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Chapter 3: Demand, Supply, and Price © 2014 Pearson Education Canada Inc. Chapter Outline/Learning Objectives Section Learning Objectives After studying this chapter, you will be able to 3.1 Demand 1. list the factors that determine the quantity demanded of a good. 2. distinguish between a shift of the demand curve and a movement along the demand curve. 3. list the factors that determine the quantity supplied of a good. 4. distinguish between a shift of the supply curve and a movement along the supply curve. 5. explain the forces that drive market price to equilibrium, and how equilibrium price is affected by changes in demand and supply. 3.2 Supply 3.3 The Determination of Price © 2014 Pearson Education Canada Inc. Chapter 3, Slide 3 3.1 Demand Quantity Demanded The total amount that consumers desire to purchase in some time period is called the quantity demanded of a product. Quantity bought (or exchanged) refers to actual purchases. Quantity demanded is a flow, as opposed to a stock. EXTENSIONS IN THEORY 3-1 The Distinction Between Stocks and Flows © 2014 Pearson Education Canada Inc. Chapter 3, Slide 4 Quantity Demanded and Price A basic hypothesis is that—ceteris paribus—the price of a product and the quantity demanded are negatively related. Why? There are usually several products that can satisfy any given want or desire. A reduction in the price of a product means that the specific desire can now be satisfied more cheaply by buying more of that product. © 2014 Pearson Education Canada Inc. Chapter 3, Slide 5 Demand Schedules and Demand Curves Fig.3-1 Demand Schedule Demand Curve Reference Point Price ($ per bushel) Quantity Demanded U $ 20 110 V 40 85 W 60 65 X 80 50 Y 100 40 © 2014 Pearson Education Canada Inc. The Demand for Apples Chapter 3, Slide 6 Determinants of Demand LO5 1. Consumer preferences • If tastes change, demand changes 2. Consumer incomes • Normal Products: buy more when income rises, less when income falls • Inferior Products: buy more when income falls, less when income rises © 2014 Pearson Education Canada Inc. 7 Determinants of Demand LO5 3. Prices of Related Products: • Products are related if a change in the price of one product causes a change in demand for the other product • Two types of related products: • Substitutes • Complements © 2014 Pearson Education Canada Inc. 8 Determinants of Demand LO5 3. Prices of Related Products • Substitute Product • similar products that can be substituted for each other • increase in price of one product causes increased demand for the related product © 2014 Pearson Education Canada Inc. 9 Determinants of Demand LO5 3. Prices of Related Products • Complementary Product • tend to be bought together • Increase in price of one product causes a decrease in demand for related product © 2014 Pearson Education Canada Inc. 10 Determinants of Demand LO5 4. Expectations of future prices, income, availability • If prices or incomes expected to rise, consumers buy more • If goods expected to be scarcer, buy more now 5. Population size, income, and age distribution • Increases in population or incomes cause increase in demand • Changes in age distribution affect demand © 2014 Pearson Education Canada Inc. 11 A change in variables other than price will shift the demand curve to a new position. Fig. 3-2 An Increase in the Demand for • average Apples household income • prices of other products • distribution of income or population • expectations about the future © 2014 Pearson Education Canada Inc. Chapter 3, Slide12 Fig. 3-3 Shifts in the Demand Curve A rightward shift indicates an increase in demand. A leftward shift indicates a decrease in demand. © 2014 Pearson Education Canada Inc. Chapter 3, Slide13 Fig. 3-4 Shifts of and Movements Along the Demand Curve A change in demand is a change in quantity demanded at every price—a shift of the entire curve. A change in quantity demanded refers to a movement from one point on a demand curve to another point, either on the same demand curve or on a new one. © 2014 Pearson Education Canada Inc. Chapter 3, Slide14 Self Test LO5 Price Demand (D1) Demand (D2) $2.00 3.00 4.00 10 000 9 600 9 200 11 000 10 600 10 200 Market for pretzels: • What might have happened to the price of a complementary product, like beer, to cause the demand for pretzels to change? • What might have happened to the price of a substitute product, like nuts? © 2014 Pearson Education Canada Inc. 2- 15 Demand Concepts Review Which of the following would cause a movement along the demand curve for ski-lift tickets, other things being equal? A) a change in tastes in favour of skiing B) an increase in population C) an increase in price as the supply curve for lift tickets shifts to the left D) a rise in the price of ski boots and skis E) a rise in average household income © 2014 Pearson Education Canada Inc. 16 If the price of tea falls and as a consequence the demand for sugar rises, then tea and sugar are A) substitute goods. B) complementary goods. C) independent goods. D) neutral goods. E) luxury goods. © 2014 Pearson Education Canada Inc. 17 3.2 Supply Quantity Supply The amount of a product that firms desire to sell in some time period is called the quantity supplied of that product. Quantity supplied is the amount that firms are willing to offer for sale and not necessarily the quantity actually sold. Quantity supplied is a flow as opposed to a stock. © 2014 Pearson Education Canada Inc. Chapter 3, Slide 18 Quantity Supplied and Price A basic hypothesis is that—ceteris paribus—the price of the product and the quantity supplied are positively related. Why? Producers are interested in making profits. If the price of a particular product rises, then the production and sale of this product is more profitable. © 2014 Pearson Education Canada Inc. Chapter 3, Slide 19 Fig. 3-5 The Supply of Apples Supply Schedule Supply Curve Reference Point Price ($ per bushel) Quantity Supplied u $ 20 20 v 40 45 w 60 65 x 80 80 y 100 95 © 2014 Pearson Education Canada Inc. Chapter 3, Slide 20 A change in supply is a change in the quantity that will be supplied at every price—a shift of the entire curve. Fig. 3-6 An Increase in the Supply of Apples A change in quantity supplied refers to a movement from one point on a supply curve to another point, either on the same supply curve or on a new one. © 2014 Pearson Education Canada Inc. Chapter 3, Slide 21 Determinants of Supply LO6 1. Prices of Productive Resources • If the price of a productive resource increases, firms will supply less 2. Business Taxes • If business taxes rise, firms will supply less 3. Technology • An improvement in technology leads to a fall in the cost of production and an increase in supply © 2014 Pearson Education Canada Inc. 22 Determinants of Supply LO6 4. Prices of Substitutes in Production • An increase in the price of one product will cause a drop in the supply of products that are substitutes in production 5. Future Expectation of Suppliers • Lower expected future prices will lead to an increase in supply 6. Number of Suppliers • A decrease in the number of suppliers will reduce market supply © 2014 Pearson Education Canada Inc. 23 Concept Check: Supply Refer to Figure 3-2. A shift of the supply curve from S to S1 could be caused by A) an increase in the price of energy-efficient light bulbs. B) a decrease in the price of energy-efficient light bulbs. C) a decrease in the price of glass, a major input in the production of energy-efficient light bulbs. D) a change in consumers' preferences away from ordinary light bulbs toward energy-efficient light bulbs. E) an expectation that new government regulations will ban the use of energy-efficient light bulbs. © 2014 Pearson Education Canada Inc. 24 In which statement is the term "supply" used correctly? (1) An increase in the price of leather will cause a decrease in the supply of leather. (2) An increase in the price of leather will cause a decrease in the supply of leather boots. A) not enough information to tell B) the second statement only C) the first statement only D) both statements E) neither statement © 2014 Pearson Education Canada Inc. 25 3.3 The Determination of Price The Concept of a Market A market may be defined as any situation in which buyers and sellers negotiate the transaction of some goods or services. Markets may differ in the degree of competition among various buyers and sellers. In a perfectly competitive market buyers and sellers are price takers. © 2014 Pearson Education Canada Inc. Chapter 3, Slide 26 Graphical Analysis of a Market At the equilibrium price, every buyer finds a seller and every seller finds a buyer—the market “clears.” Fig. 3-7 Determination of Equilibrium Price © 2014 Pearson Education Canada Inc. Chapter 3, Slide 27 Changes in Market Prices The four “laws” of supply and demand: Fig. 3-8(i) Shifts in the Demand Curve 1. An increase in demand causes an increase in both the equilibrium price and equilibrium quantity. 2. A decrease in demand causes a decrease in both equilibrium price and equilibrium quantity. © 2014 Pearson Education Canada Inc. Chapter 3, Slide 28 Changes in Market Prices 3. An increase in supply causes a decrease in the equilibrium price and an increase in the equilibrium quantity. Fig. 3-8(ii) Shifts in the Supply Curve 4. A decrease in supply causes an increase in the equilibrium price and a decrease in the equilibrium quantity. © 2014 Pearson Education Canada Inc. Chapter 3, Slide 29 Price $2.00 2.25 2.50 2.75 3.00 3.25 3.50 3.75 4.00 © 2014 Pearson Education Canada Inc. Demand 60 58 56 54 52 50 48 46 44 Supply 30 33 36 39 42 45 48 51 54 Surplus/Shortage 30 Price Demand Supply 1 $4.00 4.25 4.50 140 130 120 60 70 80 4.75 5.00 5.25 5.50 110 100 90 80 90 100 110 120 Supply 2 Equilibrium P&Q ? Supply increases by 50% - new equilibrium? © 2014 Pearson Education Canada Inc. 31 What effect will the following changes have upon (i) the demand for, (ii) the price, and (iii) the quantity traded of commercially brewed beer? - A new medical report praising the healthy effects of drinking beer - A big decrease in the price of home-brewing kits - A rapid increase in population growth - Talk of a possible future strike of brewery workers © 2014 Pearson Education Canada Inc. 32 a. Day-care services More mothers with small children are returning to the labour force; gov’t introduces subsidies for day-care operators b. Marijuana The gov’t severely increases penalties for buying and for selling c.Compact discs New processing method reduces cost of producing CDs; consumers are switching to high digital downloads d. Organic vegetables Vegetarianism increases due to medical report; tighter regulations on definition of organically grown products introduced © 2014 Pearson Education Canada Inc. 33 LO6 Self-Test What impact will the following events have on the price of wine? a) A poor harvest in the grape industry results in a big decrease in the supply of grapes b) The number of wineries increases c) The sales tax on wine increases d) The introduction of a new fermentation method reduces the time needed for the wine to ferment e) The gov’t introduces a subsidy for each bottle of wine produced domestically © 2014 Pearson Education Canada Inc. 34 APPLYING ECONOMIC CONCEPTS 3-1 Why Apples But Not iPhones? Three conditions must be satisfied in order for price determination in a market to be well described by the demand-and-supply model: 1. Large number of consumers; each one small relative to the size of the market. 2. Large number of producers; each one small relative to the size of the market. 3. Producers must be selling 'homogeneous' versions of the product. © 2014 Pearson Education Canada Inc. Chapter 3, Slide 35 EXTENSIONS IN THEORY 3-2 The Algebra of Market Equilibrium Relative Prices and Inflation The absolute price of a product is the amount of money that must be spent to acquire one unit of that product. A relative price is the price of one good in terms of another. Demand and supply curves are drawn in terms of relative prices rather than absolute prices. © 2014 Pearson Education Canada Inc. Chapter 3, Slide 36 The table below displays hypothetical demand and supply schedules for the market for overnight parcel deliveries in Canada. Quantity Demanded (millions) Price ($) Year 1 Quantity Supplied (millions) Year 2 Year 1 Year 2 30 80 95 140 125 26 90 105 135 120 22 100 115 130 115 18 110 125 125 110 14 120 135 120 105 10 130 145 115 100 © 2014 Pearson Education Canada Inc. 37 1. The equilibrium price and quantity for overnight parcel delivery in Year 1 is ________ and ________ million parcels. 2. If the price of overnight parcel delivery in Year 2 is $10, how many parcels will actually be delivered? 3. Which of the following statements describes a likely event in the market for overnight parcel delivery? From Year 1 to Year 2, A) there was a decrease in consumers' income. B) there was an improvement in technology for tracking overnight parcels. C) the price of regular parcel delivery decreased. D) there was a rise in the price of jet fuel. E) the number of suppliers of overnight parcel delivery service increased. © 2014 Pearson Education Canada Inc. 38