Chapter 3Chapter 3DEMAND &DEMAND &

SUPPLYSUPPLY

Markets and ExchangeMarkets and Exchange

What is a market?A market is a place or service that A market is a place or service that enables buyers and sellers to enables buyers and sellers to exchange goods and services.exchange goods and services.

Barter is the exchange of goods and services directly, without the involvement of money.

Monetary exchanges involve exchanging money for goods and services.

Barter—considerationsBarter—considerations Barter requires a double coincidence of

wants—each party to the exchange must want what the other has to trade.– This is often difficult to achieve, and decreases

the easy and efficiency of exchanges.– Therefore the transactions costs—the costs of

making an exchange—are high in barter exchanges.

– Money reduces the transactions costs because it does not require a double coincidence of wants.

In barter, the price of one good in terms of the other is called the relative price. It is the rate of exchange between the two goods.

Demand vs. Quantity Demand vs. Quantity DemandedDemanded

Demand is the amount of a product that people are willing and able to purchase at each possible price during a given period of time, everything else (but price) held constant. – It is a relationship between prices and

quantities. The quantity demand is the amount of a

product that people are willing and able to purchase at one, specific price. – It is a quantity.

Law of DemandLaw of Demand Law of Demand: There is an inverse

relationship between the price of a good and the quantity consumers are willing and able to purchase during a particular period of time.– As price of a good rises, consumers buy

less.– Depicts the quantity-price relationship with

all else assumed to be constant. The determinants of demand are

factors other than price that influence demand: income, tastes, prices of related goods, expectations, and numbers of buyers.

Demand Schedule andDemand Schedule andDemand Curve for VideosDemand Curve for Videos

Price Quantity

$5 10

$4 20

$3 30

$2 40

$1 50

Changes in Demand and Changes in Demand and Quantity Demanded Quantity Demanded

Change in Quantity DemandedChange in Quantity Demanded - - movement along the same demand movement along the same demand curve in response to a price change.curve in response to a price change.– Results from a price changeResults from a price change

Change in DemandChange in Demand - shift in entire - shift in entire demand curve.demand curve.– Results from a change in a determinant Results from a change in a determinant

of demand (a ceteris paribus variable)of demand (a ceteris paribus variable)

Change in Demand vs. Change in Demand vs. Change in the Quantity Change in the Quantity

DemandedDemanded

Factors that Shift DemandFactors that Shift Demand Changes in Consumer IncomeChanges in Consumer Income

– Normal goodsNormal goods: goods for which demand increases as : goods for which demand increases as income increases.income increases.

– Inferior goodsInferior goods: goods for which demand decreases as : goods for which demand decreases as income increases.income increases.

Change in the Number of BuyersChange in the Number of Buyers Change in Price of Related GoodsChange in Price of Related Goods

– Substitute goodsSubstitute goods: goods that can be used in place of : goods that can be used in place of each other.each other.

– Complementary goodsComplementary goods: goods that are used together. : goods that are used together. Changes in ExpectationsChanges in Expectations Demographic ChangesDemographic Changes Changes in Consumer Tastes and PreferencesChanges in Consumer Tastes and Preferences

Supply and Quantity Supply and Quantity SuppliedSupplied

SupplySupply is the amount of a good or is the amount of a good or service that producers are willing and service that producers are willing and able to offer for sale at each possible able to offer for sale at each possible price during a period of time, all else price during a period of time, all else constant.constant.– It is a price-quantity relationship.It is a price-quantity relationship.

The The quantity suppliedquantity supplied is the amount is the amount sellers are willing and able to offer sellers are willing and able to offer for sale during a period of time at a for sale during a period of time at a specific price, all else constant.specific price, all else constant.

Law of SupplyLaw of Supply

Law of SupplyLaw of Supply - there is a positive - there is a positive relationship between the price of a relationship between the price of a product and the amount of it that will be product and the amount of it that will be supplied.supplied.– As the price of a product rises, producers will As the price of a product rises, producers will

be willing to supply more. be willing to supply more. – The height of the supply curve at any quantity The height of the supply curve at any quantity

shows the shows the minimum priceminimum price necessary to induce necessary to induce producers producers to supplyto supply that next unit to market.that next unit to market.

– The height of the supply curve at any quantity The height of the supply curve at any quantity also shows the also shows the opportunity cost ofopportunity cost of producingproducing the the next unitnext unit of the good.of the good.

Supply Curve for VideosSupply Curve for Videos

Changes in SupplyChanges in Supply

Change in Quantity SuppliedChange in Quantity Supplied - - movement along the same supply movement along the same supply curve in response to a price change.curve in response to a price change.– Results from a change in price Results from a change in price

Change in SupplyChange in Supply - shift in entire - shift in entire supply curve.supply curve.– Results from a change in some other Results from a change in some other

variables besides price, results from a variables besides price, results from a change in a cet. par. variablechange in a cet. par. variable

Change in Supply vs. Change in Supply vs. a Change in the Quantity a Change in the Quantity

SuppliedSupplied

Factors that Shift SupplyFactors that Shift Supply

Changes in Resource PricesChanges in Resource Prices Change in Technology and Change in Technology and

ProductivityProductivity Expectations of ProducersExpectations of Producers Number of ProducersNumber of Producers Prices of Related Goods or ServicesPrices of Related Goods or Services

Decrease in SupplyDecrease in Supply

Increase in SupplyIncrease in Supply

EquilibriumEquilibrium

EquilibriumEquilibrium is the price and quantity at is the price and quantity at which the quantity supplied and the which the quantity supplied and the quantity demanded are equal.quantity demanded are equal.

A market is said to be in A market is said to be in disequilibriumdisequilibrium at at all points at which the quantities all points at which the quantities demanded and supplied are not equal.demanded and supplied are not equal.– A A surplussurplus occurs whenever S>D. occurs whenever S>D.– A A shortageshortage occurs whenever D>S. occurs whenever D>S.– Surpluses and shortages can be resolved with Surpluses and shortages can be resolved with

price changes.price changes.

Equilibrium (Table)Equilibrium (Table)

PricePrice

Per VideoPer VideoQuantity Quantity DemandedDemanded

Quantity Quantity SuppliedSupplied

StatusStatus Price ChangePrice Change

$5$5 3030 102102 SurplusSurplus Price FallsPrice Falls

$4$4 4848 8484 SurplusSurplus Price FallsPrice Falls

$3$3 6666 6666 EQUILIBRIUMEQUILIBRIUM No ChangeNo Change

$2$2 8484 4848 ShortageShortage Price RisesPrice Rises

$1$1 102102 3030 ShortageShortage Price RisesPrice Rises

Equilibrium (Graph)Equilibrium (Graph)

The Effects of a Shift of The Effects of a Shift of the Demand Curvethe Demand Curve

The Effects of a Shift of The Effects of a Shift of the Supply Curvethe Supply Curve

Price Floors and CeilingsPrice Floors and Ceilings

Price FloorPrice Floor: price is not allowed to decrease : price is not allowed to decrease below a certain level. Examples: minimum below a certain level. Examples: minimum wage, agricultural price supports.wage, agricultural price supports.– If the floor is above the equilibrium price, then If the floor is above the equilibrium price, then

it results in a surplus.it results in a surplus.– In the labor market, a “surplus” means In the labor market, a “surplus” means

unemployment. But how much? unemployment. But how much? Price Ceiling:Price Ceiling: price is not allowed to price is not allowed to

increase above a certain level. Example: increase above a certain level. Example: rent controls.rent controls.– If the ceiling is below the equilibrium price, then If the ceiling is below the equilibrium price, then

it results in a shortage.it results in a shortage.

A Price FloorA Price Floor

Figure 12: Rent ControlsFigure 12: Rent Controls