Arnold Ch03 MCW PDF

CHAPTER 3
Supply and
Demand:
Theory
©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied
or duplicated, or posted to a publicly accessible website, in whole or in part.
©iurii/Shutterstock
INTHISCHAPTER
3-1 What is Demand?

3-2 What is Supply?
3-3 The Market: Putting Supply
and Demand Together
©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. ©iurii/Shutterstock 2
3-1 What is Demand? (1 of 11)
► 3-1 What is Demand?
• Demand: The willingness and ability of buyers to

purchase different quantities of a good at different
prices during a specific period
► 3-1a The Law of Demand

• Law of Demand: As the price of a good rises, the
quantity demanded of the good falls, and as the price
of a good falls, the quantity demanded of the good
rises, ceteris paribus
– where P = price and Q = quantity demanded
► 3-1b Four Ways to Represent the Law of Demand

• In Words
• In Symbols
• In a Demand Schedule
• As a Demand Curve
• Demand Schedule: The numerical tabulation of the
quantity demanded of a good at different prices. A
demand schedule is the numerical representation of
the law of demand
• Demand Curve: The graphical representation of the
law of demand
EXHIBIT 1
Demand Schedule and Demand Curve
► 3-1c Why Does Quantity Demanded Go Down as

Price Goes Up?
• Law of Diminishing Marginal Utility: Over a
given period, the marginal (or additional) utility or
satisfaction gained by consuming equal successive
units of a good will decline as the amount consumed
increases
• Why? Because:
• People substitute lower priced goods for higher
priced goods
• Because of the Law of Diminishing Marginal
Utility
► 3-1d Individual Demand Curve and Market

Demand Curve
• There is a difference between these two demand
curves
• An individual demand curve represents the price-
quantity combinations of a particular good for a
single buyer
• A market demand curve is derived by “adding up”
individual demand curves, as shown in Exhibit 2
EXHIBIT 2
Deriving a Market Demand Schedule
and a Market Demand Curve
► 3-1e A Change in Quantity Demanded vs

a Change in Demand
• Quantity demanded = the number of units of a good
that individuals are willing and able to buy at a
particular price
• Change in quantity demanded = a movement from one
point to another point on the same demand curve that
is caused by a change in the price of the good
• Own Price: The price of a good. For example, if the
price of oranges is $1, this is its own price
• Change in demand = Shift in demand curve
EXHIBIT 3
Shifts in the Demand Curve
► 3-1e A Change in Quantity Demanded vs

a Change in Demand (cont)
• Increase in demand – Rightward shift in the
demand curve
• Decrease in demand = Leftward shift in the
demand curve
► 3-1f What Factors Cause the Demand Curve to Shift?

1. income
2. preferences
3. prices of related goods
4. the number of buyers, and
5. expectations of future prices
► 3-1f What Factors Cause the Demand Curve to

Shift? (cont)
• Normal Good: A good for which demand rises
(falls) as income rises (falls)
• Inferior Good: A good for which demand falls
(rises) as income rises (falls)
• Neutral Good: A good for which demand does

not change as income rises or falls
► 3-1f What Factors Cause the Demand Curve to

Shift? (cont)
• Substitutes: Two goods that satisfy similar needs or
desires. If two goods are substitutes, the demand for
one rises as the price of the other rises (or the demand
for one falls as the price of the other falls)
• Complements: Two goods that are used jointly in
consumption. If two goods are complements, the
demand for one rises as the price of the other falls (or
the demand for one falls as the price of the other rises)
EXHIBIT 5
Substitutes and Complements
► 3-1g Movement Factors and Shift Factors

• Economists often distinguish between:
1. factors that can bring about movement along
curves, and
2. factors that can cause shift curves
• In many economic diagrams, the movement factor is on
the vertical axis
• The shift factors for the demand curve are income,
preferences, the price of related goods, and so on; often
shift factors do not appear in the economic diagrams;
we just know what they are
• When you see a curve in this book, first ask which
factor will move us along the curve; what is the
movement factor?
EXHIBIT 6
A Change in Demand vs.
A Change in Quantity Demanded
Two Ways to Reduce the Quantity of
Smoking Demanded, Part 1
1. Shift the demand curve for cigarettes and
other tobacco products
2. Try to raise the price of cigarettes
“What is the best way to

stop this?”
19
1. Shift the demand curve for cigarettes

and other tobacco products
– Public service announcements
– Mandatory health warnings on cigarette
packages
– Prohibition of cigarette advertising on
television
● If successful
– Shift demand curve to the left
20
2. Try to raise the price of cigarettes
– Tax the manufacturer: higher price
– Movement along demand curve
• 10% ↑ in price → 4% ↓ in smoking
• Teenagers: 10% ↑ in price → 12% ↓ in smoking
21
3-2 Supply (1 of 5)
Supply: The willingness and ability of sellers to produce

and offer to sell different quantities of a good at different
prices during a specific period
► 3-2a The Law of Supply
• Law of Supply: As the price of a
good rises, the quantity supplied of
the good rises, and as the price of a
good falls, the quantity supplied of
the good falls, ceteris paribus
• (Upward-Sloping) Supply Curve: The geographical
representation of the law of supply
EXHIBIT 7
A Supply Curve
EXHIBIT 8
Supply Curves When There is No Time to
Produce More or When No More Can Be
Produced
3-2 Supply (2 of 5)
► 3-2b Why Most Supply Curves are Upward Sloping

• Most supply curves are upward sloping
• The fundamental reason for this behavior involves the
law of diminishing marginal returns, discussed in a
later chapter
• Here, we discuss the fact that an upward-sloping
supply curve reflects the fact that, under certain
conditions, a higher price is an incentive to producers
to produce more of the good
• Supply Schedule: The numerical tabulation of the
quantity supplied of a good at different prices. A
supply schedule is the numerical representation of
the law of supply
3-2 Supply (3 of 5)
► 3-2c Changes in Supply Mean Shifts in Supply Curves

• The supply of a good can rise or fall
• An increase in the supply of a good means that
suppliers are willing and able to produce and offer to
sell more of the good at all prices
• The supply of a good decreases if sellers are willing
and able to produce and offer to sell less of the good at
all prices
3-2 Supply (4 of 5)
► 3-2d What Factors Cause the Supply Curve to Shift?

1. the prices of relevant resources,
2. technology,
3. the prices of related goods,
4. the number of sellers,
5. expectations of future price,
6. taxes and subsidies, and
7. government restrictions
• Subsidy: A monetary payment by government to a
producer of a good or service
EXHIBIT 9
Deriving a Market Supply Schedule
and a Market Supply Curve
EXHIBIT 10
Shifts in the Supply Curve
3-2 Supply (5 of 5)
► 3-2e A Change in Supply Versus a Change in

Quantity Supplied
• A change in supply is not the same as a change in
quantity supplied
• A change in supply is a shift in the supply curve, as
in Exhibit 11(a)
• A change in quantity supplied refers to a movement
along a supply curve, as in Exhibit 11(b)
• The only factor that can directly cause a change in
the quantity supplied of a good is a change in the
price of the good
EXHIBIT 11
A Change in Supply vs. a Change in
Quantity Supplied
3-3 The Market: Putting Supply and
Demand Together (1 of 11)
► Market: Any arrangement where the sale and
purchase of goods and services takes place
• Buyers as a group
• Determine the demand for the product
• Sellers as a group
• Determine the supply of the product
3-3 The Market: Putting Supply and Demand Together (4 of 11)
► 3-3b The Language of Supply and Demand:

A Few Important Terms
• Equilibrium: Equilibrium means “at rest.”
• Equilibrium in a market is the price-quantity
combination from which buyers or sellers do not
tend to move away. Graphically, equilibrium is the
intersection point of the supply and demand curves
• Disequilibrium: A state of either surplus or

shortage in a market
► 3-3b The Language of Supply and Demand:

A Few Important Terms
• Surplus (Excess Supply): a condition in which the
quantity supplied is greater than the quantity
demanded. Surpluses occur only at prices above the
equilibrium price
• Shortage (Excess Demand): A condition in which
the quantity demanded is greater than the quantity
supplied. Shortages occur only at prices below the
equilibrium price
• Equilibrium Price (Market-Clearing Price): The
price at which the quantity demanded of a good
equals the quantity supplied
► 3-3b The Language of Supply and Demand: A Few

Important Terms (cont)
• Equilibrium Quantity: The quantity that
corresponds to the equilibrium price. The quantity at
which the amount of the good that buyers are willing
and able to buy equals the amount that sellers are
willing and able to sell, and both equal the amount
actually bought and sold
• Disequilibrium Price: A price other than the
equilibrium price. A price at which the quantity
demanded does not equal the quantity supplied
► 3-3c Moving to Equilibrium: What Happens to Price

When There Is a Surplus or a Shortage?
• Why Does Price Fall When There is a Surplus?
• In Exhibit 13, there is a surplus at a price of $15
• Quantity supplied is greater than quantity
demanded
• At $15, suppliers will not be able to sell all they
hoped to sell, so their inventories will grow, and
they will want to reduce inventories
• Some will lower prices to do so; some will cut back
on production; others will do a bit of both
• Price and output tend to fall until equilibrium is
achieved
► 3-3c Moving to Equilibrium: What Happens to Price When

There Is a Surplus or a Shortage? (cont)
• Why Does Price Rise When There Is a Shortage?
• In Exhibit 13, there is a shortage at a price of $5
• Quantity demanded is greater than quantity supplied
• At $5, buyers will not be able to buy all they had hoped
to buy, so some buyers will bid up the price to get sellers
to sell to them instead of others
• Some sellers, seeing buyers clamor for the goods, will
realize that they can raise the price; higher prices will
also call forth added output.
• Price and output tend to rise until equilibrium is
achieved
EXHIBIT 13
Moving to Equilibrium
EXHIBIT 14
A Summary Exhibit of a Market
(Supply and Demand)
► 3-3d Speed of Moving to Equilibrium

• Consider the stock market; a share of IBM was
$194.38 at 9:01 am, but $195.11 a few minutes later
• Obviously, the stock market equilibrates quickly
• Now, consider a house for sale; the sale price is
$400,000; ten months later, the house is still not sold
and the price is still $400,000; the price is above the
equilibrium price; equilibrium has not been achieved
• Some people will argue that supply and demand are
at work in the stock market but not in the housing
market
• But a better explanation is that not all markets
equilibrate at the same speed
► 3-3e Moving to Equilibrium: Maximum and Minimum Prices

• Exhibit 15 shows the market for good X; look at
the first unit
• What is the maximum price buyers are
willing to pay for it?
• Follow the dotted line up from the first unit to the
demand curve
• What is the minimum price sellers need to receive
before they are willing to sell this unit of good X?
• Follow the dotted line up from the first unit
to the supply curve
• Because the maximum buying price is greater
than the minimum selling price, the first unit of
good X will be exchanged
• What about the second unit?
EXHIBIT 15
Moving to Equilibrium in Terms of
Maximum and Minimum Prices
► 3-3h What Can Change Equilibrium Price and

Quantity?
• Equilibrium price and quantity are determined by

supply and demand
• Exhibit 18 illustrates eight different cases where
this scenario occurs
EXHIBIT 18
Equilibrium Price and Quantity Effects of Supply
Curve Shifts and Demand Curve Shifts
► 3-3g Equilibrium in Terms of Consumers’ and

Producers’ Surplus
• Consumer’s Surplus (CS): The difference between
the maximum price a buyer is willing and able to
pay for a good or service and the price actually paid.
(CS = Maximum buying price – price paid)
• Producers’ (Sellers’) Surplus (PS): The
difference between the price sellers receive for a
good and the minimum or lowest price for which
they would have sold the good
(PS – Price received – Minimum selling price)
• Total Surplus (TS): The sum of consumers’
surplus and producers’ surplus (TS = CS + PS)
EXHIBIT 16
Consumers’ and Producers’ Surplus
EXHIBIT 17
Equilibrium, Consumers’ Surplus, and
Producers’ Surplus

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CHAPTER 3

3-1 What is Demand?

► 3-1 What is Demand?

• Demand: The willingness and ability of buyers to

► 3-1a The Law of Demand

– where P = price and Q = quantity demanded

► 3-1b Four Ways to Represent the Law of Demand

► 3-1c Why Does Quantity Demanded Go Down as

► 3-1d Individual Demand Curve and Market

► 3-1e A Change in Quantity Demanded vs

► 3-1e A Change in Quantity Demanded vs

► 3-1f What Factors Cause the Demand Curve to Shift?

► 3-1f What Factors Cause the Demand Curve to

• Neutral Good: A good for which demand does

► 3-1f What Factors Cause the Demand Curve to

► 3-1g Movement Factors and Shift Factors

“What is the best way to

1. Shift the demand curve for cigarettes

Supply: The willingness and ability of sellers to produce

► 3-2b Why Most Supply Curves are Upward Sloping

► 3-2c Changes in Supply Mean Shifts in Supply Curves

► 3-2d What Factors Cause the Supply Curve to Shift?

► 3-2e A Change in Supply Versus a Change in

► 3-3b The Language of Supply and Demand:

• Disequilibrium: A state of either surplus or

► 3-3b The Language of Supply and Demand:

► 3-3b The Language of Supply and Demand: A Few

► 3-3c Moving to Equilibrium: What Happens to Price

► 3-3c Moving to Equilibrium: What Happens to Price When

► 3-3d Speed of Moving to Equilibrium

► 3-3e Moving to Equilibrium: Maximum and Minimum Prices

► 3-3h What Can Change Equilibrium Price and

• Equilibrium price and quantity are determined by

► 3-3g Equilibrium in Terms of Consumers’ and

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