Lecture 3 Demand and Supply

Markets Markets Arrangements that individuals have for exchanging with one another Represent the interaction of buyers and sellers 8

Markets Markets Markets for gasoline Markets for labor Stock market Market for Super Bowl tickets Compact disk market 9

Markets Markets Markets set the prices we pay and receive 10

The Law of Demand Demand Quantities of specific goods and services that individuals, taken singly or as a group, will purchase at various possible prices, other things being constant 11

The Law of Demand Law of Demand Quantity demanded is inversely related to price, all things equal 12

The Law of Demand What are we holding constant? Income Price of other goods Many other factors 13

The Law of Demand Relative prices versus 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, nominal price) 14

Money Price versus Relative Price Money Price Relative Price Price Last Year Price This Year Price Last Year Price This Year $12 $6 = 2.0 = 0.5 $14 $8 = 1.75 = 0.57 CDs $12 $14 Cassettes $6 $8

The Demand Schedule The demand schedule is a table relating prices to quantity demanded. We must consider: The time dimension Constant-quality units 18

Minidisc player-recorder

The Individual Demand Schedule Figure 3-1, Panel (a)

The Individual Demand Curve Figure 3-1, Panel (b)

The Horizontal Summation of Two Demand Schedules Figure 3-2, Panel (a)

The Horizontal Summation of Two Demand Schedules Figure 3-2, Panels (b), (c), and (d)

The Market Demand Schedule for Minidisks Figure 3-3, Panel (a)

The Market Demand Curve for Minidisks Figure 3-3, Panel (b)

Garth Brooks, Used CDs, and the Law of Demand Scenario Garth Brooks attempts to prevent the sale of used CDs Questions What impact would this have on the sale of new CDs? Does this apply to the market for used books? 25

Shifts in Demand Scenario The federal government gives every college student registered in college a minidisk player-recorder. 26

A Shift in the Demand Curve If some factor other than price changes, the only way we can show its effect is by moving the entire demand curve 5 D1 4 Price of Minidisks ($) 3 2 1 2 4 6 8 10 12 14 Quantity of Minidisks Demanded (millions of constant-quality units per year)

A Shift in the Demand Curve 5 Suppose the federal government gives every student a minidisk player-recorder D1 4 Price of Minidisks ($) 3 2 1 2 4 6 8 10 12 14 Quantity of Minidisks Demanded (millions of constant-quality units per year)

A Shift in the Demand Curve 5 Suppose the federal government gives every student a minidisk player-recorder D2 Increase in demand 4 Price of Minidisks ($) 3 2 1 D1 2 4 6 8 10 12 14 Quantity of Minidisks Demanded (millions of constant-quality units per year)

A Shift in the Demand Curve Decrease in demand 5 Suppose universities outlaw the use of minidisk player-recorders 4 Price of Minidisks ($) 3 2 D2 1 D1 2 4 6 8 10 12 14 Quantity of Minidisks Demanded (millions of constant-quality units per year)

A Shift in the Demand Curve 5 When demand increases the quantity demanded will be greater at each price D2 D1 4 a c Price of Minidisks ($) 3 2 1 2 4 6 8 10 12 14 Quantity of Minidisks Demanded (millions of constant-quality units per year)

A Shift in the Demand Curve 5 When demand increases the quantity demanded will be greater at each price 4 a b Price of Minidisks ($) 3 c d 2 D2 1 D1 2 4 6 8 10 12 14 Quantity of Minidisks Demanded (millions of constant-quality units per year)

A Shift in the Demand Curve 5 4 Price of Minidisks ($) 3 2 D2 1 D1 D3 2 4 6 8 10 12 14 Quantity of Minidisks Demanded (millions of constant-quality units per year) Figure 3-4

Shifts in Demand Determinants of demand Income 34

Shifts in Demand Determinants of demand Income Normal good vs. inferior good 34

The Determinants of Demand Shifts in Demand The Determinants of Demand Income: Normal Good Price Decrease in income decreases demand D3 Increase in income increases demand D2 D1 Q/Units

The Determinants of Demand Shifts in Demand The Determinants of Demand Income: Inferior Good Price Increase in income decreases demand D3 Decrease in income increases demand D2 D1 Q/Units

Determinants of demand Tastes and preferences Shifts in Demand Determinants of demand Tastes and preferences 34

1950’s Fashion Trend: Cat's Eye glasses

1960’s Fashion Trends: Tie-dye

1970’s Fashion Trends: Earth Shoes

1980’s Fashion Trend: Polo shirts

1990’s Trend: Grunge music

90’s Fad : Furby

Trends of the 2000’s: Geocaching

Shifts in Demand Price D3 D2 D1 Q/Units The Determinants of Demand Income: Tastes and Preferences Price Smoking • Decrease in demand D3 Sport Utility Vehicle • Increase in demand D2 D1 Q/Units

Shifts in Demand Determinants of demand The price of related goods Complements 34

Shifts in Demand Price D2 D3 D1 Q/Speakers The Determinants of Demand Price of Related Goods: Complements Price Speakers and Amplifiers • Decrease the relative price of amplifiers • Demand for speakers increases D2 D3 Speakers and Amplifiers • Increase the relative price of amplifiers • Demand for speakers decreases D1 Q/Speakers

Shifts in Demand Determinants of demand The price of related goods Substitutes 34

Shifts in Demand Price D2 D1 Q/Butter 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 D2 D1 Q/Butter

Shifts in Demand Price D2 D1 Q/Butter The Determinants of Demand Price of Related Goods: Substitutes Price D2 Butter and Margarine • Price of both = $2/lb. • Price of margarine decreases to $1/lb. • Demand for butter decreases D1 Q/Butter

Shifts in Demand Determinants of demand Expectations Future prices Income Product availability 35

The Determinants of Demand Shifts in Demand The Determinants of Demand Expectations Price D3 Expectations of a lower income or of a future price decrease increases demand Expectations of higher income or of a future price increase decreases demand D2 D1 Q/Units

Shifts in Demand Determinants of demand Market size (number of buyers) 35

The Determinants of Demand Shifts in Demand The Determinants of Demand Population Price D3 Decrease in population decreases demand Increase in the population increases demand D2 D1 Q/Units

Shifts in Demand 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 movement of the curve. 45

Shifts in Demand 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 on the curve. 46

Movement Along a Given Demand Curve 5 4 3 Price of Minidisks ($) 2 1 2 4 6 8 10 12 Quantity of Minidisks Demanded (millions of constant-quality units per year)

Movement Along a Given Demand Curve 5 D A change in the price changes the quantity of a good demanded 4 3 Price of Minidisks ($) 2 1 2 4 6 8 10 12 Quantity of Minidisks Demanded (millions of constant-quality units per year)

Movement Along a Given Demand Curve 5 D A change in the price changes the quantity of a good demanded 4 3 Price of Minidisks ($) 2 1 2 4 6 8 10 12 Quantity of Minidisks Demanded (millions of constant-quality units per year)

Movement Along a Given Demand Curve 5 A change in the price changes the quantity of a good demanded 4 3 Price of Minidisks ($) 2 1 D 2 4 6 8 10 12 Quantity of Minidisks Demanded (millions of constant-quality units per year) Figure 3-5

The Law of Supply Supply The amount of a product or service that firms are willing to sell at alternative prices 50

The Law of Supply Law of Supply The price of a product or service and the quantity supplied are directly related 51

The Supply Schedule The supply schedule is a table relating prices to quantity supplied. 52

The Individual Producer’s Supply Schedule Figure 3-6, Panel (a)

The Individual Producer’s Supply Curve Figure 3-6, Panel (b)

Horizontal Summation of Supply Curves Figure 3-7, Panel (a)

Horizontal Summation of Supply Curves Figure 3-7, Panels (b), (c), and (d)

The Market Supply Schedule for Minidisks Figure 3-8, Panel (a)

The Market Supply Curve for Minidisks Figure 3-8, Panel (b)

Shifts in Supply Scenario A new method of coating minidisks reduces the cost of producing a minidisk by 50 percent. 59

A Shift in the Supply Curve 5 S1 4 If some other factor than price changes, the only way we can show its effect is by moving the entire supply curve Price of Minidisks ($) 3 2 1 2 4 6 8 10 12 14 Quantity of Minidisks Demanded (millions of constant-quality units per year)

A Shift in the Supply Curve 5 S1 S2 4 Price of Minidisks ($) 3 If costs decrease, supply increases 2 1 2 4 6 8 10 12 14 Quantity of Minidisks Demanded (millions of constant-quality units per year)

A Shift in the Supply Curve 5 S1 S2 4 Price of Minidisks ($) 3 If costs increase, supply decreases 2 1 2 4 6 8 10 12 14 Quantity of Minidisks Demanded (millions of constant-quality units per year)

A Shift in the Supply Curve 5 S1 4 When supply increases the quantity supplied will be greater at each price Price of Minidisks ($) 3 2 1 2 4 6 8 10 12 14 Quantity of Minidisks Demanded (millions of constant-quality units per year)

A Shift in the Supply Curve 5 S2 S1 a c 4 When supply increases the quantity supplied will be greater at each price Price of Minidisks ($) 3 2 1 2 4 6 8 10 12 14 Quantity of Minidisks Demanded (millions of constant-quality units per year)

A Shift in the Supply Curve 5 S2 S1 a 4 b c Price of Minidisks ($) 3 When supply increases the quantity supplied will be greater at each price d 2 1 2 4 6 8 10 12 14 Quantity of Minidisks Demanded (millions of constant-quality units per year)

A Shift in the Supply Curve 5 S1 a c b d 4 Price of Minidisks ($) 3 When supply decreases the quantity supplied will be less at each price 2 1 2 4 6 8 10 12 14 Quantity of Minidisks Demanded (millions of constant-quality units per year)

Shifts in Supply Determinants of supply Cost of inputs Technology and productivity Taxes and subsidies Price expectations Number of firms in industry 67

The Determinants of Supply Shifts in Supply The Determinants of Supply Cost of Inputs Price Increase in income decreases supply S3 Increase in income increases demand S2 S1 Q/Units

Shifts in Supply Price S3 S2 S1 Q/Units The Determinants of Supply Technology and Productivity Price Decreases in productivity decrease supply S3 Improvements in technology or increases in productivity increase supply S2 S1 Q/Units

The Determinants of Supply Shifts in Supply The Determinants of Supply Taxes and Subsidies Price Increases in taxes or decreases in subsidies decrease supply S3 Decreases in taxes or increases in subsidies increase supply S2 S1 Q/Units

The Determinants of Supply Shifts in Supply The Determinants of Supply Price Expectations Price Expectations of lower prices decrease supply S3 Increase in the number of firms increases supply S2 S1 Q/Units

Shifts in Supply Price S3 S2 S1 Q/Units The Determinants of Supply Number of Firms in Industry Price Decrease in the number of firms decreases supply S3 Increase in the number of firms increases supply S2 S1 Q/Units

Shifts in Supply 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 movement of the curve. 73

Shifts in Supply 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 on the curve. 74

Putting Demand and Supply Together Figure 3-10

Putting Demand and Supply Together 5 S D 4 A B Excess quantity demanded at price $1 Shortage • At P = $1: Qs (A) = 2 > Qd (B) = 10 • All prices below $3 Qd > Qs • Price will pushed up 3 Price of Minidisks ($) 2 1 2 4 6 8 10 12 Quantity of Minidisks (millions of constant-quality units per year)

Putting Demand and Supply Together C Excess quantity demanded at price $5 Surplus • At P = $5: Qd (D) = 2 < Qs (C) = 10 • All prices below $3 Qd < Qs • Price will pushed up 5 S 4 3 Price of Minidisks ($) 2 1 D 2 4 6 8 10 12 Quantity of Minidisks (millions of constant-quality units per year)

Putting Demand and Supply Together Excess quantity demanded at price $5 5 S D C Equilibrium Market clearing, or equilibrium price E 4 3 Price of Minidisks ($) 2 A B 1 D Excess quantity demanded at price $1 2 4 6 8 10 12 Quantity of Minidisks (millions of constant-quality units per year)

Putting Demand and Supply Together Equilibrium The situation when quantity supplied equals quantity demanded at a particular price 83

Putting Demand and Supply Together Shortages The situation when quantity demanded is greater than quantity supplied Exists at any price below the equilibrium price Is not the same as scarcity 84

Putting Demand and Supply Together Surpluses The situation when quantity supplied is greater than quantity demanded Exists at any price above the equilibrium price 85

Why Babysitters Are Earning More The market price of babysitting services is up Increased demand as the number of children younger than 10 rose from 33 million to 40 million between 1980 and 2000 Decreased supply as the number of Americans aged 10–19 dropped by 5 percent between 1990 and 2000 86

The Changing Price of Babysitting Services Figure 3-11

Explaining Why Babysitters are Earning More Question What is likely to happen to the price of babysitting services if retiring baby boomers decide to earn extra income by offering to spend some of their time babysitting? 88

Should Shortages in the Ticket Market Be Solved by Scalpers? Figure 3-12

In China, lack of water is a big problem Issues and Applications: China’s Water Shortage—Too Little Rain or Not Enough Pricing? In China, lack of water is a big problem Construction of dams Until a few years ago water had a zero price Currently water is priced below its opportunity cost If price rose enough, shortages would disappear

Web Links The following Web links appear in the margin of this chapter in the textbook: http://usda.mannlib.cornell.edu/reports/ waobr/wasde-bb

Summary Discussion of Learning Objectives The law of demand says that prices and quantity demanded are inversely related. Relative prices must be distinguished from money, since people respond to changes in relative prices. 91

Summary Discussion of Learning Objectives A change in quantity demanded versus a change in demand A change in quantity demanded is a movement along a demand curve A change in demand is a shift of the demand curve The law of supply states that price and quantity supplied are directly related. 92

Summary Discussion of Learning Objectives A change in quantity supplied versus a change in supply A change in quantity supplied is a movement along a supply curve A change in supply is a shift of the supply curve 93

Summary Discussion of Learning Objectives Determining market price and equilibrium quantity The demand and supply curves intersect at the equilibrium point. Shortages exist when the price of a good is below the market price. Surpluses exist if the price of the good is greater than the market price. 94

End of Chapter Chapter 3 Demand and Supply