1. A firm transforms inputs into outputs and is the primary producing unit in a market economy, while a household is the consuming unit. An entrepreneur organizes and manages a firm, taking risks. 2. The theory of demand and supply can be used to predict prices and quantities in perfectly competitive markets where many buyers and sellers trade identical goods. It assumes firms maximize profits and consumers maximize utility. 3. According to the theory, the quantity demanded decreases when price rises and increases when price falls, while the quantity supplied increases when price rises and decreases when price falls, all other factors unchanged.

1. Demand and Supply Ms. AmanpreetKaur

2. The Basic Decision-Making Units A firm is an organization that transforms resources (inputs) into products (outputs). Firms are the primary producing units in a market economy. An entrepreneur is a person who organizes, manages, and assumes the risks of a firm, taking a new idea or a new product and turning it into a successful business. Households are the consuming units in an economy.

3. Theories and Predictions We need to be able to predict the consequences of alternative policies, and events that may be outside our control The mental tool we use to make such predictions is called a theory A theory is of no use if its predictions are inaccurate SUPPLY AND DEMAND 3

4. We need a theory of prices The theory of demand and supply is a simple example of an economic theory It can be used to make predictions about the price and quantity of some commodity In a free-market economy, most economic decisions are guided by prices Therefore, without a reliable theory of prices, you will get nowhere in economic analysis SUPPLY AND DEMAND 4

6. A perfectlycompetitivemarket is a market in which

7. there are many buyers

8. many sellers

9. and all sellers sell the exact same product

10. As a result, each buyer and seller has a negligible impact on the market priceSUPPLY AND DEMAND 5

11. demand SUPPLY AND DEMAND 6

12. Demand Quantity demanded is the amount of a good that buyers are willing and able to purchase Demand is a full description of how the quantity demanded changes as the price of the good changes. SUPPLY AND DEMAND 7

13. SUPPLY AND DEMAND 8 1. A decrease in price ... 2. ... increases quantity of cones demanded. Catherine’s Demand Schedule and Demand Curve Price of Ice-Cream Cone $3.00 2.50 2.00 1.50 1.00 0.50 Quantity of 0 1 2 3 4 5 6 7 8 9 10 11 12 Ice-Cream Cones Copyright © 2004 South-Western

14. Market Demand is the Sum of Individual Demands SUPPLY AND DEMAND 9

15. Law of Demand The lawof demand states that the quantity demanded of a good falls when the price of the good rises, and vice versa, provided all other factors that affect buyers’ decisions are unchanged SUPPLY AND DEMAND 10

16. “provided all other factors … are unchanged” That’s an important phrase in the wording of the Law of Demand The quantity demanded of a consumer good such as ice cream depends on The price of ice cream The prices of related goods Consumers’ incomes Consumers’ tastes Consumers’ expectations about future prices and incomes Number of buyers, etc The Law of Demand says that the quantity demanded of a good is inversely related to its price, provided all other factors are unchanged SUPPLY AND DEMAND 11

18. Changes in Price, i.e., In this example, a higher price causes lower quantity demanded.

20. Why Might Demand Increase? How can we explain the difference in Catherine’s behavior in situations A and B? Why does she consume more in situation Bat every possible price? SUPPLY AND DEMAND 14 Price Quantity Demanded

21. Shifts in the Market Demand Curve … are caused by changes in: Consumer income Prices of related goods Tastes Expectations, say, about future prices and prospects Number of buyers SUPPLY AND DEMAND 15

22. SUPPLY AND DEMAND 16 Increase in demand Decrease in demand Demand curve, D 2 Demand curve, D 1 Demand curve, D 3 Shifts in the Demand Curve Price of Ice-Cream Cone Quantity of 0 Ice-Cream Cones

24. As income increases the demand for a normal good will increase

25. As income increases the demand for an inferior good will decrease

26. Prices of Related Goods

27. When a fall in the price of one good reduces the demand for another good, the two goods are called substitutes

28. When a fall in the price of one good increases the demand for another good, the two goods are called complementsSUPPLY AND DEMAND 17

31. Demand for substitute good (chicken) shifts right

32. Price of hamburger rises

34. Substitution Effect SUPPLY AND DEMAND 21 Coke Books Movies Clothes Pepsi When the price of a good decreases, consumers substitute that good instead of other competing (substitute) goods 1. When the price of Coke decreases… 2. Consumption of Pepsi decreases… 3. Consumption of Coke increases

35. Income Effect A decrease in the price of a commodity is essentially equivalent to an increase in consumers’ income SUPPLY AND DEMAND 22

36. Lower Prices = Higher Income SUPPLY AND DEMAND 23 If income rises, Situation A becomes Situation B. If prices fall, Situation A becomes Situation C. Q: Which change is better? A: They are both equally desirable. A fall in prices is equivalent to an increase in income.

37. Income Effect SUPPLY AND DEMAND 24 Coke Books Movies Clothes Pepsi Consumers respond to a decrease in the price of a commodity as they would to an increase in income They increase their consumption of a wide range of goods, including the good that had a price decrease 1. When the price of Coke decreases… 2. Consumers feel richer… 3. Consumption of Coke and other goods increases

38. supply SUPPLY AND DEMAND 25

39. SUPPLY Quantity supplied is the amount of a good that sellers are willing and able to sell Supply is a full description of how the quantity supplied of a commodity responds to changes in its price SUPPLY AND DEMAND 26

40. Ben’s supply schedule and supply curve 27 Price of Ice-Cream Cones Supply curve $3.00 2.50 2.00 1.50 1.00 0.50 2. . . . increases quantity of cones supplied. 1. An increase in price . . . 0 12 10 11 9 1 2 3 4 5 6 7 8 Quantity of Ice-Cream Cones

41. Market supply and individual supplies 28

42. Market supply and individual supplies 29 Price of Ice Cream Cones Price of Ice Cream Cones Price of Ice Cream Cones Ben’s supply Jerry’s supply + = Market supply SBen SMarket SJerry $3.00 2.50 2.00 1.50 1.00 0.50 $3.00 2.50 2.00 1.50 1.00 0.50 $3.00 2.50 2.00 1.50 1.00 0.50 12 10 11 9 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 18 2 4 6 8 10 12 14 16 0 0 0 Quantity of Ice-Cream Cones Quantity of Ice-Cream Cones Quantity of Ice-Cream Cones

43. Law of Supply The law of supply states that, the quantity supplied of a good rises when the price of the good rises, as long as all other factors that affect suppliers’ decisions are unchanged SUPPLY AND DEMAND 30

44. Law of Supply—Explanation How can we make sense of the numbers in Ben’s supply schedule? The best guess is that his costs must be something like the cost schedule below. SUPPLY AND DEMAND 31 In this way, the Law of Supply follows from the assumption of Increasing Costs (or, Diminishing Returns)

45. SUPPLY AND DEMAND 32 Supply curve, S 3 Supply curve, S 1 Supply curve, S Decrease 2 in supply Increase in supply Shifts in the Supply Curve: What causes them? Price of Ice-Cream Cone Quantity of 0 Ice-Cream Cones

46. Shifts in the Supply Curve… … are caused by changes in Input prices Technology Number of sellers (short run) The market supply will shift right if Raw materials or labor becomes cheaper The technology becomes more efficient Number of sellers increases SUPPLY AND DEMAND 33

48. In this example, a higher price causes higher quantity supplied, and a move alongthe supply curve.

50. equilibrium SUPPLY AND DEMAND 36

51. Interaction of demand and supply We have seen what demand and supply are We have seen why demand and supply may shift Now it is time to say something about how buyers and sellers collectively determine the market outcome To do this, we assume equilibrium SUPPLY AND DEMAND 37

52. Equilibrium We assume that the price will automatically reach a level at which the quantity demanded equals the quantity supplied SUPPLY AND DEMAND 38

53. Supply-Demand Equilibrium qD = 1000 - 100p qS = -125 + 125p Equilibrium qD = qS 1000 - 100p = -125 + 125p 225p = 1125 p* = 5 q* = 500 39

54. At $2.00, the quantity demanded is equal to the quantity supplied! SUPPLY AND DEMAND TOGETHER SUPPLY AND DEMAND 40 Demand Schedule Supply Schedule

55. Equilibrium of supply and demand 41 Price of Ice-Cream Cones Equilibrium price Equilibrium Supply Equilibrium quantity $3.00 2.50 2.00 1.50 1.00 0.50 Demand 0 12 10 11 9 1 2 3 4 5 6 7 8 Quantity of Ice-Cream Cones

56. Market Dis-equilibrium 42

57. SUPPLY AND DEMAND 43 Supply Surplus $2.50 2.00 Demand 4 10 7 Quantity Quantity demanded supplied Markets Not in Equilibrium (a) Excess Supply Price of Ice-Cream Cone 0 Quantity of Ice-Cream Cones

58. Markets Not in Equilibrium Surplus When price exceeds equilibrium price, then quantity supplied is greater than quantity demanded There is excess supply or a surplus Suppliers will lower the price to increase sales, thereby moving toward equilibrium SUPPLY AND DEMAND 44

59. SUPPLY AND DEMAND 45 Supply $2.00 1.50 Shortage Demand 10 7 4 Quantity Quantity supplied demanded Markets Not in Equilibrium (b) Excess Demand Price of Ice-Cream Cone 0 Quantity of Ice-Cream Cones

60. Markets Not in Equilibrium Shortage When price is less than equilibrium price, then quantity demanded exceeds the quantity supplied There is excess demand or a shortage Suppliers will raise the price due to too many buyers chasing too few goods, thereby moving toward equilibrium SUPPLY AND DEMAND 46

61. Equilibrium Law of supply and demand The price of any good adjusts to bring the quantity supplied and the quantity demanded for that good into balance SUPPLY AND DEMAND 47

62. Let’s make some predictions We can use our understanding of the factors that shift the demand and supply curves to predict the consequences of Alternative policy proposals, and Events outside our control SUPPLY AND DEMAND 48

63. SUPPLY AND DEMAND 49 1. An increase in the price of sugar reduces the supply of ice cream. . . S2 S1 New equilibrium $2.50 2.00 2. . . . resulting in a higher price of ice cream . . . Demand 7 4 3. . . . and a lower quantity sold. How a Decrease in Supply Affects the Equilibrium Price of Ice-Cream Cone Initial equilibrium Quantity of 0 Ice-Cream Cones

64. A Shift in Both Supply and Demand SUPPLY AND DEMAND 50

65. A Shift in Both Supply and Demand SUPPLY AND DEMAND 51

66. Queries…?? SUPPLY AND DEMAND 52