The Market Forces of Supply and Demand 4 The Market Forces of Supply and Demand N. Gregory Mankiw This is perhaps the most important chapter in the textbook. It’s worth mentioning to your students that investing extra time to master this chapter will make it easier for them to learn much of the subsequent material in the book. This is also one of the longest chapters in the textbook, and this PowerPoint file is one of the most graph-intensive. Many students taking economics for the first time have difficulty grasping the graphs, which are critically important in this and all subsequent chapters in the book. So an extra degree of hand-holding might be appropriate. Accordingly, this PowerPoint has carefully detailed animations that build many of the graphs with great care. For example, we show a demand or supply schedule next to the axes, and highlight each coordinate pair in the table as the corresponding point appears on the graph. Please be assured that the presentation of graphs is more streamlined in subsequent chapters. In this early chapter, though, we do not want to leave any students behind. If your students are already very comfortable with scatter-type graphs, you may wish to simplify or turn off the animation on these slides, in order to get through them faster. Premium PowerPoint Slides by Ron Cronovich

Quantity of lattes supplied The Supply Schedule Price of lattes Quantity of lattes supplied $0.00 1.00 3 2.00 6 3.00 9 4.00 12 5.00 15 6.00 18 Supply schedule: A table that shows the relationship between the price of a good and the quantity supplied. Example: Starbucks’ supply of lattes. Notice that Starbucks’ supply schedule obeys the Law of Supply. THE MARKET FORCES OF SUPPLY AND DEMAND 1

Starbucks’ Supply Schedule & Curve Price of lattes Quantity of lattes supplied $0.00 1.00 3 2.00 6 3.00 9 4.00 12 5.00 15 6.00 18 P Q THE MARKET FORCES OF SUPPLY AND DEMAND 2

Market Supply versus Individual Supply The quantity supplied in the market is the sum of the quantities supplied by all sellers at each price. Suppose Starbucks and Jitters are the only two sellers in this market. (Qs = quantity supplied) $0.00 6.00 5.00 4.00 3.00 2.00 1.00 Price 18 15 12 9 6 3 Starbucks 12 10 8 6 4 2 Jitters Market Qs + = + = 5 + = 10 Again, the assumption of only two sellers is a clear violation of perfect competition. However, it’s much easier for students to learn how the market supply curve relates to individual supplies in the two-seller case. + = 30 25 20 15 3 3

The Market Supply Curve P QS (Market) $0.00 1.00 5 2.00 10 3.00 15 4.00 20 5.00 25 6.00 30 P Q THE MARKET FORCES OF SUPPLY AND DEMAND 4

Supply Curve Shifters The supply curve shows how price affects quantity supplied, other things being equal. These “other things” are non-price determinants of supply. Changes in them shift the S curve… “Non-price determinants of supply” simply means the things – other than the price of a good – that determine sellers’ supply of the good. THE MARKET FORCES OF SUPPLY AND DEMAND 5

Supply Curve Shifters: Input Prices Examples of input prices: wages, prices of raw materials. A fall in input prices makes production more profitable at each output price, so firms supply a larger quantity at each price, and the S curve shifts to the right. In the second bullet point, “output price” just means the price of the good that firms are producing and selling. I have used “output price” here to distinguish it from “input prices.” THE MARKET FORCES OF SUPPLY AND DEMAND 6

Supply Curve Shifters: Input Prices P Q Suppose the price of milk falls. At each price, the quantity of Lattes supplied will increase (by 5 in this example). Again, the animation here is carefully designed to help make clear that a shift in the supply curve means that there is a change in the quantity supplied at each possible price. If it seems tedious, you can turn it off. In any case, be assured that, by the end of this chapter, the animation of curve shifts will be streamlined and simplified. THE MARKET FORCES OF SUPPLY AND DEMAND 7

Supply Curve Shifters: Technology Technology determines how much inputs are required to produce a unit of output. A cost-saving technological improvement has the same effect as a fall in input prices, shifts S curve to the right. THE MARKET FORCES OF SUPPLY AND DEMAND 8

Supply Curve Shifters: # of Sellers An increase in the number of sellers increases the quantity supplied at each price, shifts S curve to the right. THE MARKET FORCES OF SUPPLY AND DEMAND 9

Supply Curve Shifters: Expectations Example: Events in the Middle East lead to expectations of higher oil prices. In response, owners of Texas oilfields reduce supply now, save some inventory to sell later at the higher price. S curve shifts left. In general, sellers may adjust supply* when their expectations of future prices change. (*If good not perishable) THE MARKET FORCES OF SUPPLY AND DEMAND 10

Summary: Variables that Influence Sellers Variable A change in this variable… Price …causes a movement along the S curve Input Prices …shifts the S curve Technology …shifts the S curve # of Sellers …shifts the S curve Expectations …shifts the S curve THE MARKET FORCES OF SUPPLY AND DEMAND 11

A C T I V E L E A R N I N G 2 Supply Curve Draw a supply curve for tax return preparation software. What happens to it in each of the following scenarios? A. Retailers cut the price of the software. B. A technological advance allows the software to be produced at lower cost. C. Professional tax return preparers raise the price of the services they provide. “Tax return preparation software” means programs like TurboTax by Quicken and TaxCut by H&R Block. 12

A C T I V E L E A R N I N G 2 A. Fall in price of tax return software Quantity of tax return software S curve does not shift. Move down along the curve to a lower P and lower Q. S1 P1 Q1 Q2 P2 13

S curve shifts to the right: at each price, Q increases. A C T I V E L E A R N I N G 2 B. Fall in cost of producing the software Price of tax return software S curve shifts to the right: at each price, Q increases. S2 S1 P1 Q2 Q1 Quantity of tax return software 14

A C T I V E L E A R N I N G 3 C. Professional preparers raise their price Price of tax return software Quantity of tax return software S1 This shifts the demand curve for tax preparation software, not the supply curve. 15

Supply and Demand Together P Q Equilibrium: P has reached the level where quantity supplied equals quantity demanded S D We now return to the latte example to illustrate the concepts of equilibrium, shortage and surplus. THE MARKET FORCES OF SUPPLY AND DEMAND 16

Equilibrium price: the price that equates quantity supplied with quantity demanded P Q S D P QD QS $0 24 1 21 5 2 18 10 3 15 4 12 20 9 25 6 30 THE MARKET FORCES OF SUPPLY AND DEMAND 17

Equilibrium quantity: the quantity supplied and quantity demanded at the equilibrium price P Q S D P QD QS $0 24 1 21 5 2 18 10 3 15 4 12 20 9 25 6 30 THE MARKET FORCES OF SUPPLY AND DEMAND 18

Surplus (a.k.a. excess supply): when quantity supplied is greater than quantity demanded P Q Example: If P = $5, S D Surplus then QD = 9 lattes and QS = 25 lattes resulting in a surplus of 16 lattes THE MARKET FORCES OF SUPPLY AND DEMAND 19

Surplus (a.k.a. excess supply): when quantity supplied is greater than quantity demanded P Q Facing a surplus, sellers try to increase sales by cutting price. S D Surplus This causes QD to rise and QS to fall… …which reduces the surplus. THE MARKET FORCES OF SUPPLY AND DEMAND 20

CHAPTER SUMMARY We can use the supply-demand diagram to analyze the effects of any event on a market: First, determine whether the event shifts one or both curves. Second, determine the direction of the shifts. Third, compare the new equilibrium to the initial one. In market economies, prices are the signals that guide economic decisions and allocate scarce resources. 21