Interaction of Demand and Supply

1. R. GLENN
HUBBAR
D
Economics
FOURTH EDITION
ANTHONY PATRICK
O’BRIE
N

2. 2 of 46© 2012 Pearson Education, Inc. Publishing as Prentice Hall
Chapter Outline and
Learning Objectives
CHAPTER
3
3.1 The Demand Side of the
Market
3.2 The Supply Side of the Market
3.3 Market Equilibrium: Putting
Demand and Supply Together
3.4 The Effect of Demand and
Supply Shifts on Equilibrium
Where Prices Come
From: The Interaction
of Demand and Supply

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Demand for tablet computers
•How many tablets do consumers want to buy?
• Affected by price of the tablets
• Affected by other factors, including prices of other goods
Supply of tablet computers
•How many tablets are producers willing to sell?
• Affected by price of the tablets
• Affected by other factors, including prices of other goods
What determines the price of a tablet computer?

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Discuss the variables that influence demand.
3.1 LEARNING OBJECTIVE
The Demand Side of the Market

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Demand Schedule:
Table showing how
many of a product will
be purchased at
various prices.
Demand Curve:
Graphical
representation of
demand schedule.
Price on y-axis.
Quantity demanded on
x-axis.
Figure 3.1
Demand

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Law of Demand:
As price changes,
quantity demanded
changes in opposite
direction, ceteris
paribus.
Implication:
Demand curve slopes
downward
Ceteris Paribus:
Latin phrase meaning
“all else equal”
Figure 3.1
Demand

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Figure 3.2A change in
something other than
price that affects
demand causes the
entire demand curve
to shift.
A shift to the right (D1
to D2) is an increase
in demand.
A shift to the left (D1
to D3) is a decrease
in demand.
Changes in demand

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Figure 3.2As the demand curve
shifts, the quantity
demanded is likely to
change, even if the
price doesn’t change.
The quantity
demanded changes
at every possible
price.
P1
Q3 Q1 Q2
Changes in demand

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Income of consumers
Increase in income increases demand if product is normal,
decreases demand if product is inferior.
Price of related goods
Increase in price of related good increases demand if
products are substitutes, decreases demand if products are
complements
Tastes and preferences
Population and demographics
Expected future prices
What would cause a change in demand?

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Normal goods:
Goods for which the demand increases as
income rises, and decreases as income falls
Examples: Clothing
Restaurant meals
Vacations
Inferior goods:
Goods for which the demand decreases as
income rises, and increases as income falls
Examples: Second-hand clothing
Ramen noodles
Are tablet computers normal or inferior goods?
Probably normal
Effect of increase in income,
if good is normal
Effect of increase in income,
if good is inferior
Changes in demand: consumer incomes

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Substitutes:
Goods and services that can be used for
the same purpose
Examples: Big Mac and Whopper
Ford F-150 and Dodge Ram
Jeans and Khakis
Complements:
Goods and services that are consumed
together
Examples: Big Mac and McDonald’s fries
Hot dogs and hot dog buns
Left shoes and right shoes
Effect on demand for Big
Macs, if price of Whopper
increases
Effect on demand for Big
Macs, if price of McDonald’s
fries increases
Changes in demand: Price of related goods

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If consumers’ tastes or preferences change,
they may buy more or less of the product
Example:
If consumers become more concerned
about eating healthily, they might decrease
their demand for fast food
Effect on demand for fast food,
if consumers want to eat
healthy
Increases in the number of people buying
something will increase the amount
demanded
Example: An increase in the elderly
population increases the
demand for medical care
Effect on demand for medical
care, as the population ages
Changes in demand: Tastes and preferences
Changes in demand: Population and demographics

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Consumers decide which products to buy
and when to buy them.
•Future products are substitutes for current
products
•An expected increase in the price
tomorrow increases demand today.
•An expected decrease in the price
tomorrow decreases demand today.
Example: If you found out the price of
gasoline would go up
tomorrow, you would
increase your demand today.
Effect on today’s gasoline
demand, if price will rise tomorrow
Changes in demand: Expected future prices

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Apple’s policy on speculation about
future products
Making
the
Connection
Apple strongly discourages its employees from speculating about
when a new model will appear. Why?
Suppose a customer learns that a new iPad model will be
available next month.
•The new model is a potential substitute for the current model
•The price of the current model will likely fall next month
•Both effects decrease current demand (bad for Apple!)

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Figure 3.3
A change in the price
of the product being
examined causes a
movement along the
demand curve.
This is a change in
quantity demanded.
Any other change
affecting demand
causes the entire
demand curve to
shift.
This is a change in
demand.
Change in demand vs. change in quantity demanded

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Discuss the variables that influence supply.
3.2 LEARNING OBJECTIVE
The Supply Side of the Market

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Figure 3.4Supply Schedule:
Table showing how
many of a product will
be available for
purchase at various
prices.
Supply Curve:
Graphical representation of supply
schedule.
Price on y-axis.
Quantity demanded on x-axis.
Supply schedule and supply curve

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Figure 3.4
Law of Supply:
As price changes, quantity supplied
changes in the same direction, ceteris
paribus.
Implication:
supply curve slopes upward
Law of supply

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Figure 3.5
A change in something
other than price that
affects supply causes
the entire supply curve
to shift.
A shift to the right (S1 to
S3) is an increase in
supply.
A shift to the left (S1 to
S2) is a decrease in
supply.
Changes in supply

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Figure 3.5
As the supply curve
shifts, the quantity
supplied is likely to
change, even if the
price doesn’t
change.
The quantity
supplied changes
at every possible
price.
P1
Q2 Q1 Q3
Changes in supply

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Price of inputs
Technological change
Prices of substitutes in production
Number of firms in the market
Expected future prices
What would cause a change in supply?

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Inputs are things used in the production
of a good or service.
Examples of inputs for tablet computers:
Computer processor
Plastic housing
Labor
An increase in the price of an input
decreases the profitability of selling the
good, causing a decrease in supply.
A decrease in the price of an input
increases the profitability of selling the
good, causing an increase in supply.
Effect of an increase in the
price of input goods
Effect of a decrease in the
price of input goods
Changes in supply: Price of inputs

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A firm may experience a positive or
negative change in its ability to produce
output given a fixed amount of inputs.
Examples:
A new, more productive variety of
wheat would increase the supply of
wheat.
Governmental restrictions on land
use for agriculture might decrease the
supply of wheat.
Changes raise or lower firms’ costs,
hence their supply of the good.
Effect of a positive change
in technology
Effect of a negative change
in technology
Changes in supply: Technological change

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Many firms can produce and sell more
than one product.
Example:
An Illinois farmer can plant corn or
soybeans. If the price of soybeans rises,
he will plant (supply) less corn.
Effect on the supply of corn,
of an increase in the price of
soybeans
Effect of a increase in the
number of firms
More firms in the market will result in
more product available at a given price
(greater supply).
Fewer firms → supply decreases.
Changes in supply: Prices of substitutes in production
Changes in supply: Number of firms in the market

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If a firm anticipates the price of its
product will be higher in the future, it
might decrease its supply today in order
to increase it in the future.
What types of products could be “stored”
like this?
Non-perishable products
Effect of an increase in
future expected price of a
good
Changes in supply: Expected future prices

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Release timing of Collateral Damage
Making
the
Connection
The Schwartzenegger film Collateral Damage was originally
scheduled to be released on October 5, 2001.
The film contained plot elements about terrorist attacks.
The production company (Warner Bros.) decided the movie
would have higher demand (higher expected future prices) if it
did not show immediately after 9/11, so it was delayed until
February 2002.

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Figure 3.6
A change in the price of
the product being
examined causes a
movement along the
supply curve.
This is a change in
quantity supplied.
Any other change
affecting supply causes
the entire supply curve to
shift.
This is a change in
supply.
Change in supply vs. change in quantity supplied

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Use a graph to illustrate market equilibrium.
3.3 LEARNING OBJECTIVE
Market Equilibrium: Putting Demand and Supply
Together

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Figure 3.8If the price of a tablet is
$600, consumers want to
buy 4 million per month,
while producers want to
sell 6 million.
This gives a surplus of 2
million tablets.
Prediction: sellers will
compete amongst
themselves, driving the
price down.
Surplus

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If the price of a tablet is
$300, consumers want to
buy 7 million per month,
while producers want to
sell 3 million.
This gives a shortage of
4 million tablets.
Prediction: sellers will
realize they can increase
the price and still sell as
many tablets, so the price
will rise.
Shortage
Figure 3.8

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At a price of $500,
consumers want to buy
5 million tablets, and
producers want to sell 5
million.
There is no reason for
the price to change.
Equilibrium price:
$500
Equilibrium quantity:
5 million per month
Figure 3.7
Market equilibrium

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Price is determined by the interaction of buyers and sellers.
Neither group can dictate price in a competitive market (i.e. one
with many buyers and sellers).
However changes in supply and/or demand will affect the price
and quantity traded.
Who determines price, buyers or sellers?

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Use demand and supply graphs to predict changes in prices and
quantities.
3.4 LEARNING OBJECTIVE
The Effect of Demand and Supply Shifts on Equilibrium

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Predictions about price and quantity in model require us to know
supply and demand curves.
Typically, we know price and quantity, but do not know the
curves that generate them.
The power of the supply and demand model is in its ability to
predict directional changes in price and quantity traded.
Usefulness of the supply and demand model

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Toshiba enters the tablet
computer market,
introducing the Thrive.
More tablets are
available at any given
price – an increase in
supply from S1 to S2.
Equilibrium price falls
from P1 to P2.
Equilibrium quantity rises
from Q1 to Q2.
The effect of shifts in supply on equilibrium
Figure 3.9

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Figure 3.9
The effect of shifts in supply on equilibrium
By how much will price
fall? By how much will
quantity rise?
We cannot say, without
knowing more
information.
For now, we can only
predict that price will
fall and quantity traded
will rise.

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Figure 3.10Consumer incomes
increase. What happens
to equilibrium in the
tablet market?
Tablets are normal
goods, so as income
rises, demand rises
(D1 to D2).
Equilibrium price rises
(P1 to P2).
Equilibrium quantity
rises (Q1 to Q2).
The effect of shifts in demand on equilibrium

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Table 3.3
Supply Curve
Unchanged
Supply Curve Shifts
to the Right
Supply Curve Shifts
to the Left
Demand Curve
Unchanged
Q unchanged
P unchanged
Q ↑
P ↓
Q ↓
P ↑
Demand Curve Shifts
to the Right Q ↑
P ↑
Demand Curve Shifts
to the Left
Q ↓
P ↓
Effects of shifts in demand and supply

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The Falling Price of Blu-ray Players
Making
the
Connection
From 2006 to 2010, the price of
Blu-ray players fell from almost
$1000 to about $120, while the
number of Blu-ray players traded
increased dramatically.
What best explains this change?
A: Increase in demand
B: Decrease in demand
C: Increase in supply
D: Decrease in supply
Can you show this change on a
supply-and-demand diagram?

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The Falling Price of Blu-ray Players
Making
the
Connection
Supply increased as additional firms started manufacturing Blu-
ray players and input costs fell.

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Suppose supply and demand
both increase.
What does our model predict?
S↑  ( P↓ and Q↑ )
D↑  ( P↑ and Q↑ )
So we can be sure
equilibrium quantity will rise;
but the effect on equilibrium
price is not clear.
Effect on price depends on
how far each curve moves.
In this graph, demand
moves more than supply.
Simultaneous shifts in supply and demand

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Suppose supply and demand
both increase.
What does our model predict?
S↑  ( P↓ and Q↑ )
D↑  ( P↑ and Q↑ )
So we can be sure equilibrium
quantity will rise; but the effect
on equilibrium price is not
clear.
Effect on price depends on
how far each curve moves.
In this graph, supply moves
more than demand.
Simultaneous shifts in supply and demand

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Supply Curve
Unchanged
Supply Curve Shifts
to the Right
Supply Curve Shifts
to the Left
Demand Curve
Unchanged
Q unchanged
P unchanged
Q ↑
P ↓
Q ↓
P ↑
Demand Curve Shifts
to the Right
Q ↑
P ↑
Q ↑
P effect uncertain
Q effect uncertain
P ↑
Demand Curve Shifts
to the Left
Q ↓
P ↓
Q effect uncertain
P ↓
Q ↓
P effect uncertain
Effects of shifts in demand and supply

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Over time, it is common for both supply and demand to shift.
The stronger of the two effects will determine the overall change
in price and quantity.
In the Blu-ray example, demand for Blu-ray players increased
from 2006 to 2010. But the supply effect was stronger.
How can we tell? Because we know the price fell; if the demand
effect were stronger, the price would have risen.
Supply and demand shifts over time

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Terminology: movement along the curve (caused by price
change) vs. shifting the curve (caused by other changes).
Not moving curves far enough to be able to illustrate a change.
Exaggerating curve shifts is okay.
Incompletely labeling diagrams.
Use your arrows!
Common misconceptions to avoid

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Shifting a curve, then shifting another curve due to the resulting
price change.
The price change does not cause a further shift in demand or
supply.
Being certain of both price and quantity changes when both
demand and supply curves move.
Only one of these effects will be certain.
Common misconceptions to avoid