Transcript McGraw-Hill/Irwin

Chapter 4
DEMAND
AND
SUPPLY
McGraw-Hill/Irwin
Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.
4-2
Today’s lecture will:
• Introduce the law of demand and draw a
•
•
•
demand curve.
Explain the importance of substitution in
the laws of supply and demand.
Distinguish between a change in
demand (shift in the curve) and a change
in quantity demanded (movement along
the demand curve).
Explain the law of supply and construct
a supply curve.
McGraw-Hill/Irwin
Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.
4-3
Today’s lecture will:
•
•
•
•
Distinguish between a change in supply (shift
in the curve) and a change in quantity supplied
(movement along the supply curve).
Explain how the laws of supply and demand
interact to bring about equilibrium.
Show the effect of shifts in demand and supply
on equilibrium price and quantity.
Explore the limitations of demand and supply
analysis.
McGraw-Hill/Irwin
Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.
4-4
The Law of Demand
• Law of demand – there is an inverse
•
relationship between price and quantity
demanded.
Other things equal:
 Quantity demanded rises as price falls
 Quantity demanded falls as price rises
• Law of demand is based on the fact that
people substitute for goods whose price
increases.
McGraw-Hill/Irwin
Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.
4-5
The Demand Curve
•
•
The demand curve is
the graphic
representation of the
law of demand.
The demand curve
slopes downward and
to the right.
As price goes up, the
quantity demanded
goes down.
PB
Price (per unit)
•
B
A
PA
D
0
QB
QA
Quantity demanded
(per unit of time)
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Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.
4-6
Other Things Constant
• Other things constant places a limitation
•
on the application of the law of demand.
All other factors, such as changing
tastes, prices of other goods, income,
and even the weather, are assumed to
remain constant, whether they actually
remain constant or not.
McGraw-Hill/Irwin
Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.
4-7
Quantity Demanded
Versus Demand
•
•
•
Quantity demanded refers to a specific
amount that will be demanded per unit of
time at a specific price.
Quantity demanded refers to a specific
point on the demand curve.
A change in quantity demanded, caused
only by a change in the price of the good
itself, is shown by a movement along a
demand curve.
McGraw-Hill/Irwin
Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.
4-8
Quantity Demanded
Versus Demand
• Demand refers to a schedule of
•
•
quantities of a good that will be bought
per unit of time at various prices, other
things constant.
It refers to the entire demand curve.
A change in demand, caused by
anything other than the good’s own
price, is shown by a shift in the demand
curve.
McGraw-Hill/Irwin
Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.
4-9
Change in quantity
demanded
$2
B
A
$1
0
D1
100
200
Quantity demanded
(per unit of time)
McGraw-Hill/Irwin
Price (per 50 miles)
Price (per 50 miles)
Quantity Demanded
Versus Demand
Change in
demand
$2
B
$1
A
D0
D1
200
100
Quantity demanded
(per unit of time)
Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.
4-10
Shift Factors of Demand
• Shift factors of demand are factors
•
that cause changes in demand (shifts
in the demand curve).
Society’s Income
 An increase in income will increase
demand for normal goods.
 An increase in income will decrease
demand for inferior goods.
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Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.
4-11
Shift Factors of Demand
• Prices of Other Goods
 When the price of a substitute good falls,
demand falls for the good whose price has
not changed.
 When the price of a complement good falls,
demand rises for the good whose price has
not changed.
• Tastes
 A change in taste will change demand with
no change in price.
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4-12
Shift Factors of Demand
• Expectations
 If you expect your income to rise, you
may consume more now.
 If you expect prices to fall in the future,
you may put off purchases today.
• Taxes and Subsidies
 Taxes increase the cost of goods,
thereby reducing demand.
 Subsidies have an opposite effect.
McGraw-Hill/Irwin
Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.
4-13
The Demand Table
• The demand table assumes:
 As price rises, quantity demanded
declines.
 Quantity demanded has a specific time
dimension to it.
 All the products involved are identical in
shape, size, quality, etc.
 Everything else is constant.
McGraw-Hill/Irwin
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4-14
A Demand Table
Price per
cassette
A
B
C
D
E
$0.50
1.00
2.00
3.00
4.00
McGraw-Hill/Irwin
DVD rentals
demanded per
week
9
8
6
4
2
Price per DVDs (in dollars)
From a Demand Table
to a Demand Curve
$6.00
A Demand Curve
5.00
4.00
3.50
3.00
2.00
1.00
.50
0
E
D
G
Demand
for DVDs
C
F
B
A
1 2 3 4 5 6 7 8 9 10 111213
Quantity of DVDs demanded (per
week)
Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.
4-15
Price per + Alice’s Bruce’s Cathy’s Market
cassette demand + demand+ demand = demand
A $.0.50
B
1.00
C
1.50
D
2.00
E
2.50
F
3.00
G
3.50
H
4.00
9
8
7
6
5
4
3
2
6
5
4
3
2
1
0
0
1
1
0
0
0
0
0
0
16
14
11
9
7
5
3
2
Price per cassette (in dollars)
Individual and Market
Demand Curves
$4.00
3.50
G
F
3.00
E
2.50
D
2.00
C
1.50
B
1.00
0.50
0
A
Cathy
BruceAlice
2 4 6 8 10 12 14 16
Quantity of cassettes
demanded per week
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4-16
The Law of Supply
•
•
•
There is a direct relationship between price and
quantity supplied.
Other things constant:
 Quantity supplied rises as price rises.
 Quantity supplied falls as price falls.
The law of supply occurs because:
 When prices rise, firms substitute production of one
good for another.
 Assuming firms’ costs are constant, a higher price
means higher profits.
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Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.
4-17
•
•
•
The supply curve is
the graphic
representation of
the law of supply.
The supply curve
slopes upward to
the right because
quantity supplied
varies directly with
price.
As price increases,
the quantity
supplied increases.
McGraw-Hill/Irwin
Price (per unit)
The Supply Curve
S
B
PB
PA
0
A
QA
QB
Quantity supplied
(per unit of time)
Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.
4-18
Quantity Supplied Versus Supply
•
•
•
Quantity supplied refers to a specific
amount that will be supplied at a specific
price.
Quantity supplied refers to a specific point
on the supply curve.
A change in quantity supplied, caused
only by a change in the price of the good
itself, is shown by a movement along the
supply curve.
McGraw-Hill/Irwin
Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.
4-19
Quantity Supplied Versus Supply
• Supply refers to a schedule of quantities
•
•
a seller is willing to sell per unit of time
at various prices, other things constant.
Supply refers to the whole supply curve.
A change in supply, caused by anything
other than the good’s price, is shown by
a shift in the supply curve.
McGraw-Hill/Irwin
Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.
4-20
S0
B
$36
$15
A
Change in
quantity
supplied
$15
Change in
Supply
A
S0
S1
B
1700 1800
1700 1900
Barrels per year (millions)
McGraw-Hill/Irwin
Price (per barrel)
Price (per barrel)
Quantity Supplied Versus Supply
Barrels per year (millions)
Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.
4-21
Shift Factors of Supply
•
•
•
Shift factors of supply are factors that cause
changes in supply (shifts in the supply curve).
Price of Inputs
 When costs go up, profits go down, so that the
incentive to supply also goes down.
Technology
 Advances in technology reduce the number of inputs
needed to produce a given supply of goods,
decreasing costs, increasing profits, leading to
increased supply.
McGraw-Hill/Irwin
Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.
4-22
Shift Factors of Supply
• Expectations
 If suppliers expect prices to rise in the
future, they may store today’s supply to sell
later, decreasing supply now.
• Taxes and Subsidies
 When taxes increase, costs go up, and
profits go down, causing a decrease in
supply.
 When subsidies increase, costs decrease,
and profits increase, leading to an increase
in supply.
McGraw-Hill/Irwin
Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.
4-23
Individual and Market Supply
Market
Price
Ann + Barry + Charlie = supply
(per DVD)
A
B
C
D
E
F
G
H
I
$0.00
0.50
1.00
1.50
2.00
2.50
3.00
3.50
4.00
0
1
2
3
4
5
6
7
8
0
0
1
2
3
4
5
5
5
0
0
0
0
0
0
0
2
2
0 $4.00
1 3.50
3
5 3.00
7 2.50
9 2.00
11
1.50
14
15 1.00
Charlie Barry
0.50
0 A1
Ann
Market
Supply
I
H
G
F
E
D
C
B CA
2
3 4 5 6
7 8 9 10 11 12 13 14 15 16
Quantity of DVDs supplied (per week)
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4-24
Equilibrium
• Equilibrium is a concept in which
•
opposing forces cancel each other out.
In a free market, the forces of supply and
demand interact to determine:
 Equilibrium price – the price toward which
the invisible hand drives the market.
 Equilibrium quantity – the amount bought
and sold at the equilibrium price.
McGraw-Hill/Irwin
Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.
4-25
Equilibrium
•
•
•
•
When the market is not in equilibrium, there is
either excess demand or excess supply.
Excess supply – a surplus, the quantity
supplied is greater than the quantity
demanded, and prices fall.
Excess demand – a shortage, the quantity
demanded is greater than the quantity
supplied, and prices rise.
When quantity demanded equals quantity
supplied, prices have no tendency to change.
McGraw-Hill/Irwin
Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.
4-26
Equilibrium
Price
(per DVD)
$3.50
QS
7
QD
3
Surplus(+)
Shortage (-)
+4
$2.50
5
5
0
$1.50
3
7
-4
Price per DVD
$5.00
Excess supply
4.00
3.50
S
A
3.00
E
2.50
C
2.00
1.50
Excess demand
1.00
1
2
3
4
5
6 7
D
8
Quantity of DVDs supplied and
demanded (per week)
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4-27
Shifts in Supply and Demand
• Shifts in either supply or demand
•
change equilibrium price.
An increase in demand or a decrease
in supply:
 Creates excess demand at the original
equilibrium price.
 Excess demand increases price until a
new higher equilibrium price and
quantity are reached.
McGraw-Hill/Irwin
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4-28
Increase in Demand
S0
B
$2.50
Excess demand
A
2.25
D0
0
McGraw-Hill/Irwin
D1
8
9
10
Quantity of DVDs (per week)
Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.
4-29
Decrease in Supply
S1
S0
C
$2.50
2.25
B
Excess demand
A
D0
0
McGraw-Hill/Irwin
8
9
10
Quantity of DVDs (per week)
Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.
4-30
Limitations of Supply and
Demand Analysis
• Sometimes supply and demand are
•
•
interconnected.
The other things constant assumption is
likely not to hold when the goods
represent a large percentage of the
entire economy.
The fallacy of composition is the false
assumption that what is true for a part
will also be true for the whole.
McGraw-Hill/Irwin
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4-31
Summary
• The law of demand states that the
•
•
quantity demanded rises as price
falls, other things constant.
The law of supply states that the
quantity supplied rises as price rises,
other things constant.
The laws of demand and supply hold
true because people can substitute.
McGraw-Hill/Irwin
Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.
4-32
Summary
• A change in quantity demanded
•
•
(supplied), caused only by a change in
the good’s own price, is a movement
along the demand (supply) curve.
A change in demand (supply) is a shift of
the entire demand (supply) curve.
Factors that affect supply and demand
other than price are called shift factors.
McGraw-Hill/Irwin
Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.
4-33
Summary
Shift Factors of Demand
Shift Factors of Supply
Income
Price of Inputs
Prices of Other Goods
Technology
Tastes
Expectations
Expectations
Taxes and Subsidies on
Producers
Taxes and Subsidies on
Consumers
McGraw-Hill/Irwin
Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.
4-34
Summary
•
•
•
•
A market demand (supply) curve is the
horizontal sum of all individual demand
(supply) curves.
When quantity demanded equals quantity
supplied at equilibrium, prices have no
tendency to change.
When quantity demanded > quantity supplied,
prices tend to rise.
When quantity supplied > quantity demanded,
prices tend to fall.
McGraw-Hill/Irwin
Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.
4-35
Summary
• When the demand curve shifts to the
•
right (left), equilibrium price rises
(declines) and equilibrium quantity
rises (falls).
When the supply curve shifts to the
right (left), equilibrium price declines
(rises) and equilibrium quantity rises
(falls).
McGraw-Hill/Irwin
Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.
4-36
Given the following demand and supply of pizza:
Price
per Pizza
Quantity
Supplied
Quantity
Demanded
$8
200
60
7
150
80
6
100
100
5
50
120
4
0
140
Review Question 4-1 What is the equilibrium price and quantity?
Equilibrium price is $6 and equilibrium quantity is 100 pizzas.
Review Question 4-2 If the price is $7, is there a shortage or surplus?
How much is the shortage or surplus? Explain how the market will
return to equilibrium.
At a price of $7, there is a surplus of 150 - 80 = 70 pizzas. Producers
will reduce the price in order to sell the surplus. As price decreases,
quantity demanded increases until the surplus is eliminated at the
equilibrium price of $6.
McGraw-Hill/Irwin
Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.