Supply and Demand

Chapter 4

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Laugher Curve
Q. What do you get when you cross the
Godfather with an economist?
A. An offer you can't understand.

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Demand
Demand means the willingness and
capacity to pay.
Prices are the tools by which the market
coordinates individual desires.

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The Law of Demand

Law of demand there is an inverse

relationship between price and quantity
demanded.
Quantity

demanded rises as price falls,

other things constant.
Quantity demanded falls as prices rise,
other things constant.

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The Law of Demand

What accounts for the law of demand?

People

tend to substitute for goods

whose price has gone up.

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The Demand Curve

The demand curve is the graphic
representation of the law of demand.
The demand curve slopes downward and
to the right.
As the price goes up, the quantity
demanded goes down.

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Price (per unit)

A Sample Demand Curve

PA

D
0

QA

Quantity demanded (per unit of time)

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Other Things Constant

Other things constant places a limitation

on the application of the law of demand.
All

other factors that affect quantity

demanded are assumed to remain
constant, whether they actually remain
constant or not.

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Other Things Constant

Other things constant places a limitation

on the application of the law of demand.
These

factors may include changing

tastes, prices of other goods, income,
even the weather.

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Shifts in Demand Versus

Movements Along a
Demand Curve
Demand refers to a schedule of quantities
of a good that will be bought per unit of
time at various prices, other things
constant.
Graphically, it refers to the entire demand
curve.

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Shifts in Demand Versus

Movements Along a
Demand Curve
Quantity demanded refers to a specific
amount that will be demand per unit of
time at a specific price.
Graphically, it refers to a specific point
on the demand curve.

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Shifts in Demand Versus

Movements Along a
Demand Curve

A movement along a demand curve is

the graphical representation of the effect
of a change in price on the quantity
demanded.

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Shifts in Demand Versus

Movements Along a
Demand Curve

A shift in demand is the graphical

representation of the effect of anything
other than price on demand.

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Price (per unit)

Change in Quantity
Demanded
$2

B
Change in quantity demanded
(a movement along the curve)

$1

D1
0

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100
200
Quantity demanded (per unit of time)

Price (per unit)

Shift in Demand
Change in demand
(a shift of the curve)

$2

$1

A
D0
D1

250
100
200
Quantity demanded (per unit of time)
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Shift Factors of Demand

Shift factors of demand are factors that

cause shifts in the demand curve:
Society's

income.
The prices of other goods.
Tastes.
Expectations.
Taxes on subsidies to consumers.

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Income
An increase in income will increase
demand for normal goods.
An increase in income will decrease
demand for inferior goods.

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Price of Other Goods

When the price of a substitute good falls,
demand falls for the good whose price has
not changed.
When the price of a complement good
falls, demand rises for the good whose
price has not changed.

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Tastes

A change in taste will change demand with

no change in price.

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Expectations
If you expect your income to rise, you may
consume more now.
If you expect prices to fall in the future, you
may put off purchases today.

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Taxes and Subsidies

Taxes levied on consumers increase the
cost of goods to consumers, thereby
reducing demand.
Subsidies have an opposite effect.

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The Demand Table

The demand table assumes all the

following:
As

price rises, quantity demanded

declines.
Quantity demanded has a specific time
dimension to it.
All the products involved are identical in
shape, size, quality, etc.
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The Demand Table

The demand table assumes all the

following:
The

schedule assumes that everything

else is held constant.

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From a Demand Table to

a Demand Curve

You plot each point in the demand table on

a graph and connect the points to derive
the demand curve.

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From a Demand Table to

a Demand Curve

The demand curve graphically conveys the

same information that is on the demand
table.

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From a Demand Table to

a Demand Curve

The curve represents the maximum price

that you will pay for various quantities of a
good you will happily pay less.

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From a Demand Table to

a Demand Curve
A Demand Table

A
B
C
D
E

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$0.50
1.00
2.00
3.00
4.00

9
8
6
4
2

Price per DVDs (in dollars)

Price per DVD rentals

cassette demanded per
week

A Demand Curve

$6.00
5.00
4.00
3.50
3.00
2.00
1.00
.50
0

E
D

G
Demand for
DVDs

C
F

1 2 3 4 5 6 7 8 9 10 11 12 13
Quantity of DVDs demanded (per week)

Individual and Market

Demand Curves

A market demand curve is the horizontal

sum of all individual demand curves.
This

is determined by adding the

individual demand curves of all the
demanders.

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Individual and Market

Demand Curves

Sellers estimate total market demand for

their product which becomes smooth and
downward sloping curve.

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From Individual Demands

to a Market Demand
Curve
A $.0.50
B
1.00
C
1.50
D
2.00
E
2.50
F
3.00
G
3.50
H
4.00

9
8
7
6
5
4
3
2

6
5
4
3
2
1
0
0

(2)
Cathys
demand

1
1
0
0
0
0
0
0

(3)
Market
demand

16
14
11
9
7
5
3
2

$4.00
Price per cassette (in dollars)

(1)
(2)
(3)
Price per Alices Bruces
cassette demand demand

3.50

3.00

2.50

2.00

1.50

1.00
0.50
0

A
Cathy

Bruce Alice Market demand

8 10 12 14 16

Quantity of cassettes demanded per week

McGraw-Hill/Irwin

2004 The McGraw-Hill Companies, Inc., All

Rights Reserved.

The Law of Demand

The demand curve is downward sloping for

the following reasons:
At

lower prices, existing demanders buy

more.
At lower prices, new demanders enter
the market.

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Supply
Individuals control the factors of production
inputs, or resources, necessary to
produce goods.
Individuals supply factors of production to
intermediaries or firms.

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Supply

The analysis of the supply of produced

goods has two parts:
An

analysis of the supply of the

factors of production to households
and firms.
An analysis of why firms transform
those factors of production into
usable goods and services.
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The Law of Supply

There is a direct relationship between price

and quantity supplied.
Quantity

supplied rises as price rises,

other things constant.
Quantity supplied falls as price falls,
other things constant.

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The Law of Supply

The law of supply is accounted for by two

factors:
When

prices rise, firms substitute

production of one good for another.
Assuming firms costs are constant, a
higher price means higher profits.

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The Supply Curve

The supply curve is the graphic
representation of the law of supply.
The supply curve slopes upward to the
right.
The slope tells us that the quantity
supplied varies directly in the same
direction with the price.

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Price (per unit)

A Sample Supply Curve

S

PA

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QA
Quantity supplied (per unit of time)

Shifts in Supply Versus

Movements Along a
Supply Curve

Supply refers to a schedule of quantities a

seller is willing to sell per unit of time at
various prices, other things constant.

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Shifts in Supply Versus

Movements Along a
Supply Curve

Quantity supplied refers to a specific

amount that will be supplied at a specific
price.

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Shifts in Supply Versus

Movements Along a
Supply Curve

Changes in price causes changes in

quantity supplied represented by a
movement along a supply curve.

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Shifts in Supply Versus

Movements Along a
Supply Curve

A movement along a supply curve the

graphic representation of the effect of a
change in price on the quantity supplied.

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Shifts in Supply Versus

Movements Along a
Supply Curve

If the amount supplied is affected by

anything other than a change in price,
there will be a shift in supply.

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Shifts in Supply Versus

Movements Along a
Supply Curve

Shift in supply the graphic

representation of the effect of a change in
a factor other than price on supply.

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Shift in Supply
S0
Price (per unit)

S1

$15

B
Shift in Supply
(a shift of the curve)

1,250
1,500
Quantity supplied (per unit of time)
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Change in Quantity
Supplied
S
Price (per unit)

$15

Change in quantity
supplied (a movement
along the curve)

1,250
1,500
Quantity supplied (per unit of time)
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Shift Factors of Supply

Other factors besides price affect how

much will be supplied:
Prices

of inputs used in the production of

a good.
Technology.
Suppliers expectations.
Taxes and subsidies.

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Price of Inputs
When costs go up, profits go down, so that
the incentive to supply also goes down.
If costs go up substantially, the firm may
even shut down.

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Technology
Advances in technology reduce the
number of inputs needed to produce a
given supply of goods.
Costs go down, profits go up, leading to
increased supply.

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Expectations

If suppliers expect prices to rise in the

future, they may store today's supply to
reap higher profits later.

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Taxes and Subsidies

When taxes go up, costs go up, and profits
go down, leading suppliers to reduce
output.
When government subsidies go up, costs
go down, and profits go up, leading
suppliers to increase output.

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The Supply Table

Each supplier follows the law of supply.
When price rises, each supplies more, or
at least as much as each did at a lower
price.

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From a Supply Table to a

Supply Curve

To derive a supply curve from a supply

table, you plot each point in the supply
table on a graph and connect the points.

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From a Supply Table to a

Supply Curve

The supply curve represents the set of

minimum prices an individual seller will
accept for various quantities of a good.

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From a Supply Table to a

Supply Curve

Competing suppliers entry into the market

places a limit on the price any supplier can
charge.

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Individual and Market

Supply Curves

The market supply curve is derived by

horizontally adding the individual supply
curves of each supplier.

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From Individual Supplies

to a Market Supply
(1)
(2)
(3)
(4)
(5)
Quantities
Price
Ann's Barry's Charlie's Market
Supplied (per DVD) Supply Supply Supply Supply
A
B
C
D
E
F
G
H
I

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$0.00
0.50
1.00
1.50
2.00
2.50
3.00
3.50
4.00

0
1
2
3
4
5
6
7
8

0
0
1
2
3
4
5
5
5

0
0
0
0
0
0
0
2
2

0
1
3
5
7
9
11
14
15

From Individual Supplies

to a Market Supply
Charlie

$4.00

Barry

Ann

Market Supply

Price per DVD

3.50

3.00

2.50

2.00

1.50

1.00

0.50
0

CA

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
Quantity of DVDs supplied (per week)

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The Interaction of Supply

and Demand

The English historian Thomas Carlyle once

said:
Teach any parrot the words supply
and demand and youve got an
economist.

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Equilibrium

Equilibrium is a concept in which opposing

dynamic forces cancel each other out.

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Equilibrium

In a free market, the forces of supply and

demand interact to determine equilibrium
quantity and equilibrium price.

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Equilibrium
Equilibrium price the price toward
which the invisible hand drives the market.
Equilibrium quantity the amount
bought and sold at the equilibrium price.

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What Equilibrium Isnt

Equilibrium isnt a state of the world, it is a
characteristic of a model.
Equilibrium isnt inherently good or bad, it
is simply a state in which dynamic
pressures offset each other.

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What Equilibrium Isnt

When the market is not in equilibrium, you

get either excess supply or excess
demand, and a tendency for price to
change.

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Excess Supply
Excess supply a surplus, the quantity
supplied is greater than quantity
demanded
Prices tend to fall.

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Excess Demand
Excess demand a shortage, the
quantity demanded is greater than quantity
supplied
Prices tend to rise.

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Price Adjusts

The greater the difference between

quantity supplied and quantity demanded,
the more pressure there is for prices to rise
or fall.

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Price Adjusts

When quantity demanded equals quantity

supplied, prices have no tendency to
change.

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The Graphical Interaction

of Supply and Demand

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The Graphical Interaction

of Supply and Demand
$5.00
Excess supply

4.00
Price per DVD

3.50

3.00
E

2.50

2.00
1.50

Excess demand

1.00
1

D
7

10 11 12

Quantity of DVDs supplied and demanded

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The Graphical Interaction

of Supply and Demand
When price is $3.50 each, quantity
supplied equals 7 and quantity demanded
equals 3.
The excess supply of 4 pushes price
down.

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The Graphical Interaction

of Supply and Demand
When price is $1.50 each, quantity
supplied equals 3 and quantity demanded
equals 7.
The excess demand of 4 pushes price up.

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The Graphical Interaction

of Supply and Demand
When price is $2.50 each, quantity
supplied equals 5 and quantity demanded
equals 5.
There is no excess supply or excess
demand, so price will not rise or fall.

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Political and Social

Forces and Equilibrium
Political and social forces can push price
away from a supply/demand equilibrium.
These forces create an equilibrium where
quantity supplied wont equal quantity
demanded.

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Shifts in Supply and

Demand

Shifts in either supply or demand change

equilibrium price and quantity.

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Increase in Demand
An increase in demand creates excess
demand at the original equilibrium price.
The excess demand pushes price upward
until a new higher price and quantity are
reached.

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Price (per DVDs)

Increase in Demand
S0
$2.50
2.25

Excess demand

D0
0

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D1

8
9
10
Quantity of DVDs (per week)

Decrease in Supply
A decrease in supply creates excess
demand at the original equilibrium price.
The excess demand pushes price upward
until a new higher price and lower quantity
are reached.

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Price (per DVDs)

Decrease in Supply
S1

S0

C
$2.50
2.25

Excess demand
A
D0

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8
9
10
Quantity of DVDs (per week)

The Limitations Of
Supply And Demand
Analysis
Sometimes supply and demand are
interconnected.
Other things don't remain constant.

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The Limitations Of
Supply And Demand
Analysis
All actions have a multitude of ripple and
possible feedback effects.
The ripple effect is smaller when the
goods are a small percentage of the entire
economy.

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The Limitations Of
Supply And Demand
Analysis
The other-things-constant assumption is
likely not to hold when the goods represent
a large percentage of the entire economy.

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The Fallacy of
Composition

The fallacy of composition is the false

assumption that what is true for a part will
also be true for the whole.

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The Fallacy of
Composition

The fallacy of composition is of central

relevance to macroeconomics.
In

macroeconomics, the other-thingsconstant assumption, central to

microeconomic supply/demand
analysis, cannot hold.

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Supply and Demand

End of Chapter 4

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