Chapter 3 Demand and Supply

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					Chapter 3 Demand and Supply
Microeconomics

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Learning Objectives
• 1. Understand the economic definitions of supply
• • • •
and demand. 2. Understand what demand shift is and why it happens. 3. Describe how the market reaches equilibrium price and quantity. 4. Describe how shifts in demand and supply cause equilibriums to change. 5. Describe what happens to an equilibrium if demand and supply shift and the same time.

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• • • • • • • • • • • •

Definitions Demand Quantity Demanded Law of Demand Shifting the Demand Curve Supply Quantity Supplied Law of Supply Shifting the Supply Curve Market Demand and Supply Market Equilibrium Changes in Market Equilibrium
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Demand
• Demand – relates the quantity of a good that
consumers would purchase at each of various possible prices, over some period of time, ceteris paribus.

• In other words:
– For ALL possible prices, demand consists of the quantities that people want in a defined amount of time. – On a graph, demand is many points.
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Demand
Price per pizza ($) 2 Quantity of pizzas per month 13 A demand schedule – a table that shows possible prices and their quantities demanded.

4
6

10
7

8
10

4
1
5

Demand
Individual Demand Curve for pizza (monthly):
Price
$10

8
6 4 2 1 4 7 10 13

D
Quantity

A demand curve – the graph of a demand schedule. Notice that the demand curve slopes down and to the right. This is a negative slope.

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Quantity Demanded
• Quantity demanded – the quantity that
consumers would purchase at a given price.

• In other words:
– For ONE (and only ONE) price, quantity demanded is the amount that people want. – On a graph, quantity demanded is ONE point.
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Quantity Demanded
• A change in price causes the quantity
demanded to change. • When this happens, we move ALONG the demand curve (the demand curve does NOT move).

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Quantity Demanded
Demand Curve for pizza (monthly):
Price
$10

8
6 4 2 1 4 7 10 13

D
Quantity

If the price changes from $8 to $4, we move ALONG the demand curve. The price change caused a change in the quantity demanded. The demand curve did NOT move.

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Law of Demand
• Law of Demand – as price falls, the quantity demanded
increases.
– If your favorite car cost 720,000 RMB, how many would you buy? – What if it cost 72,000 RMB? – What if it cost 72 RMB?

• What happens to quantity demanded if price rises?
– Quantity demanded falls.

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Shifting the Demand Curve
• We do NOT move ALONG the demand curve.
Instead, we move the demand curve.

• An INCREASE in demand: demand shifts to the
RIGHT.

• A DECREASE in demand: demand shifts to the
LEFT.

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Shifting the Demand Curve
$
An increase in demand is represented by a rightward shift in the demand curve.

10
8 6 4 2 50 100 125 150 175 200 D21

D1

Q
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Shifting the Demand Curve
$
Conversely, a decrease in demand will cause a leftward shift on the demand curve. Hence, fewer units will be demanded at every given price.

10
8 6 4 2

D1 D2
50 100 125 150 175 200

Q
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Shifting the Demand Curve
• Shift factors (cause a change in demand):
– Tastes and preferences – Substitutes – Complements – Income • Normal goods and inferior goods – Population – Expectation of future price
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Shifting the Demand Curve
• Substitutes – something that takes the
place of something else, such as one brand of cola for another.

• Examples:
– You always drink green tea. The price of green tea doubles. You change to black tea (demand for black tea increases). Black tea is a substitute for green tea.
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Shifting the Demand Curve
• Compliments – goods or services that go well
with each other, such as cream with coffee.

• Example:
– You ketchup with french fries. The cost of french fries goes down by half. This causes you to eat more ketchup (demand for ketchup increases). Ketchup is a compliment of french fries.

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Shifting the Demand Curve
• Normal goods – demand for these goods varies
directly with income.

• In other words:
– If you have more money, you buy MORE normal goods (demand increases).

• Examples:
– Housing, jewelry, new clothes.

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Shifting the Demand Curve
• Inferior goods – demand for these goods varies
inversely with income.

• In other words:
– If you have more money, you buy LESS inferior goods (demand decreases).

• Examples:
– Cold showers, bad tasting cheap food, old clothes.

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Shifting the Demand Curve
Price

Demand Shifts RIGHT When:

D2

D1

Quantity

 Prices of substitutes increase  Prices of complements decrease  Normal good-income increases  Inferior good-income decreases  Population increases  Tastes & preferences turn in favor of the product  It is believed that prices will rise in the future 19

Demand Shifts LEFT When:
 Prices of substitutes      

Shifting the Demand Curve
Price

decrease Prices of complements increase Normal good-income decreases Inferior good-income increases Population decreases Tastes & preferences turn against the product It is believed that in the future prices will fall

D1
D2

Quantity

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Supply
• Supply relates the quantity of a good that will be
offered for sale at each of various possible prices, over some period of time, ceteris paribus.

• In other words:
– For ALL possible prices, supply consists of the quantities that people will produce in a defined amount of time. – On a graph, supply is many points.
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Supply
Price per box of Cigarettes ($) 5 4 Quantity supplied (millions of boxes per year) 10 8

3
2

6
4

A supply schedule – a table that shows possible prices and their quantities supplied.
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1

2

Supply
A supply curve – the graph of a supply schedule. Notice that the supply curve slopes up and to the right. This is a positive slope.
Supply Curve for cigarettes (daily):
Price
$5 4 3 2

Qs

1
2 4 6 8 10
23

Quantity

Quantity Supplied
• Quantity supplied – the quantity that will
be offered for sale at a given price.

• In other words:
– For ONE (and only ONE) price, quantity supplied is the amount that people will sell. – On a graph, quantity supplied is ONE point.

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Quantity Supplied
• A change in price causes the quantity
supplied to change. • When this happens, we move ALONG the supply curve (the supply curve does NOT move).

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Quantity Supplied
If the price changes from $2 to $5, we move ALONG the supply curve. The price change caused a change in the quantity supplied. The supply curve did NOT move.

Supply Curve for cigarettes (daily):
Price
$5 4 3 2

Qs

1
2 4 6 8 10
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Quantity

Law of Supply
• Law of Supply – as price rises, the quantity
supplied increases.
– If your tutor someone in English for 10RMB per hour, how many hours will you work? – What if it pays 100 RMB per hour? – What if pays 1000 RMB per hour?

• What happens to quantity supplied if price falls?
– Quantity supplied falls.

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Shifting the Supply Curve
• We do NOT move ALONG the supply curve.
Instead, we move the supply curve.

• An INCREASE in supply: supply shifts to the
RIGHT.

• A DECREASE in supply: supply shifts to the
LEFT.

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Changes in Supply vs. Changes in Quantity Supplied
Price ($’s)

Supply
5
4 3 2 1 Increase Decrease

Movement ALONG the supply curve
1 2 3 4 5 Quantity
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0

Shifting the Supply Curve
• Shift Factors:
• • • • Prices of Inputs Technological Change Government or Union Restrictions (pollution) Prices of Substitutes in Production (would you make more money if you made a different good?) • Prices of Jointly Produced Goods (beef and leather) • Expected Future Prices • Number of sellers (suppliers)
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Changes in Supply - Decrease
Supply Shifts LEFT When:  Sellers expect price to rise in future.  Price of labor or any input rises.  Government or union restrictions increase cost.  Price of substitute in production rises.  Price of product produced jointly falls.  Number of sellers declines
$ S2

S1

Quantity

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Changes in Supply - Increase
$ S1 S2

Quantity

Supply Shifts RIGHT When:  Sellers expect price to decline in future.  Price of labor or any input falls.  Technological change lowers cost.  Price of substitute in production falls.  Price of product produced jointly rises.  Number of sellers increases
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Market Demand and Supply
• The market is made up of individual firms
(businesses) as well as individual costumers. • How do you thing we measure market supply and demand? • Market demand is the horizontal summation of each individual’s demand curve. • Market supply is the horizontal summation of the supply of each seller’s supply curve.
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Market Demand
Price ($) 5 4 3 2 1 0 Jack's Quantity Demanded mark's Quantity DemandedMarket Q Demanded 1 0 1 2 1 3 3 2 5 4 3 7 5 4 9 6 5 11

Demand can be one individual’s or the market as a whole
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Individual A’s Demand Curve
Price ($)
Mark’s Quantity

6 5 4

At a price of $5 Mark‘s quantity demanded is 0 units

5 4 3 2 1 0 At a price of $1 Mark‘s quantity demanded is 4 units

Demanded 0 1 2 3 4 5

3
2 1
Mark’s Demand

0
1 2 3 4 5 6 7 8 9 10 11 Quantity
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Individual B’s Demand Curve
At a price of $5 Jack’s quantity demanded is 1 unit Price ($) Jack’s Quantity Demanded 5 1 4 2 3 3 2 4 1 5 0 6 At a price of $1 Jack‘s quantity demanded is 4 units

6 5 4

3
2 1

Jack’s Demand

0
1 2 3 4 5 6 7 8 9 10 11 Quantity
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Market Demand Curve (Individual A and B’s demand curves together)
6 5 4
At a price of $5, the market quantity demanded is 1+0=1
units. Market Demand

At a price of $1, the market quantity demanded is 5+4=9
units.

3
2 1

0
1 2 3 4 5 6 7 8 9 10 11 Quantity
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Market Supply
Price ($) 5 4 3 2 1 0 Coke's Quantity Supplied 4 3 2 1 0 0 Pepsi's Quantity Supplied Market Q Supplied 5 9 4 7 3 5 2 3 1 1 0 0

Supply can be from one firm or all firms in the market.
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Company A’s Supply Curve
Coke’s Supply

5 4 3 2 1 0 1 2 3 4 5

At a price of $5 Coke supplies 4 units

At a price of $1 Coke supplies 0 units

6

7

8 9 Quantity
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Company B’s Supply Curve
Pepsi’s Supply

5 4 3 2 1 0 1 2 3 4 5 6

At a price of $5 Pepsi supplies 5 units.

At a price of $1 Pepsi supplies 1 unit.

7

8 9 Quantity
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Market Supply Curve (Individual A and B’s supply curves together)
At a price of $5, the market quantity supplied is 4+5=9 units.

5
Four by Coke

Five by Pepsi

4 3 2 1 0 1 2 3 4 5 6

Market Supply
At a price of $1, the market quantity supplied is 0+1=1 units.

7

8 9 Quantity
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Market Equilibrium
• Market Equilibrium – a situation in which
there is no tendency for either price or quantity to change.

• In other words:
– The quantity supplied equals the quantity demanded. – There is only one price where this happens; we say the market “clears”.
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Market Equilibrium
• Surplus – the excess of quantity supplied
over quantity demanded, which occurs when price is ABOVE equilibrium.

• Shortage – the excess of quantity

demanded over quantity supplied, which occurs when price is BELOW equilibrium.
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Market Equilibrium
Price ($) 5 4 3 2 1 0 Quantity Demanded 1 3 5 7 9 11 Quantity Supplied 9 7 5 3 1 0 Surplus or Shortage 8 4 0 -4 -8 -11

There is only one price that clears the market, meaning that the quantity supplied equals the quantity demanded.
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Market Equilibrium
Market equilibrium occurs where demand and supply intersect.
Producers compete for customers, lowering the price

5
Too High 4

Surplus of 4 Units

Supply

P* 3
Too Low 2 Shortage of 4 Units

1 0 1

Costumers compete for the product, raising the price

Demand

2

3

4

Q*

5

6

7

8 9 Pails of Water
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Changes in Market Equilibrium
o Adjustment from one equilibrium to the
next can be thought of as a four step process:
o For some reason, a shift occurs in either supply or demand. o The price that had been equilibrium now causes either a surplus or shortage. o If there is a surplus, price adjusts down; if a shortage, price adjusts up. o In response to changes in price, consumers adjust their quantities demanded and producers their quantity supplied until the two are equal and the market is again in equilibrium.

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Changes in Market Equilibrium
S

Snew
A

P*
B

C

D
Q*

Quantity

Step #1 - Supply shifts to the right. Step #2 – A surplus occurs at the starting price. Step #3 – Competition among the producers causes the price to fall. Step #4 - As price falls, the quantity demanded increases and the quantity supplied decreases until the two become equal, after which there is no more tendency for either price or quantity to change.

Price ($’s)

An increase in supply.
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Changes in Market Equilibrium
Snew
Step #1 - Supply shifts to the left. Step #2 – A shortage occurs at the starting price. Step #3 – Competition among the consumers causes the price to rise. Step #4 - As price rises, the quantity demanded decreases and the quantity supplied increases until the two become equal, after which there is no more tendency for either price or quantity to change.

Snew

Price ($’s)

C

S

P* B

A

D
Q*

Quantity

A decrease in supply.
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Changes in Market Equilibrium
Price ($’s)

S
C

Price ($’s)

P* P* A B

B

A

S

C

D
Q*

Dnew
Q*

D Dnew
Quantity
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Quantity An increase or decrease in demand.

Changes in Market Equilibrium
Case 1 2 3 4 Demand No change No change Right Left Supply Right Left No change No change Equilibrium P Fall Rise Rise Fall Equilibrium Q Rise Fall Rise Fall

Note: In Cases 1-4 only one of the two curves is shifting.
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Changes in Market Equilibrium
Price ($’s)

S

Snew
Same Equilibrium Price

P*

Dnew D
Q*

Quantity

Higher equilibrium quantity

Shift in demand equal to shift in supply
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Changes in Market Equilibrium
Price ($’s)

S

Snew

P*

New Equilibrium Price

Dnew D
Q*

Quantity

Higher equilibrium quantity

Shift in demand less than shift in supply
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Changes in Market Equilibrium
Price ($’s)

S

Snew
New Equilibrium Price

P*

Dnew D
Q*

Quantity

Higher equilibrium quantity

Shift in demand greater than shift in supply
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Changes in Market Equilibrium
Case 5 6 7 8 Demand Shifts right Shifts left Shifts right Shifts left Supply Shifts right Shifts left Shifts left Shifts right Equilibrium P Direction uncertain Direction uncertain Rises Falls Equilibrium Q Rises Falls Direction uncertain direction uncertain

Note: In Cases 5-8 both of the curves are shifting.
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