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Chapter 2Market Forces: Demand and Supply Copyright 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.Chapter OutlineDemandFactors that change quantity demanded and factors that change demand The demand functionConsumer surplusSupplyFactors that change quantity supplied and factors that change supplyThe supply functionProducer surplusMarket equilibriumPrice restrictions and market equilibriumPrice ceilingsPrice floorsComparative staticsChanges in demandChanges in supplySimultaneous shifts in supply and demand2-2Chapter Overview2Market demand curveIllustrates the relationship between the total quantity and price per unit of a good all consumers are willing and able to purchase, holding other variables constant. Law of demandThe quantity of a good consumers are willing and able to purchase increases (decreases) as the price falls (rises).

2-3DemandDemand3Market Demand Curve2-4Quantity(thousands per year)Price ($)Demand$400$30$202040$106080DemandChanging only price leads to changes in quantity demanded.This type of change is graphically represented by a movement along a given demand curve, holding other factors that impact demand constant.Changing factors other than price lead to changes in demand.These types of changes are graphically represented by a shift of the entire demand curve.2-5DemandChanges in Quantity DemandedChanges in Demand2-6Quantity0PriceD1Increase in demandDemandABD0D2Decrease in demandDemand ShiftersIncomeNormal goodInferior goodPrices of related goodsSubstitute goodsComplement goodsAdvertising and consumer tastesInformative advertisingPersuasive advertisingPopulationConsumer expectationsOther factors 2-7DemandAdvertising and the Demand for Clothing2-8Quantity of high-style clothing0$50$4050,000Price of high-style clothingD260,000Due to an increase in advertisingDemandD1The demand function for good X is a mathematical representation describing how many units will be purchased at different prices for good X, different prices of a related good Y, different levels of income, and other factors that affect the demand for good X.

2-9DemandThe Demand Function2-10DemandThe Linear Demand Function2-11DemandUnderstanding the Linear Demand Function2-12DemandThe Linear Demand Function in ActionInverse Demand Function2-13DemandGraphing the Inverse Demand Function in Action2-14QuantityPrice$2,02006,060DemandMarketing strategies like value pricing and price discrimination rely on understanding consumer value for products. Total consumer value is the sum of the maximum amount a consumer is willing to pay at different quantities.Total expenditure is the per-unit market price times the number of units consumed.Consumer surplus is the extra value that consumers derive from a good but do not pay for.2-15Consumer SurplusDemandQuantity in litersPrice per literDemand$50$3$212$1452-16Total Consumer Value:0.5($5 - $3)x2+(3-0)(2-0) = $8Expenditures: $(3-0) x (2-0) = $6 Consumer Surplus: 0.5($5 - $3)x(2-0) = $2DemandMarket Demand and Consumer Surplus in Action$43Consumer Surplus16Market supply curve Summarizes the relationship between the total quantity all producers are willing and able to produce at alternative prices, holding other factors affecting supply constant.Law of supplyAs the price of a good rises (falls), the quantity supplied of the good rises (falls), holding other factors affecting supply constant.2-17SupplySupplyChanging only price leads to changes in quantity supplied.This type of change is graphically represented by a movement along a given supply curve, holding other factors that impact supply constant.Changing factors other than price lead to changes in supply.These types of changes are graphically represented by a shift of the entire supply curve.2-18SupplyChanges in Quantity Supplied2-19Change in Supply in ActionQuantityPriceS20Decrease in supplySupplyABS0S1Increase in supplyInput pricesTechnology or government regulationNumber of firmsEntryExitSubstitutes in productionTaxesExcise taxAd valorem taxProducer expectations2-20SupplySupply Shifters2-21Change in Supply in ActionQuantity of gasoline per weekPrice of gasoline0t = per unit tax of 20SupplyS0S0+tt = 20$1.20$1.00t Excise tax2-22Change in Supply in ActionQuantity of backpacks per weekPrice of backpacks0SupplyS0S1 = 1.20 x S0$24$10Ad valorem tax$121,100$202,450The Supply FunctionThe supply function for good X is a mathematical representation describing how many units will be produced at different prices for X, different prices of inputs W, prices of technologically related goods, and other factors that affect the supply for good X.2-23SupplyThe Linear Supply Function2-24Supply2-25SupplyUnderstanding the Linear Supply Function2-26SupplyThe Linear Supply Function in ActionInverse Supply Function2-27SupplyThe amount producers receive in excess of the amount necessary to induce them to produce the good.2-28SupplyProducer Surplus2-29Producer Surplus in ActionQuantityPriceSupply$4000800SupplyProducer surplus29Competitive market equilibriumPrice of a good is determined by the interactions of the market demand and market supply for the good.A price and quantity such that there is no shortage or surplus in the market.Forces that drive market demand and market supply are balanced, and there is no pressure on prices or quantities to change.2-30Market EquilibriumMarket Equilibrium2-31QuantityPriceSupply0DemandSurplus ShortageMarket EquilibriumMarket Equilibrium I2-32Market Equilibrium IIMarket EquilibriumIn a competitive market equilibrium, price and quantity freely adjust to the forces of demand and supply.Sometimes the government restricts how much prices are permitted to rise or fall. Price ceilingPrice floor2-33Price Restrictions and Market EquilibriumPrice Restrictions2-34QuantityPriceSupply0DemandShortagePriceceilingNonpecuniary priceLost social welfarePrice Restrictions and Market EquilibriumPrice Ceiling in Action I2-35Price Restrictions and Market EquilibriumPrice Ceiling in Action II2-36QuantityPriceSupply0DemandSurplusPricefloorPrice Restrictions and Market EquilibriumPrice Floor in Action ICost of purchasing excess supply2-37Price Restrictions and Market EquilibriumPrice Floor in Action IIComparative static analysisThe study of the movement from one equilibrium to another.Competitive markets, operating free of price restraints, will be analyzed when:Demand changes;Supply changes;Demand and supply simultaneously change.2-38Comparative StaticsComparative StaticsIncrease in demand onlyIncrease equilibrium priceIncrease equilibrium quantityDecrease in demand onlyDecrease equilibrium priceDecrease equilibrium quantityExample of change in demand Suppose that consumer incomes are projected to increase 2.5% and the number of individuals over 25 years of age will reach an all time high by the end of next year. What is the impact on the rental car market?2-39Changes in DemandComparative Statics2-40Change in Demand in ActionQuantity (thousands rented per day)PriceSupply0$45104Demand for Rental CarsDemand1$49Demand0100Comparative Statics108Increase in supply onlyDecrease equilibrium priceIncrease equilibrium quantityDecrease in supply onlyIncrease equilibrium priceDecrease equilibrium quantityExample of change in supplySuppose that a bill before Congress would require all employers to provide health care to their workers. What is the impact on retail markets?2-41Changes in SupplyComparative Statics2-42QuantityPriceSupply00DemandSupply1Comparative StaticsChange in Supply in ActionSuppose that simultaneously the following events occur:an earthquake hit Kobe, Japan and decreased the supply of fermented rice used to make sake wine.the stress caused by the earthquake led many to increase their demand for sake, and other alcoholic beverages. What is the combined impact on Japans sake market?2-43Comparative StaticsSimultaneous Shifts in Supply and Demand2-44QuantityPriceSupply00Demand1Supply1Demand0Comparative StaticsSimultaneous Shifts in Supply and Demand in ActionJapans Sake MarketSupply2ABCDemand and supply analysis is useful forClarifying the big picture (the general impact of a current event on equilibrium prices and quantities).Organizing an action plan (needed changes in production, inventories, raw materials, human resources, marketing plans, etc.).2-45ConclusionMarket Demand Curve2-46Quantity(Millions of Barrels)Price(Dollars per Barrel)Demandoil$1400$100$6080160$20240280International Oil MarketDemandChanges in Quantity Demanded2-47International Oil MarketQuantity(Millions of Barrels)Demandoil$1400$100$9080100280Price(Dollars per Barrel)Increase in quantity demandedDemandChange in Demand2-48International Oil MarketQuantity(Millions of Barrels)Demandoil1$1400$100$9080100280Price(Dollars per Barrel)Demandoil2120140Increase in demand$160Demand2-49Quantity(Millions of Barrels)Price(Dollars per Barrel)Supplyoil0$65$608090$20International Oil MarketIncrease in quantity suppliedSupplyChange in Quantity Supplied2-50Quantity(Millions of Barrels)Price(Dollars per Barrel)Supplyoil$1400$100$6080160$20240International Oil MarketSupplyThe Market Supply Curve2-51Change in Supply in ActionQuantity(Millions of Barrels)Price(Dollars per Barrel)Supplyoil1$1400$100180$20240International Oil MarketSupplyoil2100160$50Decrease in supplySupply2-52Quantity(Millions of Barrels)Price(Dollars per Barrel)Supplyoil$1400$120$4040Qe = 120$20200280International Oil MarketDemandoilSurplus 160 million barrelsForces of demand and supply put downward pressure on price.Shortage160 million barrelsForces of demand and supply put upward pressure on price.Pe = $80Competitive market equilibriumQd(Pe) = Qs(Pe)Market EquilibriumCompetitive Market Equilibrium I2-53Quantity(Millions of Barrels)Price(Dollars per Barrel)Supplyoil$1400Pf = $120Pc = $4040Qe = 120$20200280International Oil MarketDemandoilShortage160 million barrelsPe = $80Competitive market equilibriumQd(Pe) = Qs(Pe)PriceceilingNonpecuniary priceLost social welfarePrice Restrictions and Market EquilibriumPrice Ceiling in Action IIncrease in demand onlyIncrease equilibrium priceIncrease equilibrium quantityDecrease in demand onlyDecrease equilibrium priceDecrease equilibrium quantityExample of change in demand Suppose that worldwide demand for automobiles is projected to decrease by 30% next year. What is the impact on the international crude oil market?2-54Changes in DemandComparative Statics2-55Change in Demand in ActionQuantity(Millions of Barrels)Price(Dollars per Barrel)Supplyoil$1400Pe2 = $54Qe1 = 120$20280International Oil MarketDemandoil1Pe1 = $80Demandoil2Qe2 = 68Comparative Statics55Increase in supply onlyDecrease equilibrium priceIncrease equilibrium quantityDecrease in supply onlyIncrease equilibrium priceDecrease equilibrium quantityExample of change in supplySuppose that war breaks out in a major oil-producing country in the Middle East. What is the impact on the international crude oil market?2-56Changes in SupplyComparative Statics2-57Quantity(Millions of Barrels)Price(Dollars per Barrel)Supplyoil1$1400Qe1 = 120$20280International Oil MarketDemandoilPe1 = $80Supplyoil2Pe2 = $100Qe2 = 80Comparative StaticsChange in Supply in ActionSuppose that simultaneously the following two events occur:worldwide demand for automobiles is projected to decrease by 30% next year. war breaks out in a major oil-producing country in the Middle East. What is the combined impact on the international crude oil market?2-58Comparative StaticsSimultaneous Shifts in Supply and Demand2-59Quantity(Millions of Barrels)Price(Dollars per Barrel)Supplyoil1$140Pe2 = $65Qe2 = 10Qe1 = 120$20280International Oil MarketDemandoil1Pe1 = $80Supplyoil2Demandoil2The equilibrium price increases or decreases depending on themagnitude of the demand and supply changes.Comparative StaticsSimultaneous Shifts in Supply and Demand in Action