Unit 2

Supply and Demand

Do Now
What are the 3 factors that cause the law
of demand?
This unit
● Focused on:
○ How to read a supply and demand curve
○ How to create one with a properly labelled graph
○ Factors that cause shifts to
■ Supply
■ Demand
■ Quantity Supplied
■ Quantity Demanded
○ Identify, discuss and debate the merits of
■ Price Ceilings
■ Price Floors
■ Tariffs
Demand
● A schedule or curve that shows the various amounts of a
product (resource) that consumers are willing and able to
purchase at each of a series of prices over a period of
time
● The curve decreases due to diminishing marginal
utility/return
○ Eventually resulting in zero interest in item.
Demand Schedule
● Has clear and specific
prices and quantity
demanded over a period
of time

● What can you observe

from this demand
schedule
Demand Curve
Law of Demand
● Change in Demand is different from change in quantity
demanded
○ One shifts the entire line
○ Quantity Demanded is a move along the line (slides)
○ Similar to change in PPF production amount and growing/shrinking
entire line
● Ceteris Paribus if
○ Price increases quantity demanded decreases
○ Price decreases quantity demanded increases
● Negative/Inverse relationship between price and quantity
demanded
○ Price Up = Q.D. Down
○ Price Down = Q.D. Up
9.11.23 DO NOW
What are the 3 reasons a Demand Curve is
Downward Sloping?
Reasoning for Law of Demand
● Diminishing Marginal Utility
● Income Effect: Lower prices increase purchasing power.
Lower prices increases quantity demanded.
○ More money = more consumption.
● Substitution Effect: If the price of an item increases
then consumers will choose another item that fits the
demand. Going for a relatively less expensive item that
fulfills same purpose/function
○ Example: Buying pencils if the price of pens increases
○ Example: Buying almond milk if the price of dairy milk increases
○ Example: Buying coca-cola when price of pepsi increases
Prices of Related Goods
● Price of related products
connected to the substitution
effect and complementary products
○ Pepsi Price Up
■ Quantity Demanded Down
○ Coca Cola Demand Up
■ Shifts Demand Right (for Coke)
● Shift Right = Growth
○ Pepsi Price Down
■ Quantity Demanded Up
○ Coke Demand Down
● Shift Left = Decrease /
Contraction
SUbstitute Vs. Complement
● Substitute Products are related goods that can be swapped
out.
○ Coke Vs. Pepsi
○ McDonald’s Vs. BK
○ Uber Vs. Lyft
● Complementary Goods (complements) are products that are
combined in some fashion.
○ Car + Gas
○ Peanut butter + Jelly
○ Cereal + Milk
○ Microphone + Headphones
Consumer Expectations
Expectations of Future Prices:

1. Expecting future prices of a product to go up = CURRENT

Demand will increase - future quantity demanded goes down
a. Shifts curve to the right
i. Why?
2. Expecting future prices to go down = CURRENT Demand goes
down - future quantity demanded goes up
a. Shifts curve to the left
i. Why?
Determinants of Demand
● Determines whether the entire curve shifts. Not just
quantity demanded but also demand overall
Shifters ---- INSECT
● I - Income
● N - Number of Buyers
● S - Substitutes
● E - Expectation of Future Prices
● C - Complementary
● T - Tastes
Do Now
You’re standing in line at Taco Bell, you wanted some Tacos.
What caused you to get out of line and head to KFC?
9/12 DO NOW
What does the acronym INSECT stand for?
Determinants of Demand
● Determines whether the entire curve shifts. Not just
quantity demanded but also demand overall
Shifters
● Consumers’ tastes (Preferences)
● Consumer expectations
● The number of buyers in the market
● Consumers’ income
● Prices of related goods (complementary/substitution)
Determinants of Demand Continued
● We typically assume that price is the most important
influencing factor on the quantity of any product
purchased.
○ When the consumer’s Preferences, Expectations, Number of Buyers,
Income, and/or Substitutes/Complements change; the demand curve will
shift to either the right or left.
Reviewing Supply and Demand
Market Demand
● The sum of all individual quantities demanded at various
prices
Market Demand Curve
● The sum of all individual quantities demanded at various
prices
Review of Demand
● Slide in Quantity Demanded caused by
○ Increase or Decrease in Price
○ The curve does not shift altogether
● Shift in the Demand Curve caused by
○ Any change in INSECT
■ Remember: Don’t bug out, just INSECT!
Increase In Demand
● Favorable change in consumer tastes
● Increase in the number of buyers
● Rising incomes if the product is a normal good
● Falling incomes if the product is an inferior good
● An increase in the price of a substitute good
● A decrease in the price of a complementary good
● A new consumer expectation that either prices or income
will be higher in the future
Summary of Demand
● Demand is a schedule / curve showing the amount of a product that
buyers are willing and able to purchase, in a particular time period,
at each possible price point in a series of prices
● The law of demand states that, other things equal, the quantity of a
good purchased varies INVERSELY with its price.
● The demand curve shifts because of changes in consumer
tastes/preferences, number of buyers in the market, consumer income,
prices of substitutes/complements, and consumer expectations.
● A change in demand is a shift of the demand curve; a change in quantity
demanded is a movement from one point to another ON the curve.
Sample Questions
● Is the following changes either demand or quantity
demanded? When you figure it out is it an increase or
decrease?
○ A large number of people get increases in their income
○ Apple increases the price of their iphones
○ Due to an E. Coli outbreak at Chipotle, people are dining there less.
○ People believe an upcoming Denzel Washington movie will be great
based on how awesome his most recent films have been.
 Type of Goods
● Related primarily with demand
○ Direct vs. Inverse
● Normal Good – demand for product varies directly with changes in income
○ More income means increased consumption of normal goods
○ Less income means decreased consumption
● Inferior Good – demand for product varies inversely with changes in income
○ Less income means increased consumption of inferior goods
○ More income means decreased consumption
● Substitute Good – similar goods. If the price of good A rises, the demand for substitute
good B rises
○ Xbox vs. Playstation
● Complements Good – goods that are used together. If the price of good A rises, the
demand for complement good B falls
○ Increased price of gas means decreased demand for cars
Supply

• A schedule or curve showing the various amounts of a product

that producers (owners) are willing AND able to make available
for sale at each of a series of possible prices during a specific
period of time
Law of Supply
● Producers tend to want to offer higher quantities for sale at
higher prices.
○ Why?
○ Law of Increasing Marginal Cost
■ As producers make and sell more, the cost of producing additional units
increases.
● Why?
○ Firms use the cheapest and best-suited resources first and then
use the more expensive, less-suited, and harder to obtain
resources.
○ Firms experience diminishing marginal returns as they increase
production.
■ Additional factors of production eventually results in
smaller increases of output
● Hiring more and more laborers won’t always equate to
more production
○ Why?
Supply Curve
Market Supply
• Similar to market demand
• The sum of the individual supply curves for a particular product
 Determinants of Supply
• Don’t Tiptoe, TIPTEN!
• Technology
– Better tech increases supply, less tech decreases
• Input Cost
– Costs of Production
– Less cost increases supply, more cost decreases
• Price of Other Related Goods that Could be Produced
– Other goods cost more increases supply, less cost decreases
• Substitution in Production (soccer balls produced at a manufacturing plant; price of basketballs goes
up so the plant changes to basketballs)
• Taxes, Subsidies, and Regulations
– Whole list but whatever makes it cheaper for producers increases supply
• Increase in taxes = costs more to produce = less profit
– Less taxes = better for producer
– Subsidies = lower costs for producers = good for producers
• Expectations (Future Prices)
– Example: You make Christmas ornaments. You think you can get a higher price for your items in November
and December. In February, your supply of ornaments will DECREASE but in November, your supply of
ornaments will INCREASE
• Number of Sellers
– More sellers of item in market increases supply; less decreases supply
 ● S1 to S3 depicts a leftward shift (decrease) in

Supply Shifts
supply
● S1 to S2 depicts a rightward shift (increase)
in supply
Review: Law of Supply
● Similar to law of demand
○ Major difference being the law demand has an inverse relation in terms of
price and quantity
■ I.e. if price increases quantity demanded decreases
○ Law of supply has a direct relationship between price and quantity supplied
● If price increases
○ Suppliers/producers will have more stock of the product and have more of it
produce
■ Can make more profit now
■ AKA quantity supplied increases
● If price decreases
○ Suppliers/producers will have less stock of the product and have less of it
produced
■ Are making less profit now
■ AKA quantity supplied decreases
Supply
• As:
– The price rises, the quantity supplied rises.
– The price falls, the quantity supplied falls
• Price and quantity are directly related
– Cost benefit analysis
– Marginal costs
• Change in quantity supplied is due mainly to change in prices
• The law of increasing opportunity costs states that as production increases, the cost to
produce an additional unit of that product increases as well.
Review of Shift vs. A Change in Quantity
● Supply
○ A “shift” is when entire curves moves
either left or right based on TIPTEN
○ A change in quantity supplied is when
suppliers produce more or less on a line
based on price
■ Line does not shift
■ Similar to a PPF
● Demand
○ A “shift” is when entire curves moves
either left or right based on PENIC/BESST
○ A change in quantity demanded is when
people purchase more or less based on price
■ Line does not shift
Determinants of demand + Supply
T - Technology
I- Income
I - Input Prices (ingredients)
N- Number of Buyers

S - Substitutes P - Price of Related Goods(pivot)

E - Expectation of future prices T - Taxes, Subsidies, Regulations

C - Complements E - Future Price Expectations

T - Tastes / preferences N - Number of Sellers

What’s Wrong with this Pic?
 Market Equilibrium
• Equilibrium Price: the price
where the quantity demanded
equals the quantity supplied
• Equilibrium Quantity: quantity
demanded and the quantity
supplied at the equilibrium
(market) price
• Supply meets Demand
• Is a balance between what
consumers and producers want
 Things to Remember for Price Equilibrium
● Supply vs. Quantity Supplied
○ Supply is what producer can make at current
production
○ Quantity Supplied is what producers are willing to
sell at a specific price
● Demand vs. Quantity Demanded
○ Demand is what consumers are willing to consume in
a specific situation
○ Quantity Demanded is what consumers are willing to
consume at a specific price
● AKA knowing the difference is Status Quo (quantity
supplied/demanded) vs. Changes to the Status Quo (Demand
and Supply)
 Elasticity: What is it?
● Responsiveness of consumers to a change in price

○ How much will demand rise (fall) if the price falls (increases)

● When there is a change in the price of a product how much more or less is purchased by consumers?

● Ed = Elasticity of demand

● Calculated by:

Ed = percentage change in quantity demanded of product X_

percentage change in price of product X

● Since demand is downward sloping Ed is negative

○ We use absolute values for final result

Dumb it Down
● Price Elasticity of Demand (PED) - measures how sensitive a consumer’s
quantity demanded is to a change in price.
● Elasticity of Demand (Ed) =
○ %change in Quantity
% change in price

● If demand is elastic, price increases cause large decrease in quantity

demanded
● If demand is inelastic, price increases cause small decrease in quantity
demanded
● At lower quantities (higher prices), demand is generally more elastic
● At high quantities (lower prices), demand is generally more inelastic
Results and Kinds of Elasticity
o If Ed > 1, demand is elastic
o 1.5 means elastic and consumers are responsive to price changes
o If Ed < 1, demand is inelastic
o 0.5 means elastic and consumers are not that responsive to price
changes
o If Ed = 1, demand is unit elastic
o Change in price and quantity demanded are equal/proportional
o If Ed = 0, demand is perfectly inelastic
o No change in demand from a change in price
o If Ed = ∞, demand is perfectly elastic
o A small change in price causes buyers to increase
their purchases from zero to all they can obtain
 Elastic
● Demand changes noticeably in
regard to price
○ Extreme change if Ed = ∞
● Example:
○ Snack food, rubber bands, soda, etc.
○ Products that have multiple substitutes
● Revenue for Producers
○ Increase in Price, Decrease in Revenue
○ Decrease in Price, Increase in Revenue
● Relatively Elastic
○ 1<Ed
○ Has noticeable response to price change
● Perfectly Elastic
○ Any change in price creates all-or-nothing
response
 Inelastic
● Demand changes very little in
regard to price
○ Not at all if Ed = 0
● Example:
○ Medication, gasoline, etc.
○ Products that have few, if any, substitutes
● Revenue for Producers
○ Increase in Price, Increase in Revenue
○ Decrease in Price, Decrease in Revenue
● Relatively Inelastic
○ 1>Ed >0
○ Has some response to price change but not
much
● Perfectly Inelastic
○ No changes in price will affect consumer demand
Elasticity of Demand
● Responsiveness to Changes in Price
○ AKA Willingness to buy product X after change in price from
Y to Z
○ Fundamental Rule: Change in Price Changes Quantity Demanded
■ Elasticity of Demand (Ed) =
● %change in Quantity
% change in price

● Elastic
○ Responsive to Very Responsive
○ 1<Ed
○ AKA if it’s 1 or greater it is elastic

● Inelastic
○ Barely responsive to not at all
○ 1>Ed >0
○ AKA if it’s .99999 or lower it’s inelastic
Price Elasticity of Demand Determinants
● Luxury vs Necessity
○ Nintendo Switch vs Insulin
● Income share (% of Budget)
○ Gumball vs Rent
● Narrowness of Market
○ Market for Hip-Hop
■ Market for Kanye West
● Timeframe
○ Flowers before Mother’s Day
○ It’s raining outside
● Substitutes
○ Candy Bars
■ Snickers easily replaced by another Candy
● Results in elasticity
○ Oil
■ People need oil to heat their homes, can’t easily be substituted
● Results in inelasticity
Total Revenue
● Determining factor in elasticity
○ Help determine prices and production
● Profit: Revenue - Total Cost (TC)
● IF:
○ Total revenue changes in opposite direction from price change then it is
elastic
○ Total revenue changes in same direction from price change then it is
inelastic
○ If total revenue does not change when price changes it is unit elastic
 Reading this Graphically
● Connections: Easy way to
read is comparing this to
marginal utility vs.
marginal cost
● Producers will not produce
in the area that is
inelastic
○ Total costs of production will
exceed total revenue
○ Producing at a loss
○ Will produce at unit elastic or
in the elastic range (if
monopoly)
 Calculating Elasticity
● Three Primary Ways
○ Elasticity of Demand
■ How much quantity demanded changes with price
○ Income Elasticity
■ Include the negative symbols (it determines the results)
■ How much more or less you want of an item if your income changes
● Normal Good you want more as your income inc.
● Inferior Good you want less
○ Cross Price Elasticity
■ Include the negative symbols (it determines the results)
■ How much you want of an item if the price of another item changes
● Complement (Negative/Inverse) if price increases for one item then you want
less of both
○ Ex: Hot Dogs and Ketchup
● Substitute (Positive/Direct) if price increases for one item then you want
more of the other item
○ Ex: Hamburgers vs. Hot Dogs
Income Elasticity
● Almost same equation as normal elasticity
● Difference
○ Measuring how much more or less of an item you purchase when your income
changes
● Inferior vs. Normal Good
○ Determined by the positive or negative value of the final result
■ Positive: Good is normal and that means the larger the income the
more you buy of the good
● Example: You will buy more video games if your income increases
■ Negative: Good is inferior and that means the larger the income the
less you buy of the good
● You may buy less $1 makeup products if your income increases;
you may buy more expensive and nicer quality makeup
○ Unlike normal elasticity equation you do not use the absolute value of the
final number
Cross Price Elasticity
● Almost same equation as normal elasticity
● Difference
○ Measuring how much more or less of an item you purchase when the price of another good
changes
● Complementary vs. Substitute Good
○ Determined by the positive or negative value of the final result
■ Positive: Good is a substitute and that means you buy more of it if the price of the
other good increases; you buy less of it if the price of the other good decreases
● Example: You buy more burgers if the price of hot dogs increase
■ Negative: Good is a complement and that means you buy less of it if the price of the
other good increases; you buy more of it if the price of the other good decreases
● Example: You buy less ketchup if the price of burgers increase
○ Unlike normal elasticity equation you do not use the absolute value of the final number
List of Formulas
Elasticity of Demand=

Income Elasticity=

Cross Price Elasticity=

 Application/Scenarios for Elasticity
o Large crop yields
o Creating surpluses is a problem
o Good is inelastic and going past equilibrium sees steady loss of revenue
o Taxes:
o Government won’t impose or raise excise taxes on goods that have highly
elastic demand
o Will tax goods that have inelastic demand
■ Example: “Sin Tax” on cigarettes
o Decriminalization of Illegal Drugs:
o Proponents believe it can be taxed because demand is inelastic
o Reduce profit motive to reduce crime, illegal sales
o Opponents believe that a portion of demand is elastic
■ People can be convinced not to take illegal drug
Consumer Surplus and Producer Surplus
● Defined as
○ Consumer Surplus:
■ Measure of consumer benefit for
an item.
■ Amount a consumer is willing to
pay versus what they actually pay
for an item or service.
■ Can be broken down and measured
consumer by consumer
○ Producer Surplus:
■ Measure of profit for an item or
service.
■ Amount a supplier is willing to
charge for a product and the
actual amount they ended up
charging
Shortage and Surplus
• Competition among buyers and sellers drives the price to the
equilibrium price
• Equilibrium price will change due to shifts in either (or both)
curves
• Surplus – Price > Equilibrium price
– Drives prices down
• Shortage – Price < Equilibrium price
– Drives price up
Shortage and Surplus
 A Surplus

For a shortage the equilibrium price is higher

than the market price. This means that
consumers demand more product than what
the suppliers could make

For a surplus the equilibrium price is lower

than the market price. This means that
suppliers have more product than what
consumers would want to buy
 Price Floors
● Designed to prevent prices from falling too far
○ Prices that are too low damage the producer/supplier
■ Can limit future growth
● Set a minimum price that prices cannot drop below
○ Artificially setting a new equilibrium price
● Examples: Minimum Wage
● Problems with it
○ New price (market price) is above the equilibrium price
○ Supply exceeds demand
○ Not enough people will buy all the products
○ Creates a surplus
Price Ceilings
● Designed to prevent prices from rising too high
○ Prices that are too high damage the consumer/purchaser
■ Can limit purchasing power
■ Limit number of people who want/need goods or service
● Set a maximum price that prices cannot rise above
○ Artificially setting a new equilibrium price
● Example: Rent Control for Apartments
● Problems with it
○ New price (market price) is below the equilibrium price
○ Demand exceeds supply
○ Not enough supplied item for people to buy
○ Creates a shortage
Overview: Price Ceiling and Price Floor