Supply And Demand

1. 09/02/09 1
Demand
If, for the next week, I was selling
grades for this course, how much
would you be willing and able to pay
for a 7? Explain why you’d pay this
much.
Answer this question seriously.

2. Demand Schedule
At each price, how many
people would demand a
7?
What if you heard tha
Swine Flu was getting
worse and school might
get cancelled?
What if there was a
rumor that I might be
lowering the prices?
09/02/09 2
Demand for a 7
Price
(per 7)
Quantity
Demanded

3. Demand Curve
09/02/09 3
Demand for a 7
Price
(per 7)
Quantity
Demanded
Price
Quantity (Grades of 7)

4. 09/02/09
Antu Panini Murshid--Principles of
Macroeconomics 4
Demand Schedules and
Demand Curves
Demand schedule
A demand schedule is a table that depicts
quantity demanded at every price, all else
equal
Demand curve
A demand curve shows the relationship
between the price and quantity
demanded, all else equal

5. 09/02/09
Antu Panini Murshid--Principles of
Macroeconomics 5
Demand
Desires or wants
Desire refers to people's willingness to
own a good
Demand
Demand is the amount of a good that
consumers are willing and able to buy at
various prices

6. 09/02/09
Antu Panini Murshid--Principles of
Macroeconomics 6
Determinants of Demand
Price
Consumers’ income
Tastes and preferences
Expectations about future prices
Prices of related goods (substitutes and
complements)
Number of consumers

7. 09/02/09 7
Demand
Read back through your article, and
answer the following questions:
How does the article relate to
demand?
What has caused a change in demand?

8. 09/02/09
Antu Panini Murshid--Principles of
Macroeconomics 8
The Law of Demand
How do higher prices affect the
amount of a good you are willing and
able to buy?
The law of demand
All else equal, the quantity demanded is
negatively related to price
Prices quantity demanded
↑ ↓
Prices ↓ quantity demanded
↑

9. 9
Demand for
Shoes
Price
(per pair)
Quantity
(pairs)
$100 2,000
80 4,000
60 6,000
40 8,000
20 10,000
The Demand for Shoes
Demand schedule
for shoes

10. 10
Demand for
Shoes
Price
(per pair)
Quantity
(pairs)
$100 2,000
80 4,000
60 6,000
40 8,000
20 10,000
The Demand for Shoes
Demand Curve
for shoes
Quantity (pairs of shoes)
Price
20
40
60
80
100
2,0004,0006,0008,00010,000
D

11. 09/02/09
Antu Panini Murshid--Principles of
Macroeconomics 11
Price Changes: Movement
Along the Demand Curve
A change in price will lead to a
movement along the demand curve
A price induced change in demand is
referred to as a change in quantity
demanded

12. 12
Graphing a Movement along
the Demand Curve
Suppose that the price
of shoes is $80 per
pair…
What is the quantity
demanded at this price?
We are at point A
What would happen if
the price were to
decrease to $40?
Quantity demanded
would increase to 8,000
This is illustrated by a
movement to point B
Quantity (pairs of shoes)
Price
20
40
60
80
100
2,0004,0006,0008,00010,000
A
B
D

13. 09/02/09
Antu Panini Murshid--Principles of
Macroeconomics 13
Shifts in Demand
Any factor other than price that results
in a change in demand, will cause a
shift in the demand curve
Examples:
An increase in income will shift the
demand curve for a normal good to the
right

14. 14
Graphing a Shift in the
Demand Curve
Suppose initially price
of shoes is 80 and
quantity demanded is
4,000
What happens if
income increases?
If shoes are a normal
good, demand will
increase
Suppose at $80,
quantity demanded
increases to 8000 (point
B)
The demand curve will
shift to the right
Quantity (pairs of shoes)
Price
20
40
60
80
100
2,0004,0006,0008,00010,000
A B
D
1 D
2

15. 15
The Goal of Advertising
Consider the following
demand curve for
shoes
Suppose currently the
price of shoes is $80 a
pair
This implies that
quantity demanded is
4,000 pairs
We are therefore at
point A on the demand
curve
D
1
A
Quantity (pairs of shoes)
Price
20
40
60
80
100
2,0004,0006,0008,00010,000

16. 16
The Goal of Advertising
D
1
A B
D
2
Quantity (pairs of shoes)
Price
20
40
60
80
100
2,0004,0006,0008,00010,000
Suppose an ad
campaign raises the
demand for shoes
Suppose that at $80 a
pair, the demand for
shoes is now 6,000
pairs…
…moving us to point B
…and shifting the
demand curve to the
right

17. 09/02/09
Antu Panini Murshid--Principles of
Macroeconomics 17
Income: Normal and Inferior
Goods
How does income affect demand?
An increase in income increases ability to buy
Normal goods
For normal goods an increase in income leads to
an increase in demand
Inferior goods
For inferior goods an increase in income leads to
a decrease in demand

18. 09/02/09
Antu Panini Murshid--Principles of
Macroeconomics 18
Tastes and Preferences
Changes in tastes and preferences will
affect demand, as they affect
consumers’ desires to purchase goods
and services

19. 09/02/09
Antu Panini Murshid--Principles of
Macroeconomics 19
Future Expectations
An expectation that future prices will
increase may lead to an increase in
current demand
An expectation that future prices will
decrease may lead to a decrease in
demand today as consumers’ postpone
consumption till later

20. 09/02/09
Antu Panini Murshid--Principles of
Macroeconomics 20
Substitutes and Complements
Substitutes
Similar products which can be substituted
for one another
Butter and margarine
Complements
Products that complement each other and
are often purchased in conjunction with
each other
CDs and CD players

21. 09/02/09
Antu Panini Murshid--Principles of
Macroeconomics 21
Income & Substitution Effects
Income effect
Lower prices increase your ability to buy
more
Substitution effect
Lower prices increase your willingness to
buy more as you substitute away from
more expensive alternatives

22. 09/02/09
Antu Panini Murshid--Principles of
Macroeconomics 22
Supply
Supply
Supply is the amount of a good that
producers are willing and able to offer
for sale at various price

23. 09/02/09
Antu Panini Murshid--Principles of
Macroeconomics 23
Determinants of Supply
Price
Resource prices
Technology
Number of producers

24. 09/02/09
Antu Panini Murshid--Principles of
Macroeconomics 24
The Law of Supply
The law of supply
All else equal, the quantity supplied is
positively related to price
Prices quantity supplied
↑ ↑
Prices ↓ quantity supplied
↓

25. 09/02/09
Antu Panini Murshid--Principles of
Macroeconomics 25
Rising Per-Unit Costs
Why does the supply curve slope upward?
Costs per unit tend to increase with output
Firms have to pay overtime for workers
Production bottlenecks could slow production and raise
costs
Greater depreciation of capital equipment
Higher prices allow sellers to cover these higher
costs of production

26. 09/02/09
Antu Panini Murshid--Principles of
Macroeconomics 26
Technology and Costs of
Production
Resource prices
An increase in resource prices implies an
increases in firms’ costs, which implies a
decrease in supply, unless prices increase also to
accommodate the increase in costs
Technological advances
Improvements in technology allow firms to
produce more using the same resources
Technological advances therefore reduce the
costs of production

27. 09/02/09
Antu Panini Murshid--Principles of
Macroeconomics 27
Supply Schedules and Supply
Curves
Supply schedule
A supply schedule is a table that depicts
quantity supplied at every price, all else
equal
Supply curve
A supply curve shows the relationship
between the price and quantity
demanded, all else equal

28. 28
The Supply of Shoes
Supply schedule for
shoes
Supply of Shoes
Price
(per pair)
Quantity
(pairs)
$100 10,000
80 8,000
60 6,000
40 4,000
20 2,000

29. 29
The Supply of Shoes
Supply of Shoes
Price
(per pair)
Quantity
(pairs)
$100 10,000
80 8,000
60 6,000
40 4,000
20 2,000
Quantity (pairs of shoes)
Price
20
40
60
80
100
2,0004,0006,0008,00010,000
S

30. 09/02/09
Antu Panini Murshid--Principles of
Macroeconomics 30
Price Changes: Movements
Along the Supply Curve
A change in price will lead to a
movement along the supply curve
A price induced change in supply is
referred to as a change in quantity
supplied

31. 31
Graphing a Movement along
the Demand Curve
Suppose that initially
price is 40
At a price of 40,
quantity supplied is
4,000
We are therefore at
point A
What happens when
price increases to 80?
Quantity supplied
increases to 8,000 and
we move to point B
A
B
Quantity (pairs of shoes)
Price
20
40
60
80
100
2,0004,0006,0008,00010,000
S

32. 09/02/09
Antu Panini Murshid--Principles of
Macroeconomics 32
Shifts in Supply
Any factor other than price that results
in a change in supply, will cause a shift
in the supply curve
Examples:
A decrease in production costs will shift
the supply curve to the right
A quantity tax will shift the supply curve
to the left

33. 33
The Effect of a Tax on Supply
S
1
Suppose initially price of shoes
is $40 a pair and the quantity
supplied is 4,000 (Point A)
What happens if the
government places a quantity
tax of $20 per shoe?
With a quantity tax of $20, the
government will receive $20
for each pair of shoes sold,
while the seller will receive
$40-$20=$20 for each pair of
shoes sold
A
Quantity (pairs of shoes)
Price
20
40
60
80
100
2,0004,0006,0008,00010,000
Tax=
$20

34. 34
The Effect of a Tax on Supply
S
1
But prior to the tax, at $20,
the seller would be willing
to supply 2,000 pairs of
shoes only
After the tax, even though
the price is $40, since the
seller is receiving only $20
for each pair of shoes, he
will only be willing to
supply 2,000 pairs
We move to point C…
…and supply shifts left
C
Quantity (pairs of shoes)
Price
20
40
60
80
100
2,0004,0006,0008,00010,000
B
A
S
2
Tax=
$20

35. 09/02/09
Antu Panini Murshid--Principles of
Macroeconomics 35
What Price and What
Quantity?
The demand curve shows the quantity
demanded at various prices
The supply curve shows the quantity
supplied at various prices
But which of these prices will prevail in
the market?
What quantity will actually end up
being sold?

36. 36
Let us consider the
market for shoes…
What happens at a
price of $20?
Quantity demanded
is 10,000…
Quantity supplied is
2,000…
Hence there is an
excess demand (a
shortage) of 8,000
Equilibrium Price and Quantity
in the Market for Shoes
Price
(per
pair)
Quantity
Demanded
(pairs)
Quantity
Supplied
(pairs)
Excess
(pairs)
$100 2,00010,000+ 8,000
80 4,000 8,000+ 4,000
60 6,000 6,000 0
40 8,000 4,000 - 4,000
20 10,000 2,000 - 8,000

37. 37
What happens
when price is $100?
Quantity demanded
is 2,000…
Quantity supplied
is 10,000…
Hence there is an
excess supply of
8,000
Equilibrium Price and Quantity
in the Market for Shoes
Price
(per
pair)
Quantity
Demanded
(pairs)
Quantity
Supplied
(pairs)
Excess
(pairs)
$100 2,00010,000+ 8,000
80 4,000 8,000+ 4,000
60 6,000 6,000 0
40 8,000 4,000 - 4,000
20 10,000 2,000 - 8,000

38. 38
Now consider a
price of $60?
Quantity demanded
is 6,000…
Quantity supplied
is 6,000…
Hence quantity
demanded is equal
to quantity supplied
The market clears
Equilibrium Price and Quantity
in the Market for Shoes
Price
(per
pair)
Quantity
Demanded
(pairs)
Quantity
Supplied
(pairs)
Excess
(pairs)
$100 2,00010,000+ 8,000
80 4,000 8,000+ 4,000
60 6,000 6,000 0
40 8,000 4,000 - 4,000
20 10,000 2,000 - 8,000

39. 09/02/09
Antu Panini Murshid--Principles of
Macroeconomics 39
Equilibrium Price and Quantity
The equilibrium price, is the price at
which quantity demanded equals
quantity supplied
The equilibrium quantity is the quantity
demanded and supplied at the
equilibrium price

40. 40
Stability of Equilibrium
What ensures that the
market will converge to
equilibrium?
Consider a price of $20…
At a price of $20, there is a
shortage of 8,000
Firms respond by raising
prices...
As prices rise, the quantity
demanded falls and the
quantity supplied rises…
Until the shortage is
eliminated
100
Quantity (pairs of shoes)
Price
20
40
60
80
2,0004,0006,0008,00010,000
D
S
Equilibrium
shortage

41. 41
Stability of Equilibrium
Now consider a price of
$100…
At a price of $100, there is
a surplus of 8,000
Faced with unsold stock,
firms respond by lowering
prices
As prices fall, the quantity
demanded rises and the
quantity supplied falls...
Until the surplus is
eliminated
100
Quantity (pairs of shoes)
Price
20
40
60
80
2,0004,0006,0008,00010,000
D
S
Equilibrium
surplus

42. 09/02/09
Antu Panini Murshid--Principles of
Macroeconomics 42
Price of Oranges and Airline
Tickets in the Summer
In the summer…
…the prices of oranges go down and the
quantity sold increases
…the prices of airline tickets go up and
the quantity sold increases
How can you use supply and demand
analysis to explain this apparent
paradox?

43. 09/02/09
Antu Panini Murshid--Principles of
Macroeconomics 43
Applications
Markets for oranges and airline tickets
Oil price shock
Price stabilization—buffer stock

44. 09/02/09
Antu Panini Murshid--Principles of
Macroeconomics 44
Market for Oranges and the
Market for Airline Tickets
In the summer…
…the price of oranges falls while the
quantity supplied also rises
…the price of airline tickets rise but the
quantity supplied also rises
Explain this apparent paradox

45. 45
Market for Oranges in the
Summer
Suppose that the
equilibrium price for
oranges is P
1* and
the equilibrium
quantity is Q
1*
In the summer
weather conditions
are favorable for
growing oranges...
So the supply curve
shifts to the right
Equilibrium price falls
and quantity rises
Quantity (oranges)
Price
S
2
D
Market for
Oranges
S
1
P
2
*
Q
2
*
P
1
*
Q
1
*

46. 46
Market for Airline Tickets
Suppose that the
equilibrium price for
airline tickets is P
1
*
and the equilibrium
quantity is Q
1
*
In the summer the
demand for airline
tickets increases
Demand curve shifts
right
Equilibrium price and
quantity rise
S
Market for
Airline
Tickets
D
1
P
1
*
Q
1
*
Quantity (airline tickets)
Price
D
2
P
2
*
Q
2
*

47. 09/02/09
Antu Panini Murshid--Principles of
Macroeconomics 47
Aggregate Supply and
Aggregate Demand
Consider the supply and demand for all
goods and services produced in an economy
—aggregate supply and aggregate demand
Price in this case is some measure of the
average price level
Quantity is the total output in an economy
Suppose that the aggregate supply curve is
upward sloping and the aggregate demand
curve is downward sloping

48. 09/02/09
Antu Panini Murshid--Principles of
Macroeconomics 48
OPEC 1973: AS-AD Analysis
In 1973 OPEC raised oil prices. The
result was higher inflation and higher
unemployment in many countries
Explain using aggregate supply and
aggregate demand analysis

49. 49
OPEC 1973: AS-AD Analysis
Consider the pre-oil
shock equilibrium
first (low inflation
and high output)….
After the hike in oil
prices (cost shock)
aggregate supply
shifted to the left…
…the price level rose
and output fell
Output
Price
level
AS
1
AD
Aggregate Supply and
Aggregate Demand
AS
2
P
1
*
Y
1
*
P
2
*
Y
2
*

50. 09/02/09
Antu Panini Murshid--Principles of
Macroeconomics 50
Government Intervention
Sometimes the government intervenes in the
market to influence price
For instance, the government could use a
price support, which is a legally established
minimum price above the equilibrium price
An example of a price support is an agricultural
subsidy
Alternatively the government could use a
price ceiling
An example of a price ceiling is rent control

51. 51
Price Stabilization Using Buffer
Stock Schemes
The price and supply of
agricultural products can
fluctuate considerably
A negative shock to
supply (adverse
weather) can cause a
sharp price increase…
And a positive shock
could cause a sharp
price decrease
A buffer stock scheme
works to stabilize prices
of agricultural products
Quantity (wheat)
Price
S
1
D
Market for
Wheat
S
2
Price
increases
S
3
Price
decreases
P*
Q*Q
L
*
P
H
*
P
L
*
Q
H
*

52. 52
Price Stabilization Using Buffer
Stock Schemes
First the government
sets a minimum price
above the equilibrium
This leads to an
excess supply
(surplus) of wheat
The government buys
this surplus (at price
P
H
) which it then
stockpiles
Effectively this
amounts to shifting
the demand curve to
the right
Quantity (wheat)
Price
S
1
D
Market for
Wheat
P*
Q*
P
H
*
D+D
G

53. 53
Price Stabilization Using Buffer
Stock Schemes
Now suppose that
there is a negative
shock to supply
Price should rise to
P
HH
The government uses
its reserve of wheat
to raise supply and
stabilize price at P
H
Quantity (wheat)
Price
S
1
D
Market for
Wheat
S
2
S
3
P*
Q*
P
H
*
D+D
G
P
HH
*

54. 09/02/09
Antu Panini Murshid--Principles of
Macroeconomics 54
Summary
Can you name some
determinants of demand?
What is the relationship
between price and
quantity demanded
What causes a shift in the
demand curve and what
causes a movement along
the demand curve?
Price
Quantity
D
DD

55. 09/02/09
Antu Panini Murshid--Principles of
Macroeconomics 55
Summary
What are determinants of
supply?
What is the law of
supply?
Why does a supply curve
slope upward?
Do you know the
difference between shifts
in supply and movements
along supply
Price
Quantity
S
S
S

56. 09/02/09
Antu Panini Murshid--Principles of
Macroeconomics 56
Summary
What is the
equilibrium or
market clearing
price and quantity
Do you understand
why this
equilibrium is
stable?
Price
Quantity
S
DD’
S’