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Chapter 03:Supply and Demand

  Copyright © 2013 by The McGraw-Hill Companies, Inc !ll rights reser"e# McGraw-Hill$Irwin

13e

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Supply and Demand

•  The neat thing about gasoline prices isthat great big board outside the station

that allows you to keep constant trackof how the price of gas changes. – … or it may be a huge source of

aggravation to you.

•

Why do gasoline prices uctuate somuch?

• What causes its price to rise? … to fall?

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Supply and Demand

•  The goal of this chapter is to eplainhow supply and demand really work.

 – What determines the price of a good orservice?

 – !ow does the price of a product a"ect its

production and consumption? – Why do prices and production levels

often change?

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#earning $b%ectives

• &'(&). *now the nature anddeterminants of market demand.

• &'(&+. *now the nature anddeterminants of market supply.

• &'(&'. *now how market prices areestablished.

•

&'(&,. *now what causes market pricesto change.• &'(&-. *now how government price

controls a"ect market outcomes.

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arket /articipants

• 0ll participants1 for the most part1 are tryingto obtain the maimum return from the scarceresources they have.

 – Consumers: maimi2e the utility 3satisfaction ofunmet wants4 they can get from available incomes.

 – Businesses: maimi2e pro5ts by selling goodsthat satisfy while keeping costs low.

 – Government: maimi2e the general welfare ofsociety.

•  These motives eplain most market activity.

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Speciali2ation and Trade

• ost of us cannot produce everythingwe want to consume. – Time1 talent1 and resource constraints.

• We should speciali2e and produce whatwe can at a lower opportunity cost thanothers.

• /roduce more than we need for

ourselves and ... – … trade the ecess for the goods we want

to consume 3which are produced by otherspecialists4.

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0pplication6 7nternational

 Trade•  This logic applies to international trade.

 – We speciali2e in production in which we havea lower opportunity cost and sell the ecess

to other countries. – $ther countries speciali2e in production in

which they have a lower opportunity cost andsell the ecess to us.

• 8ecause of this1 both nations are able toconsume more than if they had toproduce everything for themselves.

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 The 9ircular :low

•  There are two markets and fourparticipants6

•

9onsumers6  – They are owners of factors of production

3e.g.1 labor4 who supply them to business5rms in the factor market and earn

income. – They purchase goods and services in the

product market.

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 The 9ircular :low

• 8usiness 5rms6 they produce goods andservices for the product market using thefactors of production they bought from their

owners in the factor market.• ;overnments6 they ac

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 The 9ircular :low

International

participants

Consumers

International

participants

Business

FirmsGovernments

Product

markets

Factor 

markets

Goods and servicessupplied

Factors ofproduction supplied

Goods and servicesdemanded

Factors ofproduction demanded

Exports

Imports

Imports

Exports

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#ocating arkets

• 0 market eists wherever anechange 3transaction4 takes place.

•

=very market transaction involves anechange of dollars for goods andservice 3in product markets4 orresources 3in factor markets4. – 7n the circular ow1 goods and services or

resources ow one way1 and dollars owthe opposite way.

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=ercise

• Write down a product market inwhich you participated recently.

 – Were you a buyer or seller?

• Write down a factor market in whichyou participated recently.

 – Were you a buyer or seller?

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Supply and Demand

• Supply: the ability and willingness to sell speci5c

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 The #aw of Demand

• Law of demand: the

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7ndividual Demand and arket

Demand• =ach of us has a demand for a good or a

service if we are willing and able to pay for

it.•  The amount we buy depends on its price.

 – 7f the price goes up1 we buy less.

 – 7f the price goes down1 we buy more.

• arket demand is the collectivesummation of all buyers individualdemands.

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Demand Schedule and

9urve

! " # $0$$!$"$#0%uantity

&ri'e

()0

!)

!0

3)30

)

0

$)

$0)

0

 A

B

C

D

E

F

G

H

I

:ig '.+

&ri'e%uantity

Demanded

@-& )

  ,- +

  ,& '

  '- -

  '& A

  +- B

  +& )+

  )- )-

  )& +&

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:actors That Set Demand 8ehavior

3Determinants of Demand4•  Tastes.

• 7ncome.

• =pectations.• $ther goods6

 – Substitutes.

 – 9omplements.

• Cumber of buyers.

• 7f any of these factorschange1 demandbehavior changes.

• 0 demand behaviorchange is shown byshifting the demandcurve.

 – 7ncrease in demand6shift the curve right.

 – Decrease in demand6shift the curve left.

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9hanging Demand

3Shifting the Demand 9urve4• Demand increases 3shifts right4 when

 – Taste for the good increases.

 –

7ncome increases. – /rice of a substitute rises.

 – /rice of a complement falls.

 – :uture prices are epected to rise.

 – Cumber of buyers increases.

• ice versa1 and demand decreases 3shiftsleft4.

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ovements vs. Shifts

• Chan*e in +uantity demanded: movement along a demand curve in

response to a change in price.• Chan*e in demand: a shift of the

demand curve due to a change in

one or more of the determinants ofdemand.

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ovements vs. Shifts&ri'e

!0

3)

30)

0

$)

$0

)0

(!)

! " # $0 $ $! $" $# 0 %uantity

D1Initial demand

d 1

,ovementalon* 'urve

g1

Shift indemand

D2 In'reaseddemand

d 2

ovement along the curve6 buyers behavior does not changeE buyers only react to aprice change.Shift the curve6 buyers behavior does change.

:ig '.'

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#aw of Supply

• Law of supply: the

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Supply Schedule and 9urve

/

>s&

)&

+&

-&

,&

'&

- )& )- +&

S&ri'e%uantitySupplied

-%s.

@-& +&

  ,& )-

  '& )&

  +& -

  )& )

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:actors that Set Supply 8ehavior

3Determinants of Supply4

•  Technology

• :actor 9osts.

•  Taes andsubsidies.

• =pectations.

• $ther goods.

• Cumber of sellers.

• 7f any of these factorschange1 supply

behavior changes.•  This type of change is

shown by shifting thesupply curve. –

7ncrease in supply6 shiftthe curve right.

 – Decrease in supply6shift the curve left.

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9hanging Supply

3Shifting the Supply 9urve4• Supply increases 3shifts right4 when

 – Cew technology lowers operating costs.

 – :actor costs decrease. – Taes decrease or subsidies increase.

 – :uture prices are epected to rise.

 – /rice of alternative goods fall.

 – Cumber of sellers increases.

• ice versa1 and supply decreases 3shiftsleft4.

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ovements vs. Shifts

• Chan*e in +uantity supplied: movement along the supply curve

due to a change in price.• Chan*e in supply: a shift in the

supply curve due to one or more

changes in the determinants ofsupply.

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ovements vs. Shifts

/

>s

7nitial supply 7ncreasedsupply

/)

/+

ovementalong curve

Shift insupply

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7ndividual Supply and arket

Supply• =ach producer is willing and able to produce

a good or service if he or she can make apro5t.

•  The amount produced depends on its price. – 7f the price goes up1 more will be produced.

 – 7f the price goes down1 less will be produced.

• arket supply is the collective summation ofall producers individual supplies.

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/utting a arket Together

•  The interaction of buyersand sellers makes amarket.

• E+uili/rium: only one

price and

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=d F >s F >e.

•  The price will notchange until there is ashift in demand or insupply.

D

S&

%

&e

%e

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=

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Jesolving a arket Surplus• ,aret surplus: the

amount by which s4 eceedsd4

at a given priceE ecesssupply.

• /rice is too high.

• >s K >d1 a surplus.

• 8uyer and seller

behaviors kick in.

• /rice will fall toe

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Jesolving a arket Shortage• ,aret shorta*e: The

amount by whichd4eceeds s4 at a givenpriceE ecess demand.

• /rice is too low.

• >s L >d1 a shortage.

•

8uyer and sellerbehaviors kick in.

• /rice will rise toe

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What 9auses the /rice to

9hange?• /rice changes when e

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Demand 7ncreases• 8uyers behavior

changes.

 – Demand shifts right.

• $ld e) to

>+.

D$

S&

%

&$

%$

DShorta*e

&

%

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Demand Decreases• 8uyers behavior

changes.

 – Demand shifts left.

• $ld e) to

>+

D$

S&

%

&$

%$

D

Surplus

&

%

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Supply 7ncreases

• Sellers behavior changes.

 – Supply shifts right.

• $ld e) to>+.

D

S$&

%

&$

%$

S

Surplus

&

%

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Supply Decreases

• Sellers behavior changes.

 – Supply shifts left.

• $ld e) to>+.

D

S$&

%

&$

%$

S

Shorta*e

&

%

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Summary6 When Do /rices

9hange?• $nly when a market is in dise

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=ercise

• 7f income increases1 demand shiftsand the price will

• 7f tastes decrease1 demand shifts

and the price will• 7f cost of inputs rise1 supply shifts

and the price will

• 7f the number of sellers increase1supply shifts and the pricewill

right

fall

left

rise

right fall

rise

left

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arket $utcomes

•  The market mechanism a"ects W!0T1!$W1 and :$J W!$ to produce.

 –

1245 arkets determine which goods aredesired and which are pro5table.

 – 2615 /ro5t(seeking producers will strive toproduce goods in the most eNcient way.

 –

768 126,5 To obtain a good1 one must beboth willing and able to purchase it.

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/rice 9ontrols

• ;overnments may impose anarbitrary maimum price 3price

ceiling4 or a minimum price 3priceoor4 on a market.

 – The result is that the market cannot

reach e

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/rice 9eiling• ;overnment imposes

a maimum price lessthan /e.

•  This generates a

shortage 3>d K >s4.

•  The marketmechanism cannotclear the market.

• 0 permanent shortageeists.

D

S&

%

&e

%e

&ri'e'eilin*

%s %d

Shorta*e

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/rice :loor• ;overnment imposes a

minimum price greaterthan /e.

•  This generates a

surplus 3>s K >d4.•  The market

mechanism cannotclear the market.

•

0 permanent surpluseists.

D

S&

%

&e

%e

&ri'e9oor

%d %s

Surplus

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 The =conomy Tomorrow

•  There is an organ transplant market. – The supply of organs is limited by the number

of people willing to provide an organ to

transplant.• arket incentives could increase the

number of organs available. – 9ongress bans the purchase or sale of organs. –

$rgans are supplied at a price ceiling of @&. – This generates a shortage of organs. – 7ncrease the price1 and the

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Jevisiting the #earning

$b%ectives• &'(&). *now the nature and

determinants of market demand.

 – 0 product has a market demand ifpeople are willing and able to buy it atsome price in the market.

 –

7ts determinants are taste1 income1epectations1 other goods1 and numberof buyers.

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Jevisiting the #earning

$b%ectives• &'(&+. *now the nature and

determinants of market supply.

 – 0 product has a market supply ifbusinesses are willing and able to produceand sell it at some price in the market.

 – 7ts determinants are technology1 factorcosts1 taes and subsidies1 epectations1other goods1 and number of sellers.

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Jevisiting the #earning

$b%ectives• &'(&'. *now how market prices are

established.

 – Demand behavior and supply behaviorinteract in a market. 0t e

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Jevisiting the #earning

$b%ectives• &'(&,. *now what causes market

prices to change.

 – 0 change in demand behavior or achange in supply behavior will upsete

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Jevisiting the #earning

$b%ectives• &'(&-. *now how government price

controls a"ect market outcomes.

 – 0 price ceiling imposed by governmentresults in permanent shortages.

 – 0 price oor imposed by government

results in permanent surpluses.