1. Unit 2 S/D and Consumer Behavior

2. MARKETS AND COMPETITION
A market is a group of buyers and sellers of a particular good or service.
The terms supply and demand refer to the behavior of people as they interact with one another in markets. 4

3. MARKETS AND COMPETITION
Buyers determine demand.
Sellers determine supply 4

4. DEMAND
Quantity demanded is the amount of a good that buyers are willing and able to purchase.
Law of Demand
The law of demand states that, other things equal (ceteris paribus), the quantity demanded of a good falls when the price of the good rises.
Substitution Effect
Consumers have an incentive to substitute what is now a less expensive product for similar products that are now relatively more expensive
Income Effect
Lower price raises real income, enabling buyers to buy more of the product 8

5. The Demand Curve: The Relationship between Price and Quantity Demanded
Demand Schedule
The demand schedule is a table that shows the relationship between the price of the good and the quantity demanded. 17

6. Catherine’s Demand Schedule17

7. The Demand Curve: The Relationship between Price and Quantity Demanded
The demand curve is a graph of the relationship between the price of a good and the quantity demanded. 17

8. Catherine’s Demand Schedule and Demand Curve
Price of
Ice-Cream Cone
$3.00
2.50
1. A decrease
in price
...
2.00
1.50
1.00
0.50 1 2 3 4 5 6 7 8 9 10 11 12
Quantity of 2.
...
increases quantity
of cones demanded.
Ice-Cream Cones
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9. Market Demand versus Individual Demand
Market demand refers to the sum of all individual demands for a particular good or service.
How do we find the market?
Add all the individuals!

10. Shifts in the Demand Curve
Change in Quantity Demanded
Movement along the demand curve.
Caused by a change in the price of the product. 19

11. Changes in Quantity Demanded
Price of Ice-Cream Cones
A tax that raises the price of ice-cream cones results in a movement along the demand curve. B
$2.00 A
1.00 D 4 8
Quantity of Ice-Cream Cones

12. Shifts in the Demand Curve
Change in Demand
A shift in the demand curve, either to the left or right.
Caused by any change that alters the quantity demanded at every price. 19

13. Shifts in the Demand Curve
Number of consumers
Income of consumers
Complement price change
Expectations
Substitute price change
Tastes 11

14. Shifts in the Demand Curve
Price of
Ice-Cream
Cone
Increase
in demand
Decrease
in demand
Demand
curve, D 2
Demand
curve, D 1
Demand curve, D 3
Quantity of
Ice-Cream Cones
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15. Shifts and Changes in Demand cont.
A closer look at changes in income
Normal Good
A good that consumers
demand more when their
incomes increase
Inferior Good
demand less when their

16. Consumer Income Normal Good
Price of Hamburgers
$3.00
An increase in income...
2.50
Increase
in demand
2.00
1.50
1.00
0.50 D2 D1
Quantity of Hamburgers 1 2 3 4 5 6 7 8 9 10 11 12

17. Consumer Income Inferior Good
Price of Spam
$3.00
2.50
An increase in income...
2.00
Decrease
in demand
1.50
1.00
0.50 D1
Quantity of Spam 1 2 3 4 5 6 7 8 9 10 11 12

18. SUPPLY
Quantity supplied is the amount of a good that sellers are willing and able to sell.
Law of Supply
The law of supply states that, other things equal (ceteris paribus), the quantity supplied of a good rises when the price of the good rises. 25

19. The Supply Curve: The Relationship between Price and Quantity Supplied
Supply Schedule
The supply schedule is a table that shows the relationship between the price of the good and the quantity supplied. 29

20. Ben’s Supply Schedule
Supplied 29

21. The Supply Curve: The Relationship between Price and Quantity Supplied
The supply curve is the graph of the relationship between the price of a good and the quantity supplied. 29

22. Ben’s Supply Schedule and Supply Curve
Price of
Ice-Cream
Cone
$3.00
2.50
1. An
increase
in price
...
2.00
1.50
1.00
0.50 1 2 3 4 5 6 7 8 9 10 11 12
Quantity of
Ice-Cream Cones 2.
...
increases quantity of cones supplied.
Copyright©2003 Southwestern/Thomson Learning

23. Market Supply versus Individual Supply
Market supply refers to the sum of all individual supplies for all sellers of a particular good or service.
How do we find the market?
Add all the individuals!

24. Shifts in the Supply Curve
Change in Quantity Supplied
Movement along the supply curve.
Caused by a change in the price of the product. 30

25. Change in Quantity Supplied
Price of Ice-Cream Cone S C
$3.00
A rise in the price of ice cream cones results in a movement along the supply curve. A
1.00
Quantity of Ice-Cream Cones 1 5 30

26. Shifts in the Supply Curve
Change in Supply
A shift in the supply curve, either to the left or right.
Alters the quantity supplied at every price. 30

27. Shifts in the Supply Curve
Resource prices
Expectations
Number of producers
Technology changes
Government action (taxes, subsidies, and regulations)
Other goods prices 27

28. Shifts in the Supply Curve
Price of
Supply curve, S 3
Ice-Cream
curve,
Supply S 1
Cone
Supply
curve, S 2
Decrease
in supply
Increase
in supply
Quantity of
Ice-Cream Cones
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29. SUPPLY AND DEMAND TOGETHER
Equilibrium refers to a situation in which the price has reached the level where quantity supplied equals quantity demanded.
Equilibrium Price and Quantity
On the graph, it is where supply and demand intersect 36

30. SUPPLY AND DEMAND TOGETHER
Demand Schedule
Supply Schedule
At $2.00, the quantity demanded is equal to the quantity supplied! 36

31. The Equilibrium of Supply and Demand
Price of
Ice-Cream
Cone
Supply
Demand
Equilibrium
Equilibrium price
$2.00
Equilibrium
quantity 1 2 3 4 5 6 7 8 9 10 11 12 13
Quantity of Ice-Cream Cones
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32. Equilibrium
Surplus
When price > equilibrium price, then quantity supplied > quantity demanded.
There is excess supply or a surplus.
Suppliers will lower the price to increase sales, thereby moving toward equilibrium.

33. Markets Not in Equilibrium
(a) Excess Supply
Price of
Ice-Cream
Supply
Cone
Surplus
Demand
$2.50 10 4
2.00 7
Quantity of
Quantity
demanded
Quantity
supplied
Ice-Cream
Cones
Copyright©2003 Southwestern/Thomson Learning

34. Equilibrium
Shortage
When price < equilibrium price, then quantity demanded > the quantity supplied.
There is excess demand or a shortage.
Suppliers will raise the price due to too many buyers chasing too few goods, thereby moving toward equilibrium.

35. Markets Not in Equilibrium
(b) Excess Demand
Price of
Ice-Cream
Supply
Cone
Demand
$2.00 7
1.50 10 4
Shortage
Quantity of
Quantity
supplied
Quantity
demanded
Ice-Cream
Cones
Copyright©2003 Southwestern/Thomson Learning

36. Law of supply and demand
Equilibrium
Law of supply and demand
The claim that the price of any good adjusts to bring the quantity supplied and the quantity demanded for that good into balance.

37. How an Increase in Demand Affects the Equilibrium
Price of
Ice-Cream
1. Hot weather increases
the demand for ice cream . . .
Cone D D
Supply
New equilibrium
$2.50 10
resulting
in a higher
price . . .
2.00 7
Initial
equilibrium
Quantity of 3.
. . .
and a higher
quantity sold.
Ice-Cream Cones
Copyright©2003 Southwestern/Thomson Learning

38. How a Decrease in Supply Affects the Equilibrium
Price of
1. An increase in the
price of sugar reduces
the supply of ice cream. . .
Ice-Cream
Cone S2 S1
Demand
New
equilibrium
$2.50 4
resulting
in a higher
price of ice
cream . . .
Initial equilibrium
2.00 7
Quantity of 3.
. . .
and a lower
quantity sold.
Ice-Cream Cones
Copyright©2003 Southwestern/Thomson Learning

39. Elasticity . . .
… allows us to analyze supply and demand with greater precision.
… is a measure of how much buyers and sellers respond to changes in market conditions

40. THE ELASTICITY OF DEMAND
Price elasticity of demand is a measure of how much the quantity demanded of a good responds to a change in the price of that good.
Price elasticity of demand is the percentage change in quantity demanded given a percent change in the price.

41. The Price Elasticity of Demand and Its Determinants
Availability of Close Substitutes
Necessities versus Luxuries
Definition of the Market
Time Horizon
% of Income

42. Computing the Price Elasticity of Demand
The price elasticity of demand is computed as the percentage change in the quantity demanded divided by the percentage change in price.

43. The Midpoint Method: A Better Way to Calculate Percentage Changes and Elasticities
The midpoint formula is preferable when calculating the price elasticity of demand because it gives the same answer regardless of the direction of the change.

44. The Midpoint Method: A Better Way to Calculate Percentage Changes and Elasticities
Example: If the price of an ice cream cone increases from $2.00 to $2.20 and the amount you buy falls from 10 to 8 cones, then your elasticity of demand, using the midpoint formula, would be calculated as:

45. The Variety of Demand Curves
Inelastic Demand
Quantity demanded does not respond strongly to price changes.
Ed < 1
Elastic Demand
Quantity demanded responds strongly to changes in price.
Ed > 1

46. The Variety of Demand Curves
Perfectly Inelastic
Quantity demanded does not respond to price changes.
Perfectly Elastic
Quantity demanded changes infinitely with any change in price.
Unit Elastic
Quantity demanded changes by the same percentage as the price.

47. The Variety of Demand Curves
Because the price elasticity of demand measures how much quantity demanded responds to the price, it is closely related to the slope of the demand curve.

48. The Price Elasticity of Demand
(a) Perfectly Inelastic Demand: Elasticity Equals 0
Price
Demand
100 $5
1. An
increase
in price . . . 4
Quantity
leaves the quantity demanded unchanged.
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49. The Price Elasticity of Demand
(e) Perfectly Elastic Demand: Elasticity Equals Infinity
Price
1. At any price
above $4, quantity
demanded is zero. $4
Demand
2. At exactly $4,
consumers will
buy any quantity.
3. At a price below $4,
quantity demanded is infinite.
Quantity

50. Total Revenue and the Price Elasticity of Demand
Total revenue is the amount paid by buyers and received by sellers of a good.
Computed as the price of the good times the quantity sold.
TR = P x Q

51. Total Revenue Price $4 P × Q = $400 P (revenue) Demand 100 Quantity Q
Quantity Q
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52. Elasticity and Total Revenue along a Linear Demand Curve
With an inelastic demand curve, an increase in price leads to a decrease in quantity that is proportionately smaller. Thus, total revenue increases.

53. Figure 3 How Total Revenue Changes When Price Changes: Inelastic Demand
An Increase in price from $1
to $3 …
… leads to an Increase in total revenue from $100 to $240
Demand
Demand $3 80
Revenue = $240 $1
100
Revenue = $100
Quantity
Quantity
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54. Elasticity and Total Revenue along a Linear Demand Curve
With an elastic demand curve, an increase in the price leads to a decrease in quantity demanded that is proportionately larger. Thus, total revenue decreases.

55. How Total Revenue Changes When Price Changes: Elastic Demand
An Increase in price from $4
to $5 …
… leads to an decrease in total revenue from $200 to $100 $5 20
Demand
Demand
Revenue = $100 $4 50
Revenue = $200
Quantity
Quantity
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56. Elasticity of a Linear Demand Curve
Relationship between Demand and Total Revenue curves…on board

57. Income Elasticity of Demand
Income elasticity of demand measures how much the quantity demanded of a good responds to a change in consumers’ income.
It is computed as the percentage change in the quantity demanded divided by the percentage change in income.

58. Computing Income Elasticity

59. Income Elasticity Types of Goods
Normal Goods
Elasticity is positive
Inferior Goods
Elasticity is negative
Higher income raises the quantity demanded for normal goods but lowers the quantity demanded for inferior goods.

60. Goods consumers regard as necessities tend to be income inelastic
Income Elasticity
Goods consumers regard as necessities tend to be income inelastic
Examples include food, fuel, clothing, utilities, and medical services.
Goods consumers regard as luxuries tend to be income elastic.
Examples include sports cars, furs, and expensive foods.

61. THE ELASTICITY OF SUPPLY
Price elasticity of supply is a measure of how much the quantity supplied of a good responds to a change in the price of that good.
Price elasticity of supply is the percentage change in quantity supplied resulting from a percent change in price.

62. The Price Elasticity of Supply
(a) Perfectly Inelastic Supply: Elasticity Equals 0
Price
Supply $5
1. An
increase
in price . . . 4
100
Quantity
leaves the quantity supplied unchanged.
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63. The Price Elasticity of Supply
(e) Perfectly Elastic Supply: Elasticity Equals Infinity
Price
1. At any price
above $4, quantity
supplied is infinite. $4
Supply
2. At exactly $4,
producers will
supply any quantity.
3. At a price below $4,
quantity supplied is zero.
Quantity
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64. Determinants of Elasticity of Supply
Ability of sellers to change the amount of the good they produce.
Beach-front land is inelastic.
Books, cars, or manufactured goods are elastic.
Time period.
Supply is more elastic in the long run.

65. Computing the Price Elasticity of Supply
The price elasticity of supply is computed as the percentage change in the quantity supplied divided by the percentage change in price.

66. Cross Elasticity of Demand
Cross elasticity of demand measures how sensitive consumer purchases of one product (say, X) are to a change in the price of some other product (say, Y).
Exy = (% change in Qd of X) / (% change in P of Y)

67. Cross Elasticity of Demand
If Exy is positive, the two products are substitutes.
The larger the number, the greater the substitutability of the two products
If Exy is negative, the two products are complements,
The larger the negative number, the greater complementarity of the two products.
A zero or near zero cross elasticity suggests that the products are independent of each other.

68. REVISITING THE MARKET EQUILIBRIUM
Do the equilibrium price and quantity maximize the total welfare of buyers and sellers?
Market equilibrium reflects the way markets allocate scarce resources.
Whether the market allocation is desirable can be addressed by welfare economics.

69. Welfare Economics
Welfare economics is the study of how the allocation of resources affects economic well-being.
Buyers and sellers receive benefits from taking part in the market.
The equilibrium in a market maximizes the total welfare of buyers and sellers.

70. Welfare Economics
Consumer surplus measures economic welfare from the buyer’s side.
Producer surplus measures economic welfare from the seller’s side.

71. CONSUMER SURPLUS
Willingness to pay is the maximum amount that a buyer will pay for a good.
It measures how much the buyer values the good or service.

72. CONSUMER SURPLUS
Consumer surplus is the buyer’s willingness to pay for a good minus the amount the buyer actually pays for it.

73. Using the Demand Curve to Measure Consumer Surplus
The area below the demand curve and above the price measures the consumer surplus in the market.

74. How the Price Affects Consumer Surplus
(a) Consumer Surplus at Price P
Price A
Demand
Consumer
surplus P1 Q1 B C
Quantity
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75. How the Price Affects Consumer Surplus
(b) Consumer Surplus at Price P
Price A B C
Demand
Initial
consumer
surplus
Consumer surplus
to new consumers P1 Q1 D E F P2 Q2
Additional consumer
surplus to initial
consumers
Quantity
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76. What Does Consumer Surplus Measure?
Consumer surplus, the amount that buyers are willing to pay for a good minus the amount they actually pay for it, measures the benefit that buyers receive from a good as the buyers themselves perceive it.

77. PRODUCER SURPLUS
Producer surplus is the amount a seller is paid for a good minus the seller’s cost.
It measures the benefit to sellers participating in a market.

78. Using the Supply Curve to Measure Producer Surplus
The area below the price and above the supply curve measures the producer surplus in a market.

79. How the Price Affects Producer Surplus
(a) Producer Surplus at Price P
Price
Supply B A C Q1 P1
Producer
surplus
Quantity
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80. How the Price Affects Producer Surplus
(b) Producer Surplus at Price P
Price
Additional producer
surplus to initial
producers
Supply D E F P2 Q2
Producer surplus
to new producers B P1 C
Initial
producer
surplus A Q1
Quantity
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81. MARKET EFFICIENCY
Consumer surplus and producer surplus may be used to address the following question:
Is the allocation of resources determined by free markets in any way desirable?

82. MARKET EFFICIENCY Total surplus = Consumer surplus + Producer surplusor
= Value to buyers – Cost to sellers

83. MARKET EFFICIENCY
Efficiency is the property of a resource allocation of maximizing the total surplus received by all members of society.

84. Consumer and Producer Surplus in the Market Equilibrium
Price A C B D E
Demand
Consumer
surplus
Supply
Equilibrium
price
quantity
Producer
surplus
Quantity
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85. Supply, Demand, and Government Policies
In a free, unregulated market system, market forces establish equilibrium prices and exchange quantities.
While equilibrium conditions may be efficient, it may be true that not everyone is satisfied.
One of the roles of economists is to use their theories to assist in the development of policies. 2 2

86. CONTROLS ON PRICES
Are usually enacted when policymakers believe the market price is unfair to buyers or sellers.
Result in government-created price ceilings and floors. 3 3

87. CONTROLS ON PRICES Price Ceiling Price Floor
A legal maximum on the price at which a good can be sold.
Price Floor
A legal minimum on the price at which a good can be sold. 4 4

88. A Market with a Price Ceiling
(b) A Price Ceiling That Is Binding
Price of
Ice-Cream
Cone
Supply
Demand
Equilibrium
price $3 2
Price
ceiling 75
125
Shortage
Quantity of
Ice-Cream
Quantity
supplied
Quantity
demanded
Cones
Copyright©2003 Southwestern/Thomson Learning

89. A Market with a Price Floor
(b) A Price Floor That Is Binding
Price of
Ice-Cream
Supply
Cone
Demand
Surplus $4
Price
floor 80
120 3
Equilibrium
price
Quantity of
Ice-Cream
Quantity
demanded
Quantity
supplied
Cones
Copyright©2003 Southwestern/Thomson Learning

90. Consumer Behavior and Utility
Utility is want satisfying power
Marginal utility is extra utility gained
Law of diminishing marginal utility is the fact that utility decreases as you get more a product
Total utility is total satisfaction gained
Goal is to maximize total utility given your budget constraint

91. Consumer Behavior and Utility
Determined using marginal utility per dollar
Read Chapter 19 and answer questions 1-4 on page 370