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Supply and Demand Together
P
Equilibrium:
D
S
\$6.00
P
has reached
\$5.00
\$4.00
the level where
quantity supplied
equals
\$3.00
quantity demanded
\$2.00
\$1.00
\$0.00
Q
0
5 10 15 20 25 30 35
11
Equilibrium price:
the price that equates quantity supplied
with quantity demanded
P
D
S
\$6.00
P
Q
D
Q
S
\$5.00
\$0
24
0
\$4.00
1
21
5
2
18
10
\$3.00
3
15
15
\$2.00
4
12
20
\$1.00
5
9
25
\$0.00
Q
6
6
30
0
5 10 15 20 25 30 35
22
Equilibrium quantity:
the quantity supplied and quantity demanded at
the equilibrium price
P
D
S
\$6.00
P
Q
D
Q
S
\$5.00
\$0
24
0
\$4.00
1
21
5
2
18
10
\$3.00
3
15
15
\$2.00
4
12
20
\$1.00
5
9
25
\$0.00
Q
6
6
30
0
5 10
15
20 25 30 35
33
Surplus (a.k.a. excess supply):
when quantity supplied is greater than
quantity demanded
P
Example:
D
Surplus
S
\$6.00
If P
=
\$5,
\$5.00
then
Q D = 9 lattes
\$4.00
\$3.00
and
Q S = 25 lattes
\$2.00
\$1.00
resulting in a
surplus of 16 lattes
\$0.00
Q
0
5 10 15 20 25 30 35
44
Surplus (a.k.a. excess supply):
when quantity supplied is greater than
quantity demanded
P
D
Surplus
S
\$6.00
\$5.00
Facing a surplus,
sellers try to increase sales
by cutting price.
\$4.00
This causes
Q D to rise
and Q S to fall…
\$3.00
\$2.00
…which reduces the
surplus.
\$1.00
\$0.00
Q
0
5 10 15 20 25 30 35
55
Surplus (a.k.a. excess supply):
when quantity supplied is greater than
quantity demanded
P
D
Surplus
S
\$6.00
\$5.00
Facing a surplus,
sellers try to increase sales
by cutting price.
\$4.00
This causes
Q D to rise and Q S to fall.
\$3.00
\$2.00
\$1.00
Prices continue to fall
until market reaches
equilibrium.
\$0.00
Q
0
5 10 15 20 25 30 35
66
Shortage (a.k.a. excess demand):
when quantity demanded is greater than
quantity supplied
P
Example:
D
S
\$6.00
If P
=
\$1,
\$5.00
\$4.00
\$3.00
\$2.00
\$1.00
then
Q D = 21 lattes
and
Q S = 5 lattes
resulting in a
shortage of 16 lattes
\$0.00
Shortage
Q
0
5 10 15 20 25 30 35
77
Shortage (a.k.a. excess demand):
when quantity demanded is greater than
quantity supplied
P
D
S
\$6.00
Facing a shortage,
sellers raise the price,
\$5.00
\$4.00
\$3.00
causing Q D to fall
and Q S to rise,
…which reduces the
shortage.
\$2.00
\$1.00
Shortage
\$0.00
Q
0
5 10 15 20 25 30 35
88
Shortage (a.k.a. excess demand):
when quantity demanded is greater than
quantity supplied
P
D
S
\$6.00
Facing a shortage,
sellers raise the price,
\$5.00
\$4.00
causing Q D to fall
and Q S to rise.
\$3.00
\$2.00
Prices continue to rise
until market reaches
equilibrium.
\$1.00
Shortage
\$0.00
Q
0
5 10 15 20 25 30 35
99
Three Steps to Analyzing Changes in Eq’m
1.
2.
3.
1010
EXAMPLE:
The Market for Hybrid Cars
P
price of
S 1
hybrid cars
P 1
D 1
Q
Q 1
quantity of
hybrid cars
1111
EXAMPLE 1:
A Shift in Demand
EVENT TO BE
ANALYZED:
P
Increase in price of gas.
S
1
STEP 1:
P
2
D curve shifts
because price of gas
P
STEP 2:
1
affects demand for
D
shifts right
hybrids. because high gas price
STEP 3:
S makes curve hybrids does not more shift,
D
D
2
1
because attractive The shift price causes relative of an gas to
does other increase not cars. in affect price cost of
Q
Q 1
Q 2
producing and quantity hybrids. of
hybrid cars.
1212
EXAMPLE 1:
A Shift in Demand
Notice:
P
When P rises,
S
1
producers supply
a
larger quantity
P
2
of hybrids, even
though the S curve
P
1
has not shifted.
AlwaysAlways bebe carefulcareful toto
distinguishdistinguish b/wb/w aa
shiftshift inin aa curvecurve andand aa
movementmovement alongalong thethe
curve.curve.
D
D
2
1
Q
Q 1 Q 2
1313

Terms for Shift vs. Movement Along Curve

Change in supply: a shift in the S curve occurs when a non-price determinant of supply changes (like technology or costs)

Change in the quantity supplied:

a movement along a fixed S curve occurs when P changes

Change in demand: a shift in the D curve occurs when a non-price determinant of demand changes (like income or # of buyers)

Change in the quantity demanded:

1414

a movement along a fixed D curve occurs when P changes

EXAMPLE 2:
A Shift in Supply
EVENT: New technology
reduces cost of producing
hybrid cars.
P
S
S
1
2
STEP 1:
S
curve shifts
because event affects
P
STEP 2:
1
cost of production.
S
shifts right
P
2
D because curve event does not reduces shift,
STEP 3:
because production
technology cost, makes The shift production causes is not price one
D
1
Q
of
to
the fall factors that
Q 1 Q 2
more profitable at any
affect given and quantity price. demand. to rise.
1515
EXAMPLE 3:
A Shift in Both Supply
and Demand
EVENTS:
P
price of gas rises AND
new technology reduces
production costs
S
S
1
2
STEP 1:
P
2
Both curves shift.
P
1
STEP 2:
Both shift to the right.
STEP 3:
D
D
2
1
Q rises, but effect
Q
on P is ambiguous:
Q
Q
1
2
If demand increases more than
supply, P rises.
1616
EXAMPLE 3:
A Shift in Both Supply
and Demand
EVENTS:
P
price of gas rises AND
new technology reduces
production costs
S
S
1
2
STEP 3, cont.
P
1
But if supply
increases more
than demand,
P falls.
P
2
D
D
2
1
Q
Q
Q
1
2
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AA CC TT II VV EE
LL EE AA RR NN II NN GG
33
ShiftsShifts inin supplysupply andand demanddemand
Use the three-step method to analyze the effects of
each event on the equilibrium price and quantity of
Event A:
A fall in the price of CDs
Event B:
reduction in the royalties they must pay
for each song they sell.
Event C:
Events A and B both occur.
1818
AA CC TT II VV EE
LL EE AA RR NN II NN GG
33
A.A. FallFall inin priceprice ofof CDsCDs
The market for
STEPS
P
1. curve shifts
D
S
1
2. shifts left
D
P
1
3. and Q both fall.
P
P
2
D
D
1
2
Q
Q
Q
2
1
1919
AA CC TT II VV EE
LL EE AA RR NN II NN GG
33
B.B. FallFall inin costcost ofof royaltiesroyalties
The market for
STEPS
1.
S curve shifts
S 1
S 2
(Royalties are part
2.
S
shifts right
of sellers’ costs)
P 1
3.
P falls,
Q rises.
P 2
D 1
Q
Q 1
Q 2
2020
AA CC TT II VV EE
LL EE AA RR NN II NN GG
33
C.C. FallFall inin priceprice ofof CDsCDs andand
fallfall inin costcost ofof royaltiesroyalties
1.
2.
3.
2121

CONCLUSION:

How Prices Allocate Resources

One of the Ten Principles from Chapter 1:

Markets are usually a good way to organize economic activity.

In market economies, prices adjust to balance supply and demand. These equilibrium prices are the signals that guide economic decisions and thereby allocate scarce resources.

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CHAPTERCHAPTER SUMMARYSUMMARY

A competitive market has many buyers and sellers, each of whom has little or no influence on the market price. Economists use the supply and demand model to analyze competitive markets. The downward-sloping demand curve reflects the Law of Demand, which states that the quantity buyers demand of a good depends negatively on the good’s price.

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CHAPTERCHAPTER SUMMARYSUMMARY

Besides price, demand depends on buyers’ incomes, tastes, expectations, the prices of substitutes and complements, and number of buyers. If one of these factors changes, the D curve shifts.

The upward-sloping supply curve reflects the Law of Supply, which states that the quantity sellers supply depends positively on the good’s price.

Other determinants of supply include input prices, technology, expectations, and the # of sellers. Changes in these factors shift the S curve.

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CHAPTERCHAPTER SUMMARYSUMMARY

We can use the supply-demand diagram to analyze the effects of any event on a market:

First, determine whether the event shifts one or both curves. Second, determine the direction of the shifts. Third, compare the new equilibrium to the initial one. In market economies, prices are the signals that guide economic decisions and allocate scarce resources.

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