1. Surplus (a.k.a. excess supply):
when quantity supplied is greater than quantity demanded P Q
Facing a surplus, sellers try to increase sales by cutting price. S D
Surplus
This causes QD to rise
and QS to fall…
…which reduces the surplus.
THE MARKET FORCES OF SUPPLY AND DEMAND

2. Surplus (a.k.a. excess supply):
when quantity supplied is greater than quantity demanded P Q
Facing a surplus, sellers try to increase sales by cutting price. S D
Surplus
This causes QD to rise and QS to fall.
Prices continue to fall until market reaches equilibrium.
THE MARKET FORCES OF SUPPLY AND DEMAND 1

3. Shortage (a.k.a. excess demand):
when quantity demanded is greater than quantity supplied P Q
Example: If P = $1, S D
then QD = 21 lattes
and QS = 5 lattes
resulting in a shortage of 16 lattes
Shortage
THE MARKET FORCES OF SUPPLY AND DEMAND 2

4. Shortage (a.k.a. excess demand):
when quantity demanded is greater than quantity supplied P Q
Facing a shortage, sellers raise the price, S D
causing QD to fall
and QS to rise,
…which reduces the shortage.
Shortage
THE MARKET FORCES OF SUPPLY AND DEMAND 3

5. Shortage (a.k.a. excess demand):
when quantity demanded is greater than quantity supplied P Q
Facing a shortage, sellers raise the price, S D
causing QD to fall
and QS to rise.
Prices continue to rise until market reaches equilibrium.
Shortage
THE MARKET FORCES OF SUPPLY AND DEMAND 4

6. Three Steps to Analyzing Changes in Eq’m
To determine the effects of any event,
1. Decide whether event shifts S curve, D curve, or both.
2. Decide in which direction curve shifts.
3. Use supply-demand diagram to see how the shift changes eq’m P and Q.
Step one requires knowing all of the things that can shift D and S – the non-price determinants of demand and of supply.
THE MARKET FORCES OF SUPPLY AND DEMAND 5

7. EXAMPLE: The Market for Hybrid CarsQ
price of hybrid cars S1 D1 P1 Q1
quantity of hybrid cars
THE MARKET FORCES OF SUPPLY AND DEMAND 6

8. EXAMPLE 1: A Shift in Demand
EVENT TO BE ANALYZED: Increase in price of gas. P Q S1 D2 D1
STEP 1:
D curve shifts because price of gas affects demand for hybrids.
S curve does not shift, because price of gas does not affect cost of producing hybrids. P2 Q2
STEP 2:
D shifts right because high gas price makes hybrids more attractive relative to other cars. P1 Q1
STEP 3:
The shift causes an increase in price and quantity of hybrid cars.
THE MARKET FORCES OF SUPPLY AND DEMAND 7

9. EXAMPLE 1: A Shift in Demand
Notice: When P rises, producers supply a larger quantity of hybrids, even though the S curve has not shifted. P Q S1 D2 D1 P2 P1 Q1
Always be careful to distinguish b/w a shift in a curve and a movement along the curve. Q2
THE MARKET FORCES OF SUPPLY AND DEMAND 8

10. Terms for Shift vs. Movement Along Curve
Change in supply: a shift in the S curve
occurs when a non-price determinant of supply changes (like technology or costs)
Change in the quantity supplied: a movement along a fixed S curve
occurs when P changes
Change in demand: a shift in the D curve
occurs when a non-price determinant of demand changes (like income or # of buyers)
Change in the quantity demanded: a movement along a fixed D curve
“Supply” refers to the position of the supply curve, while “quantity supplied” refers to the specific amount that producers are willing and able to sell.
Similarly, “demand” refers to the position of the demand curve, while “quantity demanded” refers to the specific amount that consumers are willing and able to buy.
If you’d like to be a rebel, delete this slide and all references to the jargon it contains, and just use the terms “movement along a curve” and “shift in a curve.” Note, however, that this is not the official recommendation of Cengage/South-Western or Dr. Mankiw.
If you’d like to cover this slide but make it move more quickly, delete the text next to each second-level bullet (starting with “occurs when”). Instead, give the information to your students verbally or rely on them to read it in the textbook. 9 9

11. EXAMPLE 2: A Shift in Supply
EVENT: New technology reduces cost of producing hybrid cars. P Q S1 S2 D1
STEP 1:
S curve shifts because event affects cost of production.
D curve does not shift, because production technology is not one of the factors that affect demand.
STEP 2:
S shifts right because event reduces cost, makes production more profitable at any given price. P1 Q1 P2 Q2
STEP 3:
The shift causes price to fall and quantity to rise.
THE MARKET FORCES OF SUPPLY AND DEMAND 10

12. EXAMPLE 3: A Shift in Both Supply and Demand
EVENTS: price of gas rises AND new technology reduces production costs P Q S1 S2 D2 D1
STEP 1:
Both curves shift. P2 Q2 P1 Q1
STEP 2:
Both shift to the right.
STEP 3:
Q rises, but effect on P is ambiguous:
If demand increases more than supply, P rises.
THE MARKET FORCES OF SUPPLY AND DEMAND 11

13. EXAMPLE 3: A Shift in Both Supply and Demand
EVENTS: price of gas rises AND new technology reduces production costs P Q S1 S2 D2 D1
STEP 3, cont. P1 Q1
But if supply increases more than demand, P falls. P2 Q2
THE MARKET FORCES OF SUPPLY AND DEMAND 12

14. A C T I V E L E A R N I N G 3 Shifts in supply and demand
Use the three-step method to analyze the effects of each event on the equilibrium price and quantity of music downloads.
Event A: A fall in the price of CDs
Event B: Sellers of music downloads negotiate a reduction in the royalties they must pay for each song they sell.
Event C: Events A and B both occur.
Important note about Event B:
The royalties that sellers must pay the artists are part of sellers’ “costs of production.” Typically, this royalty is a fixed amount each time one of the artist’s songs is downloaded. Event B, therefore, describes a reduction in sellers’ “costs of production.” 13

15. A C T I V E L E A R N I N G 3 A. Fall in price of CDs
The market for music downloads
STEPS P Q
1. D curve shifts S1 D2 D1
2. D shifts left P1 Q1
3. P and Q both fall. P2 Q2
This is an extension of Active Learning exercise 1C, where we saw that a fall in the price of compact discs would cause a fall in demand for music downloads, because the two goods are substitutes. 14

16. A C T I V E L E A R N I N G 3 B. Fall in cost of royalties
The market for music downloads
STEPS P Q
1. S curve shifts S1 S2
(Royalties are part of sellers’ costs)
2. S shifts right D1 P1 Q1
3. P falls, Q rises. Q2 P2
NOTE: Don’t worry that the text on this slide looks garbled in “Normal view” (i.e., edit mode). It works fine in “Slide Show” (i.e., presentation mode).
Event B: Sellers of music downloads negotiate a reduction in the royalties they must pay for each song they sell. This event causes a fall in “costs of production” for sellers of music downloads. Hence, the S curve shifts to the right. 15

17. 1. Both curves shift (see parts A & B).
A C T I V E L E A R N I N G C. Fall in price of CDs and fall in cost of royalties
STEPS
1. Both curves shift (see parts A & B).
2. D shifts left, S shifts right.
3. P unambiguously falls.
Effect on Q is ambiguous: The fall in demand reduces Q, the increase in supply increases Q.
It’s not necessary to draw a graph here. The answers to steps 1 and 2 should be clear from parts A and B. The answer to step 3 is a combination of the results from A and B. 16

18. CONCLUSION: How Prices Allocate Resources
One of the Ten Principles from Chapter 1: Markets are usually a good way to organize economic activity.
In market economies, prices adjust to balance supply and demand. These equilibrium prices are the signals that guide economic decisions and thereby allocate scarce resources.
In the textbook, the conclusion of this chapter offers some very nice elaboration on the second bullet point. There is also an “In the News” box with a very nice article titled “In Praise of Price Gouging.”
THE MARKET FORCES OF SUPPLY AND DEMAND 17

19. CHAPTER SUMMARY
A competitive market has many buyers and sellers, each of whom has little or no influence on the market price.
Economists use the supply and demand model to analyze competitive markets.
The downward-sloping demand curve reflects the Law of Demand, which states that the quantity buyers demand of a good depends negatively on the good’s price. 18

20. CHAPTER SUMMARY
Besides price, demand depends on buyers’ incomes, tastes, expectations, the prices of substitutes and complements, and number of buyers. If one of these factors changes, the D curve shifts.
The upward-sloping supply curve reflects the Law of Supply, which states that the quantity sellers supply depends positively on the good’s price.
Other determinants of supply include input prices, technology, expectations, and the # of sellers. Changes in these factors shift the S curve. 19

21. CHAPTER SUMMARY
The intersection of S and D curves determines the market equilibrium. At the equilibrium price, quantity supplied equals quantity demanded.
If the market price is above equilibrium, a surplus results, which causes the price to fall. If the market price is below equilibrium, a shortage results, causing the price to rise. 20

22. CHAPTER SUMMARY
We can use the supply-demand diagram to analyze the effects of any event on a market: First, determine whether the event shifts one or both curves. Second, determine the direction of the shifts. Third, compare the new equilibrium to the initial one.
In market economies, prices are the signals that guide economic decisions and allocate scarce resources. 21