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The Basics of
Supply and
Demand
Topics to Be Discussed
Qs QS (P )
Quantity
P2
The supply curve slopes
P1 upward demonstrating that
at higher prices firms
will increase output
Q1 Q2 Quantity
At P2, produce Q1
P1
Supply curve shifts right
to S’ P2
More produced at any
price on S’ than on S
Q0 Q1 Q2 Q
Supply - A Review
Supply is determined by non-price supply-
determining variables as such as the cost of
labor, capital, and raw materials.
Changes in supply are shown by shifting the
entire supply curve.
Supply - A Review
Changes in quantity supplied are shown by
movements along the supply curve and are
caused by a change in the price of the
product.
QD QD(P)
Chapter 2: The Basics of Supply and Demand Slide 14
Supply and Demand
Price
($ per unit)
Quantity
Chapter 2: The Basics of Supply and Demand Slide 15
Supply and Demand
Price
($ per unit) The demand curve slopes
downward demonstrating
that consumers are willing
to buy more at a lower price
as the product becomes
relatively cheaper and the
consumer’s real income
increases.
Quantity
Chapter 2: The Basics of Supply and Demand Slide 16
Supply and Demand
At P2, produce Q1
Q0 Q1 Q2 Q
Chapter 2: The Basics of Supply and Demand Slide 18
Shifts in Supply and Demand
Demand - A Review
Demand is determined by non-price
demand-determining variables, such as,
income, price of related goods, and tastes.
Changes in demand are shown by shifting
the entire demand curve.
Changes in quantity demanded are shown by
movements along the demand curve.
Q0 Quantity
Q0 Quantity
Q1 Q3 Q2 Quantity
Chapter 2: The Basics of Supply and Demand Slide 24
The Market Mechanism
Surplus - Review:
Shortage
D
Q1 Q3 Q2 Quantity
Chapter 2: The Basics of Supply and Demand Slide 26
The Market Mechanism
Shortage
Surplus @ P1 of
P1
Q 1, Q 2
P3
Equilibrium @ P3,
Q3
Q1 Q3 Q2 Q
Income Increases P D D’ S
Demand shifts to D1
Shortage @ P1 of Q1, Q2 P3
P1
Equilibrium @ P3, Q3
Q2 Q1 Q3 Q
P
Income Increases & D D’ S S’
raw material prices fall
The increase in D is
greater than the P2
increase in S P1
Q1 Q2 Q
Chapter 2: The Basics of Supply and Demand Slide 32
Shifts in Supply and Demand
S1998
$0.61
$0.26
D1970
D1998
5,300 5,500 Q (million dozens)
Chapter 2: The Basics of Supply and Demand Slide 35
The Price of a College Education
$2,530
D1995
D1970
8.6 14.9 Q (millions of students enrolled))
Chapter 2: The Basics of Supply and Demand Slide 37
Changes In Market Equilibrium
Question
Why did the income distribution become
more unequal for 1977 to 1999?
Observations
Consumption of copper has increased about
a hundred fold from 1880 through 1998
indicating a large increase in demand.
The real price for copper has remained
relatively constant.
Long-Run Path of
Price and Consumption
Conclusion
Decreases in the costs of production have
increased the supply by more than enough to
offset the increase in demand.
Observation
To accurately predict the future price of a
product or service, it is necessary to consider
the potential change in supply and demand.
1970 predictions for oil and other minerals
proved incorrect because they only
considered the demand side of the market.
EP (%Q)/(% P)
Q/Q P Q
EP
P/P Q P
Price
EP - The lower portion of
4 a downward sloping
demand curve is less elastic
Q = 8 - 2P than the upper portion.
Ep = -1
2
Linear Demand Curve
Q = a - bP
Q = 8 - 2P
Ep = 0
4 8 Q
Price
Infinitely Elastic Demand
P* D
EP -
Quantity
EP 0
Q* Quantity
Q/Q I Q
EI
I/I Q I
Qb/Qb Pm Qb
EQbPm
Pm/Pm Qb Pm
Equilibrium: Q S = Q D
P 3.46 / bushel
Q 1,800 (240)(3.46) 2,630 million bushels
P QD 3.46
E
D
(2.66) .035 Inelastic
Q P 2,630
P
P QS 3.46
E S
(2.40) .032 Inelastic
Q P 2,630
P
4.00
Q D
P (266) 0.43
2,486
Price DSR
People tend to
drive smaller and
more fuel efficient
cars in the long-run
Gasoline DLR
Quantity
Price DLR
People may put
off immediate
consumption, but
eventually older cars
must be replaced.
Automobiles DSR
Quantity
Gasoline
The long-run price and income elasticities
are larger than the short-run elasticities.
Automobiles
The long-run price and income elasticities
are smaller than the short-run elasticities.
Elasticity 1 2 3 4 5 6
Elasticity 1 2 3 4 5 6
Data Explains:
1) Why the price of oil did not continue to
rise above $30/barrel even though it
rose very rapidly in the early 1970s.
2) Why automobile sales are so sensitive
to the business cycle.
SLR
Due to limited
capacity, firms
are limited by
output constraints
in the short-run.
In the long-run, they
can expand.
Quantity
Price increases
provide an incentive
to convert scrap
copper into new supply.
In the long-run, this
stock of scrap copper
begins to fall.
Quantity
P0
Short-Run
1) Supply is completely inelastic
2) Demand is relatively inelastic
3) Very large change in price
Q1 Q0 Quantity
P2
P0
Intermediate-Run
1) Supply and demand are
more elastic
2) Price falls back to P2.
3) Quantity falls to Q2
Q2 Q 0 Quantity
P0 S
Q0 Quantity
Available Data
Equilibrium Price, P*
Equilibrium Quantity, Q*
Price elasticity of supply, ES, and
demand, ED.
Price
Supply: Q = c + dP
a/b
ED = -bP*/Q*
P* ES = dP*/Q*
-c/d Demand: Q = a - bP
Q* Quantity
Demand: QD = a - bP
Supply: QS = c + dP
Step 1:
Recall:
ED - b(P * /Q*)
ES d(P * /Q*)
QD a bP
* *
QS c dP
* *
Es = d(P*/Q*) Ed = -b(P*/Q*)
d = 1.6/0.1 = 16 b = 0.8/0.1 = 8
p = 18/24 = .75
Price
Supply: QS = -4.5 + 16P
a/b
.75
7.5 Mmt/yr
Q a bP fI
E (I / Q)(Q / I )
and
f Q / I
Chapter 2: The Basics of Supply and Demand Slide 103
Understanding and Predicting the Effects
of Changing Market Conditions
1.3 = (1.0/7.5)f
f = (1.3)(7.5)/1.0 = 9.75
Q a bP fI
* *
a = 3.75
Q = 13.5 - 8P
Q = (0.80)(13.5 - 8P)
Q = 10.8 - 6.4P
Q = -4.5 + 16P
P = 15.3/22.4
P = 68.3 cents/pound
In 1995:
P* = $18/barrel
World demand and total supply = 23 bb/yr.
OPEC supply = 10 bb/yr.
Non-OPEC supply = 13 bb/yr
Short-Run Long-Run
Demand = Supply
P = 41.08
Price 45
($ per Short-Run
barrel) 40 Effect
35
30
25
20
18
15
10
5 Quantity
0 5 10 15 20 23 25 30 35 (billions barrels/yr)
P = 21.75
10
5 Quantity
(billions barrels/yr)
0 5 10 15 20 23 25 30 35
Chapter 2: The Basics of Supply and Demand Slide 121
Effects of Government Intervention --
Price Controls
If price is regulated to
be no higher than Pmax,
quantity supplied falls
P0 to Q1 and quantity
demanded increases to
Q2. A shortage results
Pmax
D
Excess demand
Q0 Quantity
Chapter 2: The Basics of Supply and Demand Slide 123
Price Controls and
Natural Gas Shortages
PES 0.2
Cross elasticity of supply for oil 0.1
D
PE 0.5
Cross elasticity of demand for oil 1.5
Supply : Q 14 2 PG .25PO
Demand : Q 5 PG 3.75PO
Supply Demand @ $2/TcF
Chapter 2: The Basics of Supply and Demand Slide 126
Price Controls and
Natural Gas Shortages
The Data: Natural Gas
At $1.00/TcF
QS 18 TcF and Q 25 TcF
Shortage 7 TcF/yr