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Introduction to Economics Demand and Supply Learning Objectives • Distinguish between a money price and a relative price • Explain the main influences on demand • Explain the main influences on supply • Explain how prices and quantities bought and sold are determined by demand and supply Copyright © 1998 Addison Wesley Longman, Inc. TM 4-2 Learning Objectives (cont.) • Explain why some prices fall, some rise, and some fluctuate • Use demand and supply to make predictions about price changes Copyright © 1998 Addison Wesley Longman, Inc. TM 4-3 Learning Objectives • Distinguish between a money price and a relative price • Explain the main influences on demand • Explain the main influences on supply • Explain how prices and quantities bought and sold are determined by demand and supply Copyright © 1998 Addison Wesley Longman, Inc. TM 4-4 Price and Opportunity Cost Price is the number of monetary units (euros, dollars, leva, yens, etc.) that must be given up in exchange for an item — this is referred to as the money price. The ratio of one price to another is referred to as the relative price. Relative prices are opportunity costs. Copyright © 1998 Addison Wesley Longman, Inc. TM 4-5 Price and Opportunity Cost • Relative Prices • price index • Supply and demand determines relative prices. • “Price falling” means the price falls relative to the average price of other goods and services. Copyright © 1998 Addison Wesley Longman, Inc. TM 4-6 The Price of Wheat Copyright © 1998 Addison Wesley Longman, Inc. TM 4-7 Learning Objectives • Distinguish between a money price and a relative price • Explain the main influences on demand • Explain the main influences on supply • Explain how prices and quantities bought and sold are determined by demand and supply Copyright © 1998 Addison Wesley Longman, Inc. TM 4-8 Demand If a person demands something, they: • Want it. • Can afford it. • Have made a definite plan to buy it. Wants are the unlimited desires or wishes that people have for goods and services. Copyright © 1998 Addison Wesley Longman, Inc. TM 4-9 Demand The quantity demanded of a good or service is the amount that consumers plan to buy during a given time period at a particular price. Copyright © 1998 Addison Wesley Longman, Inc. TM 4-10 Demand What determines buying plans? • The price of the good • The prices of related goods • Expected future prices • Income • Population • Preferences Copyright © 1998 Addison Wesley Longman, Inc. TM 4-11 Demand The Law of Demand Other things remaining the same, the higher the price of a good, the smaller is the quantity demanded. Reasons for the Law of Demand • Substitution Effect • Income Effect Copyright © 1998 Addison Wesley Longman, Inc. TM 4-12 Demand Demand Curve and Demand Schedule Demand curves show the relationship between the quantity demanded of a good and its price (ceteris paribus). Demand schedules list the quantities demanded at each different price (ceteris paribus). Copyright © 1998 Addison Wesley Longman, Inc. TM 4-13 Demand Price Quantity (dollars per CD) (millions of CD’s per week) a b 1 2 9 6 c 3 4 d 4 3 e 5 2 Copyright © 1998 Addison Wesley Longman, Inc. TM 4-14 Demand Price (dollar per CD) 6 e 5 d 4 c 3 b 2 Demand for CDs a 1 0 2 4 6 8 10 Quantity (millions of CD’s per week) Copyright © 1998 Addison Wesley Longman, Inc. TM 4-15 Demand A Change in Demand When any factor that influences buying plans other than the price of the good changes, there is a change in demand. • An increase in demand causes the demand curve to shift rightward. • A decrease in demand causes the demand curve to shift leftward. Copyright © 1998 Addison Wesley Longman, Inc. TM 4-16 A Change in Demand Price of Related Goods • Substitutes - goods used in the place of another good • Complements - goods used in conjunction with another good What Happens to Demand if the price of a substitute good increases? A complement? Copyright © 1998 Addison Wesley Longman, Inc. TM 4-17 A Change in Demand Expected Future Prices • If the price of a good is expected to rise in the future, people buy more of the good now. • If the price of a good is expected to fall in the future, people buy less of the good now. Copyright © 1998 Addison Wesley Longman, Inc. TM 4-18 A Change in Demand Income • Normal Goods — demand increases as income increases • Inferior Goods (lower quality) — demand decreases as income increases Copyright © 1998 Addison Wesley Longman, Inc. TM 4-19 A Change in Demand Population • Size and age structure Preferences • Attitudes toward goods and services Copyright © 1998 Addison Wesley Longman, Inc. TM 4-20 Original demand schedule Walkman $200 Price (dollars per CD) Walkman $50 Quantity (millions of CD’s per week) a 1 9 b 2 6 c 3 4 d 4 3 e 5 2 Copyright © 1998 Addison Wesley Longman, Inc. New demand schedule Price (dollars per CD) Quantity (millions of CDs per week) Assume the original price of Walkmans is $200. The demand schedule shows the Price-Quantity relationship for CDs. TM 4-21 New demand schedule Original demand schedule Walkman $200 Price (dollars per CD) Walkman $50 Quantity Price (dollars per CD) (millions of CDs per week) Quantity (millions of CDs per week) a 1 9 a' 1 13 b 2 6 b' 2 10 c 3 4 c' 3 8 d 4 3 d' 4 7 e 5 2 e' 5 6 Copyright © 1998 Addison Wesley Longman, Inc. TM 4-22 Demand Price (dollar per CD) 6 5 e 4 e' d 3 d' c c' 2 1 0 Copyright © 1998 Addison Wesley Longman, Inc. Demand for CDs (Walkman $50) b b' Demand for CDs (Walkman $200) 2 4 a 6 8 a' 10 12 14 Quantity (millions of CDs per week) TM 4-23 The Demand for Tapes The Law of Demand The quantity of CDs demanded Decreases if: The price of a CD rises. Increases if: The price of a CD falls. Copyright © 1998 Addison Wesley Longman, Inc. TM 4-24 The Demand for CDs Changes In Demand The demand for CDs Decreases if: • The price of a substitute falls. • The price of a complement rises. • Income falls (a CD is a normal good). • The population decreases. • The price of a CD is expected to fall in the future. Copyright © 1998 Addison Wesley Longman, Inc. TM 4-25 The Demand for CDs Changes In Demand The demand for CDs Increases if: • The price of a substitute rises. • The price of a complement falls. • Income rises (a CD is a normal good). • The population increases. • The price of a CD is expected to rise in the future. Copyright © 1998 Addison Wesley Longman, Inc. TM 4-26 A Change in the Quantity Demanded Versus a Change in Demand A movement along a demand curve, which results from a change in price, shows a change in the quantity demanded. If some other influence on buyers’ plans changes, holding price constant, there is a change in demand. Copyright © 1998 Addison Wesley Longman, Inc. TM 4-27 Price A Change in the Quantity Demanded Versus a Change in Demand Decrease in quantity demanded Decrease in Increase in demand Increase in quantity demanded demand D2 D0 D1 Quantity Copyright © 1998 Addison Wesley Longman, Inc. TM 4-28 Learning Objectives • Distinguish between a money price and a relative price • Explain the main influences on demand • Explain the main influences on supply • Explain how prices and quantities bought and sold are determined by demand and supply Copyright © 1998 Addison Wesley Longman, Inc. TM 4-29 Supply If a firm supplies a good or service, the firm • Has the resources and technology to produce it. • Can profit from producing it. • Has made a definite plan to produce it and sell it. Copyright © 1998 Addison Wesley Longman, Inc. TM 4-30 Supply The quantity supplied of a good or service is the amount that producers plan to sell during a given time period at a particular price. Copyright © 1998 Addison Wesley Longman, Inc. TM 4-31 Supply What determines selling plans? • The price of the good. • The prices of resources used to produce the good. • The prices of related goods produced. • Expected future prices. • The number of suppliers. • Technology. Copyright © 1998 Addison Wesley Longman, Inc. TM 4-32 Supply The Law of Supply Other things remaining the same, the higher the price of a good, the greater is the quantity supplied. Copyright © 1998 Addison Wesley Longman, Inc. TM 4-33 Supply Supply Curve and Supply Schedule Supply curves show the relationship between the quantity supplied of a good and its price (ceteris paribus). Supply schedules list the quantities supplied at each different price (ceteris paribus). Copyright © 1998 Addison Wesley Longman, Inc. TM 4-34 Supply Price Quantity (dollars per CD) (millions of CDs per week) a 1 0 b 2 3 c 3 4 d 4 5 e 5 6 Copyright © 1998 Addison Wesley Longman, Inc. TM 4-35 Supply Price (dollar per CD) 6 Supply of CDs 5 e 4 d 3 c 2 1 b a 0 2 4 6 8 10 Quantity (millions of CDs per week) Copyright © 1998 Addison Wesley Longman, Inc. TM 4-36 Supply A Change in Supply When any factor that influences selling plans other than the price of the good changes, there is a change in supply. • An increase in supply causes the supply to shift rightward. • A decrease in supply causes the supply curve to shift leftward. Copyright © 1998 Addison Wesley Longman, Inc. TM 4-37 A Change in Supply • Price of Productive Resources • Price of Related Goods Produced • Substitutes in Production • Complements in Production • Expected Future Prices Copyright © 1998 Addison Wesley Longman, Inc. TM 4-38 A Change in Supply • The Number of Suppliers • Technology Copyright © 1998 Addison Wesley Longman, Inc. TM 4-39 Supply Original supply schedule New supply schedule New technology Old technology Price (dollars per CD) Quantity Price (dollars per CD) (millions of CDs per week) Quantity (millions of CDs per week) a 1 0 a' 1 3 b 2 3 b' 2 6 c 3 4 c' 3 8 d 4 5 5 6 4 5 10 e d' e' Copyright © 1998 Addison Wesley Longman, Inc. 12 TM 4-40 Price (dollar per CD) Supply 6 Supply of CDs (old technology) 5 4 d' d 3 c 2 1 e' e c' b a' a 0 Copyright © 1998 Addison Wesley Longman, Inc. b' 2 4 6 8 Supply of CDs (new technology) 10 12 14 Quantity (millions of CDs per week) TM 4-41 The Supply of Tapes The Law of Supply The quantity of CDs supplied Decreases if: The price of a CD falls. Increases if: The price of a CD rises. Copyright © 1998 Addison Wesley Longman, Inc. TM 4-42 The Supply of Tapes Changes In Supply The supply of CDs Decreases if: • The price of a resource used to produce CDs rises. • The number of CD producers decreases. • The price of a substitute in production rises. Copyright © 1998 Addison Wesley Longman, Inc. TM 4-43 The Supply of CDs Changes In Supply The supply of CDs (cont.) Decreases if: • The price of a complement in production falls. • The price of a CD is expected to rise in the future. Copyright © 1998 Addison Wesley Longman, Inc. TM 4-44 The Supply of CDS Changes In Supply The supply of CDs Increases if: • The price of a resource used to produce CDs falls. • More efficient technologies for producing CDs are discovered. • The number of CD producers increases. Copyright © 1998 Addison Wesley Longman, Inc. TM 4-45 The Supply of CDs Changes In Supply The supply of CDs (cont.) Increases if: • The price of a substitute in production falls. • The price of a complement in production rises. • The price of a CD is expected to fall in the future. Copyright © 1998 Addison Wesley Longman, Inc. TM 4-46 A Change in the Quantity Supplied Versus a Change in Supply A movement along a supply curve, which results from a change in price, shows a change in the quantity supplied. If some other influence on sellers’ plans changes, holding price constant, there is a change in supply. Copyright © 1998 Addison Wesley Longman, Inc. TM 4-47 Price A Change in the Quantity Supplied Versus a Change in Supply Increase in S2 quantity supplied Decrease in supply S0 S1 Increase in supply Decrease in quantity supplied Quantity Copyright © 1998 Addison Wesley Longman, Inc. TM 4-48 Learning Objectives • Distinguish between a money price and a relative price • Explain the main influences on demand • Explain the main influences on supply • Explain how prices and quantities bought and sold are determined by demand and supply Copyright © 1998 Addison Wesley Longman, Inc. TM 4-49 Market Equilibrium Equilibrium in a market occurs when the price balances the plans of buyers and sellers. Equilibrium price is the price at which quantity demanded equals quantity supplied. Equilibrium quantity is the quantity bought and sold at the equilibrium price. Copyright © 1998 Addison Wesley Longman, Inc. TM 4-50 Market Equilibrium Price as a Regulator • If the price is too low, quantity demanded exceeds quantity supplied. • If the price is too high, quantity supplied exceeds quantity demanded. Copyright © 1998 Addison Wesley Longman, Inc. TM 4-51 Market Equilibrium Price (dollars Quantity demanded Quantity Shortage(–) supplied or surplus(+) per CD) (millions of CDS per week) 1 2 9 6 0 3 3 4 4 4 3 5 5 2 6 Copyright © 1998 Addison Wesley Longman, Inc. TM 4-52 Market Equilibrium Price (dollars Quantity demanded Quantity Shortage(–) supplied or surplus(+) per CD) (millions of CDs per week) 1 2 9 6 0 3 -9 -3 3 4 4 0 4 3 5 +2 5 2 6 +4 Copyright © 1998 Addison Wesley Longman, Inc. TM 4-53 Price (dollar per CD) Market Equilibrium Surplus of 2 million CDs at $4 a CD 6 Supply of CDs 5 4 Equilibrium 3 2 Shortage of 3 million CDs at $2 a CD 1 0 Copyright © 1998 Addison Wesley Longman, Inc. 2 4 6 Demand for CDs 8 10 Quantity (millions of CDs per week) TM 4-54 Market Equilibrium Price Adjustments • A shortage forces the price up. • A surplus forces the price down. Such price changes are mutually beneficial to both buyers and sellers. Copyright © 1998 Addison Wesley Longman, Inc. TM 4-55 Learning Objectives (cont.) • Explain why some prices fall, some rise, and some fluctuate • Use demand and supply to make predictions about price changes Copyright © 1998 Addison Wesley Longman, Inc. TM 4-56 Predicting Changes in Price and Quantity A Change in Demand What would happen to the price and quantity of CDs if the price of a Walkman falls from $200 to $50? Copyright © 1998 Addison Wesley Longman, Inc. TM 4-57 The Effects of a Change in Demand Quantity demanded Price (millions of CDs per week) (dollars per CD ) Walkman $200 Walkman $50 Quantity supplied (millions of CDs per week) 1 2 9 6 0 3 3 4 4 4 3 5 5 2 6 Copyright © 1998 Addison Wesley Longman, Inc. TM 4-58 The Effects of a Change in Demand Quantity demanded Price (dollars per CD ) (millions of CDs per week) Walkman $200 Walkman $50 Quantity supplied (millions of CDs per week) 1 2 9 6 13 10 0 3 3 4 8 4 4 3 7 5 5 2 6 6 Copyright © 1998 Addison Wesley Longman, Inc. TM 4-59 Price (dollar per CD) The Effects of a Change in Demand Supply of CDs 6 5 4 3 2 Demand for tapes (Walkman $50) 1 0 Demand for tapes (Walkman $200) 2 4 6 8 10 12 14 Quantity (millions of CDs per week) Copyright © 1998 Addison Wesley Longman, Inc. TM 4-60 A Change in Demand Prediction • When demand increases, both the price and quantity increase. • When demand decreases, both the price and quantity decrease. Copyright © 1998 Addison Wesley Longman, Inc. TM 4-61 Predicting Changes in Price and Quantity A Change in Supply What would happen to the price and quantity of CDs if a new cost-saving production technology was developed? Copyright © 1998 Addison Wesley Longman, Inc. TM 4-62 The Effects of a Change in Supply Quantity supplied Price (dollars Quantity demanded per CD ) (millions of CDs per week) (millions of CDs per week) old new technology technology 1 2 9 6 0 3 3 4 4 4 3 5 5 2 6 Copyright © 1998 Addison Wesley Longman, Inc. TM 4-63 The Effects of a Change in Supply Quantity supplied Price (dollars Quantity demanded per CD ) (millions of CDs per week) (millions of CDs per week) old new technology technology 1 2 9 6 0 3 3 6 3 4 4 8 4 3 5 10 5 2 6 12 Copyright © 1998 Addison Wesley Longman, Inc. TM 4-64 Price (dollar per CD) The Effects of a Change in Supply Supply of CDs (old technology) 6 5 4 Supply of CDs (new technology) 3 2 1 Demand for CDs 0 Copyright © 1998 Addison Wesley Longman, Inc. 2 4 6 8 10 12 14 Quantity (millions of CDs per week) TM 4-65 A Change in Supply Prediction • When supply increases, the quantity increases and the price falls. • When demand decreases, the quantity decreases and the price falls Copyright © 1998 Addison Wesley Longman, Inc. TM 4-66 Predicting Changes in Price and Quantity A Change in Both Demand and Supply What would happen if both demand and supply change together? Copyright © 1998 Addison Wesley Longman, Inc. TM 4-67 The Effects of an Increase in Both Demand and Supply Original Quantities (millions of CDs per week) Price Quantity demanded Quantity supplied 1 2 9 6 0 3 3 4 4 4 3 5 5 2 6 (dollars per CD ) Walkman $200 Copyright © 1998 Addison Wesley Longman, Inc. old technology New Quantities (millions of CDs per week) Quantity Quantity demanded supplied Walkman $50 new technology TM 4-68 The Effects of an Increase in Both Demand and Supply Original Quantities (millions of CDs per week) Price New Quantities (millions of CDs per week) Quantity demanded Quantity supplied 1 2 9 6 0 3 13 10 3 6 3 4 4 8 8 4 3 5 7 10 5 2 6 6 12 (dollars per tape ) Walkman $200 Copyright © 1998 Addison Wesley Longman, Inc. old technology Quantity Quantity demanded supplied Walkman $50 new technology TM 4-69 Price (dollar per CD) The Effects of an Increase in Both Demand and Supply Supply of CDs (old technology) 6 Supply of CDs (new technology) 5 4 3 2 Demand for CDs (Walkman $50) 1 Demand for CDs (Walkman $200) 0 Copyright © 1998 Addison Wesley Longman, Inc. 2 4 6 8 10 12 14 Quantity (millions of CDs per week) TM 4-70 A Change in Both Demand and Supply Prediction • When both demand and supply increase, the quantity increases and the price decreases, or remains constant. • When both demand and supply decreases, the quantity decreases and the price increases, decreases, or remains constant. Copyright © 1998 Addison Wesley Longman, Inc. TM 4-71 The Effects of an Decrease in Demand and an Increase in Supply Original Quantities New Quantities (millions of CDs per week) Price (dollars per CD) Quantity demanded MP3 player $400 Quantity supplied old technology 1 2 13 10 0 3 3 8 4 4 7 5 5 6 6 Copyright © 1998 Addison Wesley Longman, Inc. (millions of CDs per week) Quantity demanded MP3 player $200 Quantity supplied new technology TM 4-72 The Effects of an Decrease in Demand and an Increase in Supply Original Quantities New Quantities (millions of tapes per week) Price (dollars per CD ) Quantity demanded MP3 player $400 Quantity supplied old technology (millions of tapes per week) Quantity demanded MP3 player $200 Quantity supplied new technology 1 2 13 10 0 3 9 6 3 6 3 8 4 4 8 4 7 5 3 10 5 6 6 2 12 Copyright © 1998 Addison Wesley Longman, Inc. TM 4-73 Price (dollar per CD) The Effects of an Decrease in Demand and an Increase in Supply Supply of CDs (old technology) 6 Supply of CDs (new technology) 5 4 3 2 1 Demand for CDs (MP3 player $200) 0 2 4 6 8 10 12 Demand for CDs (MP3 player $400) 14 Quantity (millions of CDs per week) Copyright © 1998 Addison Wesley Longman, Inc. TM 4-74 The Effects of an Decrease in Demand and an Increase in Supply Prediction • When demand decreases and supply increases, the price falls and the quantity increases, decreases, or remains constant. • When demand increases and supply decreases, the price rises and the quantity increases, decreases, or remains constant. Copyright © 1998 Addison Wesley Longman, Inc. TM 4-75 Price (p) Market EQUILIBRIUM Market equilibrium Supply P* Demand 0 Copyright © 1998 Addison Wesley Longman, Inc. Q* Quantity supplied (Qs) TM 4-76 Market SURPLUS P $5 surplus S 4 3 2 1 o Copyright © 1998 Addison Wesley Longman, Inc. D 2 4 6 78 10 12 14 16 Q TM 4-77 Market DEFICIT P S $5 4 3 2 deficit 1 o D 2 4 6 78 Corn Copyright © 1998 Addison Wesley Longman, Inc. 101112 14 16 Q TM 4-78