Engineering

Economics
SUPPLY AND DEMAND
Hubbard: Selected por tions of chapter 3
What Determines the Price of Premium
Bottled Water?

Demand for premium bottled water

How many bottles of premium water do consumers want to buy?

◦ Affected by price of premium water
◦ Affected by other factors, including prices of other goods
Supply of premium bottled water

How many bottles of premium water are producers willing to sell?

◦ Affected by price of premium water
◦ Affected by other factors, including prices of other goods

We will analyze these in a perfectly competitive market

 Perfectly Competitive Markets
3 Characteristics of Perfect Competition
1. Many buyers and sellers
2. Identical products
3. No barriers to entry
The Demand Side of the Market

3.1 Learning Objective

Discuss the variables that influence demand.
Demand Schedules and Quantity
Demanded
Demand schedule: A table that Figure 3.1 A Demand Schedule and Demand
shows the relationship between Curve
the price of a product and the
quantity of the product
demanded.
Quantity demanded: The
amount of a good or service
that a consumer is willing and
able to purchase at a given
price.
Demand Curve and Market Demand
Demand curve: A curve that
shows the relationship between Figure 3.1 A Demand Schedule and Demand
the price of a product and the Curve
quantity of the product
demanded.
Market demand: the demand by
all the consumers of a given
good or service.
Ceteris Paribus
When drawing the demand curve, Figure 3.1 A Demand Schedule and
we assume ceteris paribus. Demand Curve
Ceteris paribus: The assumption
that all other variables are
constant when analyzing the
relationship between two
variables—such as price and
quantity demanded.
The Law of Demand
Law of demand: Figure 3.1 A Demand Schedule and Demand Curve
when the price falls
quantity demanded
will rise (all else
equal). Implication:
Demand curve
slopes downward
What Explains the Law of Demand?
When the price of a product falls, two effects cause consumers to purchase more of it:

The product has become cheaper relative to other goods, so consumers substitute toward it.
This is the substitution effect.

The consumer now has greater purchasing power and can buy more of everything. This is
income effect.

Substitution effect: The change in the quantity demanded due to a change in price making
the good more or less expensive relative to other goods that are substitutes.

Income effect: The change in the quantity demanded due to the effect of a change in the
good’s price on consumers’ purchasing power.
Increase and Decrease in Demand
A change in something other than Figure 3.2 Shifting the Demand
price that affects demand causes the Curve
entire demand curve to shift.
A shift to the right (D1 to D2) is an
increase in demand.
A shift to the left (D1 to D3) is a
decrease in demand.
Shifting the Demand Curve
As the demand curve shifts, the Figure 3.2 Shifting the Demand Curve
quantity demanded will change,
even if the price doesn’t change.
The quantity demanded changes at
every possible price.
Factors that Shift Market Demand
Income of consumers
◦ Increase in income increases demand if the product is normal, decreases demand if the
product is inferior.

Prices of related goods

◦ Increase in price of related good increases demand if products are substitutes,
decreases demand if products are complements

Tastes

Population and demographics

Expectations

We will discuss how each of these affects demand.

Change in Income of Consumers (1 of 2)
Table 3.1 Variables That Shift Market
Demand Curves
Normal good:
A good for which the demand increases as income
rises, and decreases as income falls.
Examples: Clothing
Restaurant meals
Vacations

Inferior good:
A good for which the demand decreases as income
rises, and increases as income falls.
Examples: Second-hand clothing
Ramen noodles

Is Premium Water normal or inferior good?

 Change in Income of Consumers (2 of 2)
Table 3.1 Variables That Shift Market Demand
Curves
Normal good:
A good for which the demand increases as income
rises, and decreases as income falls.
Examples: Clothing
Restaurant meals
Vacations

Inferior good:
A good for which the demand decreases as income
rises, and increases as income falls.
Examples: Second-hand clothing
Ramen noodles

Is public transport a normal or inferior good?

Change in the Price of Related Goods
Table 3.1 Variables That Shift Market Demand
Curves

Substitutes:
Goods and services that can be used for the same
purpose.
Examples: Big Mac and Whopper
Ford F-150 and Dodge Ram
Jeans and Khakis
Complements:
Goods and services that are used together.
Examples: Big Mac and McDonald’s fries
Hot dogs and hot dog buns
Left shoes and right shoes
Apply the Concept: Lobster – Normal Good or Inferior?
Describing a good as normal or inferior only tells us about how
consumers behave.

Do people buy more or less when their incomes rise?

In some parts of the Maritimes lobster is an inferior good –

people eat less of it when their incomes rise.

In Calgary (and other major cities) lobster is a normal good –

people eat more when their incomes rise.

Goods can be normal in one place and inferior in another.

Despite its high cost in many restaurants, lobster can still be an

inferior good.
All Canada Photos/Barrett & MacKay/Alamy Stock Photo
Change in Tastes or Population/Demographics
Table 3.1 Variables That Shift Market Demand
Curves
Tastes
If consumers’ tastes change, they may buy more or less
of the product.
Example:
If consumers become more concerned about eating
healthy, they might decrease their demand for fast
food.
Population and demographics
Increases in the number of people buying something
will increase equal to the amount being demanded.
Example: An increase in the elderly population
increases the demand for medical care.
 Apply the Concept: Forecasting the Demand for Premium
Bottled Water
To forecast future demand for premium bottled water,
manufacturers need to anticipate how demand will
change:

How will incomes change?

How will the availability of substitutes change?

How will consumers’ tastes change?

How will consumer demographics change?

Millennials have a greater demand for bottled water

and smaller demand for soda than do older
generations.
NC1/WENN/Newscom
Change in Expectations about Future Prices
Consumers decide which products to buy and when. Table 3.1 Variables That Shift Market
Future products are substitutes for current products Demand Curves

An expected increase in the price tomorrow increases

demand today.

An expected decrease in the price tomorrow decreases

demand today.

Example:
If you found out the price of gasoline would go
up tomorrow, you would increase your
demand today.
Change in Demand vs. Change in Quantity
Demanded
A change in the price of the product Table 3.3 A Change in Demand versus a Change
being examined causes a movement in Quantity Demanded
along the demand curve.
This is a change in quantity
demanded.

Any other change affecting demand

causes the entire demand curve to
shift.
This is a change in demand.
The Supply Side of the Market

3.2 Learning Objective

Discuss the variables that influence supply.
Supply Schedules and Supply Curves
Supply schedule: A table that Table 3.4 A Supply Schedule and Supply Curve
shows the relationship
between the price of a
product and the quantity of
the product supplied.
Quantity supplied: The
amount of a good or service
that a firm is willing and able
to supply at a given price.
 The Law of Supply
Supply curve: A curve that shows Table 3.4 A Supply Schedule and Supply Curve
the relationship between the
price of a product and the
quantity of the product supplied.
The law of supply: Holding
everything else constant, when
price rises quantity supplied
increases.
Implication: supply curves slope
upward.
Increase and Decrease in Supply
A change in something other Table 3.5 Shifting the Supply Curve
than price that affects supply
causes the entire supply
curve to shift.
A shift to the right (S1 to
S3) is an increase in
supply.
A shift to the left (S1 to S2)
is a decrease in supply.
 Shifts of the Supply Curve
Table 3.5 Shifting the Supply Curve
As the supply curve shifts, the quantity
supplied will change, even if the price
doesn’t change.
The quantity supplied changes at every
possible price.
Variables that Shift Market Supply
Prices of inputs
Technological change
Prices of substitutes in production
Number of firms in the market
Expected future prices

We will discuss how each of these affects supply.

Changes in Prices of Inputs
Table 3.2 Variables That Shift Market Supply Curves
Inputs are things used in the production of a good
or service.

Examples of inputs for premium water:

water
electrolytes
labour

An increase in the price of an input decreases the

profitability of selling the good, causing a decrease in
supply.
A decrease in the price of an input increases the
profitability of selling the good, causing an increase in
supply.
Technological Change
A firm may experience a positive or negative change
in its ability to produce a given level of output with a
given quantity of inputs due to technological change.
Table 3.2 Variables That Shift Market
Changes raise or lower firms’ costs, hence their Supply Curves
supply of the good.

Examples:

A new, more productive variety of wheat would

increase the supply of wheat.

Governmental restrictions on land use for agriculture

might decrease the supply of wheat.
Prices of Substitutes, and Number of Firms
Table 3.2 Variables That Shift Market Supply Curves

Prices of Substitutes
Many firms can produce and sell more than one
product.
Example:
An Ontario farmer can plant corn or soybeans. If
the price of soybeans rises, he will plant (supply)
less corn.
Number of Firms
More firms in the market will result in more
product available at a given price (greater supply).

Fewer firms → supply decreases.

Change in Expected Future Prices
If a firm anticipates that the price of its Table 3.2 Variables That Shift Market Supply
product will be higher in the future, it might Curves
decrease its supply today in order to increase
it in the future.
What types of products could be “stored” like
this?
Perishable products, or
Non-perishable products
Change in Supply vs. Change in Quantity
Supplied
A change in the price of the product Figure 3.6 A Change in Supply versus a
being examined causes a movement Change in Quantity Supplied

along the supply curve.

This is a change in quantity
supplied.

Any other change affecting supply

causes the entire supply curve to shift.
This is a change in supply.
Market Equilibrium: Putting Demand and
Supply Together

3.3 Learning Objective

Use a graph to illustrate market equilibrium.
Market Equilibrium
At a price of $2,
Figure 3.7 Market Equilibrium
consumers want to buy 80 million bottles,
and

producers want to sell 80 million bottles.

This is a market equilibrium: a situation in
which quantity demanded equals quantity
supplied.

A market equilibrium with many buyers and

sellers is a competitive market equilibrium.
Market Equilibrium Price and Quantity
In this market: Figure 3.7 Market Equilibrium
The equilibrium price of a premium
water bottle is $2, and
The equilibrium quantity is 80 million
bottles per month.

Since buyers and sellers want to trade

the same quantity at the price of $2,
we do not expect the price to change.
 A Surplus in the Market for Premium Water
(1 of 2)
At a price of $3, Figure 3.8 The Effect of Surpluses and
Shortages on the Market
consumers want to buy 60 million
bottles, while

producers want to sell 100 million.

This gives a surplus of 40 million premium

water bottles: a situation in which quantity
supplied is greater than quantity demanded.

Prediction: sellers will compete with each

other, driving the price down.
A Surplus in the Market for Premium Water
(2 of 2)
At a price of $0.5, Figure 3.8 The Effect of Surpluses and
consumers want to buy 110 million Shortages on the Market
bottles, while

producers want to sell 50 million.

This gives a shortage of 60 million
premium water bottles: a situation in which
quantity demanded is greater than
quantity supplied.

Prediction: sellers will realize they can

increase the price and still sell as many
bottles, so the price will rise.
Demand and Supply Both Count
Price is determined by the interaction of buyers and sellers.
Neither group can dictate price in a competitive market (i.e. one with many
buyers and sellers).
However changes in supply and/or demand will affect the price and quantity
traded.
What Determines How Fast
Economies Grow?
3.4 Learning Objective
Use demand and supply graphs to predict changes in prices and
quantities.
The Usefulness of the Demand and Supply
Model
Predictions about price and quantity in our model require us to know supply
and demand curves.
Typically, we know price and quantity, but do not know the curves that
generate them.
The power of the demand and supply model is in its ability to predict
directional changes in price and quantity traded.
The Effect of Shifts in Supply on Equilibrium
(1 of 2)
Figure 3.9 The Effect of an Increase in Supply on
Suppose PepsiCo introduced Equilibrium
LIFEWTR:
More premium water is supplied at
any given price—an increase in
supply from S1 to S2.
Equilibrium price falls from P1 to P2.
Equilibrium quantity rises from Q1 to
Q 2.
The Effect of Shifts in Supply on Equilibrium
(2 of 2)

By how much will price fall? Figure 3.9 The Effect of an Increase in Supply on
Equilibrium
By how much will quantity rise?
We cannot say, without knowing
more information.
For now, we can only predict that
price will fall and quantity traded
will rise.
The Effect of Shifts in Demand on
Equilibrium
Suppose incomes increase. What Figure 3.10 The Effect of an Increase in Demand on
happens to the equilibrium in the Equilibrium
premium bottled water market?
Bottled water is a normal good, so as
income rises, demand shifts to the
right (D1 to D2).
Equilibrium price rises (P1 to P2).
Equilibrium quantity rises (Q1 to Q2).
Effects of Changes in Demand or Supply
The table summarizes what happens when the demand curve shifts or the
supply curve shifts, with the other curve unchanged.

Table 3.3 How Shifts in Demand and Supply Affect Equilibrium Price (P )and
Quantity (Q)
Blank Supply Curve Supply Curve Shifts Supply Curve Shifts
Unchanged Right Left
Demand Curve Q unchanged Q increases Q decreases
Unchanged P unchanged P decreases P increases
Demand Curve Shifts Q increases Q increases Q increases or decreases P
Right P increases P increases or decreases increases
Demand Curve Shifts Q decreases Q increases or decreases Q decreases P increases or
Left P decreases P decreases decreases
 Shifts in Demand and Supply Over Time
Over time, it is likely that both Figure 3.11 Shifts in Demand and Supply

demand and supply will change.

For example, as new firms enter the
market for premium bottled water and
incomes increase, we expect:
The supply curve will shift to the
right, and
The demand curve will shift to the
right.
Demand Shifting More Than Supply
Figure 3.11 Shifts in Demand and Supply
What does our model predict?
S↑ → ( P↓ and Q↑ )
D↑ → ( P↑ and Q↑ )
So we can be sure equilibrium
quantity will rise; but the effect on
equilibrium price is not clear.
This panel shows demand shifting
more than supply: equilibrium price
and quantity both rise.
Supply Shifting More Than Demand
This panel shows supply shifting Figure 3.11 Shifts in Demand and Supply
more than demand: quantity rises,
but equilibrium price falls.
Without knowing the relative size of
the changes, the effect on
equilibrium price is ambiguous.
It is possible, but unlikely, that the
equilibrium price will remain
unchanged.
Shifts of a Curve vs. Movements Along a
Curve
Suppose an increase in supply occurs. We now know:

Equilibrium quantity will increase, and

Equilibrium price will decrease

It is tempting to believe the decrease in price will cause an increase in demand. But this is incorrect.

The decrease in price will cause a movement along with demand curve, but not an increase in
demand.

Why? The demand curve already describes how much of the good consumers want to buy, at any
given price.

When the price change occurs, we just look at the demand curve to see what happens to how much
consumers want to buy.
Common Misconceptions to Avoid
Mixing up terminology: movement along the curve (caused by price change) vs.
shifting the curve (caused by other changes).
Not moving curves far enough to be able to illustrate a change.
Exaggerating curve shifts is okay.
Incompletely labeling diagrams.
Use your arrows!
Being certain of both price and quantity changes when both demand and
supply curves move.
Only one of these effects will be certain.