Gregory N. Mankiw
Economics
Principles of
Sixth Edition
4
The Market Forces of
Supply and Demand
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Slides by
Ron Cronovich
In this chapter,
look for the answers to these questions:
What factors affect buyers demand for goods?
What factors affect sellers supply of goods?
How do supply and demand determine the price
of
of a good and the quantity sold?
How do changes in the factors that affect
demand or supply affect the market price and
quantity of a good?
How do markets allocate resources?
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1
Markets and Competition
A market is a group of buyers and sellers of a
particular product.
A competitive market is one with many buyers
and sellers, each has a negligible effect on price.
In a perfectly competitive market:
All goods exactly the same
Buyers & sellers so numerous that no one can
affect market priceeach is a price taker
In this chapter, we assume markets are perfectly
competitive.
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2
Demand
The quantity demanded of any good is the
amount of the good that buyers are willing and
able to purchase.
Law of demand: the claim that the quantity
demanded
demanded of a good falls when the price of the
good rises, other things equal
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3
The Demand Schedule
Demand schedule:
a table that shows the
relationship between the
price of a good and the
quantity demanded
Price Quantity
of
of lattes
lattes demanded
$0.00
16
1.00
14
2.00
2.00
12
Example:
Helens demand for lattes.
3.00
10
4.00
8
Notice that Helens
preferences obey the
law of demand.
5.00
6
6.00
4
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4
Helens Demand Schedule & Curve
Price Quantity
of
of lattes
lattes demanded
Price of
Lattes
$6.00
$0.00
16
1.00
14
$4.00
2.00
12
$3.00
3.00
10
$2.00
4.00
8
5.00
6
6.00
4
$5.00
$1.00
$0.00
0
5
10
Quantity
15 of Lattes
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5
Market Demand versus Individual Demand
The quantity demanded in the market is the sum of the
quantities demanded by all buyers at each price.
Suppose Helen and Ken are the only two buyers in
the Latte market. (Qd = quantity demanded)
Price
Helens Qd
Kens Qd
Market Qd
$0.00
16
+
8
=
24
1.00
14
+
7
=
21
2.00
12
+
6
=
18
3.00
10
+
5
=
15
4.00
8
+
4
=
12
5.00
6
+
3
=
9
6.00
4
+
2
=
6
The Market Demand Curve for Lattes
P
Qd
(Market)
$0.00
24
$5.00
1.00
21
$4.00
2.00
18
3.00
15
4.00
12
5.00
9
6.00
6
P
$6.00
$3.00
$2.00
$1.00
$0.00
Q
0
5
10
15
20
25
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7
Demand Curve Shifters
The demand curve shows how price affects
quantity demanded, other things being equal.
These other things are non-price determinants
of demand (i.e., things that determine buyers
demand
demand for a good, other than the goods price).
Changes in them shift the D curve
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8
Demand Curve Shifters: # of Buyers
Increase in # of buyers
increases quantity demanded at each price,
shifts D curve to the right.
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9
Demand Curve Shifters: # of Buyers
Suppose the number
of buyers increases.
Then, at each P,
Qd will increase
(by 5 in this example).
P
$6.00
$5.00
$4.00
$3.00
$2.00
$1.00
Q
$0.00
0
5
10
15
20
25
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30
10
Demand Curve Shifters: Income
Demand for a normal good is positively related
to income.
Increase in income causes
increase in quantity demanded at each price,
shifts
shifts D curve to the right.
(Demand for an inferior good is negatively
related to income. An increase in income shifts
D curves for inferior goods to the left.)
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11
Demand Curve Shifters:
Prices of
Related Goods
Two goods are substitutes if
an increase in the price of one
causes an increase in demand for the other.
Example: pizza and hamburgers.
An
An increase in the price of pizza
increases demand for hamburgers,
shifting hamburger demand curve to the right.
Other examples: Coke and Pepsi,
laptops and desktop computers,
CDs and music downloads
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12
Demand Curve Shifters:
Prices of
Related Goods
Two goods are complements if
an increase in the price of one
causes a fall in demand for the other.
Example: computers and software.
If
If price of computers rises,
people buy fewer computers,
and therefore less software.
Software demand curve shifts left.
Other examples: college tuition and textbooks,
bagels and cream cheese, eggs and bacon
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13
Demand Curve Shifters: Tastes
Anything that causes a shift in tastes toward a
good will increase demand for that good
and shift its D curve to the right.
Example:
The
The Atkins diet became popular in the 90s,
caused an increase in demand for eggs,
shifted the egg demand curve to the right.
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14
Demand Curve Shifters: Expectations
Expectations affect consumers buying decisions.
Examples:
If people expect their incomes to rise,
their demand for meals at expensive
restaurants
restaurants may increase now.
If the economy sours and people worry about
their future job security, demand for new autos
may fall now.
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15
Summary: Variables That Influence Buyers
Variable
A change in this variable
Price
causes a movement
along the D curve
# of buyers
shifts the D curve
Income
shifts the D curve
Price of
related goods
shifts the D curve
Tastes
shifts the D curve
Expectations
shifts the D curve
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16
ACTIVE LEARNING
Demand Curve
1
Draw a demand curve for music downloads.
What happens to it in each of
the following scenarios? Why?
A. The price of iPods
falls
falls
B. The price of music
downloads falls
C. The price of CDs falls
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ACTIVE LEARNING
1
A. Price of iPods falls
Music
Music downloads
and iPods are
complements.
Price of
music
downloads
A fall in price of
iPods
iPods shifts the
demand curve for
music downloads
to the right.
P1
D1
Q1
Q2
D2
Quantity of
music downloads
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ACTIVE LEARNING
1
B. Price of music downloads falls
Price of
music
downloads
The D curve
does not shift.
Move down along
curve
curve to a point with
lower P, higher Q.
P1
P2
D1
Q1
Q2
Quantity of
music downloads
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ACTIVE LEARNING
1
C. Price of CDs falls
CDs
CDs and
music downloads
are substitutes.
Price of
music
downloads
A fall in price of CDs
shifts
shifts demand for
music downloads
to the left.
P1
D2
Q2
Q1
D1
Quantity of
music downloads
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Supply
The quantity supplied of any good is the
amount that sellers are willing and able to sell.
Law of supply: the claim that the quantity
supplied of a good rises when the price of the
good
good rises, other things equal
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21
The Supply Schedule
Price
of
lattes
Quantity
of lattes
supplied
$0.00
0
1.00
3
2.00
2.00
6
Example:
Starbucks supply of lattes.
3.00
9
4.00
12
Notice that Starbucks
supply schedule obeys the
law of supply.
5.00
15
6.00
18
Supply schedule:
A table that shows the
relationship between the
price of a good and the
quantity supplied.
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22
Starbucks Supply Schedule & Curve
Price
of
lattes
Quantity
of lattes
supplied
$0.00
0
1.00
3
2.00
6
$3.00
3.00
9
$2.00
4.00
12
5.00
15
6.00
18
P
$6.00
$5.00
$4.00
$1.00
$0.00
Q
0
5
10
15
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23
Market Supply versus Individual Supply
The quantity supplied in the market is the sum of
the quantities supplied by all sellers at each price.
Suppose Starbucks and Jitters are the only two
sellers in this market. (Qs = quantity supplied)
Market Qs
Price
Starbucks
Jitters
$0.00
0
+
0
=
0
1.00
3
+
2
=
5
2.00
6
+
4
=
10
3.00
9
+
6
=
15
4.00
12
+
8
=
20
5.00
15
+
10
=
25
6.00
18
+
12
=
30
The Market Supply Curve
P
QS
(Market)
$0.00
0
1.00
5
2.00
10
$4.00
3.00
15
$3.00
4.00
20
$2.00
5.00
25
6.00
30
P
$6.00
$5.00
$1.00
Q
$0.00
0
5
10 15
20 25 30
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35
25
Supply Curve Shifters
The supply curve shows how price affects
quantity supplied, other things being equal.
These other things are non-price determinants
of supply.
Changes in them shift the S curve
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26
Supply Curve Shifters: Input Prices
Examples of input prices:
wages, prices of raw materials.
A fall in input prices makes production
more profitable at each output price,
so
so firms supply a larger quantity at each price,
and the S curve shifts to the right.
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27
Supply Curve Shifters: Input Prices
Suppose
Suppose the
price of milk falls.
At each price,
the quantity of
lattes supplied
will increase
(by 5 in this
example).
P
$6.00
$5.00
$4.00
$3.00
$2.00
$1.00
Q
$0.00
0
5
10 15
20 25 30
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35
28
Supply Curve Shifters: Technology
Technology determines how much inputs are
required to produce a unit of output.
A cost-saving technological improvement has
the same effect as a fall in input prices,
shifts
shifts S curve to the right.
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29
Supply Curve Shifters: # of Sellers
An increase in the number of sellers increases
the quantity supplied at each price,
shifts S curve to the right.
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30
Supply Curve Shifters: Expectations
Example:
Events in the Middle East lead to expectations
of higher oil prices.
In response, owners of Texas oilfields reduce
supply
supply now, save some inventory to sell later at
the higher price.
S curve shifts left.
In general, sellers may adjust supply* when their
expectations of future prices change.
(*If good not perishable)
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31
Summary: Variables that Influence Sellers
Variable
A change in this variable
Price
causes a movement
along the S curve
Input Prices
shifts the S curve
Technology
shifts the S curve
# of Sellers
shifts the S curve
Expectations
shifts the S curve
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32
ACTIVE LEARNING
Supply Curve
2
Draw a supply curve for tax
return preparation software.
What happens to it in each
of the following scenarios?
A.
A. Retailers cut the price of
the software.
B. A technological advance
allows the software to be
produced at lower cost.
C. Professional tax return preparers raise the
price of the services they provide.
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ACTIVE LEARNING
2
A. Fall in price of tax return software
Price of
tax return
software
S1
S curve does
not shift.
Move down
along
along the curve
to a lower P
and lower Q.
P1
P2
Q2
Q1
Quantity of tax
return software
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ACTIVE LEARNING
2
B. Fall in cost of producing the software
Price of
tax return
software
S1
S2
S curve shifts
to the right:
at each price,
Q increases.
P1
Q1
Q2 Quantity of tax
return software
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ACTIVE LEARNING
2
C. Professional preparers raise their price
Price of
tax return
software
S1
This shifts the
demand curve for
tax preparation
software,
software, not the
supply curve.
Quantity of tax
return software
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Supply and Demand Together
P
$6.00
D
S
$5.00
$4.00
$4.00
$3.00
Equilibrium
Equilibrium:
P has reached
the level where
quantity
quantity supplied
equals
quantity demanded
$2.00
$1.00
$0.00
Q
0
5
10 15 20 25 30 35
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37
Equilibrium price:
the price that equates quantity supplied
with quantity demanded
P
$6.00
D
S
P
QD
QS
$5.00
$0
24
0
$4.00
1
21
5
2
18
10
3
15
15
4
12
20
5
9
25
6
6
30
$3.00
$2.00
$1.00
$0.00
Q
0
5
10 15 20 25 30 35
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38
Equilibrium quantity:
the quantity supplied and quantity demanded
at the equilibrium price
P
$6.00
D
S
P
QD
QS
$5.00
$0
24
0
$4.00
1
21
5
2
18
10
3
15
15
4
12
20
5
9
25
6
6
30
$3.00
$2.00
$1.00
$0.00
Q
0
5
10 15 20 25 30 35
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39
Surplus (a.k.a. excess supply):
when quantity supplied is greater than
quantity demanded
P
$6.00
D
Surplus
Example:
If P = $5,
S
$5.00
then
QD = 9 lattes
$4.00
$4.00
and
QS = 25 lattes
$3.00
$2.00
resulting in a
surplus of 16 lattes
$1.00
$0.00
Q
0
5
10 15 20 25 30 35
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40
Surplus (a.k.a. excess supply):
when quantity supplied is greater than
quantity demanded
P
$6.00
D
$5.00
$4.00
$4.00
Surplus
S
Facing a surplus,
sellers try to increase
sales by cutting price.
This causes
QD to rise and QS to fall
$3.00
which reduces the
surplus.
$2.00
$1.00
$0.00
Q
0
5
10 15 20 25 30 35
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41
Surplus (a.k.a. excess supply):
when quantity supplied is greater than
quantity demanded
P
$6.00
D
$5.00
$4.00
$4.00
Surplus
S
Facing a surplus,
sellers try to increase
sales by cutting price.
This causes
QD to rise and QS to fall.
$3.00
Prices continue to fall
until market reaches
equilibrium.
$2.00
$1.00
$0.00
Q
0
5
10 15 20 25 30 35
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42
Shortage (a.k.a. excess demand):
when quantity demanded is greater than
quantity supplied
P
$6.00
S
D
$5.00
$4.00
$4.00
$3.00
$2.00
$1.00
$0.00
Shortage
0
5
Example:
If P = $1,
then
QD = 21 lattes
and
QS = 5 lattes
resulting in a
shortage of 16 lattes
Q
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43
Shortage (a.k.a. excess demand):
when quantity demanded is greater than
quantity supplied
P
$6.00
S
D
$5.00
Facing a shortage,
sellers raise the price,
causing QD to fall
and
and QS to rise,
which reduces the
shortage.
$4.00
$4.00
$3.00
$2.00
$1.00
Shortage
$0.00
Q
0
5
10 15 20 25 30 35
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44
Shortage (a.k.a. excess demand):
when quantity demanded is greater than
quantity supplied
P
$6.00
S
D
$5.00
Facing a shortage,
sellers raise the price,
causing QD to fall
and QS to rise.
$4.00
$4.00
$3.00
Prices continue to rise
until market reaches
equilibrium.
$2.00
$1.00
Shortage
$0.00
Q
0
5
10 15 20 25 30 35
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45
Three Steps to Analyzing Changes in Eqm
To determine the effects of any event,
1. Decide whether event shifts S curve,
D curve, or both.
2.
2. Decide in which direction curve shifts.
3. Use supplydemand diagram to see
how the shift changes eqm P and Q.
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46
EXAMPLE: The Market for Hybrid Cars
P
price of
hybrid cars
S1
P1
D1
Q1
Q
quantity of
hybrid cars
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47
EXAMPLE 1: A Shift in Demand
EVENT TO BE
ANALYZED:
P
Increase in price of gas.
STEP 1:
D curve shifts
because price of gas
STEP 2:
affects demand for
D shifts right
hybrids.
because high gas
STEP 3:
S curve doeshybrids
price makes not
The because price
shift,shift causes an
more attractive
increase in not
of gas doespricecars.
relative to other
and quantity
affect cost of of
hybrid cars.
producing hybrids.
S1
P2
P1
D1
Q1 Q2
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
D2
Q
48
EXAMPLE 1: A Shift in Demand
Notice:
When P rises,
producers supply
a larger quantity
of hybrids, even
though
though the S curve
has not shifted.
Always
Always be careful
to distinguish b/w
a shift in a curve
and a movement
along the curve.
P
S1
P2
P1
D1
Q1 Q2
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
D2
Q
49
Terms for Shift vs. Movement Along Curve
Change in supply: a shift in the S curve
occurs when a non-price determinant of supply
changes (like technology or costs)
Change in the quantity supplied:
a movement along a fixed S curve
occurs
occurs when P changes
Change in demand: a shift in the D curve
occurs when a non-price determinant of demand
changes (like income or # of buyers)
Change in the quantity demanded:
a movement along a fixed D curve
occurs when P changes
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
50
EXAMPLE 2: A Shift in Supply
EVENT: New technology
P
reduces cost of
producing hybrid cars.
S1
S2
STEP 1:
S curve shifts
because event affects P1
STEP
STEP 2:
cost of production.
P2
S shifts right
D curve does not
because event
STEP 3:
shift, because
reduces cost,
The shift causes
production technology
makes production
price one of
is not to fall theat
more profitable
and quantity to rise.
factors that affect
any given price.
demand.
D1
Q1 Q2
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Q
51
EXAMPLE 3: A Shift in Both Supply
and Demand
EVENTS:
Price of gas rises AND
new technology reduces
production costs
STEP 1:
Both curves shift.
P
S1
S2
P2
P1
STEP 2:
Both shift to the right.
STEP 3:
Q rises, but effect
on P is ambiguous:
If demand increases more
than supply, P rises.
D1
Q1
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Q2
D2
Q
52
EXAMPLE 3: A Shift in Both Supply
and Demand
EVENTS:
price of gas rises AND
new technology reduces
production costs
P
S1
S2
STEP 3, cont.
But if supply
increases more
than demand,
P falls.
P1
P2
D1
Q1
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Q2
D2
Q
53
ACTIVE LEARNING
3
Shifts in supply and demand
Use the three-step method to analyze the effects of
each event on the equilibrium price and quantity of
music downloads.
Event A: A fall in the price of CDs
Event B: Sellers of music downloads negotiate a
reduction in the royalties they must pay
for each song they sell.
Event C: Events A and B both occur.
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ACTIVE LEARNING
3
A. Fall in price of CDs
STEPS
P
1. D curve shifts
2. D shifts left
3. P and Q both
fall.
The market for
music downloads
S1
P1
P2
D2
Q2 Q1
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
D1
Q
ACTIVE LEARNING
3
B. Fall in cost of royalties
STEPS
1. S curve shifts
(Royalties are part
2. S shifts right
of
of sellers costs)
P1
3. P falls,
P2
Q rises.
P
The market for
music downloads
S1
S2
D1
Q1 Q2
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Q
ACTIVE LEARNING
3
C. Fall in price of CDs and
fall in cost of royalties
STEPS
1. Both curves shift (see parts A & B).
2. D shifts left, S shifts right.
3. P unambiguously falls.
Effect on Q is ambiguous:
The fall in demand reduces Q,
the increase in supply increases Q.
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CONCLUSION:
How Prices Allocate Resources
One of the Ten Principles from Chapter 1:
Markets are usually a good way
to organize economic activity.
In market economies, prices adjust to balance
supply
supply and demand. These equilibrium prices
are the signals that guide economic decisions
and thereby allocate scarce resources.
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58
SU MMA RY
A competitive market has many buyers and
sellers, each of whom has little or no influence
on the market price.
Economists use the supply and demand model
to analyze competitive markets.
The downward-sloping demand curve reflects
the law of demand, which states that the quantity
buyers demand of a good depends negatively
on the goods price.
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SU MMA RY
Besides price, demand depends on buyers incomes,
tastes, expectations, the prices of substitutes and
complements, and number of buyers.
If one of these factors changes, the D curve shifts.
The upward-sloping supply curve reflects the Law of
Supply, which states that the quantity sellers supply
depends positively on the goods price.
Other determinants of supply include input prices,
technology, expectations, and the # of sellers.
Changes in these factors shift the S curve.
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SU MMA RY
The intersection of S and D curves determines
the market equilibrium. At the equilibrium price,
quantity supplied equals quantity demanded.
If the market price is above equilibrium,
a surplus results, which causes the price to fall.
If the market price is below equilibrium,
a shortage results, causing the price to rise.
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SU MMA RY
We can use the supply-demand diagram to
analyze the effects of any event on a market:
First, determine whether the event shifts one or
both curves. Second, determine the direction of
the shifts. Third, compare the new equilibrium to
the initial one.
In market economies, prices are the signals that
guide economic decisions and allocate scarce
resources.
2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.