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Supply and Demand:
An Introduction
Q
Supply and Demand:

How do consumers get the goods and
services they want in the right quantities
and qualities?

Some goods and services are allocated by
the market forces of supply and demand
Supply and Demand
2
Supply and Demand:

Why do some goods and services have
shortages or surpluses and others do
not?

Some good and supplies services are
regulated by government
Supply and Demand
3
What, How, and for Whom?
Central Planning Versus the Market

Three Problems All Economic Systems
Must Address
What should be produced?
 How should it be produced?
 For whom will it be produced?

Supply and Demand
4
Centralized Economic Organizations
Agrarian society
 Former Soviet Union
 Cuba, North Korea
 China?
 Bureaucracy

Havana
Supply and Demand
5
What, How, and for Whom?
Central Planning Versus the Market

Free-Market or Capitalist Economic
Systems

Individual choices determine
 Which
careers to pursue
 Which products to produce or buy
 When to start and shut-down a business
 Who gets what, which is decided by individual
preferences and purchasing power
Supply and Demand
6
Buyers and Sellers in Markets

A Market


Consists of all buyers and sellers of a good
or service
What do you think?

What determines the price of pizza,
gasoline, a car wash, or other goods and
services?
Supply and Demand
7
The Demand Curve

A schedule or graph that tells us the
quantity of a good that buyers wish to buy
at each price
Supply and Demand
8
A Property of Demand
As price of a good or service goes down
the quantity consumers wish to buy will
increase
 Therefore, the demand curve is downwardsloping

Supply and Demand
9
The Daily Demand
Curve for Pizza in Chicago
Price
($ per slice)
4
3
2
Demand
8
12
16
Supply and Demand
Quantity
(1000s of slices per day)
10
The Demand Curve—
Taiwan Beer
Price per
Bottle
When the price is $40
per bottle, 40,000 bottles
are demanded (point A).
$40
A
B
30
At $30 per bottle,
60,000 bottles are
demanded (point B).
D
40,000
60,000
Supply and Demand
Number of Bottles
per Month
11
薄利多銷?
Supply and Demand
12
Using Price Elasticity of Demand:
Mass Transit

Elasticity studies show
that long-run demand
for mass transit is
inelastic

Therefore, a rise in fare
would increase
revenues
Supply and Demand
13

However, most cities do not raise transit
fares due to
Desire to provide low-income households
with affordable transportation
 Desire to manage traffic congestion
 Desire to limit air pollution in the city


An increase in fares would increase
revenue

Would also decrease ridership and require
the city to sacrifice these other goals
Supply and Demand
14
Buyers and Markets

The Demand Curve

Why do buyers purchase a greater quantity
at lower prices and vice-versa?
 The
substitution effect
 The income effect
Supply and Demand
15
Substitution Effect

The change in the quantity demanded of a
good that results because buyers switch to
substitutes when the price of the good
changes
Supply and Demand
16
Income Effect

The change in the quantity demanded of a
good that results because a change in the
price of a good changes the buyer’s
purchasing power
Supply and Demand
17
The Cost-Benefit Principle
The reservation price is the benefit the
buyer receives from the good
 The cost of the good is its market price
 If the reservation price (benefit) exceeds
the market price (cost) the consumer will
purchase the good
 At higher prices, benefit will exceed cost
for a smaller quantity than at lower prices

Supply and Demand
18
WTP
Price
($ per slice)
The buyers reservation price:
The largest dollar amount the
buyer would be willing to pay for
a good
4
3
2
Demand
8
12
16
Supply and Demand
Quantity
(1000s of slices per day)
19
Horizontal Interpretation
Price
($ per slice)
Price determines
quantity demanded
4
3
2
Demand
8
12
16
Supply and Demand
20
Vertical Interpretation
Price
($ per slice)
Quantity measures the
marginal buyer’s
reservation price
4
3
2
Demand
8
12
16
Supply and Demand
21
The Supply Curve

A curve or schedule showing the quantity
of a good that sellers wish to sell at each
price
Supply and Demand
22
Question

Will the opportunity cost of producing
additional units of pizza increase or
decrease?
 Hint:
Low-hanging-fruit principle
Supply and Demand
23
The Supply Curve

Sellers must receive a higher price to
produce additional units of a product to
cover the higher opportunity costs of each
additional unit
Supply and Demand
24
The Daily Supply
Curve for Pizza in Chicago
Price
($ per slice)
Supply
4
3
2
8
12
16
Supply and Demand
Quantity
(1000s of slices per day)
25
The Daily Supply
Curve for Pizza in Chicago
Horizontal Interpretation
Price
($ per slice)
Supply
4
Shows the
quantity produced
for each price
3
2
8
12
16
Supply and Demand
Quantity
(1000s of slices per day)
26
The Daily Supply
Curve for Pizza in Chicago
Vertical Interpretation
Price
($ per slice)
Supply
4
Shows the marginal
cost (reservation
price) for producing
each additional unit
3
2
8
12
16
Supply and Demand
Quantity
(1000s of slices per day)
27
Market Equilibrium

Seller’s Reservation Price

The smallest dollar amount for which a
seller would be willing to sell an additional
unit, generally equal to marginal cost
Supply and Demand
28
Market Equilibrium

Equilibrium


A system is in equilibrium when there is no
tendency for it to change
Market Equilibrium

Occurs in a market when all buyers and
sellers are satisfied with their respective
quantities at the market price
Supply and Demand
29
The Equilibrium Price and
Quantity of Pizza in Chicago
Price
($ per slice)
Supply
Equilibrium at $3
Quantity Demanded =
Quantity Supplied
4
3
2
Demand
8
12
16
Supply and Demand
Quantity
(1000s of slices per day)
30
Equilibrium Price and Equilibrium Quantity

The values of price and quantity for
which quantity supplied and quantity
demanded are equal
Supply and Demand
31
What Do You Think?
Would buyers prefer a lower price than the
equilibrium price?
 Would sellers prefer a higher price than the
equilibrium price?

Supply and Demand
32
Excess Supply
Excess supply = 8,000 slices per day
Price
($ per slice)
Supply
4
3
2
Demand
8
12
16
Supply and Demand
Quantity
(1000s of slices per day)
33
Excess Demand
Price
($ per slice)
Supply
4
Excess demand = 8,000
slices per day
3
2
Demand
8
16
Supply and Demand
Quantity
(1000s of slices per day)
34
Points Along the Demand and
Supply Curves of a Pizza Market
Demand for pizza
Supply of pizza
Price
($/slice)
Quantity demanded
(1000s of slices/day)
Price
($/slice)
Quantity supplied
(1000s of slices/day)
1
8
1
2
2
6
2
4
3
4
3
6
4
2
4
8
Supply and Demand
35
Graphing Supply and Demand and
Finding the Equilibrium Price and Quantity
Price
($per slice)
Supply
5
4
The Equilibrium Price = $2.50
The Equilibrium Quantity = 5
3
2.50
2
1
0
Demand
2
4
6
8
10
Quantity
(1000s of slices per day)
5
Supply and Demand
36
What Do You Think?

Is the market equilibrium always an ideal
outcome for all market participants?
Supply and Demand
37
An Unregulated Housing Market
Monthly Rent
($/apartment)
Supply
What Do You Think?
Is $1600 more than some
people can afford?
1600
Demand
2
Supply and Demand
Quantity
(Millions of apartments/day)
38
Rent Controls
Monthly Rent
($/apartment)
Supply
2400
Excess demand = 2 million
apartments per month
1600
Controlled = 800
Demand
0
1
2
3
Supply and Demand
Quantity
(Millions of apartments/day)
39
Market Equilibrium

Rent Controls Reconsidered

Other consequences of rent controls
 Maintenance
will decline and housing quality
will fall
 Illegal payments
 Creation of co-ops and conversion to
condominiums
 Reduction in household mobility
 Discrimination
Supply and Demand
40
Case study:

What do you think?
How can we make housing affordable for
poor people without using rent ceilings?
 Health insurance
 Tuition fee
KTR
 Fruit/Rice export
 High-speed railway

THR
Supply and Demand
41
Rent Controls
What is the impact of a rent
control set at $1,200/month?
Monthly Rent
($/apartment)
Supply
1200
What is the impact of a rent
control set at $600/month?
800
600
Demand
0
1
2
3
Supply and Demand
Quantity
(Millions of apartments/day)
42
Price Controls
in the Pizza Market
Price
($ per slice)
Supply
4
Excess demand = 8,000 slices per day
3
Price ceiling = 2
Demand
8
12
16
Supply and Demand
Quantity
(1000s of slices per day)
43
Rental control in Paris or NCCU
Supply and Demand
44
Market Equilibrium

Pizza Price Controls?

Market responses to a pizza price ceiling
 Long
lines
 Preferential treatment to selected customers
 Alternative pricing strategies
 Poorer quality ingredients
 Black-market pizzas
Supply and Demand
45
Predicting and Explaining
Changes in Prices and Quantities

Distinguishing Between

A change in the quantity demanded
A
movement along the demand curve that
occurs in response to a change in price

A change in demand
A
shift of the entire demand curve
Supply and Demand
46
An Increase in Quantity Demanded
Price
($/can)
6
D
Increase in
quantity
demanded
5
4
3
2
1
0
D
2
4
12
Supply and Demand
Quantity
(1000s of cans/day)
47
an Increase in Demand
Price
($/can)
6
D’
D
5
4
Increase in demand
3
2
D’
1
D
0
12
Supply and Demand
Quantity
(1000s of cans/day)
48
A Shift of The Demand Curve
Price per
Bottle
An increase in income
shifts the demand curve for
beers from D1 to D2.
At each price, more bottles
are demanded after the
shift
B
C
$2.00
D1
D2
80,000
Number of Bottles
per Month
60,000
Supply and Demand
49
Predicting and Explaining
Changes in Prices and Quantities

Change in the quantity supplied


A movement along the supply curve that
occurs in response to a change in price
Change in supply

A shift of the entire supply curve
Supply and Demand
50
An Increase in Quantity
Supplied vs. an Increase in Supply
Price
($/can)
S
6
5
Increase in
quantity supplied
4
3
2
S
1
0
2
4
6
8
10
Supply and Demand
Quantity
(1000s of cans/day)
51
An Increase in Quantity
Supplied vs. an Increase in Supply
Price
($/can)
6
S
S’
5
4
3
Increase in supply
2
1
S’
S
0
2
4
6
8
10
Supply and Demand
Quantity
(1000s of cans/day)
52
The Effect on the Market for Tennis
Balls of a Decline in Court Rental Fees
Price
($/ball)
S
1.40
1.00
D’
D
40
58
Supply and Demand
Quantity
(letters/month)
53
Effect on the Market for Overnight Letter Delivery of a Decline in the Price of Internet Access
Price
($/letter)
S
P
P’
D
D’
Q’
Q
Supply and Demand
Quantity
(letters/month)
54
Predicting and Explaining
Changes in Prices and Quantities

Economic Naturalist

When the Federal Government implements
a large pay increase for its employees, why
do rents for apartments near Washington
Metro stations go up relative to rents for
apartments located far away from Metro
stations?
Supply and Demand
55
Predicting and Explaining
Changes in Prices and Quantities

Shifts in Demand

Complements
 Two
goods are complements in consumption if
an increase (decrease) in the price of one
cause a decrease (increase) in the demand for
the other
Supply and Demand
56
Predicting and Explaining
Changes in Prices and Quantities

Shifts in Demand

Substitutes
 Two
goods are substitutes in consumption if an
increase (decrease) in the price of one causes
an increase (decrease) in the demand for the
other
Supply and Demand
57
Predicting and Explaining
Changes in Prices and Quantities

Shifts in Demand

Changes In Demand
 An
increase (decrease) in the demand for a
good will shift the demand curve to the right
(left)
Supply and Demand
58
Predicting and Explaining
Changes in Prices and Quantities

What do you think?

How will a decline in airfares affect intercity bus fares and the price of hotel rooms
in resort communities?
Supply and Demand
59
The Effect of a Federal Pay Raise on the Rent for
Conveniently Located Apartments in Washington D.C.
Rent
(dollars per month)
S
P’
P
D
Q
Q’
Supply and Demand
D’
Conveniently
located apartments
(units per month)
60
Predicting and Explaining
Changes in Prices and Quantities

A Change In Income

Normal Good
 One
whose demand increases (decreases)
when the incomes of buyers increase
(decrease)
Supply and Demand
61
Predicting and Explaining
Changes in Prices and Quantities

A Change In Income

Inferior Goods (Giffen Goods)
 One
whose demand decreases (increases)
when the incomes of buyers increase
(decrease)
Supply and Demand
62
Giffen Goods
Supply and Demand
63
The Effect of the Release of Jurassic
Park on the Market for Toy Dinosaurs
D’ = demand after release of movie
Price
S
P’
P
D’
D
Q
Q’
Supply and Demand
Toy Dinosaurs
(units per month)
64
The Effect of a Credible Rumor on
the Market for Apple Macintosh Computers
D’ = demand after rumor of cheaper
model soon to be released
Price
S
P
P’
D’
Q’
Q
Supply and Demand
D
Apple Computers
(units per month)
65
The Effect of the Increase in
the Population of Potential Buyers
D’ = demand after increase in population
Price
S
P’
P
D
Q
Q’
Supply and Demand
D’
Housing NY City
(units per month)
66
The Effect on the Skateboard Market
of an Increase in the Price of Fiberglass
Price
($/skateboard)
S’
S
80
60
D
800 1000
Supply and Demand
Quantity
(skateboards/month)
67
Predicting and Explaining
Changes in Prices and Quantities

What Do You Think?

Does the increase in the cost of fiberglass
have any effect on the demand curve for
skateboards?
Supply and Demand
68
The Effect on the Market for New Houses
of a Decline in Carpenters’ Wage Rates
Price
($1000/house)
S
S’
120
90
D
40
50
Supply and Demand
Quantity
(houses/month)
69
The Effect of Technical Change on the Market
for the Term Paper Revisions
Price
($/revision)
S
55
S’
7.50
D
12
36
Supply and Demand
Quantity
(millions of revisions per year)
70
Predicting and Explaining
Changes in Prices and Quantities

Other determinants of supply
Weather
 Expectations
 Number of sellers

Supply and Demand
71
Four Rules Governing the Effects
of Supply and Demand Shifts: I
An increase in demand will lead to an increase
in both the equilibrium price and quantity
Price
S
P’
P
D
Q
Q’
Supply and Demand
D’
Quantity
72
Four Rules Governing the Effects
of Supply and Demand Shifts: II
A decrease in demand will lead to a decrease
in both the equilibrium price and quantity
Price
S
P
P’
D’
Q’
D
Quantity
Q
Supply and Demand
73
Four Rules Governing the Effects
of Supply and Demand Shifts: III
An increase in supply will lead to a
decrease in the equilibrium price
and an increase in the equilibrium quantity
Price
S
S’
P
P’
D
Q
Q’
Supply and Demand
Quantity
74
Four Rules Governing the Effects
of Supply and Demand Shifts: IV
An decrease in supply will lead to
an increase in the equilibrium price
and a decrease in the equilibrium quantity
Price
S’
S
P’
P
D
Q’
Quantity
Q
Supply and Demand
75
Predicting and Explaining
Changes in Prices and Demand

Factors That Cause an Increase
(rightward or upward shift) in Demand
1. A decrease in the price of complements
to the good or service
2. An increase in the price of substitutes for
the good or service
3. An increase in income (for a normal good)
Supply and Demand
76
Predicting and Explaining
Changes in Prices and Demand

Factors That Cause an Increase
(rightward or upward shift) in Demand
4. An increased preference by demanders
for the good or service
5. An increase in the population of potential
buyers
6. An expectation of higher prices in the
future
Supply and Demand
77
Predicting and Explaining
Changes in Prices and Demand

Factors That Cause an Increase
(rightward or upward shift) in Supply
1. A decrease in the cost of materials, labor,
or other inputs used in the production of
the good or service
2. An improvement in technology that
reduces the cost of producing the good or
service
Supply and Demand
78
Predicting and Explaining
Changes in Prices and Demand

Factors That Cause an Increase
(rightward or upward shift) in Supply
3. An improvement in the weather,
especially for agricultural products
4. An increase in the number of suppliers
5. An expectation of lower prices in the
future
Supply and Demand
79
The Effects of Simultaneous
Shifts in Supply and Demand
The Market for Corn Tortilla Chips
Price
($/bag)
S
S’
P
S’ after reduction in price of
corn harvesting equipment
D’ after discovery that oils are
harmful to people’s health
P’
D
D’
Q’
Q
Supply and Demand
Millions of bags
per month
80
The Effects of Simultaneous
Shifts in Supply and Demand
The Market for Corn Tortilla Chips
Price
($/bag)
S
S’
P
S’ after reduction in price of
corn harvesting equipment
D’ after discovery that oils are
harmful to people’s health
P’
D’
Q Q’
Supply and Demand
D
Millions of bags
per month
81
Predicting and Explaining
Changes in Prices and Demand

Assume
A vitamin found in corn chips helps protect
against cancer and heart disease
 A swarm of locusts destroys part of the
corn crop


What Do You Think?

What will happen to the equilibrium price
and quantity of corn chips?
Supply and Demand
82
Predicting and Explaining
Changes in Prices and Demand

Economic Naturalist

Why do the prices of some goods, like
airline tickets to Europe, go up during the
months of heaviest consumption, while
others, like sweet corn, go down?
Supply and Demand
83
Seasonal Variation in
Air Travel and Corn Markets
High Consumption due to High Demand
Price
($/ticket)
S
PS
PW
DS
DW
QW
QS
Supply and Demand
1000s of
tickets
84
Seasonal Variation in
Air Travel and Corn Markets
Price
($/bushel)
High Consumption due to High Supply
SW
SS
PS
PW
D
QW
QS
Supply and Demand
Millions of
bushels
85
Markets and Social Welfare

What Do You Think?

When are the prices and quantities
determined in market equilibrium socially
optimal, in the sense of maximizing total
economic surplus?
Supply and Demand
86
Markets and Social Welfare

Cash On The Table

Assume
 All

exchange is purely voluntary
If so
 The
buyer’s reservation price exceeds the
seller’s reservation price and both the buyer
and seller receive an economic surplus
Supply and Demand
87
Cash On The Table

Economic metaphor for unexploited gains from exchange

Buyer’s surplus


Seller’s surplus


The difference between the buyer’s reservation price and the
price he or she actually pays
The difference between the price received by the seller and his
or her reservation price
Total surplus

The difference between the buyer’s reservation price and the
seller’s reservation price
Supply and Demand
88
Price Controls in the Pizza Market
Price
($ per slice)
Assume
•Buyer’s reservation P = $4
•Sellers reservation P = $2
•Pizza sells for $3
S
4
•Buyer’s surplus: $4 - $3 = $1
•Seller’s surplus: $3 - $2 = $1
•Total surplus: $4 - $2 = $2
3
2
D
8
12
16
Supply and Demand
Quantity
(1000s of slices per day)
89
Price Controls in the Pizza Market
Excess demand =
$8,000 slices/day
Price
($ per slice)
Assume price controls = $2
•Quantity supplied falls to 8,000
•Buyer’s reservation price ($4) is
greater than seller’s ($2)
• Both would benefit from
additional production
•There is CASH ON THE TABLE
4
3
2
D
S
8
12
16
Supply and Demand
Quantity
(1000s of slices per day)
90
Markets and Social Welfare

Smart For One, Dumb For All

Socially optimal quantity
 The
quantity of a good that results in the
maximum possible economic surplus from
producing and consuming the good

The socially optimal quantity occurs when
MC = MB
Supply and Demand
91
Markets and Social Welfare

Smart For One, Dumb For All

Economic efficiency occurs when all goods
and services are produced and consumed
at their respective socially optimal levels
Supply and Demand
92
Markets and Social Welfare

Smart For One, Dumb For All

Achieving economic efficiency
 Maximizes
the economic surplus
 Increases the economic pie
Supply and Demand
93
Markets and Social Welfare

Smart For One, Dumb For All

When is the market equilibrium efficient?
 When
all costs of producing the good or service
are borne directly by the seller
 When all benefits from the good or service
accrue directly to buyers
Supply and Demand
94
Markets and Social Welfare

Smart For One, Dumb For All

Inefficient market equilibrium
 When
some costs of production fall on people
other than those who sell the good or service
Supply and Demand
95
Markets and Social Welfare

Example: Pollution
The market is in equilibrium: MC = MB
 MC however underestimates the cost to
society of producing the good
 Therefore, the market produces more than
the efficient amount and there is no
incentive for producers and consumers to
alter their behavior

Supply and Demand
96
Markets and Social Welfare

Smart For One, Dumb For All

Inefficient market equilibrium
 When
some benefits from the good or service
accrue to people who did not buy the good or
service
Supply and Demand
97
Markets and Social Welfare

Example: Vaccinations
 The
market is in equilibrium: MC = MB
 MB underestimates the benefits to society of
consuming the vaccinations
 The market produces less than the efficient
amount of vaccinations and there is no
incentive for producers and consumers to alter
their behavior
Supply and Demand
98
Markets and Social Welfare

Smart For One, Dumb For All

In these markets
 Buyers
and sellers are behaving rationally
 Market equilibrium exists
 There are no unexploited opportunities for
individuals
 Economic surplus is not maximized
Supply and Demand
99