Chapter 2

Introducing
Supply and Demand

McGraw-Hill/Irwin

Copyright 2009 by The McGraw-Hill Companies, Inc. All

A Tale of a Desert
When water is free of charge:
Miners consume lots of water.
Government is the only supplier of water.
When price of water is high:
Miners conserve and use less water.
Private sellers find new ways to sell more
water.
2-2

Learning Objectives

What is demand?
What is law of demand?
What factors change demand?
What is supply?
What is law of supply?
What factors change supply?

2-3

Demand
Demand
= How much consumers buy at various
prices

2-4

Quantity Demanded vs. Demand

Quantity demanded
= The number of units consumers purchase
at a specific price over a specific time
period.
Demand
= The entire relationship between price and
quantity demanded over a specific time
period.
2-5

Demand for Apples

Price
$.05

Quantity
Demanded
30,000

Demand curve

$P
.30
.25

$.10

24,000

.20

$.15

18,000

.10

.15

.05

$.20

12,000

.00
0

$.25

6,000

10

20

30

40

Quantity of Apples in thousand

2-6

Law of Demand
Consumers buy less of a good as its price
increases and more of a good as its price
decreases.
As price increases, quantity demanded
falls and as price decreases, quantity
demanded rises.

2-7

Demand Curve
Demand Curve
= A graph that shows
demand relationship.
Negative relationship
between price and
quantity demanded.
Slope of demand curve
is negative.
Downward sloping
demand curve.

$P
.30
.25
.20
.15
.10
.05

.00
0

10

20

30

40

Quantity of Apples in thousand

2-8

Market Demand
Market demand = the sum total of individual
quantities demanded at each price.
Price

Bills
Janes
Sophias Market
demand demand demand demand

$.05
$.10
$.15
$.25
$.30

20
16
12
8
5

10
8
4
1
0

5
4
3
1
0

35
28
19
10
5
2-9

Change in Quantity Demanded

vs. Change in Demand
Ceteris paribus:
Change in price
causes change in
quantity demanded.
Movement along the
same demand curve.

$P
30
25

Lose
80%

20
15
10
5

D1

0
0

10

20

30

40

50

Quantity of caps in thousand

2-10

Change in Quantity Demanded

vs. Change in Demand

Ceteris paribus:
Change in something
other than price causes
change in demand.
Shift of the entire demand
curve.
Increase in demand,
demand curve shifts to
the right.
Decrease in demand,
demand curve shifts to
the left.

$P
Win world
series

30
25

Lose
80%

20
15
10

D2

D1

0
0

10

20

30

40

50

Quantity of caps in thousand

2-11

Behind Demand Curve: Substitutes

Substitutes compete with
each other to satisfy
similar needs.
Increase in price of Coke
with no change in price of
Pepsi.
Increase in price of a
good causes increase in
demand for its substitute.
What will happen if price
of Coke falls to $0.30 with
no change in price of
Pepsi?

$P
Coke
=$1.00
Coke
=$.50
.73
D2
D1

0
0

10,000

25,000

Quantity demanded of Pepsi

2-12

Behind Demand Curve: Complements

Complements used
together to satisfy wants.
Increase in price of
hamburgers with no
change in price of ketchup.
Increase in price of a good
causes decrease in
demand for its
complement.
What will happen if price of
burgers falls with no
change in price of
ketchup?

$P
High
price of
burgers

Low price
of burgers

D1
D2
Quantity demanded of ketchup

2-13

Behind Demand Curve: Income

Normal goods
= Goods consumers
buy more with higher
income.
When income
increases, there is
increase in demand
for normal goods.
Demand curve shifts
to the right

$P
Low
income

Higher
income

D2
D1
Quantity demanded of sports car

2-14

Demand for Inferior Goods

Inferior goods
= Goods consumers
buy less of with
higher income.
When income
increases, there is
decrease in demand
for inferior goods.
Demand curve shifts
to the left

$P
Higher
income

Low
income

D1
D2
Quantity demanded of pleather

2-15

Behind Demand Curve: Expectations

What would you do if you heard that you might get a
much better deal in the near future for the product you
are planning to buy now?
Osborne effect
Expectations about better deal (lower price, better
quality) in the near future cause decrease in current
demand.
= Leftward shift in the demand curve
What would happen to demand for a product when its
price is expected to increase in the near future?
2-16

Behind Demand Curve: Other Things

Tastes and Fashions

Demand increases for products

considered to be fashionable.
Advertising

Induces consumers to buy more,

increasing the demand.

2-17

Do You Know?
What is the Law of Demand?
As price increases, quantity demanded falls and as
price decreases, quantity demanded rises.
When do you move along a demand curve and
when do you move to an entirely new demand
curve?
A change in price = movement along the curve.
A change in a factor other than price = shift of the
curve.
2-18

Do You Know?
How does an increase in the price of a goods
substitute affect the demand for the original good?
= Increase in demand for the original good.
How does an increase in income affect the
demand for an inferior good?
= Decrease in demand for the inferior good.

2-19

Supply
Supply
= The quantity firms produce at various
prices.

2-20

Quantity Supplied vs. Supply

Quantity supplied
= The number of units producers want to produce
at a specific price over a specific time period.
Supply
= The entire relationship between price and
quantity supplied over a specific time period.

2-21

Supply in Competitive Markets

Competitive markets:
Markets in which individual buyers and sellers
cannot set prices.
Firms primary motive is profit.
The higher the price, the greater the profit from
production.

2-22

Law of Supply
Firms produce less of a good as its price
falls and more of a good as its price
increases.
As price increases, quantity supplied rises
and as price decreases, quantity supplied
falls.

2-23

Supply Curve
Supply Curve
= A graph that shows
supply relationship.
Positive relationship
between price and
quantity supplied.
Slope of supply curve
is positive.
Upward sloping supply
curve .

$P
S
.50

.25

0
0

15,000

50,000

Quantity supplied of Apples

2-24

Market Supply
Market supply = the sum total of individual firms supply
at each price.

Price

Firm As Firm Bs Firm Cs Market

Supply Supply Supply Supply

$.05
$.10
$.15
$.25
$.30

0
0
1
3
5

0
5
8
10
20

0
0
0
5
30

0
5
9
18
55
2-25

Change in Quantity Supplied

vs. Change in Supply

Ceteris paribus:
Change in price causes
change in quantity
supplied.
Movement along the
same supply curve.
Change in something
other than price causes
change in supply.
Shift of the entire supply
curve.

$P

.50

Fair
weather
S1

Excellent
weather
S2

.25

0
Quantity supplied of Apples

2-26

Behind Supply Curves: Costs

Ceteris paribus:
Increase in cost of
production decreases
profits.
Decrease in supply.
Supply curve shifts to
the left.

$P
High cost
S2

Low cost
S1

Quantity supplied

2-27

Behind Supply Curves: Expectations

If firms expect prices to increase in the
near future, they withhold goods to get
better prices.
Higher expected prices, decrease the
current supply.
How would you change your supply if you
expect lower price in near future?

2-28

Behind Supply Curves: Input Prices

Inputs = resources
firms use to make
goods.
With increase in input
prices or wages, firms
use less inputs or
workers.
Decrease in supply.

$P
Wage
=$6.15

Wage

S2

=$5.15
S1

Quantity supplied

2-29

Behind Supply Curves: Innovations

Innovations and
improved technology
reduce cost of
production.
Increase in supply.

$P

Before
innovation

After

S1

innovation
S2

Quantity supplied of Apples

2-30

Behind Supply Curves: Joint Production

Two or more goods are jointly produced if the
process that produces one necessarily produces
others.
When price of bacon increases:
Quantity supplied of bacon increases.
Supply of ham and pork chops
also increases.

2-31

Do You Know?
What is the Law of Supply?
As price increases, quantity supplied rises and
as price decreases, quantity supplied falls.
What is the difference between a change in
supply vs. a change in quantity supplied?
A change in price = change in quantity supplied.
A change in a factor other than price = change in
supply.
2-32

Do You Know?
How do costs affect supply?
Increase in cost of production = decrease in
supply.
How can innovation affect supply?
Innovations and advanced technology =
increase in supply.

2-33

Summary
Increase in the price causes decrease in quantity
demanded and increase in quantity supplied.

Increase in demand caused by:

Increase in price of substitutes.
Fall in price of complements.
Increase in income for normal goods.
Decrease in income for inferior goods.
Expectations of future price increase.
2-34

Summary

Increase in supply caused by:

Decrease in production costs.
Decrease in input prices.
Expectations of lower price in near future.
Innovations.
Increase in price of jointly produced good.
Demand curve is downward sloping.
Supply curve is upward sloping.
Increase causes shift to the right, decrease
causes shift to the left.
2-35

Coming Up
How do demand and supply
determine the price in the market?

2-36