Ch03:demand, supply, and market equilibrium

CHAPTERCHAPTER 3
Prepared by: Fernando QuijanoPrepared by: Fernando Quijano
and Yvonn Quijanoand Yvonn Quijano
© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray Fair
Demand, Supply,
and Market Equilibrium

CHAPTER3:CHAPTER3:
2 of© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray Fair
Firms and Households:
The Basic Decision-Making Units
• A firm is an organization that
transforms resources (inputs) into
products (outputs). Firms are the
primary producing units in a market
economy.
• An entrepreneur is a person who
organizes, manages, and assumes the
risks of a firm, taking a new idea or a
new product and turning it into a
successful business.
• Households are the consuming units in
an economy.

CHAPTER3:CHAPTER3:
Input Markets and Output Markets:
The Circular Flow
• The circular flow of
economic activity
shows how firms
and households
interact in input and
output markets.

CHAPTER3:CHAPTER3:
The Circular Flow
• Product or output
markets are the markets
in which goods and
services are exchanged.
• Input markets are the
markets in which
resources—labor,
capital, and land—used
to produce products, are
exchanged.

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The Circular Flow
• Goods and services flowGoods and services flow
clockwise. Firms provideclockwise. Firms provide
goods and services;goods and services;
households supply laborhouseholds supply labor
services.services.
• Payments (usually money)Payments (usually money)
flow in the oppositeflow in the opposite
direction (counterclockwise)direction (counterclockwise)
as the flow of laboras the flow of labor
services, goods, andservices, goods, and
services.services.

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The Circular Flow
• Input or factor markets are the
markets in which the resources used
to produce products are exchanged.
They include:
• The labor market, in which
households supply work for wages
to firms that demand labor.

CHAPTER3:CHAPTER3:
The Circular Flow
They include:
• The capital market, in which
households supply their savings,
for interest or for claims to future
profits, to firms that demand funds
to buy capital goods.

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The Circular Flow
They include:
• The land market, in which
households supply land or other
real property in exchange for rent.

CHAPTER3:CHAPTER3:
The Circular Flow
• Inputs into the production
process are also called
factors of production.

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10
Demand in Product/Output Markets
• The price of the product in
question.
• The income available to the
household.
• A household’s decision about the
quantity of a particular output to
demand depends on:

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11
• The household’s amount of
accumulated wealth.
• The prices of other products
(substitutes and complements)
available to the household.
demand depends on:

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12
• The household’s tastes and
preferences.
• The household’s expectations
about future income, wealth, and
prices.
demand depends on:

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13
• Quantity demanded is the
amount (number of units) of a
product that a household would
buy in a given time period if it
could buy all it wanted at the
current market price.

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Changes in Quantity Demanded
Versus Changes in Demand
• The most important
relationship in individual
markets is that between
market price and quantity
demanded.

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15
• We use the ceteris paribus or “all
else equal” device, to examine the
relationship between the quantity
demanded of a good per period of
time and the price of that good, while
holding income, wealth, other prices,
tastes, and expectations constant.

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16
• Changes in price affect the
quantity demanded per period.
• Changes in income, wealth,
other prices, tastes, or
expectations affect demand.

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Price and Quantity Demanded:
The Law of Demand
• A demand schedule
is a table showing
how much of a given
product a household
would be willing to
buy at different prices.
• Demand curves are
usually derived from
demand schedules.
PRICE
(PER CALL)
QUANTITY
DEMANDED
(CALLS PER
MONTH)
$ 0 30
0.50 25
3.50 7
7.00 3
10.00 1
15.00 0
ANNA'S DEMAND
SCHEDULE FOR
TELEPHONE CALLS

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18
The Law of Demand
• The demand curve is
a graph illustrating
how much of a given
product a household
would be willing to buy
at different prices.
PRICE
(PER
CALL)
QUANTITY
DEMANDED
(CALLS PER
MONTH)
$ 0 30
0.50 25
3.50 7
7.00 3
10.00 1
15.00 0
ANNA'S DEMAND
SCHEDULE FOR
TELEPHONE CALLS

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19
The Law of Demand
• The law of demand
states that there is a
negative, or inverse,
relationship between
price and the quantity
of a good demanded
and its price.
• This means that
demand curves slope
downward.

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20
Other Determinants
of Household Demand
• Income is the sum of all households
wages, salaries, profits, interest
payments, rents, and other forms of
earnings in a given period of time. It
is a flow measure.
• Wealth, or net worth, is the total
value of what a household owns
minus what it owes. It is a stock
measure.

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21
Other Determinants
of Household Demand
• Normal Goods are goods for which
demand goes up when income is
higher and for which demand goes
down when income is lower.
• Inferior Goods are goods for which
demand falls when income rises.

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22
Other Determinants
of Household Demand
• Substitutes are goods that
can serve as replacements for
one another; when the price of
one increases, demand for the
other goes up.
• Perfect substitutes are
identical products.

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23
Other Determinants
of Household Demand
• Complements are goods that
“go together”; a decrease in
the price of one results in an
increase in demand for the
other, and vice versa.

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24
Shift of Demand Versus
Movement Along a Demand Curve
• A change in demand is not
the same as a change in
quantity demanded.
• A higher price causes lower
quantity demanded and a
move along the demand
curve DA.
• Changes in determinants of
demand, other than price,
cause a change in demand,
or a shift of the entire
demand curve, from DA to DB.

CHAPTER3:CHAPTER3:
25
A Change in Demand Versus
a Change in Quantity Demanded
To summarize:
Change in price of a good or service
leads to
Change in quantity demanded
(Movement along the curve).
Change in income, preferences, or
prices of other goods or services
leads to
Change in demand
(Shift of curve).

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The Impact of a Change in Income
• Higher income
decreases the demand
for an inferior good
• Higher income
increases the demand
for a normal good

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27
The Impact of a Change
in the Price of Related Goods
• Price of hamburger rises
• Demand for
complement
good
(ketchup)
shifts left
• Demand for
substitute
good
(chicken)
shifts right
• Quantity of hamburger
demanded per month falls

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28
From Household
Demand to Market Demand
• Demand for a good or service can be
defined for an individual
household, or for a group of
households that make up a market.
• Market demand is the sum of all the
quantities of a good or service
demanded per period by all the
households buying in the market for
that good or service.

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29
From Household
Demand to Market Demand
• Assuming there are only two households in the
market, market demand is derived as follows:

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30
Supply in Product/Output Markets
• Supply decisions depend
on profit potential.
• Profit is the difference
between revenues and
costs.

CHAPTER3:CHAPTER3:
31
• A supply schedule is a
table showing how much
of a product firms will
supply at different prices.
• Quantity supplied
represents the number of
units of a product that a
firm would be willing and
able to offer for sale at a
particular price during a
given time period.
PRICE
(PER
BUSHEL)
QUANTITY
SUPPLIED
(THOUSANDS
OF BUSHELS
PER YEAR)
$ 2 0
1.75 10
2.25 20
3.00 30
4.00 45
5.00 45
CLARENCE BROWN'S
SUPPLY SCHEDULE
FOR SOYBEANS
Supply in Product/Output Markets

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32
Price and Quantity Supplied:
The Law of Supply
• AA supply curvesupply curve is a graph illustrating howis a graph illustrating how
much of a product a firm will supply permuch of a product a firm will supply per
period of time at different prices.period of time at different prices.
0
1
2
3
4
5
6
0 10 20 30 40 50
Thousands of bushels of soybeans
produced per year
Priceofsoybeansperbushel($)
PRICE
(PER
BUSHEL)
QUANTITY
SUPPLIED
(THOUSANDS
OF BUSHELS
PER YEAR)
$ 2 0
1.75 10
2.25 20
3.00 30
4.00 45
5.00 45
CLARENCE BROWN'S
SUPPLY SCHEDULE
FOR SOYBEANS

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Price and Quantity Supplied:
The Law of Supply
• The law of supply
states that there is a
positive relationship
between price and
quantity of a good
supplied.
• This means that
supply curves typically
have a positive slope.
0
1
2
3
4
5
6
0 10 20 30 40 50
Thousands of bushels of soybeans
produced per year
Priceofsoybeansperbushel($)

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34
Other Determinants of Supply
• The price of the good or service.
• The cost of producing the good,
which in turn depends on:
• The price of required inputs
(labor, capital, and land),
• The technologies that can be
used to produce the product,
• The prices of related products.

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35
• A higher price causesA higher price causes
higher quantityhigher quantity
suppliedsupplied, and a, and a
move alongmove along thethe
demand curve.demand curve.
• A change in determinantsA change in determinants
of supply other than priceof supply other than price
causes ancauses an increase inincrease in
supplysupply, or a, or a shiftshift of theof the
entire supply curve, fromentire supply curve, from
SSAA toto SSBB..
Shift of Supply Versus
Movement Along a Supply Curve

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36
• In this example, since the
factor affecting supply is not
the price of soybeans but a
technological change in
soybean production, there is
a shift of the supply curve
rather than a movement
along the supply curve.
• The technological advance means that
more output can be supplied for at any
given price level.
Shift of Supply Curve for Soybeans
Following Development of a New Seed Strain

CHAPTER3:CHAPTER3:
37
To summarize:
Change in price of a good or service
leads to
Change in quantity supplied
(Movement along the curve).
Change in costs, input prices, technology, or prices of
related goods and services
leads to
Change in supply
(Shift of curve).
Shift of Supply Versus
Movement Along a Supply Curve

CHAPTER3:CHAPTER3:
38
From Individual
Supply to Market Supply
• The supply of a good or service can
be defined for an individual firm, or
for a group of firms that make up a
market or an industry.
• Market supply is the sum of all the
quantities of a good or service
supplied per period by all the firms
selling in the market for that good or
service.

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From Individual
Supply to Market Supply
• As with market demand, market
supply is the horizontal summation
of individual firms’ supply curves.

CHAPTER3:CHAPTER3:
40
Market Equilibrium
• Market equilibrium is
the condition that exists
when quantity supplied
and quantity demanded
are equal.
• At equilibrium, there is no
tendency for the market
price to change.

CHAPTER3:CHAPTER3:
41
Market Equilibrium
• Only in equilibrium is
quantity supplied
equal to quantity
demanded.
• At any price levelAt any price level
other thanother than PP00, such as, such as
PP11, quantity supplied, quantity supplied
does not equaldoes not equal
quantity demanded.quantity demanded.

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Excess Demand
• Excess demand, or
shortage, is the condition
that exists when quantity
demanded exceeds
quantity supplied at the
current price.
• When quantity demanded
exceeds quantity supplied,
price tends to rise until
equilibrium is restored.

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43
Excess Supply
• Excess supply, or surplus,
is the condition that exists
when quantity supplied
exceeds quantity demanded
at the current price.
• When quantity supplied
exceeds quantity demanded,
price tends to fall until
equilibrium is restored.

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44
Changes in Equilibrium
• Higher demand leads to
higher equilibrium price and
higher equilibrium quantity.
• Higher supply leads to
lower equilibrium price and
higher equilibrium quantity.

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45
Changes in Equilibrium
• Lower demand leads to
lower price and lower
quantity exchanged.
• Lower supply leads to
higher price and lower
quantity exchanged.

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46
Relative Magnitudes of Change
• The relative magnitudes of change in supply and demand
determine the outcome of market equilibrium.

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47
Relative Magnitudes of Change
• When supply and demand both increase, quantityWhen supply and demand both increase, quantity
will increase, but price may go up or down.will increase, but price may go up or down.

CHAPTER3:CHAPTER3:
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Review Terms and Concepts
capital marketcapital market
complements, complementary goodscomplements, complementary goods
demand curvedemand curve
demand scheduledemand schedule
entrepreneurentrepreneur
equilibriumequilibrium
excess demand or shortageexcess demand or shortage
excess supply or surplusexcess supply or surplus
factors of productionfactors of production
firmfirm
householdshouseholds
perfect substitutesperfect substitutes
product or output marketsproduct or output markets
profitprofit
quantity demandedquantity demanded
quantity suppliedquantity supplied
shift of a demand curveshift of a demand curve
substitutessubstitutes
supply curvesupply curve
supply schedulesupply schedule
wealth or net worthwealth or net worth
incomeincome
inferior goodsinferior goods
input or factor marketsinput or factor markets
labor marketlabor market
land marketland market
law of demandlaw of demand
law of supplylaw of supply
market demandmarket demand
market supplymarket supply
movement along amovement along a
demand curvedemand curve
normal goodsnormal goods

Ch03:demand, supply, and market equilibrium

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