2 - Supply and Demand

Chapter 3
Supply and Demand
INTRODUCTION TO ECONOMICS 2e / LIEBERMAN & HALL

CHAPTER 3 / SUPPLY AND DEMAND
2005, South-Western/Thomson Learning
Slides by John F. Hall

Animations by Anthony Zambelli
Supply and Demand

Supply
and demand is an economic
model
Designed to explain how prices are

determined in certain types of markets
What
you will learn in this chapter
How the model of supply and demand

works and how to use it
Strengths and limitations of model
Lieberman & Hall; Introduction to Economics, 2005
Markets
Specific location where buying and selling takes

place, such as
Supermarket or a flea market
In economics, a market is not a place but rather
A group of buyers and sellers with the potential to trade
with each other
Economists think of the economy as a collection of

individual markets
First step in an economic analysis is to define and
characterize the market or collection of markets to
analyze
How Broadly Should We Define the

Market
Defining the market often requires

economists to group things together
Aggregation is the combining of a group of

distinct things into a single whole
Markets can be defined broadly or narrowly,

depending on our purpose
How broadly or narrowly markets are defined is

one of the most important differences between
Macroeconomics and Microeconomics
Defining Macroeconomic Markets
Goods and services are aggregated to the

highest levels
Macro models lump all consumer goods into the

single category consumption goods
Macro models will also analyze all capital goods
as one market
Macroeconomists take an overall view of the
economy without getting bogged down in details
Defining Microeconomic Markets
Markets are defined narrowly
Focus on models that define much more specific

commodities
Always involves some aggregation
Stops short of the broad levels of generality that

macroeconomics investigates
Buyers and Sellers
Buyers and sellers in a market can be

Households
Business firms
Government agencies
All three can be both buyers and sellers in the same
market, but are not always
For purposes of simplification this text will usually
follow these guidelines
In markets for consumer goods, well view business firms as
the only sellers, and households as only buyers

In most of our discussions, well be leaving out the
middleman
Competition in Markets
In imperfectly competitive markets, individual buyers or

sellers can influence the price of the product
In perfectly competitive markets (or just competitive
markets), each buyer and seller takes the market price as a
given
What makes some markets imperfectly competitive and
others perfectly competitive?
Perfectly competitive markets have many small buyers and sellers
Each is a small part of the market, and the product is standardized
Imperfectly competitive markets have just a few large buyers and

sellers
Or else the product of each seller is unique in some way
Using Supply and Demand
Supply and demand model is designed to

explain how prices are determined in
perfectly competitive markets
Perfect competition is rare but many markets
come reasonably close

Perfect competition is a matter of degree rather
than an all or nothing characteristic
Supply and demand is one of the most

versatile and widely used models in the
economists tool kit
Demand
A households quantity demanded of a good

Specific amount household would choose to buy over
some time period, given
A particular price that must be paid for the good
All other constraints on the household
Market quantity demanded (or quantity demanded)

is the specific amount of a good that all buyers in the
market would choose to buy over some time period,
given
A particular price they must pay for the good
All other constraints on households
10
Quantity Demanded
Implies a choice
How much households would like to buy when they take into account
the opportunity cost of their decisions?
Is hypothetical
Makes no assumptions about availability of the good
How much would households want to buy, at a specific price, given
real-world limits on their spending power?
Stresses price
Price of the good is one variable among many that influences
quantity demanded
Well assume that all other influences on demand are held constant,
so we can explore the relationship between price and quantity
demanded
11
The Law of Demand
States that when the price of a good rises and

everything else remains the same, the quantity of
the good demanded will fall
The words, everything else remains the same are
important
In the real world many variables change simultaneously
However, in order to understand the economy we must first
understand each variable separately

Thus we assume that, everything else remains the same, in
order to understand how demand reacts to price
12
The Demand Schedule and the

Demand Curve
Demand schedule
A list showing the quantity of a good that consumers would
choose to purchase at different prices, with all other
variables held constant
The market demand curve (or just demand curve)

shows the relationship between the price of a good
and the quantity demanded , holding constant all
other variables that influence demand
Each point on the curve shows the total buyers would
choose to buy at a specific price
Law of demand tells us that demand curves virtually

always slope downward
13
Figure 1: The Demand Curve

Price per
Bottle
$4.00
When the price is $4.00

per bottle, 40,000
bottles are demanded
(point A).
B
2.00
At $2.00 per bottle,

60,000 bottles are
demanded (point B).
D
40,000
60,000
Number of Bottles
per Month
14
Shifts vs. Movements along the

Demand Curve
A change in the price of a good causes a

movement along the demand curve
In Figure 1
A fall (rise) in price would cause a movement to the right
(left) along the demand curve
A change in income causes a shift in the demand

curve itself
In Figure 2
Demand curve has shifted to the right of the old curve
(from Figure 1) as income has risen

A change in any variable that affects demandexcept for
the goods pricecauses the demand curve to shift
15
Figure 2: A Shift of the Demand Curve

An increase in income
shifts the demand curve
for maple syrup from D1
to D2. At each price, more
bottles are demanded
after the shift.
Price per
Bottle
$2.00
60,000
C
D1
D2
80,000
Number of Bottles
per Month
16
Dangerous Curves: Change in Quantity

Demanded vs. Change in Demand
Language is important when discussing demand

Quantity demanded means
A particular amount that buyers would choose to buy at a specific
price
It is a number represented by a single point on a demand curve
When a change in the price of a good moves us along a demand
curve, it is a change in quantity demand
The term demand means

The entire relationship between price and quantity demanded
and represented by the entire demand curve

When something other than price changes, causing the entire
demand curve to shift, it is a change in demand
17
Income: Factors That Shift the

Demand Curve
An increase in income has effect of shifting

demand for normal goods to the right
However, a rise in income shifts demand for

inferior goods to the left
A rise in income will increase the demand for

a normal good, and decrease the demand
for an inferior good
18
Wealth: Factors that Shift the Demand

Curve
Your wealthat any point in timeis the
total value of everything you own minus the
total dollar amount you owe
An increase in wealth will
Increase demand (shift the curve rightward) for a

normal good
Decrease demand (shift the curve leftward) for
an inferior good
19
Prices of Related Goods: Factors that

Shift the Demand Curve
Substitutegood that can be used in place of

some other good and that fulfills more or less
the same purpose
A rise in the price of a substitute increases the
demand for a good, shifting the demand curve to the

right
Complementused together with the good we

are interested in
A rise in the price of a complement decreases the
demand for a good, shifting the demand curve to the

left
20
Other Factors that Shift the Demand

Curve
Population
As the population increases in an area
Number of buyers will ordinarily increase

Demand for a good will increase
Expected Price
An expectation that price will rise (fall) in the future shifts the current
demand curve rightward (leftward)
Tastes
Combination of all the personal factors that go into determining how
a buyer feels about a good

When tastes change toward a good, demand increases, and the
demand curve shifts to the right
When tastes change away from a good, demand decreases, and the
demand curve shifts to the left
21
Figure 3(a): Movements Along and

Shifts of the Demand Curve
Price
Price increase moves us
leftward along demand
curve
P2
Price increase moves us
rightward along demand
curve
P1
P3
2
Q1
Q3
Quantity
22
Figure 3(b): Movements Along and

Price
Entire demand curve shifts

rightward when:
income or wealth
price of substitute
price of complement
population
expected price
tastes shift toward good
D2
D1
Quantity
23
Figure 3(c): Movements Along and

Price
Entire demand curve shifts

leftward when:
income or wealth
price of substitute
price of complement
population
expected price
tastes shift toward good
D1
D2
Quantity
24
Supply
A firms quantity supplied of a good is the specific

amount its managers would choose to sell over
some time period, given
A particular price for the good
All other constraints on the firm
Market quantity supplied (or quantity supplied) is
the specific amount of a good that all sellers in the
market would choose to sell over some time period,
given
A particular price for the good
All other constraints on firms
25
Quantity Supplied
Implies a choice
Quantity that gives firms the highest possible profits when they take
account of the constraints presented to them by the real world
Is hypothetical
Does not make assumptions about firms ability to sell the good
How much would firms managers want to sell, given the price of the
good and all other constraints they must consider?
Stresses price
The price of the good is just one variable among many that
influences quantity supplied

Well assume that all other influences on supply are held constant,
so we can explore the relationship between price and quantity
supplied
26
The Law of Supply
States that when the price of a good rises

and everything else remains the same, the
quantity of the good supplied will rise
The words, everything else remains the same

are important
In the real world many variables change
simultaneously
However, in order to understand the economy we
must first understand each variable separately
We assume everything else remains the same in
order to understand how supply reacts to price
27
The Supply Schedule and The

Supply Curve
Supply scheduleshows quantities of a
good or service firms would choose to
produce and sell at different prices, with all
other variables held constant
Supply curvegraphical depiction of a
supply schedule
Shows quantity of a good or service supplied at

various prices, with all other variables held
constant
28
Figure 4: The Supply Curve

Price per
Bottle
When the price is $2.00

per bottle, 40,000 bottles
are supplied (point F).
$4.00
2.00
G
At $4.00 per bottle,
quantity supplied is
60,000 bottles (point G).
40,000
60,000
Number of Bottles
per Month
29
Shifts vs. Movements along the

Supply Curve
A change in the price of a good causes a

movement along the supply curve
In Figure 4
A rise (fall) in price would cause a rightward (leftward) movement
along the supply curve
A drop in transportation costs will cause a shift in

the supply curve itself
In Figure 5
Supply curve has shifted to the right of the old curve (from Figure
4) as transportation costs have dropped

A change in any variable that affects supplyexcept for the
goods pricecauses the supply curve to shift
30
Figure 5: A Shift of the Supply Curve

Price per
Bottle
A decrease in transportation
costs shifts the supply curve for
maple syrup from S1 to S2.
S1
S2
At each price, more bottles

are supplied after the shift
$4.00
60,000
80,000
Number of Bottles
per Month
31
Factors that Shift the Supply Curve
Input prices
A fall (rise) in the price of an input causes an increase
(decrease) in supply, shifting the supply curve to the right
(left)
Price of Related Goods

When the price of an alternate good rises (falls), the
supply curve for the good in question shifts rightward
(leftward)
Technology
Cost-saving technological advances increase the supply
of a good, shifting the supply curve to the right
32
Number of firms
An increase (decrease) in the number of sellers

with no other changesshifts the supply curve
to the right (left)
Expected price
An expectation of a future price increase

(decrease) shifts the current supply curve to the
left (right)
33
Changes in weather
Favorable weather
Increases crop yields

Causes a rightward shift of the supply curve for that crop
Unfavorable weather
Destroys crops
Shrinks yields
Shifts the supply curve leftward
Other unfavorable natural events may effect all

firms in an area
Causing a leftward shift in the supply curve
34
Figure 6(a): Changes in Supply and

in Quantity Supplied
Price
Price increase moves

us rightward along
supply curve
P2
P1
Price increase moves

us leftward along
supply curve
P3
Q3
Q1
Q2
Quantity
35
Figure 6(b): Changes in Supply and

Price
Entire supply curve shifts

rightward when:
price of input
price of alternate good
number of firms
expected price
technological advance
favorable weather
S1
S2
Quantity36
Figure 6(c): Changes in Supply and

Price
Entire supply curve shifts

rightward when:
price of input
price of alternate good
number of firms
expected price
unfavorable weather
S2
S1
Quantity37
In Summary: Factors that Shift the

Supply Curve
The short list of shift-variables for supply that
we have discussed is far from exhaustive
In some cases, even the threat of such
events can cause serious effects on
production
Basic principle is always the same
Anything that makes sellers want to sell more or

less of a good at any given price will shift supply
curve
38
Equilibrium: Putting Supply and

Demand Together
When a market is in equilibrium

Both price of good and quantity bought and sold have
settled into a state of rest
The equilibrium price and equilibrium quantity are values
for price and quantity in the market but, once achieved,
will remain constant
Unless and until supply curve or demand curve shifts
The equilibrium price and equilibrium quantity can

be found on the vertical and horizontal axes,
respectively
At point where supply and demand curves cross
39
Figure 7: Market Equilibrium

Price per
Bottle
2. causes the price

to rise . . .
3. shrinking the
excess demand . . .
S
E
$3.00
1.00
1. At a price of $1.00 per

bottle an excess demand
of 50,000 bottles . . .
H
Excess Demand
4. until price reaches its

equilibrium value of $3.00
.
J
25,000 50,000 75,000
D
Number of Bottles
per Month
40
Excess Demand: Putting Supply and

Demand Together
Excess
demand
At a given price, the excess of quantity

demanded over quantity supplied
Price
of the good will rise as buyers

compete with each other to get more of
the good than is available
41
Figure 8: Excess Supply and Price

Adjustment
Price per
Bottle
1. At a price of $5.00 per

bottle an excess supply
of 30,000 bottles . . .
Excess Supply at $5.00 S
$5.00
2. causes the
price to drop,
3.00
K
E
3. shrinking the
excess supply . . .
4. until price reaches its

equilibrium value of
$3.00.
D
35,000 50,000 65,000

Number of Bottles
per Month
42
Excess Supply: Putting Supply and

Demand Together
Excess Supply
At a given price, the excess of quantity supplied

over quantity demanded
Price of the good will fall as sellers compete

with each other to sell more of the good than
buyers want
43
Income Rises: What Happens When

Things Change
Income rises, causing an increase in

demand
Rightward shift in the demand curve causes

rightward movement along the supply curve
Equilibrium price and equilibrium quantity both
rise
Shift of one curve causes a movement along

the other curve to new equilibrium point
44
Figure 9: A Shift in Demand and a

New Equilibrium
Price per
Bottle
4. Equilibrium
price
increases
3. to a new
equilibrium.
S
F'
$4.00
3.00
2. moves us along
the supply
curve . . .
1. An increase in
demand . . .
D2
D1
5. and equilibrium quantity

increases too.
50,000 60,000
Number of Bottles of
Maple Syrup per Period
45
An Ice Storm Hits: What Happens

When Things Change
An ice storm causes a decrease in supply
Weather is a shift variable for supply curve

Any change that shifts the supply curve leftward in a
market will increase the equilibrium price
And decrease the equilibrium quantity in that market
46
Figure 10: A Shift of Supply and a New

Equilibrium
Price per
Bottle
$5.00
3.00
S2
S1
E'
D
35,000 50,000
Number of Bottles
47
Figure 11: Changes in the Market for

Handheld PCs
Price per
Handheld
PC
3. moved the market to

a new equilibrium.
2. and a decrease
in demand . . .
4. Price
decreased . . .
$500
S2002
S2003
1. An increase in
supply . . .
$400
D2002
5. and quantity
decreased as well.
D2003
2.45 3.33
Millions of Handheld PCs

per Quarter
48
Both Curves Shift

When just one curve shifts (and we know the
direction of the shift) we can determine the
direction that both equilibrium price and quantity
will move
When both curves shift (and we know the
direction of the shifts) we can determine the
direction for either price or quantitybut not both
Direction of the other will depend on which curve
shifts by more
49
The Principle of Markets and

Equilibrium
The supply-and-demand model is just one example

of a more general approach
To identify a market and examine its equilibrium
Basic Principle #4: Markets and Equilibrium
To understand how the economy behaves, economists
organize the world into separate markets and then
examine the equilibrium in each of those markets
This approach helps us predict important changes in

the economy and prepare for them
And it helps us predict important changes in the economy
our social goals and avoid policies that are likely to
backfire
50
Price Ceilings
Government-imposed maximum price that prevents the

price of a good from rising above a certain level in a market
Short side of the Market
Smaller of quantity supplied and quantity demanded at a particular
price
When quantity supplied and quantity demanded differ, short side of
market will prevail
Price ceiling creates a shortage and increases the time and

trouble required to buy the good
While the price decreases, the opportunity cost may rise
Black Market
A market created by unintended consequences of government
intervention
Goods are sold illegally at a price above the legal ceiling
51
Figure 12: A Price Ceiling in the Market

for Maple Syrup
5. With a black market, the
lower quantity sells for a
higher price than initially.
Price per
Bottle
3. and decreases
quantity supplied.
4. The result is a shortage

S
the distance between
R and V.
T
$4.00
3.00
2.00
E
V
2. increases quantity
demanded
D
40,000 50,000 60,000

1. A price ceiling lower than
the equilibrium price . . .
Number of Bottles of
Maple Syrup per Period
52
Price Floors
Government imposed minimum amount below which price is

not permitted to fall
Price floors for agricultural goods are commonly called price support
programs
When sellers produce more of the good than buyers want at

the price floor
Remaining goods become a surplus that no one wants at the
imposed price
Government responds by maintaining price floors

Uses taxpayer dollars to buy up entire excess supply of the good in
question
Prevents excess supply from doing what it would ordinarily do
Drive price down to its equilibrium value

53
The Principle of Policy Tradeoffs
In our discussion of government intervention in

markets, you may have noticed something
interesting
A policy designed to help us achieve one goal causes us
to compromise on some other goal
In fact, as you will see throughout this text, there

are virtually always tradeoffs involved in
government policy making
For this reason, we consider government policy tradeoffs
to be one of the basic principles of economics
54
The Principle of Policy Tradeoffs
Basic Principle #5: Policy Tradeoffs
Government policy is constrained by the

reactions of private decision makers
As a result, policy makers face tradeoffs
Making progress toward one goal often requires some
sacrifice of another goal
Economics is famous for making the public

aware of policy tradeoffs
55
Supply and Demand and Normative

Economics
Supply and demand offers us important lessons about the

economy
The lessons are both positive
Telling us what will happen when there is a change in a market
And normative
Suggesting what sorts of polices we should or should not pursue
Most economists believe that the mechanism of supply and

demand is an effective way to allocate resources
Why do economists feel this way?
Answering this question requires a more thorough understanding of
the economy than we can provide after just three chapters of this
book
However, when you finish your introductory study of economics, you will
know why economists treat supply and demand with such respect
56
Using Supply and Demand: The

Invasion of Kuwait
Why did Iraqs invasion of Kuwait cause the

price of oil to rise?
Immediately after the invasion, United States led

a worldwide embargo on oil from both Iraq and
Kuwait
A significant decrease in the oil industrys
productive capacity caused a shift in the supply
curve to the left
Price of oil increased
57
Figure 13: The Market For Oil

Price per
Barrel of Oil
S2
S1
E'
P2
E
P1
D
Q2
Q1
Barrels of Oil
58
Using Supply and Demand: The

Invasion of Kuwait
Why
did the price of natural gas rise as

well?
Oil is a substitute for natural gas

Rise in the price of a substitute increases
demand for a good
Rise in price of oil caused demand curve
for natural gas to shift to the right
Thus, the price of natural gas rose

59
Figure 14: The Market For Natural Gas

Price per Cubic
Foot of Natural
Gas
F'
P4
P3
D2
D1
Q3
Q4
Cubic Feet of
Natural Gas
60

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Chapter 3

Supply and Demand

INTRODUCTION TO ECONOMICS 2e / LIEBERMAN & HALL

Slides by John F. Hall

Supply and Demand

and demand is an economic

Designed to explain how prices are

you will learn in this chapter

How the model of supply and demand

Specific location where buying and selling takes

Economists think of the economy as a collection of

Lieberman & Hall; Introduction to Economics, 2005

How Broadly Should We Define the

Defining the market often requires

Aggregation is the combining of a group of

Markets can be defined broadly or narrowly,

How broadly or narrowly markets are defined is

Defining Macroeconomic Markets

Goods and services are aggregated to the

Macro models lump all consumer goods into the

Lieberman & Hall; Introduction to Economics, 2005

Defining Microeconomic Markets

Markets are defined narrowly

Focus on models that define much more specific

Always involves some aggregation

Stops short of the broad levels of generality that

Lieberman & Hall; Introduction to Economics, 2005

Buyers and Sellers

Buyers and sellers in a market can be

the only sellers, and households as only buyers

Lieberman & Hall; Introduction to Economics, 2005

In imperfectly competitive markets, individual buyers or

Imperfectly competitive markets have just a few large buyers and

Or else the product of each seller is unique in some way

Lieberman & Hall; Introduction to Economics, 2005

Using Supply and Demand

Supply and demand model is designed to

Perfect competition is rare but many markets

come reasonably close

Supply and demand is one of the most

Lieberman & Hall; Introduction to Economics, 2005

A households quantity demanded of a good

Market quantity demanded (or quantity demanded)

Lieberman & Hall; Introduction to Economics, 2005

Lieberman & Hall; Introduction to Economics, 2005

The Law of Demand

States that when the price of a good rises and

understand each variable separately

Lieberman & Hall; Introduction to Economics, 2005

The Demand Schedule and the

The market demand curve (or just demand curve)

Law of demand tells us that demand curves virtually

Lieberman & Hall; Introduction to Economics, 2005

Figure 1: The Demand Curve

When the price is $4.00

At $2.00 per bottle,

Lieberman & Hall; Introduction to Economics, 2005

Shifts vs. Movements along the

A change in the price of a good causes a

A change in income causes a shift in the demand

(from Figure 1) as income has risen

Lieberman & Hall; Introduction to Economics, 2005

Figure 2: A Shift of the Demand Curve