The Study of Economics

Chapter 3
Supply and
Demand
• What a competitive market is and how
it is described by the supply and
demand model
• What the demand curve and supply
curve are
• The difference between movements
along a curve and shifts of a curve
• How the supply and demand curves
determine a market’s equilibrium price
and equilibrium quantity
• In the case of a shortage or surplus,
how price moves the market back to
equilibrium
1
Supply and Demand
 A competitive market:
 Many buyers and sellers
 Same good or service
 The supply and demand model is a model of how a
competitive market works.
 Five key elements:





Demand curve
Supply curve
Demand and supply curve shifts
Market equilibrium
Changes in the market equilibrium
2
Demand Schedule
 A demand schedule shows
how much of a good or
service consumers will want
to buy at different prices.
The idea reflects the willingness to
pay and how it changes with price.
always catches their attention.
For example, iPhones and iPods.
Demand Schedule for Cotton
Price of cotton
(per pound)
Quantity of cotton
demanded
(billions of pounds)
$2.00
7.1
1.75
7.5
1.50
8.1
1.25
8.9
1.00
10.0
0.75
11.5
0.50
14.2
Demand Curve
Price of
cotton
(per pound)
A demand curve is the graphical
representation of the demand
schedule.
It shows how much of a good or
service consumers want to buy at any
given price.
$2.00
1.75
1.50
1.25
1.00
0.75
0.50
0
As price rises,
the quantity
demanded falls
7
9
Demand
curve, D
11
13
15
17
Quantity of cotton
(billions of pounds)
4
GLOBAL COMPARISON: Pay More, Pump Less…
 Because of high taxes,
gasoline and diesel fuel are
more than twice as expensive
in most European countries
as in the United States.
Price of
gasoline
(per
gallon)
Germany
$8
 According to the Law of
Demand, Europeans should
buy less gasoline than
Americans, and they do.
7
 Europeans consume less than
half as much fuel as
Americans, mainly because
they drive smaller cars with
better mileage.
4
6
United Kingdom
Italy
France
Spain
Japan
5
Canada
3
0
United States
0.2
0.6
1.0
1.4
Consumption of gasoline
(gallons per day per
capita)
5
An Increase in Demand
 An increase in
population and other
factors generate an
increase in demand.
 a rise in the quantity
demanded at any given
price
 This is represented by
the two demand
schedules—one
showing demand in
2007, before the rise in
population, the other
showing demand in
2010, after the rise in
population.
Demand Schedules for Cotton
Price of cotton
(per pound)
Quantity of cotton
demanded
(billions of pounds)
in 2007
in 2010
$2.00
1.75
7.1
8.5
7.5
9.0
1.50
8.1
9.7
1.25
8.9
10.0
10.7
12.0
11.5
13.8
14.2
17.0
1.00
0.75
0.50
An Increase in Demand
Price of
cotton
(per pound)
$2.00
Increase in
population 
more cotton
clothing users
1.75
Demand curve
in 2010
1.50
1.25
1.00
0.75
0.50
0
Demand curve
in 2007
7
9
D
11
13
1
15
D
2
17
Quantity of cotton
(billions of pounds)
A shift of the demand curve is a change in the quantity demanded at any
given price, represented by the change of the original demand curve to
a new position, denoted by a new demand curve.
7
Movement Along the Demand Curve
A movement along the demand curve is a change in
the quantity demanded of a good that is the result of
a change in that good’s price.
Price of
cotton
(per
pound)
A shift of the
demand curve…
$2.00
1.75
A
1.50
… is not the same thing as a
movement along the
demand curve
C
1.25
B
1.00
0.75
0.50
0
D
7
8.1
9.7
10
13
1
15
D
2
17
Quantity of cotton
(billions of pounds)
8
Shifts of the Demand Curve
Price
Increase in
demand
A “decrease in demand”
An “increase in demand”
means a leftward shift of
means a rightward shift of
the demand curve:
the demand curve:
at any given price,
at any given price,
consumers demand a
consumers demand a larger
smaller quantity than
quantity than before.
before.
(D1D2)
(D1D3)
Decrease in
demand
D
3
D
1
D
2
Quantity
9
What Causes a Demand Curve to Shift?
Changes in the Prices of Related Goods
 Substitutes: Two goods are substitutes if a fall in the price of
one of the goods makes consumers less willing to buy the
other good.
 Complements: Two goods are complements if a fall in the
price of one good makes people more willing to buy the other
good.
Changes in Income
 Normal Goods: When a rise in income increases the demand
for a good — the normal case — we say that the good is a
normal good.
 Inferior Goods: When a rise in income decreases the demand
for a good, it is an inferior good.
Changes in Tastes
Changes in Expectations
10
Individual Demand Curve and the Market Demand Curve
The market demand curve is the horizontal sum of the
individual demand curves of all consumers in that market.
(a)
Darla’s Individual
Demand Curve
(c)
Market Demand Curve
(b)
Dino’s Individual
Demand Curve
Price of blue
jeans (per pair)
Price of blue
jeans (per pair)
Price of blue
jeans (per pair)
$30
$30
$30
D Market
1
1
1
DDarla
0
3
4
Quantity of blue jeans
(pounds)
D Dino
0
2
3
Quantity of blue jeans
(pounds)
0
5
6
7
Quantity of blue jeans
(pounds)
11
ECONOMICS IN ACTION
Beating the Traffic
 If we think of an auto trip to the city center as a good that
people consume, we can use the economics of demand to
analyze anti-traffic policies.
 One common strategy is to reduce the demand for auto
trips by lowering the prices of substitutes.
 Many metropolitan areas subsidize bus and rail service,
hoping to lure commuters out of their cars.
 An alternative is to raise the price of complements: several major
U.S. cities impose high taxes on commercial parking garages and
impose short time limits on parking meters, both to raise
revenue and to discourage people from driving into the city.
12
ECONOMICS IN ACTION
Beating the Traffic
 A few major cities—including Singapore, London, Oslo, Stockholm, and Milan—
have been willing to adopt a direct and politically controversial approach:
reducing congestion by raising the price of driving.
 Under “congestion pricing” (or “congestion charging” in the United
Kingdom), a charge is imposed on cars entering the city center during
business hours.
 The current daily cost of driving in London ranges from £9 to £12. And drivers
who are caught not paying are issued a fine of £120 for each transgression.
• Studies have shown that after the implementation of congestion pricing, traffic
does indeed decrease.
 The introduction of its congestion charge in 2003 immediately
reduced traffic in the London city center by about 15%, with overall
traffic falling by 21% between 2002 and 2006.
 And there was increased use of substitutes, such as public
transportation, bicycles, motorbikes, and ride-sharing.
13
Supply Schedule
 A supply schedule
shows how much
of a good or
service would be
supplied at
different prices.
Supply Schedule for Cotton
Price of
cotton
(per pound)
Quantity of
cotton
supplied
(billions of
pounds)
$2.00
11.6
1.75
11.5
1.50
11.2
1.25
10.7
1.00
10.0
0.75
9.1
0.50
8.0
Supply Curve
Price of cotton
(per pound)
A supply curve shows
graphically how much of a
good or service people are
willing to sell at any given
price.
Supply curve,
S
$2.00
1.75
1.50
As price rises, the
quantity supplied
rises.
1.25
1.00
0.75
0.50
0
7
9
11
13
15
17
Quantity of cotton (billions of pounds)
15
An Increase in Supply
 The adoption of
improved cottongrowing technology
generated an increase
in supply — a rise in
the quantity supplied
at any given price.
 This event is
represented by the
two supply schedules
— and their
corresponding supply
curves
 one showing supply
before the new
technology was
adopted
 the other showing
supply after the new
technology was
adopted
Supply Schedule for Cotton
Price of
cotton
(per
pound)
Quantity of cotton
supplied
(billions of pounds)
Before new
technology
After new
technology
$2.00
11.6
13.9
1.75
11.5
13.8
1.50
11.2
13.4
1.25
10.7
12.8
1.00
10.0
12.0
0.75
9.1
10.9
0.50
8.0
9.6
An Increase in Supply
Price of cotton
(per pound)
S
$2.00
Technology
adoption in
cotton-growing
business 
more cotton
producers
1
S
2
Supply curve
before
new technology
1.75
1.50
1.25
1.00
Supply curve
after
new technology
0.75
0.50
0
7
9
11
13
15
17
Quantity of cotton (billions of
pounds)
A shift of the supply curve is a change in the quantity supplied of a good at
any given price.
17
Movement Along the Supply Curve
Price of cotton
(per pound)
A movement along
the supply curve…
$2.00
S
2
S
1
1.75
1.50
B
1.25
A
1.00
C
… is not the
same thing as a
shift of the
supply curve
0.75
0.50
0
7
10 11.2
12
15
17
Quantity of cotton (billions
of pounds)
A movement along the supply curve is a change in the quantity supplied of
a good that is the result of a change in that good’s price.
18
Shifts of the Supply Curve
Price
S
3
S
1
S
2
Increase in
supply
Any
Any “decrease
“increase in
supply” means a
rightward
leftward shift
shiftof
ofthe
the
supply curve:
at any
at any
given
given
price,
price,
there
there
is an increase
is a decrease
in thein
the
quantity
quantity
supplied.
supplied.
(S1
(S1 SS2)
3)
Decrease in
supply
Quantity
19
What Causes a Supply Curve to Shift?
 Changes in input prices
 An input is a good that is used to produce
another good.




Changes in the prices of related goods and services
Changes in technology
Changes in expectations
Changes in the number of producers
20
Individual Supply Curve and the Market Supply Curve
The market supply curve is the horizontal sum of the individual
supply curves of all firms in that market.
(b)
Mr. Liu’s Individual Supply
Curve
(a)
Mr. Silva’s Individual
Supply Curve
Price of
cotton (per
pound)
Price of
cotton (per
pound)
SSilva
$2
1
0
Price of
cotton (per
pound)
SLiu
$2
2
3
Quantity of cotton
(thousands of pounds)
0
SMarket
$2
1
1
(c)
Market Supply Curve
1
1
2
Quantity of cotton
(thousands of pounds)
0
1
2
3
4
5
Quantity of cotton
(thousands of pounds)
21
Supply, Demand and Equilibrium
 Equilibrium in a competitive market: when the quantity
demanded of a good equals the quantity supplied of that
good
 The price at which this takes place is the equilibrium price
(or market-clearing price)
 Every buyer finds a seller and vice versa.
 The quantity of the good bought and sold at that price is the
equilibrium quantity.
22
Market Equilibrium
Price of
cotton
(per pound)
Supply
$2.00
1.75
Market equilibrium
occurs at point E, where
the supply curve and the
demand curve intersect.
1.50
1.25
Equilibrium 1.00
price
E
Equilibrium
0.75
0.50
0
Demand
7
10
Equilibrium
quantity
13
15
17
Quantity of cotton
(billions of pounds)
23
Surplus
Price of cotton
(per pound)
There is a surplus of a
good when the quantity
supplied exceeds the
quantity demanded.
Surpluses occur when the
price is above its
equilibrium level.
Supply
$2.00
1.75
Surplus
1.50
1.25
E
1.00
0.75
0.50
0
Demand
7
8.1
Quantity
demanded
10
11.2
Quantity
supplied
13
15
17
Quantity of cotton
(billions of pounds)
24
Shortage
Price of cotton
(per pound)
There is a shortage of a
good when the quantity
demanded exceeds the
quantity supplied.
Shortages occur when the
price is below its
equilibrium level.
Supply
$2.00
1.75
1.50
1.25
E
1.00
0.75
Shortage
0.50
0
7
9.1
10
Quantity
supplied
11.5
Quantity
demanded
Demand
13
15
17
Quantity of cotton (billions
of pounds)
25
ECONOMICS IN ACTION
The Price of Admission
Compare the box office price for a recent Justin Timberlake
concert in Miami, Florida, to the StubHub.com price for seats
in the same location: $88.50 versus $155.
• Why is there such a big difference in prices?
 For major events, buying tickets from the box office means waiting
in very long lines.
 Some ticket buyers who use Internet resellers have decided that the
opportunity cost of their time is too high to spend waiting in line.
 For the major events, when box offices sell tickets at face value,
tickets often sell out within minutes. In this case, some people who
want to go to the concert badly, but missed out on the opportunity
to buy cheaper tickets from the box office, are willing to pay the
higher Internet reseller price.
26
Equilibrium and Shifts of the Demand Curve
Price of cotton
An increase in
demand…
E
P
Price
rises
… leads to a movement
along the supply curve due
to a higher equilibrium price
and higher equilibrium
quantity.
2
2
E
P
Supply
1
1
D
2
D1
Q
1
Q
2
Quantity of cotton
Quantity
rises
27
Equilibrium and Shifts of the Supply Curve
Price of
cotton
S
2
P
S
1
E2
2
Price
rises
P
A decrease in
supply…
… leads to a movement
along the demand curve
due to a higher equilibrium
price and lower equilibrium
quantity.
E1
1
Demand
Q
2
Q
1
Quantity
falls
Quantity of cotton
28
Technology Shifts of the Supply Curve
An increase in supply …
Price
S1
S2
E1
Price
falls
P1
E2
P2
… leads to a movement along the
demand curve to a lower
equilibrium price and higher
equilibrium quantity.
Technological innovation: In the early 1970s,
engineers learned how to put microscopic
electronic components onto a silicon chip;
progress in the technique has allowed ever
more components to be put on each chip.
Demand
Q1
Q2
Quantity
Quantity increases
29
Simultaneous Shifts of Supply and Demand
(a) One Possible Outcome: Price Rises, Quantity Rises
Small
decrease in
supply
Price of cotton
E
P
2
S
1
2
The
increase
in demand
Two
opposing
forces
dominates the
in
determining
thedecrease
equilibrium
supply.
quantity.
2
E
P
S
1
1
D
D
Q
1
1
Q2
2
Large increase in
demand
Quantity of cotton
30
Simultaneous Shifts of Supply and Demand
(b) Another Possible Outcome: Price Rises, Quantity Falls
Price of cotton
Large
decrease in
supply
S
2
S
E
P
2
2
E
P
D
D
Q
Two
opposing
The
decrease
in forces
supply
determining
the in
dominates
the increase
equilibrium
quantity.
demand.
Small increase
in demand
1
1
Q
2
1
1
2
1
Quantity of cotton
31
Simultaneous Shifts of Supply and Demand
We can make the following predictions about the outcome
when the supply and demand curves shift simultaneously:
Simultaneous
Shifts of
Supply and
Demand
Supply Increases
Supply Decreases
Demand
Increases
Price: ambiguous
Quantity: up
Price: up
Quantity:
ambiguous
Demand
Decreases
Price: down
Quantity:
ambiguous
Price: ambiguous
Quantity: down
32
ECONOMICS IN ACTION
The Rice Run of 2008
 The factors that lay behind the surge in rice prices were both
demand-related and supply-related: growing incomes in
China and India, traditionally large consumers of rice;
drought in Australia; and pest infestation in Vietnam.
 But it was hoarding by farmers, panic buying by consumers,
and an export ban by India, one of the largest exporters of rice,
that explained the breathtaking speed of the rise in price.
 In much of Asia, governments are major buyers of rice.
 They buy rice from their rice farmers, who are paid a
government-set price, and then sell it to the poor at subsidized
prices (prices lower than the market equilibrium price).
 Now, even farmers in rural areas of Asia have access to the
Internet and can see the price quotes on global rice exchanges.
33
ECONOMICS IN ACTION
34
ECONOMICS IN ACTION
The Rice Run of 2008
 And as rice prices rose in response to changes in demand
and supply, farmers grew dissatisfied with the government
price and instead hoarded their rice in the belief that they
would eventually get higher prices.
 This was a self-fulfilling belief, as the hoarding shifted the
supply curve leftward and raised the price of rice even
further.
35
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