# Understanding Economics

2nd edition by Mark Lovewell and Khoa Nguyen

Chapter 2 Demand and Supply

What Is Demand?
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Demand is a relationship between a product’s price and quantity demanded, or the amounts consumers will purchase at those prices.
• Quantity demanded is the dependent variable • Demand is shown using a schedule or curve. • The law of demand states that price and quantity demanded are inversely related. • Market demand is the sum of quantities demanded at each price by all consumers in a market.

The Demand Curve
Market Demand Curve for Strawberries Market Demand Schedule for Strawberries
Price (\$ per kg) 2.50 2.00 1.50 Price (\$ per kg) Quantity Demanded (millions of kg) 7 9 11 Point on graph a b c
0 1 3 5 7 9 11 13 2.50 2.00 1.50 a b c

D
1.00 0.50

Quantity Demanded (millions of kg per year)

Deriving Market Demand
Figure 2.2, page 31
Your Demand Curve for Strawberries
Price (\$ per kg) 2.50 2.00 1.50

Your Friend’s Demand Curve for Strawberries
Price (\$ per kg) 2.50 2.00 1.50 1.00 0.50 D1

1.00
0.50

D0

0 1 2 3 7 5 6 4 Quantity Demanded (kg per month)

5 0 1 2 3 4 6 7 Quantity Demanded (kg per month)

Price (\$ per kg) 2.50 2.00 1.50

You (D0)

Your Friend (D1) (kg per month)

Market (Dm)

Price (\$ per kg)

Individual and Market Demand Schedules for Strawberries

Market Demand Curve for Strawberries
2.50 2.00 1.50 1.00 0.50 0 1 2 3 4 5 Dm

1 2 3

2 3 4

3 5 7

6

7

Quantity Demanded (kg per month)

All rights reserved. .Changes in Demand (a)  Changes in demand:   are shown by shifts in the demand curve are caused by changes in demand determinants  #s of buyers in the market  Average income  Prices of other products  Consumer Preferences  Consumer expectations about future prices and incomes Copyright © 2002 by McGraw-Hill Ryerson Limited.

3.50 2.Changes in Demand (b) Figure 2.50 D0 D1 0 1 3 5 7 9 11 13 Quantity Demanded (millions of kg per year) Copyright © 2002 by McGraw-Hill Ryerson Limited. page 32 Market Demand Curve for Strawberries Market Demand Schedule for Strawberries Price (\$ per kg) Price (\$ per kg) 2.50 D2 1.00 0.50 2.50 Quantity Demanded (millions of kg) (D2) (D0) (D1) 5 7 9 7 9 11 9 11 13 2. .00 1. All rights reserved.00 1.

(turnips and secondhand suits) Copyright © 2002 by McGraw-Hill Ryerson Limited. an increase causes a leftward demand shift. All rights reserved. an increase causes a rightward demand shift.Demand Determinants (a)  Demand determinants include the following factors:   The number of buyers (an increase causes a rightward demand shift) Income  For normal products.  For inferior products. .

All rights reserved. a rise in the other product’s price causes a rightward demand shift. a rise in the other product’s price causes a leftward demand shift. (DVD player + DVD player console)   Consumer preferences Consumer expectations  Except the price to fall in the future  demand shifts leftwards Copyright © 2002 by McGraw-Hill Ryerson Limited.Demand Determinants (b)  Prices of other products   For substitute products. (butter and margarine) For complementary products. .

Changes in Quantity Demanded (b)  Changes in quantity demanded:   are shown by movements along demand curve are caused by price changes  Figure 2.4. Page 39 Copyright © 2002 by McGraw-Hill Ryerson Limited. . All rights reserved.

00 0.Changes in Quantity Demanded (b) Figure 2. All rights reserved. .00 1.00 1.50 D0 D0 D1 0 5000 6000 0 5000 Quantity Demanded (pairs of skis) Quantity Demanded (pairs of skis) Copyright © 2002 by McGraw-Hill Ryerson Limited.50 1.50 1.00 0.4. page 36 Change in Quantity Demanded Change in Demand Price (\$ per pair of skis) 2.50 a b Price (\$ per pair of skis) 2.

All rights reserved.What Is Supply?  Supply:   is a relationship between a product’s price and quantity supplied is shown using a schedule or curve  The law of supply states there is a direct relationship between price and quantity supplied. . Copyright © 2002 by McGraw-Hill Ryerson Limited.

5. page 35 Market Supply Curve for Strawberries Market Supply Schedule for Strawberries Price Quantity Supplied Points (\$ per kg) (millions of kg) on graph 1.50 2. All rights reserved.00 0.The Supply Curve Figure 2.50 2.00 2.50 1.00 1.50 d e S Price (\$ per kg) 0 1 3 5 7 9 11 13 Quantity Demanded (millions of kg per year) Copyright © 2002 by McGraw-Hill Ryerson Limited. .50 5 9 13 d e f f 2.

All rights reserved. .Changes in Supply (a)  Changes in supply:   are shown by shifts in the supply curve are caused by changes in supply determinants  #s of producers  Recourse prices  State of technology  Changes in nature  Prices of related products  Producer expectations Copyright © 2002 by McGraw-Hill Ryerson Limited.

50 2.50 2.00 0.Changes in Supply (b) Figure 2.50 1.50 S0 S1 (S2) 11 (S0) 13 (S1) 15 7 3 9 5 11 9 1.00 Quantity Supplied (millions of kg) S2 2. . page 36 Market Supply Curve for Strawberries Market Supply Schedule for Strawberries Price (\$ per kg) Price (\$ per kg) 2. All rights reserved.50 0 1 3 5 7 9 11 13 15 Quantity Demanded (millions of kg per year) Copyright © 2002 by McGraw-Hill Ryerson Limited.6.00 1.

All rights reserved.Supply Determinants (a)  Supply determinants include the following factors:     Number of producers (an increase causes a rightward supply shift) Resource prices (an increase causes a leftward supply shift) State of technology (an improvement causes a rightward supply shift) Prices of related products (an increase causes a leftward supply shift) Copyright © 2002 by McGraw-Hill Ryerson Limited. .

All rights reserved.Supply Determinants (b)   changes in nature (an improvement causes a rightward shift for some products) producer expectations (an expectation of lower prices in the future causes an immediate rightward supply shift) Copyright © 2002 by McGraw-Hill Ryerson Limited. .

Changes in Quantity Supplied (a)  Changes in quantity supplied:   are shown by movements along the supply curve are caused by price changes Copyright © 2002 by McGraw-Hill Ryerson Limited. . All rights reserved.

. All rights reserved.7. page 38 Change in Quantity Supplied 120 100 a S0 b 120 100 Change in Supply S0 S1 Price (\$ per kg) 80 60 Price (\$ per kg) 1 80 60 40 20 40 20 0 2 0 1 2 Quantity Demanded (millions of kg per year) Quantity Demanded (millions of kg per year) Copyright © 2002 by McGraw-Hill Ryerson Limited.Changes in Quantity Supplied (b) Figure 2.

Market Equilibrium (a)  When a product is in surplus:   there is excess supply price is pushed down there is excess demand price is pushed up  When a product is in shortage:   Copyright © 2002 by McGraw-Hill Ryerson Limited. All rights reserved. .

00 1. All rights reserved.Market Equilibrium (b) Figure 2.50 2.00 2.00 1.00 5 7 9 11 13 13 11 9 7 5 +8 +4 0 -4 -8 a D 0 1 9 11 13 15 5 7 Quantity (millions of kg per year) 3 Copyright © 2002 by McGraw-Hill Ryerson Limited.00 a Shortage S Surplus Price (\$ per kg) Quantities (millions of kg) D S b e b 3. page 39 Market Demand and Supply Schedules for Strawberries Surplus (+) or Shortage (-) (millions of kg) Market Demand and Supply Curves for Strawberries 3. .8.50 1.50 Price (\$ per kg) 2.50 1.00 2.

All rights reserved. . A leftward supply shift pushes equilibrium price up and equilibrium quantity down. A rightward supply shift pushes equilibrium price down and equilibrium quantity up.Changes in Equilibrium     A rightward demand shift pushes up both equilibrium price and quantity. Copyright © 2002 by McGraw-Hill Ryerson Limited. A leftward demand shift pushes down both equilibrium price and quantity.

All rights reserved.00 1.00 2. page 40 Market Demand and Supply Curves for Strawberries Market Demand and Supply Schedules for Strawberries Price (\$ per kg) Price (\$ per kg.9.50 1.Demand Changes and Equilibrium Figure 2.50 2.50 1.) 3.00 2. .00 1.00 Quantities (D0) (D1) (S) (millions of kg) 5 9 13 11 9 7 5 S 3.50 2.00 a b 7 9 11 13 15 17 shortage D0 D1 11 13 0 1 3 5 7 9 11 13 15 17 Quantity (millions of kg per year) Copyright © 2002 by McGraw-Hill Ryerson Limited.

00 2. All rights reserved.10.00 b 1.50 a 2.50 1.00 1.00 D0 Surplus S1 7 9 11 9 7 5 11 13 0 1 3 5 7 9 11 13 15 17 Quantity (millions of kg per year) Copyright © 2002 by McGraw-Hill Ryerson Limited.50 2.00 Quantities (D0) (S0) (S1) (millions of kg) 5 13 17 15 13 11 9 S0 3. page 43 Market Demand and Supply Curves for Strawberries Market Demand and Supply Schedules for Strawberries Price (\$ per kg) Price (\$ per kg) 3.00 2. .Supply Changes and Equilibrium Figure 2.50 1.

Spoilt for Choice  William Stanley Jevons:    assumed measurable utility outlined the law of diminishing marginal utility which states that a consumer’s marginal utility declines as more of a product is consumed this law can be shown by deriving the downward-sloping marginal utility graph for a given consumer and product. . All rights reserved. based on that consumer’s total utility graph Copyright © 2002 by McGraw-Hill Ryerson Limited.

All rights reserved. page 47 Consumer’s Total and Marginal Utility From Cappuccino Quantity Consumed (cups) 0 1 2 Total Utility (utils) 0 12 20 (a) (b) (c) Marginal Utility (utils) 12 8 4 2 (f) (g) (h) (i) Total Utility 28 24 c d e Utility (utils) 20 16 12 8 b 3 4 24 26 (d) (e) 4 0 a 2 1 3 Cups of Cappuccino 4 Marginal Utility Utility (utils) 16 12 8 4 0 f g h 2 1 3 Cups of Cappuccino i 4 Copyright © 2002 by McGraw-Hill Ryerson Limited.Spoilt for Choice (b) Figure A. .

The Utility-Maximizing Rule  Jevons devised the utility-maximizing rule   this rule states a consumer should reach the same marginal utility per dollar for all products consumed in mathematical terms: MU1 MU2 = P1 P2 Copyright © 2002 by McGraw-Hill Ryerson Limited. . All rights reserved.

. page 47 Cups of Cappuccino (price = \$1) Quantity Marginal Marginal Utility Utility (MU) per \$ (MU/P1=MU/\$1) (utils) (utils) 12 8 4 2 12 8 4 2 Danish Pastries (price = \$2) Quantity Marginal Marginal Utility Utility (MU) per \$ (MU/P1=MU/\$2) (utils) (utils) 16 12 8 4 8 6 4 2 0 1 2 3 4 0 1 2 3 4 Cappuccinos Marginal Utility Per \$ (utils) Marginal Utility Per \$ (utils) 12 8 4 0 2 1 3 Cups of Cappuccino 4 12 8 4 0 Danish Pastries 2 1 3 Cups of Cappuccino 4 Copyright © 2002 by McGraw-Hill Ryerson Limited.Spoilt for Choice (c) Figure B. All rights reserved.

Indifference Curves    Using indifference curves. . consumer preferences can be shown without the need to assume measurable utility An individual consumers must merely rank his/her options for various bundles of two products in order of preference A consumer may prefer one bundle to another. or be indifferent between the two Copyright © 2002 by McGraw-Hill Ryerson Limited. All rights reserved.

all points to the northeast provide more utility and all points to the southwest provide less utility Copyright © 2002 by McGraw-Hill Ryerson Limited. The curve is downward-sloping because.An Indifference Curve (a)   An indifference curve shows all bundles of two goods to which a particular consumer is indifferent. . All rights reserved. for any point on the curve.

All rights reserved. Alice derives the same level of utility. b 4 3 2 1 3 4 7 12 a b c d 2 1 c d I0 4 8 12 0 Hamburgers Copyright © 2002 by McGraw-Hill Ryerson Limited. page 50 Alice’s Indifference Curve Alice’s Indifference Schedule Milkshakes Milkshakes Hamburgers point on graph 4 3 a At each point on the curve.An Indifference Curve (b) Figure A. .

The Marginal Rate of Substitution   The absolute value of an indifference curve’s slope is the marginal rate of substitution (MRS). All rights reserved. An indifference curve is convex. . since the curve’s MRS diminishes as more of the product on the horizontal axis (hamburgers). and less on the vertical axis (milkshakes) is consumed. Copyright © 2002 by McGraw-Hill Ryerson Limited.

as hamburger consumption rises. more hamburgers must be gained to make the consumer willing to sacrifice another milkshake Copyright © 2002 by McGraw-Hill Ryerson Limited.The Diminishing Marginal Rate of Substitution  The diminishing marginal rate of substitution occurs because. . All rights reserved.

All rights reserved. . with each indifference curve further to the northeast representing a higher level of utility Copyright © 2002 by McGraw-Hill Ryerson Limited.A Map of Indifference Curves (a)  A map of indifference curves can be drawn for an individual consumer.

4 Milkshakes 3 2 1 I0 4 8 12 I1 I2 0 Hamburgers Copyright © 2002 by McGraw-Hill Ryerson Limited. All rights reserved. page 51 A Map of Indifference Curves Each curve shows points that give different levels of utility for Alice. .A Map of Indifference Curves (b) Figure B.

All rights reserved.The Budget Line (a)  A consumer’s budget line:    is drawn based on the assumption that all the consumer’s budget is spent on hamburgers and milkshakes has a vertical intercept equal to the consumer’s budget divided by the price of milkshakes a horizontal intercept equal to the consumer’s budget divided by the price of hamburgers Copyright © 2002 by McGraw-Hill Ryerson Limited. .

The Budget Line (b)   has a slope whose absolute value equals the ratio of the two prices (the price of hamburgers divided by the price of milkshakes) divides the graph into an attainable region southwest of the line. and an unattainable region northeast of the line Copyright © 2002 by McGraw-Hill Ryerson Limited. . All rights reserved.

page 52 Alice’s Budget Curve Alice’s Budget Line 5 Milkshakes Hamburgers 5 4 3 0 2 4 4 The budget curve shows all those points Alice can reach with her limited budget. \$15/\$3 Milkshakes 3 2 1 \$15/\$1. . All rights reserved.50 2 1 0 6 8 10 0 4 8 10 12 Hamburgers Copyright © 2002 by McGraw-Hill Ryerson Limited.The Budget Line (c) Figure C.

This utility-maximizing point occurs on the indifference curve that just touches the budget line at a single point.The Utility-Maximizing Point (a)   The consumer maximized utility by reaching the highest possible indifference curve on the budget line. Copyright © 2002 by McGraw-Hill Ryerson Limited. All rights reserved. .

page 51 5 4 Milkshakes b (4. 3) 3 2 Alice’s greatest achievable utility is on the indifference curve which touches her budget line at a single point. 1 I0 8 10 12 0 4 Hamburgers Copyright © 2002 by McGraw-Hill Ryerson Limited.The Utility-Maximizing Point (b) Figure D. All rights reserved. .

Copyright © 2002 by McGraw-Hill Ryerson Limited. .Deriving a Demand Curve (a)  The consumer’s demand curve for hamburgers can be found by tracing out the results of a change in the price of hamburgers given a constant money budget and price for milkshakes. All rights reserved.

Deriving a Demand Curve (b) Figure E. 53 A decline in the price of hamburgers from \$1.50 D 0 4 8 I1 I0 0 4 8 10 12 15 12 Hamburgers Quantity (hamburgers per week) Copyright © 2002 by McGraw-Hill Ryerson Limited.00 . as shown by her demand curve D.50 to \$1 causes Alice’s quantity demanded to rise from 4 to 6. p.50 Milkshakes 3 2 1 b e (6. All rights reserved.3) 1. Price (\$ per hamburger 5 4 1. .

All rights reserved. .Understanding Economics 2nd edition by Mark Lovewell Chapter 2 The End Copyright © 2002 by McGraw-Hill Ryerson Limited.