Before you jump into the demand-supply model, be sure that your students understand that a price in economics is relative price and that a relative price is an opportunity cost. Also spend some class time ensuring that they appreciate the key lessons of Chapter 2: a) Prosperity comes from specialization and exchange. b) Specialization and exchange requires the social institutions of property rights and markets. c) We must understand how markets work. You might like to explain that the most competitive markets are explicitly organized as auctions. An interesting market to describe is that at Aalsmeer in Holland, which handles a large percentage of the world’s fresh cut flowers. Roses grown in Columbia are flown to Amsterdam, auctioned at Aalsmeer, and are in vases in New York, London, and Tokyo all in less than a day. If you have an Internet connection in your classroom, you can participate in a simulation of an auction of flowers. Here is the URL (which you can also click on at the Parkin Web site) http://www.batky-howell.com/~jb/auction/daauction.cgi .
Estimating the demand for Coke (or bottled water) in the classroom. Of the hundreds of classroom experiments that are available today, very few are worth the time they take to conduct. The classic demand-revealing experiment is one of the most productive and worthwhile ones. Bring to class two bottles of ice-cold, ready-to-drink Coke, bottled water, or sports drink. (If your class is very large, bring six bottles). Tell the students that you have these drinks and ask them to indicate if they would like one. Most hands will go up and you are now ready to make two points: 1. The students have just revealed a want but not a demand. 2. You don’t have enough bottles to satisfy their wants, so you need an allocation mechanism. Ask the students to suggest some allocation mechanisms. You might get suggestions such as: give them to the oldest, the youngest, the tallest, the shortest, the first-to-the-front-of-the-class. For each one, point out the difficulty/inefficiency/inequity. If no one suggests selling them to the highest bidder, tell the class that you are indeed going to do just that. Tell them that this auction is real. The winner will get the drink and will pay. Now ask for a show of hands of those who have some cash and can afford to buy a drink. Explain that these indicate an ability to buy but not a definite plan to buy. Continues on next (hidden) slide notes page.
Now begin the auction. Appoint a student to count hands (more than one for a big class) and appoint another student to keep a spreadsheet (see the Parkin Website for a sample that you can download). Begin at a low price: say 10¢ a bottle and count the number willing to buy. Raise the price in 10¢ increments and keep tally of the number who are willing to buy at each price. When the number willing to buy equals the number of bottles you have for sale, do the transactions. (If you make a profit, and you might do so, tell the students that the profit, small though it is, will go the department fund for undergraduate activities—and deliver on that promise.) Now use the data to make a demand curve for Coke (or other drink) in your classroom today. Emphasize the law of demand. Emphasize that every demand curve relates to a market for the good (as defined by geography or some other spatial dimension) and for a given time period. Now that you have a demand curve, you can do some thought experiments that will shift it. Ask: How would this demand curve have been different if the temperature in the classroom was 10 degrees higher/lower? How would this demand curve have been different if half the class was sick and absent today? How would this demand curve have been different if there was a Coke machine right in the classroom? (Save your demand data for later. We’ll make some suggestions for its further use in Chapter 4.)
Estimating the supply of Coke (or bottled water) in the classroom. (It is best to do this next classroom activity on a different day from the demand experiment.) Tell the students that you would like a Coke (or other drink) that is available from a machine somewhere near the classroom and you want someone to get it for you. You are going to continue teaching while the student is out of the room and you will be giving hints about what is on the next test. Ask the students to raise their hand if they are willing to fetch one can of Coke if you pay $5.00. Write down the number. Lower the price you’ve willing to pay in $1 increments until the number of students willing to fetch you the drink begins to decrease. Keep track of the numbers. Lower the price you’re willing to pay in 25¢ increments until you get close to only having one student willing to fetch you the drink. Keep track of the numbers. Lower the price in smaller increments if necessary until just one student is willing to fetch you a drink. Continues on next (hidden) slide notes page.
Now use the data to make a supply curve for Coke (or other drink) in your classroom today. Emphasize the law of supply. Emphasize that every supply curve relates to a market for the good (as defined by geography or some other spatial dimension) and for a given time period. Now that you have a supply curve, you can do some thought experiments that will shift it. Ask: How would this supply curve have been different if the coke machine was a mile away? How would this supply curve have been different if half the class was sick and absent today? How would this supply curve have been different if there was a Coke machine right in the classroom? How would this supply curve have been different if the temperature in the classroom was 10 degrees higher/lower?
The magic of market equilibrium and the forces that bring it about and keep the market there need to be demonstrated with the basic diagram, with intuition, and, if you’ve got the time, with hard evidence in the form of further class activity. You might want to begin with the demand curve experiment and explain that in that market, the supply was fixed (vertical supply curve) at the quantity of bottles that you brought to class. The equilibrium occurred where the market demand curve (demand by the students) intersected your supply curve. Then you might use the supply curve experiment and explain that in that market, demand was fixed (vertical demand curve) at the quantity that you had decided to buy. The equilibrium occurred where the market supply curve (supply by the students) intersected your demand curve. Point out that the trades you made in your little economy made buyers and sellers better off. If you want to devote a class to equilibrium and the gains from trade in a market, you might want to run a double oral auction. There are lots of descriptions of these and one of the best is at Marcelo Clerici-Arias’s Web site at Stanford University— http://www.stanford.edu/~marcelo/index.html?Teaching/Docs/Experiments/Auction/auction.htm~mainFrame
The whole chapter builds up to this section, which now brings all the elements of demand, supply, and equilibrium together to make predictions. Students are remarkably ready to guess the consequences of some event that changes either demand or supply or both. They must be encouraged to work out the answer and draw the diagram . Explain that the way to answer any question that seeks a prediction about the effects of some events on a market has five steps. Walk them through the steps and have one or two students work some examples in front of the class. The five steps are: 1.Draw a demand-supply diagram and label the axes with the price and quantity of the good or service in question. 2. Think about the events that you are told occur and decide whether they change demand, supply, both demand and supply, or neither demand nor supply. 3. Do the events that change demand or supply bring an increase or a decrease? 4. Draw the new demand curve and supply curve on the diagram. Be sure to shift the curves in the correct direction—leftward for decrease and rightward for increase. (Lots of students want to move the curves upward for increase and downward for decrease—works ok for demand but exactly wrong for supply. Emphasize the left-right shift.) 5. Find the new equilibrium and compare it with the original one. Walk them through the steps and have one or two students work some examples in front of the class. It is critical at this stage to return to the distinction between a change in demand (supply) and a change in the quantity demanded (supplied). You can now use these distinctions to describe the effects of events that change market outcomes. At this point, the students know enough for it to be worthwhile emphasizing the magic of the market’s ability to coordinate plans and reallocate resources.
DE AND AND SUPPL M Y 3 CH T R AP E
ObjectivesAfter studying this chapter, you will be able to: Describe a competitive market and think about a price as an opportunity cost Explain the influences on demand Explain the influences on supply Explain how demand and supply determine prices and quantities bought and sold Use demand and supply to make predictions about changes in prices and quantities
Slide, Rocket, Roller CoasterSome prices slide, some rocket, and some roller coaster.This chapter explains how prices are determined and howmarkets guide and coordinate choices.
Markets and PricesA market is any arrangement that enables buyers andsellers to get information and do business with each other.A competitive market is a market that has many buyersand many sellers so no single buyer or seller can influencethe price.The money price of a good is the amount of moneyneeded to buy it.The relative price of a good—the ratio of its money priceto the money price of the next best alternative good—is itsopportunity cost.
DemandIf you demand something, then you: Want it, Can afford it, and Have made a definite plan to buy it.Wants are the unlimited desires or wishes people have forgoods and services. Demand reflects a decision aboutwhich wants to satisfy.The quantity demanded of a good or service is theamount that consumers plan to buy during a particulartime period, and at a particular price.
DemandWhat Determines Buying Plans?The amount of any particular good or service thatconsumers plan to buy is influenced by1. The price of the good,2. The prices of other goods,3. Expected future prices,4. Income,5. Population, and6. Preferences.
DemandThe Law of DemandThe law of demand states:Other things remaining the same, the higher the price of agood, the smaller is the quantity demanded.The law of demand results from a substitution effect an income effect
Demand Substitution effect—when the relative price (opportunity cost) of a good or service rises, people seek substitutes for it, so the quantity demanded decreases. Income effect—when the price of a good or service rises relative to income, people cannot afford all the things they previously bought, so the quantity demanded decreases.
DemandDemand Curve and Demand ScheduleThe term demand refers to the entire relationship betweenthe price of the good and quantity demanded of the good.A demand curve shows the relationship between thequantity demanded of a good and its price when all otherinfluences on consumers’ planned purchases remain thesame.
DemandFigure 3.1 shows ademand curve forrecordable compact discs(CD-Rs).A rise in the price, otherthings remaining the same,brings a decrease in thequantity demanded and amovement along thedemand curve.
Demand A demand curve is also a willingness-and-ability- to-pay curve. The smaller the quantity available, the higher is the price that someone is willing to pay for another unit. Willingness to pay measures marginal benefit.
DemandA Change in DemandWhen any factor that influences buying plans other thanthe price of the good changes, there is a change indemand for that good. The quantity of the good thatpeople plan to buy changes at each and every price, sothere is a new demand curve.When demand increases, the quantity that people plan tobuy increases at each and every price so the demandcurve shifts rightward.When demand decreases, the quantity that people plan tobuy decreases at each and every price so the demandcurve shifts leftward.
DemandTable 3.1 (page 62) summarizes the factors that changedemand. They are:Prices of related goodsA substitute is a good that can be used in place ofanother good.A complement is a good that is used in conjunction withanother good.When the price of substitute for CD-Rs rises or when theprice of a complement for CD-Rs falls, the demand for CD-Rs increases.
Demand Figure 3.2 shows the shift in the demand curve for CD-Rs when the price of CD burner falls. Because a CD burner is a complement of a CD-R, the demand for CD-Rs increases.
DemandExpected future pricesIf the price of a good is expected to rise in the future,current demand increases and the demand curve shiftsrightward.IncomeWhen income increases, consumers buy more of mostgoods and the demand curve shifts rightward. A normalgood is one for which demand increases as incomeincreases. An inferior good is a good for which demanddecreases as income increases.
Demand Population The larger the population, the greater is the demand for all goods. Preferences People with the same income have different demands if they have different preferences.
DemandA Change in the QuantityDemanded Versus aChange in DemandFigure 3.3 illustrates thedistinction between achange in demand and achange in the quantitydemanded.
DemandWhen the price of thegood changes andeverything else remainsthe same, there is achange in the quantitydemanded and amovement along thedemand curve.
Demand When one of the otherfactors that influencebuying plans changes,there is a change indemand and a shift of thedemand curve.
SupplyIf a firm supplies a good or service, then the firm: Has the resources and the technology to produce it, Can profit form producing it, and Has made a definite plan to produce and sell it.Resources and technology determine what it is possibleto produce. Supply reflects a decision about whichtechnologically feasible items to produce.The quantity supplied of a good or service is the amountthat producers plan to sell during a given time period at aparticular price.
SupplyWhat Determines Selling Plans?The amount of any particular good or service that a firmplans to supply is influenced by1. The price of the good,2. The prices of resources needed to produce it,3. The prices of related goods produced,4. Expected future prices,5. The number of suppliers, and6. Available technology.
SupplyThe Law of SupplyThe law of supply states:Other things remaining the same, the higher the price of agood, the greater is the quantity supplied.The law of supply results from the general tendency forthe marginal cost of producing a good or service toincrease as the quantity produced increases (Chapter 2,page 35).Producers are willing to supply only if they at least covertheir marginal cost of production.
SupplySupply Curve and Supply ScheduleThe term supply refers to the entire relationship betweenthe quantity supplied and the price of a good.The supply curve shows the relationship between thequantity supplied of a good and its price when all otherinfluences on producers’ planned sales remain the same.
SupplyFigure 3.4 shows a supplycurve of recordablecompact discs (CD-Rs).A rise in the price, otherthings remaining the same,brings an increase in thequantity supplied and amovement along thesupply curve.
SupplyA supply curve is also aminimum-supply-pricecurve.The greater the quantityproduced, the higher is theprice that a firm mustoffered to be willing toproduce that quantity.
SupplyA Change in SupplyWhen any factor that influences selling plans other thanthe price of the good changes, there is a change insupply of that good. The quantity of the good thatproducers plan to sell changes at each and every price, sothere is a new supply curve.When supply increases, the quantity that producers plan tosell increases at each and every price so the supply curveshifts rightward.When supply decreases, the quantity that producers planto sell decreases at each and every price so the supplycurve shifts leftward.
SupplyTable 3.2 (page 67) summarizes the factors that changesupply. They are:Prices of productive resourcesIf the price of resource used to produce a good rises, theminimum price that a supplier is willing to accept forproducing each quantity of that good rises. So a rise in theprice of productive resources decreases supply and shiftsthe supply curve leftward.
Supply Prices of related goods produced A substitute in production for a good is another good that can be produced using the same resources. Goods are compliments in production if they must be produced together. The supply of a good increases and its supply curve shifts rightward if the price of a substitute in production falls or if the price of a complement in production rises.
Supply Expected future prices If the price of a good is expected to fall in the future, current supply increases and the supply curve shifts rightward. The number of suppliers The larger the number of suppliers of a good, the greater is the supply of the good. An increase in the number of suppliers shifts the supply curve rightward.
Supply Technology Advances in technology create new products and lower the cost of producing existing products, so they increase supply and shift the supply curve rightward.
SupplyFigure 3.5 shows how anadvance in the technologyfor producing recordableCDs increases the supplyof CD-Rs and shifts thesupply curve for CD-Rsrightward.
SupplyA Change in the QuantitySupplied Versus aChange in SupplyFigure 3.6 illustrates thedistinction between achange in supply and achange in the quantitysupplied.
Supply When the price of the good changes and other influences on selling plans remain the same, there is a change in the quantity supplied and a movement along the supply curve.
SupplyWhen one of the otherfactors that influenceselling plans changes,there is a change insupply and a shift of thesupply curve.
Market EquilibriumEquilibrium is a situation in which opposing forces balanceeach other. Equilibrium in a market occurs when the pricebalances the plans of buyers and sellers.The equilibrium price is the price at which the quantitydemanded equals the quantity supplied.The equilibrium quantity is the quantity bought and soldat the equilibrium price. Price regulates buying and selling plans. Price adjusts when plans don’t match.
Market EquilibriumPrice as a RegulatorFigure 3.7 illustrates theequilibrium price andequilibrium quantity in themarket for CD-Rs.If the price of a disc is $2,the quantity suppliedexceeds the quantitydemanded and there is asurplus of discs.
Market EquilibriumIf the price of a disc is $1,the quantity demandedexceeds the quantitysupplied and there is ashortage of discs.If the price of a disc is$1.50, the quantitydemanded equals thequantity supplied andthere is neither a shortagenor a surplus of discs.
Market EquilibriumPrice AdjustmentsAt prices above theequilibrium, a surplusforces the price down.At prices below theequilibrium, a shortageforces the price up.At the equilibrium price,buying plans selling plansagree and the pricedoesn’t change.
Market EquilibriumBecause the price rises if itis below equilibrium, falls ifit is above equilibrium, andremains constant if it is atthe equilibrium, the price ispulled toward theequilibrium and remainsthere until some eventchanges the equilibrium.
Predicting Changes in Price and QuantityA Change in DemandFigure 3.8 shows the effectof a change in demand.An increase in demandshifts the demand curverightward and creates ashortage at the originalprice.The price rises and thequantity suppliedincreases.
Predicting Changes in Price and QuantityA Change in Supply Figure 3.9 shows the effect of a change in supply.An increase in supplyshifts the supply curverightward and creates asurplus at the originalprice.The price falls and thequantity demandedincreases.
Predicting Changes in Price and QuantityA Change in BothDemand and SupplyA change both demandand supply changes theequilibrium price and theequilibrium quantity but weneed to know the relativemagnitudes of the changesto predict some of theconsequences.
Predicting Changes in Price and QuantityFigure 3.10 shows theeffects of a change in bothdemand and supply in thesame direction. Anincrease in both demandand supply increases theequilibrium quantity buthas an uncertain effect onthe equilibrium price.
Predicting Changes in Price and QuantityFigure 3.11 shows theeffects of a change in bothdemand and supply whenthey change in oppositedirections. An increase insupply and a decrease indemand lowers theequilibrium price but hasan uncertain effect on theequilibrium quantity.