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R. GLENN
HUBBARD
O’BRIEN
ANTHONY PATRICK
Macroeconomics
FOURTH EDITION
CHAPTER
3
Where Prices Come
From: The Interaction
of Demand and Supply
Chapter Outline and
Learning Objectives
3.1
The Demand Side of the
Market
3.2
The Supply Side of the
Market
3.3
Market Equilibrium: Putting
Demand and Supply Together
3.4
The Effect of Demand and
Supply Shifts on Equilibrium
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The Tablet Computer Revolution
• Tablet computers were just 1 percent of the market in 2006, contrary to Bill
Gates’ prediction five years earlier that they would make up a majority of
sales in that time.
• In April 2010, Steve Jobs introduced the iPad, which was an immediate
success, and within a year the iPad 2 experienced similarly rapid sales.
• Intense competition ensued, including Research in Motion’s introduction of
the BlackBerry Playbook, increasing the available choices of products and
lowering the prices consumers pay for those products.
• AN INSIDE LOOK on page 92 discusses how the many tablet producers are
concerned about component shortages.
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Economics in Your Life
Will You Buy an Apple iPad or a Samsung Galaxy Tab?
Seven months after the iPad was introduced, Samsung introduced the Galaxy
Tab. Although at a disadvantage, it could still compete based on price and
value.
See if you can answer these questions by the end of the chapter:
Would you choose to buy a Galaxy Tab if it had a lower price than an iPad?
If your income increased, would it affect your decision about which tablet to buy?
Perfectly competitive market A market that meets the conditions of (1) many
buyers and sellers, (2) all firms selling identical products, and (3) no barriers to
new firms entering the market.
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The Demand Side of the Market
3.1 LEARNING OBJECTIVE
Discuss the variables that influence demand.
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Demand Schedules and Demand Curves
Demand schedule A table that shows the relationship between the price of a
product and the quantity of the product demanded.
Quantity demanded The amount of a good or service that a consumer is
willing and able to purchase at a given price.
Demand curve A curve that shows the relationship between the price of a
product and the quantity of the product demanded.
Market demand The demand by all the consumers of a given good or service.
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Figure 3.1
A Demand Schedule and Demand
Curve
As the price changes,
consumers change the quantity
of tablet computers they are
willing to buy.
We can show this as a demand
schedule in a table or as a
demand curve on a graph.
The table and graph both show
that as the price of tablet
computers falls, the quantity
demanded increases.
When the price of tablet
computers is $700, consumers
buy 3 million tablets per month.
When the price drops to $600,
consumers buy 4 million
tablets.
Therefore, the demand curve
for tablet computers is
downward sloping.
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Law of demand The rule that, holding everything else constant, when the price
of a product falls, the quantity demanded of the product will increase, and when
the price of a product rises, the quantity demanded of the product will decrease.
What Explains the Law of Demand?
Substitution effect The change in the quantity demanded of a good that results
from a change in price, making the good more or less expensive relative to other
goods that are substitutes.
Income effect The change in the quantity demanded of a good that results from
the effect of a change in the good’s price on consumers’ purchasing power.
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Holding Everything Else Constant: The Ceteris Paribus Condition
Ceteris paribus (“all else equal”) condition The requirement that when
analyzing the relationship between two variables—such as price and quantity
demanded—other variables must be held constant.
A shift of a demand curve is an increase or a decrease in demand. A
movement along a demand curve is an increase or a decrease in the quantity
demanded.
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Figure 3.2
Shifting the Demand Curve
When consumers
increase the quantity of a
product they want to buy
at a given price, the
market demand curve
shifts to the right, from D1
to D2.
When consumers
decrease the quantity of
a product they want to
buy at a given price, the
demand curve shifts to
the left, from D1 to D3.
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Variables That Shift Market Demand
Many variables other than price can influence market demand. We will discuss
the five most important:
• Income
Normal good A good for which the demand increases as income rises and
decreases as income falls.
Inferior good A good for which the demand increases as income falls and
decreases as income rises.
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Making
the
Connection
Are Quiznos Sandwiches Normal Goods and
Subway Sandwiches Inferior Goods?
Subway sandwiches seem to fit the
economic definition of an inferior good
because demand increases as income
falls, while Quiznos sandwiches fit the
definition of a normal good.
But remember that inferior goods are
not necessarily of low quality;
they are just goods for which
consumers increase their demand as
their incomes fall.
Subway experienced increased
sales during 2008 and 2009, while
sales of Quiznos sandwiches fell.
MyEconLab Your Turn:
For more practice, do related problem 1.11 at the end of this chapter.
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• Prices of Related Goods
Substitutes Goods and services that can be used for the same purpose.
Complements Goods and services that are used together.
• Tastes Subjective elements, such as ad campaigns or trends, can enter into
a consumer’s decision to buy a product.
• Population and Demographics
Demographics The characteristics of a population with respect to age, race,
and gender.
• Expected Future Prices Consumers choose not only which products to
buy but also when to buy them.
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Making
the
The Aging of the Baby Boom Generation
Connection
What effects will the aging of the baby boom generation have on the economy?
Older people have a greater demand for medical care but less demand for cars
than do younger people.
Aging boomers will also have an effect on the housing market.
MyEconLab Your Turn:
For more practice, do related problems 1.12 and 1.13 at the end of this chapter.
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Table 3.1
Variables That Shift Market Demand Curves
An increase in…
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shifts the demand curve…
because…
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Table 3.1
Variables That Shift Market Demand Curves
An increase in…
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shifts the demand curve…
because…
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Table 3.1
Variables That Shift Market Demand Curves
An increase in…
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shifts the demand curve…
because…
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Figure 3.3 A Change in Demand versus a Change in Quantity Demanded
If the price of tablet
computers falls from
$700 to $600, the result
will be a movement along
the demand curve from
point A to point B—an
increase in quantity
demanded from 3 million
tablets to 4 million
tablets.
If consumers’ incomes
increase, or if another
factor changes that
makes consumers want
more of the product at
every price, the demand
curve will shift to the
right—an increase in
demand.
In this case, the increase in demand from D1 to D2 causes the quantity of tablet
computers demanded at a price of $700 to increase from 3 million tablets at point A to 5
million tablets at point C.
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Making
the
Forecasting the Demand for iPads
Connection
To decide which products to develop,
firms need to forecast the demand for
those products.
Forecasting the demand for any new
product is challenging because it is
difficult to gauge how many consumers
will find the new product to be useful.
In 2011, Apple forecast that it would sell
40 million iPads during the year.
Will the future demand for tablets
such as the iPad continue to grow?
Time will tell whether the future demand for tablets will be as large as Apple and
other firms were forecasting it would be.
MyEconLab Your Turn:
For more practice, do related problem 1.16 at the end of this chapter.
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The Supply Side of the Market
3.2 LEARNING OBJECTIVE
Discuss the variables that influence supply.
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Quantity supplied The amount of a good or service that a firm is willing and
able to supply at a given price.
Supply Schedules and Supply Curves
Supply schedule A table that shows the relationship between the price of a
product and the quantity of the product supplied.
Supply curve A curve that shows the relationship between the price of a
product and the quantity of the product supplied.
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Figure 3.4 A Supply Schedule and Supply Curve
As the price changes, Apple, Toshiba, Samsung, LG, and other firms producing tablet
computers change the quantity they are willing to supply.
We can show this as a supply schedule in a table or as a supply curve on a graph.
The supply schedule and supply curve both show that as the price of tablet computers
rises, firms will increase the quantity they supply.
At a price of $600 per tablet, firms will supply 6 million tablets.
At a price of $700, firms will supply 7 million tablets.
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Law of supply The rule that, holding everything else constant, increases in
price cause increases in the quantity supplied, and decreases in price cause
decreases in the quantity supplied.
Figure 3.5
Shifting the Supply Curve
When firms increase the
quantity of a product they
want to sell at a given
price, the supply curve
shifts to the right.
The shift from S1 to S3
represents an increase in
supply.
When firms decrease the
quantity of a product they
want to sell at a given
price, the supply curve
shifts to the left.
The shift from S1 to S2
represents a decrease in
supply.
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Variables That Shift Market Supply
The following are the most important variables that shift market supply:
• Prices of Inputs A change in the price of an input—anything used in the
production of a good or service—is the most likely factor to cause the supply
curve for a product to shift.
• Technological Change
Technological change A positive or negative change in the ability of a firm to
produce a given level of output with a given quantity of inputs.
• Prices of Substitutes in Production Alternative products that a firm
could produce are called substitutes in production.
• Number of Firms in the Market A change in the number of firms in the
market will change supply.
• Expected Future Prices If a firm expects that the price of its product will
be higher in the future than it is today, it has an incentive to decrease supply
now and increase it in the future.
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Table 3.2
Variables That Shift Market Supply Curves
An increase in…
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shifts the supply curve…
because…
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Table 3.2
Variables That Shift Market Supply Curves
An increase in…
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shifts the supply curve…
because…
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Figure 3.6 A Change in Supply versus a Change in Quantity Supplied
If the price of tablet computers rises
from $500 to $600 per tablet, the
result will be a movement up the
supply curve from point A to point
B—an increase in quantity supplied
by Apple, Toshiba, Samsung, and
the other firms from 5 million to 6
million tablets.
If the price of an input decreases or
another factor changes that causes
sellers to supply more of the
product at every price, the supply
curve will shift to the right—an
increase in supply.
In this case, the increase in supply
from S1 to S2 causes the quantity of
tablet computers supplied at a price
of $600 to increase from 6 million at
point B to 8 million at point C.
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Market Equilibrium: Putting Demand and Supply Together
3.3 LEARNING OBJECTIVE
Use a graph to illustrate market equilibrium.
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Figure 3.7
Market Equilibrium
Where the demand curve
crosses the supply curve
determines market
equilibrium.
In this case, the demand
curve for tablet computers
crosses the supply curve at a
price of $500 and a quantity
of 5 million tablets.
Only at this point is the
quantity of tablet computers
consumers are willing to buy
equal to the quantity that
Apple, Amazon, Samsung,
and the other firms are
willing to sell:
The quantity demanded is
equal to the quantity
supplied.
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Market equilibrium A situation in which quantity demanded equals quantity
supplied.
Competitive market equilibrium A market equilibrium with many buyers and
many sellers.
How Markets Eliminate Surpluses and Shortages
Surplus A situation in which the quantity supplied is greater than the quantity
demanded.
Shortage A situation in which the quantity demanded is greater than the
quantity supplied.
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Figure 3.8
The Effect of Surpluses and
Shortages on the Market Price
When the market price is above
equilibrium, there will be a surplus.
In the figure, a price of $600 for
tablet computers results in 6 million
tablets being supplied but only 4
million tablets being demanded, or
a surplus of 2 million.
As Apple, Toshiba, Dell, and other
firms cut the price to dispose of the
surplus, the price will fall to the
equilibrium of $500.
When the market price is below
equilibrium, there will be a
shortage.
A price of $300 results in 7 million
tablets being demanded but only 3
million tablets being supplied, or a
shortage of 4 million tablets.
As firms find that consumers who are unable to find tablet computers available for sale are
willing to pay higher prices to get them, the price will rise to the equilibrium of $500.
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Demand and Supply Both Count
Keep in mind that the interaction of demand and supply determines the
equilibrium price.
Neither consumers nor firms can dictate what the equilibrium price will be.
No firm can sell anything at any price unless it can find a willing buyer, and no
consumer can buy anything at any price without finding a willing seller.
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Solved Problem 3.3
Demand and Supply Both Count: A Tale of Two Letters
Which letter is likely to be worth more: one written by Abraham Lincoln or one written by
his assassin, John Wilkes Booth? Auctioned off on the same day, the Booth letter sold for
$31,050, and the Lincoln letter sold for only $21,850.
Use a demand and supply graph to explain how the Booth letter has a higher market
price than the Lincoln letter, even though the demand for letters written by Lincoln is
greater than the demand for letters written by Booth.
Solving the Problem
Step 1: Review the chapter
material.
Step 2: Draw demand curves that
illustrate the greater demand for
Lincoln’s letters.
Begin by drawing two demand
curves. Label one “Demand for
Lincoln’s letters” and the other
“Demand for Booth’s letters.”
Make sure that the Lincoln demand
curve is much farther to the right
than the Booth demand curve.
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Solved Problem 3.3
Demand and Supply Both Count: A Tale of Two Letters
Which letter is likely to be worth more: one written by Abraham Lincoln or one written by
his assassin, John Wilkes Booth? Auctioned off on the same day, the Booth letter sold for
$31,050, and the Lincoln letter sold for only $21,850.
Use a demand and supply graph to explain how the Booth letter has a higher market
price than the Lincoln letter, even though the demand for letters written by Lincoln is
greater than the demand for letters written by Booth.
Solving the Problem
Step 3: Draw supply curves that
illustrate the equilibrium price of
Booth’s letters being higher than
the equilibrium price of Lincoln’s
letters.
Both demand and supply count when
determining market price.
The upward slope of the supply curves
occurs because the higher the price, the
larger the quantity of letters that will be
offered for sale by people who currently
own them.
MyEconLab Your Turn:
For more practice, do related problems 3.5 and 3.6 at the end of this chapter.
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The Effect of Demand and Supply Shifts on Equilibrium
3.4 LEARNING OBJECTIVE
Use demand and supply graphs to predict changes in prices and quantities.
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The Effect of Shifts in Supply on Equilibrium
Figure 3.9
The Effect of an Increase in
Supply on Equilibrium
If a firm enters a market, as
Toshiba entered the market for
tablet computers when it
introduced the Thrive, the
equilibrium price will fall, and the
equilibrium quantity will rise:
1. As Toshiba enters the market
for tablet computers, a larger
quantity of tablets will be
supplied at every price, so the
market supply curve shifts to
the right, from S1 to S2, which
causes a surplus of tablets at
the original price, P1.
2. The equilibrium price falls from
P1 to P2.
3. The equilibrium quantity rises
from Q1 to Q2.
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Making
the
The Falling Price of Blu-ray Players
Connection
The declining cost of manufacturing the players as other firms enter the industry
increases the quantity supplied at every price, shown by the large shift to the right of the
supply curve.
MyEconLab Your Turn:
For more practice, do related problem 4.6 at the end of this chapter.
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The Effect of Shifts in Demand on Equilibrium
Figure 3.10
The Effect of an Increase
in Demand on Equilibrium
Increases in income will
cause the equilibrium price
and quantity to rise:
1. Because tablet computers
are a normal good, as
income grows, the
quantity demanded
increases at every price,
and the market demand
curve shifts to the right,
from D1 to D2, which
causes a shortage of
tablet computers at the
original price, P1.
2. The equilibrium price rises
from P1 to P2.
3. The equilibrium quantity
rises from Q1 to Q2.
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The Effect of Shifts in Demand and Supply over Time
Figure 3.11 Shifts in Demand and Supply over Time
Whether the price of a product rises or falls over time depends on whether demand shifts
to the right more than supply.
In panel (a), demand shifts to the right more In panel (b), supply shifts to the right more
than demand, and the equilibrium price falls:
than supply, and the equilibrium price rises:
1. Supply shifts to the right more than
1. Demand shifts to the right more than
demand.
supply.
2. Equilibrium price falls from P1 to P2.
2. Equilibrium price rises from P1 to P2.
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Table 3.3
How Shifts in Demand and Supply Affect
Equilibrium Price (P) and Quantity (Q)
Demand Curve
Unchanged
Demand Curve Shifts
to the Right
Demand Curve Shifts
to the Left
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Supply Curve
Unchanged
Supply Curve Shifts
to the Right
Supply Curve Shifts
to the Left
Q unchanged
P unchanged
Q increases
P decreases
Q decreases
P increases
Q increases
P increases
Q increases
P increases
or decreases
Q increases or
decreases
P increases
Q increases or
decreases
P decreases
Q decreases
P increases
or decreases
Q decreases
P decreases
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Solved Problem 3.4
High Demand and Low Prices in the Lobster Market?
The market price is higher when demand is low than when demand is high.
Resolve this paradox, with the help of a demand and supply graph.
Solving the Problem
Step 1: Review the chapter material.
Step 2: Draw the demand and
supply graph.
Label the equilibrium price $6.00.
Label both the demand and supply
curves “in spring.”
Step 3: Add to your graph a
demand curve for summer.
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Solved Problem 3.4
High Demand and Low Prices in the Lobster Market?
The market price is higher when demand is low than when demand is high.
Resolve this paradox, with the help of a demand and supply graph.
Solving the Problem
Step 1: Review the chapter material.
Step 2: Draw the demand and
supply graph.
Label the equilibrium price $6.00.
Label both the demand and supply
curves “in spring.”
Step 3: Add to your graph a
demand curve for summer.
Step 4: Explain the graph.
The supply curve shifts to the right
by enough to cause the equilibrium
price to fall to $3.00.
Draw the new supply curve, label it
“in summer,” and label the new equilibrium price $3.00.
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Solved Problem 3.4
High Demand and Low Prices in the Lobster Market?
The market price is higher when demand is low than when demand is high.
Resolve this paradox, with the help of a demand and supply graph.
Solving the Problem
Step 1: Review the chapter material.
Step 2: Draw the demand and
supply graph.
Label the equilibrium price $6.00.
Label both the demand and supply
curves “in spring.”
Step 3: Add to your graph a
demand curve for summer.
Step 4: Explain the graph.
The supply curve shifts to the right
by enough to cause the equilibrium
price to fall to $3.00.
Draw the new supply curve, label it
“in summer,” and label the new equilibrium price $3.00.
The increase in supply is greater than the increase in demand between spring and summer.
MyEconLab Your Turn:
For more practice, do related problems 4.7 and 4.8 at the end of this chapter.
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Shifts in a Curve versus Movements along a Curve
When a shift in a demand or supply curve causes a change in equilibrium
price, the change in price does not cause a further shift in demand or supply.
Don’t Let This Happen to You
Remember: A Change in a Good’s Price Does Not Cause the Demand or Supply Curve
to Shift
The increase in demand shifts the demand curve from D1 to D2, causing a shortage,
but the demand curve will not shift further from the resulting price increase.
Changes in the price of a product result only in movements along a demand curve.
The increase in price causes a decrease in the quantity demanded, from Q3 to Q2,
but does not cause a decrease in demand. The graph on the left is incorrect.
MyEconLab Your Turn: Test your understanding by doing related problems 4.13 and 4.14 at the end of
this chapter.
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Economics in Your Life
Will You Buy an Apple iPad or a Samsung Galaxy Tab?
At the beginning of the chapter, we asked you to consider two questions:
Would you choose to buy a Samsung Galaxy Tab tablet if it had a lower price
than an Apple iPad?
and
Would your decision be affected if your income increased?
If you recognize that the two tablets are very close substitutes, then you are
likely to buy the one with the lower price.
If an increase in your income would cause you to change your decision and buy
the iPad, then the Galaxy Tab is an inferior good for you.
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AN
INSIDE
LOOK
Will Shortage of Display Screens Derail
Computer Tablet Sales?
Figure 1
An increase in demand for tablet computers
shifts the demand curve to the right.
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Figure 2
An increase in the price of an input, such as
the display screen, used in the manufacture
of tablet computers causes the supply curve
to shift to the left.
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