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Understanding Economics
5th edition
by Mark Lovewell
Copyright © 2009 by McGraw-Hill Ryerson
Limited. All rights reserved.
Chapter 2
Demand and Supply
Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.
Learning Objectives

After this chapter, you will be able to:
1.
2.
3.
comprehend the nature of demand, changes in quantity
demanded, changes in demand, and the factors that affect
demand
understand the nature of supply, changes in quantity
supplied, changes in supply, and the factors that affect
supply
explain how markets reach equilibrium – the point at which
demand and supply meet
Copyright © 2009 by McGraw-Hill Ryerson
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What Is Demand?
o
Demand is a relationship between a product’s price
and quantity demanded.
• Demand is shown using a schedule or curve.
• The law of demand states that price and quantity
demanded are inversely related.
• Market demand is the sum of quantities demanded by
all consumers in a market.
Copyright © 2009 by McGraw-Hill Ryerson
Limited. All rights reserved.
The Demand Curve
Figure 2.1, page 33
Your Demand Curve for Strawberries
Your Demand Schedule
for Strawberries
Point
on
graph
$2.50
7
a
2.00
9
b
1.50
11
c
Price ($ per kg)
Price
($ per kg)
Quantity
Demanded
(kg per month)
a
2.50
b
2.00
c
1.50
D
1.00
0.50
0
1
3
5
7
9
11
Quantity Demanded
(kg per month)
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13
Deriving Market Demand
Figure 2.2, page 35
2.50
2.00
1.50
1.00
D0
0.50
Friend’s Demand Curve for Strawberries
Price ($ per kg)
Price ($ per kg)
Your Demand Curve for Strawberries
You
Friend
Market
($ per
kg)
(D0)
(D1)
(Dm)
$2.50
2.00
1.50
(kg per month)
1
2
3
2
3
4
3
5
7
1.50
1.00
D1
0.50
Market Demand Curve for Strawberries
Price ($ per kg)
Price
2.00
5
0
1
2 3 4
6 7
Quantity Demanded (kg per month)
0
1 2 3
7
5 6
4
Quantity Demanded (kg per month)
Individual and Market Demand
Schedules for Strawberries
2.50
2.50
2.00
1.50
1.00
Dm
0.50
0
1
2
3
4
5
6
7
Quantity Demanded (kg per month)
Copyright © 2009 by McGraw-Hill Ryerson
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Changes in Demand (a)

Changes in demand:
 are shown by shifts in the demand curve
 are caused by changes in demand factors
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Changes in Demand (b)
Figure 2.3, page 36
Market Demand Curve for Strawberries
Market Demand Schedule
for Strawberries
$2.50
2.00
1.50
Quantity Demanded
(millions of kg)
(D2)
(D0)
(D1)
5
7
9
7
9
11
9
11
13
Price ($ per kg)
Price
($ per
kg)
2.50
2.00
1.50
D2
D0
D1
1.00
0.50
0
1
3
5
7
9
11
13
Quantity Demanded
(millions of kg per year)
Copyright © 2009 by McGraw-Hill Ryerson
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Demand Factors (a)

Demand factors include the following:
 The number of buyers (an increase causes a rightward
demand shift)
 Income


For normal products, an increase causes a rightward demand
shift.
For inferior products, an increase causes a leftward demand
shift.
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Demand Factors (b)

Prices of other products
 For substitute products, a rise in the other product’s
price causes a rightward demand shift.
 For complementary products, a rise in the other
product’s price causes a leftward demand shift.


Consumer preferences
Consumer expectations
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Changes in Quantity Demanded (a)

Changes in quantity demanded:
 are shown by movements along demand curve
 are caused by price changes
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Changes in Quantity Demanded (b)
Figure 2.4, page 38
2.00
a
b
1.50
1.00
D0
0.50
0
Change in Demand
Price ($ per pair of skis)
Price ($ per pair of skis)
Change in Quantity Demanded
2.00
1.50
1.00
D0
D1
0.50
5000 6000
Quantity Demanded (pairs of skis)
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0
5000
Quantity Demanded (pairs of skis)
What Is Supply?

Supply:
 is a relationship between a product’s price and quantity
supplied
 is shown using a schedule or curve

The law of supply states there is a direct relationship
between price and quantity supplied.
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The Supply Curve
Figure 2.5, page 40
Market Supply Curve for Strawberries
Market Supply Schedule
for Strawberries
f
Price Quantity Supplied Points
($ per kg) (millions of kg) on graph
$1.50
5
d
2.00
9
e
2.50
13
f
Price ($ per kg)
2.50
S
e
2.00
d
1.50
1.00
0.50
0
1
3
5
7
9
11
13
Quantity Supplied
(millions of kg per year)
Copyright © 2009 by McGraw-Hill Ryerson
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Changes in Supply (a)

Changes in supply:
 are shown by shifts in the supply curve
 are caused by changes in supply factors
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Changes in Supply (b)
Figure 2.6, page 41
Market Supply Curve for Strawberries
S2
Market Supply Schedule
for Strawberries
Quantity Supplied
(millions of kg)
(S2)
(S0)
(S1)
$2.50
11
13
15
2.00
7
9
11
1.50
3
5
7
2.50
Price ($ per kg)
Price
($ per
kg)
S0 S1
2.00
1.50
1.00
0.50
0
1
3
5
7
9
11
13
Quantity Supplied
(millions of kg per year)
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15
Supply Factors (a)

Supply factors include the following factors:
 Number of producers (an increase causes a rightward
supply shift)
 Resource prices (an increase causes a leftward supply
shift)
 State of technology (an improvement causes a rightward
supply shift)
 Prices of related products (an increase causes a leftward
supply shift)
Copyright © 2009 by McGraw-Hill Ryerson
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Supply Factors (b)
 Changes in nature (an improvement causes a rightward
shift for some products)
 Producer expectations (an expectation of lower prices in
the future causes an immediate rightward supply shift)
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Changes in Quantity Supplied (a)

Changes in quantity supplied:
 are shown by movements along the supply curve
 are caused by price changes
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Changes in Quantity Supplied (b)
Figure 2.7, page 43
Change in Quantity Supplied
S0
120
Price ($ per kg)
Price ($ per kg)
100
a
80
60
40
20
1
S0
120
b
100
0
Change in Supply
2
Quantity Supplied
(millions of kg per year)
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80
60
40
20
0
1
2
Quantity Supplied
(millions of kg per year)
S1
Market Equilibrium (a)

When a product is in surplus:
 there is excess supply
 price is pushed down

When a product is in shortage:
 there is excess demand
 price is pushed up
Copyright © 2009 by McGraw-Hill Ryerson
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Market Equilibrium (b)
Figure 2.8, page 44
Market Demand and Supply Curves
for Strawberries
Market Demand and Supply
Schedules for Strawberries
Quantities
(millions of kg)
D
S
$3.00
5
13
+8
2.50
7
11
+4
2.00
9
9
0
1.50
11
7
-4
1.00
13
5
-8
Surplus
a
2.50
Price ($ per kg)
Price
($ per
kg)
Surplus (+)
or Shortage
(-)
(millions of
kg)
S
3.00
a
e
2.00
b
b
1.50
Shortage
1.00
D
0
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1
9 11 13 15
5
7
Quantity
(millions of kg per year)
3
Changes in Equilibrium (a)




A rightward demand shift pushes up both equilibrium
price and quantity.
A leftward demand shift pushes down both
equilibrium price and quantity.
A rightward supply shift pushes equilibrium price
down and equilibrium quantity up.
A leftward supply shift pushes equilibrium price up
and equilibrium quantity down.
Copyright © 2009 by McGraw-Hill Ryerson
Limited. All rights reserved.
Demand Changes and
Equilibrium
Market Demand and Supply Curves
for Strawberries
Figure 2.9, page 46
S
3.00
Price
2.50
($ per kg.)
Quantities
(D0)
(D1)
(S)
(millions of kg)
$3.00
5
9
13
2.50
7
11
11
2.00
9
13
9
1.50
11
15
7
1.00
13
17
5
Price ($ per kg)
Market Demand and Supply
Schedules for Strawberries
b
a
2.00
1.50
shortage
1.00
0
D0
1
3
5
7
9
11 13 15
Quantity
(millions of kg per year)
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D1
17
Supply Changes and
Equilibrium
Market Demand and Supply Curves
for Strawberries
Figure 2.10, page 47
S0
3.00
Price
2.50
($ per kg)
Quantities
(D0)
(S0)
(S1)
(millions of kg)
$3.00
5
13
17
2.50
7
11
15
2.00
9
9
13
1.50
11
7
11
1.00
13
5
9
Price ($ per kg)
Market Demand and Supply
Schedules for Strawberries
S1
Surplus
a
2.00
b
1.50
1.00
0
D0
1
3
5
7
9
11 13 15
Quantity
(millions of kg per year)
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17
Changes in Equilibrium (b)

A simultaneous rightward shift in demand and supply
raises equilibrium quantity, but the effect on
equilibrium price depends on the relative sizes of the
two shifts.


if demand shifts rightward more than supply, then price
rises
if supply shifts rightward more than demand, then price
falls
Copyright © 2009 by McGraw-Hill Ryerson
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Effects of Increases in Demand
and Supply
Market Demand and Supply Curves
for Strawberries
Figure 2.11 page 48
S0
3.00
Price
2.50
Quantities
(D0) (D1) ( S0) (S1)
($ per kg.)
(millions of kg)
$3.00
5
9
13
17
2.50
7
11
11
15
2.00
9
13
9
13
1.50
11
15
7
11
1.00
13
17
5
9
Price ($ per kg)
Market Demand and Supply
Schedules for Strawberries
a
S1
b
2.00
1.50
1.00
0
D0
1
3
5
7
9
11 13 15
Quantity
(millions of kg per year)
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D1
17
Changes in Equilibrium (c)

A simultaneous rightward shift in demand and
leftward shift in supply raises equilibrium price, but
the effect on equilibrium quantity depends on the
relative sizes of the two shifts.


if supply shifts leftward more than demand shifts
rightward, then quantity falls
if demand shifts rightward more than supply shifts
leftward, then quantity rises
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Effects of a Demand Increase
and Supply Decrease
Market Demand and Supply Curves
for Strawberries
Figure 2.12 page 49
3.00
Price
2.50
Quantities
(D0) (D1) ( S0) (S1)
($ per kg.)
(millions of kg)
$3.00
5
7
13
11
2.50
7
9
11
9
2.00
9
11
9
7
1.50
11
13
7
5
1.00
13
15
5
3
Price ($ per kg)
Market Demand and Supply
Schedules for Strawberries
b
S1
S0
2.00
a
1.50
1.00
0
D0 D1
1
3
5
7
9
11 13 15
Quantity
(millions of kg per year)
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17
Spoilt for Choice

William Stanley Jevons:
 assumed measurable utility
 outlined the law of diminishing marginal utility, which
states that a consumer’s marginal utility declines as
more of a product is consumed
 showed how this law can be illustrated using the
downward-sloping marginal utility graph for a given
consumer and product, based on that consumer’s total
utility graph
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Spoilt for Choice (b)
Figure A, page 54
Total Utility
Consumer’s Total and Marginal
Utility From Cappuccino
Total
Utility
(utils)
0
0
(a)
1
12
(b)
2
20
(c)
3
24
(d)
4
26
(e)
Marginal
Utility
(utils)
12
(f)
8
(g)
4
(h)
2
(i)
Utility (utils)
12
8
4
0
f
g
h
i
2
1
3
Cups of Cappuccino
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4
e
c
20
16
b
12
8
4
0
Marginal Utility
16
d
24
Utility (utils)
Quantity
Consumed
(cups)
28
a
2
1
3
Cups of Cappuccino
4
The Utility-Maximizing Rule

Jevons devised the utility-maximizing rule


this rule states a consumer should reach the same
marginal utility per dollar for all products
consumed
in mathematical terms:
MU1
P1
=
MU2
P2
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Spoilt for Choice (c)
Figure B, page 56
Cups of Cappuccino
(price = $1)
Quantity
0
1
2
3
4
Danish Pastries
(price = $2)
Marginal
Marginal
Utility
Utility
(MU1)
per $
(MU1/P1=MU1/$1)
(utils)
(utils per $)
12
12
8
8
4
4
2
2
Quantity
0
1
2
3
4
12
8
4
0
2
1
3
Cups of Cappuccino
16
8
12
6
8
4
4
2
Danish Pastries
Marginal Utility
Per $ (utils)
Marginal Utility
Per $ (utils)
Cappuccinos
Marginal
Marginal
Utility
Utility
(MU2)
per $
(MU2/P2=MU2/$2)
(utils)
(utils per $)
4
12
8
4
0
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2
1
Pastries
3
4
Indifference Curves
(Online Learning Centre)
 Using indifference curves, consumer preferences can
be shown without the need to assume measurable
utility.
 An individual consumer must merely rank his/her
options for various bundles of two products in order of
preference.
 A consumer may prefer one bundle to another, or be
indifferent between the two.
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An Indifference Curve (a)
(Online Learning Centre)
 An indifference curve shows all bundles of two goods
to which a particular consumer is indifferent.
 The curve is downward-sloping because, for any point
on the curve, all points to the northeast provide more
utility and all points to the southwest provide less
utility.
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An Indifference Curve (b)
(Online Learning Centre)
Alice’s Indifference Curve
Alice’s Indifference Schedule
Point on
Graph
4
3
3
4
a
b
2
7
c
1
12
d
4
Milkshakes
Milkshakes Hamburgers
At each point on
the curve, Alice
derives the same
level of utility.
a
3
b
c
2
d
1
0
I0
4
8
Hamburgers
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12
The Marginal Rate of Substitution
(Online Learning Centre)
 The absolute value of an indifference curve’s slope is
the marginal rate of substitution (MRS).
 An indifference curve is convex, since the curve’s MRS
diminishes as more of the product on the horizontal
axis (hamburgers), and less on the vertical axis
(milkshakes) is consumed.
Copyright © 2009 by McGraw-Hill Ryerson
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Diminishing Marginal Rate of
Substitution (Online Learning
Centre)
 The diminishing marginal rate of substitution occurs
because, as hamburger consumption rises, more
hamburgers must be gained to make the consumer
willing to sacrifice another milkshake.
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A Map of Indifference Curves (a)
(Online Learning Centre)
 A map of indifference curves can be drawn for an
individual consumer, with each indifference curve
further to the northeast representing a higher level of
utility
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A Map of Indifference Curves (b)
(Online Learning Centre)
A Map of Indifference Curves
Each curve shows
points that give
different levels
of utility for Alice.
Milkshakes
4
3
2
1
0
I0
4
8
12
Hamburgers
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I1
I2
The Budget Line (a)
(Online Learning Centre)
 A consumer’s budget line:
 is drawn based on the assumption that all the
consumer’s budget is spent on hamburgers and
milkshakes
 has a vertical intercept equal to the consumer’s budget
divided by the price of milkshakes
 has a horizontal intercept equal to the consumer’s
budget divided by the price of hamburgers
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The Budget Line (b)
(Online Learning Centre)
 has a slope whose absolute value equals the ratio of the
two prices (the price of hamburgers divided by the price
of milkshakes)
 divides the graph into an attainable region southwest of
the line, and an unattainable region northeast of the
line
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The Budget Line (c)
(Online Learning Centre)
Alice’s Budget Line
Alice’s Budget Schedule
5
Milkshakes Hamburgers
4
0
2
3
4
2
6
1
8
0
10
$15/$3
4
Milkshakes
5
The budget curve
shows all those
points Alice
can reach with her
limited budget.
3
2
$15/$1.50
1
0
4
8
10 12
Hamburgers
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The Utility-Maximizing Point (a)
(Online Learning Centre)
 The consumer maximizes utility by reaching the
highest possible indifference curve on the budget line.
 This utility-maximizing point occurs on the
indifference curve that just touches the budget line at a
single point.
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The Utility-Maximizing Point (b)
(Online Learning Centre)
Alice’s greatest
achievable utility
is on the indifference
curve which touches
her budget line at
a single point.
5
Milkshakes
4
b (4, 3)
3
2
1
0
I0
4
8
10 12
Hamburgers
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Deriving a Demand Curve (a)
(Online Learning Centre)
 The consumer’s demand curve for hamburgers can be
found by tracing out the results of a change in the
price of hamburgers given a constant money budget
and price for milkshakes.
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Price ($ per hamburger)
Deriving a Demand Curve (b)
(Online Learning Centre)
5
Milkshakes
4
b
3
e (6,3)
2
I1
1
I0
0
4
8
10 12
Hamburgers
15
A decline in the price of
hamburgers from $1.50
to $1 causes Alice’s quantity
demanded to rise from
4 to 6, as shown by her
demand curve, D.
1.50
1.00
.50
D
0
4
8
12
Quantity (hamburgers per week)
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Chapter 2
The End
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