1. to accompany Exploring Economics 3rd Edition by Robert L. Sexton Copyright © 2005 Thomson Learning, Inc. Thomson Learning™ is a trademark used herein under license. ALL RIGHTS RESERVED. Instructors of classes adopting EXPLORING ECONOMICS, 3rd Edition by Robert L. Sexton as an assigned textbook may reproduce material from this publication for classroom use or in a secure electronic network environment that prevents downloading or reproducing the copyrighted material. Otherwise, no part of this work covered by the copyright hereon may be reproduced or used in any form or by any means—graphic, electronic, or mechanical, including, but not limited to, photocopying, recording, taping, Web distribution, information networks, or information storage and retrieval systems—without the written permission of the publisher. Printed in the United States of America ISBN 0-324-26086-5 A Lecture Presentation

2. Supply and Demand Chapter 4

3. 4.1 Markets A market is the process of buyers and sellers exchanging goods services. A market is the process of buyers and sellers exchanging goods services. Supermarkets, the New York Stock Exchange, drug stores, roadside stands, garage sales, Internet stores, and restaurants are all markets. Supermarkets, the New York Stock Exchange, drug stores, roadside stands, garage sales, Internet stores, and restaurants are all markets.

4. Every market is different. Some markets are local but numerous (such as housing or the market for cement), others are global (such as automobiles or gold). Every market is different. Some markets are local but numerous (such as housing or the market for cement), others are global (such as automobiles or gold). The important point about a market is not what it looks like, but what it does–it facilitates trade. The important point about a market is not what it looks like, but what it does–it facilitates trade.

5. Buyers, as a group, determine the demand side of the market, whether it is consumers purchasing goods or firms purchasing inputs. Buyers, as a group, determine the demand side of the market, whether it is consumers purchasing goods or firms purchasing inputs. Sellers, as a group, determine the supply side of the market, whether it is firms selling their goods or resource owners selling their inputs. Sellers, as a group, determine the supply side of the market, whether it is firms selling their goods or resource owners selling their inputs.

6. It is the interaction of buyers and sellers that determines market prices and output through the forces of supply and demand. It is the interaction of buyers and sellers that determines market prices and output through the forces of supply and demand. In this chapter, we focus on how supply and demand work in a competitive market. In this chapter, we focus on how supply and demand work in a competitive market.

7. A competitive market is one in which a number of buyers and sellers are offering similar products and no single buyer or seller can influence the market price. A competitive market is one in which a number of buyers and sellers are offering similar products and no single buyer or seller can influence the market price. Because most markets contain a large degree of competitiveness, the lessons of supply and demand can be applied to many different types of problems. Because most markets contain a large degree of competitiveness, the lessons of supply and demand can be applied to many different types of problems.

8. 4.2 Demand According to the law of demand, the quantity of a good or service demanded varies inversely with its price, ceteris paribus. According to the law of demand, the quantity of a good or service demanded varies inversely with its price, ceteris paribus. More directly, other things equal, when the price of a good or service falls, the quantity demanded increases. More directly, other things equal, when the price of a good or service falls, the quantity demanded increases.

9. There are several reasons why there is an inverse or negative relationship between price and quantity demanded: There are several reasons why there is an inverse or negative relationship between price and quantity demanded: Observed behavior tells us that consumers will buy more goods and services at lower prices than higher prices, ceteris paribus. Observed behavior tells us that consumers will buy more goods and services at lower prices than higher prices, ceteris paribus.

10. Another reason for the negative relationship is diminishing marginal utility. That is, in a given time period, a buyer will receive less satisfaction from each successive unit consumed— so consumers would only buy added units if the price were reduced. Another reason for the negative relationship is diminishing marginal utility. That is, in a given time period, a buyer will receive less satisfaction from each successive unit consumed— so consumers would only buy added units if the price were reduced.

11. Finally, there are the substitution and income effects of a price change. For example, if the price of pizza increases the quantity demanded of pizza will fall as some buyers switch out of pizza into hamburgers, tacos or some other food that substitutes for pizza. Finally, there are the substitution and income effects of a price change. For example, if the price of pizza increases the quantity demanded of pizza will fall as some buyers switch out of pizza into hamburgers, tacos or some other food that substitutes for pizza.

12. In addition, a price increase in pizza will reduce the quantity demanded of pizza because it reduces a buyer’s purchasing power. In addition, a price increase in pizza will reduce the quantity demanded of pizza because it reduces a buyer’s purchasing power. That is, the buyer cannot buy as many pieces of pizza at higher prices as at lower prices—this is called the income effect of a price change. That is, the buyer cannot buy as many pieces of pizza at higher prices as at lower prices—this is called the income effect of a price change.

13. An individual demand schedule reveals the different amounts of a particular good a person would be willing and able to buy at various possible prices in a particular time interval, other things equal. An individual demand schedule reveals the different amounts of a particular good a person would be willing and able to buy at various possible prices in a particular time interval, other things equal.

15. An individual demand curve for a particular good illustrates the same information as the individual demand schedule. An individual demand curve for a particular good illustrates the same information as the individual demand schedule. It reveals the relationship between the price and the quantity demanded, showing that when the price is higher, the quantity demanded is lower. It reveals the relationship between the price and the quantity demanded, showing that when the price is higher, the quantity demanded is lower.

17. Economists usually speak of the demand curve in terms of large groups of people. Economists usually speak of the demand curve in terms of large groups of people. The horizontal summing of the demand curves of many individuals is called the market demand curve for a product. The horizontal summing of the demand curves of many individuals is called the market demand curve for a product. It reflects the fact that the total quantity purchased in the market at a price is the sum of the quantities purchased by each demander. It reflects the fact that the total quantity purchased in the market at a price is the sum of the quantities purchased by each demander.

20. 4.3 Shifts in the Demand Curve A change in a good's price leads to a change in quantity demanded, illustrated by moving along a given demand curve. A change in a good's price leads to a change in quantity demanded, illustrated by moving along a given demand curve. But price is not the only thing that affects the quantity of a good people buy. The other factors that influence the demand curve are called determinants of demand, and they shift the entire demand curve—a change in demand. But price is not the only thing that affects the quantity of a good people buy. The other factors that influence the demand curve are called determinants of demand, and they shift the entire demand curve—a change in demand.

21. prices of related goods prices of related goods incomes of demanders incomes of demanders number of demanders number of demanders tastes of demanders tastes of demanders expectations of demanders expectations of demanders Some possible demand shifters

22. An increase in demand is represented by a rightward shift in the demand curve. An increase in demand is represented by a rightward shift in the demand curve. A decrease in demand is represented by a leftward shift in the demand curve. A decrease in demand is represented by a leftward shift in the demand curve.

24. A major variable that shifts the demand curve is the prices of related goods. A major variable that shifts the demand curve is the prices of related goods. Two goods are called substitutes if an increase in the price of one causes a decrease in the demand for the other good. Two goods are called substitutes if an increase in the price of one causes a decrease in the demand for the other good. The opposite also applies: Two goods are called substitutes if a decrease in the price of one causes an increase in the demand for the other good. The opposite also applies: Two goods are called substitutes if a decrease in the price of one causes an increase in the demand for the other good. Substitutes

26. For most people good substitutes might include: movie tickets and video rentals; jackets and sweaters; 7-Up and Sprite; and Nikes and Reeboks. For most people good substitutes might include: movie tickets and video rentals; jackets and sweaters; 7-Up and Sprite; and Nikes and Reeboks.

28. Two goods are complements if an increase in the price of one good causes a decrease in the demand for the other good. Two goods are complements if an increase in the price of one good causes a decrease in the demand for the other good. The opposite is also true: Two goods are complements if a decrease in the price of one good causes an increase in the demand for the other good. The opposite is also true: Two goods are complements if a decrease in the price of one good causes an increase in the demand for the other good.

30. Goods that “go together.” Goods that “go together.” They are often consumed or used simultaneously. They are often consumed or used simultaneously. For example: skis and bindings; hot dogs and mustard; motorcycles and motorcycle helmets; DVDs and DVD players. For example: skis and bindings; hot dogs and mustard; motorcycles and motorcycle helmets; DVDs and DVD players. Complements

32. Generally the consumption of goods and services is positively related to the income available to consumers. Generally the consumption of goods and services is positively related to the income available to consumers. As individuals receive more income, they tend to increase their purchases of most goods and services. As individuals receive more income, they tend to increase their purchases of most goods and services. Income

33. Other things equal, an increase in income usually leads to an increase in demand for goods (rightward shift). Other things equal, an increase in income usually leads to an increase in demand for goods (rightward shift). A decrease in income usually leads to a decrease in the demand for goods (leftward shift). A decrease in income usually leads to a decrease in the demand for goods (leftward shift). Such goods are called normal goods. Such goods are called normal goods. For example: CDs and movie tickets. For example: CDs and movie tickets. Income-Normal Good

35. Some goods exist for which rising (or falling) income leads to reduced (or increased) demand. Some goods exist for which rising (or falling) income leads to reduced (or increased) demand. These are called inferior goods. The term inferior does not refer to the quality of the good, but it merely shows that when income changes demand changes in the opposite direction (inversely). These are called inferior goods. The term inferior does not refer to the quality of the good, but it merely shows that when income changes demand changes in the opposite direction (inversely). For example: thrift shop clothes, store- brand products, and bus rides. For example: thrift shop clothes, store- brand products, and bus rides. Income-Inferior Good

38. The demand for a good or service will vary with the size of the potential consumer population—the number of buyers. The demand for a good or service will vary with the size of the potential consumer population—the number of buyers. An increase in the potential consumer population will increase (shift right) the demand for a good or service. An increase in the potential consumer population will increase (shift right) the demand for a good or service. Number of Buyers

39. Changes in fashions, fads, advertising, etc. can change tastes or preferences. Changes in fashions, fads, advertising, etc. can change tastes or preferences. An increase in tastes or preferences for a good or service will increase (shift right) the demand for a good or service. An increase in tastes or preferences for a good or service will increase (shift right) the demand for a good or service. Tastes

40. While changes in preferences lead to shifts in demand, much of the predictive power of economic theory stems from the assumption that tastes are relatively stable over a substantial period of time. While changes in preferences lead to shifts in demand, much of the predictive power of economic theory stems from the assumption that tastes are relatively stable over a substantial period of time. We cannot precisely and accurately measure taste changes. We cannot precisely and accurately measure taste changes.

41. An increase in the expected future price of a good will increase (shift right) the current demand for it. An increase in the expected future price of a good will increase (shift right) the current demand for it. A decrease in the expected future price of a good will decrease (shift left) the current demand for it. A decrease in the expected future price of a good will decrease (shift left) the current demand for it. Expectations

42. Or if you expect to earn additional income in the near future you may be more willing to dip into your current savings to buy something now. Or if you expect to earn additional income in the near future you may be more willing to dip into your current savings to buy something now.

44. If the price of a good changes, we say this leads to a change in quantity demanded. If the price of a good changes, we say this leads to a change in quantity demanded. If one of the other factors (determinants of demand) influencing consumer behavior changes, we say there is a change in demand. If one of the other factors (determinants of demand) influencing consumer behavior changes, we say there is a change in demand. Changes in Demand vs. Changes in Quantity Demanded Revisited:

47. 4.4 Supply The law of supply states that, other things equal, the quantity supplied will vary directly with the price of the good. The law of supply states that, other things equal, the quantity supplied will vary directly with the price of the good. According to the law of supply, According to the law of supply, the higher the price of the good, the greater the quantity supplied, the higher the price of the good, the greater the quantity supplied, and the lower the price of the good, the smaller the quantity supplied. and the lower the price of the good, the smaller the quantity supplied.

49. The quantity supplied is positively related to the price, because firms supplying goods and services want to increase their profits, and the higher the price per unit, the greater the profitability generated by supplying more of that good or service. The quantity supplied is positively related to the price, because firms supplying goods and services want to increase their profits, and the higher the price per unit, the greater the profitability generated by supplying more of that good or service. Also, if costs are rising for producers as they produce more units, they must receive a higher price to compensate producers for their higher costs. Also, if costs are rising for producers as they produce more units, they must receive a higher price to compensate producers for their higher costs.

50. An individual supply schedule reveals the different amounts of a product that a producer is willing and able to supply at various prices in a particular time interval, other things equal. An individual supply schedule reveals the different amounts of a product that a producer is willing and able to supply at various prices in a particular time interval, other things equal. An individual supply curve illustrates that information graphically. An individual supply curve illustrates that information graphically.

51. Exhibit 1: An Individual Supply Curve Price of Coffee (per pound) $5 4 3 2 1 20406080100120 Quantity of Coffee Supplied (pounds per year) 0 Juan’s supply curve

52. The market supply curve for a product is the horizontal summation of the supply curves for individual firms. The market supply curve for a product is the horizontal summation of the supply curves for individual firms. It shows the amount of goods and services suppliers are willing and able to supply at various prices. It shows the amount of goods and services suppliers are willing and able to supply at various prices.

53. Exhibit 2: A Market Supply Curve Price of Coffee (per pound) $5 4 3 2 1 246810120 Quantity of Coffee Supplied (thousands of pounds per year) Market Supply Curve

54. Changes in the price of a good lead to changes in quantity supplied, which are shown as movements along a given supply curve. Changes in the price of a good lead to changes in quantity supplied, which are shown as movements along a given supply curve. Changes in supply occur for other reasons than changes in the price of the product itself. Changes in supply occur for other reasons than changes in the price of the product itself. A change in any other factor that can affect supplier behavior results in a shift of the entire supply curve. A change in any other factor that can affect supplier behavior results in a shift of the entire supply curve. 4.5 Shifts in the Supply Curve

55. supplier input prices supplier input prices prices of related products prices of related products expectations expectations number of suppliers number of suppliers technology technology regulations regulations taxes taxes subsidies subsidies weather weather These other factors include:

56. An increase in supply shifts the supply curve to the right. An increase in supply shifts the supply curve to the right. A decrease in supply shifts the supply curve to the left. A decrease in supply shifts the supply curve to the left.

57. Exhibit 1: Supply Shifts Price Quantity 0 S3S3 S1S1 S2S2 Decrease in Supply Increase in Supply

58. Higher input prices increase the cost of production causing the supply curve to shift to the left at each and every price. Higher input prices increase the cost of production causing the supply curve to shift to the left at each and every price. Lower input prices decrease the cost of production causing the supply curve to shift to the right at each and every price. Lower input prices decrease the cost of production causing the supply curve to shift to the right at each and every price.

59. The supply of a good can be influenced by the prices of related products. The supply of a good can be influenced by the prices of related products. Firms producing a product can sometimes use their resources to produce alternative products. Firms producing a product can sometimes use their resources to produce alternative products.

60. Suppose a farmer’s land can be used to grow either barley or cotton. Suppose a farmer’s land can be used to grow either barley or cotton. If the farmer is currently growing barley and the price of barley falls then this provides an incentive for the farmer to shift acreage out of barley and into cotton. If the farmer is currently growing barley and the price of barley falls then this provides an incentive for the farmer to shift acreage out of barley and into cotton. Thus, a decrease in the price of barley will increase the supply of cotton. Thus, a decrease in the price of barley will increase the supply of cotton.

61. Price of Cotton 0 b. Market for Cotton Quantity of Cotton Supplied Exhibit 2: Substitutes in Production S2S2 S1S1 Price of Barley 0 a. Market for Barley Quantity of Barley Supplied Supply P1P1P1P1 Q1Q1Q1Q1 P2P2P2P2 Q2Q2Q2Q2

62. If producers expect a higher price in the future, they will supply less now. If producers expect a higher price in the future, they will supply less now. They would prefer to wait and sell when their goods will be more valuable. They would prefer to wait and sell when their goods will be more valuable. If producers currently expect that the price will be lower later they will supply more now. If producers currently expect that the price will be lower later they will supply more now. Otherwise, if they wait to sell, then their goods will be worth less. Otherwise, if they wait to sell, then their goods will be worth less.

63. The market supply curve is the horizontal summation of the individual supply curves. The market supply curve is the horizontal summation of the individual supply curves. So an increase in the number of suppliers will increase market supply. So an increase in the number of suppliers will increase market supply. A decrease in the number of suppliers will decrease market supply. A decrease in the number of suppliers will decrease market supply.

64. Technological progress can lower the cost of production and increase supply. Technological progress can lower the cost of production and increase supply. Supply may also change because of changes in the legal and regulatory environment in which firms operate (e.g., safety and pollution regulations, minimum wages, taxes, etc.). If such changes increase costs, they will decrease supply. If they decrease costs, they will increase supply. Supply may also change because of changes in the legal and regulatory environment in which firms operate (e.g., safety and pollution regulations, minimum wages, taxes, etc.). If such changes increase costs, they will decrease supply. If they decrease costs, they will increase supply.

65. An increase in costly government regulations, taxes or adverse production conditions will increase the cost of production, decreasing supply. An increase in costly government regulations, taxes or adverse production conditions will increase the cost of production, decreasing supply. Subsidies, the opposite of a tax can lower the cost of production and shift the supply curve to the right. Subsidies, the opposite of a tax can lower the cost of production and shift the supply curve to the right. In addition, weather can affect the supply of certain commodities. In addition, weather can affect the supply of certain commodities.

66. If the price of a good changes, it leads to a change in its quantity supplied, but not its supply. If the price of a good changes, it leads to a change in its quantity supplied, but not its supply. If one of the other factors influences sellers' behavior, it leads to a change in supply. If one of the other factors influences sellers' behavior, it leads to a change in supply.

68. Exhibit 4: Change in Supply vs. Change in Quantity Supplied Price of Cotton P2P2P2P2 0 P1P1P1P1 QAQAQAQA QCQCQCQC QBQBQBQB Quantity of Cotton S1S1 S2S2 A BC Change in quantity supplied AB Change in supply BC