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A Lecture Presentation
to accompany
Exploring Economics
3rd Edition
by Robert L. Sexton
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Chapter 4
Supply and Demand
4.1 Markets


A market is the process of buyers
and sellers exchanging goods
services.
Supermarkets, the New York Stock
Exchange, drug stores, roadside
stands, garage sales, Internet stores,
and restaurants are all markets.


Every market is different. Some
markets are local but numerous
(such as housing or the market for
cement), others are global (such as
automobiles or gold).
The important point about a market
is not what it looks like, but what it
does–it facilitates trade.


Buyers, as a group, determine the
demand side of the market, whether
it is consumers purchasing goods or
firms purchasing inputs.
Sellers, as a group, determine the
supply side of the market, whether it
is firms selling their goods or
resource owners selling their inputs.


It is the interaction of buyers and
sellers that determines market prices
and output through the forces of
supply and demand.
In this chapter, we focus on how
supply and demand work in a
competitive market.


A competitive market is one in which
a number of buyers and sellers are
offering similar products and no single
buyer or seller can influence the
market price.
Because most markets contain a large
degree of competitiveness, the lessons
of supply and demand can be applied
to many different types of problems.
4.2 Demand


According to the law of demand,
the quantity of a good or service
demanded varies inversely with its
price, ceteris paribus.
More directly, other things equal,
when the price of a good or service
falls, the quantity demanded
increases.

There are several reasons why there
is an inverse or negative relationship
between price and quantity
demanded:
 Observed behavior tells us that
consumers will buy more goods and
services at lower prices than higher
prices, ceteris paribus.

Another reason for the negative
relationship is diminishing
marginal utility. That is, in a
given time period, a buyer will
receive less satisfaction from
each successive unit consumed—
so consumers would only buy
added units if the price were
reduced.

Finally, there are the substitution
and income effects of a price
change. For example, if the price of
pizza increases the quantity
demanded of pizza will fall as some
buyers switch out of pizza into
hamburgers, tacos or some other
food that substitutes for pizza.


In addition, a price increase in pizza
will reduce the quantity demanded of
pizza because it reduces a buyer’s
purchasing power.
That is, the buyer cannot buy as
many pieces of pizza at higher prices
as at lower prices—this is called the
income effect of a price change.

An individual demand schedule
reveals the different amounts of a
particular good a person would be
willing and able to buy at various
possible prices in a particular time
interval, other things equal.


An individual demand curve for
a particular good illustrates the same
information as the individual demand
schedule.
It reveals the relationship between
the price and the quantity demanded,
showing that when the price is higher,
the quantity demanded is lower.



Economists usually speak of the demand
curve in terms of large groups of people.
The horizontal summing of the demand
curves of many individuals is called the
market demand curve for a product.
It reflects the fact that the total quantity
purchased in the market at a price is the
sum of the quantities purchased by each
demander.
4.3 Shifts in the Demand Curve


A change in a good's price leads to a
change in quantity demanded,
illustrated by moving along a given
demand curve.
But price is not the only thing that affects
the quantity of a good people buy. The
other factors that influence the demand
curve are called determinants of demand,
and they shift the entire demand curve—a
change in demand.
Some possible demand shifters





prices of related goods
incomes of demanders
number of demanders
tastes of demanders
expectations of demanders


An increase in demand is represented
by a rightward shift in the demand
curve.
A decrease in demand is represented
by a leftward shift in the demand
curve.
Substitutes



A major variable that shifts the demand
curve is the prices of related goods.
Two goods are called substitutes
if an increase in the price of one causes
a decrease in the demand for the other
good.
The opposite also applies: Two goods are
called substitutes if a decrease in the
price of one causes an increase in the
demand for the other good.

For most people good substitutes
might include: movie tickets and
video rentals; jackets and sweaters;
7-Up and Sprite; and Nikes and
Reeboks.


Two goods are complements if an
increase in the price of one good
causes a decrease in the demand for
the other good.
The opposite is also true: Two goods
are complements if a decrease in the
price of one good causes an increase
in the demand for the other good.
Complements



Goods that “go together.”
They are often consumed or used
simultaneously.
For example: skis and bindings; hot
dogs and mustard; motorcycles and
motorcycle helmets; DVDs and DVD
players.
Income


Generally the consumption of goods
and services is positively related to
the income available to consumers.
As individuals receive more income,
they tend to increase their purchases
of most goods and services.
Income-Normal Good




Other things equal, an increase in
income usually leads to an increase in
demand for goods (rightward shift).
A decrease in income usually leads to
a decrease in the demand for goods
(leftward shift).
Such goods are called normal goods.
For example: CDs and movie tickets.
Income-Inferior Good



Some goods exist for which rising (or
falling) income leads to reduced (or
increased) demand.
These are called inferior goods. The term
inferior does not refer to the quality of the
good, but it merely shows that when
income changes demand changes in the
opposite direction (inversely).
For example: thrift shop clothes, storebrand products, and bus rides.
Number of Buyers


The demand for a good or service will
vary with the size of the potential
consumer population—the number
of buyers.
An increase in the potential consumer
population will increase (shift right)
the demand for a good or service.
Tastes


Changes in fashions, fads,
advertising, etc. can change tastes
or preferences.
An increase in tastes or preferences
for a good or service will increase
(shift right) the demand for a good
or service.


While changes in preferences lead
to shifts in demand, much of the
predictive power of economic theory
stems from the assumption that
tastes are relatively stable over a
substantial period of time.
We cannot precisely and accurately
measure taste changes.
Expectations


An increase in the expected future
price of a good will increase (shift
right) the current demand for it.
A decrease in the expected future
price of a good will decrease (shift
left) the current demand for it.

Or if you expect to earn additional
income in the near future you may be
more willing to dip into your current
savings to buy something now.
Changes in Demand vs. Changes
in Quantity Demanded Revisited:


If the price of a good changes, we say
this leads to a change in quantity
demanded.
If one of the other factors
(determinants of demand) influencing
consumer behavior changes, we say
there is a change in demand.
4.4 Supply


The law of supply states that, other
things equal, the quantity supplied
will vary directly with the price of
the good.
According to the law of supply,


the higher the price of the good,
the greater the quantity supplied,
and the lower the price of the good,
the smaller the quantity supplied.


The quantity supplied is positively related
to the price, because firms supplying goods
and services want to increase their profits,
and the higher the price per unit, the
greater the profitability generated by
supplying more of that good or service.
Also, if costs are rising for producers as
they produce more units, they must
receive a higher price to compensate
producers for their higher costs.


An individual supply schedule reveals
the different amounts of a product
that a producer is willing and able to
supply at various prices in a particular
time interval, other things equal.
An individual supply curve
illustrates that information
graphically.
Price of Coffee (per pound)
Exhibit 1: An Individual
Supply Curve
$5
4
3
2
Juan’s
supply
curve
1
0
20 40 60 80 100 120
Quantity of Coffee Supplied
(pounds per year)


The market supply curve for a
product is the horizontal summation
of the supply curves for individual
firms.
It shows the amount of goods and
services suppliers are willing and
able to supply at various prices.
Quantity Supplied
(pounds per year)
Price Juan +
$5
4
3
2
1
80
70
50
30
10
+
+
+
+
+
Other
Market
=
Producers
Supply
7,920
6,930
4,950
2,970
990
=
=
=
=
=
8,000
7,000
5,000
3,000
1,000
Price of Coffee (per pound)
Exhibit 2: A Market Supply
Curve
$5
4
3
Market
Supply
Curve
2
1
0
2 4 6
8 10 12
Quantity of Coffee Supplied
(thousands of pounds per year)
4.5 Shifts in the Supply Curve



Changes in the price of a good lead to
changes in quantity supplied, which
are shown as movements along a given
supply curve.
Changes in supply occur for other
reasons than changes in the price of
the product itself.
A change in any other factor that can
affect supplier behavior results in a shift
of the entire supply curve.
These other factors include:









supplier input prices
prices of related products
expectations
number of suppliers
technology
regulations
taxes
subsidies
weather


An increase in supply shifts the
supply curve to the right.
A decrease in supply shifts the supply
curve to the left.
Exhibit 1: Supply Shifts
Price
S3
0
S1
Decrease Increase
in
in
Supply
Supply
Quantity
S2


Higher input prices increase the cost
of production causing the supply
curve to shift to the left at each
and every price.
Lower input prices decrease the cost
of production causing the supply
curve to shift to the right at each
and every price.


The supply of a good can be
influenced by the prices of related
products.
Firms producing a product can
sometimes use their resources to
produce alternative products.



Suppose a farmer’s land can be used to
grow either barley or cotton.
If the farmer is currently growing barley
and the price of barley falls then this
provides an incentive for the farmer to
shift acreage out of barley and into
cotton.
Thus, a decrease in the price of barley
will increase the supply of cotton.
Exhibit 2: Substitutes in
Production
Supply
P1
P2
0
Q2
Q1
Quantity of Barley Supplied
b. Market for Cotton
Price of Cotton
Price of Barley
a. Market for Barley
S1
S2
0
Quantity of Cotton Supplied




If producers expect a higher price in the
future, they will supply less now.
They would prefer to wait and sell when
their goods will be more valuable.
If producers currently expect that the
price will be lower later they will supply
more now.
Otherwise, if they wait to sell, then their
goods will be worth less.



The market supply curve is the
horizontal summation of the
individual supply curves.
So an increase in the number of
suppliers will increase market supply.
A decrease in the number of suppliers
will decrease market supply.


Technological progress can lower the cost
of production and increase supply.
Supply may also change because of
changes in the legal and regulatory
environment in which firms operate (e.g.,
safety and pollution regulations,
minimum wages, taxes, etc.). If such
changes increase costs, they will decrease
supply. If they decrease costs, they will
increase supply.



An increase in costly government
regulations, taxes or adverse production
conditions will increase the cost of
production, decreasing supply.
Subsidies, the opposite of a tax can
lower the cost of production and shift
the supply curve to the right.
In addition, weather can affect the
supply of certain commodities.


If the price of a good changes, it
leads to a change in its quantity
supplied, but not its supply.
If one of the other factors influences
sellers' behavior, it leads to a change
in supply.
Exhibit 4: Change in Supply vs.
Change in Quantity Supplied
Price of Cotton
S1
B
P2
P1
0
C
A
B
Change in
quantity supplied
B
C
Change in
supply
A
QA
S2
QB
QC
Quantity of Cotton