Supply and Demand Together

P
$6.00 $5.00 $4.00 $3.00 $2.00 $1.00 $0.00 0
1

Equilibrium: P has reached the level where quantity supplied equals quantity demanded

Q
5 10 15 20 25 30 35

Equilibrium price:
the price that equates quantity supplied with quantity demanded
P
$6.00 $5.00 $4.00 $3.00 $2.00 $1.00 $0.00 0
2

P $0 1 2 3 4 5

QD 24 21 18 15 12 9 6

QS 0 5 10 15 20 25 30

Q
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 $2.00 $1.00 $0.00 0
3

P $0 1 2 3 4 5

QD 24 21 18 15 12 9 6

QS 0 5 10 15 20 25 30

Q
5 10 15 20 25 30 35

Surplus (a.k.a. excess supply):

when quantity supplied is greater than quantity demanded
P
$6.00 $5.00 $4.00 $3.00 $2.00 $1.00 $0.00 0
4

Surplus

Example: If P = $5, then QD = 9 lattes and QS = 25 lattes resulting in a surplus of 16 lattes Q

10 15 20 25 30 35

Surplus (a.k.a. excess supply):

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

Surplus

Facing a surplus, sellers try to increase sales by cutting price. This causes QD to rise and QS to fall which reduces the surplus. Q

10 15 20 25 30 35

Surplus (a.k.a. excess supply):

when quantity supplied is greater than quantity demanded
P
$6.00 $5.00 $4.00 $3.00 $2.00 $1.00 $0.00 0
6

Surplus

Facing a surplus, 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

10 15 20 25 30 35

Shortage (a.k.a. excess demand):

when quantity demanded is greater than quantity supplied
P
$6.00 $5.00 $4.00 $3.00 $2.00 $1.00 $0.00 0
7

Example: If P = $1, then QD = 21 lattes and QS = 5 lattes resulting in a shortage of 16 lattes Q

Shortage
5 10 15 20 25 30 35

Shortage (a.k.a. excess demand):

when quantity demanded is greater than quantity supplied
P
$6.00 $5.00 $4.00 $3.00 $2.00 $1.00 $0.00 0
8

Facing a shortage, sellers raise the price, causing QD to fall and QS to rise, which reduces the shortage.

Shortage

Q
5 10 15 20 25 30 35

Shortage (a.k.a. excess demand):

when quantity demanded is greater than quantity supplied
P
$6.00 $5.00 $4.00 $3.00 $2.00 $1.00 $0.00 0
9

Facing a shortage, sellers raise the price, causing QD to fall and QS to rise. Prices continue to rise until market reaches equilibrium.

Shortage

Q
5 10 15 20 25 30 35

Three Steps to Analyzing Changes in Eqm

To Todetermine determinethe theeffects effectsof ofany anyevent, event, 1. Decidewhether whetherevent eventshifts shiftsSScurve, curve, 1. Decide

D Dcurve, curve,or orboth. both.

2. 2. Decide Decidein inwhich whichdirection directioncurve curveshifts. shifts. 3. 3. Use Usesupply-demand supply-demanddiagram diagramto tosee see

how .. howthe theshift shiftchanges changeseqm eqmP Pand andQ Q

10

EXAMPLE:

The Market for Hybrid Cars

P S1

price of hybrid cars

P1

D1 Q1 Q quantity of hybrid cars

11

EXAMPLE 1: A Shift in Demand

EVENT TO BE ANALYZED:

P S1 P2 P1

Increase in price of gas.

STEP 1:

D curve shifts because price of gas STEP 2: affects demand for D shifts right hybrids. because high gas price STEP 3: does S curve not shift, makes hybrids more The shiftprice causes an because of gas attractive relative to increase in price does affect cost of othernot cars. and quantity of producing hybrids. hybrid cars.
12

D1 Q1 Q2

D2 Q

EXAMPLE 1: A Shift in Demand

Notice: When P rises, producers supply a larger quantity of hybrids, even 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.
13

P S1 P2 P1

D1 Q1 Q2

D2 Q

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 occurs when a non-price determinant of demand changes (like income or # of buyers) Change in the quantity demanded: a movement along a fixed D curve occurs when P changes
14

EXAMPLE 2: A Shift in Supply

EVENT: New technology reduces cost of producing hybrid cars.
STEP 1:

P S1 S2

S curve shifts because event affects STEP 2: cost of production. S shifts right D curve event does not shift, because reduces STEP 3: production because cost, The shift causes price technology is not one makes production to the fall factors that of more profitable at any and quantity to rise. affect demand. given price.
15

P1 P2 D1 Q1 Q2 Q

EXAMPLE 3: A Shift in Both Supply

and Demand EVENTS: P price of gas rises AND new technology reduces production costs
STEP 1:

S1

S2

Both curves shift.

STEP 2:

P2 P1

Both shift to the right.

STEP 3:

Q rises, but effect on P is ambiguous: If demand increases more than supply, P rises.
16

D1 Q1 Q2

D2 Q

EXAMPLE 3: A Shift in Both Supply

and Demand EVENTS: P price of gas rises AND new technology reduces production costs
STEP 3, cont.

S1

S2

But if supply increases more than demand, P falls.

P1 P2 D1 Q1 Q2 D2 Q

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ACTIVE LEARNING

Shifts in supply and demand

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

Event C:
18

ACTIVE LEARNING

A. Fall in price of CDs

STEPS
P

The market for music downloads

S1

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

P1 P2

D2
19

D1 Q

Q2 Q1

ACTIVE LEARNING

B. Fall in cost of royalties

STEPS
P

The market for music downloads

S1 S2

1. S curve shifts (Royalties are part 2. S shifts right of sellers costs) P1 3. P falls, P2 Q rises.

D1
20

Q1 Q2

ACTIVE LEARNING

C. Fall in price of CDs and fall in cost of royalties

STEPS STEPS 1. 1. Both Both curves curves shift shift (see (see parts parts A A& & B). B). 2. 2. D D shifts shifts left, left, S S shifts shiftsright. right. 3. 3. P P unambiguously unambiguously falls. falls. Effect Effect on on Q Q is is ambiguous: ambiguous: The The fall fall in in demand demand reduces reduces Q Q,, the the increase increase in in supply supply increases increases Q Q..
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CONCLUSION:

How Prices Allocate Resources

One of the Ten Principles from Chapter 1: Markets are usually a good way to organize economic activity.

In market economies, prices adjust to balance supply and demand. These equilibrium prices are the signals that guide economic decisions and thereby allocate scarce resources.

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CHAPTER SUMMARY
A competitive market has many buyers and sellers, each of whom has little or no influence on the market price. Economists use the supply and demand model to analyze competitive markets. The downward-sloping demand curve reflects the Law of Demand, which states that the quantity buyers demand of a good depends negatively on the goods price.

23

CHAPTER SUMMARY
Besides price, demand depends on buyers incomes, tastes, expectations, the prices of substitutes and complements, and number of buyers. If one of these factors changes, the D curve shifts. The upward-sloping supply curve reflects the Law of Supply, which states that the quantity sellers supply depends positively on the goods price. Other determinants of supply include input prices, technology, expectations, and the # of sellers. Changes in these factors shift the S curve.

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CHAPTER SUMMARY
We can use the supply-demand diagram to analyze the effects of any event on a market: First, determine whether the event shifts one or both curves. Second, determine the direction of the shifts. Third, compare the new equilibrium to the initial one. In market economies, prices are the signals that guide economic decisions and allocate scarce resources.

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