UNIT 2 – Supply and Demand

 In communities around our country, people and firms act in their own best interests to answer the basic
WHAT, HOW, and FOR WHOM questions.
a. Developing out of this process are markets.
b. Markets are arrangements that individuals have for exchanging with one another.
i. Markets represent the interaction between buyers and sellers.
ii. Markets set the prices we pay and therefore allocates scarce goods and services.
iii. Examples of markets: gas, labor, stocks, etc

Chapter 3 - Demand
1. Nature of Demand
2. Changes in Demand
3. Elasticity of Demand

What is DEMAND?
1. The desire, ability and willingness to buy a product
o In order for demand to be counted in the market place, two conditions must exist:
(1) Consumer must be willing and able to buy goods and services.
(2) Demand for a product must be examined for a specific time period.

2. Demand is a microeconomic concept.

o Microeconomics - the part of the economy that deals with behavior and decision-making by small units,
such as individuals and firms.
(1) Knowledge of microeconomic concepts help explain how prices are determined and how individual
economic decisions are made.

What is QUANTITY-DEMANDED?
1. Describes the amount of a good or service that a consumer is willing and able to buy at each particular
price during a given time period.

1) The Demand Schedule

a) A listing that shows the quantity of goods/services consumers are willing and able to buy at ALL prices that
might prevail in the market at a given time.

2) The Demand Curve

a) A graphic depiction of the points corresponding to a demand schedule.
b) Illustrates the quantity that consumers will demand at each and every price.
c) At a glance, you can see the rate of change in quantity-demanded at each price.
d) Downward sloping.

3) The Law of Demand

a) The demand for an economic product varies inversely with its price.
i)  in price of a product   in the quantity-demanded.
ii)  in price of a product   in the quantity-demanded.
b) Income Effect, Substitution Effect, and Diminishing Marginal Utility help explain the inverse relationship
between P&Q because these factors affect consumers’ spending behavior.
i) Income Effect
(1) When the price of a good falls, consumers experience an increase in purchasing power.
(2) When the price of a good increases, consumers experience a decrease in PP.
(3) Purchasing power: the amount of goods and services you can purchase with a unit of currency.
ii) Substitution Effect
(1) When the price of a good changes, consumers have a tendency to substitute a similar, lower priced
product for another product that is relatively more expensive.
 iii) Diminishing Marginal Utility
(1) Utility: usefulness of a product, or the amount of satisfaction that an individual receives from
consuming a product.
(a) As consumers, we want to get the most useful and satisfactory combination of goods and
services when spending personal income.
(b) Marginal Utility: extra usefulness or satisfaction a person gets from acquiring one more unit of
a product.
(2) Diminishing Marginal Utility: as more units of a product are consumed, the satisfaction received
from consuming each additional unit declines.
(a) Example of the Law of Diminishing Marginal Utility
(i) When a consumer buys a product, the first unit will give you the most marginal utility, and
each additional product will give you some MU but not as much as the first. You will
continue to buy (or consume) a product until you reach negative utility.
(ii) Here is a hypothetical scenario.
 Rate satisfaction from 1-100, with 100 being the most satisfying.

Quantity of Cookies Consumed Total Utility Marginal Utility

1 100 -
2 180 (100 initially + 80 for the second) 80
3 240 (180 from 1&2 + 60 for the third) 60
4 290 50
5
(let’s pretend you refuse to eat this last
280 (-10 from the last) -10
cookie, but if you did, the utility would have
been negative)

DRAWING CONCLUSIONS: If you were to plot TU (Y) and # Consumed (X), it would illustrate the downward
sloping demand curve. This shows that the demand for a product is not limitless.

4) Change in QUANTITY-DEMANDED
a) A change in the quantity demanded is a change in the quantity of the product purchased in response to a
change in the price of that product.
i) This is a movement along the demand curve
b) This is different than a change in demand
i) This is a movement of the entire demand curve
ii) This means that more or less is demanded at EVERY price.
iii) There are 4 factors that cause demand to change.

5) Change in DEMAND
a) 5 non-price determinants of demand shift the entire demand curve left or right, and this means a different
quantity will be demanded at each and every price.
i) Change in Consumer Income
(1)  consumer income =  demand for goods and services =  (left) shift of curve
(2)  consumer income =  demand for goods and services =  (right) shift of curve
ii) Change in Consumer Tastes and Preferences
(1)  consumer tastes =  demand for goods and services =  shift of curve
(2)  consumer tastes =  demand for goods and services =  shift of curve
(3) Factors that may influence changes in tastes / preferences include; advertising, consumer reports,
etc.
iii) Change in Number of Consumers (market size)
(1)  consumers in the market =  demand for goods and services =  shift of curve
(2)  consumers in the market =  demand for goods and services =  shift of curve
iv) Change in Consumer Expectations
(1) Your expectations about the future may affect the demand for a good or service today.
(2)  future income =  demand for goods and services today =  shift of curve
 (3)  future income =  demand for goods and services today =  shift of curve
v) Change in Prices of Related Goods
(1) Complement Goods- goods that ‘work’ together
(a)  price of a product =  demand of its complement =  shift of curve
(b)  price of a product =  demand of its complement =  shift of curve
(2) Substitute Goods- two goods that can be used in place of one another
(a)  price of a product =  demand of its substitute =  shift of curve for product
(b)  price of a product =  demand of its substitute =  shift of curve for product

6) Elasticity of Demand: measures how sensitive consumers are to a change in price.

a) Formula for calculating elasticity: Demand Elasticity = %  Q-d ÷ %  P
b) Elastic Demand:
i) Change in price causes a larger change in quantity-demanded
(1) When price changes, you’re very responsive – your spending habits will change.
(2) Downward sloping demand curve looks flatter and more horizontal
ii) Demand elasticity calculation > 1
c) Inelastic Demand:
i) Change in price causes a smaller change in quantity-demanded
(1) When price changes, you’re not very responsive - your spending habits don’t really change.
(2) Downward sloping demand curve looks steeper and more vertical
ii) Demand elasticity calculation < 1
d) Unit Elastic Demand:
i) Change in price causes a proportional change in quantity-demanded
ii) Demand elasticity calculation = 1

Why is an understanding of elasticity important for a business?

Do you think it affects total revenue? How?

7) Determinants of Demand Elasticity

a) Questions
i) Can the purchase be delayed?
ii) Are there adequate substitutes?
iii) Does the purchase use a large portion of your income?
b) Yes to the three questions tends to make the product elastic
c) No to the three questions tends to make the product inelastic
d) Sometimes one of the questions is so important in a given situation that that question alone may override
the answers to the other two.

8) Measuring Elasticity
a) Total-revenue test: Total Revenue (total income) = Price x Quantity Demanded
i) Elastic demand results in a drop in TR from an increase in price.
ii) Inelastic demand results in a rise in TR from an increase in price.
b) Measuring the elasticity of demand for products at various prices helps owners make pricing decisions that
will generate the most revenue.
Chapter 4 - Supply
1. Nature of Supply
2. Changes in Supply
3. Making Production Decisions

What is SUPPLY?
1. The ability and willingness of producers to offer products for sale at various prices during a given time
period.
o This decision depends on the cost of producing the goods or services.

What is QUANTITY-SUPPLIED?
1. Describes the amount of goods or services that a producer is willing to sell at each particular price during a
given time period.

1) The Supply Schedule

a) A listing that shows the quantity of goods/services producers are willing to supply at various market
prices.

2) The Supply Curve

a) A graphic depiction of the points corresponding to a supply schedule.
b) Illustrates the quantity producers will supply at each and every price.
c) Upward sloping.

3) The Law of Supply

a) Quantity supplied is directly related to the price that producers charge for goods/services.
i)  price of a product,  in the quantity-supplied.
ii)  price of a product,  in the quantity-supplied.
b) The actions of producers are based on PROFIT MOTIVE.
i) Profit- $ remaining after producers have paid all of their costs.
(1) GOAL: Revenue > Costs of Production

4) Change in QUANTITY-SUPPLIED
a) A change in the quantity supplied is a change in the quantity of the product supplied in response to a
change in the price of that product.
i) This is a movement along the supply curve.
b) This is different than a change in supply.
i) This is a movement of the entire supply curve.
ii) This means more or less is supplied at EVERY price.
iii) There are 8 factors that cause supply to change.

5) Change in SUPPLY – anything that will affect the COST OF PRODUCING a product.
a) 7 non-price determinants of supply shift the entire supply curve left or right, and this means a different
quantity will be supplied at each and every price.
i) Change in Cost of Resources ~ 4 Factors of Production
(1) This includes anything involved in the production of a good/service
(a) Examples~ wages, raw materials, electricity, machinery, etc…
(2)  cost of resources (this means higher production costs) =  supply of a product =  shift of curve
(3)  cost of resources (this means lower production costs) =  supply of a product =  shift of curve
(4)  Note: If the costs of resources used to produce a product go down, the supplier can provide more
at the same price without losing any profit.
ii) Change in Taxes
(1) Definition: required payment of money to the government
(2)  taxes for a product =  supply of that product because production costs rise =  shift of curve
(3)  taxes for a product =  supply of that product because production costs are lowered =  shift
iii) Change in Subsidies
(1) Definition: payments to individuals or private businesses by the government to encourage or
protect a certain type of economic activity.
(2)  subsidies =  supply of a product because production costs are lowered =  shift of curve
(3)  subsidies =  supply of a product because production costs rise =  shift of curve
iv) Change in Government Regulations
(1) Definition: rules about how companies conduct businesses (pollution, discrimination, etc)
(2)  Gov Regs for a product =  supply of that product because production costs rise =  shift
(3)  Gov Regs for a product =  supply of that product because production costs fall =  shift
v) Change in Technology (+ Productivity)
(1) New technology and increased productivity can make production more efficient, and can increase
production without increasing costs.
(2)  Tech/Productivity =  supply of a product because production costs are lowered and profits
increase =  shift of curve
(3)  Tech/Productivity =  supply of a product because production costs rise and profits fall =  shift
of curve
vi) Change in Competition (Number of Sellers)
(1)  number of sellers =  supply of a product =  shift of supply curve
(2)  number of sellers =  supply of a product =  shift of supply curve
vii) Change in Future Expectations
(1)  in price of a product in the future =  supply today =  shift of supply curve
(2)  in price of a product in the future =  supply today =  shift of supply curve
(3) Profit motive: Producers want to supply the most at the highest possible price.
Chapter 5 – Prices
1. The Price System
2. Price Determination
3. Managing Prices

 The Price System guides producers and consumers to balance the forces of supply and demand by reaching
compromises.
o Buyers (consumers) want to buy more at a lower price
o Sellers (producers) want to sell more at a higher price

 What role do prices play in a modern mixed economy?

o Prices convey information to consumers and producers as to what to buy / produce.
o Prices motivate workers and firms to enter markets.
o Prices help markets respond to changing conditions.
o Prices guide resources to their most efficient uses.
o Bottom Line, a free enterprise economy relies on the price system to answer the three basic
economic questions.

1. Market Equilibrium
a) Definition: a situation that occurs when quantity supplied = quantity demanded at a given price.
i) This means producers and consumers have communicated effectively and are both happy.
ii) The price is right.
b) Supply and Demand Schedule
i) Equilibrium quantity is where quantity demanded = quantity supplied.
ii) Equilibrium price is the price that corresponds to the above situation.
c) Supply and Demand Curve
i) Market equilibrium is the point where the two curves intersect; the corresponding quantity is
equilibrium quantity and the corresponding price is equilibrium price.

2. Shortage – quantity supplied < quantity demanded

a) A shortage exists when the price of a product is below market equilibrium.
b) Signals to producers that they are charging too little.
i) How to fix disequilibrium: Producers raise the price
ii) Effect: as price rises, quantity demanded decreases and quantity supplied increases. The market
adjusts until it reaches equilibrium, and at this point excess demand is eliminated.

3. Surplus – quantity supplied > quantity demanded

a) A surplus exists when the price of a product is above market equilibrium.
b) Signals to a producer that they are charging too much.
i) How to fix disequilibrium: Producers can lower their price and still make a profit
ii) Effect: as price falls, quantity demanded increases and quantity supplied decreases. The market
adjusts until it reaches equilibrium, and at this point the excess supply is eliminated.

4. Effects of Changes in Supply and Demand on Market Equilibrium

a)  Supply =  Eq  Ep
b)  Supply =  Eq  Ep
c)  Demand =  Eq  Ep
d)  Demand =  Eq  Ep
5. Government Intervention: the interaction of buyers and sellers determines prices and quantities exchanged,
except when influenced by governmental policies.
a) Sometimes the government intervenes and sets prices; ultimately rationing goods.
b) Price Ceilings
i) Exist when the government sets a maximum legal price that can be charged for a product
ii) “Ceiling” ~ producers cannot charge prices above this level.
iii) Example: Rent Control
(1) Let’s say there is a sudden increase in the amount of people who want to live in Marple Township
because of the great job opportunities. With so many people wanting to live here, the rental prices for
homes and apartments have skyrocketed. As a result, many people cannot afford to live here. The
HIGH demand for a limited supply of properties drove up prices as consumers compete with each
other by paying higher prices. To ensure citizens can afford to live in Marple Township, the
Commissioners intervene in the market by setting a price ceiling on rents for apartments and houses
within the township limits.
iv) Consequences
(1) Causes a persistent shortage
(2) Leads to rationing of goods
(a) In a time of crisis (war), tires, gasoline, meat, butter were all rationed
(b) Penn State Football tickets are rationed by setting aside tickets for students and alumni
(c) Negative Effects of ‘Rationing’
(i) Unfair to ration “football tickets” – we should all have an equal chance to buy them
(ii) Costly to engage in ‘rationing’ because you need to hire people to monitor it
(iii) Black markets occur, and goods/services are exchanged illegally at prices higher than the
official market price.

c) Price Floors
i) Exist when the government sets a minimum legal price that can be charged for a product.
(1) Examples: agricultural products, minimum wage (ensures workers a certain level of income)
ii) Consequences
(1) Causes a persistent surplus (and if it is a surplus of ‘goods’, how do we dispose of it?)