TO BE USED WITH THE SUPPLY AND DEMAND GUIDE

Supply and Demand Graphs

Review of x and Y axis

A graph consists of two axes called the x (horizontal/quantity) and y (vertical/price) axes.

The point where the two axes intersect is called the origin. The origin is also identified as the point (0, 0).

X axis Moving right from the origin of (0,0), the numbers

ascend. Moving left from the origin, the numbers descend.

Y axis Moving up from the origin of (0,0), the numbers

ascend. Moving down from the origin, the numbers descend.

In this course, we will mainly be using the upper right quadrant of the graphic area.

In economics it is the norm to show the independent variable on the y-axis and the dependent variable on the x-axis.

The Demand Curve

Demand Curve - A downward sloping curve that measures the relationship between the price of a good and the quantity demanded by consumers.

Demand - The amount that consumers are willing and able to purchase at various prices.

Change in Demand – A shift in the position of the demand curve that occurs in response to a change in one or more of the determinants of demand (non-price induced change).

Law of Demand – All other factors equal, the higher the price of the good or service, the lower the quantity demanded (price induced change). And the lower the price, the higher the quantity demanded. Price and Quantity Demanded vary inversely.

Change in Quantity Demanded – A change in the quantity consumers are willing and able to purchase. It is a response to a change in the market price.

Why does the demand curve shift?The Determinants of demand

Shifts in the curve (change in demand) result from changes in one or more of the non-price determinants of demand:

Number of Consumers in the market (Size of Market) Consumer Tastes and Preferences Consumer Income Prices of Related Goods (Substitute Goods and

Complimentary Goods) Expectations about the Future

The Demand Curve: Increases In Demand

Increase in Demand

Curve shifts to the right as a result of an increase in demand by the consumers (D1 to D2). This is caused by a change in one or more of the determinants of demand.

This causes Price to increase (P1 to P2). This shows a willingness to pay a higher price for all possible quantities of the good.

Suppliers respond to the higher price by increasing Quantity Supplied (q1 to q2) .

This process results in a new Equilibrium at e2 with Equilibrium Price P2 and Equilibrium Quantity q2.

The Demand Curve: Decreases In Demand

Decrease in Demand

Demand curve shifts to the left as a result of a decrease in demand by the consumers (D1 to D2). This is caused by a change in one or more of the determinants of demand.

This causes Price to decrease (P1 to P2). This shows a decreased willingness to pay for all possible quantities of the good.

Suppliers respond to the lower price by decreasing Quantity Supplied (q1 to q2) .

This results in a new Equilibrium at e2 with Equilibrium Price P2 and Equilibrium Quantity q2.

Supply Curve

Supply Curve - A curve that normally slopes upward (to the right) representing the quantity of a product producers are willing and able to bring to market at various prices.

Supply – The amount that producers are willing and able to bring to market at various prices.

Change in Supply – A shift in the position of the supply curve in response to a change in one or more of the determinants of supply (non-price induced change).

Law of Supply – All other factors equal, the higher the price of a good or service, the greater the quantity supplied to the market (price induced change). And the lower the price, the lower the quantity supplied. Price and Quantity Supplied vary directly.

Change in Quantity Supplied – A change in the quantity producers are willing and able to bring to market. It is a response to a change in the market price.

Why does the supply curve shift?The determinants of supply

Shifts in the curve can be attributed to changes in one or more of the non-price determinants of supply:

Costs of Production: Input prices (prices of the Factors of Production - resources) Taxes Regulatory compliance costs Legal Expenses Transactions Costs

Number of Firms in the Industry (productive capacity) Relative Prices of Alternative Outputs Technology (sometimes this is grouped with costs of production as technology

determines the methods of production available to the firm)

Expectations about the Future

The Supply Curve: Increases In Supply

Increase in Supply

Supply curve shifts to the right as a result of increased supply in the market. (S1 to S2). This is caused by a change in one or more of the determinants of supply.

This causes Equilibrium Price to decrease (P1 to P2).

In response to the lower price, Quantity Demanded increases (q1 to q2).

This produces a new Equilibrium e2 at Equilibrium Price P2 and Equilibrium Quantity q2.

The Supply Curve: Decreases In Supply

Decrease in Supply

Supply curve shifts to the left as a result of decreased supply in the market. (S1 to S2). This is caused by a change in one or more of the determinants of supply.

This causes Equilibrium Price to increase (P1 to P2).

In response to the higher price, Quantity Demanded decreases (q1 to q2).

This produces a new Equilibrium at e2 and Equilibrium Price P2 and Equilibrium Quantity q2.

Steps to solve supply and demand problems

Use the following steps – in the order provided – to solve supply and demand problems.

Remember that changes occur for a reason and it is important to follow that chain of causation in all economic analysis.

The Steps: Identify the determinant change indicated in the problem; Shift the curve whose determinant has changed; Shift it in the direction indicated by the determinant change; Change the market price in line with the curve shift; Move along the other curve in response to the price change (change

in quantity demanded or quantity supplied as appropriate); Find the new market equilibrium price and quantity.

An example:The Fresh Fruit Market

Start with the Fresh Fruit market in equilibrium as shown in the graph.

At equilibrium point e, the amount that consumers wish to buy at price P is exactly equal to the amount that producers wish to sell at price P.

The quantity demanded is equal to the quantity supplied at the market price of P (quantity demanded = quantity supplied).

The market clears – there is no shortage and no surplus.

Then consumers decide to eat healthier foods, including more fresh fruit.

The determinant that changes is Consumer Tastes and Preferences.

An example:The Fresh Fruit Market – Step 2

Since consumers have now decided to consumer (buy) more fresh fruit, the demand curve shifts to the right.

This shift graphically shows that consumers want more fresh fruit.

AND that they are willing and able to pay more for all quantities of fresh fruit.

This change is shown in the graph as the shift of the demand curve

from D1 to D2.

An example:The Fresh Fruit Market – Step 3

In response to the higher demand, the market price increases (P1 to P2).

This, again, shows that consumers are willing and able to pay more of the larger quantities of fresh fruit that they now want to buy.

The new price is shown as P2 in the graph of the Fresh Fruit Market.

An example:The Fresh Fruit Market – Step 4

In response to the new higher price, producers will move along their supply curve from P1 at e1 to P2 at e2 and bring a higher quantity of fresh fruit to the market.

This is an increase in Quantity Supplied. This is a reaction to the higher price in

the market. The higher price is necessary to induce

the greater quantity supply as expanding output involves increased costs of production as more resources must be hired.

This process results in the new equilibrium point, e2, at the new equilibrium price of P2 and new equilibrium quantity of q2.

Conclusion

Follow this process as outlined in the Supply and Demand Guide and as discussed and illustrated in the previous slides.

These steps work for any determinant change for either supply or demand.

Should a problem involve a change in a determinant of demand and a determinant of supply, these steps still work and will lead you to the correct solution. In such a case, work through each determinant change

individually, then combine the two changes to produce the total change in the market and the new market equilibrium.