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MODERN PRINCIPLES OF ECONOMICSThird Edition

Supply and Demand

Chapter 3

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?

2

Definition

Demand Curve:

A function that shows the quantity

demanded at different prices.

3

Quantity Demanded:

The quantity that buyers are willing

and able to buy at a particular price.

4

Demand

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

Quantity

Demanded

5

Demand Curve

Price of oil

per barrelPrice of oil

per 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?

6

7

Reading a Demand Curve

HORIZONTAL: At $20 per barrel, buyers are willing to buy 25m barrels of oil per day.

8

Reading a Demand Curve

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.

9

Answer: b. 50

$15

Self-Check

At what price would 100 be demanded?

a. $5.

b. $1.

c. $10.

10

Answer: a. $5

$5

Law of Demand

A demand curve is negatively sloped.

The lower the price, the greater the quantity

demanded.

Demand summarizes how consumers choose to

use a good, given their preferences and the

possibilities for substitution.

11

Law of Demand

For example, when the price of oil is high,

consumers will use it only in its most valuable

uses (e.g., gasoline and jet fuel).

As the price falls, consumers will also use oil in

its less valued uses (heating and rubber

duckies).

Consumers will buy more oil at lower prices than

at higher prices.

12

Definition

13

Consumer Surplus:

The consumer’s gain from exchange,

or the difference between the

maximum price a consumer is willing

to pay for a certain quantity and the

market price.

Definition

14

Total Consumer Surplus:

The area beneath the demand curve and above the price.

Consumer Surplus:

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

Consumer Surplus

15Total consumer surplus with a linear demand curve

Self-Check

16

What is total consumer surplus if market

price is $10?

a. $500.

b. $700.

c. $1400.

Answer: b. $700 70

70 x ($30-$10)

2

Shifting the Demand Curve

An increase in demand shifts the demand

curve to the right.

• At the same price, people are willing to buy

more.

• At the same quantity, people are willing to pay

a higher price.

17

Shifting the Demand Curve

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.

18

An Increase in Demand

Shifting the Demand Curve

Decrease in demand – shifts the demand

curve to the left.

• At the same price, people are willing to buy

less.

• At the same quantity, people are willing to pay

a lower price.

19

Shifting the Demand Curve

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

20

Price of

oil/barrel

Quantity of Oil

(MBD)

A Decrease in Demand

Demand Shifters

Factors That Shift Demand:

1. Income

2. Population

3. Price of substitutes

4. Price of complements

5. Expectations

6. Tastes

21

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.

22

Self-Check

23

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 Shifters

2. Population

An increase in population will increase

demand generally.

A shift in subpopulations will change the

demand for specific goods and services.

24

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.

25

Self-Check

26

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.

Self-Check

27

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.

If orange juice and apple juice are substitutes,

an increase in the price of orange juice will:

Demand 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.

28

Demand 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.

29

30

Supply Curve

Price of oil per barrel

Quantity of oil (MBD)

Price Quantity

Supplied

$55 50

$20 30

$5 10

Reading 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?

31

Definition

32

Supply Curve:

A function that shows the quantity

supplied at different prices.

Quantity Supplied:

The quantity that sellers are willing

and able to sell at a particular price.

Law 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. 33

Top photo: Dan Lamont/Corbis Bottom: Bettmann/Corbis

Self-Check

At what price will producers be willing to

supply 50 units?

a. $10.

b. $20.

c. $30.

34

Answer: a - $10

Definition

35

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.

Definition

36

Total Producer Surplus:

The area above the supply curve

and below the price.

Producer Surplus

37

Shifting the Supply Curve

Increase in Supply - shifts the supply

curve to the right.

• At the same price producers are willing to

sell more.

• At the same quantity, producers are willing

to accept a lower price

38

Shifting the Supply Curve

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

39

Price of

oil/barrel

Shifting the Supply Curve

Decrease in supply – shifts the supply

curve to the left.

• At the same price sellers will offer less.

• At the same quantity, sellers demand a

higher price.

40

Shifting the Supply Curve

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

41

Price of

oil/barrel

Supply 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

42

Supply 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.

43

Supply 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. 44

Supply 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.

45

Supply Shifters

4. Entry or Exit of Producers

The entry of new producers increases supply,

shifting the curve down and to the right.

46

Supply 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.

47

Supply Shifters

5. Changes in Opportunity Costs

The supply curve for soybeans will shift up

and to the left. 48

Self-Check

49

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.

Self-Check

50

Suppose a new technology reduces the time it

takes to assemble a car. How would this affect

the supply of cars?

Answer: a – producers would be able to

supply more cars at the current price, shifting

the supply curve to the right.

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 consumer surplus.

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Takeaway

The difference between market price and

the minimum price which 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.

52

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.

53

Sources

54

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