You are on page 1of 30

The Market Forces of Supply and Demand

Chapter 4

Markets
A market is a group of buyers and sellers of a particular good or service. The terms supply and demand refer to the behavior of people . . . as they interact with one another in markets. And Economics, especially Microeconomics is about how supply and demand interact in markets.

Market Types or Structures


Competitive Markets
Products are the same,price takers

Monopoly Monopolistic Competition Oligopoly

Demand Curve
Price of Ice-Cream Cone

$3.00
2.50 2.00 1.50 1.00 0.50
Quantity of Ice-Cream Cones

0 1

2 3 4 5 6 7 8 9 10 11 12

Why does the Demand Curve Slope Downward?


Law of Demand
Inverse relationship between price and quantity.

Law of Diminishing Marginal Utility.


Utility is the extra satisfaction that one receives from consuming a product. Marginal means extra. Diminishing means decreasing.

Market Demand
Market demand refers to the sum of all individual demands for a particular good or service. Graphically, individual demand curves are summed horizontally to obtain the market demand curve.

Ceteris Paribus
Ceteris paribus is a Latin phrase that
means all variables other than the ones being studied are assumed to be constant. Literally, ceteris paribus means other things being equal.
The demand curve slopes downward because, ceteris paribus, lower prices imply a greater quantity demanded!

Two Simple Rules for Movements vs. Shifts


Rule One
When an independent variable changes and that variable does not appear on the graph, the curve on the graph will shift.

Rule Two
When an independent variable does appear on the graph, the curve on the graph will not shift, instead a movement along the existing curve will occur.

Lets apply these rules to the following cases of supply and demand!

Change in Quantity Demanded versus Change in Demand


Change in Quantity Demanded
Movement along the demand curve. Caused by a change in the price of the product.

Price of Cigarettes per Pack

Changes in Quantity Demanded


C
A tax that raises the price of cigarettes results in a movement along the demand curve.

$4.00

2.00

D1
0

12

20

Number of Cigarettes Smoked per Day

Change in Quantity Demanded versus Change in Demand


Change in Demand
A shift in the demand curve, either to the left or right. Caused by a change in a determinant other than the price.

Determinants of Demand
Market price Consumer income Prices of related goods Tastes Expectations What are some examples?

Consumer Income
Price of Ice-Cream Cone

Normal Good
An increase in income...
Increase in demand

$3.00
2.50 2.00 1.50 1.00 0.50

D1
0 1 2 3 4 5 6 7 8 9 10 11 12

D2
Quantity of Ice-Cream Cones

Consumer Income
Price of Ice-Cream Cone

Inferior Good

$3.00
2.50 2.00 1.50 1.00 0.50 Decrease in demand

An increase in income...

D2
0 1

D1

2 3 4 5 6 7 8 9 10 11 12

Quantity of Ice-Cream Cones

Prices of Related Goods


Substitutes & Complements

When a fall in the price of one good reduces the demand for another good, the two goods are called substitutes. When a fall in the price of one good increases the demand for another good, the two goods are called complements.

Change in Quantity Demanded versus Change in Demand


Variables that Affect Quantity Demanded

A Change in This Variable . . .


Represents a movement along the demand curve
Shifts the demand curve

Price
Income

Prices of related goods


Tastes Expectations

Shifts the demand curve


Shifts the demand curve Shifts the demand curve

Number of buyers

Shifts the demand curve

Supply Curve
Price of Ice-Cream Cone

$3.00
2.50 2.00 1.50 1.00 0.50
Quantity of Ice-Cream Cones

1 2 3 4 5 6 7 8 9 10 11 12

Law of Supply
The law of supply states that there is a direct (positive) relationship between price and quantity supplied.

Supply
Quantity supplied is the amount of a good that sellers are willing and able to sell.

Change in Quantity Supplied


Price of Ice-Cream Cone

S
C A rise in the price of ice cream cones results in a movement along the supply curve.

$3.00

1.00

Quantity of Ice-Cream Cones

Market Supply
Market supply refers to the sum of all individual supplies for all sellers of a particular good or service. Graphically, individual supply curves are summed horizontally to obtain the market supply curve.

Determinants of Supply
Market price Input prices Technology Expectations Number of producers What are some examples?

Change in Supply
Price of Ice-Cream Cone

S3
Decrease in Supply Increase in Supply

S1

S2

Quantity of Ice-Cream Cones

Change in Quantity Supplied versus Change in Supply


Variables that Affect Quantity Supplied A Change in This Variable . . .

Price Input prices Technology Expectations Number of sellers

Represents a movement along the supply curve Shifts the supply curve Shifts the supply curve Shifts the supply curve Shifts the supply curve

Price of Ice-Cream Cone

Equilibrium of Supply and Demand


Supply

$3.00 2.50 2.00 1.50

Equilibrium

1.00
0.50 0 1 2 3 4 5 6 7 8 9 10 11 12 Demand
Quantity of Ice-Cream Cones

Price of Ice-Cream Cone

Excess Supply
Surplus
Supply

$3.00 2.50 2.00 1.50

1.00
0.50 0 1 2 3 4 5 6 7 8 9 10 11 12 Demand
Quantity of Ice-Cream Cones

Excess Demand
Price of Ice-Cream Cone

Supply
$2.00
$1.50

Shortage

Demand

5 6

8 9 10 11 12 13 Quantity of Ice-Cream Cones

Three Steps To Analyzing Changes in Equilibrium


Decide whether the event shifts the supply or demand curve (or both). Decide whether the curve(s) shift(s) to the left or to the right. Examine how the shift affects equilibrium price and quantity.

Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.

How an Increase in Demand Affects the Equilibrium


Price of Ice-Cream Cone 1. Hot weather increases the demand for ice cream...

Supply
$2.50 2.00 2. ...resulting in a higher price... Initial equilibrium New equilibrium

D2

D1
0 3. ...and a higher quantity sold. 7 10 Quantity of Ice-Cream Cones

How a Decrease in Supply Affects the Equilibrium


Price of Ice-Cream Cone

S2

1. An earthquake reduces the supply of ice cream...

S1
New equilibrium

$2.50
2.00 2. ...resulting in a higher price...

Initial equilibrium

Demand

1 2 3 4

7 8 9 10 11 12 13 3. ...and a lower quantity sold.

Quantity of Ice-Cream Cones