Chapter 3

Supply, Demand, and Price

Chapter 3

Supply, Demand, and Price

Determinates of DemandDeterminates of Demand• Income

– Normal good– Inferior good

• Preferences

• Prices of Related Goods– Substitutes– Compliments

Determinates Continued…Determinates Continued…• Number of Buyers

• Expectations of Future

Change in Demand vs. Change in Quantity Demanded

Change in Demand vs. Change in Quantity Demanded

• Change in Demand– SHIFT OF CURVE

• Due to any non-price determinate

• Change in Quantity demanded– MOVEMENT ON ORIGINAL CURVE

• Due only to a change in price

Change in Demand versus Change in Quantity Demanded

Change in Demand versus Change in Quantity Demanded

a

Price

0 Quantity Demanded

A change in demand(a s hift in the

demand curve)

Price

0 Quantity Demanded

B

A

A change inquantity demanded(a movement along

the demand curve , D )

DD

D

(b)(a)

Change in DemandChange in Demand• SHIFT OF CURVE

• SHIFT LEFT??– DECREASE IN DEMAND

• SHIFT RIGHT??– INCREASE IN DEMAND

Shifts in the Demand Curve Shifts in the Demand Curve

a

Price (dollars )

30

0 500 700

Rightward s hiftin demand curve

(increas e in demand)

Quantity Demanded of Blue Jeans

Part (a)

DD

A B

Shifts in the Demand Curve Shifts in the Demand Curve

a

Price (dollars )

30

0 450 650

Leftward s hiftin demand curve

(decreas e in demand)

Quantity Demanded of Blue Jeans

Part (b)

DD

B A

Change in price of related goods

Change in price of related goods• Substitutes

– Something used in replace of another good

• Compliments– Something used with another good

Substitutes and Complements Substitutes and Complements

a

Part (a)SUBSTITUTES

Price

Quantity Demanded of Coca-Cola

Price

Quantity Demanded of Peps i-Cola

00

If Coca-Cola andPeps i-Cola ares ubs titutes , ahigher price forCoca-Cola leads to . . .

DPC1

DPC2

Qd1Qd 2

P1

P2

DCC

A

B

. . . a rightwards hift in the demandcurve for Peps i-Cola.

Substitutes and Complements Substitutes and Complements

a

COMPLEMENTSPart (b)

Price

Quantity Demanded of Tennis Rackets

Price

Quantity Demanded of Tennis Balls

00

If tennis rackets andtennis balls arecomplements , a higherprice for tennisrackets leads to . . .

DTB 2

DTB1

DTR

Qd1Qd2

P1

P2

A

B

. . . a le ftwards hift in the demandcurve for tennis balls .

SELF TEST-Do we understand??SELF TEST-Do we understand??• Substitutes

– Coke vs. Pepsi --- what happens if the price of Coke increases?

– Qd of Pepsi?• NOTHING

– Qd of Coke?• DECREASES

– Demand for Coke?• NOTHING

– Demand for Pepsi?• INCREASES

• Compliments– Tennis Balls and Tennis Rackets --- what happens

if the price of Tennis Rackets increase?– Qd of Tennis Balls?

• NOTHING

– Qd of Tennis Rackets?• DECREASES

– Demand for Tennis Balls?• DECREASES

– Demand for Tennis Rackets?• NOTHING

ExamplesExamples• The housing market: Consumer’s income

increases

• The sugar market: Saccharine is found to lead to cancer

• The jelly market: The price of peanut butter increases

• The beer market: The price of beer decreases

Does the Law of Demand Hold?

Does the Law of Demand Hold?

• The price of eating out increases from $10 to $15 and the quantity demanded of restaurants increases from 10 to 14 meals.

The Law of

Demand Holds

The Law of

Demand Holds

a

Price ($)

0Quantity Demanded

of Res taurant Meals (millions )

(b)

(a)

15

10

10 14

Price ($)

0Quantity Demandedof Res taurant Meals

(millions )

15

10

10 14

B

A

Price ($)

0Quantity Demandedof Res taurant Meals

(millions )

15

10

10 14

A

B

D

(c)

RIGHTWRONG

Thes e twopoints ,A and B,are obs erved.

B

A

The other side…supplyThe other side…supply

• Quantity supplied– Amount of a good that producers are willing

and able to sell at a particular point in time at a particular price

Important PartsImportant Parts• Able

• Willing

• Particular price

• Particular point in time

SupplySupply• Quantity Supplied at all prices during a

specific time period

• Thus…

Law of SupplyLaw of Supply

• As the price of a good increases (decreases) the quantity supplied of that good increases (decreases)

Supply ScheduleSupply Schedule• Numerical table of quantity supplied at

different prices

101

202

303

404

QuantityPrice

Supply CurveSupply Curve• Supply Curve

– Graphical representation of the relationship between price and quantity supplied

• What type of relationship do we have between price and quantity supplied?

Supply Curve Exhibit 7

Supply Curve Exhibit 7

a

Price (dollars )

0

4

1

10 20 30 40

2

3

A

B

D

C

Supply Curve

Quantity Supplied of GoodX

Stuff continued…Stuff continued…

• Change in supply– SHIFT OF SUPPLY CURVE

• Change in quantity supplied– MOVEMENT ALONG ORIGINAL SUPPLY

CURVE• Increase in supply --- shift right• Decrease in supply --- shift left

Change in Supply versus Change in Quantity Supplied

Change in Supply versus Change in Quantity Supplied

a

Price

0 Quantity Supplied

A change in s upply(a s hift in thes upply curve)

Price

(b)(a)

0 Quantity Supplied

A

B

SS S

A change inquantity

(a movement alongthe s upply curve ,S )

Shifts in the Supply Curve Shifts in the Supply Curve

aa

Price (dollars )

0

Quantity Supplied of Good X

Rightward s hiftin s upply curve

(increas e in s upply)

Part (a)

S

S

200 300

5A B

Shifts in the Supply Curve Shifts in the Supply Curve

a

Part (b)

0

Quantity Supplied of Go od X

Price (do llars )

15050

S1S2

Leftward s hiftin s upply curve

(de creas e in s upply)

5B A

Question???Question???• Can the supply curve ever be vertical?

• First…what does a vertical curve indicate about the relationship between price and quantity supplied?

Supply Curves When There Is No Time to Produce More or No More

Can Be Produced

Supply Curves When There Is No Time to Produce More or No More

Can Be Produced

a

(b)

Price

X

Supply Curve ofStradivarius Violins

Number of Stradivarius Vio lins0

Price

500

Supply Curve ofTheater Seatsfor Tonight’sPerformance

Number of Theater Seats

(a)

0

Determinates of SupplyDeterminates of Supply

• Price of inputs

• Technology

• Number of sellers

• Price expectations

• Taxes and subsidies

Examples• The computer market: The price of computer

chips decreases• The fast food market: McDonalds opens three

new stores in Bakersfield• The pencil market: The price of pencils

increases• The gasoline market: A tax is imposed on gas

station owners for each gallon of gas pumped out of their station

Market Supply CurvesMarket Supply Curves• Previous supply curve was for an

individual – Single seller

• How can we get the market curve from individual supply curves?– All sellers

• Sum the individual supply curves…

Therefore….Therefore….

Deriving a Market Supply Schedule & Curve

Deriving a Market Supply Schedule & Curve

a

QUANTITY SUPPLIED

Part (a)

ALL SUPPLIERS

99

103

109

115

119

123

OTHER SUPPLIERS

96

98

102

106

108

110

ALBERTS

2

3

4

5

6

7

BROWN

1

2

3

4

5

6

PRICE

$10

11

12

13

14

15

Deriving a Market Supply

Schedule & Curve

Deriving a Market Supply

Schedule & Curve

a

Price ($)

3

11

12

2

SupplyCurve

(Brown)Price ($) Supply

Curve(Alberts )

+

+ =

1211

3 4

Price ($)

1211

98 102Quantity Supplied

Quantity SuppliedQuantity Supplied

Supply Curve(other

s uppliers )Price ($)

1211

Quantity Supplied

103 1092 + 3 + 983 + 4 + 102

00

00

MarketSupplyCurve

Part (b)

A1

B1A2

B2

A3

B3A4

B4

Next Step….Next Step….

Putting Supply and Demand Together

Auction Model

Can think of supply and demand as an auction where

buyers bid the price down and sellers bid the price up until Qs and Qd are equal at the same price

But…• There is only one price where Qs=Qd

• This is called the equilibrium price

• The market is always working towards this price

Scissors and economics?

• Alfred Marshall compared Supply and demand to a pair of scissors– “It is impossible to say which blade is actually

doing the cutting just like it is impossible to say whether demand or supply is responsible for the price

What determines the price?

• The interaction of supply and demand

Equilibrium• Also called the market clearing price

– When Qs=Qd

• Disequilibrium– When Qs=Qd

At Disequilibrium can have…

• Shortage (excess demand)– Qd > Qs– Price too low– Price must increase to rid shortage

• Surplus (excess supply)– Qd < Qs– Price too high– Price must decrease to rid surplus

Moving to Equilibrium Moving to Equilibrium

aa

Price (dollars )

0

Quantity

S

D

5

15

50 150100

10 E

Surplus

Shortage

CONDITION

50

100

150

Surplus

Equilibrium

Shortage

QPRICE

$15

10

5

150

100

50

Qs d

Moving to Equilibrium

• If we have a surplus, price must _______ to get to equilibrium.

• Decrease

• If we have a shortage, price must _______ to get to equilibrium.

• Increase

Do Shortage and Scarcity refer to the same thing???

• NO!!

• Shortage is only when price is less than the equilibrium price

• Scarcity is always present (at all prices)

Applications of Supply and Demand

• Romanee-Conti Wine– Dated back to 1990 and sells for $800 a bottle or $8 a

sip…why?

• Ticket scalping– Why would people pay higher prices to see an event?– Prices must have been below equilibrium.

• Freeway– Why would people be willing to pay a toll to use a

road?

Remember..• Equilibrium price and quantity are

determined by the INTERACTION of supply and demand

• A change in supply, demand, or both will change the equilibrium price

• Exception: If supply and demand move in same direction and magnitude so changes are offset

Change in Supply and Demand but no change in equilibrium price

What Happens???• Increase D and S constant?• Decrease D and S constant?• D constant and increase S?• D constant and decrease S?• D increase and S decreases by equal amounts?• D decrease and S increases by equal amounts?• D increases more than S decreases?• D increases less than S decreases?

A Summary Exhibit of a Market A Summary Exhibit of a Market

a

SUPPLY

GovernmentRes tric tions

Taxesand

Sus idies

Numberof

Se llers

Expectationsof

Future Price

Technology

Prices ofRelevant

Res ouces

PRICE,QUANTITY

DEMAND

MARKET

Income

PreferencesNumber

of Buyers

Prices ofRelated Goods

(Subs titutesand

Complements )

Expectationsof Future Price

Price Controls

• Produces a barrier to which the economy can no longer operate freely– Can’t get to equilibrium price

• Two types– Price ceiling– Price Floor

Price Ceiling

• Government mandated maximum price above which legal trades cannot be made

• Price ceiling is below equilibrium price.

Price Ceiling Price Ceiling

a

0 100 150 190

8

12

18

A price ce ilingcre ates a s ho rtage

D

SPrice

(do llars

EquilibriumPrice

PriceCe iling

EquilibriumQuantity

Quantity of Good X

Shortag e

Impacts of Price Ceilings• Shortage sustained• Fewer exchanges• Non-price rationing schemes

– First come first served

• Buying & selling at prohibited prices– Black markets

• Tie in Sales– Pay certain amount for rent of the house and an amount for

renting the refrigerator

• Distort normal economic information and incentives– Lower prices is supposed to mean greater availability

Price Floor

• Government mandated minimum price below which legal trades cannot be made

• Price floor is above equilibrium price

Price Floor Price Floor

a

0 90 130 180

15

20

A price floorcreates a s urplus

D

SPrice

(dollars )

EquilibriumPrice

PriceFloor

EquilibriumQuantity

Quantity of Good X

Surplus

Impacts of Price Floors

• Sustained surpluses

• Fewer exchanges

• Example: Minimum wage

Minimum Wage

• In California the minimum wage is $6.75 per hour– Increased from $6.26 on January 1, 2002

• Government mandated minimum wage is $5.15– Last increase was on September 1, 1997

Impacts of Minimum Wage

• Surplus of unskilled

• Fewer workers overall employed

• Supply and Demand would determine wage

• Minimum wage doesn’t guarantee better standards of living for low wage employees

Effects of the Minimum

Wage

Effects of the Minimum

Wage

a

0

3.25

4.25

D

SWage Rate(dollars )

EquilibriumWage

MinimumWage

Number ofUns killed Workers

Surplus

Number of WorkersWho Want to Work at

Minimum Wage

Number of WorkersEmployed

atEquilibrium Wage

Number of WorkersEmployed at

Minimum Wage

N2

N1

N3

5.75

4.25

Homework #4

Chapter 3

Numbers: 1, 4, 8, 10, and 14

Did we understand Chapter 3???

In-class exercise 4