1. © 2006 McGraw-Hill Ryerson Limited. All rights reserved.1 Chapter 4: Supply and Demand Prepared by: Kevin Richter, Douglas College Charlene Richter, British Columbia Institute of Technology

2. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 2 Chapter Objectives 1. Explain the law of demand and what it implies.  a. Distinguish a change in demand from a change in quantity demanded.  b. Draw a demand curve from a demand table.  c. Derive the market demand curve.

3. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 3 Chapter Objectives 2. Explain the law of supply and what it implies.  a. Distinguish a change in supply from a change in quantity supplied.  b. Draw a supply curve from a supply table.  c. Derive the market supply curve. 3. Explain how prices adjust to achieve an equilibrium between demand and supply.  a. Explain the concept of equilibrium.

4. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 4 Chapter Objectives 4. Show the effects of a shift in demand or supply on the equilibrium price and quantity using real-world events.  a. Be able to determine if an observed change in price and quantity is due to a change in demand or supply.

5. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 5 Demand Demand means the willingness and capacity to pay. Prices are the tools by which the market coordinates individual desires.

6. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 6 Law of Demand Law of demand – there is an inverse relationship between price and quantity demanded.  As price falls, quantity demanded rises, other things constant.  As price rises, quantity demanded falls, other things constant.

7. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 7 Law of Demand What accounts for the law of demand?  People tend to substitute away from goods whose price has gone up.

8. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 8 Demand Curve The demand curve is the graphic representation of the law of demand. It represents the maximum price consumers will pay for an additional unit of the good.

9. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 9 Demand Curve The demand curve slopes downward and to the right. As the price goes up, the quantity demanded goes down.

10. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 10 D Price (per unit) 0 Quantity demanded (per unit of time) PAPA QAQA A Sample Demand Curve

11. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 11 Other Things Constant Other things constant means that all other factors that affect quantity demanded are assumed to remain constant, whether they actually remain constant or not. Tastes, prices of other goods, even the weather, may affect demand.

12. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 12 Demand refers to a schedule of quantities of a good that will be bought per unit of time at various prices, other things constant. Graphically, it refers to the entire demand curve. Change in Demand versus Change in Quantity Demanded

13. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 13 Quantity demanded refers to a specific amount that will be demanded per unit of time at a specific price. Graphically, it refers to a specific point on the demand curve. Change in Demand versus Change in Quantity Demanded

14. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 14 A movement along a demand curve happens when there is a change in price. We move from one point to another point on the demand curve. Change in Demand versus Change in Quantity Demanded

15. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 15 Changes in price cause changes in quantity demanded represented by a movement along a demand curve. Change in Demand versus Change in Quantity Demanded

16. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 16 Change in Quantity Demanded D1D1 Change in quantity demanded (a movement along the curve) B 0 Price (per unit) Quantity demanded (per unit of time) 100 $2 $1 200 A

17. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 17 A shift in demand happens when anything other than price changes. The entire demand curve moves to the left or right. Change in Demand versus Change in Quantity Demanded

18. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 18 D0D0 D1D1 Change in Demand Price (per unit) Quantity demanded (per unit of time) 100 $2 $1 200 B A Change in demand (a shift of the curve) 250

19. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 19 Shift Factors of Demand Shift factors of demand are factors that cause shifts in the demand curve:  Society's income.  The prices of other goods.  Tastes.  Expectations.  Population.

20. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 20 Income An increase in income may increase or decrease the demand for a good: An increase in income will increase demand for normal goods. An increase in income will decrease demand for inferior goods.

21. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 21 Price of Other Goods When the price of a substitute good falls, demand falls for the good whose price has not changed. When the price of a complement good falls, demand rises for the good whose price has not changed.

22. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 22 Tastes A change in taste will change demand with no change in price.

23. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 23 Expectations If you expect your income to rise, you may consume more now. If you expect prices to fall in the future, you may delay purchases today.

24. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 24 Population An increase in population will increase demand at every price.

25. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 25 Demand Table The demand table assumes:  The Law of Demand. (As price rises, quantity demanded declines.)  A specific time dimension.  Products are identical in shape, size, quality, etc.  Everything else is held constant.

26. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 26 From Demand Table to Demand Curve You plot each point in the demand table on a graph and connect the points to create the demand curve. The demand curve graphically conveys the same information that is on the demand table.

27. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 27 From Demand Table to Demand Curve The curve represents the maximum price that you will pay for various quantities of a good – you will happily pay less.

28. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 28 Price per cassettes (in dollars) A Demand Curve Quantity of cassettes demanded (per week) 123456789 101112 13 $6.00 5.00 4.00 3.00 2.00 1.00.50 0 3.50 E D C B A From Demand Table to Demand Curve Price per cassette ABCDEABCDE A Demand Table Cassette rentals demanded per week $0.50 1.00 2.00 3.00 4.00 9864298642 Demand for cassettes

29. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 29 Individual and Market Demand Curves A market demand curve is the horizontal sum of all individual demand curves.  This is determined by adding the individual demand curves of all the demanders.

30. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 30 Individual and Market Demand Curves Sellers estimate total market demand for their product which becomes a smooth and downward sloping curve.

31. From Individual Demands to a Market Demand Curve (1) Price per cassette $.0.50 1.00 1.50 2.00 2.50 3.00 3.50 4.00 (2) Marie’s demand (3) Pierre’s demand (2) Cathy’s demand (3) Market demand 9876543298765432 6543210065432100 1100000011000000 16 14 11 9 7 5 3 2 ABCDEFGHABCDEFGH Pierre Marie D A C E F G Quantity of cassettes demanded per week 2 $4.00 3.50 3.00 2.50 2.00 1.50 1.00 0.50 0 Price per cassette (in dollars) 46810121416 B Market demand McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Cathy

32. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 32 Law of Demand Regarding the market demand curve,  At lower prices, existing demanders buy more.  At lower prices, new demanders enter the market.  The market demand curve is flatter than the individual demand curves.

33. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 33 Supply Individuals control the factors of production – inputs necessary to produce goods. Factors of production are the resources or inputs necessary to produce goods or services.

34. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 34 Supply The supply of produced goods involves:  An analysis of the supply of the factors of production by households to firms.  An analysis of how firms transform those factors of production into usable goods and services.

35. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 35 Law of Supply There is a direct relationship between price and quantity supplied.  As price rises, quantity supplied rises, other things constant.  As price falls, quantity supplied falls, other things constant.

36. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 36 Supply Curve The supply curve is the graphic representation of the law of supply. It provides the minimum price the producer requires to produce an additional unit of output.

37. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 37 Supply Curve The supply curve slopes upward to the right, and tells us that the quantity supplied varies directly – in the same direction – with the price.

38. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 38 S A Quantity supplied (per unit of time) 0 Price (per unit) PAPA QAQA Sample Supply Curve

39. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 39 Supply refers to a schedule of quantities a seller is willing to sell per unit of time at various prices, other things constant. Graphically, it refers to the entire supply curve. Change in Supply Versus Change in Quantity Supplied

40. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 40 Quantity supplied refers to a specific amount that will be supplied at a specific price. Graphically, it refers to a specific point on the supply curve. Change in Supply Versus Change in Quantity Supplied

41. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 41 Changes in price cause changes in quantity supplied represented by a movement along a supply curve. Change in Supply Versus Change in Quantity Supplied

42. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 42 A movement along a supply curve – happens when there is a change in price. Change in Supply Versus Change in Quantity Supplied

43. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 43 Change in quantity supplied (a movement along the curve) Change in Quantity Supplied Price (per unit) Quantity supplied (per unit of time) S0S0 $25 A 1,2501,500 B $15

44. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 44 A shift in supply happens when anything other than price changes. The entire supply curve moves to the left or right. Change in Supply Versus Change in Quantity Supplied

45. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 45 Shift in supply – the graphic representation of the effect of a change in a factor other than price on supply. Change in Supply Versus Change in Quantity Supplied

46. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 46 Shift in Supply Price (per unit) Quantity supplied (per unit of time) S0S0 Shift in Supply (a shift of the curve) S1S1 $15 AB 1,2501,500

47. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 47 Shift Factors of Supply Other factors besides price affect how much will be supplied:  Prices of inputs used in the production of a good.  Technology.  Suppliers’ expectations.  Taxes and subsidies.

48. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 48 Price of Inputs When costs rise, profits decrease, so there is less incentive to supply. If costs rise substantially, the firm may even shut down.

49. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 49 Technology Advances in technology reduce the cost of production, and there is a greater incentive to supply.

50. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 50 Expectations If suppliers expect prices to rise in the future, they may store today's supply to reap higher profits later. If they expect prices to fall in the future, suppliers may sell off more of their inventories today.

51. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 51 Taxes and Subsidies When taxes go up, costs increase, and profits fall, reducing the incentive to produce. When government subsidies go up, costs fall, and profits rise, giving suppliers the incentive to increase output.

52. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 52 Supply Table Each supplier follows the law of supply. When price rises, each supplies more, or at least as much as they did at a lower price.

53. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 53 From Supply Table to Supply Curve To derive a supply curve from a supply table, you plot each point in the supply table on a graph and connect the points.

54. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 54 From Supply Table to Supply Curve The supply curve represents the set of minimum prices an individual seller will accept for various quantities of a good.

55. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 55 From Supply Table to Supply Curve Competing suppliers’ entry into the market places a limit on the price any supplier can charge.

56. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 56 Individual and Market Supply Curves The market supply curve is derived by horizontally adding the individual supply curves of each supplier.

57. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 57 From Individual Supplies to a Market Supply Quantities Supplied ABCDEFGHIABCDEFGHI (1) Price (per cassette) (2) Ann's Supply (5) Market Supply (4) Charlie's Supply $0.00 0.50 1.00 1.50 2.00 2.50 3.00 3.50 4.00 012345678012345678 001234555001234555 000000022000000022 0 1 3 5 7 9 11 14 15 (3) Barry's Supply

58. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 58 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 From Individual Supplies to a Market Supply Price per cassette CharlieBarry Ann Quantity of cassettes supplied (per week) $4.00 3.50 3.00 2.50 2.00 1.50 1.00 0.50 0 I H G F E D C B A Market Supply CACA

59. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 59 Equilibrium Equilibrium is a concept in which opposing dynamic forces cancel each other out.

60. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 60 Equilibrium In a free market, the forces of supply and demand interact to determine equilibrium quantity and equilibrium price.

61. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 61 Equilibrium Equilibrium price – the price toward which the invisible hand drives the market. Equilibrium quantity – the amount bought and sold at the equilibrium price.

62. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 62 What Equilibrium Isn’t Equilibrium isn’t a state of the world, it is a characteristic of the model used to look at the world. Equilibrium isn’t inherently good or bad, it is simply a state in which dynamic pressures offset each other.

63. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 63 What Equilibrium Isn’t Equilibrium means that the upward pressure on price is exactly offset by the downward pressure on price. When the market is not in equilibrium, you get either excess supply or excess demand, and a tendency for price to change.

64. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 64 Excess Supply Excess supply – a situation where the quantity supplied is greater than quantity demanded. Prices tend to fall.

65. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 65 Excess Demand Excess demand – a situation where the quantity demanded is greater than quantity supplied Prices tend to rise.

66. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 66 B A Marriage of Supply and Demand Price per cassette (in dollars) $5.00 4.00 3.50 3.00 2.50 2.00 1.50 1.00 S D Quantity of cassettes supplied and demanded (per week) Excess demand 123456789101112 Excess supply E

67. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 67 Interaction of Supply and Demand When price is $3.50 each, quantity supplied equals 7 and quantity demanded equals 3. The excess supply of 4 pushes price down.

68. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 68 Interaction of Supply and Demand When price is $1.50 each, quantity supplied equals 3 and quantity demanded equals 7. The excess demand of 4 pushes price up.

69. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 69 Interaction of Supply and Demand When price is $2.50 each, quantity supplied equals 5 and quantity demanded equals 5. There is no excess supply or excess demand, so price will not rise or fall.

70. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 70 Price Adjusts The greater the difference between quantity supplied and quantity demanded, the more pressure there is for prices to rise or fall. When quantity demanded equals quantity supplied, prices have no tendency to change.

71. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 71 Power of Supply and Demand Changes in either supply or demand will change equilibrium price and quantity.

72. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 72 Six Real World Examples Supply and demand can shed light on a variety of real-world events:  Brazil freeze.  Financial assets and the baby boomers.  Twenty percent excise tax.  Rice in Indonesia.  Farm labourers.  Christmas toys.

73. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 73 Sugar Shock in Brazil The crop-damaging freeze shifted the supply curve to the left. At the original price, quantity demanded exceeded quantity supplied. Price rose until the quantity demanded equaled the quantity supplied.

74. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 74 A Shift in Supply Price Quantity P1P1 P0P0 0 QeQe QSQS QDQD D0D0 S1S1 S0S0 C Excess demand B

75. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 75 Baby Boomers and Financial Assets Demographic changes among baby boomers moved the demand curve for financial assets to the right. At the original price, quantity demanded exceeded quantity supplied. Price rose until the quantity demanded equaled the quantity supplied.

76. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 76 Increase in Demand An increase in demand creates excess demand at the original equilibrium price. The excess demand pushes price upward until a new higher equilibrium price and quantity are reached.

77. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 77 Baby Boomers and Financial Assets S (f) D0D0 P1P1 QeQe Q0Q0 P0P0 D1D1 QDQD Price Quantity Excess demand

78. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 78 Baby Boomers and the Housing Market The same phenomenon occurred in the surging demand for housing among this group during the 1980s.

79. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 79 Excise Tax Korean Government imposed a 20 percent luxury tax on imported golf clubs.

80. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 80 Excise Tax A 20 percent tax levied on suppliers shifts the supply curve to the left. After the tax is imposed, the quantity of imported clubs demanded drops.

81. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 81 Excise Tax S0S0 D0D0 P1P1 Q1Q1 P0P0 Q0Q0 S1S1 (e) Price Quantity

82. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 82 Rice in Indonesia Drought, pestilence, and the financial crisis shift the supply curve to the left. The steep demand curve means that the quantity demanded does not change much with changes in price.

83. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 83 Rice in Indonesia Responding to high prices, the government imported rice and distributed it to the market, causing the supply curve to shift to the right.

84. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 84 Rice in Indonesia S0S0 Demand P1P1 Q1Q1 P2P2 Q2Q2 P0P0 Q0Q0 S1S1 S2S2 Price Quantity

85. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 85 Farm Labourers The compressed harvesting season increased the demand and increased border patrols decreased supply of labour. Demand shifted to the right and supply shifted to the left.

86. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 86 Farm Labourers At the original price, the quantity of workers demanded exceeded the quantity supplied. Price rises until the quantity demanded equals the quantity supplied. The effect on the number of labourers hired depended on the relative size of the supply shift.

87. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 87 Farm Labourers S0S0 D0D0 P1P1 S1S1 D1D1 P0P0 QeQe Price Quantity

88. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 88 Christmas Toys A Christmas craze for Furbies shifts demand to the right. A shortage ensued along with a black market.

89. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 89 Christmas Toys Finally the supplier produced more, shifting the supply curve to the right, causing the price to drop.

90. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 90 Christmas Toys P1P1 P0P0 Q S0 S0S0 D0D0 S1S1 D1D1 Q D0 Q D1 Price Quantity

91. © 2006 McGraw-Hill Ryerson Limited. All rights reserved. 91 Effects of Shifts of Demand and Supply on Price and Quantity

92. © 2006 McGraw-Hill Ryerson Limited. All rights reserved.92 Supply and Demand End of Chapter 4