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.)

Income Example with Automobiles

Shifts in Demand
• 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 Curve: a graphic representation
Supply Schedule: a table that of the relationship between price and
shows the quantity demanded for a quantity supplied of a certain good or
certain good or service at a range of service, with price on the vertical axis and
quantity on the horizontal axis.
prices.
Price (per gallon) Quantity Supplied
(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?