Market Demand and Supply Key Concepts Summary ©2005 South-Western College Publishing

Why is this chapter important? This chapter is very important because it introduces basic supply and demand analysis

What is demand? Demand represents the choice making behavior of buyers

What is supply? Supply represents the choice making behavior of sellers

What is the law of demand? The principle that there is an inverse relationship between the price of a good and the quantity buyers are willing to purchase in a defined time period, ceteris paribus

What does “ceteris paribus” mean? All else remains the same

What is a demand curve? Depicts the relationship between price and quantity demanded

Individual’s Demand Curve for Compact Discs $20 B $15 C $10 D $5 Demand Curve Q 4 8 12 16

Why do demand curves have a negative slope? At a higher price buyers will buy fewer units, and at a lower price they will buy more units

What is a demand schedule? Shows the specific quantity of a good or service that people are willing and able to buy at different prices

What is market demand? The summation of the individual demand schedules in a market

Market Demand Schedule for Compact Discs Price Fred Mary Total Demanded $25 1 + 0 = 1 $20 2 1 3 $15 3 3 6 $10 4 5 9 $5 5 7 12

P Fred’s Demand Curve $20 $15 $10 $5 D1 Q 1 2 3 4 5 6 7 8 9

P Mary’s Demand Curve $20 $15 $10 D2 $5 Q 1 2 3 4 5 6 7 8 9

P Market Demand Curve $20 $15 $10 D3 $5 Q 3 4 5 6 7 8 9 10 11 12

IMPORTANT - KNOW THE DIFFERENCE BETWEEN A CHANGE IN THE QUANTITY DEMANDED AND A CHANGE IN DEMAND

When price changes, what happens? The curve does not shift - there is a change in the quantity demanded

Change in Quantity Demanded Price

A change in price causes a change in the quantity demanded $20 A $15 B $10 D $5 Q 10 20 30 40 50

Decrease in quantity demanded Upward movement along the demand curve Price increases

Increase in quantity demanded Downward movement along the demand curve Price decreases

When something changes other than price, what happens? The whole curve shifts,there is a change in demand

P When the ceteris paribus assumption is relaxed, the whole curve can shift $20 A B $15 $10 D2 D1 $5 Q 10 20 30 40 50

Change in nonprice determinant Change in demand Change in nonprice determinant

What can cause a demand curve to shift? A change in: Number of buyers in the market Tastes and preferences Income Expectations of consumers Prices of related goods

Decrease or increase in demand Leftward or rightward shift in the demand curve Change in a Nonprice determinant

What is a normal good? Any good for which there is a direct relationship between changes in income and its demand curve

What is an inferior good? Any good for which there is an inverse relationship between changes in income and its demand curve

What are substitute goods? Goods that compete with one another for consumer purchases

What happens when the price increases for a good that has a substitute? The demand curve for the substitute good increases

What happens when the price decreases for a good that has a substitute? The demand curve for the substitute good decreases

What does a direct relationship between price and quantity mean? The two move in the same direction

What are complementary goods? Goods that are jointly consumed with another good

What happens when the price increases for a good that has a complement? The demand curve for the substitute good decreases

What happens when the price decreases for a good that has a complement? The demand curve for the substitute good increases

What does an inverse relationship between price & quantity mean? It means that the two move in opposite directions

What is the law of supply? The principle that there is a direct relationship between the price of a good and the quantity sellers are willing to offer for sale in a defined time period, ceteris paribus

Why do supply curves have a positive slope? Only at a higher price will it be profitable for sellers to incur the higher opportunity cost associated with supplying a larger quantity

A company’s Supply Curve for Compact Discs $20 $15 B $10 C $5 Q 10 20 30 40

An Individual Seller’s Supply for Compact Discs Point Price Quantity A $20 40 B 10 30 C 6 20

What is a market? Any arrangement in which buyers and sellers interact to determine the price and quantity of goods and services exchanged

What is market supply? The horizontal summation of all the quantities supplied at various prices that might prevail in the market

Market Supply Schedule for Compact Discs Price Super Sound High Vibes Total $25 25 + 35 = 60 $20 20 30 50 $15 15 25 40 $10 10 20 30 $5 5 15 20

Super Sound Supply Curve $25 $20 $15 $10 Q 10 15 20 25

High Vibes Supply Curve $25 $20 $15 $10 Q 20 25 30 35

P Market Supply Curve $25 $20 S total $15 $10 Q 40 45 55 60

IMPORTANT - KNOW THE DIFFERENCE BETWEEN A CHANGE IN THE QUANTITY SUPPLIED AND A CHANGE IN SUPPLY

When price changes, what happens? The curve does not shift - there is a change in the quantity supplied

A change in price causes a change in the quantity supplied Supply Curve A $20 $15 B $10 C $5 Q 10 20 30 40

Change in Quantity Supplied Price

When something changes other than price, what happens? The whole curve shifts - there is a change in supply

When the ceteris paribus assumption is relaxed, the whole curve can shift $20 S1 $15 $10 $5 Q 10 20 30 40

Change in nonprice determinant Change in supply Change in nonprice determinant

What can cause a supply curve to shift? A change in: 1. Number of sellers in the market 2. Technology 3. Resource prices 4. Taxes and subsidies 5. Expectations of producers 6. Prices of other goods the firm could produce

What is the equilibrium price? The price towards which the economy tends

Where is the equilibrium price? At the price where the quantity demanded and the quantity supplied are equal

The Supply & Demand for Tennis Shoes $120 S $90 Surplus $60 Shortage $30 D Q 1,000 2,000 3,000 4,000

What is the price system? A mechanism that uses the forces of supply and demand to create an equilibrium through rising and falling prices

Key Concepts

What is the law of demand? What is a demand curve? Why do demand curves have a negative slope? When price changes, what happens? When something changes other than price, what happens? What can cause a shift in a demand curve?

What is the law of supply? Why do supply curves have a positive slope? When price changes, what happens? When something changes other than price, what happens? What can cause a shift in a supply curve? What is a market? What the equilibrium price?

Summary

The law of demand states there is an inverse relationship between the price and the quantity demanded, ceteris paribus. A market demand curve is the horizontal summation of individual demand curves.

Individual’s Demand Curve for Compact Discs $20 B $15 C $10 D $5 Demand Curve Q 4 8 12 16

A change in quantity demanded is a movement along a stationary demand curve caused by a change in price. When any of the nonprice determinants of demand changes, the demand curve responds by shifting. An increase in demand (rightward shift) or a decrease in demand (leftward shift) is caused by a change in one of the nonprice determinants.

P When the ceteris paribus assumption is relaxed, the whole curve can shift $20 A B $15 $10 D2 $5 D1 Q 10 20 30 40 50

Nonprice determinants of demand: a. the number of buyers, b. tastes and preferences. c. income (normal and inferior). d. expectations of future p;rice and income changes, and e. prices of related goods (substitutes and complements)

The law of supply states there is a direst relationship between the price and the quantity supplied, ceteris paribus. The market supply curve is the horizontal summation of individual supply curves.

A change in quantity supplied is a movement along a stationary supply curve caused by a change in price. When any of the nonprice determinants of supply changes, the supply curve responds by shifting. An increase in supply (rightward shift) or a decrease in supply (leftward shift) is caused by a change in one of the nonprice determinants.

A company’s Supply Curve for Compact Discs $20 $15 B $10 C $5 Q 10 20 30 40

P When the ceteris paribus assumption is relaxed, the whole curve can shift S2 S1 $20 $15 $10 $5 Q 10 20 30 40

Nonprice determinants of supply: a. the number of sellers. b. technology c. resource prices. d. taxes and subsidies. e. expectations of future price changes, f. prices of other goods.

A surplus or shortage exists at any price where the quantity demanded and the quantity supplied are not equal. When the price of a good is greater than the equilibrium price, there is an excess quantity supplied called a surplus. When the price is less than the equilibrium price, there is an excess quantity demanded called a shortage.

Equilibrium is the unique price and quantity established at the intersection of the supply and the demand curves. Only at equilibrium does quantity demanded equal quantity supplied.

The Supply & Demand for Tennis Shoes $120 S $90 Surplus $60 Shortage $30 D Q 1,000 2,000 3,000 4,000

The price system is the supply and demand mechanism that establishes equilibrium through the ability of prices to rise or fall.

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