In This Lecture…..

Demand
Absolute Price and
Relative Price
Supply
The Market

In This Lecture…..

Consumers’ Surplus,
Producers’ Surplus,
and Total Surplus
Price Ceilings
Price Floors

1
 Theory
Economists build theories to answer
questions that do not have obvious
answers.
Cause Effect

Theory is an abstract representation

of the real world designed with the
intent to better understand the
world.

Market
Any place people come together to trade

Trade or exchange
may take place at a
physical or virtual
location

Demand
A Definition

The willingness and ability of buyers:

to purchase different quantities of a good
at different prices during a specific time
period.

2
 Law of Demand
As the price of a good rises, the
quantity demanded of the good falls,
and as the price of a good falls, the
quantity demanded of the good rises,
ceteris paribus

Price Quantity

Ceteris Paribus
A Latin term meaning “all other things
constant” or “nothing else changes.”

Ceteris paribus is an assumption used to

examine the effect of one influence on an
outcome while holding all other influences
Constant.

Demand Schedule

The numerical tabulation of the

quantity demanded of a good at
different prices. A demand schedule is
the numerical representation of the law
of demand.

3
 Downward Slopping Demand
Curve
The graphical representation of the demand
schedule and law of demand.

Prices

Absolute (Money) Price - The price of a
good in money terms.

Relative Price (opportunity cost) - The
price of a good in terms of another good.

Demand
Schedule and Graph

4
Why does the price of one more day
at Disney World cost less than the
cost of the first day?

Law of Diminishing
Marginal Utility

For a given time period, the marginal

(additional) utility or satisfaction gained by
consuming equal successive units of a good
will decline as the amount consumed
increases.

Derivation of Market Demand

Schedule

5
Derivation of Market Demand
Curve

Change in Quantity Demanded

Change in Demand

6
 Increase in Demand

Decrease in Demand

Factors Causing a Shift in the

Demand Curve

Income

Preferences

Prices of substitute goods

Prices of complementary goods

Number of buyers

Expectations of future prices

7
 Factors Causing a Shift in the
Demand Curve - Income

Normal Good - A good the demand for

which rises (falls) as income rises (falls).
Inferior Good - A good the demand for
which falls (rises) as income rises (falls).
Neutral Good – A good the demand for
which does not change as income rises or
falls.

Factors Causing a Shift in the

Demand Curve - Substitutes
Substitutes
Two goods that satisfy similar needs or
desires. If two goods are substitutes,
the demand for one rises as the price
of the other rises (or the demand for
one falls as the price of the other
falls).

Factors Causing a Shift in the

Demand Curve - Complements

Complements
Two goods that are used jointly in
consumption. If two goods are
complements, the demand for one rises as
the price of the other falls (or the demand
for one falls as the price of the other rises).

8
 Effect on Demand if Price
Increases on a Substitute Good

Effect on Demand if Price

Increases on a Complementary
Good

Self Test Questions

1. As Sandi’s income rises, her demand for
popcorn rises. As Mark’s income falls, his
demand for prepaid telephone cards
rises. What kinds of goods are popcorn
and telephone cards for the people who
demand each?
2. Why are demand curves downward
sloping?
3. Give an example that illustrates how to
derive a market demand curve.
4. What factors can change demand? What
factors can change quantity demanded?

9
 Supply
The willingness and ability of sellers
to produce and offer to sell different
quantities of a good at different prices
during a specific time period.

Law of Supply
As the price of a good rises, the quantity
supplied of the good rises, and as the price
of a good falls, the quantity supplied of the
good falls, ceteris paribus.

Price Quantity

Supply Curve
The graphical representation of the law of
supply, which states that price and quantity
supplied are directly related, ceteris paribus.

10
 Fixed Supply

Supply Schedule

The numerical tabulation of the

quantity supplied of a good at
different prices.
A supply schedule is the numerical
representation of the law of supply.

Deriving a Market Supply

Schedule

11
Deriving a Market Supply Curve

Factors that Cause the Supply

Curve to Shift

Prices of relevant resources

Technology

Number of sellers

Expectation of future prices

Taxes and subsidies

Government restrictions

Change in Supply

12
 Change in Supply

Change in Quantity Supplied

A change in quantity supplied refers to a

movement along a supply curve. The only
factor that can directly cause a change in
the quantity supplied of a good is a
change in the price of the good, or own
price.

Change in Quantity Supplied

13
 Self Test Questions
1. What would the supply curve for houses (in a
given city) look like for a time period of (a) the
next ten hours and (b) the next three months?
2. What happens to the supply curve if each of the
following occurs?
a. There is a decrease in the number of sellers.
b. A per-unit tax is placed on the production of a
good.
c. The price of a relevant resource falls.
3. “If the price of apples rises, the supply of apples
will rise.” True or false? Explain your answer.

Putting Supply and Demand

Together

Market Equilibrium
Equilibrium in a market is the price
Quantity combination from which
there is no tendency for buyers or
sellers to move away. Graphically,
equilibrium is the intersection point of
the supply and demand curves.

14
 Auction at Work in a
Market
Supply and Demand at Work
The auctioneer calls out different prices, and
buyers record how much they are willing and
able to buy. At prices of $6.00, $5.00, and $4.00,
quantity supplied is greater than quantity
demanded. At prices of $1.25 and $2.25,
quantity demanded is greater than quantity
supplied.

Auction at Work in a Market

At a price of $3.10, quantity demanded equals quantity supplied.

Equilibrium
Equilibrium Price (Market- Clearing Price)
The price at which quantity demanded
of the good equals quantity supplied

15
 Surplus and Shortage
Surplus (Excess Supply)
A condition in which quantity supplied is
Greater than quantity demanded. Surpluses
occur only at prices above equilibrium price.
Shortage (Excess Demand)
A condition in which quantity demanded is
greater than quantity supplied. Shortages
occur only at prices below equilibrium price.

Move to Market Equilibrium

Market Demand and

Supply

16
 Moving to Equilibrium

Equilibrium

Consumer, Producer and Total Surplus

Consumers’ Surplus (CS)
CS= Maximum buying price - Price paid
The difference between the maximum price a buyer is
willing and able to pay for a good or service and the price
actually paid.

Producers’ (Sellers’) Surplus (PS)

PS = Price received - Minimum Selling price
The difference between the price sellers receive for a good
and the minimum or lowest price for which they would
have sold the good.

Total Surplus (TS) TS _ CS _ PS

The sum of consumers’ surplus and producers’ surplus.

Consumer Surplus

17
 Producer Surplus

Total Surplus

Equilibrium

Equilibrium Price and Quantity Effects of

Supply and Demand Curve Shifts

18
 Self-Test Questions
1. When a person goes to the grocery store
to buy food, there is no auctioneer calling
out prices for bread, milk, and other
items. Therefore, supply and demand
cannot be operative. Do you agree or
disagree? Explain your answer.
2. The price of a given-quality personal
computer is lower today than it was five
years ago. Is this necessarily the result of a
lower demand for computers? Explain
your answer.

Self-Test Questions
(continued)

3. What is the effect on equilibrium price

and quantity of the following?
a. A decrease in demand that is greater
than the increase in supply
b. An increase in supply
c. A decrease in supply that is greater
than the increase in demand
d. A decrease in demand

Self-Test Questions
(continued)

4. At equilibrium quantity, what is the

relationship between the maximum
buying price and the minimum selling
price?
5. If the price paid is $40 and the consumers’
surplus is $4, then what is the maximum
buying price? If the minimum selling price
is $30 and producers’ surplus is $4, then
what is the price received by the seller?

19
 Price Controls
Price Ceiling
A government-mandated maximum
price above which legal trades cannot
be made.
Price Floor
A government-mandated minimum
price below which legal trades cannot
be made.

Price Ceiling

Price Floor

20
 Self Test Questions
1. Do buyers prefer lower prices to higher
prices?
2. “When there are long-lasting shortages,
there are long lines of people waiting to
buy goods. It follows that the shortages
cause the long lines.” Do you agree or
disagree? Explain your answer.
3. Who might argue for a price ceiling? a
price floor?

Next

21