Macroeconomics

Module 3: Supply and Demand

Economic Systems: Free

Market: any situation that brings

together buyers and sellers of goods or
services.

Types of Economies - In the modern

world today, there is a range of
economic systems:
• Market Economy: an economy where
economic decisions are
decentralized, resources are owned
by private individuals, and businesses
supply goods and services based on
demand.
Economic Systems: Free (cont.)

Types of Economies: In the modern

world today, there is a range of
economic systems:
• Competitive Market: a market in
which there is a large number of
buyers and sellers, so that no one
can control the market price.
• Free Economy: a market in which
the government does not intervene
in any way.
Economic Systems: Planned

Planned (or Command) Economies: an economy

where economic decisions are passed down
from government authority and where resources
are owned by the government.
• Resources and businesses are owned by the
government.
• Government decides what goods and
services will be produced and what prices will
be charged for them.
• Government decides what methods of
production will be used and how much
workers will be paid.
Economic Systems: Distinction

Primary Distinction
• The primary distinction between a free and command economy is the
degree to which the government determines what can be produced and
what prices will be charged.
Real World: Most economies in the real world are mixed; they combine
elements of command and market systems.
What Is Demand?

Demand for Goods and Services

• Demand: the relationship between the price of a certain good or service
and the quantity of that good or service someone is willing and able to buy.
• Price: what a buyer pays for a unit of the specific good or service.
• Quantity Demanded: the total number of units of a good or service
consumers wish to purchase at a given price.
• Law of Demand: the common relationship that a higher price leads to a
lower quantity demanded of a certain good or service and a lower price
leads to a higher quantity demanded, while all other variables are held
constant.
What Is Demand? (cont.)

Demand Schedule: a table that shows the quantity demanded for a certain
good or service at a range of prices.
• Example: Price is measured in dollars per gallon of gasoline. The quantity
demanded is measured in millions of gallons over some time period and over
some geographic area.
Demand Schedule Example: Table 1

Price (per gallon) Quantity Demanded (millions of

gallons)
$1.00 800
$1.20 700
$1.40 600
$1.60 550
$1.80 500
$2.00 460
$2.20 420
What Is a Demand Curve?

Demand curve: a graphic representation

of the relationship between price and
quantity demanded of a certain good or
service, with price on the vertical axis
and quantity on the horizontal axis.
• For example, the figure to the left, with
price per gallon on the vertical axis
and quantity on the horizontal axis.
• The demand schedule shows that as
price rises, quantity demanded
decreases, and vice versa.
• The downward slope of the demand
curve illustrates the law of demand—
the inverse relationship between
prices and quantity demanded.
What Is Assumed in a Demand Curve?

Ceteris Paribus: a Latin phrase meaning “other things being equal.”

• Any given demand or supply curve is based on the ceteris
paribus assumption that all else is held equal.
• When changing one variable in a function (e.g. demand for some product),
we assume everything else is held constant.
• A demand curve or a supply curve is a relationship between two, and only
two, variables when all other variables are held equal. If all else is not held
equal, then the laws of supply and demand will not necessarily hold.
What Affects a Demand Curve?

Demand Curves Affected By:

• “Willingness to purchase” suggests a
desire to buy, and it depends on what
economists call tastes and
preferences. If you neither need nor
want something, you won’t be willing
to buy it.
• “Ability to purchase” suggests that
income is important. Professors are
usually able to afford better housing
and transportation than students,
because they have more income.
What Affects a Demand Curve? (cont.)

Demand Curves Affected By:

• Prices of related goods can also affect demand. If you need a new car, the
price of a Honda may affect your demand for a Ford.
• Size or composition of the population. The more children a family has, the
greater their demand for clothing. The more driving-age children a family
has, the greater their demand for car insurance and the less for diapers and
baby formula.
Factors Affecting Demand: Income
Shifts in Demand
Income Example with Automobiles
• Initial demand for automobiles is D0.
• At point Q, if the price is $20,000 per
car, the quantity of cars demanded
is 18 million.
• D0 also shows how the quantity of
cars demanded would change as a
result of a higher or lower price. For
example, if the price of a car rose to
$22,000, the quantity demanded
would decrease to 17 million, at point
R.
Factors Affecting Demand: Income (cont.)

Shifts in Demand
Income Example with Automobiles
• Assume the economy expands and
increases many people’s incomes,
making cars more affordable. With
cars still $20,000, but with higher
incomes, the quantity demanded
increases to 20 million cars, shown at
point S.
• As a result of the higher income
levels, the demand curve shifts to the
right to the new demand curve D1,
indicating an increase in demand.
Factors Affecting Demand: Other Factors

Shift in demand happens when a change in some economic factor (other than
price) causes a different quantity to be demanded at every price.
• changing tastes or preferences
• changes in the composition of the population
• changes in the prices of related goods
• changes in expectations about future prices
Factors Affecting Demand:
Goods or Services
Good or Services Terms: The demand for a product can be affected by
changes in the prices of related goods such as substitutes or complements.
• Substitutes: goods or services that can be used in place of one another
• Complements: goods or services that are used together because the use
of one enhances the use of the other.
• Inferior good: good or service whose demand decreases when a
consumer’s income increases and demand increases when income
decreases.
• Normal good: good or service whose demand increases when a
consumer’s income increases and demand decreases when income
decreases.
Factors Affecting Demand: Six Factors

Factors Shifting Demand Curves

• Six factors that can shift demand curves are summarized in the charts above.
• The direction of the arrows indicates whether the demand curve shifts
represent an increase in demand or a decrease in demand.
What is Supply?

Supply of Goods and Services

• Supply: the relationship between the price of a certain good or
service and the quantity of that good or service producers are
willing to offer for sale.
• Law of Supply: the common relationship that a higher price leads to
a higher quantity supplied of a certain good or service and a lower
price leads to a higher quantity supplied, while all other variables
are held constant.
• Quantity Supplied: the total number of units of a good or service
producers are willing to supply at a given price.
What is Supply? (cont.)

Is Supply the Same as Quantity

Supplied?
• Supply is not the same as
quantity supplied.
• Supply refers to the curve, and
quantity supplied refers to the
(specific) point on the curve.
What is a Supply Schedule or Curve?

Supply Schedule: a table that Supply Curve: a graphic

representation of the relationship
shows the quantity
between price and quantity
demanded for a certain good supplied of a certain good or
or service at a range of prices. service, with price on the vertical
axis and quantity on the horizontal
Price (per gallon) Quantity Supplied axis.
(millions of gallons)
$1.00 800
$1.20 700
$1.40 600
$1.60 550
$1.80 500
$2.00 460
Supply Curve
$2.20 420
Factors Affecting Supply: Lowered Costs

Production Costs Affect Supply

• If other factors relevant to supply
do change, then the entire
supply curve will shift.
• A shift in supply means a change
in the quantity supplied at every
price.
Factors Affecting Supply: Lowered Costs (cont.)

Production Costs Affect Supply

• If a firm faces lower costs of
production, while the prices for the
good or service the firm produces
remain unchanged, a firm’s profits go
up.
• When a firm’s profits increase, it’s more
motivated to produce output (goods
or services), since the more it produces
the more profit it will earn.
• When costs of production fall, a firm
will tend to supply a larger quantity at
any given price for its output. This can
be shown by the supply curve shifting
to the right.
Factors Affecting Supply: Higher Costs

Shift in Supply Due Increased

Production Costs
• If a firm faces higher costs of
production, then it will earn lower
profits at any given selling price for
its products.
• As a result, a higher cost of
production typically causes a firm to
supply a smaller quantity at any
given price. In this case, the supply
curve shifts to the left.
Other Factors Affecting Supply
These graphs list the various factors which can affect supply.
Supply factors also affected by subsidies:
Subsidy: A government payment to firms to encourage production of some
good or service. From a firms perspective it reducing the cost of production.
Equilibrium, Surplus, and Shortage

Demand and Supply

• Graphs for demand and supply curves both
have price on the vertical axis and quantity on
the horizontal axis, the demand curve and
supply curve for a particular good or service
can appear on the same graph.
• Together, demand and supply determine the
price and the quantity that will be bought and
sold in a market.
• What does it mean when the quantity
demanded and the quantity supplied aren’t
the same?
• The answer is: a surplus or a shortage.
Equilibrium, Surplus, and Shortage (cont.)

Surplus or Excess Supply

• Surplus (or excess supply): situation
where the quantity demanded in a
market is less than the quantity
supplied; occurs at prices below
the equilibrium.

• Equilibrium: price and quantity

combination where supply equals
demand.
Equilibrium, Surplus, and Shortage (cont. II)

Shortage or Excess Demand

• Shortage (or excess demand): situation where
the quantity demanded in a market is greater
than the quantity supplied; occurs at prices
above the equilibrium.
• Generally any time the price for a good
is below the equilibrium level, incentives built
into the structure of demand and supply will
create pressures for the price to rise.
• Similarly, any time the price for a good
is above the equilibrium level, similar pressures
will generally cause the price to fall.
Equilibrium, Surplus, and Shortage (cont. III)

Equilibrium: Where Supply and Demand Intersect

• Equilibrium: price and quantity combination where supply equals demand.
• Equilibrium Price: the (only) price where the quantity supplied in a market
equals the quantity demanded.
• Equilibrium Quantity: the quantity both supplied and demanded at the
equilibrium price.
Equilibrium, Surplus, and Shortage (cont. IV)

Equilibrium and Economic Efficiency

• Equilibrium is important to create both a
balanced market and an efficient market.
• Efficiency: when the optimal amount of goods
are produced and consumed, minimizing
waste.
• Efficiency in the demand and supply model
has the same basic meaning:
the economy is getting as much benefit as possible
from its scarce resources, and all the possible gains
from trade have been achieved.
Changes in Equilibrium

Finding Equilibrium using the Four-Step

Process
• Step 1: Draw demand and supply
curves showing the market before
the economic change took place.
• Step 2: Decide whether the
economic change being analyzed
affects demand or supply.
• Step 3: Determine whether the effect
on demand or supply causes the
curve to shift to the right or to the left,
and sketch the new demand or
supply curve on the diagram.
• Step 4: Identify the new equilibrium,
and then compare the original
equilibrium price and quantity to the
new equilibrium price and quantity.
Finding Equilibrium Example

Use the Four-Step Process to Find Equilibrium

A Pay Raise for Postal Workers
• Step 1. Draw a demand and supply model to illustrate what the
market for the U.S. Postal Service looks like before this scenario
starts. The demand curve D and the supply curve S show the
original relationships.
• Step 2. Will a pay raise for postal workers affect supply or
demand?
• Step 3. Is the effect on supply positive or negative?
• Step 4. Compare the new equilibrium price and quantity to the
original equilibrium price.
Changes in Supply and Demand

Understand How Supply and Demand Shift a

Graph
• Demand: the relationship between the
price and the quantity demanded of a
certain good or service.
• Quantity Demanded: the total number of
units of a good or service consumers are
willing to purchase at a given price.
• Quantity Supplied: the total number of
units of a good or service producers are
willing to sell at a given price.
Changes in Supply and Demand (cont.)

Understand How Supply and Demand Shift a

Graph
• Shift in Demand: when a change in some
economic factor (other than price) causes
a different quantity to be demanded at
every price.
• Shift in Supply: when a change in some
economic factor (other than price) causes
a different quantity to be supplied at every
price.
• Supply: the relationship between price and
the quantity supplied of a certain good or
service.
Quick Review
• What are the characteristics of
market economies, including free
and competitive markets?
• What are the characteristics of a
planned, or command,
economy?
• What is demand and the law of
demand?
• What is a demand curve?
• How can you create a demand
curve using a data set?
• Which factors cause a shift in
the demand curve and
explain why the shift occurs?
• What are substitutes and
complements and give
examples?
• How do you draw a demand
curve and graphically
represent changes in
demand?
• What is supply and the law of
supply?
• What is a supply curve?
Quick Review (cont.)
• How do you create a supply curve
using a data set?
• Which factors cause a shift in the supply
curve and explain why the shift occurs?
• What are equilibrium price and
quantity? Identify them in a market.
• What are surpluses and shortages? How
do they cause the price to move
towards equilibrium?
• How do you create a graph that
illustrates equilibrium price and
quantity?
• What is the four-step process to
predict how economic conditions
cause a change in supply,
demand, and equilibrium?
• What happens to supply, demand,
and equilibrium when there is a
change in both supply and
demand?
• What are the differences between
changes in demand and changes
in the quantity demanded?
• What are the differences between
changes in supply and changes in
quantity supplied?