4
The Market Forces of Supply and Demand
In this chapter, look for the answers to these questions: What factors affect buyers’ demand for goods?
PRINCIPLES OF
What factors affect sellers’ supply of goods? How do supply and demand determine the price of
ECONOMICS
a good and the quantity sold?
FOURTH EDITION
How do changes in the factors that affect demand
N. G R E G O R Y M A N K I W
or supply affect the market price and quantity of a good?
Premium PowerPoint® Slides by Ron Cronovich 2008 update Modified by Joseph Tao-yi Wang
How do markets allocate resources? CHAPTER 4
© 2008 South-Western, a part of Cengage Learning, all rights reserved
Markets and Competition
Markets and Competition A perfectly competitive market:
A market is a group of buyers and sellers of a
• all goods exactly the same • buyers & sellers so numerous that no one can
particular product.
A competitive market is one with many buyers and sellers, each has a negligible effect on price.
In modern economics, A market is a group of buyers and sellers of a
In modern economics,
and sellers so you can always “switch”
• No one can affect market price – each is a “price taker” (since others can always “switch”)
A competitive market is one where buyers and
In this chapter, we assume markets are perfectly
sellers have a negligible effect on price because there are substitutes on either side. THE MARKET FORCES OF SUPPLY AND DEMAND
affect market price – each is a “price taker”
• There are perfect substitutes for both buyers
particular product trading under certain “rules”.
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competitive. 2
3
The Demand Schedule
Demand The quantity demanded of any good is the
Demand schedule:
amount of the good that buyers are willing and able to purchase.
A table that shows the relationship between the price of a good and the quantity demanded.
Law of demand: the claim that the quantity demanded of a good falls when the price of the good rises, other things equal
Example: Helen’s demand for lattes.
Notice that Helen’s preferences obey the Law of Demand. CHAPTER 4
THE MARKET FORCES OF SUPPLY AND DEMAND
1
THE MARKET FORCES OF SUPPLY AND DEMAND
4
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Price Quantity of of lattes lattes demanded $0.00
16
1.00
14
2.00
12
3.00
10
4.00
8
5.00
6
6.00
4
THE MARKET FORCES OF SUPPLY AND DEMAND
5
Helen’s Demand Schedule & Curve
Market Demand versus Individual Demand
Price Quantity of of lattes lattes demanded
Price of Lattes
$6.00
$0.00
16
1.00
14
$4.00
2.00
12
$3.00
3.00
10
$5.00
4.00
$2.00
0 CHAPTER 4
5
Suppose Helen and Ken are the only two buyers in
4
Quantity 15 of Lattes
10
6
THE MARKET FORCES OF SUPPLY AND DEMAND
Price
Helen’s Qd
$0.00
16
+
8
=
24
1.00
14
+
7
=
21
2.00
12
+
6
=
18
3.00
10
+
5
=
15
4.00
8
+
4
=
12
5.00
6
+
3
=
9
6.00
4
+
2
=
6
The Market Demand Curve for Lattes P
Qd (Market)
$0.00
24
$5.00
1.00
21
$4.00
2.00
18
$3.00
3.00
15
4.00
12
5.00
9
6.00
6
P $6.00
$2.00 $1.00 $0.00
(Qd = quantity demanded)
the Latte market.
6
6.00
$0.00
the quantities demanded by all buyers at each price.
8
5.00
$1.00
The quantity demanded in the market is the sum of
Ken’s Qd
Market Qd
Demand Curve Shifters The demand curve shows how price affects quantity demanded, other things being equal.
These “other things” are non-price determinants of demand (i.e., things that determine buyers’ demand for a good, other than the good’s price).
Changes in them shift the D curve…
Q 0
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5
10
15
20
25
THE MARKET FORCES OF SUPPLY AND DEMAND
8
Demand Curve Shifters: # of buyers
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THE MARKET FORCES OF SUPPLY AND DEMAND
9
Demand Curve Shifters: # of buyers
Increase in # of buyers
Suppose the number of buyers increases. Then, at each P, Qd will increase (by 5 in this example).
P
increases quantity demanded at each price, shifts D curve to the right.
$6.00 $5.00 $4.00 $3.00 $2.00 $1.00
Q
$0.00 0 CHAPTER 4
THE MARKET FORCES OF SUPPLY AND DEMAND
10
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5
10
15
20
25
30
THE MARKET FORCES OF SUPPLY AND DEMAND
11
Demand Curve Shifters: income
Demand Curve Shifters:
Demand for a normal good is positively related
prices of related goods
Two goods are substitutes if
to income.
an increase in the price of one causes an increase in demand for the other.
• Increase in income causes increase in quantity demanded at each price, shifts D curve to the right.
Example: pizza and hamburgers. An increase in the price of pizza increases demand for hamburgers, shifting hamburger demand curve to the right.
(Demand for an inferior good is negatively related to income. An increase in income shifts D curves for inferior goods to the left.)
Other examples: laptops and desktop computers, compact discs and music downloads, • In the news: Fresh and Frozen Vegetables after a typhoon
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THE MARKET FORCES OF SUPPLY AND DEMAND
Demand Curve Shifters:
12
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THE MARKET FORCES OF SUPPLY AND DEMAND
13
Demand Curve Shifters: tastes
prices of related goods
Anything that causes a shift in tastes toward a
Two goods are complements if
good will increase demand for that good and shift its D curve to the right.
an increase in the price of one causes a fall in demand for the other.
Example:
Example: computers and software.
The organic diet became popular recently, caused an increase in demand for organic food, shifted the organic demand curve to the right.
If price of computers rises, people buy fewer computers, and therefore less software. Software demand curve shifts left.
Other examples: college tuition and textbooks, bagels and cream cheese, eggs and bacon
•
In the news: gasoline and cars
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THE MARKET FORCES OF SUPPLY AND DEMAND
14
Demand Curve Shifters: expectations
CHAPTER 4
THE MARKET FORCES OF SUPPLY AND DEMAND
Summary: Variables That Affect Demand
Expectations affect consumers’ buying
Variable
decisions.
• If people expect their incomes to rise, their demand for meals at expensive restaurants may increase now.
• If the economy turns bad and people worry about their future job security, demand for new autos may fall now.
THE MARKET FORCES OF SUPPLY AND DEMAND
16
A change in this variable…
Price
…causes a movement along the D curve
No. of buyers
…shifts the D curve
Income
…shifts the D curve
Price of related goods
…shifts the D curve
Tastes
…shifts the D curve
Expectations
…shifts the D curve
Examples:
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15
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THE MARKET FORCES OF SUPPLY AND DEMAND
17
ACTIVE LEARNING
1:
ACTIVE LEARNING
Demand curve
1:
A. price of iPods falls
Draw a demand curve for music downloads. What happens to it in each of the following scenarios? Why?
Music Music downloads downloads and and iPods iPods are are complements. complements. A A fall fall in in price price of of iPods iPods shifts shifts the the demand demand curve curve for for music music downloads downloads to to the the right. right.
Price of music downloads
A. The price of iPods falls
P1
B. The price of music downloads falls D2
D1
C. The price of compact discs falls
Q2
Q1
Quantity of music downloads
18
19
1: B. price of music downloads falls
ACTIVE LEARNING
Price of music downloads
Price of music downloads
ACTIVE LEARNING
The The D D curve curve does does not not shift. shift. Move Move down down along along curve curve to to aa point point with with lower lower P, P, higher higher Q. Q.
P1 P2
CDs CDs and and music music downloads downloads are are substitutes. substitutes. A A fall fall in in price price of of CDs CDs shifts shifts demand demand for for music music downloads downloads to to the the left. left.
P1
D1 Q1
Q2
1:
C. price of CDs falls
D1
D2 Q2
Quantity of music downloads
Q1
Quantity of music downloads
20
21
The Supply Schedule
Supply
Supply schedule:
The quantity supplied of any good is the
A table that shows the relationship between the price of a good and the quantity supplied.
amount that sellers are willing and able to sell.
Law of supply: the claim that the quantity supplied of a good rises when the price of the good rises, other things equal
Example: Starbucks’ supply of lattes.
Notice that Starbucks’ supply schedule obeys the Law of Supply. CHAPTER 4
THE MARKET FORCES OF SUPPLY AND DEMAND
22
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Price of lattes
Quantity of lattes supplied
$0.00
0
1.00
3
2.00
6
3.00
9
4.00
12
5.00
15
6.00
18
THE MARKET FORCES OF SUPPLY AND DEMAND
23
Starbucks’ Supply Schedule & Curve P $6.00 $5.00 $4.00 $3.00 $2.00 $1.00 $0.00
Market Supply versus Individual Supply
Price of lattes
Quantity of lattes supplied
$0.00
0
1.00
3
2.00
6
3.00
9
4.00
12
5.00
15
6.00
18
The quantity supplied in the market is the sum of the quantities supplied by all sellers at each price.
Suppose Starbucks and Jitters are the only two sellers in this market.
Q 0
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5
10
15 24
THE MARKET FORCES OF SUPPLY AND DEMAND
(Qs = quantity supplied) Market Qs
Price
Starbucks
Jitters
$0.00
0
+
0
=
1.00
3
+
2
=
5
2.00
6
+
4
=
10
3.00
9
+
6
=
15
4.00
12
+
8
=
20
5.00
15
+
10
=
25
6.00
18
+
12
=
30
0
Supply Curve Shifters
The Market Supply Curve P $6.00
P
QS (Market)
$0.00
0
1.00
5
2.00
10
$4.00
3.00
15
$3.00
4.00
20
$2.00
5.00
25
6.00
30
$5.00
$1.00
The supply curve shows how price affects quantity supplied, other things being equal.
These “other things” are non-price determinants of supply.
Changes in them shift the S curve…
Q
$0.00 0 CHAPTER 4
5
10 15
20 25 30
35
THE MARKET FORCES OF SUPPLY AND DEMAND
26
Supply Curve Shifters: input prices
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THE MARKET FORCES OF SUPPLY AND DEMAND
27
Supply Curve Shifters: input prices
Examples of input prices:
Suppose the price of milk falls. At each price, the quantity of Lattes supplied will increase (by 5 in this example).
P
wages, prices of raw materials.
$6.00
A fall in input prices makes production
$5.00
more profitable at each output price, so firms supply a larger quantity at each price, and the S curve shifts to the right.
$4.00 $3.00 $2.00 $1.00
Q
$0.00 0 CHAPTER 4
THE MARKET FORCES OF SUPPLY AND DEMAND
28
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5
10 15
20 25 30
35
THE MARKET FORCES OF SUPPLY AND DEMAND
29
Supply Curve Shifters: technology
Supply Curve Shifters: # of sellers
Technology determines how much inputs are
An increase in the number of sellers increases
required to produce a unit of output.
the quantity supplied at each price,
A cost-saving technological improvement has
shifts S curve to the right.
the same effect as a fall in input prices, shifts S curve to the right.
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THE MARKET FORCES OF SUPPLY AND DEMAND
30
Variable
Example: • Events in the Middle East lead to expectations of higher oil prices. • In response, owners of Texas oilfields reduce supply now, save some inventory to sell later at the higher price. • S curve shifts left. supply*
In general, sellers may adjust when their expectations of future prices change. (*If good not perishable.) THE MARKET FORCES OF SUPPLY AND DEMAND
ACTIVE LEARNING
32
2:
31
A change in this variable…
Price
…causes a movement along the S curve
Input prices
…shifts the S curve
Technology
…shifts the S curve
No. of sellers
…shifts the S curve
Expectations
…shifts the S curve
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THE MARKET FORCES OF SUPPLY AND DEMAND
33
A C T I V E L E A R N I N G 2: A. fall in price of photo imaging software
Supply curve Draw a supply curve for photo imaging software. What happens to it in each of the following scenarios? A. Retailers cut the price of the software. B. A technological advance allows the software to be produced at lower cost.
THE MARKET FORCES OF SUPPLY AND DEMAND
Summary: Variables That Affect Supply
Supply Curve Shifters: expectations
CHAPTER 4
CHAPTER 4
Price of photo imaging software
S1
P1 P2
S S curve curve does does not not shift. shift. Move Move down down along along the the curve curve to to aa lower lower P P and and lower lower Q. Q.
Picture source: Wikipedia
Q2 Q1
C. Professional photoshops raise the price of the services they provide. 34
Quantity of photo imaging software
35
2: B. fall in cost of producing the software
2: C. professional photoshops raise their price
ACTIVE LEARNING
Price of photo imaging software
S1
Q2
Price of photo imaging software
S S curve curve shifts shifts to to the the right: right: at at each each price, price, Q Q increases. increases.
S2
P1
Q1
ACTIVE LEARNING
Quantity of photo imaging software
P
D
S
$5.00 $4.00 $3.00 $2.00
Equilibrium: P has reached the level where quantity supplied equals quantity demanded
P
Q
QS
$5.00
$0
24
0
$4.00
1
21
5
$3.00
2
18
10
3
15
15
4
12
20
5
9
25
6
6
30
$2.00 $1.00
$0.00
$0.00
Q 5
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10 15 20 25 30 35 38
Equilibrium quantity: The quantity supplied and quantity demanded at the equilibrium price P D S $6.00 D S P
Q
Q
24
0
$5.00
$4.00
1
21
5
$4.00
$3.00
2
18
10
$3.00
3
15
15
4
12
20
5
9
25
$1.00
6
6
30
$0.00
$1.00
Q 0
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5
THE MARKET FORCES OF SUPPLY AND DEMAND
and QS = 25 lattes resulting in a surplus of 16 lattes Q 0
40
39
then QD = 9 lattes
$2.00
10 15 20 25 30 35 THE MARKET FORCES OF SUPPLY AND DEMAND
10 15 20 25 30 35
Surplus: when quantity supplied is greater than quantity demanded P Example: D Surplus S $6.00 If P = $5,
$0
$2.00
5
CHAPTER 4
$5.00
$0.00
Q 0
THE MARKET FORCES OF SUPPLY AND DEMAND
37
Equilibrium price: The price that equates quantity supplied with quantity demanded P D S $6.00 D
$1.00
0
This This shifts shifts the the demand demand curve curve for for photo photo imaging imaging software, software, not not the the supply supply curve. curve.
Quantity of photo imaging software
36
Supply and Demand Together
$6.00
S1
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5
10 15 20 25 30 35 THE MARKET FORCES OF SUPPLY AND DEMAND
41
Surplus: when quantity supplied is greater than quantity demanded P D Surplus S Facing a surplus, $6.00 sellers try to increase $5.00 sales by cutting price.
Surplus: when quantity supplied is greater than quantity demanded P D Surplus S Facing a surplus, $6.00 sellers try to increase $5.00 sales by cutting price.
$4.00
This causes QD to rise and QS to fall…
$4.00
…which reduces the surplus.
$2.00
$3.00 $2.00 $1.00 $0.00 5
CHAPTER 4
Prices continue to fall until market reaches equilibrium.
$1.00 $0.00
Q 0
This causes QD to rise and QS to fall.
$3.00
10 15 20 25 30 35
Q 0
THE MARKET FORCES OF SUPPLY AND DEMAND
42
5
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10 15 20 25 30 35 THE MARKET FORCES OF SUPPLY AND DEMAND
Shortage: when quantity demanded is greater than quantity supplied P Example: D S $6.00 If P = $1, $5.00 then $4.00 QD = 21 lattes and $3.00 QS = 5 lattes $2.00 resulting in a $1.00 shortage of 16 lattes
Shortage: when quantity demanded is greater than quantity supplied P Facing a shortage, D S $6.00 sellers raise the price,
$0.00
$0.00
Shortage 0
5
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Q
10 15 20 25 30 35 44
Shortage: when quantity demanded is greater than quantity supplied P Facing a shortage, D S $6.00 sellers raise the price,
$2.00 $1.00
$2.00 $1.00
Shortage
Q
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5
10 15 20 25 30 35 THE MARKET FORCES OF SUPPLY AND DEMAND
45
To To determine determine the the effects effects of ofany anyevent, event, 1. 1. Decide Decide whether whetherevent eventshifts shifts SScurve, curve, DDcurve, curve,or orboth. both. 2. 2. Decide Decide in in which which direction direction curve curve shifts. shifts.
Prices continue to rise until market reaches equilibrium.
$3.00
$3.00
Three Steps to Analyzing Changes in Eq’m
causing QD to fall and QS to rise.
$4.00
causing QD to fall and QS to rise, …which reduces the shortage.
$4.00
0
THE MARKET FORCES OF SUPPLY AND DEMAND
$5.00
$5.00
43
3. 3. Use Use supply-demand supply-demand diagram diagram to to see see how the shift changes eq’m P how the shift changes eq’m Pand and Q. Q.
Shortage
$0.00
Q 0
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5
10 15 20 25 30 35 THE MARKET FORCES OF SUPPLY AND DEMAND
46
CHAPTER 4
THE MARKET FORCES OF SUPPLY AND DEMAND
47
EXAMPLE:
The Market for Hybrid Cars
EXAMPLE 1: A Change in Demand EVENT TO BE ANALYZED:
P
price of hybrid cars
P
Increase in price of gas.
S1
STEP 1:
D curve shifts because STEP 2: price of gas affects demand for D shifts right hybrids. because high gas STEP 3: does S curve not price makes hybrids The shift causes an shift, more because attractiveprice increase in price of gas does not relative to other cars. and quantity affect cost of of hybrid cars. producing hybrids.
P1
D1 Q
Q1
quantity of hybrid cars CHAPTER 4
48
THE MARKET FORCES OF SUPPLY AND DEMAND
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D2
D1
Q
Q1 Q2
• occurs when a non-price determinant of supply
S1
changes (like technology or costs)
Change in the quantity supplied:
P2
a movement along a fixed S curve • occurs when P changes
P1
Change in demand: a shift in the D curve
• occurs when a non-price determinant of
D2
D1
demand changes (like income or # of buyers) Q
Q1 Q2
Change in the quantity demanded: a movement along a fixed D curve • occurs when P changes 50
THE MARKET FORCES OF SUPPLY AND DEMAND
EXAMPLE 2: A Change in Supply
EXAMPLE 3: A Change in Both Supply
EVENT: New technology P reduces cost of producing hybrid cars.
EVENTS: price of gas rises AND new technology reduces production costs
and Demand
S1
S2
STEP 1:
S curve shifts because STEP 2: event affects P1 cost of production. P2 S shifts right D curve does not because event STEPbecause 3: shift, reduces cost, The shift causes production technology makes production price to fallof the is not one more profitable at and quantity to rise. factors thatprice. affect any given demand. CHAPTER 4
49
THE MARKET FORCES OF SUPPLY AND DEMAND
Change in supply: a shift in the S curve
P
Always be careful to distinguish b/w a shift in a curve and a movement along the curve.
P1
Terms for Shift vs. Movement Along Curve
EXAMPLE 1: A Change in Demand Notice: When P rises, producers supply a larger quantity of hybrids, even though the S curve has not shifted.
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S1
P2
STEP 1:
Both curves shift.
P S1
S2
P2 P1
STEP 2:
Both shift to the right. STEP 3:
D1 Q1 Q2
THE MARKET FORCES OF SUPPLY AND DEMAND
Q rises, but effect on P is ambiguous: If demand increases more than supply, P rises.
Q
52
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D1 Q1
Q2
THE MARKET FORCES OF SUPPLY AND DEMAND
D2 Q
53
3: Changes in supply and demand
EXAMPLE 3: A Change in Both Supply
ACTIVE LEARNING
and Demand
EVENTS: price of gas rises AND new technology reduces production costs STEP 3, cont.
But if supply increases more than demand, P falls.
P S1
Event A: A fall in the price of compact discs
P1
Event B: Sellers of music downloads negotiate a reduction in the royalties they must pay for each song they sell.
P2 D2
D1 Q1
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Use the three-step method to analyze the effects of each event on the equilibrium price and quantity of music downloads.
S2
Q
Q2
Event C: Events A and B both occur.
54
THE MARKET FORCES OF SUPPLY AND DEMAND
3:
ACTIVE LEARNING
A. fall in price of CDs P
ACTIVE LEARNING
B. fall in cost of royalties
The market for music downloads S1
STEPS
1. D curve shifts
P1
2. D shifts left
P2
55
P
The market for music downloads S1
STEPS
3. P and Q both fall. D2 Q2 Q1
3:
1. S curve shifts (royalties are part 2. S shifts right of sellers’ costs) 3. P falls, Q rises.
D1
S2
P1 P2
Q
D1 Q1 Q2
56
Q
57
CONCLUSION:
3: C. fall in price of CDs AND fall in cost of royalties ACTIVE LEARNING
How Prices Allocate Resources
One of the Ten Principles from Chapter 1: Markets are usually a good way to organize economic activity.
STEPS STEPS 1. 1. Both Both curves curves shift shift (see (see parts parts AA && B). B).
In market economies, prices adjust to balance
2. 2. D D shifts shifts left, left, SS shifts shifts right. right.
supply and demand. These equilibrium prices are the signals that guide economic decisions and thereby allocate scarce resources.
3. 3. PP unambiguously unambiguously falls. falls. Effect Effect on on Q Q is is ambiguous: ambiguous: The The fall fall in in demand demand reduces reduces Q, Q, the increase in supply the increase in supply increases increases Q. Q.
58
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THE MARKET FORCES OF SUPPLY AND DEMAND
59
CHAPTER SUMMARY A competitive market has many buyers and
CHAPTER SUMMARY Besides price, demand depends on buyers’
sellers, each of whom has little or no influence on the market price.
incomes, tastes, expectations, the prices of substitutes and complements, and # of buyers. If one of these factors changes, the D curve shifts.
Economists use the supply and demand model to
The upward-sloping supply curve reflects the Law
analyze competitive markets.
of Supply, which states that the quantity sellers supply depends positively on the good’s price.
The downward-sloping demand curve reflects the Law of Demand, which states that the quantity buyers demand of a good depends negatively on the good’s price.
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Other determinants of supply include input prices, technology, expectations, and the # of sellers. Changes in these factors shift the S curve. 60
THE MARKET FORCES OF SUPPLY AND DEMAND
CHAPTER SUMMARY The intersection of S and D curves determine
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61
THE MARKET FORCES OF SUPPLY AND DEMAND
CHAPTER SUMMARY We can use the supply-demand diagram to analyze the effects of any event on a market: First, determine whether the event shifts one or both curves. Second, determine the direction of the shifts. Third, compare the new equilibrium to the initial one.
the market equilibrium. At the equilibrium price, quantity supplied equals quantity demanded.
If the market price is above equilibrium, a surplus results, which causes the price to fall. If the market price is below equilibrium, a shortage results, causing the price to rise.
In market economies, prices are the signals that guide economic decisions and allocate scarce resources.
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THE MARKET FORCES OF SUPPLY AND DEMAND
Seeing the Invisible Hand
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63
THE MARKET FORCES OF SUPPLY AND DEMAND
Seeing the Invisible Hand
Seeing the Invisible Hand
Seeing the Invisible Hand
12
10 9
10
8 7
8
Demand
Price
Price
6 6
5
Supply
4 4
3 2
2
1 0
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 Quantity
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 Quantity
Seeing the Invisible Hand
Seeing the Invisible Hand
Seeing the Invisible Hand Seeing the Invisible Hand
12 12
10 10
8
Demand Supply
6
Price
Price
8
6
Demand
4
4 2
2 0 1
2
3
4
0
5
6
7
8
9
10
Quantity
1
3
5
7
9
11
13
15
17
19
Quantity
Seeing the Invisible Hand
Seeing the Invisible Hand Seeing the Invisible Hand 12
10
10
8
8
6
Supply
Price
Price
Seeing the Invisible Hand 12
4
4
2
2
0
Demand
6
Supply
0 1
2
3
4
5
6
7
8
9
10
Quantity
Summary • Supply, Demand, and Equilibrium • Step 1: Identify which curve shifts (or both) • Step 2: Identify what direction did it shift • Step 3: Use the S/D graph to find how equilibrium price and quantity change • Homework: Mankiw, p. 85-87, Problem 4, 7, 8, 12, 13
1
2
3
4
5
6
Quantity
7
8
9
10
