1. Fall ‘ 97Principles of Microeconomicsslide 1 This is a PowerPoint presentation on elementary supply and demand. A left mouse click or the enter key will add and element to a slide or move you to the next slide. The back space key will take you back an element or slide. If you wish to exit the presentation, the escape key will do it! R. Larry Reynolds 

2. Fall ‘ 97Principles of Microeconomicsslide 2 Demand and Supply ·Markets as allocative mechanism require: ·nonattenuated property rights [exclusive, enforceable, transferable] ·“voluntary” transactions ·Markets include all “potential buyers and sellers” ·behavior of buyers is represented by “demand” [benefits side of model] ·behavior of sellers is represented by “supply” [cost side of model]

3. Fall ‘ 97Principles of Microeconomicsslide 3 Markets, Supply and Demand ·markets include all potential buyers and sellers ·geographic boundaries of market ·markets defined by nature of product and characteristics of buyers ·conditions of entry into market ·markets, competition and substitutes

4. Fall ‘ 97Principles of Microeconomicsslide 4 Demand ·Definition: “A schedule of the quantities of a good that buyers are willing and able to purchase at each possible price during a period of time, ceteris paribus. [all other things held constant]” ·Demand can also be perceived as a schedule of the maximum prices buyers are willing and able to pay for each unit of a good.

5. Fall ‘ 97Principles of Microeconomicsslide 5 Demand Function ·Is the functional relationship between the price of the good and the quantity of that good purchased in a given time period [UT], income, other prices and preferences being held constant. ·A change in income, prices of other goods or preferences will alter [‘shift’] the demand function.

6. Fall ‘ 97Principles of Microeconomicsslide 6 Quantity demanded ·A change in the price of the good under consideration will change the “quantity demanded.” ·Q = f (P, holding M, P r, preferences constant); where: M = income P r = prices of related goods  P causes a change in X [  Q], this is a “change in quantity demanded”

7. Fall ‘ 97Principles of Microeconomicsslide 7 Change in demand ·If M, P r, or preferences change, the demand function [relationship between P and Q] will change. ·These are sometimes called “demand shifters” ·Be sure to understand difference between a “change in demand” and a “change in quantity demanded” ·change in demand --- shift of the function ·change in quantity demanded --- move on the function

8. Fall ‘ 97Principles of Microeconomicsslide 8 “Law of Demand” ·Theory and empirical evidence suggest that the relationship between Price and Quantity is an inverse or negative relationship ·At higher prices, quantity purchased is smaller, or at lower prices the quantity purchased is greater.

9. Fall ‘ 97Principles of Microeconomicsslide 9 An example of hot chocolate: There is a coffee cart in the building that primarily serves the individuals who work in the building. The market is defined to some extent by the geography of the building. Individuals who buy the hot chocolate rarely come from other buildings to purchase a cup. During the time period [UT]under consideration [8:00-9:00am on a week day ] the incomes and preferences of buyers are unlikely to change. The prices of coffee, lattes, etc. can be controlled by the vendor and the price of soft drinks from the machines remains constant. The number of workers in the building remain at a constant level. Under these circumstances, we observe the number of cups of hot chocolate [H] sold each morning as the price [P] is changed. From these observations the demand relationship is estimated.

10. Fall ‘ 97Principles of Microeconomicsslide 10 The demand relationship can be demonstrated as a table: Demand is a schedule of quantities that will be purchased at a schedule of prices during a given time period, cet. par. As the price is increased, the quantity purchased decreases.  Q < 0 [-7.5]  P > 0 [+.75] This demand relationship can be expressed as an equation: P = 2 -.1Q or Q = 20 - 10P : [Q = f (P,...) but we graph P on the Y axis and Q on the X axis.]

11. Fall ‘ 97Principles of Microeconomicsslide 11 The demand relationship can be expressed as a table (previous slide) or an equation [either P = 2 -.1Q or Q = 20 - 10P] The data from the table or equation can be graphed: QUANTITY {CUPS/UT} PRICE 2 4 6 8 10 12 14 16 18 20 22 24.25. 50.75 1.00 1.25 1.50 1.75 2.00 2.25 $...... Demand P = $2, Then Q = 0 P = $1.75, then Q = 2.5 P = $1.50, then Q = 5 P = $1.25, Q = 7.5 P = $1, then Q = 10 P = 0, then Q = 20 The demand function can be represented as a table, an equation or a graph.

12. Fall ‘ 97Principles of Microeconomicsslide 12 QUANTITY {CUPS/ UT} PRICE 2 4 6 8 10 12 14 16 18 20 22 24.25.50.75 1.00 1.25 1.50 1.75 2.00 2.25 The demand equation P = 2 -.1Q was graphed Demand [P = 2 -.1Q] A change in “quantity demanded” is a movement on the demand function caused by a change in the independent variable [ price].  P from $1.50 to $1 causes  Q from 5 to 10 units    A  A change in quantity demanded is a move from point A to B “on the demand function” caused by a change in the price!

13. Fall ‘ 97Principles of Microeconomicsslide 13 QUANTITY {CUPS/UT} PRICE 2 4 6 8 10 12 14 16 18 20 22 24.25. 50.75 1.00 1.25 1.50 1.75 2.00 2.25 The demand equation P = 2 -.1Q was graphed Demand [P = 2 -.1Q] A change in any of the parameters (income, price of related goods, preferences, population of buyers, etc.) will cause a “shift of the demand function.” 2.50 an increase in demand D’ [ P’ = 2.5 -.1Q] In this example, the intercepts have changed, the slope has remained constant a decrease in demand D`` [P`` = 1.5 -.1Q]

14. Fall ‘ 97Principles of Microeconomicsslide 14 QUANTITY {CUPS/UT} PRICE 2 4 6 8 10 12 14 16 18 20 22 24.25.50.75 1.00 1.25 1.50 1.75 2.00 2.25 2.50 Demand [P = 2 -.1Q] A change in the parameters [income, Pr, preferences, population, etc.] might alter the relationship by changing the slope an increase in the slope P = 2 -.25Q buyers are less responsive to  P a decrease in the slope P` = 2-.048076923Q buyers are more responsive to  P A change in demand refers to a movement or shift of the entire demand function

15. Fall ‘ 97Principles of Microeconomicsslide 15 Demand [P = 2 -.1Q] An increase in demand QUANTITY {CUPS/UT} PRICE 2 4 6 8 10 12 14 16 18 20 22 24. 25.50.75 1.00 1.25 1.50 1.75 2.00 2.25 2.50 D 2 [an increase in demand] increase results in a larger quantity being purchased at each price Q = 7.5 In this case, an increase in demand results in an increase in the amount that will be purchased at a price of $1.25. At this price the Quantity purchased increases from 7.5 to 18. An increase in demand!

16. Fall ‘ 97Principles of Microeconomicsslide 16 QUANTITY [steak /UT] PRICE 2 4 6 8 10 12 14 16 18 20 22 24.25.50.75 1.00 1.25 1.50 1.75 2.00 2.25 2.50 Demand [P = 2 -.1Q] Effect of a change in the price of a substitute If the price of a substitute, like chicken, increases buyers will buy more steak at each price of steak Demand for steak increases when the price of chicken increases If the price of chicken decreases, the buyers will want less steak at each possible price of steak; the demand for steak decreases! D2D2 a decrease in the demand for steak

17. Fall ‘ 97Principles of Microeconomicsslide 17 Complementary goods Two goods may be complimentary, i.e. the two goods are “used together. [tennis rackets and tennis balls or CD’s and CD Players] An increase in the price of CD’s will tend to reduce the demand [shift the demand function to the left] for CD Players CD’s/UT P CD’s D cd CD Players per UT P players D player P2P2 P1P1 Y1Y As the price of CD’s increases from P 1 to P 2, the quantity of CD’s decreases from Y1 to Y. As people buy fewer CD’s, the demand for CD players decreases. D’ player At the same price, P pl, the demand is reduced from Dto D’. X1X P pl

18. Fall ‘ 97Principles of Microeconomicsslide 18 Compliments and Substitutes ·Substitutes: ·if the price of a substitute increases, the demand for the good increases. ·if the price of a substitute decreases, the demand for the good decreases. ·Compliments: ·if the price of a compliment increases, the demand for the good decreases. ·if the price of a compliment decreases, the demand for the good increases.

19. Fall ‘ 97Principles of Microeconomicsslide 19 Demand Summary ·“Law of Demand” holds that usually as the price of a good increases, individuals will buy less of it. ·The nature of this relationship is influenced by a variety of other variables; ·income, preferences, prices of related goods, and other circumstances ·as these circumstances change, the demand relationship changes or “shifts.”

20. Fall ‘ 97Principles of Microeconomicsslide 20 Demand Summary [cont... ] ·A “change in demand” means the relationship between price and quantity was altered by a change in some other variable [a demand “shifter”] The demand “shifts.” ·A “change in quantity demanded” is a change in the quantity bought that was caused by a change in the price of the good. There is a movement on the demand function.

21. Fall ‘ 97Principles of Microeconomicsslide 21 Supply ·Supply is defined as a schedule of quantities of a good that will be produced and offered for sale at a schedule of prices during a given time [UT], ceteris paribus. ·Generally, producers are willing to offer greater quantities of a good for sale at higher prices; a positive relationship between price and quantity supplied.

22. Fall ‘ 97Principles of Microeconomicsslide 22 Supply Schedule ObservationPriceQuantity Supplied A$16 B$210 C$314 D$418 E F$5 22 Q P 2 4 6 8 10 12 14 $1 $2 $3 $4 $5 A supply schedule can be displayed as a table. The information can be represented on a graph by plotting each price quantity combination..... supply Both the graph and the table represent a supply relationship: Q = 2 + 4P

23. Fall ‘ 97Principles of Microeconomicsslide 23 Change in Quantity Supplied ·A change in the price of the good causes a change in the “quantity supplied.” ·The change in the price of the good causes a “movement on the supply function,” not a change or “shift of the supply function.”

24. Fall ‘ 97Principles of Microeconomicsslide 24 Supply Schedule ObservationPriceQuantity Supplied A$16 B$210 C$314 D$418 E F$5 22 supply Q /ut P $1 $2 $3 $4 $5 2 4 6 8 10 12 14 16 A change in the price “causes” a change in the “quantity supplied.” This can be represented by a “movement” on the supply function in the graph  P from $1 to $3  P “causes” the quantity supplied to increase from 6 to 14. PP $1 $3 “CAUSES” QQ This is a change in “quantity supplied.” Not to be confused with a “change in supply!”

25. Fall ‘ 97Principles of Microeconomicsslide 25 “Change in Supply” ·A change in supply [like a change in demand] refers to a change in the relationship between the price and quantity supplied. ·A change in supply is “caused” by a change in any variable, other than price, that influences supply ·A change in supply can be represented by a shift of the supply function on a graph

26. Fall ‘ 97Principles of Microeconomicsslide 26 “Change in Supply” [cont... ] ·There are many factors that infuence the willingness of producers to supply a good. ·technology ·prices of inputs ·returns in alternative choices ·taxes, expectations, weather, number of sellers,... ·Q s = f s (P, P inputs, technology,...)

27. Fall ‘ 97Principles of Microeconomicsslide 27 “Change in Supply” [cont... ] ·Q s = f s (P, P inputs, technology, number of sellers, taxes,...) ·A change in the price [P] causes a “change in quantity supplied;” ·a change in any other variable causes a “change in supply”

28. Fall ‘ 97Principles of Microeconomicsslide 28 Supply Schedule ObservationPriceQuantity Supplied A$16 B$210 C$314 D$418 E F$5 22 Q P $1 $2 $3 $4 $5 2 4 6 8 10 12 14 16 Given the supply schedule, supply An increase in the prices of inputs would make it more expensive to produce each unit of output, therefore, the supply decreases 4 8 12 16 20 The decreased quantity at each price “shifts” the supply curve to the left! new supply function a shift to the left is a decrease in supply The development of a “new” technology that reduces the cost of production will “shift” the supply function to the right an increase in supply

29. Fall ‘ 97Principles of Microeconomicsslide 29 Equilibrium ·Equilibrium: 1. a state of rest or balance due to the equal action of opposing forces. 2. equal balance between any powers, influences, [Webster’s Encyclopedic Unabridged Dictionary of the English Language] ·In a market an equilibrium is said to exist when the forces of supply [sellers] and demand [buyers] are in balance: the actions of sellers and buyers are coordinated. The quantity supplied equals the quantity demanded!

30. Fall ‘ 97Principles of Microeconomicsslide 30 10 20 30 40 50 60 70 80 90 100 110 120 130 10 20 30 40 50 60 70 80 90 100 P x [ Price] Q x / UT Given a demand function [ which represents the behavior or choices of buyers, Demand and a supply function that represents the behavior of sellers, Supply Where the quantity that people want to buy is equal to the quantity that the producers want to sell, there is an equilibrium quantity. 60 The price that coordinates the preferences of the buyers and sellers is the equilibrium price. $70 At the equilibrium price of $70, the quantity supplied is equal to the quantity demanded.

31. Fall ‘ 97Principles of Microeconomicsslide 31 10 20 30 40 50 60 70 80 90 100 110 120 130 10 20 30 40 50 60 70 80 90 100 P x [ Price] Q x / UT Demand Supply When the price is greater than the equilibrium price, the amount that sellers want to sell at that price [quantity supplied] exceeds the amount that buyers are willing to purchase [quantity demanded] at that price. The price is “too high.” 60 $70 equilibrium price equilibrium quantity At a Price of $90 the quantity supplied is 80, $90 80 the quantity demanded is 35 35 At $90 there is a surplus of 45 units [80-35=45] surplus = 45

32. Fall ‘ 97Principles of Microeconomicsslide 32 10 20 30 40 50 60 70 80 90 100 110 120 130 10 20 30 40 50 60 70 80 90 100 P x [ Price] Q x / UT Demand Supply 60 $70 $90 80 35 At a price of $90 a surplus of 45 units exists surplus = 45 Suppliers have more to sell than buyers will purchase at a price of $90. To get rid of these unsold units [inventory], the sellers lower the price. lower price As the price of the good is reduced, the quantity supplied decreases. Quantity supplied decreases The quantity demanded increases as the price falls. Quantity demanded increases As the price moves toward equilibrium, quantity supplied and quantity demanded are brought into equilibrium...

33. Fall ‘ 97Principles of Microeconomicsslide 33 10 20 30 40 50 60 70 80 90 100 110 120 130 10 20 30 40 50 60 70 80 90 100 P x [ Price] Q x / UT Demand Supply At a price below equilibrium the the quantity demanded exceeds the quantity supplied.. At a price of $30 the quantity demanded is 110. $30 110 The quantity supplied is 15. 15 At a price of $30 the quantity demanded exceeds the quantity supplied by 95 units [110 - 15 = 95]. This is a shortage. shortage = 95. Since the buyers cannot obtain all they want at a price of $30, some buyers will offer to pay more. Some buyers will not pay the higher price, they buy less so the quantity demanded decreases. price rises quantity demanded decreases At the higher price the quantity supplied increases quantity supplied increases As a result of market forces the market moves to equilibrium. 60 $70

34. Fall ‘ 97Principles of Microeconomicsslide 34 10 20 30 40 50 60 70 80 90 100 110 120 130 10 20 30 40 50 60 70 80 90 100 P x [ Price] Q x / UT Demand Supply 60 $70 The market for good X is in equilibrium at P x = $70 An increase in the price of a substitute [good Y] causes the demand for good X to increase. demand increases D2D2 As a result of the increased demand, market forces push P x up. price rises $89 equilibrium quantity increases 80 The increase in the demand for good X results in an increase in both the equilibrium price and quantity. Identify other factors that could increase demand!

35. Fall ‘ 97Principles of Microeconomicsslide 35 Demand 10 20 30 40 50 60 70 80 90 100 110 120 130 10 20 30 40 50 60 70 80 90 100 P x [ Price] Q x / UT Supply Given a demand function, an equilibrium is defined. A decrease in demand, D1D1 $50.89 39.2 establishes a new equilibrium at a lower price and quantity. Demand might be reduced by: a decrease in the price of a substitute, an increase in the price of a compliment, a change in income, a change in the number of buyers or their preferences, or,.... A change in the price of the good does not change demand! It changes the quantity demanded.

36. Fall ‘ 97Principles of Microeconomicsslide 36 10 20 30 40 50 60 70 80 90 100 110 120 130 10 20 30 40 50 60 70 80 90 100 P x [ Price] Q x / UT Demand Supply 60 $70 Given an equilibrium condition in a market, supply increases an increase in supply will increase the equilibrium quantity and decrease equilibrium P. S2S2 price falls $50 Quantity increases 86 Identify factors that increase supply: 1.fall in price of inputs 2.improved technology 3.increase in number of sellers 4.fall in return in alternative uses of inputs 5.or,...

37. Fall ‘ 97Principles of Microeconomicsslide 37 10 20 30 40 50 60 70 80 90 100 110 120 130 10 20 30 40 50 60 70 80 90 100 PxPx Q x / UT Demand Supply A decrease in supply decrease in supply S1S1 price rises $90 quantity decreases 35 causes the equilibrium price to increase and equilibrium quantity to decrease. What forces might cause the supply to decrease? 1. an increase in the prices of inputs 2. increase in returns from alternative actions 3. problems in technology [regulations,... ] 4. decrease in number of sellers or producers

38. Fall ‘ 97Principles of Microeconomicsslide 38 Q x / UT 10 20 30 40 50 60 70 80 90 100 110 120 130 10 20 30 40 50 60 70 80 90 100 PxPx When demand and supply both shift, the resultant effect on either equilibrium price or quantity will be indeterminate. Demand Supply demand increases D2D2 results in a market force to increase Q and increase price supply increases S2S2 results in a market force to increase Q and decrease price Both the increase in demand and supply increase quantity; increase 100 equilibrium Q increases. The increase in demand pushes price up. +P+P The increase in supply pushes price down. price might go up or down or stay the same -P-P The change in price may be positive or negative, it depends on the magnitude of the shifts in and slopes of demand and supply. If both supply and demand decrease, the  P will be indeterminate and the equilibrium Q will decrease.

39. Fall ‘ 97Principles of Microeconomicsslide 39 10 20 30 40 50 60 70 80 90 100 110 120 10 20 30 40 50 60 70 80 90 100 Q x / UT Demand Supply 60 $70 Price A decrease in supply decrease in supply S1S1 pushes price up reduces quantity 35 tends to increase P and reduce Q. An increase in demand an increase in demand tends D2D2 to push price up and increase Q tends to increase both P and Q. Result is that Price will rise, Quantity may increase, decrease or stay the same depending on the magnitudes of the shifts and slopes of supply and demand. In this example, the price increases to $105. $105 49 the quantity decreases to 49 When supply increases and demand decreases, the price will fall but the change in Q will be indeterminate!

40. Fall ‘ 97Principles of Microeconomicsslide 40 Supply and Demand Analysis ·Supply and demand is a simplistic model that provides insights into the effects of events that are related to a specific market. ·Whether an event will tend to cause the price of a good to increase or decrease is of importance to decision makers. ·To estimate the magnitude of price and quantity changes more sophisticated models are needed.