Supply and Demand

Since people want more of scarce goods than is freely available, we need a way of rationing the goods. Some possible criteria are: beauty popularity income first come, first served the market or price (supply & demand)

Law of Demand There is a negative relation between the price of a good and the amount of the good that buyers are willing to purchase.

example: price quantity demanded per month(QD) 13 400 12 450 11 500 10 550 9 600 8 650 7 700

price 13 12 11 10 9 8 7 quantity 400 450 500 550 600 650 700

price 13 12 11 10 9 8 7 Demand quantity 400 450 500 550 600 650 700

The demand curve slopes down!

Law of Supply There is a positive relation between the price of a good and the amount of the good that producers are willing to produce and sell.

example: price quantity supplied per month(Qs) 13 625 12 600 11 575 10 550 9 525 8 500 7 475

price 13 12 11 10 9 8 7 quantity 475 500 525 550 575 600 625

price 13 12 11 10 9 8 7 Supply quantity 475 500 525 550 575 600 625

The supply curve slopes up!

price 13 12 11 10 9 8 7

price QD 13 400 12 450 11 500 10 550 9 600 8 650 7 700

price QD Qs 13 400 625 12 450 600 11 500 575 10 550 550 9 600 525 8 650 500 7 700 475

price QD Qs mkt. cond. 13 400 < 625 excess supply 12 450 < 600 excess supply 11 500 < 575 excess supply 10 550 550 9 600 525 8 650 500 7 700 475

price QD Qs mkt. cond. 13 400 625 excess supply 12 450 600 excess supply 11 500 575 excess supply 10 550 550 9 600 > 525 excess demand 8 650 > 500 excess demand 7 700 > 475 excess demand

price QD Qs mkt. cond. 13 400 625 excess supply 12 450 600 excess supply 11 500 575 excess supply 10 550 = 550 equilibrium 9 600 525 excess demand 8 650 500 excess demand 7 700 475 excess demand

When the quantity demanded is equal to the quantity supplied, we have equilibrium. Equilibrium means that there is no tendency for things to change. The system is in balance.

price QD Qs mkt. cond. price pressure 13 400 625 excess supply down 12 450 600 excess supply down 11 500 575 excess supply down 10 550 550 equilibrium 9 600 525 excess demand 8 650 500 excess demand 7 700 475 excess demand

price QD Qs mkt. cond. price pressure 13 400 625 excess supply down 12 450 600 excess supply down 11 500 575 excess supply down 10 550 550 equilibrium 9 600 525 excess demand up 8 650 500 excess demand up 7 700 475 excess demand up

price QD Qs mkt. cond. price pressure 13 400 625 excess supply down 12 450 600 excess supply down 11 500 575 excess supply down 10 550 550 equilibrium none 9 600 525 excess demand up 8 650 500 excess demand up 7 700 475 excess demand up

price 13 12 11 10 9 8 7 Demand quantity 400 450 500 550 600 650 700

price 13 12 11 10 9 8 7 Supply quantity 475 500 525 550 575 600 625

Supply Demand price equilibrium 10 equilibrium price quantity 550 equilibrium quantity

The equilibrium is at the intersection of the demand curve and the supply curve. The equilibrium quantity can be read from the horizontal axis. The equilibrium price can be read from the vertical axis.

Changes in Demand & Changes in Quantity Demanded.

A change in the price of a product results in a change in the quantity demanded or a movement along the demand curve.

Suppose the price of a product is initially $12 Suppose the price of a product is initially $12. The quantity demanded is 450. We are at point A. price 13 12 11 10 9 8 7 A Demand quantity 400 450 500 550 600 650 700

If price decreases to $11, quantity demanded increases to 500 If price decreases to $11, quantity demanded increases to 500. We are now at point B on the same demand curve. price 13 12 11 10 9 8 7 B Demand quantity 400 450 500 550 600 650 700

The quantity demanded has changed The quantity demanded has changed. We have moved along a particular demand curve from one point to another. price 13 12 11 10 9 8 7 A B Demand quantity 400 450 500 550 600 650 700

If price increases from $11 to $12, quantity demanded decreases from 500 to 450. 13 12 11 10 9 8 7 Demand quantity 400 450 500 550 600 650 700

The demand curve for a product does not shift when the price of the product changes! We simply move from one point on the curve to another point on the same curve.

Do not confuse a change in the quantity demanded with a change in demand! change in quantity demanded: move along the same curve change in demand: entire curve moves

What is a change in demand? A change in demand means that at each price you want to purchase a different amount than you did previously. The entire demand curve moves when your demand is affected by something other than the price of the product.

When demand increases, the curve shifts to the right. price When demand increases, the curve shifts to the right. New Demand Demand quantity At each price, the quantity increases. So think about increasing along the quantity axis.

When demand decreases, the curve shifts to the left. price When demand decreases, the curve shifts to the left. Demand New Demand quantity At each price, the quantity decreases. So think about decreasing along the quantity axis.

What factors cause demand to change? (a shift of the entire curve) a change in income a change in the price of a related good a change in tastes for the good

A Change in Income. Suppose you buy CDs. What happens if your income increases? If you had more income, you would consider buying more CDs at each price level.

Before your income increased, if the price was 12, you bought 450 CDs Before your income increased, if the price was 12, you bought 450 CDs. Now, perhaps if the price is 12, you buy 500 CDs. price 13 12 11 10 9 8 7 Demand quantity 400 450 500 550 600 650 700

Before, if the price was 11, you bought 500 CDs Before, if the price was 11, you bought 500 CDs. Now, perhaps if the price is 11, you buy 550 CDs. price 13 12 11 10 9 8 7 Demand quantity 400 450 500 550 600 650 700

Before, if the price was 10, you bought 550 CDs Before, if the price was 10, you bought 550 CDs. Now, perhaps if the price is 10, you buy 600 CDs. price 13 12 11 10 9 8 7 Demand quantity 400 450 500 550 600 650 700

Connecting the new points, we see that when your income increased, you changed to an entirely different demand curve. price 13 12 11 10 9 8 7 New Demand Demand quantity 400 450 500 550 600 650 700

The new demand curve lies to the right of the old curve, or the demand curve has shifted to the right. Demand increased. price 13 12 11 10 9 8 7 New Demand Demand quantity 400 450 500 550 600 650 700

Similarly, if your income decreased, the Demand curve for CDs would shift left. Demand decreases. price 13 12 11 10 9 8 7 Demand New Demand quantity 400 450 500 550 600 650 700

Normal Goods and Inferior Goods When your income increased, your demand for CDs increased. When your income decreased, your demand for CDs decreased. Goods that behave this way are called normal goods.

In general for normal goods: When income increases, demand increases. (D shifts right.) When income decreases, demand decreases. (D shifts left.)

Inferior goods work the opposite way. Example: potatoes. People who have little income eat lots of potatoes, because potatoes are cheap and filling. When income rises, people eat fewer potatoes. When income falls, people eat more potatoes.

In general for inferior goods: When income increases, demand decreases. (D shifts left.) When income decreases, demand increases. (D shifts right.)

“Related Goods” fall into two categories: substitute goods complementary goods

Two goods are substitutes if you can use one good instead of the other good. Apples and pears are substitute goods.

If the price of pears increases, the demand for apples would increase If the price of pears increases, the demand for apples would increase. (D for apples shifts right.) If the price of pears decreases, the demand for apples would decrease. (D for apples shifts left.)

In general: If the price of a substitute good increases, the demand for the other good increases. (D shifts right.) If the price of a substitute good decreases, the demand for the other good decreases. (D shifts left.)

Two goods are complements if you use them together. Probably for most people, coffee and cream are complementary goods.

If the price of coffee increases, the demand for cream would decrease If the price of coffee increases, the demand for cream would decrease. (D for cream shifts left.) If the price of coffee decreases, the demand for cream would increase. (D for cream shifts right.)

In general: If the price of a complementary good increases, the demand for the other good decreases. (D shifts left.) If the price of a complementary good decreases, the demand for the other good increases. (D shifts right.)

Changes in tastes can also lead to changes in demand. Taste changes can take the form of fads or responses to new health information concerning a product.

A fad for hula hoops can result in an increase in demand for them A fad for hula hoops can result in an increase in demand for them. (D shifts right.) Findings about cancer-causing effects of chewing tobacco can reduce the demand for that product. (D shifts left.)

Changes in Supply & Changes in Quantity Supplied.

Changes in Quantity Supplied a change in the price of a product results in a change in the quantity supplied or a movement along the supply curve.

price Supply 13 12 11 10 9 8 7 If price decreases from $12 to $11, quantity supplied decreases from 600 to 575. quantity 475 500 525 550 575 600 625

price Supply 13 12 11 10 9 8 7 If price increases from $11 to $12, quantity supplied increases from 575 to 600. quantity 475 500 525 550 575 600 625

Do not confuse a change in the quantity supplied with a change in supply! change in supply: entire curve moves change in quantity supplied: move along the same curve

What is a change in supply? A change in supply means that at each price, producers are willing to produce and sell a different amount than previously. The entire supply curve moves when supply is affected by something other than the price of the product.

What factors cause supply to change? (a shift of the entire curve) a change in the price of an input a change in technology a change in weather (for agricultural products)

A Change in the Price of an Input When there is a change in the price of an input (such as labor or raw materials), the supply of a good that uses that input will change.

price New Supply Supply When the price of an input increases, the supply of the good decreases. (S shifts left.) quantity

Supply price New Supply When the price of an input decreases, the supply of the good increases. (S shifts right.) quantity

Technological Advance When there is a technological advance that makes it cheaper to produce a good, the supply of the good will increase. S shifts right.

Weather Changes When the weather becomes particularly good or particularly bad for growing a crop, the supply of that crop will change. When the weather becomes particularly good for growing a crop, the supply of that crop increases. (S shifts right.) When the weather becomes particularly bad for growing a crop, the supply of that crop decreases. (S shifts left.)

What happens to equilibrium price and quantity when supply or demand changes?

P decreases & Q increases. price S increases: P decreases & Q increases. S2 P1 P2 D quantity Q1 Q2

P increases & Q decreases. price S decreases: P increases & Q decreases. S1 P2 P1 D quantity Q2 Q1

P increases & Q increases. D increases: P increases & Q increases. price S P2 P1 D2 D1 quantity Q1 Q2

P decreases & Q decreases. D decreases: P decreases & Q decreases. price S P1 P2 D1 D2 quantity Q2 Q1

What happens to equilibrium price and quantity when both supply and demand change?

S increases & D increases: In this case, Q increases & P stays the same. price S1 S2 P2 = P1 D2 D1 quantity Q1 Q2

S increases & D increases: In this case, Q increases & P increases. price S1 P2 S2 P1 D2 D1 quantity Q1 Q2

S increases & D increases: In this case, Q increases & P decreases. price S1 S2 P1 P2 D2 D1 quantity Q1 Q2

So.... If demand increases more than supply, the price will increase. If supply increases more than demand, the price will decrease. If supply and demand increase the same amount, the price will stay the same.

In other words, what happens to the price when both supply and demand increase depends on the relative magnitudes of the changes in supply and demand.

S decreases & D decreases: P ? & Q decreases price S2 S1 P2 = P1 D1 D2 quantity Q2 Q1

S increases & D decreases: P decreases & Q ? price S1 P1 S2 P2 D1 D2 quantity Q1 = Q2

S decreases & D increases: P increases & Q ? price S2 P2 S1 P1 D2 D1 quantity Q1 = Q2

Price Ceilings and Price Floors

Price Ceiling A government imposed maximum legal price. Example: rent controls on apartments

Price Ceiling Notice that Qd > Qs Price Ceiling Notice that Qd > Qs. Thus, there is excess demand or a shortage. price S P1 Pc D quantity Qs Q1 Qd

Price Floor A government imposed minimum legal price. Examples: minimum wages, agricultural price supports

Price Floor Notice that Qs > Qd Price Floor Notice that Qs > Qd. Thus, there is excess supply or a surplus. price S Pf P1 D quantity Qd Q1 Qs