The Market Forces of Supply and Demand



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The Market Forces of Supply and Demand

  • Microeonomics
  • P R I N C I P L E S O F
  • N. Gregory Mankiw
  • Premium PowerPoint Slides by Ron Cronovich
  • 4

In this chapter, look for the answers to these questions:

  • What factors affect buyers’ demand for goods?
  • What factors affect sellers’ supply of goods?
  • How do supply and demand determine the price of a good and the quantity sold?
  • How do changes in the factors that affect demand or supply affect the market price and quantity of a good?
  • How do markets allocate resources?

Markets and Competition

  • THE MARKET FORCES OF SUPPLY AND DEMAND
  • A market is a group of buyers and sellers of a particular product.
  • A competitive market is one with many buyers and sellers, each has a negligible effect on price.
  • 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.
  • 0

Demand

  • THE MARKET FORCES OF SUPPLY AND DEMAND
  • The quantity demanded of any good is the amount of the good that buyers are willing and able to purchase.
  • Law of demand: the claim that the quantity demanded of a good falls when the price of the good rises, other things equal
  • 0

The Demand Schedule

  • THE MARKET FORCES OF SUPPLY AND DEMAND
  • Demand schedule: a table that shows the relationship between the price of a good and the quantity demanded
  • Example: Helen’s demand for lattes.
  • Quantity of lattes demanded
  • $0.00
  • 16
  • 1.00
  • 14
  • 2.00
  • 12
  • 3.00
  • 10
  • 4.00
  • 8
  • 5.00
  • 6
  • 6.00
  • 4
  • Notice that Helen’s preferences obey the Law of Demand.
  • 0

Helen’s Demand Schedule & Curve

  • THE MARKET FORCES OF SUPPLY AND DEMAND
  • Price of Lattes
  • Quantity of Lattes
  • Price of lattes
  • Quantity of lattes demanded
  • $0.00
  • 16
  • 1.00
  • 14
  • 2.00
  • 12
  • 3.00
  • 10
  • 4.00
  • 8
  • 5.00
  • 6
  • 6.00
  • 4
  • 0

Market Demand versus Individual Demand

  • The quantity demanded in the market is the sum of the quantities demanded by all buyers at each price.
  • Suppose Helen and Ken are the only two buyers in the Latte market. (Qd = quantity demanded)
  • 4
  • 6
  • 8
  • 10
  • 12
  • 14
  • 16
  • Helen’s Qd
  • 2
  • 3
  • 4
  • 5
  • 6
  • 7
  • 8
  • Ken’s Qd
  • +
  • +
  • +
  • +
  • =
  • =
  • =
  • =
  • 6
  • 9
  • 12
  • 15
  • +
  • =
  • 18
  • +
  • =
  • 21
  • +
  • =
  • 24
  • Market Qd
  • $0.00
  • 6.00
  • 5.00
  • 4.00
  • 3.00
  • 2.00
  • 1.00
  • Price
  • 0

The Market Demand Curve for Lattes

  • THE MARKET FORCES OF SUPPLY AND DEMAND
  • P
  • Q
  • P
  • Qd (Market)
  • $0.00
  • 24
  • 1.00
  • 21
  • 2.00
  • 18
  • 3.00
  • 15
  • 4.00
  • 12
  • 5.00
  • 9
  • 6.00
  • 6
  • 0

Demand Curve Shifters

  • THE MARKET FORCES OF SUPPLY AND DEMAND
  • 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…
  • 0

Demand Curve Shifters: # of Buyers

  • THE MARKET FORCES OF SUPPLY AND DEMAND
  • Increase in # of buyers increases quantity demanded at each price, shifts D curve to the right.
  • 0

Demand Curve Shifters: # of Buyers

  • THE MARKET FORCES OF SUPPLY AND DEMAND
  • P
  • Q
  • Suppose the number of buyers increases.
  • Then, at each P, Qd will increase (by 5 in this example).
  • 0

Demand Curve Shifters: Income

  • THE MARKET FORCES OF SUPPLY AND DEMAND
  • Demand for a normal good is positively related to income.
    • Increase in income causes increase in quantity demanded at each price, shifts D 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.)
  • 0

Demand Curve Shifters: Prices of Related Goods

  • THE MARKET FORCES OF SUPPLY AND DEMAND
  • Two goods are substitutes if an increase in the price of one causes an increase in demand for the other.
  • Example: pizza and hamburgers. An increase in the price of pizza increases demand for hamburgers, shifting hamburger demand curve to the right.
  • Other examples: Coke and Pepsi, laptops and desktop computers, CDs and music downloads
  • 0

Demand Curve Shifters: Prices of Related Goods

  • THE MARKET FORCES OF SUPPLY AND DEMAND
  • Two goods are complements if an increase in the price of one causes a fall in demand for the other.
  • Example: computers and software. 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
  • 0

Demand Curve Shifters: Tastes

  • THE MARKET FORCES OF SUPPLY AND DEMAND
  • Anything that causes a shift in tastes toward a good will increase demand for that good and shift its D curve to the right.
  • Example: The Atkins diet became popular in the ’90s, caused an increase in demand for eggs, shifted the egg demand curve to the right.
  • 0

Demand Curve Shifters: Expectations

  • THE MARKET FORCES OF SUPPLY AND DEMAND
  • Expectations affect consumers’ buying decisions.
  • Examples:
    • If people expect their incomes to rise, 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.
  • 0

Summary: Variables That Influence Buyers

  • THE MARKET FORCES OF SUPPLY AND DEMAND
  • Variable A change in this variable…
  • Price …causes a movement along the D curve
  • # 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
  • 0

A C T I V E L E A R N I N G 1 Demand Curve

  • A. The price of iPods falls
  • B. The price of music downloads falls
  • C. The price of CDs falls
  • Draw a demand curve for music downloads. What happens to it in each of the following scenarios? Why?

A C T I V E L E A R N I N G 1 A. Price of iPods falls

  • Q2
  • Price of music down-loads
  • Quantity of music downloads
  • D1
  • D2
  • P1
  • Q1
  • Music downloads and iPods are complements.
  • A fall in price of iPods shifts the demand curve for music downloads to the right.

A C T I V E L E A R N I N G 1 B. Price of music downloads falls

  • The D curve does not shift.
  • Move down along curve to a point with lower P, higher Q.
  • Price of music down-loads
  • Quantity of music downloads
  • D1
  • P1
  • Q1
  • Q2
  • P2

A C T I V E L E A R N I N G 1 C. Price of CDs falls

  • P1
  • Q1
  • CDs and music downloads are substitutes.
  • A fall in price of CDs shifts demand for music downloads to the left.
  • Price of music down-loads
  • Quantity of music downloads
  • D1
  • D2
  • Q2

Supply

  • THE MARKET FORCES OF SUPPLY AND DEMAND
  • The quantity supplied of any good is the 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
  • 0

The Supply Schedule

  • THE MARKET FORCES OF SUPPLY AND DEMAND
  • 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.
  • 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
  • 0

Starbucks’ Supply Schedule & Curve

  • THE MARKET FORCES OF SUPPLY AND DEMAND
  • 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
  • P
  • Q
  • 0

Market Supply versus Individual Supply

  • 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. (Qs = quantity supplied)
  • 18
  • 15
  • 12
  • 9
  • 6
  • 3
  • 0
  • Starbucks
  • 12
  • 10
  • 8
  • 6
  • 4
  • 2
  • 0
  • Jitters
  • +
  • +
  • +
  • +
  • =
  • =
  • =
  • =
  • 30
  • 25
  • 20
  • 15
  • +
  • =
  • 10
  • +
  • =
  • 5
  • +
  • =
  • 0
  • Market Qs
  • $0.00
  • 6.00
  • 5.00
  • 4.00
  • 3.00
  • 2.00
  • 1.00
  • Price
  • 0
  • THE MARKET FORCES OF SUPPLY AND DEMAND
  • P
  • Q
  • The Market Supply Curve
  • P
  • QS (Market)
  • $0.00
  • 0
  • 1.00
  • 5
  • 2.00
  • 10
  • 3.00
  • 15
  • 4.00
  • 20
  • 5.00
  • 25
  • 6.00
  • 30
  • 0

Supply Curve Shifters

  • THE MARKET FORCES OF SUPPLY AND DEMAND
  • 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…
  • 0

Supply Curve Shifters: Input Prices

  • THE MARKET FORCES OF SUPPLY AND DEMAND
  • Examples of input prices: wages, prices of raw materials.
  • A fall in input prices makes production more profitable at each output price, so firms supply a larger quantity at each price, and the S curve shifts to the right.
  • 0
  • THE MARKET FORCES OF SUPPLY AND DEMAND
  • P
  • Q
  • Suppose the price of milk falls.
  • At each price, the quantity of Lattes supplied will increase (by 5 in this example).
  • Supply Curve Shifters: Input Prices
  • 0

Supply Curve Shifters: Technology

  • THE MARKET FORCES OF SUPPLY AND DEMAND
  • 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.
  • 0

Supply Curve Shifters: # of Sellers

  • THE MARKET FORCES OF SUPPLY AND DEMAND
  • An increase in the number of sellers increases the quantity supplied at each price,
  • shifts S curve to the right.
  • 0

Supply Curve Shifters: Expectations

  • THE MARKET FORCES OF SUPPLY AND DEMAND
  • 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.
  • In general, sellers may adjust supply* when their expectations of future prices change. (*If good not perishable)
  • 0

Summary: Variables that Influence Sellers

  • THE MARKET FORCES OF SUPPLY AND DEMAND
  • Variable 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
  • 0

A C T I V E L E A R N I N G 2 Supply Curve

  • 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.

A C T I V E L E A R N I N G 2 A. Fall in price of tax return software

  • S curve does not shift.
  • Move down along the curve to a lower P and lower Q.
  • Price of tax return software
  • Quantity of tax return software
  • S1
  • P1
  • Q1
  • Q2
  • P2

A C T I V E L E A R N I N G 2 B. Fall in cost of producing the software

  • S curve shifts to the right:
  • at each price, Q increases.
  • Price of tax return software
  • Quantity of tax return software
  • S1
  • P1
  • Q1
  • S2
  • Q2

A C T I V E L E A R N I N G 3 C. Professional preparers raise their price

  • This shifts the demand curve for tax preparation software, not the supply curve.
  • Price of tax return software
  • Quantity of tax return software
  • S1

Supply and Demand Together

  • THE MARKET FORCES OF SUPPLY AND DEMAND
  • P
  • Q
  • D
  • S
  • 0

Equilibrium price:

  • THE MARKET FORCES OF SUPPLY AND DEMAND
  • D
  • S
  • P
  • Q
  • P
  • QD
  • QS
  • $0
  • 24
  • 0
  • 1
  • 21
  • 5
  • 2
  • 18
  • 10
  • 3
  • 15
  • 15
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  • 12
  • 20
  • 5
  • 9
  • 25
  • 6
  • 6
  • 30
  • the price that equates quantity supplied with quantity demanded
  • 0

Equilibrium quantity:

  • THE MARKET FORCES OF SUPPLY AND DEMAND
  • D
  • S
  • P
  • Q
  • P
  • QD
  • QS
  • $0
  • 24
  • 0
  • 1
  • 21
  • 5
  • 2
  • 18
  • 10
  • 3
  • 15
  • 15
  • 4
  • 12
  • 20
  • 5
  • 9
  • 25
  • 6
  • 6
  • 30
  • the quantity supplied and quantity demanded at the equilibrium price
  • 0

Surplus (a.k.a. excess supply):

  • THE MARKET FORCES OF SUPPLY AND DEMAND
  • P
  • Q
  • D
  • S
  • when quantity supplied is greater than quantity demanded
  • Surplus
  • Example: If P = $5,
  • then QD = 9 lattes
  • and QS = 25 lattes
  • resulting in a surplus of 16 lattes
  • 0

Surplus (a.k.a. excess supply):

  • THE MARKET FORCES OF SUPPLY AND DEMAND
  • P
  • Q
  • D
  • S
  • when quantity supplied is greater than quantity demanded
  • Facing a surplus, sellers try to increase sales by cutting price.
  • This causes QD to rise
  • Surplus
  • …which reduces the surplus.
  • and QS to fall…
  • 0

Surplus (a.k.a. excess supply):

  • THE MARKET FORCES OF SUPPLY AND DEMAND
  • P
  • Q
  • D
  • S
  • when quantity supplied is greater than quantity demanded
  • Facing a surplus, sellers try to increase sales by cutting price.
  • This causes QD to rise and QS to fall.
  • Surplus
  • Prices continue to fall until market reaches equilibrium.
  • 0

Shortage (a.k.a. excess demand):

  • THE MARKET FORCES OF SUPPLY AND DEMAND
  • P
  • Q
  • D
  • S
  • when quantity demanded is greater than quantity supplied
  • Example: If P = $1,
  • then QD = 21 lattes
  • and QS = 5 lattes
  • resulting in a shortage of 16 lattes
  • Shortage
  • 0

Shortage (a.k.a. excess demand):

  • THE MARKET FORCES OF SUPPLY AND DEMAND
  • P
  • Q
  • D
  • S
  • when quantity demanded is greater than quantity supplied
  • Facing a shortage, sellers raise the price,
  • causing QD to fall
  • …which reduces the shortage.
  • and QS to rise,
  • Shortage
  • 0

Shortage (a.k.a. excess demand):

  • THE MARKET FORCES OF SUPPLY AND DEMAND
  • P
  • Q
  • D
  • S
  • when quantity demanded is greater than quantity supplied
  • Facing a shortage, sellers raise the price,
  • causing QD to fall
  • and QS to rise.
  • Shortage
  • Prices continue to rise until market reaches equilibrium.
  • 0

Three Steps to Analyzing Changes in Eq’m

  • THE MARKET FORCES OF SUPPLY AND DEMAND
  • To determine the effects of any event,
    • 1. Decide whether event shifts S curve, D curve, or both.
    • 2. Decide in which direction curve shifts.
    • 3. Use supply-demand diagram to see how the shift changes eq’m P and Q.

EXAMPLE: The Market for Hybrid Cars

  • THE MARKET FORCES OF SUPPLY AND DEMAND
  • P
  • Q
  • D1
  • S1
  • P1
  • Q1
  • price of hybrid cars
  • quantity of hybrid cars

EXAMPLE 1: A Shift in Demand

  • THE MARKET FORCES OF SUPPLY AND DEMAND
  • STEP 1:
  • D curve shifts because price of gas affects demand for hybrids.
  • S curve does not shift, because price of gas does not affect cost of producing hybrids.
  • STEP 2:
  • D shifts right because high gas price makes hybrids more attractive relative to other cars.
  • EVENT TO BE ANALYZED: Increase in price of gas.
  • P
  • Q
  • D1
  • S1
  • P1
  • Q1
  • D2
  • P2
  • Q2
  • STEP 3:
  • The shift causes an increase in price and quantity of hybrid cars.

EXAMPLE 1: A Shift in Demand

  • THE MARKET FORCES OF SUPPLY AND DEMAND
  • P
  • Q
  • D1
  • S1
  • P1
  • Q1
  • D2
  • P2
  • Q2
  • Notice: When P rises, producers supply a larger quantity of hybrids, even though the S curve has not shifted.
  • Always be careful to distinguish b/w a shift in a curve and a movement along the curve.

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: 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

EXAMPLE 2: A Shift in Supply

  • THE MARKET FORCES OF SUPPLY AND DEMAND
  • STEP 1:
  • S curve shifts because event affects cost of production.
  • D curve does not shift, because production technology is not one of the factors that affect demand.
  • STEP 2:
  • S shifts right because event reduces cost, makes production more profitable at any given price.
  • P
  • Q
  • D1
  • S1
  • P1
  • Q1
  • S2
  • P2
  • Q2
  • EVENT: New technology reduces cost of producing hybrid cars.
  • STEP 3:
  • The shift causes price to fall and quantity to rise.

EXAMPLE 3: A Shift in Both Supply and Demand

  • THE MARKET FORCES OF SUPPLY AND DEMAND
  • P
  • Q
  • D1
  • S1
  • P1
  • Q1
  • S2
  • D2
  • P2
  • Q2
  • EVENTS: price of gas rises AND new technology reduces production costs
  • STEP 1:
  • Both curves shift.
  • STEP 2:
  • Both shift to the right.
  • STEP 3:
  • Q rises, but effect on P is ambiguous:
  • If demand increases more than supply, P rises.

EXAMPLE 3: A Shift in Both Supply and Demand

  • THE MARKET FORCES OF SUPPLY AND DEMAND
  • STEP 3, cont.
  • P
  • Q
  • D1
  • S1
  • P1
  • Q1
  • S2
  • D2
  • P2
  • Q2
  • EVENTS: price of gas rises AND new technology reduces production costs
  • But if supply increases more than demand, P falls.

A C T I V E L E A R N I N G 3 Shifts in supply and demand

  • Use the three-step method to analyze the effects of each event on the equilibrium price and quantity of music downloads.
    • Event A: A fall in the price of CDs
    • Event B: Sellers of music downloads negotiate a reduction in the royalties they must pay for each song they sell.
    • Event C: Events A and B both occur.

A C T I V E L E A R N I N G 3 A. Fall in price of CDs

  • 2. D shifts left
  • P
  • Q
  • D1
  • S1
  • P1
  • Q1
  • D2
  • The market for music downloads
  • P2
  • Q2
  • 1. D curve shifts
  • 3. P and Q both fall.
  • STEPS

A C T I V E L E A R N I N G 3 B. Fall in cost of royalties

  • P
  • Q
  • D1
  • S1
  • P1
  • Q1
  • S2
  • The market for music downloads
  • Q2
  • P2
  • 1. S curve shifts
  • 2. S shifts right
  • 3. P falls, Q rises.
  • STEPS
  • (Royalties are part of sellers’ costs)

A C T I V E L E A R N I N G 3 C. Fall in price of CDs and fall in cost of royalties

  • STEPS
  • 1. Both curves shift (see parts A & B).
  • 2. D shifts left, S shifts right.
  • 3. P unambiguously falls.
  • Effect on Q is ambiguous: The fall in demand reduces Q, the increase in supply increases Q.

CONCLUSION: How Prices Allocate Resources

  • THE MARKET FORCES OF SUPPLY AND DEMAND
  • One of the Ten Principles from Chapter 1: Markets are usually a good way to organize economic activity.
  • In market economies, prices adjust to balance supply and demand. These equilibrium prices are the signals that guide economic decisions and thereby allocate scarce resources.

CHAPTER SUMMARY

  • A competitive market has many buyers and sellers, each of whom has little or no influence on the market price.
  • Economists use the supply and demand model to 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.

CHAPTER SUMMARY

  • Besides price, demand depends on buyers’ incomes, tastes, expectations, the prices of substitutes and complements, and number of buyers. If one of these factors changes, the D curve shifts.
  • The upward-sloping supply curve reflects the Law of 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.

CHAPTER SUMMARY

  • The intersection of S and D curves determines 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.

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.

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