Chap003-Supply and Demand

Chapter 3
Supply and Demand
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved. 3-1
Chapter Objectives
• Define and explain demand in a product
or service market
• Define and explain supply
• Determine the equilibrium point in the
market for a specific good, given data on
supply and demand at different price
levels
Chapter Objectives
• Understand what causes shifts in demand
and supply
• Understand how price ceilings cause
shortages
• Understand how price floors cause
surpluses
Demand
• The schedule of quantities of a
good or service that people are
willing and able to buy at
different prices
– Sometimes a schedule is also called
a table
Hypothetical Daily Demand for Coach Seats on Round-
trip Weekly Flights Between Denver and Chicago
Table 1
$500
Price QD 450
$500 1,000 400
450 3,000 350
400 7,000 300
350 12,000 250
300 19,000 200
150
250 30,000
D
100
200 45,000
50
150 57,000
10 20 30 40 50 60 70
100 67,000
Quantity (in thousands)
Table 1
$500
Price QD 450
$500 1,000 400
450 3,000 350
400 7,000 300
350 12,000 250
300 19,000 200
150
250 30,000
D
100
200 45,000
50
150 57,000
10 20 30 40 50 60 70
100 67,000
Table 1
$500
Price QD 450
$500 1,000 400
450 3,000 350
400 7,000 300
350 12,000 250
300 19,000 200
150
250 30,000
D
100
200 45,000
50
150 57,000
10 20 30 40 50 60 70
100 67,000
Table 1
$500
Price QD 450
$500 1,000 400
450 3,000 350
400 7,000 300
350 12,000 250
300 19,000 200
150
250 30,000
D
100
200 45,000
50
150 57,000
10 20 30 40 50 60 70
100 67,000
Table 1
$500
Price QD 450
$500 1,000 400
450 3,000 350
400 7,000 300
350 12,000 250
300 19,000 200
150
250 30,000
D
100
200 45,000
50
150 57,000
10 20 30 40 50 60 70
100 67,000
Table 1
$500
Price QD 450
$500 1,000 400
450 3,000 350
400 7,000 300
350 12,000 250
300 19,000 200
150
250 30,000
D
100
200 45,000
50
150 57,000
10 20 30 40 50 60 70
100 67,000
Table 1
$500
Price QD 450
$500 1,000 400
450 3,000 350
400 7,000 300
350 12,000 250
300 19,000 200
150
250 30,000
D
100
200 45,000
50
150 57,000
10 20 30 40 50 60 70
100 67,000
Table 1
$500
Price QD 450
$500 1,000 400
450 3,000 350
400 7,000 300
350 12,000 250
300 19,000 200
150
250 30,000
D
100
200 45,000
50
150 57,000
10 20 30 40 50 60 70
100 67,000
Table 1
$500
Price QD 450
$500 1,000 400
450 3,000 350
400 7,000 300
350 12,000 250
300 19,000 200
150
250 30,000
D
100
200 45,000
50
150 57,000
10 20 30 40 50 60 70
100 67,000
Table 1
$500
Price QD 450
$500 1,000 400
450 3,000 350
400 7,000 300
350 12,000 250
300 19,000 200
150
250 30,000
D
100
200 45,000
50
150 57,000
10 20 30 40 50 60 70
100 67,000
Table 1 is the Demand Figure 1 is the Graph of the
Schedule Demand Schedule
Table 1 Figure 1
$500
Price QD 450
$500 1,000 400
450 3,000 350
400 7,000 300
350 12,000 250
300 19,000 200
150
250 30,000
D
100
200 45,000 The line is the
50
150 57,000 Demand Curve
10 20 30 40 50 60 70
100 67,000
Price and Quantity Demanded Quantity Demanded is a point
are inversely related on the Demand Curve
Table 1 Figure 1
$500
Price QD 450
$500 1,000 400
450 3,000 350
400 7,000 300
350 12,000 250
300 19,000 200
150
250 30,000
D
100
200 45,000
50
150 57,000
10 20 30 40 50 60 70
100 67,000
Remember, Demand is the Quantity Demanded is a point
entire schedule or the entire on the Demand Curve
curve
Table 1 Figure 1
$500
Price QD 450
$500 1,000 400
450 3,000 350
400 7,000 300
350 12,000 250
300 19,000 200
150
250 30,000
D
100
200 45,000
50
150 57,000
10 20 30 40 50 60 70
100 67,000
Supply
• Is the “schedule” of quantities of a
good or service that people are
willing to sell at different prices
Supply is the entire schedule
or the entire curve
Price QS $500
S
$500 62,000
450
$450 59,000
400
$400 54,000
$350 48,000 350
$300 40,000 300

$250 30,000 250
$200 200
16,000 $150
150
7,000 $100
100
2,000
50
10 20 30 40 50 60 70
Quantity Supplied is a point on
the curve
Price QS $500
S
$500 62,000
450
$450 59,000
400
$400 54,000
$350 48,000 350
$300 40,000 300

$250 30,000 250
$200 200
16,000 $150
150
7,000 $100
100
2,000
50
10 20 30 40 50 60 70
Demand and Supply Curves
S
Price QS QD $500
$500 62,000 1,000 450
$450 59,000 400
3,000 $400 54,000 350
7,000 $350 48,000 300
250
12,000 $300 40,000
200
19,000 $250 30,000
150
30,000 $200 16,000 D
100
45,000 $150 7,000
50
57,000 $100 2,000
67,000 10 20 30 40 50 60 70
Equilibrium price We can find equilibrium price

is the price where and quantity by seeing where the
QD = QS supply and demand curves cross
Surpluses and Shortages
S
Price QS QD $500
$500 62,000 1,000 450 54,000-7,000 = 47,000

$450 59,000 400
3,000 $400 54,000 350
7,000 $350 48,000 300
250
12,000 $300 40,000
200
19,000 $250 30,000
150
30,000 $200 16,000 D
100
45,000 $150 7,000
50
57,000 $100 2,000
67,000 10 20 30 40 50 60 70
Equilibrium price = EP MP > EP there is a surplus

Market price = MP
S
Price QS QD $500
$500 62,000 1,000 450 54,000-7,000 = 47,000

$450 59,000 400
3,000 $400 54,000 350
7,000 $350 48,000 300
250
12,000 $300 40,000
200
19,000 $250 30,000
150
30,000 $200 16,000 D
100
45,000 $150 7,000
50
57,000 $100 2,000
67,000 10 20 30 40 50 60 70
Equilibrium price = EP A surplus would force sellers to

Market price = MP lower their prices. Eventually,
prices would fall back to the
equilibrium price
S
Price QS QD $500
$500 62,000 1,000 450
$450 59,000 400
3,000 $400 54,000 350
7,000 $350 48,000 300
250
12,000 $300 40,000
200
19,000 $250 30,000
150
30,000 $200 16,000 D
100 57,000-7,000 = 50,000
45,000 $150 7,000
50
57,000 $100 2,000
67,000 10 20 30 40 50 60 70
Equilibrium price = EP
Market price = MP MP < EP here is a shortage
S
Price QS QD $500
$500 62,000 1,000 450
$450 59,000 400
3,000 $400 54,000 350
7,000 $350 48,000 300
250
12,000 $300 40,000
200
19,000 $250 30,000
150
30,000 $200 16,000 D
100 57,000-7,000 = 50,000
45,000 $150 7,000
50
57,000 $100 2,000
67,000 10 20 30 40 50 60 70
A shortage would allow sellers to raise

Equilibrium price = EP their prices. As prices increased people
Market price = MP would buy less. Eventually, prices
would move back to the equilibrium
price
S
Price QS QD $500
$500 62,000 1,000 450
$450 59,000 400
3,000 $400 54,000 350
7,000 $350 48,000 300
250
12,000 $300 40,000
200
19,000 $250 30,000
150
30,000 $200 16,000 D
100
45,000 $150 7,000
50
57,000 $100 2,000
67,000 10 20 30 40 50 60 70
We can see that the forces of demand

and supply work together to establish an
equilibrium price at which there are no
shortages or surpluses
The schedule changes from QD1 to QD2
Table 4 $500
S
Price QD1 QD2 450

$500 1,000 12,000 400
450 3,000 15,000 350
300
400 7,000 21,000
250
350 12,000 30,000
200
300 19,000 40,000 150
250 30,000 55,000 D1

100
D2
200 45,000 63,000 50
150 57,000 75,000 10 20 30 40 50 60 70

100 67,000 88,000
The demand curve shifts to the right from D1 to D2

This is an increase in demand
The schedule changes from QD2 to QD1
Table 4 $500
S
Price QD1 QD2 450

$500 1,000 12,000 400
450 3,000 15,000 350
300
400 7,000 21,000
250
350 12,000 30,000
200
300 19,000 40,000 150
250 30,000 55,000 D1

100
D2
200 45,000 63,000 50
150 57,000 75,000 10 20 30 40 50 60 70

100 67,000 88,000
The demand curve shifts to the left from D2 to D1

This is a decrease in demand
Shifts in Supply and Demand
If the schedule changes the Price

Supply curve shifts 500 S S
450
400
350
300
250
200
Supply decreases . . . the 150
curve shifts to the left
100
50
D
Copyright 2008 by The McGraw-Hill 10 20 30 40 50 60 70
Companies, Inc. All rights reserved. Quantity (in thousands) 3-29
If the schedule changes the Price

Supply curve shifts 500 S S
450
400
350
300
250
200
150
Supply increases . . . the 100
curve shifts to the right
50
D
If the Supply curve is S1 Price

what is the equilibrium price 500 S2 S1
and quantity? 450
400
350
300
250
The equilibrium price is 200
approximately 262 or 263
150
The equilibrium quantity is 100

approximately 35,000 50
D
If the Supply curve changes Price

to S2 what is the new 500 S2 S1
equilibrium price and 450
quantity?
400
350
300
250
The new equilibrium price 200
is approximately 325
150
The new equilibrium 100

quantity is approximately 50
26,000 D
Is a shift from S1 to S2 an Price

increase or decrease in 500 S2 S1
Supply? 450
400
350
300
250
A decrease 200
150
100
50
D
Price Floors and Ceilings
The price can go no lower
than the floor.
25
S
20
The surplus is the amount
Surplus Price
by which the quantity 15
floor
supplied is greater than the
quantity demanded 10
5
D
A price floor creates a

10 20 30 40 50 60 70
permanent surplus
Quantity
Price Floors and Ceilings
The price can go no higher
than the ceiling. S
40
The shortage is the amount 30

by which the quantity
demanded is greater than
20 Price ceiling
the quantity supplied Shortage
10
D
A price ceiling creates a

10 20 30 40 50 60 70 80
permanent shortage
Quantity
Applications of Supply and
Demand
• Interest rates are set by
– Supply and demand
• Wage rates are set by
• Rents are determined by
• The prices of nearly all goods are determined by
• The prices of nearly all services are determined
by
Hypothetical Demand for and Supply of Loanable Funds
S
20
18
16
14
12
10
2
D
100 200 300 400 500 600 700 800 9001,000 1,100
Quantity of loanable funds (in billions of dollars)
We can see that $600 billion is lent (or borrowed) at an interest rate
of 6 percent
What would happen if the supply of loanable funds increased?
S1
20 S2
18
16
14
12
10
2
D
200 400 600 800 1,000

The interest rate would decrease to 4 percent and the amount of

money borrowed would increase to $800 billion
S
20
18
16
14
12
10
6
D2
4
2
D1
200 400 600 800 1,000

If the demand for loanable funds rises to D2 the interest rate would
rise to 9 percent and the amount of money borrowed would rise to
$700 billion
Last Word
• Government sometimes interferes with the free
operation of the markets by
– Imposing prices floors and price ceilings
– This creates the problems of shortages and
surpluses
• The government may also ensure the smooth operation
of the markets by protecting property rights,
guaranteeing enforcement of legal contracts, and
issuing a supply of money that buyers and sellers
readily accept
– Property rights are essential to a free and
prosperous nation
• While governmental interference with the market
system can have adverse affects, the government does
have a substantial supportive role to play in a market
economy.
Current Issue: High Gas Prices
• Hurricane Katrina
– Temporarily shut down off shore wells
– Briefly put 10% of our refineries out of commission
– Result – a sudden drop in oil supply
– The government took a “hands” off approach
– Gasoline prices rose sharply – duh?
– People could buy all they wanted at sharply
increased prices with no wait at the pumps
The Alternative to High Gas Prices
In 1970 and 1979
• Middle east countries curtailed oil shipments to
the United States
• Resulted in reduced oil supply
• Government’s solution – restrict purchases and
hold down prices
• The result – long gas lines in many parts of the
country
• People paid less but waited much longer to
purchase gas at moderately higher prices
(sometimes one to two hours)
Summation
Gasoline Supply Decreases
• Short Run
– Prices Rise
– Many people cut back on their driving
• Long Run
– People buy more gas efficient cars
– Higher prices encourage greater exploration
for oil
– Higher prices encourage the development of
alternative energy sources
Summation
Government Restricts Purchases and Holds
Down Price Increases
• Short Run
– Prices may rise moderately
– People cut back on their driving very little if
any
– Significant waits at the gas pumps occur
• Long Run
– People have little incentive to buy more gas
efficient cars
– Lower prices discourage greater exploration
for oil
– Higher prices discourage the development of
alternative energy sources
Closing Comments
• Most economists probably believe price ceilings do
more harm than good in the long run
• Most people probably think in the short run and want
government to do something about higher prices
• Government probably is inclined to get involved
• Corporate greed probably can and will influence
government actions
• The result . . . who knows? But past history indicates it
probably won’t be good for the consumer

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Chapter 3

Supply and Demand

400 7,000 300

350 12,000 250

300 19,000 200

400 7,000 300

350 12,000 250

300 19,000 200

400 7,000 300

350 12,000 250

300 19,000 200

400 7,000 300

350 12,000 250

300 19,000 200

400 7,000 300

350 12,000 250

300 19,000 200

400 7,000 300

350 12,000 250

300 19,000 200

400 7,000 300

350 12,000 250

300 19,000 200

400 7,000 300

350 12,000 250

300 19,000 200

400 7,000 300

350 12,000 250

300 19,000 200

400 7,000 300

350 12,000 250

300 19,000 200

400 7,000 300

350 12,000 250

300 19,000 200

400 7,000 300

350 12,000 250

300 19,000 200

400 7,000 300

350 12,000 250

300 19,000 200

$300 40,000 300

$300 40,000 300

$500 62,000 1,000 450

$450 59,000 400

3,000 $400 54,000 350

7,000 $350 48,000 300

Equilibrium price We can find equilibrium price

$500 62,000 1,000 450 54,000-7,000 = 47,000

3,000 $400 54,000 350

7,000 $350 48,000 300

Equilibrium price = EP MP > EP there is a surplus

$500 62,000 1,000 450 54,000-7,000 = 47,000

3,000 $400 54,000 350

7,000 $350 48,000 300

Equilibrium price = EP A surplus would force sellers to

$500 62,000 1,000 450

$450 59,000 400

3,000 $400 54,000 350

7,000 $350 48,000 300

$500 62,000 1,000 450

$450 59,000 400

3,000 $400 54,000 350