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MB MC
Supply and Demand:An Introduction
Supply and Demand:An Introduction
Chapter 3 - Supply and Demand: An Introduction Slide 2
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Supply and Demand: An Introduction
How do consumers get the goods and services they want in the right quantities and qualities?Some goods and services are allocated by
the market forces of supply and demand
Chapter 3 - Supply and Demand: An Introduction Slide 3
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Supply and Demand: An Introduction
Why do some goods and services have shortages or surpluses and others do not?Some good and supplies services are
regulated by government
Chapter 3 - Supply and Demand: An Introduction Slide 4
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
What, How, and For Whom? Central Planning Versus the Market
Three Problems All Economic Systems Must AddressWhat should be produced?How should it be produced?For whom will it be produced?
Chapter 3 - Supply and Demand: An Introduction Slide 5
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
What, How, and For Whom? Central Planning Versus the Market
Centralized Economic OrganizationsAgrarian societyFormer Soviet UnionCubaNorth KoreaChinaBureaucracy
Chapter 3 - Supply and Demand: An Introduction Slide 6
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
What, How, and For Whom? Central Planning Versus the Market
A small number of individuals address:What
Establish production targets for factories and farms
HowPlan how to achieve the goals
For WhomDistribute the goods and services
produced
Chapter 3 - Supply and Demand: An Introduction Slide 7
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
What, How, and For Whom? Central Planning Versus the Market
Free-Market or Capitalist Economic SystemIndividual choices determine:
Which careers to pursueWhich products to produce or buyWhen to start and shut-down a businessWho gets what is decided by individual
preferences and purchasing power
Chapter 3 - Supply and Demand: An Introduction Slide 8
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Buyers and Sellers In Markets
MarketConsists of all buyers and sellers of a good
or service What do you think?
What determines the price of pizza, gasoline, a car wash, or other goods and services?
Chapter 3 - Supply and Demand: An Introduction Slide 9
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Buyers and Sellers In Markets
The Demand CurveA schedule or graph that tells us the
quantity of a good that buyers wish to buy at each price
Chapter 3 - Supply and Demand: An Introduction Slide 10
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Buyers and Sellers In Markets
A Property of DemandAs price of a good or service goes down
the quantity consumers wish to buy will increase
Therefore, the demand curve is downward-sloping
Chapter 3 - Supply and Demand: An Introduction Slide 11
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
The Daily DemandCurve for Pizza in Chicago
Price($ per slice)
Quantity(1000s of slices per day)
4
8
2
16
3
12
Demand
Chapter 3 - Supply and Demand: An Introduction Slide 12
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Buyers and Sellers In Markets
The Demand CurveWhy do buyers purchase a greater quantity
at lower prices and vice-versa?The substitution effectThe income effect
Chapter 3 - Supply and Demand: An Introduction Slide 13
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Buyers and Sellers In Markets
The Substitution EffectThe change in the quantity demanded of a
good that results because buyers switch to substitutes when the price of the good changes
Chapter 3 - Supply and Demand: An Introduction Slide 14
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Buyers and Sellers In Markets
The Income EffectThe change in the quantity demanded of a
good that results because a change in the price of a good changes the buyer’s purchasing power
Chapter 3 - Supply and Demand: An Introduction Slide 15
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Buyers and Sellers In Markets
The Cost-Benefit PrincipleThe reservation price is the benefit the buyer
receives from the goodThe cost of the good is its market priceIf the reservation price (benefit) exceeds the
market price (cost) the consumer will purchase the good
At higher prices, benefit will exceed cost for a smaller quantity than at lower prices
Chapter 3 - Supply and Demand: An Introduction Slide 16
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Buyers and Sellers In Markets
Price($ per slice)
Quantity(1000s of slices per day)
Demand
8 12 16
The buyers reservation price: The largest dollar amount the buyer would be willing to pay for a good
4
2
3
Chapter 3 - Supply and Demand: An Introduction Slide 17
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Buyers and Sellers In Markets
Horizontal Interpretation
Price determines quantity demanded
Price($ per slice)
4
2
3
8 12 16
Demand
Chapter 3 - Supply and Demand: An Introduction Slide 18
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Buyers and Sellers In Markets
Vertical Interpretation
Quantity measures the marginal buyer’s reservation price
Price($ per slice)
4
2
3
8 12 16
Demand
Chapter 3 - Supply and Demand: An Introduction Slide 19
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Buyers and Sellers In Markets
The Supply CurveA curve or schedule showing the quantity
of a good that sellers wish to sell at each price
Chapter 3 - Supply and Demand: An Introduction Slide 20
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Buyers and Sellers In Markets
QuestionWill the opportunity cost of producing
additional units of pizza increase or decrease?
Hint:Low-hanging-fruit principle
Chapter 3 - Supply and Demand: An Introduction Slide 21
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Buyers and Sellers In Markets
The Supply CurveSellers must receive a higher price to
produce additional units of product to cover the higher opportunity costs of each additional unit
Chapter 3 - Supply and Demand: An Introduction Slide 22
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
The Daily SupplyCurve for Pizza in Chicago
Price($ per slice)
Quantity(1000s of slices per day)
4
2
3
8 12 16
Supply
Chapter 3 - Supply and Demand: An Introduction Slide 23
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
The Daily SupplyCurve for Pizza in Chicago
Price($ per slice)
Quantity(1000s of slices per day)
4
2
3
8 12 16
Supply
Horizontal Interpretation
Shows the quantity produced
for each price
Chapter 3 - Supply and Demand: An Introduction Slide 24
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
The Daily SupplyCurve for Pizza in Chicago
Price($ per slice)
Quantity(1000s of slices per day)
4
2
3
8 12 16
Supply
Vertical Interpretation
Shows the marginal cost (reservation
price) for producing each additional unit
Chapter 3 - Supply and Demand: An Introduction Slide 25
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Seller’s Reservation PriceThe smallest dollar amount for which a
seller would be willing to sell an additional unit, generally equal to marginal cost
The Daily SupplyCurve for Pizza in Chicago
Chapter 3 - Supply and Demand: An Introduction Slide 26
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Market Equilibrium
EquilibriumA system is in equilibrium when there is no
tendency for it to change Market Equilibrium
Occurs in a market when all buyers and sellers are satisfied with their respective quantities at the market price
Chapter 3 - Supply and Demand: An Introduction Slide 27
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
The Equilibrium Price and Quantity of Pizza In Chicago
Price($ per slice)
Quantity(1000s of slices per day)
4
2
3
8 12 16
Supply
Demand
Equilibrium at $3
Quantity Demanded =
Quantity Supplied
Chapter 3 - Supply and Demand: An Introduction Slide 28
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Market Equilibrium
Equilibrium Price and Equilibrium QuantityThe values of price and quantity for which
quantity supplied and quantity demanded are equal
Chapter 3 - Supply and Demand: An Introduction Slide 29
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
What Do You Think?Would buyers prefer a lower price than the
equilibrium price?Would sellers prefer a higher price than the
equilibrium price?
Market Equilibrium
Chapter 3 - Supply and Demand: An Introduction Slide 30
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Excess Supply
Price($ per slice)
Quantity(1000s of slices per day)
4
2
3
8 12 16
Supply
Demand
Excess supply = 8,000 slices per day
Chapter 3 - Supply and Demand: An Introduction Slide 31
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Excess Demand
Price($ per slice)
Quantity(1000s of slices per day)
4
2
3
8 16
Excess demand = 8,000slices per day
Supply
Demand
Chapter 3 - Supply and Demand: An Introduction Slide 32
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Points Along the Demand and Supply Curves of a Pizza Market
Demand for pizza Supply of pizza
Price
($/slice)
Quantity demanded
(1000s of slices/day)
Price
($/slice)
Quantity supplied
(1000s of slices/day)
1 8 1 2
2 6 2 4
3 4 3 6
4 2 4 8
Chapter 3 - Supply and Demand: An Introduction Slide 33
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Graphing Supply and Demand and Finding the Equilibrium Price and Quantity
Price($per slice)
Quantity(1000s of slices per day)
5
2
3
4
1
4
102
Demand
0 6 8
Supply
2.50
5
The Equilibrium Price = $2.50The Equilibrium Quantity = 5
Chapter 3 - Supply and Demand: An Introduction Slide 34
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Market Equilibrium
What Do You Think?Is the market equilibrium always an ideal
outcome for all market participants?
Chapter 3 - Supply and Demand: An Introduction Slide 35
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
An Unregulated Housing Market
Monthly Rent($/apartment)
Quantity(Millions of apartments/day)
1,600
2
Supply
Demand
What Do You Think?Is $1600 more than some people can afford?
Chapter 3 - Supply and Demand: An Introduction Slide 36
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Rent Controls
Monthly Rent($/apartment)
Quantity(Millions of apartments/day)
1,600
2
Supply
Demand
2,400
Controlled = 800
1 30
Excess demand = 2 million apartments per month
Chapter 3 - Supply and Demand: An Introduction Slide 37
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Market Equilibrium
Rent Controls ReconsideredOther consequences of rent controls
Maintenance will decline and housing quality will fall
Illegal paymentsCreation of co-ops and conversion to
condominiumsReduction in household mobilityDiscrimination
Chapter 3 - Supply and Demand: An Introduction Slide 38
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Market Equilibrium
What do you think?How can we make housing affordable for
poor people without using rent ceilings?
Chapter 3 - Supply and Demand: An Introduction Slide 39
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Rent Controls
Monthly Rent($/apartment)
Quantity(Millions of apartments/day)
800
2
Supply
Demand
1,200
1 30
What is the impact of a rent control set at $1,200/month?
Chapter 3 - Supply and Demand: An Introduction Slide 40
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Price Controls In The Pizza Market
Price($ per slice)
Quantity(1000s of slices per day)
Supply
Demand
Excess demand = 8,000 slices per day
4
Price ceiling = 2
3
8 12 16
Chapter 3 - Supply and Demand: An Introduction Slide 41
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Market Equilibrium
Pizza Price Controls?Market responses to a pizza price ceiling
Long linesPreferential treatment to selected customersAlternative pricing strategiesPoorer quality ingredientsBlack-market pizzas
Chapter 3 - Supply and Demand: An Introduction Slide 42
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Predicting and Explaining Changes In Prices and Quantities
Distinguishing Between:A change in the quantity demanded
A movement along the demand curve that occurs in response to a change in price
A change in demandA shift of the entire demand curve
Chapter 3 - Supply and Demand: An Introduction Slide 43
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
An Increase In Quantity Demanded vs. An Increase In Demand
Price($/can)
Quantity(1000s of cans/day)
5
2
3
4
1
4
122
6
0 106 8
Increase in quantity
demanded
D
Chapter 3 - Supply and Demand: An Introduction Slide 44
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
An Increase In Quantity Demanded vs. An Increase In Demand
Price($/can)
Quantity(1000s of cans/day)
5
2
3
1
4
12
6
0
Increase in demand
D
D
D’
D’
Chapter 3 - Supply and Demand: An Introduction Slide 45
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Predicting and Explaining Changes In Prices and Quantities
Change in the quantity suppliedA movement along the supply curve that
occurs in response to a change in price Change in supply
A shift of the entire supply curve
Chapter 3 - Supply and Demand: An Introduction Slide 46
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
An Increase In Quantity Supplied vs. An Increase In Supplied
Price($/can)
Quantity(1000s of cans/day)
5
2
3
4
1
4
102
6
0 6 8
S
S
Increase in quantity supplied
Chapter 3 - Supply and Demand: An Introduction Slide 47
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
An Increase In Quantity Supplied vs. An Increase In Supplied
Price($/can)
Quantity(1000s of cans/day)
5
2
3
4
1
4
102
6 S
0 6 8
S
S’
S’
Increase in supply
Chapter 3 - Supply and Demand: An Introduction Slide 48
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
The Effect on the Market for TennisBalls of a Decline in Court-Rental Fees
Price($/ball)
Quantity(letters/month)
1.00
S
D
40
D’
1.40
58
Chapter 3 - Supply and Demand: An Introduction Slide 49
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Predicting and Explaining Changes In Prices and Quantities
Shifts in DemandComplements
Two goods are complements in consumption if an increase (decrease) in the price of one cause a decrease (increase) in the demand for the other
Chapter 3 - Supply and Demand: An Introduction Slide 50
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
The Effect on the Market for Overnight LetterDelivery of a Decline in the Price of Internet Access
Price($/letter)
Quantity(letters/month)
P
Q
S
D
P’
Q’
D’
Chapter 3 - Supply and Demand: An Introduction Slide 51
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Predicting and Explaining Changes In Prices and Quantities
Shifts in DemandSubstitutes
Two goods are substitutes in consumption if an increase (decrease) in the price of one causes an increase (decrease) in the demand for the other
Chapter 3 - Supply and Demand: An Introduction Slide 52
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Predicting and Explaining Changes In Prices and Quantities
What do you think?How will a decline in airfares affect inter-
city bus fares and the price of hotel rooms in resort communities?
Chapter 3 - Supply and Demand: An Introduction Slide 53
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Predicting and Explaining Changes In Prices and Quantities
Economic NaturalistWhen the Federal Government implements
a large pay increase for its employees, why do rents for apartments near Washington Metro stations go up relative to rents for apartments located far away from Metro stations?
Chapter 3 - Supply and Demand: An Introduction Slide 54
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
The Effect of a Federal Pay Raise on the Rent for Conveniently Located Apartments in Washington D.C.
Rent(dollars per
month)
Conveniently located apartments(units per month)
D
P
Q
S
P’
Q’
D’
Chapter 3 - Supply and Demand: An Introduction Slide 55
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Predicting and Explaining Changes In Prices and Quantities
Shifts in DemandChanges In Demand
An increase (decrease) in the demand for a good will shift the demand curve to the right (left)
Chapter 3 - Supply and Demand: An Introduction Slide 56
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Predicting and Explaining Changes In Prices and Quantities
A Change In IncomeNormal Good
One whose demand increases (decreases) when the incomes of buyers increase (decrease)
Chapter 3 - Supply and Demand: An Introduction Slide 57
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Predicting and Explaining Changes In Prices and Quantities
A Change In IncomeInferior Good
One whose demand decreases (increases) when the incomes of buyers increase (decrease)
Chapter 3 - Supply and Demand: An Introduction Slide 58
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
The Effect of the Release of JurassicPark on the Market for Toy Dinosaurs
Price
Toy Dinosaurs(units per month)
P
Q
D
S
D’
P’
Q’
D’ = demand after release of movie
Chapter 3 - Supply and Demand: An Introduction Slide 59
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
The Effect of a Credible Rumor onthe Market for Apple Macintosh Computers
Price
Apple Computers(units per month)
P
Q
S
D
P’
Q’
D’
D’ = demand after rumor of cheaper model soon to be released
Chapter 3 - Supply and Demand: An Introduction Slide 60
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
The Effect of the Increase inthe Population of Potential Buyers
Price
Housing NY City(units per month)
P
Q
S
D
P’
Q’
D’
D’ = demand after increase in population
Chapter 3 - Supply and Demand: An Introduction Slide 61
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Predicting and Explaining Changes In Prices and Quantities
Factors that Shift DemandPrice of complementsPrice of substitutesIncomePreferencesPopulation of potential buyersExpectations
Chapter 3 - Supply and Demand: An Introduction Slide 62
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
The Effect on the Skateboard Market of an Increase in the Price of Fiberglass
Price($/skateboard)
Quantity(skateboards/month)
60
1000
S
D
80
800
S’
Chapter 3 - Supply and Demand: An Introduction Slide 63
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Predicting and Explaining Changes In Prices and Quantities
What Do You Think?Does the increase in the cost of fiberglass
have any effect on the demand curve for skateboards?
Chapter 3 - Supply and Demand: An Introduction Slide 64
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
The Effect on the Market for New Houses of a Decline in Carpenters’ Wage Rates
Price($1000/house)
Quantity(houses/month)
120
40
D
S
90
50
S’
Chapter 3 - Supply and Demand: An Introduction Slide 65
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
The Effect of Technical Change on the Market for the Term Paper Revisions
Price($/revision)
Quantity(millions of revisions per year)
55
12
D
S
7.50
36
S’
Chapter 3 - Supply and Demand: An Introduction Slide 66
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Predicting and Explaining Changes In Prices and Quantities
Factors that Shift SupplyCosts of productionTechnologyWeatherNumber of suppliersExpectations
Chapter 3 - Supply and Demand: An Introduction Slide 67
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Price
Quantity
P
P’
Q Q’
S
D’D
An increase in demand will lead to an increasein both the equilibrium price and quantity
Four Rules Governing the Effects of Supply And Demand Shifts
Chapter 3 - Supply and Demand: An Introduction Slide 68
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Price
Quantity
P’
P
Q’ Q
S
DD’
A decrease in demand will lead to a decreasein both the equilibrium price and quantity
Four Rules Governing the Effects of Supply And Demand Shifts
Chapter 3 - Supply and Demand: An Introduction Slide 69
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
P’
P
Q Q’
S’
D
SPrice
Quantity
An increase in supply will lead to adecrease in the equilibrium priceand an increase in the equilibrium quantity
Four Rules Governing the Effects of Supply And Demand Shifts
Chapter 3 - Supply and Demand: An Introduction Slide 70
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
P
P’
Q’ Q
S
D
S’Price
Quantity
An decrease in supply will lead toan increase in the equilibrium priceand a decrease in the equilibrium quantity
Four Rules Governing the Effects of Supply And Demand Shifts
Chapter 3 - Supply and Demand: An Introduction Slide 71
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Predicting and Explaining Changes In Prices and Demand
Factors That Cause an Increase (rightward or upward shift) in Demand
1. A decrease in the price of complements to the good or service
2. An increase in the price of substitutes for the good or service
3. An increase in income (for a normal good)
Chapter 3 - Supply and Demand: An Introduction Slide 72
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Predicting and Explaining Changes In Prices and Demand
Factors That Cause an Increase (rightward or upward shift) in Demand
4. An increased preference by demanders for the good or service
5. An increase in the population of potential buyers
6. An expectation of higher prices in the future
Chapter 3 - Supply and Demand: An Introduction Slide 73
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Predicting and Explaining Changes In Prices and Demand
Factors That Cause an Increase (rightward or upward shift) in Supply
1. A decrease in the cost of materials, labor, or other inputs used in the production of the good or service
2. An improvement in technology that reduces the cost of producing the good or service
Chapter 3 - Supply and Demand: An Introduction Slide 74
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Predicting and Explaining Changes In Prices and Demand
Factors That Cause an Increase (rightward or upward shift) in Supply
3. An improvement in the weather, especially for agricultural products
4. An increase in the number of suppliers
5. An expectation of lower prices in the future
Chapter 3 - Supply and Demand: An Introduction Slide 75
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
The Effects Of Simultaneous Shifts In Supply And Demand
Price($/bag)
Millions of bags per month
P
Q
S
D
P’
Q’
D’
S’S’ after reduction in price of corn harvesting equipment
D’ after discovery that oils are harmful to people’s health
The Market for Corn Tortilla Chips
Chapter 3 - Supply and Demand: An Introduction Slide 76
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
The Effects Of Simultaneous Shifts In Supply And Demand
Price($/bag)
Millions of bags per month
P
Q
S
D
P’
Q’
D’
S’
D’ after discovery that oils are harmful to people’s health
S’ after reduction in price of corn harvesting equipment
The Market for Corn Tortilla Chips
Chapter 3 - Supply and Demand: An Introduction Slide 77
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Predicting and Explaining Changes In Prices and Demand
AssumeA vitamin found in corn chips helps protect
against cancer and heart diseasesSwarm of locusts destroys part of the corn
crop What Do You Think?
What will happen to the equilibrium price and quantity of corn chips?
Chapter 3 - Supply and Demand: An Introduction Slide 78
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Predicting and Explaining Changes In Prices and Demand
Economic NaturalistWhy do the prices of some goods, like
airline tickets to Europe, go up during the months of heaviest consumption, while others, like sweet corn, go down?
Chapter 3 - Supply and Demand: An Introduction Slide 79
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Seasonal Variation in Air Travel
Price($/ticket)
1000s of tickets
S
DS
DW
QW QS
PW
PS
High Consumption and Prices Due to High Demand
Chapter 3 - Supply and Demand: An Introduction Slide 80
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Seasonal Variation in Corn Markets
Price($/bushel)
Millions of bushels
SW
D
QW QS
PW
PS
SS
High Consumption and Low Prices due to High Supply
Chapter 3 - Supply and Demand: An Introduction Slide 81
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Markets And Social Welfare
What Do You Think?When are the prices and quantities
determined in market equilibrium socially optimal, in the sense of maximizing total economic surplus?
Chapter 3 - Supply and Demand: An Introduction Slide 82
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Markets And Social Welfare
Cash On The TableAssume:
All exchange is purely voluntary
If so: The buyer’s reservation price exceeds the
seller’s reservation price and both the buyer and seller receive an economic surplus
Chapter 3 - Supply and Demand: An Introduction Slide 83
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Markets And Social Welfare
Cash On The TableBuyer’s surplus
The difference between the buyer’s reservation price and the price he or she actually pays
Chapter 3 - Supply and Demand: An Introduction Slide 84
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Markets And Social Welfare
Cash On The TableSeller’s surplus
The difference between the price received by the seller and his or her reservation price
Chapter 3 - Supply and Demand: An Introduction Slide 85
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Markets And Social Welfare
Cash On The TableTotal surplus
The difference between the buyer’s reservation price and the seller’s reservation price
Chapter 3 - Supply and Demand: An Introduction Slide 86
MB MC
Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Markets And Social Welfare
Cash On The TableEconomic metaphor for unexploited gains
from exchange
Chapter 3 - Supply and Demand: An Introduction Slide 87
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Price Controls In The Pizza Market
Price($ per slice)
Quantity(1000s of slices per day)
S
D
3
12
4
2
8 16
Assume:•Buyer’s reservation P = $4•Sellers reservation P = $2•Pizza sells for $3
•Buyer’s surplus: $4 - $3 = $1•Seller’s surplus: $3 - $2 = $1•Total surplus: $4 - $2 = $2
Chapter 3 - Supply and Demand: An Introduction Slide 88
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Price Controls In The Pizza Market
Price($ per slice)
Quantity(1000s of slices per day)
Excess demand = $8,000 slices/day
D
4
2
3
8 12 16
Assume price controls = $2•Quantity supplied falls to 8,000•Buyer’s reservation price ($4) is greater than seller’s ($2)
• Both would benefit from additional production
•There is CASH ON THE TABLE
S
Chapter 3 - Supply and Demand: An Introduction Slide 89
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Markets And Social Welfare
Smart For One, Dumb For AllSocially optimal quantity
The quantity of a good that results in the maximum possible economic surplus from producing and consuming the good
The socially optimal quantity occurs when MC = MB
Chapter 3 - Supply and Demand: An Introduction Slide 90
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Markets And Social Welfare
Smart For One, Dumb For AllEconomic efficiency occurs when all goods
and services are produced and consumed at their respective socially optimal levels
Chapter 3 - Supply and Demand: An Introduction Slide 91
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Markets And Social Welfare
Smart For One, Dumb For AllThe Efficiency Principle
Maximize the economic surplusIncreases the economic pie
Chapter 3 - Supply and Demand: An Introduction Slide 92
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Markets And Social Welfare
Smart For One, Dumb For AllWhen is the market equilibrium efficient?
When all cost of producing the good or service are borne directly by the seller
When all benefits from the good or service accrue directly to buyers
Chapter 3 - Supply and Demand: An Introduction Slide 93
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Markets And Social Welfare
Smart For One, Dumb For AllInefficient market equilibrium
When some costs of production fall on people other than those who sell the good or service
Chapter 3 - Supply and Demand: An Introduction Slide 94
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Markets And Social Welfare
Example: PollutionThe market is in equilibrium: MC = MBMC however underestimates the cost to
society of producing the goodTherefore, the market produces more than
the efficient amount and there is no incentive for producers and consumers to alter their behavior
Chapter 3 - Supply and Demand: An Introduction Slide 95
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Markets And Social Welfare
Smart For One, Dumb For AllInefficient market equilibrium
When some benefits from the good or service accrue to people who did not buy the good or service
Chapter 3 - Supply and Demand: An Introduction Slide 96
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Markets And Social Welfare
Example: VaccinationsThe market is in equilibrium: MC = MBMB underestimates the benefits to society of
consuming the vaccinationsThe market produces less than the efficient
amount of vaccinations and there is no incentive for producers and consumers to alter their behavior
Chapter 3 - Supply and Demand: An Introduction Slide 97
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Markets And Social Welfare
Smart For One, Dumb For AllIn these markets
Buyers and sellers are behaving rationally Market equilibrium existsThere are no unexploited opportunities for
individualsEconomic surplus is not maximized
Chapter 3 - Supply and Demand: An Introduction Slide 98
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Copyright c 2007 by The McGraw-HillCompanies, Inc. All rights reserved.
Markets And Social Welfare
The Equilibrium PrincipleA market in equilibrium leaves no
unexploited opportunities for individuals, but may not exploit all gains achievable through collective action.
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End ofChapterEnd of
Chapter