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The Market Forces of Supply and Demand
Chapter 4
Copyright © 2001 by Harcourt, Inc.
All rights reserved. Requests for permission to make copies of any part of the
work should be mailed to:
Permissions Department, Harcourt College Publishers,6277 Sea Harbor Drive, Orlando, Florida 32887-6777.
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Market Type: A Competitive Market
A competitive market is a market. . .
with many buyers and sellers.
that is not controlled by any one person.
in which a narrow range of prices are established that buyers and sellers act upon.
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Competition: Perfect and Otherwise
Products are the same Numerous buyers and sellers so that each
has no influence over price Buyers and Sellers are price takers
Perfect Competition
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Competition: Perfect and Otherwise
Monopoly One seller, and seller controls price
Oligopoly Few sellers Not always aggressive competition
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Competition: Perfect and Otherwise
Monopolistic Competition Many sellers Slightly differentiated products Each seller may set price for its own
product
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Markets
A market is a group of buyers and sellers of a particular good or service.
The terms supply and demand refer to the behavior of people . . . as they interact with one another in markets.
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Markets Buyers determine demand.
Sellers determine supply.
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The Market Forces of Supply and Demand
Supply and demand are the two words that economists use most often.
Supply and demand are the forces that make market economies work.
Modern microeconomics is about supply, demand, and market equilibrium.
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Demand
is the amount of a good that buyers are
willing and able to purchase.
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Law of Demand
The law of demand states that there is an inverse relationship
between price and quantity demanded.
As prices rise, demand falls and as prices fall, demand rises
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Law of DemandThere are two reasons that explain
the Law of Demand
Income Effect As prices drop, consumers “real” income
(purchasing power) increases. They can buy more with each dollar.
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Law of Demand
Substitution EffectAs the price of a good increases consumers
will choose to purchase (substitute) another less expensive good
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Demand Schedule
The demand schedule is a table that shows the relationship
between the price of the good and the quantity demanded.
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Demand Schedule
Price Quantity$0.00 120.50 101.00 81.50 62.00 42.50 23.00 0
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Demand Curve
The demand curve is a graph relating price to quantity demanded.
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Demand Curve
$3.002.50
2.001.501.00
0.50
21 3 4 5 6 7 8 9 10
12
11
Price of Ice-Cream Cone
Quantity of Ice-Cream Cones
0
Price Quantity$0.00 120.50 101.00 81.50 62.00 42.50 23.00 0
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Ceteris Paribus
Ceteris paribus is a Latin phrase that means all variables other than the
ones being studied are assumed to be constant. Literally, ceteris paribus means “other things being equal.”
The demand curve slopes downward because, ceteris paribus, lower prices
imply a greater quantity demanded!
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Determinants of Demand
Market price Consumer income Prices of related goods Tastes Expectations Number of buyers
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Change in Quantity Demanded versus Change in Demand
Variables that Affect Quantity
Demanded
A Change in This Variable . . .
Price Represents a movementalong the demand curve
Income Shifts the demand curve
Prices of relatedgoods
Shifts the demand curve
Tastes Shifts the demand curve
Expectations Shifts the demand curve
Number ofbuyers
Shifts the demand curve
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Change in Quantity Demanded versus Change in Demand
Change in Quantity Demanded Movement along the demand curve. Caused by a change in the price of
the product.
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Changes in Quantity Demanded
0
D1
Price of Cigarettes per Pack
Number of Cigarettes Smoked per Day
A tax that raises the price of cigarettes
results in a movement along the
demand curve.
A
C
20
2.00
$4.00
12
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Change in Quantity Demanded versus Change in Demand
Change in Demand A shift in the demand curve, either to
the left or right. Caused by a change in a
determinant other than the price.
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Changes in Demand
0
D1
Price of Ice-Cream Cone
Quantity of Ice-Cream Cones
D3
D2
Increase in demand
Decrease in demand
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Consumer Income
As income increases the demand for a normal good will increase.
As income increases the demand for an inferior good will decrease.
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Consumer IncomeNormal Good
$3.002.50
2.001.501.00
0.50
21 3 4 5 6 7 8 9 10
12
11
Price of Ice-Cream Cone
Quantity of Ice-Cream Cones
0
Increasein demand
An increase
in income...
D1
D2
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Consumer IncomeInferior Good
$3.002.50
2.001.501.00
0.50
21 3 4 5 6 7 8 9 10
12
11
Price of Ice-Cream Cone
Quantity of Ice-Cream Cones
0
Decreasein demand
An increase
in income...
D1D2
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Prices of Related GoodsSubstitutes & Complements
Pairs of goods that are used in place of each other are called substitutes.Hot dogs and hamburgers
Pairs of goods that are used together are called complements.Gasoline and automobiles
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Market Demand
Market demand refers to the sum of all individual demands for a particular good or service.
Graphically, individual demand curves are summed horizontally to obtain the market demand curve.
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Supply
Quantity supplied is the amount of a good that sellers are willing and able
to sell.
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Law of Supply
The law of supply states that there is a direct (positive) relationship between
price and quantity supplied.As prices rises producers are more
willing and able to supply more.
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Supply Schedule
The supply schedule is a table that shows the relationship between the price of the good and the quantity
supplied.
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Supply Schedule
Price Quantity$0.00 00.50 01.00 11.50 22.00 32.50 43.00 5
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Supply Curve
The supply curve is the upward-sloping line relating price to quantity
supplied.
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Supply Curve
$3.002.502.00
1.501.00
0.50
21 3 4 5 6 7 8 9 10
12
11
Price of Ice-Cream Cone
Quantity of Ice-Cream Cones
0
Price Quantity$0.00 00.50 01.00 11.50 22.00 32.50 43.00 5
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Determinants of Supply
Market price Input prices Technology Expectations Number of producers
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Change in Quantity Supplied versus Change in Supply
Change in Quantity Supplied Movement along the supply curve. Caused by a change in the market price
of the product.
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Change in Quantity Supplied
1 5
Price of Ice-Cream Cone
Quantity of Ice-Cream Cones
0
S
1.00A
C$3.00
A rise in the price of ice cream cones
results in a movement along the supply curve.
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Change in Quantity Supplied versus Change in Supply
Change in Supply A shift in the supply curve, either to the
left or right. Caused by a change in a determinant
other than price.
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Change in Supply
Price of Ice-Cream Cone
Quantity of Ice-Cream Cones
0
S1 S2
S3
Increase in Supply
Decrease in Supply
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Change in Quantity Supplied versus Change in Supply
Variables that Affect Quantity Supplied
A Change in This Variable . . .
Price Represents a movement along the supply curve
Input prices Shifts the supply curve
Technology Shifts the supply curve
Expectations Shifts the supply curve
Number of sellers Shifts the supply curve
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Government Intervention
SubsidiesGovernment may provide tax breaks or
direct monetary support to a particular business or industry to increase or ensure continued production
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TaxesTaxes add to the cost of production and
decrease a business’s ability and willingness to produce
• Types of business taxes include income tax (corporate and personal), capital gains taxes, property taxes, sales taxes, and excise taxes.
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RegulationsRegulations add to the cost of production
and reduce businesses’ willingness and ability to produce.
• Government may require more safety features, pollution control devices, minimum wage.
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Market Supply
Market supply refers to the sum of all individual supplies for all sellers of a particular good or service.
Graphically, individual supply curves are summed horizontally to obtain the market supply curve.
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Supply and Demand Together
Equilibrium Price The price that balances supply and
demand. On a graph, it is the price at which the supply and demand curves intersect.
Equilibrium Quantity The quantity that balances supply and
demand. On a graph it is the quantity at which the supply and demand curves intersect.
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Supply and Demand Together
Price Quantity$0.00 00.50 01.00 11.50 42.00 72.50 103.00 13
Price Quantity$0.00 190.50 161.00 131.50 102.00 72.50 43.00 1
Demand Schedule
Supply Schedule
At $2.00, the quantity demanded is equal to the quantity supplied!
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Supply
Demand
Price of Ice-Cream Cone
Quantity of Ice-Cream Cones
Equilibrium of Supply and Demand
21 3 4 5 6 7 8 9 10 12110
$3.002.502.00
1.501.00
0.50
Equilibrium
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Price of Ice-Cream Cone
Quantity of Ice-Cream Cones
21 3 4 5 6 7 8 9 10
12110
$3.002.50
2.00
1.501.00
0.50
Supply
Demand
Surplus
Excess Supply
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Surplus
When the price is above the equilibrium price, the quantity supplied exceeds the quantity demanded. There is excess supply or a surplus. Suppliers will lower the price to increase sales, thereby moving toward equilibrium.
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Excess Demand
Quantity ofIce-Cream Cones
Price ofIce-Cream
Cone
$2.00
0 1 2 3 4 5 6 7 8 9 10 11 12 13
Supply
Demand
$1.50
Shortage
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Shortage
When the price is below the equilibrium price, the quantity demanded exceeds the quantity supplied. There is excess demand or a shortage. Suppliers will raise the price due to too many buyers chasing too few goods, thereby moving toward equilibrium.
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Three Steps To Analyzing Changes in Equilibrium
Decide whether the event shifts the supply or demand curve (or both).
Decide whether the curve(s) shift(s) to the left or to the right.
Examine how the shift affects equilibrium price and quantity.
How an Increase in Demand Affects the Equilibrium
Price ofIce-Cream
Cone
2.00
0 7 Quantity ofIce-Cream Cones
Supply
Initialequilibrium
D1
1. Hot weather increasesthe demand for ice cream...
D2
2. ...resultingin a higherprice...
$2.50
103. ...and a higherquantity sold.
New equilibrium
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Shifts in Curves versus Movements along Curves
A shift in the supply curve is called a change in supply.
A movement along a fixed supply curve is called a change in quantity supplied.
A shift in the demand curve is called a change in demand.
A movement along a fixed demand curve is called a change in quantity demanded.
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S2
How a Decrease in Supply Affects the Equilibrium
Price ofIce-Cream
Cone
2.00
0 1 2 3 4 7 8 9 11 12 Quantity ofIce-Cream Cones
13
Demand
Initial equilibrium
S1
10
1. An earthquake reducesthe supply of ice cream...
Newequilibrium
2. ...resultingin a higherprice...
$2.50
3. ...and a lowerquantity sold.
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What Happens to Price and Quantity When Supply or Demand Shifts?
No Change In Supply
An Increase In Supply
A Decrease In Supply
No Change In Demand
P same Q same
P down Q up
P up Q down
An Increase In Demand
P up Q up
P ambiguous Q up
P up Q ambiguous
A Decrease In Demand
P down Q down
P down Q ambiguous
P ambiguous Q down
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Summary
Economists use the model of supply and demand to analyze competitive markets.
The demand curve shows how the quantity of a good depends upon the price.
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Summary
According to the law of demand, as the price of a good rises, the quantity demanded falls.
In addition to price, other determinants of quantity demanded include income, tastes, expectations, and the prices of complements and substitutes.
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Summary
The supply curve shows how the quantity of a good supplied depends upon the price.
According to the law of supply, as the price of a good rises, the quantity supplied rises.
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Summary
In addition to price, other determinants of quantity supplied include input prices, technology, and expectations.
Market equilibrium is determined by the intersection of the supply and demand curves.
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Summary
Supply and demand together determine the prices of the economy’s goods and services.
In market economies, prices are the signals that guide the allocation of resources.
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Graphical Review
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How an Increase in Demand Affects the Equilibrium
Price ofIce-Cream
Cone
2.00
0 7 10 Quantity ofIce-Cream Cones
Supply
Initialequilibrium
D1
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How an Increase in Demand Affects the Equilibrium
Price ofIce-Cream
Cone
2.00
0 7 10 Quantity ofIce-Cream Cones
Supply
Initialequilibrium
D1
1. Hot weather increasesthe demand for ice cream...
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How an Increase in Demand Affects the Equilibrium
Price ofIce-Cream
Cone
2.00
0 7 10 Quantity ofIce-Cream Cones
Supply
Initialequilibrium
D1
1. Hot weather increasesthe demand for ice cream...
D2
New equilibrium$2.50
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How an Increase in Demand Affects the Equilibrium
Price ofIce-Cream
Cone
2.00
0 7 10 Quantity ofIce-Cream Cones
Supply
Initialequilibrium
D1
1. Hot weather increasesthe demand for ice cream...
D2
New equilibrium
2. ...resultingin a higherprice...
$2.50
How an Increase in Demand Affects the Equilibrium
Price ofIce-Cream
Cone
2.00
0 7 10 Quantity ofIce-Cream Cones
Supply
Initialequilibrium
D1
1. Hot weather increasesthe demand for ice cream...
D2
New equilibrium
2. ...resultingin a higherprice...
$2.50
3. ...and a higherquantity sold.
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How an Increase in Demand Affects the Equilibrium
Price ofIce-Cream
Cone
2.00
0 7 10 Quantity ofIce-Cream Cones
Supply
Initialequilibrium
D1
1. Hot weather increasesthe demand for ice cream...
D2
New equilibrium
2. ...resultingin a higherprice...
$2.50
3. ...and a higherquantity sold.
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How a Decrease in Supply Affects the Equilibrium
Price ofIce-Cream
Cone
2.00
0 1 2 3 4 5 6 7 8 9 11 12 Quantity ofIce-Cream Cones
13
Demand
Initial equilibrium
S1
10
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How a Decrease in Supply Affects the Equilibrium
Price ofIce-Cream
Cone
2.00
0 1 2 3 4 5 6 7 8 9 11 12 Quantity ofIce-Cream Cones
13
Demand
Initial equilibrium
S1
10
1. An earthquake reducesthe supply of ice cream...
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How a Decrease in Supply Affects the Equilibrium
Price ofIce-Cream
Cone
2.00
0 1 2 3 4 5 6 7 8 9 11 12 Quantity ofIce-Cream Cones
13
Demand
Initial equilibrium
S1
10
1. An earthquake reducesthe supply of ice cream...
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How a Decrease in Supply Affects the Equilibrium
Price ofIce-Cream
Cone
2.00
0 1 2 3 4 5 6 7 8 9 11 12 Quantity ofIce-Cream Cones
13
Demand
Initial equilibrium
S1
10
1. An earthquake reducesthe supply of ice cream...
Newequilibrium$2.50
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How a Decrease in Supply Affects the Equilibrium
Price ofIce-Cream
Cone
2.00
0 1 2 3 4 5 6 7 8 9 11 12 Quantity ofIce-Cream Cones
13
Demand
Initial equilibrium
S1
10
1. An earthquake reducesthe supply of ice cream...
Newequilibrium$2.50
2. ...resultingin a higherprice...
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How a Decrease in Supply Affects the Equilibrium
Price ofIce-Cream
Cone
2.00
0 1 2 3 4 7 8 9 11 12 Quantity ofIce-Cream Cones
13
Demand
Initial equilibrium
S1
10
1. An earthquake reducesthe supply of ice cream...
Newequilibrium$2.50
2. ...resultingin a higherprice...
3. ...and a lowerquantity sold.
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