Chapter 3 Supply and Demand 3-1 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter Objectives Define and explain demand in a product or service market Define and explain supply Determine the equilibrium point in the market for a specific good, given data on supply and demand at different price levels 3-2 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter Objectives Understand what causes shifts in demand and supply Understand how price ceilings cause shortages Understand how price floors cause surpluses 3-3 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Demand The schedule of quantities of a good or service that people are willing and able to buy at different prices Sometimes a schedule is also called a table 3-4 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Hypothetical Daily Demand for Coach Seats on Round-trip Weekly Flights Between Denver and Chicago Table 1 Price QD $500 1,000 450 3,000 400 7,000 350 12,000 300 19,000 250 30,000 200 45,000 150 57,000 100 67,000 3-5 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Hypothetical Daily Demand for Coach Seats on Round-trip Weekly Flights Between Denver and Chicago Table 1 Price QD $500 1,000 450 3,000 400 7,000 350 12,000 300 19,000 250 30,000 200 45,000 150 57,000 100 67,000 3-6 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Hypothetical Daily Demand for Coach Seats on Round-trip Weekly Flights Between Denver and Chicago Table 1 Price QD $500 1,000 450 3,000 400 7,000 350 12,000 300 19,000 250 30,000 200 45,000 150 57,000 100 67,000 3-7 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Hypothetical Daily Demand for Coach Seats on Round-trip Weekly Flights Between Denver and Chicago Table 1 Price QD $500 1,000 450 3,000 400 7,000 350 12,000 300 19,000 250 30,000 200 45,000 150 57,000 100 67,000 3-8 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Hypothetical Daily Demand for Coach Seats on Round-trip Weekly Flights Between Denver and Chicago Table 1 Price QD $500 1,000 450 3,000 400 7,000 350 12,000 300 19,000 250 30,000 200 45,000 150 57,000 100 67,000 3-9 Copyright 2003 by The McGraw-Hill Companies, Inc. All rights reserved.

Hypothetical Daily Demand for Coach Seats on Round-trip Weekly Flights Between Denver and Chicago Table 1 Price QD $500 1,000 450 3,000 400 7,000 350 12,000 300 19,000 250 30,000 200 45,000 150 57,000 100 67,000 3-10 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Hypothetical Daily Demand for Coach Seats on Round-trip Weekly Flights Between Denver and Chicago Table 1 Price QD $500 1,000 450 3,000 400 7,000 350 12,000 300 19,000 250 30,000 200 45,000 150 57,000 100 67,000 3-11 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Hypothetical Daily Demand for Coach Seats on Round-trip Weekly Flights Between Denver and Chicago Table 1 Price QD $500 1,000 450 3,000 400 7,000 350 12,000 300 19,000 250 30,000 200 45,000 150 57,000 100 67,000 3-12 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Hypothetical Daily Demand for Coach Seats on Round-trip Weekly Flights Between Denver and Chicago Table 1 Price QD $500 1,000 450 3,000 400 7,000 350 12,000 300 19,000 250 30,000 200 45,000 150 57,000 100 67,000 3-13 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Hypothetical Daily Demand for Coach Seats on Round-trip Weekly Flights Between Denver and Chicago Table 1 Price QD $500 1,000 450 3,000 400 7,000 350 12,000 300 19,000 250 30,000 200 45,000 150 57,000 100 67,000 3-14 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Table 1 is the Demand Schedule Figure 1 is the Graph of the Demand Schedule Table 1 Price QD $500 1,000 450 3,000 400 7,000 350 12,000 300 19,000 250 30,000 200 45,000 150 57,000 100 67,000 Figure 1 The line is the Demand Curve 3-15 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Price and Quantity Demanded are inversely related Quantity Demanded is a point on the Demand Curve Table 1 Price QD $500 1,000 450 3,000 400 7,000 350 12,000 300 19,000 250 30,000 200 45,000 150 57,000 100 67,000 Figure 1 3-16 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Remember, Demand is the entire schedule or the entire curve Quantity Demanded is a point on the Demand Curve Table 1 Price QD $500 1,000 450 3,000 400 7,000 350 12,000 300 19,000 250 30,000 200 45,000 150 57,000 100 67,000 Figure 1 3-17 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Supply Is the “schedule” of quantities of a good or service that people are willing to sell at different prices 3-18 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Supply is the entire schedule or the entire curve Price QS $500 62,000 $450 59,000 $400 54,000 $350 48,000 $300 40,000 $250 30,000 $200 16,000 $150 7,000 $100 2,000 3-19 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Quantity Supplied is a point on the curve Price QS $500 62,000 $450 59,000 $400 54,000 $350 48,000 $300 40,000 $250 30,000 $200 16,000 $150 7,000 $100 2,000 3-20 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Demand and Supply Curves Price QS QD $500 62,000 1,000 $450 59,000 3,000 $400 54,000 7,000 $350 48,000 12,000 $300 40,000 19,000 $250 30,000 30,000 $200 16,000 45,000 $150 7,000 57,000 $100 2,000 67,000 Equilibrium price is the price where QD = QS We can find equilibrium price and quantity by seeing where the supply and demand curves cross 3-21 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Demand and Supply Curves Surpluses and Shortages Price QS QD $500 62,000 1,000 $450 59,000 3,000 $400 54,000 7,000 $350 48,000 12,000 $300 40,000 19,000 $250 30,000 30,000 $200 16,000 45,000 $150 7,000 57,000 $100 2,000 67,000 54,000-7,000 = 47,000 Equilibrium price = EP Market price = MP MP > EP there is a surplus 3-22 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Demand and Supply Curves Surpluses and Shortages Price QS QD $500 62,000 1,000 $450 59,000 3,000 $400 54,000 7,000 $350 48,000 12,000 $300 40,000 19,000 $250 30,000 30,000 $200 16,000 45,000 $150 7,000 57,000 $100 2,000 67,000 54,000-7,000 = 44,000 A surplus would force sellers to lower their prices. Eventually, prices would fall back to the equilibrium price Equilibrium price = EP Market price = MP 3-23 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Demand and Supply Curves Surpluses and Shortages Price QS QD $500 62,000 1,000 $450 59,000 3,000 $400 54,000 7,000 $350 48,000 12,000 $300 40,000 19,000 $250 30,000 30,000 $200 16,000 45,000 $150 7,000 57,000 $100 2,000 67,000 57,000-7,000 = 50,000 Equilibrium price = EP Market price = MP MP < EP here is a shortage 3-24 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Demand and Supply Curves Surpluses and Shortages Price QS QD $500 62,000 1,000 $450 59,000 3,000 $400 54,000 7,000 $350 48,000 12,000 $300 40,000 19,000 $250 30,000 30,000 $200 16,000 45,000 $150 7,000 57,000 $100 2,000 67,000 57,000-7,000 = 50,000 A shortage would allow sellers to raise their prices. As prices increased people would buy less. Eventually, prices would move back to the equilibrium price Equilibrium price = EP Market price = MP 3-25 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Demand and Supply Curves Surpluses and Shortages Price QS QD $500 62,000 1,000 $450 59,000 3,000 $400 54,000 7,000 $350 48,000 12,000 $300 40,000 19,000 $250 30,000 30,000 $200 16,000 45,000 $150 7,000 57,000 $100 2,000 67,000 We can see that the forces of demand and supply work together to establish an equilibrium price at which there are no shortages or surpluses 3-26 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

The schedule changes from QD1 to QD2 Table 4 Price QD1 QD2 $500 1,000 12,000 450 3,000 15,000 400 7,000 21,000 350 12,000 30,000 300 19,000 40,000 250 30,000 55,000 200 45,000 63,000 150 57,000 75,000 100 67,000 88,000 The demand curve shifts to the right from D1 to D2 This is an increase in demand 3-27 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

The schedule changes from QD2 to QD1 Table 4 Price QD1 QD2 $500 1,000 12,000 450 3,000 15,000 400 7,000 21,000 350 12,000 30,000 300 19,000 40,000 250 30,000 55,000 200 45,000 63,000 150 57,000 75,000 100 67,000 88,000 The demand curve shifts to the left from D2 to D1 This is a decrease in demand 3-28 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Shifts in Supply and Demand Quantity (in thousands) If the schedule changes the Supply curve shifts Price S 500 S 450 400 350 300 250 200 Supply decreases . . . the curve shifts to the left 150 100 50 D 10 20 30 40 50 60 70 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Quantity (in thousands) 3-29

Shifts in Supply and Demand Quantity (in thousands) If the schedule changes the Supply curve shifts Price S 500 S 450 400 350 300 250 200 150 Supply increases . . . the curve shifts to the right 100 50 D 10 20 30 40 50 60 70 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Quantity (in thousands) 3-30

Shifts in Supply and Demand Quantity (in thousands) If the Supply curve is S1 what is the equilibrium price and quantity? Price S2 500 S1 450 400 350 300 250 The equilibrium price is approximately 262 or 263 200 150 The equilibrium quantity is approximately 35,000 100 50 D 10 20 30 40 50 60 70 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Quantity (in thousands) 3-31

Shifts in Supply and Demand Quantity (in thousands) If the Supply curve changes to S2 what is the new equilibrium price and quantity? Price S2 500 S1 450 400 350 300 250 The new equilibrium price is approximately 325 200 150 The new equilibrium quantity is approximately 26,000 100 50 D 10 20 30 40 50 60 70 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Quantity (in thousands) 3-32

Shifts in Supply and Demand Quantity (in thousands) Is a shift from S1 to S2 an increase or decrease in Supply? Price S2 500 S1 450 400 350 300 250 A decrease 200 150 100 50 D 10 20 30 40 50 60 70 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Quantity (in thousands) 3-33

Price Floors and Ceilings The price can go no lower than the floor. The surplus is the amount by which the quantity supplied is greater than the quantity demanded A price floor creates a permanent surplus 3-34 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Price Floors and Ceilings The price can go no higher than the ceiling. The shortage is the amount by which the quantity demanded is greater than the quantity supplied A price ceiling creates a permanent shortage 3-35 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Applications of Supply and Demand Interest rates are set by Supply and demand Wage rates are set by Rents are determined by The prices of nearly all goods are determined by The prices of nearly all services are determined by 3-36 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Hypothetical Demand for and Supply of Loanable Funds We can see that $600 billion is lent (or borrowed) at an interest rate of 6 percent What would happen if the supply of loanable funds increased? 3-37 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Hypothetical Demand for and Supply of Loanable Funds The interest rate would decrease to 4 percent and the amount of money borrowed would increase to $800 billion 3-38 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Hypothetical Demand for and Supply of Loanable Funds If the demand for loanable funds rises to D2 the interest rate would rise to 9 percent and the amount of money borrowed would rise to $700 billion 3-39 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

Last Word Government sometimes interferes with the free operation of the markets by Imposing prices floors and price ceilings This creates the problems of shortages and surpluses The government may also ensure the smooth operation of the markets by protecting property rights, guaranteeing enforcement of legal contracts, and issuing a supply of money that buyers and sellers readily accept Property rights are essential to a free and prosperous nation While governmental interference with the market system can have adverse affects, the government does have a substantial supportive role to play in a market economy. 3-40 Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.