Unit 2 - Supply and Demand

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Unit 2 - Supply and Demand

• The Law of Demand
• Buyers of a product will purchase more of the
  product if its price is lower and vice versa,
  assuming all other things remain constant
  (ceterisparibus).

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Unit 2 - Supply and Demand

• Two Reasons Why Buyers Buy More at Lower Prices
  and Less at Higher Prices
• The Substitution Effect
• The Income Effect

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Unit 2 - Supply and Demand

• Substitution Effect
• When the price of a product decreases, ceteris
  paribus, the product becomes cheaper. It is,
  therefore, more attractive relative to other
  products (and vice versa).

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Unit 2 - Supply and Demand

• Income Effect
• When the price of a product decreases, ceteris
  paribus, consumers have more relative income.
  They can, therefore, purchase additional products
  (and vice versa).

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Unit 2 - Supply and Demand

• One Buyer
• How much gasoline would you purchase at the
  following prices (gallons per month)?

Price Per Gallon Quantity Demanded
2.50 50
3.00 45
3.50 42
4.00 35
4.50 20
5.00 10
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Price in DollarsPer Gallon
5.00
4.50
4.00
3.50
3.00
2.50
D
Quantity Demanded
One Individuals Demand Curve
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Unit 2 - Supply and Demand - Micro

• Why Do You Purchase 10 instead of 11 Gallons of
  Gasoline When You Visit the Gas Station?

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Unit 2 - Supply and Demand - Micro

• Marginal Utility
• Marginal utility is the increase in satisfaction
  (as measured in utils) per additional item
  consumed.

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Unit 2 - Supply and Demand - Micro

• The Law of Diminishing Marginal Utility
• As consumers purchase more of a product, the
  value (satisfaction) of additional items
  purchased declines.

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Unit 2 - Supply and Demand
Price Q1buyer 1 Q2buyer 2 Q3buyer 3 Q4buyer 4 Totalmarket
2.50
3.00
3.50
4.00
4.50
5.00

• Several Buyers (the Market)
• How much gasoline would you purchase at the
  following prices (gallons/month)?

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Price in DollarsPer Gallon
5.00
4.50
4.00
3.50
3.00
2.50
D
Quantity Demanded
Market Demand Curve
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Unit 2 - Supply and Demand

• The Demand Curve
• A change in the price is a movement along the
  demand curve. This is called a change in
  quantity demanded.

Price
Individual product demand curves always extend
from the upper left to the lower right. They are
downward sloping.
A
4
B
1.75
Demand Curve
Quantity Demanded
60
80
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Unit 2 - Supply and Demand

• The Law of Supply
• Producers supply more of a product at higher
  than at lower prices, ceteris paribus (and vice
  versa).

Big Screen TVs
CDs
Cell Phones
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Unit 2 - Supply and Demand

• One Supplier
• If you had a small oil well in your backyard and
  it took you some effort to get the oil out, and
  you were able to sell the oil, how much gasoline
  would you supply if you could sell the oil at the
  following prices in the market (gallons per
  month)?

Price Per Gallon Quantity Supplied
2.50
3.00
3.50
4.00
4.50
5.00
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Price in DollarsPer Gallon
S
5.00
4.50
4.00
3.50
3.00
2.50
Quantity Supplied
Individual Supply Curve
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Unit 2 - Supply and Demand
Price Q1seller 1 Q2seller 2 Q3seller 3 Q4seller 4 Totalmarket
2.50
3.00
3.50
4.00
4.50
5.00

• Several Suppliers
• If you had a small oil well in your backyard and
  it took you some effort to get the oil out, and
  you were able to sell the oil, how much gasoline
  would you supply at the following prices (gallons
  per month)?

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Price in DollarsPer Gallon
S
5.00
4.50
4.00
3.50
3.00
2.50
Quantity Supplied
Market Supply Curve
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Unit 2 - Supply and Demand

• The Supply Curve
• A change in the price is a movement along the
  supply curve from point A to point B. This is
  called a change in _______.

Price
Supply Curve
B
4.50
A supply curve is upward sloping.
A
2
Quantity Supplied
30
90
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Unit 2 - Supply and Demand

• Reasons why producers produce more at higher
  prices
• The Substitution Effect
• When the market price increases, other competing
  products will become less profitable and less
  attractive to produce (and vice versa).
• The Income Effect
• When the price increases, the product earns more
  money (income) and the supplier has more
  incentive to produce (and vice versa).

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Unit 2 - Supply and Demand

• Equilibrium Price and Quantity
• In a free market the equilibrium price and
  quantity occur where the supply and demand curves
  intersect.

Price
S
3
D
50
Quantity
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Rent
The Case of Rent Control
S
1,800
1,000
D
Quantity Demanded
900
700
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Price of Labor
The Minimum Wage
SL
7.50
6.00
DL
Quantity Demandedof Labor
1,000
900
1,100
Minimum Wage
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Price of Labor
Minimum Wage New York Example
SL
10.00
8.50
7.50
DL
Quantity Demandedof Labor
1,000
900
1,100
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Unit 2 - Supply and Demand

• Demand Determinants
• The following changes will shift the demand
  curve to the right or to the left.
• A change in real incomes or wealth (normal and
  inferior products).
• A change in tastes or preferences.
• A change in the prices of related products
  (substitute and complementary products).
• A change in the expectation of the products
  future price or buyers future incomes.
• A change in the number of buyers (population).

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Unit 2 - Supply and Demand

• Equilibrium Price and Quantity

When demand increases, the demand curve shifts
to the right.
Equilibriumprice increases,and
equilibriumquantity increases.
Price
S
4
3
D2
D1
50
70
Quantity
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Unit 2 - Supply and Demand

• The Effect of a Change in Demand on Equilibrium
  Price and Quantity
• In the short run, when demand increases
• the equilibrium price increases, and
• the equilibrium quantity increases.
• In the short run, when demand decreases
• the equilibrium price decreases, and
• The equilibrium quantity decreases

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Unit 2 - Supply and Demand

• Supply Determinants
• The following changes will shift the supply
  curve to the right or to the left.
• An advance in technology.
• A change in input prices.
• A change in taxes, subsidies, or regulations.
• A change in the number of firms selling the
  product.

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Unit 2 - Supply and Demand

• Equilibrium Price and Quantity

When supply increases, the supply curve shifts
to the right.
Equilibriumprice decreases,and
equilibriumquantity increases.
Price
S1
S2
3
2
D
Quantity
50
60
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Unit 2 - Supply and Demand

• The Effect of a Change in Supply on Equilibrium
  Price and Quantity
• When supply increases (a rightward shift of the
  supply curve)
• The equilibrium price decreases, and
• The equilibrium quantity increases.
• When supply decreases (a leftward shift of the
  supply curve)
• The equilibrium price increases, and
• The equilibrium quantity decreases.

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Unit 2 - Supply and Demand

• Changes in Demand and Supply Example 1
• What happens to the equilibrium price and
  quantity of an Ipod (a normal product) when
  simultaneously
• Buyers incomes rise, and
• Technology to make the
• Ipods improves?

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What happens to the price and quantity
bought/sold of Ipods if incomes rise and
technology advances?

1. Price down quantity up
2. Price same quantity up
3. Price up quantity up
4. Price down quantity down
5. None of the above

Cross-Tab Label
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Unit 2 - Supply and Demand

• Changes in Demand and Supply Example 1 Answer
• An increase in incomes will increase demand
  (price and quantity increase).
• An advance in technology will increase supply
  (price decreases and quantity increases).
• The combined effect is that price change is
  indeterminate and equilibrium quantity increases.

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Unit 2 - Supply and Demand

• Changes in Demand and Supply Example 2
• What happens to the equilibrium price and
  quantity of paper towels when simultaneously
• Buyers expect the future price of paper towels
  to be significantly higherin the near future.
• The government
• taxes the production of
• paper towels.

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Determine price and quantity of paper towels when
future price is expected to rise and production
tax rises

1. Pe increases Qe decreases
2. Pe increases Qe change is unknown
3. Pe decreases Qe decreases
4. Pe increases Qe increases
5. Pe is unknown Qe decreases
6. none

Cross-Tab Label
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Unit 2 - Supply and Demand

• Changes in Demand and Supply -Example 2 Answer
• The expectation of a higher future price
  increases the current demand for the product
  (price and quantity increase).
• The imposition of a government tax reduces the
  supply (price increases and quantity decreases).
• The combined effect is that the equilibrium
  quantity change is unknown (indeterminate) and
  the equilibrium price increases.

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Unit 2 - Supply and Demand

• Consumer Surplus
• is the difference in what consumers are willing
  to pay for the price of the product and what they
  are actually paying for it in the market.

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Price
Consumer Surplus
S
8
7
6
5
D
Quantity DemandedPer Day
90
100
110
120
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Unit 2 - Supply and Demand

• Producer Surplus
• is the difference in what suppliers are willing
  to sell the product for and what they are
  actually receiving for it in the market.

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Price
S
Producer Surplus
5
4
3
2
D
Quantity DemandedPer Day
90
100
110
120
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Unit 2 - Supply and Demand

• The Free Market Economy
• Free market economy capitalist economy
  laissez-faire economy price system
• In a free market economy prices of goods and
  services, wages, interest rates, foreign exchange
  values, etc., are determined by supply and demand

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Unit 2 - Supply and Demand

• The Free Market Economy
• Should all prices, including wages, be
  determined by supply and demand?

Celebrities receive millions of dollars per year
in compensationBaltimore Sun photo by Ezra Shaw.
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Unit 2 - Supply and Demand

• The Free Market Economy and Externalities
• Do prices reflect their true market value?

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Businesses that pollute

1. Should be fined by the government and the revenue
   should be used to help clean the environment
2. Should be forced to go out of business
3. Should be allowed to operate just like any other
   business
4. No opinion/other

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Organizations that provide products that have
positive externalities

1. Should be subsidized by the government
2. Should be fully funded by the government
3. Should operate just like any other organization
4. No opinion/other

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Unit 2 - Supply and Demand

• Prices of Manufactured Products
• Manufactured products are abundantly
  available and are produced in competitive
  industries. Examples include computers, cell
  phones, CDs, and bicycles.
• Prices of manufactured goods equal the cost of
  production plus a reasonable profit. Prices are
  rarely excessive, especially in the long run.

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Unit 2 - Supply and Demand

• Prices of Limited-Supply Products
• Examples of limited-supply products include
  land, office space, labor, Super Bowl tickets,
  and products sold by monopolies.
• Prices of limited-supply products can be
  excessive, even in the long run.