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Chapter 3 DEMAND SUPPLY © 2013 Cengage Learning Gottheil — Principles of 1 Chapter 3 DEMAND SUPPLY © 2013 Cengage Learning Gottheil — Principles of 1

Economic Principles Individual and market demand Market-day, short-run and long-run supply Determination of equilibrium Economic Principles Individual and market demand Market-day, short-run and long-run supply Determination of equilibrium price and quantity © 2013 Cengage Learning Gottheil — Principles of 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. © 2013 Cengage Learning Gottheil — Principles of 3

Measuring Market Demand A change in quantity demanded shows: • People’s willingness to buy Measuring Market Demand A change in quantity demanded shows: • People’s willingness to buy specific quantities of a good or service at specific prices. © 2013 Cengage Learning Gottheil — Principles of 4

Measuring Market Demand Law of demand • The inverse relationship between price and quantity Measuring Market Demand Law of demand • The inverse relationship between price and quantity demanded. © 2013 Cengage Learning Gottheil — Principles of 5

Measuring Market Demand schedule • A schedule which shows the specific quantity of a Measuring Market 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. © 2013 Cengage Learning Gottheil — Principles of 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. © 2013 Cengage Learning Gottheil — Principles of 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 • 3 + 3 + 3 + 3 = 21. of $1? © 2013 Cengage Learning Gottheil — Principles of 8

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. © 2013 Cengage Learning Gottheil — Principles of 9

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. © 2013 Cengage Learning Gottheil — Principles of 10

Measuring Supply A supply curve graphs the relationship between price and quantity supplied. © Measuring Supply A supply curve graphs the relationship between price and quantity supplied. © 2013 Cengage Learning Gottheil — Principles of 11

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. © 2013 Cengage Learning Gottheil — Principles of 12

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 • 4 + 4 = 12. this price? © 2013 Cengage Learning Gottheil — Principles of 13

EXHIBIT 1 A INDIVIDUAL DEMAND CURVES FOR FISH © 2013 Cengage Learning Gottheil — EXHIBIT 1 A INDIVIDUAL DEMAND CURVES FOR FISH © 2013 Cengage Learning Gottheil — Principles of 14

EXHIBIT 1 B INDIVIDUAL DEMAND CURVES FOR FISH © 2013 Cengage Learning Gottheil — EXHIBIT 1 B INDIVIDUAL DEMAND CURVES FOR FISH © 2013 Cengage Learning Gottheil — Principles of 15

EXHIBIT 2 © 2013 Cengage Learning THE MARKET DEMAND CURVE Gottheil — Principles of EXHIBIT 2 © 2013 Cengage Learning THE MARKET DEMAND CURVE Gottheil — Principles of 16

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. © 2013 Cengage Learning Gottheil — Principles of 17

EXHIBIT 3 © 2013 Cengage Learning MARKET-DAY SUPPLY CURVE Gottheil — Principles of 18 EXHIBIT 3 © 2013 Cengage Learning MARKET-DAY SUPPLY CURVE Gottheil — Principles of 18

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: cannot change the • Fishermen quantity they supply once the day’s catch comes in. © 2013 Cengage Learning Gottheil — Principles of 19

EXHIBIT 4 EXCESS DEMAND EXCESS SUPPLY © 2013 Cengage Learning Gottheil — Principles of EXHIBIT 4 EXCESS DEMAND EXCESS SUPPLY © 2013 Cengage Learning Gottheil — Principles of 20

Exhibit 4: Excess Demand Excess Supply The quantity of fish purchased, when price rises Exhibit 4: Excess Demand Excess Supply The quantity of fish purchased, when price rises from $5 to $8: • Remains at 6, 000. • The market-day supply curve is a vertical line. © 2013 Cengage Learning Gottheil — Principles of 21

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 • Quantity demanded is 4, 500. $8 is: • Quantity supplied is 6, 000. • Excess supply of 1, 500. © 2013 Cengage Learning Gottheil — Principles of 22

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 • Quantity demanded is 6, 500. $4 is: • Quantity supplied is 6, 000. • Excess demand of 500. © 2013 Cengage Learning Gottheil — Principles of 23

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. © 2013 Cengage Learning Gottheil — Principles of 24

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. © 2013 Cengage Learning Gottheil — Principles of 25

EXHIBIT 5 MARKET-DAY, SHORT-RUN, AND LONG-RUN SUPPLY © 2013 Cengage Learning Gottheil — Principles EXHIBIT 5 MARKET-DAY, SHORT-RUN, AND LONG-RUN SUPPLY © 2013 Cengage Learning Gottheil — Principles of 2 6 26

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: then in the short-run If price rises, suppliers are able to increase the use of some but not all of the resources they use to produce goods and services. © 2013 Cengage Learning Gottheil — Principles of 27

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 • The short-run suppliers are able to: because: • Make modest increases in quantity supplied if price rises. • Make modest decreases in quantity supplied if price falls. © 2013 Cengage Learning Gottheil — Principles of 28

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 • This results because: in a short-run supply curve which is steeply upward • sloping. The quantity supplied is fixed on the market-day supply curve. © 2013 Cengage Learning Gottheil — Principles of 29

Exhibit 5: Market-Day, Short-Run, and Long-Run Supply curve is The long-run supply less steep Exhibit 5: Market-Day, Short-Run, and Long-Run Supply curve is The long-run supply 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. increase in price will result A given in a larger increase in quantity supplied in the long run than in the short run. 30 Gottheil — Principles of © 2013 Cengage Learning

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. in price results in a • A change in quantity demanded. • A change in demand is caused by factors other than a change in the price of that good. © 2013 Cengage Learning Gottheil — Principles of 31

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. © 2013 Cengage Learning Gottheil — Principles of 32

EXHIBIT 6 © 2013 Cengage Learning CHANGE IN DEMAND Gottheil — Principles of 33 EXHIBIT 6 © 2013 Cengage Learning CHANGE IN DEMAND Gottheil — Principles of 33

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. © 2013 Cengage Learning Gottheil — Principles of 34

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. © 2013 Cengage Learning Gottheil — Principles of 35

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. © 2013 Cengage Learning Gottheil — Principles of 36

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 fromprice of beef declines: If the D to D″. • The quantity of beef demanded will increase. • The demand curve for fish will shift left. © 2013 Cengage Learning Gottheil — Principles of 37

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 • A declines: hardwarein 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. © 2013 Cengage Learning Gottheil — Principles of 38

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 • The increase in the quantity of hardware declines: software demanded was caused by a factor other than the price of • software. The demand for software will increase. © 2013 Cengage Learning Gottheil — Principles of 39

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. © 2013 Cengage Learning Gottheil — Principles of 40

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 • The demand for day-old bakery goods will: goods will fall as consumer • incomes rise. are goods that Inferior goods people consume less of as their incomes rise. © 2013 Cengage Learning Gottheil — Principles of 41

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. © 2013 Cengage Learning Gottheil — Principles of 42

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. © 2013 Cengage Learning Gottheil — Principles of 43

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: and jelly i. Peanut butter ii. Coke and Pepsi iii. Cars and gasoline iv. Telephones and telephone books © 2013 Cengage Learning Gottheil — Principles of 44

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 Gottheil — Principles of © 2013 Cengage Learning 45

EXHIBIT 7 © 2013 Cengage Learning DISTINGUISHING CHANGES IN DEMAND FROM CHANGES IN QUANTITY EXHIBIT 7 © 2013 Cengage Learning DISTINGUISHING CHANGES IN DEMAND FROM CHANGES IN QUANTITY DEMANDED Gottheil — Principles of 46

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 • Quantity in change demanded. © 2013 Cengage Learning Gottheil — Principles of 47

Exhibit 7: Distinguishing Changes in Demand from Changes in Quantity Demanded do we In Exhibit 7: Distinguishing Changes in Demand from Changes in Quantity Demanded do we In which of the following 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. © 2013 Cengage Learning Gottheil — Principles of 48

Exhibit 7: Distinguishing Changes in Demand from Changes in Quantity Demanded do we In Exhibit 7: Distinguishing Changes in Demand from Changes in Quantity Demanded do we In which of the following 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. © 2013 Cengage Learning Gottheil — Principles of 49

EXHIBIT 8 © 2013 Cengage Learning CHANGE IN SUPPLY Gottheil — Principles of 50 EXHIBIT 8 © 2013 Cengage Learning CHANGE IN SUPPLY Gottheil — Principles of 50

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. © 2013 Cengage Learning Gottheil — Principles of 51

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″. © 2013 Cengage Learning Gottheil — Principles of 52

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. © 2013 Cengage Learning Gottheil — Principles of 53

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). © 2013 Cengage Learning Gottheil — Principles of 54

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). © 2013 Cengage Learning Gottheil — Principles of 55

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: will reduce the market supply of • This corn, because many corn farmers will switch to growing soybeans. © 2013 Cengage Learning Gottheil — Principles of 56

EXHIBIT 9 A INCREASES IN DEMAND SUPPLY © 2013 Cengage Learning Gottheil — Principles EXHIBIT 9 A INCREASES IN DEMAND SUPPLY © 2013 Cengage Learning Gottheil — Principles of 57

EXHIBIT 9 B INCREASES IN DEMAND SUPPLY © 2013 Cengage Learning Gottheil — Principles EXHIBIT 9 B INCREASES IN DEMAND SUPPLY © 2013 Cengage Learning Gottheil — Principles of 58

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. of an increase in both supply The effect 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 59 © 2013 Cengage Learning Gottheil — Principles of

EXHIBIT 10 A INCREASES IN DEMAND, DECREASES IN SUPPLY © 2013 Cengage Learning Gottheil EXHIBIT 10 A INCREASES IN DEMAND, DECREASES IN SUPPLY © 2013 Cengage Learning Gottheil — Principles of 60

EXHIBIT 10 B INCREASES IN DEMAND, DECREASES IN SUPPLY © 2013 Cengage Learning Gottheil EXHIBIT 10 B INCREASES IN DEMAND, DECREASES IN SUPPLY © 2013 Cengage Learning Gottheil — Principles of 61

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: equilibrium price increases, • The but equilibrium quantity decreases. This effect is illustrated in Exhibit 10, panel a. © 2013 Cengage Learning Gottheil — Principles of 62

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. © 2013 Cengage Learning Gottheil — Principles of 63

Demand Supply The equilibrium price of oranges will be affected if the demand for Demand Supply The equilibrium price of oranges will be affected if the demand for oranges decreases, while at the same time the supply of oranges • The equilibrium price of oranges will fall. increases: • The relative magnitude of the changes in supply and demand is needed before we can determine how the equilibrium quantity of oranges will change. © 2013 Cengage Learning Gottheil — Principles of 64

Katrina and Gasoline Prices Hurricane The real problem with Katrina and the price of Katrina and Gasoline Prices Hurricane The real problem with Katrina and the price of gasoline was due to: use of gasoline as they i. The refugees escaped. ii. The destruction of the Gulf Coast oil rigs. iii. The cutback in oil refining capacity. © 2013 Cengage Learning Gottheil — Principles of 65

Katrina and Gasoline Prices Hurricane The real problem with Katrina and the price of Katrina and Gasoline Prices Hurricane The real problem with Katrina and the price of gasoline was due to: use of gasoline as they i. The refugees escaped. ii. The destruction of the Gulf Coast oil rigs. iii. The cutback in oil refining capacity. © 2013 Cengage Learning Gottheil — Principles of 66

EXHIBIT 11 © 2013 Cengage Learning The Market for Gasoline Gottheil — Principles of EXHIBIT 11 © 2013 Cengage Learning The Market for Gasoline Gottheil — Principles of 67

Exhibit 11: The Market for Gasoline The cutback in refinery capacity shifts the supply Exhibit 11: The Market for Gasoline The cutback in refinery capacity shifts the supply curve way to the left, from S to S 0. What happens? • Quantity decreases from 400 million gals. to 360 million per day. • The average market price for gasoline increases from a pre. Katrina $2 per gal. to a post. Katrina $3. © 2013 Cengage Learning Gottheil — Principles of 68

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 as shown in Exhibit 12, which depicts 250 people and those willing to pay the market price for fish. © 2013 Cengage Learning Gottheil — Principles of 69

EXHIBIT 12 A RATIONING FUNCTION OF PRICE © 2013 Cengage Learning Gottheil — Principles EXHIBIT 12 A RATIONING FUNCTION OF PRICE © 2013 Cengage Learning Gottheil — Principles of 70

Exhibit 12: Rationing Function of Price Panel a shows what 250 people will pay Exhibit 12: Rationing Function of Price Panel a shows what 250 people will pay for fish at various prices. Only those willing to pay the market price get the fish. All others don’t. So who gets them? Look at panel b. © 2013 Cengage Learning Gottheil — Principles of 71

EXHIBIT 12 B RATIONING FUNCTION OF PRICE © 2013 Cengage Learning Gottheil — Principles EXHIBIT 12 B RATIONING FUNCTION OF PRICE © 2013 Cengage Learning Gottheil — Principles of 72

Exhibit 12: Rationing Function of Price Panel b shows market for fish and its Exhibit 12: Rationing Function of Price Panel b shows market for fish and its equilibrium price. So who gets them? • Only those willing to pay the market price get the fish. • The demand curve D and supply curve S generate a market price of $6 and a quantity demanded and supplied of 100. It means 100 of the 250 end up with fish. © 2013 Cengage Learning Gottheil — Principles of 73