The Supply and Demand Model

Chapter 3: The Supply and Demand Model

Demand

  • Demand: A relationship between price and the quantity demanded.

    • Price: The amount of money or other goods that one must pay to obtain a particular good.

    • Quantity Demanded: The quantity of a good that people want to buy at a given price during a specific time period.

    • Demand Schedule: A tabular representation of demand showing the price and quantity demanded for a particular good, all else being equal.

Table 3.1: Demand Schedule for Bicycles (Millions of Bicycles Per Year)

  • Price (dollars per bicycle) | Quantity Demanded (millions of bicycles)

    • $140 | 18

    • $160 | 14

    • $180 | 11

    • $200 | 9

    • $220 | 7

    • $240 | 5

    • $260 | 3

    • $280 | 2

    • $300 | 1

The Demand Curve

  • Demand Curve: A graph of demand showing the relationship between price and quantity demanded.

  • Law of Demand: The tendency for the quantity demanded of a good to decline as its price rises.

    • Note: For a demand curve to be consistent with the law of demand, it must be downward sloping.

Figure 3.2: The Demand Curve

  • X-Axis: Quantity Demanded (millions of bicycles)

  • Y-Axis: Price (dollars per bicycle)

Price

Quantity Demanded

300

0

260

5

220

10

180

15

140

20

Shifts in Demand

  • Changes that can cause the demand curve to shift:

    • Consumers’ Preferences

    • Consumers’ Information

    • Consumers’ Income

    • Number of Consumers in the Market

    • Consumers’ Expectations of Future Prices

    • Prices of Closely Related Goods

    • Substitutes

    • Complements

Figure 3.3: A Shift in the Demand Curve

  • Demonstrates how the demand curve can shift to the right under various conditions affecting demand.

Consumers’ Preferences

  • Changes in preferences or tastes for a product can change the amount purchased at a given price.

    • Example: Increased demand for clothing certified as not produced in sweatshops on college campuses.

Consumers’ Information

  • New information available to consumers can lead to changes in purchasing behavior, even if prices remain constant.

    • Examples:

    • Car owners bought fewer Toyota vehicles after a massive recall.

    • Demand for spinach decreased after a contamination linked to E. coli.

Consumers’ Incomes

  • Normal Goods: Goods for which demand increases as income rises and decreases when income falls.

    • Examples: Shoes, clothing, jewelry.

  • Inferior Goods: Goods for which demand decreases as income rises and increases when income falls.

    • Examples: Instant noodles, inter-city bus tickets.

Number of Consumers in the Market

  • More consumers typically increase demand, while fewer consumers decrease demand.

    • Example: Expansion of the teenage population in the late 1990s increased demand for products marketed to this demographic.

Consumers’ Expectations of Future Prices

  • Expectations:

    • Higher future prices increase present demand.

    • Lower future prices decrease present demand.

    • Example: Anticipation of higher gasoline prices leads consumers to fill tanks now.

Prices of Closely Related Goods

  • Substitute: A good that can be used in place of another good.

    • Examples: Coke as a substitute for Pepsi.

  • Complement: A good that is consumed or used together with another good.

    • Examples: Gasoline is a complement to SUVs; cream complements coffee.

  • Relationship:

    • If a substitute's price rises, the demand for the other good increases.

    • If a complement's price rises, the demand for the other good decreases.

Supply

  • Supply: A relationship between price and the quantity supplied, all other things being equal.

    • Quantity Supplied: The quantity of a good that sellers are willing to sell at a given price during a specific time period.

    • Supply Schedule: A tabular representation of the supply curve.

Table 3.2: Supply Schedule for Bicycles (Millions of Bicycles Per Year)

  • Price (dollars per bicycle) | Quantity Supplied (millions of bicycles)

    • $140 | 1

    • $160 | 4

    • $180 | 7

    • $200 | 9

    • $220 | 11

    • $240 | 13

    • $260 | 15

    • $280 | 16

    • $300 | 17

Figure 3.5: The Supply Curve

  • Graph illustrating the positive relationship between price and quantity supplied.

The Supply Curve

  • Supply Curve: A graph showing the relationship between price and quantity supplied.

  • Law of Supply: The tendency for the quantity supplied of a good to increase as its price rises.

    • Note: For a supply curve to be consistent with the law of supply, it must be upward sloping.

Shifts in Supply

  • Changes that can cause the supply curve to shift:

    • Technology

    • Weather conditions

    • Prices of inputs used in production

    • Number of firms in the market

    • Expected future selling price

    • Government taxes, subsidies, and regulations.

Figure 3.6: A Shift in the Supply Curve

  • Illustrates how the supply curve shifts to the right under certain conditions.

Technology

  • Improvements that increase production capacity or efficiency correspond to an increase in supply.

    • Example: Innovations that decrease car production time.

Weather Conditions

  • Natural events like droughts and hurricanes can affect production levels.

    • Example: Hurricane Katrina and Rita decreased oil production in certain areas.

The Price of Inputs Used in Production

  • Rising input costs can decrease supply due to higher production costs.

    • Example: Increased prices of steel and aluminum decreased the production of appliances in 2018.

The Number of Firms in the Market

  • An increase in firms typically shifts the supply curve to the right, while a decrease shifts it to the left.

    • Example: Reducing trade barriers allows more manufacturers to enter the market.

Expectations of Future Prices

  • Lower expected future selling prices can prompt increased supply now; conversely, higher prices might lead to decreased supply now.

Government Taxes, Subsidies, and Regulations

  • Increases in taxes or decreases in subsidies reduce supply.

  • Conversely, decreases in taxes or increases in subsidies boost supply.

    • Example: Sanitary regulations reduce the number of food vendors, thereby reducing supply.

Movements Along versus Shifts of the Supply Curve

  • Movement along the Supply Curve: Changes in quantity supplied due to price changes.

  • Shift in the Supply Curve: Changes in supply due to factors other than price.

Finding the Market Price

  • Equilibrium Price: The price at which quantity supplied equals quantity demanded.

  • Equilibrium Quantity: The trade quantity at the equilibrium price.

  • Market Equilibrium: The state where price equals equilibrium price and trade quantity equals equilibrium quantity.

Shortage and Surplus

  • Shortage (Excess Demand): Occurs when quantity demanded exceeds quantity supplied at a given price, usually below equilibrium price.

  • Surplus (Excess Supply): Occurs when quantity supplied exceeds quantity demanded at a price, usually above equilibrium price.

Equilibrium Dynamics

  • If prices are below equilibrium, a shortage occurs, prompting price increases to restore equilibrium.

  • If prices are above equilibrium, a surplus occurs, prompting price decreases to restore equilibrium.

Figure 3.9: Equilibrium Price and Quantity

  • Illustrates dynamics of price changes due to shortages and surpluses.

Market Outcomes When Supply or Demand Changes

  • An increase in demand shifts the demand curve right, leading to a higher equilibrium price and quantity.

  • A decrease in demand shifts the demand curve left, resulting in a lower equilibrium price and quantity.

Figure 3.10(a): Effects of a Shift in Demand

  • Illustrates the impact of increased demand on equilibrium price and quantity:

    • Equilibrium price rises from $200 to $220.

    • Equilibrium quantity rises from 9 million to 11 million.

Figure 3.10(b): Effects of a Shift in Demand

  • Shows the impact of decreased demand on equilibrium price and quantity:

    • Equilibrium price falls from $200 to $180.

    • Equilibrium quantity falls from 9 million to 7 million.

Market Outcomes When Supply or Demand Changes

  • An increase in supply shifts the supply curve to the right, leading to a lower equilibrium price and a higher equilibrium quantity.

  • A decrease in supply shifts the supply curve left, resulting in a higher equilibrium price and a lower equilibrium quantity.

Figure 3.11(a): Effects of a Shift in Supply

  • Demonstrates the effect of increased supply:

    • Equilibrium price falls from $200 to $180.

    • Equilibrium quantity rises from 9 million to 11 million.

Figure 3.11(b): Effects of a Shift in Supply

  • Illustrates the effects of decreased supply:

    • Equilibrium price rises from $200 to $220.

    • Equilibrium quantity falls from 9 million to 7 million.

Table 3.4: Effects of Shifts in Demand and Supply Curves

  • Shift | Effect on Equilibrium Price | Effect on Equilibrium Quantity

    • Increase in demand | Up | Up

    • Decrease in demand | Down | Down

    • Increase in supply | Down | Up

    • Decrease in supply | Up | Down

Summary

  • Demand: Negative relationship between price and quantity demanded; represented by a downward-sloping demand curve.

  • Supply: Positive relationship between price and quantity supplied; represented by an upward-sloping supply curve.

  • The supply and demand model helps analyze how various factors can shift the curves, explaining price fluctuations and facilitating predictions about future prices.