Introduction to Macroeconomics

Chapter 3. Microeconomic Laws of Demand and Supply

Chapter 3. Laws of Demand & Supply

1. Markets and the Role of Prices 2. Microeconomic Demand and Supply
Demand Supply

3. Demand - Supply Equilibrium

Equilibrium Disequilibrium

4. Shifts in Demand and Supply Curves 5. Case Studies

Introduction to Macroeconomics

1. Markets and the Role of Prices

Competitive Free Market - many

suppliers and many consumers (competitive) engaged in trade without government interference (free).

Prices - provide a means of

communication between suppliers and consumers regarding scarcity and wants.

Introduction to Macroeconomics

2. Micro Demand and Supply

Demand
Law of Demand Demand curve Ceteris paribus assumption

Supply
Law of Supply Supply curve Ceteris paribus assumption
Introduction to Macroeconomics

2. Micro Demand and Supply Law of Demand

As the price of a product declines relative to the price of all other goods, the quantity demanded will increase, ceteris paribus. The demand curve, a graphic representation of the Law of Demand, slopes downward to the right

Introduction to Macroeconomics

2. Micro Demand and Supply Demand Curve

50

Product Price

40 30 20 10 0 0 10

As price declines the quantity demanded increases

Demand

20

30

40

50

60

Quantity Demanded
Introduction to Macroeconomics

2. Micro Demand and Supply Demand Curve Ceteris Paribus Assumption

All other non-price factors that can affect demand are unchanged:
Prices of all other goods Income

Tastes

Introduction to Macroeconomics

2. Micro Demand and Supply Law of Supply

As the price of a product declines relative to the price of all other goods, the quantity supplied will decline, ceteris paribus. The supply curve, a graphic representation of the Law of Supply, slopes upward to the right

Introduction to Macroeconomics

2. Micro Demand and Supply Supply Curve

50

As price increases the quantity supplied increases

Product Price

40 30 20 10 0 0 10 20 30 40 50

Supply

60

Quantity Supplied
Introduction to Macroeconomics

2. Micro Demand and Supply Supply Curve Ceteris Paribus Assumption

All other non-price factors that can affect supply are unchanged: Prices of all inputs
labor, raw materials, cost of capital

Prices of all other goods

Technology
Environment (e.g., weather)
Introduction to Macroeconomics

3. Demand - Supply Equilibrium

Equilibrium Disequilibrium
Price floor Price ceiling

Introduction to Macroeconomics

3. Demand - Supply Equilibrium Equilibrium

Price at which quantity supplied equals the quantity demanded
50 40 30

Product Price

Supply

Equilibrium
20 10 0 0 10 20 30 40 50 60

Demand

Quantity
Introduction to Macroeconomics

3. Demand - Supply Equilibrium Disequilibrium

Price above the equilibrium level

quantity demanded < quantity supplied surplus (inventory build) price floor: price prevented from
dropping to equilibrium level

Price below the equilibrium level

quantity demanded > quantity supplied shortage (inventory declines) price ceiling: price prevented from
Introduction to Macroeconomics

rising to equilibrium level

3. Demand - Supply Equilibrium Price Floor

50

Demand
40

Supply Price Floor

Product Price

30 20 10 0 0 10 20 30 40 50

60

Quantity

Quantity Demanded < Quantity Supplied = Surplus Introduction to Macroeconomics

3. Demand - Supply Equilibrium Price Ceiling

50

Demand
40

Supply

Product Price

30 20 10 0 0 10 20 30 40 50 60

Price Ceiling

Quantity
Quantity Supplied < Quantity Demanded = Shortage Introduction to Macroeconomics

4. Shifts in Demand and Supply Curves

Demand Curve
Demand vs quantity demanded Demand curve shifters

Supply Curve
Supply vs quantity supplied Supply curve shifters

Change in equilibrium
Introduction to Macroeconomics

4. Shifts in Demand and Supply Curves Demand vs Quantity Demanded

Quantity Demanded refers to a point on the demand curve. A Change in Quantity Demanded refers to a movement along a stable demand curve Demand refers to the entire curve. A Change in Demand refers to a shift in the demand curve.
Introduction to Macroeconomics

4. Shifts in Demand and Supply Curves Change in Quantity Demanded

A change in price results in a movement along a demand curve
50

Product Price

40 30 20 10 0 0 10

As price declines the quantity demanded increases

Demand

20

30

40

50

60

Quantity Demanded
Introduction to Macroeconomics

4. Shifts in Demand and Supply Curves Change in Demand

A change in anything except price that affects the quantity demanded results in a shift of the demand curvve Increase in Demand: Demand Curve Shifts Right

50

Product Price

40 30 20 10 0 0 10 20

30

40

50

60

Quantity
Introduction to Macroeconomics

4. Shifts in Demand and Supply Curves Demand Curve Shifters

A change in any variable listed under the Ceteris Paribus assumptions

Change in Variable Income Demand Curve Shift

See following slide on Normal and Inferior Goods Increase in Preference Right

Tastes

Prices of Related Goods

See following slide on Complements and Substitutes

Introduction to Macroeconomics

4. Shifts in Demand and Supply Curves Income: Normal and Inferior Goods

Demand curve will shift with change in income Normal Good - as income increases,
demand for the good also increases (demand curve shifts right)

Inferior Good - as income increases,

demand for the good decreases (demand curve shifts left)
Introduction to Macroeconomics

4. Shifts in Demand and Supply Curves Price of Related Goods

Demand curve will shift with change in price of related goods Complements in Demand - demand
decreases as price of complement increases big cars and gasoline

Substitutes in Demand- demand increases

as price of substitute increases butter and margerine
Introduction to Macroeconomics

4. Shifts in Demand and Supply Curves Supply vs Quantity Supplied

Quantity Supplied refers to a point on the supply curve. A Change in Quantity Supplied refers to a movement along a stable supply curve. Supply refers to the entire curve. A Change in Supply refers to a shift in the supply curve.
Introduction to Macroeconomics

4. Shifts in Demand and Supply Curves Change in Quantity Supplied

A change in price results in a movement along a supply curve
50 40 30 20 10 0 0 10 20 30 40 50 60

Product Price

As price declines the quantity supplied decreases

Supply

Quantity
Introduction to Macroeconomics

4. Shifts in Demand and Supply Curves Change in Supply

A change in anything except price that affects the quantity supplied results in a shift of the supply curvve Increase in Supply: Supply Curve Shifts Right

50 40 30 20 10 0 0

Product Price

10

20

30

40

50

60

Quantity
Introduction to Macroeconomics

4. Shifts in Demand and Supply Curves Supply Curve Shifters A change in any variable listed under the Ceteris Paribus assumptions
Change in Variable Price of Inputs Technology Weather Prices of Related Goods
Introduction to Macroeconomics

Supply Curve Shift Left Right Left

Increase Improvement Hurricane

See next slide on complements and substitutes

4. Shifts in Demand and Supply Curves Complements and Substitutes in Supply Supply curve will shift with change in price of related goods in the production process Complements in Supply - supply increases as price of the complement increases beef and leather Substitutes in Supply - supply decreases as price of the substitute increases wheat and rye
Introduction to Macroeconomics

4. Shifts in Demand and Supply Curves Supply Curve Shift and Equilibrium
50

Demand

Supply Curve Shifts Right

Product Price

40 30 20 10 0 0 10 20 30 40 50 60
Increase in Quantity Decrease in Price

Quantity
Introduction to Macroeconomics

5. Case Studies

Recessions and microeconomic markets Rent control

Import quotas

Introduction to Macroeconomics