Chapter 17 Demand, Supply, and Equilibrium Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. 17-1

Chapter Objectives Individual and market demand Changes in demand Individual and market supply Changes in supply Graphing supply and demand curves Finding equilibrium price and quantity Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. 17-2

Demand Defined Demand is the schedule of quantities of a good or service that people will purchase at different prices –The law of demand: when the price of a good is lowered, more of it is demanded; When it is raised, less is demanded Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. 17-3

Individual and Market Demand The law of demand holds for both individuals and markets Individual demand is the schedule of quantities that a person would purchase at different prices Market demand is the schedule of quantities that everyone in the market would buy at different prices Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. 17-4

Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved Table 1 Hypothetical Individual Demand and Market Demand Schedules Quantity PricePrice Quantity demanded by Venus Price QD $

Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved Table 1 Hypothetical Individual Demand and Market Demand Schedules Quantity PricePrice Quantity demanded by Martina Price QD $

Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved Table 1 Hypothetical Individual Demand and Market Demand Schedules Quantity PricePrice Quantity demanded by Serena Price QD $

Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved Table 1 Hypothetical Individual Demand and Market Demand Schedules Quantity PricePrice Quantity demanded by Lindsay Price QD $

Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved Quantity PricePrice Price Venus Martina Serena Lindsay Total $

Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved Quantity PricePrice Price Venus Martina Serena Lindsay Total $ $

Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved Quantity PricePrice Price Venus Martina Serena Lindsay Total $ $ $

Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved Quantity PricePrice Price Venus Martina Serena Lindsay Total $ $ $ $

Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved Quantity PricePrice Price Venus Martina Serena Lindsay Total $ $ $ $ $

Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved Quantity PricePrice Price Venus Martina Serena Lindsay Total $ $ $ $ $ $

Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved Quantity PricePrice Price Venus Martina Serena Lindsay Total $ $ $ $ $ $ Market Demand

17-16 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. What Is the Market? The market is where people buy and sell –Local markets Gasoline, groceries –Regional Automobiles –National or international Computers

Changes in Demand Price QD(1) QD(2) $ $ $ $ $ $ A change in demand would be a change in the schedule Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

An Increase in Demand Price QD(1) QD(2) $ $ $ $ $ $ An increase in demand is an increase in the quantity people are willing to purchase at all prices Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. The demand curve shifts to the right

An Increase in Demand Price QD(1) QD(2) $ $ $ $ $ $ A decrease in demand means people are willing to purchase less at all prices Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. The demand curve shifts to the left

Changes in Demand D2D2 D1D1 A B C Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. Move from point A to point BA change in quantity demanded A and B are on the same line, therefore, they are on the same schedule. If they are on the same schedule, there can be no change in demand

Changes in Demand D2D2 D1D1 A B C Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. Move from point A to point BA change in quantity demanded Movement from A to B is simply a change in quantity demanded in response to a change in price

Changes in Demand E G I Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. Move from point F to point GAn increase in demand There is an increase in demand because people are willing to buy more at all prices on G’s curve which is to the right of F’s curve H F

Changes in Demand E G I Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. Move from point G to point HA decrease in demand There is a decrease in demand because people are willing to buy less at all prices on H’s curve which is to the left of G’s curve H F

Changes in Demand E G I Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. Move from point H to point IA change in quantity in demanded As long as we remain on the same curve, there is no change in demand H F

Changes in Demand L GJ Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. Move from point J to point KA change in quantity in demanded As long as we remain on the same curve, there is no change in demand N K M

Changes in Demand L GJ Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. Move from point K to point LAn increase in demand From K to L is an increase in demand because L’s demand curve is entirely to the right of K’s curve N K M

Changes in Demand L GJ Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. Move from point L to point MA decrease in demand From L to M is a decrease in demand because M’s demand curve is entirely to the left of L’s curve N K M

Changes in Demand L GJ Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. Move from point M to point NA change in demand We don’t know on which of an infinite number of possible demand curves N is situated, therefore, the most we can say is that there is a change in demand N K M

17-29 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. What Causes Changes in Demand? Changes in income Changes in the price of related goods and services Changes in taste and preferences Changes in price expectations Changes in population

17-30 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. Changes in Income The demand for NORMAL goods varies directly with income –When income goes up people buy more therefore demand goes up The demand for INFERIOR goods varies inversely with income –When income goes up people buy less, therefore demand goes down

17-31 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. Changes in the Price of Related Goods and Services Goods and services are related in two ways –They can be used as a substitute for the other Hot dogs and hamburgers; Tuna and salmon –They can complement the other Videos & VCRs; Gasoline & cars, tires

17-32 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. Prices of Substitute Goods Directly related –If the price of hamburgers goes up –The price of hot dogs would also go up As the price of hamburgers goes up people will buy less hamburgers and more hot dogs. This increases the demand for hot dogs... thus increasing the price of hot dogs

17-33 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

17-34 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. Prices of Complementary Goods Inversely related –Prices of weenies go up... the price of hot dog buns goes down The price of weenies goes up... people buy less weenies. If people buy less weenies, they will also buy less hot dog buns This decreases the demand for hot dog buns and lowers the price of hotdog buns

17-35 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

17-36 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. Changes in Taste and Preferences Taste and preferences tend to change over time –Smaller cars and less fattening foods –Preferring designer clothing and brand name sneakers –Fewer people are smoking (has been helped by a campaign to reduce smoking)

17-37 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. Changes in Price Expectations If people expect the price of something to rise, they rush out to stock up before it does –This increases the demand If people expect the price of something to fall, they will hold off buying it –This decreases the demand

17-38 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. Changes in Population As the nation’s population increases, the demand for particular goods and services increase –General growth increases the demand for food, housing, autos, etc. The changing age distribution affects demand –Next three decades there will be a higher demand for retirement homes, nursing homes, wheel chairs, bifocal glasses, etc.

17-39 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. Supply Defined Supply is a schedule of quantities of a good or service that people are willing to sell at various prices –As prices rise, people are willing to sell more –Thus, there is a positive or direct relationship between price and quantity Price rises... quantity supplied rises Prices declines... quantity supplied declines

17-40 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. Individual and Market Supply Hypothetical supply of American Cars, 2001 (in thousands) Daimler Japanese Price GM Ford Chrysler Owned Firms Total $20, ,447 18, ,976 16, ,618 14, ,648 12, ,858

17-41 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. Hypothetical Supply of American Cars, 2001

Changes in Supply Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. A change in quantity supplied

Changes in Supply Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. An increase in supply

Changes in Supply Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. A change in supply

Changes in Supply Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. A change in quantity supplied

Changes in Supply Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved An increase in supply

Changes in Supply Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. A change in quantity supplied

Changes in Supply Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. A decrease in supply

Changes in Supply Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. A change in supply

17-50 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

17-51 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

17-52 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

17-53 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

17-54 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

17-55 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

17-56 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.

Graphing the Demand and Supply Curves Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. Hypothetical Demand Schedule Price Quantity Demanded(QD) $10 1 $ 9 2 $ 8 4 $ 7 7 $ 6 12

Graphing the Demand and Supply Curves Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. Hypothetical Supply Schedule Price Quantity Supplied (QS) $10 14 $ 9 12 $ 8 9 $ 7 5 $ 6 1

Graphing the Demand and Supply Curves Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. Hypothetical Demand and Supply Schedules Price QD QS $ $ $ $ $ The equilibrium point is where the demand and supply curves cross

Graphing the Demand and Supply Curves Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. Hypothetical Demand and Supply Schedules Price QD QS $ $ $ $ $ Equilibrium quantity is 6 Equilibrium price is about $7.20

Graphing the Demand and Supply Curves Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. Above equilibrium price there are surpluses Price Price always tends toward equilibrium. If price is above equilibrium, sellers will lower prices until the price declines to the equilibrium price Price

Graphing the Demand and Supply Curves Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. Below equilibrium price there are shortages Price Price always tends toward equilibrium. If price is below equilibrium, buyers will bid prices up until the price rises to the equilibrium price Price

Finding Equilibrium Price and Quantity Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. If we draw our graphs accurately, we can usually find equilibrium price and quantity in a couple of seconds, especially if we’ve used graph paper. But sometime we need to do further analysis to find really accurate equilibrium prices and quantities Price Quantity Demanded Quantity Supplied $ $ $ $ $ Hypothetical Demand and Supply Schedule How much is the equilibrium price?

Finding Equilibrium Price and Quantity Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. Price Quantity Demanded Quantity Supplied $ $ $ $ $ Hypothetical Demand and Supply Schedule How much is the equilibrium price? First we add a “Units apart” column

Finding Equilibrium Price and Quantity Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. Price Quantity Demanded Units Apart Quantity Supplied $ $ $ $ $ Hypothetical Demand and Supply Schedule How much is the equilibrium price? First we add a “Units apart” column Equilibrium price is closer to $13 than to $12

Finding Equilibrium Price and Quantity Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. Price Quantity Demanded Units Apart Quantity Supplied $ $ $ $ $ Hypothetical Demand and Supply Schedule How much is the equilibrium price? First we add a “Units apart” column Equilibrium price is a little closer to $13 than to $12 Therefore, equilibrium price has to be something greater than $12.50 and less than $13

17-67 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. Price Quantity Demanded Units Apart Quantity Supplied $ $ $ $ $ Hypothetical Demand and Supply Schedule How much is the equilibrium quantity? Equilibrium quantity demanded is closer to 7 than 12. The midpoint between 12 and 7 is 9.5. Therefore, we know the equilibrium quantity demanded must be something less than 9.5 Equilibrium quantity supplied is closer to 12 than 6. The midpoint between 12 and 6 is 9. Therefore, we know the equilibrium quantity supplied is something more than 9.0 The equilibrium quantity has to be between 9.0 and 9.5. Anything between 9.1 and 9.4 would be acceptable. I would split the difference and say 9.2 or 9.3

17-68 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. Graph of the Previous Demand and Supply Schedule Remember, equilibrium price has to be something greater than $12.50 and less than $13 $12.60 plus or minus.05 is about the best you can do

17-69 Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved. Graph of the Previous Demand and Supply Schedule $12.60 plus or minus.05 is about the best you can do Remember, the equilibrium quantity has to be between 9.0 and 9.5. Anything between 9.1 and 9.4 would be acceptable. I would split the difference and say 9.2 or 9.3 In this instance, this technique proved useful.

Is This Type of Analysis Necessary? It isn’t when you’ve got an equilibrium price or quantity that is clearly closer to one figure than to another –You will be able to spot this when you draw your graph But when the demand and supply curves cross about halfway between two figures, then you will need to go back to the original schedule to figure out more precisely where the equilibrium point lies Copyright  2002 by The McGraw-Hill Companies, Inc. All rights reserved.