How Do Lower Prices Tend to Affect Demand

Need and Supply:
How Prices are determined in a Market Economy

REVIEW: For review exercises click Hither

Introduction

Structural Adjustment Policies

In our introductory lecture on Structural Adjustment we discussed various policies that countries are adopting all around the give-and-take to promote economic growth (increasing output rather than increasing their ability) and attain productive and allocative efficiency. Information technology is hoped that as economies move away from control economies (Chapter 23) toward mzrket economies or capitalism (chapter 4).

These policies are:

one. Privatization
2. Promotion of Contest
3. Express and Reoriented Role for Government
4.
Toll Reform: Removing Controls

5. Joining the Earth Economy
6. Macroeconomic Stability

Even though the concepts of SUPPLY and DEMAND are microeconomic concepts, they are reviewed in this macroeconomics course because non all students accept taken micro (ECO 211) and they are key principles that all economic student should primary. We will study supply and demand in this “Macroeconomics of the Gloabal Econaomy” course to ameliorate empathize why there is a worldwide movement to remove price controls and allow Supply and Demand determine prices.

In a capitalist economic system, prices are very important. They have ii cardinal functions:

1. they RATION goods and services, and
2. the GUIDE resource to where they are wanted most

By doing this they help the economy maintain allocative efficiency and productive efficiency.

In the 5Es lesson on allocative efficiency we discussed that information technology was skilful for the toll of plywood to increase in Florida later a hurricane. When the toll increased two things happened: (1) plywood was rationed to its virtually important uses (not doghouses or decks), and (2) the high prices were an incentive for more than plywood to be guided to Florida and then that they had more plywood. If the price of plywood was kept besides low the event was allocative inefficiency (a shortage).

Prices are also very important in maintaining productive efficiency. In the 5Es lecture on Productive efficiency we defined it as producing at a minimum cost. In club to minimize costs, producers must know the prices of the resources. If these resource prices are determined by need and supply then they will reflect the relative scarcity of the resource and their relative importance (more scarce and important resource will have a higher cost) and the economic system can accomplish productive efficiency.

In a capitalist society prices are determined by the interaction of need and supply. Since prices are so important, nosotros need to better sympathise how they are determined. why is the toll of gasoline $1.59 a gallon. Why does a candy bar cost $0.75? Why is the price of plywood usually $x a canvas, merely $30 a sheet after a hurricane?

Demand

If the price of a product increases what happens to need for that product? For example, If the price of pizza increases, then the demand for pizza does what?

–

–

–

–

–

–

–

Nix! If the toll of pizza increases, the demand for pizza does not change. This is because in economic science we take a more precise definition of demand. Need is Not the quantity that people purchase.

DEFINITION: Then what is demand?

Demand is a schedule that shows the various quantities that consumers are willing and able to buy at diverse prices in a given fourth dimension menstruum,
ceteris paribus. We should await more closely at this definition.

Demand is a table of numbers. Look at the table below. The whole table might correspond my demand for pizza.

Demand Schedule and Bend

As we learned in a previous lesson, whatsoever point on a graph represents two numbers, so we can plot our demand table as in the graph below.

If we assume that there are quantities and prices in-betwixt those in the tabular array (for instance if the cost was $four.50 how many pizzas would I buy?) we tin can connect the points and we get the demand curve (graph).

This is my demand for pizza. This demand curve does Not tell us what the price will be. To know what the price will be nosotros need both need and supply.

But we can see what happens to demand if the price of pizzas increases. If the toll of pizza increases, say from $six to $nine, nothing on the table changes (need does not change) considering demand already includes various prices and various quantities. Need (the table or the graph) does not change when the price changes because demand INCLUDES various prices and diverse quantities. Demand is Non how much we buy.

Note that our definition of need includes the
ceteris paribus
assumption. When we develop a need curve only the toll and quantity demanded change. Everything else is assumed to remain abiding. I don’t get a large increment in my income. I don’t win the lottery. In that location isn’t a new report out that states pizzas crusade cancer. All other factors remain the same – just the price and quantity demanded change.

Police force of Demand

Every bit we tin can see on the demand graph, at that place is an inverse relationship between toll and quantity demanded. Economists call this the Law of Need. If the price goes up, the quantity demanded goes down (but need itself stays the same). If the price decreases, quantity demanded increases. This is the Law of Demand. On a graph, an inverse relationship is represented by a downwards sloping line from left to right.

Why?

Why is the constabulary of demand true? Why is the demand curve downward sloping from left to right? Why practise people buy more at lower prices and less at college prices?

As social scientists, economists try to explain human beliefs. It is mutual sense that people deport this way – but how can we explain information technology? Economists have three explanations:

1. diminishing marginal utility
2. income effects
3. substitution effects

   Diminishing Marginal Utility

   We learned in the 5Es lesson that equity helps reduce scarcity because of the law of diminishing marginal utility. This economic principle also explains why the demand curve is downward sloping.

   Utility is the reason we swallow a proficient or service. You might call it satisfaction. I get satisfaction (utility) when I bulldoze my boat. I get utility (satisfaction?) when I get to the dentist. “Marginal” means Actress or Boosted. So, according to the law of diminishing marginal utility, the EXTRA (not the full) utility diminishes for each additional unit of measurement consumed. If we are receiving less extra utility when nosotros buy one more of a product, we won’t be willing to pay the same price. After all, it is the marginal utility that we are paying for.

   The get-go slice of pizza that I eat I really savor. Information technology gives me a lot of utility. But after a few pieces, I don’t go as much additional satisfaction from 1 more than slice as I did from the get-go piece. So, I volition only buy a 2d piece if it has a lower cost, since I am getting less boosted utility from the second piece. this explains why we buy more than when the toll goes downwardly and why we buy less when the price goes upward. Information technology explains the police force of demand.

   Income Furnishings

   Some other explanation of why the police force of demand explains human behavior is “income effects”.

   If the price of cost of pizza decreases what happens to your income?

   (Note: the “
   
   ” ways “causes”.)

   ?
   

   Nothing happens to your income when the cost of pizza decreases? (Do you get a raise when Pizza Hut has a sale?), Simply your Existent income (or the purchasing power of your income will increase.

   
   

   Then, when pizza prices decrease your real income increases. (This is like the price of pizza staying the same only you get a enhance.) The effect is that we purchase more pizza (The quantity of pizza demanded increases when the price decreases.) this explains why the police of demand is true.

   Commutation Effects

   The third explanation of the law of demand is “substitution furnishings”.

   
   

   ?
   

   If the price of pizza decreases what happens to the price of Chinese food at the restaurant downward the street? Probably nix. (I know that the Chinese restaurant where My married woman and I eat does non change their prices when Pizza Hut has a auction.) But the RELATIVE cost of Chinese food does increase

   At present, as my wife and I bulldoze past Pizza Hut on our fashion to the Chinese restaurant and we run into that Pizza Hut has a auction (
   
   toll of pizza) we start to think that the Chinese food seems more than expensive compared to the now cheaper pizza (
   
   relative toll of Chinese nutrient ). So we may decide to eat at Pizza Hut and substitute pizza for the relatively more expensive Chinese food (
   
   
   quantity of pizza demanded). This helps explicate why we buy more than pizza when the cost decreases.

Market Need

Definition:

Market place demand is the horizontal summation of the individual need curves. Or, instead of just my individual need for a product what if there were two people, or more, in the market place. the consequence would exist tat for each price, the quantities demanded would be greater since there are more people. The prices stay the same, but the quantities get larger, or the need graph shifts horizontally (to the right).

Graphically:

Sample Problem:

Given the post-obit individuals’ demand schedules for product Ten, and assuming these are the merely three consumers of Ten, which set of prices and output levels below will be on the marketplace demand bend for this product?

Answer

Determinants of Demand

The price of the product

Economists stress the importance of price in determining how much people volition buy. That is why they put price on the demand graph, but at that place are other things that affect how much of a product we buy besides the toll. When we adult my need curve for pizza we employed the
ceteris paribus
assumption. I didn’t go a big increase in my income. I didn’t win the lottery. There wasn’t a new study out that stated pizzas cause cancer. All other factors remained the same – but the price and quantity demanded changed.

Just there are other determinants of how much we need (or buy) besides the price. Nosotros call these the Not-Cost determinants of Need.

The non-price determinants of need

Let’s not talk well-nigh pizzas anymore and use a new product in our examples. – – – How near vodka? We know that when the cost of vodka goes upward we purchase less and when the cost goes down nosotros purchase more (this is the police of demand). But what else might cause u.s.a. to buy more vodka besides the price? In other words, IF THE PRICE OF VODKA STAYED THE Same, what might crusade us to purchase more or less vodka?

Economists classify the not-price determinants of demand into 5 groups:

1. expected toll (Pe)
2. price of other goods (Pog)
3. income (I or Y) (In Macroeconomics “I” usually stands for “investment” and “Y” stands for “income”.)
4. number of POTENTIAL consumers (Npot), and
   
5. tastes and preferences (T).

Let’southward briefly look at each ane here and in more item after.

Pe
– If nosotros hear that there will exist a new $5 taxation on a bottle of vodka beginning next week, what happens to the amount of vodka sold this week at the electric current cost? It probably increases since some people volition buy more than now to avoid the higher time to come prices.

Pog
– What happens to the corporeality of vodka sold if the toll of gin increases? Might not some people who were going to buy gin buy vodka instead since the price of gin went up? Or what might happen to vodka sales if the toll of lycopersicon esculentum juice goes down? peradventure at present with the cheaper tomato plant juice prices some people might desire to drink more than bloody marys (vodka mixed with tomato plant juice)? If then, vodka sales would go up.

Y (or I)
– If I get a raise and my income increases I might buy more vodka – or if my income goes downwardly I would probably buy less vodka. (And if I lost my chore I might buy a lot of vodka 🙂

Npot
– What would happen to vodka sales if they lowered the drinking historic period. This would increase the number of potential vodka consumers and they would probably sell more vodka.

Finally
T
– Tastes and preferences really means “everything else”. In that location are hundreds of factors that affect the quantity of vodka sold. Nosotros don’t want to memorize hundreds of different determinants for each production, and so economists group everything else into “tastes and preferences”. Anything that might make consumers want more or less vodka will change the quantity sold. For example, if a new study says that drinking vodka causes blindness – people will buy less. Right before a holiday people may buy more.

In order to remember these determinants of demand, call back of somebody who has had too much vodka to drink and they come up staggering into a liquor store demanding, “Thousand-g-give thou-me an-n-n-nother
p-p-p-pint
of five-v-vodka”.

Get it?

“p-p-p-pint

”

or

P,

P, P, I, N, T

or

Px,

Pe, Pog, I, Npot, T

In order to relieve me time in typing, I will type “P, P, I, North, T” instead of “the non-toll determinants of demand”.

Two Kinds of Changes Involving Demand

If the cost of a production increases what happens to demand for that product? For case, If the price of pizza increases, so the demand for pizza does what?
Nil, demand does not change when the price changes, but the quantity demanded does change. This section will help the states to ameliorate understand the difference betwixt a change in quantity demanded (

Qd) and a change in demand itself (

D). [The triangle, “

“, ways “change”.]

Alter in Quantity Demanded
(


Qd)

A change in quantity demanded caused ONLY past a alter in the Toll of the product. On a graph it is represented by a movement Along a Unmarried demand curve.

So if the price of pizza increase from $6 to $9 we will get an decrease in quantity demanded (

Qd) from 5 pizzas to 3 pizzas. This does non alter the demand schedule or the demand curve. Need does not change. Only it does result in a movement forth the SAME demand bend.

Change in Demand
(


D)

When in that location is a change in demand itself we become a new need schedule and bend. We have to alter the numbers in the demand schedule and this will SHIFT the need bend.

If at that place is an increase in demand (




D) the demand curve moves to the Correct.

When we say that the demand curves shift to the right, it means that we have to change the numbers on the demand schedule. For the same prices, the quantities increase. This shifts the curve to the RIGHT.

A subtract in demand will then shift the demand curve to the LEFT. For each price on the demand schedule, the quantities decrease.

Exist sure to draw your arrows to the Correct and LEFT. Many students want to describe the arrows perpendicular to the need curve. Don’t exercise this. E’er depict your arrows horizontally because this indicates the the prices are the aforementioned, and only the quantities modify.

A change in need is caused by a Modify in the not-cost determinants of demand:

Non-cost determinants of demand:



Pe,




Pog,




I,




Npot,




T

If these alter we go a new demand schedule and curve. To sympathise why prices are what they are, and why they change, nosotros need to empathize very well how these determinants motility the need curve. This is where it all begins. In our definition of demand we held these things constant (ceteris paribus), merely in the existent world these things do change, changing need, and ultimately irresolute prices. Then allow’s look at each determinant individually to understand how they each affect need.

Pe — expected price

Pe in the futurity







D today


Pe in the future



D today

If you lot expect the toll to get upward in the future need today will increment (shift to the right). For example, if we read that there volition exist a new revenue enhancement on vodka starting next week, people will desire to buy more at present earlier the price increases. Retailers sympathize this. How oft take yous heard “SALE ENDS Monday”? They want you to expect the cost to increase in the futurity so y’all’ll buy it today.

The opposite happens when you expect the price to go down in the futurity. In the past when my wife and I were shopping whenever I put something in the cart, she would take it out and put information technology back on the shelf! I’d ask, “why are yous doing that?”. She would say that she expected information technology to get on auction soon and we should look until it does. If you expect the price to become downwardly in the hereafter demand today decreases. (f
¯Pe in the futurity
Þ ¯D today). But, whenever I put something in the cart, she would accept it out saying that she expects it to go on sale soon. Later on awhile I got a little upset, when I’d inquire her well-nigh the items she put in the cart and she’d say that they were on sale terminal calendar week and we missed it. Finally, I went to talk to the store manager and explained the situation to him. He saved our union by explaining that most chain store have a policy stating that if an item goes on sale after you accept purchased it, you can bring in the receipt within 30 days and go a refund. Retailers understand how toll expectations affect demand.

Pog — cost of other goods

The effect of a change in the cost of other goods on demand depends on what type of other goods we are talking most. In that location are three types:

1) substitute appurtenances

Substitute goods are goods where if you purchase more of one, yous buy less of the other one. Examples of substitutes include vodka and gin, hot dogs and hamburgers, craven and beef, Coca-Cola and Pepsi.

Permit’s look at Coke and Pepsi. If the price of Coke increases it will increment the demand for Pepsi (the graph shifts to the right).I f you are going to purchase a can of Coke, you may walk right past the Pepsi machine, merely when you detect that the toll of Coke has increased, yous’ll probably turn around and purchase the Pepsi. You weren’t going to buy Pepsi before, but now, at the same cost, you are willing to buy it. So the demand for Pepsi has increased. The demand curve has shifted to the right. At the same prices, the quantities demanded are greater.

If the price of Coke increases, what happens to the demand for Coke? – – – NOTHING. Price does not modify need (as we have defined information technology) only it will change the quantity demanded.

You’ve seen a good example of this in your local grocery store. For case, I may desire to buy some java. Then I go to the coffee aisle and grab a tin of Folgers and keep downwards the aisle. But at the end of the aisle I see a display of Maxwell House coffee on sale! What do I do with the Folgers in my shopping cart? – – – – – No, I don’t put it dorsum. I take it out of my cart and put it on the Maxwell Business firm display. Haven’t you seen diverse brands mixed in with such displays? The demand for Folgers decreased (I no longer desire information technology at that price, so I take information technology out of my cart) because the price of Maxwell House decreased.

If:


P Maxwell House java



D Folgers java

2) complementary appurtenances

Complementary goods are goods where if you buy more of i you also buy more of the other one. they go together like vodka and tomato juice, rum and Coke, film and film developing, hot dogs and hot dog buns.

Let’s say that you lot want to swallow hot dogs this night and yous go to your local grocery store and put a bag of buns in your cart and caput downward the aisle to the wieners. When yous get to the wiener display you notice that their price has increased significantly so you decide non to eat hot dogs. What are you going to do with the buns? You should put them dorsum, but if you are like many people you’ll put them in the wiener brandish and move on chop-chop. But the point is, you were going to purchase the buns at their present price (they were already in your cart), but when you learned the price of hot dogs increased your need for buns decreased (the demand bend shifted to the left – at the same prices the quantities demanded decreased).

P of wieners



D of buns

Of course, if the price of i product decreases (cheaper moving-picture show developing), the demand for its complement (picture show) increases.

P of one product





D of its compliment

three) independent goods

Independent appurtenances are appurtenances where if the price of one changes, it has no effect on the demand for to other ane. For case, what happens to the demand for paper clips if the price of surfboards increases? Cipher.

 Summary (Pog):

P of i product





D of its substitute
P of one product



D of its substitute

P of one production



D of its compliment


P of one product





D of its compliment

I — income

1) normal appurtenances

For most goods, called normal goods, if consumer incomes increase, demand will increase and vice versa.

Income







D for normal goods


Income



D for normal appurtenances

And then if incomes increment, the demand curve for eating house meals, and cars, and boats, will shift to the right. At the same prices people will buy more.

2) inferior goods

For some appurtenances, called inferior goods, if consumer incomes increase demand will decrease, and vice versa. If only you had more money, you lot would purchase less of that product

Income



D for inferior appurtenances


Income







D for junior goods

The term “junior good” does not mean they are of low quality. the definition of an inferior good is one where if your income increases, need decreases. There is an inverse human relationship between income and need.

Examples of inferior goods might include used clothing, potatoes, rice, maybe generic foods. If y’all lose your job (and then your income decreases) you may shop for dress at the Salvation Regular army Thrift Shop (demand for used clothing increases).

What is a normal good for one consumer might be an junior adept for another. For case, if the income of one family increases they may buy a second small car (a normal good), simply for another family, an increase in income may hateful that they don’t purchase a small car (an inferior adept) anymore and they buy a mini van instead.

Npot — number of POTENTIAL consumers

An increase in the number of potential consumers will increment need and vice versa.

Npot







D


Npot



D

Earlier we say that if they lowered the drinking age, the demand for vodka would increase.

Often economists say that an increase in the “number of consumers” will increment demand. I prefer to use the terminology “number of POTENTIAL consumers” because if One thousand-Mart has a sale on Pepsi (price of Pepsi decreases) what happens to demand for Pepsi? — Cypher (toll does not change the demand schedule). But, if K-Mart has a auction on Pepsi (price of Pepsi decreases) what happens to the number of consumers ownership Pepsi? Information technology volition increase. (The constabulary of demand says that if price goes down, quantity demanded goes up.) So, if they have more than customers considering the price went down, what happens to demand? Zip – (cost does not change the demand schedule).

But, if the number of POTENTIAL customers changes, need will change.

Four circumstances can change the number of potential consumers:

1. population change
   If a new housing development is built in the empty field backside a small-scale shop, the number of potential consumers increases, and demand volition increase.
2. expanded marketing area
   Coors beer used to sold only out West. President Ford used to have to take it flown in to the While House because you couldn’t purchase it anyplace else. And so when Coors expanded to all states, demand increased because now there are more potential consumers.
3. new competitor (changes the demand curve facing and individual store, but NOT market need curve)
   If a new liquor shop moves in beyond the street from and existing shop, the demand for liquor of the existing store will decrease since now there are fewer potential consumers since some of the consumers walking past the store will have already bought something at the new store.
4. change in eligible consumers (i.eastward. drinking age)
   If they lower the drinking age there will exist more than potential vodka drinkers and so demand for vodka will increase.

T — tastes and preferences

There are hundreds of factors that affect the quantity of vodka sold. We don’t want to memorize hundreds of different determinants for each product, and so economists group everything else into “tastes and preferences”.
Tastes and preferences actually refers to “everything else”. Anything that increases a consumer’s preference for a product volition increment need for that production. This volition include advertizing and fads.

Supply

Introduction

Supply is more difficult for students to sympathise than demand. We are all consumers (demanders), but few of united states of america own a business (suppliers). So, recollect to call back of yourself as a business owner when we hash out supply.

Definition

Supply is a schedule which shows the diverse quantities businesses are willing and able to offer for sale at various prices in a given fourth dimension period,
ceteris paribus.

Supply is NOT the quantity available for sale. This is the way the term is often used in the popular press. Supply is the whole schedule with many prices and many quantities.

Only similar with demand, there is a difference between a change in quantity supplied and a alter in supply itself. So, if the price increases what happens to supply? The best WRONG answer would be “supply increases”, just it doesn’t. Price does not change supply, it changes quantity supplied, because supply ways the whole schedule with various prices and various quantities.

Supply Schedule and Curve

Below is a hypothetical supply schedule for pizza.

If nosotros plot these points (remember any point on a graph just represents two numbers) We get the graph below.

If nosotros assume there are quantities and prices in-between those on the schedule we get a supply curve.

Law of Supply

The police force of supply states that there is a direct relationship betwixt price and quantity supplied. In other words, when the price increases the quantity supplied also increases. This is represented by an upwards sloping line from left to right.

Why?

Why is the law of supply true? Why is the supply curve upwards sloping? Why will businesses supply more pizzas only id the price is college? I think it is just common sense. If you lot want the pizza places to piece of work harder and longer and produce more pizzas, yous have to pay them more, per pizza. Only economists, as social science, want to explain common sense. We know businesses comport this mode, but why?

There are two explanations for the law of supply and both have to do with increasing costs. Businesses require a college cost per pizza to produce more pizzas because they have higher costs per pizza. Why?

First, there are increasing costs considering of the law of increasing costs. In a previous lecture nosotros explained that the product possibilities curve is concave to the origin because of the constabulary of increasing costs. the law of increasing costs is true because not all resource are identical. Let’southward say a pizza place is just opening. The possessor figures that they volition need five employees. After putting an advertisement in the newspaper there are twenty applicants. Five have had experience working in a pizza place before. They came to the interview make clean and on fourth dimension. The other fifteen had no work experience. Many came tardily. A few were caught steeling pepperoni on the mode out. One spilled flour all over the floor. Which applicants volition exist hired? Of course it will be the five with experience and the other fifteen will be rejected considering they would be as well costly to hire. Now, if the pizza place wants to produce more pizzas they will need more than workers. This ways they will have to hire some of those who were rejected because they were more costly (less experienced, etc.). And so, they will just hire the more than costly employees if they can become a college price to comprehend the higher costs. this is one caption why the supply curve is up sloping.

Second, there are increasing costs because some resources are stock-still. This should not make sense to you. Why would there be increasing costs if we use the aforementioned quantity of some resource? Well, let’s say that the size of the kitchen and the number of ovens (capital letter resources) are fixed. This means that they don’t change. Now, if we want to produce more pizzas you volition have to cram more workers into the same size kitchen. Every bit they bump into each other and look for an oven to be complimentary they notwithstanding go paid, just the cost per pizza increases. Therefore they volition not produce more pizza unless they tin become a college price to cover these higher per unit costs. So the supply curve should be upward sloping.

Market Supply

Marketplace supply is the horizontal summation of the individual supply curves. Instead of looking at how many pizzas one pizza identify is willing and able to produce at unlike prices (individual supply), we keep the prices the same and add the quantities of additional pizza places. Prices stay the same, simply quantities increment considering there are more pizza suppliers. And so the market place supply of pizzas is further to the right (horizontal) than the individual pizza place supply curves.

determinants of Supply

The toll of the product

(





P
)

Economists stress the importance of price in determining how much will be produced. That is why they put toll on the supply graph, but in that location are other things that bear on how much of a production will be produced too the price. When we developed the supply curve for pizza we employed the
ceteris paribus
assumption. we assumed all other things stayed constant. For example in that location were no new technological discoveries, the prices of resources stayed the same, or no change in taxes. All other factors remained the same – only the price and quantity supplied changed.

But at that place are other determinants of how much business organisation supply as well the toll. We telephone call these the Non-Price determinants of Supply.

The not-cost determinants of Supply

Economists classify the non-toll determinants of supply into half dozen groups:

a. Pe — expected price
b. Pog — toll of other goods Too PRODUCED By THE FIRM
c. Pres — toll of resources
d. T –technology
e. T –taxes and subsidies
f. N — number of producers/sellers

Two Kinds of Changes Involving Supply

Alter in Quantity Supplied
(


Qs)

A change in Quantity supplied caused Merely by a change in the Cost of the product. It is represented by a motility Forth a SINGLE supply bend.

Modify in Supply
(


S)

A alter in supply is a shifting the supply curve because there is a new supply schedule. The supply curve either moves left or correct (horizontally) since the prices stay the same and only the quantities change and quantity is on the horizontal axis. Be sure to draw your arrows to the Correct and LEFT. Many students want to depict the arrows perpendicular to the supply curve. Don’t exercise this. Always describe your arrows horizontally because this indicates the the prices are the same, and only the quantities change. Also, if yous draw you arrows perpendicular to the supply curve and arrow pointing Up will point a DECREASE in supply. That could get confusing!

A change in supply is caused by a change in the non-price determinants of supply. these are the factors that we causeless were constant when we used the
ceteris paribus
assumption to develop the supply curve.

Increase in Supply

If there is an increase in supply (




S) the supply bend moves to the Correct. At the same prices, the quantities supplied will be greater

Decrease in Supply

If there is an decrease in supply (


Due south) the supply curve moves to the LEFT. At the aforementioned prices, the quantities supplied volition be smaller.

Changes in supply are caused by a Change in the non-price determinants of supply

Pe — change in expected price


Pog — modify in price of other appurtenances ALSO PRODUCED BY THE FIRM


Pres — change in price of resources


Tech — change in technology


Tax — change in taxes and subsidies


Nprod — change in number of producers/sellers

Let’s look at these determinants on at a fourth dimension. We must know how they shift the supply bend if nosotros are to utilise the supply and demand tool to understand how prices are determined in a market place economic system.

Pe — expected toll

If a concern expects that they can get a higher price in the time to come, what will happen to supply today? They volition exist less willing to sell there products today because they will know that if they waited they could become a higher price so supply today would decrease, shift to the left. (Remember, supply is not the quantity bachelor for auction.)

Let’s say that y’all want to sell you car, somebody offers you $1500 today, and you have it. You are willing to sell your auto for $1500 today. THEN, somebody says that they will swoop y’all $2000 for your car if you could await three days. At present yous await that you can get a higher price ($2000) in the hereafter, and then y’all volition probably no longer want to sell your car for $1500 today.

Pe



Southward today


Pe



S today

Pog — price of other goods Also PRODUCED BY THE FIRM

Offset, think of a business that produces ii products, like farmers who can either grow corn or soybeans. And then the toll of one increases, what happens to the supply of the other one.

So if the price of soybeans increases, what happens to the supply of corn?

If the price of soybeans increases the supply of corn will subtract. The supply curve of corn will shift to the left as farmers plant more soybeans and less corn.

P soybeans



Southward corn


P soybeans





Southward corn

If the price of soybeans increases, what happens to the supply of soybeans?

–

–

–

Zip. Remember, price does non modify supply, it changes the quantity supplied. so if the price of soybeans increases, nosotros would get an increase in the quantity supplied (same supply curve, higher quantity).

The price of resources (


Pres ), improved applied science (

Tech), and taxes and subsidies (

Revenue enhancement) all bear on supply because they change the costs of product

costs



S (shifts left)


costs





S (shifts right)

Pres — toll of resources

If the cost of a resource used to produce the product increases, this will increment the costs of production and the producer will no longer be willing to offering the aforementioned quantity at the same price. They will desire a higher price to cover the higher costs. This shifts the supply curve to the left (

S).

For Example: if the autoworkers unions receives a pregnant wage increase, this will increase the costs of producing cars and decrease the supply of cars (

Southward).

P autoworkers wages





costs of producing cars



Southward cars

Pres





costs



Southward


Pres



costs





S

Tech –technology

Does improved technology increase or subtract the costs of producing a product?

Improved technology DECREASES costs and therefore increases supply. If the technology did not decrease costs, and then it wouldn’t be used. If there is a high-tech expensive way to produce a product and a low-cost, low-tech, way to produce the same production, companies that use the low-toll methods will be able to sell the production at a lower price and beat out the high-cost producers.

Improved technology



costs







S

What has improved technology done to the costs of medical care? Improved medical technology has INCREASED the cost of medical care Merely it has as well inverse the outcome. For instance allow’s say that there is a disease where with existing low-cost technology, one-half the patients die. Now, if they invent a new loftier-cost engineering that will save all lives which technology will be used? Of class the new loftier-toll technology will be used, BUT THE PRODUCT HAS Inverse. One product is when half the patients die, the other product is when all patients live. We can’t put 2 products on one supply curve.

Let’s utilise one more medical example. Why do doctors nonetheless utilise depression-tech stethoscopes? they were using similar stethoscopes a hundred years agone. Isn’t here a high-tech electronic stethoscope? Yeah there is, and then why don’t doctors use it? Because it is more expensive AND IT GIVES THE SAME RESULTS. Doctors will utilise the cheaper applied science as long equally the results are the same. but obstetricians do use the more than expensive high-tech stethoscope considering it gives them better results. The low-tech stethoscopes tin can’t always selection out the fetal eye beat. the newer high-tech and higher-cost electronic stethoscopes tin can. The product changes.

And so, improved engineering volition decrease costs and increase supply OR it will increase costs and alter the product which we cannot put on one graph.

Taxation –taxes and subsidies

Here we volition hash out excise taxes. Excise taxes are a “per-unit” tax imposed on the product or sale of a production. Examples include the gasoline tax (and then much per gallon), the cigarette taxation (so much per pack) and the liquor revenue enhancement (so much per bottle).

Allow’southward discuss the gasoline taxation. If the revenue enhancement on gasoline increases volition this affect the demand for gasoline or the supply of gasoline? If you said demand – then which not-toll determinant of demand has changed? recollect price does not change demand.

If the tax on gasoline increases, this volition raise the cost of SELLING gasoline, and Decrease SUPPLY.

Taxes





costs



S


Taxes



costs





S

Who pays the gasoline revenue enhancement? Who pays the wages of the gas station employees? Whether you answer the consumer of the gas station owner, y’all have to give the same answer for both questions. Both taxes and wages are costs to the producer or seller. Higher gasoline taxes do not shift the demand curve, simply they may effect in a higher price and therefore a decrease in quantity demanded.

Subsidies are the opposite of taxes. Instead of the business paying the regime, the government pays the business. There are fewer subsidies than taxes. But permit’due south say the the government wants to encourage the utilise of solar free energy so they put a subsidy (or increase one) on solar energy equipment. this will subtract the costs of producing or selling the equipment considering when they produce or sell one they get a refund (subsidy) from the regime.

Subsidies



costs





S


Subsidies





costs





Southward

N — number of producers/sellers

An increment in the number of producers of a product will increment supply of that product. If the number of estimator manufacturers increases, the supply of computers will increase (shift to the right).

Nprod





S


Nprod





Due south

Marketplace Equilibrium — Equilibrium Price and Quantity

Now nosotros are ready to talk over PRICES. At the elevation of this online lecture I said:

“In a capitalist lodge prices are determined by the interaction of demand and supply. Since prices are so important, we demand to ameliorate empathize how they are determined. why is the price of gasoline $1.59 a gallon. Why does a processed bar price $0.75? Why is the toll of plywood ordinarily $10 a sheet, but $30 a sheet after a hurricane?”

Market place Equilibrium

Equilibrium ways that there is no farther trend to modify. When something is at equilibrium, it is at rest, not changing. Like a pendulum. when it is swinging, information technology is changing. We telephone call this disequilibrium. Eventually, it will cease swinging and achieve equilibrium.

Prices do something similar. They move toward an equilibrium where they come to rest and don’t alter. Merely just similar you tin button a pendulum and cause information technology to swing then slow downwards and accomplish equilibrium again, prices tin can be “pushed” and they will change to a new equilibrium. Information technology is the non-price determinants of demand and supply that “button” prices to a new equilibrium. Nosotros call this “market equilibrium”.

The equilibrium price is the price where the quantity demanded equals the quantity supplied.

Sometimes I hear people say that equilibrium is where demand equals supply. It is impossible for the whole demand curve to be the same every bit the whole supply bend (Not: D = S), only there is i price where the quantity demanded equals the quantity supplied.

Market Disequilibrium

Why will the price of pizzas exist $9? Well, let’southward take a look at what happens if the price is not at equilibrium.

If the price is $12, the quantity demanded is 2000 (Qd = 2000) and the quantity that businesses are willing to supply is 4000 (Qs = 4000). The result volition exist a
surplus
of 2000 pizzas (4000 – 2000 = 2000). If there is a surplus (more bachelor than consumers are willing to buy) the price will change – decrease. Twelve dollars is not equilibrium – it will alter.

See graph.

If the toll is $6, the quantity demanded is 5000 (Qd = 5000) and the quantity that businesses are willing to supply is 2000 (Qs = 2000). The result will exist a
shortage
of 3000 pizzas (5000 – 2000 = 3000). If there is a shortage (consumers are willing to purchase more than is available) the price will modify – increase. Six dollars is not equilibrium – information technology will modify.

Come across graph.

Changes in Demand AND Supply

Now that nosotros can find equilibrium AND we know what causes supply or demand to modify, let’s see what happens to the equilibrium toll and quantity if supply and/or need changes. After we do this, we will put it all together. It all begins with a change in one of the eleven non-price determinants:

Demand:



Pe,




Pog,




I,




Npot,




T

SUPPLY:



Pe,



Pog,



Pres,



Tech,



Taxation,



Nprod

so you must know how they bear on the graphs. We discussed this in a higher place and will review it again shortly. Here, permit’s just concentrate on what happens to price and quantity if demand and/or supply changes.

Instance ane: D changes and supply stays the same

If demand increases (shifts to the right) what effect volition this have on PRICE and QUANTITY. Be sure to DRAW THE GRAPHS. You can probably approximate what will happen to cost and quantity and get it correct quite often, only why guess when you can draw the graphs and get information technology right about all the time?
Exist SURE TO Draw THE GRAPHS!

So, if demand increases and supply stays the same you get (see graph):

If need decreases (shifts to the left) and supply stays the same you become (run into graph):

This is quite easy, but the fundamental to understanding this are the not-price determinants of supply and demand. We will review them soon.

Case ii: S changes and demand stays the same

If supply increases (shifts to the right) what effect will this have on Price and QUANTITY. Be sure to Depict THE GRAPHS. You can probably judge what volition happen to price and quantity and get information technology correct quite often, but why guess when yous can draw the graphs and get it right virtually all the time?
BE SURE TO DRAW THE GRAPHS!

Then, if supply increases and demand stays the aforementioned you go (see graph):

 If supply decreases (shifts to the left) and demand stays the same you become (see graph):

Case 3: D and Due south


both


alter

What if BOTH supply and demand change at the same time? This means what happens to price and quantity if a non-toll determinant and supply AND a not-price determinant of need change shifting the graphs at the aforementioned time?

ane. South increases, D decreases

DON’T LOOK!!!

Graph it correct now and make up one’s mind what would happen to price and quantity if supply increases and demand decreases.

In a face up-to-face class I would have my students do this themselves and tell me what happens to P and Q. So allow’s do it in this distance learning class.

–

–

–

–

What practise y’all get? What happens to price and quantity if supply increases (shifts to the right) and demand decreases (shifts to the left)?

–

–

If supply increases and demand decreases: price decreases quantity is INdeterminant

The price will decrease, but nosotros cannot tell what happens to quantity. Quantity could increase, it could decrease or information technology could stay the same. What happens to quantity depends on how much the supply and demand curves shift and since we were not told this, we cannot determine what happens to quantity. Quantity is indeterminant.

Encounter the graph below where we can encounter that if demand decreases a trivial (D2) so the equilibrium quantity volition increase, but if the demand bend decreases a lot (D4) the equilibrium quantity will decrease.

ii. S decreases, D increases

What happens to price and quantity if supply decrease and demand increases?

GRAPH IT!

–

–

–

–

If supply decreases and need increases: cost increases quantity is indeterminant

The price volition increase, but nosotros cannot tell what happens to quantity. Quantity could increase, it could decrease or it could stay the same. What happens to quantity depends on how much the supply and demand curves shift and since we were not told this, we cannot decide what happens to quantity. Quantity is indeterminant. Try graphing dissimilar shifts in D and S and see what happens to quantity.

iii. Due south increases, D increases

What happens to price and quantity if both supply and demand increase (shift to the correct)?

GRAPH It before scrolling (or looking) lower on this page.

–

–

–

–

If supply increases and need increases: quantity increases price is INdeterminant

The quantity will increase, but nosotros cannot tell what happens to price. The price could increase, it could decrease or it could stay the same. What happens to the price depends on how much the supply and demand curves shift and since we were non told this, we cannot determine what happens to cost. Cost is indeterminant.

See the graph below where we can see that if supply increases a little (S1) then the equilibrium toll volition increase, just if the supply curve increases a lot (S3) the equilibrium price volition subtract.

4. Southward decreases, D decreases

What happens to price and quantity if supply decrease and demand increases?

GRAPH IT!

–

–

–

–

If supply decreases and demand decreases: quantity decreases price is indeterminant

The quantity will decrease, but we cannot tell what happens to price. price could increase, it could decrease, or it could stay the aforementioned. What happens to cost depends on how much the supply and demand curves shift and since we were non told this, we cannot determine what happens to price. Toll is indeterminant. Try graphing unlike shifts in D and S and see what happens to price.

Using Supply and Demand

Now let’s put it all together. We can use our supply and need model to understand why prices modify. It all begins with the not-price determinants of need (


Pe,




Pog,




I,




Npot,




T) and the not-price determinants of supply (



Pe,



Pog,



Pres,



Tech,



Tax,



Nprod
). These are the factors in the existent world that crusade prices to change.

We will use supply and demand curves to illustrate how changes in these not-price determinants will touch the

price

and

quantity

of a product,
ceteris paribus. Earlier
you guess, answer the following questions:

(i) Which determinant has changed?
(ii) Will it affect supply or demand?
(three) Will supply or demand increase or decrease?
(4) GRAPH IT! What happens to price and quantity?

EXAMPLE 1

Assume the graph higher up represents the market for computers. The equilibrium cost is P1 and the equilibrium quantity is Q1. WHAT HAPPENS TO THE Toll AND QUANTITY OF COMPUTERS IF CONSUMER INCOMES Increase
ceteris paribus
?

Our goal is to empathize what happens to PRICE and QUANTITY, but don’t just judge. If yous exercise just think about it and try to figure it out in your head, you’ll probably go it correct a lot of the time. Merely wouldn’t you rather get it right most, or all, of the fourth dimension? We now accept a tool (supply and demand) that nosotros can use to better understand changes in price and quantity. And then use the tool. Once you lot become used to information technology you’ll encounter its benefits.

Answer the four questions and the graph (tool) will give you the answer.

(1) Which determinant has inverse?

Sometimes this is obvious. In this example information technology is
income.

(two) Volition it bear on supply or demand?

Income is a determinant of DEMAND. But at other times this is more difficult. For instance Pe and Pog are determinants of BOTH need and supply.

(3) Will supply or demand increase or subtract?

This is the key to using the tool correctly. We discussed above how the non-price determinants shift the curves. Computers are
normal appurtenances.
This means that if
incomes increase, need for computers volition increment.

(4) Finally, GRAPH Information technology! the graph will tell you lot what happens to toll and quantity. Run across graph below.

The graph shows that if demand increases, the
toll will increase
and the
quantity will increment.

Reply: So if consumer incomes increase,
ceteris paribus, the cost of computers volition increment and consumers will purchase more.

EXAMPLE two

Presume the graph to a higher place illustrates the market place for electronic calculators. If

improved engineering reduces the costs of producing calculators, what volition happen to the cost of calculators and to the quantity sold? (Be certain to utilize our tool.)

(1) Which determinant has changed?

Applied science

(2) Will it affect supply or need?

SUPPLY

(3) Will supply or demand increase or subtract?

SUPPLY WILL INCREASE (shift to the right)

(four) GRAPH IT! What happens to price and quantity?

Reply: If the engineering for producing calculators improves, the price of calculators will decrease and the quantity sold will increase

Example iii

Let’s practice one more than like this.

If the graph above is for Nintendo 64 Video Game Systems, what will happen to the price and quantity if at that place is a decrease in the price of personal computers?

(i) Which determinant has changed?

Pog – the product on the graph is Nintendo Video Game Systems and the price of some other product, computers, has changed

(2) Volition it affect supply or demand?

The non-price determinant, Pog, is a determinant for both supply and demand. With supply we said information technology refers to the cost of other good PRODUCED By THE SAME FIRM. Does Nintendo also produce computers? NO.

With need, Pog refers to the price of substitute and the toll of complements. Are video game systems and dwelling computers substitutes or compliments? Most people would say they are substitutes. If you buy a new home calculator, y’all tin can play games on the estimator and maybe you won’t buy a new video game organization.

So, if there is a subtract in the cost of personal computers, DEMAND FOR VIDEO GAME SYSTEMS WILL CHANGE.

(3) Will supply or need increase or decrease?

if at that place is a decrease in the cost of personal computers, DEMAND FOR VIDEO GAME SYSTEMS WILL Subtract (shift to the left).

(4) GRAPH It! What happens to price and quantity?

Answer: If there is a subtract in the price of personal computers, need for video game systems will subtract (shift to the left) and the price of video game systems will decrease and the quantity sold will decrease

MORE EXAMPLES:

For REVIEW exercises click HERE

“Existent Globe” Examples

In the “existent world” the determinants are not as like shooting fish in a barrel to option out. The tool still works, just it takes a little more practice.

If you lot read a newspaper or Internet news article about a production whose price and/or quantity has changed, you lot can utilise supply and need to analyze WHY the price and/or quantity has changed. We know that changes in the non-price determinants of demand and supply crusade prices and quantities to modify. So, to understand why, nosotros have to look for the not-price determinants in the article.

Existent-WORLD EXAMPLE 1

Beneath is a portion of an article from CNNFN.COM

Read the commodity looking for the cause of the price change and then use our supply and demand graph to ILLUSTRATE what has happened. This volition be similar to the extra credit question that you will have on exam 1.

Remember to apply our tool correctly:

(1) Which determinants have changed?
(two) Will they touch supply, demand, or both?
(3) Will supply or demand increment or decrease?
(iv) GRAPH IT! And then show what happens to cost and quantity?

Top PC makers cut prices

Compaq clears out erstwhile models; Dell passes on lower component costs

February 1, 2000: 2:44 p.m. ET

NEW YORK (CNNfn) – Ii of the world’s largest estimator makers on Tuesday announced that they have cutting prices on their commercial desktop PCs. Compaq, the No. ane PC maker, said it cut prices up to 13 percent on most of its Deskpro series commercial PCs. The price cuts are being made to clear the way for ix new Deskpro models. . . . . . . . . . . . . . . . Dell ( DELL : Enquiry , Estimates ), the globe’s 2nd largest supplier of PCs, said information technology was cutting prices considering the price of the components it uses to make them have besides dropped. Effective Mon, a Dell Precision WorkStation 210 with a Pentium III processor running at 650 one thousand thousand cycles per second will sell for $1,740, a 17.1 percent reduction, the company said. Dell also said it cut prices on the mid-range models in its Precision WorkStation 410 line past up to 15.five percent.

(i) Which determinants have changed?

The article says

“
Dell

(
DELL
:

Enquiry
,

Estimates
), the world’s second largest supplier of PCs, said it was cutting prices because the price of the components it uses to make them have also dropped.”

This indicates the at that place has been a change in the price of resources (Pres)

(ii) Will they impact supply, need, or both?

SUPPLY

(3) Volition supply or demand increment or decrease?

SUPPLY WILL Increment (shift to the right)

(4) GRAPH IT! Then evidence what happens to toll and quantity?

Reply: As the article says, the price is decreasing.

REAL-World EXAMPLE ii

Below is a portion of an article from CNNFN.COM
http://cgi.cnnfn.com/output/pfv/2000/02/01/companies/pcs_prices/

Read the commodity looking for the cause of the price change and then use our supply and need graph to ILLUSTRATE what has happened. This will be similar to the extra credit question that you volition accept on exam ane.

Remember to utilise our tool correctly:

(1) Which determinants have changed?
(ii) Will they affect supply, demand, or both?
(3) Will supply or demand increase or decrease?
(4) GRAPH It! Then show what happens to cost and quantity?

Air customers to pay for fuel

With demand for seats still strong, about carriers announce fuel surcharges

By Staff Author Chris Isidore January 21, 2000: 3:54 p.m. ET

NEW YORK (CNNfn) – Airlines are finding a source of relief for oil toll shocks they’ve rarely tapped earlier: their passengers. With oil prices hit a postal service-Gulf War high Friday, iii more carriers – The states Airways, America W and Trans World Airlines – appear surcharges, charging customers $twenty per round-trip ticket on virtually all domestic flights.     That meant that eight of the nine largest carriers in the country at present had the charges, with only No. 7 Southwest Airlines ( LUV ), the Dallas-based discount carrier, belongings off at this fourth dimension. Demand for seats opens door     The surcharge is unique in its acceptance by the typically cutthroat airline industry, and is a sign that demand for air travel remains potent. The Air Ship Association report that 71.3 percent of its members’ seats were filled last yr, the all-time rate in the history of passenger jet travel. With demand remaining strong despite the spike, airlines are in a better position to seek higher fares. “In the past, when we had the tremendous sew together in fuel, we also had a recession,” said David Swierenga, the ATA’southward chief economist. “Those two things together clobbered the manufacture. Now the economy is moving ahead , and carriers volition have a little more than flexibility on the pricing side.” . . . . . . . . .

Respond: I have

highlighted in red


the important parts of this article. Let’s analyze each i.

“With oil prices striking a post-Gulf War high Friday, three more carriers – Usa Airways, America West and Trans World Airlines – announced surcharges, charging customers $20 per circular-trip ticket on about all domestic flights.”

(one) Which determinant has inverse?

PRICE OF RESOURCES. Oil (fuel) is a resources used by the airline manufacture

(ii) Will they impact supply or demand?

SUPPLY

(iii) Will supply or demand increment or decrease?

SUPPLY WILL DECREASE (shift to the left)

(4) GRAPH IT! Then show what happens to price and quantity?

So a issue of the higher fuel prices is higher prices, but our graph shows the quantity going down and the article indicates that quantity has stayed the same or increased a little. therefore we should continue looking for determinants that have changed.

The article too says:

“
 The surcharge is unique in its credence by the typically cutthroat airline industry, and is a sign that demand for air travel remains strong.

”

AND




“At present the economy is moving ahead”.

(1) Which determinant has inverse?

INCOME (“The economy is moving ahead” means incomes are rising.)

(2) Will they affect supply or demand?

Need

(3) Will supply or demand increase or subtract?

DEMAND Will Increment (assuming air travel is a normal good)

(4) GRAPH IT! Then bear witness what happens to price and quantity?

And then as a result of the good economy we would expect prices to increase and the number of travelers to increase.

NOW Let’Due south PUT BOTH CHANGES ON THE Aforementioned GRAPH. Yous
must
practice this to prove the overall effect of all changes. We have a decrease in supply acquired by higher resources prices and an increase in demand caused by higher incomes,

The result is higher prices (encounter graph) and the quantity stays about the same as the commodity states (therefore I shifted the curves the same amount).

Other articles that you lot can analyze yourself:

• http://cnn.com/United states/9907/27/gas.prices/
• http://cnnfn.com/2000/01/21/companies/airfuel/
• http://cnn.com/Usa/9908/09/rv.boom/

ANSWERS

Market Supply: correct answer “B” [Render]