Unit 2 - Supply and Demand

 The Law of Demand

Buyers of a product will purchase more of the product if its
price is lower and vice versa, assuming all other
things remain
constant (ceteris
paribus).
Unit 2 - Supply and Demand

 Two Reasons Why Buyers Buy More at Lower Prices and

Less at Higher Prices

 The Substitution Effect

 The Income Effect
Unit 2 - Supply and Demand

 Substitution Effect
When the price of a product decreases, ceteris paribus, the
product becomes cheaper. It is, therefore, more attractive relative
to other products (and vice versa).
Unit 2 - Supply and Demand

 Income Effect
When the price of a product decreases, ceteris paribus,
consumers have more relative income. They can, therefore,
purchase additional products (and vice versa).
Unit 2 - Supply and Demand

One Buyer Price Per Quantity

Gallon Demanded

$2.50 50
How much gasoline would
you purchase at the $3.00 45
following prices (gallons
per month)? $3.50 42
$4.00 35
$4.50 20
$5.00 0
Price in Dollars
Per Gallon

5.00
4.50
4.00

3.50
3.00
2.50
D
Quantity
Demanded
One Individual’s Demand Curve
Unit 2 - Supply and Demand

 Why Do You Purchase 10 instead of 11 Gallons of

Gasoline When You Visit the Gas Station?
Unit 2 - Supply and Demand

 Marginal Utility

Marginal utility is the increase in satisfaction (as

measured in “utils”) per additional item consumed.
Unit 2 - Supply and Demand

 The Law of Diminishing Marginal Utility

As consumers purchase more of a product, the value
(satisfaction) of additional items purchased declines.
Unit 2 - Supply and Demand

Several Buyers (the Price Q1 Q2 Q3 Q4 Total

Market)
$2.50

$3.00
How much gasoline
would you $3.50
purchase at the
$4.00
following prices
(gallons/month)? $4.50

$5.00
Price in Dollars
Per Gallon

5.00
4.50
4.00

3.50
3.00
2.50
D
Quantity
Demanded
Market Demand Curve
Unit 2 - Supply and Demand

 The Demand Curve

A change in the price is a movement along the demand curve.
This is called a change in “quantity demanded”.

Price Individual product demand curves

always extend from the upper left to
the lower right. They are downward
$4 A sloping.

$1.75 B
Demand Curve

60 80 Quantity Demanded
Unit 2 - Supply and Demand

 The Law of Supply

Producers supply more of a product at higher than at lower
prices, ceteris paribus (and vice versa).

Big Screen TVs

CDs
o n es
C ell Ph
Unit 2 - Supply and Demand

One Supplier Price Per Quantity

Gallon Supplied

If you had a small oil well $2.50

in your backyard and it
took you some effort to $3.00
get the oil out, and you
were able to sell the oil, $3.50
how much gasoline would
you supply at the $4.00
following prices (gallons
per month)? $4.50
$5.00
Price in Dollars
Per Gallon

5.00 S
4.50
4.00

3.50
3.00
2.50

Quantity
Supplied
Individual Supply Curve
 Unit 2 - Supply and Demand

Several Suppliers Price Q1 Q2 Q3 Q4 Total

$2.50
If you had a small oil well in
your backyard and it took you $3.00
some effort to get the oil out,
and you were able to sell the $3.50
oil, how much gasoline
would you supply at the $4.00
following prices (gallons per
month)?
$4.50

$5.00
Price in Dollars
Per Gallon

5.00 S
4.50
4.00

3.50
3.00
2.50

Quantity
Supplied
Market Supply Curve
Unit 2 - Supply and Demand

 The Supply Curve

A change in the price is a movement along the supply curve
from point A to point B. This is called a change in “ _______.”

Price Supply Curve

$4.50 B
A supply curve is
$2 A upward sloping.

30 90 Quantity Supplied
Unit 2 - Supply and Demand

 Reasons why producers produce more at higher

prices
 The Substitution Effect
When the market price increases, other competing
products will become less profitable and less attractive to
produce (and vice versa).
 The Income Effect
When the price increases, the product earns more money
(income) and the supplier has more incentive to produce
(and vice versa).
Unit 2 - Supply and Demand

 Equilibrium Price and Quantity

In a free market the equilibrium price and quantity occur
where the supply and demand curves intersect.

Price S

$3

D
50 Quantity
 Rent
The Case of Rent Control
S

$1,800

$1,000
D

700 900 Quantity

Demanded
 Price
of Labor The Minimum Wage
SL

$7.50

$6.00

DL

900 1,000 1,100 Quantity

Demanded
Minimum Wage of Labor
 Price Minimum Wage – New York Example
of Labor

SL

$10.00

$8.50

$7.50
DL

900 1,000 1,100 Quantity

Demanded
of Labor
Unit 2 - Supply and Demand
 Demand Determinants

The following changes will shift the demand curve

to the right or to the left.
 A change in real incomes or wealth (normal and inferior products).
 A change in tastes or preferences.
 A change in the prices of related products (substitute and
complementary products).
 A change in the expectation of the product’s future price or buyers’
future incomes.
 A change in the number of buyers (population).
Unit 2 - Supply and Demand

 Equilibrium Price and Quantity

When demand increases, the

demand curve shifts to the right.

Price Equilibrium
S
price increases,
$4
and equilibrium
$3
quantity
D2 increases.
D1
50 70 Quantity
Unit 2 - Supply and Demand
 The Effect of a Change in Demand on Equilibrium Price and
Quantity

In the short run, when demand increases

1. the equilibrium price increases, and
2. the equilibrium quantity increases.

In the short run, when demand decreases

3. the equilibrium price decreases, and
4. The equilibrium quantity decreases
Unit 2 - Supply and Demand

 Supply Determinants

The following changes will shift the supply curve

to the right or to the left.
 An advance in technology.
 A change in input prices.
 A change in taxes, subsidies, or regulations.
 A change in the number of firms selling the product.
Unit 2 - Supply and Demand

 Equilibrium Price and Quantity

When supply increases, the
supply curve shifts to the right.
Equilibrium
price decreases,
Price S1
S2 and equilibrium
quantity
$3 increases.
$2
D

50 60 Quantity
Unit 2 - Supply and Demand
 The Effect of a Change in Supply on
Equilibrium Price and Quantity

When supply increases (a rightward shift of the

supply curve)
1. The equilibrium price decreases, and
2. The equilibrium quantity increases.

When supply decreases (a leftward shift of the supply

curve)
3. The equilibrium price increases, and
4. The equilibrium quantity decreases.
Unit 2 - Supply and Demand
 Changes in Demand and Supply – Example 1

What happens to the equilibrium price and quantity of an

Ipod (a normal product) when simultaneously:
 Buyers’ incomes rise,
and
 Technology to make the
Ipods improves?
Unit 2 - Supply and Demand

 Changes in Demand and Supply – Example 1 Answer

 An increase in incomes will increase demand (price and

quantity increase).
 An advance in technology will increase supply (price
decreases and quantity increases).

The combined effect is that price change is

indeterminate and equilibrium quantity increases.
Unit 2 - Supply and Demand

Changes in Demand and Supply – Example 2

What happens to the equilibrium price and quantity of

toilet paper when simultaneously
 Buyers expect the future
price of toilet paper to be
higher
 The government
taxes the production of
toilet paper
Unit 2 - Supply and Demand
 Changes in Demand and Supply -Example 2 Answer

 The expectation of a higher future price increases the

current demand for the product (price and quantity
increase).
 The imposition of a government tax reduces the supply
(price increases and quantity decreases).

The combined effect is that the equilibrium quantity

change is unknown (indeterminate) and the
equilibrium price increases.
Unit 2 - Supply and Demand

Consumer Surplus
is the difference in what consumers are willing to pay for
the price of the product and what they are actually paying
for it in the market.
Price

Consumer
Surplus
S
$8
$7
$6

$5

D Quantity
Demanded
Per Day
90 100 110 120
Unit 2 - Supply and Demand

Producer Surplus
is the difference in what suppliers are willing to sell the product for
and what they are actually receiving for it in the market.
Price

$5 Producer
Surplus
$4
$3
$2
D
90 100 110 120 Quantity
Demanded
Per Day
Unit 2 - Supply and Demand
 The Free Market Economy

Free market economy = capitalist economy = Laissez-faire economy =

price system

In a free market economy prices of goods and services, wages, interest

rates, foreign exchange values, etc., are determined by supply and
demand
Unit 2 - Supply and Demand
 Prices of Manufactured Products
Manufactured products are abundantly available and
are produced in competitive industries. Examples include
computers, cell phones, CDs, and bicycles.

Prices of manufactured goods equal the cost of production

plus a reasonable profit. Prices are rarely excessive,
especially in the long run.
Unit 2 - Supply and Demand
 Prices of Limited-Supply Products

Examples of limited-supply
products include land, office
space, labor, Super Bowl
tickets, and products sold
by monopolies.

Prices of limited-supply products can be excessive, even in the long run.