The Market Forces of Supply and

4 Demand

N. G R E G O R Y M A N K I W

PowerPoint® Slides
by Ron Cronovich

© 2007 Thomson South-Western, all rights reserved

In this chapter, look for the answers to
these questions:
▪ What factors affect buyers’ demand for goods?
▪ What factors affect sellers’ supply of goods?
▪ How do supply and demand determine the price of
a good and the quantity sold?
▪ How do changes in the factors that affect demand
or supply affect the market price and quantity of a
good?
▪ How do markets allocate resources?
CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 1
 Markets and Competition
▪ A market is a group of buyers and sellers of a
particular product.
▪ A competitive market is one with many buyers
and sellers, each has a negligible effect on price.
▪ A perfectly competitive market:
• all goods exactly the same
• buyers & sellers so numerous that no one can
affect market price – each is a “price taker”
▪ In this chapter, we assume markets are perfectly
competitive.
CHAPTER 4
THE MARKET FORCES OF SUPPLY AND DEMAND 2
 Demand
▪ Demand comes from the behavior of buyers.
▪ The quantity demanded of any good is the
amount of the good that buyers are willing and
able to purchase.
▪ Law of demand: the claim that the quantity
demanded of a good falls when the price of the
good rises, other things equal

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 3

 The Demand Schedule
Price Quantity
▪ Demand schedule: of of lattes
A table that shows the lattes demanded
relationship between the $0.00 16
price of a good and the 1.00 14
quantity demanded. 2.00 12
3.00 10
▪ Example: 4.00 8
Helen’s demand for lattes. 5.00 6
▪ Notice that Helen’s 6.00 4
preferences obey the
Law of Demand.
CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 4
 Helen’s Demand Schedule & Curve
Price of Price Quantity
Lattes of of lattes
lattes demanded
$0.00 16
1.00 14
2.00 12
3.00 10
4.00 8
5.00 6
6.00 4

Quantity
of Lattes
CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 5
 Market Demand versus Individual Demand
▪ The quantity demanded in the market is the sum of
the quantities demanded by all buyers at each price.
▪ Suppose Helen and Ken are the only two buyers in
the Latte market. (Qd = quantity demanded)
Price Helen’s Qd Ken’s Qd Market Qd
$0.00 16 + 8 = 24
1.00 14 + 7 = 21
2.00 12 + 6 = 18
3.00 10 + 5 = 15
4.00 8 + 4 = 12
5.00 6 + 3 = 9
6.00 4 + 2 = 6
 The Market Demand Curve for Lattes

Qd
P P
(Market)
$0.00 24
1.00 21
2.00 18
3.00 15
4.00 12
5.00 9
6.00 6
Q

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 7

 Demand Curve Shifters
▪ The demand curve shows how price affects
quantity demanded, other things being equal.
▪ These “other things” are non-price determinants
of demand (i.e., things that determine buyers’
demand for a good, other than the good’s price).
▪ Changes in them shift the D curve…

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 8

Demand Curve Shifters: # of buyers
▪ An increase in the number of buyers causes
an increase in quantity demanded at each price,
which shifts the demand curve to the right.

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 9

Demand Curve Shifters: # of buyers

P Suppose the number

of buyers increases.
Then, at each price,
quantity demanded
will increase
(by 5 in this example).

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 10

Demand Curve Shifters: income

▪ Demand for a normal good is positively related

to income.
• An increase in income causes increase
in quantity demanded at each price, shifting
the D curve to the right.
(Demand for an inferior good is negatively
related to income. An increase in income shifts
D curves for inferior goods to the left.)

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 11

Demand Curve Shifters: prices of
related goods
▪ Two goods are substitutes if
an increase in the price of one causes
an increase in demand for the other.
▪ Example: pizza and hamburgers.
An increase in the price of pizza
increases demand for hamburgers,
shifting hamburger demand curve to the right.
▪ Other examples: Coke and Pepsi,
laptops and desktop computers,
compact discs and music downloads
CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 12
Demand Curve Shifters: prices of
related goods
▪ Two goods are complements if
an increase in the price of one causes
a fall in demand for the other.
▪ Example: computers and software.
If price of computers rises, people buy fewer
computers, and therefore less software.
Software demand curve shifts left.
▪ Other examples: college tuition and textbooks,
bagels and cream cheese, eggs and bacon

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 13

Demand Curve Shifters: tastes

▪ Anything that causes a shift in tastes toward a

good will increase demand for that good
and shift its D curve to the right.

▪ Example:
The Atkins diet became popular in the ’90s,
caused an increase in demand for eggs,
shifted the egg demand curve to the right.

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 14

Demand Curve Shifters: expectations
▪ Expectations affect consumers’ buying
decisions.
▪ Examples:
• If people expect their incomes to rise,
their demand for meals at expensive
restaurants may increase now.
• If the economy turns bad and people worry
about their future job security, demand for
new autos may fall now.

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 15

 Summary: Variables That Affect Demand

Variable A change in this variable…

Price …causes a movement

along the D curve
No. of buyers …shifts the D curve
Income …shifts the D curve
Price of
related goods …shifts the D curve
Tastes …shifts the D curve
Expectations …shifts the D curve

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 16

ACTIVE LEARNING 1:
Demand curve
Draw a demand curve for music downloads.
What happens to it in each of the following
scenarios? Why?
A. The price of iPods
falls
B. The price of music
downloads falls
C. The price of
compact discs falls

17
 ACTIVE LEARNING 1:
A. price of iPods falls
Music downloads
Price of
music
and iPods are
down-loa complements.
ds A fall in price of
iPods shifts the
P1
demand curve for
music downloads
to the right.
D1 D2

Q1 Q2 Quantity of
music downloads
18
ACTIVE LEARNING 1:
B. price of music downloads falls

Price of
music
down-lo The D curve
ads does not shift.
Move down along
P1
curve to a point with
P2 lower P, higher Q.

D1

Q1 Q2 Quantity of
music downloads
19
ACTIVE LEARNING 1:
C. price of CDs falls

Price of CDs and

music music downloads
down-lo are substitutes.
ads
A fall in price of CDs
P1 shifts demand for
music downloads
to the left.

D2 D1

Q2 Q1 Quantity of
music downloads
20
 Supply
▪ Supply comes from the behavior of sellers.
▪ The quantity supplied of any good is the
amount that sellers are willing and able to sell.
▪ Law of supply: the claim that the quantity
supplied of a good rises when the price of the
good rises, other things equal

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 21

 The Supply Schedule

▪ Supply schedule:
Price Quantity
of of lattes
A table that shows the lattes supplied
relationship between the $0.00 0
price of a good and the 1.00 3
quantity supplied. 2.00 6

▪ Example: 3.00 9
4.00 12
Starbucks’ supply of lattes.
5.00 15
▪ Notice that Starbucks’ 6.00 18
supply schedule obeys the
Law of Supply.
CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 22
 Starbucks’ Supply Schedule & Curve
Price Quantity
P of of lattes
lattes supplied
$0.00 0
1.00 3
2.00 6
3.00 9
4.00 12
5.00 15
6.00 18
Q

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 23

 Market Supply versus Individual Supply
▪ The quantity supplied in the market is the sum of
the quantities supplied by all sellers at each price.
▪ Suppose Starbucks and Jitters are the only two
sellers in this market. (Qs = quantity supplied)
Price Starbucks Jitters Market Qs
$0.00 0 + 0 = 0
1.00 3 + 2 = 5
2.00 6 + 4 = 10
3.00 9 + 6 = 15
4.00 12 + 8 = 20
5.00 15 + 10 = 25
6.00 18 + 12 = 30
The Market Supply Curve
QS
P
(Market)
P
$0.00 0
1.00 5
2.00 10
3.00 15
4.00 20
5.00 25
6.00 30

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 25

 Supply Curve Shifters
▪ The supply curve shows how price affects
quantity supplied, other things being equal.
▪ These “other things” are non-price determinants
of supply.
▪ Changes in them shift the S curve…

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 26

Supply Curve Shifters: input prices
▪ Examples of input prices:
wages, prices of raw materials.

▪ A fall in input prices makes production

more profitable at each output price,
so firms supply a larger quantity at each price,
and the S curve shifts to the right.

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 27

Supply Curve Shifters: input prices

P Suppose the
price of milk falls.
At each price,
the quantity of
Lattes supplied
will increase
(by 5 in this
example).

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 28

Supply Curve Shifters: technology
▪ Technology determines how much inputs are
required to produce a unit of output.
▪ A cost-saving technological improvement has
same effect as a fall in input prices,
shifts the S curve to the right.

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 29

Supply Curve Shifters: # of sellers

▪ An increase in the number of sellers increases

the quantity supplied at each price,
shifts the S curve to the right.

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 30

Supply Curve Shifters: expectations

▪ Suppose a firm expects the price of the good it

sells to rise in the future.
▪ The firm may reduce supply now, to save some
of its inventory to sell later at the higher price.
▪ This would shift the S curve leftward.

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 31

Summary: Variables That Affect Supply

Variable A change in this variable…

Price …causes a movement
along the S curve
Input prices …shifts the S curve
Technology …shifts the S curve
No. of sellers …shifts the S curve
Expectations …shifts the S curve

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 32

A C T I V E L E A R N I N G 2:
Supply curve
Draw a supply curve for tax
return preparation software.
What happens to it in each
of the following scenarios?
A. Retailers cut the price of
the software.
B. A technological advance
allows the software to be
produced at lower cost.
C. Professional tax return preparers raise the
price of the services they provide.
33
ACTIVE LEARNING 2:
A. fall in price of tax return software
Price of
tax return The S curve
S1
software does not shift.
P1 Move down
along the curve
P2 to a lower P
and lower Q.

Q2 Q1 Quantity of tax
return software
34
ACTIVE LEARNING 2:
B. fall in cost of producing the software
Price of
tax return The S curve
S1 S2
software shifts to the
right:
P1
at each price,
Q increases.

Q1 Q2 Quantity of tax
return software
35
ACTIVE LEARNING 2:
C. professional preparers raise their price
Price of
tax return
S1 This shifts the
software
demand curve for
tax preparation
software, not the
supply curve.

Quantity of tax
return software
36
 Supply and Demand Together

P Equilibrium:
D S
P has reached
the level where
quantity supplied
equals
quantity demanded

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 37

 Equilibrium price:
The price that equates quantity supplied
with quantity demanded
P
D S P QD QS
$0 24 0
1 21 5
2 18 10
3 15 15
4 12 20
5 9 25
6 6 30
Q

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 38

 Equilibrium quantity:
The quantity supplied and quantity demanded
at the equilibrium price
P
D S P QD QS
$0 24 0
1 21 5
2 18 10
3 15 15
4 12 20
5 9 25
6 6 30
Q

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 39

 Surplus/ Excess Supply:
when quantity supplied is greater than
quantity demanded
P
D Surplus S Example:
If P = $5,
then
QD = 9 lattes
and
QS = 25 lattes
resulting in a surplus
of 16 lattes
Q

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 40

 Surplus:
when quantity supplied is greater than
quantity demanded
P
D Surplus S Facing a surplus,
sellers try to increase
sales by cutting the price.
This causes
QD to rise and QS to fall…
…which reduces the
surplus.

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 41

 Surplus:
when quantity supplied is greater than
quantity demanded
P
D Surplus S Facing a surplus,
sellers try to increase
sales by cutting the price.
Falling prices cause
QD to rise and QS to fall.
Prices continue to fall until
market reaches equilibrium.

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 42

 Shortage:
when quantity demanded is greater than
quantity supplied
P
D S Example:
If P = $1,
then
QD = 21 lattes
and
QS = 5 lattes
resulting in a
shortage of 16 lattes
Shortage Q

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 43

 Shortage:
when quantity demanded is greater than
quantity supplied
P
D S Facing a shortage,
sellers raise the price,
causing QD to fall
and QS to rise,
…which reduces the
shortage.

Shortage
Q

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 44

 Shortage:
when quantity demanded is greater than
quantity supplied
P
D S Facing a shortage,
sellers raise the price,
causing QD to fall
and QS to rise.
Prices continue to rise
until market reaches
equilibrium.
Shortage
Q

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 45

Three Steps to Analyzing Changes in Eq’m

To determine the effects of any event,

1. Decide whether event shifts S curve,
D curve, or both.
2. Decide in which direction curve shifts.
3. Use supply-demand diagram to see
how the shift changes eq’m P and Q.

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 46

EXAMPLE: The Market for Hybrid Cars

P
price of
S1
hybrid cars

P1

D1
Q
Q1
quantity of
hybrid cars
CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 47
EXAMPLE 1: A Change in Demand
EVENT TO BE
ANALYZED: P
Increase in price of gas. S1
STEP 1: P2
D curve shifts
because
STEP 2:
price of gas P1
affects demand for
D shifts right
hybrids.
because
STEP 3: high gas
S curve does not D1 D2
price makes hybrids
The shift
shift, causes
because an
price
more attractive Q
increase
of gas doesin price
not Q1 Q2
relative to other cars.
and quantity
affect cost of of
hybrid cars.
producing hybrids.
CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 48
EXAMPLE 1: A Change in Demand

Notice: P
When P rises,
S1
producers supply
a larger quantity P2
of hybrids, even
though the S curve P1
has not shifted.
Always be careful
D1 D2
to distinguish b/w
a shift in a curve Q
Q1 Q2
and a movement
along the curve.

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 49

Terms for Shift vs. Movement Along Curve
▪ Change in supply: a shift in the S curve
• occurs when a non-price determinant of supply
changes (like technology or costs)
▪ Change in the quantity supplied:
a movement along a fixed S curve
• occurs when P changes
▪ Change in demand: a shift in the D curve
• occurs when a non-price determinant of
demand changes (like income or # of buyers)
▪ Change in the quantity demanded:
a movement along a fixed D curve
EXAMPLE 2: A Change in Supply
EVENT: New technology
reduces cost of P
producing hybrid cars. S1 S2
STEP 1:
S curve shifts
because
STEP 2:
event affects P
1
cost of production.
S shifts right P2
D curve does not
because
STEP 3: event
shift, because D1
reduces cost,
The shift causes
production technology
makes production Q
price
is not to
onefallof the Q1 Q2
more profitable at
and quantity
factors to rise.
that affect
any given price.
demand.
CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 51
EXAMPLE 3: A Change in Both Supply
EVENTS:
and Demand
price of gas rises AND P
new technology reduces S1 S2
production costs
STEP 1: P2
Both curves shift.
P1
STEP 2:
Both shift to the right.
STEP 3: D1 D2
Q rises, but effect Q
on P is ambiguous: Q1 Q2
If demand increases more
than supply, P rises.
CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 52
EXAMPLE 3: A Change in Both Supply
EVENTS:
and Demand
price of gas rises AND P
new technology reduces S1 S2
production costs

STEP 3, cont.
P1
But if supply
increases more P2
than demand,
D1 D2
P falls.
Q
Q1 Q2

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 53

ACTIVE LEARNING 3:
Changes in supply and demand
Use the three-step method to analyze the effects of
each event on the equilibrium price and quantity of
music downloads.
Event A: A fall in the price of compact discs
Event B: Sellers of music downloads negotiate a
reduction in the royalties they must pay
for each song they sell.
Event C: Events A and B both occur.

54
ACTIVE LEARNING 3:
A. fall in price of CDs
The market for
P music downloads
S1
STEPS
1. D curve shifts P1

2. D shifts left P2

3. P and Q both
fall.
D2 D1
Q
Q2 Q1

55
ACTIVE LEARNING 3:
B. fall in cost of
The market for
royalties music downloads
P
S1 S2
STEPS
1. S curve shifts P1
(royalties are part P2
2. S shifts right
of sellers’ costs)
3. P falls,
Q rises.
D1
Q
Q1 Q2

56
ACTIVE LEARNING 3:
C. fall in price of CDs
AND fall in cost of royalties

STEPS
1. Both curves shift (see parts A & B).
2. D shifts left, S shifts right.
3. P unambiguously falls.
Effect on Q is ambiguous:
The fall in demand reduces Q,
the increase in supply increases Q.

57
 CONCLUSION:
How Prices Allocate Resources
▪ One of the Ten Principles from Chapter 1:
Markets are usually a good way
to organize economic activity.
▪ In market economies, prices adjust to balance
supply and demand. These equilibrium prices
are the signals that guide economic decisions
and thereby allocate scarce resources.

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 58

CHAPTER SUMMARY
▪ A competitive market has many buyers and
sellers, each of whom has little or no influence
on the market price.
▪ Economists use the supply and demand model to
analyze competitive markets.
▪ The downward-sloping demand curve reflects the
Law of Demand, which states that the quantity
buyers demand of a good depends negatively on
the good’s price.

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 59

CHAPTER SUMMARY
▪ Besides price, demand depends on buyers’
incomes, tastes, expectations, the prices of
substitutes and complements, and # of buyers.
If one of these factors changes, the D curve shifts.
▪ The upward-sloping supply curve reflects the Law
of Supply, which states that the quantity sellers
supply depends positively on the good’s price.
▪ Other determinants of supply include input prices,
technology, expectations, and the # of sellers.
Changes in these factors shift the S curve.
CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 60
CHAPTER SUMMARY
▪ The intersection of S and D curves determine
the market equilibrium. At the equilibrium price,
quantity supplied equals quantity demanded.
▪ If the market price is above equilibrium,
a surplus results, which causes the price to fall.
If the market price is below equilibrium,
a shortage results, causing the price to rise.

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 61

CHAPTER SUMMARY
▪ We can use the supply-demand diagram to
analyze the effects of any event on a market:
First, determine whether the event shifts one or
both curves. Second, determine the direction of
the shifts. Third, compare the new equilibrium to
the initial one.
▪ In market economies, prices are the signals that
guide economic decisions and allocate scarce
resources.

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 62