CHAPTER 3: DEMAND AND SUPPLY
MARKETS AND PRICES
• MARKET: any arrangement that enables buyers and
sellers to get information and do business with each
other
• COMPETITIVE MARKET: market that has many
buyers and many sellers that no single buyer or seller
can influence the price
• MONEY PRICE: amount of money needed to buy a
good
• RELATIVE PRICE: the ratio of a good’s money price to
the money price of the next best alternative good -
the good’s opportunity cost
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DEMAND
If you demand something, then you:
• Want it, can afford it, and have made a definite plan
to buy it
• WANTS are the unlimited desires we 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
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DEMAND
THE LAW OF DEMAND
• Other things remaining the same, the higher the
price of a good, the smaller is the quantity
demanded
• And the lower the price of the good, the larger is the
quantity demanded
• Why does a change in the price change the quantity
demanded:
– Substitution effect
– Income effect
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DEMAND
SUBSTITUTION EFFECT INCOME EFFECT
When the relative price When the price of a good
(opportunity cost) of a or service rises relative to
good or service rises, income, people cannot
people seek substitutes afford all the things they
for it, so the quantity previously bought, so the
demanded of the good or quantity demanded of the
service decreases. good or service decreases.
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DEMAND
DEMAND CURVE AND DEMAND SCHEDULE
• DEMAND: refers to the entire relationship between
the price of the good and the quantity demanded of
the good
• 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
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DEMAND
Example of a demand curve for energy bars:
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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
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DEMAND
• 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
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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
• 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 (decreases), the demand
curve shifts rightward (leftward)
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DEMAND
Six main factors that change demand of a good:
• The prices of related goods produced
• Expected future prices
• Income
• Expected future income and credit
• Population
• Preferences
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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
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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
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DEMAND
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
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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 the demand
for all goods
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DEMAND
PREFERENCES
• People with the same income have different
demands if they have different preferences
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DEMAND
Let’s look at our energy bars example and consider an
increase in income:
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DEMAND
It is very important to understand the distinction
between a change in demand and a change in the
quantity demanded.
• When the price of the good changes and other things
remain the same, the quantity demanded changes
and there is movement along 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
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DEMAND
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SUPPLY
If a firm supplies a good or service, then the firm:
• Has the resources and technology to produce it, can
profit from producing it, and has made a definite
plan to produce and sell it
• Resources and technology determine what is
possible to produce
• The QUANTITY SUPPLIED of a good or service is the
amount that producers plan to sell during a
particular time period, and at a particular price
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SUPPLY
THE LAW OF SUPPLY
• Other things remaining the same, the higher the
price of a good, the greater is the quantity supplied
• And the lower the price of the good, the smaller is
the quantity supplied
• Producers are willing to supply a good only if they
can at least cover their marginal cost of production
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SUPPLY
SUPPLY CURVE AND SUPPLY SCHEDULE
• SUPPLY: refers to the entire relationship between the
quantity supplied and the price of the good
• 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
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SUPPLY
Example of a supply curve for energy bars:
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SUPPLY
• 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
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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 for that good
• 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 (decreases), the supply curve
shifts rightward (leftward)
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SUPPLY
Six main factors that change supply of a good:
• The prices of factors of production
• The prices of related goods purchased
• Expected future prices
• The number of suppliers
• Technology
• The state of nature
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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
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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
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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, the greater is the
supply of the good. An increase in the number of
suppliers shifts the supply curve rightward
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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
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SUPPLY
THE STATE OF NATURE
• The state of nature includes all the natural forces
that influence production – eg. the weather
• A natural disaster decreases supply and shifts the
supply curve leftward
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SUPPLY
Let’s look at our energy bars example and consider an
advance in technology:
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SUPPLY
It is very important to understand the distinction
between a change in supply and a change in the
quantity supplied.
• When the price of the good changes and other
influences on sellers’ plans remain the same, the
quantity supplied changes and there is movement
along the supply curve
• If the price remains the same but one of the other
influences on sellers’ plans changes, supply changes
and the supply curve shifts
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SUPPLY
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MARKET EQUILIBRIUM
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
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MARKET EQUILIBRIUM
Energy bars example. Equilibrium occurs at the price at
which quantity demanded equals quantity supplied.
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MARKET EQUILIBRIUM
PRICE AS A REGULATOR. If the price is $2.00 a bar, the
quantity supplied exceeds the quantity demanded.
Surplus of 6 million bars.
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MARKET EQUILIBRIUM
PRICE AS A REGULATOR. If the price is $1.00 a bar, the
quantity demanded exceeds the quantity supplied.
Shortage of 9 million bars.
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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.
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PREDICTING CHANGES IN
PRICE AND QUANTITY
AN INCREASE IN DEMAND
When demand increases,
the demand curve shift
rightward.
At the original price, there
is now a shortage.
The price rises, and the
quantity supplied increases
along the supply curve.
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PREDICTING CHANGES IN
PRICE AND QUANTITY
A DECREASE IN DEMAND
When demand decreases,
the demand curve shift
leftward.
At the original price, there
is now a surplus.
The price falls, and the
quantity supplied
decreases along the supply
curve.
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PREDICTING CHANGES IN
PRICE AND QUANTITY
AN INCREASE IN SUPPLY
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.
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PREDICTING CHANGES IN
PRICE AND QUANTITY
A DECREASE IN SUPPLY
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.
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PREDICTING CHANGES IN
PRICE AND QUANTITY
BOTH DEMAND AND
SUPPLY CHANGE IN SAME
DIRECTION
An increase in demand and
an increase in supply
increases 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.
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PREDICTING CHANGES IN
PRICE AND QUANTITY
BOTH DEMAND AND
SUPPLY CHANGE IN SAME
DIRECTION
A decrease in 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 it.
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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.
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PREDICTING CHANGES IN
PRICE AND QUANTITY
BOTH DEMAND AND
SUPPLY CHANGE IN
OPPOSITE DIRECTIONS
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.
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