Transcript Chapter 3 - The Citadel

Chapter 3
Demand
and Supply
Introduction
They are small, thin and lightweight…
Some are not aware of their existence, while others
allocate a lot of time and effort in obtaining them.
What are they? They are sports trading cards.
Most can be purchased for a few dollars or less, but many
cost much more—up to thousands of dollars each!
In this chapter you will learn why the prices of different
sports trading cards can vary so widely.
Copyright © 2008 Pearson Addison Wesley. All rights reserved.
3-2
Learning Objectives
• Explain the law of demand
• Discuss the difference between money
prices and relative prices
• Distinguish between changes in demand
and changes in quantity demanded
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3-3
Learning Objectives (cont'd)
• 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
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3-4
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
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3-5
Did You Know That...
• The average price of an apartment-sized
condominium has often exceeded the
average price of a standalone house?
• The relative physical size of items does
not determine the prices at which people
exchange them for?
• By using demand and supply you can
develop a better understanding of why
relative size of an item typically has little
to do with the price at which it sells?
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3-6
Markets
• Markets
 Arrangements that individuals have for
exchanging with one another
 Represent the interaction of buyers and sellers for
goods and services
 Markets set the prices we pay and receive.
Automobile market
 Health care market
 Labor market
 Stock market

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3-7
The Law of Demand
• Demand
 A schedule showing how much of a good
or service people will purchase at any
price during a specified time period, other
things being constant
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3-8
The Law of Demand
• Law of Demand
 Quantity demanded is inversely related to
price, holding other factors constant.
 Price
#
Qd $
 Price
$
Qd #
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3-9
The Law of Demand (cont'd)
• What are we holding constant?
 Income
 Tastes and preferences
 Price of other goods
 Many other factors
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3-10
Relative Prices
versus Money Prices
• Relative prices and money prices
 Relative Price
 The
price of a commodity in terms of
another commodity
 Money Price
 Price
we observe today in today’s dollars
(absolute, or nominal price)
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3-11
Table 3-1 Money Price
versus Relative Price
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3-12
The Demand Schedule
• The demand schedule
 Table relating prices to quantity demanded
 We must consider
Time dimension
 Constant-quality units

• Demand Curve
 A graphical representation of the demand schedule
 Negatively sloped line showing inverse
relationship between price and quantity
demanded, all else equal
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3-13
Figure 3-1 The Individual Demand
Schedule and the Individual Demand
Curve, Panel (a)
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3-14
Figure 3-1 The Individual Demand
Schedule and the Individual Demand
Curve, Panel (b)
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3-15
E-Commerce Example:
Why RFID Tags Are Catching On Fast
• An RFID tag contains a tiny microchip
and a radio antenna that emits a signal for
tracking items.
• The price of an RFID tag has gone from 30
cents down to 15 cents, and is expected to
go even lower, closer to 5 cents.
• Why do you think the European Central Bank
is contemplating putting RFID tags in smaller
denomination euro notes?
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3-16
The Demand Schedule
• Individual versus market demand curves
• Market Demand
 The demand of all consumers in the
marketplace for a particular good or service
 Summation at each price of the quantity
demanded by each individual
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3-17
Figure 3-2 The Horizontal Summation of
Two Demand Curves, Panel (a)
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3-18
Figure 3-2 The Horizontal Summation of
Two Demand Curves, Panels (b), (c), (d)
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3-19
Figure 3-3 The Market Demand
Schedule for Flash Memory Pen
Drives, Panel (a)
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3-20
Figure 3-3 The Market Demand
Schedule for Flash Memory Pen
Drives, Panel (b)
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3-21
Shifts in Demand
• Scenario
 Imagine the federal government gives
every student registered in a college,
university, or technical school in the United
States a notebook computer.
 If
some factor other than price changes, we
can show its effect by moving the entire
demand curve, shifting the curve left or right.
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3-22
Figure 3-4
A Shift in the Demand Curve
Suppose universities
prohibit the use of
notebook computers
Suppose the federal
government gives
every student a
notebook computer
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3-23
Determinants of Demand
• Ceteris-Paribus Conditions
 Determinants of the relationship between
price and quantity that are unchanged
along a curve
 Changes in these factors cause a curve
to shift
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3-24
Normal and Inferior Goods
• Normal Goods
 Goods for which demand rises as income
rises, most goods are normal goods
• Inferior Goods
 Goods for which demand falls as
income rises
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3-25
Shifts in Demand
• Determinants of demand
 Income
 Tastes and preferences
 The prices of related goods
 Substitutes
 Complements
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3-26
Shifts in Demand (cont'd)
• Substitutes
 Two goods are substitutes when a change
in the price of one causes a shift in
demand for the other in the same direction
as the price change.
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3-27
Example: Kids Give Barbie Dolls
and Legos the Boot
• Barbie dolls and Lego building blocks were among
the most popular toys for many years.
• Since the early 2000s, annual purchases of such
toys have fallen by as much as 25%.
• At the same time, prices of substitute forms of
entertainment, such as video games and computer
software, have declined.
• In what direction do you think the demand curve for
toys has shifted as the prices of substitute forms of
entertainment have declined?
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3-28
Shifts in Demand (cont'd)
• Complements
 Two goods are complements when a
change in the price of one causes an
opposite shift in the demand curve for
the other.
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3-29
Shifts in Demand (cont'd)
• Determinants of demand
 Expectations
 Future
prices
 Income
 Product
availability
 Market size (number of buyers)
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3-30
Shifts in Demand (cont'd)
The Determinants of Demand
Income: Normal Good
Price
Increase in income
increases demand
Decrease in income
decreases demand
D3
D1
D2
Q/Units
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3-31
Shifts in Demand (cont'd)
The Determinants of Demand
Income: Inferior Good
Price
Decrease in income
increases demand
Increase in income
decreases demand
D3
D1
D2
Q/Units
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3-32
Shifts in Demand (cont'd)
The Determinants of Demand
Tastes and Preferences
Price
Hybrid vehicles
• Increase in demand
SUVs
• Decrease in demand
D3
D1
D2
Q/Units
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3-33
Shifts in Demand (cont'd)
The Determinants of Demand
Price of Related Goods: Substitutes
Price
Butter and Margarine
• Price of both = $2/lb
• Price of margarine
increases to $3/lb
• Demand for butter
increases
D1
D2
Q/Butter
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3-34
Shifts in Demand (cont'd)
The Determinants of Demand
Price of Related Goods: Complements
Price
Speakers and Amplifiers
• Decrease the relative
price of amplifiers
• Demand for speakers
increases
Speakers and Amplifiers
• Increase the relative
price of amplifiers
• Demand for speakers
decreases
D3
D1
D2
Q/Speakers
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3-35
Shifts in Demand (cont'd)
The Determinants of Demand
Expectations: Income, Future Prices
Price
A higher income or
expectations of a higher future
price will increase demand
A lower income or
expectations of a lower future
price will decrease demand
D3
D1
D2
Q/Units
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3-36
Shifts in Demand (cont'd)
The Determinants of Demand
Market Size (Number of Buyers)
Price
Increase in the
number of buyers
increases demand
Decrease in the
number of buyers
decreases demand
D3
D1
D2
Q/Units
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3-37
Shifts in Demand (cont'd)
• 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.
 This
is a shift of the whole curve.
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3-38
Shifts in Demand (cont'd)
• 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.
∆D is not the same as ∆Qd.
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3-39
Figure 3-5 Movement Along a
Given Demand Curve
A change in the price
changes the quantity
of a good demanded,
movement along the curve
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3-40
The Law of Supply
• Supply
 Schedule showing relationship between
price and quantity supplied for a specified
time period, other things being equal
 The amount of a product or service that
firms are willing to sell at alternative prices
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3-41
The Law of Supply (cont'd)
• Law of Supply
 The price of a product or service and the
quantity supplied are directly related.
P
# Qs #
P
$ Qs $
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3-42
The Supply Schedule
• The supply schedule is a table relating
prices to quantity supplied at each price.
• Supply Curve
 A graphical representation of the
supply schedule
 Positively sloped line showing direct
relationship between price and quantity
supplied, all else equal
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3-43
Figure 3-6 The Individual Producer’s
Supply Schedule and Supply Curve for
Flash Memory Pen Drives, Panel (a)
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3-44
Figure 3-6 The Individual Producer’s
Supply Schedule and Supply Curve for
Flash Memory Pen Drives, Panel (b)
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3-45
Figure 3-7 Horizontal Summation of
Supply Curves, Panel (a)
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3-46
Figure 3-7 Horizontal Summation of
Supply Curves, Panels (b), (c), (d)
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3-47
Figure 3-8 The Market Supply Schedule
and the Market Supply Curve for Flash
Memory Pen Drives, Panel (a)
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3-48
Figure 3-8 The Market Supply Schedule
and the Market Supply Curve for Flash
Memory Pen Drives, Panel (b)
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3-49
Shifts in Supply
• Scenario
 A new method of manufacturing flash
memory pen drives reduces the cost of
production dramatically.
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3-50
Figure 3-9
A Shift in the Supply Curve
If some other factor than
price changes,
the only
If costs increase,
way wesupply
can show
its
decreases
effect is by moving the
entire supply curve
If costs decrease,
supply increases
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3-51
Price per Flash Memory Pen Drive ($)
Figure 3-9
A Shift in the Supply Curve (cont'd)
5
S2
S1
a
4
c
When supply increases
the quantity supplied will
be greater at each price
3
2
1
0
2
4
6
8
10
12
14
Quantity of Flash Memory Pen Drives Supplied
(millions of constant-quality units per year)
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3-52
Price per Flash Memory Pen Drive ($)
Figure 3-9
A Shift in the Supply Curve (cont'd)
5
S2
S1
a
4
b
c
3
When supply increases
the quantity supplied will
be greater at each price
d
2
1
0
2
4
6
8
10
12
14
Quantity of Flash Memory Pen Drives Supplied
(millions of constant-quality units per year)
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3-53
Price per Flash Memory Pen Drive ($)
Figure 3-9
A Shift in the Supply Curve (cont'd)
S3
5
S1
b
4
d
a
When supply decreases
the quantity supplied will
be less at each price
c
3
2
1
0
2
4
6
8
10
12
14
Quantity of Flash Memory Pen Drives Supplied
(millions of constant-quality units per year)
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3-54
Shifts in Supply (cont'd)
• Determinants of supply
 Cost of inputs
 Technology and productivity
 Taxes and subsidies
 Price expectations
 Number of firms in industry
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3-55
Shifts in Supply (cont'd)
The Determinants of Supply
Cost of Inputs
Price
Increase in cost
decreases supply
S3
S1
S2
Decrease in cost
increases supply
Q/Units
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3-56
Shifts in Supply (cont'd)
The Determinants of Supply
Technology and Productivity
Price
S3
S1
S2
Decreases in productivity
decrease supply
Improvements in technology or
increases in productivity
increase supply
Q/Units
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3-57
Shifts in Supply (cont'd)
The Determinants of Supply
Taxes and Subsidies
Price
S3
S1
S2
Increases in taxes or
decreases in subsidies
decrease supply
Decreases in taxes or
increases in subsidies
increase supply
Q/Units
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3-58
Policy Example: Import Restrictions
Reduce the Supply of Cement
• U.S. cement manufacturers produce more than 80
million metric tons of cement per year.
• The rest of the cement supplied—15 to 20 million
metric tons—is imported, much of it from Mexico.
• During the 1990s the U.S. government began
imposing an import duty on Mexican cement.
• The continuation of this tariff during the 2000s
caused Mexican producers to limit sales to the
United States at any given price, reducing the U.S.
supply of cement.
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3-59
Shifts in Supply (cont'd)
The Determinants of Supply
Price Expectations
Price
Expectations of higher
future prices decrease
supply
S3
S1
S2
Expectations of lower
future prices increase
supply
Q/Units
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3-60
Shifts in Supply (cont'd)
The Determinants of Supply
Number of Firms in Industry
Price
Decrease in the
number of firms
decreases supply
S3
S1
S2
Increase in the
number of firms
increases supply
Q/Units
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3-61
Shifts in Supply (cont'd)
• 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.
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3-62
Shifts in Supply (cont'd)
• 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.
∆S is not the same as ∆Qs.
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3-63
Putting Demand
and Supply Together
• Putting demand and supply together
• Equilibrium (Market Clearing) Price
 The price that clears the market
 The price at which quantity demanded
equals quantity supplied
 The price where the demand curve
intersects the supply curve
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3-64
Figure 3-10 Putting Demand and
Supply Together, Panel (a)
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3-65
Figure 3-10 Putting Demand and
Supply Together, Panel (b)
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3-66
Putting Demand
and Supply Together (cont'd)
• Equilibrium
 The situation when quantity supplied
equals quantity demanded at a
particular price
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3-67
Putting Demand
and Supply Together (cont'd)
• Shortages
 The situation when quantity demanded is
greater than quantity supplied
 Qd
> Qs
 Exist at any price below the market
clearing price
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3-68
Putting Demand
and Supply Together (cont'd)
• Surpluses
 The situation when quantity supplied is
greater than quantity demanded
 Qd
< Qs
 Exist at any price above the market
clearing price
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3-69
Policy Example: Should Shortages in the
Ticket Market Be Solved by Scalpers?
• If you’ve ever tried to get tickets
to the big game you know all
about “shortages.”
• Since the quantity of tickets is fixed, the
price can go pretty high.
• Enter the scalper.
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3-70
Figure 3-11
Shortages of Super Bowl Tickets
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3-71
Issues and Applications: The Market
Clearing Prices of Baseball Cards
• Various companies, such as Topps and Upper Deck,
print sports trading cards that provide photos and
stats on pro athletes.
• Why are some of the market clearing prices so high?
• The answer has to do with demand and supply.
(A relatively low supply helps explain the relatively
high market clearing price.)
• You can buy a “Shoeless” Joe Jackson card for up
to $9,000!
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3-72
Table 3-2 Baseball Cards with the
Highest Market Clearing Prices
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3-73
Summary Discussion
of Learning Objectives
• The law of demand says that prices
and quantity demanded are
inversely related.
 At a higher price people buy less, at a
lower price people buy more.
• Relative prices must be distinguished
from money prices, since people
respond to changes in relative prices.
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3-74
Summary Discussion
of Learning Objectives (cont'd)
• 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.
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3-75
Summary Discussion
of Learning Objectives (cont'd)
• The law of supply states that price and
quantity supplied are directly related.
 At a high price firms offer more; at a low price
firms offer less.
• 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.
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3-76
Summary Discussion
of Learning Objectives (cont'd)
• Determining market price and
equilibrium quantity
 The demand and supply curves intersect
at the market clearing, or equilibrium point.
 Surpluses exist if the price of the good is
greater than the market price.
 Shortages exist when the price of a good
is below the market price.
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3-77
End of
Chapter 3
Demand
and Supply