1. Supply and Demand: An Introduction Supply and Demand: An Introduction Principles of Macroeconomics Dr. Gabriel X. Martinez Ave Maria University

2. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An Introduction2 Supply and Demand: An Introduction  How do consumers get the goods and services they want in the right quantities and qualities? –Some goods and services are allocated by the market forces of supply and demand. Economic forces are necessary reactions to scarcity and opportunity costs. Market forces are economic forces acting through the market.

3. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An Introduction3 Supply and Demand: An Introduction  Why do some goods and services have shortages or surpluses and others do not? –Some good and supplies services are regulated by government.

4. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An Introduction4 What, How, and for Whom? Central Planning Versus the Market  Three Problems All Economic Systems Must Address –What should be produced? –How should it be produced? –For whom will it be produced?

5. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An Introduction5 What, How, and for Whom? Central Planning Versus the Market  Centralized Economic Organizations –Agrarian societies.  Economic units are self-sustaining. A tribal chief (or the family head) decides what will be produced. –Communist societies.  Former Soviet Union  Cuba, North Korea  China –Bureaucracies.

6. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An Introduction6 What, How, and for Whom? Central Planning Versus the Market  In a Centrally Planned Economy, a small number of individuals addresses –What  Establish production targets for factories and farms –How  Plan how to achieve the goals –For Whom  Distribute the goods and services produced

7. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An Introduction7 What, How, and for Whom? Central Planning Versus the Market  Free-Market or Capitalist Economic Systems –Individual choices determine  Which careers to pursue;  Which products to produce or buy;  What technology or methods to use;  When to start and shut-down a business;  Who gets the income from economic activity.  And, surprisingly, it works!

8. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An Introduction8 Buyers and Sellers in Markets  A Market –Consists of all buyers and sellers of a good or service  What do you think? –What determines the price of pizza, gasoline, a car wash, or other goods and services?

9. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An Introduction9 Buyers and Sellers in the Market  The Price of a good is determined by –the interaction between –the value that consumers give to the good –and the cost of producing it. –Value is studied with the demand curve. –Cost is studied with the supply curve –Market Equilibrium happens when value equals cost.

10. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An Introduction10 Buyers and Sellers in Markets  The Demand Curve –A schedule or graph that tells us the quantity of a good that buyers wish to buy at each price. Demand reflects people’s willingness to pay a given price for a given quantity of a good or service.

11. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An Introduction11 Buyers and Sellers in Markets  A Property of Demand –As price of a good or service goes down the quantity consumers wish to buy will increase. P ↓ Q D ↑ –Therefore, the demand curve is downward- sloping.

12. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An Introduction12 The Yearly Demand Curve for Cell phones Price ($ per phone) Quantity (million of phones per year) 4 2 3 81216 Demand

13. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An Introduction13 Buyers and Sellers in Markets  The Supply Curve –A curve or schedule showing the quantity of a good that sellers wish to sell at each price.  Question –Will the opportunity cost of producing additional cell phones increase or decrease as you produce more cell phones?

14. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An Introduction14 Buyers and Sellers in Markets  The Supply Curve –Sellers must receive a higher price to produce additional units of a product to cover the higher opportunity costs of each additional unit. P ↓ Q S ↓

15. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An Introduction15 Buyers and Sellers in Markets Supply reflects the cost of producing a given quantity of a good or service. Price must be equal to (or higher than) cost for the seller to supply the good or service.

16. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An Introduction16 The Yearly Supply Curve of Cell phones Price ($ per phone) Quantity (million of phones per year) 4 2 3 81216 Supply

17. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An Introduction17 Market Equilibrium  Equilibrium –A system is in equilibrium when there is no tendency for it to change.  The forces in the system are balanced.  Market Equilibrium –Occurs in a market when all buyers and sellers are satisfied with their respective quantities at the market price.  The economic forces are balanced.

18. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An Introduction18 The Equilibrium Price and Quantity of Cell phones Price ($ per phone) Quantity (millions of phones per year) 4 2 3 81216 Supply Demand Equilibrium at $3 Quantity Demanded = Quantity Supplied

19. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An Introduction19 Market Equilibrium  Equilibrium Price and Equilibrium Quantity –The values of price and quantity for which quantity supplied and quantity demanded are equal

20. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An Introduction20  What Do You Think? –Would buyers prefer a lower price than the equilibrium price? –Would sellers prefer a higher price than the equilibrium price? Market Equilibrium

21. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An Introduction21  What Do You Think? –If prices are lower than the equilibrium price, there will be excess demand. –If prices are higher than the equilibrium price, there will be excess supply. Market Equilibrium

22. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An Introduction22 Excess Supply Price ($ per phone) Quantity (millions of phones per year) 4 2 3 81216 Supply Demand Excess supply = 8 million phones per year Excess supply causes prices to fall

23. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An Introduction23 Excess Demand Price ($ per phone) Quantity (million phones per year) 4 2 3 6 18 Excess demand = 12 million phones per year Supply Demand Excess demand causes prices to rise

24. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An Introduction24 Points Along the Demand and Supply Curves of a Cell Phone Market Demand for phones Supply of phones Price($/phone) Quantity demanded (million phones/day) Price($/phone) Quantity supplied (million phones/day) 1812 2624 3436 4248

25. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An Introduction25 Graphing Supply and Demand and Finding the Equilibrium Price and Quantity Price ($per slice) Quantity (1000s of slices per day) 5 2 3 4 1 4 102 Demand 0 68 Supply 2.50 5 The Equilibrium Price = $2.50 The Equilibrium Quantity = 5

26. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An Introduction26 Market Equilibrium  What Do You Think? –Is the market equilibrium always an ideal outcome for all market participants?

27. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An Introduction27 Predicting and Explaining Changes in Prices and Quantities  Distinguishing Between –A change in the quantity demanded…  A movement along the demand curve that occurs in response to a change in price  We often see this when the supply curve shifts and the market equilibrium changes.

28. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An Introduction28 Predicting and Explaining Changes in Prices and Quantities  … And –A change in demand  A shift of the entire demand curve –Caused by anything besides price, for example  Changes in people’s preferences,  Changes in incomes or population,  Changes in prices of other goods.

29. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An Introduction29 An Increase in Quantity Demanded vs. an Increase in Demand Price ($/can) Quantity (1000s of cans/day) 5 2 3 4 1 4 122 6 0 D D Increase in quantity demanded 86

30. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An Introduction30 An Increase in Quantity Demanded vs. an Increase in Demand Price ($/can) Quantity (1000s of cans/day) 5 2 3 1 4 12 6 0 D D Increase in demand D’ 14

31. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An Introduction31 Predicting and Explaining Changes in Prices and Quantities  Change in the quantity supplied –A movement along the supply curve that occurs in response to a change in price.

32. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An Introduction32 Predicting and Explaining Changes in Prices and Quantities  Change in supply –A shift of the entire supply curve.  Caused by anything besides price, for example –Changes in the cost of labor (wages), –Changes in the cost of other factors of production, –Changes in the technology of production.

33. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An Introduction33 An Increase in Quantity Supplied vs. an Increase in Supply Price ($/can) Quantity (1000s of cans/day) 5 2 3 4 1 4 102 6 068 S S Increase in quantity supplied

34. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An Introduction34 An Increase in Quantity Supplied vs. an Increase in Supply Price ($/can) Quantity (1000s of cans/day) 5 2 3 4 1 4 102 6 S 068 S S’ Increase in supply

35. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An Introduction35 Demand, Supply, and Market Equilibrium  Four Rules for Figuring out the Effects of Shifts of Demand and Supply –If Quantity Rises,  And Prices Rise, Demand has increased. –That is, demand has shifted out.  And Prices Fall, Supply has increased. –If Quantity Falls,  And Prices Fall, Demand has shifted in. –That is, demand has decreased.  And Prices Rise, Supply has shifted in.

36. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An Introduction36 Price Quantity P P’ QQ’ S D’ D An increase in demand will lead to an increase in both the equilibrium price and quantity Four Rules Governing the Effects of Supply and Demand Shifts: I Increase in Demand D ↑  P ↑ Q D ↑ Movement along Supply curve P ↑ Q S ↑

37. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An Introduction37 Price Quantity P’ P Q’Q S D D’ A decrease in demand will lead to a decrease in both the equilibrium price and quantity Four Rules Governing the Effects of Supply and Demand Shifts: II Decrease in Demand D ↓  P ↓ Q D ↓ Movement along Supply curve P ↓ Q S ↓

38. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An Introduction38 P’ P QQ’ S’ D S Price Quantity An increase in supply will lead to a decrease in the equilibrium price and an increase in the equilibrium quantity Four Rules Governing the Effects of Supply and Demand Shifts: III Increase in Supply S ↑  P ↓ Q S ↑ Movement along Demand curve P ↓ Q D ↑

39. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An Introduction39 P P’ Q’Q S D S’ Price Quantity An decrease in supply will lead to an increase in the equilibrium price and a decrease in the equilibrium quantity Four Rules Governing the Effects of Supply and Demand Shifts: IV Decrease in Supply S ↓  P ↑ Q S ↓ Movement along Demand curve P ↑ Q D ↓

40. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An Introduction40 Reasons for changes in Q Price ($/ticket) 1000s of tickets S DSDS DWDW QWQW QSQS PWPW PSPS High Quantity due to High Demand

41. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An Introduction41 Reasons for changes in Q Price ($/bushel) Millions of bushels SWSW D QWQW QSQS PWPW PSPS S High Quantity due to High Supply

42. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An Introduction42 The Effects of Simultaneous Shifts in Supply and Demand Price ($/bag) Millions of bags per month P Q S D P’ Q’ D’ S’ S’ after reduction in cost of production D’ after fall in willingness to buy Q falls because D shifts more than S.

43. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 3 - Supply and Demand: An Introduction43 The Effects of Simultaneous Shifts in Supply and Demand Price ($/bag) Millions of bags per month P Q S D P’ Q’ D’ S’ D’ after fall in willingness to buy S’ after reduction in cost of production Q rises because D shifts less than S.