MB MC

Supply and Demand:

An Introduction
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 2
Supply and Demand:
An Introduction
How do consumers get the goods and
services they want in the right quantities
and qualities?
Some goods and services are allocated by
the market forces of supply and demand
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 3
Supply and Demand:
An Introduction
Why do some goods and services have
shortages or surpluses and others do
not?
Some good and supplies services are
regulated by government
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 4
What, How, and For Whom?
Central Planning Versus the Market
Three Problems All Economic Systems
Must Address
What should be produced?
How should it be produced?
For whom will it be produced?
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 5
What, How, and For Whom?
Central Planning Versus the Market
Centralized Economic Organizations
Agrarian society
Former Soviet Union
Cuba
North Korea
China
Bureaucracy

MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 6
What, How, and For Whom?
Central Planning Versus the Market
A small number of individuals address:
What
Establish production targets for factories and
farms
How
Plan how to achieve the goals
For Whom
Distribute the goods and services
produced

MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 7
What, How, and For Whom?
Central Planning Versus the Market
Free-Market or Capitalist Economic
System
Individual choices determine:
Which careers to pursue
Which products to produce or buy
When to start and shut-down a business
Who gets what is decided by individual
preferences and purchasing power
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 8
Buyers and Sellers In Markets
Market
Consists of all buyers and sellers of a good
or service
What do you think?
What determines the price of pizza,
gasoline, a car wash, or other goods and
services?
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 9
Buyers and Sellers In Markets
The Demand Curve
A schedule or graph that tells us the
quantity of a good that buyers wish to buy
at each price
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 10
Buyers and Sellers In Markets
A Property of Demand
As price of a good or service goes down
the quantity consumers wish to buy will
increase
Therefore, the demand curve is downward-
sloping
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 11
The Daily Demand
Curve for Pizza in Chicago
Price
($ per slice)
Quantity
(1000s of slices per day)
4
8
2
16
3
12
Demand
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 12
Buyers and Sellers In Markets
The Demand Curve
Why do buyers purchase a greater quantity
at lower prices and vice-versa?
The substitution effect
The income effect
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 13
Buyers and Sellers In Markets
The Substitution Effect
The change in the quantity demanded of a
good that results because buyers switch to
substitutes when the price of the good
changes
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 14
Buyers and Sellers In Markets
The Income Effect
The change in the quantity demanded of a
good that results because a change in the
price of a good changes the buyers
purchasing power
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 15
Buyers and Sellers In Markets
The Cost-Benefit Principle
The reservation price is the benefit the
buyer receives from the good
The cost of the good is its market price
If the reservation price (benefit) exceeds
the market price (cost) the consumer will
purchase the good
At higher prices, benefit will exceed cost
for a smaller quantity than at lower prices
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 16
Buyers and Sellers In Markets
Price
($ per slice)
Quantity
(1000s of slices per day)
Demand
8 12 16
The buyers reservation price:
The largest dollar amount the
buyer would be willing to pay for
a good
4
2
3
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 17
Buyers and Sellers In Markets
Horizontal Interpretation
Price determines
quantity demanded
Price
($ per slice)
4
2
3
8 12 16
Demand
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 18
Buyers and Sellers In Markets
Vertical Interpretation
Quantity measures the
marginal buyers
reservation price
Price
($ per slice)
4
2
3
8 12 16
Demand
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 19
Buyers and Sellers In Markets
The Supply Curve
A curve or schedule showing the quantity
of a good that sellers wish to sell at each
price
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 20
Buyers and Sellers In Markets
Question
Will the opportunity cost of producing
additional units of pizza increase or
decrease?
Hint:Low-hanging-fruit principle
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 21
Buyers and Sellers In Markets
The Supply Curve
Sellers must receive a higher price to
produce additional units of product to cover
the higher opportunity costs of each
additional unit
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 22
The Daily Supply
Curve for Pizza in Chicago
Price
($ per slice)
Quantity
(1000s of slices per day)
4
2
3
8 12 16
Supply
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 23
The Daily Supply
Curve for Pizza in Chicago
Price
($ per slice)
Quantity
(1000s of slices per day)
4
2
3
8 12 16
Supply
Horizontal Interpretation
Shows the
quantity produced
for each price
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 24
The Daily Supply
Curve for Pizza in Chicago
Price
($ per slice)
Quantity
(1000s of slices per day)
4
2
3
8 12 16
Supply
Vertical Interpretation
Shows the marginal
cost (reservation
price) for producing
each additional unit
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 25
Sellers Reservation Price
The smallest dollar amount for which a
seller would be willing to sell an additional
unit, generally equal to marginal cost
The Daily Supply
Curve for Pizza in Chicago
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 26
Market Equilibrium
Equilibrium
A system is in equilibrium when there is no
tendency for it to change
Market Equilibrium
Occurs in a market when all buyers and
sellers are satisfied with their respective
quantities at the market price
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 27
The Equilibrium Price and
Quantity of Pizza In Chicago
Price
($ per slice)
Quantity
(1000s of slices per day)
4
2
3
8 12 16
Supply
Demand
Equilibrium at $3
Quantity Demanded =
Quantity Supplied
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 28
Market Equilibrium
Equilibrium Price and Equilibrium
Quantity
The values of price and quantity for which
quantity supplied and quantity demanded
are equal
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 29
What Do You Think?
Would buyers prefer a lower price than the
equilibrium price?
Would sellers prefer a higher price than the
equilibrium price?
Market Equilibrium
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 30
Excess Supply
Price
($ per slice)
Quantity
(1000s of slices per day)
4
2
3
8 12 16
Supply
Demand
Excess supply = 8,000 slices per day
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 31
Excess Demand
Price
($ per slice)
Quantity
(1000s of slices per day)
4
2
3
8 16
Excess demand = 8,000
slices per day
Supply
Demand
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 32
Points Along the Demand and
Supply Curves of a Pizza Market
Demand for pizza Supply of pizza
Price
($/slice)
Quantity demanded
(1000s of slices/day)
Price
($/slice)
Quantity supplied
(1000s of slices/day)
1 8 1 2
2 6 2 4
3 4 3 6
4 2 4 8
MB MC
Copyright c 2007 by The McGraw-Hill
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Chapter 3 - Supply and Demand: An Introduction Slide 33
Graphing Supply and Demand and
Finding the Equilibrium Price and Quantity
Price
($per slice)
Quantity
(1000s of slices per day)
5
2
3
4
1
4
10 2
Demand
0
6 8
Supply
2.50
5
The Equilibrium Price = $2.50
The Equilibrium Quantity = 5
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 34
Market Equilibrium
What Do You Think?
Is the market equilibrium always an ideal
outcome for all market participants?
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 35
An Unregulated Housing Market
Monthly Rent
($/apartment)
Quantity
(Millions of apartments/day)
1,600
2
Supply
Demand
What Do You Think?
Is $1600 more than some
people can afford?
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 36
Rent Controls
Monthly Rent
($/apartment)
Quantity
(Millions of apartments/day)
1,600
2
Supply
Demand
2,400
Controlled = 800
1 3 0
Excess demand = 2 million
apartments per month
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 37
Market Equilibrium
Rent Controls Reconsidered
Other consequences of rent controls
Maintenance will decline and housing quality
will fall
Illegal payments
Creation of co-ops and conversion to
condominiums
Reduction in household mobility
Discrimination
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 38
Market Equilibrium
What do you think?
How can we make housing affordable for
poor people without using rent ceilings?
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 39
Rent Controls
Monthly Rent
($/apartment)
Quantity
(Millions of apartments/day)
800
2
Supply
Demand
1,200
1 3 0
What is the impact of a rent
control set at $1,200/month?
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 40
Price Controls
In The Pizza Market
Price
($ per slice)
Quantity
(1000s of slices per day)
Supply
Demand
Excess demand = 8,000 slices per day
4
Price ceiling = 2
3
8 12 16
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 41
Market Equilibrium
Pizza Price Controls?
Market responses to a pizza price ceiling
Long lines
Preferential treatment to selected customers
Alternative pricing strategies
Poorer quality ingredients
Black-market pizzas
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 42
Predicting and Explaining
Changes In Prices and Quantities
Distinguishing Between:
A change in the quantity demanded
A movement along the demand curve that
occurs in response to a change in price
A change in demand
A shift of the entire demand curve
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 43
An Increase In Quantity
Demanded vs. An Increase In Demand
Price
($/can)
Quantity
(1000s of cans/day)
5
2
3
4
1
4
12 2
6
0 10 6 8
Increase in
quantity
demanded
D
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 44
An Increase In Quantity
Demanded vs. An Increase In Demand
Price
($/can)
Quantity
(1000s of cans/day)
5
2
3
1
4
12
6
0
Increase in demand
D
D
D
D
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 45
Predicting and Explaining
Changes In Prices and Quantities
Change in the quantity supplied
A movement along the supply curve that
occurs in response to a change in price
Change in supply
A shift of the entire supply curve
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 46
An Increase In Quantity
Supplied vs. An Increase In Supplied
Price
($/can)
Quantity
(1000s of cans/day)
5
2
3
4
1
4
10 2
6
0 6 8
S
S
Increase in
quantity supplied
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 47
An Increase In Quantity
Supplied vs. An Increase In Supplied
Price
($/can)
Quantity
(1000s of cans/day)
5
2
3
4
1
4
10 2
6
S
0 6 8
S
S
S
Increase in supply
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 48
The Effect on the Market for Tennis
Balls of a Decline in Court-Rental Fees
Price
($/ball)
Quantity
(letters/month)
1.00
S
D
40
D
1.40
58
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 49
Predicting and Explaining
Changes In Prices and Quantities
Shifts in Demand
Complements
Two goods are complements in consumption if
an increase (decrease) in the price of one
cause a decrease (increase) in the demand for
the other
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 50
The Effect on the Market for Overnight Letter
Delivery of a Decline in the Price of Internet Access
Price
($/letter)
Quantity
(letters/month)
P
Q
S
D
P
Q
D
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 51
Predicting and Explaining
Changes In Prices and Quantities
Shifts in Demand
Substitutes
Two goods are substitutes in consumption if an
increase (decrease) in the price of one causes
an increase (decrease) in the demand for the
other
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 52
Predicting and Explaining
Changes In Prices and Quantities
What do you think?
How will a decline in airfares affect inter-
city bus fares and the price of hotel rooms
in resort communities?
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 53
Predicting and Explaining
Changes In Prices and Quantities
Economic Naturalist
When the Federal Government implements
a large pay increase for its employees, why
do rents for apartments near Washington
Metro stations go up relative to rents for
apartments located far away from Metro
stations?
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 54
The Effect of a Federal Pay Raise on the Rent for
Conveniently Located Apartments in Washington D.C.
Rent
(dollars per month)
Conveniently
located apartments
(units per month)
D
P
Q
S
P
Q
D
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 55
Predicting and Explaining
Changes In Prices and Quantities
Shifts in Demand
Changes In Demand
An increase (decrease) in the demand for a
good will shift the demand curve to the right
(left)
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 56
Predicting and Explaining
Changes In Prices and Quantities
A Change In Income
Normal Good
One whose demand increases (decreases)
when the incomes of buyers increase
(decrease)
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 57
Predicting and Explaining
Changes In Prices and Quantities
A Change In Income
Inferior Good
One whose demand decreases (increases)
when the incomes of buyers increase
(decrease)
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 58
The Effect of the Release of Jurassic
Park on the Market for Toy Dinosaurs
Price
Toy Dinosaurs
(units per month)
P
Q
D
S
D
P
Q
D = demand after release of movie
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 59
The Effect of a Credible Rumor on
the Market for Apple Macintosh Computers
Price
Apple Computers
(units per month)
P
Q
S
D
P
Q
D
D = demand after rumor of cheaper
model soon to be released
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 60
The Effect of the Increase in
the Population of Potential Buyers
Price
Housing NY City
(units per month)
P
Q
S
D
P
Q
D
D = demand after increase in population
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 61
Predicting and Explaining
Changes In Prices and Quantities
Factors that Shift Demand
Price of complements
Price of substitutes
Income
Preferences
Population of potential buyers
Expectations
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 62
The Effect on the Skateboard Market
of an Increase in the Price of Fiberglass
Price
($/skateboard)
Quantity
(skateboards/month)
60
1000
S
D
80
800
S
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 63
Predicting and Explaining
Changes In Prices and Quantities
What Do You Think?
Does the increase in the cost of fiberglass
have any effect on the demand curve for
skateboards?
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 64
The Effect on the Market for New Houses
of a Decline in Carpenters Wage Rates
Price
($1000/house)
Quantity
(houses/month)
120
40
D
S
90
50
S
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 65
The Effect of Technical Change on the
Market for the Term Paper Revisions
Price
($/revision)
Quantity
(millions of revisions per year)
55
12
D
S
7.50
36
S
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 66
Predicting and Explaining
Changes In Prices and Quantities
Factors that Shift Supply
Costs of production
Technology
Weather
Number of suppliers
Expectations
MB MC
Copyright c 2007 by The McGraw-Hill
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Chapter 3 - Supply and Demand: An Introduction Slide 67
Price
Quantity
P
P
Q Q
S
D
D
An increase in demand will lead to an increase
in both the equilibrium price and quantity
Four Rules Governing the Effects
of Supply And Demand Shifts
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 68
Price
Quantity
P
P
Q Q
S
D
D
A decrease in demand will lead to a decrease
in both the equilibrium price and quantity
Four Rules Governing the Effects
of Supply And Demand Shifts
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 69
P
P
Q Q
S
D
S
Price
Quantity
An increase in supply will lead to a
decrease in the equilibrium price
and an increase in the equilibrium quantity
Four Rules Governing the Effects
of Supply And Demand Shifts
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 70
P
P
Q Q
S
D
S
Price
Quantity
An decrease in supply will lead to
an increase in the equilibrium price
and a decrease in the equilibrium quantity
Four Rules Governing the Effects
of Supply And Demand Shifts
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 71
Predicting and Explaining
Changes In Prices and Demand
Factors That Cause an Increase
(rightward or upward shift) in Demand
1. A decrease in the price of complements
to the good or service
2. An increase in the price of substitutes for
the good or service
3. An increase in income (for a normal
good)
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 72
Predicting and Explaining
Changes In Prices and Demand
Factors That Cause an Increase
(rightward or upward shift) in Demand
4. An increased preference by demanders
for the good or service
5. An increase in the population of potential
buyers
6. An expectation of higher prices in the
future
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 73
Predicting and Explaining
Changes In Prices and Demand
Factors That Cause an Increase
(rightward or upward shift) in Supply
1. A decrease in the cost of materials, labor,
or other inputs used in the production of
the good or service
2. An improvement in technology that
reduces the cost of producing the good or
service
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 74
Predicting and Explaining
Changes In Prices and Demand
Factors That Cause an Increase
(rightward or upward shift) in Supply
3. An improvement in the weather,
especially for agricultural products
4. An increase in the number of suppliers
5. An expectation of lower prices in the
future
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 75
The Effects Of Simultaneous
Shifts In Supply And Demand
Price
($/bag)
Millions of bags
per month
P
Q
S
D
P
Q
D
S
S after reduction in price of
corn harvesting equipment
D after discovery that oils are
harmful to peoples health
The Market for Corn Tortilla Chips
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 76
The Effects Of Simultaneous
Shifts In Supply And Demand
Price
($/bag)
Millions of bags
per month
P
Q
S
D
P
Q
D
S
D after discovery that oils are
harmful to peoples health
S after reduction in price of
corn harvesting equipment
The Market for Corn Tortilla Chips
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 77
Predicting and Explaining
Changes In Prices and Demand
Assume
A vitamin found in corn chips helps protect
against cancer and heart diseases
Swarm of locusts destroys part of the corn
crop
What Do You Think?
What will happen to the equilibrium price
and quantity of corn chips?
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 78
Predicting and Explaining
Changes In Prices and Demand
Economic Naturalist
Why do the prices of some goods, like
airline tickets to Europe, go up during the
months of heaviest consumption, while
others, like sweet corn, go down?
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 79
Seasonal Variation in Air Travel
Price
($/ticket)
1000s of
tickets
S
D
S

D
W

Q
W
Q
S

P
W

P
S

High Consumption and Prices Due to High Demand
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 80
Seasonal Variation in Corn Markets
Price
($/bushel)
Millions of
bushels
S
W

D
Q
W
Q
S

P
W

P
S
S
S

High Consumption and Low Prices due to High Supply
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 81
Markets And Social Welfare
What Do You Think?
When are the prices and quantities
determined in market equilibrium socially
optimal, in the sense of maximizing total
economic surplus?
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 82
Markets And Social Welfare
Cash On The Table
Assume:
All exchange is purely voluntary
If so:
The buyers reservation price exceeds the
sellers reservation price and both the buyer
and seller receive an economic surplus
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 83
Markets And Social Welfare
Cash On The Table
Buyers surplus
The difference between the buyers reservation
price and the price he or she actually pays
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 84
Markets And Social Welfare
Cash On The Table
Sellers surplus
The difference between the price received by
the seller and his or her reservation price
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 85
Markets And Social Welfare
Cash On The Table
Total surplus
The difference between the buyers reservation
price and the sellers reservation price
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 86
Markets And Social Welfare
Cash On The Table
Economic metaphor for unexploited gains
from exchange
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 87
Price Controls In The Pizza Market
Price
($ per slice)
Quantity
(1000s of slices per day)
S
D
3
12
4
2
8 16
Assume:
Buyers reservation P = $4
Sellers reservation P = $2
Pizza sells for $3
Buyers surplus: $4 - $3 = $1
Sellers surplus: $3 - $2 = $1
Total surplus: $4 - $2 = $2
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 88
Price Controls In The Pizza Market
Price
($ per slice)
Quantity
(1000s of slices per day)
Excess demand =
$8,000 slices/day
D
4
2
3
8 12 16
Assume price controls = $2
Quantity supplied falls to 8,000
Buyers reservation price ($4) is
greater than sellers ($2)
Both would benefit from
additional production
There is CASH ON THE TABLE
S
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 89
Markets And Social Welfare
Smart For One, Dumb For All
Socially optimal quantity
The quantity of a good that results in the
maximum possible economic surplus from
producing and consuming the good
The socially optimal quantity occurs when
MC = MB
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 90
Markets And Social Welfare
Smart For One, Dumb For All
Economic efficiency occurs when all goods
and services are produced and consumed
at their respective socially optimal levels
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 91
Markets And Social Welfare
Smart For One, Dumb For All
The Efficiency Principle
Maximize the economic surplus
Increases the economic pie
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 92
Markets And Social Welfare
Smart For One, Dumb For All
When is the market equilibrium efficient?
When all cost of producing the good or service
are borne directly by the seller
When all benefits from the good or service
accrue directly to buyers
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 93
Markets And Social Welfare
Smart For One, Dumb For All
Inefficient market equilibrium
When some costs of production fall on people
other than those who sell the good or service
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 94
Markets And Social Welfare
Example: Pollution
The market is in equilibrium: MC = MB
MC however underestimates the cost to
society of producing the good
Therefore, the market produces more than
the efficient amount and there is no
incentive for producers and consumers to
alter their behavior
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 95
Markets And Social Welfare
Smart For One, Dumb For All
Inefficient market equilibrium
When some benefits from the good or service
accrue to people who did not buy the good or
service
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 96
Markets And Social Welfare
Example: Vaccinations
The market is in equilibrium: MC = MB
MB underestimates the benefits to society of
consuming the vaccinations
The market produces less than the efficient
amount of vaccinations and there is no
incentive for producers and consumers to alter
their behavior
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 97
Markets And Social Welfare
Smart For One, Dumb For All
In these markets
Buyers and sellers are behaving rationally
Market equilibrium exists
There are no unexploited opportunities for
individuals
Economic surplus is not maximized
MB MC
Copyright c 2007 by The McGraw-Hill
Companies, Inc. All rights reserved.

Chapter 3 - Supply and Demand: An Introduction Slide 98
Markets And Social Welfare
The Equilibrium Principle
A market in equilibrium leaves no
unexploited opportunities for individuals,
but may not exploit all gains achievable
through collective action.
MB MC
End of
Chapter