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Chapter 4
SUPPLY
AND
DEMAND
McGraw-Hill/Irwin
Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved.
4-2
Today’s lecture will:
• Introduce the law of demand and draw a
•
•
•
demand curve.
Explain the importance of substitution to
the laws of supply and demand.
Distinguish between a change in
demand (shift in the curve) and a change
in quantity demanded (movement along
the demand curve).
Explain the law of supply and construct
a supply curve.
McGraw-Hill/Irwin
Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved.
4-3
Today’s lecture will:
•
•
•
•
Distinguish between a change in supply (shift
in the curve) and a change in quantity supplied
(movement along the supply curve).
Explain how the laws of supply and demand
interact to bring about equilibrium.
Show the effect of shifts in demand and supply
on equilibrium price and quantity.
Explore the limitations of demand and supply
analysis.
McGraw-Hill/Irwin
Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved.
4-4
The Law of Demand
• Law of demand – there is an inverse
•
relationship between price and quantity
demanded.
Other things equal:
 Quantity demanded rises as price falls
 Quantity demanded falls as price rises
• Law of demand is based on the fact that
people substitute for goods whose price
increases.
McGraw-Hill/Irwin
Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved.
4-5
The Demand Curve
•
The demand curve
is the graphic
representation of
the law of demand.
The demand curve
slopes downward
and to the right.
PB
Price (per unit)
•
B
A
PA
D
0
QB
QA
Quantity demanded
(per unit of time)
McGraw-Hill/Irwin
Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved.
4-6
Change in quantity
demanded
$2
B
A
$1
0
Price (per 50 miles)
Price (per 50 miles)
Quantity Demanded
Versus Demand
Change in
demand
$2
B
$1
D0
D1
100
175
200
Cars (per mile each hour)
McGraw-Hill/Irwin
A
D1
200
Cars (per mile each hour)
Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved.
4-7
Shift Factors of Demand
• Shift factors of demand are factors
•
•
•
•
•
that cause changes in demand (shifts
in the demand curve).
Society’s Income
Prices of Other Goods
Tastes
Expectations
Taxes and Subsidies
McGraw-Hill/Irwin
Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved.
4-8
A Demand Table
Price per
DVD
A
B
C
D
E
$0.50
1.00
2.00
3.00
4.00
McGraw-Hill/Irwin
DVD rentals
demanded
per week
9
8
6
4
2
Price per DVDs (in dollars)
From a Demand Table
to a Demand Curve
$6.00
A Demand Curve
5.00
4.00
3.50
3.00
2.00
1.00
.50
0
E
D
G
Demand
for DVDs
C
F
B
A
1 2 3 4 5 6 7 8 9 10 111213
Quantity of DVDs demanded
(per week)
Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved.
4-9
Individual and Market
Demand Curves
Price per + Alice’s Bruce’s Carmen’s Market
DVD
demand + demand+ demand = 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
9
8
7
6
5
4
3
2
6
5
4
3
2
1
0
0
1
1
0
0
0
0
0
0
16
14
11
9
7
5
3
2
Price per DVD (in dollars)
$4.00
3.50
3.00
2.50
2.00
1.50
G
F
Market demand
E
D
C
B
1.00
0.50
0
A
Carmen BruceAlice
2 4 6 8 10 12 14 16
Quantity of DVDs
demanded per week
McGraw-Hill/Irwin
Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved.
4-10
The Law of Supply
•
•
•
There is a direct relationship between price and
quantity supplied.
Other things constant:
 Quantity supplied rises as price rises.
 Quantity supplied falls as price falls.
The law of supply occurs because:
 When prices rise, firms substitute production of one
good for another.
 Assuming firms’ costs are constant, a higher price
means higher profits.
McGraw-Hill/Irwin
Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved.
4-11
•
•
The supply curve
is the graphic
representation of
the law of supply.
The supply curve
slopes upward to
the right because
quantity supplied
varies directly
with price.
McGraw-Hill/Irwin
Price (per unit)
The Supply Curve
S
B
PB
PA
0
A
QA
QB
Quantity supplied
(per unit of time)
Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved.
4-12
Price (per barrel)
Quantity Supplied Versus Supply
Movement
along
Supply
Curve
S1
C
$80
$50
S0
B
A
Shift in
Supply
4.1 4.3
4.6
Barrels per day (millions)
McGraw-Hill/Irwin
Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved.
4-13
Shift Factors of Supply
• Price of Inputs
• Technology
• Expectations
• Taxes and Subsidies
McGraw-Hill/Irwin
Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved.
4-14
Individual and Market Supply
Market
Price
Ann + Barry + Charlie = supply
(per DVD)
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
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 $4.00
1 3.50
3
5 3.00
7 2.50
9 2.00
11
1.50
14
15 1.00
Charlie Barry
0.50
0 A1
Ann
Market
Supply
I
H
G
F
E
D
C
B CA
2
3 4 5 6
7 8 9 10 11 12 13 14 15 16
Quantity of DVDs supplied (per week)
McGraw-Hill/Irwin
Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved.
4-15
Equilibrium
• Equilibrium is a concept in which
•
opposing forces cancel each other out.
In a free market, the forces of supply and
demand interact to determine:
 Equilibrium price – the price toward which
the invisible hand drives the market.
 Equilibrium quantity – the amount bought
and sold at the equilibrium price.
McGraw-Hill/Irwin
Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved.
4-16
Equilibrium
Price
(per DVD)
QS
$3.50
7
QD
3
Surplus(+)
Shortage (-)
+4
$2.50
5
5
0
$1.50
3
7
-4
Price per DVD
$5.00
Excess supply
4.00
S
3.50
3.00
E
2.50
2.00
1.50
Excess demand
1.00
1
2
3
4
5
6 7
D
8
Quantity of DVDs supplied and
demanded (per week)
McGraw-Hill/Irwin
Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved.
4-17
Shifts in Supply and Demand
• Shifts in either supply or demand
•
change equilibrium price.
An increase in demand or a decrease
in supply:
 Creates excess demand at the original
equilibrium price.
 Excess demand increases price until a
new higher equilibrium price and
quantity are reached.
McGraw-Hill/Irwin
Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved.
4-18
Increase in Demand
S0
B
$2.50
Excess demand
A
C
2.25
D0
0
McGraw-Hill/Irwin
D1
8
9
10
Quantity of DVDs (per week)
Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved.
4-19
Decrease in Supply
S1
S0
C
$2.50
2.25
B
A
Excess demand
D0
0
McGraw-Hill/Irwin
8
9
10
Quantity of DVDs (per week)
Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved.
4-20
Limitations of Supply and
Demand Analysis
• Sometimes supply and demand are
•
•
interconnected.
The other things constant assumption is
likely not to hold when the goods
represent a large percentage of the
entire economy.
The fallacy of composition is the false
assumption that what is true for a part
will also be true for the whole.
McGraw-Hill/Irwin
Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved.
4-21
Summary
• The law of demand states that the
•
•
quantity demanded rises as price
falls, other things constant.
The law of supply states that the
quantity supplied rises as price rises,
other things constant.
The laws of demand and supply hold
true because people can substitute.
McGraw-Hill/Irwin
Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved.
4-22
Summary
• A change in quantity demanded
•
•
(supplied), caused only by a change in
the good’s own price, is a movement
along the demand (supply) curve.
A change in demand (supply) is a shift of
the entire demand (supply) curve.
Factors that affect supply and demand
other than price are called shift factors.
McGraw-Hill/Irwin
Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved.
4-23
Summary
Shift Factors of Demand
Shift Factors of Supply
Income
Price of Inputs
Prices of Other Goods
Technology
Tastes
Expectations
Expectations
Taxes and Subsidies on
Producers
Taxes and Subsidies on
Consumers
McGraw-Hill/Irwin
Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved.
4-24
Summary
•
•
•
•
A market demand (supply) curve is the
horizontal sum of all individual demand
(supply) curves.
When quantity demanded equals quantity
supplied at equilibrium, prices have no
tendency to change.
When quantity demanded > quantity supplied,
prices tend to rise.
When quantity supplied > quantity demanded,
prices tend to fall.
McGraw-Hill/Irwin
Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved.
4-25
Summary
• When the demand curve shifts to the
•
right (left), equilibrium price rises
(declines) and equilibrium quantity
rises (falls).
When the supply curve shifts to the
right (left), equilibrium price declines
(rises) and equilibrium quantity rises
(falls).
McGraw-Hill/Irwin
Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved.
4-26
Given the following demand and supply of pizza:
Price
per Pizza
Quantity
Supplied
Quantity
Demanded
$8
200
60
7
150
80
6
100
100
5
50
120
4
0
140
Review Question 4-1 What is the equilibrium price and quantity?
Equilibrium price is $6 and equilibrium quantity is 100 pizzas.
Review Question 4-2 If the price is $7, is there a shortage or surplus?
How much is the shortage or surplus? Explain how the market will
return to equilibrium.
At a price of $7, there is a surplus of 150 - 80 = 70 pizzas. Producers
will reduce the price in order to sell the surplus. As price decreases,
quantity demanded increases until the surplus is eliminated at the
equilibrium price of $6.
McGraw-Hill/Irwin
Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved.