Chapter 3 - An Introduction to Demand and Supply

1. An Introduction to Demand
and Supply

2.  Market – is a means of interaction between
buyers and sellers for trading or exchange.
 Consumer – buys.
 Seller – sells.
TYPES OF MARKET
 Goods Market – most common type of market.
 Wet Market – where people buy pork, chicken, or
fish.
 Dry Market – where people buy shoes or clothes.
 Labor Market – where workers offer their
services and employers look for workers to hire.
 Stock Market – where commodities traded
consist of securities corporations.

3. Introduction to Demand
• 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).
 Demand Function shows how the quantity
demanded of a good is dependent on its
determinants.
 Demand Curve is the graphical presentation of the
demand schedule.

4.  Real Income – refers to the buyers’ purchasing
power obtained from his money income.
 Substitution Effect – when the price of a
commodity changes while other prices remain
constant, the consumer would tend to substitute a
lower priced commodity for the more expensive
one.
 Ceteris Paribus – “all other things are held
constant, or else equal.

5. 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 2
$4 4
$3 6
$2 8
$1 10

6. 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.

7. $0
$1
$2
$3
$4
$5
$6
0 2 4 6 8 10 12
Price
per
Widget
Quantity Demanded of Widgets
Demand Curve for Widgets
Demand Curve for Widgets

8. 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.
$0
$1
$2
$3
$4
$5
$6
0 2 4 6 8 10 12
Price
per
Widget
Quantity Demanded of Widgets
Demand Curve for Widgets
Demand Curve for
Widgets

9. Changes in Demand
 Change in the quantity demanded due to a price
change occurs ALONG the demand curve
$0
$1
$2
$3
$4
$5
$6
0 2 4 6 8 10 12
Price
per
Widget
Quantity Demanded of Widgets
Demand Curve for Widgets
Demand Curve for Widgets
•At $3 per Widget, the
Quantity demanded of
widgets is 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.

10. 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

11. 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

12. Changes in Demand
$0
$1
$2
$3
$4
$5
$6
0 2 4 6 8 10 12
Price
per
Widget
Quantity Demanded of Widgets
Demand Curve for Widgets
Demand Curve for Widgets
$0
$1
$2
$3
$4
$5
$6
0 2 4 6 8 10 12 14
Price
per
Widget
Quantity Demanded of Widets
Increase in Demand
Orginal Demand Curve
New Demand Curve
•Several factors will
change the demand for
the good (shift the entire
demand curve)
•As an example, suppose
consumer income
increases. The demand for
Widgets at all prices will
increase.

13. Changes in Demand
$0
$1
$2
$3
$4
$5
$6
0 2 4 6 8 10 12
Price
per
Widget
Quantity Demanded of Widgets
Demand Curve for Widgets
Demand Curve for Widgets
$0
$1
$2
$3
$4
$5
$6
0 2 4 6 8 10 12
Price
per
Widget
Quantity Demanded of Widgets
Decrease in Demand
Original Demand Curve
New Demand Curve
•As an example, suppose
Widgets become less
popular to own.
•Demand will also
decrease due to changes
in factors other than price.

14. 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)

15. 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).
• Supply Function shows how the quantity
offered for sale of a good is dependent on
its determinants.

16. 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 8
$3 6
$2 4
$1 2

17. 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.

18. $0
$1
$2
$3
$4
$5
$6
0 2 4 6 8 10 12
Price
per
Widget
Quantity Supplied of Widgets
Supply Curve for Widgets
Supply Curve

19. 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.
$0
$1
$2
$3
$4
$5
$6
0 2 4 6 8 10 12
Price
per
Widget
Quantity Supplied of Widgets
Supply Curve for Widgets
Supply Curve

20. 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.

21. 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.

22. Changes in Supply
$0
$1
$2
$3
$4
$5
$6
0 2 4 6 8 10 12
Price
per
Widget
Quantity Supplied of Widgets
Supply Curve for Widgets
Supply Curve
•At $3 per Widget, the
Quantity supplied of
widgets is 6.
•If the price of Widgets fell
to $2, then the Quantity
Supplied would fall to 4
Widgets.
•Change in the quantity supplied due to a price change
occurs ALONG the supply curve

23. 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

24. Changes in Supply
$0
$1
$2
$3
$4
$5
$6
0 2 4 6 8 10 12
Price
per
Widget
Quantity Supplied of Widgets
Supply Curve for Widgets
Supply Curve
$0
$1
$2
$3
$4
$5
$6
0 2 4 6 8 10 12 14
Price
per
Widget
Quantities Supplied of Widgets
Increase in Supply
Original Supply Curve
New Supply Curve
•Several factors will
change the demand for
the good (shift the entire
demand curve)
•As an example, suppose
that there is an
improvement in the
technology used to
produce widgets.

25. Changes in Supply
$0
$1
$2
$3
$4
$5
$6
0 2 4 6 8 10 12
Price
per
Widget
Quantity Supplied of Widgets
Supply Curve for Widgets
Supply Curve
$0
$1
$2
$3
$4
$5
$6
0 2 4 6 8 10 12
Price
per
Widget
Quantity Supplied of Widgets
Decrease in Supply
Original Supply Curve
New Supply Curve
•Supply can also decrease
due to factors other than
a change in price.
•As an example, suppose
that a large number of
Widget producers go out
of business, decreasing
the number of suppliers.

26. 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)

27. Elasticity of Demand and Supply

28. Elasticity
 Elasticity: the responsiveness of quantity to a change in another
variable
 Price Elasticity of Demand: the responsiveness of quantity
demanded to a change in price
 Price Elasticity of Supply: the responsiveness of quantity supplied to
a change in price
 Income Elasticity of Demand: the responsiveness of quantity
demanded to a change in income
 Cross Price Elasticity of Demand: the responsiveness of quantity
demanded of one good to a change in the price of another good

29. The Mathematical Representation of
Elasticity
Elasticity =
%ΔQ
%ΔP
=
ΔQ
ΔP
Q
P
Because the demand curve is downward sloping and the supply
curve is upward sloping the elasticity of demand is negative and
the elasticity of supply is positive. Often these signs are implicit
and ignored.

30. Elasticity Labels
 Elastic : the condition of demand when the
percentage change in quantity is larger than
the percentage change in price
 Inelastic: the condition of demand when the
percentage change in quantity is smaller than
the percentage change in price
 Unitary Elastic: the condition of demand when
the percentage change in quantity is equal to
the percentage change in price

31. The Relationship Between Slope and
Elasticity
 Elasticity and the slope of the demand curve
are not the same but they are related.
 At a given price level, elasticity is greater with
a flatter demand curve.
 With a linear demand curve (meaning a
demand curve that has a single value for the
slope) elasticity is greater at higher prices

32. Figure 1 Flatter Demand Means
Greater Elasticity
D1
D2
Q/t
P
Q*
P*
P1
P2
Q1=Q2

33. Figure 2 Higher Prices Means
Greater Elasticity
Q/t
P
D
P1
1
Q1
4
P4
Q4
3
P3
Q3
2
P2
Q2

34. Elasticity
 A good for which there are no good substitutes is
likely to be one for which you must pay whatever price
is charged. It is also likely to be one for which a lower
price will not induce substantially greater
consumption. Thus, as price changes there is very
little change in consumption, i.e. demand is inelastic
and the demand curve is steep.
 Inexpensive goods that take up little of your income
can change in price and your consumption will not
change dramatically. Thus, at low prices, demand is
inelastic.

35. Seeing Elasticity Through Total
Expenditures
 Total Expenditure Rule: if the price and the
amount you spend both go in the same direction
then demand is inelastic while if they go in
opposite directions demand is elastic.

36. Determinants of Elasticity
 Number of and Closeness of Substitutes
 The more alternatives you have the less likely you
are to pay high prices for a good and the more likely
you are to settle for something that will do.
 Time
 The longer you have to come up with alternatives to
paying high prices the more likely it is you will shift
to those alternatives.

37. Extremes of Elasticity
 Perfectly Inelastic: the condition of demand when
price changes have no effect on quantity
 Perfectly Elastic: the condition of demand when
price cannot change

38. How the Elasticity of Demand Affects
Reactions to Price Changes
Elasticity and the Demand Curve

39. Perfectly Inelastic Demand
D
Q/t
P
S2
Q1=Q2
P2
S1
P1

40. Perfectly Elastic Demand
Q/t
P
D
S2
P1=P2
Q2
S1
Q1

41. Inelastic Demand
(at moderate prices)
P
Q/t
D
S1
P1
Q1
Q2
S2
P2

42. Elastic Demand
(at moderate prices)
Q/t
P
Q1
D
S1
P1
S2
P2
Q2

43. Consumer and Producer Surplus
 Consumer Surplus: the value you get that is
in excess of what you pay to get it
 On a graph, consumer surplus is the area below the
demand curve and above the price line.
 Producer Surplus: the money the firm gets
that is in excess of its marginal costs
 On a graph, producer surplus is the area below the
price line and above the supply curve.

44. Consumer and Producer Surplus on
a Graph
Q/t
P
Demand
Supply
A
P*
B
C
0 Q*
• Value to the Consumer:
• 0ACQ*
• Consumers Pay Producers:
• OP*CQ*
• The Variable Cost to Producers:
• OBCQ*
• Consumer Surplus:
• P*AC
• Producer Surplus:
• BP*C