Supply and Demand 1

Demand Demand represents the behavior of buyers. A Demand Curve A Demand Curve shows the quantity demanded at different prices. Quantity Demanded: the ◦ The Quantity Demanded: the quantity that buyers are willing (and able) to purchase at a particular price. 2

Law of Demand Price and Quantity Demanded are negatively related 3

The Demand Curve 4 The Demand Curve for Oil Price of Oil per Barrel Quantity of Oil (MBD) $55 5 $5 50 $20 25 Demand Price Quantity Demanded $55 5 $2025 $550

Reading Demand Curves Demand curves can be read in two ways: ◦ Horizontally: How much buyers are willing and able to purchase at a certain price. ◦ Vertically: The highest price buyers are willing to pay for a certain quantity. 5

What Shifts the Demand Curve? 6 An “increase in demand” An “increase in demand” means that consumers buy more at every price level, (or consumers are willing to pay more for each quantity.) On the graph: the demand curve shifts outwards, up, and to the right.

An Increase in Demand 7 $50 80 Old Demand Curve $25 70 Price per Unit Quantity New Demand Curve Greater Quantity Demanded at the Same Price Greater Willingness to Pay for the Same Quantity

What Shifts the Demand Curve? decrease in demand” A “decrease in demand” means that consumers buy less at every price level, (or they reduce the price they’re willing to pay for a given quantity.) ◦ On the graph: the demand curve shifts inwards, down, and to the left. 8

A Decrease in Demand 9 $50 80 Old Demand Curve $25 70 Less Quantity Demanded at the Same Price Lower Willingness to Pay for the Same Quantity Price per Unit Quantity New Demand Curve

Demand Shifters Important Demand Shifters: 1.Income 2.Population 3.Price of Substitutes 4.Price of Complements 5.Expectations 6.Tastes 10

Important Demand Shifters: Income 1. The effect of changes in income on demand depends on the nature of the good in question. Normal Good: ◦ A Normal Good: demand increases when income increases (and vice versa). Inferior Good: ◦ An Inferior Good: demand decreases when income increases (and vice versa) 11

Important Demand Shifters: Population 2. As the population of an economy changes, the # of buyers of a particular good also changes, (thereby changing its demand.) ◦ What happens to the demand for formula in a country as birth rates drop? 12

Important Demand Shifters: Price of Substitutes Substitutes 3. Two goods are Substitutes if a decrease in the price of one leads to a decrease in demand for the other (or vice versa). - What happens to the demand for travel in Hawaii if the (perceived) safety cost of traveling to Mexico increases? 13

Important Demand Shifters: Price of Complements Complements 4. Two goods are Complements if a decrease in the price of one good leads to an increase in the demand for the other (or vice versa). ◦ What happens to the demand for Sport Utility Vehicles when gasoline gets more expensive? 14

Price of Complements Consumers often have to buy goods together. An increase in price of gasoline will decrease the demand for SUVs 15

Important Demand Shifters: Expectations 5. The expectation of a higher (lower) price for a good in the future increases (decreases) current demand for the good. ◦ Consumers will adjust their current spending in anticipation of the direction of future prices in order to obtain the lowest possible price.  If prices for Xbox 360 consoles are expected to drop right before Christmas, what will happen to sales during November? 16

Important Demand Shifters: Tastes 6. Tastes and preferences are subjective and will vary among consumers. ◦ Seasonal changes or fads have predictable effects on demand. ◦ What happens to demand for boots in October? To carbohydrates during the Atkins diet fad? Or to Acai berries after newly perceived health benefits? 17

What Shifts the Demand Curve? A “change in quantity demanded” is NOT the same as a “change in demand.” ◦ “Quantity demanded” changes only when the price of a good changes.  It is a movement along a fixed demand curve. ◦ “Demand” changes only when a non-price factor (demand shifter) changes.  It is a shift in the entire demand curve. 18 A “change in Quantity Demanded” A “change in Demand”

Supply What made this oil field happen? 19

Supply Supply represents the behavior of sellers. Supply Curve A Supply Curve shows the quantity supplied at different prices. Quantity Supplied ◦ The Quantity Supplied is the quantity that producers are willing and able to sell at a particular price. 20

Law of Supply What do you think happens to the quantity of human organs donated in Israel when the government issues a point system that rewards donors? Law of Supply: The Law of Supply: there is a direct relationship between price and quantity supplied. ◦ When price rises, all else equal, quantity supplied rises and vice versa 21

The Supply Curve 22 Quantity of Oil (MBD) Price of Oil per Barrel Supply Curve for Oil $5 $20 $55 Price Quantity Supplied $5550 $2030 $510 The Supply Curve for Oil

Reading Supply Curves Supply curves can be read in two ways: ◦ Horizontally: How much suppliers are willing and able to sell at a certain price. ◦ Vertically: The minimum price for which suppliers are willing to sell a certain quantity. 23

Supply Curves Why is the supply curve upward sloping? ◦ The cost of producing a good is not equal across all suppliers.  At a low price, a good is produced and sold only by the lowest cost suppliers.  At a high price, a good is also produced and sold by higher cost suppliers. 24

The Supply Curve for Oil 25 Supply Quantity of Oil (MBD) Price of Oil per Barrel $60 $40 $ Oil Shale Profitable Here Low Cost Oil Higher Cost Oil The Supply Curve for Oil

Change in Supply 26 Old Supply $50 20 Lower Costs Increase Supply Quantity of Oil (MBD) Price of Oil per Barrel New Supply $10 80 Greater Quantity Supplied at the Same Price Willing to Sell Same Quantity at Lower Prices

Change in Supply 27 Old Supply 20 Higher Costs Decrease Supply Quantity of Oil (MBD) Price of Oil per Barrel New Supply $10 80 Smaller Quantity Supplied at the Same Price Higher Price Needed to Sell Same Quantity

Supply Shifters Important Supply Shifters 1.Technological Innovations 2.Input Prices 3.Taxes and Subsidies 4.Expectations 5.Entry or Exit of Producers 6.Changes in Opportunity Costs 28

Important Supply Shifters: Technological Innovations 1. A technological innovation makes sellers willing to offer more at a given price, or sell a their quantity at a lower price. ◦ A technological innovation lowers costs and increases supply. 29

Production Technology Supply will increase for products when technology improves Examples: Computers, gaming systems, laser hair removal, flat screen TVs. 30

Important Supply Shifters: Input Prices 2. A decrease in the price of an input (all else equal) increases profits and encourages more supply (and vice versa) ◦ What will happen to the amount of new businesses if the government reduces the fees and red tape associated with new business licenses? What happens if the fees rise? 31

Important Supply Shifters: Taxes and Subsidies 3. A tax on output reduces profit and makes sellers less willing to supply at a given price, unless they can effectively raise the price without losing any sales. (for now, assume they cannot) ◦ A tax on output raises costs and decreases supply. 32

Important Supply Shifters: Taxes and Subsidies A subsidy on production makes sellers willing to supply a greater quantity at a given price, or the subsidy allows producers to sell a given quantity at a lower price. ◦ A subsidy on production lowers costs and increases supply. ◦ Graph the effect on supply of a new subsidy to fast food producers aimed at helping them market and sell overseas. 33

Taxes and Subsidies Taxes and subsidies affect profits and therefore supply. A 10% yacht tax reduced the supply of yachts 53% in the early 1990s. 34

Cotton Supply 35 ◦ When the U.S. decreases its cotton subsidies, U.S. cotton supply decreases

Important Supply Shifters: Taxes and Subsidies 36 $10 Supply With $10 Tax $10 $50 Supply Without Tax $40 60 Quantity of Oil (MBD) Price of Oil per Barrel With a $10 Tax Suppliers Require a $10 Higher Price to Sell the Same Quantity

Important Supply Shifters: Expectations 4. The expectation of a higher price for a good in the future decreases current supply of the good – if they can store the good- (and vice versa). ◦ Sellers will adjust their current offerings in anticipation of the direction of future prices in order to obtain the highest possible price. 37

Future Expectations A change in producers’ expectations about profitability will affect supply curves ◦ Windmill production increases as producers expect sales and profitability to increase. 38

Important Supply Shifters: Expectations 39 Expectations Can Shift the Supply Curve Quantity Price per Unit Supply Today Supply Today with Expectation of Future Price Increase Into Storage

Important Supply Shifters: Entry or Exit of Producers 5. As producers enter and exit the market, the overall supply changes. ◦ Entry implies more sellers in the market increasing supply. ◦ Exit implies fewer sellers in the market decreasing supply. 40

Number of Producers As more producers enter a market, supply increases (and vice versa) 41 As more firms enter the solar installation market, the number of solar installations available for sale increases

Important Supply Shifters: Entry or Exit of Producers 42 Domestic Supply Domestic Supply Plus Canadian Imports Price Quantity Entry Increases Supply Greater Quantity Supplied at the Same Price Lower Price for the Same Quantity Supplied

Important Supply Shifters: Changes in Opportunity Costs 6. Inputs used in production have opportunity costs. Sellers will choose to use those inputs where the profit is the highest ◦ Sellers will supply less of a good if the price of an alternate good using the same inputs rises (and vice versa). ◦ Sellers always chase the highest profit goods. 43

Changes in Opportunity Costs Producers have the ability to produce other goods An increase in the profitability of small cars will decrease the supply of SUVs

Important Supply Shifters: Changes in Opportunity Costs 45 $5 Supply with Low Opportunity Costs 2,800 Higher (Opportunity) Costs Reduce Supply- Rising Wheat Prices Reduce Soybean Supply Quantity of Soybeans (Millions of Bushels) Price per Unit 2,000 $7 Supply with High Opportunity Costs Smaller Quantity Supplied at the Same Price Higher Price Required to Sell the Same Quantity

What Shifts the Supply Curve? A “change in quantity supplied” is NOT the same as a “change in supply.” ◦ “Quantity supplied” changes only when the price of a good changes.  It is a movement along a fixed supply curve. ◦ “Supply” changes only when a non-price factor changes.  It is a shift in the entire supply curve. 46 A “change in Quantity Supplied” A “change in Supply”