Chapter 3: Supply and Demand: Theory - Notes and Diagrams

If the price paid for a certain item is $40 and the consumers' surplus is $4, then what is the maximum buying price for that item? If the minimum selling price is $30 and the producers' surplus is $4, then what is the price received by the seller?

$44; $34.

A Change in Demand Versus a Change in Quantity Demanded

(a) A change in demand refers to a shift in the demand curve. A change in demand can be brought about by a number of factors. (see the exhibit and the text.) (b) A change in quantity demanded refers to a movement along a given demand curve. A change in quantity demanded is brought about only by a change in (a good's) own price.

A Change in Supply Versus a Change in Quantity Supplied

(a) A change in supply refers to a shift in the supply curve. A change in supply can be brought about by several factors. (See the exhibit and the text.) (b) A change in quantity supplied refers to a movement along a given supply curve. A change in quantity supplied is brought about only by a change in (a good's) own price.

Substitutes and Complements

(a) Coca-Cola and Pepsi-Cola are substitutes: The price of one and the demand for the other are directly related. As the price of Coca-Cola rises, the demand for Pepsi-Cola increases. (b) Tennis rackets and tennis balls are complements: The price of one and the demand for the other are inversely related. As the price of tennis rackets rises, the demand for tennis balls decreases.

Shifts in the Supply Curve

(a) The supply curve shifts rightward from S1 to S2. This shift represents an increase in the supply of shirts: At each price, the quantity supplied of shirts is greater. For example, the quantity supplied at $25 increases from 600 shirts to 900 shirts. (b) The supply curve shifts leftward from S1 to S2. This shift represents a decrease in the supply of shirts: At each price, the quantity supplied of shirts is less. For example, the quantity supplied at $25 decreases from 600 shirts to 300 shirts.

Consumers' and Producers' Surplus

(a)Consumers' surplus. As the shaded area indicates, the difference between the maximum, or highest, amount that buyers would be willing to pay for a good and the price that they actually pay is consumers' surplus. (b) Producers' surplus. As the shaded area indicates, the difference between the price that sellers receive for a good and the minimum or lowest price they would be willing to sell the good for is producers' surplus.

What Factors Cause the Demand Curve to Shift?

1. income, 2. preferences, 3. prices of related goods, 4. the number of buyers, and 5. expectations of future prices.

What Factors Cause the Supply Curve to Shift?

1. the prices of relevant resources, 2. technology, 3. the prices of related goods, 4. the number of sellers, 5. expectations of future price, 6. taxes and subsidies, and 7. government restrictions.

At equilibrium quantity, what is the relationship between the maximum buying price and the minimum selling price?

At the equilibrium quantity, the maximum buying price and the minimum selling price are the same. The equilibrium quantity is the only quantity at which the maximum buying price and the minimum selling price are the same.

The price of a personal computer of a given quality is lower today than it was five years ago. Is this necessarily the result of a lower demand for computers? Explain your answer.

No. It could be the result of a higher supply of computers. Either a decrease in demand or an increase in supply will lower price.

Change in demand =

Shift in demand curve

Changes in Supply Mean

Shifts in Supply Curves

Equilibrium Price and Quantity Effects of Supply Curve Shifts and Demand Curve Shifts

The exhibit illustrates the effects on equilibrium price and quantity of a change in demand, a change in supply, and a change in both. Below each diagram, the condition leading to the effects is noted, using the following symbols: (1) a bar over a letter means constant (thus, means that supply is constant); (2) a downward-pointing arrow (↓) indicates a fall; and (3) an upward-pointing arrow (↑) indicates a rise. A rise (fall) in demand is the same as a rightward (leftward) shift in the demand curve. A rise (fall) in supply is the same as a rightward (leftward) shift in the supply curve.

What is the effect on equilibrium price and quantity of the following? a. A decrease in demand that is greater than the increase in supply b. An increase in supply c. A decrease in supply that is greater than the increase in demand d. A decrease in demand

a. Lower price and lower quantity. b. Lower price and higher quantity. c. Higher price and lower quantity. d. Lower price and lower quantity.

What happens to the supply curve if each of the following occurs? a. The number of sellers decreases. b. A per-unit tax is placed on the production of a good. c. The price of a relevant resource falls.

a. The supply curve shifts to the left. b. The supply curve shifts to the left. c. The supply curve shifts to the right.

Economists often say that every market has two sides: a buying side and a selling side.

the buying side of the market is usually referred to as the demand side; the selling side is usually referred to as the supply side.

Economists often talk about 1. a change in quantity demanded and 2. a change in demand.

Although the phrase "quantity demanded" may sound like "demand," the two are not the same. In short, a change in quantity demanded is not the same as a change in demand.

Points to Remember

1. What looks like cost plus 10 percent (cost plus some markup) could instead be supply and demand at work. 2. Supply and demand are obviously determining prices at, say, an auction. A single good (say, a painting) is for sale, and numerous buyers bid on it. The bidding stops when only one buyer is left. At the price the last bidder bid, the quantity demanded (of the painting) equals the quantity supplied, and both equal 1. Even if you do not see supply and demand at work in nonauction settings, supply and demand are still at work determining prices.

The word demand has a precise meaning in economics. It refers to:

1. the willingness and ability of buyers to purchase different quantities of a good, 2. at different prices 3. during a specific period (per day, week, etc.).

Just as the word "demand" has a specific meaning in economics, so does the word "supply." Supply refers to:

1. the willingness and ability of sellers to produce and offer to sell different quantities of a good, 2. at different prices 3. during a specific period (per day, week, etc.).

What factors can change demand? What factors can change quantity demanded?

A change in income, preferences, prices of related goods, the number of buyers, and expectations of future price can change demand. A change in the price of the good changes the quantity demanded of it. For example, a change in income can change the demand for oranges, but only a change in the price of oranges can directly change the quantity demanded of oranges.

Change in quantity demanded =

A movement from one point to another point on the same demand curve that is caused by a change in the price of the good.

Moving to Equilibrium in Terms of Maximum and Minimum Prices

As long as the maximum buying price of a good is greater than the minimum selling price, an exchange will occur. This condition is met for units 1-4. The market converges on equilibrium through a process of mutually beneficial exchanges.

Equilibrium, Consumers' Surplus, and Producers' Surplus

Consumers' surplus is greater at the equilibrium quantity (100 units) than at any other exchangeable quantity. Producers' surplus is greater at the equilibrium quantity than at any other exchangeable quantity. For example, consumers' surplus is areas A+B+C at 75 units, but areas A+B+C+D at 100 units. Producers' surplus is areas E+F+G at 75 units, but areas E+F+G+H at 100 units.

A decrease in demand is represented by a leftward shift in the demand curve and means that individuals are willing and able to buy less of a good at each and every price:

Decrease in demand = Leftward shift in the demand curve

"If the price of apples rises, the supply of apples will rise." True or false? Explain your answer.

False. If the price of apples rises, then the quantity supplied of apples will rise—not the supply. We are talking about a movement from one point on a supply curve to a point higher up on the supply curve, not about a shift in the supply curve.

Moving to Equilibrium

If there is a surplus, sellers' inventories rise above the level the sellers hold in preparation for changes in demand. Sellers will want to reduce their inventories. As a result, price and output fall until equilibrium is achieved. If there is a shortage, some buyers will bid up the price of a good to get sellers to sell to them instead of to other buyers. Some sellers will realize that they can raise the price of the goods they have for sale. Higher prices will call forth added output. Price and output rise until equilibrium is achieved. (Note: Recall that price, on the vertical axis, is price per unit of the good, and quantity, on the horizontal axis, is for a specific period. In this text, we do not specify those qualifications on the axes themselves, but consider them to be understood.)

Shifts in the Demand Curve

In part (a), the demand curve shifts rightward from DA to DB. This shift represents an increase in demand. At each price, the quantity demanded is greater than it was before. For example, the quantity demanded at $20 increases from 500 units to 600 units. In part (b), the demand curve shifts leftward from DA to DC. This shift represents a decrease in demand. At each price, the quantity demanded is less. For example, the quantity demanded at $20 decreases from 500 units to 400 units.

An increase in demand is represented by a rightward shift in the demand curve and means that individuals are willing and able to buy more of a good at each and every price:

Increase in demand = Rightward shift in the demand curve

Why Most Supply Curves Are Upward Sloping

Most supply curves are upward sloping. The fundamental reason for this behavior involves the law of diminishing marginal returns, discussed in a later chapter. Here, suffice it to say that an upward-sloping supply curve reflects the fact that, under certain conditions, a higher price is an incentive to producers to produce more of the good. The incentive comes in the form of higher profits.

Demand Schedule and Demand Curve

Part (a) shows a demand schedule for good X. Part (b) shows a demand curve, obtained by plotting the different price-quantity combinations in part (a) and connecting the points. On a demand curve, the price (in dollars) represents price per unit of the good. The quantity demanded, on the horizontal axis, is always relevant for a specific period (a week, a month, etc.).

Deriving a Market Demand Schedule and a Market Demand Curve

Part (a) shows four demand schedules combined into one table. The market demand schedule is derived by adding the quantities demanded at each price. In (b), the data points from the demand schedule are plotted to show how a market demand curve is derived. Only two points on the market demand curve are noted.

Deriving a Market Supply Schedule and a Market Supply Curve

Part (a) shows four supply schedules combined into one table. The market supply schedule is derived by adding the quantities supplied at each price. In (b), the data points from the supply schedules are plotted to show how a market supply curve is derived. Only two points on the market supply curve are noted.

As Sandi's income rises, her demand for popcorn rises. As Mark's income falls, his demand for prepaid telephone cards rises. What kinds of goods are popcorn for Sandi and telephone cards for Mark?

Popcorn is a normal good for Sandi, and prepaid telephone cards are an inferior good for Mark.

The law of demand states that as the price of a good rises, the quantity demanded of the good falls, and that as the price of a good falls, the quantity demanded of the good rises, ceteris paribus.

Simply put, the law of demand states that the price of a good and the quantity demanded of it are inversely related, ceteris paribus.

The quantity supplied is the number of units that sellers are willing and able to produce and offer to sell at a particular price.

The (upward-sloping) supply curve is the graphical representation of the law of supply.

Economists often distinguish between 1. factors that can bring about movement along curves and 2. factors that can shift curves.

The factors that cause movement along curves are sometimes called movement factors. The factors that actually shift the curves are sometimes called shift factors.

Why Does Quantity Demanded Go Down as Price Goes Up?

The first reason is that people substitute lower priced goods for higher priced goods. The second reason for the inverse relationship between price and quantity demanded has to do with the law of diminishing marginal utility, which states that, over a given period, the marginal (or additional) utility or satisfaction gained by consuming equal successive units of a good will decline as the amount of the good consumed increases.

Quantity demanded =

The number of units of a good that individuals are willing and able to buy at a particular price.

Supply Curves When There Is No Time to Produce More or When No More Can Be Produced

The supply curve is not upward sloping when there is no time to produce additional units or when additional units cannot be produced. In those cases, the supply curve is vertical.

A Supply Curve

The upward-sloping supply curve is the graphical representation of the law of supply, which states that price and quantity supplied are directly related, ceteris paribus. On a supply curve, the price (in dollars) represents the price per unit of the good. The quantity supplied, on the horizontal axis, is always relevant for a specific period (a week, a month, etc.).

A Summary Exhibit of a Market (Supply and Demand)

This exhibit ties together the topics discussed so far in the chapter. A market is composed of both supply and demand. Also shown are the factors that affect supply and demand and therefore indirectly affect the equilibrium price and quantity of a good.

Higher Prices

This illustrates the law of demand: a higher price brings about a lower quantity demanded.