1. Unit 3 Supply and Demand The Top 5
Macroeconomics
Unit 3
Supply and Demand
The Top 5
©2007, 2005 by E.H. McKay III
Some images ©2004,

2. Markets
There are two types of markets where factors of production (land, labor ,capital, entrepreneurship) and products are bought and sold.
Factor Market – A factor market is any place where the factors of production are bought and sold.
Examples of factor markets include the labor market, the real estate market or the market for machinery used to produce manufactured goods.
Consumers provide labor and land to businesses in the factor market. Capital goods are also purchased in factor markets by businesses.

3. Markets
The second type of market is called a product market. A product market is any place where finished goods and services are bought and sold. Examples of product markets include department stores, grocery stores, accounting services, and new car dealers.
In product markets consumers purchase goods and services from businesses.

4. Concept 1: The Circular Flow
The circular flow model is an economic model designed to represent the relationship between product markets and factor markets.
It illustrates the interaction between consumers, business firms, government entities, and international participants.

5. The Circular Flow Model
International
Participants
Product
Markets
Factor
Goods and services
demanded
Goods and services
supplied
Consumers
Governments
Businesses
Factors of
production supplied
Factors of
production demanded
International
Participants
A diagram of the circular flow model showing the relationship between consumers, factor markets, businesses, product markets, the government, and international particpants.

6. Concept 1: The Circular Flow
Within the circular flow model, consumers supply the factors of production to the factor markets, which produce the goods and services demanded in the product markets by consumers.
International participants also supply factors of production to the factor markets and demand products and services in the product markets.

7. Concept 1: The Circular Flow
The role of government entities within the circular flow is to obtain resources in the factor markets (similar to a business), and supply services to both consumers and businesses.
Governmental entities also provide the operating framework by establishing standards, regulations, and oversight in both the factor and product markets.

8. Concept 2: Demand
Demand is the ability and willingness to buy specific quantities of a good at alternative prices in a given time period, ceteris paribus.
When we discuss demand, we are specifically examining consumer demand for goods and services in the product markets.
Our demand for a good or service is affected by its opportunity cost – what do we have to give up in order to obtain a particular good/service. It is also affected by the cost of the product and other factors known as determinants of demand.

9. Concept 2: Demand
The demand for products and services can be examined on an individual basis.
Demand can also be examined by looking at the total demand for a product or service. This is known as the market demand.
Market demand can be defined by geographic location (for example the demand for gasoline in the state of Michigan), by group (senior citizens, etc.) or as the total demand for a good or service.

10. Concept 2: Demand
Frequently when we examine individual demand, an individual demand schedule is developed.
A demand schedule illustrates the quantities of a good or service a consumer is willing and able to buy at alternative prices in a given time period, ceteris paribus.
The next page illustrates a demand schedule.

11. Fred’s Demand Schedule for CDs
Price per CD
Quantity of CDs Demanded
$25 1
$20 2
$15 3
$10 5
$7.50 8
A table indicating a demand schedule for Fred.

12. Demand Schedule
Fred’s demand schedule reflects his interest in music and his desire to add to his CD music collection compared with other needs and desires Fred has.
It also reflects Fred’s interest in purchasing more CDs when the price drops or fewer CDs when the price rises.
A demand schedule does not tell us why Fred will buy different quantities of CDs – it just tells us what Fred is willing and able to purchase at different price levels.

13. Demand Curve
We can take the information from a demand schedule and draw a simple graph.
The graph of the demand schedule indicates the quantity demanded at each price level.
Demand curves are usually drawn with the price on the y – axis, and the quantity demanded on the x – axis.

14. A line graph of the demand curve for CDs based upon Fred’s demand schedule. The line slopes down and to the right.

15. Demand Curve
The demand curve illustrates Fred’s current demand schedule for CDs.
When a price change occurs, there is movement along the existing curve. For example if the price of CDs falls, there is movement down along the demand curve in response to the price change.
If the previous price was $20 and the new price is $15, the quantity demanded changes from 2 to 3.

16. Demand Curves and Demand
Demand curves and schedules represent consumer buying intentions, not actual purchases.
Demand curves have a downward slope indicating that as the price falls, more quantities will be purchased.
The Law of Demand states that the quantity of a good demanded in a given time period increases as its price falls, ceteris paribus. This means that as the price falls or increases, the quantity demanded will increase or fall (an inverse relationship).

17. Concept 2: Determinants of Demand
The demand curve can also shift in response to a change in tastes (desire), income, the availability of other goods, or a change in expectations associated with income, prices, and tastes.
The factors which cause the demand curve to shift are known as determinants of market demand.
Let’s examine each determinant and look at the definitions and examples for each one.

18. Concept 2: Determinants of Demand
Taste is the desire for a particular product compared to other products. Our desire for a particular product can change over time.
For example, if you are thirsty your desire for a soft drink may be high, but after you have consumed the soft drink, you may no longer be thirsty and so your desire for a soft drink is much lower.

19. Concept 2: Determinants of Demand
The next determinant of demand is income. Income refers to the amount of income the consumer has.
Changes in consumer income can affect the amount and type of consumer purchases.
For example if a consumer receives an increase in his/her salary, the consumer has more money to spend on goods and services thereby affecting the demand for goods and services by this consumer.

20. Concept 2: Determinants of Demand
Another determinant of demand is called Other Goods. This determinant is defined as the availability and price of substitute and complementary goods.
A substitute good is a good that can substitute for another good.
A complementary good is a good that is frequently consumed with another good.

21. Concept 2: Determinants of Demand
If you prefer one particular brand of soda pop and it is not available but another brand is, you may consume that brand instead.
This is an example of a substitute good. Substitute goods are goods that can substitute for each other.
The relationship between substitute goods in terms of price is that if the price of your favorite soda pop rises above other drink choices you may have, you will start purchasing the less expensive soda pop.

22. Concept 2: Determinants of Demand
Another type of good is called a complementary good. A complementary good is a good that is frequently consumed in combination with another good.
An example of two complementary goods is milk and cereal. They are frequently consumed together. If the price of cereal rises, the demand for milk will fall, ceteris paribus.

23. Concept 2: Determinants of Demand
The next determinant of demand is called Expectations. This is defined as the consumer’s expectation for income, prices, and any changes in taste.
Income expectation refers to a consumer’s expectation for changes in income. If a consumer expects to receive a salary increase, spending may increase immediately.
If a consumer expects to be laid off from his/her job, spending may immediately decline.

24. Concept 2: Determinants of Demand
Expectations for prices refers to anticipated changes in the prices of goods and services.
If prices are expected to fall, consumers will delay purchasing many goods and services in the hope that prices will decline.
If prices are expected to rise, consumers may purchase goods and services immediately rather than wait for an actual need for those items.

25. Concept 2: Determinants of Demand
Finally the last determinant is Number of Buyers. Number of buyers refers to the number of consumers seeking to purchase a good or service, and the availability of the product.
Goods or services in high demand by buyers may result in inventory depletion which will leave many potential buyers without an opportunity to purchase the product.

26. Concept 2: Changes in Demand
The determinants of demand can change over time.
Any change in tastes, income, other goods, expectations, and the number of buyers will affect the demand schedule and curve.
A shift in demand occurs when there is a change in the quantity demanded at every price level – a change has occurred in one or more of the determinants of demand.
A shift in demand produces a new demand curve.

27. Concept 2: Changes in Demand
If the price of a good or service changes, and there has been no change in the determinants of demand, then we will have movement along the existing demand curve.
Movement along the curve indicates that if the price has decreased, consumption will increase; or if the price has increased, consumption will decrease.

28. Concept 2: Changes in Demand
When the demand curve shifts to the right, there is an increase in the demand for a good or service. A determinant of demand has changed – perhaps consumers prefer a product more than before or there may have been an increase in income.
When the demand curve shifts to the left, there is a decrease in the demand for a good or service. A determinant of demand has changed – perhaps consumers expect to lose their jobs or consumers may believe that prices will fall for a good in the future.

29. Movements vs. Shifts Price 15.00 10.00 7.50 5.00 4.00 3.00 2.00 1.00
$20.00 2 4 6 8 10 12 14 16 18 20 22
Quantity
Shift in demand C A B
increased demand
Movement along curve
initial demand
A line graph showing both movement along a demand curve and a demand curve shifting. Both demand curves slope down and to the right.

30. Movements vs. Shifts
If we have a change in the quantity demanded, it means we have movement along a given demand curve, in response to a price change (from point A to point B on the graph).
If we have a change in demand, it means the demand curve has shifted due to changes in the determinants of demand: tastes, income, other goods, expectations, number of buyers (from point A to point C on the graph).

31. Concept 2: Market Demand
Market demand is the total quantity of a good or service people are willing and able to buy at alternative prices in a given time period.
Takes each consumer’s individual demand for a good or service and combines it into an overall demand schedule and curve.
Market demand is affected by the number of buyers and their tastes, incomes, other goods, and expectations.

32. Concept 2: Market Demand
To construct a market demand schedule or curve, you combine each consumer demand schedule into one schedule.
Using the new market demand schedule, you plot the curve.
The procedure for constructing the market demand schedule and curve is similar to the individual demand schedule and curve, except you are adding each consumer’s demand at various price points together for a total.

33. Market Demand Schedule for CDs
Price
Fred
Jane
Sam
Kim
Market Demand
$25 1 3
$20 2 6
$15 4 11
$10 5 18
$7.50 8 26
A table indicating the market demand for CDs of 4 different people.

34. A line graph of the market demand curve for CDs based upon the market demand schedule. The line slopes down and to the right.

35. Concept 3: Supply
Supply is defined as the ability and willingness to sell specific quantities of a good or service at alternative prices in a given time period, ceteris paribus.
When we discuss supply we are examining the behavior of businesses and their willingness to sell their products and services at different price levels.

36. Concept 3: Supply
Market Supply is the total quantities of a good or service that all sellers are willing and able to sell at alternative prices in a given time period, ceteris paribus.
Similar to demand, there are determinants of market supply. The determinants of market supply are Technology, Factor Costs, Other Goods, Taxes and Subsidies, Expectations, Number of Sellers.

37. Concept 3: Determinants of Supply
The first determinant, Technology, refers to the availability and use of technology. Technology when properly installed and implemented can lower the cost of producing a good or service. This may make a business more competitive and perhaps lower the cost of the product to the consumer.
The second determinant, Factor Costs, refers to the cost of labor, capital and land. As the prices change for these factor costs, the ability of a business to produce and sell a product or service for a profit changes too.

38. Concept 3: Determinants of Supply
The third determinant of supply, Other Goods, refers to the prices and profits available for producing other products or services. The business will evaluate the sales and profits of the current product against alternative pursuits,
The fourth determinant is called Taxes and Subsidies. It refers to the level of taxation on corporate profits and the availability of government subsidies for producing specific goods or services. Items produced that are subject to additional taxation may not be as attractive as other items that are eligible for government subsidies.

39. Concept 3: Determinants of Supply
The fifth determinant of supply is Expectations. Expectations refers to future predictions for sales, profits, and economic conditions. If future sales are expected to decline, the product line may be discontinued.
The final determinant of supply is Number of Sellers. This determinant is concerned with the level of competition and the potential for profit. Higher levels of competition can produce lower profits per unit and discourage some sellers from remaining in the market.

40. Concept 3: Law of Supply
The Law of Supply states that the quantity of a good or service supplied in a given time period increases as its price increases, ceteris paribus.
The market supply schedule and curve reflects the sellers’ intentions and not actual sales.
Supply curves are upward sloping indicating that as price increases, the quantity available for sale will increase.
In most situations there are more than one seller so our discussion revolves around market supply not individual supply.

41. Market Supply Schedule for CDs
Price
The CD Hut
CD World
CD Palace
Cheap CDs
Market Supply
$25
100
150
200
600
$20 75
125
190
490
$15 50
175
400
$10 25
300
$7.50 5 15
195
A table indicating the market supply for CDs by four different sellers.

42. Market Supply Curve for CDs
A line graph of the market supply curve based upon the market demand schedule. The line slopes up and to the right.

43. Market Supply Schedule and Curve
The market supply curve and schedule reflects sellers’ intentions, not actual sales.
As the price rises, sellers become more interested in selling more products/services.
This is the opposite of a demand schedule and curve which indicates that as price falls demand increases.
Buyers and sellers react to price changes differently.

44. Concept 3: Supply - Movements vs. Shifts
If only the price changes, then we have movement along the existing supply curve, but no shifts. This causes a change in the quantity supplied.
If there is a change in supply, then we have a change in one or more of the determinants of supply (technology, factor costs, other goods, taxes and subsidies, expectations, number of sellers). Changes in supply produce shifts of the supply curve.

45. Concept 3: Supply Shifts
When the supply curve shifts to the left, this indicates a reduction in supply due to a change in one or more determinants. For example, an increase in factor costs may cause the supply curve to shift to the left.
When the supply curve shifts to the right, there is an increase in supply due to a change in one or more determinants. For example, improvements in technology which result in lower costs per unit may cause an increase in the willingness of sellers to sell more units at the existing price.

46. Supply increases when it shifts to the right
A line graph of two supply curves indicating a shift in supply. Both lines slope upward and to the right.

47. Concept 4: Equilibrium
At some point buyers and sellers will agree on a price and quantity demanded. This location is known as the market equilibrium price and quantity.
The market equilibrium price is the price at which the quantity of a good or service demanded in a given time period equals the supply.
The market equilibrium price changes when the determinants of demand or supply change, or when the price changes.

48. Equilibrium occurs at a price of $10 and a quantity of 18
A graph indicating the intersection of a demand and supply curve. The point of intersection is called the equilibrium point.

49. Concept 4: Equilibrium
At equilibrium if the demand curve shifts to the right, demand increases but price also rises. When the demand curve shifts to the left, demand and price declines.
At equilibrium if the supply curve shifts to the right, supply increases and price falls. If the supply curve shifts to the left, supply declines and prices rise.

50. Concept 5: Surpluses and Shortages
A market surplus can occur when the quantity supplied exceeds the quantity demanded. The surplus amount is the difference between the quantity supplied and the quantity demanded.
In surplus situations, business owners will need to get rid of excess inventory by usually reducing the price or slowing down production.

51. Concept 5: Surpluses and Shortages
A market shortage can occur when the quantity of a good or service demanded exceeds the quantity supplied.
If supply is not increased to meet demand, then the price will increase and the market equilibrium will occur at a higher price.
The next graph depicts market shortages and surpluses.

52. A graph showing the intersection of market demand and supply curves
A graph showing the intersection of market demand and supply curves. If the price is higher than the equilibrium price a surplus will occur. If the price is below the equilibrium price, a shortage will occur.

53. Concept 5: Market Shortages and Surpluses
At point A on the preceding graph, the demand for CDs equals 10 units at $ However the supply at this price level is equal to 25 (point B). In this situation, a market surplus exists. If sellers wish to sell more CDs they must reduce the price.
At point C on the graph, the supply of CDs equals 10 units at a price of $ However the demand for CDs at this price equals 26 units. In this situation, a market shortage exists. If sellers do not increase supply, the price will rise.

54. Supply and Demand Issues
The equilibrium price and quantity will change whenever supply or demand shifts or there is a change in price (movement along the demand or supply curve).
Price ceilings imposed by the government will usually cause a shortage of supply if they are imposed at a price level lower than the market equilibrium price. Effective price ceilings are implemented at output levels where the market equilibrium can be maintained.

55. Summary The major concepts from this unit are: Circular flow
Demand and its determinants
Supply and its determinants
Equilibrium
Shortages and Surpluses