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ECON 151 – PRINCIPLES OF MACROECONOMICS Chapter 3: Demand and Supply Materials include content from Pearson Addison-Wesley which has been modified by the instructor and displayed with permission of the publisher. All rights reserved. Markets • Markets – Arrangements that individuals have for exchanging with one another – Represent the interaction of buyers and sellers 2 Markets • Markets – Markets for gasoline – Markets for labor – Stock market – Market for Super Bowl tickets – Compact disk market 3 Markets • Markets – Markets set the prices we pay and receive in a free, competitive environment 4 The Law of Demand • Demand – Quantities of specific goods or services that individuals, taken singly or as a group, will purchase at various possible prices, other things being constant 5 The Law of Demand • Law of Demand – Quantity demanded is inversely related to price, all things equal 6 The Law of Demand • What are we holding constant? – Income – Price of other goods – Many other factors 7 The Law of Demand • Relative prices versus money prices – Relative Price • The price of a commodity in terms of another commodity – Money Price • Price we observe today in today’s dollars (absolute, nominal price) 8 The Demand Schedule • The demand schedule is a table relating prices to quantity demanded. • We must consider: – The time dimension – Constant-quality units 9 The Individual Demand Schedule 10 Figure 3-1, Panel (a) The Individual Demand Curve 11 Figure 3-1, Panel (b) The Horizontal Summation of Two Demand Schedules 12 Figure 3-2, Panel (a) The Horizontal Summation of Two Demand Schedules 13 Figure 3-2, Panels (b), (c), (d) The Market Demand Schedule for Rewritable CD’s 14 Figure 3-3, Panel (a) The Market Demand Curve for Rewritable CD’s 15 Figure 3-3, Panel (b) Price per Rewritable CD ($) A Shift in the Demand Curve 5 Suppose the federal government gives every student a rewritable CD drive. 4 3 Increase in Demand 2 1 D1 0 D2 2 4 6 8 10 12 14 Quantity of Rewritable CDs Demanded (millions of constant-quality units per year) 16 Figure 3-4 Price per Rewritable CD ($) A Shift in the Demand Curve 5 Decrease in Demand Suppose universities prohibit the use of personal computers. 4 3 2 D2 1 D3 0 D1 2 4 6 8 10 12 14 Quantity of Rewritable CDs Demanded (millions of constant-quality units per year) 17 Figure 3-4 Price per Rewritable CD ($) A Shift in the Demand Curve When demand increases the quantity demanded will be greater at each price 5 4 3 2 b a d c 1 D1 0 D2 2 4 6 8 10 12 14 Quantity of Rewritable CDs Demanded (millions of constant-quality units per year) 18 Figure 3-4 Shifts in Demand • Determinants of demand – Income • Normal goods • Inferior goods – Tastes and preferences – The price of related goods • Complements • Substitutes 19 Shifts in Demand • Determinants of demand – Expectations • Income • Future prices – Market size (number of buyers) 20 Shifts in Demand The Determinants of Demand Income: Normal Good Price Increase in income increases demand Decrease in income decreases demand D3 D1 D2 Q/Units 21 Shifts in Demand The Determinants of Demand Income: Inferior Good Price Decrease in income increases demand Increase in income decreases demand D3 D1 D2 Q/Units 22 Shifts in Demand The Determinants of Demand Income: Tastes and Preferences Price Sport Utility Vehicle • Increase in demand Smoking • Decrease in demand D3 D1 D2 Q/Units 23 Shifts in Demand The Determinants of Demand Price of Related Goods: Substitutes Price Butter and Margarine • Price of both = $2/lb. • Price of margarine increases to $3/lb. • Demand for butter increases D1 D2 Q/Butter 24 Shifts in Demand The Determinants of Demand Price of Related Goods: Complements Price Speakers and Amplifiers • Decrease the relative price of amplifiers • Demand for speakers increases Speakers and Amplifiers • Increase the relative price of amplifiers • Demand for speakers decreases D3 D1 D2 Q/Speakers 25 Shifts in Demand The Determinants of Demand Expectations Price A higher income or expectations of a higher future price will increase demand A lower income or expectations of a lower future price will decrease demand D3 D1 D2 Q/Units 26 Shifts in Demand The Determinants of Demand Population Price Increase in the population increases demand Decrease in population decreases demand D3 D1 D2 Q/Units 27 Shifts in Demand • Changes in demand versus changes in quantity demanded – A change in one or more of the non-price determinants (income, tastes, etc.) will lead to a change in demand. – This is a shift of the whole curve. 28 Shifts in Demand • Changes in demand versus changes in quantity demanded – A change in a good’s own price leads to a change in quantity demanded. – This is a movement along the same curve. 29 Price of Rewritable CDs($) Movement Along a Given Demand Curve 5 4 3 A change in the price changes the quantity of a good demanded 2 1 D 0 Figure 3-5 2 4 6 8 10 12 Quantity of Rewritable CDs Demanded (millions of constant-quality units per year) 30 The Law of Supply • Supply – The amount of a product or service that firms are willing to sell at alternative prices 31 The Law of Supply • Law of Supply – The price of a product or service and the quantity supplied are directly related 32 The Supply Schedule • The supply schedule is a table relating prices to quantity supplied. 33 The Individual Producer’s Supply Schedule 34 Figure 3-6, Panel (a) The Individual Producer’s Supply Curve 35 Figure 3-6, Panel (b) Horizontal Summation of Supply Curves 36 Figure 3-7, Panel (a) Horizontal Summation of Supply Curves 37 Figure 3-7, Panels (b), (c), (d) The Market Supply Schedule for Rewritable CDs 38 Figure 3-8, Panel (a) The Market Supply Curve for Rewritable CDs 39 Figure 3-8, Panel (b) Shifts in Supply • In general, non-price changes that lead to higher profits lead to an increase in supply. • In general, non-price changes that lead to lower profits lead to a decrease in supply. 40 Shifts in Supply • Determinants of supply – Cost of inputs – Technology and productivity – Taxes and subsidies – Price expectations – Number of firms in industry 41 Shifts in Supply The Determinants of Supply Cost of Inputs Price Increase in cost decreases supply S3 S1 S2 Decrease in cost increases supply Q/Units 42 Shifts in Supply 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 43 Shifts in Supply 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 44 Shifts in Supply 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 45 Shifts in Supply 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 46 Shifts in Supply • 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. – This is a shift of the whole curve. 47 Shifts in Supply • Changes in supply versus changes in quantity supplied – A change in a good’s own price leads to a change in quantity supplied. – This is a movement along the same curve. 48 Putting Demand and Supply Together 49 Figure 3-10, Panel (a) Price per Rewritable CD($) Putting Demand and Supply Together S 5 4 Shortage • At P = $1: Qs (A) = 2 < Qd (B) = 10 • All prices below $3 Qd > Qs • Price will be pushed up 3 2 A 1 B D Excess quantity demanded at price $1 0 2 4 6 8 10 12 Quantity of Rewritable CDs (millions of constant-quality units per year) 50 Figure 3-10, Panel (b) Putting Demand and Supply Together Price per Rewritable CD($) Excess quantity supplied at price $5 5 S D 4 Surplus • At P = $5: Qd (D) = 2 < Qs (C) = 10 • All prices above $3 Qd < Qs • Price will be pushed down 3 2 1 D 0 Figure 3-10, Panel (b) 2 4 6 8 10 12 Quantity of Rewritable CDs (millions of constant-quality units per year) 51 Putting Demand and Supply Together Price per Rewritable CD($) Excess quantity supplied at price $5 5 S D 4 E 3 Equilibrium Market clearing, or equilibrium price 2 1 A B D Excess quantity demanded at price $1 0 Figure 3-10, Panel (b) 2 4 6 8 10 12 Quantity of Rewritable CDs (millions of constant-quality units per year) 52 Putting Demand and Supply Together • Equilibrium – The situation when quantity supplied equals quantity demanded at a particular price 53 Putting Demand and Supply Together • Shortages – The situation when quantity demanded is greater than quantity supplied – Exists at any price below the equilibrium price – Is not the same as scarcity 54 Putting Demand and Supply Together • Surpluses – The situation when quantity supplied is greater than quantity demanded – Exists at any price above the equilibrium price 55 Should Shortages in the Ticket Market Be Solved by Scalpers? Price per Ticket S P2 P1 Excess quantity demanded (shortage at price P1) Q1 Figure 3-11 D Q2 Quantity of Super Bowl Tickets 56 ECON 151 – PRINCIPLES OF MACROECONOMICS Chapter 3: Demand and Supply Materials include content from Pearson Addison-Wesley which has been modified by the instructor and displayed with permission of the publisher. All rights reserved.