1. Chapter 3 Demand and Supply

2. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-2 Introduction They are small, thin and lightweight… Some are not aware of their existence, while others allocate a lot of time and effort in obtaining them. What are they? They are sports trading cards. Most can be purchased for a few dollars or less, but many cost much more—up to thousands of dollars each! In this chapter you will learn why the prices of different sports trading cards can vary so widely.

3. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-3 Learning Objectives Explain the law of demand Discuss the difference between money prices and relative prices Distinguish between changes in demand and changes in quantity demanded

4. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-4 Learning Objectives (cont'd) Explain the law of supply Distinguish between changes in supply and changes in quantity supplied Understand how supply and demand interact to determine equilibrium price and quantity

5. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-5 Chapter Outline The Law of Demand The Demand Schedule Shifts in Demand The Law of Supply The Supply Schedule Shifts in Supply Putting Demand and Supply Together

6. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-6 Did You Know That... The average price of an apartment-sized condominium has often exceeded the average price of a standalone house? The relative physical size of items does not determine the prices at which people exchange them for? By using demand and supply you can develop a better understanding of why relative size of an item typically has little to do with the price at which it sells?

7. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-7 Markets  Arrangements that individuals have for exchanging with one another  Represent the interaction of buyers and sellers for goods and services  Markets set the prices we pay and receive.  Automobile market  Health care market  Labor market  Stock market

8. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-8 The Law of Demand Demand  A schedule showing how much of a good or service people will purchase at any price during a specified time period, other things being constant

9. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-9 The Law of Demand Law of Demand  Quantity demanded is inversely related to price, holding other factors constant.  Price  Qd   Price  Qd 

10. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-10 The Law of Demand (cont'd) What are we holding constant?  Income  Tastes and preferences  Price of other goods  Many other factors

11. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-11 Relative Prices versus Money Prices Relative prices and money prices  Relative Price  The price of a commodity in terms of another commodity  Money Price  Price we observe today in today’s dollars (absolute, or nominal price)

12. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-12 Table 3-1 Money Price versus Relative Price

13. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-13 The Demand Schedule The demand schedule  Table relating prices to quantity demanded  We must consider  Time dimension  Constant-quality units Demand Curve  A graphical representation of the demand schedule  Negatively sloped line showing inverse relationship between price and quantity demanded, all else equal

14. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-14 Figure 3-1 The Individual Demand Schedule and the Individual Demand Curve, Panel (a)

15. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-15 Figure 3-1 The Individual Demand Schedule and the Individual Demand Curve, Panel (b)

16. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-16 E-Commerce Example: Why RFID Tags Are Catching On Fast An RFID tag contains a tiny microchip and a radio antenna that emits a signal for tracking items. The price of an RFID tag has gone from 30 cents down to 15 cents, and is expected to go even lower, closer to 5 cents. Why do you think the European Central Bank is contemplating putting RFID tags in smaller denomination euro notes?

17. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-17 The Demand Schedule Individual versus market demand curves Market Demand  The demand of all consumers in the marketplace for a particular good or service  Summation at each price of the quantity demanded by each individual

18. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-18 Figure 3-2 The Horizontal Summation of Two Demand Curves, Panel (a)

19. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-19 Figure 3-2 The Horizontal Summation of Two Demand Curves, Panels (b), (c), (d)

20. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-20 Figure 3-3 The Market Demand Schedule for Flash Memory Pen Drives, Panel (a)

21. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-21 Figure 3-3 The Market Demand Schedule for Flash Memory Pen Drives, Panel (b)

22. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-22 Shifts in Demand Scenario  Imagine the federal government gives every student registered in a college, university, or technical school in the United States a notebook computer.  If some factor other than price changes, we can show its effect by moving the entire demand curve, shifting the curve left or right.

23. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-23 Figure 3-4 A Shift in the Demand Curve Suppose the federal government gives every student a notebook computer Suppose universities prohibit the use of notebook computers

24. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-24 Determinants of Demand Ceteris-Paribus Conditions  Determinants of the relationship between price and quantity that are unchanged along a curve  Changes in these factors cause a curve to shift

25. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-25 Normal and Inferior Goods Normal Goods  Goods for which demand rises as income rises, most goods are normal goods Inferior Goods  Goods for which demand falls as income rises

26. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-26 Shifts in Demand Determinants of demand  Income  Tastes and preferences  The prices of related goods  Substitutes  Complements

27. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-27 Shifts in Demand (cont'd) Substitutes  Two goods are substitutes when a change in the price of one causes a shift in demand for the other in the same direction as the price change.

28. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-28 Example: Kids Give Barbie Dolls and Legos the Boot Barbie dolls and Lego building blocks were among the most popular toys for many years. Since the early 2000s, annual purchases of such toys have fallen by as much as 25%. At the same time, prices of substitute forms of entertainment, such as video games and computer software, have declined. In what direction do you think the demand curve for toys has shifted as the prices of substitute forms of entertainment have declined?

29. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-29 Shifts in Demand (cont'd) Complements  Two goods are complements when a change in the price of one causes an opposite shift in the demand curve for the other.

30. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-30 Shifts in Demand (cont'd) Determinants of demand  Expectations  Future prices  Income  Product availability  Market size (number of buyers)

31. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-31 Shifts in Demand (cont'd) The Determinants of Demand Income: Normal Good D1D1 Q/Units D2D2 D3D3 Price Decrease in income decreases demand Increase in income increases demand

32. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-32 Shifts in Demand (cont'd) The Determinants of Demand Income: Inferior Good D1D1 Q/Units Decrease in income increases demand Increase in income decreases demand Price D2D2 D3D3

33. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-33 Shifts in Demand (cont'd) The Determinants of Demand Tastes and Preferences D1D1 Q/Units Price Hybrid vehicles Increase in demand D2D2 SUVs Decrease in demand D3D3

34. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-34 Shifts in Demand (cont'd) The Determinants of Demand Price of Related Goods: Substitutes D1D1 Q/Butter Butter and Margarine Price of both = $2/lb Price of margarine increases to $3/lb Demand for butter increases D2D2 Price

35. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-35 Shifts in Demand (cont'd) The Determinants of Demand Price of Related Goods: Complements D1D1 Q/Speakers Speakers and Amplifiers Decrease the relative price of amplifiers Demand for speakers increases D2D2 D3D3 Speakers and Amplifiers Increase the relative price of amplifiers Demand for speakers decreases Price

36. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-36 Shifts in Demand (cont'd) The Determinants of Demand Expectations: Income, Future Prices D1D1 Q/Units A higher income or expectations of a higher future price will increase demand D2D2 D3D3 A lower income or expectations of a lower future price will decrease demand Price

37. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-37 The Determinants of Demand Market Size (Number of Buyers) D1D1 Q/Units Increase in the number of buyers increases demand D2D2 D3D3 Decrease in the number of buyers decreases demand Price Shifts in Demand (cont'd)

38. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-38 Shifts in Demand (cont'd) Changes in demand versus changes in quantity demanded  A change in one or more of the non-price determinants (income, tastes, etc.) will lead to a change in demand.  This is a shift of the whole curve.

39. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-39 Shifts in Demand (cont'd) Changes in demand versus changes in quantity demanded  A change in a good’s own price leads to a change in quantity demanded.  This is a movement along the same curve.  ∆D is not the same as ∆Qd.

40. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-40 Figure 3-5 Movement Along a Given Demand Curve A change in the price changes the quantity of a good demanded, movement along the curve

41. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-41 The Law of Supply Supply  Schedule showing relationship between price and quantity supplied for a specified time period, other things being equal  The amount of a product or service that firms are willing to sell at alternative prices

42. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-42 The Law of Supply (cont'd) Law of Supply  The price of a product or service and the quantity supplied are directly related.  P  Qs   P  Qs 

43. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-43 The Supply Schedule The supply schedule is a table relating prices to quantity supplied at each price. Supply Curve  A graphical representation of the supply schedule  Positively sloped line showing direct relationship between price and quantity supplied, all else equal

44. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-44 Figure 3-6 The Individual Producer’s Supply Schedule and Supply Curve for Flash Memory Pen Drives, Panel (a)

45. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-45 Figure 3-6 The Individual Producer’s Supply Schedule and Supply Curve for Flash Memory Pen Drives, Panel (b)

46. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-46 Figure 3-7 Horizontal Summation of Supply Curves, Panel (a)

47. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-47 Figure 3-7 Horizontal Summation of Supply Curves, Panels (b), (c), (d)

48. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-48 Figure 3-8 The Market Supply Schedule and the Market Supply Curve for Flash Memory Pen Drives, Panel (a)

49. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-49 Figure 3-8 The Market Supply Schedule and the Market Supply Curve for Flash Memory Pen Drives, Panel (b)

50. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-50 Shifts in Supply Scenario  A new method of manufacturing flash memory pen drives reduces the cost of production dramatically.

51. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-51 Figure 3-9 A Shift in the Supply Curve If some other factor than price changes, the only way we can show its effect is by moving the entire supply curve If costs decrease, supply increases If costs increase, supply decreases

52. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-52 Figure 3-9 A Shift in the Supply Curve (cont'd) S1S1 Quantity of Flash Memory Pen Drives Supplied (millions of constant-quality units per year) Price per Flash Memory Pen Drive ($) 24680 1 2 3 4 5 101214 S2S2 a c When supply increases the quantity supplied will be greater at each price

53. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-53 Figure 3-9 A Shift in the Supply Curve (cont'd) S1S1 Quantity of Flash Memory Pen Drives Supplied (millions of constant-quality units per year) 24680 1 2 3 4 5 101214 a b d c S2S2 When supply increases the quantity supplied will be greater at each price Price per Flash Memory Pen Drive ($)

54. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-54 Figure 3-9 A Shift in the Supply Curve (cont'd) Quantity of Flash Memory Pen Drives Supplied (millions of constant-quality units per year) 24680 1 2 3 4 5 101214 S1S1 a c S3S3 b d When supply decreases the quantity supplied will be less at each price Price per Flash Memory Pen Drive ($)

55. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-55 Shifts in Supply (cont'd) Determinants of supply  Cost of inputs  Technology and productivity  Taxes and subsidies  Price expectations  Number of firms in industry

56. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-56 Shifts in Supply (cont'd) The Determinants of Supply Cost of Inputs S1S1 Q/Units Decrease in cost increases supply S2S2 Increase in cost decreases supply S3S3 Price

57. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-57 Shifts in Supply (cont'd) The Determinants of Supply Technology and Productivity S1S1 Q/Units Improvements in technology or increases in productivity increase supply S2S2 Decreases in productivity decrease supply S3S3 Price

58. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-58 Shifts in Supply (cont'd) The Determinants of Supply Taxes and Subsidies S1S1 Q/Units Decreases in taxes or increases in subsidies increase supply S2S2 Increases in taxes or decreases in subsidies decrease supply S3S3 Price

59. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-59 Policy Example: Import Restrictions Reduce the Supply of Cement U.S. cement manufacturers produce more than 80 million metric tons of cement per year. The rest of the cement supplied—15 to 20 million metric tons—is imported, much of it from Mexico. During the 1990s the U.S. government began imposing an import duty on Mexican cement. The continuation of this tariff during the 2000s caused Mexican producers to limit sales to the United States at any given price, reducing the U.S. supply of cement.

60. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-60 Shifts in Supply (cont'd) The Determinants of Supply Price Expectations S1S1 Q/Units Expectations of lower future prices increase supply S2S2 Expectations of higher future prices decrease supply S3S3 Price

61. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-61 Shifts in Supply (cont'd) The Determinants of Supply Number of Firms in Industry S1S1 Q/Units Increase in the number of firms increases supply S2S2 Decrease in the number of firms decreases supply S3S3 Price

62. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-62 Shifts in Supply (cont'd) Changes in supply versus changes in quantity supplied  A change in one or more of the non-price determinants will lead to a change in supply.  This is a shift of the whole curve.

63. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-63 Shifts in Supply (cont'd) Changes in supply versus changes in quantity supplied  A change in a good’s own price leads to a change in quantity supplied.  This is a movement along the same curve.  ∆S is not the same as ∆Qs.

64. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-64 Putting Demand and Supply Together Putting demand and supply together Equilibrium (Market Clearing) Price  The price that clears the market  The price at which quantity demanded equals quantity supplied  The price where the demand curve intersects the supply curve

65. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-65 Figure 3-10 Putting Demand and Supply Together, Panel (a)

66. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-66 Figure 3-10 Putting Demand and Supply Together, Panel (b)

67. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-67 Putting Demand and Supply Together (cont'd) Equilibrium  The situation when quantity supplied equals quantity demanded at a particular price

68. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-68 Putting Demand and Supply Together (cont'd) Shortages  The situation when quantity demanded is greater than quantity supplied  Qd > Qs  Exist at any price below the market clearing price

69. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-69 Putting Demand and Supply Together (cont'd) Surpluses  The situation when quantity supplied is greater than quantity demanded  Qd < Qs  Exist at any price above the market clearing price

70. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-70 Policy Example: Should Shortages in the Ticket Market Be Solved by Scalpers? If you’ve ever tried to get tickets to the big game you know all about “shortages.” Since the quantity of tickets is fixed, the price can go pretty high. Enter the scalper.

71. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-71 Figure 3-11 Shortages of Super Bowl Tickets

72. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-72 Issues and Applications: The Market Clearing Prices of Baseball Cards Various companies, such as Topps and Upper Deck, print sports trading cards that provide photos and stats on pro athletes. Why are some of the market clearing prices so high? The answer has to do with demand and supply. (A relatively low supply helps explain the relatively high market clearing price.) You can buy a “Shoeless” Joe Jackson card for up to $9,000!

73. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-73 Table 3-2 Baseball Cards with the Highest Market Clearing Prices

74. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-74 Summary Discussion of Learning Objectives The law of demand says that prices and quantity demanded are inversely related.  At a higher price people buy less, at a lower price people buy more. Relative prices must be distinguished from money prices, since people respond to changes in relative prices.

75. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-75 Summary Discussion of Learning Objectives (cont'd) A change in quantity demanded versus a change in demand  A change in quantity demanded is a movement along the same demand curve.  A change in demand is a shift of the whole demand curve.

76. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-76 Summary Discussion of Learning Objectives (cont'd) The law of supply states that price and quantity supplied are directly related.  At a high price firms offer more; at a low price firms offer less. A change in quantity supplied versus a change in supply  A change in quantity supplied is a movement along the same supply curve.  A change in supply is a shift of the whole supply curve.

77. Copyright © 2008 Pearson Addison Wesley. All rights reserved. 3-77 Summary Discussion of Learning Objectives (cont'd) Determining market price and equilibrium quantity  The demand and supply curves intersect at the market clearing, or equilibrium point.  Surpluses exist if the price of the good is greater than the market price.  Shortages exist when the price of a good is below the market price.

78. End of Chapter 3 Demand and Supply