McConnellBrue Economics

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Teach a parrot the terms "supply and demand" and
you've got an economist. Thomas Carlyle
Demand, Supply, and Market Equilibrium
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Chapter Objectives

• Demand Defined and What Affects It
• Supply Defined and What Affects It
• How Supply Demand Together Determine Market
  Equilibrium
• How Changes in Supply and Demand Affect
  Equilibrium Prices and Quantities

3
Demand

• Demand Defined
• A schedule (curve) that shows the various
  quantities of a good or service that consumers
  are willing and able to purchase at various
  possible prices during a specific time period,
  ceteris paribus.
• Individual demand shows price/qty combinations
  for individual buyer.
• Market demand is the sum of all individual
  demands.

4
Demand

• Law of Demand
• Price and quantity demanded are inversely related
  (as price falls, qty demanded increases, and vice
  versa), ceteris paribus.
• When price increases, people consume less of the
  good because
• They substitute away from the relatively higher
  priced goods to relatively lower priced goods
  (substitution effect).
• Their REAL income (purchasing power) has fallen,
  so they are not able to consume as much as before
  (income effect).

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Demand
P
Individual Demand
P
Qd
5 4 3 2 1
10 20 35 55 80
D
Q
6
Demand
Demand Can Increase or Decrease
P
6 5 4 3 2 1 0
Individual Demand
Increase in Demand
P
Qd
5 4 3 2 1
10 20 35 55 80
Price (per bushel)
D2
D1
Decrease in Demand
D3
Q
2 4 6 8 10 12 14
16 18
Quantity Demanded (bushels per week)
7
Demand
Demand Can Increase or Decrease
A change in demand means a shift of the curve -
Demand will shift if something OTHER than
price changes (if one of the underlying
assumptions change)
P
6 5 4 3 2 1 0
Individual Demand
P
Qd
5 4 3 2 1
10 20 35 55 80
Price (per bushel)
D2
D1
Decrease in Demand
D3
Q
2 4 6 8 10 12 14
16 18
Quantity Demanded (bushels per week)
8
Demand
Change in Quantity Demanded is a Movement Along
the Existing Curve
P
6 5 4 3 2 1 0
A Movement Between Any Two Points on a Demand
Curve is Called a Change in Quantity Demanded
can only be caused by a change in price of this
good.
Individual Demand
P
Qd
5 4 3 2 1
10 20 35 55 80
Price (per bushel)
D1
Q
2 4 6 8 10 12 14
16 18
Quantity Demanded (bushels per week)
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Demand
Determinants (Shifters) of Demand

• Tastes and Preferences
• Some change that makes consumers want to buy more
  or less of the good or service.
• Can be trends, fads, news reports of something
  bad for you (or good for you), change in tastes
  because of aging, etc.

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Tastes/Preferences
This is the demand curve for my new book, The
Wonderful World of Economics
P
6 5 4 3 2 1 0
What would happen to demand for my book if Oprah
endorsed it on her show?
Increase in Demand
D2
D1
Q
2 4 6 8 10 12 14
16 18
Quantity Demanded
11
Individual Demand
Determinants (Shifters) of Demand

• Tastes and Preferences
• Number of Buyers (Mkt Size)
• An increase in the number of buyers in a market,
  for whatever reason, will increase demand for a
  good (a decrease in number of buyers will
  decrease demand), ceteris paribus.

12
Number of Buyers
This is the demand curve for textbooks at UNC
Charlotte.
P
6 5 4 3 2 1 0
What would happen to demand for textbooks if UNC
Charlotte no longer required textbooks for
classes?
D1
Decrease in Demand
D3
Q
2 4 6 8 10 12 14
16 18
Quantity Demanded
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Individual Demand
Determinants (Shifters) of Demand

• Tastes and Preferences
• Number of Buyers (Mkt Size)
• Income
• Normal Goods
• When income increases, demand increases (when
  income falls, demand falls).
• Most goods are normal goods.

14
Income (Normal Good)
This is the demand curve for dinner at Carrabbas
Italian Restaurant (my fav).
P
6 5 4 3 2 1 0
What would happen to demand for eating out if
incomes increased? (assume restaurant meals are
normal goods)
Increase in Demand
D2
D1
Q
2 4 6 8 10 12 14
16 18
Quantity Demanded
15
Individual Demand
Determinants (Shifters) of Demand

• Tastes and Preferences
• Number of Buyers (Mkt Size)
• Income
• Normal Goods
• Inferior Goods
• When income falls, demand increases (when income
  increases, demand falls).
• Not necessarily a good of inferior quality.

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Income (Inferior Goods)
This is the demand curve for Ramen Noodles
P
6 5 4 3 2 1 0
What will happen to demand for Ramen noodles when
you graduate and your income goes up?
D1
Decrease in Demand
D3
Q
2 4 6 8 10 12 14
16 18
Quantity Demanded
17
Individual Demand
Determinants (Shifters) of Demand

• Tastes and Preferences
• Number of Buyers (Mkt Size)
• Income
• Price of Related Goods
• Substitute Good
• Goods that are used instead of other goods.
• When the price of one good increases, demand for
  its substitutes will increase (when price falls,
  demand for a sub will fall).

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Price of Related Goods (Substitute Goods)
This is the demand curve for Red Bull.
P
6 5 4 3 2 1 0
What will happen to demand for Red Bull when the
price of Monster (another energy drink) goes
down? (NOTE There has been NO change in the
price of Red Bull!)
Buyers will substitute away from Red Bull to the
relatively cheaper Monster.
D1
Decrease in Demand
D3
Q
2 4 6 8 10 12 14
16 18
Quantity Demanded
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Price of Related Goods (Substitute Goods)
This is the demand curve for Burger King
Whoppers.
P
6 5 4 3 2 1 0
What would happen to demand for BK Whoppers if
the price of McDonalds Big Macs goes up? (no
change in the price of Whoppers)
Increase in Demand
D2
D1
Q
2 4 6 8 10 12 14
16 18
Quantity Demanded
20
Demand
Determinants (Shifters) of Demand

• Tastes and Preferences
• Number of Buyers (Mkt Size)
• Income
• Price of Related Goods
• Substitute Good
• Complementary Good
• Goods that are used together.
• When the price of one good increases, demand for
  its complement will decrease (when price falls,
  demand for a complement will increase).

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Price of Related Goods (Complementary Goods)
This is the demand curve for DVDs.
When DVD players are more expensive, the
quantity demanded of DVD players will fall
(Law of Demand), so people do not need as many
DVDs demand will fall.
P
6 5 4 3 2 1 0
What will happen to demand for DVDs when the
price of DVD players goes up? (NOTE The price of
DVDs did not change)
D1
Decrease in Demand
D3
Q
2 4 6 8 10 12 14
16 18
Quantity Demanded
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Price of Related Goods (Complementary Goods)
This is the demand curve for i-Tunes downloads.
P
6 5 4 3 2 1 0
What would happen to demand for i-Tunes when the
price of iPods goes down?
Increase in Demand
D2
D1
Q
2 4 6 8 10 12 14
16 18
Quantity Demanded
23
Demand
Determinants (Shifters) of Demand

• Tastes and Preferences
• Number of Buyers (Mkt Size)
• Income
• Price of Related Goods
• Consumer Expectations
• If consumers expect prices to increase in the
  future, demand will increase today (if they
  expect prices to fall, demand will fall today)

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Consumer Expectations
This is the demand curve for houses.
Demand will fall today because homebuyers will
wait to buy the home in the future when prices
fall.
P
6 5 4 3 2 1 0
What will happen to demand for houses when people
expect home prices to fall in the future?
D1
Decrease in Demand
D3
Q
2 4 6 8 10 12 14
16 18
Quantity Demanded
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Demand
Determinants (Shifters) of Demand

• Tastes
• Number of Buyers
• Income
• Price of Related Goods
• Consumer Expectations

• These are the assumptions underlying the demand
  curve. When they change, demand changes
  (shifts).
• There is one thing and one thing only that moves
  us along the demand curve (change in quantity
  demanded) that is a change in the PRICE of the
  thing we are graphing.

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Change in Price (change in qty demanded)
This is the demand curve for Starbucks coffee.
P
6 5 4 3 2 1 0
What would happen to demand for Starbucks coffee
if the price of Starbucks coffee goes up from 2
to 3?
D2
D1
Q
2 4 6 8 10 12 14
16 18
Quantity Demanded
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Supply

• Supply Defined
• A schedule (curve) that shows the various
  quantities of a good or service that suppliers
  are willing and able to make available for
  purchase at various possible prices during a
  specific time period.
• Individual supply shows price/qty combinations
  for individual seller.
• Market supply is the sum of all individual supply
  curves.

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Supply

• Law of Supply
• Price and quantity supplied are positively
  related (as price increases, qty supplied
  increases, and vice versa), ceteris paribus.
• Marginal costs of production tend to increase as
  more is produced. So firms will not produce
  additional (more costly) units unless they can
  get a higher price for them to cover the higher
  marginal cost.

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Supply
P
6 5 4 3 2 1 0
Individual Supply
S1
P
Qs
5 4 3 2 1
60 50 35 20 5
Price (per bushel)
Q
10 20 30 40 50
60 70
Quantity Supplied (bushels per week)
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Supply
Supply Can Increase or Decrease
P
6 5 4 3 2 1 0
S3
Individual Supply
S1
S2
P
Qs
5 4 3 2 1
60 50 35 20 5
Price (per bushel)
Q
2 4 6 8 10
12 14
Quantity Supplied (bushels per week)
31
Supply
Supply Can Increase or Decrease
A Movement Between Any Two Points on a Supply
Curve is Called a Change in Quantity Supplied
P
6 5 4 3 2 1 0
S3
Individual Supply
S1
S2
P
Qs
5 4 3 2 1
60 50 35 20 5
Price (per bushel)
A change (increase or decrease) in Supply Means a
shift of the curve
Q
2 4 6 8 10
12 14
Quantity Supplied (bushels per week)
32
Supply
Determinants (Shifters) of Supply

• Resource Prices (costs)
• When costs of inputs increase, suppliers must
  supply less at every price, so supply will
  decrease.

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Resource Costs
This is the supply curve for Toyotas.
P
6 5 4 3 2 1 0
S2
Decrease in Supply
What would happen to the supply of Toyotas if the
cost of steel increases?
S1
Q
2 4 6 8 10
12 14
Quantity Supplied
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Resource Costs
This is the supply curve for gasoline.
P
6 5 4 3 2 1 0
S2
Decrease in Supply
What would happen to the supply of gasoline if
the cost of oil increases?
S1
Q
2 4 6 8 10
12 14
Quantity Supplied
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Supply
Determinants (Shifters) of Supply

• Resource Prices (costs)
• Technology
• Improvements in technology allow suppliers to
  produce same output with fewer resources.
• Using fewer resources lowers production costs,
  which increases supply.

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Technology
This is the supply curve for big screen TVs.
P
6 5 4 3 2 1 0
What would happen to the supply of big screen
TVs if the technology used to build them
improves?
S1
S2
Increase in Supply
Q
2 4 6 8 10
12 14
Quantity Supplied
37
Supply
Determinants (Shifters) of Supply

• Resource Prices (costs)
• Technology
• Taxes and Subsidies
• Taxes are considered costs, so when taxes
  increase, costs increase, and supply decreases.
• Subsidies are taxes in reverse, lower costs,
  supply increases.

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Supply
Determinants (Shifters) of Supply

• Resource Prices (costs)
• Technology
• Taxes and Subsidies
• Prices of Other Goods
• If a firm can produce alternative goods
  (substitutes in production), they may switch from
  one product to another higher priced good,
  decreasing supply of the original product.

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Price of Other Goods(Substitutes in production)
This is the supply curve for potatoes.
P
6 5 4 3 2 1 0
S2
Decrease in Supply
What would happen to the supply of potatoes if
the price of corn increases? (assume farmers can
grow either potatoes or corn on their land)
S1
Q
2 4 6 8 10
12 14
Quantity Supplied
40
Supply
Determinants (Shifters) of Supply

• Resource Prices
• Technology
• Taxes and Subsidies
• Prices of Other Goods
• Number of Sellers
• The greater the number of suppliers, the greater
  the supply of the good, ceteris paribus.

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Number of Sellers
This the supply curve for American flags.
P
6 5 4 3 2 1 0
S1
What happened to the supply of American flags on
9/11/2001?
S2
Increase in Supply
Q
2 4 6 8 10
12 14
Quantity Supplied
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Supply
Determinants (Shifters) of Supply

• Resource Prices
• Technology
• Taxes and Subsidies
• Prices of Other Goods
• Number of Sellers

• These are the assumptions underlying the supply
  curve. When they change, supply changes
  (shifts).
• There is one thing and one thing only that moves
  us along the supply curve (change in quantity
  supplied) that is a change in the PRICE of the
  thing we are graphing.

43
Change in Price (change in quantity supplied)
This is the supply curve for Chik-Fila
sandwiches.
P
6 5 4 3 2 1 0
S1
What will happen to the supply of Chik-Fila
sandwiches if the price of Chick-Fila sandwiches
changes from 3 to 2?
Q
2 4 6 8 10
12 14
Quantity Supplied
44
Market Equilibrium
Qty Demanded Qty Supplied
Price
Market Demand
Market Supply
6 5 4 3 2 1 0
S
P
Qd
P
Qs
5 4 3 2 1
2,000 4,000 7,000 11,000 16,000
5 4 3 2 1
12,000 10,000 7,000 4,000 1,000
D
2 4 6 8 10 12 14
16 18
7
Qty Demanded
45
Market Equilibrium
What if market price is 4? When price is above
equilibrium, market has a surplus (QDltQS).
Price
Market Demand
Market Supply
6 5 4 3 2 1 0
S
P
Qd
P
Qs
Surplus
5 4 3 2 1
2,000 4,000 7,000 11,000 16,000
5 4 3 2 1
12,000 10,000 7,000 4,000 1,000
3
D
7
2 4 6 8 10 12 14
16 18
QD QS
Qty Demanded
46
Market Equilibrium
What if market price is 2? When price is below
equilibrium, market has a shortage (QDgtQS).
Price
Market Demand
Market Supply
6 5 4 3 2 1 0
S
P
Qd
P
Qs
5 4 3 2 1
2,000 4,000 7,000 11,000 16,000
5 4 3 2 1
12,000 10,000 7,000 4,000 1,000
3
Shortage
D
7
2 4 6 8 10 12 14
16 18
QS QD
Qty Demanded
47
Market Equilibrium
When market price is not equilibrium price
Price
6 5 4 3 2 1 0
When market has shortage, price is too low. If
market is allowed to operate freely, price will
rise to equilibrium.
When market has surplus, price is too high. If
market is allowed to operate freely, price will
fall to equilibrium.
S
Surplus
Shortage
D
2 4 6 8 10 12 14
16 18
7
Qty Demanded
48
Market Equilibrium

• Changes in Demand
• Assume we begin at equilibrium price and
  quantity. What happens if something (a change in
  one of the underlying assumptions) shifts the
  demand curve?

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Change in Demand
This is the market for i-Tunes downloads.
P
What would happen to demand for i-Tunes when the
price of iPods goes down?
6 5 4 3 2 1 0
D2
D1
Q
2 4 6 8 10 12 14
16 18
Quantity Demanded
50
Change in Demand
This is the market for i-Tunes downloads.
P
6 5 4 3 2 1 0

• Demand up
• Shortage at old price will put upward pressure on
  price.
• Movement along supply curve as price increases.
• Market finds new equilibrium.

D2
D1
Q
2 4 6 8 10 12 14
16 18
Quantity Demanded
51
Change in Demand
This is the market for i-Tunes downloads.
P
6 5 4 3 2 1 0

• Market finds new equilibrium.
• EP up
• EQ up

D2
Q
2 4 6 8 10 12 14
16 18
Quantity Demanded
52
Changes in Equilibrium Price and Quantity when
Demand or Supply shift

• If one of the determinants of demand or supply
  change, the market will find a new equilibrium
  price and equilibrium quantity.
• If only PRICE changes, equilibrium WILL NOT
  CHANGE.
• Page 57 in the textbook has a good description of
  changes in equilibrium when something causes a
  shift of either curve (STUDY THESE). (Following
  two slides have the text and graphs from page 57
  for those that do not have a book yet)

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Text from page 57 of the book. Following slide
shows figures referenced here.
Changes in Supply, Demand, and Equilibrium We
know that demand might change because of
fluctuations in consumer tastes or incomes,
changes in consumer expectations, or variations
in the prices of related goods. Supply might
change in response to changes in resource prices,
technology, or taxes. What effects will such
changes in supply and demand have on equilibrium
price and quantity? Changes in Demand Suppose
that the supply of some good (for example,
potatoes) is constant and demand increases, as
shown in Fig A (next slide). As a result, the new
intersection of the supply and demand curves is
at higher values on both the price and the
quantity axes. Clearly, an increase in demand
raises both equilibrium price and equilibrium
quantity. Conversely, a decrease in demand, such
as that shown in Fig B (next slide), reduces both
equilibrium price and equilibrium quantity. (The
value of graphical analysis is now apparent We
need not fumble with columns of figures to
determine the outcomes we need only compare the
new and the old points of intersection on the
graph.) Changes in Supply What happens if the
demand for some good (for example, lettuce) is
constant but supply increases, as in Fig C (next
slide)? The new intersection of supply and demand
is located at a lower equilibrium price but at a
higher equilibrium quantity. An increase in
supply reduces equilibrium price but increases
equilibrium quantity. In contrast, if supply
decreases, as in Fig D (next slide), the
equilibrium price rises while the equilibrium
quantity declines. Figure 3.7(next
slide)  Changes in Demand and Supply and the
Effects on Price and Quantity. The increase in
demand from D1 to D2 in (a) increases both
equilibrium price and equilibrium quantity. The
decrease in demand from D1 to D2 in (b) decreases
both equilibrium price and equilibrium quantity.
The increase in supply from S1 to S2 in (c)
decreases equilibrium price and increases
equilibrium quantity. The decline in supply from
S1 to S2 in (d) increases equilibrium price and
decreases equilibrium quantity. The boxes in the
top right corners summarize the respective
changes and outcomes. The upward arrows in the
boxes signify increases in demand (D), supply
(S), equilibrium price (P), and equilibrium
quantity (Q) the downward arrows signify
decreases in these items.
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Key Terms Page

• demand
• demand schedule
• law of demand
• income effect
• substitution effect
• demand curve
• determinants of demand
• normal goods
• inferior goods
• substitute good
• complementary good
• change in demand
• change in quantity demanded

• supply
• supply schedule
• law of supply
• supply curve
• determinants of supply
• change in supply
• change in quantity supplied
• equilibrium price
• equilibrium quantity
• surplus
• shortage