Economics

Module 3: Supply and Demand

Economic Systems: Free

Market: any situation that brings

together buyers and sellers of goods or
services.

Types of Economies - In the modern

world today, there is a range of
economic systems:
• Market Economy: an economy
where economic decisions are
decentralized, resources are owned
by private individuals, and
businesses supply goods and
services based on demand.
Economic Systems: Free (cont.)

Types of Economies: In the

modern world today, there is a
range of economic systems:
• Competitive Market: a
market in which there is a large
number of buyers and sellers,
so that no one can control the
market price.
• Free Economy: a market in
which the government does not
intervene in any way.
Economic Systems: Planned

Planned (or Command) Economies: an

economy where economic decisions are
passed down from government authority and
where resources are owned by the
government.
• Resources and businesses are owned by the
government.
• Government decides what goods and
services will be produced and what prices
will be charged for them.
• Government decides what methods of
production will be used and how much
workers will be paid.
Economic Systems: Distinction

Primary Distinction
• The primary distinction between a free and command economy is the
degree to which the government determines what can be produced and
what prices will be charged.
Real World: Most economies in the real world are mixed; they combine
elements of command and market systems.
What Is Demand?

Demand for Goods and Services

• Demand: the relationship between the price of a certain good or service
and the quantity of that good or service someone is willing and able to
buy.
• Price: what a buyer pays for a unit of the specific good or service.
• Quantity Demanded: the total number of units of a good or service
consumers wish to purchase at a given price.
• Law of Demand: the common relationship that a higher price leads to a
lower quantity demanded of a certain good or service and a lower price
leads to a higher quantity demanded, while all other variables are held
constant.
What Is Demand? (cont.)

Demand Schedule: a table that shows the quantity demanded for a certain
good or service at a range of prices.
• Example: Price is measured in dollars per gallon of gasoline. The quantity
demanded is measured in millions of gallons over some time period and
over some geographic area.
Demand Schedule Example: Table 1

Price (per gallon) Quantity Demanded (millions

of gallons)
$1.00 800
$1.20 700
$1.40 600
$1.60 550
$1.80 500
$2.00 460
$2.20 420
What Is a Demand Curve?

Demand curve: a graphic representation

of the relationship between price and
quantity demanded of a certain good or
service, with price on the vertical axis and
quantity on the horizontal axis.
• For example, the figure to the left, with
price per gallon on the vertical axis and
quantity on the horizontal axis.
• The demand schedule shows that as
price rises, quantity demanded
decreases, and vice versa.
• The downward slope of the demand
curve illustrates the law of demand—the
inverse relationship between prices and
quantity demanded.
What Is Assumed in a Demand Curve?

Ceteris Paribus: a Latin phrase meaning “other things being equal.”

• Any given demand or supply curve is based on the ceteris
paribus assumption that all else is held equal.
• When changing one variable in a function (e.g. demand for some
product), we assume everything else is held constant.
• A demand curve or a supply curve is a relationship between two, and only
two, variables when all other variables are held equal. If all else is not held
equal, then the laws of supply and demand will not necessarily hold.
What Affects a Demand Curve?

Demand Curves Affected By:

• “Willingness to purchase” suggests
a desire to buy, and it depends on
what economists call tastes and
preferences. If you neither need nor
want something, you won’t be willing
to buy it.
• “Ability to purchase” suggests that
income is important. Professors are
usually able to afford better housing
and transportation than students,
because they have more income.
What Affects a Demand Curve? (cont.)

Demand Curves Affected By:

• Prices of related goods can also affect demand. If you need a new car, the
price of a Honda may affect your demand for a Ford.
• Size or composition of the population. The more children a family has,
the greater their demand for clothing. The more driving-age children a
family has, the greater their demand for car insurance and the less for
diapers and baby formula.
Factors Affecting Demand: Income
Shifts in Demand
Income Example with Automobiles
• Initial demand for automobiles is D 0.
• At point Q, if the price is $20,000 per
car, the quantity of cars demanded
is 18 million.
• D0 also shows how the quantity of
cars demanded would change as a
result of a higher or lower price. For
example, if the price of a car rose to
$22,000, the quantity demanded
would decrease to 17 million, at
point R.
Factors Affecting Demand: Income (cont.)

Shifts in Demand Income Example with

Automobiles
• Assume the economy expands
and increases many people’s
incomes, making cars more
affordable. With cars still
$20,000, but with higher
incomes, the quantity demanded
increases to 20 million cars,
shown at point S.
• As a result of the higher income
levels, the demand curve shifts to
the right to the new demand
curve D1, indicating an increase
in demand.
Factors Affecting Demand: Other Factors

Shift in demand happens when a change in some economic factor (other

than price) causes a different quantity to be demanded at every price.
• changing tastes or preferences
• changes in the composition of the population
• changes in the prices of related goods
• changes in expectations about future prices
Factors Affecting Demand:
Goods or Services
Good or Services Terms: The demand for a product can be affected by
changes in the prices of related goods such as substitutes or
complements.
• Substitutes: goods or services that can be used in place of one
another
• Complements: goods or services that are used together because the
use of one enhances the use of the other.
• Inferior good: good or service whose demand decreases when a
consumer’s income increases and demand increases when income
decreases.
• Normal good: good or service whose demand increases when a
consumer’s income increases and demand decreases when income
decreases.
Factors Affecting Demand: Six Factors

Factors Shifting Demand Curves

• Six factors that can shift demand curves are summarized in the charts
above.
• The direction of the arrows indicates whether the demand curve shifts
represent an increase in demand or a decrease in demand.
What is Supply?

Supply of Goods and Services

• Supply: the relationship between the price of a certain good or
service and the quantity of that good or service producers are
willing to offer for sale.
• Law of Supply: the common relationship that a higher price
leads to a higher quantity supplied of a certain good or service
and a lower price leads to a higher quantity supplied, while all
other variables are held constant.
• Quantity Supplied: the total number of units of a good or
service producers are willing to supply at a given price.
What is Supply? (cont.)

Is Supply the Same as

Quantity Supplied?
• Supply is not the same as
quantity supplied.
• Supply refers to the curve, and
quantity supplied refers to the
(specific) point on the curve.
What is a Supply Schedule or Curve?

Supply Schedule: a table that Supply Curve: a graphic

shows the quantity representation of the
relationship between price and
demanded for a certain good
quantity supplied of a certain
or service at a range of prices. good or service, with price on
Price (per gallon) Quantity Supplied the vertical axis and quantity
(millions of gallons) on the horizontal axis.
$1.00 800
$1.20 700
$1.40 600
$1.60 550
$1.80 500
$2.00 460
$2.20 420
Factors Affecting Supply: Lowered Costs

Production Costs Affect

Supply
• If other factors relevant to
supply do change, then the
entire supply curve will shift.
• A shift in supply means a
change in the quantity
supplied at every price.
Factors Affecting Supply: Lowered Costs (cont.)

Production Costs Affect Supply

• If a firm faces lower costs of
production, while the prices for the
good or service the firm produces
remain unchanged, a firm’s profits go
up.
• When a firm’s profits increase, it’s
more motivated to produce
output (goods or services), since the
more it produces the more profit it will
earn.
• When costs of production fall, a firm
will tend to supply a larger quantity at
any given price for its output. This
can be shown by the supply curve
shifting to the right.
Factors Affecting Supply: Higher Costs

Shift in Supply Due

Increased Production Costs
• If a firm faces higher costs of
production, then it will earn
lower profits at any given
selling price for its products.
• As a result, a higher cost of
production typically causes a
firm to supply a smaller
quantity at any given price.
In this case, the supply
curve shifts to the left.
Other Factors Affecting Supply

These graphs list the various factors which can affect

supply.

Supply factors also affected by subsidies:

Subsidy: A government payment to firms to encourage production of
some good or service. From a firms perspective it reducing the cost of
production.
Equilibrium, Surplus, and Shortage

Demand and Supply

• Graphs for demand and supply curves both
have price on the vertical axis and quantity
on the horizontal axis, the demand curve
and supply curve for a particular good or
service can appear on the same graph.
• Together, demand and supply determine the
price and the quantity that will be bought
and sold in a market.
• What does it mean when the quantity
demanded and the quantity supplied aren’t
the same?
• The answer is: a surplus or a shortage.
Equilibrium, Surplus, and Shortage (cont.)

Surplus or Excess Supply

• Surplus (or excess
supply): situation where the
quantity demanded in a market is
less than the quantity supplied;
occurs at prices above the
equilibrium.

• Equilibrium: price and quantity

combination where supply equals
demand.
Equilibrium, Surplus, and Shortage (cont. II)

Shortage or Excess Demand

• Shortage (or excess demand): situation
where the quantity demanded in a market is
greater than the quantity supplied; occurs
at prices below the equilibrium.
• Generally any time the price for a good
is below the equilibrium level, incentives
built into the structure of demand and
supply will create pressures for the price to
rise.
• Similarly, any time the price for a good
is above the equilibrium level, similar
pressures will generally cause the price to
fall.
Equilibrium, Surplus, and Shortage (cont. III)

Equilibrium: Where Supply and Demand Intersect

• Equilibrium: price and quantity combination where supply equals
demand.
• Equilibrium Price: the (only) price where the quantity supplied in a
market equals the quantity demanded.
• Equilibrium Quantity: the quantity both supplied and demanded at the
equilibrium price.
Equilibrium, Surplus, and Shortage (cont. IV)

Equilibrium and Economic Efficiency

• Equilibrium is important to create both a
balanced market and an efficient market.
• Efficiency: when the optimal amount of
goods are produced and consumed,
minimizing waste.
• Efficiency in the demand and supply model
has the same basic meaning:
the economy is getting as much benefit as
possible from its scarce resources, and all the possible
gains from trade have been achieved.
Changes in Equilibrium

Finding Equilibrium using the Four-

Step Process
• Step 1: Draw demand and supply
curves showing the market before the
economic change took place.
• Step 2: Decide whether the economic
change being analyzed affects demand
or supply.
• Step 3: Determine whether the effect
on demand or supply causes the curve
to shift to the right or to the left, and
sketch the new demand or supply
curve on the diagram.
• Step 4: Identify the new equilibrium,
and then compare the original
equilibrium price and quantity to the
new equilibrium price and quantity.
Finding Equilibrium Example

Use the Four-Step Process to Find Equilibrium

A Pay Raise for Postal Workers
• Step 1. Draw a demand and supply model to illustrate
what the market for the U.S. Postal Service looks like
before this scenario starts. The demand curve D and
the supply curve S show the original relationships.
• Step 2. Will a pay raise for postal workers affect
supply or demand?
• Step 3. Is the effect on supply positive or negative?
• Step 4. Compare the new equilibrium price and
quantity to the original equilibrium price.
Changes in Supply and Demand
Understand How Supply and
Demand Shift a Graph
• Demand: the relationship between
the price and the quantity
demanded of a certain good or
service.
• Quantity Demanded: the total
number of units of a good or service
consumers are willing to purchase at
a given price.
• Quantity Supplied: the total
number of units of a good or service
producers are willing to sell at a
given price.
Changes in Supply and Demand (cont.)

Understand How Supply and Demand Shift

a Graph
• Shift in Demand: when a change in some
economic factor (other than price) causes a
different quantity to be demanded at every
price.
• Shift in Supply: when a change in some
economic factor (other than price) causes a
different quantity to be supplied at every
price.
• Supply: the relationship between price and
the quantity supplied of a certain good or
service.
Quick Review

• What are the characteristics • Which factors cause a shift in the

of market economies, demand curve and explain why the
including free and
competitive markets? shift occurs?
• What are the characteristics • What are substitutes and
of a planned, or command, complements and give examples?
economy?
• What is demand and the law • How do you draw a demand curve
of demand? and graphically represent changes
• What is a demand curve? in demand?
• How can you create a
demand curve using a data • What is supply and the law of
set? supply?
• What is a supply curve?
Quick Review (cont.)

• How do you create a supply curve • What is the four-step process to

using a data set? predict how economic conditions
• Which factors cause a shift in the cause a change in supply,
supply curve and explain why the demand, and equilibrium?
shift occurs? • What happens to supply, demand,
• What are equilibrium price and and equilibrium when there is a
quantity? Identify them in a change in both supply and
market. demand?
• What are surpluses and shortages? • What are the differences between
How do they cause the price to changes in demand and changes
move towards equilibrium? in the quantity demanded?
• How do you create a graph that • What are the differences between
illustrates equilibrium price and changes in supply and changes in
quantity? quantity supplied?