1. MACROECONOMICS Dr. Nimantha Manamperi
Introduction

2. WHAT YOU WILL LEARN IN THIS CHAPTER
What is Economics?
The difference between Microeconomics and Macroeconomics.
What is Production Possibility Frontier?
Dynamics of Production Possibility Frontier.
What is Supply and Demand?
Supply and Demand Curves
Market Equilibrium.
Shifts in Demand and Supply curves.
WHAT YOU
WILL LEARN
IN THIS CHAPTER

3. What is Economics ?
Economics is the study of how people allocate their limited resources to satisfy their nearly unlimited wants.
Resources : Water, Crude Oil, Time, Air, Soil, labor etc …
Scarcity : Limited amount of resources, given unlimited wants.

4. MICRO VS. MACRO Economics can be divided in to two main areas.
Microeconomics
Macroeconomics
Microeconomics : The study of the individual units that make up the economy.
Macroeconomics : The study of the overall economy as a whole.

5. MICROECONOMIC QUESTIONS MACROECONOMIC QUESTIONS
MICRO VS. MACRO
Let’s begin by looking more carefully at the difference between microeconomic and macroeconomic questions.
MICROECONOMIC QUESTIONS
MACROECONOMIC QUESTIONS
Go to business school or take a job?
How many people are employed in the economy as a whole?
What determines the salary offered by Citibank to Cherie Camajo, a new Columbia MBA?
What is the annual economic growth rate in Saint Cloud in 2013?

6. MICROECONOMIC QUESTIONS MACROECONOMIC QUESTIONS
MACRO VS. MICRO
MICROECONOMIC QUESTIONS
MACROECONOMIC QUESTIONS
What determines the cost to a university or college of offering a new course?
What determines the overall level of prices in the economy as a whole?
What is the selling price of a Dell computer in the market?
What government policies should be adopted to promote full employment and growth in the economy as a whole?
What determines whether Citibank opens a new office in Shanghai?
What determines the overall trade in goods, services and financial assets between the United States and the rest of the world?

7. MICRO VS. MACRO
Microeconomics focuses on how decisions are made by individuals and firms and the consequences of those decisions.
Macroeconomics examines the aggregate behavior of the economy (that is, how the actions of all the individuals and firms in the economy interact to produce a particular level of economic performance as a whole).

8. MACRO VS. MICSO Income Output Employment Prices TOPIC MICROECONOMICS
MACROECONOMICS
Income
Income of a Person, the revenue of a Firm
The income of an entire nation or a national economy
Output
The production of a single worker
The production of an entire economy
Employment
The job status of an individual or a firm
The job status of a national population, particularly the number of people unemployed
Prices
The Price of a single good or service
The combined prices of all good and services in an economy

9. The Production Possibility Frontier (PPF)
PPF is a model that illustrates the combinations of outputs that a society can produce if all of its resources are being used efficiently.
Example :

10. The Production Possibility Frontier
Quantity of Dreamliners 30 D
Attainable
and
efficient
in production
Not Attainable A 15
curve. Production at point C is feasible but not efficient. Points A and B are feasible and efficient in production, but point D is not feasible.
Attainable
but not efficient B 9 C
Production possibility frontier
PPF 20 28 40
Quantity of small jets

11. The PPF Dynamics
Economic Growth and PPF

12. Supply and Demand A Competitive market:
Many buyers and sellers. With very low impact on market price or out put.
Same good or service.
An Imperfect Market is one in which the buyer or the seller has an influence on the market price.
The Supply and Demand model is a model of how a competitive market works.
Five key elements:
Demand curve , Supply curve , Demand and supply curve shifts
Market equilibrium , Changes in the market equilibrium

13. Demand
Lets assume that your favorite Singer is coming to Atwood to Perform music. You all get the same seating. There are no transportation cost and any other extra costs for you to attend this event.
How much are you willing to pay for the admission ticket?

14. Demand
Law of Demand :
There is an inverse relationship between price and the quantity demanded for that product.

15. Demand Schedule
A demand schedule shows how much of a good or service consumers will want to buy at different prices.
7.1
7.5
8.1
8.9
10.0
11.5
14.2
Price of cotton (per pound)
Quantity of cotton demanded (billions of pounds)
1.75
1.50
1.25
1.00
0.75
0.50
$2.00
Demand Schedule for Cotton
Notes to the instructor:
Asking the students about their willingness to pay and how it changes with price always catches their attention.
For example, you can talk about iPhones, iPods, movie tickets, or any other goods or services that you think will relate to your students.
Different students will have different willingness to pay for the example you choose, and it will also change with price.
Class exercise:
You can ask your students to select a good or service that they frequently purchase and come up with their own demand schedule indicating their willingness to pay at different prices.
This could be a 5 minutes in-class exercise. After 5 minutes, you can randomly select students and ask them about their demand schedule.
Ask what happens to their quantity demanded as price increases?

16. Price of cotton (per pound) Quantity of cotton (billions of pounds)
Demand Curve
Price of cotton (per pound)
A demand curve is the graphical representation of the demand schedule. It shows how much of a good or service consumers want to buy at any given price.
$2.00
Demand curve, D
1.75
1.50
1.25
1.00
Figure Caption:
Figure 3-1: The Demand Schedule and the Demand Curve
The demand schedule for cotton yields the corresponding demand curve, which shows how much of a good or service consumers want to buy at any given price. The demand curve and the demand schedule reflect the law of demand: As price rises, the quantity demanded falls. Similarly, a decrease in price raises the quantity demanded. As a result, the demand curve is downward sloping.
Notes to the Instructor: It could be a good idea to remind students the definition of “slope”.
They should understand that the basic demand curve for a normal good is “downward sloping” and also the intuition of its slope.
I usually underline the inverse relationship between price and quantity demanded: as one goes up, the other goes down.
More will be revealed further in the chapter.
Alternatively, you could delay the explanation about the slope until later and then go more into the details of the ”downward slope”, its intuition, exceptions, etc…
0.75
As price rises, the quantity demanded falls
0.50 7 9 11 13 15 17
Quantity of cotton (billions of pounds)

17. GLOBAL COMPARISON: Pay More, Pump Less…
Because of high taxes, gasoline and diesel fuel are more than twice as expensive in most European countries as in the United States.
According to the law of demand, Europeans should buy less gasoline than Americans, and they do.
Europeans consume less than half as much fuel as Americans, mainly because they drive smaller cars with better mileage.
Price of gasoline (per gallon)
Germany $8
United Kingdom I
taly 7
France 6
Spain
Japan 5
Canada 4 3
United States
0.2
0.6
1.0
1.4
Consumption of gasoline (gallons per day per capita)

18. An Increase in Demand
An increase in population and other factors generate an increase in demand.
a rise in the quantity demanded at any given price
This is represented by the two demand schedules—one showing demand in 2007, before the rise in population, the other showing demand in 2010, after the rise in population.
Demand Schedules for Cotton
Quantity of cotton demanded (billions of pounds)
Price of cotton (per pound)
in 2007
in 2010
$2.00
7.1
8.5
1.75
7.5
9.0
1.50
8.1
9.7
1.25
8.9
10.7
1.00
10.0
12.0
0.75
11.5
13.8
0.50
14.2
17.0

19. Price of cotton (per pound) Quantity of cotton (billions of pounds)
An Increase in Demand
Price of cotton (per pound)
$2.00
Increase in population 
more cotton clothing users 2
1.75
Demand curve in 2010
1.50
1.25
1.00
0.75
Demand curve in 2007
0.50 D D 1
Figure Caption:
Figure 3-2: An increase in demand
An increase in the population and other factors generate an increase in demand—a rise in the quantity demanded at any given price. This is represented by the two demand schedules—one showing demand in 2007, before the rise in population, the other showing demand in 2010, after the rise in population—and their corresponding demand curves. The increase in demand shifts the demand curve to the right. 7 9 11 13 15 17
Quantity of cotton (billions of pounds)
A shift of the demand curve is a change in the quantity demanded at any given price, represented by the change of the original demand curve to a new position, denoted by a new demand curve.

20. Movement Along the Demand Curve
A movement along the demand curve is a change in the quantity demanded of a good that is the result of a change in that good’s price.
Price of cotton (per pound)
A shift of the demand curve…
$2.00
1.75
… is not the same thing as a movement along the demand curve A C
1.50
1.25 B
Figure Caption:
Figure 3-3: Movement Along the Demand Curve Versus Shift of the Demand Curve
The rise in quantity demanded when going from point A to point B reflects a movement along the demand curve: it is the result of a
fall in the price of the good. The rise in quantity demanded when going from point A to point C reflects a shift of the demand curve:
it is the result of a rise in the quantity demanded at any given price.
Notes to the Instructor: It is very important that the students can distinguish between a “shift” and a “movement along” a curve.
I also give the students the general rule: any change in the value of the variables on the vertical and horizontal axis causes a “movement along” the curve. To generate a shift, we need an outside shock (change in the value of outside - exogenous – variables, which we were assuming to be constant (Ceteris Paribus), such as population, tastes, etc…
This is also a good opportunity to underline the difference between “demand” and “quantity demanded”.
In ordinary speech most people, including professional economists, use the word demand casually. For example, an economist might say “the demand for air travel has doubled over the past 15 years, partly because of falling air fares” when he or she really means that the quantity demanded has doubled. It’s OK to be a bit sloppy in ordinary conversation. But when you’re doing economic analysis, it’s important to make the distinction between changes in the quantity demanded, which involve movements along a demand curve, and shifts of the demand curve.
A movement along a curve occurs when:
1. A change in the value of the variable measured on the horizontal axis leads to a change in the value of the variable measured on the vertical axis, and vice versa. (For example, a change in x leads to a change in y, and vice versa.)
2. The values of both variables change. (For example, both x and y change.)
A shift of a curve occurs when the value of only one variable changes while the value of the other variable stays the same. (For example, x changes while y stays the same, or y changes while x stays the same.)
Class exercise questions:
You can ask your students the following exercise questions:
- The price of a can of Coke has increased from $1 to $3. Does this cause a movement along or a shift of the demand curve for Coke? Why?
- A new scientific research has proven that a regular Coke drinker lives on the average 5 years longer. Does this finding cause a movement along or a shift of the demand curve for Coke? Why?
You can ask them to write their answers on a piece of paper, supported by graphical explanations. At the end, you can ask students to correct each other’s answers.
Ten minutes would be enough to you through this exercise.
1.00
0.75
0.50 D D 1 2 7
8.1
9.7 10 13 15 17
Quantity of cotton (billions of pounds)

21. Shifts of the Demand Curve
An “increase in demand” means a rightward shift of the demand curve: at any given price, consumers demand a larger quantity than before. (D1D2)
A “decrease in demand” means a leftward shift of the demand curve: at any given price, consumers demand a smaller quantity than before. (D1D3)
Price
Increase in demand
Figure Caption:
Figure 3-4: Shifts of the Demand Curve
Any event that increases demand shifts the demand curve to the right, reflecting a rise in the quantity demanded at any given price. Any event that decreases demand shifts the demand curve to the left, reflecting a fall in the quantity demanded at any given price.
Decrease in demand D D D 3 1 2
Quantity

22. What Causes a Demand Curve to Shift?
Changes in the Prices of Related Goods
Substitutes: Two goods are substitutes if a fall in the price of one of the goods makes consumers less willing to buy the other good.
Examples :
Complements: Two goods are complements if a fall in the price of one good makes people more willing to buy the other good.
Examples:
Notes to the Instructor:
Substitutes: Ex.: muffins and donuts, cereal and oatmeal, ….
Complements: Ex: squash balls and squash racquets, iPod and earphones,…
Class exercise questions:
- What would be the effect of a sharp increase in the price of squash balls on the demand for squash racquets? Why?
- What would be the effect of a sharp increase in the price of Pepsi on the demand for Coke? Why?
An interesting example from current events is the debate on building casinos in Massachusetts. Opponents argue that building casinos in Massachusetts would cause a decline in state lottery revenues. This constitutes an example of substitutes. (Although the expected revenue decrease is only about 6%).

23. What Causes a Demand Curve to Shift?
Changes in Income
Normal Goods: When a rise in income increases the demand for a good — the normal case — we say that the good is a normal good.
Examples :
Inferior Goods: When a rise in income decreases the demand for a good, it is an inferior good.
Changes in Tastes
Changes in Expectations
Notes to the Instructor:
Class exercise questions:
- As Talya’s income goes up, she buys less “instant noodles.” What kind of a good is “instant noodles” for Talya?
- Following David Beckham and Sting, more men start to follow the fashion of wearing skirts. What would the effect of this change in tastes be on the demand for skirts?
- Scientists announce that there will be no fish left in the oceans in 5 years. What would be the effect of this announcement on demand for sushi?

24. Individual Demand Curve and the Market Demand Curve
The market demand curve is the horizontal sum of the individual demand curves of all consumers in that market.
(a)
Darla’s Individual Demand Curve
(b)
Dino’s Individual Demand Curve
(c)
Market Demand Curve
Price of blue jeans (per pair)
Price of blue jeans (per pair)
Price of blue jeans (per pair)
$30
$30
$30 D
Market
Figure Caption:
Figure 3-5: Individual Demand Curves and the Market Demand Curve
Darla and Dino are the only two consumers of blue jeans in the market. Panel (a) shows Darla’s individual demand curve: the number of pair of jeans she will buy per year at any given price. Panel (b) shows Dino’s individual demand curve. Given that Darla and Dino are the only two consumers, the market demand curve, which shows the quantity of blue jeans demanded by all consumers at any given price, is shown in panel (c). The market demand curve is the horizontal sum of the individual demand curves of all consumers. In this case, at any given price, the quantity demanded by the market is the sum of the quantities demanded by Darla and Dino. 1 1 1 D D
Darla
Dino 3 4 2 3 5 6 7
Quantity of blue jeans (pounds)
Quantity of blue jeans (pounds)
Quantity of blue jeans (pounds)

25. ECONOMICS IN ACTION Beating the Traffic
If we think of an auto trip to the city center as a good that people consume, we can use the economics of demand to analyze anti-traffic policies.
One common strategy is to reduce the demand for auto trips by lowering the prices of substitutes.
Many metropolitan areas subsidize bus and rail service, hoping to lure commuters out of their cars.
An alternative is to raise the price of complements: several major U.S. cities impose high taxes on commercial parking garages and impose short time limits on parking meters, both to raise revenue and to discourage people from driving into the city.

26. ECONOMICS IN ACTION Beating the Traffic
A few major cities—including Singapore, London, Oslo, Stockholm, and Milan—have been willing to adopt a direct and politically controversial approach: reducing congestion by raising the price of driving.
Under “congestion pricing” (or “congestion charging” in the United Kingdom), a charge is imposed on cars entering the city center during business hours.
The current daily cost of driving in London ranges from £9 to £12. And drivers who are caught not paying are issued a fine of £120 for each transgression.

27. ECONOMICS IN ACTION Beating the Traffic
Studies have shown that after the implementation of congestion pricing, traffic does indeed decrease.
The introduction of its congestion charge in 2003 immediately reduced traffic in the London city center by about 15%, with overall traffic falling by 21% between 2002 and 2006.
And there was increased use of substitutes, such as public transportation, bicycles, motorbikes, and ride-sharing.

28. Supply Schedule for Cotton
Price of
cotton
(per pound)
Quantity of
supplied
(billions of pounds)
$2.00
11.6
1.75
11.5
1.50
11.2
1.25
10.7
1.00
10.0
0.75
9.1
0.50
8.0
A supply schedule shows how much of a good or service would be supplied at different prices.
Figure Caption:
Figure 3-6: The Supply Schedule and the Supply Curve
The supply schedule for cotton is plotted to yield the corresponding supply curve, which shows how much of a good producers are willing to sell at any given price. Just as the quantity of cotton that consumers want to buy depends on the price they have to pay, the quantity that producers are willing to produce and sell—the quantity supplied—depends on the price they are offered.
Notes to the Instructor:
COTTON FIELDS (THE COTTON SONG)
Beach Boys
When I was a little bitty baby
My mama done rock me in the cradle
In them old cotton fields back home
It was back in Louisiana
Just about a mile from Texarkana
Let me tell you now well got me in a fix
I caught a nail in my tire doing lickitey splits
I had to walk a long long way to town
Came upon a nice old man well he had a hat on
Wait a minute mister can you give me some directions
I gonna want to be right off for home
Don't care if them cotton balls get rotten
When I got you baby, who needs cotton
Brother only one thing more that's gonna warm you
A summer's day out in California
It's gonna be those cotton fields back home
Give me them cotton fields
(It was back in Louisiana)
Let me hear it for the cotton fields
(Just about a mile from Texarkana)
You know that there's just no place like home
Well boy it sure feels good to breathe the air back home
You shoulda seen their faces when they seen how I grown

29. Price of cotton (per pound) Quantity of cotton (billions of pounds)
Supply Curve
Price of cotton (per pound)
A supply curve shows graphically how much of a good or service people are willing to sell at any given price.
Supply curve, S
$2.00
1.75
As price rises, the quantity supplied rises.
1.50
1.25
1.00
Figure Caption:
Figure 3-6: The Supply Schedule and the Supply Curve
The supply curve and the supply schedule reflect the fact that supply curves are usually upward sloping: the quantity supplied rises when the price rises.
Notes to the Instructor:
This could be another opportunity to remind students the definition of “slope”. They should understand that the basic supply curve for a normal good is “upward sloping” and also the intuition of its slope. As the price goes up, producers receive more for each unit of good they sell and hence they are willing to increase the amount supplied. There is a positive relationship between price and quantity supplied: as one goes up, the other one also goes up.
Alternatively, you could delay the explanation about the slope until later and then go more into the details of the ”upward slope,” its intuition, exceptions, etc…
0.75
0.50 7 9 11 13 15 17
Quantity of cotton (billions of pounds)

30. Supply Schedule for Cotton Quantity of cotton supplied
An Increase in Supply
The adoption of improved cotton-growing technology generated an increase in supply — a rise in the quantity supplied at any given price.
This event is represented by the two supply schedules — and their corresponding supply curves
one showing supply before the new technology was adopted
the other showing supply after the new technology was adopted
Supply Schedule for Cotton
Price of cotton
(per pound)
Quantity of cotton supplied
(billions of pounds)
Before new technology
After new technology
$2.00
11.6
13.9
1.75
11.5
13.8
1.50
11.2
13.4
1.25
10.7
12.8
1.00
10.0
12.0
0.75
9.1
10.9
0.50
8.0
9.6
Figure Caption:
Figure 3-7: An increase in supply
The adoption of new technology in the cotton growing business generated an increase in supply—a rise in the quantity supplied at any given price. This event is represented by the two supply schedules—one showing supply before technology adoption, the other showing supply after technology adoption—and their corresponding supply curves. The increase in supply shifts the supply curve to the right.

31. Price of cotton (per pound) Quantity of cotton (billions of pounds)
An Increase in Supply
Price of cotton (per pound) S 2 S 1
Technology adoption in cotton-growing business 
more cotton producers
$2.00
Supply curve before new technology
1.75
1.50
1.25
1.00
Supply curve
after
new technology
0.75
Figure Caption:
Figure 3-7: An increase in supply
The adoption of new technology in the cotton growing business generated an increase in supply—a rise in the quantity supplied at any given price. This event is represented by the two supply schedules—one showing supply before technology adoption, the other showing supply after technology adoption—and their corresponding supply curves. The increase in supply shifts the supply curve to the right.
0.50 7 9 11 13 15 17
Quantity of cotton (billions of pounds)
A shift of the supply curve is a change in the quantity supplied of a good at any given price.

32. Movement Along the Supply Curve
Price of cotton (per pound) S S 2
$2.00
A movement along the supply curve… 1
1.75
1.50 B
1.25 A
1.00 C
… is not the same thing as a shift of the supply curve
0.75
Figure Caption:
Figure 3-8: Movement Along the Supply Curve Versus Shift of the Supply Curve
The increase in quantity supplied when going from point A to point B reflects a movement along the supply curve: it is the result of a rise in the price of the good. The increase in quantity supplied when going from point A to point C reflects a shift of the supply curve: it is the result of an increase in the quantity supplied at any given price.
0.50 7 10
11.2 12 15 17
Quantity of cotton (billions of pounds)
A movement along the supply curve is a change in the quantity supplied of a good that is the result of a change in that good’s price.

33. Shifts of the Supply Curve
Any “decrease in supply” means a leftward shift of the supply curve: at any given price, there is a decrease in the quantity supplied. (S1 S3)
Any “increase in supply” means a rightward shift of the supply curve: at any given price, there is an increase in the quantity supplied. (S1 S2)
Price S S S 3 1 2
Increase in supply
Figure Caption:
Figure 3-9: Shifts of the Supply Curve
Any event that increases supply shifts the supply curve to the right, reflecting a rise in the quantity supplied at any given price. Any event that decreases supply shifts the supply curve to the left, reflecting a fall in the quantity supplied at any given price.
Note to the instructor:
When economists talk about an “increase in supply,” they mean a rightward shift of the supply curve: at any given price, producers supply a larger quantity of the good than before. And when economists talk about a “decrease in supply,” they mean a leftward shift of the supply curve: at any given price, producers supply a smaller quantity of the good than before.
Decrease in supply
Quantity

34. What Causes a Supply Curve to Shift?
Changes in input prices
An input is a good that is used to produce another good.
Changes in the prices of related goods and services
Changes in technology
Changes in expectations
Changes in the number of producers
Quick Question : - Internet technology allows colleges to offer more and more online courses and resources in economics. What happens to the supply of economics knowledge?
Notes to the Instructor:
Class exercise:
You can ask students the following questions:
- Internet technology allows colleges to offer more and more online courses and resources in economics. What happens to the supply of economics knowledge?

35. Individual Supply Curve and the Market Supply Curve
The market supply curve is the horizontal sum of the individual supply curves of all firms in that market.
(a)
Mr. Silva’s Individual Supply Curve
(b)
Mr. Liu’s Individual Supply Curve
(c)
Market Supply Curve
Price of cotton (per pound)
Price of cotton (per pound)
Price of cotton (per pound) S S S
Silva
Liu
Market $2 $2 $2 1 1 1
Figure Caption:
Figure 3-10: Individual Supply Curves and the Market Supply Curve
Panel (a) shows the individual supply curve for Mr. Silva, SSilva, the quantity of cotton he will sell at any given price. Panel (b) shows the individual supply curve for Mr. Liu, SLiu. The market supply curve, which shows the quantity of cotton supplied by all producers at any given price, is shown in panel (c). The market supply curve is the horizontal sum of the individual supply curves of all producers.
At any given price, the quantity supplied to the market is the sum of the quantities supplied by Mr. Silva and Mr. Liu. For example, at a price of $2 per pound, Mr. Silva supplies 3,000 pounds of cotton per year and Mr. Liu supplies 2,000 pounds per year, making the quantity supplied to the market 5,000 pounds.
Clearly, the quantity supplied to the market at any given price is larger with Mr. Liu present than it would be if Mr. Silva was the only supplier. The quantity supplied at a given price would be even larger if we added a third producer, then a fourth, and so on. So an increase in the number of producers leads to an increase in supply and a rightward shift of the supply curve. 1 2 3 1 2 1 2 3 4 5
Quantity of cotton (thousands of pounds)
Quantity of cotton (thousands of pounds)
Quantity of cotton (thousands of pounds)

36. ECONOMICS IN ACTION Only Creatures Small and Pampered
According to a recent article in the New York Times, the United States has experienced a severe decline in the number of farm veterinarians over the past two decades.
The source of the problem is competition.
Vets are being drawn away from the business of caring for farm animals into the more lucrative business of caring for pets.

37. ECONOMICS IN ACTION Only Creatures Small and Pampered
How can we translate this into supply and demand curves?
Farm veterinary services and pet veterinary services are related goods that are substitutes in production.
A veterinarian typically specializes in one type of practice or the other, and that decision often depends on the going price for the service.
America’s growing pet population, combined with the increased willingness of doting owners to spend money on their companions’ care, has driven up the price of pet veterinary services.
So, the supply curve of farm veterinarians has shifted leftward—fewer farm veterinarians are offering their services at any given price.

38. Supply, Demand and Equilibrium
Equilibrium in a competitive market: when the quantity demanded of a good equals the quantity supplied of that good
The price at which this takes place is the equilibrium price (or market-clearing price)
Every buyer finds a seller and vice versa.
The quantity of the good bought and sold at that price is the equilibrium quantity.
Notes to the Instructor:
It could be useful to go over the “Pitfall: Bought and Sold?” at this point of the lecture:
PITFALLS: BOUGHT AND SOLD?
We have been talking about the price at which a good is bought and sold, as if the two were the same. But shouldn’t we make a distinction between the price received by sellers and that paid by buyers? In principle, yes; but it is helpful at this point to sacrifice a bit of realism in the interests of simplicity - by assuming away the difference between the prices received by sellers and those paid by buyers.
In reality, there is often a middleman—someone who brings buyers and sellers together— who buys from suppliers, then sells to consumers at a markup, for example, coffee merchants who buy from coffee growers and sell to consumers. The growers generally receive less than those who eventually buy the coffee beans pay. No mystery there: that difference is how coffee merchants or any other middlemen make a living. In many markets, however, the difference between the buying and selling price is quite small. So it’s not a bad approximation to think of the price paid by buyers as being the same as the price received by sellers. And that is what we assume in this chapter.

39. Price of cotton (per pound) Quantity of cotton (billions of pounds)
Market Equilibrium
Price of cotton (per pound)
Market equilibrium occurs at point E, where the supply curve and the demand curve intersect.
Supply
$2.00
1.75
1.50
1.25
Equilibrium price E
Equilibrium
1.00
0.75
Figure Caption:
Figure 3-11: Market Equilibrium
Market equilibrium occurs at point E, where the supply curve and the demand curve intersect. In equilibrium, the quantity demanded is equal
to the quantity supplied. In this market, the equilibrium price is $1 per pound and the equilibrium quantity is 10 billion pounds per year.
Discussion:
Why do all sales and purchases in a market take place at the same price?
Suppose that a seller offered a potential buyer a price noticeably above what she knew other people to be paying. The buyer would clearly be better off walking away from this particular seller and trying someone else – unless the seller was prepared to offer a better deal. Conversely, a seller would not be willing to sell for significantly less than the amount he knew most buyers were paying; he would be better off waiting to get a more reasonable customer. Thus in any well-established, ongoing market, all sellers receive and all buyers pay approximately the same price. This is what we call the “market price”.
0.50
Demand 7 10 13 15 17
Quantity of cotton (billions of pounds)
Equilibrium quantity

40. Price of cotton (per pound) Quantity of cotton (billions of pounds)
Surplus
Price of cotton (per pound)
There is a surplus of a good when the quantity supplied exceeds the quantity demanded. Surpluses occur when the price is above its equilibrium level.
Supply
$2.00
1.75
Surplus
1.50
1.25
1.00 E
0.75
Figure Caption:
Figure 3-12: Price Above Its Equilibrium Level Creates a Surplus
The market price of $1.50 is above the equilibrium price of $1. This creates a surplus: at a price of $1.50, producers would like to sell 11.2 billion pounds but consumers want to buy only 8.1 billion pounds, so there is a surplus of 3.1 billion pounds. This surplus will push the price down until it reaches the equilibrium price of $1.
0.50
Demand 7
8.1 10
11.2 13 15 17
Quantity of cotton (billions of pounds)
Quantity demanded
Quantity supplied

41. Price of cotton (per pound) Quantity of cotton (billions of pounds)
Shortage
Price of cotton (per pound)
There is a shortage of a good when the quantity demanded exceeds the quantity supplied. Shortages occur when the price is below its equilibrium level.
Supply
$2.00
1.75
1.50
1.25
1.00 E
0.75
Figure Caption:
Figure 3-13: Price Below Its Equilibrium Level Creates a Shortage
The market price of $0.75 is below the equilibrium price of $1. This creates a shortage: consumers want to buy 11.5 billion pounds, but
only 9.1 billion pounds are for sale, so there is a shortage of 2.4 billion pounds. This shortage will push the price up until it reaches the
equilibrium price of $1.
Note to the instructor:
A current example is when Apple introduced its new iPhone 3G in the Summer of 2008, for half the price of its current iPhone model ($199), it caused a (temporary) shortage all over the US. Long lines and waiting lists were an apparent indicator of the shortage.
Shortage
0.50
Demand 7
9.1 10
11.5 13 15 17
Quantity of cotton (billions of pounds)
Quantity supplied
Quantity demanded

42. Equilibrium and Shifts of the Demand Curve
Price of cotton
An increase in demand…
Supply
… leads to a movement along the supply curve due to a higher equilibrium price and higher equilibrium quantity. E 2 P
Price rises 2 E 1 P 1 D
Figure Caption:
Figure 3-14: Equilibrium and Shifts of the Demand Curve
The original equilibrium in the market for cotton is at E1, at the intersection of the supply curve and the original demand curve, D1. A rise in
the price of polyester , a substitute, shifts the demand curve rightward to D2. A shortage exists at the original price, P1, causing both the price and quantity supplied to rise, a movement along the supply curve. A new equilibrium is reached at E2, with a higher equilibrium price, P2, and a higher equilibrium quantity, Q2. When demand for a good or service increases, the equilibrium price and the equilibrium quantity of the good or service both rise.
Note to the instructor:
Other examples: (1) The recent successes of Red Socks (Boston’s Baseball Team) caused an increase in demand for the tickets of Red Socks games.
(2) In 10 years, global warming may increase the demand for land in parts of the world earlier considered “too cold”.
Question for Class Discussion:
Coffee and tea are substitutes: if the price of tea rises (falls), the demand for coffee will increase (decrease). But how does the price of tea affect the market for coffee? 2 D 1 Q Q 1 2
Quantity of cotton
Quantity rises

43. Equilibrium and Shifts of the Supply Curve
Price of cotton S S 2 1
A decrease in supply… E 2 P 2
Price rises
… leads to a movement along the demand curve due to a higher equilibrium price and lower equilibrium quantity.
A drought causes a fall in the supply of cotton. How does this negative supply shock affect the market for cotton?
Figure Caption:
Figure 3-15: Equilibrium and Shifts of the Demand Curve
The original equilibrium in the market for cotton is at E1. A drought causes a fall in the supply of cotton and shifts the supply curve leftward from S1 to S2. A new equilibrium is established at E2, with a higher equilibrium price, P2, and a lower equilibrium quantity, Q2. P E 1 1
Demand Q Q
Quantity of cotton 2 1
Quantity falls

44. Technology Shifts of the Supply Curve
An increase in supply …
… leads to a movement along the demand curve to a lower equilibrium price and higher equilibrium quantity.
Price S2
Technological innovation: In the early 1970s, engineers learned how to put microscopic electronic components onto a silicon chip; progress in the technique has allowed ever more components to be put on each chip. E1 P1
Price falls E2 P2
Note to the instructor:
This is a different example than the one used in the textbook (it is from the previous version). You may want to use it as another example or you can hide the slide and choose to exclude it from the lecture presentation.
It could be useful to go over the “Pitfall: Which Curve is it anyway?” at this point of the lecture:
PITFALLS: WHICH CURVE IS IT, ANYWAY?
When the price of some good changes, in general we can say that this reflects a change in either supply or demand. But it is easy to get confused about which one. A helpful clue is the direction of change in the quantity. If the quantity sold changes in the same direction as the price - for example, if both the price and the quantity rise - this suggests that the demand curve has shifted. If the price and the quantity move in opposite directions, the likely cause is a shift in the supply curve.
Demand
Quantity Q1 Q2
Quantity increases

45. Simultaneous Shifts of Supply and Demand
(a) One Possible Outcome: Price Rises, Quantity Rises
Small decrease in supply
Price of cotton S S 2 1 E 2 P
The increase in demand dominates the decrease in supply.
Two opposing forces determining the equilibrium quantity. 2
Figure Caption:
Figure 3-16 (a) There is a simultaneous rightward shift of the demand curve and leftward shift of the supply curve. Here
the increase in demand is relatively larger than the decrease in supply, so the equilibrium price and equilibrium quantity both rise. E 1 P 1 D 2 D 1
Large increase in demand Q
Quantity of cotton 1 Q 2

46. Simultaneous Shifts of Supply and Demand
(b) Another Possible Outcome: Price Rises, Quantity Falls
Price of cotton
Large decrease in supply S 2 S 1
Two opposing forces determining the equilibrium quantity.
The decrease in supply dominates the increase in demand. E 2 P 2
Figure Caption:
Figure 3-16 (b) There is also a simultaneous rightward shift of the demand curve and leftward shift of the supply curve. Here the decrease in supply is relatively larger than the increase in demand, so the equilibrium price rises and the equilibrium quantity falls. E
Small increase in demand 1 P 1 D 2 D 1 Q Q
Quantity of cotton 2 1

47. Simultaneous Shifts of Supply and Demand
We can make the following predictions about the outcome when the supply and demand curves shift simultaneously:
Simultaneous Shifts of Supply and Demand
Supply Increases
Supply Decreases
Demand Increases
Price: ambiguous
Quantity: up
Price: up
Quantity: ambiguous
Demand Decreases
Price: down
Quantity: down
Note to the instructor:
In general, when supply and demand shift in opposite directions, we can’t predict what the ultimate effect will be on the quantity bought and sold. What we can say is that a curve that shifts a disproportionately greater distance than the other curve will have a disproportionately greater effect on the quantity bought and sold. That said, we can make the following prediction about the outcome when the supply and demand curves shift in opposite directions:
- When demand increases and supply decreases, the equilibrium price rises but the change in the quantity is ambiguous.
- When demand decreases and supply increases, the equilibrium price falls but the change in the quantity is ambiguous.
But suppose that the demand and supply curves shift in the same direction. This was the case in the global market for coffee beans, where both supply and demand have increased over the past decade. Can we safely make any predictions about the changes in price and quantity? In this situation, the change in quantity bought and sold can be predicted but the change in price is ambiguous. The two possible outcomes when the supply and demand curves shift in the same direction (which you should check for yourself) are as follows:
- When both demand and supply increase, the equilibrium quantity increases but the change in price is ambiguous.
- When both demand and supply decrease, the equilibrium quantity decreases but the change in price is ambiguous.

48. ECONOMICS IN ACTION The Great Tortilla Crisis
There was a sharp rise in the price of tortillas, a staple food of Mexico’s poor. The price rose from 25 cents a pound to between 35 and 45 cents a pound in just a few months in early 2007.
Why were tortilla prices soaring?
It was a classic example of what happens to equilibrium prices when supply falls.
Tortillas are made from corn, and much of Mexico’s corn is imported from the United States, with the price of corn in both countries basically set in the U.S. corn market.
And U.S. corn prices were rising rapidly thanks to surging demand in a new market: the market for ethanol.
Note to the instructor:
This example is from the old text. You can use this as a class exercise question for your students.

49. Demand and Supply Shifts at Work in the Global Economy
A recent drought in Australia reduced the amount of grass on which Australian dairy cows could feed, thus limiting the amount of milk these cows produced for export.
At the same time, a new tax levied by the government of Argentina raised the price of the milk the country exported, thereby decreasing Argentine milk sales worldwide.
These two developments produced a supply shortage in the world market, which dairy farmers in Europe couldn’t fill because of strict production quotas set by the European Union.
Note to the instructor:
This is a very recent example outside of the text. I find it interesting and it captures students’ attention.

50. ECONOMICS IN ACTION The Rice Run of 2008
The factors that lay behind the surge in rice prices were both demand-related and supply-related: growing incomes in China and India, traditionally large consumers of rice; drought in Australia; and pest infestation in Vietnam.
But it was hoarding by farmers, panic buying by consumers, and an export ban by India, one of the largest exporters of rice, that explained the breathtaking speed of the rise in price.

51. ECONOMICS IN ACTION