Introduction:

Thinking Like an 1
CHAPTER
CHAPTER
Economist

42
Supply and Demand

Teach a parrot the terms

supply and demand and
you’ve got an economist.

— Thomas Carlyle

McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
 Supply and Demand
14

Chapter Goals
 State the law of demand and distinguish shifts in
demand from movements along a demand curve.
 State the law of supply and distinguish shifts in
supply from movements along a supply curve.
 Explain how the law of demand and the law of supply
interact to bring about equilibrium.

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 Supply and Demand
14

Demand
 The law of demand states that the quantity of a good
demanded is inversely related to the good’s price
 In other words, other things equal,
• Quantity demanded rises as price falls
• Quantity demanded falls as price rises
 As prices change, people change how much they’re
willing to buy
 The law of demand is based on the fact that when
prices for a good rise, people substitute away from
that good to other goods

4-3
 Supply and Demand
14

The Demand Curve

A demand curve is the graphic representation of the
relationship between price and quantity demanded
P

The demand curve is

downward sloping

P1
As price increases,
P0 quantity demanded
decreases

Demand
Q
Q1 Q0
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 Supply and Demand
14
Shifts in Demand versus Movements Along a
Demand Curve
Quantity demanded refers to a specific amount that will be
demanded per unit of time at a specific price, other things
constant
• Refers to a specific point on the demand curve
• A change in price causes a change in quantity
demanded
• A change in price causes a movement along
the demand curve

4-5
 Supply and Demand
14
Shifts in Demand versus
Movements Along a Demand Curve
Demand refers to a schedule of quantities of a good that
will be bought per unit of time at various prices, other things
constant
• Refers to the entire demand curve
• Demand tells us how much will be bought at various
prices
• A change in anything other than price that affects
the demand curve changes the entire demand curve
• A change in the entire demand curve is a shift in
demand

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 Supply and Demand
14
Shifts in Demand versus Movements Along a
Demand Curve
P Movement along a demand curve

B A change in price
$2 causes a movement along
the demand curve
$1 A

Demand
Q
100 200

4-7
 Supply and Demand
14
Shifts in Demand versus
Movements Along a Demand Curve
P Shift in demand

A change in a shift factor

causes a shift in demand
B A
$1

Demand0
Demand1
Q
175 200

4-8
 Supply and Demand
14

Shift Factors in Demand

Important demand shift factors include:

1. Society’s (consumer’s or household’s)
income
2. The prices of other related goods
3. Tastes
4. Population and demographics
5. Expectations
6. Taxes and subsidies

4-9
 What factors influence market demand?

Income of consumers
Increase in income increases demand if product is normal,
decreases demand if 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
Expected future prices

We will discuss how each of these affects demand.

© 2015 Pearson Education Limited. 10 of 49

 Change in income of consumers
Normal goods:
Goods for which the demand increases as
income rises, and decreases as income falls.
•Examples: Clothing
Restaurant meals
Vacations
Effect of increase in
income, if good is normal
Inferior goods:
Goods for which the demand decreases as
income rises, and increases as income falls.
•Examples: Second-hand clothing
Urban mass transit (buss ride)
Effect of increase in
income, if good is
inferior

© 2015 Pearson Education Limited. 11 of 49

 Change in the price of related goods
Substitutes:
Goods and services that can be used for
the same purpose.
•Examples: Big Mac and Whopper
Ford F-150 and Dodge Ram
Effect on demand for
Jeans and Khakis Big Macs, if price of
Whopper increases
Complements:
Goods and services that are consumed
together.
•Examples: Big Mac and McDonald’s fries
Hot dogs and hot dog buns
Left shoes and right shoes
Effect on demand for Big
Macs, if price of
McDonald’s fries increases
© 2015 Pearson Education Limited. 12 of 49
 Change in tastes or population/demographics
Tastes
If consumers’ tastes change, they may buy
more or less of the product.
•Example: If consumers become more
concerned about eating
healthily, they might decrease
Effect on demand for fast
their demand for fast food. food, if consumers want
to eat healthy
Population and demographics
Increases in the number of people buying
something will increase the amount
demanded.
•Example: An increase in the elderly
population increases the Effect on demand for
demand for medical care. medical care, as the
population ages
© 2015 Pearson Education Limited. 13 of 49
 Change in expectations about future prices
Consumers decide which products to buy
and when to buy them.
• Future products are substitutes for
current products
• An expected increase in the price
tomorrow increases demand today.
• An expected decrease in the price
Effect on today’s gasoline
tomorrow decreases demand today.
demand, if price will rise
tomorrow
•Example: If you found out the price of
gasoline would go up
tomorrow, you would
increase your demand today.

© 2015 Pearson Education Limited. 14 of 49

 Taxes and Subsidies
Taxes levied on consumers increase the cost
of goods to consumers and therefore reduce
demand for those goods.

Subsidies to consumers have the opposite

effect.

Effect of subsidies on
•Example:
demand
When states host tax-free weeks during
August's back-to-school shopping season,
consumers load up on products to avoid
sales taxes. Demand for retail goods rises
during the tax holiday.

© 2015 Pearson Education Limited. 15 of 49

 Supply and Demand
14

Application: Demand Shift

What happens to demand for CDs if you won
P $1 million in the lottery?

Demand would shift out to

the right because your
income increased

Demand1

Demand0
Q

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 Supply and Demand
14

From a Demand Table to a Demand Curve

P Price per
Movie rentals
demanded per
movie
week

$8.00 E A $1.00 9

D
B $2.00 8
$6.00 Demand
for C $4.00 6
$4.00 C movies
D $6.00 4
$2.00 B
$1.00
A E $8.00 2
Q
2 4 6 8 10

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 Supply and Demand
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Individual and Market Demand Curves

Price Alice’s + Bruce’s + Carmen’s = Market

(per movie) demand demand demand demand

$2.00 8 5 1 14

$4.00 6 3 0 9

$6.00 4 1 0 5

$8.00 2 0 0 2

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 Individual and Market Demand Curves

McGraw-Hill/Irwin Colander, Economics 19

 Supply and Demand
14

Individual and Market Demand Curves

Market demand curve for movies per week
P

The market demand curve

is the horizontal sum of all
$8.00
individual demand curves

$6.00

$4.00
Market demand
for movies
$2.00

CARMEN BRUCE ALICE Q

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16

4-20
 Market Demand Curve

For the market, the law of demand is based on two

phenomena:
 At lower prices, existing demanders buy more.
 At lower prices, new demanders (some all-or-nothing
demanders like Carmen) enter the market.
• So even if individuals don't respond to small changes in
price, the market demand curve can still be smooth and
downward sloping.

McGraw-Hill/Irwin Colander, Economics 21

 Six Things to Remember about a Demand
Curve
1. A demand curve follows the law of demand: When
price rises, quantity demanded falls, and vice versa.
2. The horizontal axis—quantity—has a time
dimension.
3. The quality of each unit is the same.
4. The vertical axis—price—assumes all other prices
remain the same.
5. The demand curve assumes everything else is held
constant.
6. Effects of price changes are shown by movements
along the demand curve. Effects of anything else on
demand (shift factors) are shown by shifts of the
entire demand curve.
McGraw-Hill/Irwin Colander, Economics 22
 Supply and Demand
14

Supply
• The law of supply states that the quantity of a good
supplied is directly related to the good’s price
• In other words, other things equal,
• Quantity supplied rises as price rises
• Quantity supplied falls as price falls
• 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

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 Supply and Demand
14

The Supply Curve

A supply curve is the graphic representation of the
P
relationship between price and quantity supplied

Supply
The supply curve is
upward sloping
P1
As price increases,
P0 quantity supplied
increases

Q
Q0 Q1
4-24
 Supply and Demand
14
Shifts in Supply versus
Movements Along a Supply Curve
Quantity supplied refers to a specific amount that will be
supplied per unit of time at a specific price, other things
constant
• Refers to a specific point on the supply curve
• A change in price changes quantity supplied
• A change in price causes a change in quantity
supplied
• A change in price causes a movement along
the supply curve

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 Supply and Demand
14
Shifts in Supply versus
Movements Along a Supply Curve
Supply refers to a schedule of quantities of a good a seller
is willing to sell per unit of time at various prices, other
things constant
• Refers to the entire supply curve
• Supply tells us how much will be sold at various
prices
• A change in anything other than price that affects
the supply curve changes the entire supply curve
• A change in the entire supply curve is a shift in
supply

4-26
 Supply and Demand
14
Shifts in Supply versus
Movements Along a Supply Curve
Movement along a supply curve
P

Supply

C
$80 A change in price
causes a movement along
B the supply curve
$50

Q
4.1 4.3
4-27
 Supply and Demand
14
Shifts in Supply versus
Movements Along a Supply Curve
Shift in Supply
P
S0

S1
A change in a shift factor
causes a shift in supply

4-28
 Example: Shift vs. Movement
The supply of oil. In September 2005, Hurricane Katrina hit the Gulf
Coast region of the United States and disrupted oil supply lines and
production in the United States. U.S. production of oil declined from
4.6 to 4.1 million barrels each day.
 This disruption reduced the amount of oil U.S. producers were
offering for sale at every price, thereby shifting the supply of U.S.
oil to the left from S0 to S1, and the quantity of oil that would be
supplied at the $50 price fell from point A to point B in Figure 4-6.
 The price did not stay at $50. It rose to $80. In response to the
higher price, other areas in the United States increased their
quantity supplied (from point B to point C in Figure 4-6). That
increase due to the higher price is called a movement along the
supply curve.
If a change in quantity supplied occurs because of a higher price, it is
called a movement along the supply curve; if a change in supply
occurs because of one of the shift factors (i.e., for any reason other
than a change in price), it is called a shift in supply.
McGraw-Hill/Irwin Colander, Economics 29
Example:

McGraw-Hill/Irwin Colander, Economics 30

 Supply and Demand
14

Shift Factors in Supply

Important supply shift factors include:

1. Price of inputs
2. Technology
3. Expectations
4. Prices of substitutes in production
5. Number of firms in the market
6. Taxes and subsidies

4-31
 Changes in prices of inputs
Inputs are things used in the production of a
good or service.

Examples of inputs for smartphones:

Computer processor
Plastic housing Effect of an increase
Labor in the price of input
goods

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 Effect of a decrease
in the price of input
increase in supply. goods
© 2015 Pearson Education Limited. 32 of 49
 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. This is a
technological change.

Changes raise or lower firms’ costs, hence

Effect of a positive
their supply of the good.
change in technology

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.
Effect of a negative
change in technology

© 2015 Pearson Education Limited. 33 of 49

 Change in expected future prices
If a firm anticipates the price of its product
will be higher in the future, it might
decrease its supply today in order to
increase it in the future.

What types of products could be “stored”

like this?
Effect of an increase
Perishable products, or in future expected
Non-perishable products price of a good

© 2015 Pearson Education Limited. 34 of 49

 Prices of substitutes, and number of firms
Many firms can produce and sell more than
one product.

Example:
•An Illinois farmer can plant corn or soybeans.
If the price of soybeans rises, he will plant
Effect on the supply
(supply) less corn. of corn, of an
increase in the price
of soybeans

More firms in the market will result in more

product available at a given price (greater
supply).

•Fewer firms → supply decreases.

Effect of a increase in
the number of firms
© 2015 Pearson Education Limited. 35 of 49
 Taxes and Subsidies

Taxes levied on producers increase the cost

of goods to producers and therefore reduce
supplyfor those goods.

Effect of taxes on
supply
Subsidies to producers have the opposite
effect.

© 2015 Pearson Education Limited. 36 of 49

 Supply and Demand
14

Individual and Market Supply Curves

Price Ann’s + Barry’s + Charlie’s = Market

(per movie) Supply supply supply supply

$1.00 1 0 0 1

$3.00 3 2 0 5

$5.00 5 4 0 9

$7.00 7 5 2 14

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 Individual and Market Supply Curves

McGraw-Hill/Irwin Colander, Economics 38

 Supply and Demand
14

Individual and Market Supply Curves

Market supply curve for movies per week
The market supply curve is the
P summation of all individual
CHARLIE BARRY ANN supply curves
$7.00

$5.00

$3.00 Market supply

for movies
$1.00
Q
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

4-39
 Six Things to Remember about a Supply
Curve
1. A supply curve follows the law of supply. When price
rises, quantity supplied increases, and vice versa.
2. The horizontal axis—quantity—has a time dimension.
3. The quality of each unit is the same.
4. The vertical axis—price—assumes all other prices
remain constant.
5. The supply curve assumes everything else is constant.
6. Effects of price changes are shown by movements
along the supply curve. Effects of nonprice
determinants of supply are shown by shifts of the entire
supply curve.

McGraw-Hill/Irwin Colander, Economics 40

 Market Supply Curve
The market supply curve's upward slope is determined
by two different sources:
1. As price rises, existing suppliers supply more
2. At higher prices, new suppliers enter the market.

Sometimes existing suppliers may not be willing to

increase their quantity supplied in response to an
increase in prices, but a rise in price often brings
brand-new suppliers into the market.

• For example, a rise in teachers' salaries will have little

effect on the number of hours current teachers teach,
but it will increase the number of people choosing to
be teachers.
McGraw-Hill/Irwin Colander, Economics 41
 Supply and Demand
14

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 is the amount bought and
sold at equilibrium price
• Equilibrium price is the price toward which the
invisible hand drives the market

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 Supply and Demand
14

The Interaction of Supply and Demand

• If there is an excess supply (a surplus),

quantity supplied is greater than quantity demanded
• If there is an excess demand (a 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

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 Supply and Demand
14

The Interaction of Supply and Demand

P
Excess
supply Supply Excess supply
causes downward
P1 pressure on price

P*
Excess demand
P0 causes upward
pressure on price
Excess
demand Demand
Q

4-44
 Supply and Demand
14
Political and Social Forces and Equilibrium
If social and political forces were included in the analysis,
they’d provide a counter–pressure to the dynamic forces
of supply and demand. For example:
• Social pressures often offset economic pressures and
prevent unemployed individuals from accepting work at
lower wages than currently employed workers receive.
• Existing firms conspire to limit new competition by
lobbying Congress to pass restrictive regulations and by
devising pricing strategies to scare off new entrants.
• Renters often organize to pressure local government to
set caps on the rental price of apartments.
• Farmers use political pressure to obtain prices that are
higher than supply/demand equilibrium prices.
4-45
 Supply and Demand
14

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 prince is reached
• 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
4-46
 Supply and Demand
14

Application: A decrease in supply

P
S1
S0
A decrease in supply
P1 generates excess
demand. Price will
P0 increase until a new,
Excess higher, equilibrium
demand price is reached
D0

Q
Q1 Q0

4-47
 Supply and Demand
14

Application: A decrease in demand

P

Excess
S0
supply
A decrease in demand
generates excess supply.
P0
Price will decrease until a
P1 new, lower, equilibrium
price is reached
D0
D1
Q
Q1 Q0

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 Supply and Demand
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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.
• 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.
• Factors that affect supply and demand other than price
are called shift factors.

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 Supply and Demand
14
Chapter Summary
• Important supply shift factors include price of inputs,
technology, expectations, and taxes and subsidies to
producers
• 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
• When quantity demanded is greater than quantity
supplied, prices tend to rise; when quantity supplied is
greater than quantity demanded, prices tend to fall
4-50