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CHAPTER 3 – DEMAND AND SUPPLY ANALYSIS
(6e)
I.
Demand
Definition:
A.
Law of Demand
What is the most likely relationship between
the price of a good and the quantity
demanded of that good? The answer is found
in the law of demand.
Definition:
Two explanations of the law of demand:
The substitution effect:
The income effect:
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B.
Demand Schedule and Demand Curve
Demand may be expressed as a:
Demand schedule (a table indicating prices
and quantities demanded for a good)
See Ex. 1(a)
Demand curve (a graph of a demand
schedule)
See Ex. 1(b)
The demand curve typically has a downward
(negative) slope because of the law of
demand, which holds that a higher price will
result in a smaller quantity demanded and a
lower price will result in a greater quantity
demanded.
IMPORTANT TERMINOLOGY DISTINCTION—
Quantity Demanded (QD) versus Demand (D):
WARNING: The information in the
following two paragraphs may seem
easy to you at first, but these are
concepts with which many students
actually have a great deal of difficulty
in practice! It would be wise to study
this material VERY CAREFULLY!
Quantity demanded (QD) refers to a particular
quantity demanded at a particular price.
Quantity demanded is represented by an
individual point on the demand curve or row
on the demand schedule. When there is a
change in the price of the good, this causes a
change in quantity demanded and is shown
by a movement along the demand curve from
one point to another. A movement down to
the right along a demand curve represents an
increase in quantity demanded in response to
a decrease in price, while a movement up to
the left along a demand curve represents a
decrease in quantity demanded in response
to an increase in price.
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Demand (D) refers to the entire relation
between price and the amount of a good
demanded. Demand is represented by the
complete D schedule or D curve. When there
is a change in some factor other than the
price of the good, this causes a change in
demand and is shown by a shift of the
demand curve. A rightward shift indicates an
increase in demand, while a leftward shift
indicates a decrease in demand. (See Section
II below.)
II.
Shifts of the Demand Curve
The law of demand says that as P decreases, QD
increases, and as P increases, QD decreases, all else
being equal or other things constant. What happens
when all else is not equal or constant? In other
words, what happens when something other than a
price change affects consumers’ demand for a good?
The major factors that can affect demand (thus
shifting the demand curve) are:
A.
Changes in Consumer Income
See Ex. 2
Exactly how a change in income affects
demand depends on whether the good is a
“normal good” or an “inferior good”.
1) Normal good
Definition:
Examples:
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2) Inferior good
Definition:
Examples:
B.
Changes in the Prices of Related Goods
We will deal mostly with pairs of goods that
are either:
1) Substitutes
Definition:
Examples:
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2) Complements
Definition:
Examples:
C.
Changes in Consumer Expectations
Examples:
D.
Changes in the Number or Composition of
Consumers
E.
Changes in Consumer Tastes
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III.
Supply
Definition:
A.
Law of Supply
The most likely relationship between the price
of a good and the quantity supplied of that
good is found in the law of supply.
Definition:
B.
Supply Schedule and Supply Curve
Supply may be expressed as a:
Supply schedule (a table indicating prices and
quantities supplied for a good)
See Ex. 3(a)
Supply curve (a graph of the supply schedule)
See Ex. 3(b)
The supply curve typically has an upward
(positive) slope because of the law of supply,
which holds that a higher price will result in a
greater quantity supplied and a lower price
will result in a smaller quantity supplied.
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IMPORTANT TERMINOLOGY DISTINCTION—
Quantity Supplied (QS) versus Supply (S):
WARNING: The same warning applies
here; that is, the information in the
following two paragraphs may seem easy
to you at first, but these are concepts
with which many students actually have a
great deal of difficulty in practice! It
would be wise to study this material
VERY CAREFULLY!
Quantity supplied (QS) refers to a particular
quantity supplied at a particular price.
Quantity supplied is represented by an
individual point on the supply curve or row on
the supply schedule. When there is a change
in the price of the good, this causes a change
in quantity supplied and is shown by a
movement along the supply curve from one
point to another. A movement up to the right
along a supply curve represents an increase
in quantity supplied in response to an
increase in price, while a movement down to
the left along a supply curve represents a
decrease in quantity supplied in response to a
decrease in price.
Supply (S) refers to the entire relation
between price and the amount of a good
supplied. Supply is represented by the
complete S schedule or S curve. When there
is a change in some factor other than the
price of the good, this causes a change in
supply and is shown by a shift of the supply
curve. A rightward shift indicates an increase
in supply, while a leftward shift indicates a
decrease in supply. (See Section IV below.)
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IV.
Shifts of the Supply Curve
The law of supply says that as P increases, QS
increases, and as P decreases, QS decreases, all else
being equal or other things constant. What happens
when all else is not equal? In other words, what
happens when something other than a price change
affects producers’ supply of a good?
The major factors that can affect supply (thus shifting
the supply curve) are:
A.
Changes in Technology
See Ex. 4
Examples:
B.
Changes in the Prices of Relevant Resources
Definition of “relevant resources”:
Examples:
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C.
Changes in the Prices of Alternative Goods
Definition of “alternative goods”:
Examples:
D.
Changes in Producer Expectations
Examples:
E.
Changes in the # of Producers
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V.
Demand and Supply Create a Market
A.
Market Equilibrium
Definition:
See Ex. 5
B.
Market Disequilibrium: SURPLUS
Definition:
See Ex. 5
Market adjustments:
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C.
Market Disequilibrium: SHORTAGE
Definition:
See Ex. 5
Market adjustments:
VI.
Changes in Equilibrium Price (Pe) and Equilibrium
Quantity (Qe)
A change in one or more of the determinants of
demand or supply will lead to a change in Pe and in
Qe.
A.
Shifts of the Demand Curve
(See Section II above for factors that change
demand, i.e., that shift the demand curve.)
See Ex. 6
Learn this rule: Given an upward-sloping
supply curve, a rightward shift of the demand
curve will lead to an increase in Pe and an
increase in Qe, while a leftward shift of the
demand curve will lead to a decrease in Pe
and a decrease in Qe.
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B.
Shifts of the Supply Curve
(See Section IV above for factors that change
supply, i.e., that shift the supply curve.)
See Ex. 7
Learn this rule: Given a downward-sloping
demand curve, a rightward shift of the supply
curve will lead to a decrease in Pe and an
increase in Qe, while a leftward shift of the
supply curve will lead to an increase in Pe and
a decrease in Qe.
C.
Simultaneous Shifts of Demand and Supply
Curves
When the demand and supply curves shift at
the same time, the impact on equilibrium
price and quantity depends on the directions
of the shifts and on which curve shifts more.
See Ex. 8
Be able to answer questions like the
following: Suppose the demand for pizzas
increases dramatically while the supply of
pizzas increases only slightly. What will
happen to the equilibrium quantity of pizzas?
What will happen to the equilibrium price of
pizzas? (Hint: draw a graph!)
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VII.
Disequilibrium Prices
A market is in disequilibrium when QD does not equal
QS at the prevailing price. Usually the resulting
shortages or surpluses put upward or downward
pressure on the price until equilibrium is restored.
But what if the price is not allowed to rise or fall? For
example, what if the government imposes a price
floor or a price ceiling?
A.
Price Floor
Definition:
See Ex. 11(a)
Result:
B.
Price Ceiling
Definition:
See Ex. 11(b)
Result:
END
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