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
 Markets and Prices
 A market is any arrangement that enables buyers and sellers to get
information and do business with each other.
 A competitive market is a market that has many buyers and many
sellers so no single buyer or seller can influence the price.
 The money price of a good is the amount of money needed to buy it.
 The relative price of a good—the ratio of its money price to the
money price of the next best alternative good—is its opportunity cost.
 Demand
 If you demand something, then you
 1. Want it,
 2. Can afford it, and
 3. Have made a definite plan to buy it.
 Wants are the unlimited desires or wishes people have for goods and
services. 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 particular time period, and at a
particular price.
 Demand
 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 larger is the quantity demanded.
 Why does a change in the price change the quantity demanded? Two
reasons:
■ Substitution effect
■ Income effect
 Demand
 Substitution Effect
 When the relative price (opportunity cost) of a good or service rises,
people seek substitutes for it, so the quantity demanded of the good or
service decreases.
 Income Effect
 When the price of a good or service rises relative to income, people
cannot afford all the things they previously bought, so the quantity
demanded of the good or service decreases.
 Demand
 Demand Curve and Demand Schedule
 The term demand refers to the entire relationship between the price of
the good and quantity demanded of the good.
 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.
 Demand
Figure 3.1 shows a demand curve for energy bars.
 Demand
A rise in the price, other things
remaining the same, brings a
decrease in the quantity demanded
and a movement up along the
demand curve.
A fall in the price, other things
remaining the same, brings an
increase in the quantity demanded
and a movement down along the
demand curve.
 Demand
Willingness and
Ability to Pay
A demand curve is also a willingness-
and-ability-to-pay curve.
The smaller the quantity available,
the higher is the price that someone
is willing to pay for another unit.
Willingness to pay measures
marginal benefit.
 Demand
 A Change in Demand
 When some influence on buying plans other than the price of the good
changes, there is a change in demand for that good.
 The quantity of the good that people plan to buy changes at each and
every price, so there is a new demand curve.
 When demand increases, the demand curve shifts rightward.
 When demand decreases, the demand curve shifts leftward.
 Demand
 Six main factors that change demand are:
■ The prices of related goods
■ Expected future prices
■ Income
■ Expected future income and credit
■ Population
■ Preferences
 Demand
 Prices of Related Goods
 A substitute is a good that can be used in place of another good.
 A complement is a good that is used in conjunction with another
good.
 When the price of a substitute for an energy bar rises or when the price
of a complement of an energy bar falls, the demand for energy bars
increases.
 Demand
 Expected Future Prices
 If the price of a good is expected to rise in the future, current demand
for the good increases and the demand curve shifts rightward.
 Income
 When income increases, consumers buy more of most goods and the
demand curve shifts rightward.
 A normal good is one for which demand increases as income
increases.
 An inferior good is a good for which demand decreases as income
increases.
 Demand
 Expected Future Income and Credit
 When income is expected to increase in the future or when credit is
easy to obtain, the demand might increase now.
 Population
 The larger the population, the greater is the demand for all goods.
 Preferences
 People with the same income have different demands if they have
different preferences.
 Demand
Figure 3.2 shows an increase in demand.
An increase in income increases the demand for energy bars and shifts the
demand curve rightward.
 Demand
A Change in the Quantity
Demanded Versus a Change in
Demand
Figure 3.3 illustrates the distinction
between a change in demand and
a change in the quantity
demanded.
 Demand
 Movement Along the
Demand Curve
 When the price of the good
changes and other things
remain the same, the
quantity demanded changes
and there is a movement
along the demand curve.
 Demand
 A Shift of the Demand
Curve
 If the price remains the
same but one of the other
influences on buyers’ plans
changes, demand changes
and the demand curve
shifts.
 Supply
 If a firm supplies a good or service, then the firm
 1. Has the resources and the technology to produce it,
 2. Can profit from producing it, and
 3. Has made a definite plan to produce and sell it.
 Resources and technology determine what it is possible to produce.
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.
 Supply
 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.
 The law of supply results from the general tendency for the marginal
cost of producing a good or service to increase as the quantity
produced increases (Chapter 2, page 35).
 Producers are willing to supply a good only if they can at least cover
their marginal cost of production.
 Supply
 Supply Curve and Supply Schedule
 The term supply refers to the entire relationship between the quantity
supplied and the price of a good.
 The 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.
 Supply
Figure 3.4 shows a supply curve of energy bars.

A rise in the price, other

things remaining the
same, brings an increase
in the quantity supplied.
 Supply
 Minimum Supply Price
 A supply curve is also a
minimum-supply-price curve.
 As the quantity produced
increases, marginal cost
increases.
 The lowest price at which
someone is willing to sell an
additional unit rises.
 This lowest price is marginal
cost.
 Supply
 A Change in Supply
 When some influence on selling plans other than the price of the good
changes, there is a change in supply of that good.
 The quantity of the good that producers plan to sell changes at each
and every price, so there is a new supply curve.
 When supply increases, the supply curve shifts rightward.
 When supply decreases, the supply curve shifts leftward.
 Supply
 The six main factors that change supply of a good are
 The prices of factors of production
 The prices of related goods produced
 Expected future prices
 The number of suppliers
 Technology
 State of nature
 Supply
 Prices of Factors of Production
 If the price of a factor of production used to produce a good rises, the
minimum price that a supplier is willing to accept for producing each
quantity of that good rises.
 So a rise in the price of a factor of production decreases supply and
shifts the supply curve leftward.
 Supply
 Prices of Related Goods Produced
 A substitute in production for a good is another good that can be
produced using the same resources.
 The supply of a good increases if the price of a substitute in production
falls.
 Goods are complements in production if they must be produced
together.
 The supply of a good increases if the price of a complement in
production rises.
 Supply
 Expected Future Prices
 If the price of a good is expected to rise in the future, supply of the
good today decreases and the supply curve shifts leftward.
 The Number of Suppliers
 The larger the number of suppliers of a good, the greater is the supply
of the good. An increase in the number of suppliers shifts the supply
curve rightward.
 Supply
 Technology
 Advances in technology create new products and lower the cost of
producing existing products.
 So advances in technology increase supply and shift the supply curve
rightward.
 The State of Nature
 The state of nature includes all the natural forces that influence
production—for example, the weather.
 A natural disaster decreases supply and shifts the supply curve
leftward.
 Supply

Figure 3.5 shows an increase in supply.

An advance in the technology increases the supply of energy bars and shifts
the supply curve rightward.
 Supply
A Change in the Quantity
Supplied Versus a Change in
Supply
Figure 3.6 illustrates the
distinction between a change in
supply and a change in the
quantity supplied.
 Supply
 Movement Along the
Supply Curve
 When the price of the good
changes and other
influences on sellers’ plans
remain the same, the
quantity supplied changes
and there is a movement
along the supply curve.
 Supply
 A Shift of the Supply
Curve
 If the price remains the
same but some other
influence on sellers’ plans
changes, supply changes
and the supply curve shifts.
 Market Equilibrium
 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.
■ Price regulates buying and selling plans.
■ Price adjusts when plans don’t match.
 Market Equilibrium

 Figure 3.7 illustrates the market equilibrium—the price at which

quantity demanded equals quantity supplied.
 Market Equilibrium
Price as a Regulator

If the price is $2.00 a bar, the

quantity supplied exceeds the
quantity demanded.
There is a surplus of 6 million
energy bars.
 Market Equilibrium
Price as a Regulator

If the price is $1.00 a bar, the

quantity demanded exceeds the
quantity supplied.
A shortage of 9 million bars.
 Market Equilibrium
Price as a Regulator

If the price is $1.50 a bar, the

quantity supplied equals the
quantity demanded.
No shortage or surplus of bars.
 Market Equilibrium
 Price Adjustments
 At prices above the equilibrium
price, a surplus forces the price
down.
 At prices below the equilibrium
price, a shortage forces the price
up.
 At the equilibrium price, buyers’
plans and sellers’ plans agree
and the price doesn’t change
until an event changes demand
or supply.
 Predicting Changes in Price
and Quantity
An Increase in Demand
Figure 3.8 shows that when
demand increases the demand
curve shifts rightward.
At the original price, there is now a
shortage.
The price rises, and the quantity
supplied increases along the supply
curve.
 Predicting Changes in Price
and Quantity
 A Decrease in Demand
 The figure shows that when
demand decreases the
demand curve shifts
leftward.
 At the original price, there is
now a surplus.
 The price falls, and the
quantity supplied decreases
along the supply curve.
 Predicting Changes in Price
and Quantity
An Increase in Supply
Figure 3.9 shows that when supply
increases the supply curve shifts
rightward.
At the original price, there is now a
surplus.
The price falls, and the quantity
demanded increases along the
demand curve.
 Predicting Changes in Price
and Quantity
 A Decrease in Supply
 The figure shows that when
supply decreases the supply
curve shifts leftward.
 At the original price, there is
now a shortage.
 The price rises, and the
quantity demanded
decreases along the demand
curve.
 Predicting Changes in Price
and Quantity
 Changes in Both Demand and Supply
 A change in both demand and supply changes the equilibrium
price and the equilibrium quantity.
 Figure 3.10 illustrates changes in the same direction.
 Figure 3.11 illustrates changes in opposite directions.
 Predicting Changes in Price
and Quantity
Both Demand and Supply Change
in the Same Direction
An increase in demand and an
increase in supply increase the
equilibrium quantity.
The change in equilibrium price is
uncertain because the increase in
demand raises the price and the
increase in supply lowers it.
 Predicting Changes in Price
and Quantity
A decrease in both demand and
supply decreases the equilibrium
quantity.
The change in equilibrium price is
uncertain because the decrease in
demand lowers the price and the
decrease in supply raises the price.
 Predicting Changes in Price
and Quantity
Both Demand and Supply
Change in Opposite Directions
A decrease in demand and an increase
in supply lowers the equilibrium price.
The change in equilibrium quantity is
uncertain because the decrease in
demand decreases the quantity and
the increase
in supply increases it.
 Predicting Changes in Price
and Quantity
An increase in demand and a
decrease in supply raises the
equilibrium price.
The change in equilibrium quantity
is uncertain because the increase
in demand increases the quantity
and the decrease in supply
decreases it.