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Chapter 3
Supply, Demand,
and Price
Determinates of Demand
• Income
– Normal good
– Inferior good
• Preferences
• Prices of Related Goods
– Substitutes
– Compliments
Determinates Continued…
• Number of Buyers
• Expectations of Future
Change in Demand vs.
Change in Quantity Demanded
• Change in Demand
– SHIFT OF CURVE
• Due to any non-price determinate
• Change in Quantity demanded
– MOVEMENT ON ORIGINAL CURVE
• Due only to a change in price
Pric e
Change in Demand versus
Change in Quantity
Demanded
Pric e
A c hang e in
quantity demande d
(a mo ve me nt alo ng
the de mand c urve , D )
A c hang e in de mand
(a s hift in the
de mand c urve )
B
A
D
D
0
Quantity De mande d
(a)
D
0
Quantity De mande d
(b)
Change in Demand
• SHIFT OF CURVE
• SHIFT LEFT??
– DECREASE IN DEMAND
• SHIFT RIGHT??
– INCREASE IN DEMAND
Shifts in the Demand Curve
Part (a)
Pric e (do llars )
Rig htward s hift
in de mand c urve
(inc re as e in de mand)
30
A
B
D
D
0
500
700
Quantity De mande d o f Blue Je ans
Shifts in the Demand Curve
Part (b)
Pric e (do llars )
Le ftward s hift
in de mand c urve
(de c re as e in de mand)
30
B
A
D
D
0
450
650
Quantity Demande d of Blue Je ans
•
Change in price of related
goods
Substitutes
– Something used in replace of another good
• Compliments
– Something used with another good
Substitutes and Complements
Part (a)
S UBS TITUTES
Pric e
Pric e
P2
B
If Co c a-Co la and
Pe ps i-Co la are
s ubs titute s , a
hig he r pric e fo r
Co c a-Co la le ads to . . .
A
P1
. . . a rig htward
s hift in the de mand
c urve fo r Pe ps i-Co la.
DCC
0
Qd 2
Qd1
Quantity De manded o f Co c a-Cola
DPC 2
DPC 1
0
Quantity De mande d o f Pe ps i-Cola
Substitutes and Complements
Part (b)
COMPLEMENTS
Pric e
P2
P1
If te nnis rac ke ts and
te nnis balls are
c o mple me nts , a hig he r
pric e fo r te nnis
rac ke ts le ads to . . .
B
A
Pric e
. . . a le ftward
s hift in the de mand
c urve fo r te nnis balls .
DTB 1
DTR
0
Qd 2 Qd1
Quantity De mande d o f Te nnis Rac ke ts
DTB 2
0
Quantity De mande d o f Te nnis Balls
SELF TEST-Do we understand??
• Substitutes
– Coke vs. Pepsi --- what happens if the price of
Coke increases?
– Qd of Pepsi?
• NOTHING
– Qd of Coke?
• DECREASES
– Demand for Coke?
• NOTHING
– Demand for Pepsi?
• INCREASES
• Compliments
– Tennis Balls and Tennis Rackets --- what happens
if the price of Tennis Rackets increase?
– Qd of Tennis Balls?
• NOTHING
– Qd of Tennis Rackets?
• DECREASES
– Demand for Tennis Balls?
• DECREASES
– Demand for Tennis Rackets?
• NOTHING
Examples
• The housing market: Consumer’s income
increases
• The sugar market: Saccharine is found to
lead to cancer
• The jelly market: The price of peanut butter
increases
• The beer market: The price of beer
decreases
Does the Law of Demand
Hold?
• The price of eating out increases from $10
to $15 and the quantity demanded of
restaurants increases from 10 to 14 meals.
Pric e ($)
The Law
of
Demand
Holds
B
15
The s e two
po ints ,
A and B,
are o bs e rve d.
A
10
0
10 14
Quantity De mande d
o f Re s taurant Me als (millio ns )
(a)
WRONG
RIGHT
Pric e ($)
Pric e ($)
D
15
10
B
A
0
10 14
Quantity De mande d
o f Re s taurant Me als
(millio ns )
(b)
15
10
B
A
0
10 14
Quantity De mande d
o f Re s taurant Me als
(millio ns )
(c )
The other side…supply
• Quantity supplied
– Amount of a good that producers are willing
and able to sell at a particular point in time at
a particular price
Important Parts
•
•
•
•
Able
Willing
Particular price
Particular point in time
Supply
• Quantity Supplied at all prices during a
specific time period
• Thus…
Law of Supply
• As the price of a good increases (decreases)
the quantity supplied of that good increases
(decreases)
Supply Schedule
• Numerical table of quantity supplied at
different prices
Price
4
3
2
1
Quantity
40
30
20
10
Supply Curve
• Supply Curve
– Graphical representation of the relationship
between price and quantity supplied
• What type of relationship do we have
between price and quantity supplied?
Supply Curve
Exhibit 7
Pric e (do llars )
S upply Curve
4
D
3
C
2
1
0
B
A
20
40
10
30
Quantity S upplie d of Go o dX
Stuff continued…
• Change in supply
– SHIFT OF SUPPLY CURVE
• Change in quantity supplied
– MOVEMENT ALONG ORIGINAL SUPPLY
CURVE
• Increase in supply --- shift right
• Decrease in supply --- shift left
Change in Supply versus
Change in Quantity Supplied
Pric e
Pric e
S
S
S
B
A
A c hang e in s upply
(a s hift in the
s upply c urve )
0
Quantity S upplie d
(a)
0
A c hang e in
quantity
(a mo ve me nt alo ng
the s upply c urve ,S )
Quantity S upplie d
(b)
Shifts in the Supply Curve
Part (a)
Pric e (do llars )
Rig htward s hift
in s upply c urve
(inc re as e in s upply)
5
0
A
200
S
S
B
300
Quantity S upplie d o f Go o d X
Shifts in the Supply Curve
Pa rt (b)
Pric e (do llars )
S2
5
B
S1
A
Le ftward s hift
in s upply c urv e
(de c re as e in s upply)
0
50
150
Qu antity S upp lie d o f Go o d X
Question???
• Can the supply curve ever be vertical?
• First…what does a vertical curve indicate
about the relationship between price and
quantity supplied?
Pric e
Supply Curves When There Is No
Time to Produce More or No More
Pric e
Can Be Produced
S upply Curve o f
The ate r S e ats
fo r To nig ht’s
Pe rfo rmanc e
0
500
Numbe r o f The ate r S e ats
(a)
S upply Curve o f
S tradivarius Vio lins
0
X
Numbe r o f S tradivarius Vio lins
(b)
Determinates of Supply
•
•
•
•
•
Price of inputs
Technology
Number of sellers
Price expectations
Taxes and subsidies
Examples
• The computer market: The price of computer
chips decreases
• The fast food market: McDonalds opens three
new stores in Bakersfield
• The pencil market: The price of pencils
increases
• The gasoline market: A tax is imposed on gas
station owners for each gallon of gas pumped
out of their station
Market Supply Curves
• Previous supply curve was for an
individual
– Single seller
• How can we get the market curve from
individual supply curves?
– All sellers
• Sum the individual supply curves…
Therefore….
Deriving a Market Supply
Schedule
& Curve
Part (a)
QUANTITY S UPPLIED
PRICE
BROWN
ALBERTS
OTHER S UPPLIERS ALL S UPPLIERS
$10
1
2
96
99
11
2
3
98
103
12
3
4
102
109
13
4
5
106
115
14
5
6
108
119
15
6
7
110
123
S upply
Pric e ($) Curve
(Bro wn)
12
11
Part (b)
Pric e ($) S upply
Curve
(Albe rts )
B1
A1
+
0
2 3
Quantity S upplie d
0
Pric e ($)
S upply Curve
(o the r
s upplie rs )
12
11
B3
+
A3
0
98 102
Quantity S upplie d
12
11
=
A2
B2
3 4
Quantity S upplie d
Marke t
Pric e ($) S upply
Curve
12
B4
11
A4
0
103 109
2 + 3 + 98 Quantity S upplie d
3 + 4 + 102
Deriving
a Market
Supply
Schedule
& Curve
Next Step….
Putting Supply and Demand
Together
Auction
Model
Can think of supply
and demand as an
auction where buyers
bid the price down
and sellers bid the
price up until Qs and
Qd are equal at the
same price
But…
• There is only one price where Qs=Qd
• This is called the equilibrium price
• The market is always working towards this
price
Scissors and economics?
• Alfred Marshall compared Supply and
demand to a pair of scissors
– “It is impossible to say which blade is actually
doing the cutting just like it is impossible to
say whether demand or supply is responsible
for the price
What determines the price?
• The interaction of supply and demand
Equilibrium
• Also called the market clearing price
– When Qs=Qd
• Disequilibrium
– When Qs=Qd
At Disequilibrium can have…
• Shortage (excess demand)
– Qd > Qs
– Price too low
– Price must increase to rid shortage
• Surplus (excess supply)
– Qd < Qs
– Price too high
– Price must decrease to rid surplus
Moving to Equilibrium
Pric e (do llars )
S
15
S urplus
10
PRICE
Qs
Qd
$15
150
50
S urplus
10
100
100
Equilibrium
5
50
150
S ho rtag e
E
S ho rtag e
5
D
0
CONDITION
50
100
Quantity
150
Moving to Equilibrium
• If we have a surplus, price must _______
to get to equilibrium.
• Decrease
• If we have a shortage, price must _______
to get to equilibrium.
• Increase
Do Shortage and Scarcity refer
to the same thing???
• NO!!
• Shortage is only when price is less than
the equilibrium price
• Scarcity is always present (at all prices)
Applications of Supply and
Demand
• Romanee-Conti Wine
– Dated back to 1990 and sells for $800 a bottle or $8 a
sip…why?
• Ticket scalping
– Why would people pay higher prices to see an event?
– Prices must have been below equilibrium.
• Freeway
– Why would people be willing to pay a toll to use a
road?
Remember..
• Equilibrium price and quantity are
determined by the INTERACTION of
supply and demand
• A change in supply, demand, or both will
change the equilibrium price
• Exception: If supply and demand move in
same direction and magnitude so changes
are offset
Change in Supply and Demand but no
change in equilibrium price
What Happens???
•
•
•
•
•
•
•
•
Increase D and S constant?
Decrease D and S constant?
D constant and increase S?
D constant and decrease S?
D increase and S decreases by equal amounts?
D decrease and S increases by equal amounts?
D increases more than S decreases?
D increases less than S decreases?
A Summary Exhibit of a Market
MARKET
PRICE,
QUANTITY
DEMAND
Prefe renc e s
Inc o me
Numbe r
o f Buyers
Expe c tatio ns
o f Future Pric e
Pric e s o f
Re late d Go o ds
(S ubs titute s
and
Co mple me nts )
S UPPLY
Pric e s o f
Re le vant
Re s ouc e s
Numbe r
of
S e lle rs
Taxe s
and
S us idie s
Go ve rnme nt
Re s tric tio ns
Te c hno lo g y
Expe ctatio ns
of
Future Pric e
Price Controls
• Produces a barrier to which the economy
can no longer operate freely
– Can’t get to equilibrium price
• Two types
– Price ceiling
– Price Floor
Price Ceiling
• Government mandated maximum price
above which legal trades cannot be
made
• Price ceiling is below equilibrium price.
Pric e
(do llars
Price
Ceiling
S
18
Eq uilibrium
Pric e
Pric e
Ce iling
A pric e c e iling
c re ate s a s ho rtag e
12
8
S h o rtag e
D
0
100
150
190
Eq uilibrium
Qu antity
Qu antity o f Go o d X
Impacts of Price Ceilings
• Shortage sustained
• Fewer exchanges
• Non-price rationing schemes
– First come first served
• Buying & selling at prohibited prices
– Black markets
• Tie in Sales
– Pay certain amount for rent of the house and an amount for
renting the refrigerator
• Distort normal economic information and incentives
– Lower prices is supposed to mean greater availability
Price Floor
• Government mandated minimum price
below which legal trades cannot be made
• Price floor is above equilibrium price
Pric e
(do llars )
Pric e
Flo o r
Equilibrium
Pric e
Price
Floor
S
S urplus
20
A pric e flo o r
c re ate s a s urplus
15
D
0
90
130
180
Equilibrium
Quantity
Quantity o f Go o d X
Impacts of Price Floors
• Sustained surpluses
• Fewer exchanges
• Example: Minimum wage
Minimum Wage
• In California the minimum wage is $6.75
per hour
– Increased from $6.26 on January 1, 2002
• Government mandated minimum wage is
$5.15
– Last increase was on September 1, 1997
Impacts of Minimum Wage
• Surplus of unskilled
• Fewer workers overall employed
• Supply and Demand would determine
wage
• Minimum wage doesn’t guarantee better
standards of living for low wage
employees
Wag e Rate
(do llars )
Minimum
4.25
Wag e 5.75
S
S urplus
Effects of
the Minimum
Equilibrium
3.25
Wag e 4.25
Wage
D Numbe r o f
Uns kille d Wo rke rs
0
N
2
Numbe r o f Wo rke rs
Emplo ye d at
Minimum Wag e
N
1
Numbe r o f Wo rke rs
Emplo ye d
atEquilibrium Wag e
N3
Numbe r o f Wo rke rs
Who Want to Wo rk at
Minimum Wag e
Homework #4
Chapter 3
Numbers: 1, 4, 8, 10, and 14
Did we understand
Chapter 3???
In-class exercise 4