copyright © 2004 south-western mods 5-6-7 the market forces of supply and demand

Copyright © 2004 South-Western

Mods Mods 5-6-75-6-7The Market Forces of

Supply and Demand


Teach a parrot to say “supply and demand” and you have an economist!

• Supply and demand are the two words that economists use most often.

• Supply and demand are the forces that make market economies work.

• Modern microeconomics is about supply, demand, and market equilibrium.


• A market is a group of buyers and sellers of a particular good or service.

• The terms supply and demand refer to the behavior of people . . . as they interact with one another in markets.

MARKETS AND COMPETITION


MARKETS AND COMPETITION

• Buyers—Consumers—Households—determine demand

• Sellers—Producers—Suppliers—determine supply


Competitive Markets

• A competitive market is a market in which there are many buyers and sellers so that each has a negligible impact on the market price.


The Law of Clowns


DEMAND

• Law of Demand• The law of demand states that, other things equal,

the quantity demanded of a good falls when the price of the good rises.

• Quantity demanded is the amount of a good that buyers are willing and able to purchase.


The Demand Schedule

• Demand Schedule • The demand schedule is a table that shows the

relationship between the price of the good and the quantity demanded.


Catherine’s Demand Schedule


The Demand Curve

• Demand Curve • The demand curve is a graph of the relationship

between the price of a good and the quantity demanded.

Catherine’s Demand Schedule and Demand Curve


Price ofIce-Cream Cone

0

2.50

2.00

1.50

1.00

0.50

1 2 3 4 5 6 7 8 9 10 11 Quantity ofIce-Cream Cones

$3.00

12

1. A decrease in price ...

2. ... increases quantity of cones demanded.


Individual Demand Market Demand

• Graphically, individual demand curves are summed horizontally to obtain the market demand curve.

• Market demand refers to the sum of all individual demands for a particular good or service.


Changes to the Demand Curve

• Change in Quantity Demanded• Movement along the demand curve.• Caused by a change in the price of the product.


0

D

Price of Ice-Cream Cones

Quantity of Ice-Cream Cones

A tax that raises the price of ice-cream cones results in a

movement along the demand curve.

A

B

8

1.00

$2.00

4

Changes in Quantity Demanded


Changes to the Demand Curve

• Change in Demand• A shift in the demand curve, either to the left or

right.• Caused by any change that alters the quantity

demanded at every price.

Figure 3 Shifts in the Demand Curve

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Price ofIce-Cream

Cone

Quantity ofIce-Cream Cones

Increasein demand

Decreasein demand

Demand curve, D3

Demandcurve, D1

Demandcurve, D2

0


Shifts in the Demand Curve—Determinants of Demand

•Tastes

•Related substitutes & Complements

•Income of Buyers

•Buyer #’s

•Expectations



T—Changes in Tastes or Preferences• New information• New fad or trend

•Can shift demand to increase or decrease



R—Prices of Related Goods• When an increase in the price of one good leads to

an increase in the demand for another, the two goods are called substitutes.

• When an increase in the price of one good leads to a decrease in the demand for the other, the two goods are called complements.



I—Changes in Consumer Income• As income increases, the demand for a normal good

will increase.• As income increases, the demand for an inferior

good will decrease.


$3.002.50

2.001.501.00

0.50

21 3 4 5 6 7 8 9 10 1211

Price of Ice-Cream Cone

Quantity of Ice-Cream Cones

0

Increasein demand

An increase in income...

D1

D2

Consumer IncomeNormal Good


$3.002.50

2.001.501.00

0.50

21 3 4 5 6 7 8 9 10 1211

Price of Hamburger

Quantity of Hamburger

0

Decreasein demand

An increase in income...

D1D2

Consumer IncomeInferior Good



B—Change in number of Buyers• Increases or decreases in consumer population




E—Change in Consumer Expectations• Information that allows consumers to predict price

increases or decreases in the future will change their demand today


Demand Variables That Influence Buyers

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Variable A Change in This Variable…

Price changes Movement ALONG the demand curve

Tastes Shifts the demand curve

Related Goods Shifts the demand curve

Income Shifts the demand curve

Buyers—numbers changing Shifts the demand curve

Expectations Shifts the demand curve


SUPPLY

• Law of Supply• The law of supply states that, other things equal,

the quantity supplied of a good rises when the price of the good rises.

• Quantity supplied is the amount of a good that sellers are willing and able to sell.


The Supply Schedule

• Supply Schedule• The supply schedule is a table that shows the

relationship between the price of the good and the quantity supplied.


Ben’s Supply Schedule

Supplied


The Supply Curve

• Supply Curve• The supply curve is the graph of the relationship

between the price of a good and the quantity supplied.

Ben’s Supply Schedule and Supply Curve


Price ofIce-Cream

Cone

0

2.50

2.00

1.50

1.00

1 2 3 4 5 6 7 8 9 10 11 Quantity ofIce-Cream Cones

$3.00

12

0.50

1. Anincrease in price ...

2. ... increases quantity of cones supplied.

Supplied


Individual Supply Market Supply

• Graphically, individual supply curves are summed horizontally to obtain the market supply curve.

• Market supply refers to the sum of all individual supplies for all sellers of a particular good or service.


Changes in the Supply Curve

• Change in Quantity Supplied• Movement along the supply curve.• Caused by a change in the quantity supplied due to

price


1 5

Price of Ice-Cream Cone

Quantity of Ice-Cream Cones0

S

1.00A

C$3.00 A rise in the price

of ice cream cones results in a movement along the supply curve.

Change in Quantity Supplied


Changes in the Supply Curve

• Change in Supply• A shift in the supply curve, either to the left or

right. • Caused by a change in a determinant other than

price.

Shifts in the Supply Curve


Price ofIce-Cream

Cone

Quantity ofIce-Cream Cones

0

Increasein supply

Decreasein supply

Supply curve, S3

curve, Supply

S1Supply

curve, S2


Shifts in the Supply Curve—Determinants of Supply

•Technology

•Related prices of substitutes & complements in production

•Input Prices

•Competition

•Expectations



T—Changes in Technology• New technology applied to an industry• Will shift supply to increase



R—Prices of Related Goods or Services Produced

• When an increase in the price of one good leads to an increase in the supply of another, the two goods are called substitutes.

• When an increase in the price of one good leads to a decrease in the supply of another, the two goods are called complements.



I—Changes in Input Prices• When an increase in the price of inputs or factors of

production occur, a shift in supply will occur• If an input or resource increases in price, supply

will decrease• If an input or resource decreases in price, supply

will increase



C—Change in number of Competitors

•Increases or decreases in suppliers

•Can shift supply to increase or decrease



E—Change in Producer Expectations

•Information that allows suppliers to predict price increases or decreases in the future

•Can shift supply to increase or decrease

Supply Variables That Influence Producers


Variable A Change in This Variable…

Price changes Movement ALONG the supply curve

Technology Shifts the supply curve

Related Goods Produced Shifts the supply curve

Input Prices Shifts the supply curve

Competitors—numbers changing

Shifts the supply curve

Expectations (of Suppliers) Shifts the supply curve


SUPPLY AND DEMAND TOGETHER

• Equilibrium refers to a situation in which the price has reached the level where quantity supplied equals quantity demanded.



• Equilibrium Price• The price that balances quantity supplied and

quantity demanded. • On a graph, it is the price at which the supply and

demand curves intersect.

• Equilibrium Quantity• The quantity supplied and the quantity demanded at

the equilibrium price. • On a graph it is the quantity at which the supply and

demand curves intersect.


At $2.00, the quantity demanded is equal to the quantity supplied!


Demand Schedule

Supply Schedule

The Equilibrium of Supply and Demand


Price ofIce-Cream

Cone

0 1 2 3 4 5 6 7 8 9 10 11 12Quantity of Ice-Cream Cones

13

Equilibriumquantity

Equilibrium price Equilibrium

Supply

Demand

$2.00

Markets Not in Equilibrium


Price ofIce-Cream

Cone

0

Supply

Demand

Excess Supply

Quantitydemanded

Quantitysupplied

Surplus

Quantity ofIce-Cream

Cones

4

$2.50

10

2.00

7


Equilibrium

• Surplus• When price > equilibrium price, then quantity

supplied > quantity demanded. • There is excess supply or a surplus.

• Suppliers will lower the price to increase sales, thereby moving toward equilibrium.

Markets Not in Equilibrium


Price ofIce-Cream

Cone

0 Quantity ofIce-Cream

Cones

Supply

Demand

Excess Demand

Quantitysupplied

Quantitydemanded

1.50

10

$2.00

74

Shortage


Equilibrium

• Shortage• When price < equilibrium price, then quantity

demanded > the quantity supplied. • There is excess demand or a shortage.

• Suppliers will raise the price due to too many buyers chasing too few goods, thereby moving toward equilibrium.


Equilibrium

• Law of supply and demand• The claim that the price of any good adjusts to bring

the quantity supplied and the quantity demanded for that good into balance.

How an Increase in Demand Affects the Equilibrium


Price ofIce-Cream

Cone

0 Quantity of Ice-Cream Cones

Supply

Initialequilibrium

D

D

3. . . . and a higherquantity sold.

2. . . . resultingin a higherprice . . .

1. Hot weather increasesthe demand for ice cream . . .

2.00

7

New equilibrium$2.50

10

How a Decrease in Supply Affects the Equilibrium


Price ofIce-Cream

Cone

0 Quantity of Ice-Cream Cones

Demand

Newequilibrium

Initial equilibrium

S1

S2

2. . . . resultingin a higherprice of icecream . . .

1. An increase in theprice of sugar reducesthe supply of ice cream. . .

3. . . . and a lowerquantity sold.

2.00

7

$2.50

4


Three Steps to Analyzing Changes in Equilibrium

1. Ask yourself: Does this event shift the supply or demand curve—which Determinant (TRIBE or TRICE) is at play?

2. Ask yourself: Which direction would the curve shift—to the left or to the right?

3. Draw the supply and demand graphs to see how the shift affects equilibrium price and quantity.


Summary: Movements along Curves vs. Shifts in Curves

• A movement along a fixed demand curve is called a change in quantity demanded. That movement is

a response to price changes.• A shift in the demand curve is called a change in demand. That shift is a response to

Determinants (TRIBE).• A movement along a fixed supply curve is called a change in quantity supplied. That movement is a

response to price changes.• A shift in the supply curve is called a change in supply. That shift is a response to

Determinants (TRICE).

What Happens to Price and Quantity When Supply or Demand Shifts?


copyright © 2004 south-western mods 5-6-7 the market forces of supply and demand

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