Objectives for Chapter 6 Supply and Equilibrium

At the end of chapter 6, you will be able to:

1. Define the Law of Supply
2. Differentiate Between the Causes of a Movement Along the Supply Curve and
a Shift in Supply
. !a"e and #$plain the Four Factors that will cause the Supply of a %iven &roduct to Shift
to the 'eft (or to the )i*ht+.
,. #$plain equilibrium- #$plain how the e.uilibriu" price and .uantity are deter"ined-
/. 0f the price is above e.uilibriu", e$plain what will result- 0f the price is below e.uilibriu",
e$plain what will result-
6. #$plain what will happen to the price and the .uantity in each of the followin* cases (as well
as why this will happen+:
a. there is an increase in de"and or a decrease in de"and
b. there is an increase in supply or a decrease in supply
1. #$plain what will happen to the price and the .uantity in each of the followin* cases, as well
as why it will happen:
a. both de"and and supply increase c. de"and increases and supply decreases
b. both de"and and supply decrease d. de"and decreases and supply increases
1
Chapter 6 Supply And Equilibrium (latest revision 2ay 2336+
!" Supply
0n Chapter /, we focused e$clusively on the behaviors of buyers. But buyers are only half of
the "ar4et. 5e "ust also consider the behaviors of sellers. Discussin* sellers is so"ewhat
easier because we can safely assume that sellers have only one motivation# to ma$imi%e their
profits. Sellers will be "otivated to do "ore of anythin* that increases profits and less of
anythin* that decreases profits. Their total profits are calculated as the difference between
their total revenues and their total costs of production.
'et us be*in with the total revenues, the "oney ta4en in fro" sellin* the product. 6otal
revenues are calculated as the price of the product times the quantity sold. So, if we sell 133
units of the product at 713 each, our total revenues e.ual 71,333. 0f we sell 133 units at 723, our
total revenues e.ual 72,333. Since we *ain "ore revenues if the price is 723 than if it is 713, we
would li4ely want to sell "ore units of the product. So we can conclude that as the price of the
product rises (falls), the quantity supplied rises (falls). We call this statement the law of
supply. (%o bac4 and co"pare this state"ent with the law of de"and.+ 6o illustrate the law of
supply, you would e$pect that "ore and "ore ho"es would be built after 188/ when the prices
of ho"es be*an risin* *reatly. 6his is indeed what has occurred. 9ou would e$pect electric
power producers to produce "ore electricity after the prices doubled in the su""er of 2333. And
you would e$pect that "ore and "ore people would want to beco"e en*ineers and scientists
when the prices paid for these people (called the wa*es+ rose. A*ain, indeed, this is what has
occurred. (Does it "a4e any sense that when the tic4et prices char*ed for baseball and football
*a"es rose, 2a:or 'ea*ue Baseball chan*ed fro" 1/, *a"es to 162 *a"es per year and the
!ational ;ootball 'ea*ue chan*ed fro" 12 *a"es to 16 *a"es per year-+
5e can illustrate the law of supply with a supply schedule for ho"es.
Price of Homes Quantity Supplied
1 $300,000 3000
2 $350,000 4000
3 $400,000 5000
4 $450,000 6000
5 $500,000 7000
6 $550,000 8000
7 $600,000 9000
8 $650,000 10000
9 $700,000 11000
13 $750,000 12000
11 $800,000 13000
12 $850,000 14000
6he schedule shows that, as the price char*ed for ho"es rises, sellers wish to sell "ore ho"es.
5e can also plot this in the *raph below. 6his *raph depicts the law of supply as an
2
up&ard'sloping line. !otice that the line does not be*in at the ori*in. 6here is so"e price <<<
above =ero <<< at which no seller will produce at all. As with the de"and *raph, we move along
the line if the price of the product chan*es. (So we "ove alon* the line fro" point 11 to point 12
if the price rises fro" 7>33,333 to 7>/3,333 per ho"e. 6his tells us the .uantity supplied, which
rises fro" 1,333 ho"es to 1,,333 ho"es.+ 5e shift the line if anythin* else chan*es. 'et us
now consider the factors that cause shifts in supply, called the determinants of supply. 6here
are four deter"inants of supply.
(eterminants of Supply
(1+ 6he *oal of a co"pany, as stated above, is to "a$i"i=e profits, calculated as the difference
between the total revenues and the total costs of production. So, one of the deter"inants of
supply "ust be the total costs of production. s costs of production rise, profits fall, and
therefore the quantity supplied falls (shifts to the left). !onversely, as costs of production fall,
the profits rise, and the quantity supplied rises (shifts to the right)" Costs include the costs of
natural resources such as wood used in buildin* a ho"e, the costs of labor (wa*es and benefits+,
interest rates, ta$es, and the costs of the capital *oods. 5e will consider the" "any ti"es
throu*hout the course.
(2+ 5hen we considered de"and, one of the deter"inants was population (the nu"ber of
buyers+. 6he sa"e is true for supply. ?ne of the deter"inants of supply is the number of sellers
of the product. When the number of sellers increases, the supply increases (shifts to the

right). When the number of sellers falls, the supply decreases (shifts to the left). 0n this
course, we will see that a "a:or reason for the increase in the nu"ber of sellers of "any products
has been the openin* of international trade @ a topic that will be discussed several ti"es.
(+ 5hen we considered de"and, one of the deter"inants was the price of a substitute *ood.
A*ain, the sa"e is true for supply. 0n this case, the substitute is a substitute for the seller <<<
another good also produced by the same seller. 6his "ay or "ay not be a substitute for the
buyer. ;or e$a"ple, wheat and corn can be *rown on the sa"e landA they are substitutes for the
seller. So are avocados and oran*es or Coca Cola and Diet Co4e (because they are produced by
the sa"e co"pany+. "f the price of the other good rises, the supply of the good in question
falls (shifts to the left). ;or e$a"ple, if the *ood in .uestion is wheat and the price of corn rises,
sellers will produce less wheat (and "ore corn+. 0f the price of re*ular Coca Cola rises, the
supplier will produce less Diet Co4e (and "ore re*ular Coca Cola+. ?n the other hand, if the
price of the other good falls, the supply of the good in question rises (shifts to the right).
)e"e"ber that *oods are substitutes for the seller if they are produced by the sa"e co"pany.
(,+ ;inally, when we considered de"and, one of the deter"inants was e$pectations. 6his is
also true for supply. Sellers also have e$pectations that affect their behavior. "f sellers e#pect the
price to rise, they will want to sell less today (shift to the left) and wait for the price to rise later.
Bo"e sellers will hold their ho"es off the "ar4et if they believe the prices will rise soon. 0n
181, oil tan4ers re"ained offshore while an*ry "otorists waited in lon* lines for *asoline.
6he reason was that the price of *asoline was 6 cents per *allon. 6he *overn"ent was allowin*
the price to rise only 2 cents per wee4A the oil co"panies esti"ated that it would rise to about 6/
cents. So they reduced supply and waited until the price would reach the predicted 6/ cents.
Conversely, if sellers e#pect the price to fall, they want to sell more now (shift to the right). At
the be*innin* of 188/, holders of 2e$ican pesos believed that the price would fall. 6hey *ot rid
of the" (sold the" in the forei*n e$chan*e "ar4et+ as fast as they could. 6he sa"e is true for
holder of stoc4s (ownership shares in co"panies+ in the period after 2331.
"n summary, supply will shift to the left (right) if$
(%) costs of production rise (fall)
(&) the number of sellers falls (rises)
(') the price of another good produced by the same seller rises (falls)
(() sellers e#pect the price of the product to rise (fall) in the near future.
)raphing Supply
6he *raphs of a shift to the left and of a shift to the ri*ht are shown below. 6he possible
reasons for the shifts are also shown. shift to the left (right) means that sellers want to
produce and sell fewer (more) homes than they did before at any price. (6he shift is to the left
and represents a decrease. 0t is !?6 a shift up. 6he *raph is read left to ri*ht, not up and down.+
,
&rice of Bo"es
Supply2
Supply1






3 Cuantity of Bo"es
&rice of Bo"es

Supply1

Supply2


3 Cuantity of Bo"es

*est +our ,nderstanding
Consider an oran*e *rove. 0n each of the followin* cases, state whether there is a "ove"ent alon* the
supply curve of oran*es, a shift in the supply curve of to the ri*ht, or a shift in the supply curve to the left:
1. the wa*es paid to hired wor4ers rises DDDDDDDDDDDDDDDDDDDDD
2. the nu"ber of oran*e *rowers rises DDDDDDDDDDDDDDDDDDDDD
. the price paid by consu"ers for avocados rises DDDDDDDDDDDDDDDDDDDDD
,. the price paid by consu"ers for oran*es rises DDDDDDDDDDDDDDDDDDDDD
/. oran*e *rowers e$pect the price of oran*es to rise *reatly soon DDDD
-" Equilibrium
!ow, we can ta4e the two sides of the "ar4et, de"and and supply, and put the" to*ether.
6his will allow us to deter"ine the .uantity produced and the price of the product. 0n the *raph
on the followin* pa*e, the de"and curve and the supply curve have been superi"posed on each
other. 6hey reflect the de"and and supply schedules that we had before.
/
S,../+ S01F*S /EF* 1F
(1+ costs of production rise
(1+ the nu"ber of sellers falls
(2+ the price of a different
product produced by the
sa"e seller rises
(+ sellers e$pect the price to
rise
S,../+ S01F*S 21)0*
1F#
(1+ costs of production fall
(2+ the nu"ber of sellers
rises
(+ the price of a different
product produced by the
sa"e seller falls
(,+ sellers e$pect the price to
fall
&rice Cuantity De"anded Cuantity Supplied
7>/3,333 3 1,,333
7>33,333 1333 1,333
71/3,333 2333 12,333
7133,333 333 11,333
76/3,333 ,333 13,333
7633,333 /333 8,333
7//3,333 6333 >,333
7/33,333 1333 1,333
7,/3,333 >333 6,333
7,33,333 8333 /,333
7/3,333 13333 ,,333
733,333 11333 ,333
Assu"e that, for whatever reason, the price is 7>33,333 per ho"e. 6he de"and curve tells us
that buyers wish to buy 1,333 ho"es (point 1+. 6he supply curve tells us sellers wish to sell
1,333 ho"es (point 1+. 5e have a proble". 6here are 12,333 ho"es that sellers wish to sell
that no one wishes to buy (1,333 < 1,333+. 6his is called a surplus. %raphs "ay see" abstract
but surpluses are not. A seller 4nows there is a surplus by the fact that *oods for sale are not
sellin*. )esale ho"es *o on sale and sit for "onths and "onths without any buyer "a4in* an
offer. !ew ho"es have the E%rand ?penin*E fla*s out for "onths and even years. #ventually,
sellers fi*ure out that they "ust lo&er the price. As the price falls, buyers will buy "ore (a
"ove"ent alon* the de"and curve+. Sellers "ay even choose to sell less at the lower price,
ta4in* ho"es off the "ar4et (a "ove"ent alon* the supply curve+. 6he surplus beco"es s"aller
and s"aller until it disappears.
!ow assu"e that the price be*ins at 733,333 per ho"e. 6he de"and curve tells us that
buyers wish to buy 11,333 ho"es (point +. 6he supply curve tells us that sellers wish to sell
,333 ho"es (point 11+. 5e have a proble". All ,333 ho"es for sale will sell .uic4ly and
"any "ore buyers will co"e see4in* to buy. 5e call this a shortage. A shorta*e is also easy to
reco*ni=e. ;ifty ho"es *o on sale for a "ini"u" price. A wee4 before orders are to be ta4en,
about /33 people line up to spend a wee4 in line. 0t is easy for sellers to reali=e that there was a
shorta*e. 6he "ini"u" price obviously was too low.
6
As a result, sellers raise the price. 6he hi*her price will cause buyers to buy less ("ove alon*
the de"and curve+. 0t "ay also induce sellers to sell "ore ho"es ("ove alon* the supply curve+.
6he shorta*e beco"es s"aller and s"aller until it disappears.
At the price of 7/33,333 (point 1+, there is no surplus. 6here is also no shorta*e. Sellers want
to sell 1,333 ho"es. 6his is e$actly what buyers want to buy. 6here is no reason to either lower
to raise the price. 5e call 7/33,333 the equilibrium price. 5e call 1,333 ho"es the
equilibrium quantity. 6he de"and and the supply are e.ual. All forces affectin* the price or
.uantity are in balanceA there is no tendency to chan*e. 5e started our analysis by as4in* what
deter"ined the .uantity produced and the price of the product. 5e now 4now that the .uantity
produced will be 1,333 ho"es and the price will be 7/33,333 per ho"e. 6he price and the
.uantity of ho"es will stay at these levels until so"ethin* happens to chan*e the".
*est +our ,nderstanding
6he followin* are de"and and supply schedules for co"puters:
0f the &rice is: 6he Cuantity De"anded is: and 6he Cuantity Supplied is:
71333 /33 133
712/3 ,33 233
71/33 33 33
711/3 233 ,33
72333 133 /33
6he e.uilibriu" price is 7DDDDDDDDDDDDDDDDDD and the e.uilibriu" .uantity is
DDDDDDDDD. 0f the price were 72333, there would be a DDDDDDDDDDDDDDDDDD
(shorta*e or surplus-+ e.ual to DDDDDDDDDDDDDDDDDD co"puters.
1
3" Changes in Equilibrium
Case !: Assu"e that we be*in with a "ar4et for ho"es in e.uilibriu". 6hen, so"ethin*
chan*es. 'et us assu"e that income rises. Bow do we analy=e this case-
Does inco"e affect de"and or supply- 6he answer, as we saw in the last chapter, is demand.
5ill there be a shift or "ove"ent alon* de"and- 6he answer is shift, because the chan*e is
caused by so"ethin* other than the price. 0s the shift ri*ht or left- 6he de"and will increase,
which is a shift to the right. 6he data below are repeated.
1f the price is# *he quantity demanded is# *he quantity supplied is
1ncome 4 5678777 1ncome 4 5!778777
7>/3,333 3 2333 1,333
7>33,333 1333 333 1333
71/3,333 2333 ,333 12333
7133,333 333 /333 11333
76/3,333 ,333 6333 13333
7633,333 /333 1333 8333
7//3,333 6333 >333 >333
7/33,333 1333 8333 1333
7,/3,333 >333 13333 6333
7,33,333 8333 11333 /333
7/3,333 13333 12333 ,333
733,333 11333 1333 333
>
6he de"and shifts fro" the blue line to the yellow line. Fust loo4in* at the data and at the *raph
tells us that there will be a new e.uilibriu" price and .uantity. *he equilibrium price &ill rise
to 56678777 and the equilibrium quantity &ill rise to 98777 homes. 5ith the aid of the
nu"bers and the *raph, we can e$plain what occurs. Buyers wish to buy "ore ho"es (8333+ at
the price of 7/33,333 per ho"e because they have "ore inco"e. But there are no "ore ho"es to
buy (1333+. 6his causes a shorta*e to result (a shorta*e of 2333 ho"es+. )eco*ni=in* the
shorta*e, sellers will raise the price (fro" 7/33,333 to 7//3,333+. As the price rises, sellers will
desire to sell "ore ho"es (fro" 1333 ho"es to >333 ho"es+. And buyers will buy fewer ho"es
(fro" 8333 ho"es bac4 to >333 ho"es+. 6he shorta*e will be eli"inated.
Case -: A*ain, assu"e that there is a "ar4et for ho"es that be*ins in e.uilibriu". 0n this case,
the chan*e that occurs is an increase in the price of &ood. Bow do we analy=e this case-
Since wood is used to build ho"es, this is an increase in a cost of production. Do costs of
production affect the de"and or the supply- 6he answer, as shown earlier in this chapter, is
supply. 5ill there be a shift in or "ove"ent alon* the supply- 6he answer is a shift, since the
cause is so"ethin* other than the price of the product. 5ill the shift be ri*ht or left- Since costs
are increasin*, supply &ill decrease ''' a shift to the left.
1f the price is# quantity demanded is# quantity supplied is# ne& quantity supplied is#
7>/3,333 3 1,333 12333
7>33,333 1333 1333 11333
71/3,333 2333 12333 13333
7133,333 333 11333 8333
76/3,333 ,333 13333 >333
7633,333 /333 8333 1333
7//3,333 6333 >333 6333
7/33,333 1333 1333 /333
7,/3,333 >333 6333 ,333
7,33,333 8333 /333 333
7/3,333 13333 ,333 2333
733,333 11333 333 1333

8
6he supply curve shifts fro" the red line to the yellow line. ;ro" loo4in* at the nu"bers and the
*raph, you can see that the price of homes &ill rise to 56678777 &hile the quantity of homes
&ill fall to 68777. 5ith the aid of the nu"bers and the *raph, we can e$plain what occurs. As
costs rise, sellin* ho"es beco"es less profitable. Sellers wish to sell less (shift fro" red to
yellow <<< fro" 1333 ho"es to /333 ho"es+. But, buyers still want the sa"e nu"ber of ho"es
(1333 ho"es+. 6he result is the creation of a shortage (of 2333 ho"es+. )eco*ni=in* the
shorta*e, sellers will raise the price (fro" 7/33,333 to 7//3,333+. As the price rises, buyers will
buy fewer ho"es (fro" 1,333 to 6,333+ while sellers will sell "ore ho"es (fro" /333 ho"es to
6333 ho"es+. 6he shorta*e will be eli"inated.
Case 3: A*ain, assu"e that the "ar4et for ho"es be*ins in e.uilibriu". 0n this case, the chan*e
that occurs is that buyers and sellers both e$pect the price to rise soon. Bow do we analy=e
this case-
0n this case, both buyers and sellers are affected. Since the case involves e$pectations, both
the de"and curve and the supply curve will shift. *he demand curve shifts to the right :from
blue to yello&; because buyers &ill &ant to buy more homes no&8 before the price rises"
*he supply curve shifts to the left :from red to teal; because sellers &ill &ant to pull their
homes off the mar<et and &ait for the price to rise. As shown in the *raph below, if the
de"and curve shifts to the ri*ht and the supply curve shifts to the left, &e <no& &ithout doubt
that the price of homes &ill rise :to 56778777;" By itself, an increase in the de"and for ho"es
will "a4e the price of ho"es rise. By itself, a decrease in the supply of ho"es will "a4e the
13
price of ho"es rise. So the price of ho"es will definitely rise. =ut &e cannot say definitively
&hat &ill happen to the quantity of homes. By itself, an increase in the de"and for ho"es
will "a4e the .uantity of ho"es rise. By itself, a decrease in the supply of ho"es will "a4e the
.uantity of ho"es fall. 0f both happen si"ultaneously, we cannot 4now what will happen to the
.uantity of ho"es unless we 4now which of the two shifts is *reater. ?n the *raph below, the
.uantity bou*ht and sold stayed the sa"e at 1,333. But this is a pure coincidence of the way the
*raph was drawn.
*est +our ,nderstanding
1. Assu"e that the "ar4et for auto"obiles be*ins in e.uilibriu". Draw the de"and and supply curves
for auto"obiles in the *raph below. 'abel all a$es and curves. Show the e.uilibriu" price and .uantity.
6hen, the price of gasoline rises. 2a4e the appropriate chan*e on the *raph on the ne$t pa*e. Show
the new e.uilibriu".
5hen the new e.uilibriu" is reached, the price will have DDDDDDDDDDD(risen or fallen-+ and the
.uantity will have DDDDDDDDDDDDDDDDDDD(risen or fallen-+
&rice
DDDDDDDDDDDDDDDDDDDDDDDDDDDDDDDDDDDD
3 Cuantity
11
2. Assu"e that the "ar4et for oran*es be*ins in e.uilibriu". Draw the de"and and supply curves for
oran*es in the *raph below. 'abel all a$es and curves. Show the e.uilibriu" price and .uantity.
6hen, there is an increase in the price of &ater gro&ers must pay. 5ater, of course, is needed to
*row oran*es. 2a4e the appropriate chan*e on the *raph. Show the new e.uilibriu".
5hen the new e.uilibriu" is reached, the price will have DDDDDDDDDDD(risen or fallen-+ and the
.uantity will have DDDDDDDDDDDDDDDDDDD(risen or fallen-+
&rice
DDDDDDDDDDDDDDDDDDDDDDDDDDDDDDDDDDDDCuantity
. Do the sa"e type of analysis for an increase in rents char*ed on apart"ents.. 6he product is ho"es.
Gse your own *raph.
,. Do the sa"e type of analysis for an increase in interest rates paid to borrow "oney to buy ho"es.
Gse your own *raph.
/. Do the sa"e type of analysis if the nu"ber of ho"ebuilders is reduced as so"e co"panies *o out of
business. Gse your own *raph.
>" Summary
6his chapter first e$a"ined the behavior of sellers. 0t started with the fact that sellers respond
to chan*es in the price of the product. 5hen the price of the product rises, the .uantity supplied
rises. And when the price of the product falls, the .uantity supplied falls. 6his is called the Law
of Supply. 6he chapter also e$plained the four determinants of supply. (1+ As costs of
production rise (fall+, the supply of a product falls (rises+. (2+ As the nu"ber of sellers rises
(falls+, the supply rises (falls+. (+ As the price of a different product also produced by the seller
rises (falls+, the supply of the product in .uestion falls (rises+. And finally (,+, as sellers e$pect
the price to rise (fall+ in the future, the supply of the product on the "ar4et today falls (rises+.
0n the second part, this chapter illustrated how "ar4ets reach an equilibrium price and an
equilibrium quantity. 5hen there are shortages, the price will rise until the shorta*es are
eli"inated. 5hen there are surpluses, the price will fall until the surpluses are eli"inated. 5hen
so"ethin* occurs to chan*e either the de"and for the product or the supply of the product, the
e.uilibriu" is disturbed te"porarily. Bowever, a new and different e.uilibriu" price and
.uantity will occur. ;ro" this analysis of the response to a chan*e in either the de"and for or
the supply of a product, we can learn "uch about two "ar4ets that are of *reat i"portance @ the
forei*n e$chan*e "ar4et and the stoc4 "ar4et. 6hese are the topics of the ne$t chapter.
12
.ractice ?ui% for Chapter 6
1. 6he la& of supply states that, other thin*s bein* unchan*ed,
a. as the price rises, the .uantity supplied rises c. as the supply rises, the price falls
b. as the price rises, the .uantity supplied falls d. as the de"and rises, the supply falls
;or .uestions 2, , ,, /, and 6, answer (a+ if there is a "ove"ent alon* the supply curve, (b+ if the supply curve
shifts to the left, and (c+ if the supply curve shifts to the ri*ht.
2. 6he product is electricity and there is an increase in the price of electricity.
. 6he product is auto"obiles and there is a technical chan*e "a4in* auto"obile wor4ers "ore productive.
,. 6he product is fast food and there is an increase in the "ini"u" wa*e paid to fast food wor4ers.
/. 6he product is shares of stoc4. Stoc4holders believe that the price of the stoc4 will fall soon.
6. 6he product is co"puter operatin* syste"s and there is an increase in the nu"ber of co"panies producin*
co"puter operatin* syste"s.
1. Gsin* the nu"bers below, what is the equilibrium price-
&rice De"and Supply
71 13 6
72 8 1
7 > >
7, 1 8
a. 1 b. 2 c. d. ,
>. 0f the price is belo& equilibrium,
a. .uantity de"anded e.uals .uantity supplied c. there are surpluses
b. there are shorta*es d. supply "ust shift to the ri*ht
8. Assu"e that a "ar4et be*ins in e.uilibriu". 6hen, there is an increase in buyers@ incomes. 5hen the new
e.uilibriu" is reached:
a. the price and the .uantity will both have risen
b. the price and the .uantity will both have fallen
c. the price will have risen and the .uantity will have fallen
d. the price will have fallen and the .uantity will have risen
13. Assu"e that a "ar4et be*ins in e.uilibriu". 6hen, there is an increase in a cost of production. 5hen the
new e.uilibriu" is reached:
a. the price and the .uantity will both have risen c. the price will have risen and the .uantity will have fallen
b. the price and the .uantity will both have fallen d. the price will have fallen and the .uantity will have risen
Answers: 1. A 2. A . C ,. B /. C 6. C 1. C >. B 8. A 13. C
1