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© 2007 Thomson South-Western, all rights reserved
N. G R E G O R Y M A N K I W
PowerPoint® Slidesby Ron Cronovich
4
ECONOMICSP R I N C I P L E S O F
F O U R T H E D I T I O N
The Market Forces of Supply and Demand
2CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
In this chapter, look for the answers to these questions: What factors affect buyers’ demand for goods?
What factors affect sellers’ supply of goods?
How do supply and demand determine the price of a good and the quantity sold?
How do changes in the factors that affect demand or supply affect the market price and quantity of a good?
How do markets allocate resources?
3CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
Markets and Competition
A market is a group of buyers and sellers of a particular product.
A competitive market is one with many buyers and sellers, each has a negligible effect on price.
A perfectly competitive market:• all goods exactly the same• buyers & sellers so numerous that no one can
affect market price – each is a “price taker”
In this chapter, we assume markets are perfectly competitive.
4
Demand: is a willingness and an ability to pay (comes from the behavior of buyers)
The demand function:
Demand = f{Price, income, the prices of related goods, tastes, etc.}
Prices are the tool by which market coordinates individuals’ desires and limits how much people demand. Thus, price mechanism ensures what people demand matches what’s available Example: when goods are scarce, the market reduces the quantity people demand; as their prices go up, people buy fewer goods, vice versa
other things constant(ceteris paribus)
Demand
5CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
Cont,…
The quantity demanded of any good is the amount of the good that buyers are willing and able to purchase.
6
Quantity Demanded
1) Desired quantityIt is the amount that consumers wish to purchase, given the price of the product, other prices, their incomes, their taste and everything else that might matter
2) Effective quantityIt is not an idle dream but it is the amounts that people are willing to buy, given the price they must pay for the product
3) Continuous flow of purchaseIt must therefore expressed as so much per period of time: 1 million units per day, etc.
Quantity Demanded
Source: Lipsey and Courant
7
Quantity demanded rises as price falls, other things constant or alternatively:
Quantity demanded falls as price rises, other things constant
As price changes, people change how much of a particular good they are willing to buy
What accounts for the law of demand?
Individual’s tendency to substitute other goods for goods whose relative price has gone up
An inverse relationship between price and quantity demanded, other things constant
The Law of Demand
8CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
The Demand Schedule
Demand schedule: A table that shows the relationship between the price of a good and the quantity demanded.
Example: Helen’s demand for lattes.
Price of
lattes
Quantity of lattes
demanded
$0.00 16
1.00 14
2.00 12
3.00 10
4.00 8
5.00 6
6.00 4 Notice that Helen’s preferences obey the Law of Demand.
9CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
$0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
0 5 10 15
Price of Lattes
Quantity of Lattes
Helen’s Demand Schedule & Curve
Price of
lattes
Quantity of lattes
demanded
$0.00 16
1.00 14
2.00 12
3.00 10
4.00 8
5.00 6
6.00 4
10
Konsumen cenderung membagi pendapatannya untuk mengkonsumsi bermacam barang. Peningkatan harga salah satu barang yang dikonsumsinya berarti lebih sedikit barang lain yang bisa dikonsumsi atau harga relatif barang yang naik tersebut menjadi lebih mahal diukur dengan unit barang lainnya. Hal ini yang mendorong konsumen untuk mengurangi jumlah yang diminta ketika harga naik
Hukum utilitas marginal yang semakin menurun
Semakin banyak unit barang yang dikonsumsi, tambahan kepuasan (utilitas) yang diperoleh dari mengkonsumsi unit barang terakhir akan semakin menurun
Alasan Kurva Permintaan Berslope Negatif
11
From Individual Demand to Market
Demand
Market Demand versus Individual Demand The quantity demanded in the market is the sum of
the quantities demanded by all buyers at each price.
Suppose Helen and Ken are the only two buyers in the Latte market. (Qd = quantity demanded)
4
6
8
10
12
14
16
Helen’s Qd
2
3
4
5
6
7
8
Ken’s Qd
+
+
+
+
=
=
=
=
6
9
12
15
+ = 18
+ = 21
+ = 24
Market Qd
$0.00
6.00
5.00
4.00
3.00
2.00
1.00
Price
13CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
$0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
0 5 10 15 20 25
P
Q
The Market Demand Curve for Lattes
PQd
(Market)
$0.00 24
1.00 21
2.00 18
3.00 15
4.00 12
5.00 9
6.00 6
14
Price (per DVD)
Alice’s Demand
Terry’s Demand
Raul’s Demand
Market Demand
A $ 0.50 6 3 2 11
B $ 1.00 5 2 1 8
C $ 1.50 4 1 0 5
D $ 2.00 3 0 0 3
E $ 2.50 2 0 0 2
F $ 3.00 1 0 0 1
Another Example
Demand for DVD
15
Alice
Terry
Raul
Market Demand
Prices of DVD
3.00
2.50
2.00
1.50
1.00
0.50Quantities
of DVD1 2 3 4 5 6 7 8 9 10 11
Cont,…
16
Changes in quantity demanded
Vs.Changes in demand
17
Happens due to price movements, a change in price changes the quantity demanded
Graphically, this situation is showed by a movement along a demand curve
APA
QA
Qd
Price of X
Quantity of X
PB
QB
B
Change in quantity demanded
18
Happens due to the change in anything other than price (the ‘constant factors’)
Graphically, this situation is showed by a shift in demand (a shift in entire demand curve)
Qd1
Price of X
Quantity of X
PA
QA
Qd2
QB
A B
Change in demand
19CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
Demand Curve Shifters
The demand curve shows how price affects quantity demanded, other things being equal.
These “other things” are non-price determinants of demand (i.e., things that determine buyers’ demand for a good, other than the good’s price).
Changes in them shift the D curve…
20CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
Demand Curve Shifters: # of buyers
An increase in the number of buyers causesan increase in quantity demanded at each price, which shifts the demand curve to the right.
21CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
$0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
0 5 10 15 20 25 30
P
Q
Suppose the number of buyers increases. Then, at each price, quantity demanded will increase (by 5 in this example).
Demand Curve Shifters: # of buyers
22CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
Demand for a normal good is positively related to income. • An increase in income causes increase
in quantity demanded at each price, shifting the D curve to the right.
(Demand for an inferior good is negatively related to income. An increase in income shifts D curves for inferior goods to the left.)
Demand Curve Shifters: income
23CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
Two goods are substitutes if an increase in the price of one causes an increase in demand for the other.
Example: pizza and hamburgers. An increase in the price of pizza increases demand for hamburgers, shifting hamburger demand curve to the right.
Other examples: Coke and Pepsi, laptops and desktop computers, compact discs and music downloads
Demand Curve Shifters: prices of related
goods
24CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
Two goods are complements if an increase in the price of one causes a fall in demand for the other.
Example: computers and software. If price of computers rises, people buy fewer computers, and therefore less software. Software demand curve shifts left.
Other examples: college tuition and textbooks, bagels and cream cheese, eggs and bacon
Demand Curve Shifters: prices of related
goods
25CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
Anything that causes a shift in tastes toward a good will increase demand for that good and shift its D curve to the right.
Example: The Atkins diet became popular in the ’90s, caused an increase in demand for eggs, shifted the egg demand curve to the right.
Demand Curve Shifters: tastes
26CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
Expectations affect consumers’ buying decisions.
Examples:
• If people expect their incomes to rise, their demand for meals at expensive restaurants may increase now.
• If the economy turns bad and people worry about their future job security, demand for new autos may fall now.
Demand Curve Shifters: expectations
27
Taxes Taxes levied on consumers increase the
cost of goods to consumers and therefore reduce demand for those goods
Subsidies Subsidies have the opposite effect Subsidies reduce the cost of goods to
consumers and therefore increase demand for those goods
Demand Curve Shifters: taxes & subsidies
28
Population growth does not by itself create new demand. The additional people must have purchasing power (that is, earning income) before demand is change
If population growth results in an extra employed people, then the following statement is usually true:
An increase in population will shift the demand of most products to the right, indicating that more will be bought at each price
Demand Curve Shifters: population growth
29CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
Summary: Variables That Affect Demand
Variable A change in this variable…
Price …causes a movement along the D curve
No. of buyers …shifts the D curve
Income …shifts the D curve
Price ofrelated goods …shifts the D curve
Tastes …shifts the D curve
Expectations …shifts the D curve
30CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
Cont,…
Variable A change in this variable…
Taxes …shifts the D curve
Subsidies …shifts the D curve
Populationgrowth …shifts the D curve
31CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
Additional Information on Demand
Each individual has his/her owns limitations on how much of goods or services that they can consume..The limit is perhaps time constraint, the number of his/her fortunes or the work of the law of diminishing marginal utility—an increase in consuming one good/service will eventually decrease utility derived from that consumption Consequently, these facts are depicted on the graph by the intersection of the demand curve with each of the axis – Case and Fair
32CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
The demand curve will intersect with axis if…
Axis causes…
Price (Y) the limitation on consumer’s income and wealth
Quantity (X) the limitation of time and the work of the law of
diminishing marginal utility
Cont.,…
33CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
$0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
0 5 10 15 20 25 30
P
Q
Cont.,…
34
Kurva permintaan akan memotong sumbu harga (Y) sebagai akibat terbatasnya pendapatan dan kekayaan rumah tangga. Akan ada tingkat harga tertentu yang maksimal bisa disanggupi oleh konsumen
Kurva permintaan akan memotong sumbu kuantitas (X) sebagai akibat keterbatasan waktu dan hukum utilitas marginal yang semakin menurun. Keterbatasan waktu menyebabkan jumlah yang diminta konsumen pada saat harga suatu barang adalah nol terbatas. Pada tingkat konsumsi tertentu, tambahan utilitas yg didapat dari mengkonsumsi suatu barang sama dengan nol. Sehingga mengkonsumsi lebih banyak dari titik ini tidak memberikan manfaat bagi konsumen.
Kurva Permintaan Memotong Sumbu
A C T I V E L E A R N I N G 1: Demand curve
A. The price of iPods falls
B. The price of music downloads falls
C. The price of compact discs falls
35
Draw a demand curve for music downloads. What happens to it in each of the following scenarios? Why?
A C T I V E L E A R N I N G 1: A. price of iPods falls
36
Q2
Price of music down-loads
Quantity of music downloads
D1D2
P1
Q1
Music downloads and iPods are complements.
A fall in price of iPods shifts the demand curve for music downloads to the right.
Music downloads and iPods are complements.
A fall in price of iPods shifts the demand curve for music downloads to the right.
A C T I V E L E A R N I N G 1: B. price of music downloads falls
37
The D curve does not shift.
Move down along curve to a point with lower P, higher Q.
The D curve does not shift.
Move down along curve to a point with lower P, higher Q.
Price of music down-loads
Quantity of music downloads
D1
P1
Q1 Q2
P2
A C T I V E L E A R N I N G 1: C. price of CDs falls
38
P1
Q1
CDs and music downloads are substitutes.
A fall in price of CDs shifts demand for music downloads to the left.
CDs and music downloads are substitutes.
A fall in price of CDs shifts demand for music downloads to the left.
Price of music down-loads
Quantity of music downloads
D1D2
Q2
39CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
Supply
Supply comes from the behavior of sellers.
The quantity supplied of any good is the amount that sellers are willing and able to sell.
Law of supply: the claim that the quantity supplied of a good rises when the price of the good rises, other things equal
40CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
The Supply Schedule
Supply schedule: A table that shows the relationship between the price of a good and the quantity supplied.
Example: Starbucks’ supply of lattes.
Notice that Starbucks’ supply schedule obeys the Law of Supply.
Price of
lattes
Quantity of lattes supplied
$0.00 0
1.00 3
2.00 6
3.00 9
4.00 12
5.00 15
6.00 18
41CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
$0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
0 5 10 15
Starbucks’ Supply Schedule & Curve
Price of
lattes
Quantity of lattes supplied
$0.00 0
1.00 3
2.00 6
3.00 9
4.00 12
5.00 15
6.00 18
P
Q
Market Supply versus Individual Supply
The quantity supplied in the market is the sum of the quantities supplied by all sellers at each price.
Suppose Starbucks and Jitters are the only two sellers in this market. (Qs = quantity supplied)
18
15
12
9
6
3
0
Starbucks
12
10
8
6
4
2
0
Jitters
+
+
+
+
=
=
=
=
30
25
20
15
+ = 10
+ = 5
+ = 0
Market Qs
$0.00
6.00
5.00
4.00
3.00
2.00
1.00
Price
43CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
$0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
0 5 10 15 20 25 30 35
P
Q
The Market Supply Curve
PQS
(Market)
$0.00 0
1.00 5
2.00 10
3.00 15
4.00 20
5.00 25
6.00 30
44CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
Supply Curve Shifters
The supply curve shows how price affects quantity supplied, other things being equal.
These “other things” are non-price determinants of supply.
Changes in them shift the S curve…
45CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
Supply Curve Shifters: input prices
Examples of input prices: wages, prices of raw materials.
A fall in input prices makes production more profitable at each output price, so firms supply a larger quantity at each price, and the S curve shifts to the right.
46CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
$0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
0 5 10 15 20 25 30 35
P
Q
Suppose the price of milk falls. At each price, the quantity of Lattes supplied will increase (by 5 in this example).
Supply Curve Shifters: input prices
47CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
Supply Curve Shifters: technology
Technology determines how much inputs are required to produce a unit of output.
A cost-saving technological improvement has same effect as a fall in input prices, shifts the S curve to the right.
48CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
Supply Curve Shifters: # of sellers
An increase in the number of sellers increases the quantity supplied at each price,
shifts the S curve to the right.
49CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
Supply Curve Shifters: expectations
Suppose a firm expects the price of the good it sells to rise in the future.
The firm may reduce supply now, to save some of its inventory to sell later at the higher price.
This would shift the S curve leftward.
50CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
Summary: Variables That Affect Supply
Variable A change in this variable…
Price …causes a movement along the S curve
Input prices …shifts the S curve
Technology …shifts the S curve
No. of sellers …shifts the S curve
Expectations …shifts the S curve
A C T I V E L E A R N I N G 2: Supply curve
51
Draw a supply curve for tax return preparation software.
What happens to it in each of the following scenarios? A. Retailers cut the price of
the software.
B. A technological advance allows the software to be produced at lower cost.
C. Professional tax return preparers raise the price of the services they provide.
A C T I V E L E A R N I N G 2: A. fall in price of tax return software
52
The S curve does not shift.
Move down along the curve to a lower P and lower Q.
The S curve does not shift.
Move down along the curve to a lower P and lower Q.
Price of tax return software
Quantity of tax return software
S1
P1
Q1Q2
P2
A C T I V E L E A R N I N G 2: B. fall in cost of producing the software
53
The S curve shifts to the right:
at each price, Q increases.
The S curve shifts to the right:
at each price, Q increases.
Price of tax return software
Quantity of tax return software
S1
P1
Q1
S2
Q2
A C T I V E L E A R N I N G 2: C. professional preparers raise their price
54
This shifts the demand curve for tax preparation software, not the supply curve.
This shifts the demand curve for tax preparation software, not the supply curve.
Price of tax return software
Quantity of tax return software
S1
55CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
$0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
0 5 10 15 20 25 30 35
P
Q
Supply and Demand Together
D S Equilibrium: P has reached the level where quantity supplied equals quantity demanded
56CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
D S
$0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
0 5 10 15 20 25 30 35
P
Q
Equilibrium price:
P QD QS
$0 24 0
1 21 5
2 18 10
3 15 15
4 12 20
5 9 25
6 6 30
The price that equates quantity supplied with quantity demanded
57CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
D S
$0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
0 5 10 15 20 25 30 35
P
Q
Equilibrium quantity:
P QD QS
$0 24 0
1 21 5
2 18 10
3 15 15
4 12 20
5 9 25
6 6 30
The quantity supplied and quantity demanded at the equilibrium price
58CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
$0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
0 5 10 15 20 25 30 35
P
Q
D S
Surplus:when quantity supplied is greater than quantity demanded
Surplus Example: If P = $5,
then QD = 9 lattes
and QS = 25 lattes
resulting in a surplus of 16 lattes
59CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
$0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
0 5 10 15 20 25 30 35
P
Q
D S
Surplus:when quantity supplied is greater than quantity demanded
Facing a surplus, sellers try to increase sales by cutting the price.
This causes QD to rise
Surplus
…which reduces the surplus.
and QS to fall…
60CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
$0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
0 5 10 15 20 25 30 35
P
Q
D S
Surplus:when quantity supplied is greater than quantity demanded
Facing a surplus, sellers try to increase sales by cutting the price.
Falling prices cause QD to rise and QS to fall.
Surplus
Prices continue to fall until market reaches equilibrium.
61CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
$0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
0 5 10 15 20 25 30 35
P
Q
D S
Shortage:when quantity demanded is greater than quantity supplied
Example: If P = $1,
then QD = 21 lattes
and QS = 5 lattes
resulting in a shortage of 16 lattes
Shortage
62CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
$0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
0 5 10 15 20 25 30 35
P
Q
D S
Shortage:when quantity demanded is greater than quantity supplied
Facing a shortage, sellers raise the price,
causing QD to fall
…which reduces the shortage.
and QS to rise,
Shortage
63CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
$0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
0 5 10 15 20 25 30 35
P
Q
D S
Shortage:when quantity demanded is greater than quantity supplied
Facing a shortage, sellers raise the price,
causing QD to falland QS to rise.
Shortage
Prices continue to rise until market reaches equilibrium.
64CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
Three Steps to Analyzing Changes in Eq’m
1. Decide whether event shifts S curve, D curve, or both.
2. Decide in which direction curve shifts.
3. Use supply-demand diagram to see how the shift changes eq’m P and Q.
1. Decide whether event shifts S curve, D curve, or both.
2. Decide in which direction curve shifts.
3. Use supply-demand diagram to see how the shift changes eq’m P and Q.
To determine the effects of any event,
65CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
EXAMPLE: The Market for Hybrid Cars
P
Q
D1
S1
P1
Q1
price of hybrid cars
quantity of hybrid cars
66CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
STEP 1:
D curve shifts because price of gas affects demand for hybrids.
S curve does not shift, because price of gas does not affect cost of producing hybrids.
STEP 2:
D shifts rightbecause high gas price makes hybrids more attractive relative to other cars.
EXAMPLE 1: A Change in Demand
EVENT TO BE ANALYZED: Increase in price of gas.
P
Q
D1
S1
P1
Q1
D2
P2
Q2
STEP 3:
The shift causes an increase in price and quantity of hybrid cars.
67CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
EXAMPLE 1: A Change in Demand
P
Q
D1
S1
P1
Q1
D2
P2
Q2
Notice: When P rises, producers supply a larger quantity of hybrids, even though the S curve has not shifted.
Always be careful to distinguish b/w a shift in a curve and a movement along the curve.
Terms for Shift vs. Movement Along Curve
Change in supply: a shift in the S curve• occurs when a non-price determinant of supply
changes (like technology or costs)
Change in the quantity supplied: a movement along a fixed S curve • occurs when P changes
Change in demand: a shift in the D curve• occurs when a non-price determinant of
demand changes (like income or # of buyers)
Change in the quantity demanded: a movement along a fixed D curve• occurs when P changes
69CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
STEP 1:
S curve shifts because event affects cost of production.
D curve does not shift, because production technology is not one of the factors that affect demand.
STEP 2:
S shifts rightbecause event reduces cost, makes production more profitable at any given price.
EXAMPLE 2: A Change in Supply
P
Q
D1
S1
P1
Q1
S2
P2
Q2
EVENT: New technology reduces cost of producing hybrid cars.
STEP 3:
The shift causes price to fall and quantity to rise.
70CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
EXAMPLE 3: A Change in Both Supply and Demand
P
Q
D1
S1
P1
Q1
S2
D2
P2
Q2
EVENTS: price of gas rises AND new technology reduces production costs
STEP 1: Both curves shift.
STEP 2: Both shift to the right.
STEP 3: Q rises, but effect on P is ambiguous: If demand increases more than supply, P rises.
71CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
EXAMPLE 3: A Change in Both Supply and Demand
STEP 3, cont.
P
Q
D1
S1
P1
Q1
S2
D2
P2
Q2
EVENTS: price of gas rises AND new technology reduces production costs
But if supply increases more than demand, P falls.
A C T I V E L E A R N I N G 3: Changes in supply and demand
72
Use the three-step method to analyze the effects of each event on the equilibrium price and quantity of music downloads.
Event A: A fall in the price of compact discs
Event B: Sellers of music downloads negotiate a reduction in the royalties they must pay for each song they sell.
Event C: Events A and B both occur.
2. D shifts left
A C T I V E L E A R N I N G 3: A. fall in price of CDs
73
P
QD1
S1
P1
Q1
D2
The market for music downloads
P2
Q2
1. D curve shifts
3. P and Q both fall.
STEPS
A C T I V E L E A R N I N G 3: B. fall in cost of royalties
74
P
QD1
S1
P1
Q1
S2
The market for music downloads
Q2
P2
1. S curve shifts
2. S shifts right
3. P falls, Q rises.
STEPS
(royalties are part of sellers’ costs)
A C T I V E L E A R N I N G 3: C. fall in price of CDs AND fall in cost of royalties
75
STEPS
1. Both curves shift (see parts A & B).
2. D shifts left, S shifts right.
3. P unambiguously falls.
Effect on Q is ambiguous: The fall in demand reduces Q, the increase in supply increases Q.
STEPS
1. Both curves shift (see parts A & B).
2. D shifts left, S shifts right.
3. P unambiguously falls.
Effect on Q is ambiguous: The fall in demand reduces Q, the increase in supply increases Q.
76CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
CONCLUSION: How Prices Allocate Resources
One of the Ten Principles from Chapter 1: Markets are usually a good way to organize economic activity.
In market economies, prices adjust to balance supply and demand. These equilibrium prices are the signals that guide economic decisions and thereby allocate scarce resources.
77CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
CHAPTER SUMMARY A competitive market has many buyers and
sellers, each of whom has little or no influence on the market price.
Economists use the supply and demand model to analyze competitive markets.
The downward-sloping demand curve reflects the Law of Demand, which states that the quantity buyers demand of a good depends negatively on the good’s price.
78CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
CHAPTER SUMMARY Besides price, demand depends on buyers’
incomes, tastes, expectations, the prices of substitutes and complements, and # of buyers. If one of these factors changes, the D curve shifts.
The upward-sloping supply curve reflects the Law of Supply, which states that the quantity sellers supply depends positively on the good’s price.
Other determinants of supply include input prices, technology, expectations, and the # of sellers. Changes in these factors shift the S curve.
79CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
CHAPTER SUMMARY The intersection of S and D curves determine
the market equilibrium. At the equilibrium price, quantity supplied equals quantity demanded.
If the market price is above equilibrium, a surplus results, which causes the price to fall. If the market price is below equilibrium, a shortage results, causing the price to rise.
80CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND
CHAPTER SUMMARY We can use the supply-demand diagram to
analyze the effects of any event on a market:First, determine whether the event shifts one or both curves. Second, determine the direction of the shifts. Third, compare the new equilibrium to the initial one.
In market economies, prices are the signals that guide economic decisions and allocate scarce resources.