CH 03

Economics: Theory & Practice 9
th
Edition Welch & Welch
John Wiley & Sons, Inc. 2010 All Rights Reserved
Chapter Three:
Demand, Supply, & Price Determination
Chapter Objectives
3-2
To explain what economists mean by demand and supply and how they work using
schedules and graphs.
To show how demand and supply are affected by changes in price and nonprice factors.
To demonstrate how demand and supply interact in markets to determine prices, and to
show equilibrium price and quantity shortages and surpluses in a market.
To explain how changes in demand and changes in supply affect equilibrium prices and
quantities in markets.
To illustrate how government-imposed price ceilings and price floors influence market
conditions.
To introduce the concept and calculation of price elasticity, which measures buyers and
sellers sensitivities to price changes.
th
Chapter Three Overview
Demand: The Buyers Side
Supply: The Sellers Side
Market Demand & Supply
Equilibrium Price & Quantity
Changes in Quantity: Demanded & Supplied
Changes in Demand & Supply
Changes in Equilibrium Price & Quantity
Chapter Three
3-3
Price Elasticity of Demand & Supply
Measuring Price Elasticity
Limiting Price Movements
th
Demand:
The different amounts of a product that a buyer would purchase at different
prices in a defined time period when all nonprice factors are held constant.

Demand Schedule:
A list of the amounts of a product that a buyer would purchase at different
3-4
th
Law of Demand:
There is an inverse relationship between the price of a product and the
quantity demanded.

Demand Curve:
A line on a graph that illustrates a demand schedule; it slopes downward
because of the inverse relationship between price and quantity demanded.
3-5
th
Supply:
The different amounts of a product that a seller would offer for sale at
different prices in a defined time period when all nonprice factors are held
constant.

Supply Schedule:
A list of the amounts of a product that a seller would offer for sale at different
3-6
th
Law of Supply:
There is a direct relationship between the price of a product and the
quantity supplied. As price increases, the quantity of a good or service
a supplier is willing to offer will increase, and as price decreases, the
quantity supplied will decrease

Supply Curve:
A line on a graph that illustrates a
supply schedule; it slopes upward
because of the direct relationship
between price and quantity supplied.
3-7
th
Market Demand & Supply
Market:
A place or situation in which the buyers and sellers of a product
interact for the purpose of exchange.

Market Demand and Market Supply:
The demand of all buyers and supply of all sellers in a market for a
good or service; found by adding together all individual demand or
supply schedules.
3-8
th
Equilibrium & Price Quantity
Shortage:
Occurs in a market when the
quantity demanded is greater than
the quantity supplied, or when the
products price is below the
equilibrium price.

Surplus:
Occurs in a market when the
quantity demanded is less than the
quantity supplied, or when the
products price is above the
equilibrium price.
3-9
th
Equilibrium & Price Quantity
Equilibrium Price & Quantity:
The price and quantity where demand equals supply; price and quantity toward which a
free market automatically moves.
Also called the market clearing price.
Price that sets buyers plans equal to sellers plans.

Market Clearing Price:
Equilibrium price; price at which the quantity demanded equals the quantity supplied.
3-10
th
Changes in Quantity Demanded & Supplied
Change in Quantity Demanded and Quantity Supplied:
A change in the amount of a product demanded or supplied that is caused by a
change in its price; represented by a movement along a demand or supply curve
from one pricequantity point to another.
3-11
Movement along a demand
curve from one price-
quantity point to another
due to a change in price.
Movement along a supply
curve from one price-
quantity point to another
due to a change in price.
th
Changes in Demand
Change in Demand:
A change in the demand schedule and curve for a product
caused by a change in a nonprice factor influencing the
products demand; the demand curve shifts to the right or left.
3-12
th
Changes in Demand
3-13
Nonprice Factors Influencing Demand:
Taste, fashion, and popularity.
Buyers incomes & expectations concerning future income, prices, or availabilities.
Prices of goods related as substitutes and compliments.
The number of buyers in the market.

Examples:
A change in a nonprice, such as an increase in Gwens income, causes a change in the
amount of an item demanded at each price.
After her income increased, the number of cans of cola that Gwen demands each week
increased at every price.
An increase in her demand for cola causes the demand curve to shift to the right as she
demands more cans of cola.
th
Changes in Demand
3-14
Increase in Demand:
A change in a nonprice influence on demand causes more of a product to be
demanded at each price; the demand curve shifts to the right.

Decrease in Demand:
A change in a nonprice influence on demand causes less of a product to be
demanded at each price; the demand curve shifts to the left.
th
Changes in Supply
3-15
Change in Supply:
A change in the supply schedule and curve for a product caused by a
change in a nonprice factor influencing the products supply; the supply
curve shifts to the right or left.

Nonprice Factors Influencing Supply:
Nonprice factors, such as the cost of production and the number of
sellers in the market, that help to determine the supply of a product.
th
Changes in Supply
3-16
Increase in Supply:
A change in a nonprice influence on supply causes more of a product to
be supplied at each price; the supply curve shifts to the right.

Decrease in Supply:
A change in a nonprice influence on supply causes less of a product to be
supplied at each price; the supply curve shifts to the left.
th
Changes in Demand & Supply
3-17
Change in Demand & Supply:
Change in the demand or
supply schedule due to a
change in a nonprice factor.

Causes the demand or supply
curve to shift to the left or
the right depending on the
nature of the change.
th
3-18
Effect of an Increase or Decrease in Demand:
Causes the equilibrium price and quantity to decrease as
demand shifts from D1 to D2.
th
3-19
Effect of an Increase or Decrease in Supply:
Causes an increase in the equilibrium price as the quantity
decreases, supply shifts from S1 to S2.
th
3-20
Price Ceiling (Upper Price Limit):
A government-set maximum price that can be charged for a good or
service; if the equilibrium price is above the price ceiling, a shortage
will develop.

Price Floor (Lower Price Limit):
A government-set minimum price that can be charged for a good or
service; if the equilibrium price is below the price floor, a surplus
will develop.

Usury Laws:
State laws setting maximum interest rates that can be charged for
certain types of loans.

th
Price Floors and Ceilings
3-21
th
Price Elasticity of Demand and Supply
3-22
Price Elasticity:
A measure of the strength of buyers or sellers' responses
to a price change.

Price Elastic:
A strong response to a price change; occurs when the
percentage change in the quantity demanded or supplied
is greater than the percentage change in price.

Price Inelastic:
A weak response to a price change; occurs when the
percentage change in the quantity demanded or supplied
is less than the percentage change in price.
th
3-23
Factors Affecting Price Elasticity of Demand:
Necessities versus luxury goods:
Strong response to price changes in luxury goods.
Weak response to price changes in necessities.
Substitutes:
Strong response to price changes in products with many substitutes
or similar alternatives.
Weak response to price changes in products that have few
substitutes or similar alternatives.
Proportion of income:
Strong response to price changes in goods or services that require
a greater proportion of income.
Weak response to price changes in goods or services that require a
lesser proportion of income.

Factor Affecting Price Elasticity of Supply:
Time to react
th
3-24
Price Elasticity of Demand & Total Revenue:
Strong response to a price change:
Causes revenue to move in the opposite direction of the change in price.

Weak response to a price change:
Causes revenue to move in the same direction of the change in price.

th
3-25
Determining Percentage Changes:
Use the table below to assist you in determining
percentage changes.

Determining Price Elasticity:
Use the table below and your elasticity coefficient to
assist you in determining if the demand or supply is
elastic, inelastic, or unitary elastic.

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Economics: Theory & Practice 9

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