Supply and Demand

Supply and Demand What people want and why

Demand • Demand represents the behavior of buyers. • A Demand Curve shows the quantity demanded at different prices. • The Quantity Demanded: the quantity that buyers are willing (and able) to purchase at a particular price.

Law of Demand • Price and Quantity Demanded are negatively related

The Demand Curve The Demand Curve for Oil Price of Oil per Barrel $55 $20 Demand $5 Quantity of Oil (MBD) 5 25 50

Reading Demand Curves • Demand curves can be read in two ways: • Horizontally:How much buyers are willing and able to purchase at a certain price. • Vertically:The highest price buyers are willing to pay for a certain quantity.

Intuition of the Demand Curve When the price is high, oil will only be used in the high value products. If the price falls, oil will also be used in lower value products. Priceof Oil per Barrel Higher Valued Uses of Oil $120 Lower Valued Uses of Oil $20 Demand 20 120 Quantity of Oil (MBD)

Consumer Surplus • Consumer Surplusis the consumer’s gain from exchange, • the difference between the highest price a consumer will pay at a given quantity and the actual market price.

To next Try it! Your roommate just bought an iPadfor $600. She would have been willing to pay $1,000 for a machine that could make her life so much more worthwhile. How much consumer surplus does your roommate enjoy from the iPad? $600 $400 $1600 $1400

What Shifts the Demand Curve? • An “increase in demand” means that consumers buy more at every price level, orconsumers are willing to pay more for each quantity. • On the graph: the demand curve shifts outwards, up, and to the right.

What Shifts the Demand Curve? • A “decrease in demand” means that consumers buy less at every price level, (or they reduce the price they’re willing to pay for a given quantity.) • On the graph: the demand curve shifts inwards, down, and to the left.

A Decrease in Demand Price per Unit Lower Willingness to Pay for the Same Quantity $50 Less Quantity Demanded at the Same Price $25 Old Demand Curve New Demand Curve Quantity 70 80

An Increase in Demand Price per Unit $50 Greater Willingness to Pay for the Same Quantity Greater Quantity Demanded at the Same Price $25 New Demand Curve Old Demand Curve 70 80 Quantity

Demand Shifters • Important Demand Shifters: • Income • Population • Price of Substitutes • Price of Complements • Expectations • Tastes

Important Demand Shifters:Income • The effect of changes in income on demand depends on the nature of the good in question. • A Normal Good: demand increases when income increases (and vice versa). • An Inferior Good: demand decreases when income increases (and vice versa)

To next Try it! When the price of petroleum goes up, the demand for natural gas ______, the demand for coal ______, and the demand for solar power ______. increases; increases; increases increases; increases; decreases decreases; decreases; increases decreases; decreases; decreases

Important Demand Shifters:Population • As the populationof an economy changes, the # of buyersof a particular good also changes, (thereby changing its demand.) • What happens to the demand for diapers in Russia as birth rates drop?

Important Demand Shifters: Price of Substitutes • Two goods are Substitutes if buying one causes you to not buy the other. • A decrease in the price of one leads to a decrease in demand for the other (or vice versa). • What happens to the demand for travel to Hawaii if the (perceived) safety • cost of traveling to Mexico increases?

Important Demand Shifters: Price of Complements • Two goods are Complementsif • buying one causes you to buy the other. • A decrease in the price of one good leads to an increase in the demand for the other. • What happens to the demand for Sport Utility Vehicles when gasoline gets more expensive?

Price of Complements • Consumers often have to buy goods together. • An increase in price of gasoline will decrease the demand for SUVs

Important Demand Shifters: Expectations • The expectation of a higher (lower) price for a good in the future increases (decreases) current demand for the good. • Consumers will adjust their current spending in anticipation of the direction of future prices in order to obtain the lowest possible price. • If prices for Xbox one consoles are expected to drop right after Christmas, what will happen to sales during November?

Important Demand Shifters: Tastes • Tastes and preferences are subjective and will vary among consumers. • Seasonal changes or fads have predictable effects on demand. • What happens to demand for boots in October? To carbohydrates during the Atkins diet fad? Or to Acai berries after newly perceived health benefits?

What Shifts the Demand Curve? • A “change in quantity demanded” isNOTthe same asa “change in demand.” • “Quantity demanded” changes only when thepriceof a good changes. • It is a movement along a fixed demand curve. • “Demand” changes only when a non-price factor (demand shifter) changes. • It is a shift in the entire demand curve. A “change in Quantity Demanded” A “change in Demand”

Supply What made this oil field happen?

Supply • Supply represents the behavior of sellers. • A Supply Curveshows the quantity supplied at different prices. • The Quantity Suppliedis the quantity that producers are willing and able to sell at a particular price.

Law of Supply • What do you think happened to the quantity of marijuana sold in Colorado when it became legal? • The Law of Supply: there is a direct relationship between profit and quantity supplied. • When price rises, all else equal, quantity supplied rises.

The Supply Curve Price of Oil per Barrel The Supply Curve for Oil Supply Curve for Oil $55 $20 $5 Quantity of Oil (MBD) 10 50 30

Reading Supply Curves • Supply curves can be read in two ways: • Horizontally:How much suppliers are willing and able to sell at a certain price. • Vertically:The minimum price for which suppliers are willing to sell a certain quantity.

Supply Curves • Why is the supply curve upward sloping? • The cost of producing a good is not equal across all suppliers. • At a low price, a good is produced and sold only by the lowest cost suppliers. • At a high price, a good is also produced and sold by higher cost suppliers.

The Supply Curve for Oil Price of Oil per Barrel The Supply Curve for Oil Supply $60 Oil Shale Profitable Here $40 Higher Cost Oil Low Cost Oil $20 Quantity of Oil (MBD) 20 40 60 80 100

Producer Surplus • Producer Surplusis the producer’s gain from exchange • the difference between the market price and the minimum price at which producers would be willing to sell a certain quantity.

Change in Supply Price of Oil per Barrel Old Supply Greater Quantity Supplied at the Same Price New Supply $50 $10 Lower Costs Increase Supply Willing to Sell Same Quantity at Lower Prices Quantity of Oil (MBD) 20 80

Change in Supply New Supply Price of Oil per Barrel Old Supply Smaller Quantity Supplied at the Same Price $10 Higher Price Needed to Sell Same Quantity Higher Costs Decrease Supply Quantity of Oil (MBD) 20 80

Supply Shifters • Important Supply Shifters • Technological Innovations • Investment Costs • Taxes and Subsidies • Expectations • Entry or Exit of Producers • Changes in Opportunity Costs

Important Supply Shifters:Technological Innovations • A technological innovation makes sellers willing to offer more at a given price, or sell a their quantity at a lower price. • A technological innovation lowers costsand increases supply.

Production Technology Supply will increase for products when technology improves • Examples: Computers, gaming systems, laser hair removal, flat screen TVs.

Important Supply Shifters:Investment Costs • A decrease in the price of an investment (all else equal) increases profits and encourages more supply (and vice versa) • What will happen to the amount of new businesses if the government reduces the fees and paperwork associated with new business licenses? What happens if the fees rise? • (Truck Example)

Important Supply Shifters: Taxes and Subsidies • A taxon output reduces profit and makes sellers less willing to supply at a given price, unless they can effectively raise the price without losing any sales. • (What kind of product would that be?) • A tax on output raises costs and decreases supply. • Graph the effect on supply of a new shoe tax in your notes.

Important Supply Shifters: Taxes and Subsidies • A subsidyon production makes sellers willing to supply a greater quantity at a given price, or the subsidy allows producers to sell a given quantity at a lower price. • A subsidy on production lowers costs and increases supply. • Graph the effect on supply of a new subsidy to fast food producers aimed at helping them market and sell overseas.

Taxes and Subsidies • Taxes and subsidies affect profits and therefore supply. • A 10% yacht tax reduced the supply of yachts 53% in the early 1990s.

When the U.S. decreases its cotton subsidies, U.S. cotton supply decreases Cotton Supply

Important Supply Shifters:Taxes and Subsidies With a $10 Tax Suppliers Require a $10 Higher Price to Sell the Same Quantity Price of Oil per Barrel Supply With $10 Tax $50 Supply Without Tax $10 $10 $10 $40 60 Quantity of Oil (MBD)

Important Supply Shifters: Expectations • The expectation of a higher price for a good in the future decreases current supply of the good – if they can store the good- (and vice versa). • Sellers will adjust their current offerings in anticipation of the direction of future prices in order to obtain the highest possible price.

Future Expectations • A change in producers’ expectations about profitability will affect supply curves • Windmill production increases as producers expect sales and profitability to increase.

Important Supply Shifters:Expectations Expectations Can Shift the Supply Curve Price per Unit Supply Today with Expectation of Future Price Increase Supply Today Into Storage Quantity

Important Supply Shifters: Entry or Exit of Producers • As producers enter and exit the market, the overall supply changes. • Entryimplies more sellers in the market increasing supply. • Exitimplies fewer sellers in the market decreasing supply. • What will happen to the supply for Marijuana in California if the drug is legalized for general use?

As more firms enter the solar installation market, the number of solar installations available for sale increases Number of Producers • As more producers enter a market, supply increases (and vice versa)

Important Supply Shifters: Entry or Exit of Producers Entry Increases Supply Greater Quantity Supplied at the Same Price Price Domestic Supply Domestic Supply Plus Canadian Imports Lower Price for the Same Quantity Supplied Quantity

Important Supply Shifters: Changes in Opportunity Costs • Inputs used in production have opportunity costs. Sellers will choose to use those inputs where the profit is the highest • Sellers will supply less of a good if the price of an alternate good using the same inputs rises (and vice versa). • Sellers always chase the highest profit goods.

Changes in Opportunity Costs • Producers have the ability to produce other goods • An increase in the profitability of small cars will decrease the supply of SUVs 3- 49

Important Supply Shifters:Changes in Opportunity Costs Higher (Opportunity) Costs Reduce Supply- Rising Wheat Prices Reduce Soybean Supply Price per Unit Higher Price Required to Sell the Same Quantity Supply with High Opportunity Costs $7 Supply with Low Opportunity Costs $5 Smaller Quantity Supplied at the Same Price Quantity of Soybeans (Millions of Bushels) 2,800 2,000

Supply and Demand