Introduction. Learning Objectives. Chapter 3. Demand and Supply

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Chapter 3 Demand and Supply

3-2

Introduction

Three decades ago, 45% of U.S. residents were classified as

“overweight”. Today, about 67% fall into this category.

One explanation for higher body weights is less exercise; another is that people simply consume more food than in the past.

Determining why individuals eat more requires understanding of how two key variables—price and income—influence desired consumption of an item such as food.

Learning Objectives

• Explain the law of demand

• Discuss the difference between money prices and relative prices

• Distinguish between changes in demand

and changes in quantity demanded

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3-4

Learning Objectives (cont'd)

• Explain the law of supply

• Distinguish between changes in supply and changes in quantity supplied

• Understand how supply and demand interact to determine equilibrium price and quantity

3-5

Chapter Outline

• Demand

• The Demand Schedule

• Shifts in Demand

• The Law of Supply

• The Supply Schedule

• Shifts in Supply

• Putting Demand and Supply Together

Did You Know That...

• No new oil refineries have been built in the U.S. since 1976?

• Recently, however, Hyperion, a Dallas-

based company, announced its intention to

build a new refinery at Elk Pont, South

Dakota.

(3)

3-7

Did You Know That… (cont’d)

• Markets

– Arrangements that individuals have for exchanging with one another

– Represent the interaction of buyers and sellers for goods and services

– Markets set the prices we pay and receive.

• Automobile market

• Health care market

• Labor market

• Stock market

3-8

Demand

• A schedule showing how much of a good or service people will purchase at any price during a specified time period, other things being constant

Demand (cont’d)

• Law of Demand

– Quantity demanded is inversely related to price, holding other factors constant.

• Price Qd

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3-10

Demand (cont’d)

• What are we holding constant?

– Income

– Tastes and preferences – Price of other goods – Many other factors

3-11

Demand (cont’d)

• Relative prices and money prices – Relative Price

• The price of a commodity in terms of another commodity

– Money Price

• Price we observe today in today’s dollars (absolute, or nominal price)

Table 3-1 Money Price versus

Relative Price

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3-13

E-Commerce Example: Quality-Adjusting the Price of Broadband Service

• In most U.S. areas, broadband Internet service is priced at about $15 per month compared to France, where price is about $36 per month.

• U.S. providers, however, typically offer broadband speeds of less than 0.77 megabit per second compared to 20 megabits per second in France.

• Thus, the U.S. speed-adjusted price is nearly 10 times higher than in France.

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The Demand Schedule

• The demand schedule

– Table relating prices to quantity demanded – We must consider

• Time dimension

• Constant-quality units

• Demand Curve

– A graphical representation of the demand schedule – Negatively sloped line showing inverse

relationship between price and quantity demanded, all else equal

Figure 3-1 The Individual Demand Schedule

and the Individual Demand Curve, Panel (a)

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Figure 3-1 The Individual Demand Schedule and the Individual Demand Curve, Panel (b)

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The Demand Schedule (cont’d)

• Individual versus market demand curves

• Market Demand

– The demand of all consumers in the marketplace for a particular good or service – Summation at each price of the quantity

demanded by each individual

Figure 3-2 The Horizontal Summation of

Two Demand Curves, Panel (a)

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Figure 3-2 The Horizontal Summation of Two Demand Curves, Panels (b), (c), (d)

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Figure 3-3 The Market Demand Schedule for Secure Digital Cards, Panel (a)

Figure 3-3 The Market Demand Schedule

for Secure Digital Cards, Panel (b)

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Shifts in Demand

• Scenario

– Imagine the federal government gives every student registered in a college, university, or technical school in the United States a laptop with a slot for secure digital cards.

• If some factor other than price changes, we can show its effect by moving the entire demand curve, shifting the curve left or right.

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Figure 3-4 A Shift in the Demand Curve

Suppose the federal government gives every student a notebook computer Suppose universities

prohibit the use of notebook computers

Determinants of Demand

• Ceteris-Paribus Conditions

– Determinants of the relationship between price

and quantity that are unchanged along a curve

– Changes in these factors cause a curve to shift

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Normal and Inferior Goods

• Normal Goods

– Goods for which demand rises as income rises;

most goods are normal goods

• Inferior Goods

– Goods for which demand falls as income rises

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Shifts in Demand

• Determinants of demand – Income

– Tastes and preferences – The prices of related goods

• Substitutes

• Complements

Shifts in Demand (cont'd)

• Substitutes

– Two goods are substitutes when a change in the

price of one causes a shift in demand for the

other in the same direction as the price change.

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Example: Diamonds May Not Really Be Forever

• The day that sellers of diamonds have long dreaded has arrived. Several experts examine three gems.

• The first gem is a real diamond; the second is cubic zirconia;

the third is a gem-quality diamond produced in a lab—known as a “synthetic” diamond.

• The jewelry experts pronounce the synthetic gem as the highest quality of the three.

• In what direction do you think the demand curve for real diamonds has shifted as lower-priced synthetic diamonds have become available?

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Shifts in Demand (cont'd)

• Complements

– Two goods are complements when a change in the price of one causes an opposite shift in the demand curve for the other.

Shifts in Demand (cont'd)

• Determinants of demand – Expectations

• Future prices

• Income

• Product availability

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Shifts in Demand (cont'd)

The Determinants of Demand Income: Normal Good

D

1

Q/Units D

2

D

3

Price

Decrease in income decreases demand

Increase in income increases demand

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Shifts in Demand (cont'd)

The Determinants of Demand Income: Inferior Good

D

₁

Q/Units Decrease in income increases demand

Increase in income decreases demand Price

D

₂

D

₃

Shifts in Demand (cont'd)

The Determinants of Demand Tastes and Preferences

D

₁

Q/Units Price

Hybrid vehicles

• Increase in demand

D

₂

SUVs

• Decrease in demand

D

₃

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Shifts in Demand (cont'd)

The Determinants of Demand Price of Related Goods: Substitutes

D

1

Q/Butter Butter and Margarine

• Price of both = $2/lb

• Price of margarine increases to $3/lb

• Demand for butter increases

D

2

Price

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Shifts in Demand (cont'd)

The Determinants of Demand Price of Related Goods: Complements

D

₁

Q/Speakers Speakers and Amplifiers

• Decrease the relative price of amplifiers

• Demand for speakers increases

D

₂

D

₃

Speakers and Amplifiers

• Increase the relative price of amplifiers

• Demand for speakers decreases Price

Shifts in Demand (cont'd)

The Determinants of Demand Expectations: Income, Future Prices

A higher income or

expectations of a higher future

price will increase demand

Price

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3-37 The Determinants of Demand

Market Size (Number of Buyers)

D

1

Q/Units Increase in the number of buyers increases demand

D

2

D

3

Decrease in the

number of buyers decreases demand Price

Shifts in Demand (cont'd)

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Shifts in Demand (cont'd)

• Changes in demand versus changes in quantity demanded

– A change in one or more of the non-price determinants (income, tastes, etc.) will lead to a change in demand.

• This is a shift of the whole curve.

Shifts in Demand (cont'd)

• Changes in demand versus changes in quantity demanded

– A change in a good’s own price leads to a change in quantity demanded.

• This is a movement along the same curve.

– ∆D is not the same as ∆Qd.

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3-40

Figure 3-5 Movement Along a Given Demand Curve

A change in the price changes the quantity of a good demanded, movement along the curve

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The Law of Supply

• Supply

– Schedule showing relationship between price and quantity supplied for a specified time period, other things being equal

– The amount of a product or service that firms are willing to sell at alternative prices

The Law of Supply (cont'd)

• Law of Supply

– The price of a product or service and the quantity supplied are directly related.

• P Qs

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3-43

The Supply Schedule

• The supply schedule is a table relating prices to quantity supplied at each price.

• Supply Curve

– A graphical representation of the supply schedule

– Positively sloped line showing direct relationship between price and quantity supplied, all else equal

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Figure 3-6 The Individual Producer’s Supply Schedule and Supply Curve for Secure Digital Cards, Panel (a)

Figure 3-6 The Individual Producer’s Supply

Schedule and Supply Curve for Secure Digital

Cards, Panel (b)

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3-46

Figure 3-7 Horizontal Summation of Supply Curves, Panel (a)

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Figure 3-7 Horizontal Summation of Supply Curves, Panels (b), (c), (d)

Figure 3-8 The Market Supply Schedule

and the Market Supply Curve for Secure

Digital Cards, Panel (a)

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3-49

Figure 3-8 The Market Supply Schedule and the Market Supply Curve for Secure Digital Cards, Panel (b)

3-50

Shifts in Supply

• Scenario

– A new method of manufacturing SD cards significantly reduces the cost of production.

– What will producers of SD cards do?

Figure 3-9 A Shift in the Supply Curve

If some other factor than price changes, the only way we can show its effect is by moving the entire supply curve

If costs decrease,

supply increases

If costs increase,

supply decreases

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3-52 S

₁

Quantity of Flash Memory Pen Drives Supplied (millions of constant-quality units per year)

Price per Flas h M em ory Pen Dri ve ($)

2 4 6 8

0 1 2 3 4 5

10 12 14

S

₂

a

c When supply increases

the quantity supplied will be greater at each price

Figure 3-9 A Shift in the Supply Curve (cont’d)

3-53 S

₁

Quantity of Flash Memory Pen Drives Supplied (millions of constant-quality units per year)

2 4 6 8

0 1 2 3 4 5

10 12 14

a b d c

S

₂

When supply increases the quantity supplied will be greater at each price

Price per Flas h M em ory Pen Dri ve ($)

Figure 3-9 A Shift in the Supply Curve (cont’d)

2 3 4

5 S

₁

a c

S

₃

b

d When supply decreases

the quantity supplied will be less at each price

h M em ory Pen Dri ve ($)

Figure 3-9 A Shift in the Supply

Curve (cont’d)

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3-55

Shifts in Supply (cont'd)

• Determinants of supply – Cost of inputs

– Technology and productivity – Taxes and subsidies – Price expectations

– Number of firms in industry

3-56

Shifts in Supply (cont'd)

The Determinants of Supply Cost of Inputs

S

1

Q/Units Decrease in cost increases supply S

2

Increase in cost

decreases supply S

3

Price

Shifts in Supply (cont'd)

The Determinants of Supply Technology and Productivity

S

1

Q/Units Improvements in technology or increases in productivity increase supply

S

2

Decreases in productivity

decrease supply

S

3

Price

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3-58

Shifts in Supply (cont'd)

The Determinants of Supply Taxes and Subsidies

S

1

Q/Units Decreases in taxes or increases in subsidies increase supply

S

2

Increases in taxes or

decreases in subsidies decrease supply

S

3

Price

3-59

Shifts in Supply (cont'd)

The Determinants of Supply Price Expectations

S

1

Q/Units Expectations of lower future prices increase supply

S

2

Expectations of higher

future prices decrease supply

S

3

Price

Shifts in Supply (cont'd)

The Determinants of Supply Number of Firms in Industry

S

1

Increase in the S

2

Decrease in the

number of firms decreases supply

S

3

Price

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3-61

Shifts in Supply (cont'd)

• Changes in supply versus changes in quantity supplied

– A change in one or more of the non-price determinants will lead to a change in supply.

• This is a shift of the whole curve.

3-62

Shifts in Supply (cont'd)

• Changes in supply versus changes in quantity supplied

– A change in a good’s own price leads to a change in quantity supplied.

• This is a movement along the same curve.

– ∆S is not the same as ∆Qs.

International Policy Example:

Government Subsidies Generate More Train Traffic in Europe

• Recently, national governments of the European Union decided to shoulder most of the regular expenses associated with maintaining rail track networks, providing a subsidy per kilometer of track traversed by rail freight.

• European rail companies have responded by increasing the amounts of freight transport services they provide.

• Thus, the provision of government subsidies has

brought about an increase in the supply of

European rail-freight services.

(22)

3-64

Putting Demand and Supply Together

• Putting demand and supply together

• Equilibrium (Market Clearing) Price – The price that clears the market

– The price at which quantity demanded equals quantity supplied

– The price where the demand curve intersects the supply curve

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Figure 3-10 Putting Demand and Supply Together, Panel (a)

Figure 3-10 Putting Demand and

Supply Together, Panel (b)

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3-67

Putting Demand

and Supply Together (cont'd)

• Equilibrium

– The situation when quantity supplied equals quantity demanded at a particular price – There tends to be no movement of the price of

the quantity away from this point unless demand or supply changes.

– Equilibrium is a stable point – any point that is not equilibrium is unstable and will not persist.

3-68

Putting Demand

and Supply Together (cont'd)

• Shortages

– The situation when quantity demanded is greater than quantity supplied

• Qd > Qs

– Exist at any price below the market clearing price

Putting Demand

and Supply Together (cont'd)

• Surpluses

– The situation when quantity supplied is greater than quantity demanded

•Qd < Qs

– Exist at any price above the market

clearing price

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3-70

Policy Example: Should Shortages in the Ticket Market Be Solved by Scalpers?

• If you’ve ever tried to get tickets to the big game you know all about “shortages.”

• Since the quantity of tickets is fixed, the price can go pretty high.

• Enter the scalper.

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Figure 3-11 Shortages of Super Bowl Tickets

Issues and Applications: Why Are People Eating More?

• Being overweight predisposes an individual to ailments such as arthritis, diabetes, heart disease, high blood pressure, respiratory problems, and strokes.

• Yet, about two-thirds of the U.S. population is overweight.

• A more sedentary lifestyle and increased calorie consumption help explain the increase in body mass of the average U.S.

resident.

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3-73

Issues And Applications: Why Are People Eating More? (cont’d)

• One reason people today buy and eat more food is simply because food is cheaper than it used to be.

• Incomes have also risen over the same time span and most food items are normal goods, hence demand for food has risen.

• Without additional exercise, people have been gaining more weight.

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Figure 3-12 U.S. Calorie Consumption and the Relative Price of Food, Panel (a)

Figure 3-12 U.S. Calorie Consumption

and the Relative Price of Food, Panel (b)

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Summary Discussion of Learning Objectives

• The law of demand says that prices and quantity demanded are

inversely related.

– At a higher price people buy less, at a lower price people buy more.

• Relative prices must be distinguished from money prices, since people respond to changes in relative prices.

3-77

Summary Discussion

of Learning Objectives (cont'd)

• A change in quantity demanded versus a change in demand

– A change in quantity demanded is a movement along the same demand curve.

– A change in demand is a shift of the whole demand curve.

Summary Discussion

of Learning Objectives (cont'd)

• The law of supply states that price and quantity supplied are directly related.

– At a high price firms offer more; at a low price firms offer less.

• A change in quantity supplied versus a

change in supply

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3-79

Summary Discussion

of Learning Objectives (cont'd)

• Determining market price and equilibrium quantity

– The demand and supply curves intersect at the market clearing, or equilibrium point.

– Surpluses exist if the price of the good is greater than the market price.

– Shortages exist when the price of a good is

below the market price.

Introduction. Learning Objectives. Chapter 3. Demand and Supply

Chapter 3

Demand and Supply

3-2

Introduction

Three decades ago, 45% of U.S. residents were classified as

“overweight”. Today, about 67% fall into this category.

One explanation for higher body weights is less exercise; another is that people simply consume more food than in the past.

Determining why individuals eat more requires understanding of how two key variables—price and income—influence desired consumption of an item such as food.

Learning Objectives

• Explain the law of demand

• Discuss the difference between money prices and relative prices

• Distinguish between changes in demand

and changes in quantity demanded

3-4

Learning Objectives (cont'd)

• Explain the law of supply

• Distinguish between changes in supply and changes in quantity supplied

• Understand how supply and demand interact to determine equilibrium price and quantity

3-5

Chapter Outline

• Demand

• The Demand Schedule

• Shifts in Demand

• The Law of Supply

• The Supply Schedule

• Shifts in Supply

• Putting Demand and Supply Together

Did You Know That...

• No new oil refineries have been built in the U.S. since 1976?

• Recently, however, Hyperion, a Dallas-

based company, announced its intention to

build a new refinery at Elk Pont, South

Dakota.

3-7

Did You Know That… (cont’d)

• Markets

– Arrangements that individuals have for exchanging with one another

– Represent the interaction of buyers and sellers for goods and services

– Markets set the prices we pay and receive.

• Automobile market

• Health care market

• Labor market

• Stock market

3-8

Demand

• A schedule showing how much of a good or service people will purchase at any price during a specified time period, other things being constant

Demand (cont’d)

• Law of Demand

– Quantity demanded is inversely related to price, holding other factors constant.

• Price  Qd 

• Price  Qd 

3-10

Demand (cont’d)

• What are we holding constant?

– Income

– Tastes and preferences – Price of other goods – Many other factors

3-11

Demand (cont’d)

• Relative prices and money prices – Relative Price

• The price of a commodity in terms of another commodity

– Money Price

• Price we observe today in today’s dollars (absolute, or nominal price)

Table 3-1 Money Price versus

Relative Price

3-13

E-Commerce Example: Quality-Adjusting the Price of Broadband Service

• In most U.S. areas, broadband Internet service is priced at about $15 per month compared to France, where price is about $36 per month.

• U.S. providers, however, typically offer broadband speeds of less than 0.77 megabit per second compared to 20 megabits per second in France.

• Thus, the U.S. speed-adjusted price is nearly 10 times higher than in France.

3-14

The Demand Schedule

• The demand schedule

– Table relating prices to quantity demanded – We must consider

• Time dimension

• Constant-quality units

• Demand Curve

– A graphical representation of the demand schedule – Negatively sloped line showing inverse

relationship between price and quantity demanded, all else equal

Figure 3-1 The Individual Demand Schedule

• Price Qd

• Price Qd