Session 4Supply and Demand

Disclaimer: The views expressed are those of the presenters and do not necessarily reflect those of the Federal Reserve Bank of Dallas or the Federal Reserve System.

TEKS

(2) Economics. The student understands the interaction of supply, demand, and price. The student is expected to:

(A) understand the effect of changes in price on the quantity demanded and quantity supplied;(B) identify the non-price determinants that create changes in supply and demand, which result in a new equilibrium price; and(C) interpret a supply-and-demand graph using supply-and-demand schedules.

Teaching the Terms

• Market• Demand• Supply• Determinants• Surplus• Shortage

Markets

• A market facilitates the interaction of a buyer and a seller as they complete a transaction

• Buyers, as a group, determine the demand• Sellers, as a group, determine the

supply

Characteristics of Competitive Markets

• Identical goods or services• Enough buyers and sellers so that no

participant can influence the market price – everyone is a price taker

Demand

• Law of demand• Quantity demanded• Demand schedule• Demand curve• Determinants of demand

The Law of Demand

As the price rises,

the quantity demand falls.

Demand

Price Quantity

$5 10$4 20$3 30$2 40$1 50

10 20 30 40 500

1

2

3

4

5

6

Demand for ____

QuantityPr

ice

Determinants of Demand

• Income• Price of related goods– Complements– Substitutes

• Tastes or preferences• Expectations• Number of buyers

Shifting Demand

10 20 30 40 500

1

2

3

4

5

6

7

8

Quantity

Pric

e

Supply

• Law of supply• Quantity supplied• Supply schedule• Supply curve• Determinants of supply

The Law of Supply

As the price rises,

the quantity supplied rises.

Supply

Price Quantity

$5 50$4 40$3 30$2 20$1 10 10 20 30 40 50

0

1

2

3

4

5

6

Supply of ____

Quantity

Pric

e

Determinants of Supply

• Input prices• Technology• Expectations• Number of sellers

Shifting Supply

10 20 30 40 500

1

2

3

4

5

6

7

8

Quantity

Pric

e

Market Equilibrium

Price Quantity Demanded

Quantity Supplied

$5 10 50$4 20 40$3 30 30$2 40 20$1 50 10

Market Equilibrium

10 20 30 40 500

1

2

3

4

5

6

Quantity

Pric

e

Supply

Demand

Market Equilibrium

•Quantity demanded is less than quantity supplied Qd < QsSurplus•Quantity demanded is equal to quantity supplied Qd = Qs

Equilibrium

•Quantity demanded is greater than quantity supplied Qd > Qs

Shortage

Practice

• Draw the graph.• Which curve is shifting because of the

changing market conditions? Supply? Demand? Both?

• Which direction is the shift?• Draw the shift.• What is the impact on price and quantity?

Price Controls

• Price Ceiling– If price is fixed BELOW the market clearing price– Creates a shortage because Qd > Qs

• Rent controls

• Price Floor– If price is fixed ABOVE the market clearing price– Creates a surplus because Qd < Qs

• Minimum wage

Price Elasticity of Demand

• Measures the responsiveness of quantity demanded to a change in price

• Determinants– Availability of close substitutes– Necessities versus luxuries– Definition of the market (food vs. ice cream vs.

chocolate ice cream)– Time horizon

Price Elasticity and Total Revenue

• If demand for a good is elastic, price increases lead to lower total revenue

• If demand for a good is inelastic, price increases lead to higher total revenue

Price Elasticity of Supply

• Measures the responsiveness of quantity supplied to a change in price

• Determinants– Availability of inputs – Time

Questions?