Chapter 3 Supply and Demand 2017 Worth Publishers

Outline • The Demand Curve for Oil • Consumer Surplus • What Shifts the Demand Curve? • The Supply Curve for Oil • Producer Surplus • What Shifts the Supply Curve? • Takeaway 3 -2

Introduction • Supply, demand, and the idea of equilibrium are the most important tools in economics. • They explain how prices are determined. • Changes in demand supply can plunge an economy into recession or set off a boom. 3 -3

Definition Demand Curve: A function that shows the quantity demanded at different prices. Quantity Demanded: The quantity that buyers are willing and able to buy at a particular price. 3 -4

Demand for Oil Demand • • Price Quantity Demanded $55 5 $20 25 $5 50 Quantity Demanded This table shows demand for oil—the quantities demanded at different prices. The data can be used to construct a demand curve. 3 -5

Demand Curve Priceofofoil per perbarrel Price Quantity Demanded $55 5 $20 25 $5 50 Quantity of oil (MBD) 3 -6

Reading a Demand Curve A Demand Curve Can Be Read: • Horizontally: At a given price, how much are people willing to buy? • Vertically: What are people willing to pay for a given quantity? 3 -7

Reading a Demand Curve HORIZONTAL: At $20 per barrel, buyers are willing to buy 25 m barrels of oil per day. 3 -8

Reading a Demand Curve VERTICAL: The maximum price that buyers are willing to pay to purchase 25 m barrels per day is $20 per barrel. 3 -9

Self-Check What quantity is demanded at $15? a. 10. b. 50. c. 75. $15 Answer: b. 50 3 -10

Self-Check At what price would 100 be demanded? a. $5. b. $1. c. $10. $5 Answer: a. $5 3 -11

Law of Demand • A demand curve is negatively sloped. • Show the relation between price and qty demanded • The lower the price, the greater the quantity demanded. • Demand summarizes how consumers choose to use a good, given: • their preferences • the possibilities for substitution. • NOTE: a demand curve assumes that all other factors (like income, etc) are constant 3 -12

Law of Demand • Consumers will buy more oil at lower prices than at higher prices. • When the price is high, consumers will use it only in its most valuable uses. 3 -13

Law of Demand • As the price falls, consumers will also use oil in its less valued uses (heating and rubber duckies). 3 -14

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Definition Consumer Surplus: The consumer’s gain from exchange; difference between the maximum price a consumer is willing to pay for a certain quantity and the market price. Total Consumer Surplus: The area beneath the demand curve and above the price. 3 -16

Consumer Surplus Total consumer surplus with a linear demand curve 3 -17

Self-Check What is total consumer surplus if market price is $10? a. $500. b. $700. c. $1400. 70 × ($30 – $10) 2 Answer: b. $700 70 3 -18

Shifting the Demand Curve • An increase in demand shifts the demand curve to the right. • At each price, people are willing to buy more. • At each quantity, people are willing to pay a higher price. 3 -19

Shifting the Demand Curve Price of oil/barrel An Increase in Demand Willing to pay a higher price for same quantity. $50 Willing to buy more at the same price. $25 New Demand Old Demand 0 70 140 Quantity of Oil (MBD) 3 -20

Shifting the Demand Curve • Decrease in demand—shifts the demand curve to the left. • At each price, people are willing to buy less. • At each quantity, people are willing to pay a lower price. 3 -21

Shifting the Demand Curve Price of oil/barrel A Decrease in Demand Willing to buy less at the same price. $50 Willing to pay a lower price for the same quantity $25 Old Demand New Demand 0 62 74 Quantity of Oil (MBD) 3 -22

Demand Shifters Factors That Shift Demand: 1. 2. 3. 4. 5. 6. Income Population Price of substitutes Price of complements Expectations Tastes 3 -23

Demand Shifters 1. Income • When people get richer, they buy more stuff. • When an increase in income increases the demand for a good, it is a normal good. • Most goods are normal goods. • When an increase in income decreases the demand for a good, it is an inferior good. 3 -24

Inferior Goods 25

Self-Check If i. Pads are a normal good, when incomes increase, the demand curve for i. Pads will: a. Shift to the right. b. Shift to the left. c. Not change. Answer: a. Higher incomes increase demand for a normal good, shifting the demand curve to the right. 3 -26

Demand Shifters 2. Population • An increase in population will increase demand generally. • A shift in subpopulations will change the demand for specific goods and services. 3 -27

Demand Shifters 3. Prices of Substitutes • A substitute is a good that can be consumed instead of another good. • A decrease in the price of a substitute will decrease demand for the other good. • Examples: • Butter vs margarine • Coke vs Pepsi • Home ownership vs renting 3 -28

Self-Check If orange juice and apple juice are substitutes, an increase in the price of orange juice will: a. Increase demand for apple juice. b. Decrease demand for apple juice. c. Not affect demand for apple juice. Answer: a. Increase demand for apple juice. A higher price for orange juice will cause some people to substitute the now lower-priced apple juice. This increases the demand for apple juice. 3 -29

Demand Shifters 4. Prices of Complements • Complements are things that go well together. • A drop in the price of a complement increases demand for the complementary good. • Examples: • Smart phones and cell phone service providers • Cars and gasoline • DVD players and DVD disks 3 -30

Demand Shifters 5. Expectations • The expectation of a reduction in future supply increases the demand today. 6. Tastes • Changes in tastes caused by fads, fashions, and advertising can all increase or decrease demand. 3 -31

Supply Curve Price of oil per barrel Price Quantity Supplied $55 50 $20 30 $5 10 Quantity of oil (MBD) 3 -32

Reading a Supply Curve A Supply Curve Can Be Read: • Horizontally: At a given price, how much are suppliers willing to sell? • Vertically: To produce a given quantity, what price must sellers be paid? 3 -33

Definition Supply Curve: A function that shows the quantity supplied at different prices. Quantity Supplied: The quantity that sellers are willing and able to sell at a particular price. 3 -34

Law of Supply Photos: 24 Novembers/Shutterstock • As the price of oil rises, it becomes profitable to extract from more costly sources. • As the price rises, the quantity supplied increases. 3 -35

Self-Check At what price will producers be willing to supply 50 units? a. $10. b. $20. c. $30. Answer: a. $10 3 -36

Definition Producer Surplus: The producer’s gain from exchange, or the difference between the market price and the minimum price at which a producer would be willing to sell a particular quantity. Total Producer Surplus: The area above the supply curve and below the price. 3 -37

Producer Surplus 3 -38

Shifting the Supply Curve • Increase in Supply—shifts the supply curve to the right. • At each price producers are willing to sell more. • At each quantity, producers are willing to accept a lower price 3 -39

Shifting the Supply Curve Price of oil/barrel Increase in supply $60 Old supply New supply Greater quantity supplied at the same price 40 Willing to accept a lower price for the same quantity 18 0 60 80 Quantity of Oil (MBD) 3 -40

Shifting the Supply Curve • Decrease in supply—shifts the supply curve to the left. • At each price sellers will offer less. • At each quantity, sellers demand a higher price. 3 -41

Shifting the Supply Curve Price of oil/barrel Decrease in supply New supply Old supply $50 Higher price required for the same quantity $28 Smaller quantity supplied at the same price 20 60 Quantity of Oil (MBD) 3 -42

Supply Shifters Factors That Shift Supply: 1. Technological innovations and changes in the price of inputs 2. Taxes and subsidies 3. Expectations 4. Entry or exit of producers 5. Changes in opportunity costs 3 -43

Supply Shifters 1. Technological Innovations • Improvements in technology can reduce costs, thus increasing supply. • A reduction in input prices also reduces costs and thus has a similar effect. • Examples: computers, TVs, cars, etc 3 -44

Supply Shifters 2. Taxes and Subsidies • A tax on output has the same effect as an increase in costs. • A subsidy is the reverse of a tax. 3 -45

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Supply Shifters 3. Expectations • Suppliers who expect prices to increase will store goods for future sale and sell less today. • The expectation of a future price increase therefore decreases current supply. • Supply curve shifts to the left. 3 -47

Supply Shifters 4. Entry or Exit of Producers • The entry of new producers increases supply, shifting the curve down and to the right. 3 -48

Supply Shifters 5. Changes in Opportunity Costs • An increase in opportunity costs shifts the supply curve up and to the left. • If the price of wheat increases, the opportunity cost of growing soybeans increases. • Some farmers will shift away from producing soybeans and start producing wheat. 3 -49

Supply Shifters 5. Changes in Opportunity Costs • The supply curve for soybeans will shift up and to the left. 3 -50

Self-Check Suppose a new technology reduces the time it takes to assemble a car. How would this affect the supply of cars? a. Shift supply to the right. b. Shift supply to the left. c. It would have no effect on supply. Answer: a. Producers would be able to supply more cars at the current price, shifting the supply curve to the right. 3 -51

Are We Ever Going to Run Out of Oil? • What does the supply curve concept tell us about this? • http: //youtu. be/Ac. Wk. N 4 ng. R 2 Y • Example: copper vs fiber optics 52

Takeaway • A demand curve shows how customers respond to higher prices by buying less, and to lower prices by buying more. • A supply curve shows how producers respond to higher prices by producing more, and to lower prices by producing less. • The difference between market price and the maximum a consumer is willing to pay is the consumer’s gain from exchange, or consumer surplus. 3 -53

Takeaway • The difference between market price and the minimum price that a producer is willing to accept is the producer’s gain from exchange, or producer surplus. • An increase in demand means that buyers want a greater quantity at the same price or, equivalently, they are willing to pay a higher price for the same quantity. 3 -54

Takeaway • An increase in supply means that sellers are willing to sell a greater quantity at the same price or, equivalently, they are willing to sell a given quantity at a lower price. 3 -55