Chapter 3: Supply and Demand

Chapter Objectives Define and explain demand in a product or service market Define and explain supply Determine the equilibrium point in the market for a specific good, given data on supply and demand at different price levels

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Chapter 3Supply and Demand3-1Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Chapter ObjectivesDefine and explain demand in a product or service marketDefine and explain supplyDetermine the equilibrium point in the market for a specific good, given data on supply and demand at different price levels3-2Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Chapter ObjectivesUnderstand what causes shifts in demand and supplyUnderstand how price ceilings cause shortagesUnderstand how price floors cause surpluses3-3Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.The schedule of quantities of a good or service that people are willing and able to buy at different pricesSometimes a schedule is also called a tableDemandCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.3-4Hypothetical Daily Demand for Coach Seats on Round-Trip Weekly Flights between Denver and Chicago Table 1Price QD$500 1,000 450 3,000 400 7,000 350 12,000 300 19,000 250 30,000 200 45,000 150 57,000 100 67,000 3-5Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Hypothetical Daily Demand for Coach Seats on Round-Trip Weekly Flights between Denver and Chicago Table 1Price QD$500 1,000 450 3,000 400 7,000 350 12,000 300 19,000 250 30,000 200 45,000 150 57,000 100 67,000 3-6Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Hypothetical Daily Demand for Coach Seats on Round-Trip Weekly Flights between Denver and Chicago Table 1Price QD$500 1,000 450 3,000 400 7,000 350 12,000 300 19,000 250 30,000 200 45,000 150 57,000 100 67,000 3-7Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Hypothetical Daily Demand for Coach Seats on Round-Trip Weekly Flights between Denver and Chicago Table 1Price QD$500 1,000 450 3,000 400 7,000 350 12,000 300 19,000 250 30,000 200 45,000 150 57,000 100 67,000 3-8Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Hypothetical Daily Demand for Coach Seats on Round-Trip Weekly Flights between Denver and Chicago Table 1Price QD$500 1,000 450 3,000 400 7,000 350 12,000 300 19,000 250 30,000 200 45,000 150 57,000 100 67,000 3-9Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Hypothetical Daily Demand for Coach Seats on Round-Trip Weekly Flights between Denver and Chicago Table 1Price QD$500 1,000 450 3,000 400 7,000 350 12,000 300 19,000 250 30,000 200 45,000 150 57,000 100 67,000 3-10Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Hypothetical Daily Demand for Coach Seats on Round-Trip Weekly Flights between Denver and Chicago Table 1Price QD$500 1,000 450 3,000 400 7,000 350 12,000 300 19,000 250 30,000 200 45,000 150 57,000 100 67,000 3-11Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Hypothetical Daily Demand for Coach Seats on Round-Trip Weekly Flights between Denver and Chicago Table 1Price QD$500 1,000 450 3,000 400 7,000 350 12,000 300 19,000 250 30,000 200 45,000 150 57,000 100 67,000 3-12Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Hypothetical Daily Demand for Coach Seats on Round-Trip Weekly Flights between Denver and Chicago Table 1Price QD$500 1,000 450 3,000 400 7,000 350 12,000 300 19,000 250 30,000 200 45,000 150 57,000 100 67,000 3-13Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Hypothetical Daily Demand for Coach Seats on Round-Trip Weekly Flights between Denver and Chicago Table 1Price QD$500 1,000 450 3,000 400 7,000 350 12,000 300 19,000 250 30,000 200 45,000 150 57,000 100 67,000 3-14Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Hypothetical Daily Demand for Coach Seats on Round-trip Weekly Flights between Denver and Chicago Table 1Price QD$500 1,000 450 3,000 400 7,000 350 12,000 300 19,000 250 30,000 200 45,000 150 57,000 100 67,000 3-15Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Table 1Price QD$500 1,000 450 3,000 400 7,000 350 12,000 300 19,000 250 30,000 200 45,000 150 57,000 100 67,000 3-16Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Table 1 is the Demand ScheduleFigure 1 is the Graph of the Demand ScheduleFigure 1The line is the Demand Curve Table 1Price QD$500 1,000 450 3,000 400 7,000 350 12,000 300 19,000 250 30,000 200 45,000 150 57,000 100 67,000 3-17Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Figure 1Price and Quantity Demanded are inversely relatedQuantity Demanded is a point on the Demand Curve Table 1Price QD$500 1,000 450 3,000 400 7,000 350 12,000 300 19,000 250 30,000 200 45,000 150 57,000 100 67,000 3-18Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Figure 1Remember, Demand is the entire schedule or the entire curveQuantity Demanded is a point on the Demand Curve SupplyIs the “schedule” of quantities of a good or service that people are willing to sell at various prices3-19Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.3-20Price QS $500 62,000 $450 59,000 $400 54,000 $350 48,000 $300 40,000 $250 30,000 $200 16,000 $150 7,000 $100 2,000 Supply is the entire schedule or the entire curveCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.3-21Price QS $500 62,000 $450 59,000 $400 54,000 $350 48,000 $300 40,000 $250 30,000 $200 16,000 $150 7,000 $100 2,000 Quantity Supplied is a point on the curveCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.3-22Price QS QD $500 62,000 1,000 $450 59,000 3,000 $400 54,000 7,000 $350 48,000 12,000 $300 40,000 19,000 $250 30,000 30,000 $200 16,000 45,000 $150 7,000 57,000 $100 2,000 67,000 Demand and Supply CurvesEquilibrium price is the price where QD = QS We can find equilibrium price and quantity by seeing where the supply and demand curves crossCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.3-23Price QS QD $500 62,000 1,000 $450 59,000 3,000 $400 54,000 7,000 $350 48,000 12,000 $300 40,000 19,000 $250 30,000 30,000 $200 16,000 45,000 $150 7,000 57,000 $100 2,000 67,000 Demand and Supply CurvesEquilibrium price = EP Market price = MPMP > EP there is a surplusSurpluses and Shortages54,000-7,000 = 44,000Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.3-24Price QS QD $500 62,000 1,000 $450 59,000 3,000 $400 54,000 7,000 $350 48,000 12,000 $300 40,000 19,000 $250 30,000 30,000 $200 16,000 45,000 $150 7,000 57,000 $100 2,000 67,000 Demand and Supply CurvesEquilibrium price = EP Market price = MPSurpluses and Shortages54,000-7,000 = 44,000A surplus would force sellers to lower their prices. Eventually, prices would fall back to the equilibrium price Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.3-25Price QS QD $500 62,000 1,000 $450 59,000 3,000 $400 54,000 7,000 $350 48,000 12,000 $300 40,000 19,000 $250 30,000 30,000 $200 16,000 45,000 $150 7,000 57,000 $100 2,000 67,000 Demand and Supply CurvesEquilibrium price = EP Market price = MPSurpluses and Shortages57,000-7,000 = 44,000MP < EP here is a shortageCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.3-26Price QS QD $500 62,000 1,000 $450 59,000 3,000 $400 54,000 7,000 $350 48,000 12,000 $300 40,000 19,000 $250 30,000 30,000 $200 16,000 45,000 $150 7,000 57,000 $100 2,000 67,000 Demand and Supply CurvesEquilibrium price = EP Market price = MPSurpluses and Shortages57,000-7,000 = 44,000A shortage would allow sellers to raise their prices. As prices increased people would buy less. Eventually, prices would move back to the equilibrium price Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.3-27Price QS QD $500 62,000 1,000 $450 59,000 3,000 $400 54,000 7,000 $350 48,000 12,000 $300 40,000 19,000 $250 30,000 30,000 $200 16,000 45,000 $150 7,000 57,000 $100 2,000 67,000 Demand and Supply CurvesSurpluses and ShortagesWe can see that the forces of demand and supply work together to establish an equilibrium price at which there are no shortages or surplusesCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.3-28 Table 4Price QD1 QD2$500 1,000 12,000 450 3,000 15,000 400 7,000 21,000 350 12,000 30,000 300 19,000 40,000 250 30,000 55,000 200 45,000 63,000 150 57,000 75,000 100 67,000 88,000The schedule changes from QD1 to QD2The demand curve shifts to the right from D1 to D2This is an increase in demandCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.3-29 Table 4Price QD1 QD2$500 1,000 12,000 450 3,000 15,000 400 7,000 21,000 350 12,000 30,000 300 19,000 40,000 250 30,000 55,000 200 45,000 63,000 150 57,000 75,000 100 67,000 88,000The schedule changes from QD2 to QD1The demand curve shifts to the left from D2 to D1This is a decrease in demandPriceQuantity (in thousands)50100150200250300350400450500 10 20 30 40 50 60 70 SDShifts in Supply and DemandIf the schedule changes the Supply curve shiftsSupply decreases . . . the curve shifts to the leftS3-30Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.PriceQuantity (in thousands)50100150200250300350400450500 10 20 30 40 50 60 70 SDShifts in Supply and DemandIf the schedule changes the Supply curve shiftsSupply increases . . . the curve shifts to the rightSCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.3-31PriceQuantity (in thousands)50100150200250300350400450500 10 20 30 40 50 60 70 S1DShifts in Supply and DemandIf the Supply curve is S1 what is the equilibrium price and quantity?The equilibrium price is approximately 262 or 263S2The equilibrium quantity is approximately 35,0003-32Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.PriceQuantity (in thousands)50100150200250300350400450500 10 20 30 40 50 60 70 S1DShifts in Supply and DemandIf the Supply curve changes to S2 what is the new equilibrium price and quantity?The new equilibrium price is approximately 325S2The new equilibrium quantity is approximately 26,0003-33Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.PriceQuantity (in thousands)50100150200250300350400450500 10 20 30 40 50 60 70 S1DShifts in Supply and DemandIs a shift from S1 to S2 an increase or decrease in Supply?A decreaseS2Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.3-343-35Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Price Floors and CeilingsThe price can go no lower than the floor.A price floor creates a permanent surplusThe surplus is the amount by which the quantity supplied is greater than the quantity demanded3-36Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Price Floors and CeilingsThe price can go no higher than the ceiling.A price ceiling creates a permanent shortageThe shortage is the amount by which the quantity demanded is greater than the quantity suppliedApplications of Supply and Demand Interest rates are set bySupply and demandWage rates are set bySupply and demandRents are determined bySupply and demandPrices of nearly all goods are determined bySupply and demandPrices of nearly all services are determined bySupply and demand3-37Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.3-38Hypothetical Demand for and Supply of Loanable FundsWe can see that $600 billion is lent (or borrowed) at an interest rate of 6%What would happen if the supply of loanable funds increased?Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.3-39Hypothetical Demand for and Supply of Loanable FundsThe interest rate would decrease to 4% and the amount of money borrowed would increase to $800 billionCopyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.3-40Hypothetical Demand for and Supply of Loanable FundsIf the demand for loanable funds rises to D2 the interest rate would rise to 9% and the amount of money borrowed would rise to $700 billionPrice Mechanism (The Forces of Supply & Demand)Operates an automatic guidance systemSometimes this is called the “invisible hand”Efficiently allocates the limited means of production toward the satisfaction of human wantsProvides consumers with an endless stream of goods and servicesIn a sense, the price system has failed poor peopleMany are working 50 or 60 hours a week, but they are still poor3-41Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.