Chapter 4

Supply and Demand

McGraw-Hill/Irwin
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Learning Objectives

In this chapter youll learn how to:

1.
2.
3.

4.
5.
6.
7.

Define and explain demand in a product or service market.

Define and explain supply.
Determine the equilibrium point in the market for a specific
good, given data on supply and demand at different price
levels.
Explain what causes shifts in demand and supply.
Explain how price ceilings cause shortages.
Explain how price floors cause surpluses.
Apply supply and demand analysis to real world problems.

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Demand

The schedule of quantities of a good or service that

people are willing and able to buy at different prices.

Sometimes a schedule is also called a table.

Demand shows how much quantity of a good or

service can be sold at different prices.

People pay for goods or services according to how

many benefits those goods or services will yield.

Generally less quantity will be demanded as prices

increase since people will find relatively less expensive
substitutes to provide similar levels of benefits.

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Demand Schedule and Curve

Table 1

Price $250

Price

QD

$500

1,000

$500
450

450

3,000

400
350

400
350

7,000
12,000

300

19,000

250

30,000

200

45,000

150

57,000

100

67,000

300
250
200
150
D

100
50
10

20 30 40 50 60 70
Quantity (in thousands)

Quantity 30,000

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Shifts in Demand

A change in the price of a good or service moves us

along a given demand schedule/curve.

Shifts in supply move us along a given demand

schedule/curve.

A change in the demand schedule results in a shift of

the demand schedule/curve.

If consumer preferences change for whatever reason that will

shift the demand curve either outward or inward depending
upon the nature of the change.

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Demand Curve Shift Out

When a demand curve shifts

outward, people are willing to
buy more goods or services
at the same price.
Preferences change and the
product or service is
perceived to yield more
benefits than before.
If scientific studies come out
that show DVDs increase
peoples life expectancy, we
may expect an outward shift.

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Demand Curve Shift In

When a demand curve shifts

inward, people are willing to
buy fewer goods at previous
prices.
Preferences change and the
good or service is perceived
to yield fewer benefits than
before.
If scientific studies
demonstrated those who
consumed pizza had fewer
dates than those who did not,
we could expect an inward
shift of the demand curve.
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Questions for Thought and Discussion

Why do markets show that people demand fewer

goods at higher prices?

What would happen to demand for the various

services and products under the following scenarios?
Will the curve shift and in which direction?

Oprah Winfrey expresses concern about mad cow disease

and beef. What happens to the demand for hamburgers?
The National Institute for Health releases a study that shows
mandarin oranges reduce the probability of getting cancer.
What happens to demand for mandarin oranges?
The manufacturers of Frisbees discover a new, less
expensive polymer to make Frisbees. What happens to the
demand for Frisbees?

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Supply

Is the schedule of quantities of a good or service that

people are willing to sell at different prices.

In general, the higher the price, the more of a good or

service individuals are willing to supply. As price
increases so does quantity provided.

This happens because different producers face

different opportunity costs and as the price increases
or decreases, producing a good or service becomes
more or less attractive to producers at the margins.

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Supply Schedule
Quantity
Supplied is a
point on the
curve

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Shifts in Supply

Changes in the demand schedule (consumer

behavior) moves us along an existing supply schedule
(the market with the producers who could respond
relatively quickly to consumer behavior).

Changes in the cost of factors of production or

increases in productivity shift the supply curve.

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Supply Curve Shift Inwards

When a supply curve shifts

inward, businesses will only
supply what they did before
the shift at higher prices.
As costs change for
businesses, opportunity
costs change.
If the cost of oil hits 100
dollars a barrel, that would
shift the supply curve in and
raise prices for gas
assuming demand remains
the same.

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Supply Shift Outwards

When a supply curve shifts

outwards businesses are
willing to supply the same
amount that they did before
the shift at lower price
levels.
Improvements in
technology, lower resource
costs, or higher factor
productivity can result in
this sort of shift.
If gasoline refiners could
find a good substitute for oil
to produce gasoline that
was less costly, this would
result in an outward shift in
the gasoline supply curve.

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Equilibrium

Equilibrium price is the price at which quantity

demanded equals quantity supplied.

A surplus occurs when the market price is above

equilibrium price.

A shortage occurs when the market price is below

equilibrium price.

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A Picture of Equilibrium

Equilibrium occurs at the

point where supply equals
demand.
In others words, costs for the
marginal producer equal the
benefits of the marginal
consumer.
If price were higher than
equilibrium, more producers
would want to produce goods
or services than consumers
would want to consume.
If the price were lower, more
consumers would want to
consume goods or services
than producers would want to
produce.

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Shifts and Equilibrium

If there are shifts in demand

or supply, a new equilibrium
point will be found on the
basis of new perceived
benefits or changes in costs.

In this instance, a demand

driven increase for iPhones
pushes price up and the
quantity of subscriptions up.

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Questions for Thought and Discussion

Why is equilibrium viewed to be efficient?

What happens if price is not at an equilibrium point?

What do prices represent to producers and

consumers?

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Government and the Market

The government may ensure the smooth operation of

the markets by protecting property rights,
guaranteeing enforcement of legal contracts, and
issuing a supply of money that buyers and sellers
readily accept.

Government sometimes interferes with the free

operation of the markets by

Property rights are essential to a free and prosperous nation.

Imposing prices floors and price ceilings.

This creates the problems of shortages and surpluses.

While governmental interference with the market

system can have adverse affects, the government
does have a substantial supportive role to play in a
market economy.
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Price Floors

Sometimes producers do not

like the price they are getting
for their product.
They may lobby the
government to put in a price
floor.
A price floor results in a
surplus being supplied at the
higher price.
Suppliers end up supplying
more than consumers want to
buy.
Minimum wage is a classic
example of a price floor.

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QE

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Minimum Wage as a Price Floor

If you note, workers want to

supply QS worth of
themselves at $10/hour.

Employers want to hire QD at

that price.

The end result is QD workers

are hired at $10/hour.

Fewer workers are hired with

a price floor than would be
hired under market
equilibrium conditions at a
wage rate of $7/hour.
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Who Benefits and Who Is Hurt by Minimum

Wage

Everybody who would be making $7/hour but is now

getting $10/hour benefits from minimum wage.
Everybody who would have been employed at $7/hour
but is now unemployed at $10/hour is hurt.
Consumers who could have purchased the good or
service produced at a lower price but cannot because
of the higher cost of making the good or service are
hurt.
Most economists generally believe efficiency is a good
thing and distorting the price mechanism that gives us
this efficiency does more harm than good.

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Questions for Thought and Discussion

How do you think price floors for agricultural

commodities would impact the market for these
commodities?

Does the minimum wage help the poor?

How do you think the minimum wage impacts your

life?

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Price Ceilings

Sometimes buyers do not like

the price they need to pay for
a good or service.

Buyers may lobby

government to put a price
cap on what sellers can
charge.

A classic example of a price

ceiling is rent control.

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Rent Control as a Price Ceiling

When rent control is in place

producers can not charge a
price above P1.

At P1 landlords (producers)
are only willing to supply QS
but potential renters want QD
at this price.

A shortage results and

instead of having QE units of
housing rented, only QS units
of housing are rented.

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Who Benefits and Who Is Hurt by Rent Control

People who live in rent controlled properties get their

housing at bargain prices.

People looking for housing will have a harder time

finding housing and will have to put up with more
inconveniences in the housing market because rent
control reduces the incentives of business people to
provide quality housing options.

Rent control can misallocate a scarce resource

(housing) to people who value the resource less than
market value.
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Questions for Thought and Discussion

If price floors and price ceilings are inefficient why do

politicians make laws that create these inefficiencies?

Can you think of any time when rent control would be

a good policy choice for a government?

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Gasoline Markets and Price: Hurricane Katrina

Case Study

Hurricane Katrina and the market solution

Temporarily shut down off shore wells.

Briefly put 10% of our refineries out of commission.
Result: A sudden drop in oil supply.
The government took a hands off approach.
Gasoline prices rose sharply (duh?).
People could buy all they wanted at sharply increased prices
with no wait at the pumps.

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Gasoline Markets and Price: Oil Embargoes

and a Government Response Case Study

Oil crises in the 1970s

Middle eastern countries curtailed oil shipments to the United

States.
This resulted in reduced oil supply.
Governments solution: Restrict purchases and hold down
prices.
The result: Long gas lines in many parts of the country.
People paid less but waited much longer to purchase gas at
moderately higher prices (sometimes 12 hours).

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Summation of Market Outcomes to

Reduction in Supply

Short Run

Prices rise.

Many people cut back on their driving.

Long Run

People buy more gas efficient cars.

Higher prices encourage greater exploration for oil.
Higher prices encourage the development of alternative
energy sources.

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Summation of Government Intervention

Solution to Supply Reduction

Short Run

Prices are held down or climb slowly.

People cut back on their driving very little if any.
Significant waits at the gas pumps occur and time becomes
the rationing method for gasoline.

Long Run

People have little incentive to buy more gas efficient cars.

Lower prices discourage greater exploration for oil.
Threat of government interference in energy sector
discourages the development of alternative energy sources.

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Closing Comments

Most economists probably believe price ceilings do

more harm than good in the long run.
Most people probably think in the short run and want
government to do something about higher prices.
Government probably is inclined to get involved.
Corporate greed probably can and will influence
government actions.
The result . . . who knows? But past history indicates
it probably wont be good for the consumer.

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Questions for Thought and Discussion

Was allowing the price mechanism to allocate gas

more fair than forcing people to wait in lines or buy gas
on days based upon the numbers on their license
plates?

Would corporations have incentives to lobby the

government for price floors or ceilings?

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