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?
● Peopletend 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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 A Sample Demand Curve
Price (per unit)

PA A

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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 Change in Quantity
Demanded

$2 B
Price (per unit)

Change in quantity demanded

(a movement along the curve)

A
$1

D1
0
100 200
Quantity demanded (per unit of time)

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 Shift in Demand

Change in demand
(a shift of the curve)
$2
Price (per unit)

B A
$1

D0

D1
100 200 250
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'sincome.
● 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
A Demand Table $6.0
0 Curve
Price perDVD rentals 5.00

Price per DVDs (in

cassette demanded
per week 4.00 E

A $0.5 9 3.50 G
3.00 D
B 0 8 Demand
dollars)
2.00 C for
C 1.00 6 DVDs
D 2.00 4 1.00
F B
A
E 3.00 2 .50
0
4.00 1 2 3 4 5 6 7 8 9 10111213
Quantity of DVDs demanded
(per week)

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 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
(1) (2) (3) (2) (3) $4.0

Price per cassette (in dollars)

Price per Alice’s Bruce’s Cathy’s Market 0 G
cassette demand demand demand demand 3.50
3.00 F
A $.0.50 9 6 1 16 E
B 1.00 8 5 1 14 2.50
D
C 1.50 7 4 0 11 2.00
D 2.00 6 3 0 9 C
1.50
E 2.50 5 2 0 7 B
F 3.00 4 1 0 5 1.00
A
G 3.50 3 0 0 3 0.50
H 4.00 2 0 0 2 Cathy BruceAlice
Market demand
0
2 4 6 8 10 12 14 16
Quantity of cassettes demanded per we

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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 A Sample Supply Curve
Price (per unit)

A
PA

0
QA
Quantity supplied (per unit of time)

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 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
S1
Price (per unit)

A B
$15
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
Price (per unit) S0

Change in quantity
A supplied (a movement
$15
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:
● Pricesof 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 $0.00 0 0 0 0
B 0.50 1 0 0 1
C 1.00 2 1 0 3
D 1.50 3 2 0 5
E 2.00 4 3 0 7
F 2.50 5 4 0 9
G 3.00 6 5 0 11
H 3.50 7 5 2 14
I 4.00 8 5 2 15

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 From Individual Supplies
to a Market Supply
Charlie Barry Ann Market Supply
$4.00 I
3.50 H
3.00 G
Price per DVD

2.50 F
2.00 E
1.50 D
1.00 C
0.50 B CA
0 A
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 you’ve 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 Isn’t
■ Equilibrium isn’t a state of the world, it is a
characteristic of a model.
■ Equilibrium isn’t inherently good or bad, it
is simply a state in which dynamic
pressures offset each other.

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 What Equilibrium Isn’t
■ 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
S
4.00 Excess supply
Price per DVD

3.50 A
3.00
2.50 E

2.00 C
1.50
Excess demand
1.00 D
1 2 3 4 5 6 7 8 9 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 won’t 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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 Increase in Demand
S0
Price (per DVDs)

B
$2.50 Excess demand
A
2.25

D0 D1

0 8 9 10
Quantity of DVDs (per week)

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 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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 Decrease in Supply
S1
S0
Price (per DVDs)

C
$2.50 Excess demand
B
2.25 A

D0

0 8 9 10
Quantity of DVDs (per week)

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 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.
● Inmacroeconomics, the other-things-
constant assumption, central to
microeconomic supply/demand
analysis, cannot hold.

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 Supply and Demand

End of Chapter 4

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