The Market Forces of Supply and Demand

Markets
A

market is a group of buyers and sellers of f a particular ti l good d or service. i The terms supply and demand refer to the b h i of behavior f people l . . . as they th i interact t t with one another in markets. And A dE Economics, i especially i ll Microeconomics is about how supply and demand interact in markets. markets

Market a et Types ypes o or Structures

Competitive Markets
Products are the same,price takers

Monopoly Monopolistic Competition Oligopoly

Demand Curve
Price of Ice-Cream Cone

$3.00 2.50 2.00 1.50 1.00 0.50

Quantity of Ice-Cream Cones

0 1

2 3 4 5 6 7 8 9 10 11 12

Why y does t the e Demand e a d Curve Slope Downward?

Law of Demand
Inverse relationship between price and quantity.

Law of Diminishing Marginal Utility.

Utility is the extra satisfaction that one receives ece ves from o consuming co su g a product. p oduct. Marginal means extra. Diminishing means decreasing.

M k tD Market Demand d
Market

demand refers to the sum of all individual demands for a particular good or service. Graphically, G i individual i i i demand curves are summed horizontally to obtain the market demand curve.

Ceteris Paribus
Ceteris p paribus is a Latin p phrase that
means all variables other than the ones being studied are assumed to be constant. Literally, ceteris paribus means other things being equal. equal
The demand curve slopes downward because, ceteris paribus, lower prices imply a greater quantity demanded!

Two o Simple S p e Rules u es for o Movements vs. Shifts

Rule One
When an independent variable changes and that variable does not appear on the graph graph, the curve on the graph will shift.

Rule Two
When an independent variable does appear on the graph, the curve on the graph will not shift, instead a movement along the existing curve will occur.

Lets apply these rules to the following cases of supply and demand!

Change in Quantity Demanded versus Change in Demand

Ch Change i in Quantity Q tit Demanded D d d
Movement

along the demand curve. Caused by a change in the price of p the product.

Price of Cigarettes per Pack

Changes in Quantity Demanded

C
A tax that raises the price of cigarettes results in a movement along the demand curve.

$4 00 $4.00

2.00

D1
0

12

20

Number of Cigarettes Smoked per Day

Change in Quantity Demanded versus Change in Demand

Ch Change i in Demand D d
A

shift in the demand curve, either to the left or right. Caused by y a change g in a determinant other than the price.

D t Determinants i t of fD Demand d
Market

price Consumer income Prices of related goods Tastes T Expectations What are some examples?

Consumer Income
Price of Ice-Cream Cone

N Normal lG Good d
An increase in income...
Increase in demand

$3.00 2.50 2.00 1.50 1.00 0.50

D1
0 1 2 3 4 5 6 7 8 9 10 11 12

D2
Quantity of Ice-Cream Cones

Consumer Income
Price of Ice-Cream Cone

I f i Good Inferior G d

$3.00 2.50 2.00 1.50 1.00 0.50 Decrease in demand

An increase in income...

D2
0 1

D1

2 3 4 5 6 7 8 9 10 11 12

Quantity of Ice-Cream Cones

Prices of Related Goods

Substitutes & Complements
When Wh

a fall f ll in i the th price i of f one good d reduces the demand for another good, the two goods are called substitutes. When a fall in the price of one good increases the demand for another good the two goods are called good, complements.

Change in Quantity Demanded versus Change in Demand

Variables that Affect Quantity Demanded

A Change in This Variable . . .

Represents R t a movement t along the demand curve Shifts the demand curve Shifts the demand curve Shifts the demand curve Shifts the demand curve Shifts the demand curve

P i Price Income Prices of related goods Tastes Expectations Number of buyers

Price of Ice-Cream Cone

S Supply l Curve C

$3.00 2.50 2.00 1.50 1.00 0.50

Quantity of Ice-Cream Cones

1 2 3 4 5 6 7 8 9 10 11 12

Law of Supply
The law of supply states that there is a direct (positive) relationship between price and q p quantity y supplied. pp

S Supply l
Quantity supplied is the amount of a good that sellers are willing i i and able to sell.

Change in Quantity Supplied

Price of Ice-Cream C Cone

S
C A rise in the price p of ice cream cones results in a movement along the supply curve.

$3.00

1.00

Quantity of Ice-Cream Cones

M k tS Market Supply l
Market

supply refers to the sum of all individual supplies for all sellers of a particular good or service. Graphically, G i individual i i i supply curves are summed horizontally to obtain the market supply curve.

Determinants of Supply
Market

price Input I t prices i Technology gy Expectations Number N b of f producers d What are some examples? p

Change in Supply
Price of Ice-Cream C Cone

S3
Decrease in Supply Increase in i Supply

S1

S2

Quantity of Ice-Cream Cones

Change in Quantity Supplied versus Change in Supply

Variables that Affect Quantity Supplied A Change in This Variable . . .

Price Input prices Technology Expectations Number of sellers

Represents a movement along the supply curve Shifts the supply curve Shifts the supply curve Shifts the supply curve Shifts the supply curve

Price of Ice-Cream C Cone

Equilibrium of Supply and Demand

Supply

$3.00 2.50 2.00 1.50 1.00 0.50 0 1 2 3 4 5 6 7 8 9 10 11 12 Demand

Quantity of Ice-Cream Cones

Equilibrium ilib i

Price of Ice-Cream C Cone

E Excess S Supply l
Surplus
Supply

$3.00 2.50 2.00 1.50 1.00 0.50 0

Demand 1 2 3 4 5 6 7 8 9 10 11 12
Quantity of Ice-Cream Cones

Excess Demand
Price of o Ice-Cream Cone

Supply pp y
$2.00 $1.50

Shortage g

Demand

5 6

8 9 10 11 12 13 Quantity of Ice-Cream Cones

Three Steps To Analyzing Changes in Equilibrium

Decide

whether the event shifts the supply l or demand d d curve ( (or b both). th) Decide whether the curve(s) shift(s) to the left or to the right. Examine how the shift affects equilibrium price and quantity.

Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.

How an Increase in Demand Affects the Equilibrium

Price of I Ice-Cream C Cone 1. Hot weather increases the demand for ice cream...

Supply
$2.50 $ 2.00 2. ...resulting in a higher price... Initial equilibrium ilib i New equilibrium

D2

D1
0 3. ...and a higher quantity sold. 7 10 Quantity of Ice-Cream Cones

How a Decrease in Supply Aff t the Affects th Equilibrium E ilib i

Price of Ice Cream Ice-Cream Cone

S2

1. An earthquake reduces 1 the supply of ice cream...

S1
New equilibrium

$2.50 2.00 2. ...resulting in a higher price...

Initial equilibrium

Demand

1 2 3 4

7 8 9 10 11 12 13 3. ...and a lower quantity sold.

Quantity of Ice-Cream Cones