1. Supply, Demand, and Price
Microeconomics
Supply, Demand, and Price

2. Standard
SSEMI2- The student will explain how the Law of Demand, the Law of Supply, prices, and profits work to determine production and distribution in a market economy.
Define the Law of Supply and the Law of Demand.
Describe the role of buyers and sellers in determining market clearing price
Illustrate on a graph how supply and demand determine equilibrium price and quantity.
Explain how prices serve as incentives in a market economy
Essential Question: How does quantity demanded and price impact each other?

3. Quick Review 3 Economic Questions What to produce?
How much to produce?
Who gets what?

4. Supply and Demand Overview
In a market system the interaction of buyers and sellers determines the prices of most goods as well as what quantity of a good will be produced
Buyers demand goods
Sellers supply goods
Interactions between the groups lead to an agreement on prices and quantity traded

5. Demand
Demand- the desire to own something and the ability to pay for it
The Law of Demand- Consumers buy more a good when its price decreases and less when its price increases

6. Demand Schedule
Demand Schedule- a table that lists the quantity of a good a person will buy at each different price
Market Demand Schedule- a table that lists the quantity of a good all consumers in a market will buy at each different price; allows business owners to predict sales at several different price levels
Individual Demand Schedule
Market Demand Schedule
Price of a slice of pizza
Quantity demanded per day
$.50 5
300
$1.00 4
250
$1.50 3
200
$2.00 2
150
$2.50 1
100
$3.00 50

7. Demand Graph
Demand Curve- a graphic representation of a demand schedule
Vertical Axis- labeled with the lowest possible prices at the bottom and the highest at the top
Horizontal Axis- lowest quantity at the left and highest quantity at the right

8. Demand Curve
Demand curves only show the relationship between the price of the good and the quantity purchased; they assume ceteris paribus- Latin phrase that means all other things are held constant
Demand curves on the graph slopes downward to the right; as price decreases, demand increases

9. Price per slice (in dollars)
Demand Curve
Market Demand Curve
3.00
2.50
2.00
1.50
1.00
.50 50
100
150
200
250
300
350
Slices of pizza per day
Price per slice (in dollars)
This illustrates our market demand schedule for pizzas from earlier.
Demand

10. Shifts of the Demand Curve
Changes in Demand
A demand curve is accurate as long as there are no changes other than price that could affect the consumer’s decision
When ceteris paribus is dropped and other factors change the entire demand curve shifts
Increase in demand- the curve shifts right
Decrease in demand- the curve shifts left
A shift if the demand curve means that at every price consumers buy a different quantity than before

11. What Changes Demand?
A change in price does NOT cause the demand curve to shift- price changes are already built in

12. What Changes Demand? Recall the definition Taste (desire)
Income (ability to pay)
Complimentary Items
Substitutes
Expectations

13. Taste
As we grow up, hear information, learn more etc our opinions and feelings change
The way we want, desire, feel or like something is TASTE

14. Income
Due to our salary, pay checks, job opportunities we have more or less money to spend.
This change in Income changes our ability to buy

15. Complimentary Goods These items go together.
For example if the cost of peanut butter goes way down, we desire more jelly. (if cost goes up we will desire less jelly)

16. Substitutes These items can be exchanged for the other.
If the cost of peanut butter goes way up, we may buy more pizza for lunch. Pizza can be exchanged for PB and J sandwiches.

17. Expectations
What people anticipate will occur in the future

18. What Changes Demand? Remember TICS changes demand!! Taste (desire)
Income (ability to pay)
Complimentary Items
Substitutes
Expectations

19. Elasticity of Demand
Elasticity of Demand- a measure of how consumers react to a change in price
Inelastic- the demand for a good you will keep buying despite a price increase
Elastic- describes that demand is sensitive to a change in price

20. Calculating Elasticity
Remember that the law of demand says that whenever there is an increase in price, there will be a decrease in demand
Price range helps to determine the elasticity of a price
Demand for a good at one price may be elastic but at another price the same good might be inelastic

21. Calculating Elasticity
Elasticity is calculated by using the following formula:
Elasticity of Demand= percentage change in demand of a good
percentage change in the price of the good
Percentage Change= Original number-New Number X 100
Original Number
Results may be negative, but all negatives are dropped.

22. Values of Elasticity
If the elasticity of demand for a good is less than 1, demand is inelastic
If elasticity is greater than 1, demand is elastic
If elasticity is equal to 1, demand is unitary elastic

23. Elasticity
If the price of a pizza goes up from $1 to $1.50, and the quantity of the pizza fell from 4 to 3.
The change in price is ____
The change in quantity demanded is ___
Is the price of pizza elastic or inelastic?
Price is 50 %
Demand is 25%

24. Factors Affecting Elasticity
Availability of substitutes- Lack of substitutes makes a good’s demand inelastic; substitutes makes a good’s demand elastic
Relative importance- how much of your budget you spend on a good will determine its elasticity
Necessities versus luxuries

25. Change Over Time
Consumers often take time to respond to price changes- demand is inelastic for the short term
Demand for a good becomes elastic as consumer find substitutes

26. Elasticity and Total Revenue
Total revenue is defined as the amount of money the company receives by selling its goods
If a good is elastic, an increase in price may cause a firm’s total revenue to go down
If a good is inelastic, an increase in price will make up for lower sales

27. Elasticity and Pricing Policies
Firms use elasticity of a good to figure out whether or not it would be helpful or harmful to their revenue to raise the price of a good.

28. Total Revenue and Price
If Price Increases & total revenue increases= inelastic
If Price decrease & total revenue decreases= inelastic
If Price increases & total revenue decreases= elastic
If Price decreases & total revenue increases= elastic

29. Are the Following Elastic or Inelastic?
Salt
New Cars
Pork Chops
European Vacation
Insulin
Insulin at one of four drug stores in a shopping mall
Gasoline purchased on day after a 20% price increase
Gasoline purchased one year after a 20% price increase

30. Supply
Supply- the amount of goods available; used by economists to refer to the relationship between price and quantity supplied
Law of Supply- tendency of suppliers to offer more of a good at a higher price; the higher the price the larger the quantity produced
Quantity Supplied- the amount a supplier is willing and able to supply at a certain price

31. Supply Continued
As the price of a good rises, existing firms will produce more in order to earn additional revenue
New firms have an incentive to enter the market to earn a profit for themselves
If the price falls, some firms produce less and others might drop out of the market

32. Higher Production
If a firm is earning a profit then an increase in price- ceteris paribus- will increase the firms profits

33. The Supply Schedule
Supply Schedule- a chart that lists how much of a good a supplier will offer at different prices
Market Supply Schedule- a chart that lists how much of a good all suppliers will offer at different prices
Like demand schedules a change in price is built in the schedule

34. The Supply Graph
Supply Curve- a graph of the quantity supplied of a good at different prices
Vertical- price
Horizontal- quantity of the good supplied
Rises from left to right
Market Supply Curve- a graph of the quantity supplied of a good by all suppliers at different prices

35. Output (slices per day)
Supply Curve
Market Supply Curve
Price (in dollars)
Output (slices per day)
3.00
2.50
2.00
1.50
1.00
.50
500
1000
1500
2000
2500
3000
3500
Supply

36. What Changes Supply? Sellers Technology Regulations Input Costs
Recall The Definition
Sellers
Technology
Regulations
Input Costs
Productivity
Expectations

37. Sellers
Depending on the circumstance there are sometimes more or less sellers based on competition or product availability

38. Technology This changes the manner in which we make our products
This deals with efficiency

39. Regulations
Regulation- a government intervention in a market that affects the production of a good
Subsidy- a government payment that supports a business or market
Excise Tax- a tax on the production or sale of a good (ex. Tax on cigarettes)

40. Input Costs
This involves the changes that effect the materials, fixed cost and other variable costs it takes to produce the product.

41. Productivity This changes the manner in which we make our products
This deals with efficiency
And often focuses on the people and training

42. Expectations What is going to happen…how do businesses prepare for it?
Ex. Christmas Production

43. This is why you need to remember
Sellers
Technology
Regulations
Input Costs
Productivity
Expectations

44. Supply and Elasticity
Elasticity of Supply– a measure of the way quantity supplied reacts to a change in price
If elasticity is greater than 1, supply is elastic- supply is sensitive to change in price
If elasticity is less than 1, supply is inelastic
If elasticity is equal to 1, supply is unitary elastic

45. What affects elasticity of supply?
Time
In the short run, a firm cannot easily change its output level, so supply is inelastic.
In the long run, firms are more flexible, so supply can become more elastic

46. Price of a slice of pizza Combined Supply and Demand Schedule
The point at which quantity demanded and quantity supplied come together is known as equilibrium (market clearing price).
Price per slice
Equilibrium Point
Finding Equilibrium
Price of a slice of pizza
Quantity demanded
Quantity supplied
Result
Combined Supply and Demand Schedule
$ .50
300
100
$3.50
$3.00
$2.50
$2.00
$1.50
$1.00
$.50
Slices of pizza per day 50
150
200
250
350
Supply
Demand
$2.00
$2.50
$3.00
150
100 50
250
300
350
Surplus from excess supply
$1.00
250
150
Shortage from excess demand
$1.50
200
Equilibrium
Equilibrium Price a
Equilibrium Quantity

47. Combining Supply and Demand
At Equilibrium the market for a good is stable
The Equilibrium Price and Quantity can be found where quantity supplied equals quantity demanded or where the two curves cross.

48. Disequilibrium
Disequilibrium- describes any price or quantity not at equilibrium; when quantity supplied is not equal to quantity demanded in a market
Excess Demand- when quantity demanded is more than quantity supplied
Sellers will raise their prices
Excess Supply- when quantity supplied is more than quantity demanded
Sellers will lower their prices
Interactions between buyers and sellers will always push the market back towards equilibrium.

49. Government Intervention
Price Ceiling- a maximum price that can be legally charged for a good or service
Rent Control- a price control placed on rent (has occurred in New York City)
What do you think are the problems with rent control?

50. Government Regulation
Price Floor- a minimum price for a good or service
Minimum Wage- minimum price that an employer can pay a worker for an hour of labor
Minimum Wage can cause a surplus of labor

51. Shifts in Supply Understanding a Shift Excess Supply A Fall in Supply
Since markets tend to move toward equilibrium, a change in supply will set market forces in motion that lead the market to a new equilibrium price and quantity sold.
Excess Supply
A surplus is a situation in which quantity supplied is greater than quantity demanded. If a surplus occurs, producers reduce prices to sell their products. This creates a new market equilibrium.
A Fall in Supply
The exact opposite will occur when supply is decreased. As supply decreases, producers will raise prices and demand will decrease.

52. Shifts in Demand Excess Demand
A shortage is a situation in which quantity demanded is greater than quantity supplied.
Search Costs
Search costs are the financial and opportunity costs consumers pay when searching for a good or service.
A Fall in Demand
When demand falls, suppliers respond by cutting prices, and a new market equilibrium is found.

53. Analyzing Shifts in Supply and Demand
$800
$600
$400
$200
Price
Output (in millions)
Graph A: A Change in Supply 1 2 3 4 5
Graph B: A Change in Demand
Output (in thousands)
$60
$50
$40
$30
$20
$10
900
800
700
600
500
400
300
200
100
Price
Original supply
Demand a
New demand c b
New supply b c
Supply
Original demand a
Graph A shows how the market finds a new equilibrium when there is an increase in supply.
Graph B shows how the market finds a new equilibrium when there is an increase in demand.

54. Prices in a Free Market
Prices help move land, labor, and capital into the hands of producers and finished goods into the hands of buyers.

55. The Advantages of Prices
Price as incentive
Prices are a signal that tell a consumer or producer how to adjust
Prices as signals
Low Price- buyers purchase more; sellers make less
High Price- buyers purchase less; sellers make more

56. The Advantages of Prices
Flexibility
Prices can be easily increased to solve the problem of excess demand
Prices can be easily decreased to solve the problem of excess supply
Supply Shock- a sudden shortage of a good
Rationing- a system of allocating scarce goods and services using criteria other than price
Raising prices is the quickest way to solve excess demand

57. A Wide Choice of Goods
A benefit of a market-based economy is the diversity of goods and services consumers can buy
Market economy allows price to allocate resources efficiently
In a market economy there are incentives to raise prices in return for profit

58. Wealth of Nations Wealth of Nations- Written by Adam Smith in 1776
Businesses prosper by finding out what people want and then providing it

59. Market Problems
Imperfect Competition- there are not enough producers of a good to drive prices down
Spillover Costs- costs of production that affect people who have no control over how much of a good is produced
Imperfect Information