Supply and Demand: Theory: Chapte R

CHAPTE
R 3
Supply and
Demand:
Theory
©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied
or duplicated, or posted to a publicly accessible website, in whole or in part.
©iurii/Shutterstock
INTHISCHAPT
ER
3-1 What is Demand?
3-2 Supply
3-3 The Market: Putting Supply
and Demand Together
©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. ©iurii/Shutterstock 2
3-1 What is Demand? (1 of 11)
► 3-1 What is Demand?

• Market: Any place people come together to trade
• Demand: The willingness and ability of buyers to purchase
different quantities of a good at different prices during a
specific period
► 3-1a The Law of Demand

• Law of Demand: As the price of a good rises, the quantity
demanded of the good falls, and as the price of a good falls,
the quantity demanded of the good rises, ceteris paribus
– where P = price and Q = quantity demanded
► 3-1b Four Ways to Represent the Law of Demand

• In Words
• In Symbols
• In a Demand Schedule
• As a Demand Curve
• Demand Schedule: The numerical tabulation of the quantity
demanded of a good at different prices. A demand schedule is
the numerical representation of the law of demand
• Demand Curve: The graphical representation of the law of
demand
EXHIBIT 1
Demand Schedule and Demand Curve
► 3-1c Why Does Quantity Demanded Go Down as Price Goes

Up?
• Law of Diminishing Marginal Utility: Over a given period,
the marginal (or additional) utility or satisfaction gained by
consuming equal successive units of a good will decline as the
amount consumed increases
• Why? Because:
• People substitute lower priced goods for higher priced
goods
• Because of the Law of Diminishing Marginal Utility
► 3-1d Individual Demand Curve and Market

Demand Curve
• There is a difference between these two demand curves
• An individual demand curve represents the price-quantity
combinations of a particular good for a single buyer
• A market demand curve is derived by “adding up”
individual demand curves, as shown in Exhibit 2
EXHIBIT 2
Deriving a Market Demand Schedule and a
Market Demand Curve
► 3-1e A Change in Quantity Demanded vs

a Change in Demand
• Quantity demanded = the number of units of a good that
individuals are willing and able to buy at a particular price
• Change in quantity demanded = a movement from one point
to another point on the same demand curve that is caused by
a change in the price of the good
• Own Price: The price of a good. For example, if the price of
oranges is $1, this is its own price
• Change in demand = Shift in demand curve
EXHIBIT 3
Shifts in the Demand Curve
► 3-1e A Change in Quantity Demanded vs

a Change in Demand (cont)
• Increase in demand – Rightward shift in the demand
curve
• Decrease in demand = Leftward shift in the demand
curve
► 3-1f What Factors Cause the Demand Curve to Shift?

1. income
2. preferences
3. prices of related goods
4. the number of buyers, and
5. expectations of future prices
► 3-1f What Factors Cause the Demand Curve to Shift?

(cont)
• Normal Good: A good for which demand rises (falls) as
income rises (falls)
• Inferior Good: A good for which demand falls (rises) as
income rises (falls)
• Neutral Good: A good for which demand does not

change as income rises or falls
EXHIBIT 4
Kindles and the Law of Demand
► 3-1f What Factors Cause the Demand Curve to

Shift? (cont)
• Substitutes: Two goods that satisfy similar needs or desires. If
two goods are substitutes, the demand for one rises as the price
of the other rises (or the demand for one falls as the price of the
other falls)
• Complements: Two goods that are used jointly in consumption.
If two goods are complements, the demand for one rises as the
price of the other falls (or the demand for one falls as the price
of the other rises)
EXHIBIT 5
Substitutes and Complements
► 3-1g Movement Factors and Shift Factors

• Economists often distinguish between:
1. factors that can bring about movement along curves, and
2. factors that can cause shift curves
• In many economic diagrams, the movement factor is on the
vertical axis
• The shift factors for the demand curve are income, preferences,
the price of related goods, and so on; often shift factors do not
appear in the economic diagrams; we just know what they are
• When you see a curve in this book, first ask which factor will
move us along the curve; what is the movement factor?
EXHIBIT 6
A Change in Demand vs.
A Change in Quantity Demanded
3-2 Supply (1 of 5)
Supply: The willingness and ability of sellers to produce and offer to

sell different quantities of a good at different prices during a specific
period
► 3-2a The Law of Supply
• Law of Supply: As the price of a
good rises, the quantity supplied of
the good rises, and as the price of a
good falls, the quantity supplied of
the good falls, ceteris paribus
• (Upward-Sloping) Supply Curve: The geographical
representation of the law of supply
EXHIBIT 7
A Supply Curve
EXHIBIT 8
Supply Curves When There is No Time to
Produce More or When No More Can Be
Produced
3-2 Supply (2 of 5)
► 3-2b Why Most Supply Curves are Upward Sloping

• Most supply curves are upward sloping
• The fundamental reason for this behavior involves the law of
diminishing marginal returns, discussed in a later chapter
• Here, we discuss the fact that an upward-sloping supply curve
reflects the fact that, under certain conditions, a higher price is
an incentive to producers to produce more of the good
• Supply Schedule: The numerical tabulation of the quantity
supplied of a good at different prices. A supply schedule is the
numerical representation of the law of supply
3-2 Supply (3 of 5)
► 3-2c Changes in Supply Mean Shifts in Supply Curves

• The supply of a good can rise or fall
• An increase in the supply of a good means that suppliers are
willing and able to produce and offer to sell more of the good
at all prices
• The supply of a good decreases if sellers are willing and able
to produce and offer to sell less of the good at all prices
3-2 Supply (4 of 5)
► 3-2d What Factors Cause the Supply Curve to Shift?

1. the prices of relevant resources,
2. technology,
3. the prices of related goods,
4. the number of sellers,
5. expectations of future price,
6. taxes and subsidies, and
7. government restrictions
• Subsidy: A monetary payment by government to a producer
of a good or service
EXHIBIT 9
Deriving a Market Supply Schedule and a
Market Supply Curve
EXHIBIT 10
Shifts in the Supply Curve
3-2 Supply (5 of 5)
► 3-2e A Change in Supply Versus a Change in Quantity

Supplied
• A change in supply is not the same as a change in quantity
supplied
• A change in supply is a shift in the supply curve, as in
Exhibit 11(a)
• A change in quantity supplied refers to a movement along a
supply curve, as in Exhibit 11(b)
• The only factor that can directly cause a change in the
quantity supplied of a good is a change in the price of the
good
EXHIBIT 11
A Change in Supply vs. a Change in
Quantity Supplied
3-3 The Market: Putting Supply and
Demand Together (1 of 11)
► 3-3a Supply and Demand at Work at an Auction
• In Exhibit 12, the supply curve of corn is vertical
• It intersects the horizontal axis at 40,000 bushels; that is, the
quantity supplied is 40,000 bushels
• The demand curve for corn is downward sloping
• Now, suppose you are at a computerized auction where
bushels of corn are bought and sold
• The auction begins; follow along in Exhibit 12 as it
develops, and the auctioneer announces changing prices
EXHIBIT 12
Supply and Demand at Work at an Auction
3-3 The Market: Putting Supply and Demand Together (2 of 11)
► 3-3b The Language of Supply and Demand:

A Few Important Terms
• Surplus (Excess Supply): a condition in which the quantity
supplied is greater than the quantity demanded. Surpluses
occur only at prices above the equilibrium price
• Shortage (Excess Demand): A condition in which the
quantity demanded is greater than the quantity supplied.
Shortages occur only at prices below the equilibrium price
• Equilibrium Price (Market-Clearing Price): The price at
which the quantity demanded of a good equals the quantity
supplied
► 3-3b The Language of Supply and Demand: A Few

Important Terms (cont)
• Equilibrium Quantity: The quantity that corresponds to the
equilibrium price. The quantity at which the amount of the
good that buyers are willing and able to buy equals the
amount that sellers are willing and able to sell, and both equal
the amount actually bought and sold
• Disequilibrium Price: A price other than the equilibrium
price. A price at which the quantity demanded does not equal
the quantity supplied
► 3-3b The Language of Supply and Demand:

A Few Important Terms (cont)
• Disequilibrium: A state of either surplus or shortage in a
market
• Equilibrium: Equilibrium means “at rest.” Equilibrium in a
market is the price-quantity combination from which buyers
or sellers do not tend to move away. Graphically, equilibrium
is the intersection point of the supply and demand curves
► 3-3c Moving to Equilibrium: What Happens to Price When

There Is a Surplus or a Shortage?
• Why Does Price Fall When There is a Surplus?
• In Exhibit 13, there is a surplus at a price of $15
• Quantity supplied is greater than quantity demanded
• At $15, suppliers will not be able to sell all they hoped to
sell, so their inventories will grow, and they will want to
reduce inventories
• Some will lower prices to do so; some will cut back on
production; others will do a bit of both
• Price and output tend to fall until equilibrium is achieved
► 3-3c Moving to Equilibrium: What Happens to Price When

There Is a Surplus or a Shortage? (cont)
• Why Does Price Rise When There Is a Shortage?
• In Exhibit 13, there is a shortage at a price of $5
• Quantity demanded is greater than quantity supplied
• At $5, buyers will not be able to buy all they had hoped to
buy, so some buyers will bid up the price to get sellers to
sell to them instead of others
• Some sellers, seeing buyers clamor for the goods, will
realize that they can raise the price; higher prices will also
call forth added output.
• Price and output tend to rise until equilibrium is achieved
EXHIBIT 13
Moving to Equilibrium
EXHIBIT 14
A Summary Exhibit of a Market (Supply
and Demand)
► 3-3d Speed of Moving to Equilibrium

• Consider the stock market; a share of IBM was $194.38 at
9:01 am, but $195.11 a few minutes later
• Obviously, the stock market equilibrates quickly
• Now, consider a house for sale; the sale price is $400,000; ten
months later, the house is still not sold and the price is still
$400,000; the price is above the equilibrium price;
equilibrium has not been achieved
• Some people will argue that supply and demand are at work in
the stock market but not in the housing market
• But a better explanation is that not all markets equilibrate at
the same speed
► 3-3e Moving to Equilibrium: Maximum and Minimum Prices

• Exhibit 15 shows the market for good X; look at
the first unit
• What is the maximum price buyers are
willing to pay for it?
• Follow the dotted line up from the first unit to the
demand curve
• What is the minimum price sellers need to receive
before they are willing to sell this unit of good X?
• Follow the dotted line up from the first unit
to the supply curve
• Because the maximum buying price is greater
than the minimum selling price, the first unit of
good X will be exchanged
• What about the second unit?
EXHIBIT 15
Moving to Equilibrium in Terms of
Maximum and Minimum Prices
► 3-3f The Connection Between Equilibrium and Predictions

• Equilibrium represents a balance of forces from which there is
no tendency to move
• Disequilibrium represents an imbalance, from which there is a
tendency to move; something is going to happen
• The economist's concept of equilibrium is related to her
predictions; it is a two-step process:
1. the economist compares “what is” with what exists in
equilibrium
2. If “what is” is not what exists in equilibrium, then the
economists predicts the path the market will take to get
from “what is” to equilibrium
► 3-3g Equilibrium in Terms of Consumers’ and Producers’

Surplus
• Consumer’s Surplus (CS): The difference between the
maximum price a buyer is willing and able to pay for a good
or service and the price actually paid. (CS = Maximum
buying price – price paid)
• Producers’ (Sellers’) Surplus (PS): The difference
between the price sellers receive for a good and the
minimum or lowest price for which they would have sold
the good
(PS – Price received – Minimum selling price)
• Total Surplus (TS): The sum of consumers’ surplus and
producers’ surplus (TS = CS + PS)
EXHIBIT 16
Consumers’ and Producers’ Surplus
EXHIBIT 17
Equilibrium, Consumers’ Surplus, and
Producers’ Surplus
► 3-3h What Can Change Equilibrium Price and Quantity?

• Equilibrium price and quantity are determined by supply
and demand
• Exhibit 18 illustrates eight different cases where this
scenario occurs
► 3-3i Epilogue: Who Feeds Cleveland?
• The market feeds Cleveland
• Spontaneous Order: The spontaneous and unintended
emergence of order out of the self-interested actions of
individuals; an unintended consequence of human action,
with emphasis placed on the word “unintended”
EXHIBIT 18
Equilibrium Price and Quantity Effects of Supply
Curve Shifts and Demand Curve Shifts

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CHAPTE

► 3-1 What is Demand?

► 3-1a The Law of Demand

– where P = price and Q = quantity demanded

► 3-1b Four Ways to Represent the Law of Demand

► 3-1c Why Does Quantity Demanded Go Down as Price Goes

► 3-1d Individual Demand Curve and Market

► 3-1e A Change in Quantity Demanded vs

► 3-1e A Change in Quantity Demanded vs

► 3-1f What Factors Cause the Demand Curve to Shift?

► 3-1f What Factors Cause the Demand Curve to Shift?

• Neutral Good: A good for which demand does not

► 3-1f What Factors Cause the Demand Curve to

► 3-1g Movement Factors and Shift Factors

Supply: The willingness and ability of sellers to produce and offer to

► 3-2b Why Most Supply Curves are Upward Sloping

► 3-2c Changes in Supply Mean Shifts in Supply Curves

► 3-2d What Factors Cause the Supply Curve to Shift?

► 3-2e A Change in Supply Versus a Change in Quantity

► 3-3b The Language of Supply and Demand:

► 3-3b The Language of Supply and Demand: A Few

► 3-3b The Language of Supply and Demand:

► 3-3c Moving to Equilibrium: What Happens to Price When

► 3-3c Moving to Equilibrium: What Happens to Price When

► 3-3d Speed of Moving to Equilibrium

► 3-3e Moving to Equilibrium: Maximum and Minimum Prices

► 3-3f The Connection Between Equilibrium and Predictions

► 3-3g Equilibrium in Terms of Consumers’ and Producers’

► 3-3h What Can Change Equilibrium Price and Quantity?

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