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Microeconomics

Sultan Qaboos University

Lecture 3

Supply and Demand

The goal of this chapter is to explain how


supply and demand really work.

What determines the price of a good or


service?
How does the price of a product affect its
production and consumption?
Why do prices and production levels often
change?

Learning Objectives

Know the nature and determinants of


market demand.
Know the nature and determinants of
market supply.
Know how market prices are established.
Know what causes market prices to
change.
Know how government price controls
affect market outcomes.

Supply and Demand

Supply: the ability and willingness to sell


specific quantities of a good at
alternative prices in a given time period,
ceteris paribus.
Demand: the ability and willingness to
buy specific quantities of a good at
alternative prices in a given time period,
ceteris paribus.
Ceteris paribus: the assumption that
nothing else is changing.

Outline

Demand
The Law of Demand
Shifts in Demand
Supply
The Law of Supply
Shifts in Supply

The Demand ScheduleCurve

Demand schedule

Table relating prices to quantities demanded

Demand Curve

A graphical representation of the demand


schedule

Negatively sloped line showing the inverse


relationship between the price and the
quantity demanded (other things being
equal, Ceteris-Paribus condition)

Demand Schedule and


Curve
Price

Quantity
Demanded

$50

45

40

35

30

25

20

12

15

15

10

20

Price

$50
45
40
35
30
25
20
15
10
5

A
B
C
D
E
F
G
H
I

0 2 4 6 8 101214161820
Quantity

Individual versus market demand


curves

Each of us has a demand for a good or a


service if we are willing and able to pay for
it.
The amount we buy depends on its price.

If the price goes up, we buy less.


If the price goes down, we buy more.

Market demand is the collective


summation of all buyers individual
demands.

The Horizontal Summation of Two Demand


Curves, Panel (a)

The Horizontal Summation of Two Demand


Curves, Panels (b), (c), (d)

The Law of Demand

The quantity demanded of a good in a given


time period increases as its price falls,
ceteris paribus (and vice versa).
Inverse relationship between price (P) and
quantity demanded (Qd).
A downward-sloping curve on a market
diagram
When

the price of a good goes up, people buy less


of it, other things being equal.
When the price of a good goes down, people buy
more of it, other things being equal.

Factors That Set Demand Behavior


(Determinants of Demand)

Tastes.
Income.
Expectations.
Other goods:

Substitutes.
Complements.

Number of buyers.

If any of these factors


change, demand
behavior changes.
A demand behavior
change is shown by
shifting the demand
curve.

Increase in demand:
shift the curve right.
Decrease in demand:
shift the curve left.

Changing Demand
(Shifting the Demand Curve)

Demand increases (shifts right) when


Taste

for the good increases.


Income increases.
Price of a substitute rises.
Price of a complement falls.
Future prices are expected to rise.
Number of buyers increases.

Vice versa, and demand decreases (shifts


left).

Movements vs. Shifts

Change in quantity demanded: movement along a


demand curve in response to a change in price.

Change in demand: a shift of the demand curve due to


a change in one or more of the determinants of
demand. Whenever there is a change in a ceteris
paribus condition, there will be a change in demand.

The only thing that can cause the entire curve to move
is a change in a determinant other than the goods own
price.

Quantity demanded is a number. Demand is a


behavior.

Movements vs. Shifts


Price
Shift in
demand

$45
40

d2

d1

35
30
25

g1

Movement
along curve

20
15

D2 Increase
d
demand

D1
Initial demand

10
5
0

10

12

14

16

18

20

22 Quantity

Movement along the curve: buyers behavior does not change; buyers only react to a
price change.
Shift the curve: buyers behavior does change.

Shifts in Demand

Substitutes

Two goods are substitutes when a change


in the price of one causes a shift in demand
for the other in the same direction as the
price change

Example: coffee and tea

Change in the price of a substitute good

Price of coffee rises:

Shifts in Demand

Complementary goods

Two goods are complements when a


change in the price of one causes an
opposite shift in the demand curve for the
other

Example: DVD and DVD player

Change in the price of a


complementary good

Price of DVDs rises:

Supply

Schedule showing relationship between


price and quantity supplied for a
specified time period, other things being
equal

The amount of a product or service that


firms are willing and able to sell at
alternative prices

Example: Steel Producers Reduce Production When


the Price of Steel Falls

When the market price of steel declined from


$660 per ton to below $625 per ton, steel
manufacturers responded by cutting back on
production.

This is consistent with the upward-sloping supply


curve of steel.

The Supply Schedule-Curve

The supply schedule is a table relating


prices to quantity supplied at each price.

Supply Curve

A graphical representation of the supply


schedule

Positively sloped line (curve) showing the


direct relationship between price and
quantity supplied, all else being equal

Supply Schedule and Curve


Price

Quantity
Supplied
(Qs)

P
50

$50

20

40

40

15

30

30

10

20

20

10

10

10

15

20

Qs

Individual Supply and Market


Supply

Each producer is willing and able to produce a


good or service if he or she can make a profit.
The amount produced depends on its price.

If the price goes up, more will be produced.


If the price goes down, less will be produced.

Market supply is the collective summation of


all producers individual supplies.

The Individual Producers Supply Schedule for


Magnetic Optical Disks, Panel (a)

The Individual Producers Supply Curve for


Magnetic Optical Disks, Panel (b)

Horizontal Summation of Supply


Curves, Panel (a)

Horizontal Summation of Supply Curves,


Panels (b), (c), (d)

The Law of Supply

The quantity of a good supplied in a


given time period increases as its price
increases, ceteris paribus, and vice
versa.

Direct relationship between price (P) and


quantity supplied (Qs).

It is an upward-sloping curve on a
market diagram.

Factors that Set Supply Behavior


(Determinants of Supply)

Technology
Factor Costs
Taxes and
subsidies
Expectations
Other goods
Number of sellers

If any of these factors


change, supply
behavior changes.
This type of change is
shown by shifting the
supply curve.

Increase in supply: shift


the curve right.
Decrease in supply: shift
the curve left.

Changing Supply
(Shifting the Supply Curve)

Supply increases (shifts right) when

New technology lowers operating costs.


Factor costs decrease.
Taxes decrease or subsidies increase.
Future prices are expected to rise.
Price of alternative goods fall.
Number of sellers increases.

Vice versa, and supply decreases (shifts


left).

Movements vs. Shifts

Change in quantity supplied: movement along the


supply curve due to a change in price.

Change in supply: a shift in the supply curve due to


one or more changes in the determinants of supply.

Whenever there is a change in a ceteris paribus


condition, there will be a change in supply.

The only thing that can cause the entire curve to move
to the right or to the left is a change in a determinant
other than the goods own price.

Movements vs. Shifts


Initial supply

Increased
supply

P
P2
Movement
along curve
P1

Shift in
supply

Qs

Example: Cotton Price Movements Squeeze


and Stretch Clothing Supply

Between 2009 and 2010, the price of


cotton increased by 55 percent.

Clothing manufacturers responded by


reducing
the number of cotton garments supplied
at any given price.

During 2011, cotton prices decreased.

In response, there was an increase in the


supply of cotton clothes.

Summary Discussion

A product has a market demand if people are


willing and able to buy it at some price in the
market.

Its determinants are taste, income,


expectations, other goods, and number of
buyers.

The law of demand says that prices and


quantity demanded are inversely related

At a higher price people buy less, at a lower


price people buy more

Summary Discussion (cont'd)

A change in quantity demanded versus a


change in demand

A change in quantity demanded is a


movement along the same demand curve

A change in demand is a shift of the whole


demand curve

Summary Discussion (cont'd)

A product has a market supply if


businesses are willing and able to produce
and sell it at some price in the market.

Its determinants are technology, factor costs,


taxes and subsidies, expectations, other
goods, and number of sellers.

The law of supply states that price and


quantity supplied are directly related

Firms offer more at a higher price; firms offer


less at a lower price

Summary Discussion
(cont'd)

A change in quantity supplied versus a


change in supply

A change in quantity supplied is a


movement along the same supply curve
A change in supply is a shift of the whole
supply curve