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Chapter 3 Supply and Demand Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 3-1 Chapter Objectives • Define and explain demand in a product or service market • Define and explain supply • Determine the equilibrium point in the market for a specific good, given data on supply and demand at different price levels Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 3-2 Chapter Objectives • Understand what causes shifts in demand and supply • Understand how price ceilings cause shortages • Understand how price floors cause surpluses Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 3-3 Demand • The schedule of quantities of a good or service that people are willing and able to buy at different prices – Sometimes a schedule is also called a table Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 3-4 Hypothetical Daily Demand for Coach Seats on RoundTrip Weekly Flights between Denver and Chicago Table 1 $500 Price QD $500 1,000 400 450 3,000 350 400 7,000 300 350 12,000 250 300 19,000 200 250 30,000 150 200 45,000 100 150 57,000 100 67,000 450 D 50 10 20 30 40 50 60 Quantity (in thousands) Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 70 3-5 Hypothetical Daily Demand for Coach Seats on RoundTrip Weekly Flights between Denver and Chicago Table 1 $500 Price QD $500 1,000 400 450 3,000 350 400 7,000 300 350 12,000 250 300 19,000 200 250 30,000 150 200 45,000 100 150 57,000 100 67,000 450 D 50 10 20 30 40 50 60 Quantity (in thousands) Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 70 3-6 Hypothetical Daily Demand for Coach Seats on RoundTrip Weekly Flights between Denver and Chicago Table 1 $500 Price QD $500 1,000 400 450 3,000 350 400 7,000 300 350 12,000 250 300 19,000 200 250 30,000 150 200 45,000 100 150 57,000 100 67,000 450 D 50 10 20 30 40 50 60 Quantity (in thousands) Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 70 3-7 Hypothetical Daily Demand for Coach Seats on RoundTrip Weekly Flights between Denver and Chicago Table 1 $500 Price QD $500 1,000 400 450 3,000 350 400 7,000 300 350 12,000 250 300 19,000 200 250 30,000 150 200 45,000 100 150 57,000 100 67,000 450 D 50 10 20 30 40 50 60 Quantity (in thousands) Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 70 3-8 Hypothetical Daily Demand for Coach Seats on RoundTrip Weekly Flights between Denver and Chicago Table 1 $500 Price QD $500 1,000 400 450 3,000 350 400 7,000 300 350 12,000 250 300 19,000 200 250 30,000 150 200 45,000 100 150 57,000 100 67,000 450 D 50 10 20 30 40 50 60 Quantity (in thousands) Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 70 3-9 Hypothetical Daily Demand for Coach Seats on RoundTrip Weekly Flights between Denver and Chicago Table 1 $500 Price QD $500 1,000 400 450 3,000 350 400 7,000 300 350 12,000 250 300 19,000 200 250 30,000 150 200 45,000 100 150 57,000 100 67,000 450 D 50 10 20 30 40 50 60 Quantity (in thousands) Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 70 3-10 Hypothetical Daily Demand for Coach Seats on RoundTrip Weekly Flights between Denver and Chicago Table 1 $500 Price QD $500 1,000 400 450 3,000 350 400 7,000 300 350 12,000 250 300 19,000 200 250 30,000 150 200 45,000 100 150 57,000 100 67,000 450 D 50 10 20 30 40 50 60 Quantity (in thousands) Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 70 3-11 Hypothetical Daily Demand for Coach Seats on RoundTrip Weekly Flights between Denver and Chicago Table 1 $500 Price QD $500 1,000 400 450 3,000 350 400 7,000 300 350 12,000 250 300 19,000 200 250 30,000 150 200 45,000 100 150 57,000 100 67,000 450 D 50 10 20 30 40 50 60 Quantity (in thousands) Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 70 3-12 Hypothetical Daily Demand for Coach Seats on RoundTrip Weekly Flights between Denver and Chicago Table 1 $500 Price QD $500 1,000 400 450 3,000 350 400 7,000 300 350 12,000 250 300 19,000 200 250 30,000 150 200 45,000 100 150 57,000 100 67,000 450 D 50 10 20 30 40 50 60 Quantity (in thousands) Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 70 3-13 Hypothetical Daily Demand for Coach Seats on RoundTrip Weekly Flights between Denver and Chicago Table 1 $500 Price QD $500 1,000 400 450 3,000 350 400 7,000 300 350 12,000 250 300 19,000 200 250 30,000 150 200 45,000 100 150 57,000 100 67,000 450 D 50 10 20 30 40 50 60 Quantity (in thousands) Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 70 3-14 Hypothetical Daily Demand for Coach Seats on Roundtrip Weekly Flights between Denver and Chicago Table 1 $500 Price QD $500 1,000 400 450 3,000 350 400 7,000 300 350 12,000 250 300 19,000 200 250 30,000 150 200 45,000 100 150 57,000 100 67,000 450 D 50 10 20 30 40 50 60 Quantity (in thousands) Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 70 3-15 Table 1 is the Demand Schedule Table 1 Figure 1 is the Graph of the Demand Schedule Figure 1 $500 Price QD $500 1,000 400 450 3,000 350 400 7,000 300 350 12,000 250 300 19,000 200 250 30,000 150 200 45,000 100 150 57,000 100 67,000 450 50 The line is the Demand Curve 10 20 30 40 50 60 Quantity (in thousands) Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. D 70 3-16 Quantity Demanded is a point on the Demand Curve Price and Quantity Demanded are inversely related Table 1 Figure 1 $500 Price QD $500 1,000 400 450 3,000 350 400 7,000 300 350 12,000 250 300 19,000 200 250 30,000 150 200 45,000 100 150 57,000 100 67,000 450 D 50 10 20 30 40 50 60 Quantity (in thousands) Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 70 3-17 Remember, Demand is the entire schedule or the entire curve Table 1 Quantity Demanded is a point on the Demand Curve Figure 1 $500 Price QD $500 1,000 400 450 3,000 350 400 7,000 300 350 12,000 250 300 19,000 200 250 30,000 150 200 45,000 100 150 57,000 100 67,000 450 D 50 10 20 30 40 50 60 Quantity (in thousands) Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 70 3-18 Supply • Is the “schedule” of quantities of a good or service that people are willing to sell at various prices Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 3-19 Supply is the entire schedule or the entire curve Price $500 $450 $400 $350 $300 $250 $200 $150 $100 QS 62,000 59,000 54,000 48,000 40,000 30,000 16,000 7,000 2,000 S $500 450 400 350 300 250 200 150 100 50 10 20 30 40 50 60 Quantity (in thousands) Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 70 3-20 Quantity Supplied is a point on the curve Price $500 $450 $400 $350 $300 $250 $200 $150 $100 QS 62,000 59,000 54,000 48,000 40,000 30,000 16,000 7,000 2,000 S $500 450 400 350 300 250 200 150 100 50 10 20 30 40 50 60 Quantity (in thousands) Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 70 3-21 Demand and Supply Curves Price $500 $450 $400 $350 $300 $250 $200 $150 $100 QS 62,000 59,000 54,000 48,000 40,000 30,000 16,000 7,000 2,000 QD 1,000 3,000 7,000 12,000 19,000 30,000 45,000 57,000 67,000 S $500 450 400 350 300 250 200 150 D 100 50 10 Equilibrium price is the price where QD = QS 20 30 40 50 60 Quantity (in thousands) 70 We can find equilibrium price and quantity by seeing where the supply and demand curves cross Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 3-22 Demand and Supply Curves Surpluses and Shortages Price $500 $450 $400 $350 $300 $250 $200 $150 $100 QS 62,000 59,000 54,000 48,000 40,000 30,000 16,000 7,000 2,000 QD 1,000 3,000 7,000 12,000 19,000 30,000 45,000 57,000 67,000 S $500 450 54,000-7,000 = 44,000 400 350 300 250 200 150 D 100 50 10 Equilibrium price = EP Market price = MP 20 30 40 50 60 Quantity (in thousands) 70 MP > EP there is a surplus Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 3-23 Demand and Supply Curves Surpluses and Shortages Price $500 $450 $400 $350 $300 $250 $200 $150 $100 QS 62,000 59,000 54,000 48,000 40,000 30,000 16,000 7,000 2,000 QD 1,000 3,000 7,000 12,000 19,000 30,000 45,000 57,000 67,000 S $500 450 54,000-7,000 = 44,000 400 350 300 250 200 150 D 100 50 10 Equilibrium price = EP Market price = MP 20 30 40 50 60 Quantity (in thousands) 70 A surplus would force sellers to lower their prices. Eventually, prices would fall back to the equilibrium price Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 3-24 Demand and Supply Curves Surpluses and Shortages Price $500 $450 $400 $350 $300 $250 $200 $150 $100 QS 62,000 59,000 54,000 48,000 40,000 30,000 16,000 7,000 2,000 QD 1,000 3,000 7,000 12,000 19,000 30,000 45,000 57,000 67,000 S $500 450 400 350 300 250 200 150 100 57,000-7,000 = 44,000 50 10 Equilibrium price = EP Market price = MP D 20 30 40 50 60 Quantity (in thousands) 70 MP < EP here is a shortage Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 3-25 Demand and Supply Curves Surpluses and Shortages Price $500 $450 $400 $350 $300 $250 $200 $150 $100 QS 62,000 59,000 54,000 48,000 40,000 30,000 16,000 7,000 2,000 QD 1,000 3,000 7,000 12,000 19,000 30,000 45,000 57,000 67,000 S $500 450 400 350 300 250 200 150 100 57,000-7,000 = 44,000 50 10 Equilibrium price = EP Market price = MP D 20 30 40 50 60 Quantity (in thousands) 70 A shortage would allow sellers to raise their prices. As prices increased people would buy less. Eventually, prices would move back to the equilibrium price Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 3-26 Demand and Supply Curves Surpluses and Shortages Price $500 $450 $400 $350 $300 $250 $200 $150 $100 QS 62,000 59,000 54,000 48,000 40,000 30,000 16,000 7,000 2,000 QD 1,000 3,000 7,000 12,000 19,000 30,000 45,000 57,000 67,000 S $500 450 400 350 300 250 200 150 D 100 50 10 20 30 40 50 60 Quantity (in thousands) 70 We can see that the forces of demand and supply work together to establish an equilibrium price at which there are no shortages or surpluses Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 3-27 The schedule changes from QD1 to QD2 Table 4 Price QD1 S $500 QD2 450 $500 1,000 12,000 400 450 3,000 15,000 350 400 7,000 21,000 300 250 350 12,000 30,000 300 19,000 40,000 150 250 30,000 55,000 100 200 45,000 63,000 50 150 57,000 75,000 100 88,000 67,000 200 D1 D2 10 20 30 40 50 60 Quantity (in thousands) 70 The demand curve shifts to the right from D1 to D2 This is an increase in demand Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 3-28 The schedule changes from QD2 to QD1 Table 4 Price QD1 S $500 QD2 450 $500 1,000 12,000 400 450 3,000 15,000 350 400 7,000 21,000 300 250 350 12,000 30,000 300 19,000 40,000 150 250 30,000 55,000 100 200 45,000 63,000 50 150 57,000 75,000 100 88,000 67,000 200 D1 D2 10 20 30 40 50 60 Quantity (in thousands) 70 The demand curve shifts to the left from D2 to D1 This is a decrease in demand Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 3-29 Shifts in Supply and Demand If the schedule changes the Supply curve shifts Price 500 S S 450 400 350 300 250 200 Supply decreases . . . the curve shifts to the left 150 100 50 Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. D 10 20 30 40 50 60 70 Quantity (in thousands) 3-30 Shifts in Supply and Demand If the schedule changes the Supply curve shifts Price 500 S S 450 400 350 300 250 200 150 Supply increases . . . the curve shifts to the right Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 100 50 D 10 20 30 40 50 60 70 Quantity (in thousands) 3-31 Shifts in Supply and Demand If the Supply curve is S1 what is the equilibrium price and quantity? Price 500 S2 S1 450 400 350 300 250 The equilibrium price is approximately 262 or 263 200 150 The equilibrium quantity is approximately 35,000 Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 100 50 D 10 20 30 40 50 60 70 Quantity (in thousands) 3-32 Shifts in Supply and Demand If the Supply curve changes to S2 what is the new equilibrium price and quantity? Price 500 S2 S1 450 400 350 300 250 The new equilibrium price is approximately 325 200 150 The new equilibrium quantity is approximately 26,000 Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 100 50 D 10 20 30 40 50 60 70 Quantity (in thousands) 3-33 Shifts in Supply and Demand Is a shift from S1 to S2 an increase or decrease in Supply? Price 500 S2 S1 450 400 350 300 250 A decrease 200 150 100 50 Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. D 10 20 30 40 50 60 70 Quantity (in thousands) 3-34 Price Floors and Ceilings The price can go no lower than the floor. The surplus is the amount by which the quantity supplied is greater than the quantity demanded A price floor creates a permanent surplus Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 3-35 Price Floors and Ceilings The price can go no higher than the ceiling. The shortage is the amount by which the quantity demanded is greater than the quantity supplied A price ceiling creates a permanent shortage Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 3-36 Applications of Supply and Demand • Interest rates are set by – Supply and demand • Wage rates are set by – Supply and demand • Rents are determined by – Supply and demand • Prices of nearly all goods are determined by – Supply and demand • Prices of nearly all services are determined by – Supply and demand Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 3-37 Hypothetical Demand for and Supply of Loanable Funds S 20 18 16 14 12 10 8 6 4 2 D 100 200 300 400 500 600 700 800 900 1,000 1,100 Quantity of loanable f unds (in billions of dollars) We can see that $600 billion is lent (or borrowed) at an interest rate of 6% What would happen if the supply of loanable funds increased? Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 3-38 Hypothetical Demand for and Supply of Loanable Funds S1 20 S2 18 16 14 12 10 8 6 4 2 D 200 400 600 800 1,000 Quantity of loanable f unds (in billions of dollars) The interest rate would decrease to 4% and the amount of money borrowed would increase to $800 billion Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 3-39 Hypothetical Demand for and Supply of Loanable Funds S 20 18 16 14 12 10 8 6 D2 4 2 D1 200 400 600 800 1,000 Quantity of loanable f unds (in billions of dollars) If the demand for loanable funds rises to D2 the interest rate would rise to 9% and the amount of money borrowed would rise to $700 billion Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 3-40 Price Mechanism (The Forces of Supply & Demand) • Operates an automatic guidance system – Sometimes this is called the “invisible hand” – Efficiently allocates the limited means of production toward the satisfaction of human wants – Provides consumers with an endless stream of goods and services • In a sense, the price system has failed poor people – Many are working 50 or 60 hours a week, but they are still poor Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved. 3-41