Chapter

4
Demand
and Supply

CHAPTER OUTLINE
1. Distinguish between quantity demanded and demand, and explain what
determines demand.
A. Competitive Markets
B. The Law of Demand
C. Demand Schedule and Demand Curve
D. Changes in Demand
1. Prices of Related Goods
2. Expected Future Prices
3. Income
4. Expectations
5. Number of Buyers
6. Preferences
E. Illustrating Changes in Buying Plans
2. Distinguish between quantity supplied and supply, and explain what determines
supply.
A. The Law of Supply
B. Supply Schedule and Supply Curve
C. Changes in Supply
1. Prices of Related Goods
2. Prices of Resources and Other Inputs
3. Expectations
4. Number of Sellers
5. Productivity
D. Illustrating Changes in Selling Plans
3. Explain how demand and supply determine price and quantity in a market, and
explain the effects of changes in demand and supply.
A. Price: A Market’s Automatic Regulator
B. Predicting Price Changes: Three Questions
C Effects of Changes in Demand
D. Effects of Changes in Supply
E. Effects of Changes in Both Demand and Supply

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52 Part 1 . INTRODUCTION

1. Both Demand and Supply Change In the Same Direction

2. Both Demand and Supply Change In Opposite Directions
4. Explain how price floors, price ceilings, and sticky prices cause surpluses,
unemployment, and shortages.
A. Price Floor
B. Price Ceiling or Price Cap
C. Sticky Price

 What’s New in this Edition?

While the main content of Chapter 4 is largely the same for
the eighth edition, there is a new “Eye on the Global Econ-
omy” that focuses on cocoa and chocolate and “Eye on the
Price of Coffee.” These replace “Eye on Tuition” and the
“Eye on the Global Economy” that focused on solar panels.

 Where We Are
In Chapter 4, we create a tool (the supply-demand graph) to
use in examining how a market operates. The chapter ex-
plains how to derive demand and supply curves. By combin-
ing the supply and demand curves, we see how the market
determines market equilibrium. We also see how a change in
supply, a change in demand, or a change in both affects the
price and quantity in the market equilibrium.

 Where We’ve Been

We’ve explored how scarcity and opportunity costs require
us to make choices. We’ve also looked at the U.S. and global
economies and established the basic idea that markets deter-
mine What, How, and Who.

 Where We’re Going

Now that we’ve created a tool to examine how market prices
and quantities are determined, we use it to see how market
equilibrium responds to changes in prices. This responsive-
ness, or elasticity, plays a role in how taxes affect the market
and the efficiency and fairness of government influences.

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 Chapter 4 . Demand and Supply 53

IN THE CLASSROOM

 Class Time Needed

You might try to cover these topics in four sessions, though if you have a lot of
examples, or participation from the class, the time could lengthen to five classes.
Take as much time as possible on the differences between movements along
the supply and demand curves versus shifts in the curves. Go over the reasons
for the shifts and give several examples, always reinforcing the process of an-
swering the 3 questions for analyzing changes in equilibrium.
An estimate of the time per checkpoint is:
 4.1 Demand—60 to 75 minutes
 4.2 Supply—60 to 75 minutes
 4.3 Market Equilibrium—60 to 90 minutes
 4.4 Price Rigidities—20 to 25 minutes

Classroom Activity: When it comes to introducing demand, pick an object that your students
buy, say a bottle of Pepsi. Bring a bottle to class as a visual aid and simulate a market for this
good in which the students are consumers and you are the seller. Set up a price range for this
good (starting at $0.60 and going up to $1.60 in $0.20 increments). Then ask for 3-4 volunteers
and ask them one at a time how many bottles of Pepsi they would be willing and able to buy
right then at each price. From this you can set up a demand schedule for Pepsi on the board
that illustrates the relationship between price and quantity demanded. Sum all of the individ-
ual demands together to calculate a market demand. This demand schedule can be used to
set up the law of demand and to help students distinguish between quantity demanded and
demand for individuals and for the market. Then draw the resulting market demand curve
on the board. This market demand curve will illustrate the downward slope indicative of the
law of demand and can further be used to distinguish between changes in quantity de-
manded and changes in demand - the difference between movements along the demand
curve and shifts of the demand curve. You can also break students into groups and have
them brainstorm a list of factors that could change the demand for Pepsi and shift the de-
mand curve. Make sure they keep the product identical in their analysis and ask them to
think about any factor, other than the price of Pepsi, which would change the amount of
Pepsi that people would be willing and able to purchase. After allowing students time to
brainstorm this list, you can use their ideas about what specifically causes a change in de-
mand for Pepsi to create the list of what factors change demand in a market in general.

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54 Part 1 . INTRODUCTION

CHAPTER LECTURE

Lecture Launcher: Consider starting your introductory lecture of demand and supply by reach-
ing back to an “Eye on the U.S. Economy” from chapter 3 and using a story made famous by
Milton Friedman. Ask the class if someone has a regular pencil. Have a student hold up the
pencil and ask the class to think about how that pencil got into this student’s hand: someone
grew and harvested a tree, someone made the graphite center, someone grew the rubber that
made the eraser, someone made the brass eraser holder, someone made the yellow paint, and
someone assembled all these bits. Shippers, wholesalers, and a retailer all played a part in
getting that pencil to your student’s hand. Emphasize that no one told anyone this student
wanted a pencil. Markets did all this work. You can use this example of the power of the
market to segue into the study of demand and supply.

 4.1 Demand
Competitive Markets
 Markets vary in the intensity of competition. This chapter studies a competitive market,
which is a market that has many buyers and sellers, so no single buyer or seller can influ-
ence price. Also it is important to stress that no coordinated action on the part of govern-
ment or any other central authority is required to make markets work efficiently.

 Land Mine: Students often have a difficult time accepting that all sellers are price takers, so
be sure to point out that a competitive market is just one type of market structure and the other
market structures will be analyzed in greater detail as the semester progresses. The idea is to start
with the simplest market structure to work with and build in complexity from there, so that other
market structures (where firms may have some price setting ability) will be addressed after stu-
dents can work with a competitive market. You may even find it useful to introduce the terms
monopoly, oligopoly, and monopolistic competition at this point as foreshadowing of where they
will be building up to. However, they have to walk before they can run…
Law of Demand
 The price of a good or service affects the quantity people plan to buy. The quantity de-
manded of a good or service is the amount that consumers are willing and able to buy
during a given time period at a specified price.
 The law of demand states that other things remaining the same, if the price of a good
rises, the quantity demanded of that good decreases; and if the price of a good falls, the
quantity demanded of that good increases.

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 Chapter 4 . Demand and Supply 55

Demand Schedule and Demand Curve

 The demand for a good refers to the entire relationship between the price of the good and
the quantity demanded of the good when all other influences on buying plans remain the
same.
 A demand schedule is a list of the quantities demanded at each different price when all
other influences on buying plans re-
mains the same. The table below gives
the demand schedule for a good.

Price Quantity
(dollars) demanded
1 50
2 40
3 30
4 20
5 10
 A demand curve is a graph of the rela-
tionship between the quantity de-
manded of a good and its price when all
other influences on consumers’ planned
purchases remain the same. The figure
illustrates the demand curve resulting
from the demand schedule in the table.
Changes in Demand
 A change in quantity demanded is a change in the quantity of a good that people plan to
buy that results from a change in the price of the good with all other influences on buy-
ing plans remaining the same. When any factor that influences buying plans other than
the price of the good changes, there is a change in demand and the demand curve shifts.
An increase in demand shifts the demand curve rightward and a decrease in demand
shifts the demand curve leftward. Five factors change demand:
 Prices of Related Goods: A substitute is a good that can be consumed in place of an-
other good (grape jelly and strawberry jelly) and a complement is a good that is con-
sumed with another good (peanut butter and jelly). A rise in the price of a substitute
or a fall in the price of a complement increases the demand for the good.
 Expected Future Prices: A rise in the expected future price of a good increases the
current demand for that good as consumers stockpile now in anticipation of buying
less in the future at higher expected prices. A fall in the expected future price de-
creases current demand as consumers delay their purchases in anticipation of taking
advantage of lower expected future prices.
 Income: A normal good is a good for which demand increases when income increases
and demand decreases when income decreases. An inferior good is a good for which

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56 Part 1 . INTRODUCTION

demand decreases when income increases and demand increases when income de-
creases (such as generic goods, instant ramen noodles, canned meat)
 Expected Future Income and Credit: When income is expected to increase in the fu-
ture or when credit is easy or inexpensive to get, the demand for some goods in-
creases. This effect is especially evident with big ticket items.
 Number of buyers: The larger the number of buyers, the larger is the demand.
 Preferences: Preferences are an individual’s attitudes toward goods and services. If
people “like” a good more, the demand for it increases.

Change in the Quantity Demanded Versus Change in Demand

 A change in price results in a move-
ment along the demand curve, which is
change in the quantity demanded. A
change in other factors shifts the de-
mand curve, which is a change in de-
mand.
 In the figure, the movement along de-
mand curve D0 from point a to point b
as a result of the price rising from $2 to
$4 is a change in the quantity de-
manded. The shift of the demand curve
from D0 to the new demand curve D1 is
a change in demand.
 Understanding the difference between
change in demand versus change in
the quantity demanded. It is crucial for
your students to understand the difference between a “change in demand” and “change
in the quantity demanded.” A useful exercise to get students to see the difference is to
put a list of situations on the board and ask them to identify each as either a “change in
demand” or a “change in the quantity demanded.” Before you do that there is a simple
rule that you can impart that will help students solve the exercise much more easily. The
rule is that the price of the good or service itself is the only factor that can cause a change
in the quantity demanded. Anything else that affects demand is a change in demand.

Below is a quick list of scenarios you might wish to pose to ask if there is a change in demand
(the demand curve shifts) or a change in the quantity demanded (a movement along the demand
curve).
 The local gas station raises the price of its gasoline (change in the quantity demanded).
 People purchase more new automobiles when their income rises (change in demand).
 Sales of Pepsi rise in the face of a price hike for Coke (change in demand for Pepsi and
change in the quantity demanded of Coke).

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 Chapter 4 . Demand and Supply 57

 Purchases of personal computers increase when retail stores slash prices (change in the quan-
tity demanded).

 4.2 Supply
Law of Supply
 The price of a good or service affects the quantity firms plan to sell. The quantity supplied
of a good or service is the amount that people are willing and able to sell during a given
time period at a specified price.
 The law of supply states that other things remaining the same, if the price of a good rises,
the quantity supplied of that good increases; and if the price of a good falls, the quantity
supplied of that good increases. The law of supply occurs because an increase in the
quantity of a good produced results in an increase in its marginal cost. So the price must
rise in order to induce firms to increase the quantity they produce.

Supply Schedule and Supply Curve

 The supply is the relationship between the quantity supplied and the price of the good
when all other influences on selling plans remain the same.
 A supply schedule is a list of the quantities supplied at each different price when all other
influences on selling plans remain the
same. The table below gives the supply
schedule for a good.

Price Quantity
(dollars) supplied
1 10
2 20
3 30
4 40
5 50
 A supply curve is a graph of the rela-
tionship between the quantity supplied
of a good and its price when all other
influences on selling plans remain the
same. The figure illustrates the supply
curve resulting from the supply sched-
ule in the table.
Changes in Supply
 A change in quantity supplied is a change in the quantity of a good that suppliers plan to
sell that results from a change in the price of the good. When any factor that influences
selling plans other than the price of the good changes, there is a change in supply and the
supply curve shifts. An increase in supply shifts the supply curve rightward and a de-
crease in supply shifts the supply curve leftward. Five factors change supply:

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58 Part 1 . INTRODUCTION

 Prices of Related Goods: A substitute in production is a good that can be produced in

place of another good, such as Pepsi and Mountain Dew. A complement in production
is a good that must be produced along with the initial good, such as wood and wood
pulp. A fall in the price of a substitute in production or a rise in the price of a comple-
ment in production increases the supply of the good.
 Prices of Resources and Other Inputs: If the price of a resource used to produce the
good rises, the cost of producing the good rises so the supply of the good decreases.

 Land Mine: Make sure to clearly distinguish between the terms “wage
rates” and “income,” as students often treat these terms as synonyms. This
creates tremendous confusion, as changes in income will change demand,
but changes in wage rates will change supply. Remind students that
changes in wage rates may not always translate to predictable changes in
income. For example, if wage rates increase, firms may want to use less la-
bor. So, some workers will be paid more per hour, though fewer hours are
being worked – leaving the impact on total income brought home by work-
ers potentially unchanged. Students need to accept that “wage rates” is just
a term used for the price of an input (labor) and is not the same as income.
This will be especially important for students in macroeconomics, as they
will encounter this again when working with aggregate demand and aggre-
gate supply.
 Expected Future Prices: Expectations about future prices affect current supply. If the
price of a good is expected to rise in the future, the current supply of the good de-
creases.
 Number of Sellers: If the number of suppliers increases, the supply increases.
 Productivity: Productivity is output per unit of input. An increase in productivity
lowers costs and increases supply. Technological advances and increased capital
raise productivity and thereby increase the supply. Natural disasters lower produc-
tivity and thereby decrease the supply.

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 Chapter 4 . Demand and Supply 59

Change in the Quantity Supplied Versus Change in Supply

 A change in price results in a movement
along the supply curve, which is change
in the quantity supplied. A change in
other factors shifts the supply curve,
which is a change in supply.
 In the figure, the movement along
supply curve S0 from point a to
point b as a result of the price rising
from $2 to $4 is a change in the
quantity supplied. The shift of the
supply curve from S0 to the new
supply curve S1 is a change in sup-
ply.

 4.3 Market Equilibrium

 An equilibrium is a situation in which op-
posing forces balance.
 The equilibrium price is the price at
which the quantity demanded equals the
quantity supplied. The equilibrium quan-
tity is the quantity bought and sold at
the equilibrium price. In the figure, the
equilibrium price is $3 and the equilib-
rium quantity is 30 per week.

There is an old joke in the economics profession:

“If you can teach a parrot to say demand and
supply you've taught the bird how to become an
economist.” This is one occasion where reality
mirrors humor rather than the other way
around. Stress to students that demand and supply analysis is so powerful that a large number of
questions can be answered in economics by relying on it. Remind them that if they have difficulty
at first that they should not be embarrassed. After all, it took the economics profession about a
hundred years before it finalized this model. Indeed, back in the dim mists of time, circa 1870 or
so, economists struggled to understand if it was the supply or the demand that determined the
price and quantity of a good. Nowadays we know that these efforts were misguided. To borrow

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60 Part 1 . INTRODUCTION

from the great economist Alfred Marshall, demand and supply curves are like the blades on a
pair of scissors. It does not make sense to ask which blade does the cutting because the cutting
takes both blades and occurs at the intersection of the two blades. Likewise, it takes both the de-
mand and supply to determine the price and quantity and the price and quantity are determined
at the intersection of the demand and supply curves.

Price: A Market’s Automatic Regulator

 The law of market forces states “When there is a shortage, the price rises; and when there
is a surplus, the price falls.
 Surplus (or excess supply): A situation in which the quantity supplied exceeds the
quantity demanded. If the price is above the equilibrium price, firms plan to sell
more than consumers plan to buy. A surplus results, which forces the price lower, to-
ward the equilibrium price. In the figure, there is a surplus at any price above $3 and
so the price is forced lower, toward the equilibrium price.
 Shortage (or excess demand): A situation in which the quantity demanded exceeds the
quantity supplied. If the price is below the equilibrium price, consumers plan to buy
more than firms plan to sell. A shortage results, which forces the price higher, toward
the equilibrium price. In the figure, there is a shortage at any price below $3 and so
the price is forced higher, toward the equilibrium price.
Classroom activity: The law of market forces is important, so you want your students to grasp
why prices are driven to the equilibrium. You can choose a good, like concert tickets to the
hottest band. Draw a demand-supply graph with a reasonable equilibrium price and quan-
tity. Ask the students what would happen if the concert promoter decided to charge only $20
a ticket. Would students line up before dawn to buy them? Yes! Explain that this is a case of
excess demand. Ask them what could the promoter do to get the crowds to go away? Hope-
fully they will answer, “Raise ticket prices!” Show them how the market pressures the price
to rise to the equilibrium price and use the graph to show how the promoter and students
move up their respective supply and demand curves. You can do the same thing for excess
supply. Let the promoter try to sell tickets for $1,000 each. Again, move down along the sup-
ply and demand curves as the market pressures the price to fall. Market forces pushing to-
wards the equilibrium can be compared to a buoy in the ocean. The natural state for the buoy
is to point straight up (equilibrium), though sometimes forces act upon that buoy that cause it
to rock to one side or the other. When this happens, the buoy tries to right itself to point
straight up again (equilibrium). It’s not to say that a buoy (or markets) will always be at equi-
librium, but when it deviates from equilibrium it will be pushed back towards it.

Predicting Price Changes: Three Questions

To determine how an event affects the equilibrium, answer three questions:
 Does the event affect the demand or the supply?
 Does the event increase or decrease demand or supply? This question determines
whether the demand or supply curve shifts rightward or leftward.
 What are the new equilibrium price and quantity and how have they changed?

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 Chapter 4 . Demand and Supply 61

Effects of Changes in Demand

 If the demand for a good or service in-
creases, the demand curve shifts right-
ward. As a result, the equilibrium price
and the equilibrium quantity increase.
 If the demand for a good or service de-
creases, the demand curve shifts left-
ward. As a result, the equilibrium price
and the equilibrium quantity decrease.
 Supply does not change and the supply
curve does not shift. Instead there is a
change in the quantity supplied and a
movement along the supply curve.
 The figure illustrates an increase in de-
mand. In the figure the demand curve
shifts from D0 to D1. As a result, the
equilibrium price rises from $3 to $4
and the equilibrium quantity increases
from 30 to 40. The supply curve does not shift; there is a movement along the supply
curve.
Effects of Changes in Supply
 If the supply of a good or service in-
creases, the supply curve shifts right-
ward. As a result, the equilibrium price
falls and the equilibrium quantity in-
creases.
 If the supply of a good or service de-
creases, the supply curve shifts leftward.
As a result, the equilibrium price rises
and the equilibrium quantity decreases.
 Demand does not change and the de-
mand curve does not shift. There is a
change in the quantity demanded and a
movement along the demand curve.
 The figure illustrates an increase in sup-
ply. In the figure the supply curve shifts
from S0 to S1. As a result, the equilib-
rium price falls from $3 to $2 and the
equilibrium quantity increases from 30 to 40. The demand curve does not shift; there is a
movement along the demand curve.

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62 Part 1 . INTRODUCTION

Effects of Changes in Both Demand and Supply

Both Demand and Supply Change In the Same Direction
 If both the demand and the supply of a
good or service increase, both the de-
mand and supply curves shift right-
ward. The quantity unambiguously in-
creases but the effect on the price is am-
biguous.
 If the increase in demand is greater
than the increase in supply, the
price rises.
 If the increase in demand is the
same size as the increase in supply,
the price does not change.
 If the increase in demand is less
than the increase in supply, the
price falls.
 The figure illustrates an increase in
both demand and supply: the de-
mand curve shifts from D0 to D1 and the supply curve shifts from S0 to S1. The shifts
are the same size, so the equilibrium price does not change and the equilibrium quan-
tity increases from 30 to 50.
 If both the demand and the supply of a good or service decrease, both the demand and
supply curves shift leftward. The quantity unambiguously decreases but the effect on the
price is ambiguous.
 If the decrease in demand is greater than the decrease in supply, the price falls.
 If the decrease in demand is the same size as the decrease in supply, the price does
not change.
 If the decrease in demand is less than the decrease in supply, the price rises.

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 Chapter 4 . Demand and Supply 63

Both Demand and Supply Change In Opposite Directions

 If the demand increases and the sup-
ply decreases, the demand curve shifts
rightward and the supply curve shifts
leftward. The price unambiguously
rises but the effect on the quantity is
ambiguous.
 If the increase in demand is greater
than the decrease in supply, the
quantity increases.
 If the increase in demand is the
same size as the decrease in sup-
ply, the quantity does not change.
 If the increase in demand is less
than the decrease in supply, the
quantity decreases.
 The figure illustrates an increase in
demand and a decrease in supply.
In the figure the demand curve shifts from D0 to D1 and the supply curve shifts from
S0 to S1. The shifts are the same size, so the equilibrium quantity does not change and
the equilibrium price rises from $3 to $5.
 If the demand decreases and the supply increases, the demand curve shifts leftward and
the supply curves shifts rightward. The price unambiguously falls but the effect on the
quantity is ambiguous.
 If the decrease in demand is greater than the increase in supply, the quantity de-
creases.
 If the decrease in demand is the same size as the increase in supply, the quantity does
not change.
 If the decrease in demand is less than the increase in supply, the quantity increases.

The entire chapter builds up to using the demand/supply model to predict changes in the equilib-
rium price and quantity. Students are remarkably ready to guess the consequences of some event
that changes either demand, or supply or both. They must be encouraged to work out the answer
and draw the diagram. Explain that the way to answer any question that seeks a prediction about
the effects of some event or events on a market has five steps:
Step 1. Draw a demand-supply graph and label the axes with the price and quantity of the good
or service in question.
Step 2. Think about the event or events and decide whether they change demand, supply, both
demand and supply, neither demand nor supply. If an event impacts demand or supply, stu-
dents must always be able to identify one of the factors from the list of factors that change de-
mand and supply. Students should make flash cards of these two lists to study and keep along
side them while working on homework assignments.

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64 Part 1 . INTRODUCTION

Step 3. Do the events that change demand or supply bring an increase or a decrease?
Step 4. Draw the new demand curve and supply curve on the diagram. Be sure to shift the curve
or curves in the correct direction—leftward for decrease and rightward for increase. (Lots of stu-
dents want to move the curves upward for increase and downward for decrease—works OK for
demand but is wrong for supply. Emphasize the leftward versus rightward shift.)
Step 5. Find the new equilibrium and compare it with the original one.
Walk them through the steps and have one or two students work some examples in front of the
class. It is critical at this stage to return to the distinction between a change in demand and a
change in the quantity demanded and between a change in supply and a change in the quantity
supplied. You can now use these distinctions to describe the effects of events that change market
outcomes. After working through some examples as a class, break students into smaller groups
and have them practice examples– always verbalizing their thought process as they work
through the steps. This group setting allows for the peer effect to take hold, as some students will
pick up the model work very quickly, while others will take a bit longer. Once groups are able to
work through these examples fairly quickly and accurately, have students try examples individu-
ally and you can walk around and monitor their progress. This can help you identify which stu-
dents are still struggling and will need additional assistance and practice. For all students,
there’s almost no way you can give them enough practice with this model. I tell my students that
the supply and demand model is to economics what addition and subtraction are to math – with-
out mastering that basic foundation, it’s impossible to move on and learn more complex material.

 4.4 Price Rigidities

Price Floor
 A price floor is the lowest price at which it is legal to trade a particular good, service, or
factor of production. An example of a
price floor is a minimum wage law, a
government regulation that makes hiring
labor for less than specified wage illegal.
 A price floor imposed below the
equilibrium price has no effect.
 A price floor set above the equilib-
rium price creates a surplus because
at the price floor the quantity sup-
plied exceeds the quantity de-
manded.
 In the labor market, if the minimum
wage is set above the equilibrium
wage, unemployment occurs.
 In the figure, the equilibrium wage
rate is $9 per hour and the equilib-
rium employment is 200,000 work-

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 Chapter 4 . Demand and Supply 65

ers. If a minimum wage of $12 per hour is imposed, then the quantity of employment
decreases to 150,000, the quantity of workers demanded. The quantity of labor sup-
plied is 225,000, so there is unemployment of 75,000 workers. The length of the arrow
equals the amount of unemployment.

Price Ceiling
 A price ceiling or price cap is the highest price at which it is legal to trade a particular
good, service, or factor of production. An example of a price ceiling is a rent ceiling, a law
that makes it illegal for landlords to charge a rent that exceeds a set limit.
 A price ceiling imposed above the equilibrium price has no effect.
 A price ceiling set below the equilibrium price creates a shortage because at the price
ceiling the quantity demanded exceeds the quantity supplied.
Sticky Price
 Restrictions on the price, such as long-term contracts with labor unions that fix wages for
at least one year and often for as many as three years, can keep the market price from
reaching its equilibrium. These restrictions make the price sticky and can create surpluses
or shortages.

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66 Part 1 . INTRODUCTION

USING EYE ON YOUR LIFE

 Understanding and Using Demand and Supply

This Eye points out that students will encounter supply and demand throughout
their life. You can mention to them that supply and demand is also highly rele-
vant when it comes to investing. For instance, in 2004 the price of ethanol soared
because of government initiatives for use of ethanol in fuel. These initiatives in-
creased the demand for ethanol and thereby lead to dramatic price hikes ... and
equally dramatic increases in the profits of ethanol producers and their stock
prices. If a student had been able to “guess” in 2003 that the government was
likely to respond to high oil prices by enacting policies that favored ethanol, that
student could have made a killing in the stock market. Indeed, supply and de-
mand are perhaps the real fundamental that underlies stock prices!

USING EYE ON THE GLOBAL ECONOMY

 The Markets for Cocoa and Chocolate

This Eye can be used to further reinforce the key distinction between a change in
demand and a change in quantity demanded – one of largest stumbling blocks
for students early on in their first economics course. Ask them if they think the
rising price of cocoa would lead to a decrease in consumption (as the law of de-
mand would dictate). After identifying that both cocoa prices and quantities
have been increasing over the past few years, ask them to use the demand and
supply framework to graphically illustrate and explain how that would be possi-
ble, making sure to accentuate that the law of demand only explains how the
quantity demanded responds to price changes when other things remain the same.
After they feel comfortable with the model, explain those factors identified in the
Eye that have not remained the same and have been driving the rising demand.
You can then have them consider other potential factors that could lead to
changes in cocoa prices, such as health studies (change in demand), changes in
the prices of other sweets (change in demand), weather that affects crop yields
(change in supply), or technology (change in supply). You can also ask them to
consider the impact on the market if chocolate producers were not allowed to
change prices in the face of these changes (the creation of shortages or surpluses).

While we often use the demand and supply framework to attempt to explain
how an event may cause changes to demand or supply and then attempt to pre-
dict the ensuing changes to prices and quantities, it is useful to also work cause-
effect in reverse. When students are provided with the end result in a market
(changes to price and quantity), they should be capable of working backwards to
figure out if the market experienced a change in demand or supply. It is also

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helpful to provide students with an easy rule of thumb: if the price and quantity
are changing in the same direction, it is demand that is causing those changes. If
the price and quantity are changing in opposite directions, it is supply that is
causing those changes. This same line of reasoning can also be applied to deter-
mine the relative magnitudes of changes when there are changes to both demand
AND supply happening simultaneously.

USING EYE ON THE PRICE OF COFFEE

 Why Did the Price of Coffee Rise in 2014?

You can use this story to review the key fact that factors that shift the supply
curve generally do not shift the demand curve. In particular, the coffee rust fun-
gus affects only the supply curve and has no effect on the demand curve. To
demonstrate this point, ask you students how many of them knew there was an
outbreak of a fungus called coffee rust in South America in 2014? Very few, if
any, will have ever heard of the fungus, not to mention know about recent out-
breaks. This fact can serve as an excellent reminder of the point that the factors
that affect supply do not affect demand. Ask your students how these changes
could have affected their demand if they didn’t know of it. So, the only factor
that influenced their coffee purchasing was the higher price of coffee not the poor
crop yields as a result of the fungus. So the change in the price of coffee leads to a
movement along the demand curve, not a shift of the demand curve.

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68 Part 1 . INTRODUCTION

ADDITIONAL EXERCISES FOR ASSIGNMENT

 Questions
 Checkpoint 4.1 Demand
1. The Internet was born in 1969. For the next 20 years, mainly scientists in
universities and research laboratories used it. But in the 1990s, the use of
Internet service increased dramatically and the price per hour of Internet
service fell.
1a. Are there any substitutes for Internet service? If so, provide an example.
1b. Are there any complements of Internet service? If so, provide an example.
1c. What are the main developments that brought about the dramatic increase
in the quantity of Internet service during the 1990s?
1d. Which developments that you identified in part (c) shifted the demand
curve for Internet service rightward?
1e. Which developments that you identified in part (c) increased the quantity
demanded of Internet service?
2. Answer and explain your answer for each of the events listed below.
2a. What happens to the demand curve for pumpkins in October?
2b. What happens to the demand curve for Gatorade in summer?
2c. What happens to the demand curve for gasoline if 20 percent of all new
cars are required to be electric powered?
2d. What happens to the demand and the demand curve for beef if more peo-
ple decide to become vegans?
2e. The price of a concert ticket increases. What is the effect on the demand
curve for concerts?
2f. Because of concerns about terrorism, more firms want to buy metal detec-
tors. What happens to the demand for metal detectors?
2g. More people decide to have a pet cat. What is the effect of this decision on
the demand for cat food?
 Checkpoint 4.2 Supply
3. In the market for SUVs, several events occur one at a time. Explain the in-
fluence of each event on the quantity supplied of SUVs and the supply of
SUVs. Illustrate the effects of each event by either a movement along the
supply curve or a shift in the supply curve and say which event or events
illustrates the law of supply in action. The events are:
3a. The price of a truck rises.
3b. The price of an SUV falls.
3c. The price of an SUV is expected to fall next year.
3d. An SUV engine defect requires a huge and costly manufacturer's recall to
replace the defective engines.
3e. A new robot technology lowers the cost of producing SUVs.

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 Chapter 4 . Demand and Supply 69

4. Answer and explain your answer for each of the events listed below.
4a. What happens to the supply curve of new homes if the wage rate paid to
carpenters falls?
4b. Companies can produce both cardigan sweaters and pullover sweaters.
What happens to the supply curve of cardigan sweaters if the price of a
pullover sweater increases?
 Checkpoint 4.3 Market Equilibrium
5. Suppose a technological advance lowers the cost of producing computer
memory chips. What is the effect of this change on the demand for memory
chips, the supply of memory chips, the equilibrium price of memory chips,
and the equilibrium quantity of memory chips?
6. Suppose people read reports that eating oatmeal helps prevent heart dis-
ease. What is the effect of this change on the equilibrium price of oatmeal
and the equilibrium quantity of oatmeal?
7. What happens to equilibrium price and the equilibrium quantity of each
good described in the situations described below? Illustrate your answers.
7a. Sunnyvale is named the most livable city in the United States. At the same
time, the wage rates of homebuilders, electricians, and plumbers in Sunny-
vale increase. Describe what happens to the new home market in Sunnyvale.
7b. The price of airline fuel falls by 10 percent. At the same time, people’s in-
comes increase and they prefer to fly to their vacation destinations. De-
scribe what happens to the market for airline travel.
7c. Installation costs for small satellite TV dishes fall by 10 percent. At the same
time, network owners increase the cost of programming packages shown
via satellite TV dish systems. Describe what happens in the market for
small satellite TV dishes.
8. During 2004, orange growers in Florida experienced three hurricanes. As a
result, the amount of oranges harvested in Florida was smaller than usual.
Orange growers in other states experienced normal growing conditions.
What was the effect of the smaller harvests in Florida? How do you think
the price of oranges and the quantity bought and sold changed in early
2005? What do you predict happened to the price of frozen orange juice in
early 2005? Use graphs of the orange market and the frozen orange juice
market to illustrate your answers.

 Answers
 Checkpoint 4.1 Demand
1a. There are five services provided by the Internet: e-mail, information on
Web pages, home shopping services, information on fast breaking news,
and entertainment. The only substitute for Internet e-mail service, if a per-
son is interested in the speed of service, is the telephone. For bulky or

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70 Part 1 . INTRODUCTION

unique items (like large documents, magazines, bills, photographs) or if

you don’t mind waiting, postal services are substitutes. In terms of Web
pages, some provide a great deal of information and others provide mini-
mal, basic information on their firms. If you need the basic information and
you want it fast, there are no real substitutes for the Internet. If you want
detailed information, substitutes for the Internet are phone calls or litera-
ture sent from the firm. For home shopping, catalogs and home shopping
channels on television are substitutes, though slower (in the case of cata-
logs) or generally without as much information (in the case of television
home shopping channels). For information on fast breaking news, possibly
radio or television is a substitute. For entertainment, substitutes abound.
For instance, listening to music can be done by accessing an Internet radio
station or, as substitutes, a local radio station or a CD. The Internet has car-
toons, for which comic books and cartoons on television are substitutes.
More generally, anything that provides entertainment substitutes for the In-
ternet’s entertainment services, though some (watching a movie on a DVD)
are not particularly close substitutes.
1b. The complements to the Internet are computers, phone lines, modems, ca-
ble modems, and DSL lines provided by the phone service.
1c. The main developments are quicker and cheaper computers and modems
and more Internet providers supplying better service. Additionally, more
people now own computers.
1d. The new, cheaper computers and modems, which are complements of In-
ternet service have shifted the demand curve for Internet service rightward.
More people now own computers, and this change in the number of buyers
also shifts the demand curve rightward.
1e. The increase in quantity demanded occurs when the supply curve shifts.
An increase in the number of providers and an increase in technology shift
the supply curve rightward. When the supply curve shifts, rightward there
is a movement down along the demand curve and an increase in the quan-
tity demanded.
2a. As people prepare for fall holidays, people increase their preferences for
pumpkins. The demand curve for pumpkins shifts rightward.
2b. People exercise more in the summer and spend more time outside getting
thirsty. There is an increase in the demand for Gatorade during the summer
and the demand curve for Gatorade shifts rightward.
2c. As more cars are required to be electric powered, the demand for gasoline
decreases. The demand curve for gasoline shifts leftward.
2d. As more people decide to become vegans, the demand for beef decreases
and the demand curve for beef shifts leftward.

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 Chapter 4 . Demand and Supply 71

2e. There is a movement up along the demand curve for concerts. The demand
curve does not shift because the only factor that change is the price.
2f. Firms have increased their preferences for metal detectors. The demand for
metal detectors increases and the demand curve shifts rightward.
2g. Cat food and cats are complements. As more people decide they want a pet
cat, the demand for cat food increases.

 Checkpoint 4.2 Supply

3a. A truck is a substitute in production for an
SUV. If the price of a truck rises, auto mak-
ers produce more trucks and fewer SUVs.
The supply curve for SUVs shifts leftward
from S0 to S1 as shown in Figure 4.1.

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72 Part 1 . INTRODUCTION

3b. When the price of an SUV falls, there is a

movement down along the supply curve for
SUVs. This outcome is shown in Figure 4.2
in which the price falls from P0 to P1, and the
quantity supplied decreases from Q0 to Q1.

3c. If we expect the price of SUVs to fall next

year, suppliers increase the current supply
to take advantage of current higher prices.
The supply curve shifts rightward from S0 to
S1, as shown in Figure 4.3.
3d. To replace the defective engines, the auto
maker incurs higher production costs. The
cost hike decreases the supply and shifts the
supply curve leftward, as in Figure 4.1.
3e. The new robot technology decreases produc-
tion costs for SUVs. This change increases
the supply of SUVs so the supply curve for
SUVs shifts rightward, as in Figure 4.3.
4a. Carpenters help produce new homes, so
they are a resource used in the production of
new homes. As the wage rate paid to carpen-
ters falls, the cost of producing housing de-
creases. The supply of new homes increases
and the supply curve of new homes shifts rightward.
4b. Cardigan sweaters and pullover sweaters are substitutes in production. If
the price of a pullover sweater increases, the supply of cardigan sweaters
decreases. The supply curve of cardigan sweaters shifts leftward.
 Checkpoint 4.3 Market Equilibrium
5. The technological advance has no effect on the demand for memory chips.

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 Chapter 4 . Demand and Supply 73

The supply of memory chips increases. The equilibrium price of a memory

chip falls and the equilibrium quantity of a memory chip increases.
6. The reports increase people’s preference for oatmeal. The demand for oat-
meal increases. The equilibrium price of oatmeal rises and the equilibrium
quantity increases.

7a. As people hear how nice it is to live in Sunny-

vale, the demand for new homes in Sunnyvale
increases and the demand curve in Fig. 4.4a
shifts rightward, from D0 to D1. At the same
time, an increase in building costs decreases
the supply of new homes, so the supply curve
shifts leftward from S0 to S1. As Figures 4.4a,
4.4b, and 4.4c show, the equilibrium price of
new homes increases, from P0 to P1 in the fig-
ures. What happens to the equilibrium quan-
tity depends on which curve shifts the most. If
the curves shift the same amount, as in Figure
4.4a, the equilibrium quantity does not change.
If the demand curve shifts more than the sup-
ply curve, as in Figure 4.4b, the equilibrium
quantity increases. If the supply curve shifts
more than the demand curve, as in Figure 4.4c,
the equilibrium quantity decreases.

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74 Part 1 . INTRODUCTION

7b. As the price of airline fuel falls, airlines’ costs

fall. The supply of airline travel increases and
the supply curve of airline travel shifts right-
ward in Fig. 4.5a from S0 to S1. At the same
time, people decide to take more airline trips,
so the demand curve for airline travel shifts
rightward from D0 to D1. As figures 4.5a, 4.5b,
and 4.5c show, the equilibrium quantity in-
creases from Q0 to Q1. The figures also show
that the effect on the price is indeterminate
unless you know which curve shifts the most.

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 Chapter 4 . Demand and Supply 75

7c. A decrease in installation costs is a decrease in

production costs. The supply curve of satellite
TV dishes shifts rightward in Fig. 4.6a from S0
to S1. At the same time, the price of program-
ming, which is a complement of satellite TV
dishes, increases. The demand curve for satel-
lite dishes shifts leftward from D0 to D1. Fig-
ures 4.6a, 4.6b, and 4.6c each demonstrates that
the equilibrium price of satellite dishes de-
creases from P0 to P1. But the effect on the
quantity is ambiguous.

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76 Part 1 . INTRODUCTION

8. Figure 4.7 shows the effect of the smaller

harvest of oranges. The equilibrium in the
world market for oranges in a normal year
has an (assumed) equilibrium price of a ton
of oranges of $2,000 and an (assumed) equi-
librium quantity of oranges is 60 million
tons a year. Then the smaller harvest of or-
anges in Florida decreases the supply of or-
anges and the supply curve shifts leftward.
In Figure 4.7, the supply curve of oranges
shifts leftward from S0 to S1. The equilib-
rium price of a ton of oranges rises from
$2,000 a ton to $2,100 a ton, and the equilib-
rium quantity of oranges decreases from 60
million tons to 55 million tons of oranges a
year. The price of a ton of oranges rose and
the quantity of oranges decreased.
Oranges are an input used to produce
frozen orange juice. The higher price of a
ton of oranges means that the price of a re-
source used to produce frozen orange juice
rises. The supply of frozen orange juice de-
creases so that the supply curve shifts left-
ward. Figure 4.8 illustrates this situation.
The equilibrium in the market for frozen
orange juice in a normal year has an (as-
sumed) equilibrium price of $5,000 a ton
and an (assumed) equilibrium quantity of
10 million tons a year. The hike in the price
of oranges decreases the supply of orange
juice and the supply curve shifts leftward.
In Figure 4.8, the supply curve shifts left-
ward from S0 to S1. The equilibrium price
of a ton of frozen orange juice rises from
$5,000 a ton to $6,000 a ton, and the equilib-
rium quantity of frozen orange juice de-
creases from 10 million tons to 9 million
tons.

© 2018 Pearson Education, Inc.