mcgraw-hill/irwin copyright 2006 by the mcgraw-hill companies, inc. all rights reserved. demand and...

McGraw-Hill/Irwin Copyright 2006 by The McGraw-Hill Companies, Inc. All rights reserved.

DEMAND DEMAND AND AND

SUPPLYSUPPLY

Chapter 4Chapter 4


4-2

Today’s lecture will:Today’s lecture will:• Introduce the law of demand and draw a

demand curve.

• Explain the importance of substitution in the laws of supply and demand.

• Distinguish between a change in demand (shift in the curve) and a change in quantity demanded (movement along the demand curve).

• Explain the law of supply and construct a supply curve.


4-3

Today’s lecture will:Today’s lecture will:

• Distinguish between a change in supply (shift in the curve) and a change in quantity supplied (movement along the supply curve).

• Explain how the laws of supply and demand interact to bring about equilibrium.

• Show the effect of shifts in demand and supply on equilibrium price and quantity.

• Explore the limitations of demand and supply analysis.


4-4

The Law of Demand The Law of Demand

• Law of demand – there is an inverse relationship between price and quantity demanded.

• Other things equal: Quantity demanded rises as price falls Quantity demanded falls as price rises

• Law of demand is based on the fact that people substitute for goods whose price increases.


4-5

The Demand CurveThe Demand Curve

• The demand curve is the graphic representation of the law of demand.

• The demand curve slopes downward and to the right.

• As price goes up, the quantity demanded goes down.

D

Pri

ce

(pe

r u

nit

)

0

Quantity demanded (per unit of time)

PA

QA

A

B

QB

PB


4-6

Other Things ConstantOther Things Constant

• Other things constant places a limitation on the application of the law of demand.

• All other factors, such as changing tastes, prices of other goods, income, and even the weather, are assumed to remain constant, whether they actually remain constant or not.


4-7

Quantity Demanded Quantity Demanded Versus DemandVersus Demand

• Quantity demanded refers to a specific amount that will be demanded per unit of time at a specific price.

• Quantity demanded refers to a specific point on the demand curve.

• A change in quantity demanded, caused only by a change in the price of the good itself, is shown by a movement along a demand curve.


4-8


• Demand refers to a schedule of quantities of a good that will be bought per unit of time at various prices, other things constant.

• It refers to the entire demand curve.

• A change in demand, caused by anything other than the good’s own price, is shown by a shift in the demand curve.


4-9

B

100

$2


D1

Change in quantity demanded

0

Pri

ce

(pe

r 5

0 m

iles

)


$1

200

AP

ric

e (p

er

50

mile

s)


D0

D1

$2

$1

100

BA

Change in demand

200


4-10

Shift Factors of DemandShift Factors of Demand

• Shift factors of demand are factors that cause changes in demand (shifts in the demand curve).

• Society’s Income An increase in income will increase

demand for normal goods. An increase in income will decrease

demand for inferior goods.


4-11


• Prices of Other Goods When the price of a substitute good falls,

demand falls for the good whose price has not changed.

When the price of a complement good falls, demand rises for the good whose price has not changed.

• Tastes A change in taste will change demand with

no change in price.


4-12


• Expectations If you expect your income to rise, you

may consume more now. If you expect prices to fall in the future,

you may put off purchases today.

• Taxes and Subsidies Taxes increase the cost of goods,

thereby reducing demand. Subsidies have an opposite effect.


4-13

The Demand TableThe Demand Table

• The demand table assumes: As price rises, quantity demanded

declines. Quantity demanded has a specific time

dimension to it. All the products involved are identical in

shape, size, quality, etc. Everything else is constant.


4-14

From a Demand Table From a Demand Table to a Demand Curveto a Demand Curve

Pri

ce p

er D

VD

s (i

n d

oll

ars) A Demand Curve

Quantity of DVDs demanded (per week)

1 2 3 4 5 6 7 8 9 101112

13

$6.00

5.00

4.00

3.00

2.00

1.00 .50

0

3.50

E

D

C

BFA

A Demand Table

ABCDE

$0.50 1.002.003.004.00

98642

Price per cassette

DVD rentals demanded per

week

Demand for DVDs

G


4-15

Individual and Market Individual and Market Demand CurvesDemand Curves

Price per cassette

$.0.501.001.502.002.503.003.504.00

Alice’s demand

Market demand

98765432

65432100

11000000

16141197532

ABCDEFGH Cathy BruceAlice

D

A

C

EF

G

Quantity of cassettes demanded per week

2

$4.00

3.50

3.00

2.50

2.00

1.50

1.00

0.50

0

Pri

ce p

er c

asse

tte

(in

do

llars

)

4 6 8 10 12 14 16

B

+ Bruce’s demand

Cathy’s demand

+ + =


4-16

The Law of SupplyThe Law of Supply• There is a direct relationship between price and

quantity supplied.

• Other things constant: Quantity supplied rises as price rises. Quantity supplied falls as price falls.

• The law of supply occurs because: When prices rise, firms substitute production of one

good for another. Assuming firms’ costs are constant, a higher price

means higher profits.


4-17

The Supply CurveThe Supply Curve

• The supply curve is the graphic representation of the law of supply.

• The supply curve slopes upward to the right because quantity supplied varies directly with price.

• As price increases, the quantity supplied increases. Quantity supplied

(per unit of time)

0

Pri

ce

(pe

r u

nit

) S

APA

QA

BPB

QB


4-18

Quantity Supplied Versus SupplyQuantity Supplied Versus Supply

• Quantity supplied refers to a specific amount that will be supplied at a specific price.

• Quantity supplied refers to a specific point on the supply curve.

• A change in quantity supplied, caused only by a change in the price of the good itself, is shown by a movement along the supply curve.


4-19


• Supply refers to a schedule of quantities a seller is willing to sell per unit of time at various prices, other things constant.

• Supply refers to the whole supply curve.

• A change in supply, caused by anything other than the good’s price, is shown by a shift in the supply curve.


4-20


Pri

ce

(pe

r b

arr

el)

Barrels per year (millions)

S0Change in Supply S1

$15A B

1700 1800

Change in quantity supplied

Pri

ce

(pe

r b

arr

el)

Barrels per year (millions)

S0

$15A

1700 1900

B$36


4-21

Shift Factors of SupplyShift Factors of Supply

• Shift factors of supply are factors that cause changes in supply (shifts in the supply curve).

• Price of Inputs When costs go up, profits go down, so that the

incentive to supply also goes down.

• Technology Advances in technology reduce the number of inputs

needed to produce a given supply of goods, decreasing costs, increasing profits, leading to increased supply.


4-22

Shift Factors of SupplyShift Factors of Supply

• Expectations If suppliers expect prices to rise in the

future, they may store today’s supply to sell later, decreasing supply now.

• Taxes and Subsidies When taxes increase, costs go up, and

profits go down, causing a decrease in supply.

When subsidies increase, costs decrease, and profits increase, leading to an increase in supply.


4-23

Individual and Market SupplyIndividual and Market Supply

Price (per DVD)

ABCDEFGHI

$0.000.501.001.502.002.503.003.504.00

012345678

001234555

000000022

013579

111415

AnnMarket

supplyCharlieBarry+ + =

Quantity of DVDs supplied (per week)

$4.00

3.50

3.00

2.50

2.00

1.50

1.00

0.50

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16

Charlie Barry Ann

0

IH

G

F

E

D

C

BA

Market Supply

CA


4-24

EquilibriumEquilibrium

• Equilibrium is a concept in which opposing forces cancel each other out.

• In a free market, the forces of supply and demand interact to determine: Equilibrium price – the price toward which

the invisible hand drives the market. Equilibrium quantity – the amount bought

and sold at the equilibrium price.


4-25


• When the market is not in equilibrium, there is either excess demand or excess supply.

• Excess supply – a surplus, the quantity supplied is greater than the quantity demanded, and prices fall.

• Excess demand – a shortage, the quantity demanded is greater than the quantity supplied, and prices rise.

• When quantity demanded equals quantity supplied, prices have no tendency to change.


4-26


Price

(per DVD)QS QD

Surplus(+)

Shortage (-)

$3.50 7 3 +4

$2.50 5 5 0

$1.50 3 7 -4

A

Pri

ce p

er D

VD

$5.00

4.00

3.50

3.00

2.50

2.00

1.50

1.00

S

D

Quantity of DVDs supplied and demanded (per week)

C

Excess demand

1 2 3 4 5 6

Excess supply

E

7 8


4-27

Shifts in Supply and DemandShifts in Supply and Demand

• Shifts in either supply or demand change equilibrium price.

• An increase in demand or a decrease in supply: Creates excess demand at the original

equilibrium price. Excess demand increases price until a

new higher equilibrium price and quantity are reached.


4-28

Increase in DemandIncrease in DemandP

rice

(p

er D

VD

s)

A

S0

Quantity of DVDs (per week)

$2.50

2.25

0 98 10

D0 D1

B Excess demand


4-29

B Excess demandA

Pri

ce (

per

DV

Ds)

Quantity of DVDs (per week)

$2.50

2.25

0 98 10

D0

S0C

S1

Decrease in SupplyDecrease in Supply


4-30

Limitations of Supply and Limitations of Supply and Demand AnalysisDemand Analysis

• Sometimes supply and demand are interconnected.

• The other things constant assumption is likely not to hold when the goods represent a large percentage of the entire economy.

• The fallacy of composition is the false assumption that what is true for a part will also be true for the whole.


4-31

SummarySummary

• The law of demand states that the quantity demanded rises as price falls, other things constant.

• The law of supply states that the quantity supplied rises as price rises, other things constant.

• The laws of demand and supply hold true because people can substitute.


4-32

SummarySummary

• A change in quantity demanded (supplied), caused only by a change in the good’s own price, is a movement along the demand (supply) curve.

• A change in demand (supply) is a shift of the entire demand (supply) curve.

• Factors that affect supply and demand other than price are called shift factors.


4-33

SummarySummary

Shift Factors of Demand Shift Factors of Supply

Income Price of Inputs

Prices of Other Goods Technology

Tastes Expectations

ExpectationsTaxes and Subsidies on

Producers

Taxes and Subsidies on Consumers


4-34

SummarySummary

• A market demand (supply) curve is the horizontal sum of all individual demand (supply) curves.

• When quantity demanded equals quantity supplied at equilibrium, prices have no tendency to change.

• When quantity demanded > quantity supplied, prices tend to rise.

• When quantity supplied > quantity demanded, prices tend to fall.


4-35

SummarySummary

• When the demand curve shifts to the right (left), equilibrium price rises (declines) and equilibrium quantity rises (falls).

• When the supply curve shifts to the right (left), equilibrium price declines (rises) and equilibrium quantity rises (falls).


4-36

Given the following demand and supply of pizza:

Price Quantity Quantityper Pizza Supplied Demanded

$8 200 60 7 150 80 6 100 100 5 50 120 4 0 140 Review Question 4-1 What is the equilibrium price and quantity?

Review Question 4-2 If the price is $7, is there a shortage or surplus?How much is the shortage or surplus? Explain how the market will return to equilibrium.

Equilibrium price is $6 and equilibrium quantity is 100 pizzas.

At a price of $7, there is a surplus of 150 - 80 = 70 pizzas. Producerswill reduce the price in order to sell the surplus. As price decreases,quantity demanded increases until the surplus is eliminated at the equilibrium price of $6.

mcgraw-hill/irwin copyright 2006 by the mcgraw-hill companies, inc. all rights reserved. demand and...

Documents