. Suppliers’ expectations. Taxes and subsidies.


Price of InputsPrice of Inputs When costs go up, profits go down, so that

the incentive to supply also goes down. If costs go up substantially, the firm may

even shut down.


TechnologyTechnology Advances in technology reduce the

number of inputs needed to produce a given supply of goods.

Costs go down, profits go up, leading to increased supply.


ExpectationsExpectations If suppliers expect prices to rise in the

future, they may store today's supply to reap higher profits later.


Taxes and SubsidiesTaxes and Subsidies When taxes go up, costs go up, and profits

go down, leading suppliers to reduce output.

When government subsidies go up, costs go down, and profits go up, leading suppliers to increase output.


The Supply TableThe Supply Table Each supplier follows the law of supply. When price rises, each supplies more, or

at least as much as each did at a lower price.


From a Supply Table to a From a Supply Table to a Supply CurveSupply Curve To derive a supply curve from a supply

table, you plot each point in the supply table on a graph and connect the points.


From a Supply Table to a From a Supply Table to a Supply CurveSupply Curve The supply curve represents the set of

minimum prices an individual seller will accept for various quantities of a good.


From a Supply Table to a From a Supply Table to a Supply CurveSupply Curve Competing suppliers’ entry into the market

places a limit on the price any supplier can charge.


Individual and Market Individual and Market Supply CurvesSupply Curves The market supply curve is derived by

horizontally adding the individual supply curves of each supplier.


From Individual Supplies From Individual Supplies to a Market Supplyto a Market Supply

Quantities Supplied

ABCDEFGHI

(1)Price

(per DVD)

(2) Ann's Supply

(5)MarketSupply

(4)Charlie'sSupply

$0.000.501.001.502.002.503.003.504.00

012345678

001234555

000000022

013579111415

(3)Barry's Supply


1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16

From Individual Supplies From Individual Supplies to a Market Supplyto a Market Supply

Pric

e pe

r DV

D

Charlie Barry Ann

Quantity of DVDs supplied (per week)

$4.00

3.50

3.00

2.50

2.00 1.50

1.00

0.50 0

IH

G

F

ED

C

BA

Market Supply

CA


The Interaction of Supply The Interaction of Supply and Demandand Demand The English historian Thomas Carlyle once

said:“Teach any parrot the words supply and demand and you’ve got an economist.”


EquilibriumEquilibrium Equilibrium is a concept in which opposing

dynamic forces cancel each other out.


EquilibriumEquilibrium In a free market, the forces of supply and

demand interact to determine equilibrium quantity and equilibrium price.


EquilibriumEquilibrium Equilibrium price – the price toward

which the invisible hand drives the market. Equilibrium quantity – the amount

bought and sold at the equilibrium price.


What Equilibrium Isn’tWhat Equilibrium Isn’t Equilibrium isn’t a state of the world, it is a

characteristic of a model. Equilibrium isn’t inherently good or bad, it

is simply a state in which dynamic pressures offset each other.


What Equilibrium Isn’tWhat Equilibrium Isn’t When the market is not in equilibrium, you

get either excess supply or excess demand, and a tendency for price to change.


Excess SupplyExcess Supply Excess supply – a surplus, the quantity

supplied is greater than quantity demanded

Prices tend to fall.


Excess DemandExcess Demand Excess demand – a shortage, the quantity

demanded is greater than quantity supplied

Prices tend to rise.


Price AdjustsPrice Adjusts The greater the difference between

quantity supplied and quantity demanded, the more pressure there is for prices to rise or fall.


Price AdjustsPrice Adjusts When quantity demanded equals quantity

supplied, prices have no tendency to change.


The Graphical Interaction The Graphical Interaction of Supply and Demandof Supply and Demand


A

The Graphical Interaction The Graphical Interaction of Supply and Demandof Supply and Demand

Pric

e pe

r DV

D

$5.00

4.00

3.50

3.00

2.50

2.00

1.50

1.00

S

D

Quantity of DVDs supplied and demanded

C

Excess demand

1 2 3 4 5 6 7 8 9 10 11 12

Excess supply

E


The Graphical Interaction The Graphical Interaction of Supply and Demandof Supply and Demand When price is $3.50 each, quantity

supplied equals 7 and quantity demanded equals 3.

The excess supply of 4 pushes price down.




The excess demand of 4 pushes price up.




There is no excess supply or excess demand, so price will not rise or fall.


Political and Social Political and Social Forces and EquilibriumForces and Equilibrium Political and social forces can push price

away from a supply/demand equilibrium. These forces create an equilibrium where

quantity supplied won’t equal quantity demanded.


Shifts in Supply and Shifts in Supply and DemandDemand Shifts in either supply or demand change

equilibrium price and quantity.


Increase in DemandIncrease in Demand An increase in demand creates excess

demand at the original equilibrium price. The excess demand pushes price upward

until a new higher price and quantity are reached.


Pr ic

e (p

e r D

VD

s )

A

S0

Quantity of DVDs (per week)

$2.50

2.25

0 98 10

Excess demand

D1

Increase in DemandIncrease in Demand

D0

B


Decrease in SupplyDecrease in Supply A decrease in supply creates excess

demand at the original equilibrium price. The excess demand pushes price upward

until a new higher price and lower quantity are reached.


A

Decrease in SupplyDecrease in SupplyP

r ice

(per

DV

Ds )

Quantity of DVDs (per week)

$2.50

2.25

0 98 10

D0

S1S0

C

B Excess demand


The Limitations Of The Limitations Of Supply And Demand Supply And Demand AnalysisAnalysis Sometimes supply and demand are

interconnected. Other things don't remain constant.


The Limitations Of The Limitations Of Supply And Demand Supply And Demand AnalysisAnalysis All actions have a multitude of ripple and

possible feedback effects. The ripple effect is smaller when the

goods are a small percentage of the entire economy.


The Limitations Of The Limitations Of Supply And Demand Supply And Demand AnalysisAnalysis The other-things-constant assumption is

likely not to hold when the goods represent a large percentage of the entire economy.


The Fallacy of The Fallacy of CompositionComposition The fallacy of composition is the false

assumption that what is true for a part will also be true for the whole.


The Fallacy of The Fallacy of CompositionComposition The fallacy of composition is of central

relevance to macroeconomics. In macroeconomics, the other-things-

constant assumption, central to microeconomic supply/demand analysis, cannot hold.

Micro232 2004 - jafgac

Supply and DemandSupply and Demand

End of Chapter 4

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Chap004 Demand & Supply