Chapter 3 ©2010 Worth Publishers Supply and Demand Slides created by Dr. Amy Scott.

Chapter 3

©2010 Worth Publishers

Supply and Demand

Slides created by Dr. Amy Scott

WAKE UP AND DON’T SMELL THE COFFEE

Who decided to raise the prices of coffee beans?Nobody: prices went up because of events outside anyone’s control.

The main cause of rising bean prices was a significant decline in the supply of coffee beans from the world’s two leading coffee exporters: Brazil and Vietnam.

In this chapter, we lay out the pieces that make up the supply and demand model,, and show how this model can be used to understand how many markets behave.

Chapter Objectives1. Competitive Market2. Supply and demand model

A. Demand curveB. The difference between movements along a

curve and shifts of a curveC. Supply curveD. Equilibrium price and quantity as

determined by supply and demand curvesE. Shortage or surplus and how price moves

the market back to equilibriumF. New equilibrium after shifts of the curves

Competitive Market

A competitive market is: Has many buyers and sellers Offers same good or service No individual’s actions have a noticeable

effect on the price at which the good or service is sold.

In other words: no one party can influence price

Behavior of this type of market is well described by Supply and Demand

Supply and Demand Model

The supply and demand model is a model of how a competitive market works.

It has five key elements: Demand curve Supply curve Demand and supply curve shifts Market equilibrium Changes in the market equilibrium

Demand Curve A demand curve is the graphical

representation of the demand schedule;

it shows how much of a good or service consumers want to buy at any given price.

Law of Demand: A higher a price for a good, other things equal, leads people to demand smaller quantities of that good.

Demand Schedule

A demand schedule shows how much of a good or service consumers will want to buy at different prices.

7.1

7.5

8.1

8.9

10.0

11.5

14.2

Price of coffee beans (per

pound)

Quantity of coffee beans demanded

(billions of pounds)

1.75

1.50

1.25

1.00

0.75

0.50

$2.00

Demand Schedule for Coffee Beans

Demand CurveA demand curve is the graphical representation of the demand schedule; it shows how much of a good or service consumers want to buy at any given price.

70 9 11 1513 17

$2.00

1.75

1.50

1.25

1.00

0.75

0.50

Price of coffee bean (per gallon)

Quantity of coffee beans (billions of

pounds)

Demand curve, D

As price rises, the quantity demanded falls

Because of high taxes, gasoline and diesel fuel are more than twice as expensive in most European countries as in the United States.

According to the law of demand, Europeans should buy less gasoline than Americans, and they do: Europeans consume less than half as much fuel as Americans, mainly because they drive smaller cars with better mileage.

Pay More, Pump Less

An Increase in Demand

An increase in the population and other factors generate an increase in demand – a rise in the quantity demanded at any given price.

This is represented by the two demand schedules - one showing demand in 2002, before the rise in population, the other showing demand in 2009, after the rise in population.

7.17.58.18.9

10.011.514.2

8.59.09.7

10.712.013.817.0

in 2002 in 2009

$2.001.751.501.251.000.750.50


pound)

Quantity of coffee beans demanded

(billions of pounds)

Demand Schedules for Coffee Beans

A shift of the demand curve is a change in the quantity demanded at any given price, represented by the change of the original demand curve to a new position, denoted by a new demand curve.

Increase in population more coffee

drinkers

Price of coffee

beans (per gallon)

70 9 11 1513 17

$2.00

1.75

1.50

1.25

1.00

0.75

0.50 D1 D2

Demand curve in 2009

Demand curve in 2002


pounds)

An Increase in Demand

Movement Along the Demand Curve

7 8.1 9.70 10 1513 17

$2.00

1.75

1.50

1.25

1.00

0.75

0.50 D1 D2

A C

B

A shift of the demand curve…

… is not the same thing as a movement along the demand curve


gallon)


pounds)

A movement along the demand curve is a change in the quantity demanded of a good that is the result of a change in that good’s price.

Shifts of the Demand CurveA “decrease in demand”, means a leftward shift of the demand curve: at any given price, consumers demand a smaller quantity than before. (D1D3)

Price

Quantity

D3

D1

D2

Increase in demand

Decrease in demand

An “increase in demand” means a rightward shift of the demand curve: at any given price, consumers demand a larger quantity than before. (D1D2)

Demand versus Quantity Demanded

A shift of the demand curve is a change in the quantity demanded at any given price, represented by the change of the original demand curve to a new position, denoted by a new demand curve.A movement along the demand curve is a change in the quantity demanded of a good that is the result of a change in that good’s price.

What Causes a Demand Curve to Shift?

1. Changes in the Prices of Related GoodsA. Substitutes: Two goods are substitutes

if a fall in the price of one of the goods makes consumers less willing to buy the other good.

Ex., Coke vs. Pepsi

B. Complements: Two goods are complements if a fall in the price of one good makes people more willing to buy the other good.

Ex., Hot dogs and Hot Dog buns

What Causes a Demand Curve to Shift?

2. Changes in IncomeA. Normal Goods: When a rise in income

increases the demand for a good – that good is a normal good.

B. Inferior Goods: When a rise in income decreases the demand for a good, it is an inferior good.

3. Changes in Tastes4. Changes in Expectations5. Changes in number of consumers

Individual Demand Curve and the Market Demand CurveThe market demand curve is the horizontal sum of the individual demand curves of all consumers in that market.

DDarla DDino

0 0 10 203020 0

$2

1

$2

1

$2

1

30 40 50

DMarket

(a)

Darla’s Individual Demand Curve

(b)

Dino’s Individual Demand Curve

(c)

Market Demand CurvePrice of coffee

beans (per pound)

Price of coffee

beans (per pound)

Price of coffee

beans (per pound)

Quantity of coffee beans (pounds)



Beating the Traffic All cities have traffic problems and many local

authorities try to discourage driving to the city. In 2003, London imposed a ‘congestion charge’

of £8 (about $13) on all cars entering the city during business hours. If people pay the day after they have driven then the charge increases to £10 (about $16). If they don’t pay and get caught the fine is £120 (about $195).

The result of this new policy confirms the law of demand: three years after the charge was put in place, traffic in central London was about 10 percent lower than before the charge.

C. People buy more long-stem roses the week of Valentine’s Day, even though the prices are higher than at other times during the year.

1. This represents a shift of the demand curve.

2. This represents a movement along the demand curve.

Explain whether each of the following events represents (i) a shift of the demand curve or (ii) a movement along the demand curve

D. The sharp rise in the price of gasoline leads many commuters to join carpools in order to reduce their gasoline purchases.

1. This represents a shift of the demand curve.

2. This represents a movement along the demand curve.

Supply Curve A supply curve is the graphical

representation of the supply schedule;

it shows how much of a good or service producers are willing to sell at any given price.

Law of Supply: A higher price for a good, other things equal, the greater the quantities of that good is produced.

Supply Schedule

A supply schedule shows how much of a good or service would be supplied at different prices.

Supply Schedule for Coffee Beans

Price of coffee beans(per pound)

Quantity ofcoffee beans

supplied(billions of pounds)

$2.00 11.6

1.75 11.5

1.50 11.2

1.25 10.7

1.00 10.0

0.75 9.1

0.50 8.0

Supply Curve

Quantity of coffee beans (billions of pounds)

Price of coffee beans (per pound)

70 9 11 1513 17

$2.00

1.75

1.50

1.25

1.00

0.75

0.50

As price rises, the quantity supplied

rises.

A supply curve shows graphically how much of a good or service people are willing to sell at any given price.

Supply curve, S

An Increase in Supply

The entry of Vietnam into the coffee bean business generated an increase in supply—a rise in the quantity supplied at any given price.

This event is represented by the two supply schedules—one showing supply before Vietnam’s entry, the other showing supply after Vietnam came in.

Supply Schedule for Coffee Beans


Quantity of beans supplied (billions of pounds)

Before entry After entry

$2.00 11.6 13.9

1.75 11.5 13.8

1.50 11.2 13.4

1.25 10.7 12.8

1.00 10.0 12.0

0.75 9.1 10.9

0.50 8.0 9.6

An Increase in Supply

A shift of the supply curve is a change in the quantity supplied of a good at any given price.

Vietnam enters coffee bean business more coffee producers

70 9 11 13 15 17

$2.00

1.75

1.50

1.25

1.00

0.75

0.50

S1

S2


pound)


… is not the same thing as a shift of the supply curve

A movement along the supply curve…

Movement Along the Supply Curve Versus Shift of the Supply Curve

A movement along the supply curve is a change in the quantity supplied of a good that is the result of a change in that good’s price.

70 10 11.2 12 15 17

$2.00

1.75

1.50

1.25

1.00

0.75

0.50

S1S2

AC

B


pound)


… is not the same thing as a shift of the supply curve

A movement along the supply curve…

Any “increase in supply” means a rightward shift of the supply curve: at any given price, there is an increase in the quantity supplied. (S1 S2)

Shifts of the Supply Curve

S3

S1

S2

Price

Quantity

Decrease in supply

Increase in supply

Any “decrease in supply” means a leftward shift of the supply curve: at any given price, there is a decrease in the quantity supplied. (S1 S3)

1. Changes in input prices An input is a good that is used to produce

another good.2. Changes in the prices of related goods and

services3. Changes in technology4. Changes in expectations5. Changes in the number of producers

What Causes a Supply Curve to Shift?

Individual Supply Curve and the Market Supply Curve

The market supply curve is the horizontal sum of the individual supply curves of all firms in that market.

SFigueroa SBien Pho

1 2 31 22 31 4 500 0

$2

1

$2

1

$2

1

SMarket

(a)

Mr. Figueroa’s Individual Supply Curve

(b)

Mr. Bien Pho’s Individual Supply Curve

(c)

Market Supply CurvePrice of coffee

beans (per pound)

Price of coffee

beans (per pound)

Price of coffee

beans (per pound)




Only creatures small and pampered During the 1970s there was a popular

British television show entitled All Creatures Great and Small that chronicled the life of a country veterinarian.

Today, veterinarians make more money tending to small animals than to farm animals. Consequently there has been a large drop off in the number of farm veterinarians and an increase in the number of veterinarians tending to pets.

A. More homeowners put their houses up for sale during a real estate boom that causes prices to rise.

1. This represents a shift of the supply curve.

2. This represents a movement along the supply curve.

Explain whether each of the following events represents (i) a shift of the supply curve or (ii) a movement along the supply curve

B. Many strawberry farmers open temporary roadside stands during harvest season, even though prices are usually low at that time.



1. This represents a shift of the supply curve.2. This represents a movement along the supply

curve.


C. Immediately after the school year begins, fast-food chains must raise wages to attract workers.

D. Many construction workers temporarily move to areas that have suffered hurricane damage, lured by higher wages offered.



E. Since new technologies have made it possible to build larger ships (which are cheaper to run per passenger), Caribbean cruise lines have offered more berths, at lower prices, than before.




Supply, Demand and Equilibrium

Equilibrium in a competitive market is whenquantity demanded = quantity supplied

The price at which this takes place is the equilibrium price (a.k.a. market-clearing price):

Every buyer finds a seller and vice versa. The quantity of the good bought and sold at

that price is the equilibrium quantity.

Market equilibrium occurs at point E, where the supply curve and the demand curve intersect.



70 10 1513 17

$2.00

1.75

1.50

1.25

1.00

0.75

0.50

Supply

Demand

E EquilibriumEquilibrium price

Equilibrium quantity

Market Equilibrium

Bought and Sold

Sometimes the bought and sold price are not the same because there is a middleman

A middleman brings buyers and sellers together by buying from buyers, marking it up and selling to sellers.

PITFALLS

Surplus and Shortage Surplus of a good is when

quantity supplied > quantity demanded.

Surpluses occur when the price is above its equilibrium level.

Shortage of a good is when quantity demanded > quantity

suppliedShortages occur when the price is

below its equilibrium level.

There is a surplus of a good when the quantity supplied exceeds the quantity demanded. Surpluses occur when the price is above its equilibrium level.

70 10 1513 17

$2.00

1.75

1.50

1.25

1.00

0.75

0.50

Supply

Demand

8.1 11.2

E

Surplus

Quantity demanded

Quantity supplied



Surplus

70 10 1513 17

$2.00

1.75

1.50

1.25

1.00

0.75

0.50

Supply

Demand

9.1 11.5

E

Shortage

Quantity demanded

Quantity supplied


pound)


There is a shortage of a good when the quantity demanded exceeds the quantity supplied. Shortages occur when the price is below its equilibrium level.

Shortage

Compare the box office price for a recent Justin Timberlake concert in Miami, Florida, to the StubHub.com price for seats in the same location: $88.50 versus $155.

Why is there such a big difference in prices? For major events, buying tickets from the box office means waiting in very long lines. Ticket buyers who use Internet resellers have decided that the opportunity cost of their time is too high to spend waiting in line. For those major events with online box offices selling tickets at face value, tickets often sell out within minutes.

In this case, some people who want to go to the concert badly but have missed out on the opportunity to buy cheaper tickets from the online box office are willing to pay the higher Internet reseller price.

The Price of Admission:

In the following situation, the market is initially in equilibrium.

A) 2005 was a very good year for California wine-grape growers, who produced a bumper-sized crop. This causes:

1. a shortage of grapes and prices rise.

2. a shortage of grapes and prices fall.

3. a surplus of grapes and prices rise.

4. a surplus of grapes and prices fall.

1. a shortage of hotel rooms and prices rise.

2. a shortage of hotel rooms and prices fall.

3. a surplus of hotel rooms and prices rise.

4. a surplus of hotel rooms and prices fall.

B) After a hurricane, Florida hoteliers often find that people cancel their upcoming vacations, leaving them with empty hotel rooms. This causes:


C) After a heavy snowfall, many people want to buy secondhand snow blowers at the local tool shop. This causes:

1. a shortage of secondhand snow blowers and prices rise.

2. a shortage of secondhand snow blowers and prices fall.

3. a surplus of secondhand snow blowers and prices rise.

4. a surplus of secondhand snow blowers and prices fall.


Equilibrium and Shifts of the Demand Curve

Q2Q

1

P2

P1

D2

Supply

D1

E2

E1

Price of coffee beans

Quantity of coffee beans

Price rises

Quantity rises

An increase in demand…

… leads to a movement along the supply curve due to a higher equilibrium price and higher equilibrium quantity

Equilibrium and Shifts of the Supply Curve

P2

P1

Q1

Q2

Demand

E1

S1

S2

E2

Price of coffee beans

Quantity of coffee beans

Price rises

Quantity falls

A decrease in supply…

… leads to a movement along the demand curve due to a higher equilibrium price and lower equilibrium quantity

Technology Shifts of the Supply Curve

Price

Quantity

S1

Demand

E1

E2

An increase in supply …

P2

P1

Q1

Q2

… leads to a movement along the demand curve to a lower equilibrium price and higher equilibrium quantity.

Price falls

Quantity increases

S2

Technological innovation: In the early 1970s, engineers learned how to put microscopic electronic components onto a silicon chip; progress in the technique has allowed ever more components to be put on each chip.

Simultaneous Shifts of Supply and Demand

Two opposing forces determining the equilibrium quantity.

The increase in demand dominates the decrease in supply.

Quantity of coffeeQ2Q

1

P2

P1

S2

D2D

1

S1

E1

E2

(a) One possible outcome: Price Rises, Quantity Rises

Price of coffee

Small decrease in supply

Large increase in demand

New equilibrium depends on the magnitude of the shifts


Two opposing forces determining the equilibrium quantity.

Q1

Q2

P2

P1

S2

D2

D1

S1

E1

E2

(b) Another Possibility Outcome: Price Rises, Quantity FallsPrice of coffee

Quantity of coffee

Large decrease in supply

Small increase in demand

Simultaneous Shifts of Supply and DemandWe can make the following predictions about the outcome when the supply and demand curves shift simultaneously:


Supply Increases Supply Decreases

Demand Increases

Price: ambiguousQuantity: up

Price: upQuantity: ambiguous

Demand Decreases

Price: downQuantity: ambiguous

Price: ambiguousQuantity: down

Which Curve is it Anyway?

When the price of a good changes, in general this reflects a change in either supply or demand.

But which curve? A hint is to look at the quantity.

If the quantity changes in the same direction as price then this suggests the demand curve has shifted.

If quantity changes in the opposite direction as price, the likely cause is a shift in the supply curve.

PITFALLS

The ease of transmitting photos over the Internet and the relatively low cost of international travel beautiful young women from all over the world, eagerly trying to make it as models = influx of aspiring models from around the world

In addition the tastes of many of those who hire models have changed they prefer celebrities

What happened to the equilibrium price of a young (not a celebrity) fashion model? Use your supply and demand curves to determine the salaries of “America’s Next Best Models”…

Tribulations on the Runway

The “war on drugs” shifts the supply curve to the left.

However, we can see by comparing the original equilibrium E1 with the new equilibrium E2 that the actual reduction in the quantity of drugs supplied is much smaller than the shift of the supply curve.

The equilibrium price has risen from P1 to P2, and this induces suppliers to provide drugs despite the risks.

Another Example: Supply, Demand and Controlled Substances

Price

Quantity

S1

Demand

E1

E2P2

P1

Q1Q2

Price rises

Quantity falls

S2

There was a sharp rise in the price of tortillas, a staple food of Mexico’s poor, which had gone from 25 cents a pound to between 35 and 45 cents a pound in just a few months in early 2007.

Why were tortilla prices soaring? It was a classic example of what happens to

equilibrium prices when supply falls. Tortillas are made from corn; much of Mexico’s corn is imported from the United States, with the price of corn in both countries basically set in the U.S. corn market. U.S. corn prices were rising rapidly thanks to surging demand in a new market: the market for ethanol.

The Great Tortilla Crisis

A recent drought in Australia reduced the amount of grass on which Australian dairy cows could feed, thus limiting the amount of milk these cows produced for export.

At the same time, a new tax levied by the government of Argentina raised the price of the milk the country exported, thereby decreasing Argentine milk sales worldwide.

These two developments produced a supply shortage in the world market, which dairy farmers in Europe couldn’t fill because of strict production quotas set by the European Union.

Demand and Supply Shifts at Work in the Global Economy

In China, meanwhile, demand for milk and milk products increased, as rising income levels drove higher per-capita consumption.

All these occurrences resulted in a strong upward pressure on the price of milk everywhere in 2007.

Demand and Supply Shifts at Work in the Global Economy

1. gasoline2. cars

As the price of gasoline fell in the United States during the 1990s, more people bought large cars. What is the market in question in this scenario?

As the price of gasoline fell in the United States during the 1990s, more people bought large cars. Did supply or demand shift, and which way?

1. supply shifted left2. supply shifted right3. demand shifted left4. demand shifted right

As the price of gasoline fell in the United States during the 1990s, more people bought large cars. What is the effect on prices and quantity?

1. quantity and price fell2. quantity and price rose3. quantity fell and price

rose4. quantity rose and price

fell

As technological innovation has lowered the cost of recycling used paper, fresh paper made from recycled stock is used more frequently. What is the market in question in this scenario?

1. recycled paper2. fresh paper made from recycled paper

As technological innovation has lowered the cost of recycling used paper, fresh paper made from recycled stock is used more frequently. Does supply or demand shift, and which way?

1. supply shifts left2. supply shifts right3. demand shifts left4. demand shifts right

As technological innovation has lowered the cost of recycling used paper, fresh paper made from recycled stock is used more frequently. What is the effect on price and quantity?

1. quantity and price fell2. quantity and price rose3. quantity fell and price

rose4. quantity rose and price

fell

As a local cable company offers cheaper pay-per-view films, local movie theaters have more unfilled seats. What is the market in question in this scenario?

1. pay-per-view movies2. movies at a local

movie theater

As a local cable company offers cheaper pay-per-view films, local movie theaters have more unfilled seats. Does supply or demand shift, and which way?

1. supply shifts left2. supply shifts right3. demand shifts left4. demand shifts right

As a local cable company offers cheaper pay-per-view films, local movie theaters have more unfilled seats. What is the effect on prices and quantity?

1. quantity and price fall2. quantity and price rise3. quantity falls and price rises4. quantity rises and price falls

Periodically, a computer chip maker like Intel introduces a new chip that is faster than the previous one.

In response, demand for computers using the earlier chip decreases as customers put off purchases in anticipation of machines containing the new chip.

Simultaneously, computer makers increase their production of computers containing the earlier chip in order to clear out their stocks of those chips.

1. it shifts left2. it shift right

What happens to the supply curve for computers using the earlier chip?

1. it shifts left2. it shift right

What happens to the demand curve for computers using the earlier chip?

1. True2. False

The equilibrium quantity for computers using the earlier chip must fall.

1. True2. False

The equilibrium price for computers using the earlier chip must fall.

1. The supply and demand model illustrates how a competitive market works.

2. The demand schedule shows the quantity demanded at each price and is represented graphically by a demand curve. The law of demand says that demand curves slope downward.

3. A movement along the demand curve occurs when a price change leads to a change in the quantity demanded. When economists talk of increasing or decreasing demand, they mean shifts of the demand curve—a change in the quantity demanded at any given price.

1 of 4Summary

4. There are five main factors that shift the demand curve:1. A change in the prices of related goods or

services2. A change in income3. A change in tastes4. A change in expectations5. A change in the number of consumers

5. The market demand curve for a good or service is the horizontal sum of the individual demand curves of all consumers in the market.

6. The supply schedule shows the quantity supplied at each price and is represented graphically by a supply curve. Supply curves usually slope upward.

2 of 4Summary

7. A movement along the supply curve occurs when a price change leads to a change in the quantity supplied. When economists discuss increasing or decreasing supply, they mean shifts of the supply curve—a change in the quantity supplied at any given price.

8. There are five main factors that shift the supply curve:• A change in input prices• A change in the prices of related goods and services• A change in technology• A change in expectations• A change in the number of producers

9. The market supply curve for a good or service is the horizontal sum of the individual supply curves of all producers in the market.

3 of 4Summary

10. The supply and demand model is based on the principle that the price in a market moves to its equilibrium price, (market-clearing price), the price at which the quantity demanded = quantity supplied. This quantity is the equilibrium quantity. When the price is above its market-clearing level, there is a surplus that pushes the price down. When the price is below its market-clearing level, there is a shortage that pushes the price up.

11. An increase in demand increases both the equilibrium price and the equilibrium quantity; a decrease in demand has the opposite effect. An increase in supply reduces the equilibrium price and increases the equilibrium quantity; a decrease in supply has the opposite effect.

12. Shifts of the demand curve and the supply curve can happen simultaneously.

4 of 4Summary

Chapter 3 ©2010 Worth Publishers Supply and Demand Slides created by Dr. Amy Scott.

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Transcript of Chapter 3 ©2010 Worth Publishers Supply and Demand Slides created by Dr. Amy Scott.