Economics 111.3 Winter 14

January 17th, 2014Lecture 5

Ch. 3

Shifts in Demand: a recapDemand Shifters are

changes in:• tastes (preferences)• number of buyers• money (nominal)

income• prices of related goods• expectations

Normal good – a good, for which, all else equal, an increase in income leads to an increase in

quantity demanded

Inferior good – a good, for which, all else equal, an increase in income leads to a

decrease in quantity demanded

4. Changes in prices of related goods.

Change in Demand, cont’d

Related Goods

Substitutes — goods used in the place of another good

Complements — goods used in conjunction with another good

Change in Demand, cont’d

• when two products are SUBSTITUTES, price of one & demand for the other move in the same direction

Good A and Good B are substitutes.If price of Good A Falls…

Market for Good B

when two products are COMPLEMENTS, price of one and demand for the other move in opposite directions

Changes in prices of related goods, cont’d

Market for blank tapes

Study question• If the demand curve for product B shifts to the

right as the price of product A declines, it can be concluded that: A) both A and B are inferior goods. B) A is a superior good and B is an inferior good. C) A is an inferior good and B is a superior good. D) A and B are complementary goods.

E) A and B are substitute goods.

5. Changes in expectations about future prices or incomes

• If you expect prices to fall in the future, you may put off purchases today.

• If you expect your income to rise, you may consume more now.

Change in Demand, cont’d

Example: Demand for Tapes

The demand for tapes decreases if:– the price of a substitute falls.– the price of a complement rises.– income falls (a tape is a normal

good).– the population decreases.– the price of a tape is expected to

fall in the future.

Study questionWhich of the following statements is correct?

A) A decline in the price of product X will increase the demand for substitute product Y. B) A decrease in income will decrease the demand for an inferior good. C) An increase in income will reduce the demand for a normal good.

D) An increase in the price of C will decrease the demand for complementary product D.

Individual and Market Demand Goods

• A market demand curve is the horizontal sum of all individual demand curves.–This is determined by adding the

individual demand curves of all the consumers (“demanders”).

Individual Demand 1

$0

$1

$2

$3

$4

$5

0 20 40 60 80

quantity

pri

ce

Individual Demand 2

$0

$1

$2

$3

$4

$5

0 20 40 60 80

quantity

pri

ce

Market Demand

$0

$1

$2

$3

$4

$5

0 50 100 150

quantity

pri

ce

35 39

74

price QD–1st buyer

QD–2nd

buyer

QD–market

$5 10 12

$4 20 23

$3 35 39

$2 55 60

$1 80 87

22

43

74

115

167

+ =

Market Demand

Supply: a schedule or a curve showing the amounts that producers are willing and able to make available for sale at each of a series of possible prices, during

some specified period of time

0

1

2

3

4

5

6

0 10 20 30 40 50 60

pri

ce

quantity

SupplyPrice per

bushel

Quantity supplied per week

$5 60

4 50

3 35

2 20

1 5

Law of Supply

• all else being constant, as price rises, the quantity supplied rises (& vice-versa)

• Rationale:– Revenue motive: price is revenue to suppliers– Cost motive: higher price necessary to induce

higher supply, to cover higher costs of production

A Change in the Quantity Supplied Versus a Change in Supply

• When price of the product changes, there is a movement along the supply curve

• When any other determinant of supply changes, there is a shift in the supply curve

Supply Shifters are changes in:• factor prices• technology• taxes and subsidies• prices of other goods• price expectations• number of sellers

Determinants of Supply

Changes in factor prices:• increase will decrease supply and shift curve to the

left as less will be supplied at each price

Rationale:1. If costs rise, then profits go down, and there is less

incentive to supply.2. If costs go up substantially, the firm may even shut

down.

Changes in Supply

Changes in technology:• new technology will decrease costs &

increase supply (This is especially true when new technology replaces labour)

Changes in Supply

PA S S′

QA

Changes in taxes and subsidies (taxes in reverse):

• increases in taxes will reduce supply

Changes in Supply

PA SS′

QA

Changes in prices of other goods:• higher prices of substitutes in production

will reduce supply and vice versa

Changes in Supply

PA SS′

QA

Changes in price expectations:• of the future price of a product• difficult to generalizeChanges in number of sellers:• as the number of sellers increases, so does

supply

Changes in Supply

Equilibrium As The Marriage of Supply and Demand

• Supply and demand come together to determine equilibrium quantity and equilibrium price.

Equilibrium, cont’d• When quantity demanded equals quantity

supplied, prices have no tendency to change.• Equilibrium is a concept in which opposing

dynamic forces cancel each other out.• Equilibrium isn’t a state of the world—it's a

characteristic of the model used to look at the world.

• Equilibrium isn’t inherently good or bad—but simply a state in which dynamic pressures offset each other.

The Law of Supply and Demand

• Conventional (free market) Economics claims that the price of any good adjusts to bring the supply and demand for that good into balance.

• Excess supply – a situation in which quantity supplied is greater than quantity demanded. The same as “surplus”

• Excess demand – a situation in which quantity demanded is greater than quantity supplied. The same as “shortage”

Excess supply

Excess demand

The Law of Supply and Demand, cont’d

• The larger the difference between quantity demanded and quantity supplied, the greater the pressure for prices to rise (if there is excess demand) or fall (if there is excess supply).