Module 2b demand and supply

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Demand and Supply
“Talk is cheap because supply exceeds demand.”
-Author Unknown

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Demand and Supply
As we will learn in this module, prices and quantities are
determined by participants in each market.
But who are the participants?
Households
Businesses

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These participants interact to determine what
is produced and how much it costs!
Business
Buy Resources
Sell Products
Households
Sell Resources
Buy Products
Resource
Market
Product
Market
Goods & Services
Land,Labor,
Capital,Entrepreneurs
Goods&Services
Resources
Wages, Rents, Interest, profits
Consumption
Expenditures
Costs
Revenue
Participants include
businesses and households
Households sell resources to
businesses in exchange for
payment. They use these
payments to purchase
products.

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So what is demand?
A schedule or curve that shows the
quantity of a product that customers
(households) would purchase at a
given set of possible prices in a
particular time.

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An example of a demand schedule
Imagine that I talked to every consumer in an economy (or
in this class) and found out what quantity of a good they
would want at particular prices. Perhaps that survey would
generate the following results:
At a price of $10, no one
would want this good
At a price of $2, 8 units
would be demanded
We could plot these data points
to see a “demand curve” as is
done on the next slide…

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Demand Curve – price (P) and quantity
demand (Qd) have a negative relationship
Note: market demand is the sum of each individual demand
This is the Demand curve
A red box like this usually
means that this information is
important and will appear on
your test!
Notice the “downward slope”
suggesting that as price
increases, consumer want less
of this item. This leads us to the
law of demand…
The Law of Demand- All else
equal, as price falls, the
quantity demanded increases
and as price rises, the
quantity demanded decreases

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Let’s turn our attention to supply
Imagine that I talked to every company in an
economy and found out what quantity of a good
they would produce at particular prices. Perhaps
the table below would summarize my findings:
We could plot these data
points to see a “supply curve”
as is done on the next slide…
At a price of $10,
producers may be
excited and want to
supply 10 units
At a price of $2, only 2
units would be supplied

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Supply Curve – price (P) and quantity
supplied (Qs) have a positive relationship
This is the Supply curve
Supplied
Notice the “upward slope”
suggesting that as price
increases, producers want to
make more of this item. This
leads us to the law of supply…
The Law of Supply All else
equal, as price falls, the
quantity supplied falls and
as price rises, the quantity
supplied increases

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Putting them together gives us a market
For this market,
the equilibrium
price will be $5
For this market, the equilibrium
quantity will be 5 units
If left alone, a
market will always
find this
“equilibrium”
point.
But how do we
know that this
will work?
Now we have a market…we have a
demand curve representing the
buyer and a supply curve
representing a seller.
So what will happen? How will
these “participants” determine price
and quantity?
It is at this point
where supply
equals demand.
Here, these
participants agree
upon price!

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How do we know that the market will price
this good at $5 and supply 5 units?
If the price
was set at $6
Then quantity demanded
(Qd) would be 4 units…
…and quantity supplied (Qs)
would be 6 units
Producers
would wind up
with a surplus
and would
eventually
reduce prices
to sell the extra
units!
In other words, there would be a surplus of 2 units!

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On the other hand, shortages drive
prices up
If the price
was set at $2
Then Qs would be 2
units…
…and Qd would be 8
units
Producers
would wind up
with a
shortage.
Consumers
would
eventually offer
a higher price!
In other words, there would be a shortage of 6 units!

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Markets are amazing things!
So if left alone, a market…or
specifically the participants in it…
will drive prices to this point.
It is at equilibrium that the forces of
supply and demand are equal…
And the market clears!

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Let’s explore Supply and
Demand in more detail
•  There are differences between changes in
quantity demand and changes in demand
•  There are differences between changes in
quantity supplied and changes in supply

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Changes in quantity demand:
Movements along the demand curves
A change in price (from $7 to $4)
will result in a change in the
quantity demanded (from 3 to 6
units)

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Real world example: airline pricing
What do airlines do if many seats are
open a week before the flight?
They sell them at reduced prices,
perhaps in Internet specials.

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Changes in quantity supplied:
Movements along the supply curves
A change in price (from
$5 to $8) will result in a
change in the quantity
supplied (from 5 to 8
units)
Supplied

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Changes in demand cause a shift in the
demand curve (in this case an increase)
Think of it this way…
each of the points that
make up this line have
shifted to the right!
Previously, at a price of
$8, 2 units were
demanded.
Now, given some new
information, we demand
4 units at $8.
Note that the new demand
curve is shown as D with an
apostrophe after it (D’).

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Here is an example of a decrease in demand
Here, the idea is the
same…except we are
demanding LESS of this
good!

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Changes in demand have an impact on
price and quantity
•  If Demand P Q
•  If Demand P Q
We are now exploring another Key Learning
Outcome: Economic events can shift supply
and demand curves and that affects the price of
a good and how much of it we buy!

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Factors affecting demand:
Prices of related goods can affect demand
If french fry prices double, demand for
ketchup will probably decline
Demand for Ketchup
These goods are compliments
When the price of one goes up, we
demand less of the other!

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Price of related goods can affect demand
If beer prices double, demand for wine
will probably increase
Demand for Wine
These goods are substitutes
When the price of one goes up, we
demand MORE of the other!

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Income can affect demand
If income increases, demand for most
goods will probably increase
Demand for normal goods
These goods are normal
When our income goes up, we demand
more of these items.

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Income can affect demand
If income increases, demand for
inferior goods will probably decrease
Demand for Inferior Goods
Some goods such as Spam are inferior
(at least according to me. You may love Spam.)
When our income goes up, we demand
less of these items!

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Other factors affecting demand
Expected Future Prices
Population
Tastes and Preferences
If consumers think prices will fall, they
may demand less of a product now
As population grows, demand for most
goods increases
Fads can affect demand. For example
a hot Christmas item such as an Xbox
or a “Tickle Me Elmo” may cause
demand to increase

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Changes in supply cause a shift in the
supply curve (in this case an increase)

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Here is an example of a decrease in supply

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Changes in supply have an impact on
price and quantity
•  If Supply P Q
•  If Supply P Q

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Factors affecting supply:
Prices of related goods can affect supply
If price of beef falls, supply of leather
will probably fall
Supply of Leather
These goods are compliments in
production

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Price of related goods can affect supply
If corn prices fall, supply of soybeans
will probably increase
Supply of Soybeans
These goods are substitutes in
production

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number of suppliers
As more suppliers enter the market,
supply will increase

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Weather
Weather can help or hurt a market
Market for Orange JuiceMarket for Skiing
Cold
weather
can
destroy
the
orange
market
Cold
weather
can help
the ski
market

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Technology
Improved technology may increase supply
Market for Autos

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Other factors affecting supply
Expected Future Prices
Taxes and Incentives
If producers think prices will fall, they may
provide more of a product now
Governments use taxes and
incentives to encourage of discourage
the production of certain goods

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In Summary
In a command
economy, some
central authority has to
decide price and
quantity for every good
sold.
That is obviously
difficult to do and
errors routinely result
in surpluses or
shortages.
A market has its own built in
rationing system.
Those that want it at the prevailing
price get to buy it. Those that do
not want to pay that much can
leave it.
If an item becomes very popular, its
price may rise and new suppliers
may add to the supply.
If an item loses appeal, it’s price
may fall. That will discourage
producers and reduce the amount
of goods made.
Therefore, markets serve as great
rationing mechanisms!
Here we see another
Key Learning Outcome:
Many events can shift
supply and demand
curves and when they
do, prices and
quantities change!

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Supply and Demand:
Individual exercises
Review the following six slides and
determine the new price and quantity
Answers appear at the end of this presentation.

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#2 - Beanie Babies

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#5 – Orange Juice

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Answers
Q1: New equilibrium price is $2, new equilibrium quantity is 3 units.
Q5: Cannot be determined…Buyers and Sellers do not agree on a price!
Expect questions like this on the test. If you do not
understand these, please let me know!
slacroix@tcc.edu

Module 2b demand and supply

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