1. Supply and Demand:
An Introduction

2. Supply and Demand:
How do consumers get the goods and services they want in the right quantities and qualities?
Some goods and services are allocated by the market forces of supply and demand
Supply and Demand

3. Supply and Demand:
Why do some goods and services have shortages or surpluses and others do not?
Some good and supplies services are regulated by government
Supply and Demand

4. What, How, and for Whom? Central Planning Versus the Market
Three Problems All Economic Systems Must Address
What should be produced?
How should it be produced?
For whom will it be produced?
Supply and Demand

5. Centralized Economic Organizations
Agrarian society
Former Soviet Union
Cuba, North Korea
China?
Bureaucracy
Havana
Supply and Demand

6. What, How, and for Whom? Central Planning Versus the Market
Free-Market or Capitalist Economic Systems
Individual choices determine
Which careers to pursue
Which products to produce or buy
When to start and shut-down a business
Who gets what, which is decided by individual preferences and purchasing power
Supply and Demand

7. Buyers and Sellers in Markets
A Market
Consists of all buyers and sellers of a good or service
What do you think?
What determines the price of pizza, gasoline, a car wash, or other goods and services?
Supply and Demand

8. The Demand Curve
A schedule or graph that tells us the quantity of a good that buyers wish to buy at each price
Supply and Demand

9. A Property of Demand
As price of a good or service goes down the quantity consumers wish to buy will increase
Therefore, the demand curve is downward-sloping
Supply and Demand

10. The Daily Demand Curve for Pizza in Chicago
Price
($ per slice) 4 3 2
Demand
Quantity
(1000s of slices per day) 8 12 16
Supply and Demand

11. The Demand Curve—Taiwan Beer
Number of Bottles per Month
Price per Bottle
When the price is $40 per bottle, 40,000 bottles are demanded (point A). A
$40
At $30 per bottle, 60,000 bottles are demanded (point B). B 30 D
40,000
60,000
Supply and Demand

12. 薄利多銷?
Supply and Demand

13. Using Price Elasticity of Demand: Mass Transit
Elasticity studies show that long-run demand for mass transit is inelastic
Therefore, a rise in fare would increase revenues
Supply and Demand

14. However, most cities do not raise transit fares due to
Desire to provide low-income households with affordable transportation
Desire to manage traffic congestion
Desire to limit air pollution in the city
An increase in fares would increase revenue
Would also decrease ridership and require the city to sacrifice these other goals
Supply and Demand

15. Buyers and Markets The Demand Curve
Why do buyers purchase a greater quantity at lower prices and vice-versa?
The substitution effect
The income effect
Supply and Demand

16. Substitution Effect
The change in the quantity demanded of a good that results because buyers switch to substitutes when the price of the good changes
Supply and Demand

17. Income Effect
The change in the quantity demanded of a good that results because a change in the price of a good changes the buyer’s purchasing power
Supply and Demand

18. The Cost-Benefit Principle
The reservation price is the benefit the buyer receives from the good
The cost of the good is its market price
If the reservation price (benefit) exceeds the market price (cost) the consumer will purchase the good
At higher prices, benefit will exceed cost for a smaller quantity than at lower prices
Supply and Demand

19. WTP
Price
($ per slice) 8 12 16
The buyers reservation price: The largest dollar amount the buyer would be willing to pay for a good 4 2 3
Demand
Quantity
(1000s of slices per day)
Supply and Demand

20. Price determines quantity demanded
Horizontal Interpretation
Price
($ per slice)
Price determines quantity demanded 4 3 2
Demand 8 12 16
Supply and Demand

21. Quantity measures the marginal buyer’s reservation price
Vertical Interpretation
Price
($ per slice)
Quantity measures the marginal buyer’s reservation price 4 3 2
Demand 8 12 16
Supply and Demand

22. The Supply Curve
A curve or schedule showing the quantity of a good that sellers wish to sell at each price
Supply and Demand

23. Question
Will the opportunity cost of producing additional units of pizza increase or decrease?
Hint: Low-hanging-fruit principle
Supply and Demand

24. The Supply Curve
Sellers must receive a higher price to produce additional units of a product to cover the higher opportunity costs of each additional unit
Supply and Demand

25. The Daily Supply Curve for Pizza in Chicago
Price
($ per slice)
Supply 4 2 3 8 12 16
Quantity
(1000s of slices per day)
Supply and Demand

26. The Daily Supply Curve for Pizza in Chicago
Horizontal Interpretation
Price
($ per slice)
Supply 4
Shows the quantity produced for each price 3 2
Quantity
(1000s of slices per day) 8 12 16
Supply and Demand

27. The Daily Supply Curve for Pizza in Chicago
Vertical Interpretation
Price
($ per slice)
Supply 4
Shows the marginal cost (reservation price) for producing each additional unit 3 2
Quantity
(1000s of slices per day) 8 12 16
Supply and Demand

28. Market Equilibrium Seller’s Reservation Price
The smallest dollar amount for which a seller would be willing to sell an additional unit, generally equal to marginal cost
Supply and Demand

29. Market Equilibrium Equilibrium Market Equilibrium
A system is in equilibrium when there is no tendency for it to change
Market Equilibrium
Occurs in a market when all buyers and sellers are satisfied with their respective quantities at the market price
Supply and Demand

30. The Equilibrium Price and Quantity of Pizza in Chicago
($ per slice)
Supply
Demand 4
Equilibrium at $3
Quantity Demanded =
Quantity Supplied 3 2
Quantity
(1000s of slices per day) 8 12 16
Supply and Demand

31. Equilibrium Price and Equilibrium Quantity
The values of price and quantity for which quantity supplied and quantity demanded are equal
Supply and Demand

32. What Do You Think?
Would buyers prefer a lower price than the equilibrium price?
Would sellers prefer a higher price than the equilibrium price?
Supply and Demand

33. Excess supply = 8,000 slices per day
Price
($ per slice)
Supply
Demand 4 3 2
Quantity
(1000s of slices per day) 8 12 16
Supply and Demand

34. Excess Demand Supply Demand 4 Excess demand = 8,000 slices per day 3 2
Price
($ per slice)
Supply 4
Excess demand = 8,000
slices per day 3 2
Demand
Quantity
(1000s of slices per day) 8 16
Supply and Demand

35. Points Along the Demand and Supply Curves of a Pizza Market
Demand for pizza
Supply of pizza
Price
($/slice)
Quantity demanded
(1000s of slices/day)
Quantity supplied 1 8 2 6 4 3
Supply and Demand

36. Graphing Supply and Demand and Finding the Equilibrium Price and Quantity
($per slice)
Supply 5 4
The Equilibrium Price = $2.50
The Equilibrium Quantity = 5 3
2.50 2 1
Demand
Quantity
(1000s of slices per day) 2 4 6 8 10 5
Supply and Demand

37. What Do You Think?
Is the market equilibrium always an ideal outcome for all market participants?
Supply and Demand

38. An Unregulated Housing Market
Monthly Rent
($/apartment)
Supply
What Do You Think?
Is $1600 more than some people can afford?
1600
Demand
Quantity
(Millions of apartments/day) 2
Supply and Demand

39. Excess demand = 2 million apartments per month
Rent Controls
Monthly Rent
($/apartment)
Supply
2400
Excess demand = 2 million apartments per month
1600
Controlled = 800
Demand
Quantity
(Millions of apartments/day) 1 2 3
Supply and Demand

40. Market Equilibrium Rent Controls Reconsidered
Other consequences of rent controls
Maintenance will decline and housing quality will fall
Illegal payments
Creation of co-ops and conversion to condominiums
Reduction in household mobility
Discrimination
Supply and Demand

41. Case study: What do you think?
How can we make housing affordable for poor people without using rent ceilings?
Health insurance
Tuition fee
Fruit/Rice export
High-speed railway
KTR
THR
Supply and Demand

42. Rent Controls Supply Demand
What is the impact of a rent control set at $1,200/month?
Monthly Rent
($/apartment)
Supply
1200
800
What is the impact of a rent control set at $600/month?
600
Demand
Quantity
(Millions of apartments/day) 1 2 3
Supply and Demand

43. Price Controls in the Pizza Market
($ per slice)
Supply 4
Excess demand = 8,000 slices per day 3
Price ceiling = 2
Demand
Quantity
(1000s of slices per day) 8 12 16
Supply and Demand

44. Rental control in Paris or NCCU
Supply and Demand

45. Market Equilibrium Pizza Price Controls?
Market responses to a pizza price ceiling
Long lines
Preferential treatment to selected customers
Alternative pricing strategies
Poorer quality ingredients
Black-market pizzas
Supply and Demand

46. Predicting and Explaining Changes in Prices and Quantities
Distinguishing Between
A change in the quantity demanded
A movement along the demand curve that occurs in response to a change in price
A change in demand
A shift of the entire demand curve
Supply and Demand

47. An Increase in Quantity Demanded
Price
($/can) D 6
Increase in quantity demanded 5 4 3 2 1
Quantity
(1000s of cans/day) 2 4 12
Supply and Demand

48. an Increase in Demand D’ D Increase in demand D’ D 6 5 4 3 2 1 12
Price
($/can) D’ D 6 5 4
Increase in demand 3 2 D’ 1 D
Quantity
(1000s of cans/day) 12
Supply and Demand

49. A Shift of The Demand Curve
Number of Bottles per Month
Price per Bottle
An increase in income shifts the demand curve for beers from D1 to D2. D2 D1
At each price, more bottles are demanded after the shift B C
$2.00
60,000
80,000
Supply and Demand

50. Predicting and Explaining Changes in Prices and Quantities
Change in the quantity supplied
A movement along the supply curve that occurs in response to a change in price
Change in supply
A shift of the entire supply curve
Supply and Demand

51. An Increase in Quantity Supplied vs. an Increase in Supply
Price
($/can) S 6 5
Increase in quantity supplied 4 3 2 1
Quantity
(1000s of cans/day) 2 4 6 8 10
Supply and Demand

52. An Increase in Quantity Supplied vs. an Increase in Supply
Price
($/can) 6 S S’ 5 4 3
Increase in supply 2 1 S S’
Quantity
(1000s of cans/day) 2 4 6 8 10
Supply and Demand

53. The Effect on the Market for Tennis Balls of a Decline in Court Rental Fees
Price
($/ball)
1.00 S D 40 D’
1.40 58
Quantity
(letters/month)
Supply and Demand

54. Effect on the Market for Overnight Letter Deliv- ery of a Decline in the Price of Internet Access
Quantity
(letters/month) Q’ Q
Supply and Demand

55. Predicting and Explaining Changes in Prices and Quantities
Economic Naturalist
When the Federal Government implements a large pay increase for its employees, why do rents for apartments near Washington Metro stations go up relative to rents for apartments located far away from Metro stations?
Supply and Demand

56. Predicting and Explaining Changes in Prices and Quantities
Shifts in Demand
Complements
Two goods are complements in consumption if an increase (decrease) in the price of one cause a decrease (increase) in the demand for the other
Supply and Demand

57. Predicting and Explaining Changes in Prices and Quantities
Shifts in Demand
Substitutes
Two goods are substitutes in consumption if an increase (decrease) in the price of one causes an increase (decrease) in the demand for the other
Supply and Demand

58. Predicting and Explaining Changes in Prices and Quantities
Shifts in Demand
Changes In Demand
An increase (decrease) in the demand for a good will shift the demand curve to the right (left)
Supply and Demand

59. Predicting and Explaining Changes in Prices and Quantities
What do you think?
How will a decline in airfares affect inter-city bus fares and the price of hotel rooms in resort communities?
Supply and Demand

60. The Effect of a Federal Pay Raise on the Rent for Conveniently Located Apartments in Washington D.C.
(dollars per month) D P Q S P’ Q’ D’
Conveniently located apartments
(units per month)
Supply and Demand

61. Predicting and Explaining Changes in Prices and Quantities
A Change In Income
Normal Good
One whose demand increases (decreases) when the incomes of buyers increase (decrease)
Supply and Demand

62. Predicting and Explaining Changes in Prices and Quantities
A Change In Income
Inferior Goods (Giffen Goods)
One whose demand decreases (increases) when the incomes of buyers increase (decrease)
Supply and Demand

63. Giffen Goods
Supply and Demand

64. The Effect of the Release of Jurassic Park on the Market for Toy DinosaursQ’
D’ = demand after release of movie
Price S P D
Toy Dinosaurs
(units per month) Q
Supply and Demand

65. The Effect of a Credible Rumor on the Market for Apple Macintosh ComputersQ’ D’
D’ = demand after rumor of cheaper model soon to be released
Price S P D
Apple Computers
(units per month) Q
Supply and Demand

66. The Effect of the Increase in the Population of Potential BuyersQ’ D’
D’ = demand after increase in population
Price S P D
Housing NY City
(units per month) Q
Supply and Demand

67. The Effect on the Skateboard Market of an Increase in the Price of Fiberglass80
800 S’ S 60 D
Quantity
(skateboards/month)
1000
Supply and Demand

68. Predicting and Explaining Changes in Prices and Quantities
What Do You Think?
Does the increase in the cost of fiberglass have any effect on the demand curve for skateboards?
Supply and Demand

69. The Effect on the Market for New Houses of a Decline in Carpenters’ Wage Rates
Price
($1000/house) S 90 50 S’
120 D
Quantity
(houses/month) 40
Supply and Demand

70. (millions of revisions per year)
The Effect of Technical Change on the Market for the Term Paper Revisions
Price
($/revision) S 55
7.50 36 S’ D
Quantity
(millions of revisions per year) 12
Supply and Demand

71. Predicting and Explaining Changes in Prices and Quantities
Other determinants of supply
Weather
Expectations
Number of sellers
Supply and Demand

72. Four Rules Governing the Effects of Supply and Demand Shifts: I
An increase in demand will lead to an increase
in both the equilibrium price and quantity
Price S P’ P D’ D
Quantity Q Q’
Supply and Demand

73. Four Rules Governing the Effects of Supply and Demand Shifts: II
A decrease in demand will lead to a decrease
in both the equilibrium price and quantity
Price S P P’ D D’
Quantity Q’ Q
Supply and Demand

74. Four Rules Governing the Effects of Supply and Demand Shifts: III
An increase in supply will lead to a
decrease in the equilibrium price
and an increase in the equilibrium quantity
Price S S’ P P’ D
Quantity Q Q’
Supply and Demand

75. Four Rules Governing the Effects of Supply and Demand Shifts: IV
An decrease in supply will lead to
an increase in the equilibrium price
and a decrease in the equilibrium quantity
Price S’ S P’ P D
Quantity Q’ Q
Supply and Demand

76. Predicting and Explaining Changes in Prices and Demand
Factors That Cause an Increase (rightward or upward shift) in Demand
A decrease in the price of complements to the good or service
An increase in the price of substitutes for the good or service
An increase in income (for a normal good)
Supply and Demand

77. Predicting and Explaining Changes in Prices and Demand
Factors That Cause an Increase (rightward or upward shift) in Demand
An increased preference by demanders for the good or service
An increase in the population of potential buyers
An expectation of higher prices in the future
Supply and Demand

78. Predicting and Explaining Changes in Prices and Demand
Factors That Cause an Increase (rightward or upward shift) in Supply
A decrease in the cost of materials, labor, or other inputs used in the production of the good or service
An improvement in technology that reduces the cost of producing the good or service
Supply and Demand

79. Predicting and Explaining Changes in Prices and Demand
Factors That Cause an Increase (rightward or upward shift) in Supply
An improvement in the weather, especially for agricultural products
An increase in the number of suppliers
An expectation of lower prices in the future
Supply and Demand

80. The Effects of Simultaneous Shifts in Supply and Demand
The Market for Corn Tortilla Chips
Price
($/bag) P Q S D P’ Q’ D’ S’
S’ after reduction in price of corn harvesting equipment
D’ after discovery that oils are harmful to people’s health
Millions of bags per month
Supply and Demand

81. The Effects of Simultaneous Shifts in Supply and Demand
The Market for Corn Tortilla Chips
Price
($/bag) S P’ Q’ D’ S’
D’ after discovery that oils are harmful to people’s health
S’ after reduction in price of corn harvesting equipment P D
Millions of bags per month Q
Supply and Demand

82. Predicting and Explaining Changes in Prices and Demand
Assume
A vitamin found in corn chips helps protect against cancer and heart disease
A swarm of locusts destroys part of the corn crop
What Do You Think?
What will happen to the equilibrium price and quantity of corn chips?
Supply and Demand

83. Predicting and Explaining Changes in Prices and Demand
Economic Naturalist
Why do the prices of some goods, like airline tickets to Europe, go up during the months of heaviest consumption, while others, like sweet corn, go down?
Supply and Demand

84. Seasonal Variation in Air Travel and Corn Markets
Price
($/ticket)
1000s of tickets S DS DW QW QS PW PS
High Consumption due to High Demand
Supply and Demand

85. Seasonal Variation in Air Travel and Corn Markets
Price
($/bushel)
Millions of bushels SW D QW QS PW PS SS
High Consumption due to High Supply
Supply and Demand

86. Markets and Social Welfare
What Do You Think?
When are the prices and quantities determined in market equilibrium socially optimal, in the sense of maximizing total economic surplus?
Supply and Demand

87. Markets and Social Welfare
Cash On The Table
Assume
All exchange is purely voluntary
If so
The buyer’s reservation price exceeds the seller’s reservation price and both the buyer and seller receive an economic surplus
Supply and Demand

88. Cash On The Table
Economic metaphor for unexploited gains from exchange
Buyer’s surplus
The difference between the buyer’s reservation price and the price he or she actually pays
Seller’s surplus
The difference between the price received by the seller and his or her reservation price
Total surplus
The difference between the buyer’s reservation price and the seller’s reservation price
Supply and Demand

89. Price Controls in the Pizza Market4 2 8 16
Assume
Buyer’s reservation P = $4
Sellers reservation P = $2
Pizza sells for $3
Buyer’s surplus: $4 - $3 = $1
Seller’s surplus: $3 - $2 = $1
Total surplus: $4 - $2 = $2
Price
($ per slice) S D 3 12
Quantity
(1000s of slices per day)
Supply and Demand

90. Price Controls in the Pizza Market
Excess demand = $8,000 slices/day
Assume price controls = $2
Quantity supplied falls to 8,000
Buyer’s reservation price ($4) is greater than seller’s ($2)
Both would benefit from additional production
There is CASH ON THE TABLE
Price
($ per slice) 4 3 2 S D
Quantity
(1000s of slices per day) 8 12 16
Supply and Demand

91. Markets and Social Welfare
Smart For One, Dumb For All
Socially optimal quantity
The quantity of a good that results in the maximum possible economic surplus from producing and consuming the good
The socially optimal quantity occurs when MC = MB
Supply and Demand

92. Markets and Social Welfare
Smart For One, Dumb For All
Economic efficiency occurs when all goods and services are produced and consumed at their respective socially optimal levels
Supply and Demand

93. Markets and Social Welfare
Smart For One, Dumb For All
Achieving economic efficiency
Maximizes the economic surplus
Increases the economic pie
Supply and Demand

94. Markets and Social Welfare
Smart For One, Dumb For All
When is the market equilibrium efficient?
When all costs of producing the good or service are borne directly by the seller
When all benefits from the good or service accrue directly to buyers
Supply and Demand

95. Markets and Social Welfare
Smart For One, Dumb For All
Inefficient market equilibrium
When some costs of production fall on people other than those who sell the good or service
Supply and Demand

96. Markets and Social Welfare
Example: Pollution
The market is in equilibrium: MC = MB
MC however underestimates the cost to society of producing the good
Therefore, the market produces more than the efficient amount and there is no incentive for producers and consumers to alter their behavior
Supply and Demand

97. Markets and Social Welfare
Smart For One, Dumb For All
Inefficient market equilibrium
When some benefits from the good or service accrue to people who did not buy the good or service
Supply and Demand

98. Markets and Social Welfare
Example: Vaccinations
The market is in equilibrium: MC = MB
MB underestimates the benefits to society of consuming the vaccinations
The market produces less than the efficient amount of vaccinations and there is no incentive for producers and consumers to alter their behavior
Supply and Demand

99. Markets and Social Welfare
Smart For One, Dumb For All
In these markets
Buyers and sellers are behaving rationally
Market equilibrium exists
There are no unexploited opportunities for individuals
Economic surplus is not maximized
Supply and Demand