Micro232 2004 - jafgac

Supply and Demand

Chapter 4
Micro232 2004 JAFGAC
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.
Micro232 2004 JAFGAC
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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Quantity demanded (per unit of time)
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A
A Sample Demand Curve
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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.
Micro232 2004 JAFGAC
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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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.

Shifts in Demand Versus
Movements Along a Demand
Curve
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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.
Shifts in Demand Versus
Movements Along a Demand
Curve
Micro232 2004 JAFGAC
A movement along a demand curve is
the graphical representation of the effect
of a change in price on the quantity
demanded.
Shifts in Demand Versus
Movements Along a Demand
Curve
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A shift in demand is the graphical
representation of the effect of anything
other than price on demand.
Shifts in Demand Versus
Movements Along a Demand
Curve
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Change in Quantity Demanded
D
1
Change in quantity demanded
(a movement along the curve)
B
0
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Quantity demanded (per unit of time)
100
$2
$1
200
A
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Shift in Demand
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Quantity demanded (per unit of time)
100
$2
$1
200
B A
Change in demand
(a shift of the curve)
250
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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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P
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A Demand Curve
Quantity of DVDs demanded (per week)
1 2 3 4 5 6 7 8 9 10 11 12

13
$6.00
5.00
4.00
3.00
2.00
1.00
.50
0
3.50
E
D
C
B F
A
From a Demand Table to a
Demand Curve
Price per
cassette
A
B
C
D
E
A Demand Table
DVD rentals
demanded per
week
$0.50
1.00
2.00
3.00
4.00
9
8
6
4
2
Demand for
DVDs
G
Micro232 2004 JAFGAC
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.
Micro232 2004 JAFGAC
Individual and Market
Demand Curves
Sellers estimate total market demand for
their product which becomes smooth and
downward sloping curve.
From Individual Demands
to a Market Demand Curve
(1)
Price per
cassette
$.0.50
1.00
1.50
2.00
2.50
3.00
3.50
4.00
(2)
Alices
demand
(3)
Bruces
demand
(2)
Cathys
demand
(3)
Market
demand
9
8
7
6
5
4
3
2
6
5
4
3
2
1
0
0
1
1
0
0
0
0
0
0
16
14
11
9
7
5
3
2
A
B
C
D
E
F
G
H
Cathy Bruce Alice
D
A
C
E
F
G
Quantity of cassettes demanded per week
2
$4.00
3.50
3.00
2.50
2.00
1.50
1.00
0.50
0
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4 6 8 10 12 14 16
B
Market demand
McGraw-Hill/Irwin
2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
Micro232 2004 JAFGAC
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.
Micro232 2004 JAFGAC
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.
Micro232 2004 JAFGAC
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.
Micro232 2004 JAFGAC
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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S
A
Quantity supplied (per unit of time)
0
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Q
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A Sample Supply Curve
Micro232 2004 JAFGAC
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.
Micro232 2004 JAFGAC
Quantity supplied refers to a specific
amount that will be supplied at a specific
price.
Shifts in Supply Versus
Movements Along a Supply
Curve
Micro232 2004 JAFGAC
Changes in price causes changes in
quantity supplied represented by a
movement along a supply curve.
Shifts in Supply Versus
Movements Along a Supply
Curve
Micro232 2004 JAFGAC
A movement along a supply curve the
graphic representation of the effect of a
change in price on the quantity supplied.
Shifts in Supply Versus
Movements Along a Supply
Curve
Micro232 2004 JAFGAC
If the amount supplied is affected by
anything other than a change in price,
there will be a shift in supply.
Shifts in Supply Versus
Movements Along a Supply
Curve
Micro232 2004 JAFGAC
Shift in supply the graphic
representation of the effect of a change in
a factor other than price on supply.
Shifts in Supply Versus
Movements Along a Supply
Curve
Micro232 2004 JAFGAC
Shift in Supply
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Quantity supplied (per unit of time)
S
0

Shift in Supply
(a shift of the curve)
S
1
$15
A B
1,250 1,500
Micro232 2004 JAFGAC
Change in quantity
supplied (a movement
along the curve)
Change in Quantity Supplied
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Quantity supplied (per unit of time)
S
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$15
A
1,250 1,500
B
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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.
Micro232 2004 JAFGAC
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.
Micro232 2004 JAFGAC
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.
Micro232 2004 JAFGAC
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.
Micro232 2004 JAFGAC
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.
Micro232 2004 JAFGAC
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.
Micro232 2004 JAFGAC
From a Supply Table to a
Supply Curve
Competing suppliers entry into the market
places a limit on the price any supplier can
charge.
Micro232 2004 JAFGAC
Individual and Market Supply
Curves
The market supply curve is derived by
horizontally adding the individual supply
curves of each supplier.
Micro232 2004 JAFGAC

From Individual Supplies to a
Market Supply
Quantities
Supplied
A
B
C
D
E
F
G
H
I
(1)
Price
(per DVD)
(2)
Ann's
Supply
(5)
Market
Supply
(4)
Charlie's
Supply
$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
(3)
Barry's
Supply
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1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
From Individual Supplies to a
Market Supply
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Charlie Barry
Ann
Quantity of DVDs supplied (per week)
$4.00
3.50
3.00
2.50
2.00
1.50
1.00
0.50
0
I
H
G
F
E
D
C
B
A
Market Supply
C
A

Micro232 2004 JAFGAC
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.
Micro232 2004 JAFGAC
Equilibrium
Equilibrium is a concept in which opposing
dynamic forces cancel each other out.
Micro232 2004 JAFGAC
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.
Micro232 2004 JAFGAC
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.
Micro232 2004 JAFGAC
Excess Supply
Excess supply a surplus, the quantity
supplied is greater than quantity demanded
Prices tend to fall.
Micro232 2004 JAFGAC
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.
Micro232 2004 JAFGAC
The Graphical Interaction of
Supply and Demand
Price (per
DVD)
Quantity
Supplied
Quantity
Demanded
Surplus (+)
Shortage (-)
$1.50 7 3 +4
$2.50 5 5 0
$3.50 3 7 -4

Micro232 2004 JAFGAC
A
The Graphical Interaction of
Supply and Demand
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$5.00
4.00
3.50
3.00
2.50
2.00
1.50
1.00
S
D
Quantity of DVDs supplied and demanded
C
Excess demand
1 2 3 4 5 6 7 8 9 10 11 12
Excess supply
E
Micro232 2004 JAFGAC
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.
Micro232 2004 JAFGAC
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.
Micro232 2004 JAFGAC
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.
Micro232 2004 JAFGAC
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.
Micro232 2004 JAFGAC
A
S
0

Quantity of DVDs (per week)
$2.50
2.25
0
9 8 10
Excess demand
D
1

Increase in Demand
D
0

B
Micro232 2004 JAFGAC
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.
Micro232 2004 JAFGAC
A
Decrease in Supply
Quantity of DVDs (per week)
$2.50
2.25
0
9 8 10
D
0

S
1

S
0

C
B
Excess demand
Micro232 2004 JAFGAC
The Limitations Of Supply
And Demand Analysis
Sometimes supply and demand are
interconnected.
Other things don't remain constant.
Micro232 2004 JAFGAC
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.
Micro232 2004 JAFGAC
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.
Micro232 2004 JAFGAC
The Fallacy of Composition
The fallacy of composition is of central
relevance to macroeconomics.
In macroeconomics, the other-things-
constant assumption, central to
microeconomic supply/demand analysis,
cannot hold.
Micro232 2004 - jafgac
Supply and Demand
End of Chapter 4