DEMAND

SUPPLY AND DEMAND*

SUPPLY AND DEMAND

DemandQuantity demanded is the amount of a good that buyers are willing and able to purchaseDemand is a full description of how the quantity demanded changes as the price of the good changes.*SUPPLY AND DEMAND

SUPPLY AND DEMAND

Catherines Demand Schedule and Demand CurveCopyright 2004 South-Western

Price ofIce-Cream Cone02.502.001.501.000.501234567891011Quantity ofIce-Cream Cones$3.0012*SUPPLY AND DEMAND

SUPPLY AND DEMAND

Market Demand is the Sum of Individual Demands*SUPPLY AND DEMAND

SUPPLY AND DEMAND

Law of DemandThe law of demand states that the quantity demanded of a good falls when the price of the good rises, and vice versa, provided all other factors that affect buyers decisions are unchanged

*SUPPLY AND DEMAND

SUPPLY AND DEMAND

provided all other factors are unchangedThats an important phrase in the wording of the Law of DemandThe quantity demanded of a consumer good such as ice cream depends onThe price of ice creamThe prices of related goodsConsumers incomesConsumers tastesConsumers expectations about future prices and incomesNumber of buyers, etcThe Law of Demand says that the quantity demanded of a good is inversely related to its price, provided all other factors are unchanged

*SUPPLY AND DEMAND

SUPPLY AND DEMAND

Why Might Demand Increase?How can we explain the difference in Catherines behavior in situations A and B?Why does she consume more in situation B at every possible price?

PriceQuantity Demanded*SUPPLY AND DEMAND

Quantity DemandedPriceSituation ASituation B0.0012200.5010161.008121.50682.00462.50243.0002

SUPPLY AND DEMAND

Shifts in the Market Demand Curve are caused by changes in:Consumer incomePrices of related goodsTastesExpectations, say, about future prices and prospectsNumber of buyers

*SUPPLY AND DEMAND

SUPPLY AND DEMAND*

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Shifts in the Demand CurvePrice ofIce-CreamConeQuantity ofIce-Cream Cones0*SUPPLY AND DEMAND

SUPPLY AND DEMAND

Shifts in the Demand CurveConsumer IncomeAs income increases the demand for a normal good will increaseAs income increases the demand for an inferior good will decreasePrices of Related GoodsWhen a fall in the price of one good reduces the demand for another good, the two goods are called substitutesWhen a fall in the price of one good increases the demand for another good, the two goods are called complements

*SUPPLY AND DEMAND

SUPPLY AND DEMAND

The Law of DemandExplanations There are two ways to explain the Law of DemandSubstitution effectIncome effect

*SUPPLY AND DEMAND

SUPPLY AND DEMAND

Substitution EffectWhen the price of a good decreases, consumers substitute that good instead of other competing (substitute) goods

1. When the price of Coke decreases2. Consumption of Pepsi decreases3. Consumption of Coke increases*SUPPLY AND DEMAND

SUPPLY AND DEMAND

Income EffectA decrease in the price of a commodity is essentially equivalent to an increase in consumers income

*SUPPLY AND DEMAND

SUPPLY AND DEMAND

SUPPLY AND DEMAND*Lower Prices = Higher IncomeIf prices fall, Situation A becomes Situation C. If income rises, Situation A becomes Situation B. Q: Which change is better?A: They are both equally desirable. A fall in prices is equivalent to an increase in income.

Situation APrice of an Apple$1.00Price of an Orange$2.00Income$10.00

Situation BPrice of an Apple$1.00Price of an Orange$2.00Income$20.00

Situation CPrice of an Apple$0.50Price of an Orange$1.00Income$10.00

SUPPLY AND DEMAND*

SUPPLY AND DEMAND*Income EffectConsumers respond to a decrease in the price of a commodity as they would to an increase in incomeThey increase their consumption of a wide range of goods, including the good that had a price decrease

1. When the price of Coke decreases2. Consumers feel richer3. Consumption of Coke and other goods increases

SUPPLY AND DEMAND

SUPPLY

SUPPLY AND DEMAND*

SUPPLY AND DEMAND

SUPPLYQuantity supplied is the amount of a good that sellers are willing and able to sellSupply is a full description of how the quantity supplied of a commodity responds to changes in its price*SUPPLY AND DEMAND

SUPPLY AND DEMAND*

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Bens supply schedule and supply curve*

Price ofIce-cream coneQuantity ofCones supplied$0.000.501.001.502.002.503.000 cones012345

Market supply and individual supplies*

Price of ice-cream coneBen Jerry Market $0.000.501.001.502.002.503.000012345+0002468=001471013

Market supply and individual supplies*

Benssupply

Jerryssupply+=

Marketsupply

SUPPLY AND DEMAND*Law of SupplyThe law of supply states that, the quantity supplied of a good rises when the price of the good rises, as long as all other factors that affect suppliers decisions are unchanged

SUPPLY AND DEMAND

SUPPLY AND DEMAND*Law of SupplyExplanation How can we make sense of the numbers in Bens supply schedule?The best guess is that his costs must be something like the cost schedule below.

In this way, the Law of Supply follows from the assumption of Increasing Costs (or, Diminishing Returns)

A specific ice-cream coneIts cost ($)1st 0.752nd 1.353rd 1.754th 2.305th 2.856th 3.10

SUPPLY AND DEMAND*

Shifts in the Supply Curve: What causes them?Price ofIce-CreamConeQuantity ofIce-Cream Cones0*SUPPLY AND DEMAND

SUPPLY AND DEMAND

SUPPLY AND DEMAND*Supply ShiftHow could Bens supply have increased?

Anything that reduces production costs, shifts supply to the right.

Bens Supply SchedulePrice ($)Quantity SuppliedBeforeAfter0.00000.50011.00121.50232.00342.50453.0056

Ice-cream coneIts cost ($)BeforeAfter1st 0.750.452nd 1.350.853rd 1.751.454th 2.301.955th 2.852.456th 3.102.90

SUPPLY AND DEMAND*

Shifts in the Supply Curve are caused by changes inInput pricesTechnologyNumber of sellers (short run)The market supply will shift right ifRaw materials or labor becomes cheaperThe technology becomes more efficientNumber of sellers increases

*SUPPLY AND DEMAND

SUPPLY AND DEMAND*

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EQUILIBRIUM

SUPPLY AND DEMAND*

SUPPLY AND DEMAND

Interaction of demand and supplyWe have seen what demand and supply areWe have seen why demand and supply may shiftNow it is time to say something about how buyers and sellers collectively determine the market outcomeTo do this, we assume equilibrium

SUPPLY AND DEMAND*

SUPPLY AND DEMAND

Equilibrium We assume that the price will automatically reach a level at which the quantity demanded equals the quantity supplied

SUPPLY AND DEMAND*

SUPPLY AND DEMAND

At $2.00, the quantity demanded is equal to the quantity supplied!SUPPLY AND DEMAND TOGETHERDemand ScheduleSupply Schedule*SUPPLY AND DEMAND

SUPPLY AND DEMAND*

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Equilibrium of supply and demand*

EquilibriumCan we justify the assumption of equilibrium?

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Markets Not in EquilibriumPrice ofIce-CreamCone0(a) Excess SupplyQuantity ofIce-CreamCones*SUPPLY AND DEMAND

SUPPLY AND DEMAND

Markets Not in EquilibriumSurplusWhen price exceeds equilibrium price, then quantity supplied is greater than quantity demandedThere is excess supply or a surplusSuppliers will lower the price to increase sales, thereby moving toward equilibrium

*SUPPLY AND DEMAND

SUPPLY AND DEMAND

Markets Not in EquilibriumPrice ofIce-CreamCone0Quantity ofIce-CreamCones(b) Excess Demand*SUPPLY AND DEMAND

SUPPLY AND DEMAND

Markets Not in EquilibriumShortageWhen price is less than equilibrium price, then quantity demanded exceeds the quantity suppliedThere is excess demand or a shortage Suppliers will raise the price due to too many buyers chasing too few goods, thereby moving toward equilibrium

*SUPPLY AND DEMAND

SUPPLY AND DEMAND

EquilibriumLaw of supply and demandThe price of any good adjusts to bring the quantity supplied and the quantity demanded for that good into balance

*SUPPLY AND DEMAND

SUPPLY AND DEMAND

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