Ch. 21Ch. 21Demand and SupplyDemand and Supply

Section 1Section 1

DemandDemand

An Introduction to DemandAn Introduction to Demand

In the U.S., the forces of supply and demand In the U.S., the forces of supply and demand work together to set priceswork together to set prices

Demand – Demand – the desire, willingness, and ability to the desire, willingness, and ability to buy a good or service.buy a good or service.

3 things must be in place if demand is to exist:3 things must be in place if demand is to exist:

1.1. Consumer must Consumer must wantwant a good or service a good or service

2.2. Consumer must Consumer must be willingbe willing to buy it to buy it

3.3. Consumer must Consumer must havehave the resources the resources to buy to buy itit

Individual Demand ScheduleIndividual Demand Schedule Demand schedule – Demand schedule – table that lists the various table that lists the various

quantities of a product or service that someone is quantities of a product or service that someone is willing to buy over a range of possible priceswilling to buy over a range of possible prices

Can be shown as points on a graph.Can be shown as points on a graph. Prices = vertical axisPrices = vertical axis Quantities = horizontal axisQuantities = horizontal axis

Each point shows how many units of a product an Each point shows how many units of a product an individual will buy at a certain priceindividual will buy at a certain price

Demand Curve – Demand Curve – the line that connects these the line that connects these pointspoints

Individual Demand ScheduleIndividual Demand Schedule

The demand curve will The demand curve will alwaysalways slope downward slope downward

This shows that people are less willing to buy at a This shows that people are less willing to buy at a higher price, and more willing to buy at a lower higher price, and more willing to buy at a lower price.price.

This principle is known as the This principle is known as the law of demand – law of demand – quantity demanded and price will always move in quantity demanded and price will always move in opposite directionsopposite directions

Q PQ P

Market DemandMarket Demand

Market Demand – Market Demand – the total demand of all the total demand of all consumers for a product or service.consumers for a product or service.

Market demand can be shown as a Market demand can be shown as a demand schedule (table) and demand demand schedule (table) and demand curve (graph)curve (graph)

Marginal UtilityMarginal Utility

We buy products for their We buy products for their utility – utility – the the pleasure, usefulness, or satisfaction they pleasure, usefulness, or satisfaction they give us. give us.

Utility of a good will be different for different Utility of a good will be different for different peoplepeople

Some products may have no utility for some Some products may have no utility for some peoplepeople

Ex. Ex. Pizza when you are hungryPizza when you are hungry

Marginal Utility (cont.)Marginal Utility (cont.) Diminishing Marginal Utility – Diminishing Marginal Utility – states that our states that our

additional satisfaction tends to go down as we additional satisfaction tends to go down as we consume more and more unitsconsume more and more units

When we make a purchase, we consider whether When we make a purchase, we consider whether the satisfaction we expect to gain is worth the the satisfaction we expect to gain is worth the money we must give up.money we must give up.

If the marginal utility > marginal costs = we make If the marginal utility > marginal costs = we make the purchasethe purchase

If the marginal utility < marginal costs = we walk If the marginal utility < marginal costs = we walk awayaway

Marginal Utility (cont.)Marginal Utility (cont.)

Because marginal utility diminishes, we Because marginal utility diminishes, we would be willing to pay less for the second would be willing to pay less for the second item than the first.item than the first.

We would also be willing to pay even less We would also be willing to pay even less for the third itemfor the third item

Diminishing Marginal Utility can best be Diminishing Marginal Utility can best be visualized in a downward sloping demand visualized in a downward sloping demand curve.curve.

Section 2Section 2Factors Affecting DemandFactors Affecting Demand

Market Demand can change when:Market Demand can change when:1.1. More consumers enter the marketMore consumers enter the market2.2. When incomes changeWhen incomes change3.3. When tastes changeWhen tastes change4.4. When expectations changeWhen expectations change5.5. When prices of related goods When prices of related goods

changechange

A graph of a market demand curve can A graph of a market demand curve can show these changesshow these changes

Factors Affecting Demand Factors Affecting Demand (cont.)(cont.)

When demand goes down, people are willing When demand goes down, people are willing to buy fewer items at all possible prices.to buy fewer items at all possible prices.

The Demand Curve will The Demand Curve will shift to the left.shift to the left.

When demand goes up, people are willing to When demand goes up, people are willing to buy more items at all possible prices.buy more items at all possible prices.

The Demand Curve will The Demand Curve will shift to the right.shift to the right.

Change In the # of Change In the # of ConsumersConsumers

Demand is related to the number of Demand is related to the number of consumers in the areaconsumers in the area

When more people move into an area, When more people move into an area, they buy more goods and services from they buy more goods and services from local businesses.local businesses.

Demand Curve shifts to the rightDemand Curve shifts to the right

Change In the # of Consumers Change In the # of Consumers (cont.)(cont.)

When many people move away from a region, When many people move away from a region, demands for goods and services in the area demands for goods and services in the area decreases.decreases.

The Demand Curve shifts to the leftThe Demand Curve shifts to the left

The number of consumers in an area can The number of consumers in an area can change due to changes in change due to changes in – Birthrates Birthrates -- death rates -- death rates – ImmigrationImmigration -- migration -- migration

Change in Consumer Change in Consumer IncomeIncome

Income changes affect demandIncome changes affect demand

When economy is healthy, people receive raises When economy is healthy, people receive raises or move to better paying jobs/positionsor move to better paying jobs/positions

With more income, people are willing to buy With more income, people are willing to buy more of a product at more of a product at anyany particular price particular price

In hard times, people lose their jobs. With less In hard times, people lose their jobs. With less income, people buy less and demand goes downincome, people buy less and demand goes down

Change in Consumer TasteChange in Consumer Taste

Consumer’s tastes change frequently Consumer’s tastes change frequently

When a product is popular, the demand When a product is popular, the demand curve curve shifts to the rightshifts to the right

When a product becomes outdated and When a product becomes outdated and obsolete, the popularity fades and demand obsolete, the popularity fades and demand decreases decreases shifting the demand curve shifting the demand curve to the leftto the left

Change in Consumer Change in Consumer ExpectationsExpectations

People’s expectations can have an affect on People’s expectations can have an affect on demanddemand

If people believe hard times are on the way, If people believe hard times are on the way, they will buy less they will buy less shifting the curve to shifting the curve to the leftthe left

If people expect shortages of something, If people expect shortages of something, demand increases demand increases shifting the curve to shifting the curve to the rightthe right

Price Changes in GoodsPrice Changes in Goods Competing products are called Competing products are called substitutes substitutes because because

consumers can use one in place of the otherconsumers can use one in place of the other

Ex. JIF >>>> Peter PanEx. JIF >>>> Peter Pan

Coca-Cola >>>> PepsiCoca-Cola >>>> Pepsi

hamburgers >>>> hot dogshamburgers >>>> hot dogs

orange juice >>>> ???orange juice >>>> ???

A change in the price of one good causes the A change in the price of one good causes the demand for its substitute to move in the same demand for its substitute to move in the same directiondirection

Price Changes in Goods Price Changes in Goods (cont.)(cont.)

Compliments Compliments are products that are used are products that are used together. together.

Ex. JIF >>>> grape jellyEx. JIF >>>> grape jelly Captain Crunch >>>> milkCaptain Crunch >>>> milk

hot dogs >>>> bunshot dogs >>>> buns computers >>>> ???computers >>>> ???

The demand for one complimentary The demand for one complimentary product moves in the opposite direction as product moves in the opposite direction as the price of the otherthe price of the other..

Price Changes in Goods Price Changes in Goods (cont.)(cont.)

Question:Question:

If the price of DVD players increased, If the price of DVD players increased, what would you expect to happen to what would you expect to happen to the demand of DVD movies???the demand of DVD movies???

Demand would dropDemand would drop

Demand ElasticityDemand Elasticity

When prices rise, we know that quantity When prices rise, we know that quantity demanded will go down, but we do not know by demanded will go down, but we do not know by how muchhow much

Demand Elasticity Demand Elasticity is the extent to which a is the extent to which a change in price causes a change in the quantity change in price causes a change in the quantity demanded for a productdemanded for a product

Ex. $1.00 >>>$1.25 is a 25% increase for an ice Ex. $1.00 >>>$1.25 is a 25% increase for an ice cream cone but how much will the price change cream cone but how much will the price change affect the people’s demand for the productaffect the people’s demand for the product

Demand ElasticityDemand Elasticity

For some goods and services, demand is elastic.For some goods and services, demand is elastic.

Each change in price causes a relatively larger Each change in price causes a relatively larger percentage change in quantity demandedpercentage change in quantity demanded

When the price of a product changes a When the price of a product changes a little, the quantity demanded changes a lotlittle, the quantity demanded changes a lot

Price change % Price change % << demand change % = elastic demand change % = elastic

Demand Elasticity (cont.)Demand Elasticity (cont.)

Demand for a good or service tends to be Demand for a good or service tends to be elastic if it has an attractive substitute.elastic if it has an attractive substitute.

Demand also tends to be elastic if the Demand also tends to be elastic if the purchase for the item can be postponed.purchase for the item can be postponed.

Demand InelasticityDemand Inelasticity For some goods and services, demand tends For some goods and services, demand tends

to be inelasticto be inelastic

Price changes have Price changes have little effectlittle effect on the on the quantity demanded quantity demanded

Demand for goods with few or no substitutes Demand for goods with few or no substitutes tend to be inelastictend to be inelastic

Price change % Price change % >> demand change % = demand change % = inelasticinelastic

Demand Elasticity and Demand Elasticity and InelasticityInelasticity

Question:Question:

Suppose the price of electricity went Suppose the price of electricity went up 25%. As a result, the quantity of up 25%. As a result, the quantity of electricity demanded dropped by 2%. electricity demanded dropped by 2%. Would you describe the demand for Would you describe the demand for electricity as elastic or inelastic???electricity as elastic or inelastic???

electricity would be inelasticelectricity would be inelastic

Section 3Section 3What is Supply?What is Supply?

Supply – Supply – the various quantities of a good the various quantities of a good or service that producers are willing to sell or service that producers are willing to sell at all possible market prices.at all possible market prices.

Supply can refer to the output of one Supply can refer to the output of one producer or the output of all producers in producer or the output of all producers in the market.the market.

Producers offer different quantities of a Producers offer different quantities of a product depending on the price that product depending on the price that buyers are willing to paybuyers are willing to pay

What is Supply? (cont.)What is Supply? (cont.)

Quantity supplied varies according to Quantity supplied varies according to price, but in the opposite directionprice, but in the opposite direction

As price rises, quantity supplied rises, and As price rises, quantity supplied rises, and quantity demanded fallsquantity demanded falls

P S DP S D

What is Supply? (cont.)What is Supply? (cont.)

Law of Supply Law of Supply dictates that sellers will dictates that sellers will normally offer more for sale at higher normally offer more for sale at higher prices and less at lower pricesprices and less at lower prices

Higher prices mean higher profitHigher prices mean higher profit

Higher profits are incentive to produce Higher profits are incentive to produce more.more.

Supply Schedule, Supply Supply Schedule, Supply CurveCurve

Supply Schedule – Supply Schedule – table that shows the quantities table that shows the quantities producers are willing to supply at various pricesproducers are willing to supply at various prices

As a graph form it can show the As a graph form it can show the supply curve supply curve

The supply curve is opposite to the demand curve The supply curve is opposite to the demand curve in that in that it normally slopes upward from left to it normally slopes upward from left to right.right.

This reflects the fact that suppliers are generally This reflects the fact that suppliers are generally willing to offer more product at higher prices, less willing to offer more product at higher prices, less at lower pricesat lower prices

ProfitProfit

Businesses provide goods and services to Businesses provide goods and services to the public with the hopes of earning a the public with the hopes of earning a profit – profit – the money left over after a the money left over after a business covers it costs.business covers it costs.

You try to sell at prices high enough to You try to sell at prices high enough to cover your costs with something left overcover your costs with something left over

It is the primary goal for business owners in It is the primary goal for business owners in our economyour economy

Profit (cont.)Profit (cont.)

Producers have a few options with what Producers have a few options with what they can do with the profit from their they can do with the profit from their businessbusiness

1.1. Increase wages or hire on more Increase wages or hire on more workersworkers

2.2. Invest back into the business by Invest back into the business by purchasing new space or equipmentpurchasing new space or equipment

3.3. Keep it all for themselves Keep it all for themselves

Market SupplyMarket Supply Market Supply – Market Supply – total of the supply total of the supply

schedules for all providers of the same good schedules for all providers of the same good or serviceor service

Works just like individual supply schedule Works just like individual supply schedule and curve; just on a larger scale.and curve; just on a larger scale.

Price has the most influence on quantity Price has the most influence on quantity suppliedsupplied

Ex. Car Washing/laborEx. Car Washing/labor

Factors Affecting SupplyFactors Affecting Supply

Keep in mind, when the market supply goes Keep in mind, when the market supply goes down down supply curve shifts to the left; supply curve shifts to the left; when the market supply goes up when the market supply goes up supply supply curve shifts to the right.curve shifts to the right.

Why would supply change in the whole Why would supply change in the whole market?market?

8 factors or reasons that would affect 8 factors or reasons that would affect supply.supply.

Factors Affecting Supply Factors Affecting Supply (cont.)(cont.)

1.1. Changes in the Cost of ResourcesChanges in the Cost of Resources

When prices for resources fall, cost of production When prices for resources fall, cost of production falls; producers willing to offer more at all pricesfalls; producers willing to offer more at all prices

2. Productivity2. Productivity

Efficiency is more output in same amount of Efficiency is more output in same amount of time; reduces production costs; more products time; reduces production costs; more products at every priceat every price

3. Technology3. Technology

Refers to methods or processes used to make Refers to methods or processes used to make goods or services; new technology can speed up goods or services; new technology can speed up production thus cutting costsproduction thus cutting costs

Factors Affecting Supply Factors Affecting Supply (cont.)(cont.)

4.4. Change in government policyChange in government policy

Tighter vs. relaxed government regulations can Tighter vs. relaxed government regulations can affect costs of productionaffect costs of production

5.5. Change in Taxes and SubsidiesChange in Taxes and Subsidies

Subsidy—gov’t payment to an individual or Subsidy—gov’t payment to an individual or business for certain actions; encourage business for certain actions; encourage producers to enter or even stay in the market; producers to enter or even stay in the market; taxes and subsidies change production coststaxes and subsidies change production costs

6. Producer Expectations6. Producer Expectations

Predictions on what demand might look like in Predictions on what demand might look like in the near futurethe near future

Factors Affecting Supply Factors Affecting Supply (cont.)(cont.)

7.7. Number of SuppliersNumber of Suppliers

As more firms enter an industry, supply As more firms enter an industry, supply increases; suppliers leave, market supply increases; suppliers leave, market supply decreasesdecreases

Elasticity of SupplyElasticity of Supply

Supply Elasticity–Supply Elasticity– measures how measures how quantity supplied of a good/service quantity supplied of a good/service changes in response to a change in pricechanges in response to a change in price

QS changes a lot compared to price QS changes a lot compared to price =supply elastic =supply elastic

QS changes little compared to price QS changes little compared to price =supply inelastic=supply inelastic

Elasticity of Supply (cont.)Elasticity of Supply (cont.)

Products that cannot be made quickly or Products that cannot be made quickly or are expensive to produce tend to be are expensive to produce tend to be inelasticinelastic

Products that can be made quickly without Products that can be made quickly without large investments of money or skilled large investments of money or skilled labor tend to be supply elasticlabor tend to be supply elastic

Section 4Section 4Markets and PricesMarkets and Prices

Forces of Forces of supply and demand supply and demand work together in work together in markets to establish prices.markets to establish prices.

Prices form the basis of economic decisionPrices form the basis of economic decision

Surplus – Surplus – QS is higher than QDQS is higher than QD

signals that the price is too high; consumers will not signals that the price is too high; consumers will not buy all of the product suppliers are willing to sellbuy all of the product suppliers are willing to sell

Will not last long, price will be lowered to move Will not last long, price will be lowered to move productproduct

Markets and Prices (cont.)Markets and Prices (cont.) Shortage – Shortage – QD is higher than QSQD is higher than QS

signals that the price is too low; suppliers signals that the price is too low; suppliers will not supply all of the product that will not supply all of the product that consumers are willing to buy.consumers are willing to buy.

Will not last long, sellers will raise their priceWill not last long, sellers will raise their price

If left to itself, economy will fix itself. If left to itself, economy will fix itself. Surplus forces price down; Shortage forces Surplus forces price down; Shortage forces

price up until balance is achievedprice up until balance is achieved

Markets and Prices (cont.)Markets and Prices (cont.)

Equilibrium Price – Equilibrium Price – point at which supply point at which supply and demand are balanced; neither surplus and demand are balanced; neither surplus or shortage existor shortage exist

Temporary changes may occur (Hurricane Temporary changes may occur (Hurricane Katrina or Gustov) but the market will Katrina or Gustov) but the market will adjust to reach a new equilibrium priceadjust to reach a new equilibrium price

Price ControlsPrice Controls

Price Ceiling – Price Ceiling – Gov’t set maximum price Gov’t set maximum price that can be charged for a good or service that can be charged for a good or service

Price Floor -- Price Floor -- Gov’t set minimum price Gov’t set minimum price that can be charged for a good or service that can be charged for a good or service

Price as SignalsPrice as Signals

Prices are signals that help businesses and Prices are signals that help businesses and consumers make decisionsconsumers make decisions

Prices help businesses and consumers Prices help businesses and consumers answer the 3 basic economic questions:answer the 3 basic economic questions:

WHAT TO PRODUCEWHAT TO PRODUCE

HOW TO PRODUCEHOW TO PRODUCE

FOR WHOM TO PRODUCEFOR WHOM TO PRODUCE

Advantages of PricesAdvantages of Prices

1.1. Prices are NeutralPrices are Neutral

favor neither producer or consumer; favor neither producer or consumer; merely a merely a compromisecompromise between the two between the two

2.2. Prices are FlexiblePrices are Flexible

both react to unforeseen events by both react to unforeseen events by adjusting production and consumption adjusting production and consumption based on the new pricesbased on the new prices

Advantages of Prices (cont.)Advantages of Prices (cont.)

Prices and Freedom of ChoicePrices and Freedom of Choice

Pricing system and market economy provides Pricing system and market economy provides consumers a variety of products and prices consumers a variety of products and prices to choose from unlike command economiesto choose from unlike command economies

Prices are FamiliarPrices are Familiar

This allows us to make buys quickly and This allows us to make buys quickly and efficiently; no misunderstanding, we know efficiently; no misunderstanding, we know through prices the value of particular through prices the value of particular productsproducts