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Supply and Demand McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 4-2 Laugher Curve Q. What do you get when you cross the Godfather with an economist? A. An offer you can't understand. McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 4-3 Demand Demand means the willingness and capacity to pay. McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 4-4 Demand Prices are the tools by which the market coordinates individual desires. McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 4-5 The Law of Demand Quantity demanded rises as price falls, other things constant. Quantity demanded falls as prices rise, other things constant. Thus, there is an inverse relationship between price and quantity demanded. McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 4-6 The Law of Demand What accounts for the law of demand? People tend to substitute for goods whose price has gone up McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 4-7 The Demand Curve The demand curve is the graphic representation of the law of demand. The demand curve slopes downward and to the right. As the price goes up, the quantity demanded goes down. McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 4-8 The Demand Curve The slope tells us that quantity demanded varies indirectly—in the opposite direction—with price. McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 4-9 Other Things Constant Other things constant means that all other factors that affect the analysis are assumed to remain constant, whether they actually remain constant or not. These factors may include changing tastes, prices of other goods, even the weather. McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 4 - 10 Price (per unit) A Sample Demand Curve PA A D 0 QA Quantity demanded (per unit of time) McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 4 - 11 Shifts in Demand Versus Movements Along a Demand Curve Demand refers to a schedule of quantities of a good that will be bought per unit of time at various prices, other things constant. Graphically, it refers to the entire demand curve. McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 4 - 12 Shifts in Demand Versus Movements Along a Demand Curve Quantity demanded refers to a specific amount that will be demand per unit of time at a specific price. Graphically, it refers to a specific point on the demand curve. McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 4 - 13 Shifts in Demand Versus Movements Along a Demand Curve A movement along a demand curve is the graphical representation of the effect of a change in price on the quantity demanded. McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 4 - 14 Shifts in Demand Versus Movements Along a Demand Curve A shift in demand is the graphical representation of the effect of anything other than price on demand. The original curve will move to the right or to the left. McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 4 - 15 Price (per unit) Change in Quantity Demanded $2 B Change in quantity demanded (a movement along the curve) $1 A D1 0 McGraw-Hill/Irwin 100 200 Quantity demanded (per unit of time) Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 4 - 16 Price (per unit) Shift in Demand Change in demand (a shift of the curve) $2 $1 B A D0 D1 250 100 200 Quantity demanded (per unit of time) McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 4 - 17 Shift Factors of Demand Shift factors of demand are those that cause shifts in the demand curve to the right or left. McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 4 - 18 Shift Factors of Demand Shift factors of demand include—but are not limited—to the following: Society's income The prices of other goods Tastes Expectations McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 4 - 19 Shift Factors of Demand A rise in income will increase demand for goods. When the prices of substitute goods fall, you will consume less of the good whose price has not changed. A change in taste will change demand with no change in price. McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 4 - 20 Shift Factors of Demand If you expect your income to rise, you may consume more now. If you expect prices to fall in the future, you may put off purchases today. McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 4 - 21 The Demand Table The demand table assumes all the following: As price rises, quantity demanded declines. Quantity demanded has a specific time dimension to it. McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 4 - 22 The Demand Table The demand table assumes all the following: All the products involved are identical in shape, size, quality, etc. The schedule assumes that everything else is held constant. McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 4 - 23 From a Demand Table to a Demand Curve You plot each point in the demand table on a graph and connect the points to derive the demand curve. McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 4 - 24 From a Demand Table to a Demand Curve The demand curve graphically conveys the same information that is on the demand table. McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 4 - 25 From a Demand Table to a Demand Curve The curve represents the maximum price that you will for various quantities of a good—you will happily pay less. McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 4 - 26 From a Demand Table to a Demand Curve A Demand Table $0.50 1.00 2.00 3.00 4.00 9 8 6 4 2 Price per cassette (in dollars) Price per Cassette rentals cassette demanded per week A B C D E A Demand Curve $6.00 5.00 4.00 3.50 3.00 E D G 2.00 C 1.00 .50 0 F Demand for cassettes B A 1 2 3 4 5 6 7 8 9 10 11 12 13 Quantity of cassettes demanded (per week) McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 4 - 27 Individual and Market Demand Goods A market demand curve is the horizontal sum of all individual demand curves. This is determined by adding the individual demand curves of all the demanders. McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 4 - 28 Individual and Market Demand Goods Real world sellers do not add up individual demand curves. McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 4 - 29 Individual and Market Demand Goods They estimate total market demand for their product which becomes smooth and downward sloping curve. McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 4 - 30 Individual and Market Demand Goods The demand curve is downward sloping for the following reasons: At lower prices, existing demanders buy more. At lower prices, new demanders enter the market. McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 4 - 31 From Individual Demands to a Market A $.0.50 B 1.00 C 1.50 D 2.00 E 2.50 F 3.00 G 3.50 H 4.00 9 8 7 6 5 4 3 2 6 5 4 3 2 1 0 0 (2) Cathy’s demand 1 1 0 0 0 0 0 0 (3) Market demand 16 14 11 9 7 5 3 2 $4.00 Price per cassette (in dollars) (1) (2) (3) Price per Alice’s Bruce’s cassette demand demand 3.50 G F 3.00 E 2.50 D 2.00 C 1.50 B 1.00 0.50 A Cathy 0 2 4 Bruce Alice 6 8 10 12 14 16 Quantity of cassettes demanded per week McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 4 - 32 Supply Individuals control the factors of production. Factors of production are the resources or inputs, necessary to produce goods or services. McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 4 - 33 Supply Individuals supply factors of production to intermediaries or firms. McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 4 - 34 Supply The analysis of the supply of produced goods has two parts: An analysis of the supply of the factors of production to households and firms. An analysis of why firms transform those factors of production into usable goods and services. McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 4 - 35 The Law of Supply Quantity supplied rises as price rises, other things constant. Quantity supplied falls as price falls, other things constant. Thus, there is a direct relationship between price and quantity supplied. McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 4 - 36 The Law of Supply The law of supply is accounted for by two factors: In the face of rising prices, firms arrange their activities to supply more of the good to the market, substituting production of that good for the production of other goods. Assuming firms' costs are constant, a higher price means higher profits. McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 4 - 37 The Supply Curve The supply curve is the graphic representation of the law of supply. The supply curve slopes upward to the right. The slope tells us that the quantity supplied varies directly—in the same direction—with the price. McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 4 - 38 Price (per unit) A Sample Supply Curve S PA 0 McGraw-Hill/Irwin A QA Quantity supplied (per unit of time) Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 4 - 39 Shifts in Supply Versus Movements Along a Supply Curve Supply refers to a schedule of quantities a seller is willing to sell per unit of time at various prices, other things constant. McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 4 - 40 Shifts in Supply Versus Movements Along a Supply Curve If the amount supplied is affected by anything other than a change in price, there will be a shift in supply. Shift in supply -- the graphic representation of the effect of a change in a factor other than price on supply. McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 4 - 41 Shifts in Supply Versus Movements Along a Supply Curve Quantity supplied refers to a specific amount that will be supplied at a specific price. McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 4 - 42 Shifts in Supply Versus Movements Along a Supply Curve Changes in price causes changes in quantity supplied represented by a movement along a supply curve. McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 4 - 43 Shift in Supply S0 Price (per unit) S1 $15 A B Shift in Supply (a shift of the curve) 1,250 1,500 Quantity supplied (per unit of time) McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 4 - 44 Change in Quantity Supplied Price (per unit) S0 B $15 A Change in quantity supplied (a movement along the curve) 1,250 1,500 Quantity supplied (per unit of time) McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 4 - 45 Shift Factors of Supply Shift factors of supply are those factors that cause shifts in the entire supply curve to the left or right. McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 4 - 46 Shift Factors of Supply The following are shift factors of supply: Changes in the prices of inputs used in the production of a good Changes in technology Changes in suppliers' expectations Changes in taxes and subsidies McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 4 - 47 Shift Factors of Supply Changes in the prices of inputs used in the production of a good. If costs go up, then profits go down, and the incentive to supply also goes down. If costs go up substantially, the firm may even shut down. McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 4 - 48 Shift Factors of Supply Technology makes costs go down, profits go up, thus the incentive to supply also goes up. This is especially true when technology replaces labor. McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 4 - 49 Shift Factors of Supply If they expect prices to rise in the future, suppliers may store today's production for an expected windfall later. If they expect prices to fall in the future, suppliers may sell off more of their inventories today. McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 4 - 50 Shift Factors of Supply If taxes go up, costs also go up, and profits go down, leading suppliers to reduce output. If government subsidies go up, costs go down, and profits go up, leading suppliers to increase output. McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 4 - 51 From a Supply Table to a Supply Curve To derive a supply curve from a supply table, you plot each point in the supply table on a graph and connect the points. McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 4 - 52 From a Supply Table to a Supply Curve The supply curve represents the set of minimum prices an individual seller will accept for various quantities of a good. McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 4 - 53 From a Supply Table to a Supply Curve Competing suppliers’ entry into the market places a limit on the price any supplier can charge. McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 4 - 54 Individual and Market Supply Curves The market supply curve is derived by horizontally adding the individual supply curves of each supplier. McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 4 - 55 From Individual Supplies to a Market Supply (1) (2) (3) (4) (5) Quantities Price Ann's Barry's Charlie's Market Supplied (in dollars) Supply Supply Supply Supply A B C D E F G H I McGraw-Hill/Irwin $0.00 0.50 1.00 1.50 2.00 2.50 3.00 3.50 4.00 0 1 2 3 4 5 6 7 8 0 0 1 2 3 4 5 5 5 0 0 0 0 0 0 0 2 2 0 1 3 5 7 9 11 14 15 Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 4 - 56 Price per cassette (in dollars) From Individual Supplies to a Market Supply $4.00 Charlie Barry Ann Market Supply 3.50 H 3.00 G 2.50 F 2.00 E 1.50 D 1.00 0.50 0 A I C B CA 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 Quantity of cassettes supplied (per week) McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 4 - 57 The Marriage of Supply and Demand The English historian Thomas Carlyle once said: “Teach any parrot the words supply and demand and you’ve got an economist.” McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 4 - 58 The Dynamic Laws of Supply and Demand Supply and demand come together to determine equilibrium quantity and equilibrium price. McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 4 - 59 Excess Supply and Excess Demand Excess supply – prices tend to fall if quantity supplied is greater than quantity demanded. Excess demand – prices tend to rise if quantity demanded is greater than quantity supplied. McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 4 - 60 Price Adjusts The larger the difference between quantity demanded and quantity supplied, the greater the pressure for prices to rise (if there is excess demand) or fall (if there is excess supply. McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 4 - 61 Price Adjusts When quantity demanded equals quantity supplied, prices have no tendency to change. McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 4 - 62 Price per cassette (in dollars) The Marriage of Supply and Demand $5.00 S Excess supply 4.00 3.50 A 3.00 B E 2.50 C 2.00 1.50 Excess demand 1.00 1 McGraw-Hill/Irwin Excess supply D 2 3 4 5 6 7 8 9 10 11 12 Quantity of cassettes supplied and demanded (per week) Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 4 - 63 Equilibrium Equilibrium is a concept in which opposing dynamic forces pushing cancel each other out. McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 4 - 64 Equilibrium In supply and demand analysis, equilibrium means that the upward pressure on price is exactly offset by the downward pressure on price. McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 4 - 65 Equilibrium Equilibrium price is the price toward which the invisible hand drives the market. Equilibrium quantity is the amount bought and sold at the equilibrium price. McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 4 - 66 Equilibrium Isn't: A state of the world—it's a characteristic of the model used to look at the world. Inherently good or bad—but simply a state in which dynamic pressures offset each other. McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 4 - 67 Desirable Characteristics of Supply/Demand Equilibrium Consumer surplus – the distance between the demand curve and the price the demander pays is net benefit to consumers. McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 4 - 68 Desirable Characteristics of Supply/Demand Equilibrium Producer surplus – if a producer receives more than the price he would be willing to sell it for, he receives a net benefit. McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 4 - 69 Desirable Characteristics of Supply/Demand Equilibrium What's good about equilibrium is that it makes the combination of consumer and producer surplus as large as it can be. McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 4 - 70 Desirable Characteristics of Supply/Demand Equilibrium Markets allow trade, thereby leading to an increase in the combination of consumer and producer surplus. McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. 4 - 71 Consumer and Producer Surplus $10 9 Consumer Surplus 8 Lost 7 Surplus 6 5 4 Producer 3 Surplus 2 1 0 1 2 3 4 5 6 7 8 Quantity McGraw-Hill/Irwin Supply Demand 9 10 Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Supply and Demand End of Chapter 4 McGraw-Hill/Irwin Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.