chapter

4 Supply and Demand

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4.1 Markets

• A market is the process of buyers

and sellers exchanging goods
services.
• Supermarkets, the New York Stock
Exchange, drug stores, roadside
stands, garage sales, Internet
stores, and restaurants are all
markets.

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• Every market is different. Some
markets are local (such as housing
or the market for cement), but
numerous others are global (such
as automobiles or gold).
• The important point about a market
is not what it looks like, but
what it does–it facilitates trade.

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• Buyers, as a group, determine the
demand side of the market, whether
it is consumers purchasing goods
or firms purchasing inputs.
• Sellers, as a group, determine the
supply side of the market, whether
it is firms selling their goods or
resource owners selling their
inputs.

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• It is the interaction of buyers and
sellers that determines market
prices and output through the
forces of supply and demand.
• In this chapter, we focus on how
supply and demand work in a
competitive market.

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• A competitive market is one in
which a number of buyers and
sellers are offering similar
products and no single buyer or
seller can influence the market
price.
• Because most markets contain a
large degree of competitiveness,
the lessons of supply and demand
can be applied to many different
types of problems.
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4.2 Demand

• According to the law of demand,

the quantity of a good or service
demanded varies inversely with its
price, ceteris paribus.
• More directly, other things equal,
when the price of a good or
service falls, the quantity
demanded increases.

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• An individual demand schedule
reveals the different amounts of a
particular good a person would be
willing and able to buy at various
possible prices in a particular
time interval, other things equal.

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 Elizabeth’s Demand Schedule for Coffee

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• An individual demand curve is a
graphical representation that
shows the inverse relationship
between price and quantity
demanded.
• It reveals the relationship
between the price and the quantity
demanded, showing that when the
price is higher, the quantity
demanded is lower.

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 Elizabeth’s Demand Curve for Coffee

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• Economists usually speak of the
demand curve in terms of large
groups of people.
• The horizontal summing of the
demand curves of many individuals
is called the market demand curve
for a product.
• The market demand curve shows the
amounts that all the buyers in the
market would be willing and able
to buy at various prices.

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 Creating a Market Demand Curve

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 A Market Demand Curve

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4.3 Shifts in the Demand

• A change in a good's price leads to

a change in quantity demanded,
illustrated by moving along a given
demand curve.
• But price is not the only thing
that affects the quantity of a good
people buy. The other factors that
influence the demand curve are
called determinants of demand, and
they shift the entire demand curve—
a change in demand.

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Some possible demand
shifters
• prices of related goods
• incomes of demanders
• number of demanders
• tastes of demanders
• expectations of demanders

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• An increase in demand is
represented by a rightward shift
in the demand curve.
• A decrease in demand is
represented by a leftward shift in
the demand curve.

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 Demand Shifts

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Substitutes
• A major variable that shifts the
demand curve is the prices of
related goods.
• Two goods are called substitutes
if an increase in the price of one
causes a increase in the demand for
the other good.
• The opposite also applies: Two goods
are called substitutes if a decrease
in the price of one causes an
increase in the demand for the other
good.
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©2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
• For most people, good substitutes
might include: movie tickets and
video rentals; jackets and
sweaters; 7-Up and Sprite; and
Nikes and Reeboks.

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 Substitute Goods

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Complements

• Two goods are complements if an

increase in the price of one good
causes a decrease in the demand
for the other good.
• The opposite is also true: Two
goods are complements if a
decrease in the price of one good
causes an increase in the demand
for the other good.

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©2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
• Complements are goods that “go
together.”
• They are often consumed or used
simultaneously.
• For example: skis and bindings;
hot dogs and bun; motorcycles and
motorcycle helmets; DVDs and DVD
players.

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 Complementary Goods

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 Income

• Generally the consumption of goods

and services is positively related
to the income available to
consumers.
• As individuals receive more
income, they tend to increase
their purchases of most goods and
services.

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Income-Normal Good
• Other things equal, an increase in
income usually leads to an
increase in demand for goods
(rightward shift).
• A decrease in income usually leads
to a decrease in the demand for
goods (leftward shift).
• Such goods are called normal
goods.
• For example: CDs and movie
tickets.

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©2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Income-Inferior Good
• Some goods exist for which rising
(or falling) income leads to reduced
(or increased) demand.
• These are called inferior goods. The
term inferior does not refer to the
quality of the good, but it merely
shows that when income changes
demand changes in the opposite
direction (inversely).
• For example: thrift shop clothes,
store-brand products, and bus rides.

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 Normal and Inferior Goods

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Number of Buyers

• The demand for a good or service

will vary with the size of the
potential consumer population—the
number of buyers.
• An increase in the potential
consumer population will increase
(shift right) the demand for a
good or service.

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Consumer’s Preferences and Information

• Changes in fashions, fads,

advertising, etc. can change
tastes or preferences.
• An increase in tastes or
preferences for a good or service
will increase (shift right) the
demand for a good or service.

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• While changes in preferences lead
to shifts in demand, much of the
predictive power of economic theory
stems from the assumption that
tastes are relatively stable over a
substantial period of time.

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Expectations

• An increase in the expected future

price of a good will increase
(shift right) the current demand
for it.
• A decrease in the expected future
price of a good will decrease
(shift left) the current demand for
it.

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• Or if you expect to earn
additional income in the near
future you may be more willing to
dip into your current savings to
buy something now.

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Changes in Demand vs. Changes
in Quantity Demanded Revisited:

• If the price of a good changes, we

say this leads to a change in
quantity demanded.
• If one of the other factors
(determinants of demand)
influencing consumer behavior
changes, we say there is a change
in demand.

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 Possible Demand Shifters

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Change in Demand Versus Change in Quantity Demanded

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4.4 Supply
• The law of supply states that, other
things equal, the quantity supplied
will vary directly with the price of
the good.
• According to the law of supply,
• the higher the price of the good,
the greater the quantity supplied,
• and the lower the price of the
good, the smaller the quantity
supplied.

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©2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
• The quantity supplied is positively
related to the price, because firms
supplying goods and services want
to increase their profits, and the
higher the price per unit, the
greater the profitability generated
by supplying more of that good or
service.
• Also, if costs are rising for
producers as they produce more
units, they must receive a higher
price to compensate producers for
their higher costs.

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• An individual supply schedule
reveals the different amounts of a
product that a producer is willing
and able to supply at various
prices in a particular time
interval, other things equal.
• An individual supply curve
illustrates that information
graphically.

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 An Individual Supply Curve

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• The market supply curve for a
product is the horizontal
summation of the supply curves
for individual firms.
• It shows the amount of goods and
services suppliers are willing
and
able to supply at various prices.

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 A Market Supply Curve

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4.5 Shifts in the Supply Curve
• Changes in the price of a good lead
to changes in quantity supplied,
which are shown as movements along a
given supply curve.
• Changes in supply occur for other
reasons than changes in the price of
the product itself.
• A change in any other factor that
can affect supplier behavior results
in a shift of the entire supply
curve.

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These other factors include:

• input prices
• prices of substitutes in
production
• expectations
• number of suppliers
• technology
• regulations
• taxes
• subsidies
• weather

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• An increase in supply shifts the
supply curve to the right.
• A decrease in supply shifts the
supply curve to the left.

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 Supply Shifts

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• Higher input prices increase the
cost of production causing the
supply curve to shift to the left
at each
and every price.
• Lower input prices decrease the
cost of production causing the
supply curve to shift to the right
at each
and every price.

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• The supply of a good can be
influenced by the prices of
related products.
• Firms producing a product can
sometimes use their resources to
produce alternative products.

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• Suppose a farmer’s land can be used
to grow either barley or cotton.
• If the farmer is currently growing
barley and the price of barley
falls then this provides an
incentive for the farmer to shift
acreage out of barley and into
cotton.
• Thus, a decrease in the price of
barley will increase the supply of
cotton.

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Substitutes and Complements in Production
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• If producers expect a higher price
in the future, they will supply
less now.
• They would prefer to wait and sell
when their goods will be more
valuable.
• If producers currently expect that
the price will be lower later they
will supply more now.
• Otherwise, if they wait to sell,
then their goods will be worth
less.
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• The market supply curve is the
horizontal summation of the
individual supply curves.
• So an increase in the number of
suppliers will increase market
supply.
• A decrease in the number of
suppliers will decrease market
supply.

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• Technological progress can lower
the cost of production and increase
supply.
• Supply may also change because of
changes in the legal and regulatory
environment in which firms operate
(e.g., safety and pollution
regulations.). If such changes
increase costs, they will decrease
supply. If they decrease costs,
they will increase supply.

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• An increase in costly government
regulations, taxes or adverse
production conditions will
increase the cost of production,
decreasing supply.
• Subsidies, the opposite of a tax
can lower the cost of production
and shift the supply curve to the
right.
• In addition, weather can affect
the supply of certain commodities.

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• If the price of a good changes, it
leads to a change in its quantity
supplied, but not its supply.
• If one of the other factors
influences sellers' behavior, it
leads to a change in supply.

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 Possible Supply Shifts

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Change in Supply vs Change in Quantity Supplied

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