Introduction. Learning Objectives. Learning Objectives. Chapter 3. Demand and Supply. Explain the law of demand. Explain the law of supply

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1 Chapter Demand and Supply Introduction Newly-minted Ph.D. economists have faced a difficult job market for academic positions in recent years. This is because two factors have simultaneously increased the supply of economics instructors and decreased the demand for their services. Slide - Learning Objectives Learning Objectives Explain the law of demand Discuss the difference between money prices and relative prices Distinguish between a change in demand and a change in quantity demanded Explain the law of supply Distinguish between changes in supply and changes in quantity supplied Understand how supply and demand interact to determine equilibrium price and quantity Slide - Slide -

2 Chapter Outline Chapter Outline The Law of Demand The Demand Schedule Shifts in Demand The Law of Supply The Supply Schedule Shifts in Supply Putting Demand and Supply Together Slide - Slide -6 Did You Know That... Markets Even though overall prices trend steadily upwards, some prices hold steady or decline? The average price of a desktop personal computer has fallen by almost 0 percent? Demand and supply can explain most of relative price changes? Markets Arrangements that individuals have for exchanging with one another Represent the interaction of buyers and sellers Slide -7 Slide -8

3 Markets Markets Markets Markets for gasoline Markets for labor Stock market Market for Super Bowl tickets Compact disk market Markets Markets set the prices we pay and receive Slide -9 Slide -0 The Law of Demand The Law of Demand Demand Quantities of specific goods or services that individuals, taken singly or as a group, will purchase at various possible prices, other things being constant Law of Demand Quantity demanded is inversely related to price, all things equal Slide - Slide -

4 The Law of Demand The Law of Demand What are we holding constant? Income of other goods Many other factors Relative prices versus money prices Relative The price of a commodity in terms of another commodity Money we observe today in today s dollars (absolute, nominal price) Slide - Slide - Money versus Relative Example: per Constant-Quality Unit Money Relative Last Year This Year Last Year This Year Many products, for which you pay one price, contain many features. DVDs $0 $8 $0 $0 =.0 $8 $6 =.7 The right to return an item for a refund may be one feature that is included in the price. Videocassettes $0 $6 $0 $0 = 0. $6 = 0.7 $8 Some retailers now are finding ways to unbundle these various features, by offering consumers the option of paying extra if they wish to use them. Table - Slide - Slide -6

5 The Demand Schedule The Individual Demand Schedule The demand schedule is a table relating prices to quantity demanded. We must consider: The time dimension Constant-quality units Slide -7 Figure -, Panel (a) Slide -8 The Individual Demand Curve The Horizontal Summation of Two Demand Schedules Figure -, Panel (b) Slide -9 Figure -, Panel (a) Slide -0

6 The Horizontal Summation of Two Demand Schedules The Market Demand Schedule for Rewritable CD s Figure -, Panels (b), (c), (d) Slide - Figure -, Panel (a) Slide - The Market Demand Curve for Rewritable CD s Policy Example: Preventing Traffic Jams Expressways in Japan are subject to tolls. Increased toll rates in recent years have resulted in lower traffic volume. Figure -, Panel (b) Slide - Slide -

7 Shifts in Demand A Shift in the Demand Curve Scenario The federal government gives every student registered in college a rewritable CD drive to use with a personal computer. per Rewritable CD ($) Suppose the federal government gives every student a rewritable CD drive. D Increase in Demand D Slide - Figure - Slide -6 A Shift in the Demand Curve A Shift in the Demand Curve per Rewritable CD ($) Decrease in Demand D D Suppose universities prohibit the use of personal computers. D per Rewritable CD ($) a c When demand increases the quantity demanded will be greater at each price b D d D Figure - Slide -7 Figure - Slide -8

8 Shifts in Demand Shifts in Demand Determinants of demand Income Tastes and preferences The price of related goods Complements Substitutes Determinants of demand Expectations Future prices Income Product availability Market size (number of buyers) Slide -9 Slide -0 Shifts in Demand Shifts in Demand The Determinants of Demand Income: Normal Good The Determinants of Demand Income: Inferior Good Increase in income increases demand Decrease in income increases demand Decrease in income decreases demand D D D Increase in income decreases demand D D D Q/Units Slide - Q/Units Slide -

9 Shifts in Demand Shifts in Demand The Determinants of Demand Income: Tastes and Preferences Sport Utility Vehicle Increase in demand The Determinants of Demand of Related Goods: Substitutes Butter and Margarine of both = $/lb. of margarine increases to $/lb. Demand for butter increases Smoking Decrease in demand D D D D D Q/Units Slide - Q/Butter Slide - Shifts in Demand Shifts in Demand The Determinants of Demand of Related Goods: Complements The Determinants of Demand Expectations Speakers and Amplifiers Decrease the relative price of amplifiers Demand for speakers increases A higher income or expectations of a higher future price will increase demand Speakers and Amplifiers Increase the relative price of amplifiers Demand for speakers decreases D D D A lower income or expectations of a lower future price will decrease demand D D D Q/Speakers Slide - Q/Units Slide -6

10 Shifts in Demand Shifts in Demand The Determinants of Demand Population Increase in the population increases demand Changes in demand versus changes in quantity demanded A change in one or more of the non-price determinants (income, tastes, etc.) will lead to a change in demand. Decrease in population decreases demand This is a shift of the whole curve. D D D Q/Units Slide -7 Slide -8 Shifts in Demand Movement Along a Given Demand Curve Changes in demand versus changes in quantity demanded A change in a good s own price leads to a change in quantity demanded. This is a movement along the same curve. of Rewritable CDs($) Slide -9 Figure Slide -0

11 Movement Along a Given Demand Curve Movement Along a Given Demand Curve of Rewritable CDs($) A change in the price changes the quantity of a good demanded D of Rewritable CDs($) A change in the price changes the quantity of a good demanded D Figure - Slide - Figure - Slide - Movement Along a Given Demand Curve Example: Higher Honey s of Rewritable CDs($) A change in the price changes the quantity of a good demanded D 0 Honey prices more than doubled between 000 and 00. Many food manufacturers switched to other flavorings as a substitute. This shows that an increase in the price of honey led to an increase in the demand for a substitute good. Figure - Slide - Slide -

12 The Law of Supply The Law of Supply Supply The amount of a product or service that firms are willing to sell at alternative prices Law of Supply The price of a product or service and the quantity supplied are directly related Slide - Slide -6 The Supply Schedule The Individual Producer s Supply Schedule The supply schedule is a table relating prices to quantity supplied. Slide -7 Figure -6, Panel (a) Slide -8

13 The Individual Producer s Supply Curve Horizontal Summation of Supply Curves Figure -6, Panel (b) Slide -9 Figure -7, Panel (a) Slide -0 Horizontal Summation of Supply Curves The Market Supply Schedule for Rewritable CDs Figure -7, Panels (b), (c), (d) Slide - Figure -8, Panel (a) Slide -

14 The Market Supply Curve for Rewritable CDs Shifts in Supply Scenario A new method of manufacturing rewritable CDs reduces the cost of production by 0 percent. Figure -8, Panel (b) Slide - Slide - A Shift in the Supply Curve A Shift in the Supply Curve per Rewritable CD ($) S If some other factor than price changes, the only way we can show its effect is by moving the entire supply curve per Rewritable CD ($) S S If costs decrease, supply increases Figure -9 Slide - Figure -9 Slide -6

15 A Shift in the Supply Curve A Shift in the Supply Curve S per Rewritable CD ($) S S If costs increase, supply decreases per Rewritable CD ($) S When supply increases the quantity supplied will be greater at each price Figure -9 Slide -7 Figure -9 Slide -8 A Shift in the Supply Curve A Shift in the Supply Curve per Rewritable CD ($) c a S S When supply increases the quantity supplied will be greater at each price per Rewritable CD ($) c a d S b S When supply increases the quantity supplied will be greater at each price Figure -9 Slide -9 Figure -9 Slide -60

16 A Shift in the Supply Curve Policy Example: The Supply of New Housing per Rewritable CD ($) d b c a S S When supply decreases the quantity supplied will be less at each price Environmental regulations in California add to the costs of new housing construction. These higher costs serve to reduce the supply of new housing Figure -9 Slide -6 Slide -6 Shifts in Supply Shifts in Supply Determinants of supply Cost of inputs Technology and productivity Increase in cost decreases supply The Determinants of Supply Cost of Inputs S S S Taxes and subsidies expectations Decrease in cost increases supply Number of firms in industry Slide -6 Q/Units Slide -6

17 Shifts in Supply Shifts in Supply The Determinants of Supply Technology and Productivity Decreases in productivity decrease supply S S S Increases in taxes or decreases in subsidies decrease supply The Determinants of Supply Taxes and Subsidies S S S Improvements in technology or increases in productivity increase supply Decreases in taxes or increases in subsidies increase supply Q/Units Slide -6 Q/Units Slide -66 Shifts in Supply Shifts in Supply Expectations of higher future prices decrease supply The Determinants of Supply Expectations S S S Decrease in the number of firms decreases supply The Determinants of Supply Number of Firms in Industry S S S Expectations of lower future prices increase supply Increase in the number of firms increases supply Q/Units Slide -67 Q/Units Slide -68

18 Shifts in Supply Shifts in Supply Changes in supply versus changes in quantity supplied A change in one or more of the non-price determinants will lead to a change in supply. This is a shift of the whole curve. Changes in supply versus changes in quantity supplied A change in a good s own price leads to a change in quantity supplied. This is a movement along the same curve. Slide -69 Slide -70 Putting Demand and Supply Together Putting Demand and Supply Together per Rewritable CD($) A D Excess quantity demanded at price $ S Shortage At P = $: Q s (A) = < Q d (B) = 0 All prices below $ Q d > Q s will be pushed up B Quantity of Rewritable CDs Figure -0, Panel (a) Slide -7 Figure -0, Panel (b) Slide -7

19 Putting Demand and Supply Together Excess quantity supplied at price $ Putting Demand and Supply Together Excess quantity supplied at price $ per Rewritable CD($) D S Surplus At P = $: Q d (D) = < Q s (C) = 0 All prices above $ Q d < Q s will be pushed down D per Rewritable CD($) A D E D Excess quantity demanded at price $ S Equilibrium Market clearing, or equilibrium price B Quantity of Rewritable CDs Quantity of Rewritable CDs Figure -0, Panel (b) Slide -7 Figure -0, Panel (b) Slide -7 Equilibrium Putting Demand and Supply Together The situation when quantity supplied equals quantity demanded at a particular price Shortages Putting Demand and Supply Together The situation when quantity demanded is greater than quantity supplied Exists at any price below the equilibrium price Is not the same as scarcity Slide -7 Slide -76

20 Putting Demand and Supply Together Should Shortages in the Ticket Market Be Solved by Scalpers? Surpluses S The situation when quantity supplied is greater than quantity demanded Exists at any price above the equilibrium price per Ticket P P Excess quantity demanded (shortage at price P ) D Q Q Slide -77 Figure - Quantity of Super Bowl Tickets Slide -78 Example: Rail Transport s and Logjams Issues and Applications: Your Economics Instructor s Salary May Be Lagging A recent increase in the amount of grains ready for market led to a shortage of freight space on trains used for shipping. In response, freight rates rose. Both the quantity of grain to be shipped declined a bit, and the amount of rail cars available rose, eliminating the shortage. More students have pursued academic careers in economics, increasing the supply of instructors. The demand for all college professors has declined, as private colleges have lost endowment income and state universities have experienced funding cutbacks. The simultaneous increase in supply and decrease in demand has lowered salaries for economics instructors. Slide -79 Slide -80

21 Issues and Applications: Your Economics Instructor s Salary May Be Lagging Summary Discussion of Learning Objectives The law of demand says that prices and quantity demanded are inversely related. Relative prices must be distinguished from money, since people respond to changes in relative prices. Figure - Slide -8 Slide -8 Summary Discussion of Learning Objectives Summary Discussion of Learning Objectives A change in quantity demanded versus a change in demand A change in quantity demanded is a movement along the same demand curve A change in demand is a shift of the whole demand curve The law of supply states that price and quantity supplied are directly related. A change in quantity supplied versus a change in supply A change in quantity supplied is a movement along the same supply curve A change in supply is a shift of the whole supply curve Slide -8 Slide -8

22 Summary Discussion of Learning Objectives Determining market price and equilibrium quantity The demand and supply curves intersect at the equilibrium point. Shortages exist when the price of a good is below the market price. Surpluses exist if the price of the good is greater than the market price. End of Chapter Demand and Supply Slide -8

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