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SAYRE | MORRIS Seventh Edition CHAPTER 2 Demand and Supply: an Introduction © 2012 McGraw-Hill Ryerson Limited 2-1 LO1 Demand • the quantities that consumers are willing and able to buy over a period of time at various prices • must be willing to purchase it AND • must have ability to pay for it © 2012 McGraw-Hill Ryerson Limited 2-2 LO1 Demand • the quantities that consumers are willing and able to buy over a period of time at various prices • shows relationship between quantity & price • price is the most important determinant • “ceteris paribus” – all else remains the same © 2012 McGraw-Hill Ryerson Limited 2-3 LO1 Demand Demand Schedule • A table showing the various quantities demanded at different prices Demand Curve • A graphic representation of a demand schedule © 2012 McGraw-Hill Ryerson Limited 2-4 LO1 Demand Schedule Price Per Case of Beer $17 18 19 20 21 22 Quantity Demanded (cases per month) © 2012 McGraw-Hill Ryerson Limited 7 6 5 4 3 2 2-5 LO1 Demand Curve Price Price $17 Quantity 7 18 19 20 6 5 4 21 22 3 2 $19 $18 $17 1 2 3 4 5 6 7 Quantity © 2012 McGraw-Hill Ryerson Limited 2-6 LO1 Demand Curve Price $19 $18 $17 Demand curve 1 2 3 4 5 6 7 Quantity © 2012 McGraw-Hill Ryerson Limited 2-7 LO1 Demand Curve Price $19 $18 $17 - as price increases, quantity demanded decreases - movement is along an existing demand line B A 1 2 3 4 5 6 7 Quantity © 2012 McGraw-Hill Ryerson Limited 2-8 LO1 Why the Demand Curve Slopes Downward 1. Income effect • The effect of a price change on real income, and therefore on quantity demanded • Real income is measured in terms of the goods and services it will buy • Real income will increase if prices fall, or decrease if prices rise. © 2012 McGraw-Hill Ryerson Limited 2-9 Real Income Example 20 Years Ago Today $2.50 $5.75 © 2012 McGraw-Hill Ryerson Limited 2- 10 LO1 Why the Demand Curve Slopes Downward 2. Substitution effect • The substitution of one product for another as a result of a change in their relative prices © 2012 McGraw-Hill Ryerson Limited 2-11 LO1 Market Demand • The total demand for a product or service from all consumers • It is the summation of all individual demand curves • Consumers do not set prices; they react to different prices by altering their quantity demanded © 2012 McGraw-Hill Ryerson Limited 2-12 LO1 Market Demand Schedule Quantity demanded (cases/month) $/case Tomiko Abdi Jan Market demand $18 6 + 4 + 9 = 19 $19 5 4 7 16 $20 4 4 6 14 $21 3 3 3 9 $22 2 3 1 6 © 2012 McGraw-Hill Ryerson Limited 2-13 Market Demand Schedule P LO1 Market demand is the horizontal summation of all individual demands. 22 21 20 19 18 DJAN DTOMIKO DABDI DMARKET 0 2 4 6 8 10 12 14 16 18 20 © 2012 McGraw-Hill Ryerson Limited Q 2-14 LO2 Supply • the quantities that producers are willing and able to supply over a period of time at various prices © 2012 McGraw-Hill Ryerson Limited 2-15 LO2 Supply Supply Schedule • A table showing the various quantities supplied per period of time at different prices Supply Curve • A graphic representation of the supply schedule © 2012 McGraw-Hill Ryerson Limited 2-16 LO2 Supply Schedule Price Per Case of Beer $18 19 20 21 22 Quantity Supplied (cases per month) © 2012 McGraw-Hill Ryerson Limited 2 3 4 5 6 2-17 LO2 Supply Curve Price Price $18 Quantity 2 19 20 21 3 4 5 22 6 $20 $19 $18 1 2 3 4 5 6 7 Quantity © 2012 McGraw-Hill Ryerson Limited 2-18 LO2 Supply Curve Price $20 $19 $18 - as price increases, quantity supplied (Qs) increases - movement is along an existing supply line B A 1 2 3 4 5 6 7 Quantity © 2012 McGraw-Hill Ryerson Limited 2-19 LO2 Why the Supply Curve Slopes Upward • • • Suppliers are motivated by profit Higher price means more profit. Greater profit means more suppliers are willing to produce the product Costs rise as more is produced, so higher prices are required to supply more © 2012 McGraw-Hill Ryerson Limited 2-20 LO2 Market Supply Curve • Total supply from all producers of a product • Horizontal summation of each individual producer’s supply curve Assumptions: • producers are all making a similar product • consumers have no preference as to which supplier or product they use © 2012 McGraw-Hill Ryerson Limited 2-21 LO2 Market Supply Schedule Quantity supplied (cases/month) $/case Bobbie 2 Other Brewers + 6 Market Supply = 8 $18 $19 3 9 12 $20 4 12 16 $21 5 15 20 $22 6 18 24 © 2012 McGraw-Hill Ryerson Limited 2-22 Market Supply Curve P 22 SBOBBI + SOTHER = LO2 SMARKET 21 20 19 18 Market supply is the total quantity of all producers at each price. 0 2 4 6 8 10 12 14 16 18 20 © 2012 McGraw-Hill Ryerson Limited Q 2-23 Market Equilibrium LO3. LO4 Market • A mechanism that allows buyers and sellers to exchange products or services Equilibrium • The point where quantity demanded equals quantity supplied • There is neither a shortage nor a surplus QD = QS © 2012 McGraw-Hill Ryerson Limited 2-24 LO4 Market Equilibrium Surplus • the amount by which quantity supplied is greater than quantity demanded • occurs at prices above equilibrium Shortage • the amount by which quantity supplied is less than quantity demanded • occurs at prices below equilibrium © 2012 McGraw-Hill Ryerson Limited 2-25 LO4 Market Equilibrium Quantity supplied (cases/month) $/case $18 Market Supply 8 Market Demand _ 22 $19 12 18 -6 $20 16 16 0 $21 20 9 +11 $22 24 6 +18 © 2012 McGraw-Hill Ryerson Limited Shortage/ Surplus = -14 2-26 LO4 Market Equilibrium P Supply Demand The market is in equilibrium when QS = QD $20 16 © 2012 McGraw-Hill Ryerson Limited Q 2-27 LO4 Shortage P Supply Demand At a price lower than equilibrium, QS < QD there is a shortage $20 $18 shortage 16 8 (QS ) 22 (QD ) © 2012 McGraw-Hill Ryerson Limited Q 2-28 LO4 Surplus P Supply Demand $22 At a price higher than equilibrium, QS > QD there is a surplus $20 surplus 6 (QD ) 16 24 (QS ) © 2012 McGraw-Hill Ryerson Limited Q 2-29 LO4 Market Adjustments When there is a Surplus: • producers drop the price to sell excess stock • as price drops: - quantity demanded increases - quantity supplied falls • market moves back to equilibrium price, quantity © 2012 McGraw-Hill Ryerson Limited 2-30 LO4 Market Adjustment - Surplus P Supply Demand $22 $20 surplus 6 (QD ) 16 24 (QS ) © 2012 McGraw-Hill Ryerson Limited Q 2-31 LO4 Market Adjustment - Surplus P Supply Demand - Sellers drop price to sell excess - Buyers buy more at lower price - Sellers supply less at lower price - Back to equilibrium $22 $20 surplus 6 (QD ) 16 24 (QS ) © 2012 McGraw-Hill Ryerson Limited Q 2-32 LO4 Market Adjustments When there is a Shortage: • buyers bid up the price • as price rises: - quantity demanded decreases - quantity supplied increases • market moves back to equilibrium price, quantity © 2012 McGraw-Hill Ryerson Limited 2-33