Supply, Demand, and the Market Process Chapter 3

Chapter 3 Objectives Describe consumer behavior. Separate the difference between a change in demand and a change in quantity demanded. Describe firm behavior. Separate the difference between a change in supply and a change in quantity supplied. Investigate how a market establishes an equilibrium price.

The Law of Demand There is an inverse relationship between the price of a good and the quantity of it buyers are willing and able to purchase When the price rises, quantity demanded falls When the price falls, quantity demanded rises Ceteris paribus!

The Market Demand Schedule Quantity demanded – the number that people are willing and able to buy at each price Pizza Demand Schedule Price Quantity Demanded $20 10 16 60 12 110 8 160 4 210

The Market Demand Curve Pizza Demand Schedule Pizza Demand Curve Price Quantity Demanded $20 10 16 60 12 110 8 160 4 210

The Demand Curve: A Tell All Story about Consumers How much do consumers value the good? Max amount willing to buy at any given price Consumers value additional units less

Consumer Surplus Consumer Surplus – the difference between the maximum price consumers are willing to pay and the price they actually pay. Represents the net benefit of buying the good. Example: You’re willing to pay $25 for a shirt. You buy it for $15. Your consumer surplus is $25 - $15 = $10.

Consumer Surplus On a graph, consumer surplus is the area below the demand curve and above the price Price P1 Demand Q1 Quantity

Consumer Surplus Marginal value – height of demand curve at each quantity Total value – the combined value of all units purchased Price P1 Demand Q1 Quantity

Consumer Surplus Lower price  more consumer surplus Higher price  less consumer surplus Consume good until Price = Marginal Value Price reflects marginal value, not total value

Substitutes Products that serve similar purposes

Elastic and Inelastic Demand Many substitutes are available Quantity demanded is quite responsive to a change in price The demand curve is relatively flat (but still downward sloping) Red Nike Running Shoes Price Demand Quantity

Elastic and Inelastic Demand Few substitutes are available Quantity demanded is not very responsive to a change in price The demand curve is relatively steep (but still downward sloping) Econ Text Price Demand Quantity

Change in Quantity Demanded vs. Change in Demand Increase in Quantity Demanded Increase in Demand Price Price D2 D1 Q1 Q2 Quantity Quantity

Change in Quantity Demanded vs. Change in Demand Decrease in Quantity Demanded Decrease in Demand Price Price D1 D2 Q2 Q1 Quantity Quantity

Change in Quantity Demanded vs. Change in Demand Change in Quantity Demanded: caused by a change in the price of the good. Change in Demand: caused by changes in factors other than a good’s price that influence consumer decisions Consumer income Number of consumers Price of related goods Expectations Demographics Tastes and preferences

Demand Shifter #1 Change in Consumer Income For most goods, An increase in income leads to an increase in demand for the good A decrease in income leads to a decrease in demand for the good Examples: food, clothing, housing

Demand Shifter #2 Changes in the Number of Consumers in the Market When the number of consumers increases, demand increases falls, demand decreases

Demand Shifter # 3 Changes in Prices of Related Goods Substitutes -- goods that perform similar functions or fulfill similar needs When the price of a substitute changes, the demand for the other good is impacted

Demand Shifter # 3 Changes in Prices of Related Goods An increase in the price of one substitute good leads to an increase in the demand for the other An decrease in the price of one substitute good leads to an decrease in the demand for the other Prices of substitutes move in the same direction

Demand Shifter # 3 Changes in Prices of Related Goods Complements -- products consumed jointly When the price of a complement changes, the demand for the other good is impacted

Demand Shifter # 3 Changes in Prices of Related Goods An increase in the price of one complement good leads to an decrease in the demand for the other An decrease in the price of one complement good leads to an increase in the demand for the other Prices of complements move in opposite directions

Complements or Substitutes?

Demand Shifter # 4 Changes in Consumer Expectations Expectations about the future can shift demand curves in the present Expect rain tomorrow, demand for umbrellas increases today. Expect a raise in the future, demand for clothing increases today.

Demand Shifter # 5 Demographic Changes Changes in sex, race, or age of population change demand for certain goods

Demand Shifter #6 Changes in Consumer Tastes and Preferences Tastes and preferences change due to changes in trends, information, and people