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Chapter 3: Where Prices Come From: The Interaction of Demand and Supply
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Chapter 3: Where Prices Come From: The Interaction of Demand and Supply
Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e.
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Chapter 3: Where Prices Come From: The Interaction of Demand and Supply
CHAPTER
3
Where Prices
Come From:
The Interaction of
Demand and Supply
The intense competition
among firms selling
energy drinks is a striking
example of how the
market responds to
changes in consumer
tastes.
Prepared by:
Fernando Quijano
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Chapter 3: Where Prices Come From: The Interaction of Demand and Supply
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
Discuss the variables that influence
demand.
3.2 The Supply Side of the Market
Discuss the variables that influence
supply.
3.3 Market Equilibrium: Putting Demand and
Supply Together
Use a graph to illustrate market
equilibrium.
3.4 The Effect of Demand and Supply Shifts
on Equilibrium
Use demand and supply graphs to predict
changes in prices and quantities
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Chapter 3: Where Prices Come From: The Interaction of Demand and Supply
Where Prices Come From:
The Interaction of Demand and Supply
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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3.1 LEARNING OBJECTIVE
The Demand Side of the Market
Discuss the variables that
influence demand.
Chapter 3: Where Prices Come From: The Interaction of Demand and Supply
Demand Schedules and Demand Curves
Demand schedule A table showing 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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3.1 LEARNING OBJECTIVE
The Demand Side of the Market
Discuss the variables that
influence demand.
Chapter 3: Where Prices Come From: The Interaction of Demand and Supply
Demand Schedules and Demand Curves
FIGURE 3-1
A Demand Schedule and
Demand Curve
As the price changes, consumers
change the quantity of energy
drinks 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 energy drinks falls,
the quantity demanded rises.
When the price of energy drinks is
$3.00, consumers buy 60 million
cans per day. When the price drops
to $2.50, consumers buy 70 million
cans.
Therefore, the demand curve for
energy drinks is downward sloping.
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3.1 LEARNING OBJECTIVE
The Demand Side of the Market
Discuss the variables that
influence demand.
Chapter 3: Where Prices Come From: The Interaction of Demand and Supply
The Law of Demand
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.
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3.1 LEARNING OBJECTIVE
The Demand Side of the Market
Discuss the variables that
influence demand.
Chapter 3: Where Prices Come From: The Interaction of Demand and Supply
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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3.1 LEARNING OBJECTIVE
Chapter 3: Where Prices Come From: The Interaction of Demand and Supply
The Demand Side of the Market
Discuss the variables that
influence demand.
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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3.1 LEARNING OBJECTIVE
Chapter 3: Where Prices Come From: The Interaction of Demand and Supply
The Demand Side of the Market
Discuss the variables that
influence demand.
Holding Everything Else Constant:
The Ceteris Paribus Condition
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 any given price, the
demand curve shifts to the left,
from D1 to D3.
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3.1 LEARNING OBJECTIVE
The Demand Side of the Market
Discuss the variables that
influence demand.
Chapter 3: Where Prices Come From: The Interaction of Demand and Supply
Variables That Shift Market Demand
Many variables other than price can influence
market demand.
• 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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3.1 LEARNING OBJECTIVE
Making
the
Are Big Macs an Inferior Good?
Discuss the variables that
influence demand.
Chapter 3: Where Prices Come From: The Interaction of Demand and Supply
Connection
Big Macs seem to fit the economic
definition of an inferior good
because demand increased as
income fell. 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.
McDonald’s restaurants experienced increased
sales during 2008 and 2009, despite the
recession.
YOUR TURN: Test your understanding by doing related problem 1.8 at the end of
this chapter.
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3.1 LEARNING OBJECTIVE
The Demand Side of the Market
Discuss the variables that
influence demand.
Chapter 3: Where Prices Come From: The Interaction of Demand and Supply
Variables That Shift Market Demand
• 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
Consumers can be influenced by an
advertising campaign for a product.
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3.1 LEARNING OBJECTIVE
The Demand Side of the Market
Discuss the variables that
influence demand.
Chapter 3: Where Prices Come From: The Interaction of Demand and Supply
Variables That Shift Market Demand
• 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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3.1 LEARNING OBJECTIVE
Making
The Aging of the
Connection Baby Boom Generation
Chapter 3: Where Prices Come From: The Interaction of Demand and Supply
the
Discuss the variables that
influence demand.
What effects will the aging of the baby boom generation have on the economy?
Older people have a greater demand for medical care than do younger people.
Aging boomers will also have an effect on the housing market.
YOUR TURN: Test your understanding by doing related problem 1.9 at the end of
this chapter.
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3.1 LEARNING OBJECTIVE
The Demand Side of the Market
Discuss the variables that
influence demand.
Chapter 3: Where Prices Come From: The Interaction of Demand and Supply
Variables That Shift Market Demand
TABLE 3-1
Variables That Shift Market Demand Curves
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3.1 LEARNING OBJECTIVE
The Demand Side of the Market
Discuss the variables that
influence demand.
Chapter 3: Where Prices Come From: The Interaction of Demand and Supply
Variables That Shift Market Demand
TABLE 3-1
Variables That Shift Market Demand Curves
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3.1 LEARNING OBJECTIVE
The Demand Side of the Market
Discuss the variables that
influence demand.
Chapter 3: Where Prices Come From: The Interaction of Demand and Supply
Variables That Shift Market Demand
TABLE 3-1
Variables That Shift Market Demand Curves
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3.1 LEARNING OBJECTIVE
The Demand Side of the Market
Discuss the variables that
influence demand.
Chapter 3: Where Prices Come From: The Interaction of Demand and Supply
Variables That Shift Market Demand
TABLE 3-1
Variables That Shift Market Demand Curves
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3.1 LEARNING OBJECTIVE
The Demand Side of the Market
Discuss the variables that
influence demand.
Chapter 3: Where Prices Come From: The Interaction of Demand and Supply
A Change in Demand versus a Change in Quantity Demanded
FIGURE 3-3
A Change in Demand versus a
Change in Quantity Demanded
If the price of digital music players falls
from $3.00 to $2.50, the result will be a
movement along the demand curve from
point A to point B—an increase in
quantity demanded from 60 million cans
to 70 million cans.
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 energy
drinks demanded at a price of $3.00 to
increase from 60 million cans at point A
to 80 million cans at point C.
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3.1 LEARNING OBJECTIVE
Chapter 3: Where Prices Come From: The Interaction of Demand and Supply
Making Red Bull and the Future
the
Demand for Energy Drinks
Connection
Discuss the variables that
influence demand.
It is important for managers to
accurately forecast the demand for
their products because it helps
them determine how much of a
good to produce.
Will Red Bull continue to
grow its share of the energy
drink market?
YOUR TURN: Test your understanding by doing related problem 1.11 at the end
of this chapter.
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3.2 Learning Objective
Chapter 3: Where Prices Come From: The Interaction of Demand and Supply
The Supply Side of the Market
Discuss the variables that
influence supply.
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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3.2 Learning Objective
The Supply Side of the Market
Discuss the variables that
influence supply.
Chapter 3: Where Prices Come From: The Interaction of Demand and Supply
Supply Schedules and Supply Curves
FIGURE 3-4
A Supply Schedule and Supply Curve
As the price changes, Red Bull, Monster
Energy, Rockstar, and the other firms
producing energy drinks 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 energy drinks rises,
firms will increase the quantity they supply.
At a price of $2.50 per can, firms will supply
90 million cans. At a price of $3.00, firms will
supply 100 million cans.
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3.2 Learning Objective
The Supply Side of the Market
Discuss the variables that
influence supply.
Chapter 3: Where Prices Come From: The Interaction of Demand and Supply
The Law of Supply
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.
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3.2 Learning Objective
The Supply Side of the Market
Discuss the variables that
influence supply.
Chapter 3: Where Prices Come From: The Interaction of Demand and Supply
The Law of Supply
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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3.2 Learning Objective
The Supply Side of the Market
Discuss the variables that
influence supply.
Chapter 3: Where Prices Come From: The Interaction of Demand and Supply
Variables That Shift Market Supply
The following are the most important variables that shift market supply:
•
•
Prices of inputs
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
Number of firms in the market
Expected future prices
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3.2 Learning Objective
The Supply Side of the Market
Discuss the variables that
influence supply.
Chapter 3: Where Prices Come From: The Interaction of Demand and Supply
Variables That Shift Market Supply
TABLE 3-2
Variables That Shift Market Supply Curves
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3.2 Learning Objective
The Supply Side of the Market
Discuss the variables that
influence supply.
Chapter 3: Where Prices Come From: The Interaction of Demand and Supply
Variables That Shift Market Supply
TABLE 3-2
Variables That Shift Market Supply Curves (continued)
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3.2 Learning Objective
The Supply Side of the Market
Discuss the variables that
influence supply.
Chapter 3: Where Prices Come From: The Interaction of Demand and Supply
Variables That Shift Market Supply
TABLE 3-2
Variables That Shift Market Supply Curves (continued)
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3.2 Learning Objective
The Supply Side of the Market
Discuss the variables that
influence supply.
Chapter 3: Where Prices Come From: The Interaction of Demand and Supply
A Change in Supply versus a Change in Quantity Supplied
FIGURE 3-6
A Change in Supply versus a
Change in Quantity Supplied
If the price of energy drinks rises from
$2.00 to $2.50 per can, the result will be a
movement up the supply curve from point
A to point B—an increase in quantity
supplied by Red Bull, Monster Energy,
Rockstar, and the other firms from 80
million to 90 million cans.
If the price of an input decreases or
another factor changes that makes sellers
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 energy
drinks supplied at a price of $2.50 to
increase from 90 million cans at point B to
110 million cans at point C.
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Chapter 3: Where Prices Come From: The Interaction of Demand and Supply
Market Equilibrium: Putting Demand
and Supply Together
3.3 Learning Objective
Use a graph to illustrate
market equilibrium.
FIGURE 3-7
Market Equilibrium
Where the demand curve crosses
the supply curve determines market
equilibrium.
In this case, the demand curve for
energy drinks crosses the supply
curve at a price of $2.00 and a
quantity of 80 million cans.
Only at this point is the quantity of
energy drinks consumers are willing
to buy equal to the quantity that Red
Bull, Monster Energy, Rockstar, and
the other firms are willing to sell: The
quantity demanded is equal to the
quantity supplied.
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Chapter 3: Where Prices Come From: The Interaction of Demand and Supply
Market Equilibrium: Putting Demand
and Supply Together
3.3 Learning Objective
Use a graph to illustrate
market equilibrium.
Market equilibrium A situation in
which quantity demanded equals
quantity supplied.
Competitive market equilibrium
A market equilibrium with many
buyers and many sellers.
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Market Equilibrium: Putting Demand
and Supply Together
3.3 Learning Objective
Use a graph to illustrate
market equilibrium.
Chapter 3: Where Prices Come From: The Interaction of Demand and Supply
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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Market Equilibrium: Putting Demand
and Supply Together
3.3 Learning Objective
Use a graph to illustrate
market equilibrium.
Chapter 3: Where Prices Come From: The Interaction of Demand and Supply
How Markets Eliminate Surpluses and Shortages
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 $2.50 for energy
drinks results in 90 million cans being
supplied but only 70 million cans
being demanded, or a surplus of 20
million. As Red Bull, Monster Energy,
Rockstar, and the other firms cut the
price to dispose of the surplus, the
price will fall to the equilibrium of
$2.00.
When the market price is below
equilibrium, there will be a shortage.
A price of $1.00 results in 100 million
cans being demanded but only 60
million cans being supplied, or a
shortage of 40 million cans. As
consumers who are unable to buy
energy drinks offer to pay higher
prices, the price will rise to the
equilibrium of $2.00.
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Market Equilibrium: Putting Demand
and Supply Together
3.3 Learning Objective
Use a graph to illustrate
market equilibrium.
Chapter 3: Where Prices Come From: The Interaction of Demand and Supply
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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3.3 Learning Objective
Solved Problem
3-3
Use a graph to illustrate
market equilibrium.
Chapter 3: Where Prices Come From: The Interaction of Demand and Supply
Demand and Supply Both
Count: A Tale of Two Letters
Both demand and supply
count when determining
market price.
The demand for Lincoln’s
letters is much greater than
the demand for Booth’s
letters,
but the supply of Booth’s
letters is very small.
Historians believe that only
eight letters written by
Booth exist today.
YOUR TURN: For more practice, do related problems 3.4 and 3.5 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.
Chapter 3: Where Prices Come From: The Interaction of Demand and Supply
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 Coca-Cola
entered the market for energy drinks when it
launched Full Throttle, the equilibrium price
will fall, and the equilibrium quantity will rise:
1. As Coca-Cola enters the market for
energy drinks, a larger quantity of energy
drinks will be supplied at every price, so
the market supply curve shifts to the right,
from S1 to S2, which causes a surplus of
cans 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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3.4 Learning Objective
Making
Chapter 3: Where Prices Come From: The Interaction of Demand and Supply
The Falling Price of
the
Connection LCD Televisions
Use demand and supply
graphs to predict changes
in prices and quantities.
An increase in supply drove the price of a typical large LCD television from
$4,000 in fall 2004 to $1,000 at the end of 2008, increasing the quantity
demanded worldwide from 8 million to 105 million.
YOUR TURN: Test your understanding by doing related problem 4.7 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.
Chapter 3: Where Prices Come From: The Interaction of Demand and Supply
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 energy drinks 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 energy drinks 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 Demand and Supply
Shifts on Equilibrium
3.4 Learning Objective
Use demand and supply
graphs to predict changes
in prices and quantities.
Chapter 3: Where Prices Come From: The Interaction of Demand and Supply
The Effect of Shifts in Demand and Supply over Time
FIGURE 3-11
Shifts in Demand and Supply over Time
In panel (a), demand shifts to the right more than
supply, and the equilibrium price rises:
In panel (b), supply shifts to the right more than
demand, and the equilibrium price falls:
1. Demand shifts to the right more than supply.
2. Equilibrium price rises from P1 to P2.
1. Supply shifts to the right more than demand.
2. Equilibrium price falls from P1 to P2.
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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.
Chapter 3: Where Prices Come From: The Interaction of Demand and Supply
The Effect of Shifts in Demand and Supply over Time
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
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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3.4 Learning Objective
Solved Problem
3-4
Chapter 3: Where Prices Come From: The Interaction of Demand and Supply
High Demand and Low Prices
in the Lobster Market?
Use demand and supply
graphs to predict changes
in prices and quantities.
Supply and demand for lobster both
increase during the summer, but the
increase in supply is greater than the
increase in demand, therefore,
equilibrium price falls.
YOUR TURN: For more practice, do related problems 4.5 and 4.6 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.
Chapter 3: Where Prices Come From: The Interaction of Demand and Supply
Shifts in a Curve versus Movements along a Curve
When analyzing markets using demand and supply curves, it is important to remember
that 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
YOUR TURN: Test your understanding by doing related problems 4.13 and 4.14
at the end of this chapter.
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AN INSIDE
LOOK
>> How Does Advertising Help Red Bull
Chapter 3: Where Prices Come From: The Interaction of Demand and Supply
Increase Demand for Its Energy Drink?
Advertising may cause an increase in the demand for Red Bull.
Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e.
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Chapter 3: Where Prices Come From: The Interaction of Demand and Supply
KEY TERMS
Ceteris paribus (“all else equal”)
condition
Competitive market equilibrium
Complements
Demand curve
Demand schedule
Demographics
Income effect
Inferior good
Law of demand
Law of supply
Market demand
Market equilibrium
Normal good
Perfectly competitive market
Quantity demanded
Quantity supplied
Shortage
Substitutes
Substitution effect
Supply curve
Supply schedule
Surplus
Technological change
Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Economics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e.
46 of 46