Demand and Supply. Learning Objectives By the end of this section, you will be able to: Identify factors that affect demand Graph demand curves and demand shifts Identify factors that affect supply Graph supply curves and supply shifts. When does ceteris paribus apply? Shift in Demand A shift in demand means that at any price and at every price , the quantity demanded will be different than it was before.
Figure 2. Demand Curve. The demand curve can be used to identify how much consumers would buy at any given price. Figure 3. Demand Curve with Income Increase. With an increase in income, consumers will purchase larger quantities, pushing demand to the right.
Figure 4. Demand Curve Shifted Right. With an increase in income, consumers will purchase larger quantities, pushing demand to the right, and causing the demand curve to shift right. Shift in Supply We know that a supply curve shows the minimum price a firm will accept to produce a given quantity of output.
Figure 7. Supply Curve. The supply curve can be used to show the minimum price a firm will accept to produce a given quantity of output. Figure 8. Setting Prices. The cost of production and the desired profit equal the price a firm will set for a product. Figure 9. Increasing Costs Leads to Increasing Price. Because the cost of production and the desired profit equal the price a firm will set for a product, if the cost of production increases, the price for the product will also need to increase.
Figure Supply Curve Shifts. When the cost of production increases, the supply curve shifts upwardly to a new price level. Self-Check Questions Why do economists use the ceteris paribus assumption? In an analysis of the market for paint, an economist discovers the facts listed below. State whether each of these changes will affect supply or demand, and in what direction. There have recently been some important cost-saving inventions in the technology for making paint.
Paint is lasting longer, so that property owners need not repaint as often. Because of severe hailstorms, many people need to repaint now. The hailstorms damaged several factories that make paint, forcing them to close down for several months. Many changes are affecting the market for oil. Predict how each of the following events will affect the equilibrium price and quantity in the market for oil. In each case, state how the event will affect the supply and demand diagram. Create a sketch of the diagram if necessary.
Cars are becoming more fuel efficient, and therefore get more miles to the gallon. The winter is exceptionally cold. A major discovery of new oil is made off the coast of Norway. The economies of some major oil-using nations, like Japan, slow down. A war in the Middle East disrupts oil-pumping schedules. Landlords install additional insulation in buildings.
The price of solar energy falls dramatically. Chemical companies invent a new, popular kind of plastic made from oil. Review Questions When analyzing a market, how do economists deal with the problem that many factors that affect the market are changing at the same time? Name some factors that can cause a shift in the demand curve in markets for goods and services.
Name some factors that can cause a shift in the supply curve in markets for goods and services. Critical Thinking Questions Consider the demand for hamburgers.
If the price of a substitute good for example, hot dogs increases and the price of a complement good for example, hamburger buns increases, can you tell for sure what will happen to the demand for hamburgers? Why or why not? Illustrate your answer with a graph.
Justify your answer. We know that a change in the price of a product causes a movement along the demand curve. Suppose consumers believe that prices will be rising in the future.
How will that affect demand for the product in the present? Can you show this graphically? Suppose there is soda tax to curb obesity. What should a reduction in the soda tax do to the supply of sodas and to the equilibrium price and quantity?
Hint : assume that the soda tax is collected from the sellers. Problems Table 6 shows information on the demand and supply for bicycles, where the quantities of bicycles are measured in thousands. At what price is the quantity supplied equal to 48,? Graph the demand and supply curve for bicycles. How can you determine the equilibrium price and quantity from the graph? How can you determine the equilibrium price and quantity from the table?
What are the equilibrium price and equilibrium quantity? Would a shortage or surplus exist? If so, how large would the shortage or surplus be? The computer market in recent years has seen many more computers sell at much lower prices. What shift in demand or supply is most likely to explain this outcome? Sketch a demand and supply diagram and explain your reasoning for each.
A rise in demand A fall in demand A rise in supply A fall in supply. Ceteris paribus allows you to look at the effect of one factor at a time on what it is you are trying to analyze. When you have analyzed all the factors individually, you add the results together to get the final answer. An improvement in technology that reduces the cost of production will cause an increase in supply. Alternatively, you can think of this as a reduction in price necessary for firms to supply any quantity.
Either way, this can be shown as a rightward or downward shift in the supply curve. An improvement in product quality is treated as an increase in tastes or preferences, meaning consumers demand more paint at any price level, so demand increases or shifts to the right.
If this seems counterintuitive, note that demand in the future for the longer-lasting paint will fall, since consumers are essentially shifting demand from the future to the present. An increase in need causes an increase in demand or a rightward shift in the demand curve.
Factory damage means that firms are unable to supply as much in the present. Technically, this is an increase in the cost of production. Either way you look at it, the supply curve shifts to the left.
More fuel-efficient cars means there is less need for gasoline. This causes a leftward shift in the demand for gasoline and thus oil. Since the demand curve is shifting down the supply curve, the equilibrium price and quantity both fall. Cold weather increases the need for heating oil. This causes a rightward shift in the demand for heating oil and thus oil.
Since the demand curve is shifting up the supply curve, the equilibrium price and quantity both rise. A discovery of new oil will make oil more abundant. This can be shown as a rightward shift in the supply curve, which will cause a decrease in the equilibrium price along with an increase in the equilibrium quantity. The supply curve shifts down the demand curve so price and quantity follow the law of demand.
If price goes down, then the quantity goes up. When an economy slows down, it produces less output and demands less input, including energy, which is used in the production of virtually everything.
A decrease in demand for energy will be reflected as a decrease in the demand for oil, or a leftward shift in demand for oil. Since the demand curve is shifting down the supply curve, both the equilibrium price and quantity of oil will fall.
Disruption of oil pumping will reduce the supply of oil. Why will businesses supply more pizzas only id the price is higher? I think it is just common sense.
If you want the pizza places to work harder and longer and produce more pizzas, you have to pay them more, per pizza. But economists, as social science, want to explain common sense. We know businesses behave this way, but why? There are two explanations for the law of supply and both have to do with increasing costs. Businesses require a higher price per pizza to produce more pizzas because they have higher costs per pizza.
First, there are increasing costs because of the law of increasing costs. In a previous lecture we explained that the production possibilities curve is concave to the origin because of the law of increasing costs. Let's say a pizza place is just opening. The owner figures that they will need five employees. After putting an ad in the paper there are twenty applicants. Five have had experience working in a pizza place before.
They came to the interview clean and on time. The other fifteen had no work experience. Many came late. A few were caught steeling pepperoni on the way out.
One spilled flour all over the floor. Which applicants will be hired? Of course it will be the five with experience and the other fifteen will be rejected because they would be too costly to hire. NOW, if the pizza place wants to produce more pizzas they will need more workers. This means they will have to hire some of those who were rejected because they were more costly less experienced, etc. So, they will only hire the more costly employees if they can get a higher price to cover the higher costs.
Second, there are increasing costs because some resources are fixed. This should not make sense to you. Why would there be increasing costs if we use the same quantity of some resource? Well, let's say that the size of the kitchen and the number of ovens capital resources are fixed. This means that they don't change. Now, if we want to produce more pizzas you will have to cram more workers into the same size kitchen.
As they bump into each other and wait for an oven to be free they still get paid, but the cost per pizza increases. Therefore they will not produce more pizza unless they can get a higher price to cover these higher per unit costs.
So the supply curve should be upward sloping. Market supply is the horizontal summation of the individual supply curves. Instead of looking at how many pizzas one pizza place is willing and able to produce at different prices individual supply , we keep the prices the same and add the quantities of additional pizza places.
Prices stay the same, but quantities increase because there are more pizza suppliers. So the market supply of pizzas is further to the right horizontal than the individual pizza place supply curves. The price of the product P. But there are other determinants of how much business supply besides the price.
We call these the Non-Price determinants of Supply. Change in Quantity Supplied Qs. Change in Supply S. A change in supply is a shifting the supply curve because there is a new supply schedule. The supply curve either moves left or right horizontally since the prices stay the same and only the quantities change and quantity is on the horizontal axis.
Many students want to draw the arrows perpendicular to the supply curve. That could get confusing! A change in supply is caused by a change in the non-price determinants of supply. At the same prices, the quantities supplied will be greater. At the same prices, the quantities supplied will be smaller.
Let's look at these determinants on at a time. We must know how they shift the supply curve if we are to use the supply and demand tool to understand how prices are determined in a market economy.
Pe S today Pe S today. If the price of soybeans increases the supply of corn will decrease. The supply curve of corn will shift to the left as farmers plant more soybeans and less corn. P soybeans S corn P soybeans S corn. Remember, price does not change supply, it changes the quantity supplied.
The price of resources Pres , improved technology Tech , and taxes and subsidies Tax all affect supply because they change the costs of production. Pres -- price of resources. For Example: if the autoworkers unions receives a significant wage increase, this will increase the costs of producing cars and decrease the supply of cars S. P autoworkers wages costs of producing cars S cars. Pres costs S Pres costs S.
Tech --technology. If the technology did not decrease costs, then it wouldn't be used. If there is a high-tech expensive way to produce a product and a low-cost, low-tech, way to produce the same product, companies that use the low-cost methods will be able to sell the product at a lower price and beat out the high-cost producers.
Improved technology costs S. What has improved technology done to the costs of medical care? For example let's say that there is a disease where with existing low-cost technology, half the patients die. Now, if they invent a new high-cost technology that will save all lives which technology will be used?
One product is when half the patients die, the other product is when all patients live. We can't put two products on one supply curve.
Let's use one more medical example. Why do doctors still use low-tech stethoscopes? Isn't here a high-tech electronic stethoscope? Yes there is, so why don't doctors use it? Doctors will use the cheaper technology as long as the results are the same. The low-tech stethoscopes can't always pick out the fetal heart beat.
The product changes. So, improved technology will decrease costs and increase supply OR it will increase costs and change the product which we cannot put on one graph. Tax --taxes and subsidies.
Let's discuss the gasoline tax. If the tax on gasoline increases will this affect the demand for gasoline or the supply of gasoline? If you said demand - then which non-price determinant of demand has changed? Taxes costs S Taxes costs S.
Who pays the gasoline tax? Who pays the wages of the gas station employees? Whether you answer the consumer of the gas station owner, you have to give the same answer for both questions. Both taxes and wages are costs to the producer or seller. Higher gasoline taxes do not shift the demand curve, but they may result in a higher price and therefore a decrease in quantity demanded. Subsidies are the opposite of taxes. Instead of the business paying the government, the government pays the business.
There are fewer subsidies than taxes. But let's say the the government wants to encourage the use of solar energy so they put a subsidy or increase one on solar energy equipment. Subsidies costs S Subsidies costs S. Nprod S Nprod S. Equilibrium means that there is no further tendency to change. When something is at equilibrium, it is at rest, not changing. Like a pendulum. We call this disequilibrium. Eventually, it will stop swinging and achieve equilibrium.
Prices do something similar. They move toward an equilibrium where they come to rest and don't change. But just like you can push a pendulum and cause it to swing and then slow down and achieve equilibrium again, prices can be "pushed" and they will change to a new equilibrium.
It is the non-price determinants of demand and supply that "push" prices to a new equilibrium. We call this "market equilibrium". Sometimes I hear people say that equilibrium is where demand equals supply. Well, let's take a look at what happens if the price is not at equilibrium. If there is a surplus more available than consumers are willing to purchase the price will change - decrease. Twelve dollars is not equilibrium - it will change. If there is a shortage consumers are willing to purchase more than is available the price will change - increase.
Six dollars is not equilibrium - it will change. After we do this, we will put it all together. It all begins with a change in one of the eleven non-price determinants:. We discussed this above and will review it again soon. You can probably guess what will happen to price and quantity and get it correct quite often, but why guess when you can draw the graphs and get it right almost all the time? So, if demand increases and supply stays the same you get see graph :.
This is quite easy, but the key to understanding this are the non-price determinants of supply and demand. We will review them soon. If supply decreases shifts to the left and demand stays the same you get see graph :. What if BOTH supply and demand change at the same time? This means what happens to price and quantity if a non-price determinant and supply AND a non-price determinant of demand change shifting the graphs at the same time? Graph it right now and determine what would happen to price and quantity if supply increases and demand decreases.
In a face-to-face class I would have my students do this themselves and tell me what happens to P and Q. So let's do it in this distance learning class.
What do you get? What happens to price and quantity if supply increases shifts to the right and demand decreases shifts to the left? The price will decrease, but we cannot tell what happens to quantity. Quantity could increase, it could decrease or it could stay the same.
What happens to quantity depends on how much the supply and demand curves shift and since we were not told this, we cannot determine what happens to quantity. Measure content performance. Develop and improve products. List of Partners vendors. The law of supply and demand is a theory that explains the interaction between the sellers of a resource and the buyers for that resource. The theory defines the relationship between the price of a given good or product and the willingness of people to either buy or sell it.
Generally, as price increases, people are willing to supply more and demand less and vice versa when the price falls. The theory is based on two separate "laws," the law of demand and the law of supply. The two laws interact to determine the actual market price and volume of goods on the market.
The law of supply and demand , one of the most basic economic laws, ties into almost all economic principles somehow. In practice, people's willingness to supply and demand a good determines the market equilibrium price or the price where the quantity of the good that people are willing to supply equals the quantity that people demand. However, multiple factors can affect both supply and demand, causing them to increase or decrease in various ways. The law of demand states that if all other factors remain equal, the higher the price of a good, the fewer people will demand that good.
In other words, the higher the price, the lower the quantity demanded. The amount of a good that buyers purchase at a higher price is less because as the price of a good goes up, so does the opportunity cost of buying that good.
As a result, people will naturally avoid buying a product that will force them to forgo the consumption of something else they value more. The chart below shows that the curve is a downward slope. Like the law of demand, the law of supply demonstrates the quantities sold at a specific price. But unlike the law of demand, the supply relationship shows an upward slope.
This means that the higher the price, the higher the quantity supplied. From the seller's perspective, each additional unit's opportunity cost tends to be higher and higher. Producers supply more at a higher price because the higher selling price justifies the higher opportunity cost of each additional unit sold.
It is important for both supply and demand to understand that time is always a dimension on these charts. The quantity demanded or supplied, found along the horizontal axis, is always measured in units of the good over a given time interval.
Longer or shorter time intervals can influence the shapes of both the supply and demand curves. At any given point in time, the supply of a good brought to market is fixed. In other words, the supply curve, in this case, is a vertical line, while the demand curve is always downward sloping due to the law of diminishing marginal utility. Sellers can charge no more than the market will bear based on consumer demand at that point in time.
Over longer intervals of time, however, suppliers can increase or decrease the quantity they supply to the market based on the price they expect to charge. So over time, the supply curve slopes upward; the more suppliers expect to charge, the more they will be willing to produce and bring to market. For all periods, the demand curve slopes downward because of the law of diminishing marginal utility. The first unit of a good that any buyer demands will always be put to that buyer's highest valued use.
For each additional unit, the buyer will use it or plan to use it for a successively lower-valued use. For economics, the "movements" and "shifts" in relation to the supply and demand curves represent very different market phenomena. A movement refers to a change along a curve. On the demand curve, a movement denotes a change in both price and quantity demanded from one point to another on the curve. The movement implies that the demand relationship remains consistent.
Therefore, a movement along the demand curve will occur when the price of the good changes and the quantity demanded changes per the original demand relationship. In other words, a movement occurs when a change in the quantity demanded is caused only by a change in price and vice versa.
Like a movement along the demand curve, the supply curve means that the supply relationship remains consistent. Therefore, a movement along the supply curve will occur when the price of the good changes and the quantity supplied changes by the original supply relationship. In other words, a movement occurs when a change in quantity supplied is caused only by a change in price and vice versa.
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