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1 CHAPTER 4 Supply and Demand Teach a parrot the terms supply and demand and you ve got an economist. Thomas Carlyle McGraw-Hill/Irwin Copyright 2010 by the McGraw-Hill Companies, Inc. All rights reserved.

2 Demand The law of demand states that the quantity of a good demanded is inversely related to the good s price In other words: Quantity demanded rises as price falls Quantity demanded falls as price rises 4-2

3 Demand Demand refers to a schedule of quantities of a good that will be bought per unit of time at various prices McGraw-Hill/Irwin Colander, Economics 3

4 The Demand Curve P A demand curve is the graphic representation of the relationship between price and quantity demanded The demand curve is downward sloping D Q As price increases, quantity demanded decreases 4-4

5 Demand vs. Quantity Demanded Demand refers to the entire demand curve Quantity demanded tells us how much will be bought at a specific price 4-5

6 Demand vs. Quantity Demanded A change in price changes quantity demanded this refers to a movement along the demand curve A change in anything other than price that affects the demand curve changes the entire demand curve this causes a shift in demand (a new demand curve) McGraw-Hill/Irwin Colander, Economics 6

7 P Shifts in Demand vs. Movement Along a Demand Curve Movement along a demand curve \$12 \$8 B A A change in price causes a movement along the demand curve D 1 Q 4-7

8 Shift Factors in Demand 1. Consumer income: an increase in income leads to buying more normal goods and buying fewer inferior goods When consumer income increases, they demand more normal goods Examples: new car, LCD TV, etc. 4-8

9 Shift Factors in Demand When consumer income increases, they demand less inferior goods Examples: used books, off-brands, potatoes, corn, Dunkin Donuts coffee McGraw-Hill/Irwin Colander, Economics 9

10 Shift Factors in Demand 2. Market size/population: if the number of consumers increases, or decreases, it also affects the market size Example: a significant increase in population in the Southwest will increase demand for housing Example: A decrease in population in a city would decrease demand for housing McGraw-Hill/Irwin Colander, Economics 10

11 Shift Factors in Demand 3. Consumer tastes and preferences: when a good/service is popular, consumers demand more of it at all prices When the product becomes less popular, consumers demand less of it McGraw-Hill/Irwin Colander, Economics 11

12 Shift Factors in Demand Example: if turkey burgers become more popular because they are healthier, demand for turkey burgers will increase Example: if skateboarding becomes less popular, the demand for skateboards will decrease McGraw-Hill/Irwin Colander, Economics 12

13 Shift Factors in Demand 4. Consumer expectation of price: If consumers believe the price of a good will increase in the future, they consume it now If consumers believe the price of the good will be decrease in the future they will wait to consume it McGraw-Hill/Irwin Colander, Economics 13

14 Shift Factors in Demand Example: if you believe the price of a DVD will increase in the future, you will buy it now shifting demand to the right (an increase in demand) Example: if you believe the price of shoes will decrease in the future, you will buy them later shifting demand to the left (a decrease in demand) McGraw-Hill/Irwin Colander, Economics 14

15 Shift Factors in Demand 5. Substitute goods: goods and services that can be used in place of each other If the price of a substitute good drops, people will buy that good and not the original item McGraw-Hill/Irwin Colander, Economics 15

16 Shift Factors in Demand Example: the price of Kroger brand cereal drops so we consume that rather than the higher priced name brand The demand for Kroger cereal increases and the demand for name brand cereal decreases McGraw-Hill/Irwin Colander, Economics 16

17 Shift Factors in Demand 6. Complementary goods: goods that are used together An increase in the demand for one good increases the demand for the complementary good Example: an increase in the demand for hamburgers increases the demand for ketchup McGraw-Hill/Irwin Colander, Economics 17

18 Drawing the Graph: An Increase in Demand P S 1 P P 2 P 1 Q D 1 D 2 Q 1 Q 2 Q

19 Drawing the Graph: A Decrease in Demand P S 1 P P 1 P 2 Q D 2 D 1 Q 2 Q 1 Q

20 Individual and Market Demand Schedule/ Curves Price per DVD Alice s demand + Bruce s demand + Carmen s demand = Market demand \$ \$ \$ \$

21 Individual and Market Demand Curves P Market demand curve for DVDs per week \$4.00 The market demand curve is the summation of all individual demand curves \$3.00 \$2.00 Market demand for DVDs \$1.00 CARMEN BRUCE ALICE Q 4-21

22 Supply McGraw-Hill/Irwin Colander, Economics 22

23 Supply The law of supply states that the quantity of a good supplied is directly related to the good s price In other words: Quantity supplied rises as price rises Quantity supplied falls as price falls 4-23

24 Supply The law of supply occurs because: When prices rise, firms substitute production of one good for another Assuming firm s costs are constant, a higher price means higher profit McGraw-Hill/Irwin Colander, Economics 24

25 The Supply Curve A supply curve is the graphic representation of the relationship between price and quantity supplied P S The supply curve is upward sloping Q As price increases, quantity supplied increases 4-25

26 Shifts in Supply vs. Movement Along a Supply Curve Supply: schedule of quantities a seller is willing to sell at various prices Quantity supplied: specific amount that will be supplied at a specific price (a point on the supply curve) 4-26

27 Shifts in Supply vs. Movements Along a Supply Curve A change in price changes quantity supplied this is represented by the movement along the supply curve A change in anything other than price that affects the supply curve changes the entire supply curve this causes a shift in supply (a new supply curve) McGraw-Hill/Irwin Colander, Economics 27

28 P Shifts in Supply vs. Movement Along a Supply Curve Movement along a supply curve S A change in price causes a movement along the supply curve Q 4-28

29 Shift Factors in Supply 1. Input costs: the price of the resources used to make products If the price of an input increases, supply decreases If the price of an input decreases, supply increases Example: if the price of peanuts, an input in cereal bars, goes up, supply for cereal bars decreases 4-29

30 Shift Factors in Supply 2. Labor productivity: the amount of goods or services that a person can produce in a given time Specialized division of labor can allow more goods to be produced at a lower price Better-trained workers can produce more goods in less time Increased labor productivity results in an Colander, Economics 30 increase in supply

31 Shift Factors in Supply 3. Technology: applying innovations to production Increases in technology/more efficient ways of producing goods always increase supply McGraw-Hill/Irwin Colander, Economics 31

32 Shift Factors in Supply 4. Government action: can affect the costs of production positively and negatively Can be in the form of a tax or subsidy Taxes always decrease supply Example: An excise tax can be placed on goods to discourage the use of specific goods (such as alcohol and tobacco) McGraw-Hill/Irwin Colander, Economics 32

33 Shift Factors in Supply Governments can also use subsidies Subsides always increase supply Example: If the government subsidies the cost of vaccines it makes them less expensive and increases supply McGraw-Hill/Irwin Colander, Economics 33

34 Shift Factors in Supply 5. Producer expectation of price: based on if the producer expects the price of a product to rise or fall in the future If the producer expects the price to rise in the future, they will supply less now (this decreases supply) If the producer expects the price to be lower in the future, they will supply more now (this increases supply) McGraw-Hill/Irwin Colander, Economics 34

35 Shift Factors in Supply 6. Number of producers/suppliers: an increase in the number of producers means more competition An increase in the number of producers in a market increases supply If a supplier leaves the market this decreases supply McGraw-Hill/Irwin Colander, Economics 35

36 Drawing the Graph: An Increase in Supply P S 1 S 2 P P 1 P 2 Q D 1 Q 1 Q 2 Q

37 Drawing the Graph: A Decrease in Supply P S 2 S 1 P P 2 P 1 Q D 1 Q Q 2 Q 1

38 Individual and Market Supply Schedule/Curve Price per DVD Ann s Supply + Barry s supply + Charlie s supply = Market supply \$ \$ \$ \$

39 Individual and Market Demand Curves Market supply curve for DVDs per week P The market supply curve is the summation of all individual supply curves \$4.00 CHARLIE BARRY ANN \$3.00 \$2.00 Market supply for DVDs \$ Q 4-39

40 The Interaction of Supply and Demand Equilibrium is a concept in which opposing dynamic forces cancel each other out In the free market, the forces of supply and demand interact to determine: Equilibrium quantity: amount bought and sold at equilibrium price Equilibrium price: price toward which the invisible hand drives the market 4-40

41 The Interaction of Supply and Demand If there is an excess supply (surplus), quantity supplied is greater than quantity demanded If there is an excess demand (shortage), quantity demanded is greater than quantity supplied Prices adjust and tend to rise when there is excess demand and fall when there is excess supply to reach an equilibrium 4-41

42 Shifts in Supply and Demand Shifts in either supply or demand change equilibrium price An increase in demand or a decrease in supply: Creates excess demand at the original equilibrium price Excess demand increases price until a new higher equilibrium price is reached 4-42

43 Shifts in Supply and Demand A decrease in demand or an increase in supply Creates excess supply at the original equilibrium price Excess supply decreases price until a new lower equilibrium price is reached McGraw-Hill/Irwin Colander, Economics 43

44 Chapter Summary The law of demand states that the quantity demanded rises as price falls, other things constant The law of supply states that the quantity supplied rises as price rises, other things constant The laws of demand and supply hold true because people can substitute A change in quantity demanded (supplied), caused by only a change in the good s own price, is a movement along the demand (supply) curve A change in demand (supply) is a shift of the entire demand (supply) curve 4-44

45 Chapter Summary Factors that affect supply and demand other than price are called shift factors Important supply shift factors include price of inputs, technology, expectations, and taxes and subsidies Important demand shift factors include society s income, the price of other goods, tastes, expectations, and taxes and subsidies to consumers A market demand (supply) curve is the horizontal sum of all individual demand (supply) curves When quantity demanded equals quantity supplied at equilibrium, prices have no tendency to change 4-45

46 Chapter Summary When quantity demanded is greater than quantity supplied, prices tend to rise When quantity supplied is greater than quantity demanded, prices tend to fall When the demand curve shifts to the right (left), equilibrium price rises (declines) and equilibrium quantity rises (falls) When the supply curve shifts to the right (left), equilibrium price decline (rises) and equilibrium quantity rises (falls) 4-46

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