CHAPTER
4
In this chapter, look for the answers to these questions:
The Market Forces of Supply and Demand
What factors affect buyers’ demand for goods? What factors affect sellers’ supply of goods?
Microeonomics
How do supply and demand determine the price of
PRINCIPLES OF
a good and the quantity sold?
N. Gregory Mankiw
How do changes in the factors that affect demand or supply affect the market price and quantity of a good?
Premium PowerPoint Slides by Ron Cronovich
How do markets allocate resources? 1
© 2009 South-Western, a part of Cengage Learning, all rights reserved
Markets and Competition
Demand The quantity demanded of any good is the
A market is a group of buyers and sellers of a
amount of the good that buyers are willing and able to purchase.
particular product.
A competitive market is one with many buyers
Law of demand: the claim that the quantity
and sellers, each has a negligible effect on price.
demanded of a good falls when the price of the good rises, other things equal
In a perfectly competitive market: All goods exactly the same Buyers & sellers so numerous that no one can affect market price – each is a “price taker”
In this chapter, we assume markets are perfectly competitive. THE MARKET FORCES OF SUPPLY AND DEMAND
2
THE MARKET FORCES OF SUPPLY AND DEMAND
3
1
The Demand Schedule
Helen’s Demand Schedule & Curve
Price Quantity of of lattes lattes demanded
Demand schedule: a table that shows the relationship between the price of a good and the quantity demanded
Example: Helen’s demand for lattes.
Notice that Helen’s preferences obey the Law of Demand.
$0.00
16
1.00
14
2.00
12
3.00
10
4.00
8
5.00
6
6.00
4
$6.00
$0.00
16
1.00
14
$4.00
2.00
12
$3.00
3.00
10
$2.00
4.00
8
5.00
6
6.00
4
$5.00
$1.00 $0.00 0 4
THE MARKET FORCES OF SUPPLY AND DEMAND
Quantity 15 of Lattes
10
5
The Market Demand Curve for Lattes
quantities demanded by all buyers at each price.
P
Suppose Helen and Ken are the only two buyers in
$6.00
(Qd = quantity demanded) Ken’s Qd
5
THE MARKET FORCES OF SUPPLY AND DEMAND
Market Demand versus Individual Demand The quantity demanded in the market is the sum of the the Latte market.
Price Quantity of of lattes lattes demanded
Price of Lattes
Market Qd
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
Price
Helen’s Qd
$0.00
16
+
8
=
24
1.00
14
+
7
=
21
2.00
12
+
6
=
18
3.00
10
+
5
=
15
$1.00
4.00
8
+
4
=
12
$0.00
5.00
6
+
3
=
9
6.00
4
+
2
=
6
$2.00
Q 0
6
P
5
10
15
20
25
THE MARKET FORCES OF SUPPLY AND DEMAND
7
2
Demand Curve Shifters
Demand Curve Shifters: # of Buyers
The demand curve shows how price affects
Increase in # of buyers
quantity demanded, other things being equal.
increases quantity demanded at each price, shifts D curve to the right.
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…
8
THE MARKET FORCES OF SUPPLY AND DEMAND
Demand for a normal good is positively related
Suppose the number of buyers increases. Then, at each P, Qd will increase (by 5 in this example).
$6.00 $5.00 $4.00
9
Demand Curve Shifters: Income
Demand Curve Shifters: # of Buyers P
THE MARKET FORCES OF SUPPLY AND DEMAND
to income. Increase in income causes increase in quantity demanded at each price, shifts D curve to the right.
$3.00
(Demand for an inferior good is negatively related to income. An increase in income shifts D curves for inferior goods to the left.)
$2.00 $1.00
Q
$0.00 0
5
10
15
20
25
30
THE MARKET FORCES OF SUPPLY AND DEMAND
10
THE MARKET FORCES OF SUPPLY AND DEMAND
11
3
Demand Curve Shifters: Prices of Related Goods
Demand Curve Shifters: Prices of Related Goods
Two goods are substitutes if
Two goods are complements if an increase in the price of one causes a fall in demand for the other.
an increase in the price of one causes an increase in demand for the other.
Example: computers and software.
Example: pizza and hamburgers.
If price of computers rises, people buy fewer computers, and therefore less software. Software demand curve shifts left.
An increase in the price of pizza increases demand for hamburgers, shifting hamburger demand curve to the right.
Other examples: Coke and Pepsi,
Other examples: college tuition and textbooks,
laptops and desktop computers, CDs and music downloads
bagels and cream cheese, eggs and bacon
THE MARKET FORCES OF SUPPLY AND DEMAND
12
THE MARKET FORCES OF SUPPLY AND DEMAND
Demand Curve Shifters: Tastes
Demand Curve Shifters: Expectations
Anything that causes a shift in tastes toward a
Expectations affect consumers’ buying
13
decisions.
good will increase demand for that good and shift its D curve to the right.
Examples: If people expect their incomes to rise,
Example: The Atkins diet became popular in the ’90s, caused an increase in demand for eggs, shifted the egg demand curve to the right.
their demand for meals at expensive restaurants may increase now.
If the economy sours and people worry about their future job security, demand for new autos may fall now.
THE MARKET FORCES OF SUPPLY AND DEMAND
14
THE MARKET FORCES OF SUPPLY AND DEMAND
15
4
Summary: Variables That Influence Buyers Variable
ACTIVE LEARNING
Demand Curve
A change in this variable…
Draw a demand curve for music downloads. What happens to it in each of the following scenarios? Why?
Price
…causes a movement along the D curve
# of buyers
…shifts the D curve
Income
…shifts the D curve
A. The price of iPods falls
Price of related goods
…shifts the D curve
B. The price of music downloads falls
Tastes
…shifts the D curve
C. The price of CDs falls
Expectations
…shifts the D curve 16
THE MARKET FORCES OF SUPPLY AND DEMAND
ACTIVE LEARNING
1
P1
Q1
Q2
1
B. Price of music downloads falls 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.
D1
17
ACTIVE LEARNING
A. Price of iPods falls Price of music downloads
1
Price of music downloads
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
D2
D1 Q1
Quantity of music downloads 18
Q2
Quantity of music downloads 19
5
ACTIVE LEARNING
Supply
1
C. Price of CDs falls
The quantity supplied of any good is the 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.
Price of music downloads
P1
Q1
Law of supply: the claim that the quantity supplied of a good rises when the price of the good rises, other things equal
D1
D2 Q2
amount that sellers are willing and able to sell.
Quantity of music downloads 20
The Supply Schedule Supply schedule: A table that shows the relationship between the price of a good and the quantity supplied.
Example: Starbucks’ supply of lattes.
Notice that Starbucks’ supply schedule obeys the Law of Supply. THE MARKET FORCES OF SUPPLY AND DEMAND
21
THE MARKET FORCES OF SUPPLY AND DEMAND
Starbucks’ Supply Schedule & Curve
Price of lattes
Quantity of lattes supplied
$0.00
0
1.00
3
2.00
6
3.00
9
$3.00
3.00
9
4.00
12
$2.00
4.00
12
5.00
15
5.00
15
6.00
18
6.00
18
P $6.00 $5.00 $4.00
$1.00 $0.00
Quantity of lattes supplied
$0.00
0
1.00
3
2.00
6
Q 0
22
Price of lattes
5
10
15
THE MARKET FORCES OF SUPPLY AND DEMAND
23
6
Market Supply versus Individual Supply
The Market Supply Curve
The quantity supplied in the market is the sum of the quantities supplied by all sellers at each price.
P
Suppose Starbucks and Jitters are the only two (Qs
sellers in this market.
$6.00
= quantity supplied)
Starbucks
$0.00
0
+
0
=
0
1.00
3
+
2
=
5
Jitters
$0.00
0
1.00
5
2.00
10
$4.00
3.00
15
$3.00
4.00
20
5.00
25
6.00
30
2.00
6
+
4
=
10
$2.00
3.00
9
+
6
=
15
$1.00
4.00
12
+
8
=
20
$0.00
5.00
15
+
10
=
25
6.00
18
+
12
=
30
Q 0
24
Supply Curve Shifters
5
10 15
20 25 30
35
THE MARKET FORCES OF SUPPLY AND DEMAND
25
Supply Curve Shifters: Input Prices
The supply curve shows how price affects
Examples of input prices:
quantity supplied, other things being equal.
wages, prices of raw materials.
These “other things” are non-price determinants
A fall in input prices makes production
of supply.
more profitable at each output price, so firms supply a larger quantity at each price, and the S curve shifts to the right.
Changes in them shift the S curve…
THE MARKET FORCES OF SUPPLY AND DEMAND
QS (Market)
$5.00
Market Qs
Price
P
26
THE MARKET FORCES OF SUPPLY AND DEMAND
27
7
Supply Curve Shifters: Technology
Supply Curve Shifters: Input Prices Suppose the price of milk falls. At each price, the quantity of Lattes supplied will increase (by 5 in this example).
P $6.00 $5.00 $4.00 $3.00 $2.00
Technology determines how much inputs are required to produce a unit of output.
A cost-saving technological improvement has the same effect as a fall in input prices, shifts S curve to the right.
$1.00
Q
$0.00 0
5
10 15
20 25 30
35
THE MARKET FORCES OF SUPPLY AND DEMAND
28
Supply Curve Shifters: # of Sellers
THE MARKET FORCES OF SUPPLY AND DEMAND
29
Supply Curve Shifters: Expectations
An increase in the number of sellers increases
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.
the quantity supplied at each price, shifts S curve to the right.
In general, sellers may adjust supply* when their expectations of future prices change. (*If good not perishable) THE MARKET FORCES OF SUPPLY AND DEMAND
30
THE MARKET FORCES OF SUPPLY AND DEMAND
31
8
Summary: Variables that Influence Sellers Variable
ACTIVE LEARNING
Supply Curve
A change in this variable…
Price
…causes a movement along the S curve
Input Prices
…shifts the S curve
Technology
…shifts the S curve
# of Sellers
…shifts the S curve
Expectations
…shifts the S curve
2
Draw a supply curve for tax return preparation 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. C. Professional tax return preparers raise the price of the services they provide.
THE MARKET FORCES OF SUPPLY AND DEMAND
ACTIVE LEARNING
32
2
ACTIVE LEARNING
A. Fall in price of tax return software
Price of tax return software
S1
P1 P2
Q2 Q1
33
2
B. Fall in cost of producing the software
Price of tax return software
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.
S1
P1
Q1
Quantity of tax return software
S2
S S curve curve shifts shifts to to the the right: right: at at each each price, price, Q Q increases. increases.
Q2 Quantity of tax return software
34
35
9
ACTIVE LEARNING
Supply and Demand Together
3
C. Professional preparers raise their price Price of tax return software
P
S1
$6.00
This This shifts shifts the the demand curve for for demand curve tax tax preparation preparation software, software, not not the the supply supply curve. curve.
D
S
$5.00 $4.00 $3.00 $2.00
Equilibrium: P has reached the level where quantity supplied equals quantity demanded
$1.00 $0.00
Quantity of tax return software
Q 0
36
D
37
THE MARKET FORCES OF SUPPLY AND DEMAND
the price that equates quantity supplied with quantity demanded P
10 15 20 25 30 35
Equilibrium quantity:
Equilibrium price:
$6.00
5
the quantity supplied and quantity demanded at the equilibrium price P
S
D
S
P
QD
QS
$6.00
P
QD
QS
$5.00
$0
24
0
$5.00
$0
24
0
$4.00
1
21
5
$4.00
1
21
5
$3.00
2
18
10
$3.00
2
18
10
3
15
15
3
15
15
4
12
20
4
12
20
5
9
25
5
9
25
6
6
30
6
6
30
$2.00 $1.00 $0.00
Q 0
5
$2.00 $1.00 $0.00
10 15 20 25 30 35
THE MARKET FORCES OF SUPPLY AND DEMAND
Q 0
38
5
10 15 20 25 30 35
THE MARKET FORCES OF SUPPLY AND DEMAND
39
10
Surplus (a.k.a. excess supply):
Surplus (a.k.a. excess supply):
when quantity supplied is greater than quantity demanded P $6.00
D
Surplus
when quantity supplied is greater than quantity demanded P
Example: If P = $5,
S
$5.00 $4.00 $3.00 $2.00 $1.00 $0.00
$6.00
then QD = 9 lattes
$5.00
and QS = 25 lattes
$3.00
resulting in a surplus of 16 lattes
$1.00
5
This causes QD to rise and QS to fall… …which reduces the surplus. Q 0
40
D
$5.00 $4.00 $3.00 $2.00 $1.00
Surplus
S
5
P $6.00
S
D
$5.00
This causes QD to rise and QS to fall.
$4.00
Prices continue to fall until market reaches equilibrium.
$2.00
$3.00
$1.00 $0.00
10 15 20 25 30 35
THE MARKET FORCES OF SUPPLY AND DEMAND
41
when quantity demanded is greater than quantity supplied
Q 0
10 15 20 25 30 35
Shortage (a.k.a. excess demand):
Facing a surplus, sellers try to increase sales by cutting price.
$0.00
5
THE MARKET FORCES OF SUPPLY AND DEMAND
when quantity supplied is greater than quantity demanded P
Facing a surplus, sellers try to increase sales by cutting price.
$0.00
Surplus (a.k.a. excess supply):
$6.00
S
$2.00
10 15 20 25 30 35
THE MARKET FORCES OF SUPPLY AND DEMAND
Surplus
$4.00
Q 0
D
Shortage 0
42
5
Example: If P = $1, then QD = 21 lattes and QS = 5 lattes resulting in a shortage of 16 lattes Q
10 15 20 25 30 35
THE MARKET FORCES OF SUPPLY AND DEMAND
43
11
Shortage (a.k.a. excess demand):
Shortage (a.k.a. excess demand):
when quantity demanded is greater than quantity supplied P $6.00
S
D
$5.00
when quantity demanded is greater than quantity supplied P
Facing a shortage, sellers raise the price,
$6.00 $5.00
causing QD to fall and QS to rise, …which reduces the shortage.
$4.00 $3.00 $2.00 $1.00
$3.00
5
Prices continue to rise until market reaches equilibrium.
$2.00 $1.00
10 15 20 25 30 35
THE MARKET FORCES OF SUPPLY AND DEMAND
Shortage
$0.00
Q 0
Facing a shortage, sellers raise the price, causing QD to fall and QS to rise.
$4.00
Shortage
$0.00
S
D
Q 0
44
Three Steps to Analyzing Changes in Eq’m
5
10 15 20 25 30 35
EXAMPLE: The Market for Hybrid Cars P
price of hybrid cars
To To determine determine the the effects effects of of any any event, event,
45
THE MARKET FORCES OF SUPPLY AND DEMAND
S1
1. 1. Decide Decide whether whether event event shifts shiftsSScurve, curve,
DDcurve, curve, or or both. both.
P1
2. 2. Decide Decide in in which which direction direction curve curve shifts. shifts. 3. 3. Use Use supply-demand supply-demand diagram diagram to tosee see
D1
how howthe the shift shiftchanges changes eq’m eq’mPP and and Q. Q. Q1
Q quantity of hybrid cars
THE MARKET FORCES OF SUPPLY AND DEMAND
46
THE MARKET FORCES OF SUPPLY AND DEMAND
47
12
EXAMPLE 1:
A Shift in Demand
EVENT TO BE ANALYZED:
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, because more attractiveprice increase in price of gas does not relative to other cars. and quantity affect cost of of hybrid cars. producing hybrids.
S1
P2 P1
D1
Q
THE MARKET FORCES OF SUPPLY AND DEMAND
P S1 P2 P1
Always be careful to distinguish b/w a shift in a curve and a movement along the curve.
D2
Q1 Q2
48
Terms for Shift vs. Movement Along Curve Change in supply: a shift in the S curve occurs when a non-price determinant of supply changes (like technology or costs)
Change in the quantity supplied:
D2
D1
Q
Q1 Q2
49
THE MARKET FORCES OF SUPPLY AND DEMAND
EXAMPLE 2:
A Shift in Supply
EVENT: New technology P reduces cost of producing hybrid cars.
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.
a movement along a fixed S curve occurs when P changes
Change in demand: a shift in the D curve occurs when a non-price determinant of demand changes (like income or # of buyers)
Change in the quantity demanded: a movement along a fixed D curve occurs when P changes
A Shift in Demand
Notice: When P rises, producers supply a larger quantity of hybrids, even though the S curve has not shifted.
P
Increase in price of gas. STEP 1:
EXAMPLE 1:
50
D1 Q1 Q2
THE MARKET FORCES OF SUPPLY AND DEMAND
Q
51
13
EXAMPLE 3:
A Shift in Both Supply and Demand
EVENTS: price of gas rises AND new technology reduces production costs STEP 1:
Both curves shift.
EXAMPLE 3:
EVENTS: price of gas rises AND new technology reduces production costs
P S1
S2
P2
STEP 3, cont.
P1
But if supply increases more than demand, P falls.
STEP 2:
Both shift to the right. STEP 3:
D1
Q rises, but effect on P is ambiguous: If demand increases more than supply, P rises.
Q1
Q2
D2
P S1
P1
D1 Q1
52
3
D2 Q
Q2
53
THE MARKET FORCES OF SUPPLY AND DEMAND
ACTIVE LEARNING
Shifts in supply and demand
S2
P2
Q
THE MARKET FORCES OF SUPPLY AND DEMAND
ACTIVE LEARNING
A Shift in Both Supply and Demand
3
A. Fall in price of CDs
Use the three-step method to analyze the effects of each event on the equilibrium price and quantity of music downloads.
STEPS P
1. D curve shifts
Event A: A fall in the price of CDs
2. D shifts left
Event B: Sellers of music downloads negotiate a reduction in the royalties they must pay for each song they sell.
3. P and Q both fall.
The market for music downloads S1
P1 P2
Event C: Events A and B both occur.
D2 Q2 Q1 54
D1 Q 55
14
ACTIVE LEARNING
3
ACTIVE LEARNING
STEPS
1. S curve shifts (Royalties are part 2. S shifts right of sellers’ costs) P1 3. P falls, P2 Q rises.
P
The market for music downloads S1
3
C. Fall in price of CDs and fall in cost of royalties
B. Fall in cost of royalties
STEPS STEPS
S2
1. 1. Both Both curves curves shift shift (see (see parts parts AA && B). B). 2. 2. D D shifts shifts left, left, SS shifts shifts right. right. 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 the increase increase in in supply supply increases increases Q. Q.
D1 Q1 Q2
Q 56
CONCLUSION:
57
CHAPTER SUMMARY
How Prices Allocate Resources One of the Ten Principles from Chapter 1:
A competitive market has many buyers and sellers,
Markets are usually a good way to organize economic activity.
each of whom has little or no influence on the market price.
In market economies, prices adjust to balance
Economists use the supply and demand model to
supply and demand. These equilibrium prices are the signals that guide economic decisions and thereby allocate scarce resources.
analyze competitive markets.
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.
THE MARKET FORCES OF SUPPLY AND DEMAND
58
59
15
CHAPTER SUMMARY
CHAPTER SUMMARY
Besides price, demand depends on buyers’ incomes,
The intersection of S and D curves determines the
tastes, expectations, the prices of substitutes and complements, and number of buyers. If one of these factors changes, the D curve shifts.
market equilibrium. At the equilibrium price, quantity supplied equals quantity demanded.
If the market price is above equilibrium,
The upward-sloping supply curve reflects the Law of
a surplus results, which causes the price to fall. If the market price is below equilibrium, a shortage results, causing the price to rise.
Supply, which states that the quantity sellers supply depends positively on the good’s price.
Other determinants of supply include input prices, technology, expectations, and the # of sellers. Changes in these factors shift the S curve. 60
61
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.
In market economies, prices are the signals that guide economic decisions and allocate scarce resources. 62
16
