Ch 3: Supply and Demand

Introduction & Real-World Motivation

• Soft-drink vs bottled water trend

  • Media headline: consumers seemingly switch to healthier bottled water.

  • Economics lens: a >20 % decline in the relative price of water vs soft drinks also drives the shift.

• Milk market anecdote

  • \text{Money price of milk}\downarrow\ \text{by >}\frac{1}{3}\ \Rightarrow\ \text{Quantity supplied}\downarrow by “millions of gallons.”

  • Illustrates joint operation of demand & supply.

Markets & Price Discovery

• Market (general definition)

  • All institutional/physical arrangements enabling exchange.

  • Examples: automobile, health-care, high-speed Internet.

  • Central activity: price determination.

Learning Objectives (Chapter 3)

• 3.1 Law of demand.

• 3.2 Change in demand vs change in quantity demanded.

• 3.3 Law of supply.

• 3.4 Change in supply vs change in quantity supplied.

• 3.5 Interaction → equilibrium price & quantity.

Demand

• Definition

  • Schedule showing quantities consumers will purchase at alternative prices in a given time period, ceteris paribus.

• Law of Demand

  • Inverse P\uparrow \Rightarrow Qd\downarrow; P\downarrow \Rightarrow Qd\uparrow (holding all else constant).

• Ceteris-Paribus Conditions held constant on a single demand curve

  • Income, tastes/preferences, prices of related goods, expectations, number of buyers, etc.

• Money vs Relative Prices

  • Money price = nominal P^{\$}.

  • Relative price = price expressed in terms of another good: P{A/B}=\frac{PA}{P_B}.

  • Example (restaurant meals vs groceries, 2008-present): P{restaurant}/P{home} rose 12 %.

• Quality-adjusted price example (old vs modern violins)

  • Blindfold tests ⇒ modern $\$1{,}000$ violins judged superior; old “Strads” had higher quality-adjusted prices.

Demand Schedule & Curve

• Table lists {price, quantity} for constant-quality unit per period.

• Demand curve = downward-sloping visual of schedule.

• Figure 3-1 Example (wireless earbuds):

  • Combination A–E shows 10 \rightarrow 50 units as P falls 5\$ \rightarrow 1\$.

• Pay-What-You-Want (PWYW) behavior

  • Charitable settings: altruism ⇒ actual payments > self-interested WTP.

Market Demand

• Horizontal summation of individual curves: QD^{market}=\sumi Q_{di}(P).

• Figure 3-2: two buyers → combined demand for earbuds rises from 20 to 110 units as P moves 5→1.

• Figure 3-3: whole market (millions of earbuds) illustrates same principle.

Shifts in Demand

• Conceptual rule

  • Any change in a ceteris-paribus factor shifts the entire curve; price change alone ⇒ move along curve.

• Graphical representation (Fig. 3-4): right shift D1 \rightarrow D2, left shift D1 \rightarrow D3.

• Determinants & Direction

  • Income

  • Normal good: income↑ ⇒ demand↑.

  • Inferior good: income↑ ⇒ demand↓.

  • Prices of related goods

  • Substitutes: P{sub}\uparrow \Rightarrow D{good}\uparrow (same direction).

    • China solar vs coal: cheaper solar ↓→ coal demand falls >4 %/yr.

  • Complements: P{comp}\uparrow \Rightarrow D{good}\downarrow (opposite direction).

  • Expectations

  • Expected future price ↑ ⇒ current demand ↑.

  • Expected future income ↑ ⇒ current demand ↑.

  • Expected shortages ↓availability ⇒ current demand ↑.

  • Market size (# buyers) ↑ ⇒ demand curve shifts right.

• Change vs. Movement

  • Shift = “change in demand.”

  • Movement = “change in quantity demanded.” (Fig. 3-5 illustrates point‐to‐point moves.)

Supply

• Definition

  • Schedule of quantities sellers will offer at alternative prices during a time period, c.p.

• Law of Supply

  • Direct relationship: P\uparrow \Rightarrow Qs\uparrow\,,\; P\downarrow \Rightarrow Qs\downarrow.

• Supply Schedule & Curve

  • Figure 3-6: producer supplies 55k → 20k units as P falls 5→1.

• Market Supply

  • Horizontal addition: QS^{market}=\sumj Q_{sj}(P).

  • Figure 3-7: two suppliers; Figure 3-8: whole industry (millions of units).

Shifts in Supply

• Rule analogue to demand

  • Shift when a non-price determinant changes; movement when P itself changes.

• Determinants

  • Technology/Productivity ↑ ⇒ supply right (costs ↓).

  • Ex: additive manufacturing (3-D printed jewelry) allows more output at any P.

  • Input costs ↑ ⇒ supply left.

  • Price expectations

  • Anticipated future P↑ ⇒ suppliers hold back today ⇒ supply left.

  • Note simultaneous buyer reaction: demand right (What-Happens-When box).

  • Taxes ↑ / Subsidies ↓ ⇒ supply left; reverse moves right.

  • # Firms ↑ ⇒ supply right.

• Graph (Fig. 3-9): S1 \rightarrow S2 (right shift) lowers market price at each quantity.

Market Equilibrium

• Equilibrium (market-clearing) price P^*

  • Defined by intersection where Qd(P^)=Qs(P^).

  • Stable; absent shocks price gravitates to P^*.

• Table/Graph (Fig. 3-10)

  • Earbuds: P^=3\$\,,\; Q^=6 million/yr.

  • Surplus (excess supply) when P> P^*: drives price down.

  • Shortage (excess demand) when P< P^*: drives price up.

• Shortage vs Scarcity

  • Scarcity = fundamental limited resources; always present.

  • Shortage = market phenomenon at given P < P^*.

• International vegetable shortage

  • UK heat wave ↓ supply → equilibrium prices ↑: broccoli +37 %, cauliflower +81 %, etc.

Applications & Extended Examples

• Panera Bread kiosks

  • Waiting time ↓ 8→1 min reduces quality-adjusted price; demand for meals ↑.

• Soft-drink vs Bottled water case study (Issues & Apps)

  • Demand shift story (health) incomplete; relative price of water ↓ >20 % while soft-drink price ↑.

  • Water & soda are substitutes; fall in P_{water} shifts water demand right & soda demand left.

AI & Tourism Demand (Data-Driven Insight)

• Demand for tourism depends on P, income, tastes, and complements/substitutes.

• Key c.p. variable: number of tourists.

• Big-data/AI improve estimation accuracy → better policy & pricing decisions.

Summary of Learning Objectives

• 3.1 Law of demand: P\uparrow \Rightarrow Q_d\downarrow; people react to relative, not nominal prices only.

• 3.2 Change in demand vs quantity demanded: shift vs movement.

• 3.3 Law of supply: P\uparrow \Rightarrow Q_s\uparrow.

• 3.4 Change in supply vs quantity supplied: shift vs movement.

• 3.5 Equilibrium via intersection: surplus when P>P^, shortage when P.

Key Numerical / Formula Recap

• Relative price formula: P{A/B}=\frac{PA}{P_B}.

  • Table 3-1 cloud servers vs external drives example:

  • Year 1: P_{cloud/ex} = \frac{300}{150}=2.0.

  • Year 2: P_{cloud/ex} = \frac{210}{140}=1.5.

• Horizontal summation (demand or supply): Q^{market}(P) = \sumi Qi(P).

• Market-clearing condition: Qs(P^) = Qd(P^)$$.