Chapter 5

Price: The Role of Supply and Demand

© 2001 South-Western College Publishing

2

Law of Demand

The quantity purchased of a good or service is inversely related to the price, all other things being equal

3

Quantity Demanded vs. Demand

Quantity Demanded:

The quantities of a good or service that people will purchase at a specific price over a given period of time.

Demand:

A schedule of the total quantities of a good or service that purchasers will buy at different prices at a given time

4

Demand

Individual demand:

– quantity of a good or service that an individual or firm stands ready to buy at various prices at a given time

Market demand:

– sum of the individual demands in the marketplace

5

Demand Schedule/Demand Curve

Demand Schedule:Demand Schedule:– table showing the various quantities of a

good or service that will be purchased at various prices

Demand Curve:Demand Curve:– curve that indicates the number of units

of a good or service that consumers will buy at various prices at a given time

6

Demand Curve for Internet Time

$1.55

1.50

1.45

1.40

1.35

1.30

1.25

1.20

1.15

1.10

1.05

0 1 2 3 4 5 6 7 8 9 10 11 12 13 Quantity (millions

of hours)

Pri

ce p

er

H

ou

r

D

7

Changes in Demand

Change in Quantity Demanded:– Movement along the demand curve that

occurs because the price of the product has changed

Change in Demand:– Change in the amounts of the product

that would be purchased at the same given prices; a shift in the entire demand curve

8Quantity (millions of hours)

Demand Curves for Internet Time

$1.55

1.50

1.45

1.40

1.35

1.30

1.25

1.20

1.15

1.10

1.05

0 1 2 3 4 5 6 7 8 9 10 11 12 13

Pri

ce p

er

H

ou

r

DD2

D1

9

Supply

Supply: The total quantities of a good or service that sellers stand ready to sell at different prices at a given time

Individual Supply: Quantities offered for sale at various prices at a given time by an individual seller

Market Supply: Sum of the individual supply schedules in the marketplace

10

Supply

Supply Schedule: Table showing the various quantities of a good or service that sellers will offer at various prices at a given time

Supply Curve: Line showing the number of units of a good or service that will be offered for sale at different prices at a given time

11

Law of Supply

The quantity offered by sellers of a good or service is directly related to price, all things being equal.

12

Changes in Supply

Change in the Quantity Supplied: Movement along the supply curve that occurs because the price of the product has changed

Change in Supply: A change in the amount of the product that would be offered for sale at the same given price; a shift of the entire supply curve

13Quantity (millions of hours)

Supply Curves for Internet Time

$1.55

1.50

1.45

1.40

1.35

1.30

1.25

1.20

1.15

1.10

1.05

0 1 2 3 4 5 6 7 8 9 10 11 12 13

Pri

ce p

er

H

ou

r

SS2 S1

14

Determinants of Supply

Changes in the cost of resources

Technology

Expectations of future prices

Prices of related products

15

Equilibrium Price

The price at which the quantity demanded equals the quantity supplied

16Quantity (millions of hours)

Demand, Supply, and Market Price for Internet Time

$1.55

1.50

1.45

1.40

1.35

1.30

1.25

1.20

1.15

1.10

1.05

0 1 2 3 4 5 6 7 8 9 10 11 12 13

Pri

ce p

er

H

ou

r

SupplyDemand

EE

17Quantity (millions of hours)

Surplus, Shortage, and Equilibriumfor Internet Time

$1.55

1.50

1.45

1.40

1.35

1.30

1.25

1.20

1.15

1.10

1.05

0 1 2 3 4 5 6 7 8 9 10 11 12 13

Pri

ce p

er

H

ou

r

SupplyDemand

E

Surplus

Shortage

18

Alternate Supply and Demand Positions

D

D1

SP

Q/t Q/t

P

D

SS1

Demand Increases(D becomes D1 )

Demand Decreases(D1 becomes D)

Supply Increases(S becomes S1 )

Supply Decreases(S1 becomes S)

19

Price Ceiling

Government mandated maximum price that can be charged for a good or a service

20

Effects of a Price Ceiling on Rental Housing

700

500

0 18,000 30,000 40,000

ShortageD

S

E

Mon

thly

Pri

ce

($)

Quantity (housing units)

21

Price Floor

Government mandated minimum price that can be charged for a good or a service

22

Effects of a Price Floor on Wheat

3.00

2.00

0 75,000 100,000 115,000

Surplus

D

SP

rice p

er

bu

sh

el ($

)

Quantity (bushels)

23

Price Elasticity of Demand

Measure of the sensitivity or responsiveness of quantity demanded to a change in price

– Formula method

– Total revenue method

24

D2

D2

Quantity/Time

Demand Curve Showing Different Elasticities

$13

12

11

10

9

8

7

6

5

4

3

2

1

0 1,600 2,000 2,400

Pri

ce

D

DD1

D1

25

Formula Method

price in change percentagedemanded quantity in change percentageelasticity Price

)/2P(PPP

)/2Q(QQQ

21

12

21

12

26

Unit Elastic Demand

Demand that exists when a percentage change in price causes an equal percentage change in quantity demanded

– has an elasticity coefficient equal to 1.0

27

Elastic Demand

Demand that exists when a percentage change in price causes a greater percentage change in quantity demanded

– has an elastic coefficient greater than 1.0

28

Inelastic Demand

Demand that exists when a percentage change in price causes a smaller percentage change in quantity demanded

– has an elasticity coefficient less than 1.0

29

Total Revenue Method

If price changes and total revenue is constant, unit elasticity of demand exists

If price changes and total revenue moves in the opposite direction, demand is elastic

If price changes and total revenue moves in the same direction, demand is inelastic

30

Characteristics Affecting Price Elasticity of Demand

Trend Toward Elastic Demand

Luxuries Large expenditures Durable goods Substitute goods Multiple uses

Trend Toward Inelastic Demand

Necessities Small expenditures Perishable goods Complementary goods Limited uses

31

D1

Three Demand Curves Showing Different Elasticities

P P P

Q/t Q/t Q/t

D2

D3

(a) (b) (c)

Perfectly Elastic

Perfectly Inelastic

Perfectly Unit

Elastic

32Quantity/Time

Demand Curve Showing Different Elasticities

$12

11

10

9

8

7

6

5

4

3

2

1

Pri

ce

Elas

tic

dem

and

0 10 20 30 40 50 60 70 80 90 100 110 120

Uni

t Ela

stic

Inel

astic

de

man

d

33

Other Types of Elasticity

Cross elasticity of demand

Income elasticity of demand

Price elasticity of supply

34

Cross Elasticity of Demand

Measure of the responsiveness of the quantity demanded of one product as a result of a change in the price of another product

Aof price in change percentageB of demandedquantity in change percentage

demand of elasticity Cross

35

Income Elasticity of Demand

Measure of the responsiveness of the quantity demanded to a change in income

income in change percentagequantity in change of percentage

demand of elasticity Income

36

Price Elasticity of Supply

Measure of the responsiveness of the quantity supplied to a change in price

price in change percentagesuppliedquantity in change percentage

supply of elasticity Price

37

Time and Elasticity of Supply - Intermediate

P1

P2

Q Q/t

D1

S

D

P

38

Time and Elasticity of Supply - Short Run

P2

P

Q Q2 Q/t

D1

S

D

P

39

Time and Elasticity of Supply - Long Run

P3

P

Q Q3 Q/t

D1

S

D

P

40

Effects of a Tax on Cigarettes

D

S

Price per Pack

($)

40 50

D

S

Quantity (millions of packs)

3.25

3.00

Quantity (millions of packs)

S + $1

3.7

5

3.0

0

48 50

S + $1

ee

R R

Price per Pack

($)