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Chapter 3 Demand Supply © 2002 South-Western Chapter 3 Demand Supply © 2002 South-Western

Economic Principles • Individual and Market Demand • Market-day, Short-run and Long -run Supply Economic Principles • Individual and Market Demand • Market-day, Short-run and Long -run Supply • Determination of Equilibrium Price and Quantity 2

Price Formation Market price is a reflection of people’s willingness to buy and sell. Price Formation Market price is a reflection of people’s willingness to buy and sell. - How does price reflect what buyers are willing to do? 3

Measuring Consumer Demand A change in quantity demanded shows: • People’s willingness to buy Measuring Consumer Demand A change in quantity demanded shows: • People’s willingness to buy specific quantities of a good or service at specific prices. 4

Measuring Individual Demand Law of Demand: • The inverse relationship between price and quantity Measuring Individual Demand Law of Demand: • The inverse relationship between price and quantity demanded. • As price increases, quantity demanded decreases, and vice versa. 5

Measuring Individual Demand Schedule: • A schedule which shows the specific quantity of a Measuring Individual Demand Schedule: • A schedule which shows the specific quantity of a good or service that people are willing and able to buy at different prices. 6

Measuring Market Demand Aggregate the demand of many individuals into market demand by: • Measuring Market Demand Aggregate the demand of many individuals into market demand by: • Adding up the quantities purchased by all consumers at given market prices. 7

Measuring Market Demand If each of the seven dwarfs buys three cups of coffee Measuring Market Demand If each of the seven dwarfs buys three cups of coffee per week at Snow White’s Café at a price of $1/cup, what is market quantity demanded at a price of $1? • 3+3+3+3 = 21. 8

Market Demand • • The sum of all individuals demand in a market. 9 Market Demand • • The sum of all individuals demand in a market. 9

Measuring Supply Schedule: • It is a schedule showing the specific quantity of a Measuring Supply Schedule: • It is a schedule showing the specific quantity of a good or service that suppliers are willing and able to provide at different prices. 10

Measuring Supply Market-day supply: • A market situation in which the quantity of a Measuring Supply Market-day supply: • A market situation in which the quantity of a good supplied is fixed, regardless of price. • The fisherman example: They want to sell all fish, regardless of the price. Also, can’t add to their supply in the middle of the day. 11

Measuring Supply A supply curve graphs the relationship between price and quantity supplied. 12 Measuring Supply A supply curve graphs the relationship between price and quantity supplied. 12

Measuring Supply The supply curve is upward-sloping. • Higher prices provide sellers with an Measuring Supply The supply curve is upward-sloping. • Higher prices provide sellers with an incentive to increase quantity supplied. • As price increases, quantity supplied increases, and vice versa. 13

Measuring Supply If there are three builders in a small town, and if each Measuring Supply If there are three builders in a small town, and if each supplies 4 houses per year at a price of $150, 000, what is market quantity supplied at this price? • 4 + 4 = 12. 14

EXHIBIT 1 A INDIVIDUAL DEMAND CURVES FOR FISH 15 EXHIBIT 1 A INDIVIDUAL DEMAND CURVES FOR FISH 15

EXHIBIT 1 B INDIVIDUAL DEMAND CURVES FOR FISH 16 EXHIBIT 1 B INDIVIDUAL DEMAND CURVES FOR FISH 16

EXHIBIT 2 THE MARKET DEMAND CURVE 17 EXHIBIT 2 THE MARKET DEMAND CURVE 17

Exhibit 2: The Market Demand Curve The curve in Exhibit 2 represents: • The Exhibit 2: The Market Demand Curve The curve in Exhibit 2 represents: • The market demand for fish. • It is the sum of all individual demands for fish. 18

EXHIBIT 3 MARKET-DAY SUPPLY CURVE 19 EXHIBIT 3 MARKET-DAY SUPPLY CURVE 19

Exhibit 3: Market-Day Supply Curve The market-day supply curve for fish is a vertical Exhibit 3: Market-Day Supply Curve The market-day supply curve for fish is a vertical line because: • Fishermen cannot change the quantity they supply, once the day’s catch is in. 20

EXHIBIT 4 EXCESS DEMAND EXCESS SUPPLY 21 EXHIBIT 4 EXCESS DEMAND EXCESS SUPPLY 21

Exhibit 4: Excess Demand Excess Supply The quantity of fish supplied, when price rises Exhibit 4: Excess Demand Excess Supply The quantity of fish supplied, when price rises from $5 to $8: • Remains at 6, 000. • The market-day supply curve is a vertical line. 22

Excess Supply • The difference, at a particular price, between quantity supplied and quantity Excess Supply • The difference, at a particular price, between quantity supplied and quantity demanded, quantity supplied being the greater. • What will suppliers do if there is excess supply? 23

Excess Demanded • The difference, at a particular price, between quantity demanded and quantity Excess Demanded • The difference, at a particular price, between quantity demanded and quantity supplied, quantity demanded being greater. • What will suppliers do if there is excess demand? 24

Exhibit 4: Excess Demand Excess Supply The relationship between quantity demanded and quantity supplied Exhibit 4: Excess Demand Excess Supply The relationship between quantity demanded and quantity supplied at a price of $8 is: • Quantity demanded is 4, 500. • Quantity supplied is 6, 000. • Excess supply of 1, 500. 25

Exhibit 4: Excess Demand Excess Supply The relationship between quantity demanded and quantity supplied Exhibit 4: Excess Demand Excess Supply The relationship between quantity demanded and quantity supplied at a price of $4 is: • Quantity demanded is 6, 500. • Quantity supplied is 6, 000. • Excess demand of 500. 26

Exhibit 4: Excess Demand Excess Supply The relationship between quantity demanded and quantity supplied Exhibit 4: Excess Demand Excess Supply The relationship between quantity demanded and quantity supplied at a price of $5 is: • They are equal. 27

Determining Equilibrium Price What is unique about the Equilibrium Price? • Quantity demanded is Determining Equilibrium Price What is unique about the Equilibrium Price? • Quantity demanded is equal to quantity supplied. • There is neither an excess supply nor an excess demand. • Price gravitates toward the equilibrium price, in well-functioning competitive markets. 28

Excess Supply • What will suppliers do if there’s an excess supply on the Excess Supply • What will suppliers do if there’s an excess supply on the market? • An incentive for suppliers to cut prices. 29

EXHIBIT 5 MARKET-DAY, SHORT-RUN, AND LONG-RUN SUPPLY 30 EXHIBIT 5 MARKET-DAY, SHORT-RUN, AND LONG-RUN SUPPLY 30

Equilibrium • The price that equates quantity demanded to quantity supplied. If any disturbance Equilibrium • The price that equates quantity demanded to quantity supplied. If any disturbance from that price occurs, excess demanded or excess supply emerges to drive price back to equilibrium. • Price always tends toward equilibrium. 31

Exhibit 5: Market-Day, Short-Run, and Long-Run Supply The short-run supply curve slopes upward, while Exhibit 5: Market-Day, Short-Run, and Long-Run Supply The short-run supply curve slopes upward, while the market-day supply curve is a vertical line because: • If price rises, then in the short-run suppliers are able to increase the use of some but not all of the resources they use to produce goods and services. 32

Short-Run • The time interval during which suppliers are able to change the quantity Short-Run • The time interval during which suppliers are able to change the quantity of some but not all resources they use to produce the goods and services. 33

Long Run • The time interval during which suppliers are able to change the Long Run • The time interval during which suppliers are able to change the quantity of all the resources they use to produce goods and services. 34

Exhibit 5: Market-Day, Short-Run, and Long-Run Supply The short-run supply curve slopes upward, while Exhibit 5: Market-Day, Short-Run, and Long-Run Supply The short-run supply curve slopes upward, while the market-day supply curve is a vertical line because: • The short-run suppliers are able to: • Make modest increases in quantity supplied if price rises. • Make modest decreases in quantity supplied if price falls 35

Exhibit 5: Market-Day, Short-Run, and Long-Run Supply The short-run supply curve slopes upward, while Exhibit 5: Market-Day, Short-Run, and Long-Run Supply The short-run supply curve slopes upward, while the market-day supply curve is a vertical line because: • This results in a short-run supply curve which is steeply upward-sloping. • The quantity supplied is fixed on the market-day supply curve. 36

Exhibit 5: Market-Day, Short-Run, and Long-Run Supply The long-run supply curve is less steep Exhibit 5: Market-Day, Short-Run, and Long-Run Supply The long-run supply curve is less steep than the short-run supply curve because: • Suppliers are able to change the quantity of all resources they use to produce goods and services during this time interval. • A given increase in price will result in a larger increase in quantity supplied in the long run than in the short run. 37

Theoretical Perspective • How Long does it take to get to the long run? Theoretical Perspective • How Long does it take to get to the long run? -It Depends on the industry. 38

Theoretical Perspective • Ex: It would take farmers longer to get to the market-day Theoretical Perspective • Ex: It would take farmers longer to get to the market-day supply curve because they already have their foods planted they can’t just give up and find new jobs but if a babysitter had a low wage of $3 an hour she/he could just find a new job. 39

Long-Run Supply Curve • Why don’t suppliers shift instantaneously to the long run when Long-Run Supply Curve • Why don’t suppliers shift instantaneously to the long run when prices change? -It’s not easy to quit outright even if there are job opportunities, like fishermen they have an emotional investment in their business and little experience at other jobs. 40

Short-Run/Long-Run • The short-run supply curve shows moderate flexibility in adjusting quantity supplied to Short-Run/Long-Run • The short-run supply curve shows moderate flexibility in adjusting quantity supplied to the price, while the long-run supply curve has the most gradual slope, reflecting the fishermen's ability to adjust fully to price. 41

Change in Demand A change in price will not result in a change in Change in Demand A change in price will not result in a change in demand. • A change in price results in a change in quantity demanded. • A change in demand is caused by factors other than a change in the price of that good. 42

Change in Demand A change in a consumer’s income will result in a change Change in Demand A change in a consumer’s income will result in a change in demand. • A change in a consumer’s income will cause the demand curve to shift. • Income increases, demand shifts out • Income decreases, demand shifts in 43

Change in Demand • A normal good is a good whose demand increases or Change in Demand • A normal good is a good whose demand increases or decreases when people's incomes increase or decrease. • Ex: Luxury cars; As people’s income increases, demand for luxury cars increases. • Opposite is an inferior good. Ex: Day-old bread; As people’s income increases, demand for day-old bread decreases. 44

Change in Demand • A substitute good are goods that can replace each other. Change in Demand • A substitute good are goods that can replace each other. When the price of one increases, the demand for the other increases. • Ex: When the price of beef increases, the demand for chicken increases. • A complementary good are goods used in conjunction with each other. When the price of one increases, the demand for the other decreases. Ex: Peanut butter and jelly; when the price of peanut butter increases, demand for jelly decreases. 45

Change in Demand A change in Demand will include: 1. Change in income 2. Change in Demand A change in Demand will include: 1. Change in income 2. Change in Taste 3. Change in the Prices of other goods 4. Change in Expectations about future prices. 5. Change in population on size 6. Change in Demand or a change in quantity demanded. 46

EXHIBIT 6 CHANGE IN DEMAND 47 EXHIBIT 6 CHANGE IN DEMAND 47

Exhibit 6: Change in Demand In Exhibit 6, when the demand curve shifts from Exhibit 6: Change in Demand In Exhibit 6, when the demand curve shifts from D to D’, the equilibrium price and quantity demanded: • The equilibrium price rises from $5 to $6. • The quantity demanded rises from 6, 000 to 6, 500. 48

Exhibit 6: Change in Demand If fish are a normal good and consumer incomes Exhibit 6: Change in Demand If fish are a normal good and consumer incomes have increased, the demand will shift from D to D’. • If a good is normal, then an increase in consumer income will increase demand. 49

Exhibit 6: Change in Demand In Exhibit 6, when the demand curve shifts from Exhibit 6: Change in Demand In Exhibit 6, when the demand curve shifts from D to D”, the equilibrium price and quantity demanded: • The equilibrium price falls from $5 to $4. • The quantity demanded falls from 6, 000 to 5, 500. 50

Exhibit 6: Change in Demand If fish and beef are substitutes, then a decrease Exhibit 6: Change in Demand If fish and beef are substitutes, then a decrease in the price of beef will cause demand to shift from D to D’’. • If the price of beef declines: • The quantity of beef demanded will increase. • The demand curve for fish will shift left. 51

Changes in Demand What happens to the demand for software when computer hardware and Changes in Demand What happens to the demand for software when computer hardware and software complements, and the price of hardware declines: • A decline in hardware prices will increase the quantity of hardware demanded. • If more hardware is purchased, the result will be more software purchased, since they are complements. 52

Changes in Demand What happens to the demand for software when computer hardware and Changes in Demand What happens to the demand for software when computer hardware and software complements, and the price of hardware declines: • The increase in the quantity of software demanded was caused by a factor other than the price of software. • The demand for software will increase. 53

Changes in Demand If consumers anticipate that computer hardware will become considerably cheaper in Changes in Demand If consumers anticipate that computer hardware will become considerably cheaper in the coming months, today’s demand for hardware: • Today’s demand will decrease (shift to the left). • Some consumers will delay their purchase in anticipation of lower future prices. 54

Changes in Demand The demand for day-old bakery goods if consumer incomes rise, and Changes in Demand The demand for day-old bakery goods if consumer incomes rise, and day-old bakery goods are inferior goods will: • The demand for day-old bakery goods will fall as consumer incomes rise. • Inferior goods are goods that people consume less of as their incomes rise. 55

Changes in Demand When students are gone during the summer, the demand for pizza Changes in Demand When students are gone during the summer, the demand for pizza slices on campus: • The demand will fall because there will be fewer consumers. 56

Changes in Demand If the Surgeon General announces that cheeseburgers reduce heart attack risk Changes in Demand If the Surgeon General announces that cheeseburgers reduce heart attack risk and prevent premature baldness, this will affect market demand for cheeseburgers: • The demand will rise. • The news will increase consumer tastes and preferences for cheeseburgers. 57

Changes in Demand Which of the following are most likely to be consumer substitutes: Changes in Demand Which of the following are most likely to be consumer substitutes: i. Peanut butter and jelly. ii. Coke and Pepsi. iii. Cars and gasoline. iv. Telephones and telephone books. 58

Changes in Demand Which of the following are most likely to be consumer substitutes: Changes in Demand Which of the following are most likely to be consumer substitutes: i. Coke and Pepsi. 59

EXHIBIT 7 DISTINGUISHING CHANGES IN DEMAND FROM CHANGES IN QUANTITY DEMANDED 60 EXHIBIT 7 DISTINGUISHING CHANGES IN DEMAND FROM CHANGES IN QUANTITY DEMANDED 60

Exhibit 7: Distinguishing Changes in Demand from Changes in Quantity Demanded Movement along the Exhibit 7: Distinguishing Changes in Demand from Changes in Quantity Demanded Movement along the demand curve D from a price of $10 to a price of $7 illustrates a change in Quantity demanded. 61

Exhibit 7: Distinguishing Changes in Demand from Changes in Quantity Demanded In which of Exhibit 7: Distinguishing Changes in Demand from Changes in Quantity Demanded In which of the following do we know for certain that a change in demand occurred: i. Price declined and quantity demanded increased. ii. Price remained the same and quantity demanded increased. 62

Exhibit 7: Distinguishing Changes in Demand from Changes in Quantity Demanded In which of Exhibit 7: Distinguishing Changes in Demand from Changes in Quantity Demanded In which of the following do we know for certain that a change in demand occurred: i. Price declined and quantity demanded increased. ii. Price remained the same and quantity demanded increased. 63

Changes in Demand • What is the difference between a change in demand a Changes in Demand • What is the difference between a change in demand a change in quantity demanded? 64

EXHIBIT 8 CHANGE IN SUPPLY 65 EXHIBIT 8 CHANGE IN SUPPLY 65

Exhibit 8: Change in Supply When the supply changes from curve S to curve Exhibit 8: Change in Supply When the supply changes from curve S to curve S’, this is an increase in supply. 66

Change in Supply A change in supply will include the following: 1. Changes in Change in Supply A change in supply will include the following: 1. Changes in technology 2. Changes in Resource Price 3. Changes in the Prices of Other Goods 4. Changes in the number of Suppliers 67

Exhibit 8: Change in Supply What would cause the equilibrium to shift from point Exhibit 8: Change in Supply What would cause the equilibrium to shift from point a. to point b. in Exhibit 8? • A decrease in supply from S’ to S’’. 68

Changes in Supply A Change in Supply: • A change in quantity supplied of Changes in Supply A Change in Supply: • A change in quantity supplied of a good or service that is caused by factors other than a change in the price of that good. 69

Changes in Supply If a labor union successfully negotiates a large pay increase, this Changes in Supply If a labor union successfully negotiates a large pay increase, this will affect the supply curve for the product they make by: • Higher wages, like any other increase in resource prices, will cause the supply curve to shift inwards to the left (a decrease in supply). 70

Changes in Supply If more sellers enter the market, this will affect the market Changes in Supply If more sellers enter the market, this will affect the market supply curve: • An increase in the number of sellers will cause the supply curve to shift outwards to the right (an increase in supply). 71

Changes in Supply Suppose that farmers who grow soybeans can also grow corn. If Changes in Supply Suppose that farmers who grow soybeans can also grow corn. If the price of soybeans triples, how this will affect the market supply of corn by: • This will reduce the market supply of corn, because many corn farmers will switch to growing soybeans. 72

EXHIBIT 9 A INCREASES IN DEMAND SUPPLY 73 EXHIBIT 9 A INCREASES IN DEMAND SUPPLY 73

EXHIBIT 9 B INCREASES IN DEMAND SUPPLY 74 EXHIBIT 9 B INCREASES IN DEMAND SUPPLY 74

Exhibit 9: Increases in Demand Supply (panel a) When both demand supply increase: • Exhibit 9: Increases in Demand Supply (panel a) When both demand supply increase: • Equilibrium quantity increases. • The effect of an increase in both supply an demand on price depends on the relative size of the increases. If the increase in demand is larger than the increase in supply, then price rises. 75

EXHIBIT 10 A INCREASES IN DEMAND, DECREASES IN SUPPLY 76 EXHIBIT 10 A INCREASES IN DEMAND, DECREASES IN SUPPLY 76

EXHIBIT 10 B INCREASES IN DEMAND, DECREASES IN SUPPLY 77 EXHIBIT 10 B INCREASES IN DEMAND, DECREASES IN SUPPLY 77

Exhibit 10: Increases in Demand, Decreases in Supply When demand increases a little and Exhibit 10: Increases in Demand, Decreases in Supply When demand increases a little and supply decreases a lot: • The equilibrium price increases, but equilibrium quantity decreases. This effect is illustrated in Exhibit 10, panel a. 78

Exhibit 10: Increases in Demand, Decreases in Supply When demand increases a lot and Exhibit 10: Increases in Demand, Decreases in Supply When demand increases a lot and supply decreases a little: • The equilibrium price and quantity both increase. This effect is illustrated in Exhibit 10, panel b. 79

Demand Supply The equilibrium price of peaches will be affected if the demand for Demand Supply The equilibrium price of peaches will be affected if the demand for peaches decreases, while at the same time the supply of peaches increases: • The equilibrium price of peaches will fall. • The relative magnitude of the changes in supply and demand is needed before we can determine how the equilibrium quantity of peaches will change. 80

Price as a Rationing Mechanism Price rations scarce goods and services in a market: Price as a Rationing Mechanism Price rations scarce goods and services in a market: • It rations out goods in a market in such a way that only those who have a high willingness-to-pay get them. 81

EXHIBIT 11 A RATIONING FUNCTION OF PRICE 82 EXHIBIT 11 A RATIONING FUNCTION OF PRICE 82

EXHIBIT 11 B RATIONING FUNCTION OF PRICE 83 EXHIBIT 11 B RATIONING FUNCTION OF PRICE 83

QUESTIONS and ANSWERS • Draw a demand curve representing King Richard’s plea “A horse, QUESTIONS and ANSWERS • Draw a demand curve representing King Richard’s plea “A horse, a horse, my kingdom for a horse!” 84

QUESTIONS and ANSWERS • Draw a demand curve representing King Richard’s plea “A horse, QUESTIONS and ANSWERS • Draw a demand curve representing King Richard’s plea “A horse, a horse, my kingdom for a horse!” • The demand curve is a vertical line reaching infinity at a quantity of one. In that dramatic scene, Richard III declares that he would be willing to buy a horse at any price. Why? Because he will die otherwise! (In fact, he didn’t get the horse and that was the end of Richard. ) Wouldn’t you offer everything you own if your life depended on it? Note also that he would demand only one horse, even if horse sellers were willing to offer any quantity of horses at a price of $1 each. What would Richard III do with two horses? 85

QUESTIONS and ANSWERS • Explain why the market-day supply curve for fish described in QUESTIONS and ANSWERS • Explain why the market-day supply curve for fish described in the chapter is drawn vertically. 86

QUESTIONS and ANSWERS • Explain why the market-day supply curve for fish described in QUESTIONS and ANSWERS • Explain why the market-day supply curve for fish described in the chapter is drawn vertically. • The vertical line indicates that the quantity supplied is fixed whatever the price. It reflects the fact that suppliers, however willing they are to supply more at higher prices and fewer at lower prices do not have time—be sure to stress the time element—to adjust their supplies to the quantity they would be willing to supply. 87

QUESTIONS and ANSWERS • Why are the slopes of the short-run suply curve and QUESTIONS and ANSWERS • Why are the slopes of the short-run suply curve and the long-run supply curve different? 88

QUESTIONS and ANSWERS • • Why are the slopes of the short-run supply curve QUESTIONS and ANSWERS • • Why are the slopes of the short-run supply curve and the long-run supply curve different? The slopes are different because the suppliers’ ability to adjust the quantity they are able to supply to the quantity they are willing to supply is a function of time. Suppose auto prices increased 25 percent and Ford, happy with the increase, is willing to increase output tenfold. But can it? Ford would need new assembly lines. These lines can’t be built in a week or even a month. Ford can order more assembly lines, but until they are built and functioning, Ford cannot possibly increase its production tenfold. What can it do? Given the quantity of assembly lines it already has, it can switch from a two-shift to a three-shift day, work those assembly lines on weekends and holidays, hire more workers, and buy more raw materials. In this way, it could double the output of its existing lines. The short run— which is “in the meantime”—is limited to the doubling, because at least one of the resources it uses—the assembly line—is fixed. In the long run, with the new assembly lines in place, Ford can produce the tenfold increase it is willing to supply because no resource supply is fixed. 89

QUESTIONS and ANSWERS • “Prices always tend toward equilibrium. ” Discuss this statement by QUESTIONS and ANSWERS • “Prices always tend toward equilibrium. ” Discuss this statement by demonstrating why every other price is unsustainable. ” 90

QUESTIONS and ANSWERS • “Prices always tend toward equilibruim. ” Discuss this statement by QUESTIONS and ANSWERS • “Prices always tend toward equilibruim. ” Discuss this statement by demonstrating why every other price is unsustainable. ” When price is greater than the equilibrium price, excess supply emerges. Not all suppliers are able to sell the quantities they are willing to supply, and, fearful that they will be left with unsold goods, they cut their price. As a result price falls. On the other hand, when price is below equilibrium, excess demand emerges and demanders, fearful that they will be left without goods, bid up the price. In each case, price moves in the direction of equilibrium. 91

QUESTIONS and ANSWERS • Suppose NAFTA (the U. S. free trade agreement with Canada QUESTIONS and ANSWERS • Suppose NAFTA (the U. S. free trade agreement with Canada and Mexico) allows the neighboring economies to enter our slipper market. Draw a graph showing the probable effects of their entry on price and quantity of slippers demanded and supplied in the United States. 92

QUESTIONS and ANSWERS • Suppose NAFTA (the U. S. free trade agreement with Canada QUESTIONS and ANSWERS • Suppose NAFTA (the U. S. free trade agreement with Canada and Mexico) allows the neighboring economies to enter our slipper market. Draw a graph showing the probable effects of their entry on price and quantity of slippers demanded and supplied in the United States. • The supply curve of slippers in the U. S. shifts to the right showing greater quantity supplied at every price. As a result, the equilibrium price of slippers falls and the quantity bought and sold increases. Note: A ceteris paribus assumption has to be made concerning the demand curve. It remains unchanged. See the following exhibit. 93

QUESTIONS and ANSWERS • When the price of hamburgers rises, the demand for fish QUESTIONS and ANSWERS • When the price of hamburgers rises, the demand for fish rises. When the price of hamburger rises the demand for hamburger buns falls. Why? 94

QUESTIONS and ANSWERS • When the price of hamburgers rises, the demand for fish QUESTIONS and ANSWERS • When the price of hamburgers rises, the demand for fish rises. When the price of hamburger rises the demand for hamburger buns falls. Why? • Hamburgers and fish are substitute goods. Ceteris paribus, when the price of hamburgers goes up, hamburgers become more expensive relative to fish. Some former hamburger eaters, now looking at the more expensive hamburger, may decide eat fish instead. That is, the result of an increase in the price of hamburgers is an outward shift in the demand for fish. On the other hand, hamburgers and hamburger buns are complementary goods. Many people eat their hamburgers on buns. When the price of hamburgers increases, the quantity of hamburgers demanded decreases. If fewer hamburgers are eaten, fewer hamburger buns are demanded. That is why when the price of hamburgers increases, the demand for hamburger buns decreases. 95

QUESTIONS and ANSWERS • Hans Giepnepp is frustrated every year. In March, the price QUESTIONS and ANSWERS • Hans Giepnepp is frustrated every year. In March, the price of tomatoes is $1. 75 per pound. That is sufficient incentive for him to plant tomatoes in his yard. But in August, when the crop is ready for picking, prices at the grocer have fallen to 25 cents per pound. “I always run into this bad lunch, ” he laments. Why is his problem not a matter of luck? 96

QUESTIONS and ANSWERS • • Hans Giepnepp is frustrated every year. In March, the QUESTIONS and ANSWERS • • Hans Giepnepp is frustrated every year. In March, the price of tomatoes is $1. 75 per pound. That is sufficient incentive for him to plant tomatoes in his yard. But in August, when the crop is ready for picking, prices at the grocer have fallen to 25 cents per pound. “I always run into this bad lunch, ” he laments. Why is his problem not a matter of luck? Many people react the same way Hans does. They go to the grocer in March and purchase the $1. 75 per pound tomatoes. Their natural reaction is to grow their own. But it takes time. Come August, almost everyone, including commercial tomato growers, have greater supplies of tomatoes. The demand curve for tomatoes remains relatively unchanged —people’s tastes don’t change that much—but the supply curve of tomatoes shifts dramatically to the right. As a result, price plunges to 25 cents per pound. Hans should have known this would happen. It happens year after year. (Actually, most people grow their own tomatoes because they enjoy gardening and homegrown tomatoes always taste better. It is also considerably cheaper. ) 97

QUESTIONS and ANSWERS • Because there was a rumor in May that the price QUESTIONS and ANSWERS • Because there was a rumor in May that the price of compact disc players was going to increase in August, the demand for compact disc players went up in May. Explain. 98

QUESTIONS and ANSWERS • Because there was a rumor in May that the price QUESTIONS and ANSWERS • Because there was a rumor in May that the price of compact disc players was going to increase in August, the demand for compact disc players went up in May. Explain. • If you were thinking about buying a compact disc player and heard that its price will soon increase, wouldn’t you buy one now? If you wait, you will pay more later. But you’re not the only one reacting to that information. As a result, the market demand curve shifts to the right now and the price of compact disc players increases. 99

QUESTIONS and ANSWERS • How would each of the following events affect the international QUESTIONS and ANSWERS • How would each of the following events affect the international price of oil (in each case ceteris paribus): (a) the U. S. gives economic assistance to oil-rich Ukraine in the form of oildrilling technology; (b) Iraq, in a war against Saudi Arabia, destroys 50 percent of Saudi oil wells; (c) a U. S. invention uses sea-water to fuel automobiles; (d) Western European homes are heated solely by solar power; and (e) the world’s population doubles. 100

QUESTIONS and ANSWERS • How would each of the following evetns affect the international QUESTIONS and ANSWERS • How would each of the following evetns affect the international price of oil (in each case ceteris paribus): (a) the U. S. gives economic assistance to oil-rich Ukraine in the form of oil-drilling technology; (b) Iraq, in a war against Saudi Arabia, destroys 50 percent of Saudi oil wells; (c) a U. S. invention uses sea-water to fuel automobiles; (d) Western European homes are heated solely by solar power; and (e) the world’s population doubles. • (a) The world’s supply of oil increases, thus reducing the price of oil. (b) The world’s supply of oil decreases, thus increasing the price of oil. (c) The sea-water and oil (both used as an energy source) are substitute goods—with supplies of energy-providing sea-water on the market, the price of oil falls. (d) Solar power and oil are also substitute goods, so when more homes use solar power, the price of oil falls. (e) With more people demanding more of all goods, the demand curve for oil shifts to the right, raising the price of oil. 101

QUESTIONS and ANSWERS • How do you explain the fact that a single rose QUESTIONS and ANSWERS • How do you explain the fact that a single rose at the supermarket florist is $1. 49 every day of the year except the week before and during Valentine’s Day, when it increases to $3. 50? 102

QUESTIONS and ANSWERS • How do you explain the fact that a single rose QUESTIONS and ANSWERS • How do you explain the fact that a single rose at the supermarket florist is $1. 49 every day of the year except the week before and during Valentine’s Day, when it increases to $3. 50? • Think in terms of shifts in the supply and the demand curve for roses. The Valentine’s Day market dominates the week’s supply curve. Suppliers manipulate the rose-growing cycle of their rose plants so that roses mature in great quantities a day or so before Valentine’s Day. As a result, the quantity supplied during the manipulation stage is reduced, and the supply curve for those days shifts to the left, raising price. Although the supply curve on Valentine’s Day increases, the demand curve for roses increases even more so, increasing the price of a rose to $3. 50. 103

QUESTIONS and ANSWERS • How do you explain the fact that years ago, cheese QUESTIONS and ANSWERS • How do you explain the fact that years ago, cheese was considered the poor person’s food, selling for less than a quarter of the price of beef? Today, beef and cheese are priced approximately the same. 104

QUESTIONS and ANSWERS • How do you explain the fact that years ago, cheese QUESTIONS and ANSWERS • How do you explain the fact that years ago, cheese was considered the poor person’s food, selling for less than a quarter of the price of beef? Today, beef and cheese are priced approximately the same. • There are several acceptable explanations. Suppose people’s tastes for meat change because they believe that red meat is unhealthy. The demand curve for red meat falls, causing the price of red meat to fall. If people substitute cheese for meat, the demand curve for cheese shifts to the right, and the price of cheese rises. The combination of falling meat prices and rising cheese prices may result in both prices being equal. 105

QUESTIONS and ANSWERS • Jerry Seinfeld is a very funny comedian. He always sells QUESTIONS and ANSWERS • Jerry Seinfeld is a very funny comedian. He always sells out. So how do you explain the fact that when ticket prices are $10 , there are lines around the block a mile long for those tickets, and when the price is $40, he sells out, but there are no lines to be seen. 106

QUESTIONS and ANSWERS • Jerry Seinfeld is a very funny comedian. He always sells QUESTIONS and ANSWERS • Jerry Seinfeld is a very funny comedian. He always sells out. So how do you explain the fact that when ticket prices are $10 , there are lines around the block a mile long for those tickets, and when the price is $40, he sells out, but there are no lines to be seen. • At $10, there is a strong excess demand for tickets (depicted by those long lines described in the question). But at $40, the excess demand disappears (along with those lines) even though there is sufficient demand to fill every seat. 107

QUESTIONS and ANSWERS • Orange juice producers are dismayed and puzzled. An economist told QUESTIONS and ANSWERS • Orange juice producers are dismayed and puzzled. An economist told them that the reason the demand for orange juice fell is that a new technology allows tomato producers to pick ripe tomatoes more quickly, with less damage and at lower cost. Can you make the connection? 108

QUESTIONS and ANSWERS • Orange juice producers are dismayed and puzzled. An economist told QUESTIONS and ANSWERS • Orange juice producers are dismayed and puzzled. An economist told them that the reason the demand for orange juice fell is that a new technology allows tomato producers to pick ripe tomatoes more quickly, with less damage and at lower cost. Can you make the connection? • Here’s the connection. For many people, orange juice and tomato juice are substitute goods. When the new technology lowers the costs of production of tomato juice, the supply curve for tomato juice shifts to the right, causing the price of tomato juice to fall. As a result, the demand curve for orange juice—the substitute good— shifts to the left, lowering the price of orange juice. 109

QUESTIONS and ANSWERS • Professor Carrie Meyer of George Mason University presents her students QUESTIONS and ANSWERS • Professor Carrie Meyer of George Mason University presents her students with the following scenario: “Suppose a frost destroys much of the coffee harvest in Colombia. Show why equilibrium price and quantity change. Suppose, during this period, many coffee drinkers learn to kick the coffee habit. What happens to price an quantity when coffee production returns to normal in the following year? ” How would you answer her question? 110

QUESTIONS and ANSWERS • • Professor Carrie Meyer of George Mason University presents her QUESTIONS and ANSWERS • • Professor Carrie Meyer of George Mason University presents her students with the following scenario: “Suppose a frost destroys much of the coffee harvest in Colombia. Show why equilibrium price and quantity change. Suppose, during this period, many coffee drinkers learn to kick the coffee habit. What happens to price an quantity when coffee production returns to normal in the following year? ” How would you answer her question? Because of the frost, the supply curve shifts to the left, causing the price of coffee to rise and the quantity bought and sold to fall. But, during the same period, coffee drinkers kick the habit so that the demand curve shifts to the left, causing both price and the quantity bought and sold to fall. Net result? Because one factor raises price while another lowers it, we really don’t know what happens to price. But quantity definitely falls. The next year, with coffee production back to normal, the supply curve shifts to the left—to its initial position—but with fewer coffee drinkers around (many having kicked the habit), the demand curve stays where it was. The only effect on price, then, is the decrease in demand, so price and quantity are lower than they were before last year’s frost. 111

PROBLEMS • Suppose the communities of Urbana, Champaign, Rantoul, and Danville make up the PROBLEMS • Suppose the communities of Urbana, Champaign, Rantoul, and Danville make up the east-central Illinois market for eggplant. And suppose, at a price of $2, the quantity demanded in Champaign is 2, 000, in Urbana 1, 000 in Rantoul 400, and in Danville 600. When price falls to $1 the quantity demanded in Champaign becomes 3, 000 in Urbana 1, 500, in Rantoul 500, and in Danville 700. With these data, graph the east-central Illinois market for eggplant, connecting the points to form a demand curve. 112

PROBLEMS • • Suppose the communities of Urbana, Champaign, Rantoul, and Danville make up PROBLEMS • • Suppose the communities of Urbana, Champaign, Rantoul, and Danville make up the east-central Illinois market for eggplant. And suppose, at a price of $2, the quantity demanded in Champaign is 2, 000, in Urbana 1, 000 in Rantoul 400, and in Danville 600. When price falls to $1 the quantity demanded in Champaign becomes 3, 000 in Urbana 1, 500, in Rantoul 500, and in Danville 700. With these data, graph the east-central Illinois market for eggplant, connecting the points to form a demand curve. 1. Market demand is the sum of individual demands and regional demand is the sum of each community’s demands. In this case, draw a demand curve showing the two data points given—quantity demanded is 4, 000 at a price of $2 and 6, 000 at a price of $1. Draw a line connecting these points to the horizontal and vertical axes. That’s the demand curve. Note that at $4, few if any eggplants would be demanded. At $0. 50, quantity demanded would be approximately 7, 000. See the following exhibit. 113

Problems • Suppose people leave neighboring Indiana and Iowa to settle in east-central Illinois. Problems • Suppose people leave neighboring Indiana and Iowa to settle in east-central Illinois. Show on the graph of practice problem 1 what happens to the demand curve for eggplant in the east-central Illinois market. 114

Problems • Suppose people leave neighboring Indiana and Iowa to settle in east-central Illinois. Problems • Suppose people leave neighboring Indiana and Iowa to settle in east-central Illinois. Show on the graph of practice problem 1 what happens to the demand curve for eggplant in the eastcentral Illinois market. • The demand curve would shift to the right. At every price, quantity demanded would be greater. 115

Problems • Would such an influx of people to eastcentral Illinois change the demand Problems • Would such an influx of people to eastcentral Illinois change the demand curve for eggplant or the quantity demanded of eggplant? 116

Problems • Would such an influx of people to east-central Illinois change the demand Problems • Would such an influx of people to east-central Illinois change the demand curve for eggplant or the quantity demanded of eggplant? • It would change the demand for eggplants. A change in quantity demanded shows movement along the same demand curve. In this case, however, the demand curve itself shifts to the right. 117

Problems • Suppose the market for holiday candles was described by the following schedule Problems • Suppose the market for holiday candles was described by the following schedule • Draw the demanded and supply curves and identify the equilibrium price. What effect would a 1, 000 -unit decrease in demand at every price level have on the demand curve, supply curve, and equilibrium price? 118

Problems • Suppose the market for holiday candles was described by the following schedule Problems • Suppose the market for holiday candles was described by the following schedule • Draw the demanded and supply curves and identify the equilibrium price. What effect would a 1, 000 -unit decrease in demand at every price level have on the demand curve, supply curve, and equilibrium price? • The equilibrium price is $3. 50 and the quantity bought and sold is 3, 500. When the demand curve shifts to the left, reflecting the decrease in demand—there are 1, 000 fewer candles demanded at every price—the equilibrium price falls to $3 and the quantity bought and sold falls to 3, 000. The supply curve remains unchanged. See the following exhibit. 119

Problems • The following are the various demand supply schedules for pizza. Let’s start Problems • The following are the various demand supply schedules for pizza. Let’s start by assuming that the demand supply on the pizza market and D 2 and S 2. (a) What is the equilibrium price an quantity of pizza? (b) Now suppose people’s tastes switch to pizza. What happens to equilibrium price and quantity? (c) Let’s add another change to the market. This time let’s assume that, although what that change in taste, the price of pizza ingredients (cheese, onions, and so on) falls. What happens to equilibrium price. (a) If demand supply on the market are D 2 and S 2, equilibrium price is $4 and equilibrium quantity is 12. (b) The demand curve changes to D 3. Equilibrium price increases to $5 and equilibrium quantity increases to 14. (c) The supply curve changes to S 3. Equilibrium price falls back to $4 and equilibrium quantity increases to 16. 120

Activities • • 3 4 5 6 7 8 Unit 1 Multiple Choice Questions, Activities • • 3 4 5 6 7 8 Unit 1 Multiple Choice Questions, Short Free. Response Questions, Long Free-Response Questions 121