Economy assignment

ECON251 Spring 2022

Finance Department

Chapter 3

Demand and Supply

Discuss the variables that influence demand.

• Discuss the variables that influence supply

• Use a graph to illustrate market equilibrium.

The Interaction of Demand and Supply

•Demand schedule A table showing the relationship between the price of a product and the quantity of the product demanded.

•Quantity demanded The amount of a good or service that a consumer is willing and able to purchase at a given price.

•Demand curve A curve that shows the relationship between the price of a product and the quantity of the product demanded.

•Market demand The demand by all the consumers of a given good or service.

The Demand Side of the Market Demand Schedules and Demand Curves

FIGURE 3-1

A Demand Schedule and Demand

Curve

The Demand Side of the Market Demand Schedules and Demand Curves

As the price changes, consumers change the

quantity of energy drinks they are willing to buy.

We can show this as a demand schedule in a

table or as a demand curve on a graph.

The table and graph both show that as the price

of energy drinks falls, the quantity demanded

rises.

When the price of energy drinks is $3.00,

consumers buy 60 million cans per day. When

the price drops to $2.50, consumers buy 70

million cans.

Therefore, the demand curve for energy drinks

is downward sloping.

The Demand Side of the Market

•Law of demand The rule that, holding everything else constant, when the price of a product falls, the quantity demanded of the product will increase, and when the price of a product rises, the quantity demanded of the product will decrease.

The Law of Demand

The Most Important Factor on the Demand Side PRICE

We are discussing Price of the book (price of one particular good) here.

First, at P=10 kd, Quantity Demanded is 55 books.

1)When P decreases to 7kd Q Demanded increases to 75 books and D curve moves down from point A to point C

2) Now, if P increases from 10kd to 12kd, Q Demanded decreases to 40 books and D curve moves up from point A to point B

Important Note: When the price of one particular good is changed, as a result Q Demanded is changed and D curve moves along itself (up, if P increases and down, if P decreases)

A

C

B

Cases of 5 Demand Factors Factor 1. Income (change in income results in changes on demand of Normal goods and Inferior goods)

Case: If income increases:

Normal Goods (high quality, expensive) Inferior Goods (low quality, cheap)

Demand for Mais AlGhanim Demand for McDonalds

Factor 2. Price of Related Goods (Substitutes: Tea and Coffee, sugar and honey); Complements: Ink and Printer). (Change in Price of one related good results in the change of Demand on another good)

Case on Substitutes: Price of Tea increased Case on Complementary goods: Price of Ink increased

Demand on Tea Demand on Coffee Demand on Ink Demand on Printers

Cases of 5 Demand Factors Factor 3. Population and Demographics (change in the number of population or demographics (% composition of population) result in changes in demand of Normal goods and Inferior goods)

Case: If population increases: Case: If % of children under 5 years increases:

Demand for all goods Demand for Toys

Factor 4. Future Price Expectations (If buyers expect high price in the future, they buy more now; If they expect low prices in the future, they buy less now)

Case: Price of Gold will increase in two months Case: Price of Rice will decrease next month

Demand on Gold Demand on Rice

Cases of 5 Demand Factors Factor 5. Taste (people follow trends and style)

Case: If Business education is considered prestigious and beneficial for the future:

Demand for Business Education

Important Notes: Under all those 5 Demand factors

1. Entire Demand is changed.

2. Demand Curve shifts to the Right (if Demand increases), or to the Left (if Demand decreases)

The Demand Side of the Market

•Substitution effect The change in the quantity demanded of a good that results from a change in price, making the good more or less expensive relative to other goods that are substitutes.

•Income effect The change in the quantity demanded of a good that results from the effect of a change in the good’s price on consumers’ purchasing power.

What Explains the Law of Demand?

The Demand Side of the Market

•Ceteris paribus (“all else equal”) condition The requirement that when analyzing the relationship between two variables—such as price and quantity demanded—other variables must be held constant.

•A shift of a demand curve is an increase or a decrease in demand. A movement along a demand curve is an increase or a decrease in the quantity demanded.

Holding Everything Else Constant:

The Ceteris Paribus Condition

FIGURE 3-2

Shifting the

Demand Curve

Holding Everything Else Constant:

The Ceteris Paribus Condition

The Demand Side of the Market

When consumers increase the quantity of

a product they want to buy at a given

price, the market demand curve shifts to

the right, from D1 to D2.

When consumers decrease the quantity of

a product they want to buy at any given

price, the demand curve shifts to the left,

from D1 to D3.

The Demand Side of the Market

•Normal good A good for which the demand increases as income rises and decreases as income falls.

•Inferior good A good for which the demand increases as income falls and decreases as income rises.

Variables That Shift Market Demand

• Income

Many variables other than price can influence market demand.

The Demand Side of the Market

•Substitutes Goods and services that can be used for the same purpose.

• Complements Goods and services that are used together.

Variables That Shift Market Demand

• Prices of related goods

Consumers can be influenced by an advertising campaign for a product.

• Tastes

The Demand Side of the Market

•Demographics The characteristics of a population with respect to age, race, and gender.

• Population and demographics

• Expected future prices

Consumers choose not only which products to buy but also when to buy them.

Variables That Shift Market Demand

The Demand Side of the Market Variables That Shift Market Demand

TABLE 3-1

Variables That Shift Market Demand Curves

The Demand Side of the Market Variables That Shift Market Demand

TABLE 3-1

Variables That Shift Market Demand Curves

The Demand Side of the Market Variables That Shift Market Demand

TABLE 3-1

Variables That Shift Market Demand Curves

The Demand Side of the Market Variables That Shift Market Demand

TABLE 3-1

Variables That Shift Market Demand Curves

FIGURE 3-3

A Change in Demand versus a Change in

Quantity Demanded

If the price of digital music players falls from $3.00 to

$2.50, the result will be a movement along the demand

curve from point A to point B—an increase in quantity

demanded from 60 million cans to 70 million cans.

If consumers’ incomes increase, or if another factor

changes that makes consumers want more of the

product at every price, the demand curve will shift to the

right—an increase in demand. In this case, the increase

in demand from D1 to D2 causes the quantity of energy

drinks demanded at a price of $3.00 to increase from 60

million cans at point A to 80 million cans at point C.

A Change in Demand versus a Change in Quantity Demanded

The Demand Side of the Market

•Red Bull and the Future Demand for Energy Drinks

Making the

Connection

Will Red Bull continue to grow its

share of the energy drink market?

It is important for managers to accurately

forecast the demand for their products because

it helps them determine how much of a good to

produce.

YOUR TURN: Test your understanding by doing related problem 1.11 at the end of this chapter.

Discuss the variables that influence demand.

3.1 LEARNING OBJECTIVE

•Supply schedule A table that shows the relationship between the price of a product and the quantity of the product supplied.

•Supply curve A curve that shows the relationship between the price of a product and the quantity of the product supplied.

The Supply Side of the Market

Supply Schedules and Supply Curves

Quantity supplied The amount of a good or service that a firm is willing and able to supply at a given price.

The Supply Side of the Market Supply Schedules and Supply Curves

FIGURE 3-4

A Supply Schedule and Supply Curve

As the price changes, Red Bull, Monster Energy, Rockstar,

and the other firms producing energy drinks change the

quantity they are willing to supply. We can show this as a

supply schedule in a table or as a supply curve on a graph.

The supply schedule and supply curve both show that as the

price of energy drinks rises, firms will increase the quantity

they supply.

At a price of $2.50 per can, firms will supply 90 million cans.

At a price of $3.00, firms will supply 100 million cans.

The Supply Side of the Market

•Law of supply The rule that, holding everything else constant, increases in price cause increases in the quantity supplied, and decreases in price cause decreases in the quantity supplied.

The Law of Supply

The Supply Side of the Market

FIGURE 3-5

Shifting the Supply Curve

The Law of Supply

When firms increase the quantity of a product

they want to sell at a given price, the supply

curve shifts to the right.

The shift from S1 to S3 represents an

increase in supply.

When firms decrease the quantity of a

product they want to sell at a given price, the

supply curve shifts to the left.

The shift from S1 to S2 represents a decrease

in supply.

The Supply Side of the Market Variables That Shift Market Supply

• Prices of substitutes in production • Number of firms in the market • Expected future prices

Technological change A positive or negative change in the ability of a firm to produce a given level of output with a given quantity of inputs.

The following are the most important variables that shift market supply:

• Prices of inputs

• Technological change

The Most Important Factor on the Supply Side PRICE

We are discussing Price of the book (price of one particular good) here.

First, at P=16 kd, Quantity Supplied is 55 books (point A).

1)When P increases to 22kd Q Supplied increases to 75 books and S curve moves up from point A to point B

2) Now, if P decreases from 16kd to 12kd, Q Supplied decreases to 40 books and S curve moves down from point A to point C

Important Note: When the price of one particular good is changed, as a result Q Supplied is changed and S curve moves along itself (up, if P increases and down, if P decreases)

Cases of 5 Supply Factors Factor 1. Prices of Inputs/Resources (change in price of resources that firm is using) Factor 2. Number of Firms (If more firms start operating on the market,

they produce and supply more)

Case: Price of steel (metal) increases: Case: Price of Computer chips decreases: Case: 2 more vegetable farms started operating in Kuwait

Supply of Cars Supply of Computers Supply of Vegetables

Factor 3. Technological Change (New machinery; Inventions) Factor 4. Price of substitutes (iPhone and iPads)

Case: BMW implemented new robots Case: Apple company found that iPhones are sold at a higher price than iPads

Supply of BMW cars Supply of iPhones Supply of iPads

Cases of 5 Supply Factors Factor 5. Future Price Expectations (If sellers expect high price in the future, they supply less now; If they expect low prices in the future, they sell more now)

Case: Price of Gold will increase in two months Case: Price of Rice will decrease next month

Supply of Gold Supply of Rice

Important Notes: Under all those 5 Supply factors: 1. Entire Supply is changed. 2. Supply Curve shifts to the Right (if Supply increases), or to the Left (if Supply decreases)

The Supply Side of the Market Variables That Shift Market Supply

TABLE 3-2

Variables That Shift Market Supply Curves

The Supply Side of the Market Variables That Shift Market Supply

TABLE 3-2

Variables That Shift Market Supply Curves (continued)

The Supply Side of the Market Variables That Shift Market Supply

TABLE 3-2

Variables That Shift Market Supply Curves (continued)

The Supply Side of the Market

FIGURE 3-6

A Change in Supply versus a Change in

Quantity Supplied

A Change in Supply versus a Change in Quantity Supplied

If the price of energy drinks rises from $2.00 to $2.50 per

can, the result will be a movement up the supply curve

from point A to point B—an increase in quantity supplied

by Red Bull, Monster Energy, Rockstar, and the other

firms from 80 million to 90 million cans.

If the price of an input decreases or another factor

changes that makes sellers supply more of the product

at every price, the supply curve will shift to the right—an

increase in supply.

In this case, the increase in supply from S1 to S2 causes

the quantity of energy drinks supplied at a price of $2.50

to increase from 90 million cans at point B to 110 million

cans at point C.

Discuss the variables that influence supply.

3.2 Learning Objective

Solved Problem 3-2

To (Soy) bean or Not to (Soy) bean?

a. If both crops can be grown on the same land, why would a farmer choose

to produce corn rather than soybeans?

b. Which of the variables that influence supply would explain a farmer’s

choice to produce soybeans or corn?

In solving the problem, consider the following:

• Variables that shift market supply.

• The expected profitability of the two crops.

• The variable “prices of substitutes in production”.

YOUR TURN: For more practice, do related problem 2.6 at the end of this chapter.

Market Equilibrium: Putting Demand and Supply Together

FIGURE 3-7

Market Equilibrium

Where the demand curve crosses the supply

curve determines market equilibrium.

In this case, the demand curve for energy drinks

crosses the supply curve at a price of $2.00 and a

quantity of 80 million cans.

Only at this point is the quantity of energy drinks

consumers are willing to buy equal to the quantity

that Red Bull, Monster Energy, Rockstar, and the

other firms are willing to sell: The quantity

demanded is equal to the quantity supplied.

Putting together Demand and Supply

Market Equilibrium: Putting Demand and Supply Together

FIGURE 3-8

The Effect of Surpluses and Shortages

on the Market Price

How Markets Eliminate Surpluses and Shortages

When the market price is above equilibrium, there

will be a surplus. In the figure, a price of $2.50 for

energy drinks results in 90 million cans being

supplied but only 70 million cans being demanded,

or a surplus of 20 million. As Red Bull, Monster

Energy, Rockstar, and the other firms cut the price

to dispose of the surplus, the price will fall to the

equilibrium of $2.00.

When the market price is below equilibrium, there

will be a shortage. A price of $1.00 results in 100

million cans being demanded but only 60 million

cans being supplied, or a shortage of 40 million

cans. As consumers who are unable to buy energy

drinks offer to pay higher prices, the price will rise

to the equilibrium of $2.00.

•Market equilibrium A situation in which quantity demanded equals quantity supplied.

•Competitive market equilibrium A market equilibrium with many buyers and many sellers.

Market Equilibrium: Putting Demand and Supply Together

Market Equilibrium: Putting Demand and Supply Together

Surplus A situation in which the quantity supplied is greater than the quantity demanded.

Shortage A situation in which the quantity demanded is greater than the quantity supplied.

How Markets Eliminate Surpluses and Shortages

Practicing on Equilibrium, Shortage and Surplus

Market Equilibrium: Putting Demand and Supply Together Demand and Supply Both Count

Keep in mind that the interaction of demand and supply determines the equilibrium price.

Neither consumers nor firms can dictate what the equilibrium price will be.

No firm can sell anything at any price unless it can find a willing buyer, and no consumer can buy anything at any price without finding a willing seller.

The Effect of Demand and Supply Shifts on Equilibrium

FIGURE 3-9

The Effect of an Increase in Supply on

Equilibrium

The Effect of Shifts in Supply on Equilibrium

1. As Coca-Cola enters the market for energy drinks, a

larger quantity of energy drinks will be supplied at every

price, so the market supply curve shifts to the right, from

S1 to S2, which causes a surplus of cans at the original

price, P1.

2. The equilibrium price falls from P1 to P2.

3. The equilibrium quantity rises from Q1 to Q2.

If a firm enters a market, as Coca-Cola entered the market

for energy drinks when it launched Full Throttle, the

equilibrium price will fall, and the equilibrium quantity will

rise:

•The Falling Price of LCD Televisions

Making the

Connection

An increase in supply drove the price of a typical large LCD television from $4,000 in fall 2004 to $1,000

at the end of 2008, increasing the quantity demanded worldwide from 8 million to 105 million.

YOUR TURN: Test your understanding by doing related problem 4.7 at the end of this chapter.

The Effect of Demand and Supply Shifts on Equilibrium

FIGURE 3-10

The Effect of an Increase in Demand

on Equilibrium

The Effect of Shifts in Demand on Equilibrium

Increases in income will cause the equilibrium price and

quantity to rise:

1. Because energy drinks are a normal good, as

income grows, the quantity demanded

increases at every price, and the market

demand curve shifts to the right, from D1 to

D2, which causes a shortage of energy drinks

at the original price, P1.

2. The equilibrium price rises from P1 to P2.

3. The equilibrium quantity rises from Q1 to Q2.

The Effect of Demand and Supply Shifts on Equilibrium

FIGURE 3-11

Shifts in Demand and Supply over Time

The Effect of Shifts in Demand and Supply over Time

In panel (a), demand shifts to the right more than supply, and the

equilibrium price rises:

1. Demand shifts to the right more than supply.

2. Equilibrium price rises from P1 to P2.

In panel (b), supply shifts to the right more than demand, and the

equilibrium price falls:

1. Supply shifts to the right more than demand.

2. Equilibrium price falls from P1 to P2.

The Effect of Demand and Supply Shifts on Equilibrium

TABLE 3-3

How Shifts in Demand and Supply Affect Equilibrium

Price (P) and Quantity (Q)

The Effect of Shifts in Demand and Supply over Time

SUPPLY CURVE

UNCHANGED

SUPPLY CURVE

SHIFTS TO THE RIGHT

SUPPLY CURVE SHIFTS TO THE

LEFT

DEMAND CURVE UNCHANGED Q unchanged

P unchanged

Q increases

P decreases

Q decreases

P increases

DEMAND CURVE

SHIFTS TO THE RIGHT Q increases

P increases

Q increases

P increases or

decreases

Q increases or

decreases

P increases

DEMAND CURVE

SHIFTS TO THE LEFT

Q decreases

P decreases

Q increases or

decreases

P decreases

Q decreases

P increases or

decreases

Solved Problem 3-4

High Demand and Low Prices in the

Lobster Market?

Supply and demand for lobster both increase

during the summer, but the increase in supply is

greater than the increase in demand, therefore,

equilibrium price falls.

YOUR TURN: For more practice, do related problems 4.5 and 4.6 at the end of this chapter.

How Does Advertising Help Red Bull Increase Demand for

Its Energy Drink?

AN INSIDE LOOK >>

Advertising may cause an increase in the demand for Red Bull.