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Unformatted text preview: 9160335_CH03_p053-080.qxd 6/22/09 8:56 AM Page 53 PA RT TWO How Markets Work 3 Demand and Supply After studying this chapter, you will be able to: ■ Describe a competitive market and think about a price as an opportunity cost ■ Explain the influences on demand ■ Explain the influences on supply ■ Explain how demand and supply determine prices and quantities bought and sold ■ Use the demand and supply model to make predictions about changes in prices and quantities What makes the prices of oil and gasoline double in just one year? Will these prices keep on rising? Are the oil companies taking advantage of people? This chapter enables you to answer these and similar questions about prices—prices that rise, prices that fall, and prices that fluctuate. You already know that economics is about the choices people make to cope with scarcity and how those choices helps us to answer the big economic question: What, how, and for whom goods and services are produced? respond to incentives. Prices act as incentives. You’re going to At the end of the chapter, in Reading Between the Lines, see how people respond to prices and how prices get deter- we’ll apply the model to market for gasoline and explain mined by demand and supply. The demand and supply model why the price increased so sharply in 2008. that you study in this chapter is the main tool of economics. It 53 9160335_CH03_p053-080.qxd 54 6/22/09 8:56 AM Page 54 CHAPTER 3 Demand and Supply ◆ Markets and Prices When you need a new pair of running shoes, want a bagel and a latte, plan to upgrade your cell phone, or need to fly home for Thanksgiving, you must find a place where people sell those items or offer those services. The place in which you find them is a market. You learned in Chapter 2 (p. 44) that a market is any arrangement that enables buyers and sellers to get information and to do business with each other. A market has two sides: buyers and sellers. There are markets for goods such as apples and hiking boots, for services such as haircuts and tennis lessons, for resources such as computer programmers and earthmovers, and for other manufactured inputs such as memory chips and auto parts. There are also markets for money such as Japanese yen and for financial securities such as Yahoo! stock. Only our imagination limits what can be traded in markets. Some markets are physical places where buyers and sellers meet and where an auctioneer or a broker helps to determine the prices. Examples of this type of market are the New York Stock Exchange and the wholesale fish, meat, and produce markets. Some markets are groups of people spread around the world who never meet and know little about each other but are connected through the Internet or by telephone and fax. Examples are the e-commerce markets and the currency markets. But most markets are unorganized collections of buyers and sellers. You do most of your trading in this type of market. An example is the market for basketball shoes. The buyers in this $3 billion-a-year market are the 45 million Americans who play basketball (or who want to make a fashion statement). The sellers are the tens of thousands of retail sports equipment and footwear stores. Each buyer can visit several different stores, and each seller knows that the buyer has a choice of stores. Markets vary in the intensity of competition that buyers and sellers face. In this chapter, we’re going to study a competitive market—a market that has many buyers and many sellers, so no single buyer or seller can influence the price. Producers offer items for sale only if the price is high enough to cover their opportunity cost. And consumers respond to changing opportunity cost by seeking cheaper alternatives to expensive items. We are going to study how people respond to prices and the forces that determine prices. But to pursue these tasks, we need to understand the relationship between a price and an opportunity cost. In everyday life, the price of an object is the number of dollars that must be given up in exchange for it. Economists refer to this price as the money price. The opportunity cost of an action is the highest-valued alternative forgone. If, when you buy a cup of coffee, the highest-valued thing you forgo is some gum, then the opportunity cost of the coffee is the quantity of gum forgone. We can calculate the quantity of gum forgone from the money prices of the coffee and the gum. If the money price of coffee is $1 a cup and the money price of gum is 50¢ a pack, then the opportunity cost of one cup of coffee is two packs of gum. To calculate this opportunity cost, we divide the price of a cup of coffee by the price of a pack of gum and find the ratio of one price to the other. The ratio of one price to another is called a relative price, and a relative price is an opportunity cost. We can express the relative price of coffee in terms of gum or any other good. The normal way of expressing a relative price is in terms of a “basket” of all goods and services. To calculate this relative price, we divide the money price of a good by the money price of a “basket” of all goods (called a price index). The resulting relative price tells us the opportunity cost of the good in terms of how much of the “basket” we must give up to buy it. The demand and supply model that we are about to study determines relative prices, and the word “price” means relative price. When we predict that a price will fall, we do not mean that its money price will fall—although it might. We mean that its relative price will fall. That is, its price will fall relative to the average price of other goods and services. Review Quiz ◆ 1 2 3 What is the distinction between a money price and a relative price? Explain why a relative price is an opportunity cost. Think of examples of goods whose relative price has risen or fallen by a large amount. Work Study Plan 3.1 and get instant feedback. Let’s begin our study of demand and supply, starting with demand. 9160335_CH03_p053-080.qxd 6/22/09 8:56 AM Page 55 Demand ◆ Demand If you demand something, then you 1. Want it, 2. Can afford it, and 3. Plan to buy it. Wants are the unlimited desires or wishes that people have for goods and services. How many times have you thought that you would like something “if only you could afford it” or “if it weren’t so expensive”? Scarcity guarantees that many—perhaps most—of our wants will never be satisfied. Demand reflects a decision about which wants to satisfy. The quantity demanded of a good or service is the amount that consumers plan to buy during a given time period at a particular price. The quantity demanded is not necessarily the same as the quantity actually bought. Sometimes the quantity demanded exceeds the amount of goods available, so the quantity bought is less than the quantity demanded. The quantity demanded is measured as an amount per unit of time. For example, suppose that you buy one cup of coffee a day. The quantity of coffee that you demand can be expressed as 1 cup per day, 7 cups per week, or 365 cups per year. Many factors influence buying plans, and one of them is the price. We look first at the relationship between the quantity demanded of a good and its price. To study this relationship, we keep all other influences on buying plans the same and we ask: How, other things remaining the same, does the quantity demanded of a good change as its price changes? The law of demand provides the answer. The Law of Demand The law of demand states Other things remaining the same, the higher the price of a good, the smaller is the quantity demanded; and the lower the price of a good, the greater is the quantity demanded. Why does a higher price reduce the quantity demanded? For two reasons: ■ ■ Substitution effect Income effect 55 Substitution Effect When the price of a good rises, other things remaining the same, its relative price— its opportunity cost—rises. Although each good is unique, it has substitutes—other goods that can be used in its place. As the opportunity cost of a good rises, the incentive to economize on its use and switch to a substitute becomes stronger. Income Effect When a price rises, other things remaining the same, the price rises relative to income. Faced with a higher price and an unchanged income, people cannot afford to buy all the things they previously bought. They must decrease the quantities demanded of at least some goods and services. Normally, the good whose price has increased will be one of the goods that people buy less of. To see the substitution effect and the income effect at work, think about the effects of a change in the price of an energy bar. Several different goods are substitutes for an energy bar. For example, an energy drink could be consumed instead of an energy bar. Suppose that an energy bar initially sells for $3 and then its price falls to $1.50. People now substitute energy bars for energy drinks—the substitution effect. And with a budget that now has some slack from the lower price of an energy bar, people buy even more energy bars—the income effect. The quantity of energy bars demanded increases for these two reasons. Now suppose that an energy bar initially sells for $3 and then the price doubles to $6. People now buy fewer energy bars and more energy drinks—the substitution effect. And faced with a tighter budget, people buy even fewer energy bars—the income effect. The quantity of energy bars demanded decreases for these two reasons. Demand Curve and Demand Schedule You are now about to study one of the two most used curves in economics: the demand curve. And you are going to encounter one of the most critical distinctions: the distinction between demand and quantity demanded. The term demand refers to the entire relationship between the price of a good and the quantity demanded of that good. Demand is illustrated by the demand curve and the demand schedule. The term quantity demanded refers to a point on a demand curve—the quantity demanded at a particular price. 9160335_CH03_p053-080.qxd 8:56 AM Page 56 CHAPTER 3 Demand and Supply Figure 3.1 shows the demand curve for energy bars. A demand curve shows the relationship between the quantity demanded of a good and its price when all other influences on consumers’ planned purchases remain the same. The table in Fig. 3.1 is the demand schedule for energy bars. A demand schedule lists the quantities demanded at each price when all the other influences on consumers’ planned purchases remain the same. For example, if the price of a bar is 50¢, the quantity demanded is 22 million a week. If the price is $2.50, the quantity demanded is 5 million a week. The other rows of the table show the quantities demanded at prices of $1.00, $1.50, and $2.00. We graph the demand schedule as a demand curve with the quantity demanded on the x-axis and the price on the y-axis. The points on the demand curve labeled A through E correspond to the rows of the demand schedule. For example, point A on the graph shows a quantity demanded of 22 million energy bars a week at a price of 50¢ a bar. The Demand Curve FIGURE 3.1 Price (dollars per bar) 56 6/22/09 3.00 E 2.50 D 2.00 C 1.50 B 1.00 Demand for energy bars A 0.50 0 5 15 20 25 10 Quantity demanded (millions of bars per week) Quantity demanded Willingness and Ability to Pay Another way of look- Price ing at the demand curve is as a willingness-and-ability-to-pay curve. The willingness and ability to pay is a measure of marginal benefit. If a small quantity is available, the highest price that someone is willing and able to pay for one more unit is high. But as the quantity available increases, the marginal benefit of each additional unit falls and the highest price that someone is willing and able to pay also falls along the demand curve. In Fig. 3.1, if only 5 million energy bars are available each week, the highest price that someone is willing to pay for the 5 millionth bar is $2.50. But if 22 million energy bars are available each week, someone is willing to pay 50¢ for the last bar bought. (dollars per bar) (millions of bars per week) A 0.50 22 B 1.00 15 C 1.50 10 D 2.00 7 E 2.50 5 A Change in Demand When any factor that influences buying plans other than the price of the good changes, there is a change in demand. Figure 3.2 illustrates an increase in demand. When demand increases, the demand curve shifts rightward and the quantity demanded at each price is greater. For example, at $2.50 a bar, the quantity demanded on the original (blue) demand curve is 5 million energy bars a week. On the new (red) demand curve, at $2.50 a bar, the quantity demanded is 15 million bars a week. Look closely at the numbers in the table and check that the quantity demanded at each price is greater. The table shows a demand schedule for energy bars. At a price of 50¢ a bar, 22 million bars a week are demanded; at a price of $1.50 a bar, 10 million bars a week are demanded. The demand curve shows the relationship between quantity demanded and price, other things remaining the same. The demand curve slopes downward: As the price decreases, the quantity demanded increases. The demand curve can be read in two ways. For a given price, the demand curve tells us the quantity that people plan to buy. For example, at a price of $1.50 a bar, people plan to buy 10 million bars a week. For a given quantity, the demand curve tells us the maximum price that consumers are willing and able to pay for the last bar available. For example, the maximum price that consumers will pay for the 15 millionth bar is $1.00. animation 9160335_CH03_p053-080.qxd 6/22/09 8:56 AM Page 57 Demand An Increase in Demand Price (dollars per bar) FIGURE 3.2 Six main factors bring changes in demand. They are changes in 3.00 ■ ■ E 2.50 E' ■ ■ D 2.00 D' ■ ■ C 1.50 B' Demand for energy bars (original) 0.50 5 0 A Demand for energy bars (new) A' 10 25 30 15 20 35 Quantity demanded (millions of bars per week) Original demand schedule New demand schedule Original income New higher income Quantity demanded Price (dollars per bar) 0.50 22 B 1.00 C Quantity demanded Price (millions of bars per week) A (dollars per bar) (millions of bars per week) A' 0.50 32 15 B' 1.00 25 1.50 10 C' 1.50 20 D 2.00 7 D' 2.00 17 E 2.50 5 E' 2.50 15 A change in any influence on buyers’ plans other than the price of the good itself results in a new demand schedule and a shift of the demand curve. A change in income changes the demand for energy bars. At a price of $1.50 a bar, 10 million bars a week are demanded at the original income (row C of the table) and 20 million bars a week are demanded at the new higher income (row C '). A rise in income increases the demand for energy bars. The demand curve shifts rightward, as shown by the shift arrow and the resulting red curve. animation The prices of related goods Expected future prices Income Expected future income and credit Population Preferences C' B 1.00 57 Prices of Related Goods The quantity of energy bars that consumers plan to buy depends in part on the prices of substitutes for energy bars. A substitute is a good that can be used in place of another good. For example, a bus ride is a substitute for a train ride; a hamburger is a substitute for a hot dog; and an energy drink is a substitute for an energy bar. If the price of a substitute for an energy bar rises, people buy less of the substitute and more energy bars. For example, if the price of an energy drink rises, people buy fewer energy drinks and more energy bars. The demand for energy bars increases. The quantity of energy bars that people plan to buy also depends on the prices of complements with energy bars. A complement is a good that is used in conjunction with another good. Hamburgers and fries are complements, and so are energy bars and exercise. If the price of an hour at the gym falls, people buy more gym time and more energy bars. Expected Future Prices If the price of a good is expected to rise in the future and if the good can be stored, the opportunity cost of obtaining the good for future use is lower today than it will be when the price has increased. So people retime their purchases—they substitute over time. They buy more of the good now before its price is expected to rise (and less afterward), so the demand for the good today increases. For example, suppose that a Florida frost damages the season’s orange crop. You expect the price of orange juice to rise, so you fill your freezer with enough frozen juice to get you through the next six months. Your current demand for frozen orange juice has increased, and your future demand has decreased. Similarly, if the price of a good is expected to fall in the future, the opportunity cost of buying the good today is high relative to what it is expected to be in the future. So again, people retime their purchases. They buy less of the good now before its price 9160335_CH03_p053-080.qxd 58 6/22/09 8:56 AM Page 58 CHAPTER 3 Demand and Supply falls, so the demand for the good decreases today and increases in the future. Computer prices are constantly falling, and this fact poses a dilemma. Will you buy a new computer now, in time for the start of the school year, or will you wait until the price has fallen some more? Because people expect computer prices to keep falling, the current demand for computers is less (and the future demand is greater) than it otherwise would be. Income Consumers’ income influences demand. When income increases, consumers buy more of most goods; and when income decreases, consumers buy less of most goods. Although an increase in income leads to an increase in the demand for most goods, it does not lead to an increase in the demand for all goods. A normal good is one for which demand increases as income increases. An inferior good is one for which demand decreases as income increases. As incomes increase, the demand for air travel (a normal good) increases and the demand for long-distance bus trips (an inferior good) decreases. TABLE 3.1 The Demand for Energy Bars The Law of Demand The quantity of energy bars demanded Decreases if: ■ The price of an energy bar rises Increases if: ■ The price of an energy bar falls Changes in Demand The demand for energy bars Decreases if: Increases if: ■ The price of a substitute falls ■ The price of a substitute rises ■ The price of a complement rises ■ The price of a complement falls ■ The price of an energy bar is expected to fall ■ The price of an energy bar is expected to rise ■ Income falls* ■ Income rises* ■ Expected future income falls or credit becomes harder to get ■ Expected future income rises or credit becomes easier to get ■ The population decreases ■ The population increases Expected Future Income and Credit When income is expected to increase in the future, or when credit is easy to obtain, demand might increase now. For example, a salesperson gets the news that she will receive a big bonus at the end of the year, so she goes into debt and buys a new car right now. Population Demand also depends on the size and the age structure of the population. The larger the population, the greater is the demand for all goods and services; the smaller the population, the smaller is the demand for all goods and services. For example, the demand for parking spaces or movies or just about anything that you can imagine is much greater in New York City (population 7.5 million) than it is in Boise, Idaho (population 150,000). Also, the larger the proportion of the population in a given age group, the greater is the demand for the goods and services used by that age group. For example, during the 1990s, a decrease in the college-age population decreased the demand for college places. During those same years, the number of Americans aged 85 years and over increased by more than 1 million. As a result, the demand for nursing home services increased. *An energy bar is a normal good. Preferences Demand depends on preferences. Preferences determine the value that people place on each good and service. Preferences depend on such things as the weather, information, and fashion. For example, greater health and fitness awareness has shifted preferences in favor of energy bars, so the demand for energy bars has increased. Table 3.1 summarizes the influences on demand and the direction of those influences. A Change in the Quantity Demanded Versus a Change in Demand Changes in the influences on buyers’ plans bring either a change in the quantity demanded or a change in demand. Equivalently, they bring either a movement along the demand curve or a shift of the demand curve. The distinction between a change in the quantity demanded and a change in demand is 9160335_CH03_p053-080.qxd 6/22/09 8:56 AM Page 59 Demand the same as that between a movement along the demand curve and a shift of the demand curve. A point on the demand curve shows the quantity demanded at a given price. So a movement along the demand curve shows a change in the quantity demanded. The entire demand curve shows demand. So a shift of the demand curve shows a change in demand. Figure 3.3 illustrates these distinctions. 59 A Change in the Quantity Demanded Versus a Change in Demand Price FIGURE 3.3 Decrease in quantity demanded Movement Along the Demand Curve If the price of the good changes but no other influence on buying plans changes, we illustrate the effect as a movement along the demand curve. A fall in the price of a good increases the quantity demanded of it. In Fig. 3.3, we illustrate the effect of a fall in price as a movement down along the demand curve D0. A rise in the price of a good decreases the quantity demanded of it. In Fig. 3.3, we illustrate the effect of a rise in price as a movement up along the demand curve D0. A Shift of the Demand Curve If the price of a good remains constant but some other influence on buyers’ plans changes, there is a change in demand for that good. We illustrate a change in demand as a shift of the demand curve. For example, if more people work out at the gym, consumers buy more energy bars regardless of the price of a bar. That is what a rightward shift of the demand curve shows—more energy bars are demanded at each price. In Fig. 3.3, there is a change in demand and the demand curve shifts when any influence on buyers’ plans changes, other than the price of the good. Demand increases and the demand curve shifts rightward (to the red demand curve D1) if the price of a substitute rises, the price of a complement falls, the expected future price of the good rises, income increases (for a normal good), expected future income or credit increases, or the population increases. Demand decreases and the demand curve shifts leftward (to the red demand curve D2) if the price of a substitute falls, the price of a complement rises, the expected future price of the good falls, income decreases (for a normal good), expected future income or credit decreases, or the population decreases. (For an inferior good, the effects of changes in income are in the opposite direction to those described above.) Decrease in Increase in demand demand Increase in quantity demanded D1 D0 D2 0 Quantity When the price of the good changes, there is a movement along the demand curve and a change in the quantity demanded, shown by the blue arrows on demand curve D0. When any other influence on buyers’ plans changes, there is a shift of the demand curve and a change in demand. An increase in demand shifts the demand curve rightward (from D0 to D1). A decrease in demand shifts the demand curve leftward (from D0 to D2). animation Review Quiz ◆ 1 2 3 4 5 Define the quantity demanded of a good or service. What is the law of demand and how do we illustrate it? What does the demand curve tell us about the price that consumers are willing to pay? List all the influences on buying plans that change demand, and for each influence, say whether it increases or decreases demand. Why does demand not change when the price of a good changes with no change in the other influences on buying plans? Work Study Plan 3.2 and get instant feedback. 9160335_CH03_p053-080.qxd 60 6/22/09 8:56 AM Page 60 CHAPTER 3 Demand and Supply ◆ Supply If a firm supplies a good or service, the firm 1. Has the resources and technology to produce it, 2. Can profit from producing it, and 3. Plans to produce it and sell it. A supply is more than just having the resources and the technology to produce something. Resources and technology are the constraints that limit what is possible. Many useful things can be produced, but they are not produced unless it is profitable to do so. Supply reflects a decision about which technologically feasible items to produce. The quantity supplied of a good or service is the amount that producers plan to sell during a given time period at a particular price. The quantity supplied is not necessarily the same amount as the quantity actually sold. Sometimes the quantity supplied is greater than the quantity demanded, so the quantity sold is less than the quantity supplied. Like the quantity demanded, the quantity supplied is measured as an amount per unit of time. For example, suppose that GM produces 1,000 cars a day. The quantity of cars supplied by GM can be expressed as 1,000 a day, 7,000 a week, or 365,000 a year. Without the time dimension, we cannot tell whether a particular quantity is large or small. Many factors influence selling plans, and again one of them is the price of the good. We look first at the relationship between the quantity supplied of a good and its price. Just as we did when we studied demand, to isolate the relationship between the quantity supplied of a good and its price, we keep all other influences on selling plans the same and ask: How does the quantity supplied of a good change as its price changes when other things remain the same? The law of supply provides the answer. The Law of Supply The law of supply states: Other things remaining the same, the higher the price of a good, the greater is the quantity supplied; and the lower the price of a good, the smaller is the quantity supplied. Why does a higher price increase the quantity supplied? It is because marginal cost increases. As the quantity produced of any good increases, the marginal cost of producing the good increases. (You can refresh your memory of increasing marginal cost in Chapter 2, p. 35.) It is never worth producing a good if the price received for the good does not at least cover the marginal cost of producing it. When the price of a good rises, other things remaining the same, producers are willing to incur a higher marginal cost, so they increase production. The higher price brings forth an increase in the quantity supplied. Let’s now illustrate the law of supply with a supply curve and a supply schedule. Supply Curve and Supply Schedule You are now going to study the second of the two most used curves in economics: the supply curve. And you’re going to learn about the critical distinction between supply and quantity supplied. The term supply refers to the entire relationship between the price of a good and the quantity supplied of it. Supply is illustrated by the supply curve and the supply schedule. The term quantity supplied refers to a point on a supply curve—the quantity supplied at a particular price. Figure 3.4 shows the supply curve of energy bars. A supply curve shows the relationship between the quantity supplied of a good and its price when all other influences on producers’ planned sales remain the same. The supply curve is a graph of a supply schedule. The table in Fig. 3.4 sets out the supply schedule for energy bars. A supply schedule lists the quantities supplied at each price when all the other influences on producers’ planned sales remain the same. For example, if the price of a bar is 50¢, the quantity supplied is zero—in row A of the table. If the price of a bar is $1.00, the quantity supplied is 6 million energy bars a week—in row B. The other rows of the table show the quantities supplied at prices of $1.50, $2.00, and $2.50. To make a supply curve, we graph the quantity supplied on the x-axis and the price on the y-axis, just as in the case of the demand curve. The points on the supply curve labeled A through E correspond to the rows of the supply schedule. For example, point A on the graph shows a quantity supplied of zero at a price of 50¢ an energy bar. 9160335_CH03_p053-080.qxd 6/22/09 8:56 AM Page 61 Supply The Supply Curve Price (dollars per bar) FIGURE 3.4 3.00 Supply of energy bars 2.50 E 2.00 D 1.50 C 1.00 B 0.50 A 61 Minimum Supply Price The supply curve can be interpreted as a minimum-supply-price curve—a curve that shows the lowest price at which someone is willing to sell. This lowest price is the marginal cost. If a small quantity is produced, the lowest price at which someone is willing to sell one more unit is low. But as the quantity produced increases, the marginal cost of each additional unit rises, so the lowest price at which someone is willing to sell rises along the supply curve. In Fig. 3.4, if 15 million bars are produced each week, the lowest price at which someone is willing to sell the 15 millionth bar is $2.50. But if 10 million bars are produced each week, someone is willing to accept $1.50 for the last bar produced. A Change in Supply 0 5 15 20 25 10 Quantity supplied (millions of bars per week) Price Quantity supplied (dollars per bar) (millions of bars per week) When any factor that influences selling plans other than the price of the good changes, there is a change in supply. Six main factors bring changes in supply. They are changes in ■ A 0.50 0 ■ B 1.00 6 ■ C 1.50 10 D 2.00 13 E 2.50 15 ■ ■ ■ The prices of factors of production The prices of related goods produced Expected future prices The number of suppliers Technology The state of nature Prices of Factors of Production The prices of the facThe table shows the supply schedule of energy bars. For example, at a price of $1.00, 6 million bars a week are supplied; at a price of $2.50, 15 million bars a week are supplied. The supply curve shows the relationship between the quantity supplied and the price, other things remaining the same. The supply curve slopes upward: As the price of a good increases, the quantity supplied increases. A supply curve can be read in two ways. For a given price, the supply curve tells us the quantity that producers plan to sell at that price. For example, at a price of $1.50 a bar, producers are willing to sell 10 million bars a week. For a given quantity, the supply curve tells us the minimum price at which producers are willing to sell one more bar. For example, if 15 million bars are produced each week, the lowest price at which a producer is willing to sell the 15 millionth bar is $2.50. animation tors of production used to produce a good influence its supply. To see this influence, think about the supply curve as a minimum-supply-price curve. If the price of a factor of production rises, the lowest price that a producer is willing to accept for that good rises, so supply decreases. For example, during 2008, as the price of jet fuel increased, the supply of air travel decreased. Similarly, a rise in the minimum wage decreases the supply of hamburgers. Prices of Related Goods Produced The prices of related goods that firms produce influence supply. For example, if the price of energy gel rises, firms switch production from bars to gel. The supply of energy bars decreases. Energy bars and energy gel are substitutes in production—goods that can be produced by using the same resources. If the price of beef rises, the supply of cowhide increases. Beef and cowhide are complements in production—goods that must be produced together. 9160335_CH03_p053-080.qxd 62 6/22/09 8:56 AM Page 62 CHAPTER 3 Demand and Supply Expected Future Prices If the price of a good The Number of Suppliers The larger the number of firms that produce a good, the greater is the supply of the good. And as firms enter an industry, the supply in that industry increases. As firms leave an industry, the supply in that industry decreases. mean the way that factors of production are used to produce a good. A technology change occurs when a new method is discovered that lowers the cost of producing a good. For example, new methods used in the factories that produce computer chips have lowered the cost and increased the supply of chips. Changes in the influences on producers’ planned sales bring either a change in the quantity supplied or a change in supply. Equivalently, they bring either a movement along the supply curve or a shift of the supply curve. A point on the supply curve shows the quantity supplied at a given price. A movement along the supply curve shows a change in the quantity supplied. The entire supply curve shows supply. A shift of the supply curve shows a change in supply. 2.50 E 2.00 E' D' D C' C B' B 0.50 A 0 Supply of energy bars (new) Supply of energy bars (original) 1.00 The State of Nature The state of nature includes all A Change in the Quantity Supplied Versus a Change in Supply 3.00 1.50 Technology The term “technology” is used broadly to the natural forces that influence production. It includes the state of the weather and, more broadly, the natural environment. Good weather can increase the supply of many agricultural products and bad weather can decrease their supply. Extreme natural events such as earthquakes, tornadoes, and hurricanes can also influence supply. Figure 3.5 illustrates an increase in supply. When supply increases, the supply curve shifts rightward and the quantity supplied at each price is larger. For example, at $1.00 per bar, on the original (blue) supply curve, the quantity supplied is 6 million bars a week. On the new (red) supply curve, the quantity supplied is 15 million bars a week. Look closely at the numbers in the table in Fig. 3.5 and check that the quantity supplied is larger at each price. Table 3.2 summarizes the influences on supply and the directions of those influences. An Increase in Supply FIGURE 3.5 Price (dollars per bar) is expected to rise, the return from selling the good in the future is higher than it is today. So supply decreases today and increases in the future. A' 25 30 15 20 35 10 Quantity supplied (millions of bars per week) 5 Original supply schedule New supply schedule Old technology New technology Quantity supplied Price (dollars per bar) Quantity supplied Price (millions of bars per week) (dollars per bar) (millions of bars per week) A 0.50 0 A' 0.50 7 B 1.00 6 B' 1.00 15 C 1.50 10 C' 1.50 20 D 2.00 13 D' 2.00 25 E 2.50 15 E' 2.50 27 A change in any influence on sellers’ plans other than the price of the good itself results in a new supply schedule and a shift of the supply curve. For example, a new, cost-saving technology for producing energy bars changes the supply of energy bars. At a price of $1.50 a bar, 10 million bars a week are supplied when producers use the old technology (row C of the table) and 20 million energy bars a week are supplied when producers use the new technology (row C '). An advance in technology increases the supply of energy bars. The supply curve shifts rightward, as shown by the shift arrow and the resulting red curve. animation 9160335_CH03_p053-080.qxd 6/22/09 8:56 AM Page 63 Supply FIGURE 3.6 A Change in the Quantity Supplied Versus a Change in Supply Price Figure 3.6 illustrates and summarizes these distinctions. If the price of the good falls and other things remain the same, the quantity supplied of that good decreases and there is a movement down along the supply curve S0. If the price of the good rises and other things remain the same, the quantity supplied increases and there is a movement up along the supply curve S0. When any other influence on selling plans changes, the supply curve shifts and there is a change in supply. If supply increases, the supply curve shifts rightward to S1. If supply decreases, the supply curve shifts leftward to S2. S2 S0 S1 Increase in quantity supplied Decrease in Increase in supply TABLE 3.2 63 supply The Supply of Energy Bars Decrease in quantity supplied The Law of Supply The quantity of energy bars supplied Decreases if: ■ The price of an energy bar falls Increases if: ■ The price of an energy bar rises Changes in Supply The supply of energy bars Decreases if: Increases if: ■ The price of a factor of production used to produce energy bars rises ■ The price of a factor of production used to produce energy bars falls ■ The price of a substitute in production rises ■ The price of a substitute in production falls The price of a complement in production falls ■ The price of an energy bar is expected to rise ■ ■ The number of suppliers of bars decreases ■ The number of suppliers of bars increases ■ A technology change decreases energy bar production ■ A technology change increases energy bar production A natural event decreases energy bar production ■ ■ ■ ■ The price of a complement in production rises The price of an energy bar is expected to fall A natural event increases energy bar production Quantity 0 When the price of the good changes, there is a movement along the supply curve and a change in the quantity supplied, shown by the blue arrows on supply curve S0. When any other influence on selling plans changes, there is a shift of the supply curve and a change in supply. An increase in supply shifts the supply curve rightward (from S0 to S1), and a decrease in supply shifts the supply curve leftward (from S0 to S2). animation Review Quiz ◆ 1 2 3 4 5 Define the quantity supplied of a good or service. What is the law of supply and how do we illustrate it? What does the supply curve tell us about the producer’s minimum supply price? List all the influences on selling plans, and for each influence, say whether it changes supply. What happens to the quantity of cell phones supplied and the supply of cell phones if the price of a cell phone falls? Work Study Plan 3.3 and get instant feedback. Now we’re going to combine demand and supply and see how prices and quantities are determined. 9160335_CH03_p053-080.qxd 64 6/22/09 8:56 AM Page 64 CHAPTER 3 Demand and Supply ◆ Market Equilibrium ■ ■ Price regulates buying and selling plans. Price adjusts when plans don’t match. Price (dollars per bar) We have seen that when the price of a good rises, the quantity demanded decreases and the quantity supplied increases. We are now going to see how the price adjusts to coordinate the plans of buyers and sellers and achieve an equilibrium in the market. An equilibrium is a situation in which opposing forces balance each other. Equilibrium in a market occurs when the price balances the plans of buyers and sellers. The equilibrium price is the price at which the quantity demanded equals the quantity supplied. The equilibrium quantity is the quantity bought and sold at the equilibrium price. A market moves toward its equilibrium because FIGURE 3.7 Equilibrium 3.00 Surplus of 6 million bars at $2.00 a bar 2.50 2.00 Equilibrium 1.50 1.00 Demand for energy bars Shortage of 9 million bars at $1.00 a bar 0.50 0 5 10 Price as a Regulator The price of a good regulates the quantities demanded and supplied. If the price is too high, the quantity supplied exceeds the quantity demanded. If the price is too low, the quantity demanded exceeds the quantity supplied. There is one price at which the quantity demanded equals the quantity supplied. Let’s work out what that price is. Figure 3.7 shows the market for energy bars. The table shows the demand schedule (from Fig. 3.1) and the supply schedule (from Fig. 3.4). If the price of a bar is 50¢, the quantity demanded is 22 million bars a week but no bars are supplied. There is a shortage of 22 million bars a week. This shortage is shown in the final column of the table. At a price of $1.00 a bar, there is still a shortage but only of 9 million bars a week. If the price of a bar is $2.50, the quantity supplied is 15 million bars a week but the quantity demanded is only 5 million. There is a surplus of 10 million bars a week. The one price at which there is neither a shortage nor a surplus is $1.50 a bar. At that price, the quantity demanded is equal to the quantity supplied: 10 million bars a week. The equilibrium price is $1.50 a bar, and the equilibrium quantity is 10 million bars a week. Figure 3.7 shows that the demand curve and the supply curve intersect at the equilibrium price of $1.50 a bar. At each price above $1.50 a bar, there is a surplus of bars. For example, at $2.00 a bar, the surplus is 6 Supply of energy bars Price (dollars per bar) Quantity demanded 15 20 25 Quantity (millions of bars per week) Quantity supplied Shortage (–) or surplus (+) (millions of bars per week) 0.50 22 0 –22 1.00 15 6 –9 1.50 10 10 0 2.00 7 13 +6 2.50 5 15 +10 The table lists the quantity demanded and the quantity supplied as well as the shortage or surplus of bars at each price. If the price is $1.00 a bar, 15 million bars a week are demanded and 6 million are supplied. There is a shortage of 9 million bars a week, and the price rises. If the price is $2.00 a bar, 7 million bars a week are demanded and 13 million are supplied. There is a surplus of 6 million bars a week, and the price falls. If the price is $1.50 a bar, 10 million bars a week are demanded and 10 million bars are supplied. There is neither a shortage nor a surplus. Neither buyers nor sellers have an incentive to change the price. The price at which the quantity demanded equals the quantity supplied is the equilibrium price. And 10 million bars a week is the equilibrium quantity. animation 9160335_CH03_p053-080.qxd 6/22/09 8:56 AM Page 65 Market Equilibrium million bars a week, as shown by the blue arrow. At each price below $1.50 a bar, there is a shortage of bars. For example, at $1.00 a bar, the shortage is 9 million bars a week, as shown by the red arrow. Price Adjustments You’ve seen that if the price is below equilibrium, there is a shortage and that if the price is above equilibrium, there is a surplus. But can we count on the price to change and eliminate a shortage or a surplus? We can, because such price changes are beneficial to both buyers and sellers. Let’s see why the price changes when there is a shortage or a surplus. A Shortage Forces the Price Up Suppose the price of an energy bar is $1. Consumers plan to buy 15 million bars a week, and producers plan to sell 6 million bars a week. Consumers can’t force producers to sell more than they plan, so the quantity that is actually offered for sale is 6 million bars a week. In this situation, powerful forces operate to increase the price and move it toward the equilibrium price. Some producers, noticing lines of unsatisfied consumers, raise the price. Some producers increase their output. As producers push the price up, the price rises toward its equilibrium. The rising price reduces the shortage because it decreases the quantity demanded and increases the quantity supplied. When the price has increased to the point at which there is no longer a shortage, the forces moving the price stop operating and the price comes to rest at its equilibrium. A Surplus Forces the Price Down Suppose the price of a bar is $2. Producers plan to sell 13 million bars a week, and consumers plan to buy 7 million bars a week. Producers cannot force consumers to buy more than they plan, so the quantity that is actually bought is 7 million bars a week. In this situation, powerful forces operate to lower the price and move it toward the equilibrium price. Some producers, unable to sell the quantities of energy bars they planned to sell, cut their prices. In addition, some producers scale back production. As producers cut the price, the price falls toward its equilibrium. The falling price decreases the surplus because it increases the quantity demanded and decreases the quantity supplied. When the price has fallen to the point at which there is no longer a surplus, the forces moving the price stop operating and the price comes to rest at its equilibrium. 65 The Best Deal Available for Buyers and Sellers When the price is below equilibrium, it is forced upward. Why don’t buyers resist the increase and refuse to buy at the higher price? Because they value the good more highly than the current price and they can’t satisfy their demand at the current price. In some markets—for example, the markets that operate on eBay—the buyers might even be the ones who force the price up by offering to pay a higher price. When the price is above equilibrium, it is bid downward. Why don’t sellers resist this decrease and refuse to sell at the lower price? Because their minimum supply price is below the current price and they cannot sell all they would like to at the current price. Normally, it is the sellers who force the price down by offering lower prices to gain market share. At the price at which the quantity demanded and the quantity supplied are equal, neither buyers nor sellers can do business at a better price. Buyers pay the highest price they are willing to pay for the last unit bought, and sellers receive the lowest price at which they are willing to supply the last unit sold. When people freely make offers to buy and sell and when demanders try to buy at the lowest possible price and suppliers try to sell at the highest possible price, the price at which trade takes place is the equilibrium price—the price at which the quantity demanded equals the quantity supplied. The price coordinates the plans of buyers and sellers, and no one has an incentive to change it. Review Quiz ◆ 1 2 3 4 5 6 7 What is the equilibrium price of a good or service? Over what range of prices does a shortage arise? Over what range of prices does a surplus arise? What happens to the price when there is a shortage? What happens to the price when there is a surplus? Why is the price at which the quantity demanded equals the quantity supplied the equilibrium price? Why is the equilibrium price the best deal available for both buyers and sellers? Work Study Plan 3.4 and get instant feedback. 9160335_CH03_p053-080.qxd 66 6/22/09 8:56 AM Page 66 CHAPTER 3 Demand and Supply ◆ Predicting Changes in Price FIGURE 3.8 The demand and supply model that we have just studied provides us with a powerful way of analyzing influences on prices and the quantities bought and sold. According to the model, a change in price stems from a change in demand, a change in supply, or a change in both demand and supply. Let’s look first at the effects of a change in demand. Price (dollars per bar) and Quantity The Effects of a Change in Demand 3.00 Supply of energy bars 2.50 2.00 1.50 An Increase in Demand When more and more people join health clubs, the demand for energy bars increases. The table in Fig. 3.8 shows the original and new demand schedules for energy bars (the same as those in Fig. 3.2) as well as the supply schedule of energy bars. When demand increases, there is a shortage at the original equilibrium price of $1.50 a bar. To eliminate the shortage, the price must rise. The price that makes the quantity demanded and quantity supplied equal again is $2.50 a bar. At this price, 15 million bars are bought and sold each week. When demand increases, both the price and the quantity increase. Figure 3.8 shows these changes. The figure shows the original demand for and supply of energy bars. The original equilibrium price is $1.50 an energy bar, and the quantity is 10 million energy bars a week. When demand increases, the demand curve shifts rightward. The equilibrium price rises to $2.50 an energy bar, and the quantity supplied increases to 15 million energy bars a week, as highlighted in the figure. There is an increase in the quantity supplied but no change in supply—a movement along, but no shift of, the supply curve. A Decrease in Demand We can reverse this change in demand. Start at a price of $2.50 a bar with 15 million energy bars a week being bought and sold, and then work out what happens if demand decreases to its original level. Such a decrease in demand might arise if people switch to energy gel (a substitute for energy bars). The decrease in demand shifts the demand curve leftward. The equilibrium price falls to $1.50 a bar, and the equilibrium quantity decreases to 10 million bars a week. Demand for energy bars (new) 1.00 0.50 0 Demand for energy bars (original) 5 10 15 25 30 20 35 Quantity (millions of bars per week) Quantity demanded Price (millions of bars per week) Quantity supplied (dollars per bar) Original New (millions of bars per week) 0.50 22 32 1.00 15 25 6 1.50 10 20 10 2.00 7 17 13 2.50 5 15 15 0 Initially, the demand for energy bars is the blue demand curve. The equilibrium price is $1.50 a bar, and the equilibrium quantity is 10 million bars a week. When more healthconscious people do more exercise, the demand for energy bars increases and the demand curve shifts rightward to become the red curve. At $1.50 a bar, there is now a shortage of 10 million bars a week. The price of a bar rises to a new equilibrium of $2.50. As the price rises to $2.50, the quantity supplied increases—shown by the blue arrow on the supply curve—to the new equilibrium quantity of 15 million bars a week. Following an increase in demand, the quantity supplied increases but supply does not change—the supply curve does not shift. animation 9160335_CH03_p053-080.qxd 6/22/09 8:56 AM Page 67 Predicting Changes in Price and Quantity We can now make our first two predictions: An Increase in Supply When Nestlé (the producer of PowerBar) and other energy bar producers switch to a new cost-saving technology, the supply of energy bars increases. Figure 3.9 shows the new supply schedule (the same one that was shown in Fig. 3.5). What are the new equilibrium price and quantity? The price falls to $1.00 a bar, and the quantity increases to 15 million bars a week. You can see why by looking at the quantities demanded and supplied at the old price of $1.50 a bar. The quantity supplied at that price is 20 million bars a week, and there is a surplus of bars. The price falls. Only when the price is $1.00 a bar does the quantity supplied equal the quantity demanded. Figure 3.9 illustrates the effect of an increase in supply. It shows the demand curve for energy bars and the original and new supply curves. The initial equilibrium price is $1.50 a bar, and the quantity is 10 million bars a week. When supply increases, the supply curve shifts rightward. The equilibrium price falls to $1.00 a bar, and the quantity demanded increases to 15 million bars a week, highlighted in the figure. There is an increase in the quantity demanded but no change in demand—a movement along, but no shift of, the demand curve. A Decrease in Supply Start out at a price of $1.00 a bar with 15 million bars a week being bought and sold. Then suppose that the cost of labor or raw materials rises and the supply of energy bars decreases. The decrease in supply shifts the supply curve leftward. The equilibrium price rises to $1.50 a bar, and the equilibrium quantity decreases to 10 million bars a week. We can now make two more predictions: 1. When supply increases, the quantity increases and the price falls. 2. When supply decreases, the quantity decreases and the price rises. Price (dollars per bar) 1. When demand increases, both the price and the quantity increase. 2. When demand decreases, both the price and the quantity decrease. FIGURE 3.9 67 The Effects of a Change in Supply 3.00 Supply of energy bars (original) Supply of energy bars (new) 2.50 2.00 1.50 1.00 Demand for energy bars 0.50 0 5 10 25 30 15 20 35 Quantity supplied (millions of bars per week) Price Quantity demanded (dollars per bar) (millions of bars per week) Quantity supplied (millions of bars per week) Original New 0.50 22 0 7 1.00 15 6 15 1.50 10 10 20 2.00 7 13 25 2.50 5 15 27 Initially, the supply of energy bars is shown by the blue supply curve. The equilibrium price is $1.50 a bar, and the equilibrium quantity is 10 million bars a week. When the new cost-saving technology is adopted, the supply of energy bars increases and the supply curve shifts rightward to become the red curve. At $1.50 a bar, there is now a surplus of 10 million bars a week. The price of an energy bar falls to a new equilibrium of $1.00 a bar. As the price falls to $1.00, the quantity demanded increases—shown by the blue arrow on the demand curve—to the new equilibrium quantity of 15 million bars a week. Following an increase in supply, the quantity demanded increases but demand does not change—the demand curve does not shift. animation 9160335_CH03_p053-080.qxd 8:56 AM Page 68 CHAPTER 3 Demand and Supply How Markets Interact to Reallocate Resources Fuel, Food, and Fertilizer The demand and supply model provides insights into all competitive markets. Here, we’ll apply what you’ve learned to the markets for ■ ■ ■ Crude oil Corn Fertilizers Crude Oil Crude oil is like the life-blood of the global economy. It is used to fuel our cars, airplanes, trains, and buses, to generate electricity, and to produce a wide range of plastics. When the price of crude oil rises, the cost of transportation, power, and materials all increase. In 2006, the price of a barrel of oil was $50. In 2008, the price had reached $135. While the price of oil has been rising, the quantity of oil produced and consumed has barely changed. Since 2006, the world has produced a steady 85 million barrels of oil a day. Who or what has been raising the price of oil? Is it the fault of greedy oil producers? Oil producers might be greedy, and some of them might be big enough to withhold supply and raise the price, but it wouldn’t be in their self-interest to do so. The higher price would bring forth a greater quantity supplied from other producers and the profit of the one limiting supply would fall. Producers could try to cooperate and jointly withhold supply. The Organization of Petroleum Exporting Countries, OPEC, is such a group of suppliers. But OPEC doesn’t control the world supply and its members self-interests are to produce the quantities that give them the maximum attainable profit. So even though the global oil market has some big players, they don’t fix the price. Instead, the actions of thousands of buyers and sellers and the forces of demand and supply determine the price of oil. So how have demand and supply changed? Because the price has increased with an unchanged quantity, demand must have increased and supply must have decreased. Demand has increased for two reasons. First, world production, particularly in China and India, is expanding at a rapid rate. The increased production of electricity, gasoline, plastics, and other oil-using goods has increased the demand for oil. Second, the rapid expansion of production in China, India, and other developing economies is expected to continue. So the demand for oil is expected to keep increasing at a rapid rate. As the demand for oil keeps increasing, the price of oil will keep rising and be expected to keep rising. A higher expected future price increases demand yet further. It also decreases supply because producers know they can get a greater return from their oil by leaving it in the ground and selling it in a later year. So an expected rise in price brings both an increase in demand and a decrease in supply, which in turn brings an actual rise in price. Because an expected price rise brings an actual price rise, it is possible for expectations to create a process called a speculative bubble. In a speculative bubble, the price rises purely because it is expected to rise and events reinforce the expectation. No one knows whether the world oil market was in a bubble in 2008, but bubbles always burst, so we will eventually know. Figure 1 illustrates the events that we’ve just described and summarizes the forces at work on demand and supply in the world market for oil. Price (dollars per barrel) 68 6/22/09 200 Rise in incomes in China and India and rise in expected future price increase demand 175 S2008 150 Rise in expected future price decreases supply S2006 135 100 75 50 25 0 D2008 Price of oil rises but quantity remains the same 75 80 D2006 90 95 85 100 Quantity (millions of barrels per day) Figure 1 The Market for Crude Oil 9160335_CH03_p053-080.qxd 6/22/09 8:56 AM Page 69 Predicting Changes in Price and Quantity 69 Corn is used as food, animal feed, and a source of ethanol. Global corn production increased during the past few years, but the price also increased. The story of the production and price of corn, like the story of the price of oil, begins in China and India. Greater production and higher incomes in these countries have increased the demand for corn. Some of the increase in demand is for corn as food. But more of the increase is for corn as cattle feed, driven by an increased demand for beef—it takes 7 pounds of corn to produce 1 pound of beef. In addition, mandated targets for ethanol production (see Chapter 2, pp. 34 and 46–47) have increased the demand for corn as a source of biofuel. While the demand for corn has increased, the supply has decreased. Drought in several parts of the world cut production and decreased supply. Higher fertilizer prices increased the cost of growing corn, which also decreased supply. So the demand for corn increased and the supply of corn decreased. This combination of changes in demand and supply raised the price of corn. Also, the increase in demand was greater than the decrease in supply, so the quantity of corn increased. Figure 2 provides a summary of the events that we’ve just described in the market for corn. Nitrogen, potassium, and potash are not on your daily shopping list, but you consume them many times each day. They are the reason why our farms are so productive. And like the prices of oil and corn, the prices of fertilizers have gone skyward. The increase in the global production of corn and other grains as food and sources of biofuels has increased the demand for fertilizers. All fertilizers are costly to produce and use energyintensive processes. Nitrogen is particularly energy intensive and uses natural gas. Potash is made from deposits of chloride and sodium chloride that are found 900 meters or deeper underground, and energy is required to bring the material to the surface and more energy is used to separate the chemicals and turn them into fertilizer. All energy sources are substitutes, so the rise in the price of oil has increased the prices of all other energy sources. Consequently, the energy cost of producing fertilizers has risen. This higher cost of production has decreased the supply of fertilizers. The increase in demand and the decrease in supply combine to raise the price. The increase in demand has been greater than the decrease in supply, so the quantity of fertilizer has increased. Figure 3 illustrates the market for fertilizers. 350 300 Rise in incomes in China and India and increase in use of corn to make biofuel increase the demand for corn Drought and rise in price of fertilizer decrease the supply of corn S2008 S2006 240 200 150 D2008 Price of corn rises D2006 100 0 650 700 Increase in demand exceeds decrease in supply, so quantity increases 750 780 850 900 Quantity (millions of tons per year) Figure 2 The Market for Corn Price (percentage of 2006 price) Fertilizers Price (dollars per ton) Corn 300 Increase in grain production increases the demand for fertilizer S2008 S2006 250 Rise in the price of oil raises the cost of producing fertilizer and decreases its supply 200 150 100 50 0 200 D2008 Price of fertilizer rises D2006 225 Increase in demand exceeds decrease in supply, so quantity increases 275 300 325 250 Quantity (millions of tons per year) Figure 3 The Market for Fertilizer 9160335_CH03_p053-080.qxd 6/22/09 8:56 AM Page 70 CHAPTER 3 Demand and Supply Supply 3.00 2.50 2.00 Equilibrium 1.50 2.50 2.00 Demand (new) 1.50 1.00 Demand Demand (original) 0.50 10 15 20 Quantity (millions of bars) (b) Increase in demand Price (dollars per bar) Supply (original) 2.50 Supply (new) 2.00 Supply (new) 2.50 2.00 1.50 1.00 Demand Supply (original) 3.00 2.50 Supply (new) 2.00 1.50 ? Demand (new) 0.50 10 15 20 Quantity (millions of bars) 10 15 20 Quantity (millions of bars) Demand (original) 10 0.50 15 20 Quantity (millions of bars) 0 ? 5 ? Demand (new) 10 15 20 Quantity (millions of bars) (d) Increase in supply (e) Increase in both demand and supply (f) Decrease in demand; increase in supply Price (dollars per bar) 0 Demand (original) 1.00 Price (dollars per bar) 5 6 Price (dollars per bar) 0 Demand (new) 0 ? 1.00 0.50 Demand (original) (c) Decrease in demand Supply (original) 3.00 1.50 2.00 0.50 10 15 20 Quantity (millions of bars) 5 0 (a) No change in demand or supply 3.00 2.50 1.00 Price (dollars per bar) 5 Supply 3.00 1.50 1.00 0.50 0 Supply 3.00 Price (dollars per bar) The Effects of All the Possible Changes in Demand and Supply Price (dollars per bar) Price (dollars per bar) FIGURE 3.10 Price (dollars per bar) 70 Supply (new) 3.00 Supply (original) 2.50 2.00 Supply (new) 3.00 Supply (original) 2.50 2.00 Demand (new) Supply (new) 3.00 Supply (original) 2.50 2.00 1.50 1.50 1.50 1.00 1.00 ? 1.00 Demand 0.50 Demand (original) 5 15 20 10 Quantity (millions of bars) (g) Decrease in supply animation 0 5 15 20 10 Quantity (millions of bars) 0 Demand (original) 0.50 0.50 ? 0 ? Demand (newl) ? (h) Increase in demand; decrease in supply 5 15 20 10 Quantity (millions of bars) (i) Decrease in both demand and supply 9160335_CH03_p053-080.qxd 6/22/09 8:56 AM Page 71 Predicting Changes in Price and Quantity All the Possible Changes in Demand and Supply Figure 3.10 brings together and summarizes the effects of all the possible changes in demand and supply. With what you’ve learned about the effects of a change in either demand or supply, you can predict what happens if both demand and supply change together. Let’s begin by reviewing what you already know. Change in Demand with No Change in Supply The first row of Fig. 3.10, parts (a), (b), and (c), summarizes the effects of a change in demand with no change in supply. In part (a), with no change in either demand or supply, neither the price nor the quantity changes. With an increase in demand and no change in supply in part (b), both the price and quantity increase. And with a decrease in demand and no change in supply in part (c), both the price and the quantity decrease. Change in Supply with No Change in Demand The first column of Fig. 3.10, parts (a), (d), and (g), summarizes the effects of a change in supply with no change in demand. With an increase in supply and no change in demand in part (d), the price falls and quantity increases. And with a decrease in supply and no change in demand in part (g), the price rises and the quantity decreases. Increase in Both Demand and Supply You’ve seen that an increase in demand raises the price and increases the quantity. And you’ve seen that an increase in supply lowers the price and increases the quantity. Fig. 3.10(e) combines these two changes. Because either an increase in demand or an increase in supply increases the quantity, the quantity also increases when both demand and supply increase. But the effect on the price is uncertain. An increase in demand raises the price and an increase in supply lowers the price, so we can’t say whether the price will rise or fall when both demand and supply increase. We need to know the magnitudes of the changes in demand and supply to predict the effects on price. In the example in Fig. 3.10(e), the price does not change. But notice that if demand increases by slightly more than the amount shown in the figure, the price will rise. And if supply increases by slightly more than the amount shown in the figure, the price will fall. 71 Decrease in Both Demand and Supply Figure 3.10(i) shows the case in which demand and supply both decrease. For the same reasons as those we’ve just reviewed, when both demand and supply decrease, the quantity decreases, and again the direction of the price change is uncertain. Decrease in Demand and Increase in Supply You’ve seen that a decrease in demand lowers the price and decreases the quantity. And you’ve seen that an increase in supply lowers the price and increases the quantity. Fig. 3.10(f ) combines these two changes. Both the decrease in demand and the increase in supply lower the price, so the price falls. But a decrease in demand decreases the quantity and an increase in supply increases the quantity, so we can’t predict the direction in which the quantity will change unless we know the magnitudes of the changes in demand and supply. In the example in Fig. 3.10(f ), the quantity does not change. But notice that if demand decreases by slightly more than the amount shown in the figure, the quantity will decrease. And if supply increases by slightly more than the amount shown in the figure, the quantity will increase. Increase in Demand and Decrease in Supply Figure 3.10(h) shows the case in which demand increases and supply decreases. Now, the price rises, and again the direction of the quantity change is uncertain. Review Quiz ◆ What is the effect on the price of an MP3 player (such as an iPod) and the quantity of MP3 players if 1 The price of a PC falls or the price of an MP3 download rises? (Draw the diagrams!) 2 More firms produce MP3 players or electronics workers’ wages rise? (Draw the diagrams!) 3 Any two of the events in questions 1 and 2 occur together? (Draw the diagrams!) Work Study Plan 3.5 and get instant feedback. ◆ Now that you understand the demand and supply model and the predictions that it makes, try to get into the habit of using the model in your everyday life. To see how you might use the model, take a look at Reading Between the Lines on pp. 72–73, which uses the tools of demand and supply to explain the rising price of gasoline in 2008. 9160335_CH03_p053-080.qxd 6/22/09 8:56 AM Page 72 READING BETWEEN THE LINES Demand and Supply: The Price of Gasoline Record Gas Prices Squeeze Drivers Americans feel the pinch as retail gasoline hits all-time high of $3.51 a gallon CNN Money April 22, 2008 NEW YORK (AP)—Cabbies here complain their take-home pay is thinner than it used to be. Trucking companies across the country are making drivers slow down to conserve fuel. Filling station owners plead that really, really, the skyrocketing prices aren’t their fault. … With gas prices now averaging $3.51 a gallon nationwide, … more and more Americans who have to drive are weighing the need for each and every trip. … Some would-be drivers are considering less energy-dependent alternatives simply for money’s sake. In Los Angeles, for example, fiction writer Brian Edwards sold his gas-guzzling Ford truck and now relies on his skateboard or the bus to get around. Sharon Cooper of Chicago, meanwhile, said she is planning to buy a bicycle to use on her 2 1/2-mile commute to work. … “It’s hell,” said legal aide Zebib Yemane, … “When going downhill, I used to step on the gas. Now I don’t.” … “Bottom line, we can’t afford it no more, man. It’s too much,” Bak Zoumane said as he filled up his yellow cab at a BP station in midtown New York. The West African immigrant said his next car will likely be a hybrid so he won’t have to pay so much at the pump. Gasoline prices typically rise in the spring as stations switch over to pricier summer-grade fuel and demand picks up as more travelers take to the road. But this year prices are rising even faster than normal, experts say, because of the massive jump in benchmark crude prices, which spiked to a record $117.76 a barrel Monday. … © 2008 Cable News Network. A Time Warner Company. All Rights Reserved. Essence of the Story ■ The retail price of gasoline hit a record high of $3.51 a gallon in April 2008. ■ Gas station owners said the high prices weren't their fault. ■ Drivers weighed the need for each trip and conserved energy by slowing down, easing off the gas when going down hill, or switching to hybrid vehicles. ■ Some people found alternative means of transportation that include the bus, a bicycle, or even a skateboard. 72 ■ The switch to summer-grade fuel and a seasonal increase in travel normally raise the price of gasoline in the spring. ■ In 2008, gas prices rose faster than normal because of a large rise in the price of crude oil, which reached $118 a barrel. 6/22/09 8:56 AM Page 73 Economic Analysis ■ ■ ■ ■ In April 2007, the average price of gasoline was $2.75 a gallon and 9.3 million barrels of gasoline were consumed on average each day. Figure 1 shows the market for gasoline in April 2007. The demand curve is D, the supply curve is S2007, and the market equilibrium is at 9.3 million barrels a day and $2.75 a gallon. Price (dollars per gallon) 9160335_CH03_p053-080.qxd Between April 2007 and April 2008, the price of crude oil increased from $65 a barrel to $118 a barrel. Equilibrium quantity ■ The rise in the price of crude oil raised the cost of producing gasoline and decreased the supply of gasoline. ■ Figure 2 shows what had happened in the market for gasoline by April 2008. ■ Demand remained unchanged, but supply decreased from S2007 to S2008. ■ Because demand was unchanged and supply decreased, the price increased and the quantity decreased. ■ ■ The equilibrium price increased from $2.75 a gallon to $3.51 a gallon and the equilibrium quantity decreased from 9.3 million barrels a day to 9.2 million barrels a day. You can see the effects of drivers conserving gasoline, switching to hybrid vehicles, and finding alternative means of transportation that include the bus, a bicycle, or even a skateboard. ■ This analysis of the market for gasoline emphasizes the distinction between a change in demand and a change in the quantity demanded and a change in supply and a change in the quantity supplied. ■ 9.1 9.2 9.3 9.4 Quantity (millions of barrels per day) Figure 1 The gasoline market in 2007 4.50 A rise in the price of crude oil decreases the supply of gasoline S2008 S2007 4.00 3.51 3.00 The price of gasoline rises 2.75 2.50 0 The quantity of gasoline decreases 9.0 The quantity of gasoline demanded decreases D 9.1 9.2 9.3 9.4 Quantity (millions of barrels per day) Figure 2 The gasoline market in 2008 Supply decreases—the supply curve shifts leftward. ■ 9.0 D In this example, there is a change in supply, no change in demand, and a change in the quantity demanded. ■ 0 Price (dollars per gallon) ■ Equilibrium price 2.50 The combined effects of these two factors left the demand for gasoline the same in 2008 as it had been in 2007. The price of crude oil was the biggest influence on the market for gasoline during 2007 and 2008. 3.50 2.75 Slightly higher incomes increased demand and the gradual move toward hybrid vehicles and the increased use of ethanol decreased demand. ■ S2007 4.00 3.00 Two main factors influenced the demand for gasoline in the year to April 2008. ■ 4.50 The demand curve does not shift, but as the price of gasoline rises, the quantity of gasoline demanded decreases in a movement along the demand curve D. 73 9160335_CH03_p053-080.qxd 6/22/09 8:56 AM Page 74 CHAPTER 3 Demand and Supply 74 MATHEMATICAL NOTE ◆ Demand, Supply, and Equilibrium Demand Curve The law of demand says that as the price of a good or service falls, the quantity demanded of that good or service increases. We can illustrate the law of demand by drawing a graph of the demand curve or writing down an equation. When the demand curve is a straight line, the following equation describes it: P = a - bQ D, where P is the price and Q D is the quantity demanded. The a and b are positive constants. The demand equation tells us three things: a The law of supply says that as the price of a good or service rises, the quantity supplied of that good or service increases. We can illustrate the law of supply by drawing a graph of the supply curve or writing down an equation. When the supply curve is a straight line, the following equation describes it: P = c + dQ S, where P is the price and Q S is the quantity supplied. The c and d are positive constants. The supply equation tells us three things: 1. The price at which sellers are not willing to supply the good (Q S is zero). That is, if the price is c, then no one is willing to sell the good. You can see the price c in Figure 2. It is the price at which the supply curve hits the yaxis—what we call the supply curve’s “intercept on the y-axis.” 2. As the price rises, the quantity supplied increases. If Q S is a positive number, then the price P must be greater than c. And as Q S increases, the price P becomes larger. That is, as the quantity increases, the minimum price that sellers are willing to accept for the last unit rises. 3. The constant d tells us how fast the minimum price at which someone is willing to sell the good rises as the quantity increases. That is, the constant d tells us about the steepness of the supply curve. The equation tells us that the slope of the supply curve is d. Price (P ) Price (P ) 1. The price at which no one is willing to buy the good (Q D is zero). That is, if the price is a, then the quantity demanded is zero. You can see the price a in Figure 1. It is the price at which the demand curve hits the y-axis—what we call the demand curve’s “intercept on the y-axis.” 2. As the price falls, the quantity demanded increases. If Q D is a positive number, then the price P must be less than a. And as Q D gets larger, the price P becomes smaller. That is, as the quantity increases, the maximum price that buyers are willing to pay for the last unit of the good falls. 3. The constant b tells us how fast the maximum price that someone is willing to pay for the good falls as the quantity increases. That is, the constant b tells us about the steepness of the demand curve. The equation tells us that the slope of the demand curve is –b. Supply Curve Intercept on y-axis is a Supply Intercept on y-axis is c Slope is –b Slope is d c Demand 0 Quantity demanded (QD) Figure 1 Demand curve 0 Figure 2 Supply curve Quantity supplied (QS) 9160335_CH03_p053-080.qxd 6/22/09 8:56 AM Page 75 Mathematical Note Market Equilibrium 75 Using the demand equation, we have Demand and supply determine market equilibrium. Figure 3 shows the equilibrium price (P *) and equilibrium quantity (Q*) at the intersection of the demand curve and the supply curve. We can use the equations to find the equilibrium price and equilibrium quantity. The price of a good adjusts until the quantity demanded Q D equals the quantity supplied Q S. So at the equilibrium price (P*) and equilibrium quantity (Q*), P* = a - b a P* = a - c b b + d a1b + d2 - b1a - c2 b + d ad + bc P* = . b + d Alternatively, using the supply equation, we have Q D = Q S = Q*. P* = c + d a To find the equilibrium price and equilibrium quantity, substitute Q* for QD in the demand equation and Q* for QS in the supply equation. Then the price is the equilibrium price (P*), which gives P* = a - c b b + d c1b + d2 + d1a - c2 b + d ad + bc P* = . b + d P* = a - bQ* P* = c + dQ*. An Example Notice that a - bQ* = c + dQ*. The demand for ice-cream cones is Now solve for Q*: P = 800 - 2Q D. a - c = bQ* + dQ* a - c = 1b + d2Q* a - c Q* = . b + d To find the equilibrium price, (P*), substitute for Q* in either the demand equation or the supply equation. The supply of ice-cream cones is P = 200 + 1Q S. The price of a cone is expressed in cents, and the quantities are expressed in cones per day. To find the equilibrium price (P*) and equilibrium quantity (Q*), substitute Q* for Q D and Q S and P* for P. That is, Price P* = 800 - 2Q* P* = 200 + 1Q*. Supply Market equilibrium Now solve for Q*: 800 - 2Q* = 200 + 1Q* 600 = 3Q* P* Q* = 200. And Demand 0 Q* Quantity Figure 3 Market equilibrium P* = 800 - 212002 = 400. The equilibrium price is $4 a cone, and the equilibrium quantity is 200 cones per day. 9160335_CH03_p053-080.qxd 76 6/22/09 8:56 AM Page 76 CHAPTER 3 Demand and Supply SUMMARY ◆ Key Points ■ Markets and Prices (p. 54) ■ ■ ■ A competitive market is one that has so many buyers and sellers that no single buyer or seller can influence the price. Opportunity cost is a relative price. Demand and supply determine relative prices. Market Equilibrium (pp. 64–65) ■ ■ Demand (pp. 55–59) ■ ■ ■ Demand is the relationship between the quantity demanded of a good and its price when all other influences on buying plans remain the same. The higher the price of a good, other things remaining the same, the smaller is the quantity demanded—the law of demand. Demand depends on the prices of related goods (substitutes and complements), expected future prices, income, expected future income and credit, population, and preferences. ■ ■ Supply is the relationship between the quantity supplied of a good and its price when all other influences on selling plans remain the same. The higher the price of a good, other things remaining the same, the greater is the quantity supplied—the law of supply. At the equilibrium price, the quantity demanded equals the quantity supplied. At any price above equilibrium, there is a surplus and the price falls. At any price below equilibrium, there is a shortage and the price rises. Predicting Changes in Price and Quantity (pp. 66–71) ■ ■ Supply (pp. 60–63) ■ Supply depends on the prices of resources used to produce a good, the prices of related goods produced, expected future prices, the number of suppliers, technology, and the state of nature. ■ An increase in demand brings a rise in the price and an increase in the quantity supplied. A decrease in demand brings a fall in the price and a decrease in the quantity supplied. An increase in supply brings a fall in the price and an increase in the quantity demanded. A decrease in supply brings a rise in the price and a decrease in the quantity demanded. An increase in demand and an increase in supply bring an increased quantity but an uncertain price change. An increase in demand and a decrease in supply bring a higher price but an uncertain change in quantity. Key Figures Figure 3.1 Figure 3.3 Figure 3.4 The Demand Curve, 56 A Change in the Quantity Demanded Versus a Change in Demand, 59 The Supply Curve, 61 Figure 3.6 Figure 3.7 Figure 3.10 A Change in the Quantity Supplied Versus a Change in Supply, 63 Equilibrium, 64 The Effects of All the Possible Changes in Demand and Supply, 70 Key Terms change in demand, 56 change in supply, 61 change in the quantity demanded, 59 change in the quantity supplied, 62 competitive market, 54 complement, 57 demand, 55 demand curve, 56 equilibrium price, 64 equilibrium quantity, 64 inferior good, 58 law of demand, 55 law of supply, 60 money price, 54 normal good, 58 quantity demanded, 55 quantity supplied, 60 relative price, 54 speculative bubble, 68 substitute, 57 supply, 60 supply curve, 60 9160335_CH03_p053-080.qxd 6/22/09 8:56 AM Page 77 Problems and Applications PROBLEMS and APPLICATIONS 77 ◆ Work problems 1–13 in Chapter 3 Study Plan and get instant feedback. Work problems 16–28 as Homework, a Quiz, or a Test if assigned by your instructor. 1. William Gregg owned a mill in South Carolina. In December 1862, he placed a notice in the Edgehill Advertiser announcing his willingness to exchange cloth for food and other items. Here is an extract: 1 yard of cloth for 1 pound of bacon 2 yards of cloth for 1 pound of butter 4 yards of cloth for 1 pound of wool 8 yards of cloth for 1 bushel of salt a. What is the relative price of butter in terms of wool? b. If the money price of bacon was 20¢ a pound, what do you predict was the money price of butter? c. If the money price of bacon was 20¢ a pound and the money price of salt was $2.00 a bushel, do you think anyone would accept Mr. Gregg’s offer of cloth for salt? 2. The price of food increased during the past year. a. Explain why the law of demand applies to food just as it does to all other goods and services. b. Explain how the substitution effect influences food purchases and provide some examples of substitutions that people might make when the price of food rises and other things remain the same. c. Explain how the income effect influences food purchases and provide some examples of the income effect that might occur when the price of food rises and other things remain the same. 3. Place the following goods and services into pairs of likely substitutes and into pairs of likely complements. (You may use an item in more than one pair.) The goods and services are coal, oil, natural gas, wheat, corn, rye, pasta, pizza, sausage, skateboard, roller blades, video game, laptop, iPod, cell phone, text message, email, phone call, voice mail 4. During 2008, the average income in China increased by 10 percent. Compared to 2007, how do you expect the following would change: a. The demand for beef? Explain your answer. b. The demand for rice? Explain your answer. 5. In January 2007, the price of gasoline was $2.38 a gallon. By May 2008, the price had increased to $3.84 a gallon. Assume that there were no changes in average income, population, or any other influence on buying plans. How would you expect the rise in the price of gasoline to affect a. The demand for gasoline? Explain your answer. b. The quantity of gasoline demanded? Explain your answer. 6. In 2008, the price of corn increased by 35 percent and some cotton farmers in Texas stopped growing cotton and started to grow corn. a. Does this fact illustrate the law of demand or the law of supply? Explain your answer. b. Why would a cotton farmer grow corn? 7. American to Cut Flights, Charge for Luggage American Airlines announced yesterday that it will begin charging passengers $15 for their first piece of checked luggage, in addition to raising other fees and cutting domestic flights as it grapples with record-high fuel prices. Boston Herald, May 22, 2008 a. How does this news clip illustrate a change in supply? Explain your answer. b What is the influence on supply identified in the news clip? Explain your answer. c. Explain how supply changes. 8. Oil Soars to New Record Over $135 The price of oil hit a record high above $135 a barrel on Thursday—more than twice what it cost a year ago ... OPEC has so far blamed price rises on speculators and says there is no shortage of oil. BBC News, May 22, 2008 a. Explain how the price of oil can rise even though there is no shortage of oil. b If a shortage of oil does occur, what does that imply about price adjustments and the role of price as a regulator in the market for oil? c If OPEC is correct, what factors might have 9160335_CH03_p053-080.qxd 6/22/09 8:56 AM Page 78 CHAPTER 3 Demand and Supply 78 changed demand and/or supply and shifted the demand curve and/or the supply curve to cause the price to rise? 9. “As more people buy computers, the demand for Internet service increases and the price of Internet service decreases. The fall in the price of Internet service decreases the supply of Internet service.” Is this statement true or false? Explain. 10. The following events occur one at a time: (i) The price of crude oil rises. (ii) The price of a car rises. (iii) All speed limits on highways are abolished. (iv) Robots cut car production costs. Which of these events will increase or decrease (state which occurs) a. The demand for gasoline? b. The supply of gasoline? c. The quantity of gasoline demanded? d. The quantity of gasoline supplied? 11. The demand and supply schedules for gum are Price (cents per pack) a. b. c. d. e. Quantity demanded Quantity supplied (millions of packs a week) 20 180 60 40 140 100 60 100 140 80 60 180 100 20 220 Draw a graph of the gum market, label the axes and the curves, and mark in the equilibrium price and quantity. Suppose that the price of gum is 70¢ a pack. Describe the situation in the gum market and explain how the price adjusts. Suppose that the price of gum is 30¢ a pack. Describe the situation in the gum market and explain how the price adjusts. A fire destroys some factories that produce gum and the quantity of gum supplied decreases by 40 million packs a week at each price. Explain what happens in the market for gum and illustrate the changes on your graph. If at the time the fire occurs in d, there is an increase in the teenage population, which increases the quantity of gum demanded by 40 million packs a week at each price, what are the new equilibrium price and quantity of gum? Illustrate these changes in your graph. 12. Eurostar Boosted by Da Vinci Code Eurostar, the train service linking London to Paris … , said on Wednesday first-half sales rose 6 per cent, boosted by devotees of the blockbuster Da Vinci movie. CNN, July 26, 2006 a. Explain how Da Vinci Code fans helped to raise Eurostar’s sales. b. CNN commented on the “fierce competition from budget airlines.” Explain the effect of this competition on Eurostar’s sales. c. What markets in Paris do you think these fans influenced? Explain the influence on three markets. 13. Of Gambling, Grannies, and Good Sense Nevada has the fastest growing elderly population of any state. … Las Vegas has … plenty of jobs for the over 50s. The Economist, July 26, 2006 Explain how grannies have influenced the a. Demand side of some Las Vegas markets. b. Supply side of other Las Vegas markets. 14. Use the link on MyEconLab (Textbook Resources, Chapter 3, Web Links) to obtain data on the prices and quantities of bananas in 1985 and 2002. a. Make a graph to illustrate the market for bananas in 1985 and 2002. b. On the graph, show the changes in demand and supply and the changes in the quantity demanded and the quantity supplied that are consistent with the price and quantity data. c. Why do you think the demand for and supply of bananas changed? 15. Use the link on MyEconLab (Textbook Resources, Chapter 3, Web Links) to obtain data on the price of oil since 2000. a. Describe how the price of oil changed. b. Use a demand-supply graph to explain what happens to the price when supply increases or decreases and demand is unchanged. c. What do you predict would happen to the price of oil if a new drilling technology permitted deeper ocean sources to be used? d. What do you predict would happen to the price of oil if a clean and safe nuclear technology were developed? e. How does a higher price of oil influence the market for ethanol? f. How does an increase in the supply of ethanol influence the market for oil? 9160335_CH03_p053-080.qxd 6/22/09 8:56 AM Page 79 Problems and Applications 21. In 2008, as the prices of homes fell across the United States, the number of homes offered for sale decreased. a. Does this fact illustrate the law of demand or the law of supply? Explain your answer. b. Why would home owners hold off trying to sell? 22. G.M. Cuts Production for Quarter General Motors cut its fourth-quarter production schedule by 10 percent on Tuesday as a tightening credit market caused sales at the Ford Motor Company, Chrysler and even Toyota to decline in August. … Bob Carter, group vice president for Toyota Motor Sales USA, said … dealerships were still seeing fewer potential customers browsing the lots. The New York Times, September 5, 2007 Explain whether this news clip illustrates a. A change in supply b. A change in the quantity supplied c. A change in demand d. A change in the quantity demanded 23. The figure illustrates the market for pizza. Price (dollars per pizza) 16. What features of the world market for crude oil make it a competitive market? 17. The money price of a textbook is $90 and the money price of the Wii game Super Mario Galaxy is $45. a. What is the opportunity cost of a textbook in terms of the Wii game? b. What is the relative price of the Wii game in terms of textbooks? 18. The price of gasoline has increased during the past year. a. Explain why the law of demand applies to gasoline just as it does to all other goods and services. b. Explain how the substitution effect influences gasoline purchases and provide some examples of substitutions that people might make when the price of gasoline rises and other things remain the same. c. Explain how the income effect influences gasoline purchases and provide some examples of the income effects that might occur when the price of gasoline rises and other things remain the same. 19. Classify the following pairs of goods and services as substitutes, complements, substitutes in production, or complements in production. a. Bottled water and health club memberships b. French fries and baked potatoes c. Leather purses and leather shoes d. SUVs and pickup trucks e. Diet coke and regular coke f. Low-fat milk and cream 20. Think about the demand for the three popular game consoles: XBox, PS3, and Wii. Explain the effect the following event on the demand for XBox games and the quantity of XBox games demanded, other things remaining the same. a. The price of an XBox falls. b. The prices of a PS3 and a Wii fall. c. The number of people writing and producing XBox games increases. d. Consumers’ incomes increase. e. Programmers who write code for XBox games become more costly to hire. f. The price of an XBox game is expected to fall. g. A new game console comes onto the market, which is a close substitute for XBox. 79 16 14 12 10 0 100 200 300 400 Quantity (pizzas per day) a. Label the curves. Which curve shows the willingness to pay for a pizza? b. If the price of a pizza is $16, is there a shortage or a surplus and does the price rise or fall? c. Sellers want to receive the highest possible price, so why would they be willing to accept less than $16 a pizza? d. If the price of a pizza is $12, is there a shortage or a surplus and does the price rise or fall? e. Buyers want to pay the lowest possible price, so why would they be willing to pay more than $12 for a pizza? 9160335_CH03_p053-080.qxd 80 6/22/09 8:56 AM Page 80 CHAPTER 3 Demand and Supply 24. Plenty of “For Sale” Signs but Actual Sales Lagging Like spring flowers, the “For Sale” signs are sprouting in front yards all over the country. But anxious sellers are facing the most brutal environment in decades, with a slumping economy, falling home prices, and rising mortgage foreclosures. The New York Times, May 26, 2008 a. Describe the changes in demand and supply in the market for homes in the United States. b. Is there a surplus of homes? c. What does the information in the news clip imply about price adjustments and the role of price as a regulator in the market for homes? 25. ‘Popcorn Movie’ Experience Gets Pricier … cinemas are raising … prices. … Demand for field corn, used for animal feed, … corn syrup and … ethanol, has caused its price to explode. That’s caused some farmers to shift from popcorn to easier-to-grow field corn, cutting supply and pushing its price higher, too. … USA Today, May 24, 2008 Explain and illustrate graphically the events described in the news clip in the markets for a. Popcorn. b. Viewing movies in the theater. 26. The table sets out the demand and supply schedules for potato chips. Price (cents per bag) 50 60 70 80 90 100 Quantity demanded Quantity supplied (millions of bags per week) 160 150 140 130 120 110 130 140 150 160 170 180 a. Draw a graph of the potato chip market and mark in the equilibrium price and quantity. b. If the price is 60¢ a bag, is there a shortage or a surplus, and how does the price adjust? c. If a new dip increases the quantity of potato chips that people want to buy by 30 million bags per week at each price, how does the demand and/or supply of chips change? d. If a new dip has the effect described in c, how does the price and quantity of chips change? e. If a virus destroys potato crops and the quantity of potato chips produced decreases by 40 million bags a week at each price, how does the supply of chips change? f. If the virus that destroys the potato crops in e hits just as the new dip in c comes onto the market, how does the price and quantity of chips change? 27. Sony’s Blu-Ray Wins High-Definition War Toshiba Corp. yesterday raised the white flag in the war over the next-generation home movie format, announcing the end of its HD DVD business in a victory for Sony Corp.’s Blu-ray technology. The move could finally jump-start a high-definition home DVD market that has been hamstrung as consumers waited on the sidelines for the battle to play out in a fight reminiscent of the VHS-Betamax videotape war of the 1980s. The Washington Times, February 20, 2008 How would you expect the end of Toshiba’s HD DVD format to influence a. The price of a used Toshiba player on eBay? Would the outcome that you predict result from a change in demand or a change in supply or both, and in which directions? b. The price of a Blu-ray player? c. The demand for Blu-ray format movies? d. The supply of Blu-ray format movies? e. The price of Blu-ray format movies? f. The quantity of Blu-ray format movies? 28. After you have studied Reading Between the Lines on pp. 72–73, answer the following questions: a. How high did the retail price of gasoline go in April 2008? b. What substitutions did drivers make to decrease the quantity of gasoline demanded? c. Why would the switch to summer-grade fuel and the seasonal increase in travel normally raise the price of gasoline in the spring? d. What were the two main factors that influenced the demand for gasoline in 2008 and how did they change demand? e. What was the main influence on the supply of gasoline during 2007 and 2008 and how did supply change? f. How did the combination of the factors you have noted in d and e influence the price and quantity of gasoline? g. Was the change in quantity a change in the quantity demanded or a change in the quantity supplied? ...
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