Supply and Demand Basics

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Supply and Demand Basics
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Market Demand Defined

• Market Demand (D)--relationship between price and
  the quantity consumers are willing to buy (all
  other things equal)
• represented by the demand curve

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Market Demand Defined
Sample Demand Schedule(for DVDs) for Bob and
Sue
From http//www.harcourtcollege.com/econ/mankiw/c
drom/ch04index.html
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Market Demand (cont.)
Price
0
Quantity
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Market Demand (cont.)
Price
Demand Curve
Combinations of products consumers want at
various prices
0
Quantity
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Demand (cont.)

• Quantity Demanded (Qd)--amount of a good or
  service consumers want to purchase at one
  particular price
• one point on the demand curve

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Demand (cont.)
Price
Demand Curve
Quantity
0
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Demand (cont.)
Price
Demand Curve
P1
Quantity
0
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Demand (cont.)
Price
Demand Curve
Represents what buyers demand at the price P1
P1
Quantity
0
Quantity Demanded (Qd1)
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Demand (Cont.)

• DO NOT CONFUSE DEMAND WITH QUANTITY
  DEMANDED!!
• Why is the demand curve downward sloping?
• buyers want more at lower prices (less at higher
  prices)
• Buyers look to maximize their utility
• get the most bang for their buck
• As prices rise, the quantity demanded falls

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Shifts in the Demand Curve

• 1. Change in number of consumers in the market
  for a product
• more consumers--gthigher demand
• 2. Change in tastes and preferences
• more fashionable a product--gthigher demand
• 3. Change in consumer income
• more income--gthigher demand

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Shifts in the Demand Curve

• 4. Change in price of related goods
• compliments goods that go with other goods
• if hot dog prices increase, market demand for
  mustard will decrease
• substitutes goods bought in place of other
  goods
• if movie ticket prices increase, demand for video
  rentals will increase
• NOTE changes in price do not shift the demand
  curveresult in move along the curve

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Market Supply Defined

• Market Supply (S)the relationship between price
  and the quantity producers are willing to produce
  (all other things equal)
• represented by the supply curve

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Market Supply Defined
Sample Supply Schedulefor ACME and AJAX
Basketballs
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Market Supply (con.t)
Price
Supply Curve
All combinations sellers provide at various
prices
Quantity
0
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Supply (cont.)

• Quantity Supplied (Qs)specific amount of a good
  (or service) producers want to produce at one
  particular price
• one point on the supply curve

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Supply (cont.)
Price
Supply Curve
Quantity
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Supply (cont.)
Price
Supply Curve
Quantity
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Supply (cont.)
Price
Supply Curve
Quantity
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Supply (cont.)
Price
Supply Curve
P1
Quantity
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Supply (cont.)
Price
Supply Curve
P1
Represents what seller will supply at the price
P1
Quantity
Quantity Supplied (Qs1)
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Supply (cont.)

• DO NOT CONFUSE MARKET SUPPLY WITH QUANTITY
  SUPPLIED!!
• Why does the supply curve slope upward?
• Sellers are motivated by PROFIT!!
• Sellers want to sell more at higher prices
• PROFIT rises as revenue goes up (all other things
  equal)

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Shifts in the Supply Curve

• Events that cause supply curve to shift
• 1. Change in cost of factors of production
• produce more (or less) for same costs
• e.g., labor costs go up, supply will decrease
• cost of rubber falls, supply of tires will
  increase
• 2. Improved technology
• leads to increased productivity
• means supply will increase

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Shifts in Supply (cont.)

• 3. Natural events
• e.g., freeze in Florida limits the supply of
  oranges
• 4. Change in number of sellers in market
• if fewer firms produce tires, there will be fewer
  tires to buy.
• NOTE changes in price do not shift the supply
  curvemove along curve

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Market Clearing Price

• Price where supply and demand curves intersect
• At this price, amount a buyer wants and that a
  seller will provide are just equal
• no surplus or shortage in the market.

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Market Clearing Price
Point where S and D cross is the market clearing
price
Price
Quantity
0
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Market Clearing Price
Point where S and D cross is the market clearing
price
Price
S
Quantity
0
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Market Clearing Price
Point where S and D cross is the market clearing
price
Price
S
D
Quantity
0
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Market Clearing Price
Point where S and D cross is the market clearing
price
Price
S
P is price both buyers and sellers agree on
P
D
Quantity
0
Q
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Shifts in the Supply/Demand Curves

• Handy Dandy Supply and Demand Graph
• What happens to Market Clearing Price and
  Quantity if supply increases (curve shifts to the
  right)?
• P falls, Q rises
• What happens to Market Clearing Price and
  Quantity if demand increases (curve shifts to the
  right)?
• P rises, Q rises
• Online Quiz

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Price Elasticity of Demand (Lesson 6)

• Why do people continue to buy about as much
  gasoline as they always have?
• Why do smokers continue to smoke even as the
  price of a pack of cigarettes approaches 3.00?

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Price Elasticity of Demand (cont.)

• The quantity of cigarettes and gasoline consumers
  desire is not very responsive to changes in
  price
• Both goods are said to be inelastic

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Price Elasticity of Demand (cont.)

• Price elasticity of demand (PEoD) measures the
  strength of the relationship between price (P)
  and quantity demanded (Qd)
• PEoD change in Qd / change in P
• PEoD is a function of the slope of the D curve
  (steeper the slope, less elastic the good)

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Price Elasticity of Demand (cont.)
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Price Elasticity of Demand (cont.)

• If P of cigarettes increased by 20, and Qd
  decreased by 2, then PEoD .1
• PEoD lt 1 inelastic (price increases have less
  impact)
• PEoD 1 unit elastic (1 unit to 1 unit impact)
• PEoD gt 1 elastic (price increases have greater
  impact)

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Price Elasticity of Demand (cont.)
Elastic demand? Inelastic demand?
PEoD 2 ? elastic (like Pepsi)
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Price Elasticity of Demand (cont.)
Elastic demand? Inelastic demand?
PEoD .1 ? inelastic (like cigarettes)
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Price Elasticity of Demand (cont.)

• Factors affecting PEoD
• Availability of substitutes Coke and Pepsi are
  close substitutes gasoline and coal are not
• Goods with more substitutes tend to be more
  elastic
• Income greater the income level, the less
  sensitive consumers are to changes in P.
• Goods that require small proportion of income
  tend to be
• Time In the short-run, cigarettes are very
  inelastic, but if smoker quits gradually,
  cigarettes are more elastic over time

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Price Elasticity of Demand (cont.)
Estimated Price Elasticities
elasticity
coefficient item short run Airline
travel 0.1 Medical care 0.3 Natural
gas 1.4 Auto tires 0.9 Stationery 0.5 Gasolin
e 0.2 Housing 0.3 Automobiles 1.9 Movies 0.9
Jewelry watches 0.4 Radio TV
repair 0.5 Foreign travel 0.1 Glass, china,
etc. 1.5
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Price Elasticity of Demand (cont.)

• Why do we care about PEoD?
• Producers need to know BY HOW MUCH quantity will
  change when price changes.
• PEoD is related to firms total revenue (which
  drives profit).
• Firms in very elastic markets could earn higher
  profits by lowering prices