3

DEMAND AND SUPPLY

© 2012 Pearson Addison-Wesley
 What makes the prices of oil and gasoline double
in just one year?
Will the price of gasoline keep on rising?
Are the oil companies taking advantage of people?
Some prices rise, some fall, and some fluctuate.
This chapter explains how markets determine
prices and why prices change.

© 2012 Pearson Addison-Wesley

 Market and Prices

A market is any arrangement that enables buyers and

sellers to get information and do business with each other.
A competitive market is a market that has many buyers
and many sellers so no single buyer or seller can influence
the price.
The money price of a good is the amount of money
needed to buy it.
The relative price of a good—the ratio of its money price
to the money price of the next best alternative good—is its
opportunity cost.

© 2012 Pearson Addison-Wesley

 Demand

If you demand something, then you

1. Want it,
2. Can afford it, and
3. Have made a definite plan to buy it.
Wants are the unlimited desires or wishes people have for
goods and services. Demand reflects a decision about
which wants to satisfy.
The quantity demanded of a good or service is the
amount that consumers plan to buy during a particular
time period, and at a particular price.

© 2012 Pearson Addison-Wesley

 Demand

The Law of Demand

The law of demand states:
Other things remaining the same, the higher the price of a
good, the smaller is the quantity demanded; and
the lower the price of a good, the larger is the quantity
demanded.
The law of demand results from
 Substitution effect
 Income effect

© 2012 Pearson Addison-Wesley

 Demand

Substitution Effect
When the relative price (opportunity cost) of a good or
service rises, people seek substitutes for it, so the
quantity demanded of the good or service decreases.

Income Effect
When the price of a good or service rises relative to
income, people cannot afford all the things they
previously bought, so the quantity demanded of the
good or service decreases.

© 2012 Pearson Addison-Wesley

 Demand

Demand Curve and Demand Schedule

The term demand refers to the entire relationship between
the price of the good and quantity demanded of the good.
A demand curve shows the relationship between the
quantity demanded of a good and its price when all other
influences on consumers’ planned purchases remain the
same.

© 2012 Pearson Addison-Wesley

 Demand
Figure 3.1 shows a demand curve for energy bars.

© 2012 Pearson Addison-Wesley

 Demand

A rise in the price, other

things remaining the same,
brings a decrease in the
quantity demanded and a
movement up along the
demand curve.
A fall in the price, other
things remaining the same,
brings an increase in the
quantity demanded and a
movement down along the
demand curve.

© 2012 Pearson Addison-Wesley

 Demand

Willingness and
Ability to Pay
A demand curve is also a
willingness-and-ability-to-
pay curve.
The smaller the quantity
available, the higher is the
price that someone is
willing to pay for another
unit.
Willingness to pay
measures marginal benefit.
© 2012 Pearson Addison-Wesley
 Demand

A Change in Demand
When some influence on buying plans other than the price
of the good changes, there is a change in demand for
that good.
The quantity of the good that people plan to buy changes
at each and every price, so there is a new demand curve.
When demand increases, the demand curve shifts
rightward.
When demand decreases, the demand curve shifts
leftward.

© 2012 Pearson Addison-Wesley

 Demand

Six main factors that change demand are

 The prices of related goods
 Expected future prices
 Income
 Expected future income and credit
 Population
 Preferences

© 2012 Pearson Addison-Wesley

 Demand

Prices of Related Goods

A substitute is a good that can be used in place of
another good.
A complement is a good that is used in conjunction with
another good.
When the price of substitute for an energy bar rises or
when the price of a complement of an energy bar falls, the
demand for energy bars increases.

© 2012 Pearson Addison-Wesley

 Demand

Expected Future Prices

If the expected future price of a good rises, current
demand for the good increases and the demand curve
shifts rightward.
Income
When income increases, consumers buy more of most
goods and the demand curve shifts rightward.
A normal good is one for which demand increases as
income increases.
An inferior good is a good for which demand decreases
as income increases.
© 2012 Pearson Addison-Wesley
 Demand

Expected Future Income and Credit

When expected future income increases or when credit is
easy to obtain, the demand might increase now.
Population
The larger the population, the greater is the demand for all
goods.
Preferences
People with the same income have different demands if
they have different preferences.

© 2012 Pearson Addison-Wesley

 Demand

Figure 3.2 shows an

increase in demand.
Because an energy bar
is a normal good, an
increase in income
increases the demand
for energy bars.

© 2012 Pearson Addison-Wesley

 Demand

A Change in the Quantity

Demanded Versus a
Change in Demand
Figure 3.3 illustrates the
distinction between a
change in demand and a
change in the quantity
demanded.

© 2012 Pearson Addison-Wesley

 Demand

Movement Along the

Demand Curve
When the price of the good
changes and everything
else remains the same, the
quantity demanded
changes and there is a
movement along the
demand curve.

© 2012 Pearson Addison-Wesley

 Demand

A Shift of the Demand

Curve
If the price remains the
same but one of the other
influences on buyers’
plans changes, demand
changes and the demand
curve shifts.

© 2012 Pearson Addison-Wesley

 Lecture 2 objectives:

The nature of supply

The Law of Supply
 Cause of movement along the supply
curve
Causes of shifts in the supply curve

© 2012 Pearson Addison-Wesley

 Supply
If a firm supplies a good or service, then the firm
1. Has the resources and the technology to produce it,
2. Can profit from producing it, and
3. Has made a definite plan to produce and sell it.
Resources and technology determine what it is possible to
produce. Supply reflects a decision about which
technologically feasible items to produce.
The quantity supplied of a good or service is the amount
that producers plan to sell during a given time period at a
particular price.

© 2012 Pearson Addison-Wesley

© 2012 Pearson Addison-Wesley
 Supply
The Law of Supply
The law of supply states:
Other things remaining the same, the higher the price of a
good, the greater is the quantity supplied; and
the lower the price of a good, the smaller is the quantity
supplied.
The law of supply results from the general tendency for the
marginal cost of producing a good or service to increase
as the quantity produced increases (Chapter 2, page 35).
Producers are willing to supply a good only if they can at
least cover their marginal cost of production.

© 2012 Pearson Addison-Wesley

 Supply

Supply Curve and Supply Schedule

The term supply refers to the entire relationship between
the quantity supplied and the price of a good.
The supply curve shows the relationship between the
quantity supplied of a good and its price when all other
influences on producers’ planned sales remain the same.

© 2012 Pearson Addison-Wesley

 Supply

Figure 3.4 shows a supply

curve of energy bars.
A rise in the price of an
energy bar, other things
remaining the same,
brings an increase in the
quantity supplied.

© 2012 Pearson Addison-Wesley

 https://www.youtube.com/watch?v=nKvrbO
q1OfI

© 2012 Pearson Addison-Wesley

 Supply

Minimum Supply Price

A supply curve is also a
minimum-supply-price
curve.
As the quantity produced
increases, marginal cost
increases.
The lowest price at which
someone is willing to sell
an additional unit rises.
This lowest price is
marginal cost.

© 2012 Pearson Addison-Wesley

 Supply

A Change in Supply
When some influence on selling plans other than the price
of the good changes, there is a change in supply of that
good.
The quantity of the good that producers plan to sell
changes at each and every price, so there is a new supply
curve.
When supply increases, the supply curve shifts rightward.
When supply decreases, the supply curve shifts leftward.

© 2012 Pearson Addison-Wesley

 Supply

The five main factors that change supply of a good are

 The prices of factors of production
 The prices of related goods produced
 Expected future prices
 The number of suppliers
 Technology
 State of nature

© 2012 Pearson Addison-Wesley

 Supply

Prices of Factors of
Production
If the price of a factor of
production used to
produce a good rises, the
minimum price that a
supplier is willing to accept
for producing each
quantity of that good rises.
So a rise in the price of a
factor of production
decreases supply and
shifts the supply curve
leftward.
© 2012 Pearson Addison-Wesley
 Supply

Prices of Related Goods Produced

A substitute in production for a good is another good that
can be produced using the same resources.
The supply of a good increases if the price of a substitute
in production falls.
Goods are complements in production if they must be
produced together.
The supply of a good increases if the price of a
complement in production rises.

© 2012 Pearson Addison-Wesley

 Change in price of substitute in production

© 2012 Pearson Addison-Wesley

 Supply

Expected Future Prices

If the expected future price of a good rises, the supply of
the good today decreases and the supply curve shifts
leftward.
The Number of Suppliers
The larger the number of suppliers of a good, the greater
is the supply of the good. An increase in the number of
suppliers shifts the supply curve rightward.

© 2012 Pearson Addison-Wesley

 Supply

Technology
Advances in technology create new products and lower
the cost of producing existing products.
So advances in technology increase supply and shift the
supply curve rightward.
The State of Nature
The state of nature includes all the natural forces that
influence production—for example, the weather.
A natural disaster decreases supply and shifts the supply
curve leftward.
Climatic conditions (important for agricultural supply)

© 2012 Pearson Addison-Wesley

 Supply

Figure 3.5 shows an

increase in supply.
An advance in the
technology for producing
energy bars increases the
supply of energy bars and
shifts the supply curve
rightward.

© 2012 Pearson Addison-Wesley

 Supply

A Change in the Quantity

Supplied Versus a
Change in Supply
Figure 3.6 illustrates the
distinction between a
change in supply and a
change in the quantity
supplied.

© 2012 Pearson Addison-Wesley

 Mini exercise

• New oil fields starts up in production

In each case BE
PREPARED TO EXPLAIN
http://reffonomics.com/c3.ht
ml • Whether THE move
along the supply curve
is a contraction or
expansion

• Or whether THE shift in

the supply curve is to
the left or right

© 2012 Pearson Addison-Wesley

Supply images
…. The milk market!
 The supply of milk

© 2012 Pearson Addison-Wesley

 The milk supply chain

© 2012 Pearson Addison-Wesley

 Factors affecting the market supply of
milk

Productivity in milk industry

The number of suppliers in the industry

Costs of packaging and transportation

Government subsidies to milk producers

© 2012 Pearson Addison-Wesley

 Joint Supply

Two products are in joint supply when a

rise in the output of one product leads to
a rise in the supply of the other product

Can ewe
think of
examples of
joint supply?

© 2012 Pearson Addison-Wesley

 Diagram to show joint supply
Two products are in joint supply when a rise in the output of one product leads
to a rise in the supply of the other product

S Beef
Price Price
S Beef hide
P2
S1

P1 P3

P4

D D
Q1 Q2 Qa Qb Qc

Quantity bought and sold Quantity bought and sold

© 2012 Pearson Addison-Wesley

 Supply

Movement Along the

Supply Curve
When the price of the good
changes and other
influences on sellers’ plans
remain the same, the
quantity supplied changes
and there is a movement
along the supply curve.

© 2012 Pearson Addison-Wesley

 Supply

A Shift of the Supply

Curve
If the price remains the
same but some other
influence on sellers’ plans
changes, supply changes
and the supply curve
shifts.

© 2012 Pearson Addison-Wesley

 Market Equilibrium

Equilibrium is a situation in which opposing forces balance

each other. Equilibrium in a market occurs when the price
balances the plans of buyers and sellers.
The equilibrium price is the price at which the quantity
demanded equals the quantity supplied.
The equilibrium quantity is the quantity bought and sold
at the equilibrium price.
 Price regulates buying and selling plans.
 Price adjusts when plans don’t match.

© 2012 Pearson Addison-Wesley

 Market Equilibrium

Price as a Regulator
Figure 3.7 illustrates the
equilibrium price and
equilibrium quantity.
If the price is $2.00 a bar,
the quantity supplied
exceeds the quantity
demanded.
There is a surplus of
6 million energy bars.

© 2012 Pearson Addison-Wesley

 Market Equilibrium

If the price is $1.00 a bar,

the quantity demanded
exceeds the quantity
supplied.
There is a shortage of
9 million energy bars.
If the price is $1.50 a bar, the
quantity demanded equals
the quantity supplied.
There is neither a shortage
nor a surplus of energy bars.

© 2012 Pearson Addison-Wesley

 Market Equilibrium
Price Adjustments
At any price above the
equilibrium price, a surplus
forces the price down.
At any price below the
equilibrium price, a shortage
forces the price up.
At the equilibrium price,
buyers’ plans and sellers’
plans agree and the price
doesn’t change until some
event changes either
demand or supply.

© 2012 Pearson Addison-Wesley

 Predicting Changes in Price and Quantity

An Increase in Demand
Figure 3.8 shows that
when demand increases
the demand curve shifts
rightward.
At the original price, there
is now a shortage.
The price rises, and the
quantity supplied increases
along the supply curve.

© 2012 Pearson Addison-Wesley

 Predicting Changes in Price and Quantity

An Increase in Supply
Figure 3.9 shows that
when supply increases
the supply curve shifts
rightward.
At the original price, there
is now a surplus.
The price falls, and the
quantity demanded
increases along the
demand curve.

© 2012 Pearson Addison-Wesley

 Predicting Changes in Price and Quantity

All Possible Changes in

Demand and Supply
A change demand or
supply or both demand
and supply changes the
equilibrium price and the
equilibrium quantity.

© 2012 Pearson Addison-Wesley

 Predicting Changes in Price and Quantity

Change in Demand with

No Change in Supply

When demand increases,

there is a movement up
along the supply curve.

The equilibrium price rises

and the equilibrium
quantity increases.

© 2012 Pearson Addison-Wesley

 Predicting Changes in Price and Quantity

When demand decreases,

the equilibrium price falls
and the equilibrium
quantity decreases.

© 2012 Pearson Addison-Wesley

 Predicting Changes in Price and Quantity

Change in Supply with

No Change in Demand

When supply increases,

there is a movement
down along the demand
curve.

The equilibrium price falls

and the equilibrium
quantity increases.

© 2012 Pearson Addison-Wesley

 Predicting Changes in Price and Quantity

When supply decreases,

the equilibrium price rises

and the equilibrium
quantity decreases.

© 2012 Pearson Addison-Wesley

 Predicting Changes in Price and Quantity

Increase in Both Demand

and Supply

An increase in demand and

an increase in supply
increase the equilibrium
quantity.

The change in equilibrium

price is uncertain because the
increase in demand raises the
equilibrium price and the
increase in supply lowers it.
© 2012 Pearson Addison-Wesley
 Predicting Changes in Price and Quantity

Decrease in Both Demand

and Supply

A decrease in both demand

and supply decreases the
equilibrium quantity.

The change in equilibrium

price is uncertain because
the decrease in demand
lowers the equilibrium price
and the decrease in supply
raises it.
© 2012 Pearson Addison-Wesley
 Predicting Changes in Price and Quantity

Decrease in Demand and

Increase in Supply

A decrease in demand and

an increase in supply lowers
the equilibrium price.

The change in equilibrium

quantity is uncertain because
the decrease in demand
decreases the equilibrium
quantity and the increase in
supply increases it.
© 2012 Pearson Addison-Wesley
 Predicting Changes in Price and Quantity

Increase in Demand and

Decrease in Supply

An increase in demand and a

decrease in supply raises the
equilibrium price.

The change in equilibrium

quantity is uncertain because
the increase in demand
increases the equilibrium
quantity and the decrease in
supply decreases it.
© 2012 Pearson Addison-Wesley
 Mini exercise

• New oil fields starts up in production

In each case BE
PREPARED TO EXPLAIN
http://reffonomics.com/c3.ht
ml • Whether THE move
along the supply curve
is a contraction or
expansion

• Or whether THE shift in

the supply curve is to
the left or right

© 2012 Pearson Addison-Wesley