Ch. 3: Demand and Supply

Ch. 3: Demand and Supply Objectives • Determinants of demand and supply • Use demand and supply to understand how markets determine prices and quantities • Use demand and supply to make predictions about changes in prices and quantities

Markets and Prices • Market • any arrangement that enables buyers and sellers to get information and do business with each other. • Competitive market • a market that has many buyers and many sellers • no single buyer or seller can influence the price. • Money price of a good • the amount of money needed to buy it. • Relative price of a good • the ratio of its money price to the money price of the next best alternative good • the opportunity cost of the good expressed in units of the other good.

Demand • Quantity demanded of a good or service • the amount that consumers plan to buy during a particular time period at a particular price. • The Law of Demand • Other things remaining the same, the higher the price of a good, the smaller is the quantity demanded. • The law of demand results from • a substitution effect • an income effect

Demand Demand • the entire relationship between the price of the good and quantity demanded of the good. Demand curve • shows the relationship between the QD of a good and its price, ceteris parabus

Demand • This figure shows a demand curve for gasoline • A rise in the price, ceteris paribus, brings a decrease in the QD and a movement along the demand curve. Price D # gallons per week

Demand A D-curve is also • Willingness-to-pay curve. • Willingness to pay measures marginal benefit. Price D # gallons per week

Demand • A Change in Demand • The quantity of the good that people plan to buy changes at each and every price, so there is a new demand curve. • When demand increases, • QD increases at each and every price • the demand curve shifts rightward. • When demand decreases, • QD decreases at each and every price • the demand curve shifts leftward.

Demand Change in Demand vs. Change in Quantity Demanded

Factors that change demand • Prices of related goods • substitute in consumption • complement in consumption • Income • Normal good • Inferior good • Luxury good • Expected future prices • Population • Taxes on buyers • Consumer preferences

If the price of Coca-Cola increases, the demand for Coca-cola would: • Shift right • Shift left • Not change

If the price of Pepsi increases, the demand curve for Coca-cola will • Shift right • Shift left • Not change

Which of the following would decrease the demand for bread? • Higher incomes if bread is an inferior good • The expectation that bread prices will fall next week • Higher prices for peanut butter. • All of the above.

If people receive new information leading them to believe that the price of gasoline will rise sharply next week, the demand for gasoline this week will: • Increase and shift right. • Decrease and shift left. • Not change.

Supply Quantity supplied (QS) of a good or service • the amount that producers plan to sell during a given time period at a particular price. The Law of Supply • Other things remaining the same, the higher the price of a good, the greater is the quantity supplied. • results from tendency for the marginal cost of producing a good or service to increase as the quantity produced increases (more later) • Producers are willing to supply only if they at least cover their marginal cost of production.

Supply • Supply • the entire relationship between the quantity supplied and the price of a good. • Supply curve • shows relationship between QS and price of a good, ceteris paribus.

Supply Curve $ per gallon • A supply curve for gasoline. • A rise in the price, ceteris paribus, brings an increase in QS and a movement along the supply curve. S Gallons per day

Supply • A supply curve is also a minimum-supply-price curve. • The greater the quantity produced, the higher is the price that producers must be offered to be willing to produce that quantity. S Gallons per day

Supply • A Change in Supply • occurs when the quantity of the good that producers plan to sell changes at each and every price, so there is a new supply curve. • When supply increases, • QS increases at each and every price • supply curve shifts rightward. • When supply decreases, • QS decreases at each and every price • supply curve shifts leftward.

Factors that change supply. • Prices of inputs • Prices of related goods produced • Substitutes in production • Complements in production • Expected future prices • Number of sellers • Taxes on Sellers • Technology

Supply Change in supply vs. change in quantity supplied

If off-shore drilling for oil is allowed in the U.S., the supply curve for oil will: • Increase and shift right • Decrease and shift left • Not change.

If oil producers believe that oil prices will rise sharply next, the supply of oil this week will: • Increase and shift right • Decrease and shift left • Not change.

If the price of chicken wings increases, the supply of chicken legs will: • Increase and shift right • Decrease and shift left • Not change.

Market Equilibrium Equilibrium • situation in which opposing forces balance each other. • occurs when the price balances the plans of buyers and sellers. Equilibrium price • price at which the quantity demanded equals the quantity supplied. Equilibrium quantity • quantity bought and sold at the equilibrium price.

Market Equilibrium Price Adjustments If P>Pequil: • a surplus forces the price down. If P<Pequil: • a shortage forces the price up. At the equilibrium price, • QS=QD • and the price doesn’t change. S D

A shortage occurs whenever price is _____ the equilibrium price and a surplus occurs whenever price is _____ the equilibrium price. • Above; above. • Above; below. • Below; below. • Below; above.

If the price of gasoline is above the equilibrium price, we should find • Excess demand and a shortage • Excess supply and a shortage • Excess demand and a surplus • Excess supply and a surplus

Predicting Changes in Price and Quantity • Illustrate Effect on Equilibrium Price and Quantity if: • Demand increases • Supply increases • Demand and supply simultaneously increase. • Practice with Supply/Demand to: • Predict effect of “shock” to market. • Understand the type of “shock” that might have caused an observed change in P & Q.

As the price of gasoline increases, we should expect the demand for hybrid (high gas mileage cars) to _____ and the supply of hybrids to _____. • Rise; rise. • Rise; not change. • Not change; rise. • Not change; fall

As the price of gasoline increases, we should expect the equilibrium price of hybrid cars to ____ and the equilibrium quantity of hybrid cars to _____ • Rise; rise. • Rise; not change. • Not change; rise. • Not change; fall

Which of the following could explain the simultaneous decrease in the price of i-phones and an increase in the number sold per month? • Lower costs of production for the i-phone. • Lower monthly service charges for the plan purchased with i-phones. • Both of the above.

Price controls • A price ceiling is a maximum allowable price. • Results in a continuing shortage if ceiling is BELOW equilibrium price. • A price floor is a minimum allowable price. • Results in a continuing surplus if floor is ABOVE equilibrium price.

Suppose that the equilibrium price of gasoline is $3.50 per gallon. Which of the following would lead to a shortage of gasoline? • A price ceiling at $4 • A price ceiling at $3 • A price floor at $3 • A price floor at $4

Suppose that there is a price floor of $3 per bushel for corn and the current equilibrium price is $3. If there is an increase in demand for corn resulting from increased ethanol production, this will lead to: • A shortage • A surplus • Neither a shortage or surplus, but higher corn prices.

Suppose that there is a price ceiling of $3 per bushel for corn and the current equilibrium price is $3. If there is an increase in fuel prices making it more costly to grow corn, this will lead to: • A shortage • A surplus • Neither a shortage or surplus, but higher corn prices.

Ch. 3: Demand and Supply