CH 3 S and D Notes

CHAPTER
In this chapter, look f l k for the answers to these questions: h h

What factors affect buyers demand for goods? What factors affect sellers supply of goods? How do supply and demand determine the price of
g quantity sold? y a good and the q
Basic Elements of Supply and Demand y
How do changes in the factors that affect demand

or supply affect the market price and quantity of a good?
How do markets allocate resources?

1
Markets and Competition

A market is a group of buyers and sellers of a
particular product.
A competitive market is one with many buyers

and sellers, each has a negligible effect on price.
In a perfectly competitive market: All goods exactly the same Buyers & sellers so numerous that no one can
affect market price each is a price taker
Demand
2
We assume markets are perfectly competitive.
Demand
The quantity demanded of any good is the
amount of the good that buyers are willing and able to purchase.
The Demand Schedule

Demand schedule:
a table that shows the relationship between the price of a good and the quantity d i demanded d d
Price Q Pi Quantity tit of of lattes lattes demanded $0.00 1.00 2.00 3.00 4.00 5.00 6.00 16 14 12 10 8 6 4
Law of demand: the claim that the quantity q y

demanded of a good falls when the price of the good rises, other things equal
Example: p
Helens demand for lattes.
Notice that Helens

preferences obey the Law of Demand Demand.
THE MARKET FORCES OF SUPPLY AND DEMAND
4
Helens Demand Schedule & Curve

Price of Lattes Price Q Pi Quantity tit of of lattes lattes demanded $0.00 1.00 2.00 3.00 4.00 5.00 6.00 Quantity y 15 of Lattes
6
Market Demand versus Individual Demand Th quantity d The i demanded i the market i the sum of the d d in h k is h f h
quantities demanded by all buyers at each price.
$6.00 $6 00 $5.00 $4.00 $3.00 $2.00 $1.00 $1 00 $0.00 0 5 10
16 14 12 10 8 6 4
S Suppose Helen and K are th only t H l d Ken the l two b buyers i in

the Latte market.
Price $0.00 1.00 1 00 2.00 3.00 3 00 4.00 5.00 5 00 6.00
(Qd = quantity demanded)

Kens Qd + + + + + + + 8 7 6 5 4 3 2 = = = = = = = Market Qd 24 21 18 15 12 9 6
7
Helens Qd 16 14 12 10 8 6 4
The Market Demand Curve for Lattes

P
$6.00 $6 00 $5.00 $4.00 $3.00 $2.00 $1.00 $1 00 $0.00 0 5 10 15 20 25
8
The Market Demand Curve

When the price is $2.00, Catherine will demand 4 ice-cream cones.
Catherines Demand
Price of IceCream Cone
P $0.00 1.00 2.00 3.00 4.00 4 00 5.00 6.00 6 00
Qd (Market) 24 21 18 15 12 9 6
When the price is $ $2.00, Nicholas will demand 3 ice-cream cones.

Nicholass Demand
The Th market demand at k td d t $2.00 will be 7 ice-cream cones.

Market Demand
=
2.00 2 00
2.00 1.00
2.00 2 00 1.00
1.00
13
Quantity of Ice-Cream Cones
When the price is $1.00, Catherine will demand 8 ice-cream cones.
When the price is $1.00, Nicholas will demand 5 ice-cream cones.
The market demand at $ $1.00, will be 13 ice, cream cones.
The market demand curve is the horizontal sum of the individual demand 2007 Thomson South-Western curves!
Movement along the Demand Curve

Change in Quantity Demanded Movement along the demand curve. g Caused by a change in the price of the
product.
Changes in Quantity Demanded

Price of IceCream Cones
$2.00 $2 00
A tax on sellers of icecream cones raises the price of ice-cream cones and results in a movement along the t l th demand curve.
A
1.00
D
0
Demand Curve Shifters

The demand curve shows how price affects
quantity demanded, other things being equal.
Price of Ice-Cream Cone
Shifts in the Demand Curve
These other things are non-price

( , g determinants of demand (i.e., things that determine buyers demand for a good, other than the goods price).
Increase in demand
Changes in them shift the D curve
Decrease in demand Demand curve, D2 Demand curve, D1 Demand curve D3 curve, 0 Quantity of Ice-Cream Cones
12
Demand Curve Shifters: # of Buyers

Increase in # of buyers
increases quantity demanded at each price, shifts D curve to the right.
Demand Curve Shifters: # of Buyers

P
$6.00 $6 00 $5.00 $4.00 $3.00 $2.00 $1.00 $1 00 $0.00 0 5 10 15 20 25 30
15 14
Suppose the number of buyers increases. Then, at each P, Qd will increase (by 5 in this example).
Demand Curve Shifters: Income

Demand for a normal good is positively related
to income. Increase in income causes increase in quantity demanded at each p q y price, shifts D curve to the right. (Demand for an inferior good is negatively related to income. An increase in income shifts D curves for inferior goods to the left.)
Consumer Income Normal Good

$3.00 2.50 2.00 1.50 1.00 0.50 Increase in demand
An increase in income...
D1
16
0 1
2 3 4 5 6 7 8 9 10 11 12
D2
Inferior goods examples
Consumer Income Inferior Good

$3.00 $3 00 2.50 2.00 1.50 1.00 0.50 Decrease in demand
An increase in income... i i
D2
0 1
18
D1
2 3 4 5 6 7 8 9 10 11 12
Quantity of Ice-Cream I C Cones
Demand Curve Shifters: Prices of Related G d R l t d Goods Two goods are substitutes if
an i increase i th price of one in the i f causes an increase in demand for the other.
Demand Curve Shifters: Prices of Related G d R l t d Goods Two goods are complements if
an i increase i th price of one in the i f causes a fall in demand for the other.
Example: pizza and hamburgers.

An increase in the price of pizza increases d i demand f h b d for hamburgers, shifting hamburger demand curve to the right.
Example: computers and software.

If price of computers rises, people buy fewer computers, and therefore less software. t d th f l ft Software demand curve shifts left.
Other examples: Coke and Pepsi,

laptops and desktop computers, CDs d CD and music d i downloads l d
20
Other examples: college tuition and textbooks,

bagels and cream cheese, eggs and bacon
21
Demand Curve Shifters: Tastes

Anything that causes a shift in tastes toward a
g good will increase demand for that g good and shift its D curve to the right.
Demand Curve Shifters: Expectations

Expectations affect consumers buying
decisions.
Example:
The Atkins diet became popular in the 90s, gg , caused an increase in demand for eggs, shifted the egg demand curve to the right.
Examples: If people expect their incomes to rise rise,

their demand for meals at expensive restaurants may increase now now.
If the economy sours and people worry about

their future job security demand for new security, autos may fall now.
22
23
Summary: Variables That Influence Buyers

Variable Price # of b f buyers Income Price of related goods Tastes Expectations A change in this variable causes a movement causes along the D curve shifts the D curve hift th shifts the D curve shifts the D curve shifts the D curve shifts the D curve shifts
24
ACTIVE LEARNING
Demand Cur e Curve
Draw a demand curve for music downloads. What h Wh t happens to it in each of t i h f the following scenarios? Why?
A. The price of iPods falls B. The price of music downloads falls C. The price of CDs falls
25
ACTIVE LEARNING
A. A Price of iPods falls

Price of music downloads
ACTIVE LEARNING
B. Price of music downloads falls B

Music downloads and iPods are complements. A fall in price of iPods shifts the demand curve for music downloads to the right.
The Th D curve does not shift. Move down along curve to a point with lower P, higher Q.
P1
P1 P2 D1 Q1
26
D1 Q1 Q2
D2 Q2
Quantity of y music downloads

27
ACTIVE LEARNING
C. Price of CDs falls C

CDs and music downloads are substitutes. A fall in price of CDs shifts demand for music downloads to the left.
D2 Q2 Q1 D1
28
P1
Supply
Supply
The quantity supplied of any good is the
amount that sellers are willing and able to sell.
The Supply Schedule

Supply schedule:
A table that shows the relationship between the price of a good and the quantity supplied. tit li d
Price of lattes $0.00 1.00 2.00 3.00 4.00 5.00 6.00 Quantity of lattes supplied 0 3 6 9 12 15 18
Law of supply: the claim that the quantity

supplied of a g pp good rises when the p price of the good rises, other things equal
Example: p
Starbucks supply of lattes.
Notice that Starbucks Starbucks

supply schedule obeys the Law of Supply Supply.
30
31
Starbucks Supply Schedule & Curve

P
$6.00 $6 00 $5.00 $4.00 $3.00 $2.00 $1.00 $1 00 $0.00
Market Supply versus Individual Supply
Price of lattes $0.00 1.00 2.00 3.00 4.00 5.00 6.00
Quantity of lattes supplied 0 3 6 9 12 15 18
Th quantity supplied iin th market iis th sum of The tit li d the k t the f
the quantities supplied by all sellers at each price.
S Suppose St b k and UCC are th only t Starbucks d the l two

sellers in this market.
Price $0.00 1.00 1 00 2.00 3.00 3 00 4.00 5.00 5 00
32
(Qs = quantity supplied)

UCC + + + + + + + 0 2 4 6 8 10 12 = = = = = = = Market Qs 0 5 10 15 20 25 30
33
Starbucks 0 3 6 9 12 15 18
Q
0 5 10 15
6.00
The Market Supply Curve

P
P
$6.00 $6 00 $5.00 $4.00 $ $3.00 $2.00 $1.00 $1 00 $0.00 0 5 10 15 20 25 30 35
QS (Market) 0 5 10 15 20 25 30
$0.00 $0 00 1.00 2.00 3.00 4.00 5.00 6.00
Q
34
Change in Quantity Supplied

Supply Curve Shifters

The supply curve shows how price affects
quantity supplied, other things being equal.
S
C A rise in the price of ice cream cones results in a movement along the supply curve.
These other things are non-price

pp y determinants of supply.
$3.00
Changes in them shift the S curve
1.00
37
Shifts in the Supply Curve

Price of Ice-Cream Cone Supply curve, S3 Supply curve, S1 Supply curve, S2
Supply Curve Shifters: Input Prices

Examples of input prices:
wages, prices of raw materials.
Decrease in supply pp y
A fall in input prices makes production

more profitable at each output price price, so firms supply a larger quantity at each price, and the S curve shifts to the right right.
Increase in supply
39
Supply Curve Shifters: Input Prices

P
$6.00 $6 00 $5.00 $4.00 $ $3.00 $2.00 $1.00 $1 00 $0.00 0 5 10 15 20 25 30 35
40
Supply Curve Shifters: Technology

Technology determines how much inputs are
required to produce a unit of output.
Suppose the price of milk falls falls. At each price, q y the quantity of Lattes supplied will increase (by in this (b 5 i thi example). Q
A cost-saving technological improvement has

p prices, , the same effect as a fall in input p shifts S curve to the right.
41
Supply Curve Shifters: # of Sellers

An increase in the number of sellers increases
the quantity supplied at each price price, shifts S curve to the right.
Supply Curve Shifters: Expectations

Example: E t in the Middl E t llead t expectations of Events i th Middle East d to t ti f higher oil prices. In response owners of Texas oilfields reduce response, supply now, save some inventory to sell later at the higher price. S curve shifts left. In general, sellers may adjust supply* when their general expectations of future prices change. (*If good not perishable)
42
43
Summary: Variables that Influence Sellers

Variable Price Pi Input Prices gy Technology # of Sellers Expectations E t ti A change in this variable causes a movement along the S curve shifts the S curve shifts the S curve shifts the S curve shifts the S curve hift th
ACTIVE LEARNING
Supply Curve Suppl Cur e
Draw a supply curve for tax return preparation software. What happens to it in each of the following scenarios?
A. Retailers cut the price of the software. software B. A technological advance allows the software to be produced at lower cost. C. Professional tax return preparers raise the price of the services they provide.
44
45
ACTIVE LEARNING
A. Fall i A F ll in price of tax return software i ft t ft

Price of tax return software
ACTIVE LEARNING
B. Fall in B F ll i cost of producing th software t f d i the ft

S1
S curve does not shift. Move down along the curve to a lower P and lower Q.
S1
S2
S curve shifts hift to the right: at each price price, Q increases.
P1 P2
P1
Q2 Q1
Quantity of tax y return software

46
Q1
Q2 Quantity of tax y
return software
47
ACTIVE LEARNING
C. P f i C Professional preparers raise th i price l i their i

Supply and Demand Together
S1
This shifts the demand curve for tax preparation software, not the supply curve curve.
Quantity of tax y return software

48 49
Supply and Demand Together

P
$6.00 $5.00 $4.00 $3.00 $3 00 $2.00 $1.00 $0.00 0 5 10 15 20 25 30 35
50
Equilibrium price:
the price that equates quantity supplied with quantity demanded
P
$6.00 $5.00 $4.00 $3.00 $3 00 $2.00 $1.00
Equilibrium: P has reached the level where quantity supplied q equals quantity demanded
P $ $0 1 2 3 4 5
QD 24 21 18 15 12 9 6
QS 0 5 10 15 20 25 30
51
$0.00 0 5 10 15 20 25 30 35
Equilibrium quantity:
the quantity supplied and quantity demanded at the equilibrium price
P
$6.00 $5.00 $4.00 $3.00 $3 00 $2.00 $1.00 $0.00 0 5 10 15 20 25 30 35
52
Excess demand
P $ $0 1 2 3 4 5
QD 24 21 18 15 12 9 6
QS 0 5 10 15 20 25 30
53
Shortage (a.k.a. excess demand):

when quantity demanded is greater than quantity supplied
P
$6.00 $5.00 $4.00 $3.00 $3 00 $2.00 $1.00 $0.00 0 5

P
$6.00 $5.00 $4.00 $3.00 $3 00 $2.00 $1.00 $0.00 0
54
Example: E l If P = $1, then QD = 21 lattes and QS = 5 lattes resulting in a shortage of 16 lattes Q
Facing F i a shortage, h t sellers raise the price, causing QD to fall and QS to rise, which reduces the which shortage.
Shortage
Shortage
10 15 20 25 30 35
Q
5 10 15 20 25 30 35
55

P
$6.00 $5.00 $4.00 $3.00 $3 00 $2.00 $1.00 $0.00 0 5 10 15 20 25 30 35
56
Facing F i a shortage, h t sellers raise the price, causing QD to fall and QS to rise. Prices continue to rise until market reaches equilibrium. q
Shortage
Q
57
Surplus (a.k.a. excess supply):

when quantity supplied is greater than quantity demanded
P
$6.00 $5.00 $4.00 $3.00 $3 00 $2.00 $1.00 $0.00 0 5 10 15 20 25 30 35
58

P
$6.00 $5.00 $4.00 $3.00 $3 00 $2.00 $1.00 $0.00 0 5 10 15 20 25 30 35
59
Surplus
Example: If P = $5, then QD = 9 lattes and QS = 25 lattes g resulting in a surplus of 16 lattes Q
Surplus
Facing F i a surplus, l sellers try to increase sales by cutting price. This causes QD to rise and QS to fall which reduces the surplus. Q

P
$6.00 $5.00 $4.00 $3.00 $3 00 $2.00 $1.00 $0.00 0 5 10 15 20 25 30 35
60
Three Steps to Analyzing Changes in Eqm

To determine the effects of any event,
1. Decide whether event shifts S curve,
Surplus
Facing F i a surplus, l sellers try to increase sales by cutting price. This causes QD to rise and QS to fall. Prices continue to fall until market reaches equilibrium. Q
D curve or both curve, both.

2. Decide in which direction curve shifts. 3. Use supply-demand diagram to see
how the shift changes eqm P and Q. g q Q
61
EXAMPLE: The Market for Hybrid Cars

price of hybrid h b id cars P S1
EXAMPLE 1:
EVENT TO BE ANALYZED:
A Shift in Demand
P S1 P2 P1
Increase in price of g p gas.

STEP 1:
P1
D1 Q1 Q quantity of hybrid cars

62
D curve shifts because price of gas STEP 2: affects demand for D shifts right hybrids. because high gas STEP 3: S curve doeshybrids price makes not The shift, because price shift shift causes an more attractive increase in not of gas doespricecars. relative to other and quantity affect cost of of hybrid cars. producing hybrids.
D1 Q1 Q2
D2 Q
63
EXAMPLE 1:
A Shift in Demand
P S1 P2 P1
Notice: When P rises, producers supply d l a larger quantity of hybrids, even hybrids though the S curve has not shifted. Always be careful to distinguish b/w a shift in a curve and a movement along the curve curve.
Terms for Shift vs. Movement Along Curve Change in supply: a shift in the S curve
occurs when a non-price determinant of supply changes (like technology or costs)
Change in the quantity supplied:

a movement along a fixed S curve occurs when P changes
Change in demand: a shift in the D curve

D1 Q1 Q2 D2 Q
occurs when a non-price determinant of demand changes (like income or # of buyers)
Change in the quantity demanded:

64
a movement along a fixed D curve occurs when P changes
65
EXAMPLE 2:
A Shift in Supply
S1 S2
EXAMPLE 3:
EVENT: New technology P reduces cost of p producing hybrid cars. g y

STEP 1:
EVENTS: price of gas rises AND new technology reduces production costs
STEP 1:
A Shift in Both Supply and Demand

P S1 S2
S curve shifts because event affects P1 STEP 2: cost of production. P2 S shifts right D curve does not because event STEP 3: shift, because reduces cost, The shift causes production technology makes production price one of is not to fall theat more profitable and quantity to rise. factors that affect any given price price. demand.
Both curves shift.

STEP 2:
P2 P1
Both shift to the right.

D1 Q1 Q2 Q
STEP 3:
Q rises, b t effect i but ff t on P is ambiguous: If demand increases more than supply, P rises.
66
D1 Q1 Q2
D2 Q
67
EXAMPLE 3:
EVENTS: price of gas rises AND new technology reduces production costs
STEP 3, cont. t
A Shift in Both Supply and Demand

P S1 S2
But if supply increases more than demand, P falls.
P1 P2 D1 Q1 Q2 D2 Q
68
What Happens to Price and Quantity When Supply or Demand Shifts?
ACTIVE LEARNING
Shifts in suppl and demand supply

Use the three-step method to analyze the effects of each event on the equilibrium price and quantity of music downloads. Event A: A fall in the price of CDs Event B: Sellers of music downloads negotiate a reduction in the royalties they must pay g y for each song they sell. Event C: Events A and B both occur.
71
ACTIVE LEARNING
A. A Fall in price of CDs

STEPS
ACTIVE LEARNING
B. B Fall in cost of royalties ro alties

STEPS
1. D curve shifts 2. D shifts left 3. 3 P and Q both fall.

P1 P2
The market for music downloads

S1
1. S curve shifts (Royalties are part 2. S shifts right of sellers costs) P1 3. falls, 3 P falls P2 Q rises.
The market for music downloads

S1 S2
D2 Q2 Q1
D1 Q
72
D1 Q1 Q2 Q
73
ACTIVE LEARNING
C. Fall in price of CDs and C fall in cost of royalties

STEPS 1. Both curves shift (see parts A & B). 2. D shifts left, S shifts right. g 3. P unambiguously falls. Effect on Q is ambiguous: The fall in demand reduces Q, pp y the increase in supply increases Q.
74
TEN PRINCIPLES OF ECONOMICS
2007 Thomson South-Western
How Prices Allocate Resources

One of the Ten Principles from Chapter 1:
Markets are usually a good way s all a to organize economic activity.
CONCLUSION:
In market economies, prices adjust to balance

supply and demand. These equilibrium prices are th signals th t guide economic d i i the i l that id i decisions and thereby allocate scarce resources.
76

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CHAPTER

In this chapter, look f l k for the answers to these questions: h h

Basic Elements of Supply and Demand y

How do changes in the factors that affect demand

How do markets allocate resources?

Markets and Competition

A competitive market is one with many buyers

We assume markets are perfectly competitive.

The Demand Schedule

Law of demand: the claim that the quantity q y

Notice that Helens

THE MARKET FORCES OF SUPPLY AND DEMAND

Helens Demand Schedule & Curve

$6.00 $6 00 $5.00 $4.00 $3.00 $2.00 $1.00 $1 00 $0.00 0 5 10

S Suppose Helen and K are th only t H l d Ken the l two b buyers i in

(Qd = quantity demanded)

THE MARKET FORCES OF SUPPLY AND DEMAND

The Market Demand Curve for Lattes

The Market Demand Curve

P $0.00 1.00 2.00 3.00 4.00 4 00 5.00 6.00 6 00

When the price is $ $2.00, Nicholas will demand 3 ice-cream cones.

The Th market demand at k td d t $2.00 will be 7 ice-cream cones.

Price of IceCream Cone

Quantity of Ice-Cream Cones

Quantity of Ice-Cream Cones

Quantity of Ice-Cream Cones

When the price is $1.00, Catherine will demand 8 ice-cream cones.

When the price is $1.00, Nicholas will demand 5 ice-cream cones.

The market demand at $ $1.00, will be 13 ice, cream cones.

THE MARKET FORCES OF SUPPLY AND DEMAND

Movement along the Demand Curve

Changes in Quantity Demanded

Quantity of Ice-Cream Cones

Demand Curve Shifters

Shifts in the Demand Curve

These other things are non-price

Changes in them shift the D curve

THE MARKET FORCES OF SUPPLY AND DEMAND

Demand Curve Shifters: # of Buyers

Demand Curve Shifters: # of Buyers

THE MARKET FORCES OF SUPPLY AND DEMAND

THE MARKET FORCES OF SUPPLY AND DEMAND

Demand Curve Shifters: Income

Consumer Income Normal Good

$3.00 2.50 2.00 1.50 1.00 0.50 Increase in demand

Quantity of Ice-Cream Cones

Inferior goods examples

Consumer Income Inferior Good

$3.00 $3 00 2.50 2.00 1.50 1.00 0.50 Decrease in demand

Quantity of Ice-Cream I C Cones

Example: pizza and hamburgers.

Example: computers and software.

Other examples: Coke and Pepsi,

Other examples: college tuition and textbooks,

Demand Curve Shifters: Tastes

Demand Curve Shifters: Expectations

Examples: If people expect their incomes to rise rise,

If the economy sours and people worry about

THE MARKET FORCES OF SUPPLY AND DEMAND

THE MARKET FORCES OF SUPPLY AND DEMAND

Summary: Variables That Influence Buyers

Demand Cur e Curve