Copyright © 2005 by McGraw-Hill Ryerson Limited. All rights reserved. Understanding Economics 3rd edition by Mark Lovewell, Khoa Nguyen and Brennan Thompson Chapter 2 Demand and Supply Copyright © 2005 by McGraw-Hill Ryerson Limited. All rights reserved.

Learning Objectives In this chapter, you will: consider the nature of demand, changes in quantity demanded, changes in demand, and the factors that affect demand examine the nature of supply, changes in quantity supplied, changes in supply, and the factors that affect supply see how markets reach equilibrium – the point at which demand and supply meet

Outline of Topics T1 The Role of Demand T2 The Role of Supply T3 How Competitive Markets Operate

T1 The Role of Demand What Is Demand? Demand is a relationship between a product’s price and quantity demanded. Quantity demanded: the amount of a product consumers are willing to purchase at each price Demand is shown using a schedule or curve. (See figure 2.1 on page 29) Demand curve: a graph that expresses possible combinations of prices and quantities demanded of a product The law of demand states that price and quantity demanded are inversely related. Market demand : the sum of all consumers’ quantities demanded for a product at each price in a market. (See Figure 2.2 on page 31) 1

The Demand Curve Figure 2.1, page 29 Your Demand Curve for Strawberries Your Demand Schedule for Strawberries 2.50 a b Quantity Demanded (kg per month) Point on graph 2.00 Price ($ per kg) c 1.50 Price ($ per kg) D $2.50 7 a 1.00 2.00 9 b 0.50 1.50 11 c 1 3 5 7 9 11 13 Quantity Demanded (kg per month) 3

Deriving Market Demand Figure 2.2, page 31 Your Demand Curve for Strawberries Friend’s Demand Curve for Strawberries 2.50 2.50 2.00 2.00 Price ($ per kg) 1.50 Price ($ per kg) 1.50 1.00 1.00 D0 D1 0.50 0.50 1 2 3 4 5 6 7 1 2 3 4 5 6 7 Quantity Demanded (kg per month) Quantity Demanded (kg per month) Market Demand Curve for Strawberries Individual and Market Demand Schedules for Strawberries 2.50 Price ($ per kg) You (D0) Friend (D1) Market (Dm) 2.00 Price ($ per kg) 1.50 Dm 1.00 (kg per month) 0.50 $2.50 2.00 1.50 1 2 3 2 3 4 3 5 7 1 2 3 4 5 6 7 Quantity Demanded (kg per month) 3

Changes in Demand (a) Changes in demand: are shown by shifts in the demand curve are caused by changes in demand determinants Demand determinants: factors that can cause an increase or a decrease in a product’s demand The five main demand determinants (Would be discussed later) Number of buyers in a market Their average Income Prices of Other Products Consumer Preferences Consumer Expectations about future prices and incomes. 2

Changes in Demand (b) Figure 2.3, page 32 Market Demand Curve for Strawberries Market Demand Schedule for Strawberries 0.50 1.00 1.50 2.00 2.50 Price ($ per kg) Quantity Demanded (millions of kg) (D2) (D0) (D1) Price ($ per kg) D2 D0 D1 $2.50 5 7 9 2.00 7 9 11 1.50 9 11 13 1 3 5 7 9 11 13 Quantity Demanded (millions of kg per year) 3

Demand Determinants (a) Demand determinants include the following factors: The number of buyers (an increase causes a rightward demand shift) Increase in Demand: an increase in the quantity demanded of a product at all prices Decrease in Demand: a decrease in the quantity demanded of a product at all prices Income For normal products, an increase causes a rightward demand shift. Normal products: products whose demand changes directly with income For inferior products, an increase causes a leftward demand shift. 4

Demand Determinants (b) Inferior products: products whose demand changes inversely with income For substitute products, a rise in the other product’s price causes a rightward demand shift. Substitute Products: products that can be consumed in place of one another For complementary products, a rise in the other product’s price causes a leftward demand shift. Complementary products: products that are consumed together Consumer preferences Consumer expectations 5

Changes in Quantity Demanded (a) are shown by movements along demand curve are caused by price changes See Figure 2.4, page 33

Changes in Quantity Demanded (b) Figure 2.4, page 33 5000 6000 Quantity Demanded (pairs of skis) Change in Quantity Demanded Price ($ per pair of skis) 0.50 1.00 1.50 2.00 5000 Quantity Demanded (pairs of skis) Change in Demand Price ($ per pair of skis) 0.50 1.00 1.50 2.00 a b D0 D0 D1 3

T2, The role of Supply What Is Supply? Supply: is a relationship between a product’s price and quantity supplied is shown using a schedule or curve Quantity supplied:the amount of a product businesses are willing to supply at each price Supply curve: a graph that expresses possible combinations of prices an quantities supplied of a product ( see Figure 2.5, page 35) The law of supply states there is a direct relationship between price and quantity supplied. 6

The Supply Curve Figure 2.5, page 35 Market Supply Curve for Strawberries Market Supply Schedule for Strawberries f S 0.50 1.00 1.50 2.00 2.50 e Price ($ per kg) Quantity Supplied (millions of kg) Points on graph d $1.50 5 d Price ($ per kg) 2.00 9 e 2.50 13 f 1 3 5 7 9 11 13 Quantity Supplied (millions of kg per year) 3

Changes in Supply (a) Changes in supply: The number of producers are shown by shifts in the supply curve are caused by changes in supply determinants Supply determinants: factors that can cause an increase or a decrease in a product’s supply The six main supply determinants (Would be discussed closely later) The number of producers Resource prices The state of technology Changes in nature The price of related products Producer expectation 7

Changes in Supply (b) Figure 2.6, page 36 Market Supply Curve for Strawberries S2 S0 S1 Market Supply Schedule for Strawberries 0.50 1.00 1.50 2.00 2.50 Price ($ per kg) Quantity Supplied (millions of kg) (S2) (S0) (S1) Price ($ per kg) $2.50 11 13 15 2.00 7 9 11 1.50 3 5 7 1 3 5 7 9 11 13 15 Quantity Supplied (millions of kg per year) 3

Supply Determinants (a) Supply determinants include the following factors: Number of producers (an increase causes a rightward supply shift) Increase in supply: an increase in the quantity supplied of a product at all prices Decrease in supply: a decrease in the quantity supplied of a product at all prices Resource prices (an increase causes a leftward supply shift because of an increase of costs) State of technology (an improvement causes a rightward supply shift) Prices of related products (example: a declines in the price of tobacco, the supply for ginseng increases a rightward supply shift of ginseng) 9

Supply Determinants (b) Changes in nature (an improvement causes a rightward shift for some products) See other examples on page 37 Producer expectations (an expectation of lower prices in the future causes an immediate rightward supply shift)

Changes in Quantity Supplied (a) are shown by movements along the supply curve are caused by price changes See Figure 2.7, page 38

Changes in Quantity Supplied (b) Figure 2.7, page 38 1 2 Quantity Supplied (millions of kg per year) Change in Quantity Supplied Price ($ per kg) 20 40 60 80 100 120 Change in Supply 1 2 Quantity Supplied (millions of kg per year) Price ($ per kg) 20 40 60 80 100 120 S0 S0 S1 b a 3

T 3, How Competitive Markets Operate Market Equilibrium: the stable point at which demand and supply curves intersect ( the quantity demanded = the quantity supplied) When a product is in surplus: Surplus: an excess of quantity supplied over quantity demand there is excess supply price is pushed down When a product is in shortage: Shortage: an excess of quantity demanded over quantity supplied there is excess demand price is pushed up 10

Market Equilibrium Figure 2.8, page 40 Market Demand and Supply Schedules for Strawberries Market Demand and Supply Curves for Strawberries S 3.00 Surplus (+) or Shortage (-) (millions of kg) Surplus Quantities Price ($ per kg) 2.50 (millions of kg) D S a a 2.00 e $3.00 5 13 +8 2.50 7 11 +4 2.00 9 9 0 1.50 11 7 -4 1.00 13 5 -8 Price ($ per kg) 1.50 b b Shortage 1.00 D 1 3 5 7 9 11 13 15 Quantity (millions of kg per year)

Changes in Equilibrium A rightward demand shift pushes up both equilibrium price and quantity. A leftward demand shift pushes down both equilibrium price and quantity. A rightward supply shift pushes equilibrium price down and equilibrium quantity up. A leftward supply shift pushes equilibrium price up and equilibrium quantity down. 12

Demand Changes and Equilibrium Figure 2.9, page 41 Market Demand and Supply Curves for Strawberries Market Demand and Supply Schedules for Strawberries Price Quantities (D0) (D1) (S) ($ per kg.) (millions of kg) S 1.00 1.50 2.00 2.50 3.00 b a shortage Price ($ per kg) $3.00 5 9 13 2.50 7 11 11 D0 D1 2.00 9 13 9 1.50 11 15 7 1.00 13 17 5 1 3 5 7 9 11 13 15 17 Quantity (millions of kg per year)

Supply Changes and Equilibrium Figure 2.10, page 42 Market Demand and Supply Curves for Strawberries Market Demand and Supply Schedules for Strawberries Price Quantities ($ per kg) (millions of kg) S0 S1 1.00 1.50 2.00 2.50 3.00 Surplus (D0) (S0) (S1) a b Price ($ per kg) $3.00 5 13 17 2.50 7 11 15 D0 2.00 9 9 13 1.50 11 7 11 1.00 13 5 9 1 3 5 7 9 11 13 15 17 Quantity (millions of kg per year)