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Understanding Economics

6th edition
by Mark Lovewell

Copyright 2012 by McGraw-Hill Ryerson


Limited. All rights reserved.

Understanding Economics
6th edition
by Mark Lovewell

Chapter 2
Demand and Supply
Copyright 2012 by McGraw-Hill Ryerson Limited. All rights reserved.

Learning Objectives
After this chapter, you will be able to:
1. comprehend the nature of demand, changes in

quantity demanded, changes in demand, and the


factors that affect demand
2. understand the nature of supply, changes in
quantity supplied, changes in supply, and the
factors that affect supply
3. explain how markets reach equilibrium the point
at which demand and supply meet

Copyright 2012 by McGraw-Hill Ryerson


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What Is Demand?

Demand is a relationship between a products


price and quantity demanded.
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 by all consumers in a market.

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The Demand Curve


Figure 2.1, page 34

Your Demand Curve for Strawberries


Your Demand Schedule
for Strawberries
Point
on
graph

$2.50

2.00

1.50

11

Price ($ per kg)

Quantity
Demanded
(kg per month)

Price
($ per kg)

2.50

2.00

1.50

D
1.00
0.50

11

Quantity Demanded
(kg per month)

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13

Deriving Market Demand


Your Demand Curve for Strawberries

Friends Demand Curve for Strawberries

Price ($ per kg)

Price ($ per kg)

Figure 2.2, page 36


2.00
1.50
1.00

D0

0.50

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

Individual and Market Demand


Schedules for Strawberries
Price

You

Friend

Market

($ per
kg)

(D0)

(D1)

(Dm)

$2.50
2.00
1.50

(kg per month)


1
2
3

2
3
4

3
5
7

2.50
2.00
1.50
1.00

D1

0.50

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

Market Demand Curve for Strawberries


Price ($ per kg)

2.50

2.50
2.00
1.50
1.00

Dm

0.50
0

Quantity Demanded (kg per month)

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Changes in Demand (a)

Changes in demand:
are shown by shifts in the demand curve
are caused by changes in demand factors

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Changes in Demand (b)


Figure 2.3, page 37

Market Demand Curve for Strawberries


Market Demand Schedule
for Strawberries

$2.50
2.00
1.50

Quantity Demanded
(millions of kg)
(D2)
(D0)
(D1)
5
7
9

7
9
11

9
11
13

Price ($ per kg)

Price
($ per
kg)

2.50
2.00
1.50

D2

1.00

D0

D1

0.50

11

13

Quantity Demanded
(millions of kg per year)

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Demand Factors (a)

Demand factors include the following:


The number of buyers (an increase causes a

rightward demand shift)


Income
For normal products, an increase causes a rightward
demand shift.
For inferior products, an increase causes a leftward
demand shift.

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Demand Factors (b)

Prices of other products


For substitute products, a rise in the other

products price causes a rightward demand


shift.
For complementary products, a rise in the other
products price causes a leftward demand shift.

Consumer preferences
Consumer expectations

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Changes in Quantity
Demanded (a)

Changes in quantity demanded:


are shown by movements along demand curve
are caused by price changes

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Changes in Quantity Demanded (b)


Figure 2.4, page 39

2.00

a
b

1.50
1.00

D0

0.50

Change in Demand

Price ($ per pair of skis)

Price ($ per pair of skis)

Change in Quantity Demanded

2.00
1.50
1.00

D0

0.50

5000 6000
Quantity Demanded (pairs of skis)

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D1

5000
Quantity Demanded (pairs of skis)

What Is Supply?

Supply:
is a relationship between a products 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.

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The Supply Curve


Figure 2.5, page 41

Market Supply Curve for Strawberries


Market Supply Schedule
for Strawberries

Price Quantity Supplied Points


($ per kg) (millions of kg) on graph
$2.50

13

2.00

1.50

Price ($ per kg)

2.50

2.00

1.50
1.00
0.50

11

13

Quantity Supplied
(millions of kg per year)

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Changes in Supply (a)

Changes in supply:
are shown by shifts in the supply curve
are caused by changes in supply factors

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Changes in Supply (b)


Figure 2.6, page 42

Market Supply Curve for Strawberries


S2

Market Supply Schedule


for Strawberries

$2.50

11

13

15

2.00

11

1.50

2.50

Price ($ per kg)

Price
Quantity Supplied
($ per
(millions of kg)
kg) (S )
(S0)
(S1)
2

S0 S1

2.00
1.50
1.00
0.50

11

13

Quantity Supplied
(millions of kg per year)

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15

Supply Factors (a)

Supply factors include the following:


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)

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Supply Factors (b)


Changes in nature (for some products, an

improvement causes a rightward supply shift)


Producer expectations (an expectation of lower
prices in the future causes an immediate
rightward supply shift)

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Changes in Quantity Supplied (a)

Changes in quantity supplied:


are shown by movements along the supply

curve
are caused by price changes

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Changes in Quantity Supplied (b)


Figure 2.7, page 44

Change in Quantity Supplied


S0

120

Price ($ per kg)

Price ($ per kg)

100

80
60
40
20
1

S0

120

100

Change in Supply

Quantity Supplied
(millions of kg per year)

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80
60
40
20

Quantity Supplied
(millions of kg per year)

S1

Market Equilibrium (a)

When a product is in surplus:


there is excess supply
price is pushed down

When a product is in shortage:


there is excess demand
price is pushed up

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Market Equilibrium (b)


Figure 2.8, page 46

Market Demand and Supply Curves


for Strawberries

Market Demand and Supply


Schedules for Strawberries

Quantities

Price (millions of kg)


($ per D
S
kg)

$3.00

13

13

2.50

11

11

2.00

1.50

11

1.00

13

Surplus

2.50
Price ($ per kg)

Surplus (+)
or Shortage
(-)
(millions of
kg)

3.00
a

a
e

2.00

1.50

Shortage

1.00

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9 11 13 15
5
7
Quantity
(millions of kg per year)
3

Changes in Equilibrium
(a)

A rightward demand shift pushes up both


equilibrium price and quantity.
A leftward demand shift pushes down both
equilibrium price and quantity.
A rightward supply shift pushes equilibrium
price down and equilibrium quantity up.
A leftward supply shift pushes equilibrium
price up and equilibrium quantity down.

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Demand Changes and


Equilibrium
Market Demand and Supply Curves
Figure 2.9, page 47

for Strawberries
3.00

Price

2.50

Quantities
(D1) (S)
(millions of kg)

(D0)
($ per kg.)
$3.00

13

2.50

11

11

2.00

13

1.50

11

15

1.00

13

17

Price ($ per kg)

Market Demand and Supply


Schedules for Strawberries

b
a

2.00
1.50

shortage

1.00

D0

11 13 15

Quantity
(millions of kg per year)
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D1

17

Supply Changes and


Equilibrium
Market Demand and Supply Curves
Figure 2.10, page 48

for Strawberries
3.00

Price

2.50

($ per kg)

Quantities
(S0)
(S1)
(millions of kg)

(D0)

$3.00

13

17

2.50

11

15

2.00

13

1.50

11

11

1.00

13

Price ($ per kg)

Market Demand and Supply


Schedules for Strawberries

S0

S1

Surplus
a

2.00
b

1.50
1.00

D0

11 13 15

Quantity
(millions of kg per year)
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17

Changes in Equilibrium
(b)

A simultaneous rightward shift in demand and


supply raises equilibrium quantity, but the
effect on equilibrium price depends on the
relative sizes of the two shifts.
if demand shifts rightward more than supply,
then price rises
if supply shifts rightward more than demand,
then price falls

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Effects of Increases in Demand and


Supply
Market Demand and Supply Curves
Figure 2.11 page 49

for Strawberries

Market Demand and Supply


Schedules for Strawberries

$3.00

13

17

2.50

11

11

15

2.00

13

13

1.50

11

15

11

1.00

13

17

Price ($ per kg)

Price
Quantities
(D0) (D1) ( S0) (S1)
($ per kg.)
(millions of kg)

3.00
2.50

S0

S1

2.00
1.50
1.00

D0

11 13 15

Quantity
(millions of kg per year)
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D1

17

Changes in Equilibrium
(c)

A simultaneous rightward shift in demand and


leftward shift in supply raises equilibrium
price, but the effect on equilibrium quantity
depends on the relative sizes of the two shifts.
if supply shifts leftward more than demand
shifts rightward, then quantity falls
if demand shifts rightward more than supply
shifts leftward, then quantity rises

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Effects of a Demand Increase and


Supply Decrease
Market Demand and Supply Curves
Figure 2.12 page 50

for Strawberries

Market Demand and Supply


Schedules for Strawberries

$3.00

13

11

2.50

11

2.00

11

1.50

11

13

1.00

13

15

3.00

Price ($ per kg)

Price
Quantities
(D0) (D1) ( S0) (S1)
($ per kg.)
(millions of kg)

S0

2.50
2.00
a
1.50
1.00

D0 D1

11 13 15

Quantity
(millions of kg per year)
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17

Spoilt for Choice

William Stanley Jevons:


assumed measurable utility
outlined the law of diminishing marginal utility,

which states that a consumers marginal utility


declines as more of a product is consumed
showed how this law can be illustrated using
the downward-sloping marginal utility graph for
a given consumer and product, based on that
consumers total utility graph

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Spoilt for Choice (b)


Figure A, page 57

Total Utility

Consumers Total and Marginal


Utility From Cappuccino
Total
Utility
(utils)
0

Margina
l
Utility
(utils)

(a)

12 (b)

20

24 (d)

26 (e)

12

(f)

(g)

(h)

(i)

(c)

Utility (utils)

Marginal Utility
12
8
4
0

f
g
h

2
1
3
Cups of Cappuccino

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20
16

12
8
4
0

16

24
Utility (utils)

Quantity
Consume
d
(cups)
0

28

a
2
1
3
Cups of Cappuccino

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

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Spoilt for Choice (c)


Figure B, page 58

Cups of Cappuccino
(price = $1)

Danish Pastries
(price = $2)

Quantity Margina
Marginal
l
Utility
Utility
per $
(MU1) (MU1/P1=MU1/$1)
(utils per $)
(utils)
0
12
12
1
8
8
2
4
4
3
2
2
4

Quantity Margina
Marginal
l
Utility
Utility
per $
(MU2) (MU2/P2=MU2/$2)
(utils per $)
(utils)
0
16
1
12
8
2
8
6
3
4
4
4
2

Danish Pastries

12
8
4
0

2
1
3
Cups of Cappuccino

Marginal Utility
Per $ (utils)

Marginal Utility
Per $ (utils)

Cappuccinos
12
8
4
0

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2
1
Pastries

Through the Ranks (OLC)


Indifference Curves
Using indifference curves, consumer

preferences can be shown without the need to


assume measurable utility.
An individual consumer 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.

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Through the Ranks (OLC)


An Indifference Curve (a)
An indifference curve shows all bundles of two

goods to which a particular consumer is


indifferent.
The curve is downward-sloping because, for
any point on the curve, all points to the
northeast provide more utility and all points to
the southwest provide less utility.

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Through the Ranks (OLC)


An Indifference Curve (b)
Alices Indifference Curve
Alices Indifference Schedule
Point on

4
3

3
4

a
b

12

Milkshakes

Milkshakes Hamburgers
Graph

At each point on
the curve, Alice
derives the same
level of utility.

b
c

I0
4

Hamburgers

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12

Through the Ranks (OLC)


The Marginal Rate of
Substitution
The absolute value of an indifference curves

slope is the marginal rate of substitution


(MRS).
An indifference curve is convex, since the
curves MRS diminishes as more of the
product on the horizontal axis (hamburgers),
and less on the vertical axis (milkshakes) is
consumed.

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Through the Ranks (OLC)


Diminishing Marginal Rate of
Substitution
The diminishing marginal rate of substitution

occurs because, as hamburger consumption


rises, more hamburgers must be gained to
make the consumer willing to sacrifice another
milkshake.

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Through the Ranks (OLC)


A Map of Indifference Curves (a)
A map of indifference curves can be drawn for

an individual consumer, with each indifference


curve further to the northeast representing a
higher level of utility

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Through the Ranks (OLC)


A Map of Indifference Curves (b)
A Map of Indifference Curves
Each curve shows
points that give
different levels
of utility for Alice.

Milkshakes

4
3
2
1

I0
4

12

Hamburgers

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I1

I2

Through the Ranks (OLC)


The Budget Line (a)
A consumers budget line:
is drawn based on the assumption that all the
consumers budget is spent on hamburgers and
milkshakes
has a vertical intercept equal to the consumers
budget divided by the price of milkshakes
has a horizontal intercept equal to the
consumers budget divided by the price of
hamburgers

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Through the Ranks (OLC)


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

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Through the Ranks (OLC)


The Budget Line (c)
Alices Budget Line
Alices Budget Schedule
5
Milkshakes Hamburgers

0
2

10

Milkshakes

The budget curve


shows all those
points Alice
can reach with her
limited budget.

$15/$3

3
2

$15/$1.50

10 12

Hamburgers

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Through the Ranks (OLC)


The Utility-Maximizing Point (a)
The consumer maximizes utility by reaching

the highest possible indifference curve on the


budget line.
This utility-maximizing point occurs on the
indifference curve that just touches the
budget line at a single point.

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Through the Ranks (OLC)


The Utility-Maximizing Point
(b)
Alices greatest
achievable utility
is on the indifference
curve which touches
her budget line at
a single point.

Milkshakes

4
b (4, 3)

3
2
1

I0
4

10

12

Hamburgers

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Through the Ranks (OLC)


Deriving a Demand Curve (a)
The consumers 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.

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Through the Ranks (OLC)


Deriving a Demand Curve (b)
Price ($ per hamburger)

Milkshakes

4
b

e (6,3)

2
I1

1
I0
0

10 12

Hamburgers

15

A decline in the price of


hamburgers from $1.50
to $1 causes Alices quantity
demanded to rise from
4 to 6, as shown by her
demand curve, D.

1.50

1.00
.50
D
0

12

Quantity (hamburgers per week)

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Understanding Economics
66h edition
by Mark Lovewell

Chapter 2
The End
Copyright 2012 by McGraw-Hill Ryerson Limited. All rights reserved.