CHAPTER

CHAPTER 4AP MACROECONOMICS

Supply, Demand, Prices, and Elasticity

THE MARKET FORCES OF SUPPLY AND DEMAND2

Markets and CompetitionA market is a group of buyers and sellers of

a particular product. A competitive market is one with many

buyers and sellers, each has a negligible effect on price.

In a perfectly competitive market: All goods exactly the same Buyers & sellers so numerous that no one

can affect market price – each is a “price taker”

In this chapter, we assume markets are perfectly competitive.

What is the law of demand?As the price of a product increases, the quantity demanded decreasesAs the price of a product decreases, the quantity demanded increases

What do you need to have demand?WILLING + ABLE = DEMAND

What creates the law of demand? Income effect Substitution effect

Quantity Demanded vs. Demand Quantity Demanded is the amount of a good or service people

are willing and able to buy at a particular PRICE other things being equal.

Demand is the entire schedule. It represents the amount people are willing and able to buy at ALL price levels.

The Law of Demand

PriceQuantity demanded

GRAPHING DEMAND Demand schedule

A list of the quantities demanded at each different price when all the other influences on buying plans remain the same.

Demand curveA graph of the relationship between the quantity demanded of a good and its price when all other influences on buying plans remain the same.

INDIVIDUAL VS. MARKET DEMAND

Market demand The sum of the demands of all the buyers in a market.The market demand curve is the horizontal sum of the demand curves of all buyers in the market.

REMOVING THE ASSUMPTION: SHIFTING THE DEMAND CURVE

Changes in Demand A change in the

quantity that people plan to buy when any influence other than the price of the good changes.

A change in demand means that there is a new demand schedule and a new demand curve.

What happens?When demand

decreases, the demand curve shifts leftward from D0 to D1.

When demand increases, the demand curve shifts rightward from D0 to D2.

WHAT WILL CAUSE A SHIFT IN DEMAND?

The main influences on buying plans that change demand are

1. Prices of related goods (compliments and substitutes)

2. Income (normal and inferior goods)3. Expectations 4. Number of buyers (population)5. Consumer Preference/Tastes and

Advertising

To illustrate the difference….

THE MARKET FORCES OF SUPPLY AND DEMAND

Review: Variables That Influence Buyers

Variable A change in this variable…

Price …causes a movement along the D curve

# of buyers …shifts the D curve

Income …shifts the D curve

Price ofrelated goods …shifts the D curve

Tastes …shifts the D curve

Expectations …shifts the D curve

SUPPLYSupply

The relationship between the quantity supplied of a good and the price of the good when all other influences on selling plans remain the same.

Quantity suppliedThe amount of a good, service, or resource that people are willing and able to sell during a specified period at a specified price.

The Law of Supply Other things remaining the same (ceteris paribus),

•If the price of a good rises, the quantity supplied of that good increases.

•If the price of a good falls, the quantity supplied of that good decreases.

Supply schedule ~ A list of the quantities supplied at each different price when all other influences on selling plans remain the same.

Supply curve ~A graph of the relationship between the quantity supplied and the price of the good when all other influences on selling plans remain the same.

INDIVIDUAL VS. MARKET SUPPLY

Market supply The sum of the supplies of all sellers in a market.

The market supply curve is the horizontal sum of the supply curves of all the sellers in the market.

A change in the quantity that suppliers plan to sell when any influence on selling plans other than the price of the good changes.

A change in supply means that there is a new supply schedule and a new supply curve.What Happens?

When supply decreases, the supply curve shifts leftward from S0 to S1.

When supply increases, the supply curve shifts rightward from S0 to S2.

CHANGES IN SUPPLY

What will cause a change in supply?

The main influences on selling plans that change supply are:

1. Prices of resources and other inputs

2. Expectations

3. Number of sellers

4. Technology/Productivity

CHANGES IN QUANTITY SUPPLIED VERSUS SUPPLY

Change in quantity suppliedA change in the quantity of a good that suppliers plan to sell that results from a change in the price of the good.Change in supplyA change in the quantity that suppliers plan to sell when any influence on selling plans other than the price of the good changes.

THE MARKET FORCES OF SUPPLY AND DEMAND

24

Summary: Variables that Influence Sellers

Variable A change in this variable…

Price …causes a movement along the S curve

Input Prices …shifts the S curve

Technology …shifts the S curve

# of Sellers …shifts the S curve

Expectations …shifts the S curve

MARKET EQUILIBRIUM

Market equilibriumWhen the quantity demanded equals the quantity supplied—when buyers’ and sellers’ plans are consistent.

Equilibrium priceThe price at which the quantity demanded equals the quantity supplied.

Equilibrium quantityThe quantity bought and sold at the equilibrium price.

MARKET EQUILIBRIUM

1. Market equilibrium at the intersection of the demand curve and the supply curve.

2. The equilibrium price is $1 a bottle.

3. The equilibrium quantity is 10 million bottles a day.

MARKET EQUILIBRIUM: AUTOMATIC REGULATION

Law of market forces• When there is a shortage, the price rises.• When there is a surplus, the price falls.

Shortage or Excess DemandThe quantity demanded exceeds the quantity supplied.

Surplus or Excess SupplyThe quantity supplied exceeds the quantity demanded.

MARKET EQUILIBRIUM

At 75 cents a bottle:1. Quantity is demanded 11

million bottles.

3. There is a shortage of 2 million bottles.

4. Price rises until the shortage is eliminated and the market is in equilibrium.

2. Quantity supplied is 9 million bottles.

4.3 MARKET EQUILIBRIUM

At $1.50 a bottle:1. Quantity supplied is

11 million bottles.

3. There is a surplus of 2 million bottles.

4. Price falls until the surplus is eliminated and the market is in equilibrium.

2. Quantity demanded is 9 million bottles.

Predicting Price Changes: Three Questions

We can work out the effects of an event by answering:

1. Does the event change demand or supply?2. Does the event increase or decrease demand

or supply—shift the demand curve or the supply curve rightward or leftward?

3. What are the new equilibrium price and equilibrium quantity and how have they changed?

Effects of Changes in Demand

Event: A new study says that tap water is unsafe.

To work out the effects on the market for bottled water:

1. With tap water unsafe, demand for bottled water changes.

2. The demand for bottled water increases, the demand curve shifts rightward.

3. What are the new equilibrium price and equilibrium quantity and how have they changed?

MARKET EQUILIBRIUM

1. An increase in demand shifts the demand curve rightward.

2. At $1.00 a bottle, there is a shortage, so the price rises.

3. Quantity supplied increases along the supply curve.

4. Equilibrium quantity increases.

MARKET EQUILIBRIUM

Event: A new zero-calorie sports drink is invented.

To work out the effects on the market for bottled water:

1. The new drink is a substitute for bottled water, so the demand for bottled water changes

2. The demand for bottled water decreases, the demand curve shifts leftward.

3. What are the new equilibrium price and equilibrium quantity and how have they changed?

MARKET EQUILIBRIUM

1. A decrease in demand shifts the demand curve leftward.

2. At $1.00 a bottle, there is a surplus, so the price falls.

3. Quantity supplied decreases along the supply curve.

4. Equilibrium quantity decreases.

MARKET EQUILIBRIUM

When demand changes:

• The supply curve does not shift.

• But there is a change in the quantity supplied.

• Equilibrium price and equilibrium quantity change in the same direction as the change in demand.

Effects of Changes in Supply

Event: Europeans produce bottled water in the United States.

To work out the effects on the market for bottled water:

1. With more suppliers of bottled water, supply changes.

2. The supply of bottled water increases, the supply curve shifts rightward.

3. What are the new equilibrium price and equilibrium quantity and how have they changed?

MARKET EQUILIBRIUM

1. An increase in supply shifts the supply curve rightward.

2. At $1.00 a bottle, there is a surplus, so the price falls.

3. Quantity demanded increases along the demand curve.

4. Equilibrium quantity increases.

MARKET EQUILIBRIUM

Event: Drought dries up some springs in the United States.

To work out the effects on the market for bottled water:

1. Drought changes the supply of bottled water.2. The supply of bottled water decreases, the

supply curve shifts leftward.3. What are the new equilibrium price and

equilibrium quantity and how have they changed?

MARKET EQUILIBRIUM

1. A decrease in supply shifts the supply curve leftward.

2. At $1.00 a bottle, there is a shortage, so the price rises.

3. Quantity demanded decreases along the demand curve.

4. Equilibrium quantity decreases.

MARKET EQUILIBRIUM

When supply changes:

• The demand curve does not shift.

• But there is a change in the quantity demanded.

• Equilibrium price changes in the same direction as the change in supply.

• Equilibrium quantity changes in the opposite direction to the change in supply.

Changes in Both Demand and Supply

When two events occur at the same time, work out how

each event influences the market:

1. Does each event change demand or supply? 2. Does either event increase or decrease

demand or increase or decrease supply?3. What are the new equilibrium price and

equilibrium quantity and how have they changed?

MARKET EQUILIBRIUM

An increase in demandshifts the demand curverightward; an increasein supply shifts the supplycurve rightward.

1. Equilibrium quantity increases.

2. Equilibrium price might rise or fall.

Increase in Both Demand and Supply

• Increases the equilibrium quantity. • The change in the equilibrium price is ambiguous

because the:

Increase in demand raises the price.

Increase in supply lowers the price.

MARKET EQUILIBRIUM

This figure shows theeffects of a decrease inboth demand and supply.

A decrease in demandshifts the demand curveleftward; a decrease insupply shifts the supplycurve leftward.

3. Equilibrium quantity decreases.

4. Equilibrium price might rise or fall.

MARKET EQUILIBRIUM

Decrease in Both Demand and Supply• Decreases the equilibrium quantity. • The change in the equilibrium price is ambiguous

because the:

Decrease in demand lowers the price

Decrease in supply raises the price.

MARKET EQUILIBRIUMThe figure shows the effectsof an increase in demandand a decrease in supply.

An increase in demand shiftsthe demand curve rightward;a decrease in supply shiftsthe supply curve leftward.

1. Equilibrium price rises.

2. Equilibrium quantity might increase, decrease, or not change.

MARKET EQUILIBRIUM

Increase in Demand and Decrease in Supply• Raises the equilibrium price. • The change in the equilibrium quantity is

ambiguous because the:

Increase in demand increases the quantity.

Decrease in supply decreases the quantity.

MARKET EQUILIBRIUMThis figure shows the effectsof a decrease in demandand an increase in supply.

A decrease in demand shiftsthe demand curve leftward;an increase in supply shiftsthe supply curve rightward.

3. Equilibrium price falls.

4. Equilibrium quantity might increase, decrease, or not change.

MARKET EQUILIBRIUM

Decrease in Demand and Increase in Supply• Lowers the equilibrium price. • The change in the equilibrium quantity is

ambiguous because the:

Decrease in demand decreases the quantity.

Increase in supply increases the quantity.