Supply and Demand Tatiana Pino February 2 2011 The Demand Curve Law of Demand there is an inverse negative relationship between the price of a good and the quantity that buyers are willing to purchase Results in a downward sloping curve See chart As price increases quantity demanded decreases The height of the demand curve at any quantity shows the maximum price that consumers are willing to pay for an additional unit When consumers have more of the good they value it less Law of Diminishing Marginal Utility Consumer Surplus Consumer surplus the difference between the maximum amount consumers would be willing to pay and the amount that they actually pay The area below the demand curve but above the price Prices fall cid 224 consumer surplus increases in size Prices rise cid 224 consumer surplus decreases in size i e Willing to pay 20 but in reality only pay 10 cid 224 consumer surplus 10 Willing to Pay 20 15 10 1 2 3 Price 5 CS 15 CS 10 CS 5 Total CS 30 See chart Demand vs Quantity Demanded Change in quantity demanded A movement along the curve Caused by a change in the price of that good Increase in quantity demanded movement down on the curve to the right because price is lower Decrease in quantity demanded movement up the curve to the left because price is higher See chart Change in Demand A shift of the curve Caused by a change in anything that affects demand other than the price of the good i e 21st birthday at a club cid 224 influence how many shots you buy Not buying good because of prices Increase in demand curve shifts right Decrease in demand curve shifts left See chart Shifters of Demand 1 Change in consumer income how much money you have Normal goods Income increases cid 224 Demand increases Inferior goods things you buy because they re cheap but not because you love them Income increases cid 224 Demand decreases This is because you can afford the better stuff now 2 What makes a good normal or inferior depends on preference 2 Change in number of consumers of consumers increases cid 224 Demand increases More people to buy things 3 Change in the price of a related good Substitutions Beef and chicken Price of substitution increases cid 224 Demand for original good increases Price of chicken increases cid 224 Demand for beef increases Compliments Milk and Cereal Price of compliment increases cid 224 Demand decreases Price of milk increases cid 224 Demand for cereal decreases 4 Change in expectations Expected change in price sale is coming up Price in future increases cid 224 Demand right now increases Expected change in income getting a raise in two weeks Income in future increases cid 224 Demand spending money now increases 5 Change in consumer tastes and preferences Consumer popularity increases cid 224 Demand increases i e Michel Phelps posters after 8 gold medals vs when he was caught with weed Examples What would happen to the demand for beef if the price of chicken increased Demand would increase 3 What would happen to your demand for steak normal good if your income decreased Demand would decrease What would happen to the demand for milk if the price of milk fell NOTHING PRICE EFFECTS QUALITY DEMANDED NOT DEMAND The Supply Curve Law of supply there is a direct positive relationship between the price of a good and the amount that suppliers are willing to produce Results in an upward sloping curve See chart As price increases quantity supplied increases The height of the supply curve indicates the minimum price necessary to induce producers to supply an additional unit Producer Surplus Producer surplus the difference between the minimum price suppliers are willing to accept and the price they actually receive The area above the supply curve but below price Price falls Surplus decreases Price rises Surplus increases Consumer Edward 4000 Price 3000 Producer Viviane 2000 Consumer Surplus 1000 Producer Surplus 1000 Supply vs Quantity Supplied Change in quantity supplied a movement along the curve 4 Caused by a change in the price of that good Increase in quantity supplied Movement up the curve to the right Decrease in quantity supplied movement down the curve to the left See chart Change in supply a shift of the curve Caused by a change in anything that affects supply other than the price of the good Increase in supply curve shifts right Decrease in supply curve shifts left See chart Shifters of Supply 1 A change in resource anything used to make the good price i e increase in the price of steel less cars are made Price of resource increases cid 224 Supply decreases 2 A change in technology i e Printing press can make more books more efficiently Technology increase cid 224 Supply increase Changes in nature and politics Nature Politics Depends on the change i e Crop freeze 4 Change in taxes i e Yacht tax Taxes increase cid 224 Supply decreases Elasticity 5 Inelastic Changes in quantity are not sensitive to changes in price inelastic curves are steeper more vertical Elastic Changes in quantity are sensitive to changes in price elastic curves are flatter more horizontal See charts Market Equilibrium See all charts Market equilibrium A state in which conflicting forces of supply and demand are in balance Occurs when supply curve intersects demand curve In market equilibrium All trades that generate more benefit then costs are undertaken No trades where costs exceed benefits are undertaken The combined area of consumer and producer surplus is maximized Market equilibrium is economically efficient no excess supply or excess demand Excess supply quantity supplied quantity demanded Excess demand quantity demanded quality supplied 6 February 14 2011 Changes in Demand Demand changes Price moves in same direction Quantity moves in same direction i e Demand increases Price increases Quantity increases i e Demand decreases Price decreases Quantity decreases Changes in Supply Supply changes Price moves in opposite direction Quantity moves in same direction i e Supply increases Price decreases Quantity increases i e Supply decreases Price increases Quantity decreases Changes in Both Look at graphs 1 2 3 Demand increases Supply increases Result Demand decreases Supply decreases Result Demand increases Supply decreases Result Quantity increases Quantity increases Quantity increases Quantity decreases Quantity decreases Quantity decreases Quantity increases Quantity decreases Quantity Price increases Price decreases Price Price decreases Price increases Price Price increases Price