Download Ch 4: Supply And Demand

Chapter 4:
Supply and
Demand
Prepared by:
Kevin Richter, Douglas College
Charlene Richter,
British Columbia Institute of Technology
© 2006 McGraw-Hill Ryerson Limited. All
rights reserved.
1
Chapter Objectives

1. Explain the law of demand and what it
implies.



a. Distinguish a change in demand from a change
in quantity demanded.
b. Draw a demand curve from a demand table.
c. Derive the market demand curve.
© 2006 McGraw-Hill Ryerson Limited. All
rights reserved.
2
Chapter Objectives

2. Explain the law of supply and what it
implies.




a. Distinguish a change in supply from a change
in quantity supplied.
b. Draw a supply curve from a supply table.
c. Derive the market supply curve.
3. Explain how prices adjust to achieve an
equilibrium between demand and supply.

a. Explain the concept of equilibrium.
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3
Chapter Objectives

4. Show the effects of a shift in demand or
supply on the equilibrium price and quantity
using real-world events.

a. Be able to determine if an observed change in
price and quantity is due to a change in demand
or supply.
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rights reserved.
4
Demand

Demand means the willingness and capacity
to pay.

Prices are the tools by which the market
coordinates individual desires.
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5
Law of Demand

Law of demand – there is an inverse
relationship between price and quantity
demanded.

As price falls, quantity demanded rises, other
things constant.

As price rises, quantity demanded falls, other
things constant.
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6
Law of Demand

What accounts for the law of demand?

People tend to substitute away from goods whose
price has gone up.
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7
Demand Curve

The demand curve is the graphic
representation of the law of demand.

It represents the maximum price consumers
will pay for an additional unit of the good.
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8
Demand Curve

The demand curve slopes downward and to
the right.

As the price goes up, the quantity demanded
goes down.
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9
Price (per unit)
Sample Demand Curve
PA
A
D
0
QA
Quantity demanded (per unit of time)
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10
Other Things Constant

Other things constant means that all other
factors that affect quantity demanded are
assumed to remain constant, whether they
actually remain constant or not.

Tastes, prices of other goods, even the
weather, may affect demand.
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11
Change in Demand versus Change in
Quantity Demanded

Demand refers to a schedule of quantities of
a good that will be bought per unit of time at
various prices, other things constant.

Graphically, it refers to the entire demand
curve.
© 2006 McGraw-Hill Ryerson Limited. All
rights reserved.
12
Change in Demand versus Change in
Quantity Demanded

Quantity demanded refers to a specific
amount that will be demanded per unit of time
at a specific price.

Graphically, it refers to a specific point on
the demand curve.
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rights reserved.
13
Change in Demand versus Change in
Quantity Demanded

A movement along a demand curve
happens when there is a change in price.

We move from one point to another point
on the demand curve.
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14
Change in Demand versus Change in
Quantity Demanded
Changes in price
cause changes in quantity demanded
represented by a movement along a demand
curve.
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rights reserved.
15
Price (per unit)
Change in Quantity Demanded
$2
B
Change in quantity demanded
(a movement along the curve)
$1
A
D1
0
100
200
Quantity demanded (per unit of time)
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16
Change in Demand versus Change in
Quantity Demanded

A shift in demand happens when anything
other than price changes.

The entire demand curve moves to the left or
right.
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17
Price (per unit)
Change in Demand
Change in demand
(a shift of the curve)
$2
$1
B
A
D0
D1
250
100
200
Quantity demanded (per unit of time)
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18
Shift Factors of Demand

Shift factors of demand are factors that cause
shifts in the demand curve:





Society's income.
The prices of other goods.
Tastes.
Expectations.
Population.
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19
Income

An increase in income may increase or
decrease the demand for a good:

An increase in income will increase demand
for normal goods.

An increase in income will decrease demand
for inferior goods.
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20
Price of Other Goods

When the price of a substitute good falls,
demand falls for the good whose price has
not changed.

When the price of a complement good falls,
demand rises for the good whose price has
not changed.
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21
Tastes

A change in taste will change demand with no
change in price.
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22
Expectations

If you expect your income to rise, you may
consume more now.

If you expect prices to fall in the future, you
may delay purchases today.
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23
Population

An increase in population will increase
demand at every price.
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24
Demand Table

The demand table assumes:

The Law of Demand. (As price rises, quantity
demanded declines.)

A specific time dimension.

Products are identical in shape, size, quality, etc.

Everything else is held constant.
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25
From Demand Table to Demand Curve

You plot each point in the demand table on a
graph and connect the points to create the
demand curve.

The demand curve graphically conveys the
same information that is on the demand
table.
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26
From Demand Table to Demand Curve

The curve represents the maximum price that
you will pay for various quantities of a good –
you will happily pay less.
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27
From Demand Table to Demand Curve
Price per Cassette rentals
cassette demanded per
week
A
B
C
D
E
$0.50
1.00
2.00
3.00
4.00
9
8
6
4
2
Price per cassettes (in dollars)
A Demand Table
A Demand Curve
$6.00
5.00
4.00
3.50
3.00
E
2.00
1.00
.50
0
D
Demand for
cassettes
C
B
A
1 2 3 4 5 6 7 8 9 10 11 12 13
Quantity of cassettes demanded (per week)
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28
Individual and Market Demand
Curves

A market demand curve is the horizontal sum
of all individual demand curves.

This is determined by adding the individual
demand curves of all the demanders.
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29
Individual and Market Demand
Curves

Sellers estimate total market demand for their
product which becomes a smooth and
downward sloping curve.
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30
From Individual Demands
to a Market Demand Curve
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
(2)
Cathy’s
demand
1
1
0
0
0
0
0
0
(3)
Market
demand
16
14
11
9
7
5
3
2
$4.00
Price per cassette (in dollars)
(1)
(2)
(3)
Price per Marie’s Pierre’s
cassette demand demand
G
3.50
F
3.00
E
2.50
D
2.00
C
1.50
B
1.00
0.50
0
Market demand
A
Cathy
Pierre Marie
2
6
4
8 10 12 14 16
Quantity of cassettes demanded per week
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
Law of Demand

Regarding the market demand curve,

At lower prices, existing demanders buy more.

At lower prices, new demanders enter the market.

The market demand curve is flatter than the
individual demand curves.
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32
Supply

Individuals control the factors of production –
inputs necessary to produce goods.

Factors of production are the resources or
inputs necessary to produce goods or
services.
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33
Supply

The supply of produced goods involves:

An analysis of the supply of the factors of
production by households to firms.

An analysis of how firms transform those factors
of production into usable goods and services.
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34
Law of Supply

There is a direct relationship between price
and quantity supplied.


As price rises, quantity supplied rises, other things
constant.
As price falls, quantity supplied falls, other things
constant.
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35
Supply Curve

The supply curve is the graphic
representation of the law of supply.

It provides the minimum price the producer
requires to produce an additional unit of
output.
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36
Supply Curve

The supply curve slopes upward to the right,
and tells us that the quantity supplied varies
directly – in the same direction – with the
price.
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37
Price (per unit)
Sample Supply Curve
S
PA
0
A
QA
Quantity supplied (per unit of time)
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38
Change in Supply Versus Change in
Quantity Supplied

Supply refers to a schedule of quantities a
seller is willing to sell per unit of time at
various prices, other things constant.

Graphically, it refers to the entire supply
curve.
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rights reserved.
39
Change in Supply Versus Change in
Quantity Supplied

Quantity supplied refers to a specific
amount that will be supplied at a specific
price.

Graphically, it refers to a specific point on
the supply curve.
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40
Change in Supply Versus Change in
Quantity Supplied
Changes in price
cause changes in quantity supplied
represented by a movement along a supply
curve.
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rights reserved.
41
Change in Supply Versus Change in
Quantity Supplied

A movement along a supply curve –
happens when there is a change in price.
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42
Change in Quantity Supplied
Price (per unit)
S0
B
$25
$15
A
Change in quantity
supplied (a movement
along the curve)
1,250
1,500
Quantity supplied (per unit of time)
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43
Change in Supply Versus Change in
Quantity Supplied

A shift in supply happens when anything
other than price changes.

The entire supply curve moves to the left or
right.
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rights reserved.
44
Change in Supply Versus Change in
Quantity Supplied

Shift in supply – the graphic representation
of the effect of a change in a factor other than
price on supply.
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45
Shift in Supply
S0
Price (per unit)
S1
$15
A
B
Shift in Supply
(a shift of the curve)
1,250
1,500
Quantity supplied (per unit of time)
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46
Shift Factors of Supply

Other factors besides price affect how much
will be supplied:

Prices of inputs used in the production of a good.

Technology.

Suppliers’ expectations.

Taxes and subsidies.
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47
Price of Inputs

When costs rise, profits decrease, so there is
less incentive to supply.

If costs rise substantially, the firm may even
shut down.
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48
Technology

Advances in technology reduce the cost of
production, and there is a greater incentive to
supply.
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49
Expectations

If suppliers expect prices to rise in the future,
they may store today's supply to reap higher
profits later.

If they expect prices to fall in the future,
suppliers may sell off more of their
inventories today.
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50
Taxes and Subsidies

When taxes go up, costs increase, and profits
fall, reducing the incentive to produce.

When government subsidies go up, costs fall,
and profits rise, giving suppliers the incentive
to increase output.
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51
Supply Table

Each supplier follows the law of supply.

When price rises, each supplies more, or at
least as much as they did at a lower price.
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52
From Supply Table to Supply Curve

To derive a supply curve from a supply table,
you plot each point in the supply table on a
graph and connect the points.
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53
From Supply Table to Supply Curve

The supply curve represents the set of
minimum prices an individual seller will
accept for various quantities of a good.
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54
From Supply Table to Supply Curve

Competing suppliers’ entry into the market
places a limit on the price any supplier can
charge.
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55
Individual and Market Supply Curves

The market supply curve is derived by
horizontally adding the individual supply
curves of each supplier.
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56
From Individual Supplies to a Market
Supply
(1)
Price
Quantities
Supplied
(per cassette)
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
(2)
(3)
(4)
(5)
Ann's Barry's Charlie's Market
Supply Supply Supply Supply
0
1
2
3
4
5
6
7
8
0
0
1
2
3
4
5
5
5
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rights reserved.
0
0
0
0
0
0
0
2
2
0
1
3
5
7
9
11
14
15
57
From Individual Supplies to a Market
Supply
$4.00
Charlie
Barry
Ann
Market Supply
Price per cassette
3.50
H
3.00
G
2.50
F
2.00
E
1.50
D
1.00
0.50
0 A
I
C
B
CA
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
Quantity of cassettes supplied (per week)
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58
Equilibrium

Equilibrium is a concept in which opposing
dynamic forces cancel each other out.
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59
Equilibrium

In a free market, the forces of supply and
demand interact to determine equilibrium
quantity and equilibrium price.
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60
Equilibrium

Equilibrium price – the price toward which
the invisible hand drives the market.

Equilibrium quantity – the amount bought
and sold at the equilibrium price.
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61
What Equilibrium Isn’t

Equilibrium isn’t a state of the world, it is a
characteristic of the model used to look at the
world.

Equilibrium isn’t inherently good or bad, it is
simply a state in which dynamic pressures
offset each other.
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62
What Equilibrium Isn’t

Equilibrium means that the upward pressure
on price is exactly offset by the downward
pressure on price.

When the market is not in equilibrium, you
get either excess supply or excess demand,
and a tendency for price to change.
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63
Excess Supply

Excess supply – a situation where the
quantity supplied is greater than quantity
demanded.

Prices tend to fall.
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64
Excess Demand

Excess demand – a situation where the
quantity demanded is greater than quantity
supplied

Prices tend to rise.
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65
Price per cassette (in dollars)
Marriage of Supply and Demand
$5.00
S
Excess supply
4.00
3.50
A
3.00
E
2.50
2.00
B
1.50
Excess demand
1.00
1
D
2 3 4 5 6 7 8 9 10 11 12
Quantity of cassettes supplied and demanded
(per week)
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66
Interaction of Supply and Demand

When price is $3.50 each, quantity supplied
equals 7 and quantity demanded equals 3.

The excess supply of 4 pushes price down.
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67
Interaction of Supply and Demand

When price is $1.50 each, quantity supplied
equals 3 and quantity demanded equals 7.

The excess demand of 4 pushes price up.
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68
Interaction of Supply and Demand

When price is $2.50 each, quantity supplied
equals 5 and quantity demanded equals 5.

There is no excess supply or excess
demand, so price will not rise or fall.
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69
Price Adjusts

The greater the difference between quantity
supplied and quantity demanded, the more
pressure there is for prices to rise or fall.

When quantity demanded equals quantity
supplied, prices have no tendency to change.
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70
Power of Supply and Demand

Changes in either supply or demand will
change equilibrium price and quantity.
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71
Six Real World Examples

Supply and demand can shed light on a
variety of real-world events:






Brazil freeze.
Financial assets and the baby boomers.
Twenty percent excise tax.
Rice in Indonesia.
Farm labourers.
Christmas toys.
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72
Sugar Shock in Brazil

The crop-damaging freeze shifted the supply
curve to the left.

At the original price, quantity demanded
exceeded quantity supplied.

Price rose until the quantity demanded
equaled the quantity supplied.
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73
Shift in Supply
S1
C
P1
P0
S0
Excess demand
A
B
D0
0
QS
Qe
QD
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rights reserved.
Quantity
74
Baby Boomers and Financial Assets

Demographic changes among baby boomers
moved the demand curve for financial assets
to the right.

At the original price, quantity demanded
exceeded quantity supplied.

Price rose until the quantity demanded
equaled the quantity supplied.
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75
Increase in Demand

An increase in demand creates excess
demand at the original equilibrium price.

The excess demand pushes price upward
until a new higher equilibrium price and
quantity are reached.
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76
Baby Boomers and Financial Assets
Price
S
Excess
demand
P1
P0
D1
D0
(f)
Q0
Qe
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rights reserved.
QD
Quantity
77
Baby Boomers and the Housing Market

The same phenomenon occurred in the
surging demand for housing among this
group during the 1980s.
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78
Excise Tax

Korean Government imposed a 20 percent
luxury tax on imported golf clubs.
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79
Excise Tax

A 20 percent tax levied on suppliers shifts the
supply curve to the left.

After the tax is imposed, the quantity of
imported clubs demanded drops.
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80
Excise Tax
Price
S1
S0
P1
P0
D0
(e)
Q1
Q0
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rights reserved.
Quantity
81
Rice in Indonesia

Drought, pestilence, and the financial crisis
shift the supply curve to the left.

The steep demand curve means that the
quantity demanded does not change much
with changes in price.
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82
Rice in Indonesia

Responding to high prices, the government
imported rice and distributed it to the market,
causing the supply curve to shift to the right.
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83
Rice in Indonesia
Price
S1
S2
S0
P1
P2
P0
Demand
Q1 Q2 Q0
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rights reserved.
Quantity
84
Farm Labourers

The compressed harvesting season
increased the demand and increased border
patrols decreased supply of labour.

Demand shifted to the right and supply
shifted to the left.
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85
Farm Labourers

At the original price, the quantity of workers
demanded exceeded the quantity supplied.

Price rises until the quantity demanded
equals the quantity supplied.

The effect on the number of labourers hired
depended on the relative size of the supply
shift.
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86
Farm Labourers
Price
S1
S0
P1
P0
D1
D0
Qe
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rights reserved.
Quantity
87
Christmas Toys

A Christmas craze for Furbies shifts demand
to the right.

A shortage ensued along with a black market.
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88
Christmas Toys

Finally the supplier produced more, shifting
the supply curve to the right, causing the
price to drop.
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89
Christmas Toys
Price
S0
S1
P1
P0
D1
D0
QS0
QD0
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rights reserved.
QD1
Quantity
90
Effects of Shifts of Demand and Supply
on Price and Quantity
No change in
supply
No change
in demand
No change.
Demand
shifts out
Price rises;
Quantity rises.
Demand
shifts in
Price falls.
Quantity falls.
Supply shifts out
Supply shifts in
Price falls;
Quantity rises.
Quantity rises;
Price could be
higher or lower.
Price rises;
Quantity falls.
Price falls;
Quantity could rise
or fall.
Quantity falls;
Price could rise
or fall.
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rights reserved.
Price rises;
Quantity could
rise or fall.
91
Supply and Demand
End of Chapter 4
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92