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Supply, Demand, and

Market Equilibrium

Introduction to Demand
The forces of supply and demand work together to set prices.
Demand is the desire, willingness, and ability to buy a good or

service.
Supply can refer to one individual consumer or to the total demand

of all consumers in the market (market demand).


Based on that definition, which of the following do you have a

demand for?

Introduction to Demand
A demand schedule is a table that lists the various

quantities of a product or service that someone is willing to


buy over a range of possible prices.

Price per Widget ($)

Quantity Demanded of
Widget per day

$5

$4

$3

$2

$1

10

Introduction to Demand
A demand schedule can be shown as points on a graph.
The graph lists prices on the vertical axis and quantities

demanded on the horizontal axis.


Each point on the graph shows how many units of the
product or service an individual will buy at a particular
price.
The demand curve is the line that connects these points.

Demand Curve for Widgets


$6

$5

Price per Widget

$4

$3
Demand Curve for Widgets

$2

$1

$0
0

6
8
Quantity Demanded of Widgets

10

12

What do you notice about the demand


curve?

How would you describe the slope of the


demand curve?
Do you think that price and quantity
demanded tend to have this relationship?

Introduction to Demand
The demand curve slopes downward.
This shows that people are normally willing to buy less of a

product at a high price and more at a low price.


According to the law of demand, quantity demanded and
price move in opposite directions.
Demand Curve for Widgets
Price per Widget

$6
$5
$4
$3
Demand Curve for Widgets

$2

$1
$0
0

4
6
8
10
Quantity Demanded of Widgets

12

Introduction
to
Demand

We buy products for their utility- the pleasure, usefulness, or

satisfaction they give us.


What is your utility for the following products? (Measure your
utility by the maximum amount you would be willing to pay
for this product)

Do we have the same utility for these goods?

Introduction to Demand
One reason the demand curve slopes downward is due to
diminish marginal utility

The principle of diminishing marginal utility says


that our additional satisfaction tends to go down as we
consume more and more units.

To make a buying decision, we consider whether the


satisfaction we expect to gain is worth the money we must
give up.

Changes in Demand

Change in the quantity demanded due to a price change occurs

ALONG the demand curve


Demand Curve for Widgets

At $3 per Widget, the


Quantity demanded of
widgets is 6.

$6

An increase in the Price of


Widgets from $3 to $4 will
lead to a decrease in the
Quantity Demanded of
Widgets from 6 to 4.

$5

Price per Widget

$4

$3
Demand Curve for Widgets
$2

$1

$0
0

6
8
Quantity Demanded of Widgets

10

12

Changes in Demand
Demand Curves can also shift in response to the following

factors:
Buyers (# of): changes in the number of consumers

Income: changes in consumers income


Tastes: changes in preference or popularity of product/ service
Expectations: changes in what consumers expect to happen in the

future
Related goods: compliments and substitutes
BITER: factors that shift the demand curve

Changes in Demand
Prices of related goods affect on demand
Substitute goods a substitute is a product that can be used in the

place of another.
The price of the substitute good and demand for the other good are directly

related
For example, Coke Price

Pepsi Demand

Complementary goods a compliment is a good that goes well

with another good.


When goods are complements, there is an inverse relationship between the

price of one and the demand for the other


For example, Peanut Butter
Jam Demand

Changes in Demand
Demand
Increase
Curve
in Demand
for Widgets

Several factors will


change the demand for
the good (shift the entire
demand curve)

$6$6

As an example, suppose
consumer income
increases. The demand for
Widgets at all prices will
increase.

$5$5

Price per Widget


Price per Widget

$4$4

$3$3

Orginal Demand Curve


Demand Curve for Widgets
New Demand Curve

$2$2

$1$1

$0$0
00

2 2

6
6
8
8
Quantity
QuantityDemanded
Demanded
ofofWidgets
Widets

10

10

12

12 14

Changes in Demand
Demand
Decrease
Curve
in Demand
for Widgets
$6$6

Demand will also


decrease due to changes
in factors other than price.

As an example, suppose
Widgets become less
popular to own.

$5$5

Price per Widget


Price per Widget

$4$4

$3$3

Original Demand Curve


Demand Curve for Widgets
New Demand Curve

$2
$2

$1
$1

$0
$0
0
0

6
8
6
Quantity Demanded
of Widgets 8
Quantity Demanded of Widgets

10
10

12
12

Changes in Demand
Changes in any of the factors other than price causes the
demand curve to shift either:
Decrease in Demand shifts to the Left (Less demanded at

each price)
OR
Increase in Demand shifts to the Right (More demanded at
each price)

Demand Practice

Price

1. The income of the Pago-Pagans declines


after a typhoon hits the island.

D1

D
Quantity

Price

2. Pago-Pagan is named on of the most beautiful


islands in the world and tourism to the island
doubles.

D1
D

Quantity

Price

3. The price of Frisbees decreases. (Frisbees are a


substitute good for boomerangs)

D1

D
Quantity

Price

4. The price of boomerang t-shirts decreases, which I


assume all of you know are a complementary good.

D1
D
Quantity

Price

5. The Boomerang Manufactures decide to add a money


back guarantee on their product, which increases the
popularity for them.

D1
D
Quantity

Price

6. Many Pago-pagans begin to believe that they


may lose their jobs in the near future. (Think
expectations!)

D1

D
Quantity

Price

7. Come up with your own story about boomerangs and the


Pago-Pagans. Write down the story, draw the change in
demand based on the story, and explain why demand
changed.

D
Quantity

Introduction to Supply

Supply refers to the various quantities of a good or


service that producers are willing to sell at all possible
market prices.

Supply can refer to the output of one producer or to


the total output of all producers in the market
(market supply).

Introduction to Supply
A supply schedule is a table that shows the quantities

producers are willing to supply at various prices

Price per Widget ($)

Quantity Supplied of Widget


per day

$5

10

$4

$3

$2

$1

Introduction to Supply
A supply schedule can be shown as points on a graph.
The graph lists prices on the vertical axis and quantities

supplied on the horizontal axis.


Each point on the graph shows how many units of the
product or service a producer (or group of producers)
would willing sell at a particular price.
The supply curve is the line that connects these points.

Supply Curve for Widgets


$6

$5

Price per Widget

$4

$3
Supply Curve

$2

$1

$0
0

6
Quantity Supplied of Widgets

10

12

What do you notice about the supply curve?


How would you describe the slope of the supply
curve?
Do you think that price and quantity supplied
tend to have this relationship?

Introduction to Supply

As the price for a good rises, the quantity supplied rises and
the quantity demanded falls. As the price falls, the quantity
supplied falls and the quantity demanded rises.
The law of supply holds that producers will normally offer
more for sale at higher prices and less at lower prices.
Supply Curve for Widgets
$6
$5

Price per Widget

$4
$3
Supply Curve

$2
$1
$0
0

4
6
8
Quantity Supplied of Widgets

10

12

Introduction to Supply
The reason the supply curve slopes upward is due to costs and

profit.
Producers purchase resources and use them to produce output.
Producers will incur costs as they bid resources away from their

alternative uses.

Introduction to Supply
Businesses provide goods and services hoping to make a

profit.

Profit is the money a business has left over after it


covers its costs.
Businesses try to sell at prices high enough to cover
their costs with some profit left over.
The higher the price for a good, the more profit a
business will make after paying the cost for resources.

Changes in Supply

Change in the quantity supplied due to a price change


occurs ALONG the supply curve
At $3 per Widget, the
Quantity supplied of
widgets is 6.

Supply Curve for Widgets


$6

If the price of Widgets fell


to $2, then the Quantity
Supplied would fall to 4
Widgets.

$5

Price per Widget

$4

$3

Supply Curve

$2

$1

$0
0

6
Quantity Supplied of Widgets

10

12

Changes in Supply
Supply Curves can also shift in response to the following factors:
Subsidies and taxes: government subsides encourage production,

while taxes discourage production


Technology: improvements in production increase ability of firms
to supply
Other goods: businesses consider the price of goods they could be
producing
Number of sellers: how many firms are in the market
Expectations: businesses consider future prices and economic
conditions
Resource costs: cost to purchase factors of production will
influence business decisions
STONER: factors that shift the supply curve

Changes in Supply
Several factors will
change the demand for
the good (shift the entire
demand curve)

Supply
Increase
Curveinfor
Supply
Widgets
$6

As an example, suppose
that there is an
improvement in the
technology used to
produce widgets.

$5

Price per Widget

$4

$3

Original Supply Curve


Supply Curve
New Supply Curve

$2

$1

$0
0

6
6 8
Quantities
Quantity
Supplied
Supplied
of Widgets
of Widgets

810

12 10

14

12

Changes in Supply
Supply can also decrease
due to factors other than
a change in price.

Supply
Decrease
in Curve
Supplyfor Widgets
$6

As an example, suppose
that a large number of
Widget producers go out
of business, decreasing
the number of suppliers.

$5

Price per Widget

$4

$3

Original Supply Curve


Supply Curve
New Supply Curve

$2

$1

$0
0

22

4 4

6 6
8
Quantity
Quantity
Supplied
Supplied
of Widgets
of Widgets

10

10

12

12

Changes in Supply
Changes in any of the factors other than price causes the
supply curve to shift either:
Decrease in Supply shifts to the Left (Less supplied at each

price)
OR
Increase in Supply shifts to the Right (More supplied at each
price)

Supply Practice

Cost to Produce

Cost of Resources Falls

Cost of Resources
Rises
Productivity Decreases

Productivity Increases

New Technology

Higher Taxes

Lower Taxes

Government Pays
Subsidy

Amount of Supply

Supply Curve Shifts

Price

1. The government of Pago-Paga adds a


subsidy to boomerang production.

S1

Quantity

Price

2. Boomerang producers also produce Frisbees.


The price of Frisbees goes up.
S1
S

Quantity

Price

3. The government of Pago-Paga adds a new


tax to boomerang production.
S1
S

Quantity

Price

4. Boomerang producers expect an increase in


the popularity of boomerangs worldwide.

S1

Quantity

Price

5. The price of plastic, a major input in boomerang


production, increases.
S1
S

Quantity

Price

6. Pago-Pagan workers are introduced to coffee as PagoPaga become integrated into the world market and their
productivity increases drastically.

S1

Quantity

Price

7. Come up with your own story about boomerangs and the


Pago-Pagans. Write down the story, draw the change in
supply based on the story, and explain why supply
changed.

Quantity

Supply and Demand at Work


Markets bring buyers and sellers together.
The forces of supply and demand work together in

markets to establish prices.


In our economy, prices form the basis of economic
decisions.

Supply and Demand at Work


Supply and Demand Schedule can be combined into one

chart.
Price per Widget ($)

Quantity Demanded
of Widget per day

Quantity Supplied
of Widget per day

$5

10

$4

$3

$2

$1

10

Supply and Demand at Work


Supply and Demand for Widgets
$6

$5

Price per Widget

$4

$3

Demand Curve
Supply Curve

$2

$1

$0
0

6
Quantity of Widgets

10

12

Supply and Demand at Work

A surplus is the amount by which the quantity


supplied is higher than the quantity demanded.

A surplus signals that the price is too high.


At that price, consumers will not buy all of the product
that suppliers are willing to supply.
In a competitive market, a surplus will not last. Sellers
will lower their price to sell their goods.

Supply and Demand at Work


Supply and Demand for Widgets

Suppose that the price in


the Widget market is $4.
At $4, Quantity
demanded will be 4
Widgets

$6

Surplus

At $4, Quantity supplied


will be 8 Widgets.

$5

At $4, there will be a


surplus of 4 Widgets.

Price per Widget

$4

$3

Demand Curve
Supply Curve

$2

$1

$0
0

6
Quantity of Widgets

10

12

Supply and Demand at Work


A shortage is the amount by which the quantity

demanded is higher than the quantity supplied


A shortage signals that the price is too low.

At that price, suppliers will not supply all of the product

that consumers are willing to buy.


In a competitive market, a shortage will not last. Sellers
will raise their price.

Supply and Demand at Work


Supply and Demand for Widgets

Suppose that the price in


the Widget market is $2.

$6

At $2, Quantity supplied


will be 4 Widgets

$5

At $2, Quantity
demanded will be 8
Widgets.
At $2, there will be a
shortage of 4 Widgets.

Price per Widget

$4

$3

Demand Curve
Supply Curve

$2

$1

Shortage

$0
0

10

12

Supply and Demand at Work

When operating without restriction, our market


economy eliminates shortages and surpluses.

Over time, a surplus forces the price down and a shortage forces
the price up until supply and demand are balanced.
The point where they achieve balance is the equilibrium price.
At this price, neither a surplus nor a shortage exists.

Once the market price reaches equilibrium, it tends to stay


there until either supply or demand changes.

When that happens, a temporary surplus or shortage occurs until


the price adjusts to reach a new equilibrium price.

Supply and Demand at Work


Supply and Demand for Widgets

At $3, Quantity supplied


will be 6 Widgets

$6

Price per Widget

Suppose that the price in


the Widget market is $3.

$5

At $3, Quantity
demanded will be 6
Widgets.

$4

At $3, there will be


neither a surplus or a
shortage.

$3

Demand Curve
Supply Curve

$2

$1

$0
0

6
Quantity of Widgets

10

12

Supply and Demand Practice

Supply and Demand for Boomerangs


$12

Surplus
$10

Price per Boomerang

$8

$6

Demand
Supply

$4

$2

$0
0

6
Quantity of Boomerangs

10

12

Supply and Demand for Boomerangs


$12

$10

Price per Boomerang

$8

$6

Demand
Supply

$4

$2

Shortage
$0
0

6
Quantity of Boomerangs

10

12

Supply and Demand for Boomerangs


$12

Market Equilibrium
$10

Price per Boomerang

$8

$6

Demand
Supply

$4

$2

$0
0

6
Quantity of Boomerangs

10

12

Supply and Demand for Boomerangs


$12

$10

Price per Boomerang

$8

Original Demand

$6

Supply
New Demand

$4

$2

$0
0

8
Quantity of Boomerangs

10

12

14

16

Price

1. The income of the Chapel Hill townies


declines after an early loss during March
Madness.

P1
P2
D
D1
Q2

Q1

Quantity

Price

2. Chapel Hill is named one of the most


beautiful towns in North Carolina and
tourism doubles

P2

P1

D1

D
Q1

Q2

Quantity

Price

3. The price of blue ties decreases. (Blue


ties are a substitute good for purple ties)

P1

P2
D1
Q2

Q1

D
Quantity

Price

4. The Federal government has been warning the


public about the possibility of a recession and job
loss in the RDU area. (Think expectations!)

P1
P2

D1
Q2

Q1

D
Quantity

Price

5. The price of purple striped shirts decreases (Purple


striped shirts are a complement to purple ties)

P2

P1
D1

D
Q1

Q2

Quantity

6. The price of silk increases (ties are made


with silk).

Price

S1
S

P2
P1

D
Q2 Q1

Quantity

Price

7. The government adds a subsidy to tie


production.

S
S1

P1
P2

D
Q1

Q2

Quantity

Price

8. After the release of Alan Greenspans first jazz


flute album, purple tie producers are expecting a
huge increase in demand and thus an increase in
the price.

S1

P1
P2

D
Q1

Q2

Quantity

9. Congress enacts new tax on the production of


purple ties.

Price

S1
S

P2

P1

D
Q2

Q1

Quantity

Price

10. As the popularity of purple ties sweeps the


greater Orange County area, new producers
enter the purple tie market.

S
S1

P1
P2
D
Q1

Q2

Quantity

Price

11. Purple ties are named by GQ magazine as a must


have for all young professionals. At the same time, a
new textile machine decreases the cost of producing
purple ties.

S1

P1
D1
D
Q1

Q2

Quantity

12. The price of pink ties (a related good that most purple tie producers also
produce) rises as spring approaches. Tie consumers in Chapel Hill begin to
expect purple ties to be put on sale since spring is coming, so they put off

purchasing.

Price

S1
S

P1

D1
Q2

Q1

Quantity

Disequilibrium
Describes a market that is not in equilibrium:
the quantity supplied is not equal to the quantity
demanded at the actual price.

Elasticity
A measure of the relationship between a change in the quantity
demanded of a particular good and a change in its price. Price
elasticity of demand is a term in economics often used when
discussing price sensitivity.

If a small change in price is accompanied by a large change in


quantity demanded, the product is said to be elastic (or
responsive to price changes). Conversely, a product is inelastic
if a large change in price is accompanied by a small amount of
change in quantity demanded.

Factors Affecting Demand


Price of the Product

There is an inverse (negative) relationship between the price of


a product and the amount of that product consumers are
willing and able to buy. Consumers want to buy more of a
product at a low price and less of a product at a high price. This
inverse relationship between price and the amount consumers
are willing and able to buy is often referred to as The Law of
Demand.

The Consumer's Income

The effect that income has on the amount of a product that


consumers are willing and able to buy depends on the type of
good we're talking about. For most goods, there is a positive
(direct) relationship between a consumer's income and the
amount of the good that one is willing and able to buy. In other
words, for these goods when income rises the demand for the
product will increase; when income falls, the demand for the
product will decrease. We call these types of goods normal
goods.

The Price of Related Goods

As with income, the effect that this has on the amount that one
is willing and able to buy depends on the type of good we're
talking about. Think about two goods that are typically
consumed together. For example, bagels and cream cheese. We
call these types of goods compliments. If the price of a bagel
goes up, the Law of Demand tells us that we will be
willing/able to buy fewer bagels. But if we want fewer bagels,
we will also want to use less cream cheese (since we typically
use them together). Therefore, an increase in the price of bagels
means we want to purchase less cream cheese. We can
summarize this by saying that when two goods are
complements, there is an inverse relationship between the price
of one good and the demand for the other good.

The Tastes and Preferences of Consumers

This is a less tangible item that still can have a big impact on
demand. There are all kinds of things that can change one's tastes
or preferences that cause people to want to buy more or less of a
product. For example, if a celebrity endorses a new product, this
may increase the demand for a product. On the other hand, if a
new health study comes out saying something is bad for your
health, this may decrease the demand for the product. Another
example is that a person may have a higher demand for an
umbrella on a rainy day than on a sunny day.

The Consumer's Expectations

It doesn't just matter what is currently going on - one's


expectations for the future can also affect how much of a
product one is willing and able to buy. For example, if you hear
that Apple will soon introduce a new iPod that has more
memory and longer battery life, you (and other consumers)
may decide to wait to buy an iPod until the new product comes
out. When people decide to wait, they are decreasing the
current demand for iPods because of what they expect to
happen in the future.

The Number of Consumers in the Market

As more or fewer consumers enter the market this has a direct


effect on the amount of a product that consumers (in general)
are willing and able to buy. For example, a pizza shop located
near a University will have more demand and thus higher sales
during the fall and spring semesters. In the summers, when less
students are taking classes, the demand for their product will
decrease because the number of consumers in the area has
significantly decreased.

Production Cost
A cost incurred by a business when manufacturing a good or
producing a service. Production costs combine raw material
and labor. To figure out the cost of production per unit, the cost
of production is divided by the number of units produced. A
company that knows how much it will cost to produce an item,
or produce a service, will have a clearer picture of how to
better price the item or service and what will be the total cost
to the company.

Businesses that know their production costs know the total


expense to the production line, or how much the entire process
will cost to produce the item. If costs are too high, these can be
decreased or possibly eliminated. Production costs can be used
to compare the expenses of different activities within the
company. In production, there are direct costs and indirect
costs. For example, direct costs for manufacturing an
automobile are materials such as the plastic, metal or labor
incurred to produce such an item. Indirect costs include
overhead such as rent, salaries or utility expense.

Market supply
Supply is the quantity of a good or service that a producer is
willing and able to supply onto the market at a given price in a
given time period. Normally as the market price of a
commodity rises, producers will expand their supply onto the
market.

There are three main reasons why supply curves for most

products slope upwards from left to right giving a positive


relationship between the market price and quantity supplied
When the market price rises (for example following an
increase in consumer demand), it becomes more profitable for
businesses to increase their output. Higher prices send signals
to firms that they can increase their profits by satisfying demand
in the market. When output rises, a firm's costs may rise,
therefore a higher price is needed to justify the extra output
and cover these extra costs of production. Higher prices makes
it more profitable for other firms to start producing that
product so we may see new firms entering the market leading
to an increase in supply available for consumers to buy For
these reasons we find that more is supplied at a higher price
than at a lower price.