Principles of Economics I
(Macroeconomics)

Demand and Supply
(Part 1 of 2)

Overview

Have you any questions on the previous lesson,
homework, or materials listed on the previous
daily class outline?

2. Course Objectives

 List the first three course objectives from text page  61  :

1.  Distinguish between money price and
a relative price.

2.  Explain the main influences on demand.

3.  Explain the main influences on supply.

3. Outline

A. The money price of a product is the dollars that must be used to buy it; the relative price of a product is the ratio of its money price to the money price of another product.

1. A product’s relative price is the opportunity cost of buying it. This opportunity cost is expressed in terms of the amount of another good that is foregone by buying the product.

2. Dividing a product’s money price by the price index yields the product’s price relative to the average prices of all other products in the economy.

B. Because a product’s relative price equals its opportunity cost, the demand and supply for it depend on its relative price. Hence the demand and supply model determines relative prices, not money prices.

A. The quantity demanded of a good is the amount consumers plan to buy in a given period of time at a particular price.

1. Wants are the unlimited desires or wishes people have for products; the quantity demanded shows the amount people are actually willing to buy.

B. The law of demand states that "other things remaining the same, the higher the price of a good, the smaller is the quantity demanded."

1. The law of demand is the result of two effects:

a) The substitution effect points out that when the relative price of a product rises, people buy less of it because the opportunity cost of consuming it has increased.

b) The income effect points out that a higher price for a product effectively lowers people’s incomes and, as a result, reduces their purchases of most goods.

C. The demand for a product is the entire relationship between all possible prices and the quantities that people demand at every possible price. The quantity demanded is the amount that people will buy at a particular price.

D. The demand curve graphs the relationship between the quantity demanded of a good and its price.

E The demand curve also shows people’s willingness-and-ability-to-pay; that is, for any given quantity, it shows the highest price people are willing to pay for the last unit purchased. Because the amount that people are willing to pay measures their benefit from the good, the demand curve is also the marginal benefit curve.

F. The demand curve shifts so that there is a change in demand when some influence other than the price of the product itself changes. Factors that shift a product’s demand curve are:

1. Prices of related goods, which have two possible relationships:

a) Substitutes — goods that can be used in place of the product being studied. A rise (fall) in the price of a substitute shifts the demand curve rightward (leftward).

b) Complements — goods used in combination with the good under study. A rise (fall) in the price of a complement shifts the demand curve leftward (rightward).

2. Income, again with two possible relationships:

a) A normal good is one for which an increase (decrease) in consumers’ incomes shifts the demand curve rightward (leftward).

b) An inferior good is a good for which an increase (decrease) in consumers’ incomes shifts the demand curve leftward (rightward).

3. The larger (smaller) the population, the larger (smaller) is the demand for all goods.

4. Changes in people’s preferences affect their demand for a product.

5. If the expected future price of the product is forecast to rise (fall) and the good can be stored, consumers increase (decrease) their current demand for it.

G. The distinction between a "change in the quantity demanded" and a "change in demand" is crucial. A change in the quantity demanded, that is, a movement along the demand curve, occurs when the price of the product changes. A change in demand refers to a shift in the entire demand curve.

A. The quantity supplied of a good is the amount that producers plan to sell in a given period of time.

B. The law of supply is that "other things remaining the same, the higher the price of a good, the greater is the quantity supplied."

1. A higher price increases the quantity supplied because producing larger quantities increases the marginal cost of production. Hence greater quantities are supplied only if the price rises to cover the higher marginal cost.

C. Supply is the entire relationship between all possible prices and the quantity supplied at every price.

D. The supply curve graphs the relationship between the quantity supplied and the price of a product.

1. The supply curve shows firms’ minimum supply price; that is, for any quantity, it shows the minimum price that firms must receive in order to supply the last unit of the given quantity.

F. A change in supply (a shift in the supply curve) occurs whenever some factor that affects the supply of the good, other than its price, changes. Such variables include:

1. Prices of productive resources. A rise (fall) in the prices of resources shifts the supply curve leftward (rightward).

2. An increase in technology shifts the supply curve rightward.

3. An increase (decrease) in the number of suppliers shifts the supply curve rightward (leftward).

4. Prices of other goods produced, which have two possible relationships:

a) When the price of a substitute in production rises (falls), the supply curve for the good shifts leftward (rightward).

b) A rise (fall) in the price of a complement in production shifts the supply curve rightward (leftward).

5. If the expected future price of the product rises (falls), the supply curve in the present period shifts leftward (rightward).

G. Similar to demand, the distinction between a "change in supply" and a "change in the quantity supplied" is crucial. The former refers to a shift in the entire demand curve, whereas the latter refers to a movement along the supply curve.

4. PowerPoint Viewgraphs (slides 4-7, slides 8-39, and slides 40-69)

(The viewgraphs provide assistance in mastering the course objectives.)

5. Economics in Action Tutorial

Insert your CD-rom in your computer.  Start Economics in Action.

You'll use the portion of your Economics in Action CD called Demand and Supply.  Complete the first section of the tutorial related to Walkman's Watch.  Then take the drag and drop quiz to measure your understanding.

6. Discussion Questions and Problems (study guide pages 52-57)

Begin the odd-numbered true/false, multiple choice, and problems in your study guide.  Check your answers using study guide pages 58-64.

7. Homework

1.  Review Key Concepts pages 49-52 in your study guide.
2.  Complete the odd-numbered Questions from your study guide pages 52-57 and check your answers on pages 58-64.
3.  Compare your class notes and your understanding of the homework Questions with your study partner.
4.  Meet the persons who formalized the laws of supply and demand in their present format. Take a few minutes to read about Alfred and Mary Paley Marshall, pages 88-89 in your text.

8. Summary

1.  This chapter has terms to memorize and an analytical model called demand and supply to master which looks like the blades of a scissors.

2.  You must memorize the items which increase or decrease demand, so as to recognize their effects when reading the "news."

3. You must be able to move the demand curve appropriately as the result of today's presentation.  During the next lesson you must be able to move the supply curve appropriately.  The supply curve shifts rightward or leftward to due a second set of variables which must be memorized.

4. Shifting the demand and supply curves appropriately will produce an intersection from which we can determine the resulting relative price and quantity of a good which simultaneously satisfy buyers and sellers.