Download Demand Curve

Modern Principles:
Microeconomics
Tyler Cowen
and Alex Tabarrok
Chapter 2
Supply and Demand
Copyright © 2010 Worth Publishers • Modern Principles: Microeconomics • Cowen/Tabarrok
Introduction
• The model of supply and demand is
one of the most important tools in
economics.
• The model is a simple presentation of
exchange that captures the behavior
of both buyers and sellers.
Slide 2 of 55
The Demand Curve for Oil
• Demand represents the behavior of
buyers.
• A Demand Curve is a function that
shows the quantity demanded at
different prices.
 The Quantity Demanded is the quantity
that buyers are willing and able to
purchase at a particular price.
Slide 3 of 55
The Demand Curve for Oil
• The Law of Demand indicates an inverse
relationship between price and quantity
demanded.
 When price rises, all else equal, quantity
demanded falls.
 When price falls, all else equal, quantity
demanded rises.
• Demand curves consistent with the law of
demand are downward sloping.
Slide 4 of 55
Demand Curves
The Demand Curve for Oil is a Function Showing the Quantity of
Oil Demanded at Different Prices
Price of Oil
per Barrel
$55
$20
$5
Price
Quantity
Demanded
$55
5
$20
25
$5
50
Demand
5
25
50
Quantity of Oil (MBD)
Slide 5 of 55
Demand Curves
• Demand curves can be read in two ways:
 Horizontally: How much buyers are willing
and able to purchase at a given price.
 Vertically: The maximum price for which
buyers are willing to pay for a given quantity.
• Demand curves thus reveal the quantity
demanded at a given price or the maximum
willingness to pay for a given quantity.
Slide 6 of 55
The Demand Curve for Oil
Horizontal Reading
Price of Oil
per Barrel
$55
Start $20
Demand
$5
5
25
End
50
Quantity of Oil (MBD)
Slide 7 of 55
The Demand Curve for Oil
Vertical Reading
Price of Oil
per Barrel
$55
End
$20
Demand
$5
5
25
Start
50
Quantity of Oil (MBD)
Slide 8 of 55
Demand Curves
• Why is the demand curve downward
sloping?
 A good is not equally valuable in all of its
uses.
• At a high price, a good is consumed in only
its highest valued use.
• At a low price, a good is also consumed in
its lower valued uses.
 The value of a good’s use will depend on
the availability of substitutes.
Slide 9 of 55
The Demand Curve for Oil
When the price of oil is high, oil will only be used in higher valued
uses. As the price falls, oil will also be used in lower valued uses
Price of Oil
per Barrel
Higher Valued
Uses of Oil
$120
Lower Valued
Uses of Oil
$20
Demand
Quantity of Oil (MBD)
20
120
Slide 10 of 55
Consumer Surplus
• Consumer Surplus is the consumer’s gain
from exchange, or the difference between the
maximum price a consumer is willing to pay
for a given quantity and the market price.
• Total consumer surplus is the sum of
consumer surplus of all buyers.
• Graphically, total consumer surplus is
measured by the area below the demand
curve and above the price.
Slide 11 of 55
Consumer Surplus
Consumer Surplus is the Area beneath the Demand Curve and
above the Price
Price of Oil
per Barrel
80
Area of Triangle
Height
The President’s
Consumer Surplus
Total Consumer Surplus
at a Price of $20
½(Base x Height)
Base
Joe’s Consumer Surplus
½(80-20)x90 =
$2,700
20
Demand
Quantity of Oil (MBD)
90
Slide 12 of 55
What Shifts the Demand Curve?
• The demand curve
 An increase in demand means that quantity
demanded at a given price increases, or the
maximum willingness to pay for a given
quantity rises.
• Graphically, an increase in demand shifts the demand
curve outwards, up, and to the right.
 A decrease in demand means that quantity
demanded at a given price decreases, or the
maximum willingness to pay for a given
quantity falls.
• Graphically, a decrease in demand shifts the demand
curve inwards, down, and to the left.
Slide 13 of 55
Change in Demand
An Increase in Demand
Price
per Unit
Greater Willingness to Pay
for the Same Quantity
$50
Greater Quantity Demanded at
the Same Price
$25
New Demand
Old Demand
Quantity
70
80
Slide 14 of 55
Change in Demand
A Decrease in Demand
Price
per Unit
Lower Willingness to Pay
for the Same Quantity
$50
Less Quantity Demanded at the
Same Price
$25
Old Demand
Curve
New Demand
Curve
Quantity
70
80
Slide 15 of 55
Important Demand Shifters
• Important Demand Shifters
1.
2.
3.
4.
5.
6.
Income
Population
Price of Substitutes
Price of Complements
Expectations
Tastes
Slide 16 of 55
Important Demand Shifters - Income
1. The effect of changes in income on
demand depends on the nature of the
good in question.
 A Normal Good is a good for which demand
increases (decreases) when income increases
(decreases).
 An Inferior Good is a good for which demand
decreases (increases) when income increases
(decreases).
Slide 17 of 55
Important Demand Shifters - Population
2. As the population of an economy
changes, the number of buyers of a
particular good also changes, directly
influencing its demand.
 More buyers of a good increases its
demand.
 Fewer buyers of a good decreases its
demand.
Slide 18 of 55
Important Demand Shifters - Price of Substitutes
3. Two goods are Substitutes if a
decrease (increase) in the price of
one good leads to a decrease
(increase) in demand for the other
good.
Slide 19 of 55
Important Demand Shifters - Price of Complements
4. Two goods are Complements if a
decrease (increase) in the price of
one good leads to an increase
(decrease) in the demand for the
other.
Slide 20 of 55
Important Demand Shifters - Expectations
5. The expectation of a higher (lower)
price for a good in the future
increases (decreases) current
demand for the good.
 Consumers will adjust their current
spending in anticipation of the direction
of future prices in order to obtain the
lowest possible price.
Slide 21 of 55
Important Demand Shifters - Tastes
6. Tastes and preferences are
subjective and will vary among
consumers.
 Some issues like seasonal changes or
fads, however, will have rather
predictable effects on demand.
Slide 22 of 55
What Shifts the Demand Curve?
• A change in quantity demanded is NOT the
same as a change in demand.
 Quantity demanded changes only when the
price of a good changes.
 Graphically, a change in quantity demanded is
represented by a movement along a fixed
demand curve.
 Demand changes only when a non-price factor
(demand shifter) changes.
 Graphically, a change in demand is
represented by a shift in the entire demand
curve.
Slide 23 of 55
CHECK YOURSELF
Economic growth in India is raising the
incomes of Indian workers. What do you
predict will happen to the demand for
automobiles? What about the demand for
charcoal bricks for home heating?
As the price of oil rises, what do you predict
will happen to the demand for mopeds?
Slide 24 of 55
The Supply Curve for Oil
• Supply represents the behavior of
sellers.
• A Supply Curve is a function that
shows the quantity supplied at
different prices.
 The Quantity Supplied is the quantity
that producers are willing and able to sell
at a particular price.
Slide 25 of 55
The Supply Curve for Oil
• The Law of Supply indicates a direct
relationship between price and quantity
supplied.
 When price rises, all else equal, quantity
supplied rises.
 When price falls, all else equal, quantity
supplied falls.
• Supply curves consistent with the law of
supply are upward sloping.
Slide 26 of 55
Supply Curves
The Supply Curve for Oil is a Function Showing the Quantity of Oil
Supplied at Different Prices
Price of Oil
per Barrel
Supply Curve for Oil
$55
$20
Price
Quantity
Supplied
$55
50
$20
30
$5
10
$5
Quantity of Oil (MBD)
10
30
50
Slide 27 of 55
Supply Curves
• Supply curves can be read in two ways:
 Horizontally: How much suppliers are willing
and able to sell at a given price.
 Vertically: The minimum price for which
suppliers are willing to sell a given quantity.
• Supply curves, thus, reveal the quantity
supplied at a given price, or the minimum
price at which suppliers will sell a given
quantity.
Slide 28 of 55
The Supply Curve for Oil
Horizontal Reading
Price of Oil
per Barrel
Supply Curve for Oil
$55
Start $20
$5
Quantity of Oil (MBD)
10
30
End
50
Slide 29 of 55
Supply Curves
Vertical Reading
Price of Oil
per Barrel
Supply Curve for Oil
$55
End $20
$5
Quantity of Oil (MBD)
10
30
Start
50
Slide 30 of 55
Supply Curves
• Why is the supply curve upward sloping?
 The cost of producing a good is not equal
across all suppliers.
• At a low price, a good is produced and sold
only by the lowest cost suppliers.
• At a high price, a good is also produced and
sold by higher cost suppliers.
Slide 31 of 55
The Supply Curve for Oil
The Supply Curve for Oil
Price of Oil
per Barrel
Supply
$60
Oil Shale
Profitable Here
$40
Higher Cost Oil
Low Cost Oil
$20
Quantity of Oil (MBD)
20
40
60
80
100
Slide 32 of 55
Producer Surplus
• Producer Surplus is the producer’s gain
from exchange, or the difference between
the market price and the minimum price at
which producers would be willing to sell a
given quantity.
• Total producer surplus is the sum of the
producer surplus of each seller.
• Graphically, total producer surplus is
measured by the area above the supply
curve and below the price.
Slide 33 of 55
Producer Surplus
Producer Surplus is the Area Above the Supply Curve and Below
the Price
Price of Oil
per Barrel
$60
Supply Curve
$40
$20
Total Producer Surplus
at a Price of $40
Quantity of Oil (MBD)
20
40
60
80
Slide 34 of 55
Important Supply Shifters
• Changes in Supply
 An increase in supply means that quantity supplied at
a given price increases, or the minimum willingness to
sell for a given quantity falls.
• Graphically, an increase in supply shifts the supply curve down
and to the right.
 A decrease in supply means that quantity supplied at
a given price decreases, or the minimum willingness to
sell a given quantity rises.
• Graphically, a decrease in supply shifts the supply curve up
and to the left.
 Changes in supply are inversely related to the costs of
production.
Slide 35 of 55
Change in Supply
Lower Costs Increase Supply
Price of Oil
per Barrel
Greater Quantity
Supplied at the
Same Price
Old Supply
New Supply
$50
$10
Willing to Sell
Same Quantity
at Lower Prices
Quantity of Oil (MBD)
20
80
Slide 36 of 55
Change in Supply
Higher Costs Decrease Supply
Price of Oil
per Barrel
Smaller Quantity
Supplied at the
Same Price
New Supply
Old Supply
$50
Higher Price
Needed to Sell
Same Quantity
$10
Quantity of Oil (MBD)
20
80
Slide 37 of 55
Important Supply Shifters
• Important Supply Shifters
1.
2.
3.
4.
5.
6.
Technological Innovations
Input Prices
Taxes and Subsidies
Expectations
Entry or Exit of Producers
Changes in Opportunity Costs
Slide 38 of 55
Important Supply Shifters - Technological Innovations
1. A technological innovation makes sellers
willing to supply a greater quantity at a
given price, or the new technology allows
producers to sell a given quantity at a
lower price.
 A technological innovation lowers costs
and increases supply.
Slide 39 of 55
Important Supply Shifters - Input Prices
2. A decrease (increase) in the price of an
input makes sellers willing to supply a
greater (lesser) quantity at a given price,
or the lower (higher) input price allows
producers to sell a given quantity at a
lower (higher) price.
 A decrease (increase) in the price of an input
lowers (raises) costs and increases
(decreases) supply.
Slide 40 of 55
Important Supply Shifters - Taxes and Subsidies
3. A tax on output makes sellers willing to supply a
lesser quantity at a given price, or the tax forces
producers to sell a given quantity at a higher
price.
 A tax on output raises costs and decreases supply.
•
A subsidy on production makes sellers willing to
supply a greater quantity at a given price, or the
subsidy allows producers to sell a given quantity
at a lower price.
 A subsidy on production lowers costs and increases
supply.
Slide 41 of 55
Important Supply Shifters - Taxes and Subsidies
With a $10 Tax Suppliers Require a $10 Higher Price to Sell the
Same Quantity
Price of Oil
per Barrel
Supply With $10 Tax
$10
$10
$10
$50
Supply Without Tax
$40
Quantity of Oil (MBD)
60
Slide 42 of 55
Important Supply Shifters - Expectations
4. The expectation of a higher (lower) price
for a good in the future decreases
(increases) current supply of the good.
 Sellers will adjust their current offerings in
anticipation of the direction of future
prices in order to obtain the highest
possible price.
Slide 43 of 55
Important Supply Shifters - Expectations
Expectations Can Shift the Supply Curve
Price
per Unit
Supply Today with
Expectation of Future
Price Increase
Supply Today
Into Storage
Quantity
Slide 44 of 55
Important Supply Shifters - Entry or Exit of Producers
5. As producers enter and exit the market,
the number of sellers of a particular
good changes, directly influencing
supply.
 Entry implies more sellers in the market
increasing supply.
 Exit implies fewer sellers in the market
decreasing supply.
Slide 45 of 55
Important Supply Shifters - Entry or Exit of Producers
Entry Increases Supply
Greater Quantity Supplied
at the Same Price
Price
Domestic Supply
Domestic Supply Plus
Canadian Imports
Lower Price for the Same
Quantity Supplied
Quantity
Slide 46 of 55
Important Supply Shifters - Changes in Opportunity Costs
6. Inputs used in production have
opportunity costs, and sellers will
choose to employ those inputs in the
production of the highest priced finished
goods.
 Sellers will supply less (more) of a good
if the price of an alternate good using the
same inputs rises (falls).
Slide 47 of 55
Important Supply Shifters – Changes in Opportunity Costs
Higher (Opportunity) Costs Reduce Supply
Price
per Unit
Higher Price Required to
Sell the Same Quantity
Supply with High Opportunity Costs
$7
Supply with Low Opportunity Costs
$5
Smaller Quantity Supplied at
the Same Price
2,000
2,800
Quantity of Soybeans
(Millions of Bushels)
Slide 48 of 55
What Shifts the Supply Curve?
• A change in quantity supplied is NOT the
same as a change in supply.
 Quantity supplied changes only when the price
of a good changes.
 Graphically, a change in quantity supplied is
represented by a movement along a fixed
supply curve.
 Supply changes only when a non-price factor
changes.
 Graphically, a change in supply is represented
by a shift in the entire supply curve.
Slide 49 of 55
CHECK YOURSELF
Technological innovations in chip
making have driven down the costs of
producing computers. What happens
to the supply curve for computers?
Why?
The U.S. government subsidizes
making ethanol as a fuel made from
corn. What effect does the subsidy
have on the supply curve for ethanol?
Slide 50 of 55
Takeaway
• Demand represents the behavior of buyers.
• A demand curve is a function that shows the
quantity demanded at different prices.
• Demand curves are downward sloping.
• Consumer Surplus is the consumer’s gain from
exchange, or the difference between the
maximum price a consumer is willing to pay for a
given quantity and the market price.
• Graphically, total consumer surplus is measured
by the area below the demand curve and above
the price.
Slide 51 of 55
Takeaway
• An increase in demand shifts the demand curve
upward, out, and to the right.
• A decrease in demand shifts the demand curve
inward, down, and to the left.
• Important Demand Shifters
1.
2.
3.
4.
5.
6.
Income
Population
Price of Substitutes
Price of Complements
Expectations
Tastes
Slide 52 of 55
Takeaway
• Supply represents the behavior of sellers.
• A supply curve is a function that shows the
quantity supplied at different prices.
• Supply curves are upward sloping.
• Producer Surplus is the producer’s gain from
exchange, or the difference between the market
price and the minimum price at which producers
would be willing to sell a given quantity.
• Graphically, total producer surplus is measured
by the area above the supply curve and below
the price.
Slide 53 of 55
Takeaway
• An increase in supply shifts the supply curve
down and to the right.
• A decrease in supply shifts the supply curve up
and to the left.
• Important Supply Shifters
1.
2.
3.
4.
5.
6.
Technological Innovations
Input Prices
Taxes and Subsidies
Expectations
Entry or Exit of Producers
Changes in Opportunity Costs
Slide 54 of 55