Chapter 2Introducing Supply and DemandMcGraw-Hill/IrwinCopyright 2009 by The McGraw-Hill Companies, Inc. All Rights Reserved.

A Tale of a Desert

When water is free of charge:Miners consume lots of water. Government is the only supplier of water.

When price of water is high:Miners conserve and use less water.Private sellers find new ways to sell more water.

Learning ObjectivesWhat is demand?What is law of demand?What factors change demand?What is supply?What is law of supply?What factors change supply?

DemandDemand = How much consumers buy at various prices

Quantity Demanded vs. DemandQuantity demanded= The number of units consumers purchase at a specific price over a specific time period.Demand = The entire relationship between price and quantity demanded over a specific time period.

Demand for Apples $P.30.25.20.15.10.05.00

0 10 20 30 40 Quantity of Apples in thousandDDemand curve

Law of DemandConsumers buy less of a good as its price increases and more of a good as its price decreases.As price increases, quantity demanded falls and as price decreases, quantity demanded rises.

Demand Curve $P.30.25.20.15.10.05.00

0 10 20 30 40 Quantity of Apples in thousandDDemand Curve= A graph that shows demand relationship.Negative relationship between price and quantity demanded.Slope of demand curve is negative.Downward sloping demand curve.

Market DemandMarket demand = the sum total of individual quantities demanded at each price.

Change in Quantity Demanded vs. Change in Demand $P3025201510 5 0

0 10 20 30 40 50 Quantity of caps in thousandCeteris paribus:Change in price causes change in quantity demanded.Movement along the same demand curve.

Lose 80%D1

Change in Quantity Demanded vs. Change in Demand $P3025201510 5 0

0 10 20 30 40 50 Quantity of caps in thousandCeteris paribus:Change in something other than price causes change in demand.Shift of the entire demand curve.Increase in demand, demand curve shifts to the right.Decrease in demand, demand curve shifts to the left.Lose 80%Win world seriesD1D2

Behind Demand Curve: Substitutes $P

.73

0

0 10,000 25,000 Quantity demanded of PepsiSubstitutes compete with each other to satisfy similar needs.Increase in price of Coke with no change in price of Pepsi.Increase in price of a good causes increase in demand for its substitute.What will happen if price of Coke falls to $0.30 with no change in price of Pepsi?Coke =$.50Coke =$1.00D1D2

Behind Demand Curve: Complements $P

Quantity demanded of ketchupComplements used together to satisfy wants.Increase in price of hamburgers with no change in price of ketchup.Increase in price of a good causes decrease in demand for its complement.What will happen if price of burgers falls with no change in price of ketchup?High price of burgersLow price of burgersD2D1

Behind Demand Curve: Income $P

Quantity demanded of sports carNormal goods = Goods consumers buy more with higher income.When income increases, there is increase in demand for normal goods.Demand curve shifts to the rightHigher incomeLow incomeD1D2

Demand for Inferior Goods $P

Quantity demanded of pleatherInferior goods = Goods consumers buy less of with higher income.When income increases, there is decrease in demand for inferior goods.Demand curve shifts to the leftHigher incomeLow incomeD2D1

Behind Demand Curve: ExpectationsWhat would you do if you heard that you might get a much better deal in the near future for the product you are planning to buy now? Osborne effectExpectations about better deal (lower price, better quality) in the near future cause decrease in current demand. = Leftward shift in the demand curve

What would happen to demand for a product when its price is expected to increase in the near future?

Behind Demand Curve: Other ThingsTastes and FashionsDemand increases for products considered to be fashionable.Advertising Induces consumers to buy more, increasing the demand.

Do You Know?What is the Law of Demand?As price increases, quantity demanded falls and as price decreases, quantity demanded rises.

When do you move along a demand curve and when do you move to an entirely new demand curve?A change in price = movement along the curve.A change in a factor other than price = shift of the curve.

Do You Know?How does an increase in the price of a goods substitute affect the demand for the original good?= Increase in demand for the original good.

How does an increase in income affect the demand for an inferior good?= Decrease in demand for the inferior good.

SupplySupply = The quantity firms produce at various prices.

Quantity Supplied vs. SupplyQuantity supplied= The number of units producers want to produce at a specific price over a specific time period.

Supply = The entire relationship between price and quantity supplied over a specific time period.

Supply in Competitive MarketsCompetitive markets:Markets in which individual buyers and sellers cannot set prices.Firms primary motive is profit.The higher the price, the greater the profit from production.

Law of SupplyFirms produce less of a good as its price falls and more of a good as its price increases.As price increases, quantity supplied rises and as price decreases, quantity supplied falls.

Supply Curve $P

.50

.25

0

0 15,000 50,000 Quantity supplied of ApplesSupply Curve= A graph that shows supply relationship.Positive relationship between price and quantity supplied.Slope of supply curve is positive.Upward sloping supply curve .

S

Market SupplyMarket supply = the sum total of individual firms supply at each price.

Change in Quantity Supplied vs. Change in Supply $P

.50

.25

0

Quantity supplied of ApplesCeteris paribus:Change in price causes change in quantity supplied.Movement along the same supply curve.Change in something other than price causes change in supply.Shift of the entire supply curve.Excellent weatherS2Fair weatherS1

Behind Supply Curves: Costs $P

Quantity suppliedCeteris paribus:Increase in cost of production decreases profits.Decrease in supply.Supply curve shifts to the left.Low costS1High costS2

Behind Supply Curves: ExpectationsIf firms expect prices to increase in the near future, they withhold goods to get better prices.Higher expected prices, decrease the current supply.How would you change your supply if you expect lower price in near future?

Behind Supply Curves: Input Prices $P

Quantity suppliedInputs = resources firms use to make goods.With increase in input prices or wages, firms use less inputs or workers.Decrease in supply.Wage=$5.15S1Wage =$6.15S2

Behind Supply Curves: Innovations $P

Quantity supplied of ApplesInnovations and improved technology reduce cost of production.Increase in supply.AfterinnovationS2Before innovationS1

Behind Supply Curves: Joint ProductionTwo or more goods are jointly produced if the process that produces one necessarily produces others.

When price of bacon increases:Quantity supplied of bacon increases.Supply of ham and pork chops also increases.

Do You Know?What is the Law of Supply?As price increases, quantity supplied rises and as price decreases, quantity supplied falls.

What is the difference between a change in supply vs. a change in quantity supplied?A change in price = change in quantity supplied.A change in a factor other than price = change in supply.

Do You Know?How do costs affect supply?Increase in cost of production = decrease in supply.

How can innovation affect supply?Innovations and advanced technology = increase in supply.

SummaryIncrease in the price causes decrease in quantity demanded and increase in quantity supplied.Increase in demand caused by:Increase in price of substitutes.Fall in price of complements.Increase in income for normal goods.Decrease in income for inferior goods.Expectations of future price increase.

SummaryIncrease in supply caused by:Decrease in production costs.Decrease in input prices.Expectations of lower price in near future.Innovations.Increase in price of jointly produced good.Demand curve is downward sloping.Supply curve is upward sloping.Increase causes shift to the right, decrease causes shift to the left.

Coming Up How do demand and supply determine the price in the market?