Lovewell2 ppt02

Understanding Economics
2nd edition by Mark Lovewell and Khoa Nguyen
Chapter 2 Demand and Supply

Copyright 2002 by McGraw-Hill Ryerson Limited. All rights reserved.
What Is Demand?
o
Demand is a relationship between a products price and quantity demanded, or the amounts consumers will purchase at those prices.
Quantity demanded is the dependent variable Demand is shown using a schedule or curve. The law of demand states that price and quantity demanded are inversely related. Market demand is the sum of quantities demanded at each price by all consumers in a market.
The Demand Curve

Market Demand Curve for Strawberries Market Demand Schedule for Strawberries
Price ($ per kg) 2.50 2.00 1.50 Price ($ per kg) Quantity Demanded (millions of kg) 7 9 11 Point on graph a b c
0 1 3 5 7 9 11 13 2.50 2.00 1.50 a b c
D
1.00 0.50
Quantity Demanded (millions of kg per year)
Deriving Market Demand

Figure 2.2, page 31
Your Demand Curve for Strawberries
Price ($ per kg) 2.50 2.00 1.50
Your Friends Demand Curve for Strawberries

Price ($ per kg) 2.50 2.00 1.50 1.00 0.50 D1
1.00
0.50
D0
0 1 2 3 7 5 6 4 Quantity Demanded (kg per month)
5 0 1 2 3 4 6 7 Quantity Demanded (kg per month)
Price ($ per kg) 2.50 2.00 1.50
You (D0)
Your Friend (D1) (kg per month)
Market (Dm)
Price ($ per kg)
Individual and Market Demand Schedules for Strawberries
Market Demand Curve for Strawberries

2.50 2.00 1.50 1.00 0.50 0 1 2 3 4 5 Dm
1 2 3
2 3 4
3 5 7
Quantity Demanded (kg per month)
Changes in Demand (a)
Changes in demand:

are shown by shifts in the demand curve are caused by changes in demand determinants #s of buyers in the market Average income Prices of other products Consumer Preferences Consumer expectations about future prices and incomes
Changes in Demand (b)

Figure 2.3, page 32
Market Demand Curve for Strawberries Market Demand Schedule for Strawberries
Price ($ per kg) Price ($ per kg) 2.50 2.00 1.50 Quantity Demanded (millions of kg) (D2) (D0) (D1) 5 7 9 7 9 11 9 11 13
2.50 2.00 1.50
D2
1.00 0.50
D0
D1
11
13
Demand Determinants (a)
Demand determinants include the following factors:
The number of buyers (an increase causes a rightward demand shift) Income For normal products, an increase causes a rightward demand shift. For inferior products, an increase causes a leftward demand shift. (turnips and secondhand suits)
Demand Determinants (b)
Prices of other products
For substitute products, a rise in the other products price causes a rightward demand shift. (butter and margarine) For complementary products, a rise in the other products price causes a leftward demand shift. (DVD player + DVD player console)
Consumer preferences Consumer expectations
Except the price to fall in the future demand shifts leftwards
Changes in Quantity Demanded (b)
Changes in quantity demanded:
are shown by movements along demand curve are caused by price changes
Figure 2.4, Page 39
Changes in Quantity Demanded (b)

Figure 2.4, page 36
Change in Quantity Demanded
Change in Demand
Price ($ per pair of skis)
2.00 1.50 1.00 0.50
a b
Price ($ per pair of skis)
2.00 1.50 1.00 0.50 D0
D0
D1
5000 6000
5000
Quantity Demanded (pairs of skis)
Quantity Demanded (pairs of skis)
What Is Supply?
Supply:
is a relationship between a products price and quantity supplied is shown using a schedule or curve
The law of supply states there is a direct relationship between price and quantity supplied.
The Supply Curve

Figure 2.5, page 35
Market Supply Curve for Strawberries Market Supply Schedule for Strawberries
Price Quantity Supplied Points ($ per kg) (millions of kg) on graph 1.50 2.00 2.50 5 9 13 d e f
f 2.50 2.00 1.50 1.00 0.50 d e
Price ($ per kg)
11
13
Changes in Supply (a)
Changes in supply:

are shown by shifts in the supply curve are caused by changes in supply determinants #s of producers Recourse prices State of technology Changes in nature Prices of related products Producer expectations
Changes in Supply (b)

Figure 2.6, page 36
Market Supply Curve for Strawberries Market Supply Schedule for Strawberries
Price ($ per kg) Price ($ per kg) 2.50 2.00 Quantity Supplied (millions of kg) S2
2.50 2.00 1.50 1.00 0.50
S0 S1
(S2)
11
(S0)
13
(S1)
15
7 3
9
5
11
9
1.50
11
13
15
Supply Determinants (a)
Supply determinants include the following factors:
Number of producers (an increase causes a rightward supply shift) Resource prices (an increase causes a leftward supply shift) State of technology (an improvement causes a rightward supply shift) Prices of related products (an increase causes a leftward supply shift)
Supply Determinants (b)
changes in nature (an improvement causes a rightward shift for some products) producer expectations (an expectation of lower prices in the future causes an immediate rightward supply shift)
Changes in Quantity Supplied (a)
Changes in quantity supplied:
are shown by movements along the supply curve are caused by price changes
Changes in Quantity Supplied (b)

Figure 2.7, page 38
Change in Quantity Supplied
120 100 a S0 b 120 100
Change in Supply
S0 S1
Price ($ per kg)
80 60
Price ($ per kg)

1
80 60 40 20
40
20
Market Equilibrium (a)
When a product is in surplus:

there is excess supply price is pushed down there is excess demand price is pushed up
When a product is in shortage:
Market Equilibrium (b)

Figure 2.8, page 39
Market Demand and Supply Schedules for Strawberries
Surplus (+) or Shortage (-) (millions of kg)
Market Demand and Supply Curves for Strawberries

3.00 2.50 Price ($ per kg) 2.00 1.50 1.00 a
Shortage
S
Surplus
Price ($ per kg)
Quantities
(millions of kg) D S
b e
3.00 2.50 2.00 1.50 1.00
5 7 9 11 13
13 11 9 7 5
+8 +4 0 -4 -8
9 11 13 15 5 7 Quantity (millions of kg per year) 3
Changes in Equilibrium
A rightward demand shift pushes up both equilibrium price and quantity. A leftward demand shift pushes down both equilibrium price and quantity. A rightward supply shift pushes equilibrium price down and equilibrium quantity up. A leftward supply shift pushes equilibrium price up and equilibrium quantity down.
Demand Changes and Equilibrium

Figure 2.9, page 40

Price ($ per kg)
Price ($ per kg.) 3.00 2.50 2.00 1.50 1.00 Quantities (D0) (D1) (S) (millions of kg) 5 9 13 11 9 7 5
3.00 2.50 2.00 1.50 1.00 a b
7
9
11
13 15 17
shortage
D0 D1
11
13
11 13 15
17
Quantity (millions of kg per year)

Supply Changes and Equilibrium

Figure 2.10, page 43

Price ($ per kg)
Price ($ per kg) 3.00 2.50 2.00 1.50 1.00 Quantities (D0) (S0) (S1) (millions of kg) 5 13 17 15 13 11 9
S0
3.00 2.50 a 2.00 b 1.50 1.00 D0 Surplus
S1
7
9
11
9 7 5
11
13
11 13 15
17
Quantity (millions of kg per year)

Spoilt for Choice
William Stanley Jevons:

assumed measurable utility outlined the law of diminishing marginal utility which states that a consumers marginal utility declines as more of a product is consumed this law can be shown by deriving the downward-sloping marginal utility graph for a given consumer and product, based on that consumers total utility graph
Spoilt for Choice (b)

Figure A, page 47
Consumers Total and Marginal Utility From Cappuccino
Quantity Consumed (cups) 0 1 2 Total Utility (utils) 0 12 20 (a) (b) (c) Marginal Utility (utils) 12 8 4 2 (f) (g) (h) (i)
Total Utility
28 24 c d e
Utility (utils)
20 16 12 8 b
3
4
24
26
(d)
(e)
4
0
a 2 1 3 Cups of Cappuccino 4
Marginal Utility
Utility (utils) 16 12 8 4 0
f g
h 2 1 3 Cups of Cappuccino i 4
The Utility-Maximizing Rule
Jevons devised the utility-maximizing rule
this rule states a consumer should reach the same marginal utility per dollar for all products consumed in mathematical terms: MU1 MU2 = P1 P2
Spoilt for Choice (c)

Figure B, page 47
Cups of Cappuccino (price = $1)
Quantity Marginal Marginal Utility Utility (MU) per $ (MU/P1=MU/$1) (utils) (utils)
12 8 4 2 12 8 4 2
Danish Pastries (price = $2)

Quantity Marginal Marginal Utility Utility (MU) per $ (MU/P1=MU/$2) (utils) (utils)
16 12 8 4 8 6 4 2
0 1 2 3 4
0 1 2 3 4
Cappuccinos
Marginal Utility Per $ (utils)
Marginal Utility Per $ (utils) 12 8 4 0 2 1 3 Cups of Cappuccino 4 12 8 4 0
Danish Pastries
2 1 3 Cups of Cappuccino
Indifference Curves
Using indifference curves, consumer preferences can be shown without the need to assume measurable utility An individual consumers must merely rank his/her options for various bundles of two products in order of preference A consumer may prefer one bundle to another, or be indifferent between the two
An Indifference Curve (a)
An indifference curve shows all bundles of two goods to which a particular consumer is indifferent. The curve is downward-sloping because, for any point on the curve, all points to the northeast provide more utility and all points to the southwest provide less utility
An Indifference Curve (b)

Figure A, page 50
Alices Indifference Curve Alices Indifference Schedule Milkshakes
Milkshakes Hamburgers point on graph 4 3
a At each point on the curve, Alice derives the same level of utility.
4 3
2 1
3 4 7 12
a b
c d
2
1
c
d
I0 4 8 12
Hamburgers
The Marginal Rate of Substitution
The absolute value of an indifference curves slope is the marginal rate of substitution (MRS). An indifference curve is convex, since the curves MRS diminishes as more of the product on the horizontal axis (hamburgers), and less on the vertical axis (milkshakes) is consumed.
The Diminishing Marginal Rate of Substitution
The diminishing marginal rate of substitution occurs because, as hamburger consumption rises, more hamburgers must be gained to make the consumer willing to sacrifice another milkshake
A Map of Indifference Curves (a)
A map of indifference curves can be drawn for an individual consumer, with each indifference curve further to the northeast representing a higher level of utility
A Map of Indifference Curves (b)

Figure B, page 51
A Map of Indifference Curves
Each curve shows points that give different levels of utility for Alice.
Milkshakes
3 2 1
I0 4 8 12
I1
I2
Hamburgers
The Budget Line (a)
A consumers budget line:
is drawn based on the assumption that all the consumers budget is spent on hamburgers and milkshakes has a vertical intercept equal to the consumers budget divided by the price of milkshakes a horizontal intercept equal to the consumers budget divided by the price of hamburgers
The Budget Line (b)
has a slope whose absolute value equals the ratio of the two prices (the price of hamburgers divided by the price of milkshakes) divides the graph into an attainable region southwest of the line, and an unattainable region northeast of the line
The Budget Line (c)

Figure C, page 52
Alices Budget Curve Alices Budget Line
5 Milkshakes Hamburgers 5 4 3 0 2 4 4
The budget curve shows all those points Alice can reach with her limited budget.
$15/$3
Milkshakes
3 2 1
$15/$1.50
2
1 0
6
8 10
10 12
Hamburgers
The Utility-Maximizing Point (a)
The consumer maximized utility by reaching the highest possible indifference curve on the budget line. This utility-maximizing point occurs on the indifference curve that just touches the budget line at a single point.
The Utility-Maximizing Point (b)

Figure D, page 51
5 4
Milkshakes
b (4, 3)
3 2
Alices greatest achievable utility is on the indifference curve which touches her budget line at a single point.
I0 8 10 12
Hamburgers
Deriving a Demand Curve (a)
The consumers demand curve for hamburgers can be found by tracing out the results of a change in the price of hamburgers given a constant money budget and price for milkshakes.
Deriving a Demand Curve (b)

Figure E, p. 53
A decline in the price of hamburgers from $1.50 to $1 causes Alices quantity demanded to rise from 4 to 6, as shown by her demand curve D.
Price ($ per hamburger
5
4
1.50
Milkshakes
3 2 1
e (6,3)
1.00 .50 D 0 4 8
I1 I0
10 12
15
12
Hamburgers
Quantity (hamburgers per week)
Understanding Economics
2nd edition by Mark Lovewell
Chapter 2 The End


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Understanding Economics

2nd edition by Mark Lovewell and Khoa Nguyen

Chapter 2 Demand and Supply

The Demand Curve

Quantity Demanded (millions of kg per year)

Copyright 2002 by McGraw-Hill Ryerson Limited. All rights reserved.

Deriving Market Demand

Your Friends Demand Curve for Strawberries

0 1 2 3 7 5 6 4 Quantity Demanded (kg per month)

5 0 1 2 3 4 6 7 Quantity Demanded (kg per month)

Price ($ per kg) 2.50 2.00 1.50

Your Friend (D1) (kg per month)

Price ($ per kg)

Individual and Market Demand Schedules for Strawberries

Market Demand Curve for Strawberries

Quantity Demanded (kg per month)

Copyright 2002 by McGraw-Hill Ryerson Limited. All rights reserved.

Changes in Demand (a)

Copyright 2002 by McGraw-Hill Ryerson Limited. All rights reserved.

Changes in Demand (b)

Quantity Demanded (millions of kg per year)

Copyright 2002 by McGraw-Hill Ryerson Limited. All rights reserved.

Demand Determinants (a)

Demand determinants include the following factors:

Copyright 2002 by McGraw-Hill Ryerson Limited. All rights reserved.

Demand Determinants (b)

Prices of other products

Consumer preferences Consumer expectations

Except the price to fall in the future demand shifts leftwards

Copyright 2002 by McGraw-Hill Ryerson Limited. All rights reserved.

Changes in Quantity Demanded (b)

Changes in quantity demanded:

Figure 2.4, Page 39

Copyright 2002 by McGraw-Hill Ryerson Limited. All rights reserved.

Changes in Quantity Demanded (b)

Change in Quantity Demanded

Price ($ per pair of skis)

2.00 1.50 1.00 0.50

Price ($ per pair of skis)

2.00 1.50 1.00 0.50 D0

Quantity Demanded (pairs of skis)

Quantity Demanded (pairs of skis)

Copyright 2002 by McGraw-Hill Ryerson Limited. All rights reserved.

Copyright 2002 by McGraw-Hill Ryerson Limited. All rights reserved.

The Supply Curve

Price ($ per kg)

Quantity Demanded (millions of kg per year)

Copyright 2002 by McGraw-Hill Ryerson Limited. All rights reserved.

Changes in Supply (a)

Copyright 2002 by McGraw-Hill Ryerson Limited. All rights reserved.

Changes in Supply (b)

Quantity Demanded (millions of kg per year)

Copyright 2002 by McGraw-Hill Ryerson Limited. All rights reserved.

Supply Determinants (a)

Supply determinants include the following factors:

Copyright 2002 by McGraw-Hill Ryerson Limited. All rights reserved.

Supply Determinants (b)

Copyright 2002 by McGraw-Hill Ryerson Limited. All rights reserved.

Changes in Quantity Supplied (a)

Changes in quantity supplied:

Copyright 2002 by McGraw-Hill Ryerson Limited. All rights reserved.

Changes in Quantity Supplied (b)

Price ($ per kg)