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Ln03 miller950022 17_ln03

  1. 1. Chapter 3 Demand and Supply
  2. 2. Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-2 Introduction Over the past 30 years, college tuition and fees have increased significantly. Annual tuition that would have been about $2,000 in the 1980s is now at a level of around $20,000. Textbook prices have experienced a sizable increase as well. Students now typically pay $1,000 a year for books, compared to an annual expense of about $200 in the 1980s. In this chapter you will learn what has caused these prices to rise.
  3. 3. Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-3 Learning Objectives • Explain the law of demand • Discuss the difference between money prices and relative prices • Distinguish between changes in demand and changes in quantity demanded
  4. 4. Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-4 Learning Objectives (cont'd) • Explain the law of supply • Distinguish between changes in supply and changes in quantity supplied • Understand how supply and demand interact to determine equilibrium price and quantity
  5. 5. Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-5 Chapter Outline • Demand • The Demand Schedule • Shifts in Demand • The Law of Supply • The Supply Schedule • Shifts in Supply • Putting Demand and Supply Together
  6. 6. Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-6 Did You Know That ... • After truck freight-hauling prices jumped in the early 2010s, rail shipments of freight containers rose by more than 10 percent? • Higher truck-transportation prices induced many companies to choose rail transportation as a substitute. • By using demand and supply, you can develop a better understanding of why sometimes we observe large increases in the purchase of items such as rail freight services.
  7. 7. Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-7 Did You Know That … (cont’d) • Market – All of the arrangements that individuals have for exchanging with one another – Examples of markets: • Automobile market • Health-care market • Market for high-speed internet access – One of the most important activities in these markets in the determination of prices.
  8. 8. Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-8 Demand • A schedule showing how much of a good or service people will purchase at any price during a specified time period, other things being constant
  9. 9. Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-9 Demand (cont’d) • Law of Demand – A negative, or inverse, relationship between the price of any good or service and the quantity demanded, holding other factors constant (ceteris paribus) • When the price of a good goes up, people buy less of it, other things being equal. • When the price of a good goes down, people buy more of it, other things being equal.
  10. 10. Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-10 Demand (cont’d) • What are we holding constant? – Income – Tastes and preferences – Price of other goods – Many other factors
  11. 11. Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-11 Demand (cont’d) • Relative prices and money prices – Relative Price • The price of a commodity in terms of another commodity – Money Price • Price we observe today in today’s dollars (absolute, or nominal price)
  12. 12. Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-12 Table 3-1 Money Price versus Relative Price
  13. 13. Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-13 Example: Why Sales of Electric Cars are Stuck in Low Gear • Prices of electric autos exceed prices of hybrid versions by at least 30 percent and prices of gasoline powered versions by 50 percent. • The quality-adjusted prices of electric cars are even higher when we take into account the limited range of distance over which they can operate. • Beyond a distance of roughly 250 miles, the batteries in electric cars cease to function. • This limitation in their usefulness helps explain why sales of electric cars remain a small portion of the overall automobile market.
  14. 14. Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-14 The Demand Schedule • Demand schedule – Table relating prices to quantities demanded – We must also consider: • Time dimension (e.g., per year) • Constant-quality units
  15. 15. Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-15 The Demand Schedule (cont’d) • Demand Curve – A graphical representation of the demand schedule – Negatively sloped line showing the inverse relationship between the price and the quantity demanded (other things being equal)
  16. 16. Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-16 Figure 3-1 The Individual Demand Schedule and the Individual Demand Curve, Panel (a)
  17. 17. Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-17 Figure 3-1 The Individual Demand Schedule and the Individual Demand Curve, Panel (b)
  18. 18. Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-18 The Demand Schedule (cont’d) • Individual versus market demand curves • Market Demand – The demand of all consumers in the marketplace for a particular good or service – Summation at each price of the quantity demanded by each individual
  19. 19. Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-19 Figure 3-2 The Horizontal Summation of Two Demand Curves, Panel (a)
  20. 20. Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-20 Figure 3-2 The Horizontal Summation of Two Demand Curves, Panels (b), (c), (d)
  21. 21. Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-21 Figure 3-3 The Market Demand Schedule for Magneto Optical Disks, Panel (a)
  22. 22. Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-22 Figure 3-3 The Market Demand Schedule for Magneto Optical Disks, Panel (b)
  23. 23. Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-23 Shifts in Demand • Scenario – Imagine the government gives every registered college student in the United States a magneto optical disk drive. • If some factor other than price changes, we can show its effect by moving the entire demand curve, shifting the curve left or right. • In this case, there will be an increase in the number of MO disks demanded at each and every possible price.
  24. 24. Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-24 Figure 3-4 A Shift in the Demand Curve
  25. 25. Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-25 Shifts in Demand (cont’d) • Ceteris-Paribus Conditions – Determinants of the relationship between price and quantity that are unchanged along a curve – Changes in these factors cause a curve to shift
  26. 26. Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-26 Shifts in Demand (cont’d) • Normal Goods – Goods for which demand rises as income rises; most goods are normal goods • Inferior Goods – Goods for which demand falls as income rises
  27. 27. Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-27 Example: Lower Incomes Boost the Demand for Reconditioned Cellphones • U.S. residents who have been out of work or who are classified as discouraged workers are earning much lower incomes than they did a few years ago. • Many of these people have purchased reconditioned cellphones, a cheaper alternative to a new phone. • This allows us to identify reconditioned cellphones as an inferior good.
  28. 28. Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-28 Shifts in Demand (cont’d) • Determinants of demand – Income – Tastes and preferences – The prices of related goods • Substitutes • Complements
  29. 29. Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-29 Shifts in Demand (cont'd) • Substitutes – Two goods are substitutes when a change in the price of one causes a shift in demand for the other in the same direction as the price change
  30. 30. Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-30 Shifts in Demand (cont'd) • Complements – Two goods are complements when a change in the price of one causes an opposite shift in the demand curve for the other
  31. 31. Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-31 Example: Why Fewer Wine Bottles Have Natural Cork Stoppers • Cork bottle stoppers have traditionally been used for wine bottles because wine can “breathe” air through the porous cell structure of natural cork. • Since the early 2000s, prices of natural cork bottle stoppers have risen above prices of plastic stoppers, and this translates into higher prices for wine in cork-furnished bottles. • In response, consumers have purchased more wine bottled with plastic stoppers.
  32. 32. Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-32 Shifts in Demand (cont'd) • Determinants of demand – Expectations • Future prices • Income • Product availability – Market size (number of buyers)
  33. 33. Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-33 Policy Example: An Expected Uranium Price Implosion Cuts Uranium Demand • Following the 2011 earthquake and tsunami in Japan, many countries announced plans to decrease their reliance on nuclear power as a source of energy. • This led to an expectation of lower uranium prices in the future. • As a consequence, purchases of uranium were delayed, and the uranium price dropped immediately.
  34. 34. Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-34 Shifts in Demand (cont'd) • Changes in demand versus changes in quantity demanded – Whenever there is a change in a ceteris paribus condition, there will be a change in demand • A shift of the entire demand curve to the right or to the left • The only thing that can cause the entire curve to move is a change in a determinant other than the good’s own price
  35. 35. Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-35 Shifts in Demand (cont'd) • Changes in demand versus changes in quantity demanded – A change in a good’s own price leads to a change in quantity demanded (a single point on a demand curve) for any given demand curve • A movement along the same demand curve
  36. 36. Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-36 Figure 3-5: Movement Along a Given Demand Curve
  37. 37. Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-37 The Law of Supply • Supply – Schedule showing relationship between price and quantity supplied for a specified time period, other things being equal – The amount of a product or service that firms are willing to sell at alternative prices
  38. 38. Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-38 The Law of Supply (cont'd) • Law of Supply – The higher the price of a good, the more of that good sellers will make available over a specified time period, other things being equal • At higher prices, a larger quantity will generally be supplied than at lower prices, all other things held constant. • At lower prices, a smaller quantity will generally be supplied than at higher prices, all other things held constant.
  39. 39. Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-39 Example: Steel Producers Reduce Production When the Price of Steel Falls • When the market price of steel declined from $660 per ton to below $625 per ton, steel manufacturers responded by cutting back on production. • This is consistent with the upward-sloping supply curve of steel.
  40. 40. Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-40 The Supply Schedule • The supply schedule is a table relating prices to quantity supplied at each price. • Supply Curve – A graphical representation of the supply schedule – Positively sloped line (curve) showing the direct relationship between price and quantity supplied, all else being equal
  41. 41. Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-41 Figure 3-6 The Individual Producer’s Supply Schedule and Supply Curve for Magnetic Optical Disks, Panel (a)
  42. 42. Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-42 Figure 3-6 The Individual Producer’s Supply Schedule and Supply Curve for Magnetic Optical Disks, Panel (b)
  43. 43. Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-43 Figure 3-7 Horizontal Summation of Supply Curves, Panel (a)
  44. 44. Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-44 Figure 3-7 Horizontal Summation of Supply Curves, Panels (b), (c), (d)
  45. 45. Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-45 Figure 3-8 The Market Supply Schedule and the Market Supply Curve for Magnetic Optical Disks, Panel (a)
  46. 46. Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-46 Figure 3-8 The Market Supply Schedule and the Market Supply Curve for Magnetic Optical Disks, Panel (b)
  47. 47. Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-47 Shifts in Supply • Scenario – A new method of manufacturing magnetic optical disks significantly reduces the cost of production. – Producers of MO disks will supply more product at any given price.
  48. 48. Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-48 Example: Cotton Price Movements Squeeze and Stretch Clothing Supply • Between 2009 and 2010, the price of cotton increased by 55 percent. – Clothing manufacturers responded by reducing the number of cotton garments supplied at any given price. • During 2011, cotton prices decreased. – In response, there was an increase in the supply of cotton clothes.
  49. 49. Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-49 Figure 3-9 Shifts in the Supply Curve
  50. 50. Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-50 Shifts in Supply (cont'd) • Determinants of supply – Cost of inputs – Technology and productivity – Taxes and subsidies – Price expectations – Number of firms in industry
  51. 51. Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-51 What If . . . politicians oppose a higher gasoline price yet favor higher fuel taxes? • A decrease in the market supply of gasoline results in higher prices. – Members of Congress may then complain that gas prices are “too high”. – Yet, these same elected officials may favor higher fuel taxes. – A tax imposed on gasoline has the same effect as a decrease in supply.
  52. 52. Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-52 Example: How Deadly Southern Twisters Pummeled U.S. Poultry Supply • Between April 26 and April 28 of 2011, there were 278 tornadoes in the U.S. • Many of the twisters hit Alabama, where poultry farmers typically supply about 12 percent of the national poultry market. • Damage to chicken-processing plants resulted in a decrease in the number of firms supplying the market.
  53. 53. Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-53 Shifts in Supply (cont'd) • Changes in supply versus changes in quantity supplied – Whenever there is a change in a ceteris paribus condition, there will be a change in supply • A shift of the entire supply curve to the right or to the left • The only thing that can cause the entire curve to move is a change in a determinant other than the good’s own price
  54. 54. Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-54 Shifts in Supply (cont'd) • Changes in supply versus changes in quantity supplied – A change in a good’s own price leads to a change in quantity supplied (a single point on a supply curve) for any given supply curve • A movement along the same supply curve
  55. 55. Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-55 Putting Demand and Supply Together • Putting demand and supply together • Equilibrium (Market Clearing) Price – The price that clears the market – The price at which quantity demanded equals quantity supplied – The price where the demand curve intersects the supply curve
  56. 56. Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-56 Figure 3-10 Putting Demand and Supply Together, Panel (a)
  57. 57. Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-57 Figure 3-10 Putting Demand and Supply Together, Panel (b)
  58. 58. Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-58 Putting Demand and Supply Together (cont'd) • Equilibrium – The situation when quantity supplied equals quantity demanded at a particular price – There tends to be no movement of the price of the quantity away from this point unless demand or supply changes – Equilibrium is a stable point – any point that is not equilibrium is unstable and will not persist
  59. 59. Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-59 Putting Demand and Supply Together (cont'd) • The equilibrium price – The price toward which the market price will automatically tend to gravitate, – There is no outcome better than this price for both consumers and producers
  60. 60. Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-60 Putting Demand and Supply Together (cont'd) • Shortages – The situation when quantity demanded is greater than quantity supplied – Exist at any price below the market clearing price – Shortages and scarcity are not the same thing
  61. 61. Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-61 Example: Production Breakdowns Create a Shortage of a Life-Saving Drug • Each year, 20,000 new cases of acute lymphoblastic leukemia are diagnosed. – Cytarabine is the drug commonly used to treat this disease. • Recently, all of the firms manufacturing this drug experienced problems that slowed or halted production of the drug. • A shortage of cytarabine resulted, and the drug was rationed by medical professionals who judged the urgency of need in various individuals.
  62. 62. Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-62 Putting Demand and Supply Together (cont'd) • Surpluses – The situation when quantity supplied is greater than quantity demanded – Exist at any price above the market clearing price
  63. 63. Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-63 Policy Example: Should Shortages in the Ticket Market Be Solved by Scalpers? • If you’ve ever tried to get tickets to the big game you know all about “shortages” • Since the quantity of tickets is fixed, the price can go pretty high • Enter the scalper
  64. 64. Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-64 Figure 3-11 Shortages of Super Bowl Tickets
  65. 65. Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-65 You Are There … Why the Casket Industry Is on Life Support • The CEO of a casket manufacturer described his industry as one that isn’t growing. • Falling prices for a substitute good, cremations, are the primary reason. • The typical price for a traditional casket burial exceeds $7,200. This compares to $1,300 for the average price of a cremation service. • This decreasing price of a lower-priced substitute has caused a decline of the demand for caskets.
  66. 66. Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-66 Issues & Applications: Your Higher Education Bills Really Are Increasing • What explains the higher prices that students are paying for a college education, as compared to prices 30 years ago? • The figure on the following slide displays an index measure of three variables from 1978 to 2010: – 1) U.S. college tuition and fees – 2) U.S. educational books and supplies – 3) The level of consumer prices overall
  67. 67. Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-67 Issues & Applications: Your Higher Education Bills Really Are Increasing (cont’d) Figure 3-12 Indexes of Prices for Higher-Education-Related Items and All Goods and Services since 1978
  68. 68. Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-68 Issues & Applications: Your Higher Education Bills Really Are Increasing (cont’d) • The figure on the preceding slide shows that the money prices of tuition and textbooks have increased substantially since 1978. • The relative prices of these goods have increased as well. • Compared to 1978: – Relative tuition has tripled – Relative textbook prices have doubled • The equilibrium prices of these goods and services have increased over the past four decades.
  69. 69. Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-69 Summary Discussion of Learning Objectives • The law of demand says that prices and quantity demanded are inversely related – At a higher price people buy less, at a lower price people buy more • Relative prices must be distinguished from money prices, since people respond to changes in relative prices
  70. 70. Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-70 Summary Discussion of Learning Objectives (cont'd) • A change in quantity demanded versus a change in demand – A change in quantity demanded is a movement along the same demand curve – A change in demand is a shift of the whole demand curve
  71. 71. Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-71 Summary Discussion of Learning Objectives (cont'd) • The law of supply states that price and quantity supplied are directly related – Firms offer more at a higher price; firms offer less at a lower price • A change in quantity supplied versus a change in supply – A change in quantity supplied is a movement along the same supply curve – A change in supply is a shift of the whole supply curve
  72. 72. Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-72 Summary Discussion of Learning Objectives (cont'd) • Determining market price and equilibrium quantity – The demand and supply curves intersect at the market clearing, or equilibrium point – Surpluses exist if the price of the good is greater than the market price – Shortages exist when the price of a good is below the market price

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