Chapter 4: Supply and Demand

Demand Chapter 4: Supply and Demand n Demand means the willingness and capacity to pay. n Prices are the tools by which the market coordinates in...
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Demand

Chapter 4: Supply and Demand

n

Demand means the willingness and capacity to pay.

n

Prices are the tools by which the market coordinates individual desires.

Prepared by: Kevin Richter, Douglas College Charlene Richter, British Columbia Institute of Technology

© 2006 McGraw-Hill Ryerson Limited. All rights reserved.

Law of Demand n

q

q

As price falls, quantity demanded rises, other things constant. As price rises, quantity demanded falls, other things constant. Why? People tend to substitute away from goods whose price has increased. © 2006 McGraw-Hill Ryerson Limited. All rights reserved.

n

As the price goes up, the quantity demanded goes down.

The demand curve is the graphic representation of the law of demand.

n

It represents the maximum price consumers will pay for an additional unit of the good.

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Sample Demand Curve

Price (per unit)

The demand curve slopes downward and to the right.

n

3

Demand Curve n

2

Demand Curve

Law of demand – there is an inverse relationship between price and quantity demanded. q

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1

PA

A

D 0

QA Quantity demanded (per unit of time)

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Other Things Constant Other things constant means that all other factors that affect quantity demanded are assumed to remain constant, whether they actually remain constant or not.

n

Tastes, prices of other goods, even the weather, may affect demand.

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n

Demand refers to a schedule of quantities of a good that will be bought per unit of time at various prices, other things constant.

n

Graphically, it refers to the entire demand curve.

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Change in Demand versus Change in Quantity Demanded

Change in Demand versus Change in Quantity Demanded n

Quantity demanded refers to a specific amount that will be demanded per unit of time at a specific price.

n

Graphically, it refers to a specific point on the demand curve.

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n

A movement along a demand curve happens when there is a change in price.

n

We move from one point to another point on the demand curve.

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Change in Demand versus Change in Quantity Demanded

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Change in Quantity Demanded

Changes in price cause changes in quantity demanded represented by a movement along a demand curve.

Price (per unit)

n

Change in Demand versus Change in Quantity Demanded

$2

B Change in quantity demanded (a movement along the curve)

$1

A

D1 0 © 2006 McGraw-Hill Ryerson Limited. All rights reserved.

11

100 200 Quantity demanded (per unit of time) © 2006 McGraw-Hill Ryerson Limited. All rights reserved.

12

n

A shift in demand happens when anything other than price changes.

n

The entire demand curve moves to the left or right.

Price (per unit)

Change in Demand

Change in Demand versus Change in Quantity Demanded

Change in demand (a shift of the curve)

$2

$1

B

A D0 D1

100 200 250 Quantity demanded (per unit of time) © 2006 McGraw-Hill Ryerson Limited. All rights reserved.

Shift Factors of Demand n

q q q q

Society's income. The prices of other goods. Tastes. Expectations. Population.

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When the price of a substitute good falls, demand falls for the good whose price has not changed.

n

When the price of a complement good falls, demand rises for the good whose price has not changed.

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n

An increase in income will increase demand for normal goods.

n

An increase in income will decrease demand for inferior goods.

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Price of Other Goods n

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Income

Shift factors of demand are factors that cause shifts in the demand curve: q

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Tastes n

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A change in taste will change demand with no change in price.

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Expectations

Population

n

If you expect your income to rise, you may consume more now.

n

If you expect prices to fall in the future, you may delay purchases today.

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n

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From Demand Table to Demand Curve

The demand table assumes: The Law of Demand (as price rises, quantity demanded declines).

q

A specific time dimension.

q

Products are identical in shape, size, quality, etc.

q

Everything else is held constant.

n

You plot each point in the demand table on a graph and connect the points to create the demand curve.

n

The demand curve graphically conveys the same information that is on the demand table.

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From Demand Table to Demand Curve

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From Demand Table to Demand Curve

The curve represents the maximum price that you will pay for various quantities of a good – you will happily pay less.

A Demand Table Price per Cassette rentals cassette demanded per week

A B C D E

$0.50 1.00 2.00 3.00 4.00

9 8 6 4 2

A Demand Curve

$6.00 Price per cassettes (in dollars)

q

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n

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Demand Table n

An increase in population will increase demand at every price.

5.00 4.00 3.50 3.00

E

2.00 1.00 .50 0

D Demand for cassettes

C B

A

1 2 3 4 5 6 7 8 9 10 11 12 13 Quantity of cassettes demanded (per week)

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n

From Individual Demands to a Market Demand Curve

A market demand curve is the horizontal sum of all individual demand curves. q

(1) (2) Price per Marie’s cassette demand

A $.0.50 B 1.00 C 1.50 D 2.00 E 2.50 F 3.00 G 3.50 H 4.00

This is determined by adding the individual demand curves of all the demanders.

9 8 7 6 5 4 3 2

(3) Pierre’s demand

6 5 4 3 2 1 0 0

(2) Cathy’s demand

1 1 0 0 0 0 0 0

(3) Market demand

16 14 11 9 7 5 3 2

$4.00 3.50 Price per cassette (in dollars)

Individual and Market Demand Curves

G F

3.00

E

2.50

D

2.00

C

1.50

B

1.00 0.50 0

Market demand

A Cathy

Pierre Marie

2 4 6

8 10 12 14 16

Quantity of cassettes demanded per week © 2006 McGraw-Hill Ryerson Limited. All rights reserved.

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Law of Demand n

q

At lower prices, existing demanders buy more.

q

At lower prices, new demanders enter the market.

q

The market demand curve is flatter than the individual demand curves.

q

Individuals control the factors of production – inputs necessary to produce goods.

n

Factors of production are the resources or inputs necessary to produce goods or services.

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Law of Supply

The supply of produced goods involves: q

n

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Supply n

© 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.

Supply

Regarding the market demand curve,

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McGraw -Hill/Irwin

n

An analysis of the supply of the factors of production by households to firms.

q

An analysis of how firms transform those factors of production into usable goods and services.

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There is a direct relationship between price and quantity supplied.

q

29

As price rises, quantity supplied rises, other things constant. As price falls, quantity supplied falls, other things constant.

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n

The supply curve is the graphic representation of the law of supply.

n

It shows the minimum price the producer requires to produce one more unit of output.

n

Sample Supply Curve

Price (per unit)

Supply Curve

The supply curve slopes upward to the right, and tells us that the quantity supplied varies directly with the price. © 2006 McGraw-Hill Ryerson Limited. All rights reserved.

S

PA

0

QA Quantity supplied (per unit of time) © 2006 McGraw-Hill Ryerson Limited. All rights reserved.

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Change in Supply Versus Change in Quantity Supplied

A

Change in Supply Versus Change in Quantity Supplied

n

Supply refers to a schedule of quantities a seller is willing to sell per unit of time at various prices, other things constant.

n

Quantity supplied refers to a specific amount that will be supplied at a specific price.

n

Graphically, it refers to the entire supply curve.

n

Graphically, it refers to a specific point on the supply curve.

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© 2006 McGraw-Hill Ryerson Limited. All rights reserved.

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Change in Supply Versus Change in Quantity Supplied

Change in Supply Versus Change in Quantity Supplied Changes in price cause changes in quantity supplied represented by a movement along a supply curve.

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n

35

A movement along a supply curve – happens when there is a change in price.

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36

Change in Quantity Supplied

Change in Supply Versus Change in Quantity Supplied

Price (per unit)

S0 B

$25

Change in quantity supplied (a movement along the curve)

A

$15

n

A shift in supply happens when anything other than price changes.

n

The entire supply curve moves to the left or right.

1,250 1,500 Quantity supplied (per unit of time) © 2006 McGraw-Hill Ryerson Limited. All rights reserved.

© 2006 McGraw-Hill Ryerson Limited. All rights reserved.

37

Shift in Supply

Shift Factors of Supply S0

n

Price (per unit)

S1

$15

38

A

Other factors besides price affect how much will be supplied: q

Prices of inputs used in the production of a good.

q

Technology.

q

Suppliers’ expectations.

q

Taxes and subsidies.

B Shift in Supply (a shift of the curve)

1,250 1,500 Quantity supplied (per unit of time) © 2006 McGraw-Hill Ryerson Limited. All rights reserved.

Price of Inputs

40

Technology

n

When costs rise, profits decrease, so there is less incentive to supply.

n

If costs rise substantially, the firm may even shut down.

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n

Advances in technology reduce the cost of production, and there is a greater incentive to supply.

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Expectations

Taxes and Subsidies

n

If suppliers expect prices to rise in the future, they may store today's supply to reap higher profits later.

n

If they expect prices to fall in the future, suppliers may sell off more of their inventories today.

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n

When taxes go up, costs increase, and profits fall, reducing the incentive to produce.

n

When government subsidies go up, costs fall, and profits rise, giving suppliers the incentive to increase output.

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Supply Table

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From Supply Table to Supply Curve

n

Each supplier follows the law of supply.

n

When price rises, each supplies more, or at least as much as they did at a lower price.

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n

n

The supply curve represents the set of minimum prices an individual seller will accept for various quantities of a good.

n

Competing suppliers’ entry into the market places a limit on the price any supplier can charge.

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© 2006 McGraw-Hill Ryerson Limited. All rights reserved.

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From Supply Table to Supply Curve

To derive a supply curve from a supply table, you plot each point in the supply table on a graph and connect the points.

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Individual and Market Supply Curves n

47

The market supply curve is derived by horizontally adding the individual supply curves of each supplier.

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From Individual Supplies to a Market Supply (per cassette)

A B C D E F G H I

$0.00 0.50 1.00 1.50 2.00 2.50 3.00 3.50 4.00

$4.00

(2) (3) (4) (5) Ann's Barry's Charlie's Market Supply Supply Supply Supply 0 1 2 3 4 5 6 7 8

0 0 1 2 3 4 5 5 5

0 0 0 0 0 0 0 2 2

0 1 3 5 7 9 11 14 15

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Charlie

Barry

Ann

Market Supply

3.50 Price per cassette

(1) Price

Quantities Supplied

From Individual Supplies to a Market Supply

3.00 2.50

G F

2.00

E

1.50 1.00 0.50 0 A

I

H

D B

C CA

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 Quantity of cassettes supplied (per week) © 2006 McGraw-Hill Ryerson Limited. All rights reserved.

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Equilibrium

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Equilibrium

n

Equilibrium is a concept in which opposing dynamic forces cancel each other out so there is no reason for anything to change.

n

In a free market, the forces of supply and demand interact to determine equilibrium quantity and equilibrium price.

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n

Equilibrium price – the price toward which the invisible hand drives the market.

n

Equilibrium quantity – the amount bought and sold at the equilibrium price.

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What Equilibrium Isn’t

Excess Supply

n

Equilibrium isn’t inherently good or bad, it is simply a state in which dynamic pressures offset each other.

n

Excess supply or a surplus is a situation where the quantity supplied is greater than quantity demanded.

n

When the market is not in equilibrium, you get either excess supply or excess demand, and a tendency for price to change.

n

Prices tend to fall.

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Excess Demand

n

Excess demand or a shortage is a situation where the quantity demanded is greater than quantity supplied

Price per cassette (in dollars)

n

Marriage of Supply and Demand

Prices tend to rise.

$5.00

S Excess supply

4.00 3.50

A

3.00

E

2.50 2.00

B

1.50 Excess demand

1.00 1

2

3

4

5

6

7

D 8

9

10 11 12

Quantity of cassettes supplied and demanded (per week) © 2006 McGraw-Hill Ryerson Limited. All rights reserved.

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55

Interaction of Supply and Demand

Interaction of Supply and Demand

n

When price is $3.50 each, quantity supplied equals 7 and quantity demanded equals 3.

n

When price is $1.50 each, quantity supplied equals 3 and quantity demanded equals 7.

n

The excess supply of 4 pushes price down.

n

The excess demand of 4 pushes price up.

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When price is $2.50 each, quantity supplied equals 5 and quantity demanded equals 5.

n

There is no excess supply or excess demand, so price will not rise or fall.

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Interaction of Supply and Demand n

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Price Adjusts

59

n

The greater the difference between quantity supplied and quantity demanded, the more pressure there is for prices to rise or fall.

n

When quantity demanded equals quantity supplied, prices have no tendency to change – we have a market equilibrium

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Power of Supply and Demand n

Six Real World Examples n

Changes in either supply or demand will change equilibrium price and quantity.

Supply and demand can shed light on a variety of real-world events: q q q q q q

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n

Shift in Supply

The crop-damaging freeze shifted the supply curve to the left.

S1 S0

P0

Price rose until the quantity demanded equaled the quantity supplied.

Excess demand A

B

D0 0

QS

Qe

QD

Quantity

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Baby Boomers and Financial Assets n

C

P1

At the original price, quantity demanded exceeded quantity supplied.

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Price

n

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Sugar Shock in Brazil n

Brazil freeze. Financial assets and the baby boomers. Twenty percent excise tax. Rice in Indonesia. Farm labourers. Christmas toys.

64

Baby Boomers and Financial Assets

Demographic changes among baby boomers moved the demand curve for financial assets to the right.

Price

S Excess demand

P1 n

At the original price, quantity demanded exceeded quantity supplied.

P0 D1

n

Price rose until the quantity demanded equaled the quantity supplied.

D0 (f)

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65

Q0

Qe

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QD

Quantity 66

Baby Boomers and the Housing Market n

The same phenomenon occurred in the surging demand for housing among this group during the 1980s.

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Excise Tax n

Korean Government imposed a 20 percent luxury tax on imported golf clubs.

n

A 20 percent tax levied on suppliers shifts the supply curve to the left.

n

After the tax is imposed, the quantity of imported clubs demanded drops. © 2006 McGraw-Hill Ryerson Limited. All rights reserved.

67

Excise Tax

68

Rice in Indonesia

Price

n

Drought, pestilence, and the financial crisis shift the supply curve to the left.

n

The steep demand curve means that the quantity demanded does not change much with changes in price.

S1 S0

P1 P0

D0 Q1

(e)

Q0

Quantity

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Rice in Indonesia n

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Rice in Indonesia

Responding to high prices, the government imports rice and distributed it to the market, causing the supply curve to shift to the right.

Price

S1

S2

S0

P1 P2 P0

Demand Q1 Q2 Q0 © 2006 McGraw-Hill Ryerson Limited. All rights reserved.

71

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Quantity 72

Farm Labourers in the U.S. n

n

Farm Labourers

The compressed harvesting season increased the demand and increased border patrols decreased supply of labour.

n

At the original price, the quantity of workers demanded exceeded the quantity supplied.

n

Price rises until the quantity demanded equals the quantity supplied.

n

The effect on the number of labourers hired depended on the relative size of the supply shift.

Demand shifted to the right and supply shifted to the left.

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Farm Labourers

74

Christmas Toys

Price

n

A Christmas craze for Furbies shifts demand to the right.

n

A shortage ensued along with a black market.

S1 S0

P1

P0

D1 D0 Qe

Quantity

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Christmas Toys n

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Christmas Toys

Finally the supplier produced more, shifting the supply curve to the right, causing the price to drop.

Price

S0 S1

P1 P0 D1 D0 QS0 © 2006 McGraw-Hill Ryerson Limited. All rights reserved.

77

QD0

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QD1

Quantity 78

Effects of Shifts of Demand and Supply on Price and Quantity No change in supply No change in demand

No change.

Demand shifts out

Price rises; Quantity rises.

Demand shifts in

Price falls. Quantity falls.

Supply shifts out

Supply shifts in

Price falls;

Price rises; Quantity falls.

Quantity rises. Quantity rises; Price could be higher or lower. Price falls; Quantity could rise or fall.

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Supply and Demand

Price rises; Quantity could rise or fall. Quantity falls; Price could rise or fall.

End of Chapter 4

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