02 - The Bascis of Supply and Demand - sp2017

Chapter 2 The Basics of Supply
and Demand
Read Pindyck and Rubinfeld (2013), Chapter 2
Microeconomics, 8h Edition by
R.S. Pindyck and D.L. Rubinfeld
Adapted by Chairat Aemkulwat for
Econ I: 2900111
Chapter 2 The Basics of Supply and Demand . Chairat Aemkulwat . Economics I: 2900111 1/3/2017
CHAPTER 2 OUTLINE
2.1 Supply and Demand
2.2 The Market Mechanism
2.3 Changes in Market Equilibrium
2.4 Elasticities of Supply and Demand
2.5 Short-Run versus Long-Run Elasticities
2.7 Effects of Government Intervention—Price Controls
Chapter 2 The Basics of Supply and Demand . Chairat Aemkulwat . Economics I: 2900111 2
The Basics of Supply and Demand
Supply-demand analysis is a fundamental and powerful tool

that can be applied to a wide variety of interesting and
important problems. To name a few:
• Understanding and predicting how changing world economic
conditions affect market price and production
• Evaluating the impact of government price controls, minimum wages,
price supports, and production incentives
• Determining how taxes, subsidies, tariffs, and import quotas affect
consumers and producers
Chapter 2 The Basics of Supply and Demand . Chairat Aemkulwat . Economics I: 2900111
3
2.1 SUPPLY AND DEMAND
The Supply Curve
● supply curve Relationship between the quantity of a good that

producers are willing to sell and the price of the good.
Figure 2.1
The Supply Curve
The supply curve, labeled S in

the figure, shows how the
quantity of a good offered for
sale changes as the price of the
good changes. The supply
curve is upward sloping: The
higher the price, the more firms
are able and willing to produce
and sell.
If production costs fall, firms

can produce the same quantity
at a lower price or a larger
quantity at the same price. The
supply curve then shifts to the
right (from S to S’).
The Supply Curve

The supply curve is thus a relationship between the quantity
supplied and the price. We can write this relationship as an equation:
QS = QS(P)
Other Variables That Affect Supply
The quantity that producers are willing to sell depends not only on the price
they receive but also on their production costs, including wages, interest
charges, and the costs of raw materials.
When production costs decrease, output increases no matter what the
market price happens to be. The entire supply curve thus shifts to the right.
Economists often use the phrase change in supply to refer to shifts in the
supply curve, while reserving the phrase change in the quantity supplied to
apply to movements along the supply curve.
The Demand Curve
Figure 2.2
The Demand Curve
The demand curve, labeled D,

shows how the quantity of a good
demanded by consumers
depends on its price. The
demand curve is downward
sloping; holding other things
equal, consumers will want to
purchase more of a good as its
price goes down.
The quantity demanded may also
depend on other variables, such
as income, the weather, and the
prices of other goods. For most
products, the quantity demanded
increases when income rises.
A higher income level shifts the
demand curve to the right (from D
to D’).
The Demand Curve
● demand curve Relationship

between the quantity of a good that
consumers are willing to buy and the
price of the good.
We can write this relationship between quantity

demanded and price as an equation:
QD = QD(P)
The Demand Curve
Shifting the Demand Curve
If the market price were held constant, we would expect to see an increase in
the quantity demanded as a result of consumers’ higher incomes. Because
this increase would occur no matter what the market price, the result would
be a shift to the right of the entire demand curve.
Shifting the Demand Curve

● substitutes Two goods for which an increase in the
price of one leads to an increase in the quantity
demanded of the other.
● complements Two goods for which an increase in

the price of one leads to a decrease in the quantity
demanded of the other.
2.2 THE MARKET MECHANISM
Figure 2.3
Supply and Demand
The market clears at price P0

and quantity Q0.
At the higher price P1, a surplus

develops, so price falls.
At the lower price P2, there is a

shortage, so price is bid up.
Equilibrium
● equilibrium (or market clearing) price

Price that equates the quantity supplied
to the quantity demanded.
● market mechanism Tendency in a free

market for price to change until the market
clears.
● surplus Situation in which the quantity

supplied exceeds the quantity demanded.
● shortage Situation in which the quantity

demanded exceeds the quantity supplied.
When Can We Use the Supply-Demand Model?
We are assuming that at any given price, a given quantity will be produced
and sold.
This assumption makes sense only if a market is at least roughly competitive.

By this we mean that both sellers and buyers should have little market
power—i.e., little ability individually to affect the market price.
Suppose that supply were controlled by a single producer.

If the demand curve shifts in a particular way, it may be in the monopolist’s
interest to keep the quantity fixed but change the price, or to keep the price
fixed and change the quantity.
2.3 CHANGES IN MARKET EQUILIBRIUM
Figure 2.4
New Equilibrium Following
Shift in Supply
When the supply curve

shifts to the right, the
market clears at a lower
price P3 and a larger
quantity Q3.
Figure 2.5
Shift in Demand
When the demand curve

shifts to the right,
the market clears at a
higher price P3 and a
larger quantity Q3.
Figure 2.6
Shifts in Supply and Demand
Supply and demand curves
shift over time as market
conditions change.
In this example, rightward
shifts of the supply and
demand curves lead to a
slightly higher price and a
much larger quantity.
In general, changes in price
and quantity depend on the
amount by which each
curve shifts and the shape
of each curve.
From 1970 to 2007, the real (constant-dollar) price of eggs fell by 49

percent, while the real price of a college education rose by 105
percent.
The mechanization of poultry farms sharply reduced the cost of
producing eggs, shifting the supply curve downward. The demand
curve for eggs shifted to the left as a more health-conscious
population tended to avoid eggs.
As for college, increases in the costs of equipping and maintaining
modern classrooms, laboratories, and libraries, along with increases
in faculty salaries, pushed the supply curve up. The demand curve
shifted to the right as a larger percentage of a growing number of
high school graduates decided that a college education was
essential.
Figure 2.6
Market for Eggs
(a) The supply curve for

eggs shifted downward
as production costs fell;
the demand curve
shifted to the left as
consumer preferences
changed.
As a result, the real
price of eggs fell
sharply and egg
consumption rose.
Figure 2.7
Market for College

Education
(b) The supply curve for a

college education shifted
up as the costs of
equipment, maintenance,
and staffing rose.
The demand curve shifted
to the right as a growing
number of high school
graduates desired a
college education.
As a result, both price and
enrollments rose sharply.
2.3
Over the past two decades, the wages of skilled high-income workers
have grown substantially, while the wages of unskilled low-income
workers have fallen slightly.
From 1978 to 2005, people in the top 20 percent of the income

distribution experienced an increase in their average real pretax
household income of 50 percent, while those in the bottom 20 percent
saw their average real pretax income increase by only 6 percent.
While the supply of unskilled workers—people with limited

educations—has grown substantially, the demand for them has risen
only slightly.
On the other hand, while the supply of skilled workers has grown
slowly, the demand has risen dramatically, pushing wages up.
Wage Inequality in Thailand
Percentage Annual growth rate
1990 2000 2008 1990-2000 2000-2008 1990-2008
White-collar workers 20 28.9 31 4.70% 3.90% 4.40%

Skilled and unskilled workers 16.4 20.7 29.7 3.30% 9.10% 5.40%
Monthly Wages Annual Growth Rate
1990-2000 2000-2008 1990-2008

1990 2000 2008
White-collar Workers
8,002 9,316 14,011 1.50% 5.20% 3.20%
Skilled and unskilled workers
4,840 5,589 5,719 1.40% 0.30% 0.90%
Minimum Wage 3,298 4,336 4,268 2.8% -0.2% 1.4%
Figure 2.8
Consumption and the Price
of Copper
Although annual
consumption of copper
has increased about a
hundredfold,
the real (inflation-
adjusted) price has not
changed much.
Figure 2.9
Long-Run Movements of
Supply and Demand for
Mineral Resources
Although demand for

most resources has
increased dramatically
over the past century,
prices have fallen or
risen only slightly in real
(inflation-adjusted) terms
because cost reductions
have shifted the supply
curve to the right just as
dramatically.
Figure 2.10
Supply and Demand for

New York City Office Space
Following 9/11 the

supply curve shifted to
the left, but the demand
curve also shifted to the
left, so that the average
rental price fell.
2. Use supply and demand curves to illustrate
how each of the following events would affect
the price of butter and the quantity of butter
bought and sold:
a) An increase in the price of margarine.
b) An increase in the price of milk.
c) A decrease in average income levels.

a) An increase in the price of margarine.
Ans.
Butter and margarine are substitute goods for most people. Therefore, an
increase in the price of margarine will cause people to increase their
consumption of butter, thereby shifting the demand curve for butter out
from D1 to D2 in Figure 2.2.a. This shift in demand causes the equilibrium
price of butter to rise from P1 to P2 and the equilibrium quantity to increase
from Q1 to Q2.
b) An increase in the price of milk.

Ans.
Milk is the main ingredient in butter. An increase in the price of milk
increases the cost of producing butter, which reduces the supply of
butter. The supply curve for butter shifts from S1 to S2 in Figure 2.2.b,
resulting in a higher equilibrium price, P2 and a lower equilibrium
quantity, Q2, for butter.
c) A decrease in average income levels.

Ans.
Assuming that butter is a normal good, a decrease in average income
will cause the demand curve for butter to decrease (i.e., shift from D1
to D2). This will result in a decline in the equilibrium price from P1 to
P2, and a decline in the equilibrium quantity from Q1 to Q2. See
Figure 2.2.c.
2.4 ELASTICITIES OF SUPPLY AND DEMAND
● elasticity Percentage change in one variable resulting from a 1-

percent increase in another.
Price Elasticity of Demand
● price elasticity of demand Percentage change in quantity

demanded of a good resulting from a 1-percent increase in its
price.
(2.1)
Linear Demand Curve

● linear demand curve Demand curve that is a straight line.
Figure 2.11
Linear Demand Curve
The price elasticity of demand

depends not only on the slope
of the demand curve but also
on the price and quantity.
The elasticity, therefore, varies
along the curve as price and
quantity change. Slope is
constant for this linear demand
curve.
Near the top, because price is
high and quantity is small, the
elasticity is large in magnitude.
The elasticity becomes smaller
as we move down the curve.
Linear Demand Curve
Figure 2.12
(a) Infinitely Elastic Demand
For a horizontal demand

curve, ΔQ/ΔP is infinite.
Because a tiny change in price
leads to an enormous change
in demand, the elasticity of
demand is infinite.
● infinitely elastic demand Principle that consumers will buy as much

of a good as they can get at a single price, but for any higher price the
quantity demanded drops to zero, while for any lower price the
quantity demanded increases without limit.
Linear Demand Curve
Figure 2.12
(b) Completely Inelastic Demand
For a vertical demand curve,

ΔQ/ΔP is zero. Because the
quantity demanded is the same
no matter what the price, the
elasticity of demand is zero.
● completely inelastic demand Principle that consumers will buy a

fixed quantity of a good regardless of its price.
Other Demand Elasticities

● income elasticity of demand Percentage change in the quantity
demanded resulting from a 1-percent increase in income.
(2.2)
● cross-price elasticity of demand Percentage change in the

quantity demanded of one good resulting from a 1-percent increase in
the price of another.
(2.3)
Elasticities of Supply
● price elasticity of supply Percentage change in quantity supplied
resulting from a 1-percent increase in price.
Point versus Arc Elasticities
● point elasticity of demand Price elasticity at a particular point on

the demand curve.
Arc Elasticity of Demand
● arc elasticity of demand Price elasticity calculated over a range of

prices.
(2.4)
For a few decades, changes in the wheat market had

major implications for both American farmers and U.S.
agricultural policy.
To understand what happened, let’s examine the behavior of supply

and demand beginning in 1981.
By setting the quantity supplied equal to the quantity demanded, we

can determine the market-clearing price of wheat for 1981:
Substituting into the supply curve equation, we get
We use the demand curve to find the price elasticity of demand:
Thus demand is inelastic.
We can likewise calculate the price elasticity of supply:
Because these supply and demand curves are linear, the price
elasticities will vary as we move along the curves.
2.5 SHORT-RUN VERSUS LONG-RUN ELASTICITIES
Demand
Figure 2.13
(a) Gasoline: Short-Run and Long-Run
Demand Curves
In the short run, an increase in price

has only a small effect on the quantity
of gasoline demanded. Motorists may
drive less, but they will not change the
kinds of cars they are driving
overnight.
In the longer run, however, because
they will shift to smaller and more fuel-
efficient cars, the effect of the price
increase will be larger. Demand,
therefore, is more elastic in the long
run than in the short run.
Demand
Demand and Durability
Figure 2.13
(b) Automobiles: Short-Run and Long-Run
Demand Curves
The opposite is true for automobile

demand. If price increases,
consumers initially defer buying new
cars; thus annual quantity demanded
falls sharply.
In the longer run, however, old cars
wear out and must be replaced; thus
annual quantity demanded picks up.
Demand, therefore, is less elastic in
the long run than in the short run.
Demand
Income Elasticities
Income elasticities also differ from the short run to the long run.
For most goods and services—foods, beverages, fuel, entertainment,
etc.— the income elasticity of demand is larger in the long run than in
the short run.
For a durable good, the opposite is true. The short-run income elasticity
of demand will be much larger than the long-run elasticity.
Demand
Cyclical Industries
Figure 2.15
Consumption of Durables versus
Nondurables
Annual growth rates are compared
for GDP, consumer expenditures
on durable goods (automobiles,
appliances, furniture, etc.), and
consumer expenditures on
nondurable goods (food, clothing,
services, etc.).
Because the stock of durables is
large compared with annual
demand, short-run demand
elasticities are larger than long-run
elasticities. Like capital equipment,
industries that produce consumer
durables are “cyclical” (i.e.,
changes in GDP are magnified).
This is not true for producers of
nondurables.
Demand
TABLE 2.1 Demand for Gasoline

Number of Years Allowed to Pass Following
a Price or Income Change
Elasticity 1 2 3 5 10
Price −0.2 −0.3 −0.4 −0.5 −0.8
Income 0.2 0.4 0.5 0.6 1.0
TABLE 2.2 Demand for Automobiles

Number of Years Allowed to Pass Following
a Price or Income Change
Elasticity 1 2 3 5 10
Price −1.2 −0.9 −0.8 −0.6 −0.4
Income 3.0 2.3 1.9 1.4 1.0
Supply
Supply and Durability
Figure 2.16
Copper: Short-Run and Long-Run
Supply Curves
Like that of most goods, the

supply of primary copper,
shown in part (a), is more
elastic in the long run.
If price increases, firms would
like to produce more but are
limited by capacity constraints
in the short run.
In the longer run, they can add
to capacity and produce more.
Supply
Supply and Durability
Figure 2.16
Copper: Short-Run and Long-Run
Supply Curves
Part (b) shows supply curves

for secondary copper.
If the price increases, there is a
greater incentive to convert
scrap copper into new supply.
Initially, therefore, secondary
supply (i.e., supply from scrap)
increases sharply. (short run)
But later, as the stock of scrap
falls, secondary supply
contracts (long run).
Table 2.3 Supply of Copper
Secondary supply is therefore
less elastic in the long run than Price Elasticity of: Short-Run Long-Run
in the short run. Primary supply 0.20 1.60
Secondary supply 0.43 0.31
Total supply 0.25 1.50
Figure 2.17
Price of Brazilian Coffee
When droughts or
freezes damage
Brazil’s coffee trees,
the price of coffee can
soar.
The price usually falls
again after a few
years, as demand
and supply adjust.
Figure 2.18
Supply and Demand for Coffee
(a) A freeze or drought in

Brazil causes the supply
curve to shift to the left.
In the short run, supply is
completely inelastic; only a
fixed number of coffee
beans can be harvested.
Demand is also relatively
inelastic; consumers
change their habits only
slowly.
As a result, the initial effect
of the freeze is a sharp
increase in price, from P0 to
P1.
Figure 2.18
(b) In the intermediate run,

supply and demand are
both more elastic; thus
price falls part of the way
back, to P2.
Figure 2.18
(c) In the long run, supply

is extremely elastic;
because new coffee trees
will have had time to
mature, the effect of the
freeze will have
disappeared. Price returns
to P0.
7. Are the following statements true or
false? Explain your answers.
a) The supply of apartments is more inelastic in the short run

than the long run.
b) The elasticity of demand is the same as the slope of the

demand curve.
c) The cross-price elasticity will always be positive.

a) The supply of apartments is more inelastic in the short
run than the long run.
Ans.
True. In the short run it is difficult to change the supply of apartments in response to a change in
price. Increasing the supply requires constructing new apartment buildings, which can take a year
or more. Therefore, the elasticity of supply is more inelastic in the short run than in the long run, or
said another way, the elasticity of supply is less elastic in the short run than in the long run.
b) The elasticity of demand is the same as the slope of the

demand curve.
Ans.
False. Elasticity of demand is the percentage change in quantity demanded divided by the
percentage change in the price of the product. In contrast, the slope of the demand curve is the
change in quantity demanded (in units) divided by the change in price (typically in dollars). The
difference is that elasticity uses percentage changes while the slope is based on changes in the
number of units and number of dollars.
c) The cross-price elasticity will always be positive.

Ans.
False. The cross price elasticity measures the percentage change in the quantity demanded of one
good due to a one percent change in the price of another good. This elasticity will be positive for
substitutes (an increase in the price of hot dogs is likely to cause an increase in the quantity
demanded of hamburgers) and negative for complements (an increase in the price of hot dogs is
likely to cause a decrease in the quantity demanded of hot dog buns).
2.7 EFFECTS OF GOVERNMENT INTERVENTION—
PRICE CONTROLS
Figure 2.24
Effects of Price Controls
Without price controls, the

market clears at the equilibrium
price and quantity P0 and Q0.
If price is regulated to be no
higher than Pmax, the quantity
supplied falls to Q1, the
quantity demanded increases
to Q2, and a shortage
develops.
PRICE CONTROLS
Figure 2.25
Price of Natural Gas
PRICE CONTROLS
The (free-market) wholesale price of natural gas was $6.40 per mcf
(million cubic feet);
Production and consumption of gas were 23 Tcf (trillion cubic feet);
The average price of crude oil (which affects the supply and demand for
natural gas) was about $50 per barrel.
Supply: Q = 15.90 + 0.72PG + 0.05PO
Demand: Q = -10.35 - 0.18PG + 0.69PO
Substitute $3.00 for PG in both the supply and demand equations
(keeping the price of oil, PO, fixed at $50).
You should find that the supply equation gives a quantity supplied of
20.6 Tcf and the demand equation a quantity demanded of 23.6 Tcf.
Therefore, these price controls would create an excess demand of
23.6 − 20.6 = 3.0 Tcf.
Question
13. Suppose the demand for natural gas is perfectly inelastic.

What would be the effect, if any, of natural gas price
controls?
Ans.
If the demand for natural gas is perfectly inelastic, the demand curve is
vertical. Consumers will demand the same quantity regardless of
price. In this case, price controls will have no effect on the quantity
demanded, but they will still cause a shortage if the supply curve is
upward sloping and the regulated price is set below the market-
clearing price, because suppliers will produce less natural gas than
consumers wish to purchase.
CHAPTER 2 RECAP
2.1 Supply and Demand
2.2 The Market Mechanism
2.3 Changes in Market Equilibrium
2.4 Elasticities of Supply and Demand
2.5 Short-Run versus Long-Run Elasticities
2.6 Understanding and Predicting the Effects of Changing Market
Conditions
2.7 Effects of Government Intervention—Price Controls


02 - The Bascis of Supply and Demand - sp2017

Uploaded by

Copyright:

Available Formats

02 - The Bascis of Supply and Demand - sp2017

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

02 - The Bascis of Supply and Demand - sp2017

Uploaded by

Copyright:

Available Formats

Chapter 2 The Basics of Supply

2.1 Supply and Demand

2.2 The Market Mechanism

2.3 Changes in Market Equilibrium

2.4 Elasticities of Supply and Demand

2.5 Short-Run versus Long-Run Elasticities

2.7 Effects of Government Intervention—Price Controls

Supply-demand analysis is a fundamental and powerful tool

The Supply Curve

● supply curve Relationship between the quantity of a good that

The Supply Curve

The supply curve, labeled S in

If production costs fall, firms

The Supply Curve

Other Variables That Affect Supply

The Demand Curve

The demand curve, labeled D,

● demand curve Relationship

We can write this relationship between quantity

The Demand Curve

Shifting the Demand Curve

Shifting the Demand Curve

● complements Two goods for which an increase in

Supply and Demand

The market clears at price P0

At the higher price P1, a surplus

At the lower price P2, there is a

● equilibrium (or market clearing) price

● market mechanism Tendency in a free

● surplus Situation in which the quantity

● shortage Situation in which the quantity

When Can We Use the Supply-Demand Model?

This assumption makes sense only if a market is at least roughly competitive.

Suppose that supply were controlled by a single producer.

When the supply curve

When the demand curve

From 1970 to 2007, the real (constant-dollar) price of eggs fell by 49

(a) The supply curve for

Market for College

(b) The supply curve for a

From 1978 to 2005, people in the top 20 percent of the income

While the supply of unskilled workers—people with limited

Percentage Annual growth rate

1990 2000 2008 1990-2000 2000-2008 1990-2008

White-collar workers 20 28.9 31 4.70% 3.90% 4.40%

Monthly Wages Annual Growth Rate

1990-2000 2000-2008 1990-2008

Minimum Wage 3,298 4,336 4,268 2.8% -0.2% 1.4%

Although demand for

Supply and Demand for

Following 9/11 the

b) An increase in the price of milk.

c) A decrease in average income levels.

b) An increase in the price of milk.

c) A decrease in average income levels.

● elasticity Percentage change in one variable resulting from a 1-

Price Elasticity of Demand

● price elasticity of demand Percentage change in quantity

Linear Demand Curve