DEMAND AND SUPPLYEconomics 101

Lecturer: Jack Wu

DEMAND AND SUPPLY

Demand and supply are the two words that economists use most often.

Demand and supply are the forces that make market economies work.

Modern microeconomics is about supply, demand, and market equilibrium.

MARKET

A market is a group of buyers and sellers of a particular good or service.

Buyers determine demand. Sellers determine supply

COMPETITIVE MARKET

A competitive market is a market in which there are many buyers and sellers so that each has a negligible impact on the market price.

PERFECT COMPETITION

Products are the same Numerous buyers and sellers so that each

has no influence over price Buyers and Sellers are price takers

NO COMPETITION

Monopoly: One seller, and seller controls price

Monopsony: One buyer, and buyer controls price

IMPERFECT COMPETITION

Oligopoly Few sellers Not always aggressive competition

Monopolistic Competition Many sellers Slightly differentiated products Each seller may set price for its own product

DEMAND

Quantity demanded is the amount of a good that buyers are willing and able to purchase.

Law of Demand The law of demand states that, other things

equal, the quantity demanded of a good falls when the price of the good rises.

DEMAND SCHEDULE

Demand Schedule The demand schedule is a table that shows the

relationship between the price of the good and the quantity demanded.

EXAMPLE OF DEMAND SCHEDULE

Price Quantity ($ per movie) (movies per month) 10.00 0 7.50 1 5.00 2 2.50 4 0.00 7

DEMAND CURVE

Demand Curve The demand curve is a graph of the relationship

between the price of a good and the quantity demanded.

0

2.50

5

7.50

10

1 4 72

individual demand curve

Quantity (Movies a month)

Pri

ce (

$ p

er

movie

)

INDIVIDUAL DEMAND CURVE

TWO VIEWS

for every possible price, it shows the quantity demanded

for each unit of item, it shows the maximum price that the buyer is willing to pay

ANOTHER EXAMPLE OF DEMAND SCHEDULE

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Price ofIce-Cream Cone

0

2.50

2.00

1.50

1.00

0.50

1 2 3 4 5 6 7 8 9 10 11 Quantity ofIce-Cream Cones

$3.00

12

1. A decrease in price ...

2. ... increases quantity of cones demanded.

ANOTHER WAY OF DEMAND CURVE

NEGATIVE PRICE?

A negative price case:

Hoover’s special promotion -- two free air tickets (worth more than £400) for purchase of appliance over £100. promotion attracted over 100,000 customers Hoover incurred £48 million loss

CETERIS PARIBUS

When a demand curve is drawn, everything but price and quantity demanded is held constant.

Definition: a Latin phrase, translated as “other things being equal”.

MARKET DEMAND

Market demand refers to the sum of all individual demands for a particular good or service.

Graphically, individual demand curves are summed horizontally to obtain the market demand curve.

CHANGE IN QUANTITY DEMANDED

Change in Quantity Demanded Movement along the demand curve. Caused by a change in the price of the product.

0

D

Price of Ice-Cream Cones

Quantity of Ice-Cream Cones

A tax that raises the price of ice-cream cones results in a

movement along the demand curve.

A

B

8

1.00

$2.00

4

CHANGES IN QUANTITY DEMANDED

CHANGE IN DEMAND

Change in Demand A shift in the demand curve, either to the left or

right. Caused by any change that alters the quantity

demanded at every price.

Copyright©2003 Southwestern/Thomson Learning

Price ofIce-Cream

Cone

Quantity ofIce-Cream Cones

Increasein demand

Decreasein demand

Demand curve, D3

Demandcurve, D1

Demandcurve, D2

0

CHANGE IN DEMAND

SHIFT IN THE DEMAND CURVE

Consumer incomePrices of related goodsTastesExpectationsNumber of buyers

DEMAND AND INCOME

Changes in incomenormal good – demand increases

with incomeinferior good – demand falls with

income -- example: potato

INFERIOR GOOD V.S. BADS

Inferior good is different from “bads”. Examples of “bads”: pollution or garbage

DEMAND AND PRICES OF RELATED GOODS Prices of Related Goods

When a fall in the price of one good reduces the demand for another good, the two goods are called substitutes.

When a fall in the price of one good increases the demand for another good, the two goods are called complements.

CASE STUDY

Two ways to reduce the quantity of smoking demanded:

-- Public service announcements, mandatory health warnings on cigarette packages, and the prohibition of cigarette advertising on TV (shift demand curve)

-- Raising the price of cigarettes through tobacco taxes (move along demand curve)

SUMMARY

variable change Demand Shift

Income (Normal) Rise (fall) Rise (fall) Right (left)

Income (Inferior) Rise (fall) Fall (rise) Left (right)

Price of substitute Rise (fall) Rise (fall) Right (left)

Price of complement Rise (fall) Fall (rise) Left (right)

Taste Rise (fall) Rise (fall) Right (left)

Expected Price Rise (fall) Rise (fall) Right (left)

Number of buyers Rise (fall) Rise (fall) Right (left)

SUPPLY

Quantity supplied is the amount of a good that sellers are willing and able to sell.

Law of Supply The law of supply states that, other things equal,

the quantity supplied of a good rises when the price of the good rises.

SUPPLY SCHEDULE

Supply Schedule The supply schedule is a table that shows the

relationship between the price of the good and the quantity supplied.

EXAMPLE OF SUPPLY SCHEDULE

SUPPLY CURVE

Supply Curve The supply curve is the graph of the relationship

between the price of a good and the quantity supplied.

Copyright©2003 Southwestern/Thomson Learning

Price ofIce-Cream

Cone

0

2.50

2.00

1.50

1.00

1 2 3 4 5 6 7 8 9 10 11 Quantity ofIce-Cream Cones

$3.00

12

0.50

1. Anincrease in price ...

2. ... increases quantity of cones supplied.

TWO VIEWS

For every possible price, it shows the production rate

For each unit of item, it shows the minimum price that the seller is willing to accept

MARKET SUPPLY

Market supply refers to the sum of all individual supplies for all sellers of a particular good or service.

Graphically, individual supply curves are summed horizontally to obtain the market supply curve.

CHANGE IN QUANTITY SUPPLIED

Change in Quantity Supplied Movement along the supply curve. Caused by a change in price.

1 5

Price of Ice-Cream Cone

Quantity of Ice-Cream Cones0

S

1.00A

C$3.00 A rise in the price

of ice cream cones results in a movement along the supply curve.

CHANGE IN QUANTITY SUPPLIED

CHANGE IN SUPPLY

Change in Supply A shift in the supply curve, either to the left or

right. Caused by a change in a determinant other than

price.

FIGURE 7 SHIFTS IN THE SUPPLY CURVE

Copyright©2003 Southwestern/Thomson Learning

Price ofIce-Cream

Cone

Quantity ofIce-Cream Cones

0

Increasein supply

Decreasein supply

Supply curve, S3

curve, Supply

S1Supply

curve, S2

SHIFT IN THE SUPPLY CURVE

Input prices Technology Expectations Number of sellers

SUMMARY

variable change Supply Shift

Input (factor) price

Rise (fall)

Fall (rise) Left (right)

Technology Rise (fall)

Rise (fall) Right (left)

Expected Price

Rise (fall)

Fall (rise) Left (right)

Number of sellers

Rise (fall)

Rise (fall) Right (left)

EQUILIBRIUM

Equilibrium refers to a situation in which the price has reached the level where quantity supplied equals quantity demanded.

EQUILIBRIUM PRICE AND QUANTITY Equilibrium Price

The price that balances quantity supplied and quantity demanded.

On a graph, it is the price at which the supply and demand curves intersect.

Equilibrium Quantity The quantity supplied and the quantity

demanded at the equilibrium price. On a graph it is the quantity at which the supply

and demand curves intersect.

Copyright©2003 Southwestern/Thomson Learning

Price ofIce-Cream

Cone

0 1 2 3 4 5 6 7 8 9 10 11 12Quantity of Ice-Cream Cones

13

Equilibriumquantity

Equilibrium price Equilibrium

Supply

Demand

$2.00

SURPLUS AND SHORTAGE Surplus

When price > equilibrium price, then quantity supplied > quantity demanded. There is excess supply or a surplus. Suppliers will lower the price to increase sales, thereby

moving toward equilibrium. Shortage

When price < equilibrium price, then quantity demanded > the quantity supplied. There is excess demand or a shortage. Suppliers will raise the price due to too many buyers

chasing too few goods, thereby moving toward equilibrium.

ALTERNATIVE EXAMPLE: #2 LEAD PENCILS

Price Quantity demanded Quantity supplied

0.05 1000 400

0.10 800 500

0.15 600 600

0.20 400 700

0.25 200 800

QUICK QUIZ 1

Draw demand and supply curves Find equilibrium price and quantity

QUICK QUIZ 2

How would following events shift either the demand or the supply of #2 lead pencil?

-- an increase in the use of standardized exams (using opscan forms)

-- a decrease in the price of ink pens -- a start of a school year

Copyright©2003 Southwestern/Thomson Learning

Price ofIce-Cream

Cone

0 Quantity of Ice-Cream Cones

Supply

Initialequilibrium

D

D

3. . . . and a higherquantity sold.

2. . . . resultingin a higherprice . . .

1. Hot weather increasesthe demand for ice cream . . .

2.00

7

New equilibrium$2.50

10

INCREASE IN DEMAND

Copyright©2003 Southwestern/Thomson Learning

Price ofIce-Cream

Cone

0 Quantity of Ice-Cream Cones

Demand

Newequilibrium

Initial equilibrium

S1

S2

2. . . . resultingin a higherprice of icecream . . .

1. An increase in theprice of sugar reducesthe supply of ice cream. . .

3. . . . and a lowerquantity sold.

2.00

7

$2.50

4

DECREASE IN SUPPLY

SUMMARY

DISCUSSION

Each of the events listed below has an impact on the market for bicycles.

1.An increase in the price of automobile.2.A decrease in incomes of consumers if bicycles

are a normal good.

DISCUSSION-CONTINUED

3.An increase in the price of steel used to make bicycle frames.

4.An environmental movement shifts tastes toward bicycling.

DISCUSSION-CONTINUED

5.Consumers expect the price of bicycles to fall in the future.

6.A technological advance in the manufacture of bicycles.

DISCUSSION-CONTINUED

7.A reduction in the price of bicycle helmets and shoes.

8.A decrease in incomes of consumers if bicycles are an inferior good.