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Chapter

|3 |Demand and Supply |

Chapter Key Ideas

Slide, Rocket, Roller Coaster

A. Some prices slide, some rocket, and some roller coaster.

B. This chapter explains how prices are determined by demand and supply.

Outline

I. Markets and Prices

A. A market is any arrangement that enables buyers and sellers to get information and do business with each other.

B. A competitive market is a market that has many buyers and many sellers so no single buyer or seller can influence the price.

C. The money price of a good is the amount of money needed to buy it. The relative price of a good is the ratio of its money price to the money price of another good or a market basket of goods. A relative price is an opportunity cost.

II. Demand

A. Wants are the unlimited desires or wishes people have for goods and services. Demand reflects a decision about which wants to satisfy. The quantity demanded of a good or service is the amount that consumers plan to buy during a particular time period, and at a particular price.

B. The Law of Demand

1. The law of demand states: Other things remaining the same, the higher the price of a good, the smaller is the quantity demanded; and the lower the price of a good, the greater is the quantity demanded.

2. The law of demand results from:

a) the substitution effect—when the relative price (opportunity cost) of a good or service rises, people seek substitutes for it—and

b) the income effect—when the price of a good or service rises relative to income, people cannot afford all the things they previously bought.

C. Demand Curve and Demand Schedule

1. The term demand refers to the entire relationship between the price of the good and quantity demanded of the good.

a) The demand curve shows the relationship between the quantity demanded of a good and its price, holding all other influences constant. Figure 3.1 shows a demand curve for recordable compact discs (CD-Rs).

b) A demand curve is also a willingness-and-ability-to-pay curve, which means that a demand curve is a marginal benefit curve.

D. A Change in Demand

1. When any factor that influences buying plans other than the price of the good changes, there is a change in demand for that good. The quantity of the good that people plan to buy changes at each and every price, so there is a new demand curve.

a) When demand increases, the quantity that people plan to buy increases at each and every price. The demand curve shifts rightward.

b) When demand decreases, the quantity that people plan to buy decreases at each and every price. The demand curve shifts leftward.

2. The factors that change demand (summarized in Table 3.1 page 62) are:

a) Prices of related goods: A substitute is a good that can be used in place of another good. A complement is a good that is used in conjunction with another good. Using the CD-R example, the demand for CD-Rs increases (decreases) and its demand curve shifts rightward (leftward) if the price of a substitute for a CD-R rises (falls) or if the price of a complement of a CD-R falls (rises). Figure 3.2 shows the shift in the demand curve for CD-Rs when the price of CD-R burners—a complement—falls.

b) Expected future prices: If the price of a good is expected to rise (fall) in the future, current demand increases (decreases) and the demand curve shifts rightward (leftward).

c) Income: When income increases (decreases), consumers buy more (less) of most goods and the demand curve shifts rightward (leftward). A normal good is one for which demand increases as income increases. An inferior good is one for which demand decreases as income increases.

d) Expected future income: When expected future income increases, demand might increase.

e) Population: The larger (smaller) the population, the greater (smaller) is the demand for all goods.

f) Preferences: People with the same income have different demands if they have different preferences.

E. A Change in the Quantity Demanded Versus a Change in Demand

Figure 3.3 illustrates the distinction between a change in demand and a change in the quantity demanded.

1. When the price of the good changes and everything else remains the same, there is a movement along the demand curve and a change in the quantity demanded.

2. When any other influence on buyers’ plans changes, there is a shift of the demand curve and a change in demand.

III. Supply

A. Resources and technology determine what it is possible to produce. Supply reflects a decision about which technologically feasible items to produce. The quantity supplied of a good or service is the amount that producers plan to sell during a given time period at a particular price.

B. The Law of Supply

1. The law of supply states: “Other things remaining the same, the higher the price of a good, the greater is the quantity supplied; and the lower the price of a good, the smaller is the quantity supplied.”

2. The law of supply results because the marginal cost of producing a good or service increases as the quantity produced increases (Chapter 2, page 35).

3. Producers are willing to supply a good only if the price at least covers the marginal cost of producing the good.

C. Supply Curve and Supply Schedule

1. The term supply refers to the entire relationship between the quantity supplied and the price of a good.

2 The supply curve shows the relationship between the quantity supplied of a good and its price when all other influences on producers’ planned sales remain the same. Figure 3.4 shows the supply curve for CD-Rs.

3. The supply curve also shows the producers’ minimum-supply price for an additional unit to be supplied. It shows the lowest price at which someone is willing to sell another unit.

D. A Change in Supply

1. When any factor that influences selling plans other than the price of the good changes, there is a change in supply of that good. The quantity of the good that producers plan to sell changes at each and every price, so there is a new supply curve.

a) When supply increases, the quantity that producers plan to sell increases at each and every price. The supply curve shifts rightward.

b) When supply decreases, the quantity that producers plan to sell decreases at each and every price. The supply curve shifts leftward.

2. The factors that change supply (summarized in Table 3.2 page 67) are:

a) Prices of productive resources: If the price of resource used to produce a good rises (falls), the minimum price that a supplier is willing to accept for producing each quantity of that good rises (falls). So a rise (fall) in the price of productive resources decreases (increases) supply and shifts the supply curve leftward (rightward).

b) Prices of related goods produced: A substitute in production for a good is another good that can be produced using the same resources. Goods are compliments in production if they must be produced together. The supply of a good increases (decreases) and its supply curve shifts rightward (leftward) if the price of a substitute in production falls (rises) or if the price of a complement in production rises (falls).

c) Expected future prices: If the price of a good is expected to fall (rise) in the future, current supply increases (decreases) and the supply curve shifts rightward (leftward).

d) The number of suppliers: The larger the number of suppliers of a good, the greater is the supply of the good. An increase (decrease) in the number of suppliers shifts the supply curve rightward (leftward).

e) Technology: Advances in technology create new products and lower the cost of producing existing products, so they increase supply and shift the supply curve rightward.

E. A Change in the Quantity Supplied Versus a Change in Supply

Figure 3.6 illustrates the distinction between a change in supply and a change in the quantity supplied.

1. When the price of the good changes and everything else remains the same, there is a movement along the supply curve and a change in the quantity supplied.

2. When one of the other factors that influence selling plans changes, there is a shift of the supply curve and a change in supply.

IV. Market Equilibrium

A. Equilibrium is a situation in which opposing forces balance each other. Equilibrium in a market occurs when the price balances the plans of buyers and sellers.

1. The equilibrium price is the price at which the quantity demanded equals the quantity supplied.

2. The equilibrium quantity is the quantity bought and sold at the equilibrium price.

B. Price as a Regulator

1. A market moves toward its equilibrium because the price regulates buying and selling plans and the price adjusts when plans don’t match.

2. Figure 3.7 illustrates the equilibrium price and equilibrium quantity in the market for CD-Rs.

C. Price Adjustments

1. At prices below the equilibrium price, a shortage arises, which forces the price up.

2. At prices above the equilibrium price, a surplus arises, which forces the price down.

3. At the equilibrium price, buying plans and selling plans agree, so the price doesn’t change.

4. The price coordinates the plans of buyers and sellers, and at the equilibrium price no one has an incentive to change it.

V. Predicting Changes in Price and Quantity

A. A change in demand or a change in supply changes the equilibrium price and the equilibrium quantity in a predictable way.

B. A Change in Demand

1. Figure 3.8 shows the effect of a change in demand.

2. An increase in demand raises the equilibrium price and increases the equilibrium quantity.

3. A decrease in demand lowers the equilibrium price and decreases the equilibrium quantity.

C. A Change in Supply

1. Figure 3.9 shows the effect of a change in supply.

2. An increase in supply lowers the equilibrium price and increases the equilibrium quantity.

3. A decrease in supply raises the equilibrium price and decreases the equilibrium quantity.

D. A Change in Both Demand and Supply

A change both demand and supply changes the equilibrium price and the equilibrium quantity but we need to know the relative magnitudes of the changes to predict some of the consequences.

1. Figure 3.10 shows the effects of an increase in both demand and supply. An increase (decrease) in both demand and supply increases (decreases) the equilibrium quantity but has an uncertain effect on the equilibrium price. If the increase (decrease) in demand exceeds the increase (decrease) in supply, the price rises (falls).

2. Figure 3.11 shows the effects of a decrease in demand and an increase in supply. An increase (decrease) in supply and a decrease (increase) in demand lowers (raises) the equilibrium price but has an uncertain effect on the equilibrium quantity. If the increase (decrease) in supply exceeds the decrease (increase) in demand, the quantity increases (decreases).

Reading Between the Lines

A news article discusses the high price of gasoline following the blackout in the Northeast in the summer of 2003.The analysis examines the impact of the blackout, which temporarily shut down refineries, a rupture in a gasoline pipeline, and high demand on the price of gasoline. A distinction between the money price and the relative price is considered.

New in the Seventh Edition

The lists of factors that change demand and supply are immediately followed by a description of the factors. Expected future income has been added as a factor of demand. The Reading Between the Lines is new and provides a straightforward example of using demand and supply to understand a change in the price of gasoline.

Teaching Suggestions

1. Markets and Prices

Before you jump into the demand-supply model, be sure that your students understand that a price in economics is relative price and that a relative price is an opportunity cost. Also spend some class time ensuring that they appreciate the key lessons of Chapter 2:

a) Prosperity comes from specialization and exchange.

b) Specialization and exchange requires the social institutions of property rights and markets.

c) We must understand how markets work.

You might like to explain that the most competitive markets are explicitly organized as auctions. An interesting market to describe is that at Aalsmeer in Holland, which handles a large percentage of the world’s fresh cut flowers. Roses grown in Columbia are flown to Amsterdam, auctioned at Aalsmeer, and are in vases in New York, London, and Tokyo all in less than a day. If you have an Internet connection in your classroom, you can participate in a simulation of an auction of flowers. Here is the URL (which you can also click on at the Parkin Web site)

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2. Demand

Estimating the demand for Coke (or bottled water) in the classroom.

Of the hundreds of classroom experiments that are available today, very few are worth the time they take to conduct. The classic demand-revealing experiment is one of the most productive and worthwhile ones.

Bring to class two bottles of ice-cold, ready-to-drink Coke, bottled water, or sports drink. (If your class is very large, bring six bottles).

Tell the students that you have these drinks and ask them to indicate if they would like one. Most hands will go up and you are now ready to make two points:

1. The students have just revealed a want but not a demand.

2. You don’t have enough bottles to satisfy their wants, so you need an allocation mechanism.

Ask the students to suggest some allocation mechanisms. You might get suggestions such as: give them to the oldest, the youngest, the tallest, the shortest, the first-to-the-front-of-the-class. For each one, point out the difficulty/inefficiency/inequity.

If no one suggests selling them to the highest bidder, tell the class that you are indeed going to do just that. Tell them that this auction is real. The winner will get the drink and will pay.

Now ask for a show of hands of those who have some cash and can afford to buy a drink. Explain that these indicate an ability to buy but not a definite plan to buy.

Now begin the auction. Appoint a student to count hands (more than one for a big class) and appoint another student to keep a spreadsheet (see the Parkin Website for a sample that you can download).

Begin at a low price: say 10¢ a bottle and count the number willing to buy.

Raise the price in 10¢ increments and keep tally of the number who are willing to buy at each price.

When the number willing to buy equals the number of bottles you have for sale, do the transactions. (If you make a profit, and you might do so, tell the students that the profit, small though it is, will go the department fund for undergraduate activities—and deliver on that promise.)

Now use the data to make a demand curve for Coke (or other drink) in your classroom today.

Emphasize the law of demand.

Emphasize that every demand curve relates to a market for the good (as defined by geography or some other spatial dimension) and for a given time period.

Now that you have a demand curve, you can do some thought experiments that will shift it. Ask:

How would this demand curve have been different if the temperature in the classroom was 10 degrees higher/lower?

How would this demand curve have been different if half the class was sick and absent today?

How would this demand curve have been different if there was a Coke machine right in the classroom?

(Save your demand data for later. We’ll make some suggestions for its further use in Chapter 4.)

3. Supply

Estimating the supply of Coke (or bottled water) in the classroom.

(It is best to do this next classroom activity on a different day from the demand experiment.)

Tell the students that you would like a Coke (or other drink) that is available from a machine somewhere near the classroom and you want someone to get it for you. You are going to continue teaching while the student is out of the room and you will be giving hints about what is on the next test.

Ask the students to raise their hand if they are willing to fetch one can of Coke if you pay $5.00. Write down the number.

Lower the price you’ve willing to pay in $1 increments until the number of students willing to fetch you the drink begins to decrease. Keep track of the numbers.

Lower the price you’re willing to pay in 25¢ increments until you get close to only having one student willing to fetch you the drink. Keep track of the numbers.

Lower the price in smaller increments if necessary until just one student is willing to fetch you a drink.

Now use the data to make a supply curve for Coke (or other drink) in your classroom today.

Emphasize the law of supply.

Emphasize that every supply curve relates to a market for the good (as defined by geography or some other spatial dimension) and for a given time period.

Now that you have a supply curve, you can do some thought experiments that will shift it. Ask:

How would this supply curve have been different if the coke machine was a mile away?

How would this supply curve have been different if half the class was sick and absent today?

How would this supply curve have been different if there was a Coke machine right in the classroom?

How would this supply curve have been different if the temperature in the classroom was 10 degrees higher/lower?

4. Market Equilibrium

The magic of market equilibrium and the forces that bring it about and keep the market there need to be demonstrated with the basic diagram, with intuition, and, if you’ve got the time, with hard evidence in the form of further class activity.

You might want to begin with the demand curve experiment and explain that in that market, the supply was fixed (vertical supply curve) at the quantity of bottles that you brought to class. The equilibrium occurred where the market demand curve (demand by the students) intersected your supply curve.

Then you might use the supply curve experiment and explain that in that market, demand was fixed (vertical demand curve) at the quantity that you had decided to buy. The equilibrium occurred where the market supply curve (supply by the students) intersected your demand curve.

Point out that the trades you made in your little economy made buyers and sellers better off.

If you want to devote a class to equilibrium and the gains from trade in a market, you might want to run a double oral auction. There are lots of descriptions of these and one of the best is at Marcelo Clerici-Arias’s Web site at Stanford University—

5. Predicting Changes in Price and Quantity

A. The whole chapter builds up to this section, which now brings all the elements of demand, supply, and equilibrium together to make predictions.

B. Students are remarkably ready to guess the consequences of some event that changes either demand or supply or both. They must be encouraged to work out the answer and draw the diagram.

C. Explain that the way to answer any question that seeks a prediction about the effects of some event(s) on a market has five steps. Walk them through the steps and have one or two students work some examples in front of the class. The five steps are:

1. Draw a demand-supply diagram and label the axes with the price and quantity of the good or service in question.

2. Think about the event(s) that you are told occur and decide whether they change demand, supply, both demand and supply, or neither demand nor supply.

3. Do the events that change demand or supply bring an increase or a decrease?

4. Draw the new demand curve and supply curve on the diagram. Be sure to shift the curve(s) in the correct direction—leftward for decrease and rightward for increase. (Lots of students want to move the curves upward for increase and downward for decrease—works ok for demand but exactly wrong for supply. Emphasize the left-right shift.)

5. Find the new equilibrium and compare it with the original one.

Walk them through the steps and have one or two students work some examples in front of the class.

D. It is critical at this stage to return to the distinction between a change in demand (supply) and a change in the quantity demanded (supplied). You can now use these distinctions to describe the effects of events that change market outcomes.

E. At this point, the students know enough for it to be worthwhile emphasizing the magic of the market’s ability to coordinate plans and reallocate resources.

The Big Picture

Where we have been

In Chapter 3, the students have had their first encounter with demand and supply and the powerful forces that determine price and quantity in a competitive market. The chapter builds on Chapter 2, which provides the simplest rigorous description of the economic problem and the implications of the pursuit of an efficient use of resources. If you have time, it is worth forging links between Chapters 2 and 3. Chapter 2 explains why we trade in markets. Chapter 3 shows how trade in markets determines where on the PPF the economy operates.

Where we are going

Demand and supply lie at the heart of the principles course. Eventually, we derive the demand curve and the supply curve from deeper views of the choices that people and firms make. But there is much to be gained from using the demand and supply analysis before embarking on its deeper derivation. In Chapter 4, the student next learns about the elasticity of demand and supply so that the qualitative predictions of the current chapter can become quantitative. Then, in Chapter 5, the student returns to the concept of efficiency encountered in Chapter 2 and learns whether and when the market outcome is efficient. Chapter 6 puts the demand and supply analysis to work to study price floors and ceilings, taxes, and illegal trading. Throughout the macroeconomic chapters, the demand and supply model will show up in the examination of markets such as the labor market, the capital market, and the money market.

Overhead Transparencies

|Transparency |Text figure |Transparency title |

|12 |Figure 3.1 |The Demand Curve |

|13 |Figure 3.3 |A Change in the Quantity Demanded Versus a Change in Demand |

|14 |Figure 3.4 |The Supply Curve |

|15 |Figure 3.6 |A Change in the Quantity Supplied Versus a Change in Supply |

|16 |Figure 3.7 |Equilibrium |

|17 |Figure 3.8 |The Effects of a Change in Demand |

|19 |Figure 3.9 |The Effects of a Change in Supply |

Electronic Supplements

MyEconLab

MyEconLab provides pre- and post-tests for each chapter so that students can assess their own progress. Results on these tests feed an individualized study plan that helps students focus their attention in the areas where they most need help.

Instructors can create and assign tests, quizzes, or graded homework assignments that incorporate graphing questions. Questions are automatically graded and results are tracked using an online grade book.

PowerPoint Lecture Notes

PowerPoint Electronic Lecture Notes with speaking notes are available and offer a full summary of the chapter.

PowerPoint Electronic Lecture Notes for students are available in MyEconLab.

Instructor CD-ROM with Computerized Test Banks

This CD-ROM contains Computerized Test Bank Files, Test Bank, and Instructor’s Manual files in Microsoft Word, and PowerPoint files. All test banks are available in Test Generator Software.

Additional Discussion Questions

1. “John Q: Could a legal market for human organ donations have saved his dying son?” An opinion piece written by Richard Epstein in The Wall Street Journal (2/21/02) about the donation of human organs for transplant operations. He raises the issue that if a market for human donor organs were legal, the dilemma of a lack of organs, as raised by Denzel Washington’s character in the movie “John Q,” might be closer to fiction rather than fact. You can use this movie and the motive of the main character as an intriguing basis for getting students to construct and interpret the demand and supply model.

“Can we illustrate a market for something as vital as organ donations?” Begin by asking the students to graph a demand and supply model for the market for human organ donations, making sure that their model reflects the real-life characteristics of this unique market: i) the federal government does not allow individuals or businesses to engage in the buying and selling of human organs, unless the organs are donated and received for free, ii) a small number of organs are donated by living volunteers (like kidney donations) or by the families of the recently deceased (especially after an otherwise healthy individual suffers an accidental death), meaning that the positively sloped supply curve for human organ donations intercepts the quantity axis at some positive value, iii) the demand curve for organs must intercept the supply curve at a positive price.

“Are there unintended consequences when market forces are ignored?” The government wants to assure that poor people have the same access to available organ transplants as rich people, so it imposes a zero-price restriction on the market. However, this creates a shortage of organs available for transplant, where the quantity of organs demanded at a zero price far exceeds the quantity supplied. If the market for organ donations were unregulated, then the equilibrium price for an organ would surely increase, but so would the total number of people receiving an organ transplant, and presumably, the total number of people who would survive to live another day.

“Should society institute a policy that maximizes the numbers of lives saved or manipulates the characteristics of those fewer lives that do get saved?” Conclude this discussion with a great set-up for the efficiency versus equity issues developed later in chapter five. Our command of the demand and supply model for human organ donations allows us to discover an important insight into one aspect of health care policy: the government places a lower priority for maximizing the total number of people saved regardless of income, and a higher priority on achieving a “proper” income mix among the smaller number of people that are saved by being one of the few receiving organ transplants.

2. “What are some goods that college students might buy today but will give up when they enter the workforce after graduation?” College students usually recognize that they will change their consumption patterns when they are employed after college graduation. Use this to get the students to appreciate inferior goods. When you were an undergraduate, you probably complained about having to eat mostly canned soup or beans as a cheap staple to fill your hungry stomach on a small budget. You swore that when you finally entered the workforce you wouldn’t eat soup or beans again, unless under extreme duress. Today the single food item most frequently cited by students as an inferior good is the Raman style noodles—those dry, thin, near flavorless oriental style noodles that are reconstituted with boiling water. Get the students to create a list other such inferior goods they will avoid when their incomes increase. This gets them to carefully consider how income changes can cause demand curves to shift in an unintuitive manner for an inferior good.

3. “Because computers are cheaper and more abundantly available now than a decade ago, doesn’t this mean the supply curve for computers is downward sloping?” This is a real world example for illustrating the confusion between changes in supply and changes in the quantity supplied. (It is easier to analyze this example if the students assume that consumer demand for computer software applications has not changed over the last decade.)

“Has anything in the world of computer manufacturing changed over the last decade?” Point out that the observation about falling computer prices with rising quantities sold assumes that nothing significant has changed in the computer industry. Emphasize how such statements reflect how the ceteris paribus condition of careful economic analysis has been violated. Over the years, advances in technology have allowed computer makers to: i) offer greater computer power and versatility for contemporary software applications at the same opportunity cost of resources (market price) as before, or ii) to provide the same level of computer power and versatility for contemporary software applications at lower opportunity costs (market prices) as before. Either way, this represents a rightward shift in the supply curve for computers. The students should recognize that the two prices and two quantities that give the appearance of more computers offered for less are actually from two separate supply curves.

4. “Since the average price of a car has increased substantially over the last 30 years, and the number of cars owned has risen faster than the population, doesn’t this mean that the demand curve for cars is upward sloping?” This is a real world example for illustrating the confusion between changes in demand and changes in the quantity demanded. (It is easier to analyze this example if the students assume that automobile production technology has not changed over these last three decades.)

“Has anything in the world of consumers changed over the last decade?” Point out that this real world observation of car prices and rising quantities sold over time assumes that nothing significant has changed in the consumers’ environment. Emphasize how statements such as these reflect how the ceteris paribus condition of careful economic analysis has been violated. Consumer incomes have increased significantly over the last three decades, allowing them to: i) consume greater personal transportation opportunities for more family members while giving up the same amount of other goods as before, or ii) consume the same level of personal transportation opportunities while giving up less of all other goods as before. Either way, this represents a rightward shift in the demand curve for automobiles. The students should recognize that the two prices and quantities that give the appearance of more automobiles demanded at higher prices are actually from two separate demand curves.

“If the status of the family automobile has increased in recent decades, what affect would this have on consumer demand?” There is evidence that the proportion of income that typical families spend on automobiles (versus all other goods) has increased substantially over the last 30 years. This means that the percent increase in automobile purchases has been higher than the percent increase in family incomes. This makes for a great lead into the measures of the income elasticity of demand discussed in Chapter 4.

Answers to the Review Quizzes

Page 58

1. The money price of a good is the dollar amount that must be paid for it. The relative price of a good is its money price expressed as a ratio to the money price of another good. Thus the relative price is the amount of the other good that must be foregone to purchase a unit of the first good.

2. The relative price of a good is the opportunity cost of buying that good because it shows how much of the next best alternative good must be forgone in order to buy a unit of the first good.

3. There are many potential examples that students may give. Some examples of items where both the money price and the relative price have risen over time are college tuition; automobiles; movie theater tickets.

4. As in the previous question, many examples may be given. Some examples of items where both the money price and the relative price have fallen over time are personal computers; televisions; calculators.

Page 63

1. The quantity demanded of a good or service is the amount that consumers plan to buy during a particular time period, and at a particular price.

2. The law of demand states: “Other things remaining the same, the higher the price of a good, the smaller is the quantity demanded.” The law of demand is illustrated by a downward-sloping demand curve drawn with the quantity demanded on the horizontal axis and the price on the vertical axis. The slope is negative to show that the higher the price of a good, the lower is the quantity demanded.

3. For any fixed quantity of a good available, the height of the demand curve shows the maximum price that consumers are willing to pay for that quantity of the good. The price on the demand curve at this quantity indicates the marginal benefit to consumers of the last unit consumed at that quantity.

4. Influences that change the demand for a product include:

• The prices of related goods. A rise (fall) in the price of a substitute good shifts the demand curve for the first good rightward (left). A rise (fall) in the price of a complement good shifts the demand curve for the first good leftward (right).

• The expected future price of the product. A rise (fall) in the expected future price of a good shifts the demand curve in the current period rightward (left).

• Consumer income. For a normal good, an increase (decrease) in income shifts the demand curve rightward (left). For an inferior good, an increase in income shifts the demand curve leftward (right).

• Expected future income. For a normal good, an increase (decrease) in expected future income shifts the demand curve rightward (left). For an inferior good, an increase in expected future income shifts the demand curve leftward (right).

• The population. An increase (decrease) in population in the market shifts the demand curve rightward (left).

• People’s preferences. If people’s preferences for a good rise (fall), this shifts the demand curve rightward (left).

5. If the price of Palm Pilots falls and nothing else changes, then the quantity of Palm Pilots demanded will rise, but the demand for Palm Pilots will remain unchanged.

Page 67

1. The quantity supplied of a good or service is the amount of the good or service that firms plan to sell in a particular period of time at a specified price.

2. The law of supply holds that “other things remaining the same, the higher the price of a good, the greater is the quantity supplied.” The law of supply is illustrated by an upward-sloping supply curve drawn with the quantity supplied on the horizontal axis and the price on the vertical axis. The slope is positive to show that the higher the price of a good, the greater is the quantity supplied.

3. For any quantity, the height of the supply curve shows the minimum price that suppliers must receive to produce that quantity of output. As a result, the price is the marginal cost of the last unit produced at this level of output.

4. Influences that change the supply of a product include:

• Prices of productive resources. A rise (fall) in the price of a productive resource increases firms’ costs of production and causes the supply curve for the product to shift leftward (right).

• Prices of other related goods produced. If the sale price of a substitute in production rises (falls), firms decrease their sales of the original good and the supply curve for the original good shifts leftward (right). A rise (fall) in the price of a complement in production increases (decreases) production of the original good, causing the supply curve of the original good to shift rightward (left).

• The expected future price of the product. A rise (fall) in the expected future price of the product causes suppliers to reduce (increase) the amount they sell today. This change in expectations shifts the supply curve in the current period leftward (right).

• Technology. An advance in technology shifts the supply curve rightward.

• The number of sellers. An increase (decrease) in the number of sellers in a market increases the quantity of the good available at every price, and shifts the supply curve rightward (left).

5. If the price of Palm Pilots falls and nothing else changes, then the quantity of Palm Pilots supplied will rise, but the supply for Palm Pilots will remain unchanged.

Page 69

1. Equilibrium price is the price for which the quantity demanded by the buyers is equal to the quantity supplied by the sellers.

2. A shortage arises at market prices below the equilibrium price.

3. A surplus arises at market prices above the equilibrium price.

4. A shortage causes prices to rise, decreasing quantity demanded and increasing quantity supplied until the equilibrium price is attained.

5. A surplus causes prices to fall, decreasing quantity supplied and increasing quantity demanded until the equilibrium price is attained.

6. At the equilibrium price, the quantity demanded by consumers equals the quantity supplied by producers. At this price, the plans of producers and consumers are coordinated and there is no influence on the price to move away from equilibrium.

7. The equilibrium price reflects that the highest price consumers are willing to pay for that level of goods or services is just equal to the minimum price that suppliers would require for delivering it. If less (more) quantity were supplied, then the price that consumers would be willing to pay at this lower level of goods or services supplied would be higher (lower) than the minimum price that suppliers would require to supply it. This means that suppliers would gain profits from raising (lowering) their price at the lower level of supply or by increasing (decreasing) their level supplied. Either way, the supply curve will shift rightward (left) and the market price will rise (fall) to the equilibrium price.

Page 73

(a) A fall in the price of a PC increases the demand for CD-Rs because a PC is a complement of a CD-R. The demand curve for CD-Rs shifts rightward. Supply remains unchanged. The price of a CD-R rises and the quantity of CD-Rs increases. You can illustrate this outcome by drawing a diagram like Figure 3.8 page 70.

(b) A rise in the price of an MP3 download decreases the demand for CD-Rs because an MP3 download is a complement of a CD-R. The demand curve for CD-Rs shifts leftward. Supply remains unchanged. The price of a CD-R falls and the quantity of CD-Rs decreases. You can illustrate this outcome by drawing a diagram like Figure 3.8 page 70 but with the arrows pointing in the opposite directions.

(c) An increase in the number of firms that produce CD-Rs increases the supply of CD-Rs. The supply curve of CD-Rs shifts rightward. Demand remains unchanged. The price of a CD-R falls and the quantity of CD-Rs increases. You can illustrate this outcome by drawing a diagram like Figure 3.9 page 71.

(d) A rise in the wages of CD-R producers decreases the supply of CD-Rs because it increases the cost of producing CD-Rs. The supply curve of CD-Rs shifts leftward. Demand remains unchanged. The price of a CD-R rises and the quantity of CD-Rs decreases. You can illustrate this outcome by drawing a diagram like Figure 3.9 page 71 but with the arrows pointing in the opposite directions.

(e) There are six combinations:

(1) If (a) and (b) occur together, demand might increase or decrease, supply is unchanged, so the outcome cannot be predicted. You can illustrate this outcome by drawing a diagram like Figure 3.8 page 70 but with the demand curve possibly shifting in either direction.

(2) If (a) and (c) occur together, demand increases and supply increases so the quantity increases and the price might rise or fall. You can illustrate this outcome by drawing a diagram like Figure 3.10 page 72.

(3) If (a) and (d) occur together, demand increases and supply decreases so the price rises and quantity might increase or decrease. You can illustrate this outcome by drawing a diagram like Figure 3.11 page 73 but with the arrows pointing in the opposite directions.

(4) If (b) and (c) occur together, demand decreases and supply increases so the price falls and quantity might increase or decrease. You can illustrate this outcome by drawing a diagram like Figure 3.11 page 73.

(5) If (b) and (d) occur together, demand decreases and supply decreases so the quantity decreases and the price might rise or fall. You can illustrate this outcome by drawing a diagram like Figure 3.10 page 72 but with the arrows pointing in the opposite directions.

(6) If (c) and (d) occur together, supply might increase or decrease, demand is unchanged, so the outcome cannot be predicted. You can illustrate this outcome by drawing a diagram like Figure 3.9 page 71 but with the supply curve possibly shifting in either direction.

Answers to the Problems

1. a. The price of an audiotape will rise, and the quantity of audiotapes sold will increase.

CDs and audiotapes are substitutes. If the price of a CD rises, people will buy more audiotapes and fewer CDs. The demand for audiotapes will increase. The price of an audiotape will rise, and more audiotapes will be sold..

b. The price of an audiotape will fall, and fewer audiotapes will be sold.

Walkmans and audiotapes are complements. If the price of a Walkman rises, fewer Walkmans will be bought. The demand for audiotapes will decrease. The price of an audiotape will fall, and people will buy fewer audiotapes.

c. The price of an audiotape will fall and fewer audiotapes will be sold.

The increase in the supply of CD players will lower the price of a CD player. With CD players cheaper than they were, some people will buy CD players. The demand for CDs will increase, and the demand for audiotapes will decrease. The price of an audiotape will fall, and people will buy fewer audiotapes.

d. The price of an audiotape will rise, and the quantity sold will increase.

An increase in consumers’ income will increase the demand for audiotapes. As a result, the price of an audiotape will rise and the quantity bought will increase.

e. The price of an audiotape will rise, and the quantity sold will decrease.

If the workers who make audiotapes get a pay raise, the cost of making an audiotape increases and the supply of audiotapes decreases. The price will rise, and people will buy fewer audiotapes.

f. The quantity sold will decrease, but the price might rise, fall, or stay the same.

Walkmans and audiotapes are complements. If the price of a Walkman rises, fewer Walkmans will be bought and so the demand for audiotapes will decrease. The price of an audiotape will fall, and people will buy fewer audiotapes. If the wages paid to workers who make audiotapes rise, the supply of audiotapes decreases. The quantity of audiotapes sold will decrease, and the price of an audiotape will rise. Taking the two events together, the quantity sold will decrease, but the price might rise, fall, or stay the same.

2. a. The price of a DVD player falls, and fewer DVD players will be sold.

A DVD is a complement of a DVD player. If the price of a DVD rises, fewer people will want to own a DVD player, so the demand for DVD players will decrease. With all other influences on the demand and supply of DVD players remaining the same, the price of a DVD player will fall. The quantity of DVD players bought will decrease.

b. The price of a DVD player rises, and more DVD players will be sold.

A DVD is a complement of a DVD player. If the price of a DVD falls, more people will want to own a DVD player, so the demand for DVD players will increase. With all other influences on the demand and supply of DVD players remaining the same, the price of a DVD player will rise. The quantity of DVD players bought will increase.

c. The price of a DVD player will fall, and the quantity of DVD players sold will increase.

If the supply of DVD players increases, the price of a DVD player will fall and the quantity bought will increase.

d. The price of a DVD player will fall, and fewer DVD players will be sold.

The decrease in consumers’ incomes will decrease the demand for DVD players. Other things remaining the same, the price of a DVD player will fall and fewer DVD players will bought.

e. The price of a DVD player will rise, and the quantity sold will decrease.

If the wage of workers who produce DVD players increases, the cost of producing a DVD player increases and the supply of DVD players decreases. Other things remaining the same, the price will rise, and people will buy fewer DVD players.

f. The price of a DVD player will rise, but the quantity might increase, decrease, or remain the same.

A rise in the wage rate of the workers who make DVD players will decrease the supply of DVD players. The fall in the price of a DVD will increase the demand for DVD players. Taking the two events together, the decrease in supply and the increase in demand will lead to a rise in the price of a DVD player. The quantity bought might increase, decrease, or remain the same.

3. a. (ii) and (iii) and (iv)

The demand for gasoline will change if the price of a car changes, all speed limits on highways are abolished, or robot production cuts the cost of producing a car. If the price of a car rises, the quantity of cars bought decrease. So the demand for gasoline decreases. If all speed limits on highways are abolished, people will drive faster and use more gasoline. The demand for gasoline increases. If robot production plants lower the cost of producing a car, the supply of cars will increase. With no change in the demand for cars, the price of a car will fall and more cars will be bought. The demand for gasoline increases.

b. (i)

The supply of gasoline will change if the price of crude oil changes. If the price of crude oil rises, the cost of producing gasoline will rise. So the supply of gasoline decreases.

c. (i)

If the price of crude oil (a resource used to make gasoline) rises, the cost of producing gasoline will rise. So the supply of gasoline decreases. The demand for gasoline does not change, so the price of gasoline will rise and there is a movement up the demand curve for gasoline. The quantity demanded of gasoline decreases.

d. (ii) and (iii) and (iv)

If the price of a car rises, the quantity of cars bought decrease. So the demand for gasoline decreases. The supply of gasoline does not change, so the price of gasoline falls and there is a movement down the supply curve of gasoline. The quantity supplied of gasoline decreases.

If all speed limits on highways are abolished, people will drive faster and use more gasoline. The demand for gasoline increases. The supply of gasoline does not change, so the price of gasoline rises and there is a movement up along the supply curve. The quantity supplied of gasoline increases.

If robot production plants lower the cost of producing a car, the supply of cars will increase. With no change in the demand for cars, the price of a car will fall and more cars will be bought. The demand for gasoline increases. The supply of gasoline does not change, so the price of gasoline rises and the quantity of gasoline supplied increases.

4. a. (i)

The demand for leather bags will increase when airfares halve. More people will plan on buying an air ticket and will also plan on buying a travel bag. Then demand for leather bags will increase.

b. (ii), (iii), and (iv)

The supply of leather will decrease when the price of beef falls. Cowhide (from which leather is made) is a complement in production of beef. If the price of beef falls, fewer cows will be slaughtered and less cowhide will be produced. The supply of leather decreases. The price of leather will rise and the supply of leather bags will decrease.

The producers of leather bags will switch to using the cheaper cloth. The supply of leather bags will decrease.

A new technology for cutting leather will lower the cost of making a leather bag and the increase the supply of leather bags.

c. (ii), (iii), and (iv)

When the supply of leather bags changes, there is a shift of the supply curve and a movement along the demand curve. The quantity demanded of leather bags will increase if the supply of leather bags increases and the quantity demanded of leather bags will decrease if the supply of leather bags decreases. So a fall in the price of beef and a new cheaper cloth for making bags will lead to a decrease in the quantity demanded of leather bags. A new technology increases the supply of leather bags and increases the quantity demanded of leather bags.

d. (i)

When the demand for leather bags changes, there is a shift of the demand curve and a movement along the supply curve. The quantity supplied of leather bags will increase if airfares halve.

5. a. The demand curve is the curve that slopes down toward to the right. The supply curve is the curve that slopes up toward to the right.

b. The equilibrium price is $14 a pizza, and the equilibrium quantity is 200 pizzas a day.

Market equilibrium is determined at the intersection of the demand curve and supply curve.

6. a. The demand curve is the curve that slopes downward to the right. The supply curve is the curve that slopes upward toward to the right.

b. The equilibrium price is $3 a fish, and the equilibrium quantity is 100 fish a day.

Market equilibrium is determined at the intersection of the demand curve and supply curve.

7. a. The equilibrium price is 50 cents a pack, and the equilibrium quantity is 120 million packs a week.

The price of a pack adjusts until the quantity demanded equals the quantity supplied. At 50 cents a pack, the quantity demanded is 120 million packs a week and the quantity supplied is 120 million packs a week.

b. At 70 cents a pack, there will be a surplus of gum and the price will fall.

At 70 cents a pack, the quantity demanded is 80 million packs a week and the quantity supplied is 160 million packs a week. There is a surplus of 80 million packs a week. The price will fall until market equilibrium is restored—50 cents a pack.

8. a. The equilibrium price is 65 cents a bag, and the equilibrium quantity is 145 million bags a week.

The price of a bag adjusts until the quantity demanded equals the quantity supplied. At 65 cents a bag, the quantity demanded is 145 million bags a week and the quantity supplied is 145 million bags a week.

b. At 60 cents a bag, there will be a shortage of potato chips and the price will rise.

At 60 cents a bag, the quantity demanded is 150 million bags a week and the quantity supplied is 140 million bags a week. There is a shortage of 10 million bags a week. The price will rise until market equilibrium is restored—65 cents a bag.

9. a. The supply curve has shifted leftward.

As the number of gum-producing factories decreases, the supply of gum decreases. There is a new supply schedule, and the supply curve shifts leftward.

b. There has been a movement along the demand curve.

The supply of gum decreases, and the supply curve shifts leftward. Demand does not change, so the price rises along the demand curve.

9. c. The equilibrium price is 60 cents, and the equilibrium quantity is 100 million packs a week.

Supply decreases by 40 millions packs a week. That is, the quantity supplied at each price decreases by 40 million packs. The quantity supplied at 50 cents is now 80 million packs, and there is a shortage of gum. The price rises to 60 cents a pack, at which the quantity supplied equals the quantity demanded (100 million packs a week).

10. a. There has been a movement along the supply curve.

The demand for potato chips increases, and the demand curve shifts rightward. Supply does not change, so the price rises along the supply curve.

b. The demand curve has shifted rightward.

As the new dip comes onto the market, the demand for potato chips increases. There is a new demand schedule, and the demand curve shifts rightward.

c. The equilibrium price is 80 cents, and the equilibrium quantity is 160 million bags a week.

Demand increases by 30 millions bags a week. That is, the quantity demanded at each price increases by 30 million bags. The quantity demanded at 65 cents is now 17potatoe chips. The price rises to 80 cents a bag, at which the quantity supplied equals the quantity demanded (160 million bags a week).

11. The new price is 70 cents a pack, and the quantity is 120 million packs a week.

The demand for gum increases, and the demand curve shifts rightward. The quantity demanded at each price increases by 40 million packs. The result of the fire is a price of 60 cents a pack. At this price, there is now a shortage of gum. The price of gum will rise until the shortage is eliminated.

12. The new price is 100 cents a bag, and the quantity is 140 million bags a week.

The supply of potato chips decreases, and the supply curve shifts leftward. The quantity supplied at each price decreases by 40 million bags. The result of the new dip entering the market is a price of 80 cents a bag. At this price, there is now a shortage of potato chips. The price of potato chips will rise until the shortage is eliminated.

Additional Problems

1. What is the effect on the price of hotdogs and the quantity of hotdogs sold if

a. The price of a hamburger rises?

b. The price of a hotdog bun rises?

c. The supply of hotdog sausages increases?

d. Consumers’ incomes increase?

e. The wage rate of a hotdog seller increases?

f. If the wage rate of the hotdog seller rises and at the same time prices of ketchup, mustard, and relish fall?

2. Suppose that one of the following events occurs:

(i) The price of wool rises.

(ii) The price of sweaters falls.

(iii) A close substitute for wool is invented.

(iv) A new high-speed loom is invented.

Which of the above events increases or decreases (state which,

a. The demand for wool?

b. The supply of wool?

c. The quantity of wool demanded?

d. The quantity of wool supplied?

3. The figure illustrates the market for bread.

a. Label the curves in the figure.

b. What are the equilibrium price of bread and the equilibrium quantity of bread?

[pic]

4. The demand and supply schedules for potato chips are

Price Quantity Quantity

(cents demanded supplied

per bag) (millions of bags per week)

40 170 90

50 160 100

60 150 110

70 140 120

80 130 130

90 120 140

100 110 150

110 100 160

a. What are the equilibrium price and equilibrium quantity of potato chips?

b. If chips were 60 cents a bag, describe the situation in the market for potato chips and explain what would happen to the price of a bag of chips.

5. In problem 4, suppose a new snack food comes onto the market and as a result the demand for potato chips decreases by 40 million bags per week.

a. Has there been a shift in or a movement along the supply curve of chips?

b. Has there been a shift in or a movement along the demand curve for chips?

c. What is the new equilibrium price and quantity of chips?

6. In problem 5, suppose that a flood destroys several potato farms and as a result supply decreases by 20 million bags a week at the same time as the new snack food comes onto the market. What is the new equilibrium price and quantity of chips?

Solutions to Additional Problems

1. a. The price of a hot dog rises, and the quantity of hot dogs sold increases.

Hot dogs and hamburgers are substitutes. If the price of a hamburger rises, people buy more hot dogs and fewer hamburgers. The demand for hot dogs increases. The price of a hot dog rises, and more hot dogs are sold.

b. The price of a hot dog falls, and fewer hot dogs are sold.

Hot dog buns and hot dogs are complements. If the price of a hot dog bun rises, fewer hot dog buns are bought. The demand for hot dogs decreases. The price of a hot dog falls, and people buy fewer hot dogs.

c. The price of a hot dog falls and more hot dogs are sold.

The increase in the supply of hot dog sausages lowers the price of hot dog sausages. Hot dog sausages are a resource used in the production of hot dogs. With the lower priced resource, the supply of hot dogs increases. The price of a hot dog falls and people buy more hot dogs.

d. The price of a hot dog rises, and the quantity sold increases.

An increase in consumers' income increases the demand for hot dogs. As a result, the price of a hot dog rises and the quantity bought increases.

e. The price of a hot dog rises, and the quantity sold decreases.

If the wage of the hot dog seller increases, the cost of producing a hot dog increases and the supply of hot dogs decreases. The price rises, and people buy fewer hotdogs.

f. The price of a hot dog rises, but the quantity might increase, decrease, or remain the same.

Ketchup, mustard, and relish are complements of hot dogs. If the price of a ketchup, mustard, and relish fall, more ketchup, mustard, and relish are bought and the demand for hot dogs increases. The price of a hot dog rises, and people buy more hot dogs. If the wage of the hot dog seller increases, the cost of producing a hot dog increases and the supply of hot dogs decreases. The price rises, and people buy fewer hotdogs. Taking the two events together, the price of a hot dog rises, but the quantity might increase, decrease, or remain the same.

2. a. (ii) and (iii)

Wool is used in the production of sweaters. If the price of a sweater falls because the supply of sweaters has increased, then the equilibrium quantity of sweaters increases and the demand for wool increases. If the price of a sweater falls because the demand for sweaters has decreased, then the equilibrium quantity of sweaters decreases and the demand for wool decreases.

If a close substitute for wool is invented, some sweater producers will switch from wool to the substitute. When they do, the demand for wool decreases.

b. (iv)

If a new high-speed loom is invented, the cost of making wool will fall and the supply of wool will increase.

c. (i) and (iv)

If the price of wool rises there is a movement up along the demand curve. The quantity demanded of wool decreases.

If a new high-speed loom is invented, the cost of producing wool will fall. So the supply of wool increases. With no change in the demand for wool, the price of wool will fall and there is a movement down along the demand curve for wool. The quantity demanded of wool increases.

d. (i), (ii), and (iii)

If the price of wool rises there is a movement up along the supply curve. The quantity supplied of wool increases.

If the price of a sweater falls because the supply of sweaters has increased, then the equilibrium quantity of sweaters increases and the demand for wool increases. With no change in the supply of wool, the price of wool rises and the quantity of wool supplied increases. If the price of a sweater falls because the demand for sweaters has increased, then the equilibrium quantity of sweaters decreases and the demand for wool decreases. With no change in the supply of wool, the price of wool falls and the quantity of wool supplied decreases.

If some sweater producers switch to using the new close substitute for wool, the demand for wool will decrease. With no change in the supply of wool, the price of wool falls and the quantity of wool supplied decreases.

3. a. The demand curve is the curve that slopes down toward to the right. The supply curve is the curve that slopes up toward to the right.

b. The equilibrium price is $3 a loaf, and the equilibrium quantity is 100 loaves a day.

Market equilibrium is determined at the intersection of the demand curve and supply curve.

4. a. The equilibrium price is 80 cents a bag, and the equilibrium quantity is 130 million bags a week.

The price of a bag adjusts until the quantity demanded equals the quantity supplied. At 80 cents a bag, the quantity demanded is 130 million bags a week and the quantity supplied is 130 million bags a week.

b. At 60 cents a bag, there will be a shortage of potato chips and the price will rise.

At 60 cents a bag, the quantity demanded is 150 million bags a week and the quantity supplied is 110 million bags a week. There is a shortage of 40 million bags a week. The price will rise until market equilibrium is restored—80 cents a bag.

5. a. There has been a movement along the supply curve.

The demand for potato chips decreases, and the demand curve shifts leftward. Supply does not change, so the price falls along the supply curve.

b. The demand curve has shifted leftward.

As the new snack food comes onto the market, the demand for potato chips decreases. There is a new demand schedule, and the demand curve shifts leftward.

c. The equilibrium price is 60 cents, and the equilibrium quantity is 110 million bags a week.

Demand decreases by 40 millions bags a week. That is, the quantity demanded at each price decreases by 40 million bags. The quantity demanded at 80 cents is now 90 million bags, and there is a surplus of potato chips. The price falls to 60 cents a bag, at which the quantity supplied equals the quantity demanded (110 million bags a week).

6. The new price is 70 cents a bag, and the quantity is 100 million bags a week.

The supply of potato chips decreases, and the supply curve shifts leftward. The quantity supplied at each price decreases by 20 million bags. The result of the new snack food entering the market is a price of 60 cents a bag. At this price, there is now a shortage of potato chips. The price of potato chips will rise until the shortage is eliminated.

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