MODERN PRINCIPLES OF ECONOMICS Chapter 3 Fourth Edition ... · Supply Shifters 5. Changes in...

MODERN PRINCIPLES OF ECONOMICSFourth EditionChapter 3Chapter 3Chapter 3Chapter 3

Supply and Demand

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Outline

• The Demand Curve for Oil

• Consumer Surplus

• What Shifts the Demand Curve?

• The Supply Curve for Oil

• Producer Surplus

• What Shifts the Supply Curve?

• Takeaway

3-2

Introduction

• Supply, demand, and the idea of equilibrium are the most important tools in economics.

• They explain how prices are determined.

• Changes in demand and supply can plunge an economy into recession or set off a boom.

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Definition

Demand Curve:

A function that shows the quantity

demanded at different prices.

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Quantity Demanded:

The quantity that buyers are willing

and able to buy at a particular price.

Demand

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Demand for Oil

Price Quantity

Demanded

$55 5

$20 25

$5 50

• This table shows demand for oil—the quantities

demanded at different prices.

• The data can be used to construct a demand curve.

Demand

QuantityDemanded

Demand Curve

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Price of oilper barrelPrice of oilper barrel

Quantity of oil (MBD)

Price Quantity

Demanded

$55 5

$20 25

$5 50

Reading a Demand Curve

A Demand Curve Can Be Read:

• Horizontally: At a given price, how much are people willing to buy?

• Vertically: What are people willing to pay for a given quantity?

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Reading a Demand Curve

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HORIZONTAL: At $20 per barrel, buyers are willing to buy

25m barrels of oil per day.

Reading a Demand Curve

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VERTICAL: The maximum price that buyers are willing to

pay to purchase 25m barrels per day is $20 per barrel.

Self-Check

What quantity is demanded at $15?

a. 10.

b. 50.

c. 75.

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Answer: b. 50

$15

Self-Check

At what price would 100 be demanded?

a. $5.

b. $1.

c. $10.

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Answer: a. $5

$5

Law of DemandLaw of DemandLaw of DemandLaw of Demand

• A demand curve is negatively sloped.

• Show the relation between price and qty demanded

• The lower the price, the greater the quantity demanded.

• Demand summarizes how consumers choose to use a good, given:

• their preferences

• the possibilities for substitution.

• NOTE: a demand curve assumes that all other factors (like income, etc) are constant

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Law of Demand

• Consumers will buy more oil at lower prices than at higher prices.

• When the price is high, consumers will use it only in its most valuable uses.

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Law of Demand

• As the price falls, consumers will also use oil in its less valued uses (heating and rubber duckies).

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Law of DemandLaw of DemandLaw of DemandLaw of Demand

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Definition

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Consumer Surplus:

The consumer’s gain from exchange; difference

between the maximum price a consumer is

willing to pay for a certain quantity and the

market price.

Total Consumer Surplus:

The area beneath the demand curve and above

the price.

Consumer Surplus

3-17

Total consumer surplus with a linear demand curve

Self-Check

What is total consumer surplus if market price is $10?

a. $500.

b. $700.

c. $1400.

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Answer: b. $70070

70 × ($30 – $10)2

Shifting the Demand CurveShifting the Demand CurveShifting the Demand CurveShifting the Demand Curve

•An increase in demand shifts the demand curve to the right.

•At each price, people are willing to buy more.

•At each quantity, people are willing to pay a higher price.

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Shifting the Demand Curve

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Quantity of Oil(MBD)

Price of oil/barrel

Old Demand

0 70 140

$50

$25New Demand

Willing to pay a higher price for same quantity.

Willing to buy more at the same price.

An Increase in Demand

Shifting the Demand Curve

•Decrease in demand—shifts the demand curve to the left.

•At each price, people are willing to buy less.

•At each quantity, people are willing to pay a lower price.

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Shifting the Demand Curve

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Old Demand

0 74

$25

$50

New Demand

Willing to buy less at the same price.

Willing to pay a lower price for the same quantity

62

Price of oil/barrel

Quantity of Oil(MBD)

A Decrease in Demand

Demand ShiftersDemand ShiftersDemand ShiftersDemand Shifters

Factors That Shift Demand:

1. Income

2. Population

3. Price of substitutes

4. Price of complements

5. Expectations

6. Tastes

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Demand Shifters

1. Income

• When people get richer, they buy more stuff.

• When an increase in income increases the demand for a good, it is a normal good.

• Most goods are normal goods.

• When an increase in income decreases the demand for a good, it is an inferior good.

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Inferior GoodsInferior GoodsInferior GoodsInferior Goods

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Self-Check

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If iPads are a normal good, when incomes increase, the demand curve for iPads will:

a. Shift to the right.

b. Shift to the left.

c. Not change.

Answer: a. Higher incomes increase demand for a normal good, shifting the demand curve to the right.

Demand ShiftersDemand ShiftersDemand ShiftersDemand Shifters

2. Population

• An increase in population will increase demand generally.

• A shift in subpopulations will change the demand for specific goods and services.

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Demand Shifters

3. Prices of Substitutes

• A substitute is a good that can be consumed instead of another good.

• A decrease in the price of a substitute will decrease demand for the other good.

• Examples:• Butter vs margarine

• Coke vs Pepsi

• Home ownership vs renting

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Self-Check

3-29

If orange juice and apple juice are substitutes, an increase in the price of orange juice will:

a. Increase demand for apple juice.

b. Decrease demand for apple juice.

c. Not affect demand for apple juice.

Answer: a. Increase demand for apple juice. A higher price for orange juice will cause some people to substitute the now lower-priced apple juice. This increases the demand for apple juice.

Demand ShiftersDemand ShiftersDemand ShiftersDemand Shifters

4. Prices of Complements

• Complements are things that go well together.

• A drop in the price of a complement increases demand for the complementary good.

• Examples:• Smart phones and cell phone service providers

• Cars and gasoline

• DVD players and DVD disks

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Demand ShiftersDemand ShiftersDemand ShiftersDemand Shifters

5. Expectations

• The expectation of a reduction in future supply increases the demand today.

6. Tastes

• Changes in tastes caused by fads, fashions, and advertising can all increase or decrease demand.

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Supply Curve Supply Curve Supply Curve Supply Curve

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Price of oil per barrel

Quantity of oil (MBD)

Price Quantity Supplied

$55 50

$20 30

$5 10

Reading a Supply CurveReading a Supply CurveReading a Supply CurveReading a Supply Curve

A Supply Curve Can Be Read:

• Horizontally: At a given price, how much are suppliers willing to sell?

• Vertically: To produce a given quantity, what price must sellers be paid?

3-33

DefinitionDefinitionDefinitionDefinition

Supply Curve:

A function that shows the quantity

supplied at different prices.

3-34

Quantity Supplied:

The quantity that sellers are willing

and able to sell at a particular price.

Law of SupplyLaw of SupplyLaw of SupplyLaw of Supply

• As the price of oil rises, it becomes profitable to extract from more costly sources.

• As the price rises, the quantity supplied increases. 3-35

Photos: 24Novembers/Shutterstock

SelfSelfSelfSelf----CheckCheckCheckCheck

At what price will producers be willing to supply 50 units?

a. $10.

b. $20.

c. $30.

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Answer: a. $10

Definition

3-37

Producer Surplus:

The producer’s gain from exchange, or the

difference between the market price and the

minimum price at which a producer would

be willing to sell a particular quantity.

Total Producer Surplus:

The area above the supply curve and below

the price.

Producer Surplus

3-38

Shifting the Supply Curve Shifting the Supply Curve Shifting the Supply Curve Shifting the Supply Curve

•Increase in Supply—shifts the supply curve to the right.

•At each price producers are willing to sell more.

•At each quantity, producers are willing to accept a lower price

3-39

Shifting the Supply Curve Shifting the Supply Curve Shifting the Supply Curve Shifting the Supply Curve

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Quantity of Oil(MBD)

Old supply

Increase in supply

0

40

$60

8060

New supply

Greater quantity supplied at the

same price Willing to accept a lower price for

the same quantity

18

Price of oil/barrel

Shifting the Supply Curve Shifting the Supply Curve Shifting the Supply Curve Shifting the Supply Curve

•Decrease in supply—shifts the supply curve to the left.

•At each price sellers will offer less.

•At each quantity, sellers demand a higher price.

3-41

Shifting the Supply Curve

3-42

Quantity of Oil(MBD)

Old supply

Decrease in supply

$50

20 60

New supply

Smaller quantity supplied at the same price

Higher price required for the same quantity

$28

Price of oil/barrel

Supply ShiftersSupply ShiftersSupply ShiftersSupply Shifters

Factors That Shift Supply:

1. Technological innovations and changes in the price of inputs

2. Taxes and subsidies

3. Expectations

4. Entry or exit of producers

5. Changes in opportunity costs

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Supply ShiftersSupply ShiftersSupply ShiftersSupply Shifters

1. Technological Innovations

• Improvements in technology can reduce costs, thus increasing supply.

• A reduction in input prices also reduces costs and thus has a similar effect.

• Examples: computers, TVs, cars, etc

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Supply ShiftersSupply ShiftersSupply ShiftersSupply Shifters

2. Taxes and Subsidies

• A tax on output has the same effect as an increase in costs.

• A subsidy is the reverse of a tax. 3-45

Supply Shifters

46

Supply ShiftersSupply ShiftersSupply ShiftersSupply Shifters

3. Expectations

• Suppliers who expect prices to increase will store goods for future sale and sell less today.

• The expectation of a future price increase therefore decreases current supply.

• Supply curve shifts to the left.

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Supply ShiftersSupply ShiftersSupply ShiftersSupply Shifters

4. Entry or Exit of Producers

• The entry of new producers increases supply, shifting the curve down and to the right.

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Supply ShiftersSupply ShiftersSupply ShiftersSupply Shifters

5. Changes in Opportunity Costs

• An increase in opportunity costs shifts the supply curve up and to the left.

• If the price of wheat increases, the opportunity cost of growing soybeans increases.

• Some farmers will shift away from producing soybeans and start producing wheat.

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Supply ShiftersSupply ShiftersSupply ShiftersSupply Shifters

5. Changes in Opportunity Costs

• The supply curve for soybeans will shift up and to the left.

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Self-Check

Suppose a new technology reduces the time it takes to assemble a car. How would this affect the supply of cars?

a. Shift supply to the right.

b. Shift supply to the left.

c. It would have no effect on supply.

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Answer: a. Producers would be able to supply more cars at the current price, shifting the supply curve to the right.

Are We Ever Going to Run Out of Oil?Are We Ever Going to Run Out of Oil?Are We Ever Going to Run Out of Oil?Are We Ever Going to Run Out of Oil?

•What does the supply curve concept tell us about this?

•http://youtu.be/AcWkN4ngR2Y

•Example: copper vs fiber optics

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Takeaway

• A demand curve shows how customers respond to higher prices by buying less, and to lower prices by buying more.

• A supply curve shows how producers respond to higher prices by producing more, and to lower prices by producing less.

• The difference between market price and the maximum a consumer is willing to pay is the consumer’s gain from exchange, or consumersurplus.

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Takeaway

• The difference between market price and the minimum price that a producer is willing to accept is the producer’s gain from exchange, or producer surplus.

• An increase in demand means that buyers want a greater quantity at the same price or, equivalently, they are willing to pay a higher price for the same quantity.

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Takeaway

• An increase in supply means that sellers are willing to sell a greater quantity at the same price or, equivalently, they are willing to sell a given quantity at a lower price.

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