3 The Market at Work:

Supply and Demand

Previously . . .

• “Scarcity” refers to the limited nature of

society’s resources.
• The production possibilities frontier (PPF)
is an illustration of the goods and services
an economy is capable of producing.
• Trade is mutually beneficial for both
parties involved.
Big Questions

1. What are the fundamentals of markets?

2. What determines demand?
3. What determines supply?
4. How do supply and demand shifts affect a
market?
Markets and the Nature of
Competition
• Firms
– Supply goods and service
• Consumers
– Want to purchase goods supplied by firms
• Exchange happens
– Through prices established in markets
– Supply or demand factors can change the
market price.
Markets
• Sellers and buyers come together to form
a market.
– Markets exist whenever goods and services
are exchanged.
– Doesn’t have to be a physical place
Markets
• Market economy
– Resources are allocated among households
and firms with little or no government
interference.
– The “main” economic structure of the United
States
– Prices are determined by the forces of supply
and demand.
– Buying and selling is voluntary.
 Competitive Markets
• Characteristics of a competitive market
– Many buyers and sellers
– No one individual has any influence over the price.
– The price is determined by the entire market.
• Examples
– One fisherman does not
determine the price of fish
at the market.
– One farmer does not
determine the price of corn.
Monopoly
• Imperfect market
– Buyer or seller has an influence on the price
• Monopoly
– Exists when a single company supplies the
entire market for a good or service
– “Mono” = one
• Examples
– Standard Oil
– DeBeers diamonds in
early 20th century
Demand

• Quantity demanded
– The amount of a good purchased at a given
price
• Law of demand
– All other things equal, there is an inverse
relationship between price and quantity
demanded
– Inverse: two variables move in opposite
directions
Demand

• Demand schedule
– Table showing the relationship between price
and quantity demanded
• Demand curve
– Graph of the relationship between price and
quantity demanded
• Market demand
– Horizontal sum of all individual quantities
demanded by each buyer in the market at
each price
 Demand

Meredith’s Demand Schedule for

Salmon Fillets
Salmon Fillets
Price of Salmon
Demanded
Higher price $20.00 0 Lower quantity
$17.50 1 demanded
$15.00 2
$12.50 3
$10.00 4
$ 7.50 5
$ 5.00 6 Higher quantity
Lower price
demanded
$ 2.50 7
$ 0.00 8
Demand Curve
Market Demand

Price of Meredith’s Derek’s Market

Salmon Demand Demand Demand
$20.00 0 0 0
$17.50 1 0 1
$15.00 2 1 3
$12.50
$10.00
3
4 + 1
2 =
4
6
$ 7.50 5 2 7
$ 5.00 6 3 9
$ 2.50 7 3 10
$ 0.00 8 4 12
Market Demand
Shifts in Demand

• Movement along a demand curve

– Caused by a change in the price of the good
– Inverse relationship between price and
quantity demanded
• Shift in demand
– Caused by changes in non-price factors
– Entire demand curve will shift to the left or
right
Shifts in Demand
Graphical Summary of Demand
Movement versus Shift
• The next few slides give a summary of the
possible movements and shift that we could see
when considering demand.
Increase in Quantity Demanded

P Caused by price
A decrease
$12

Move from point

$10 B A to point B

Movement along
D a demand curve
7 8 Q
Price↓ Qd↑
Decrease in Quantity Demanded

Caused by price
P
B increase
$50
Move from point
A A to point B
$30
Movement along
D a demand curve

4 6 Q Price↑ Qd↓
 Increase in Demand

Caused by non-
P price factors

Entire demand
curve shifts to
the right

D1 D2 Willing to buy
Q more at ANY
price
 Decrease in Demand

Caused by non-
P price factors

Entire demand
curve shifts to
the left

D2 D1 Willing to buy
Q less at ANY price
Demand Shifters

1. Changes in income
• Normal good
– Good in which we buy more of when we get more
income
– Direct relationship between income and demand
• Inferior good
– Good in which we buy less of when we get more
income
– Inverse relationship between income and demand
Normal and Inferior Goods
Normal Goods Inferior Goods
• Steak • Canned meat, SPAM
• Housing • Ramen
• Laptop • Mac ’n’ cheese
• TV • Secondhand clothing
• Sit-down restaurant meals
• Name-brand
clothing
Demand Shifters

2. Price of related goods

• Complements
– Two goods used together
– Inverse relationship between the price of good
X and demand for good Y
• Substitutes
– Goods that can be used in place of each other
– Direct relationship between the price of good
X and demand for good Y
Substitutes and Complements in
Consumption
Complements Substitutes
• Cheese and crackers • Coke and Pepsi
• Milk and cereal • Snickers and Milky Way
• Printers and toner • Butter and margarine
• Peanut butter and jelly • Pizza Hut and Dominos
• Various items in the store
with multiple brands
Demand Shifters

3. Changes in Tastes and Preferences

• A good may become more fashionable or may
come into season.
– New style becomes popular
– Demand increases (shifts right) as a result
• A good may go out of style or out of season.
– Demand decreases (shifts left)
– Lower demand for frozen pizza in summer
• New information about a good
– Can change tastes for better or worse
Demand Shifters

4. Future expectations
– Our consumption today may depend on what
we think the price may be tomorrow.
5. Number of buyers
– Recall the market demand curve
– More individual buyers means more market
demand.
– Aging, immigration, war, and birth rates can
affect the number of buyers for various goods.
Multiple Market Effects

• Goods are often related

– Substitutes and complements
• This means that one economic event
– Can affect multiple markets
• Consider an increase in the price of
peanut butter
– This will affect the demand for peanut butter
and the demand for jelly, but in different ways!
 Multiple Market Effects
• Event: price of peanut butter increases
Peanut butter: Jelly:
Movement along A shift in demand
the demand curve
P P
B
$4
A
$3
D D2 D1
2 4 Q Q
Practice What You Know—
Demand Quiz 1
Oreos
P Event:
A
$3 The price of
Oreos falls.

$2 B

D
4 5 Q
 Practice What You Know—
Demand Quiz 1
Movie Tickets
P Event:
B
$20 The price of
movie tickets
increases.
$15 A

D
2 3 Q
 Practice What You Know—
Demand Quiz 1
Big Macs
Event:
P
The price of a
Burger King
Whopper
falls.

D2 D1
Q
Practice What You Know—
Demand Quiz 1
Steak Dinners Event:
P
You get a
promotion
and pay raise
at your job.

D1 D2
Q
 Practice What You Know—
Demand Quiz 1
Ramen Noodles
Event:
P
You get a
promotion
and pay raise
at your job.

D2 D1
Q
 Practice What You Know—
Demand Quiz 1
Pizza
Event:
P
The price of
your favorite
beverage
falls.

D1 D2
Q
 Practice What You Know—
Demand Quiz 1
Old men’s demand for oranges
Event:
P Doctors
discover that
oranges cure
baldness.

D1 D2
Q
Practice What You Know—
Demand Quiz 2
• The following three questions
are considering the market for
the same good.
• The good in question is
PEPSI.
• We are considering:
– Change in quantity demanded
(movement), and
– Change in demand (shift).
Practice What You Know—
Demand Quiz 2
• Assume you like Pepsi, and your income
increases.

A.The demand for Pepsi increases.

B.The demand for Pepsi decreases.
C.The quantity demanded for Pepsi increases.
D.The quantity demanded for Pepsi decreases.
Practice What You Know—
Demand Quiz 2
• Assume the price of Pepsi decreases.

A.The demand for Pepsi increases.

B.The demand for Pepsi decreases.
C.The quantity demanded for Pepsi increases.
D.The quantity demanded for Pepsi decreases.
Practice What You Know—
Demand Quiz 2
• Assume the price of Coke decreases.

A.The demand for Pepsi increases.

B.The demand for Pepsi decreases.
C.The quantity demanded for Pepsi increases.
D.The quantity demanded for Pepsi decreases.
Summary of Demand Shifters