Chapter 3 Supply and Demand

CoreEconomics 2nd edition by Gerald W. Stone

2011 Worth Publishers CoreEconomics Stone

Slides By: Debbie Evercloud

Chapter Outline
Markets Supply Demand Market Equilibrium Putting Supply and Demand to Work Alfred Marshall: 1842 - 1924

2011 Worth Publishers CoreEconomics Stone

Learning Objectives
At the end of the chapter, the student will be able to:
Describe the nature and purpose of markets Describe the nature of demand Identify the determinants of demand Distinguish between a change in demand and a change in quantity demanded Account for the shape of the supply curve Describe the determinants of supply
2011 Worth Publishers CoreEconomics Stone

Learning Objectives
At the end of the chapter, the student will be able to:
Distinguish between a change in supply and a change in quantity supplied Solve for market equilibrium Predict the effects of shifts in supply and demand Understand the impact of government intervention in markets

2011 Worth Publishers CoreEconomics Stone

Supply and Demand Analysis

Models of supply and demand are the foundation of economic theory. They provide a framework for understanding marketplace events and outcomes.

2011 Worth Publishers CoreEconomics Stone

Markets
Markets allow buyers and sellers to transact with one another. Markets can be limited to one locality, such as a lemonade stand. Or, like e-commerce, they can be global.

2011 Worth Publishers CoreEconomics Stone

The Role of Prices

Prices allow shoppers to make comparisons between the relative cost of different goods. Rising prices encourage firms to supply more of a product.

2011 Worth Publishers CoreEconomics Stone

Markets
Markets are institutions that enable buyers and sellers to interact and transact business. Markets differ in geographical location, products offered, and size. Prices contain a wealth of information for both buyers and sellers.

2011 Worth Publishers CoreEconomics Stone

Markets

Through their purchases, consumers signal their willingness to exchange money for particular products at particular prices. These signals help businesses decide what to produce, and how much of it to produce. The market economy is also called the price system.
2011 Worth Publishers CoreEconomics Stone

Demand
Demand refers to the products that consumers will buy during a certain period of time. The Law of Demand asserts that consumers will buy more of a product as its price falls.

2011 Worth Publishers CoreEconomics Stone

The Cost of Consumption

The monetary price of a product is only one component of the consumption cost. There is also the element of time involved.

2011 Worth Publishers CoreEconomics Stone

The Demand Curve

What is conveyed by the downward slope of the demand curve?
Price is measured on the vertical axis. Quantity is measured horizontally. A downward-sloping line indicates that these two variables are inversely related.

2011 Worth Publishers CoreEconomics Stone

Market Demand
Individual demand curves can be summed horizontally to derive market demand. More consumers will enter the market as the price falls. Statistical techniques can be used to estimate real-world demand curves.

2011 Worth Publishers CoreEconomics Stone

Determinants of Demand
In drawing one demand curve, we hold other factors constant:
Tastes and Preferences Income Prices of related goods Number of buyers Future expectations

2011 Worth Publishers CoreEconomics Stone

Tastes and Preferences

As one product comes more into fashion, the demand will increase. What do firms do to influence consumer tastes in their favor?

2011 Worth Publishers CoreEconomics Stone

Income
For normal goods, demand increases as incomes rise. For inferior goods, demand decreases as incomes rise. Examples of inferior goods include public transportation, second-hand furniture, and fake gemstones.

2011 Worth Publishers CoreEconomics Stone

Prices of Related Goods

Substitute goods are those used in place of one another:
Movies and plays Grape jelly and plum jam

Complement goods are those typically consumed together:

Movies and popcorn Grape jelly and peanut butter
2011 Worth Publishers CoreEconomics Stone

The Number of Buyers

As more consumers enter the market, demand shifts to the right
Example: As average life spans are extended, there will be an increasing demand for retirement communities.

2011 Worth Publishers CoreEconomics Stone

Future Expectations
If consumers expect shortages of certain products in the future, they are inclined to buy these goods immediately, thereby increasing the present demand for these products.

2011 Worth Publishers CoreEconomics Stone

Future Expectations
During Floridas hurricane season, news of an approaching storm will lead to an increased demand for batteries, plywood, and nails.

2011 Worth Publishers CoreEconomics Stone

Changes in Demand
Note that a change in demand is different from a change in quantity demanded. A change in demand occurs when the entire curve shifts. This means that the quantity demanded at every given price will be different from what it was before.

2011 Worth Publishers CoreEconomics Stone

Changes in Demand
Panel A Change in Demand Panel B Change in Quantity Demanded

Price ($)

D1 D0

D2

Price ($)

80

40

20 Quantity (computer games)

40

Quantity (computer games)

2011 Worth Publishers CoreEconomics Stone

Demand
Demand refers to the quantity of products people are willing and able to purchase during some specific time period, all other relevant factors being held constant. Price and quantity demanded have an inverse relationship known as the Law of Demand, depicted as a downward-sloping curve.

2011 Worth Publishers CoreEconomics Stone

Demand
A market demand is the horizontal sum of all of the individual demand curves. Demand curves shift when one or more of the determinants of demand change. The determinants of demand are: consumer tastes and preferences, income, prices of substitutes and complements, the number of buyers in a market, and expectations about future prices, incomes, and product availability.
2011 Worth Publishers CoreEconomics Stone

Demand
A shift of a demand curve is a change in demand. An increase in demand is a shift up and to the right. A decrease in demand is a shift down and to the left. A change in quantity demanded occurs only when the price of a product changes, leading consumers to adjust their purchases along the existing demand curve.

2011 Worth Publishers CoreEconomics Stone

Supply
Supply is the maximum amount of a product that producers will offer for sale at various prices, all other factors being held constant. The Law of Supply states that higher prices will lead producers to offer more of their goods and services for sale during a given time period.

2011 Worth Publishers CoreEconomics Stone

Determinants of Supply
Production Technology Costs of Resources Prices of Other Commodities Future Expectations Number of Sellers Taxes and Subsidies

2011 Worth Publishers CoreEconomics Stone

Production Technology
Technology determines how much output can be produced from given quantities of resources. It also determines the nature of products that can be supplied to the market.

2011 Worth Publishers CoreEconomics Stone

Costs of Resources
If resources such as raw materials, energy, or labor become more expensive, production costs will rise. This causes a reduction in supply.

2011 Worth Publishers CoreEconomics Stone

Prices of Other Commodities

Producers typically can choose which specific good to supply to the market. If a farmer can choose between growing celery and radishes, then an increase in the price of celery will reduce the supply of radishes.

2011 Worth Publishers CoreEconomics Stone

Expectations
When producers expect the prices of their goods to rise in the near future, they may react by withholding current production from the market, causing supply to decrease. Yet, expectations of price cuts can also temporarily increase the supply of goods on the market as producers try to sell off their inventories before the price cuts take effect.
2011 Worth Publishers CoreEconomics Stone

Number of Sellers
As more firms enter an industry, supply will increase. The quantity available at any given price will be higher than before.
This shifts the supply curve to the right.

2011 Worth Publishers CoreEconomics Stone

Taxes and Subsidies

Taxes represent a cost to business, so they serve to decrease supply. In contrast, subsidies will encourage more production.
A tax will shift supply to the left. A subsidy will shift supply to the right.

2011 Worth Publishers CoreEconomics Stone

Changes in Supply
Change in Supply Change in Quantity Supplied

S0 Price ($) Price ($) S1

80

40

20 Quantity (computer games)

40

Quantity (computer games)

2011 Worth Publishers CoreEconomics Stone

Supply
Supply is the quantity of a product producers are willing and able to put on the market at various prices, all other relevant factors being held constant. As with demand, market supply is arrived at by horizontally summing the individual supplies of all of the firms in the market.

2011 Worth Publishers CoreEconomics Stone

Supply
A change in supply occurs when one or more of the determinants of supply change. The determinants of supply are production technology, the cost of resource inputs, prices of other commodities, expectations, the numbers of sellers or producers in the market, and taxes and subsidies.

2011 Worth Publishers CoreEconomics Stone

Market Equilibrium
A market will determine the price at which the quantity of a product demanded is equal to the quantity supplied. At this price, the market will be in equilibrium, meaning that the amount consumers wish to purchase at this price is matched exactly by the amount producers wish to sell.
2011 Worth Publishers CoreEconomics Stone

Market Equilibrium
S0

Surplus

Price ($)

80 e 40 Shortage
D0

The pressure on market price is always in the direction of equilibrium.

20

40

Quantity (computer games)

2011 Worth Publishers CoreEconomics Stone

Deviations from Equilibrium

If the price of a good is held above equilibrium price, a surplus results. Shortages occur when the price is held below equilibrium.

2011 Worth Publishers CoreEconomics Stone

Shifts in Demand
An increase in demand will lead to a higher equilibrium price and a higher equilibrium quantity. A decrease in demand creates a lower equilibrium price and a lower equilibrium quantity.

2011 Worth Publishers CoreEconomics Stone

Shifts in Supply
An increase in supply will lead to a lower equilibrium price and a higher equilibrium quantity. A decrease in supply creates a higher equilibrium price and a lower equilibrium quantity.

2011 Worth Publishers CoreEconomics Stone

Examples of Market Outcomes

An increase in the supply of grapes and a decrease in the demand for wine led to lower wine prices in 2001. An increase in the price of jumbo tires used on mining equipment led to higher prices for copper, coal, and zinc in 2006.
2011 Worth Publishers CoreEconomics Stone

Market Equilibrium
Together, supply and demand determine market equilibrium. Equilibrium occurs when quantity supplied exactly equals quantity demanded.
Price S

D Quantity
2011 Worth Publishers CoreEconomics Stone

Market Equilibrium
The equilibrium price is also called the market-clearing price. When supply and demand change, equilibrium price and output change. When only one curve shifts, the resulting changes in equilibrium price and quantity can be predicted.

2011 Worth Publishers CoreEconomics Stone

Market Equilibrium
When both curves shift, we can predict the change in equilibrium price in some cases, and the change in equilibrium quantity in others, but never both. The relative magnitudes of the shifts must be known in order to predict the effect on both equilibrium price and quantity.

2011 Worth Publishers CoreEconomics Stone

Try It!
When the price of cameras decreases and people buy more cameras, this can be explained by A) an increase in demand for cameras. B) an increase in the supply of cameras. C) a decrease in demand for cameras. D) A decrease in the supply of cameras.

2011 Worth Publishers CoreEconomics Stone

Try It!
When the price of cameras decreases and people buy more cameras, this can be explained by A) an increase in demand for cameras. B) an increase in the supply of cameras. Correct! C) a decrease in demand for cameras. D) A decrease in the supply of cameras.
2011 Worth Publishers CoreEconomics Stone

Chapter Summary
Markets are institutions that enable buyers and sellers to interact with one another. Demand is the quantity consumers will purchase at various possible prices of a good.

2011 Worth Publishers CoreEconomics Stone

Chapter Summary
Supply is the quantity producers will bring to market at various possible prices. The interaction of supply and demand will establish a point of equilibrium, at which the quantity demanded will equal the quantity supplied.

2011 Worth Publishers CoreEconomics Stone