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DYNAMIC P OWERP OINT S LIDES BY S OLINA LINDAHL

CHAPTER

Supply and Demand

C
OPYRIGHT

2012 W

ORTH

UBLISHERS

CHAPTER OUTLINE
Demand curve Quantity demanded Consumer surplus Total consumer surplus Normal good Inferior good Substitutes For applications, click here Supply curve Quantity supplied Producer surplus Total producer surplus

Complements
To Try it! questions
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Food for Thought.

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

Demand

What made him buy it?

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Demand
Demand represents the behavior of buyers. A Demand Curve shows the quantity demanded at different prices.
The Quantity Demanded: the quantity that buyers are willing (and able) to purchase at a particular price.

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Law of Demand
Price and Quantity Demanded are negatively related

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The Demand Curve

The Demand Curve for Oil
Price of Oil per Barrel $55 Price $55 $20 $20 $5 5
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Quantity Demanded

5
25 50

$5

Demand 25 50 Quantity of Oil (MBD)

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Reading Demand Curves

Demand curves can be read in two ways:
Horizontally: How much buyers are willing and able to purchase at a certain price. Vertically: The highest price buyers are willing to pay for a certain quantity.

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Intuition of the Demand Curve

Price of Oil per Barrel
$120 Higher Valued Uses of Oil

When the price is high, oil will only be used in the high value products. If the price falls, oil will also be used in lower value products.

$20

Lower Valued Uses of Oil

Demand
20 120 Quantity of Oil (MBD) BACK

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Consumer Surplus
Consumer Surplus is the consumers gain from exchange,
the difference between the highest price a consumer will pay at a given quantity and the actual market price.

Total consumer surplus is the sum of consumer surplus of all buyers.

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Try it!
Your roommate just bought an iPad for $600. She would have been willing to pay $1,000 for a machine that could make her life so much more worthwhile. How much consumer surplus does your roommate enjoy from the iPad? a) $600 b) $400 c) $1600 d) $1400
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Consumer Surplus
Consumer Surplus is the Area beneath the Demand Curve and above the Price

Price of Oil per Barrel 80

Area of Triangle The Presidents Consumer Surplus

Height

Total Consumer Surplus at a Price of $20

(Base x Height) Base

(80-20)x90 = $2,700 20

Joes Consumer Surplus

Demand 90 Quantity of Oil (MBD)

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Try it!
If the price is $2010, what is the consumer surplus? a) $3,588,000 b) $1,794,000 c) $6,000,000 d) $3,000,000

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What Shifts the Demand Curve?

An increase in demand means that consumers buy more at every price level, (or consumers are willing to pay more for each quantity.)
On the graph: the demand curve shifts outwards, up, and to the right.

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What Shifts the Demand Curve?

A decrease in demand means that consumers buy less at every price level, (or they reduce the price theyre willing to pay for a given quantity.)
On the graph: the demand curve shifts inwards, down, and to the left.

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A Decrease in Demand
Price per Unit $50

Lower Willingness to Pay for the Same Quantity

Less Quantity Demanded at the Same Price $25

Old Demand Curve New Demand Curve

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Quantity
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An Increase in Demand
Price per Unit $50 Greater Willingness to Pay for the Same Quantity Greater Quantity Demanded at the Same Price $25
New Demand Curve Old Demand Curve

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Quantity
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Demand Shifters

Important Demand Shifters:

1. Income 2. Population 3. Price of Substitutes 4. Price of Complements 5. Expectations 6. Tastes
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Important Demand Shifters:

Income

1. The effect of changes in income on demand depends on the nature of the good in question.
A Normal Good: demand increases when income increases (and vice versa). An Inferior Good: demand decreases when income increases (and vice versa)
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Try it!
When the price of petroleum goes up, the demand for natural gas ______, the demand for coal ______, and the demand for solar power ______. a) increases; increases; increases b) increases; increases; decreases c) decreases; decreases; increases d) decreases; decreases; decreases

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Important Demand Shifters:

Population

2. As the population of an economy changes, the # of buyers of a particular good also changes, (thereby changing its demand.)
What happens to the demand for diapers in Russia as birth rates drop?

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Important Demand Shifters:

Price of Substitutes
3. Two goods are Substitutes if a decrease in the price of one leads to a decrease in demand for the other (or vice versa).
- What happens to the demand for

travel in Hawaii if the (perceived) safety cost of traveling to Mexico increases?

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Important Demand Shifters:

Price of Complements
4. Two goods are Complements if a decrease in the price of one good leads to an increase in the demand for the other (or vice versa).
What happens to the demand for Sport Utility Vehicles when gasoline gets more expensive?

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Price of Complements

Consumers often have to buy goods together. An increase in price of gasoline will decrease the demand for SUVs
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Important Demand Shifters:

Expectations

5. The expectation of a higher (lower) price for a good in the future increases (decreases) current demand for the good.
Consumers will adjust their current spending in anticipation of the direction of future prices in order to obtain the lowest possible price.
If prices for Xbox 360 consoles are expected to drop right before Christmas, what will happen to sales during November?
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Important Demand Shifters:

Tastes

6. Tastes and preferences are subjective and will vary among consumers.
Seasonal changes or fads have predictable effects on demand. What happens to demand for boots in October? To carbohydrates during the Atkins diet fad? Or to Acai berries after newly perceived health benefits?
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What Shifts the Demand Curve?

A change in quantity demanded is NOT the same as a change in demand. Quantity demanded changes only when the price of a good changes.
It is a movement along a fixed demand curve.

Demand changes only when a non-price factor (demand shifter) changes.

It is a shift in the entire demand curve.
A change in Quantity Demanded

A change in Demand

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Try it!
When the price of a good increases the quantity demanded ______. When the price of a good decreases the quantity demanded ______. a) rises; rises b) rises; falls c) falls; rises d) falls; falls
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Supply

What made this oil field happen?

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Supply
Supply represents the behavior of sellers. A Supply Curve shows the quantity supplied at different prices.
The Quantity Supplied is the quantity that producers are willing and able to sell at a particular price.

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Law of Supply
What do you think happens to the quantity of human organs donated in Israel when the government issues a point system that rewards donors? The Law of Supply: there is a direct relationship between price and quantity supplied.
When price rises, all else equal, quantity supplied rises and vice versa

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The Supply Curve

Price of Oil per Barrel

The Supply Curve for Oil

Supply Curve for Oil

$55 Price Quantity Supplied

$55
$20 $20 $5

50
30 10

$5 10
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30

50

Quantity of Oil (MBD)

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Reading Supply Curves

Supply curves can be read in two ways:
Horizontally: How much suppliers are willing and able to sell at a certain price. Vertically: The minimum price for which suppliers are willing to sell a certain quantity.

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Supply Curves
Why is the supply curve upward sloping?
The cost of producing a good is not equal across all suppliers. At a low price, a good is produced and sold only by the lowest cost suppliers. At a high price, a good is also produced and sold by higher cost suppliers.
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The Supply Curve for Oil

Price of Oil per Barrel $60

The Supply Curve for Oil

Supply
Oil Shale Profitable Here

$40 Higher Cost Oil Low Cost Oil $20

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40

60

80

Quantity of Oil 100 (MBD)

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Furthermore

Does sex have a price? See this blog post for a discussion about changes in supply and demand for sex.
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Producer Surplus
Producer Surplus is the producers gain from exchange
the difference between the market price and the minimum price at which producers would be willing to sell a certain quantity.

Total producer surplus is the sum of the producer surplus of each seller. Graphically, total producer surplus is measured by the area above the supply curve and below the price.
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Producer Surplus
Producer Surplus is the Area Above the Supply Curve and Below the Price Price of Oil per Barrel

$60

Supply Curve

$40

$20 Total Producer Surplus at a Price of $40 20

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40

60

80

Quantity of Oil (MBD)

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Try it!
Using the following diagram, calculate total producer surplus if the price of oil is $50 per barrel. a) 0 b) $45 c) $1,350 d) $2,700

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Change in Supply
Price of Oil per Barrel $50 Greater Quantity Supplied at the Same Price Old Supply New Supply

$10

Willing to Sell Same Quantity at Lower Prices 20

40

Lower Costs Increase Supply

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Quantity of Oil (MBD)

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Change in Supply
Price of Oil per Barrel New Supply

Smaller Quantity Supplied at the Same Price $10 Higher Price Needed to Sell Same Quantity

Old Supply

Higher Costs Decrease Supply

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80

Quantity of Oil (MBD)

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Supply Shifters
Important Supply Shifters
1. Technological Innovations 2. Input Prices 3. Taxes and Subsidies 4. Expectations 5. Entry or Exit of Producers 6. Changes in Opportunity Costs
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Important Supply Shifters:

Technological Innovations
1. A technological innovation makes sellers willing to offer more at a given price, or sell a their quantity at a lower price.
A technological innovation lowers costs and increases supply.

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Production Technology
Supply will increase for products when technology improves
Examples: Computers, gaming systems, laser
hair removal, flat screen TVs.

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Important Supply Shifters:

Input Prices

2. A decrease in the price of an input (all else equal) increases profits and encourages more supply (and vice versa)
What will happen to the amount of new businesses if the government reduces the fees and red tape associated with new business licenses? What happens if the fees rise?

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Important Supply Shifters:

Taxes and Subsidies

3. A tax on output reduces profit and makes sellers less willing to supply at a given price, unless they can effectively raise the price without losing any sales. (for now, assume they cannot)
A tax on output raises costs and decreases supply. Graph the effect on supply of a new cigarette tax in your notes.

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Important Supply Shifters:

Taxes and Subsidies

A subsidy on production makes sellers willing to supply a greater quantity at a given price, or the subsidy allows producers to sell a given quantity at a lower price.
A subsidy on production lowers costs and increases supply. Graph the effect on supply of a new subsidy to fast food producers aimed at helping them market and sell overseas.
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Taxes and Subsidies

Taxes and subsidies affect profits and therefore supply. A 10% yacht tax reduced the supply of yachts 53% in the early 1990s.
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Cotton Supply

When the U.S. decreases its cotton subsidies, U.S. cotton supply decreases
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Important Supply Shifters:

Taxes and Subsidies

With a $10 Tax Suppliers Require a $10 Higher Price to Sell the Same Quantity Price of Oil per Barrel $50 $10 $10 Supply Without Tax Supply With $10 Tax

$40

$10

50

60

Quantity of Oil (MBD)

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Important Supply Shifters:

Expectations

4. The expectation of a higher price for a good in the future decreases current supply of the good if they can store the good- (and vice versa).
Sellers will adjust their current offerings in anticipation of the direction of future prices in order to obtain the highest possible price.

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Future 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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Important Supply Shifters:

Expectations
Price per Unit

Expectations Can Shift the Supply Curve

Supply Today with Expectation of Future Price Increase

Supply Today

Into Storage

Quantity
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Important Supply Shifters:

Entry or Exit of Producers

5. As producers enter and exit the market, the overall supply changes.
Entry implies more sellers in the market increasing supply. Exit implies fewer sellers in the market decreasing supply.
What will happen to the supply for Marijuana in California if the drug is legalized for general use?
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Number of Producers
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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Important Supply Shifters:

Entry or Exit of Producers

Entry Increases Supply
Price
Greater Quantity Supplied at the Same Price Domestic Supply Plus Canadian Imports

Domestic Supply

Lower Price for the Same Quantity Supplied

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Quantity
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Important Supply Shifters:

Changes in Opportunity Costs

6. Inputs used in production have opportunity costs. Sellers will choose to use those inputs where the profit is the highest Sellers will supply less of a good if the price of an alternate good using the same inputs rises (and vice versa). Sellers always chase the highest profit goods.

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Changes in Opportunity Costs

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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Important Supply Shifters:

Changes in Opportunity Costs

Higher (Opportunity) Costs Reduce Supply- Rising Wheat Prices Reduce Soybean Supply
Price per Unit Higher Price Required to Sell the Same Quantity $7 $5 Smaller Quantity Supplied at the Same Price Quantity of Soybeans (Millions 2,800 of Bushels)
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Supply with High Opportunity Costs

Supply with Low Opportunity Costs

2,000
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What Shifts the Supply Curve?

A change in quantity supplied is NOT the same as a change in supply.
Quantity supplied changes only when the price of a good changes.
It is a movement along a fixed supply curve.

Supply changes only when a non-price factor changes.

It is a shift in the entire supply curve.
A change in Quantity Supplied

A change in Supply
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Try it!

Market Price of Marijuana

Explain using the concepts of supply, demand, and transport costs (including in this case smuggling costs) the pattern of prices you see here

Try it!
The market price of the product is $20 per unit. Calculate the dollar amount of consumer surplus being earned in this market. a) $120,000 b) $60,000 c) $100,000 d) $80,000
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