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CHAPTER
3 In this chapter,
look for the answers to these questions:
 What factors affect buyers’ demand for goods?
The Market Forces of  What factors affect sellers’ supply of goods?
 How do supply and demand determine the price of
Supply and Demand a good and the quantity sold?
 How do changes in the factors that affect demand
or supply affect the market price and quantity of a
good?
 How do markets allocate resources?
© 2009 South-Western, a part of Cengage Learning, all rights reserved 1

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Markets and Competition Demand

 A market is a group of buyers and sellers of a  The quantity demanded of any good is the
particular product. amount of the good that buyers are willing and
able to purchase.
 A competitive market is one with many buyers
and sellers, each has a negligible effect on price.  Law of demand: the claim that the quantity
demanded of a good falls when the price of the
 In a perfectly competitive market:
good rises, other things equal
 All goods exactly the same
 Buyers & sellers so numerous that no one can
affect market price – each is a “price taker”
 In this chapter, we assume markets are perfectly
competitive.
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The Demand Schedule Helen’s Demand Schedule & Curve

Price Quantity Price of Price Quantity
 Demand schedule: of of lattes Lattes of of lattes
a table that shows the lattes demanded lattes demanded
relationship between the $0.00 16 $0.00 16
price of a good and the 1.00 14 1.00 14
quantity demanded 2.00 12 2.00 12
 Example: 3.00 10 3.00 10
Helen’s demand for lattes. 4.00 8 4.00 8
5.00 6 5.00 6
 Notice that Helen’s 6.00 4 6.00 4
preferences obey the
Law of Demand. Quantity
of Lattes
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Market Demand versus Individual Demand The Market Demand Curve for Lattes
 The quantity demanded in the market is the sum of the Qd
quantities demanded by all buyers at each price. P P
(Market)
 Suppose Helen and Ken are the only two buyers in $0.00 24
the Latte market. (Qd = quantity demanded) 1.00 21
Price Helen’s Qd Ken’s Qd Market Qd 2.00 18
$0.00 16 + 8 = 24 3.00 15
1.00 14 + 7 = 21 4.00 12
2.00 12 + 6 = 18 5.00 9
3.00 10 + 5 = 15 6.00 6
4.00 8 + 4 = 12 Q
5.00 6 + 3 = 9
6.00 4 + 2 = 6 6 THE MARKET FORCES OF SUPPLY AND DEMAND 7

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Demand Curve Shifters Demand Curve Shifters: # of Buyers

 The demand curve shows how price affects  Increase in # of buyers
quantity demanded, other things being equal. increases quantity demanded at each price,
shifts D curve to the right.
 These “other things” are non-price determinants
of demand (i.e., things that determine buyers’
demand for a good, other than the good’s price).
 Changes in them shift the D curve…

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Demand Curve Shifters: # of Buyers Demand Curve Shifters: Income

P Suppose the number  Demand for a normal good is positively related

of buyers increases. to income.
Then, at each P,  Increase in income causes
Qd will increase increase in quantity demanded at each price,
(by 5 in this example). shifts D curve to the right.
(Demand for an inferior good is negatively
related to income. An increase in income shifts
D curves for inferior goods to the left.)

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Demand Curve Shifters: Prices of
Related Goods
 Two goods are substitutes if
an increase in the price of one
causes an increase in demand for the other.
 Example: pizza and hamburgers.
An increase in the price of pizza
increases demand for hamburgers,
shifting hamburger demand curve to the right.
 Other examples: Coke and Pepsi,
laptops and desktop computers,
CDs and music downloads
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Demand Curve Shifters: Tastes
 Anything that causes a shift in tastes toward a
good will increase demand for that good
and shift its D curve to the right.
 Example:
The Atkins diet became popular in the ’90s,
caused an increase in demand for eggs,
shifted the egg demand curve to the right.
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Demand Curve Shifters: Prices of
Related Goods
 Two goods are complements if
an increase in the price of one
causes a fall in demand for the other.
 Example: computers and software.
If price of computers rises, people buy fewer
computers, and therefore less software.
Software demand curve shifts left.
 Other examples: college tuition and textbooks,
bagels and cream cheese, eggs and bacon
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Demand Curve Shifters: Expectations
 Expectations affect consumers’ buying
decisions.
 Examples:
 If people expect their incomes to rise,
their demand for meals at expensive
restaurants may increase now.
 If the economy sours and people worry about
their future job security, demand for new
autos may fall now.
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Summary: Variables That Influence Buyers ACTIVE LEARNING 1

Variable A change in this variable…
Demand Curve
Draw a demand curve for music downloads.
Price …causes a movement What happens to it in each of
along the D curve the following scenarios? Why?
# of buyers …shifts the D curve
A. The price of iPods
Income …shifts the D curve falls
Price of B. The price of music
related goods …shifts the D curve downloads falls
Tastes …shifts the D curve C. The price of CDs falls
Expectations …shifts the D curve
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ACTIVE LEARNING 1 ACTIVE LEARNING 1

A. Price of iPods falls B. Price of music downloads falls
Music downloads
Price of and iPods are Price of
music music The D curve
down- complements. down- does not shift.
loads A fall in price of loads
Move down along
iPods shifts the curve to a point with
P1 demand curve for P1
lower P, higher Q.
music downloads P2
to the right.
D1 D2 D1

Q1 Q2 Quantity of Q1 Q2 Quantity of
music downloads music downloads
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ACTIVE LEARNING 1 Supply

C. Price of CDs falls  The quantity supplied of any good is the
Price of CDs and amount that sellers are willing and able to sell.
music music downloads
down- are substitutes.
 Law of supply: the claim that the quantity
loads supplied of a good rises when the price of the
A fall in price of CDs
good rises, other things equal
P1 shifts demand for
music downloads
to the left.

D2 D1

Q2 Q1 Quantity of
music downloads
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The Supply Schedule Starbucks’ Supply Schedule & Curve

Price Quantity Price Quantity
 Supply schedule:
of of lattes P of of lattes
A table that shows the lattes supplied lattes supplied
relationship between the $0.00 0 $0.00 0
price of a good and the 1.00 3 1.00 3
quantity supplied. 2.00 6 2.00 6
 Example: 3.00 9 3.00 9
Starbucks’ supply of lattes. 4.00 12 4.00 12
5.00 15 5.00 15
 Notice that Starbucks’ 6.00 18 6.00 18
supply schedule obeys the
Q
Law of Supply.
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Market Supply versus Individual Supply The Market Supply Curve

 The quantity supplied in the market is the sum of P
QS
the quantities supplied by all sellers at each price. (Market)
P
$0.00 0
 Suppose Starbucks and Jitters are the only two
sellers in this market. (Qs = quantity supplied) 1.00 5
2.00 10
Price Starbucks Jitters Market Qs 3.00 15
$0.00 0 + 0 = 0 4.00 20
1.00 3 + 2 = 5 5.00 25
2.00 6 + 4 = 10 6.00 30
3.00 9 + 6 = 15
4.00 12 + 8 = 20 Q
5.00 15 + 10 = 25
6.00 18 + 12 = 30 24 THE MARKET FORCES OF SUPPLY AND DEMAND 25

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Supply Curve Shifters Supply Curve Shifters: Input Prices

 The supply curve shows how price affects
quantity supplied, other things being equal.
 These “other things” are non-price determinants
of supply.
 Changes in them shift the S curve…
 Examples of input prices:
wages, prices of raw materials.
 A fall in input prices makes production
more profitable at each output price,
so firms supply a larger quantity at each price,
and the S curve shifts to the right.

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Supply Curve Shifters: Input Prices Supply Curve Shifters: Technology

 Technology determines how much inputs are
P Suppose the
required to produce a unit of output.
price of milk falls.
At each price,  A cost-saving technological improvement has
the quantity of the same effect as a fall in input prices,
Lattes supplied shifts S curve to the right.
will increase
(by 5 in this
example).

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Supply Curve Shifters: # of Sellers Supply Curve Shifters: Expectations

 An increase in the number of sellers increases Example:

the quantity supplied at each price,
shifts S curve to the right.
THE MARKET FORCES OF SUPPLY AND DEMAND
 Events in the Middle East lead to expectations of
higher oil prices.
 In response, owners of Texas oilfields reduce
supply now, save some inventory to sell later at
the higher price.
 S curve shifts left.
In general, sellers may adjust supply* when their
expectations of future prices change.
(*If good not perishable)
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Summary: Variables that Influence Sellers ACTIVE LEARNING 2

Supply Curve
Variable A change in this variable…
Draw a supply curve for tax
Price …causes a movement return preparation software.
along the S curve What happens to it in each
Input Prices …shifts the S curve of the following scenarios?
A. Retailers cut the price of
Technology …shifts the S curve
the software.
# of Sellers …shifts the S curve B. A technological advance
Expectations …shifts the S curve allows the software to be
produced at lower cost.
C. Professional tax return preparers raise the
price of the services they provide.
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ACTIVE LEARNING 2 ACTIVE LEARNING 2

A. Fall in price of tax return software B. Fall in cost of producing the software
Price of Price of
tax return S curve does tax return S curve shifts
S1 S1 S2
software not shift. software to the right:
Move down at each price,
P1 P1
along the curve Q increases.
P2 to a lower P
and lower Q.

Q2 Q1 Quantity of tax Q1 Q2 Quantity of tax

return software return software
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ACTIVE LEARNING 3 Supply and Demand Together

C. Professional preparers raise their price
Price of P
tax return D S Equilibrium:
S1 This shifts the
software P has reached
demand curve for
the level where
tax preparation
software, not the
quantity supplied
supply curve. equals
quantity demanded

Quantity of tax Q
return software
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Equilibrium price: Equilibrium quantity:

the price that equates quantity supplied the quantity supplied and quantity demanded
with quantity demanded at the equilibrium price
P P
D S D S
P QD QS P QD QS
$0 24 0 $0 24 0
1 21 5 1 21 5
2 18 10 2 18 10
3 15 15 3 15 15
4 12 20 4 12 20
5 9 25 5 9 25
6 6 30 6 6 30
Q Q

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Surplus (a.k.a. excess supply): Surplus (a.k.a. excess supply):

when quantity supplied is greater than when quantity supplied is greater than
quantity demanded quantity demanded
P Example: P
D Surplus S D Surplus S Facing a surplus,
If P = $5, sellers try to increase
then sales by cutting price.
QD = 9 lattes This causes
and QD to rise and QS to fall…
QS = 25 lattes
…which reduces the
resulting in a surplus.
surplus of 16 lattes
Q Q

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Surplus (a.k.a. excess supply): Shortage (a.k.a. excess demand):

when quantity supplied is greater than when quantity demanded is greater than
quantity demanded quantity supplied
P P
D Surplus S Facing a surplus, D S Example:
sellers try to increase If P = $1,
sales by cutting price. then
This causes QD = 21 lattes
QD to rise and QS to fall. and
Prices continue to fall QS = 5 lattes
until market reaches resulting in a
equilibrium. shortage of 16 lattes
Q Shortage Q

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Shortage (a.k.a. excess demand): Shortage (a.k.a. excess demand):

when quantity demanded is greater than when quantity demanded is greater than
quantity supplied quantity supplied
P P
D S Facing a shortage, D S Facing a shortage,
sellers raise the price, sellers raise the price,
causing QD to fall causing QD to fall
and QS to rise, and QS to rise.
…which reduces the Prices continue to rise
shortage. until market reaches
equilibrium.
Shortage Shortage
Q Q

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Equilibrium Three Steps to Analyzing Changes in Eq’m

 In most free markets, surpluses and shortages
are only temporary because prices eventually
move toward their equilibrium levels. Indeed, this
phenomenon is so pervasive that it is called the
law of supply and demand: The price of any
good adjusts to bring the quantity supplied and
quantity demanded of that good into balance.
To determine the effects of any event,
1. Decide whether event shifts S curve,
D curve, or both.
2. Decide in which direction curve shifts.
3. Use supply-demand diagram to see
how the shift changes eq’m P and Q.

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EXAMPLE: The Market for Hybrid Cars EXAMPLE 1: A Shift in Demand

EVENT TO BE
P ANALYZED: P
price of
S1 Increase in price of gas. S1
hybrid cars
STEP 1: P2
D curve shifts
P1 because
STEP 2: price of gas P1
affects demand for
D shifts right
hybrids.
because
STEP high gas
3: does
D1 S curve not
price makes hybrids D1 D2
The
shift,shift causes an
Q more because
attractiveprice Q
Q1 increase
of gas does in price
not cars. Q1 Q2
relative to other
and quantity
affect cost of of
quantity of
hybrid cars.
producing hybrids.
hybrid cars
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EXAMPLE 1: A Shift in Demand Terms for Shift vs. Movement Along Curve
 Change in supply: a shift in the S curve
Notice: P occurs when a non-price determinant of supply
When P rises,
S1 changes (like technology or costs)
producers supply
a larger quantity P2  Change in the quantity supplied:
of hybrids, even a movement along a fixed S curve
though the S curve P1 occurs when P changes
has not shifted.
 Change in demand: a shift in the D curve
Always be careful occurs when a non-price determinant of demand
D1 D2
to distinguish b/w changes (like income or # of buyers)
a shift in a curve Q
Q1 Q2  Change in the quantity demanded:
and a movement
along the curve. a movement along a fixed D curve
occurs when P changes
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EXAMPLE 2: A Shift in Supply EXAMPLE 3: A Shift in Both Supply

EVENT: New technology EVENTS: and Demand
reduces cost of P price of gas rises AND P
producing hybrid cars. S1 S2 new technology reduces S1 S2
STEP 1: production costs
S curve shifts STEP 1: P2
because Both curves shift.
STEP 2: event affects P1 P1
cost of production. STEP 2:
S shifts right P2
D curve does not Both shift to the right.
because
STEPbecause
3: event
shift,
reduces cost, D1 STEP 3: D1 D2
The shift causes
production technology Q rises, but effect
makes production Q Q
price
is not to
onefallof the Q1 Q2 on P is ambiguous: Q1 Q2
more profitable at
and quantity
factors to rise.
thatprice.
affect If demand increases more
any given
demand. than supply, P rises.
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EXAMPLE 3: A Shift in Both Supply ACTIVE LEARNING 3

EVENTS: and Demand Shifts in supply and demand
price of gas rises AND P
S1 S2 Use the three-step method to analyze the effects of
new technology reduces
production costs each event on the equilibrium price and quantity of
music downloads.
STEP 3, cont.
P1 Event A: A fall in the price of CDs
But if supply
increases more P2 Event B: Sellers of music downloads negotiate a
than demand, reduction in the royalties they must pay
D1 D2
P falls. for each song they sell.
Q
Q1 Q2 Event C: Events A and B both occur.

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ACTIVE LEARNING 3 ACTIVE LEARNING 3

A. Fall in price of CDs B. Fall in cost of royalties
The market for STEPS The market for
STEPS
P music downloads music downloads
P
1. D curve shifts 1. S curve shifts
S1 S1 S2
2. D shifts left (Royalties are part
P1 of sellers’ costs) P1
3. P and Q both 2. S shifts right
fall. P2 P2
3. P falls,
Q rises.

D2 D1 D1
Q Q
Q2 Q1 Q1 Q2
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ACTIVE LEARNING 3 Exercise

C. Fall in price of CDs and  Use the three-step method to analyze the effects
fall in cost of royalties of each event on the equilibrium price and
quantity of ice cream.
STEPS
 Event A: During one summer, the weather
1. Both curves shift (see parts A & B). is very hot.
2. D shifts left, S shifts right.  Event B: During another summer, a
3. P unambiguously falls. hurricane destroys part of sugarcane crop and
Effect on Q is ambiguous: drives up the price of sugar.
The fall in demand reduces Q,  Event C: Heat wave and the hurricane
the increase in supply increases Q.
occur during the same summer.
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Exercise Exercise

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Exercise Exercise
 Explain each of the following statements using
supply-and-demand diagrams.
a) “When a cold snap hits Florida, the price of orange
juice rises in supermarkets throughout the country.”
b) “When the weather turns warm in New England
every summer, the price of hotel rooms in
Caribbean resorts plummets.”
c) “When a war breaks out in the Middle East, the
price of gasoline rises and the price of a used
Cadillac falls.”

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Exercise: Answer Exercise

Over the past 40 years, technological advances
have reduced the cost of computer chips. How do
you think this has affected the market for
computers? For computer software? For
typewriters?

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Exercise: Answer Exercise

Scientists reveal that eating oranges decreases the
risk of diabetes, and at the same time, farmers use
a new fertilizer that makes orange trees produce
more oranges. Illustrate and explain what effect
these changes have on the equilibrium price and
quantity of oranges.

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CONCLUSION:
How Prices Allocate Resources
 One of the Ten Principles from Chapter 1:
Markets are usually a good way
to organize economic activity.
 In market economies, prices adjust to balance
supply and demand. These equilibrium prices
are the signals that guide economic decisions
and thereby allocate scarce resources.
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CHAPTER SUMMARY
 Besides price, demand depends on buyers’ incomes,
tastes, expectations, the prices of substitutes and
complements, and number of buyers.
If one of these factors changes, the D curve shifts.
 The upward-sloping supply curve reflects the Law of
Supply, which states that the quantity sellers supply
depends positively on the good’s price.
 Other determinants of supply include input prices,
technology, expectations, and the # of sellers.
Changes in these factors shift the S curve.
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CHAPTER SUMMARY
 A competitive market has many buyers and sellers,
each of whom has little or no influence
on the market price.
 Economists use the supply and demand model to
analyze competitive markets.
 The downward-sloping demand curve reflects the
Law of Demand, which states that the quantity
buyers demand of a good depends negatively on
the good’s price.
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CHAPTER SUMMARY
 The intersection of S and D curves determines the
market equilibrium. At the equilibrium price,
quantity supplied equals quantity demanded.
 If the market price is above equilibrium,
a surplus results, which causes the price to fall.
If the market price is below equilibrium,
a shortage results, causing the price to rise.
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CHAPTER SUMMARY

 We can use the supply-demand diagram to

analyze the effects of any event on a market:
First, determine whether the event shifts one or
both curves. Second, determine the direction of
the shifts. Third, compare the new equilibrium to
the initial one.
 In market economies, prices are the signals that
guide economic decisions and allocate scarce
resources.
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