CHAPTER 3 Demand and Supply. Chapter 3 Demand, Supply and Relative Prices Demand and supply determine relative prices. The word “price” means relative

CHAPTER 3Demand and

Supply

Chapter 3Demand, Supply and

Relative Prices Demand and supply determine

relative prices. The word “price” means relative

price. Price is an opportunity cost. If we predict a price will fall, we mean

its price will fall relative to the average price of other goods and services.

Calculation of Relative Prices

Relative price is usually calculated by dividing the price of a good in question by a price index.

The most commonly used price index is the CPI (Consumer Price Index).

The CPI represents the “average” price of consumer goods in a particular month or year.

Demand

The quantity demanded of a good or service is the amount that consumers plan to (or are willing to) buy in a given period of time at a particular (relative) price.

Quantity demanded is measured as an amount per unit time: pizzas per day, pizzas per week, or pizzas per year.

The Law of Demand

Other things remaining the same, the higher the price of a good, the smaller is the quantity demanded.

The phrase “other things being equal” is sometimes abbreviated with the Latin phrase ceteris paribus (cet. par.).

Thus, when we say price changes, we mean relative price changes.

Demand Scheduleand Demand Curve

A demand schedule lists the quantities demanded at each different price when all the other influences on consumers’ planned purchases remain the same.

A demand curve is a graph of the demand schedule.

Demand Schedule

a .50 9

b 1.00 6

c 1.50 4

d 2.00 3

e 2.50 2

Price Quantity Demanded(dollars per CD-R) (millions of CD-Rs per week)

Demand Curve

0 2 4 6 8 10

.50

1.00

1.50

2.00

2.50

3.00

Quantity (millions of CD-Rs per week)

Pri

ce (

doll

ar p

er C

D-R

)

Demand Curve

0 2 4 6 8 10

.50

1.00

1.50

2.00

2.50

3.00


Pri

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e

d

c

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a

Demand Curve

0 2 4 6 8 10

.50

1.00

1.50

2.00

2.50

3.00

e

d

c

b

aDemand for CD-Rs


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Factors ThatInfluence Demand

Price (of the good in question) Prices of related goods Income Expected future price Population Preferences (or Tastes)

Price

If the price of the good rises, the quantity demanded falls (a movement up along the demand curve).

If the price of the good falls, the quantity demanded rises (a movement down along the demand curve).

Prices of Related Goods A substitute is a good that can be used in

place of another good. If the price of a CD-RW rises, the demand for CD-Rs rises (demand curve shifts out to the right) .

A complement is a good that is used in conjunction with another good. If the price of a CD burner rises, the demand for CD-Rs falls (demand curve shifts in to the left).

Example-Decrease in Price of a Complement

Original demand schedule New demand schedule

CD Burner $300 CD Burner $100

Price Quantity Price Quantity (dollars (millions of CD-Rs (dollars (millions of CD-Rs

per CD-R) per week) per CD-R) per week))

a .50 9

b 1.00 6

c 1.50 4

d 2.00 3

e 2.50 2

Assume the original price of A CD Burner is $300. The demand schedule showsthe Price-Quantity relationship for CD-Rs.

Example-Decrease in Price of a Complement

Original demand schedule New demand schedule

CD Burner $300 CD Burner $100

Price Quantity Price Quantity (dollars (millions of CD-Rs (dollars (millions of CD-Rs

per CD-R) per week) per CD-R) per week))

a .50 9 a’ .50 13

b 1.00 6 b’ 1.00 10

c 1.50 4 c’ 1.50 8

d 2.00 3 d’ 2.00 7

e 2.50 2 e’ 2.50 6

Demand Before Price of Complement Decreases

0 2 4 6 8 10 12 14

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1.00

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e

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aDemand for CD-Rs(CD Burner $300)

Demand after Price ofComplement Decreases

0 2 4 6 8 10 12 14

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e

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aDemand for CD-Rs(CD Burner $300)


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e'

d'

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a'

Demand for CD-Rs(CD Burner $100)

Income Normal goods are those for which

demand increases as income increases (demand curve shifts out to the right).

Inferior goods are those for which demand decreases as income increases (demand curve shifts in to the left).

The terms normal and inferior do not necessarily refer to the quality of the product

Expected Future Price

If the price of a good is expected to rise in the future and if the good can be stored, people will often substitute over time by buying more of the good today.

Demand for the good increases (demand curve shifts out to the right). This is sometimes called speculation.

Population Other things remaining the same, the

larger the population, the greater is the demand for all goods and services (demand curve shifts out to the right).

The smaller the population, the smaller is the demand for all goods and services (demand curve shifts in to the left).

Preferences (or Tastes)

Preferences are an individual’s attitudes toward goods and services.

Different people have different preferences and will therefore have different demands for a particular good or service.

Summary of Changes in Demand

Changes In Demand– The demand for CD-Rs

• Decreases if:– The price of a substitute falls– The price of a complement rises– Income falls (since CD-R is a normal good)– The price of a CD-R is expected to fall in the future– The population decreases– Preferences decrease

Summary of Changes in Demand

Changes In Demand– The demand for CD-Rs

• Increases if:– The price of a substitute rises– The price of a complement falls– Income rises (since CD-R is a normal good)– The price of a CD-R is expected to rise in the future– The population increases– Preferences increase

Movement Along Versus a Shift of the Demand Curve

If the price of a good changes but everything else remains the same, there is a movement along the demand curve.

If the price of a good remains constant but some other influence on buyers’ plans changes, there is a shift of the demand curve.

A Change in Quantity Demanded Versus a Change

in Demand A movement along the demand curve

shows a change in the quantity demanded.

A shift of the demand curve shows a change in demand.

A Change in the Quantity Demanded Versus a Change in Demand

Quantity

Pri

ce

D0

Quantity

Pri

ce

D0

Decrease inquantitydemanded

Increase inquantitydemanded


Quantity

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Q0


Quantity

Pri

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D0

P0

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Q0Q1


Quantity

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P2

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Q0 Q2Q1


Quantity

Pri

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D0


Quantity

Pri

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D0

D1

Increase in

demand


Pri

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Quantity

D0

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D2

Increase inDecrease in demand demand


Quantity

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D0

D1

D2D0

Decrease inquantitydemanded

Increase inquantitydemanded

Increase in

demand

Decrease in demand


Supply If a firm supplies a good or service,

the firm– Has the resources and technology to produce it,– Can profit from producing it, and– Has made a definite plan to produce it and sell

it.

Supply

The amount of a good or service that producers plan to (or are willing to) sell during a given time period at a particular price is called the quantity supplied.

Quantity supplied is not necessarily the same as the quantity actually sold (which depends on the interaction of supply and demand).

The Law of Supply

Other things remaining the same, the higher the price of a good, the greater is the quantity supplied.

Increasing opportunity cost is the reason behind the law of supply.

Supply Scheduleand Supply Curve

A supply schedule lists the quantities supplied at each different price when all other influences on the amount firms plan to sell remain the same.

A supply curve is a graph of a supply schedule.

Supply Schedule

a .50 0

b 1.00 3

c 1.50 4

d 2.00 5

e 2.50 6

Price Quantity (dollars per CD-R) (millions of CD-Rs per week)

Supply Curve

Quantity (millions of CD-Rs per week)0 2 4 6 8 10

.50

1.00

1.50

2.00

2.50

3.00

Pri

ce (

doll

ar p

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D-R

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Supply Curve

Quantity (millions of CD-Rs per week)0 2 4 6 8 10

.50

1.00

1.50

2.00

2.50

3.00

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a

b

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d

e

Supply Curve

0 2 4 6 8 10

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1.00

1.50

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2.50

3.00


Pri

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Supply of CD-Rs

a

b

c

d

e

Other Influences on Supply Besides Price

Prices of factors of production Prices of other goods produced Expected future prices The number of suppliers Technology

Prices of Factorsof Production

A change in the price of a factor of production causes supply to change by changing production costs.

For example, suppose the product is automobiles and the price of labor increases. Automakers will cut back on their supply (the supply curve will shift to the left).

Prices of Related GoodsProduced - Substitutes

Two goods are substitutes in production if the same factors of production can be used to produce each good. Examples are sedans and sports cars.

If the price of sports cars rises, the quantity supplied of sports cars rises (move up the supply curve) and the supply of sedans falls (the supply curve of sedans shifts to the left).

Prices of Related GoodsProduced - Complements

Two goods are complements in production if they are produced together. Examples are beef and cowhide.

If the price of cowhide rises, the quantity supplied of cowhide rises (move up along the supply curve) and the supply of beef rises (the supply curve of beef shifts to the right).

Expected Future Prices

If producers expect the price of a good to be higher in the future (and the good can be stored), they may substitute over time.

This means they will offer a smaller quantity of the good for sale today so the current supply decreases (the supply curve shifts to the left) .

The Number of Suppliers

Other things remaining the same, the larger the number of producers supplying a good, the larger is the supply of the good (the supply curve shifts to the right).

Technology

New technologies that enable producers to use less (or cheaper) factors of production lower the cost of production and increase supply (the supply curve shifts to the right).

Supply Response to Change in Technology

Original supply scheduleOld technology

Price Quantity (dollars (millions of CD-Rs per CD-R) per week)

a .50 0

b 1.00 3

c 1.50 4

d 2.00 5

e 2.50 6

Original supply schedule New supply schedule Old technology New technology

Price Quantity Price Quantity (dollars (millions of CD-Rs (dollars (millions of CD-Rs per CD-R) per week) per CD-R) per week)

a .50 0 a' .50

b 1.00 3 b' 1.00

c 1.50 4 c' 1.50

d 2.00 5 d' 2.00

e 2.50 6 e' 2.50


Original supply schedule New supply schedule

Old technology New technology

Price Quantity Price Quantity

(dollars (millions of CD-Rs (dollars (millions of CD-Rs

per CD-R) per week) per CD-R) per week)

a .50 0 a' .50 3

b 1.00 3 b' 1.00 6

c 1.50 4 c' 1.50 8

d 2.00 5 d' 2.00 10

e 2.50 6 e' 2.50 12


Quantity (millions of CD-Rs per week)0 2 4 6 8 10 12 14

.50

1.00

1.50

2.00

2.50

3.00

Pri

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D-R

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Supply of CD-Rs(old technology)

e

d

c

b

a



Pri

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0 2 4 6 8 10 12 14

.50

1.00

1.50

2.00

2.50

3.00 Supply of CD-Rs(new technology)

a a'

b'

c'

d'

e'e

d

c

b



Movement Along Versus a Shift of the Supply Curve

If the price of a good changes but everything else influencing supply remains constant, there is a movement along the supply curve.

If the price of a good remains the same but another influence on supply changes, there is a shift of the supply curve.

A Change in Quantity Supplied Versus a Change

in Supply A movement along the supply curve

shows a change in quantity supplied. A shift of the supply curve shows a

change in supply.

A Change in the Quantity Supplied Versus a Change in Supply

Quantity

Pri

ce S0


Quantity

Pri

ce S0

Decrease inquantitysupplied

Increase inquantitysupplied


Quantity

Pri

ce S0

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Q0


Quantity

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Q1Q0

P1


Quantity

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P1

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Q2


Quantity

S1

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supply

Increase in


Quantity

S1

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ce S0S2

supply

Increase inDecrease in

supply


Quantity

Pri

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Decrease inquantitysupplied

Increase inquantitysupplied

S0 S1S2

Increase in

supply supply

Decrease in

Price Determination

The price of a good regulates the quantities demanded and supplied.

There is one price, and only one price, at which the quantity demanded equals the quantity supplied.

Price is the rationing (or regulating) mechanism

Shortages

If the price is too low, the quantity demanded exceeds the quantity supplied. People are willing to pay more for the good.

To eliminate this shortage, sellers will raise the price, increasing the quantity supplied and reducing the quantity demanded.

Surpluses

If the price is too high, the quantity supplied exceeds the quantity demand. Inventories pile up.

To eliminate this surplus, sellers will lower the price, reducing quantity supplied and increasing quantity demanded.

Market Equilibrium

The market equilibrium price is the price at which the quantity demanded equals the quantity supplied.

The market equilibrium quantity is the quantity bought and sold at the equilibrium price.

At market equilibrium, both buyers and sellers are satisfied. This is not true at any other price or quantity.

Market Equilibrium

Quantity Quantity Shortage(–)

Price demanded supplied or surplus(+)

(dollars

per CD-R) (millions of CD-Rs per week)

.50 9 0

1.00 6 3

1.50 4 4

2.00 3 5

2.50 2 6

Market Equilibrium


Price demanded supplied or surplus(+)(dollars


.50 9 0–9

1.00 6 3

1.50 4 4

2.00 3 5

2.50 2 6

Market Equilibrium




.50 9 0–9

1.00 6 3–3

1.50 4 4

2.00 3 5

2.50 2 6

Market Equilibrium




.50 9 0–9

1.00 6 3–3

1.50 4 4 0

2.00 3 5

2.50 2 6

Market Equilibrium




.50 9 0–9

1.00 6 3–3

1.50 4 4 0

2.00 3 5 +2

2.50 2 6

Market Equilibrium




.50 9 0–9

1.00 6 3–3

1.50 4 4 0

2.00 3 5 +2

2.50 2 6 +4

Market Equilibrium




.50 9 0–9

1.00 6 3–3

1.50 4 4 0

2.00 3 5 +2

2.50 2 6 +4

Market Equilibrium

0 2 4 6 8 10

.50

1.00

1.50

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3.00


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Market Equilibrium

0 2 4 6 8 10

.50

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1.50

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3.00


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Demand for CD-Rs

Market Equilibrium

0 2 4 6 8 10

.50

1.00

1.50

2.00

2.50

3.00


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Supply of CD-Rs

Demand for CD-Rs

Market Equilibrium

0 2 4 6 8 10

.50

1.00

1.50

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2.50

3.00


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Supply of CD-Rs

Demand for CD-Rs

A Shortage Forcesthe Price Up

If demand exceeds supply, sellers will raise price, decreasing quantity demanded.

A Surplus Forcesthe Price Down

If supply exceeds demand, sellers will see their inventories of unsold goods piling up and will cut price to sell them.

Market Equilibrium

0 2 4 6 8 10

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Supply of CD-Rs

Surplus of2 million CD-Rsat $2 a CD-R

Shortage of 3 million CD-Rs at $1 a CD-R

Demand for CD-Rs

Equilibrium

The Best Deal Availablefor Buyers and Sellers

The equilibrium price is the best deal available for buyers and sellers.

This is the price at which trade takes place.

Predicting Changes inPrice and Quantity

The theory we have just studied provides us with a powerful way of analyzing influences on prices and the quantities bought and sold.

A change in price must be caused by either a change in demand or a change in supply.

A Change in Demand

An increase in demand shifts the demand curve up and to the right.

The new equilibrium price and quantity are higher.

Predicting Changes in Price and Quantity

A Change in Demand– What would happen to the price and quantity of

CD-Rs if the price of a CD Burner falls from $300 to $100.

The Effects of a Change in Demand

Quantity demanded Price (millions of CD-Rs per week)(dollars Quantity suppliedper CD-R ) CD Burner $300 CD Burner $100 (millions of CD-Rs per week)

.50 9 0

1.00 6 3

1.50 4 4

2.00 3 5

2.50 2 6



.50 9 0

1.00 6 3

1.50 4 4

2.00 3 5

2.50 2 6



.50 9 13 0

1.00 6 10 3

1.50 4 8 4

2.00 3 7 5

2.50 2 6 6



.50 9 13 0

1.00 6 10 3

1.50 4 8 4

2.00 3 7 5

2.50 2 6 6



.50

1.00

1.50

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Supply of CD-Rs




.50

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Supply of CD-Rs





.50

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Supply of CD-Rs



A Change in Supply

An increase in supply shifts the supply curve down and to the right.

The new equilibrium price is lower, but the equilibrium quantity is higher.

The Effects of a Change in Supply

Quantity supplied Price (millions of CD-Rs per week)

(dollars Quantity demanded old newper CD-R ) (millions of CD-Rs per week) technology technology

.50 9 0

1.00 6 3

1.50 4 4

2.00 3 5

2.50 2 6




.50 9 0

1.00 6 3

1.50 4 4

2.00 3 5

2.50 2 6



.50 9 0 3

1.00 6 3 6

1.50 4 4 8

2.00 3 5 10

2.50 2 6 12




.50 9 0 3

1.00 6 3 6

1.50 4 4 8

2.00 3 5 10

2.50 2 6 12



.50

1.00

1.50

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3.00

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Demand for CD-Rs




.50

1.00

1.50

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Demand for CD-Rs

Supply of CD-Rs(new technology)



.50

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Demand for CD-Rs



A Change in BothDemand and Supply

Both curves shift. The direction in which price and

quantity change will depend on how each curve shifts.

Demand and Supply Change in the Same Direction

If demand and supply increase, both the demand and supply curves shift out.

The new equilibrium quantity will be higher.

The new equilibrium price may be higher, lower, or it may remain the same.

The Effects of an Increase in Both Demand and Supply

Original Quantities New Quantities (millions of CD-Rs per week) (millions of CD-Rs per

week)

Price Quantity Quantity Quantity Quantity (dollars demanded supplied demanded suppliedper CD-R ) CD Burner old CD Burner new

$300 technology $100 technology

.50 9 0

1.00 6 3

1.50 4 4

2.00 3 5

2.50 2 6



week)



.50 9 01.00 6 3 1.50 4 4 2.00 3 5 2.50 2 6



week)



.50 9 0 13 3

1.00 6 3 10 6

1.50 4 4 8 8

2.00 3 5 7 10

2.50 2 6 6 12



week)



.50 9 0 13 31.00 6 3 10 61.50 4 4 8 82.00 3 5 7 102.50 2 6 6 12



.50

1.00

1.50

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2.50

3.00

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.50

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1.50

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.50

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A Decrease in Both Demand and Supply

When both demand and supply decrease, the quantity decreases and the price increases, decreases, or remains constant

The Effects of a Decrease in Both Demand and Supply


.50

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Supply of CD-Rs(wage=$9)



.50

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Demand and Supply Change in Opposite Directions

Suppose supply increases but demand decreases.

Price falls. The direction in which quantity

changes will depend on the magnitude of the shifts in the two curves.

The Effects of an Decrease in Demand and an Increase in Supply

Original Quantities New Quantities (millions of CD-Rs per week) (millions of CD-Rs per week)

Price Quantity Quantity Quantity Quantity (dollars demanded supplied demanded suppliedper CD-R ) MP3 download old MP3 download new

free technology $20 technology

.50 13 0

1.00 10 3

1.50 8 4

2.00 7 5

2.50 6 6





.50 13 0

1.00 10 3

1.50 8 4

2.00 7 5

2.50 6 6





.50 13 0 9 3

1.00 10 3 6 6

1.50 8 4 4 8

2.00 7 5 3 10

2.50 6 6 2 12





.50 13 0 9 3

1.00 10 3 6 6

1.50 8 4 4 8

2.00 7 5 3 10

2.50 6 6 2 12

A Decrease in Demand and an Increase in Supply


.50

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Demand for CD-Rs(MP3 Download free)



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Demand for CD-Rs(MP3 Download $20)



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Demand for CD-Rs(MP3 Download $20)


The Effects of an Increase in Demand and a Decrease in

Supply

When demand increases and supply decreases, the price rises and the quantity increases, decreases, or remains constant.

An Increase in Demand and a Decrease in Supply


.50

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Demand for CD-Rs(MP3 download $20)




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Demand for CD-Rs(MP3 download free)





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Demand for CD-Rs(MP3 download free)



Documents

CHAPTER 3 Demand and Supply. Chapter 3 Demand, Supply and Relative Prices Demand and supply determine relative prices. The word “price” means relative