Chapter 3 Demand and Supply
Introduction They are small, thin and lightweight… Some are not aware of their existence, while others allocate a lot of time and effort in obtaining them. What are they? They are sports trading cards. Most can be purchased for a few dollars or less, but many cost much more—up to thousands of dollars each! In this chapter you will learn why the prices of different sports trading cards can vary so widely.
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Learning Objectives • Explain the law of demand • Discuss the difference between money prices and relative prices • Distinguish between changes in demand and changes in quantity demanded
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Learning Objectives (cont'd) • Explain the law of supply • Distinguish between changes in supply and changes in quantity supplied • Understand how supply and demand interact to determine equilibrium price and quantity
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Chapter Outline • The Law of Demand • The Demand Schedule • Shifts in Demand • The Law of Supply • The Supply Schedule • Shifts in Supply • Putting Demand and Supply Together Copyright © 2008 Pearson Addison Wesley. All rights reserved.
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Did You Know That... • The average price of an apartment-sized condominium has often exceeded the average price of a standalone house? • The relative physical size of items does not determine the prices at which people exchange them for? • By using demand and supply you can develop a better understanding of why relative size of an item typically has little to do with the price at which it sells? Copyright © 2008 Pearson Addison Wesley. All rights reserved.
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Markets • Markets Arrangements that individuals have for
exchanging with one another
Represent the interaction of buyers and sellers for
goods and services
Markets set the prices we pay and receive. Automobile market Health care market ¾ Labor market ¾ Stock market ¾ ¾
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The Law of Demand • Demand A schedule showing how much of a good
or service people will purchase at any price during a specified time period, other things being constant
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The Law of Demand • Law of Demand Quantity demanded is inversely related to
price, holding other factors constant. ¾ Price
Qd
¾ Price
Qd
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The Law of Demand (cont'd) • What are we holding constant? Income Tastes and preferences Price of other goods Many other factors
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Relative Prices versus Money Prices • Relative prices and money prices Relative Price ¾ The
price of a commodity in terms of another commodity
Money Price ¾ Price
we observe today in today’s dollars (absolute, or nominal price)
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Table 3-1 Money Price versus Relative Price
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The Demand Schedule • The demand schedule Table relating prices to quantity demanded We must consider ¾ ¾
Time dimension Constant-quality units
• Demand Curve A graphical representation of the demand schedule Negatively sloped line showing inverse
relationship between price and quantity demanded, all else equal
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Figure 3-1 The Individual Demand Schedule and the Individual Demand Curve, Panel (a)
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Figure 3-1 The Individual Demand Schedule and the Individual Demand Curve, Panel (b)
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E-Commerce Example: Why RFID Tags Are Catching On Fast • An RFID tag contains a tiny microchip and a radio antenna that emits a signal for tracking items. • The price of an RFID tag has gone from 30 cents down to 15 cents, and is expected to go even lower, closer to 5 cents. • Why do you think the European Central Bank is contemplating putting RFID tags in smaller denomination euro notes? Copyright © 2008 Pearson Addison Wesley. All rights reserved.
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The Demand Schedule • Individual versus market demand curves • Market Demand The demand of all consumers in the
marketplace for a particular good or service Summation at each price of the quantity
demanded by each individual
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Figure 3-2 The Horizontal Summation of Two Demand Curves, Panel (a)
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Figure 3-2 The Horizontal Summation of Two Demand Curves, Panels (b), (c), (d)
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Figure 3-3 The Market Demand Schedule for Flash Memory Pen Drives, Panel (a)
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Figure 3-3 The Market Demand Schedule for Flash Memory Pen Drives, Panel (b)
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Shifts in Demand • Scenario Imagine the federal government gives
every student registered in a college, university, or technical school in the United States a notebook computer. ¾ If
some factor other than price changes, we can show its effect by moving the entire demand curve, shifting the curve left or right.
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Figure 3-4 A Shift in the Demand Curve Suppose universities prohibit the use of notebook computers
Suppose the federal government gives every student a notebook computer
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Determinants of Demand • Ceteris-Paribus Conditions Determinants of the relationship between
price and quantity that are unchanged along a curve Changes in these factors cause a curve
to shift
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Normal and Inferior Goods • Normal Goods Goods for which demand rises as income
rises, most goods are normal goods
• Inferior Goods Goods for which demand falls as
income rises
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Shifts in Demand • Determinants of demand Income Tastes and preferences The prices of related goods ¾ Substitutes ¾ Complements
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Shifts in Demand (cont'd) • Substitutes Two goods are substitutes when a change
in the price of one causes a shift in demand for the other in the same direction as the price change.
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Example: Kids Give Barbie Dolls and Legos the Boot • Barbie dolls and Lego building blocks were among the most popular toys for many years. • Since the early 2000s, annual purchases of such toys have fallen by as much as 25%. • At the same time, prices of substitute forms of entertainment, such as video games and computer software, have declined. • In what direction do you think the demand curve for toys has shifted as the prices of substitute forms of entertainment have declined?
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Shifts in Demand (cont'd) • Complements Two goods are complements when a
change in the price of one causes an opposite shift in the demand curve for the other.
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Shifts in Demand (cont'd) • Determinants of demand Expectations ¾ Future
prices
¾ Income ¾ Product
availability
Market size (number of buyers)
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Shifts in Demand (cont'd) The Determinants of Demand Income: Normal Good
Price
Increase in income increases demand
Decrease in income decreases demand
D3
D1
D2
Q/Units 3-31
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Shifts in Demand (cont'd) The Determinants of Demand Income: Inferior Good
Price
Decrease in income increases demand
Increase in income decreases demand
D3
D1
D2
Q/Units 3-32
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Shifts in Demand (cont'd) The Determinants of Demand Tastes and Preferences
Price
Hybrid vehicles • Increase in demand
SUVs • Decrease in demand
D3
D1
D2
Q/Units Copyright © 2008 Pearson Addison Wesley. All rights reserved.
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Shifts in Demand (cont'd) The Determinants of Demand Price of Related Goods: Substitutes
Price Butter and Margarine • Price of both = $2/lb • Price of margarine increases to $3/lb • Demand for butter increases
D1
D2
Q/Butter 3-34
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Shifts in Demand (cont'd) The Determinants of Demand Price of Related Goods: Complements
Price Speakers and Amplifiers • Decrease the relative price of amplifiers • Demand for speakers increases
Speakers and Amplifiers • Increase the relative price of amplifiers • Demand for speakers decreases
D3
D1
D2
Q/Speakers 3-35
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Shifts in Demand (cont'd) The Determinants of Demand Expectations: Income, Future Prices
Price A higher income or expectations of a higher future price will increase demand
A lower income or expectations of a lower future price will decrease demand
D3
D1
D2
Q/Units Copyright © 2008 Pearson Addison Wesley. All rights reserved.
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Shifts in Demand (cont'd) The Determinants of Demand Market Size (Number of Buyers)
Price Increase in the number of buyers increases demand
Decrease in the number of buyers decreases demand
D3
D1
D2
Q/Units Copyright © 2008 Pearson Addison Wesley. All rights reserved.
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Shifts in Demand (cont'd) • Changes in demand versus changes in quantity demanded A change in one or more of the non-price
determinants (income, tastes, etc.) will lead to a change in demand. ¾ This
is a shift of the whole curve.
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Shifts in Demand (cont'd) • Changes in demand versus changes in quantity demanded A change in a good’s own price leads to a
change in quantity demanded. ¾ This
is a movement along the same curve.
∆D is not the same as ∆Qd.
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Figure 3-5 Movement Along a Given Demand Curve
A change in the price changes the quantity of a good demanded, movement along the curve
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The Law of Supply • Supply Schedule showing relationship between
price and quantity supplied for a specified time period, other things being equal The amount of a product or service that
firms are willing to sell at alternative prices
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The Law of Supply (cont'd) • Law of Supply The price of a product or service and the
quantity supplied are directly related. ¾P
Qs
¾P
Qs
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The Supply Schedule • The supply schedule is a table relating prices to quantity supplied at each price. • Supply Curve A graphical representation of the
supply schedule Positively sloped line showing direct
relationship between price and quantity supplied, all else equal Copyright © 2008 Pearson Addison Wesley. All rights reserved.
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Figure 3-6 The Individual Producer’s Supply Schedule and Supply Curve for Flash Memory Pen Drives, Panel (a)
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Figure 3-6 The Individual Producer’s Supply Schedule and Supply Curve for Flash Memory Pen Drives, Panel (b)
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Figure 3-7 Horizontal Summation of Supply Curves, Panel (a)
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Figure 3-7 Horizontal Summation of Supply Curves, Panels (b), (c), (d)
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Figure 3-8 The Market Supply Schedule and the Market Supply Curve for Flash Memory Pen Drives, Panel (a)
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Figure 3-8 The Market Supply Schedule and the Market Supply Curve for Flash Memory Pen Drives, Panel (b)
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Shifts in Supply • Scenario A new method of manufacturing flash
memory pen drives reduces the cost of production dramatically.
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Figure 3-9 A Shift in the Supply Curve If some other factor than price changes, the only If costs increase, way wesupply can show its decreases effect is by moving the entire supply curve
If costs decrease, supply increases
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Price per Flash Memory Pen Drive ($)
Figure 3-9 A Shift in the Supply Curve (cont'd) 5
S2
S1 a
4 c
3
When supply increases the quantity supplied will be greater at each price
2 1 0
2
4
6
10
8
12
14
Quantity of Flash Memory Pen Drives Supplied (millions of constant-quality units per year) 3-52
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Price per Flash Memory Pen Drive ($)
Figure 3-9 A Shift in the Supply Curve (cont'd) 5
S2
S1 a
4
b c
3
When supply increases the quantity supplied will be greater at each price
d
2 1 0
2
4
6
10
8
12
14
Quantity of Flash Memory Pen Drives Supplied (millions of constant-quality units per year) 3-53
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Price per Flash Memory Pen Drive ($)
Figure 3-9 A Shift in the Supply Curve (cont'd) S3 5
S1 b
4 3
d
a When supply decreases the quantity supplied will be less at each price
c
2 1 0
2
4
6
8
10
12
14
Quantity of Flash Memory Pen Drives Supplied (millions of constant-quality units per year) Copyright © 2008 Pearson Addison Wesley. All rights reserved.
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Shifts in Supply (cont'd) • Determinants of supply Cost of inputs Technology and productivity Taxes and subsidies Price expectations Number of firms in industry
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Shifts in Supply (cont'd) The Determinants of Supply Cost of Inputs
Price Increase in cost decreases supply
S3
S1
S2
Decrease in cost increases supply
Q/Units 3-56
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Shifts in Supply (cont'd) The Determinants of Supply Technology and Productivity
Price
S3
S1
S2
Decreases in productivity decrease supply
Improvements in technology or increases in productivity increase supply
Q/Units Copyright © 2008 Pearson Addison Wesley. All rights reserved.
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Shifts in Supply (cont'd) The Determinants of Supply Taxes and Subsidies
Price
S3
S1
S2
Increases in taxes or decreases in subsidies decrease supply Decreases in taxes or increases in subsidies increase supply
Q/Units 3-58
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Policy Example: Import Restrictions Reduce the Supply of Cement • U.S. cement manufacturers produce more than 80 million metric tons of cement per year. • The rest of the cement supplied—15 to 20 million metric tons—is imported, much of it from Mexico. • During the 1990s the U.S. government began imposing an import duty on Mexican cement. • The continuation of this tariff during the 2000s caused Mexican producers to limit sales to the United States at any given price, reducing the U.S. supply of cement. 3-59
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Shifts in Supply (cont'd) The Determinants of Supply Price Expectations
Price Expectations of higher future prices decrease supply
S3
S1
S2
Expectations of lower future prices increase supply
Q/Units Copyright © 2008 Pearson Addison Wesley. All rights reserved.
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Shifts in Supply (cont'd) The Determinants of Supply Number of Firms in Industry
Price Decrease in the number of firms decreases supply
S3
S1
S2
Increase in the number of firms increases supply
Q/Units Copyright © 2008 Pearson Addison Wesley. All rights reserved.
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Shifts in Supply (cont'd) • Changes in supply versus changes in quantity supplied A change in one or more of the non-price
determinants will lead to a change in supply. ¾ This
is a shift of the whole curve.
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Shifts in Supply (cont'd) • Changes in supply versus changes in quantity supplied A change in a good’s own price leads to a
change in quantity supplied. ¾ This
is a movement along the same curve.
∆S is not the same as ∆Qs.
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Putting Demand and Supply Together • Putting demand and supply together • Equilibrium (Market Clearing) Price The price that clears the market The price at which quantity demanded
equals quantity supplied The price where the demand curve
intersects the supply curve Copyright © 2008 Pearson Addison Wesley. All rights reserved.
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Figure 3-10 Putting Demand and Supply Together, Panel (a)
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Figure 3-10 Putting Demand and Supply Together, Panel (b)
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Putting Demand and Supply Together (cont'd) • Equilibrium The situation when quantity supplied
equals quantity demanded at a particular price
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Putting Demand and Supply Together (cont'd) • Shortages The situation when quantity demanded is
greater than quantity supplied ¾ Qd
> Qs
Exist at any price below the market
clearing price
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Putting Demand and Supply Together (cont'd) • Surpluses The situation when quantity supplied is
greater than quantity demanded ¾ Qd
< Qs
Exist at any price above the market
clearing price
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Policy Example: Should Shortages in the Ticket Market Be Solved by Scalpers? • If you’ve ever tried to get tickets to the big game you know all about “shortages.” • Since the quantity of tickets is fixed, the price can go pretty high. • Enter the scalper.
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Figure 3-11 Shortages of Super Bowl Tickets
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Issues and Applications: The Market Clearing Prices of Baseball Cards • Various companies, such as Topps and Upper Deck, print sports trading cards that provide photos and stats on pro athletes. • Why are some of the market clearing prices so high? • The answer has to do with demand and supply. (A relatively low supply helps explain the relatively high market clearing price.) • You can buy a “Shoeless” Joe Jackson card for up to $9,000!
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Table 3-2 Baseball Cards with the Highest Market Clearing Prices
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Summary Discussion of Learning Objectives • The law of demand says that prices and quantity demanded are inversely related. At a higher price people buy less, at a
lower price people buy more.
• Relative prices must be distinguished from money prices, since people respond to changes in relative prices. Copyright © 2008 Pearson Addison Wesley. All rights reserved.
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Summary Discussion of Learning Objectives (cont'd) • A change in quantity demanded versus a change in demand A change in quantity demanded is a
movement along the same demand curve. A change in demand is a shift of the whole
demand curve.
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Summary Discussion of Learning Objectives (cont'd) • The law of supply states that price and quantity supplied are directly related. At a high price firms offer more; at a low price
firms offer less.
• A change in quantity supplied versus a change in supply A change in quantity supplied is a movement
along the same supply curve.
A change in supply is a shift of the whole
supply curve.
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Summary Discussion of Learning Objectives (cont'd) • Determining market price and equilibrium quantity The demand and supply curves intersect
at the market clearing, or equilibrium point. Surpluses exist if the price of the good is
greater than the market price. Shortages exist when the price of a good
is below the market price. 3-77
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End of Chapter 3 Demand and Supply
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