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Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-2
Introduction
Over the past 30 years, college tuition and fees have
increased significantly. Annual tuition that would have
been about $2,000 in the 1980s is now at a level of around
$20,000.
Textbook prices have experienced a sizable increase as
well. Students now typically pay $1,000 a year for books,
compared to an annual expense of about $200 in the
1980s.
In this chapter you will learn what has caused these
prices to rise.

Learning Objectives
• Explain the law of demand
• Discuss the difference between money
prices and relative prices
• Distinguish between changes in demand
and changes in quantity demanded

Learning Objectives (cont'd)
• Explain the law of supply
• Distinguish between changes in supply and
changes in quantity supplied
• Understand how supply and demand
interact to determine equilibrium price and
quantity

Chapter Outline
• Demand
• The Demand Schedule
• Shifts in Demand
• The Law of Supply
• The Supply Schedule
• Shifts in Supply
• Putting Demand and Supply Together

Did You Know That ...
• After truck freight-hauling prices jumped in the
early 2010s, rail shipments of freight containers
rose by more than 10 percent?
• Higher truck-transportation prices induced many
companies to choose rail transportation as a
substitute.
• By using demand and supply, you can develop a
better understanding of why sometimes we
observe large increases in the purchase of items
such as rail freight services.

Did You Know That … (cont’d)
• Market
– All of the arrangements that individuals have
for exchanging with one another
– Examples of markets:
• Automobile market
• Health-care market
• Market for high-speed internet access
– One of the most important activities in these
markets in the determination of prices.

Demand
• A schedule showing how much of a good or
service people will purchase at any price
during a specified time period, other things
being constant

Demand (cont’d)
• Law of Demand
– A negative, or inverse, relationship between the
price of any good or service and the quantity
demanded, holding other factors constant
(ceteris paribus)
• When the price of a good goes up, people buy less of
it, other things being equal.
• When the price of a good goes down, people buy more
of it, other things being equal.

Demand (cont’d)
• What are we holding constant?
– Income
– Tastes and preferences
– Price of other goods
– Many other factors

Demand (cont’d)
• Relative prices and money prices
– Relative Price
• The price of a commodity in terms of
another commodity
– Money Price
• Price we observe today in today’s dollars (absolute, or
nominal price)

Table 3-1 Money Price versus Relative
Price

Example: Why Sales of Electric Cars are Stuck in
Low Gear
• Prices of electric autos exceed prices of hybrid
versions by at least 30 percent and prices of
gasoline powered versions by 50 percent.
• The quality-adjusted prices of electric cars are even
higher when we take into account the limited range
of distance over which they can operate.
• Beyond a distance of roughly 250 miles, the
batteries in electric cars cease to function.
• This limitation in their usefulness helps explain why
sales of electric cars remain a small portion
of the overall automobile market.

The Demand Schedule
• Demand schedule
– Table relating prices to quantities demanded
– We must also consider:
• Time dimension (e.g., per year)
• Constant-quality units

The Demand Schedule (cont’d)
• Demand Curve
– A graphical representation of the demand
schedule
– Negatively sloped line showing the inverse
relationship between the price and the quantity
demanded (other things being equal)

Figure 3-1 The Individual Demand Schedule and the
Individual Demand Curve, Panel (a)

Figure 3-1 The Individual Demand Schedule and the
Individual Demand Curve, Panel (b)

The Demand Schedule (cont’d)
• Individual versus market demand curves
• Market Demand
– The demand of all consumers in the marketplace
for a particular good or service
– Summation at each price of the quantity
demanded by each individual

Figure 3-2 The Horizontal Summation of Two
Demand Curves, Panel (a)

Figure 3-2 The Horizontal Summation of Two
Demand Curves, Panels (b), (c), (d)

Figure 3-3 The Market Demand Schedule for
Magneto Optical Disks, Panel (a)

Figure 3-3 The Market Demand Schedule for
Magneto Optical Disks, Panel (b)

Shifts in Demand
• Scenario
– Imagine the government gives every registered
college student in the United States a magneto
optical disk drive.
• If some factor other than price changes, we can show
its effect by moving the entire demand curve, shifting
the curve left or right.
• In this case, there will be an increase in the number of
MO disks demanded at each and every possible price.

Figure 3-4 A Shift in the Demand Curve

Shifts in Demand (cont’d)
• Ceteris-Paribus Conditions
– Determinants of the relationship between price
and quantity that are unchanged along a curve
– Changes in these factors cause a curve to shift

• Normal Goods
– Goods for which demand rises as income rises;
most goods are normal goods
• Inferior Goods
– Goods for which demand falls as income rises

Example: Lower Incomes Boost the Demand for
Reconditioned Cellphones
• U.S. residents who have been out of work
or who are classified as discouraged
workers are earning much lower incomes
than they did a few years ago.
• Many of these people have purchased
reconditioned cellphones, a cheaper
alternative to a new phone.
• This allows us to identify reconditioned
cellphones as an inferior good.

• Determinants of demand
– Income
– Tastes and preferences
– The prices of related goods
• Substitutes
• Complements

Shifts in Demand (cont'd)
• Substitutes
– Two goods are substitutes when a change in the
price of one causes a shift in demand for the
other in the same direction as the price change

• Complements
– Two goods are complements when a change in
the price of one causes an opposite shift in the
demand curve for the other

Example: Why Fewer Wine Bottles Have Natural
Cork Stoppers
• Cork bottle stoppers have traditionally been used
for wine bottles because wine can “breathe” air
through the porous cell structure of natural cork.
• Since the early 2000s, prices of natural cork bottle
stoppers have risen above prices of plastic
stoppers, and this translates into higher prices for
wine in cork-furnished bottles.
• In response, consumers have purchased more wine
bottled with plastic stoppers.

• Determinants of demand
– Expectations
• Future prices
• Income
• Product availability
– Market size (number of buyers)

Policy Example: An Expected Uranium
Price Implosion Cuts Uranium Demand
• Following the 2011 earthquake and tsunami
in Japan, many countries announced plans
to decrease their reliance on nuclear power
as a source of energy.
• This led to an expectation of lower uranium
prices in the future.
• As a consequence, purchases of uranium
were delayed, and the uranium price
dropped immediately.

• Changes in demand versus changes in
quantity demanded
– Whenever there is a change in a ceteris paribus
condition, there will be a change in demand
• A shift of the entire demand curve to the right or to the
left
• The only thing that can cause the entire curve to move
is a change in a determinant other than the good’s own
price

• Changes in demand versus changes in
quantity demanded
– A change in a good’s own price leads to a
change in quantity demanded (a single point on
a demand curve) for any given demand curve
• A movement along the same demand curve

Figure 3-5: Movement Along a Given
Demand Curve

The Law of Supply
• Supply
– Schedule showing relationship between price
and quantity supplied for a specified time period,
other things being equal
– The amount of a product or service that firms
are willing to sell at alternative prices

The Law of Supply (cont'd)
• Law of Supply
– The higher the price of a good, the more of that
good sellers will make available over a specified
time period, other things being equal
• At higher prices, a larger quantity will generally be
supplied than at lower prices, all other things held
constant.
• At lower prices, a smaller quantity will generally be
supplied than at higher prices, all other things held
constant.

Example: Steel Producers Reduce Production
When the Price of Steel Falls
• When the market price of steel declined
from $660 per ton to below $625 per ton,
steel manufacturers responded by cutting
back on production.
• This is consistent with the upward-sloping
supply curve of steel.

The Supply Schedule
• The supply schedule is a table relating
prices to quantity supplied at each price.
• Supply Curve
– A graphical representation of the
supply schedule
– Positively sloped line (curve) showing the direct
relationship between price and quantity
supplied, all else being equal

Figure 3-6 The Individual Producer’s Supply
Schedule and Supply Curve for Magnetic Optical
Disks, Panel (a)

Figure 3-6 The Individual Producer’s Supply
Schedule and Supply Curve for Magnetic Optical
Disks, Panel (b)

Figure 3-7 Horizontal Summation of
Supply Curves, Panel (a)

Figure 3-7 Horizontal Summation of
Supply Curves, Panels (b), (c), (d)

Figure 3-8 The Market Supply Schedule and the
Market Supply Curve for Magnetic Optical Disks,
Panel (a)

Figure 3-8 The Market Supply Schedule and the
Market Supply Curve for Magnetic Optical Disks,
Panel (b)

Shifts in Supply
• Scenario
– A new method of manufacturing magnetic
optical disks significantly reduces the cost of
production.
– Producers of MO disks will supply more product
at any given price.

Example: Cotton Price Movements
Squeeze and Stretch Clothing Supply
• Between 2009 and 2010, the price of cotton
increased by 55 percent.
– Clothing manufacturers responded by reducing
the number of cotton garments supplied
at any given price.
• During 2011, cotton prices decreased.
– In response, there was an increase in the supply
of cotton clothes.

Figure 3-9 Shifts in the Supply Curve

Shifts in Supply (cont'd)
• Determinants of supply
– Cost of inputs
– Technology and productivity
– Taxes and subsidies
– Price expectations
– Number of firms in industry

What If . . . politicians oppose a higher
gasoline price yet favor higher fuel taxes?
• A decrease in the market supply of gasoline
results in higher prices.
– Members of Congress may then complain that
gas prices are “too high”.
– Yet, these same elected officials may favor
higher fuel taxes.
– A tax imposed on gasoline has the same effect
as a decrease in supply.

Example: How Deadly Southern Twisters
Pummeled U.S. Poultry Supply
• Between April 26 and April 28 of 2011,
there were 278 tornadoes in the U.S.
• Many of the twisters hit Alabama, where
poultry farmers typically supply about 12
percent of the national poultry market.
• Damage to chicken-processing plants
resulted in a decrease in the number of
firms supplying the market.

• Changes in supply versus changes in
quantity supplied
– Whenever there is a change in a ceteris paribus
condition, there will be a change in supply
• A shift of the entire supply curve to the right or to the
left
• The only thing that can cause the entire curve to move
is a change in a determinant other than the good’s own
price

• Changes in supply versus changes in
quantity supplied
– A change in a good’s own price leads to a
change in quantity supplied (a single point on a
supply curve) for any given supply curve
• A movement along the same supply curve

Putting Demand
and Supply Together
• Putting demand and supply together
• Equilibrium (Market Clearing) Price
– The price that clears the market
– The price at which quantity demanded equals
quantity supplied
– The price where the demand curve intersects the
supply curve

Figure 3-10 Putting Demand and
Supply Together, Panel (a)

Figure 3-10 Putting Demand and
Supply Together, Panel (b)

Putting Demand
and Supply Together (cont'd)
• Equilibrium
– The situation when quantity supplied equals
quantity demanded at a particular price
– There tends to be no movement of the price of
the quantity away from this point unless
demand or supply changes
– Equilibrium is a stable point – any point that is
not equilibrium is unstable and will not persist

Putting Demand
• The equilibrium price
– The price toward which the market price will
automatically tend to gravitate,
– There is no outcome better than this price for
both consumers and producers

Putting Demand
• Shortages
– The situation when quantity demanded is
greater than quantity supplied
– Exist at any price below the market clearing
price
– Shortages and scarcity are not the same thing

Example: Production Breakdowns Create a
Shortage of a Life-Saving Drug
• Each year, 20,000 new cases of acute
lymphoblastic leukemia are diagnosed.
– Cytarabine is the drug commonly used to treat this
disease.
• Recently, all of the firms manufacturing this drug
experienced problems that slowed or halted
production of the drug.
• A shortage of cytarabine resulted, and the drug
was rationed by medical professionals who judged
the urgency of need in various individuals.

Putting Demand
• Surpluses
– The situation when quantity supplied is greater
than quantity demanded
– Exist at any price above the market clearing
price

Policy Example: Should Shortages in the Ticket
Market Be Solved by Scalpers?
• If you’ve ever tried to get tickets to the big game
you know all about “shortages”
• Since the quantity of tickets is fixed, the price can
go pretty high
• Enter the scalper

Figure 3-11 Shortages of Super Bowl
Tickets

You Are There … Why the Casket Industry Is on
Life Support
• The CEO of a casket manufacturer described his
industry as one that isn’t growing.
• Falling prices for a substitute good, cremations, are
the primary reason.
• The typical price for a traditional casket burial
exceeds $7,200. This compares to $1,300 for the
average price of a cremation service.
• This decreasing price of a lower-priced substitute
has caused a decline of the demand for caskets.

Issues & Applications: Your Higher Education
Bills Really Are Increasing
• What explains the higher prices that students are
paying for a college education, as compared to
prices 30 years ago?
• The figure on the following slide displays an index
measure of three variables from 1978 to 2010:
– 1) U.S. college tuition and fees
– 2) U.S. educational books and supplies
– 3) The level of consumer prices overall

Issues & Applications: Your Higher Education Bills
Really Are Increasing (cont’d)
Figure 3-12 Indexes of Prices for Higher-Education-Related
Items and All Goods and Services since 1978

Issues & Applications: Your Higher Education
Bills Really Are Increasing (cont’d)
• The figure on the preceding slide shows that the
money prices of tuition and textbooks have
increased substantially since 1978.
• The relative prices of these goods have increased
as well.
• Compared to 1978:
– Relative tuition has tripled
– Relative textbook prices have doubled
• The equilibrium prices of these goods and services
have increased over the past four decades.

Summary Discussion
of Learning Objectives
• The law of demand says that prices
and quantity demanded are
inversely related
– At a higher price people buy less, at a lower
price people buy more
• Relative prices must be distinguished from
money prices, since people respond to
changes in relative prices

Summary Discussion
of Learning Objectives (cont'd)
• A change in quantity demanded versus a
change in demand
– A change in quantity demanded is a movement
along the same demand curve
– A change in demand is a shift of the whole
demand curve

Summary Discussion
• The law of supply states that price and
quantity supplied are directly related
– Firms offer more at a higher price; firms offer
less at a lower price
• A change in quantity supplied versus a
change in supply
– A change in quantity supplied is a movement
along the same supply curve
– A change in supply is a shift of the whole
supply curve

Summary Discussion
• Determining market price and equilibrium
quantity
– The demand and supply curves intersect at the
market clearing, or equilibrium point
– Surpluses exist if the price of the good is greater
than the market price
– Shortages exist when the price of a good is
below the market price

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