Economics

• 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.)

Shifts in Demand Income Example with Automobiles

• 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 Schedule: a table that Supply Curve: a graphic

shows the quantity demanded for a representation of the relationship
between price and quantity supplied of
certain good or service at a range of
a certain good or service, with price on
prices. the vertical axis and quantity on the
Price (per gallon) Quantity Supplied (millions horizontal axis.
of gallons)

$1.00 800
$1.20 700
$1.40 600
$1.60 550
$1.80 500
$2.00 460
$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
above 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 below 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?