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Ch. 3: Supply and Demand: Ch. 3: Supply and Demand:

TheoryTheory

James R. Russell, Ph.D., Professor of Economics & Management, Oral Roberts James R. Russell, Ph.D., Professor of Economics & Management, Oral Roberts UniversityUniversity©2005 Thomson Business & Professional Publishing, A Division of Thomson ©2005 Thomson Business & Professional Publishing, A Division of Thomson LearningLearning

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DemandDemand

DemandDemand: (1) the willingness and ability : (1) the willingness and ability of buyers to purchase different of buyers to purchase different quantities of a good (2) at different quantities of a good (2) at different prices (3) during a specific period of prices (3) during a specific period of time.time.

Law of DemandLaw of Demand: as the price of a good : as the price of a good rises, quantity demanded of that good rises, quantity demanded of that good falls, as the price of a good falls, falls, as the price of a good falls, quantity demanded of that good rises, quantity demanded of that good rises, ceteris paribus.ceteris paribus.

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Four Ways to Four Ways to Represent The Law Of Represent The Law Of DemandDemand

In Words: “As In Words: “As price rises, price rises, quantity quantity demanded falls”demanded falls”

In Symbols: In Symbols: PPQQdd In a Demand In a Demand

ScheduleSchedule As a Demand As a Demand

CurveCurve

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Exhibit 1: Demand Schedule and Demand Curve

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PricesPrices

Absolute PriceAbsolute Price: the price of a : the price of a good in money terms.good in money terms.

Relative PriceRelative Price: the price of a : the price of a good in terms of another good. good in terms of another good.

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Why Quantity Demanded Why Quantity Demanded Goes Down As Price Goes Goes Down As Price Goes UpUp1.1. People substitute lower-priced goods People substitute lower-priced goods

for higher-priced goods.for higher-priced goods.

2.2. The Law of Diminishing Marginal The Law of Diminishing Marginal UtilityUtility: for a given time period, the : for a given time period, the marginal (additional) utility or marginal (additional) utility or satisfaction gained by consuming satisfaction gained by consuming equal successive units of a good will equal successive units of a good will decline as the amount consumed decline as the amount consumed increases.increases.

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Exhibit 2: Deriving a Market Demand Schedule and a Market Demand Curve

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Change in Quantity Change in Quantity Demanded versus a Change Demanded versus a Change in Demandin Demand

Change in Quantity Change in Quantity DemandedDemanded: a movement from : a movement from one point to another point on the one point to another point on the same demand curve caused by a same demand curve caused by a change in the price of the good.change in the price of the good.

Change in DemandChange in Demand: a shift in : a shift in the demand curvethe demand curve– Increase in demand: a shift to the Increase in demand: a shift to the

rightright– Decrease in demand: as shift to the Decrease in demand: as shift to the

leftleft

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Exhibit 3: Shifts in the Demand Curve

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Causes of Change in Causes of Change in the Demand Curvethe Demand Curve

IncomeIncome PreferencesPreferences Prices of Related GoodsPrices of Related Goods Number of BuyersNumber of Buyers Expectations of Future Expectations of Future

PricePrice

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Income Induced Changes Income Induced Changes in Demandin Demand

NormalNormal GoodGood: a good the : a good the demand for which rises (falls) as demand for which rises (falls) as income rises (falls).income rises (falls).

InferiorInferior GoodGood: a good the : a good the demand for which rises (falls) as demand for which rises (falls) as income falls (rises).income falls (rises).

Neutral GoodNeutral Good: a good the : a good the demand for which does not demand for which does not change as income rises or falls.change as income rises or falls.

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Preferences and Preferences and Related GoodsRelated Goods PreferencesPreferences:: affect the amount of a good affect the amount of a good

they are willing to buy at a particular price they are willing to buy at a particular price (Ex: favorite food, favorite author)(Ex: favorite food, favorite author)

SubstitutesSubstitutes:: the demand for product X the demand for product X increases as the price for substitute Y increases as the price for substitute Y increases, and the demand for product X increases, and the demand for product X falls as the price for Y falls, (Ex:Coke and falls as the price for Y falls, (Ex:Coke and Pepsi).Pepsi).

ComplementsComplements:: the price of product A falls the price of product A falls as the demand for product B rises, and the as the demand for product B rises, and the price of product A rises as the demand for price of product A rises as the demand for product B falls, (Ex: Ketchup and Hot Dog product B falls, (Ex: Ketchup and Hot Dog Buns).Buns).

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Exhibit 4: Substitutes and Complements

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Number of Buyers and Number of Buyers and Expectation of Future Expectation of Future PricePrice Number of BuyersNumber of Buyers: More : More

Buyers, More Demand; Fewer Buyers, More Demand; Fewer Buyers, Less Demand.Buyers, Less Demand.

Price ExpectationsPrice Expectations::– Expect higher price tomorrow, buy Expect higher price tomorrow, buy

more today, increase in demand.more today, increase in demand.– Expect lower price tomorrow, buy Expect lower price tomorrow, buy

less today, decrease in demand.less today, decrease in demand.

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Exhibit 5: A Change in Demand versus a Change in Quantity Demanded

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Self-TestSelf-Test

As Sandi’s income rises, her demand for As Sandi’s income rises, her demand for popcorn rises. As Mark’s income falls, his popcorn rises. As Mark’s income falls, his demand for prepaid telephone cards demand for prepaid telephone cards rises. What kinds of goods are popcorn rises. What kinds of goods are popcorn and telephone cards for the people who and telephone cards for the people who demand each?demand each?

Why are demand curves downward Why are demand curves downward sloping?sloping?

Give an example that illustrates how to Give an example that illustrates how to derive a market demand curve.derive a market demand curve.

What factors can change demand? What What factors can change demand? What factors can change quantity demanded?factors can change quantity demanded?

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SupplySupply

SupplySupply: The (1) willingness and ability : The (1) willingness and ability of sellers to produce and offer to sell of sellers to produce and offer to sell different quantities of a good (2) at different quantities of a good (2) at different prices (3) during a specific different prices (3) during a specific period of time.period of time.

Law of SupplyLaw of Supply: As the price of a good : As the price of a good rises, the quantity supplied of the good rises, the quantity supplied of the good rises; and as the price of a good falls, rises; and as the price of a good falls, the quantity supplied of the good falls.the quantity supplied of the good falls.

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Exhibit 6: A Supply CurveExhibit 6: A Supply Curve

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Exhibit 7: Supply Curves When There is No Time to Produce More or No More Can Be Produced

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Why Most Supply Why Most Supply Curves Slope Curves Slope Upwards?Upwards?

Most supply curves Most supply curves slope upward slope upward because costs rise because costs rise when more of a when more of a good is produced.good is produced.

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Market Supply CurveMarket Supply Curve

Market Supply Market Supply CurveCurve: represents : represents the price-quantity the price-quantity combinations for all combinations for all sellers of a sellers of a particular good.particular good.

Individual supply Individual supply CurveCurve: represents : represents the price-quantity the price-quantity combinations for a combinations for a single sellersingle seller

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Exhibit 8: Deriving a Market Supply Schedule and a Market Supply Curve

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Factors Which Can Factors Which Can Shift the Supply CurveShift the Supply Curve

Prices of Relevant ResourcesPrices of Relevant Resources TechnologyTechnology Number of SellersNumber of Sellers Expectations of Future PriceExpectations of Future Price Taxes and SubsidiesTaxes and Subsidies Government RestrictionsGovernment Restrictions

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Changes in Quantity Changes in Quantity Supplied versus Changes Supplied versus Changes in Supplyin Supply

Changes in Quantity SuppliedChanges in Quantity Supplied: a : a movement along the supply curve.movement along the supply curve.

Changes in SupplyChanges in Supply: a shift in the : a shift in the supply curve.supply curve.– Increase in supply: a shift to the right.Increase in supply: a shift to the right.– Decrease in supply: a shift to the left.Decrease in supply: a shift to the left.

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Exhibit 10: A Change in Supply versus a Change in Quantity Supplied

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Self-TestSelf-Test

What would the supply curve of houses in What would the supply curve of houses in your city look like in the next 10 hours? your city look like in the next 10 hours? In three months?In three months?

What happens to the supply curve if each What happens to the supply curve if each of the following occurs?of the following occurs?– There is a decrease in the number of sellers.There is a decrease in the number of sellers.– A per-unit tax is placed on the production of a A per-unit tax is placed on the production of a

good.good.– The price of a relevant resource falls.The price of a relevant resource falls.

““If the price of apples rises, the supply of If the price of apples rises, the supply of apples will rise.” True or false? Explain.apples will rise.” True or false? Explain.

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Exhibit 11: Supply and Demand at Work at an Auction

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Market LanguageMarket Language

If quantity supplied is greater than the If quantity supplied is greater than the quantity demanded, the good has a quantity demanded, the good has a surplussurplus or or excess supplyexcess supply..

If quantity demanded is greater than If quantity demanded is greater than quantity supplied, a quantity supplied, a shortageshortage or or excess excess demanddemand exists. exists.

The price at which quantity demanded The price at which quantity demanded equals quantity supplied is the equals quantity supplied is the equilibrium priceequilibrium price, or the , or the market-market-clearing priceclearing price..

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More Market LanguageMore Market Language

Equilibrium QuantityEquilibrium Quantity: the quantity that : the quantity that corresponds to the equilibrium price. corresponds to the equilibrium price.

Disequilibrium PriceDisequilibrium Price: any price at : any price at which quantity demanded is not equal to which quantity demanded is not equal to quantity supplied.quantity supplied.

DisequilibriumDisequilibrium: a market that is : a market that is exhibiting either a surplus or a shortage exhibiting either a surplus or a shortage is in disequilibrium.is in disequilibrium.

EquilibriumEquilibrium. A market in which quantity . A market in which quantity demanded equals quantity supplied is in demanded equals quantity supplied is in equilibrium.equilibrium.

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Exhibit 12: Moving to Equilibrium

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Exhibit 13: A Summary Exhibit of a Market (Supply and Demand)

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Exhibit 14: Moving to Equilibrium in Terms of Maximum and Minimum Prices

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Equilibrium In Terms of Equilibrium In Terms of Consumers’ and Producers’ Consumers’ and Producers’ SurplusSurplus

Consumers’ SurplusConsumers’ Surplus: the difference : the difference between the maximum price a buyer between the maximum price a buyer would be willing and able to pay for a would be willing and able to pay for a good or service and the price actually good or service and the price actually paid.paid.

Producers’ SurplusProducers’ Surplus: the difference : the difference between the price sellers receive for a between the price sellers receive for a good and the minimum or lowest price good and the minimum or lowest price they would have sold the good.they would have sold the good.

Total SurplusTotal Surplus = Consumers’ Surplus = Consumers’ Surplus + Producers’ Surplus+ Producers’ Surplus

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Exhibit 15: Consumers’ and Producers’ Surplus

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Exhibit 16: Equilibrium, Consumers’ Surplus, and Producers’ Surplus

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Exhibit 17: Equilibrium Price and Quantity Effects of Supply Curve Shifts and Demand Curve Shifts

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What Can Change What Can Change Equilibrium Price and Equilibrium Price and Quantity?Quantity?

Demand rises and supply is constant: Demand rises and supply is constant: Equilibrium price rises, Equilibrium quantity Equilibrium price rises, Equilibrium quantity rises.rises.

Demand falls, supply is constant: Equilibrium Demand falls, supply is constant: Equilibrium price falls, Equilibrium quantity falls.price falls, Equilibrium quantity falls.

Supply rises, demand is constant: Equilibrium Supply rises, demand is constant: Equilibrium price falls, Equilibrium quantity rises.price falls, Equilibrium quantity rises.

Supply falls, demand is constant: Equilibrium Supply falls, demand is constant: Equilibrium price rises, Equilibrium quantity falls.price rises, Equilibrium quantity falls.

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What Can Change What Can Change Equilibrium Price and Equilibrium Price and Quantity?Quantity? Demand rises and supply falls by an equal Demand rises and supply falls by an equal

amount: Equilibrium rises, Equilibrium amount: Equilibrium rises, Equilibrium quantity is constant.quantity is constant.

Demand falls and supply rises by an equal Demand falls and supply rises by an equal amount: Equilibrium price falls, Equilibrium amount: Equilibrium price falls, Equilibrium quantity is constant.quantity is constant.

Demand rises by a greater amount than Demand rises by a greater amount than supply falls: Equilibrium price and quantity supply falls: Equilibrium price and quantity rise.rise.

Demand rises by a lesser amount than supply Demand rises by a lesser amount than supply falls: Equilibrium price rises, Equilibrium falls: Equilibrium price rises, Equilibrium quantity falls.quantity falls.

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Self-TestSelf-Test

When a person goes to the grocery store to When a person goes to the grocery store to buy food, there is no auctioneer calling out buy food, there is no auctioneer calling out prices for bread, milk, and other items. prices for bread, milk, and other items. Therefore, supply and demand cannot be Therefore, supply and demand cannot be operative. Do you agree or disagree? operative. Do you agree or disagree? Explain.Explain.

The price of a given quality personal The price of a given quality personal computer is lower today than it was five computer is lower today than it was five years ago. Is this necessarily the result of a years ago. Is this necessarily the result of a lower demand for computers? Explain.lower demand for computers? Explain.

If the price paid is $40 and consumers’ If the price paid is $40 and consumers’ surplus is $6, then what is the maximum surplus is $6, then what is the maximum buying price? If the minimum selling price is buying price? If the minimum selling price is $30 and producers’ surplus is $4, then what $30 and producers’ surplus is $4, then what is the price received by the seller?is the price received by the seller?

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Self-TestSelf-Test

What is the effect on equilibrium price What is the effect on equilibrium price and quantity of the following:and quantity of the following:– A decrease in demand that is greater than A decrease in demand that is greater than

the increase in supplythe increase in supply– An increase in supplyAn increase in supply– A decrease in supply that is greater than the A decrease in supply that is greater than the

increase in demandincrease in demand– A decrease in demandA decrease in demand

At equilibrium quantity, what is the At equilibrium quantity, what is the relationship between “maximum buying relationship between “maximum buying price” and the “minimum selling price?”price” and the “minimum selling price?”

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Price Controls (Price Price Controls (Price Ceiling)Ceiling) Price CeilingPrice Ceiling: a government : a government

mandated maximum price above mandated maximum price above which legal trades cannot be made.which legal trades cannot be made.

Price Ceilings may cause:Price Ceilings may cause:1)1) ShortagesShortages

2)2) Fewer ExchangesFewer Exchanges

3)3) Non-price Rationing DevicesNon-price Rationing Devices

4)4) Buying and Selling at a Prohibited PriceBuying and Selling at a Prohibited Price

5)5) Tie in SalesTie in Sales

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Exhibit 18: A Price Ceiling

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Price Controls (Price Price Controls (Price Floor)Floor)

Price FloorPrice Floor: a government : a government mandated minimum price below mandated minimum price below which legal trades cannot be made.which legal trades cannot be made.

Price floors can cause: Price floors can cause: – SurplusesSurpluses– Fewer Exchanges.Fewer Exchanges.

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Exhibit 19: A Price Floor

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Self-TestSelf-Test

Do buyers prefer lower prices to higher Do buyers prefer lower prices to higher prices?prices?

When there are long-lasting shortages, When there are long-lasting shortages, there are long lines of people waiting to there are long lines of people waiting to buy goods. It follows that the shortages buy goods. It follows that the shortages cause the long lines.” Do you agree or cause the long lines.” Do you agree or disagree? Explain you answer.disagree? Explain you answer.

Who might argue for a Price Ceiling? A Who might argue for a Price Ceiling? A Price Floor? Price Floor?

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Coming Up (Ch. 4): Supply Coming Up (Ch. 4): Supply and Demand: Practiceand Demand: Practice