Topic #7: Introduction to Demand and Supply

1. Topic #7: Introduction to Demand and Supply Dr David Penn Associate Professor of Economics and Director of the Business and Economic Research Center

2. Introduction to Demand and Supply • The Supply and Demand model helps us understand how many markets behave. • If we know how markets work, we can explain why gasoline prices rise and why natural gas is becoming less expensive, for example.

3. Introduction to Demand and Supply • What determines demand? • What determines supply? • How do supply and demand interact? • What is the role of prices?

4. Model of Supply and Demand Assumptions: 1) Competitive markets, many buyers and sellers. 2) Buyers prefer more goods to fewer goods.

5. Determining Demand Demand – amount we are willing and able to purchase at various prices. Law of Demand – as price falls, quantity demandedrises, other things being equal. This describes an inverserelationship between price and quantity demanded.

6. Demand Schedule for Cotton The Demand Schedule shows how much cotton consumers are willing to purchase at various possible prices. For example, if the price is $2 per pound, consumers will be willing to purchase 7 billion lbs. And if the price drops to $1.25 per pound, consumer purchases will rise to 10 billion pounds. These points are plotted on a demand curve in the next slide.

7. Demand Curve for Cotton The Demand Curve shows that as the price of cotton rises, the quantity of cotton demanded falls. Assumption: all other factors that might affect cotton purchases remain the same. This is known as the ceteris paribus assumption.

8. Shifts of the Demand Curve The demand curve can shift if we relax the ceteris paribus assumption. As one example, an increase in the number of consumers due to population growth can shift the demand curve to the right over time. When the demand curve shifts right there is an increase in the quantity demanded at any given price. The 2007 and 2013 demand schedules are shown in the next slide.

9. Demand Schedule for Cotton Quantity demand for any given price rises from 2007 to 2013 due to population growth. Example: at a price of $1.75, consumer purchases rise from 8 billion lbs in 2007 to 10 billion lbs in 2013. Quantity demand rises at all the other prices also. As a result, the demand curve shifts to the right (previous slide).

10. Movement along the demand curve vs shift of the demand curve Movement along the demand curve is not the same as a shift in the demand curve. For example, movement from A to B on is called a change in quantity demanded, since the demand curve is not shifting. But a move from A to C is called a change in demand, since the demand curve shifts. This may seem like a very technical point but language matters.

11. Shifts of the demand curve A shift to the right (from D1 to D2) is called an increase in demand. A shift to the left (from D1 to D3) is called a decrease in demand.

12. Shifts of the demand curve • Changes in income, • Changes of prices of related goods, • Changes in tastes, • Changes in expectations, and • Changes in the number of consumers. Economists believe that the demand curve can shift for any one of five reasons:

13. Shifts in Demand • 1) Changes in income – • for Normal goods – demand increases as income increases (demand curve shifts right) • for Inferior goods – demand decreases as income increases (demand curve shifts left).

14. Shifts of Demand • 2) Prices of related goods – a related good is either a substitute or a complement: • for Substitutes – an increase in the price of one increases the demand for the other (shifts the demand curve to the right). • for Complements – an increase in the price of one decreases demand for the other (shifts the demand curve to the left).

15. Shifts of Demand 3) Changes in tastes – tastes may change due to demographic trends and changes in fashion. 4) Expectations – an expected change in a future price will change demand today. a) if we believe price will rise tomorrow, we buy more today (today’s demand curve shifts right). b) if we believe price will fall tomorrow, we buy less today (today’s demand curve shifts left).

16. Shifts of Demand 5) Changes in the number of consumers – population growth and in-migration will increase demand (shift right), while population decline will cause demand to decrease (shift left).

17. Test your knowledge • The following has to do with the market for new autos. Name the factor and the direction of the change in demand: • 1) Used car prices fall. • 2) New car prices expected to rise. • 3) Consumers become concerned about jobs. • 4) Automakers offer new rebates. • 5) Household income drops. • 6) Consumers become more energy aware.

18. Test your knowledge - answers • 1) Used car prices fall – change in the prices of related goods (assuming used cars and new cars are substitutes); demand for new cars will fall. • 2) New car prices are expected to rise – change in expectations; today’s demand for new cars will rise. • 3) Consumers become concerned about jobs – change in expected income; today’s demand for new cars falls. • 4) Automakers offer new rebates – the net price of new cars falls, causing a movement along the demand curve. The demand curve does not shift.

19. Test your knowledge - answers • 5) Household income drops – change in income; demand for new cars shifts falls (shifts left). • 6) Consumers become more energy aware – change in tastes; demand for fuel efficient new cars rises (shifts right), but demand for gas guzzlers falls (shifts left).

20. Next • Continue to the ‘Supply’ powerpoint