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DEMAND AND
SUPPLY
K e y C o n c e p t s
Markets and Prices
A competitive market is one that has so many buyers and sellers so that no single buyer or seller can influ- ence the price. The ratio of the money price of one good to the money price of another good is the relative price. The relative price of a product is the product’s opportunity cost. The demand for and supply of a product depend, in part, on its relative price.
Demand
The quantity demanded of a good is the amount that consumers plan to buy during a time period at a par- ticular price. The law of demand states that “other things remaining the same, the higher the price of a good, the smaller is the quantity demanded.” Higher prices decrease the quantity demanded for two reasons:
♦ Substitution effect — a higher relative price raises the opportunity cost of buying a good and so people buy less of it.
♦ Income effect — a higher relative price reduces the amount of goods people can buy. Usually this effect decreases the amount people buy of the product that rose in price.
Demand is the entire relationship between the price of a good and the quantity demanded. A demand curve shows the inverse relationship between the quantity demanded and price, everything else remaining the same. For each quantity, a demand curve shows the highest price someone is willing to pay for that unit. This highest price is the marginal benefit a consumer receives for that unit of output.
Demand Curves
F I G U R E 3. 1
Price (dollars per street hockey ball)
Quantity (thousands of street hockey balls per week)
0 1 2 3 4 5 6
1
2
3
4
5
D (^1)
D (^2)
Demand curves
♦ Demand curves are negatively sloped, as illustrated in Figure 3.1. ♦ A change in the price of the product leads to a change in the quantity demanded and a movement along the demand curve. The higher the price of a good, the lower is the quantity demanded. This re- lationship is shown in Figure 3.1 with the move- ment along D 1 from 4,000 to 2,000 street hockey balls demanded per week in response to a rise in price from $2 to $4 for a street hockey ball. A change in demand and a shift in the demand curve , occur when any factor that affects buying plans, other than the price of the product changes. An increase in demand means that the demand curve shifts rightward, such as the shift from D 1 to D 2 in Figure 3.1; a de-
C h a p t e r
4 6 C H A P T E R 3
crease in demand refers to a shift leftward. The demand curve shifts from changes in the following:
♦ prices of related goods — a rise in the price of a sub- stitute increases demand and the demand curve shifts rightward; a rise in the price of a complement decreases demand and the demand curve shifts left- ward.
♦ expected future prices — if a product’s price is ex- pected to rise in the future, the current demand for it increases and the demand curve shifts rightward.
♦ income — for a normal good , an increase in income increases demand and the demand curve shifts rightward; for an inferior good an increase in in- come decreases demand and the demand curve shifts leftward.
♦ population — an increase in population increases demand and the demand curve shifts rightward.
♦ preferences — if people decide they like a good more, its demand increases and the demand curve shifts rightward.
Supply
The quantity supplied is the amount of a good that producers plan to sell at a particular price during a given time period.
The law of supply states that “other things remaining the same, the higher the price of a good, the greater is the quantity supplied.” Supply is the entire relationship between the price of a good and the quantity supplied. A supply curve shows the positive relationship between the price and the quantity supplied. For each quantity, the supply curve shows the minimum price a supplier must receive in order to produce that unit of output.
♦ Supply curves are positively sloped, as shown in Figure 3.2.
♦ A change in the price of the product leads to a change in the quantity supplied and a movement along the supply curve. It is illustrated in Figure 3. as the movement along (^) S 1 from 2,000 street hockey balls supplied per week to 4,000 balls when the price rises from $2 for a ball to $4.
A change in supply is illustrated as a shift in the supply curve. An increase in supply is equivalent to a shift rightward in the supply curve, shown in Figure 3.2 as the shift from S 1 to S 2 ; a decrease in supply is a left- ward shift in the supply curve. There is a change in
Supply Curves
F I G U R E 3. 2
Price (dollars per street hockey ball)
Quantity (thousands of street hockey balls per week)
0 1 2 3 4 5 6
1
2
3
4
5
S (^1) S (^2) Supply curves
supply and a shift in the supply curve in response to changes in the following: ♦ prices of productive resources — a rise in the price (cost) of an input decreases supply and the supply curve shifts leftward. ♦ prices of related goods produced — a rise in the price of a substitute in production decreases supply and the supply curve shifts leftward; a rise in the price of a complement in production increases supply and the supply curve shifts rightward. ♦ expected future prices — if the price is expected to rise in the future, the current supply decreases and the supply curve shifts leftward. ♦ number of suppliers — an increase in the number of suppliers increases the supply and the supply curve shifts rightward. ♦ technology — an advance in technology increases supply and the supply curve shifts rightward.
Market Equilibrium The equilibrium price is determined by the intersec- tion of the demand and supply curves. It is the price at which the quantity demanded equals the quantity sup- plied. The equilibrium quantity is the quantity bought and sold at the equilibrium price. Figure 3. shows the equilibrium price, $3, and the equilibrium quantity, 3,000 street hockey balls per week. At a price below the equilibrium price, a shortage exists and the
4 8 C H A P T E R 3
Now come two more difficult parts that you must practice. Suppose that you are dealing with a situa- tion in which one influence changes. First, deter- mine whether the influence shifts the demand or the supply curve. Aside from the effect of the ex- pected future price, most factors generally shift only one curve and you must decide which one. Second, determine whether the curve that is affected shifts rightward (increases) or shifts leftward (decreases). From here on, it’s more straightforward: Take the figure you have already drawn, shift the appropriate curve, and read off the answer!
The Effect of an Increase in Demand
F I G U R E 3. 4
Price (dollars per
television set)
Quantity (thousands of television sets per day)
0 1 2 3 4 5 6
100
200
300
400
500
S
D (^1)
D (^2)
5.5. 5.5. CHANGES IN D EMAND D O NOT CAUSE
CHANGES IN S UPPLY ; CHANGES IN S UPPLY D O
NOT CAUSE CHANGES IN D EMAND : Do not make the common error of believing that an in- crease in demand, that is, a rightward shift in the demand curve, causes an increase in supply, a rightward shift in the supply curve. Use Figure 3.4, which illustrates the market for television sets, as an example. An increase in demand shifts the demand curve rightward, as shown. This shift means the equilibrium price of a television rises (from $ for a set to $400) and the equilibrium quantity in- creases (from 3,000 sets per day to 4,000). But the shift in the demand curve does not cause the supply curve to shift. Instead, there is a movement along the unchanging supply curve.
Q u e s t i o n s
True/False and Explain
Markets and Prices
- A good with a high relative price must have a low opportunity cost.
- A product’s relative price can fall even though its money price rises.
Demand
- The law of demand states that, if nothing else changes, as the price of a good rises, the quantity demanded decreases.
- A decrease in income decreases the demand for all products.
- “An increase in demand” means a movement down and rightward along a demand curve.
- New technology for manufacturing computer chips shifts the demand curve for computer chips.
Supply
- A supply curve shows the maximum price required in order to have the last unit of output produced.
- A rise in the price of chicken feed decreases the supply of chickens.
- A rise in the price of orange juice shifts the supply curve of orange juice rightward.
Market Equilibrium
- Once a market is at its equilibrium price, unless something changes, the price will not change.
- If there is a surplus of a good, its price falls.
Predicting Changes in Price and Quantity
- If the expected future price of a good rises, its cur- rent price rises.
- A rise in the price of a product decreases the quan- tity demanded, so there can never be a situation with both the product’s equilibrium price rising and equilibrium quantity increasing.
- If both the demand and supply curves shift right- ward, the equilibrium quantity definitely increases.
- If both the demand and supply curves shift right- ward, the equilibrium price definitely rises.
D E M A N D A N D S U P P L Y 4 9
Multiple Choice
Markets and Prices
- The opportunity cost of a product is the same as its a. money price. b. relative price. c. price index. d. None of the above.
- The money price of a pizza is $12 per pizza and the money price of a taco is $2 per taco. The relative price of a pizza is a. $12 per pizza. b. $24 per pizza. c. 6 tacos per pizza. d. 1 6 pizza.
Demand
- The law of demand concludes that a rise in the price of a golf ball ____ the quantity demanded and ____. a. increases; shifts the demand curve rightward. b. decreases; shifts the demand curve leftward. c. decreases; creates a movement upward along the demand curve. d. increases; creates a movement downward along the demand curve.
- If a rise in the price of gasoline decreases the de- mand for large cars, a. gasoline and large cars are substitutes in con- sumption. b. gasoline and large cars are complements in con- sumption. c. gasoline is an inferior good. d. large cars are an inferior good.
- A normal good is one a. with a downward sloping demand curve. b. for which demand increases when the price of a substitute rises. c. for which demand increases when income in- creases. d. None of the above.
- Some sales managers are talking shop. Which of the following quotations refers to a movement along the demand curve? a. “Since our competitors raised their prices our sales have doubled.” b. “It has been an unusually mild winter; our sales of wool scarves are down from last year.” c. “We decided to cut our prices, and the increase in our sales has been remarkable.” d. None of the above.
Multiple Choice Question 7
F I G U R E 3. 5
Price (dollars)
Quantity (units per hour)
D (^1)
D (^2)
0 1 2 3 4 5 6
10
20
30
40
50
- Which of the following could result in the shift in the demand curve illustrated in Figure 3.5? a. An increase in the quantity demanded b. A rise in the price of a substitute good c. A rise in the price of a complement d. A fall in the price of the product
Supply
- A fall in the price of a good leads to producers de- creasing the quantity of the good supplied. This result illustrates a. the law of supply. b. the law of demand. c. a change in supply. d. the nature of an inferior good.
D E M A N D A N D S U P P L Y 5 1
- In a market, at the equilibrium price, a. neither buyers nor sellers can do business at a better price. b. buyers are willing to pay a higher price, but sell- ers do not ask for a higher price. c. buyers are paying the minimum price they are willing to pay for any amount of output and sell- ers are charging the maximum price they are willing to charge for any amount of production. d. None of the above is true.
Predicting Changes in Price and Quantity
- For consumers, pizza and hamburgers are substi- tutes. A rise in the price of pizza ____ the price of a hamburger and ____ in the quantity of hamburgers. a. raises; increases b. raises; decreases c. lowers; increases d. lowers; decreases
- How does an unusually cold winter affect the equi- librium price and quantity of anti-freeze? a. It raises the price and increases the quantity. b. It raises the price and decreases the quantity. c. It lowers the price and increases the quantity. d. It lowers the price and decreases the quantity.
- You notice that the price of wheat rises and the quantity of wheat increases. This set of observations can be the result of the a. demand for wheat curve shifting rightward. b. demand for wheat curve shifting leftward. c. supply of wheat curve shifting rightward. d. supply of wheat curve shifting leftward.
- A technological improvement lowers the cost of producing coffee. As a result, the price of a pound of coffee ____ and the quantity of coffee ____. a. rises; increases b. rises; decreases c. falls; increases d. falls; decreases
- The number of firms producing computer memory chips decreases. As a result, the price of a memory chip ____ and the quantity of memory chips ____. a. rises; increases b. rises; decreases c. falls; increases d. falls; decreases
For the next five questions, suppose that the price of paper used in books rises and simultaneously (and independently) more people decide they want to read books.
- The rise in the price of paper shifts the a. demand curve rightward. b. demand curve leftward. c. supply curve rightward. d. supply curve leftward.
- The fact that more people want to read books shifts the a. demand curve rightward. b. demand curve leftward. c. supply curve rightward. d. supply curve leftward.
- The equilibrium quantity of books a. definitely increases. b. definitely does not change. c. definitely decreases. d. might increase, not change, or decrease.
- The equilibrium price of a book a. definitely rises. b. definitely does not change. c. definitely falls. d. might rise, not change, or fall.
- Suppose that the effect from people deciding they want to read more books is larger than the effect from the increase in the price of paper. In this case, the equilibrium quantity of books a. definitely increases. b. definitely does not change. c. definitely decreases. d. might increase, not change, or decrease.
5 2 C H A P T E R 3
- Which of the following definitely raises the equilib- rium price? a. An increase in both demand and supply. b. A decrease in both demand and supply. c. An increase in demand combined with a decrease in supply. d. A decrease in demand combined with an increase in supply.
- Is it possible for the price of a good to stay the same while the quantity increases? a. Yes, if both the demand and supply of the good increase by the same amount. b. Yes, if the demand increases by the same amount the supply decreases. c. Yes, if the supply increases and the demand does not change. d. No, it is not possible.
Short Answer Problems
- a. This year the price of a hamburger is $2 and the price of a compact disc is $12. In terms of ham- burgers, what is the relative price of a compact disc? In terms of hamburgers, what is the op- portunity cost of buying a compact disc? How are the two answers related? b. Next year the (money) price of a compact disc doubles to $24 and the (money) price of a hamburger remains at $2. Now what is the relative price of a compact disc? c. The following year the (money) price of a com- pact disc stays at $24 and the (money) price of a hamburger doubles to $4. What is the relative price of a compact disc? d. In the next year, the (money) price of a compact disc doubles to $48 and the money price of a hamburger triples to $12. What is the relative price of a compact disc? e. Can a product’s relative price fall even though its money price has risen? Why or why not?
- a. When drawing a demand curve, what five influ- ences are assumed not to change? b. If any of these influences change, what happens to the demand curve? c. When drawing a supply curve, what five influ- ences are assumed not to change? d. If any of these influences change, what happens to the supply curve?
- a. Table 3.1 presents the demand and supply schedules for comic books. Graph these demand and supply schedules in Figure 3.7. What is the equilibrium price? The equilibrium quantity? b. What is the marginal benefit received by the consumer of the 12,000,000th comic book? What is the minimum price for which a pro- ducer is willing to produce the 12,000,000th comic book?
T A B L E 3. 1 Demand and Supply Schedules
Price (per comic book)
Quantity demanded (per month)
Quantity supplied (per month) $2.50 14,000,000 8,000, 3.00 13,000,000 10,000, 3.50 12,000,000 12,000, 4.00 11,000,000 13,000, 4.50 10,000,000 14,000,
Short Answer Problem 3
0
6 8 10 12 14
F I G U R E 3. 7
16 Quantity (millions of comic books per month)
Price (dollars per comic books)
c. Suppose that the price of a movie, a substitute for comic books, rises so that at every price of a comic book consumers now want to buy 2,000,000 more comic books than before. That is, at the price of $2.50, consumers now will buy 16,000,000 comics; and so on. Plot this new demand curve in Figure 3.7. What is the new equilibrium price? The new equilibrium quan- tity?
5 4 C H A P T E R 3
A n s w e r s
True/False Answers
Markets and Prices
- F A product’s relative price is its opportunity cost.
- T A good’s relative price will fall if its money price rises less than the money prices of other goods.
Demand
- T The law of demand points out the negative rela- tionship between a product’s price and the quantity demanded.
- F Demand decreases for normal goods but in- creases for inferior goods.
- F The term “increase in demand” refers to a right- ward shift in the demand curve.
- F Changes in technology are not a factor that shifts the demand curve. (Changes in technology will shift the supply curve.)
Supply
- F The supply curve shows the minimum price that suppliers must receive in order to produce the last unit supplied.
- T Chicken feed is a resource used to produce chickens, so a rise in its price shifts the supply curve of chickens leftward.
- F The rise in the price of orange juice creates a movement along the supply curve to a larger quantity supplied (that is, upward and right- ward), but it does not shift the supply curve.
Market Equilibrium
- T Once at the equilibrium price, because the op- posing forces of supply and demand are in bal- ance, the situation can persist indefinitely until something changes.
- T A surplus of a product results in its price falling until it reaches the equilibrium price.
Predicting Changes in Price and Quantity
- T The rise in the future price shifts the demand curve rightward and the supply curve leftward, unambiguously raising the current price.
- F The inverse relationship between the price and quantity demanded holds along a fixed demand curve. But if the demand curve shifts rightward,
the equilibrium price rises and the equilibrium quantity increases.
- T The equilibrium quantity definitely increases when both the demand and supply increase.
- F The price rises if the shift in the demand curve is larger than that in the supply curve; but if the shifts are the same size, the price does not change and if the supply shift is larger, the price falls.
Multiple Choice Answers Markets and Prices
- b A product’s relative price tells how much of an- other good must be foregone to have another unit of the product, which is the opportunity cost of the product.
- c The relative price of the pizza is its money price relative to the money price of a taco, which equals ($12 per pizza)/($2 per taco) or 6 tacos per pizza.
Demand
- a The law of demand points out that a higher price decreases the quantity demanded and cre- ates a movement upward along the demand curve.
- b The definition of complementary goods is that a rise in the price of one decreases the demand for the other.
- c This is the definition of a “normal good.”
- c A reduction in the price of the product leads to a movement along its demand curve.
- b A rise in the price of a substitute shifts the de- mand curve rightward.
Supply
- a The law of supply points out the positive rela- tionship between the price of a product and the quantity supplied.
- c A change in preferences shifts the demand curve, not the supply curve.
- d Jet fuel is a resource used to produce airplane trips, so a rise in the price (cost) of this resource decreases the supply of airplane trips.
- c For any unit of output, the supply curve shows the minimum price for which a producer is willing to produce and sell that unit of output.
D E M A N D A N D S U P P L Y 5 5
- a An increase in supply is reflected by a rightward shift of the supply curve.
- c A change in the cost to produce a product shifts the supply curve but does not shift the demand curve.
- c An “increase in supply” means that the supply curve shifts rightward; a “decrease in supply” means the supply curve shifts leftward.
Market Equilibrium
- d At equilibrium, consumers and suppliers are simultaneously satisfied insofar as the quantity consumers are willing to buy matches the quan- tity producers are willing to sell.
- c A shortage occurs when the price is below the equilibrium price. The quantity demanded ex- ceeds the quantity supplied and the resulting shortage means the price rises until it reaches its equilibrium.
Multiple Choice Question 17
F I G U R E 3. 8
Price (dollars)
Quantity (units per hour)
0 1 2 3 4 5 6
2
4
6
8
10
S
D
- d There is surplus because, as illustrated in Figure 3.8, the quantity supplied at the price of $8 is 4. This quantity exceeds 2, the quantity demanded.
- a Buyers cannot find anyone willing to sell to at a lower price and sellers cannot find anyone will- ing to buy at a higher price.
Predicting Changes in Price and Quantity
- a The rise in the price of a pizza increases the de- mand for hamburgers, which results in a rise in
the price of a hamburger and an increase in the quantity of hamburgers.
- a The cold winter shifts the demand curve right- ward, as consumers increase their demand for antifreeze; the supply curve does not shift. As a result, the equilibrium price rises and the quan- tity increases.
Multiple Choice Question 21
F I G U R E 3. 9
Price (dollars per bushel of wheat)
Quantity (billions of bushels of wheat per year)
0 10 20 30 40 50 60
1
2
3
4
5
S
D (^1)
D (^2)
- a Figure 3.9 shows that an increase in the demand for wheat, so that the demand curve shifts from D 1 to D 2 , raises the price of wheat from $3 a bushel to $4 and increases its quantity from 30 billion bushels of wheat a year to 40 billion.
- c The technological improvement increases the supply, that is, the supply curve shifts rightward. As a result, the quantity increases and the price falls.
- b The decrease in the number of firms producing memory chips decreases the supply of memory chips, which raises the price and decreases the quantity of chips.
- d Paper is a resource used in the manufacture of books, so a rise in the price of paper shifts the supply curve of books leftward.
- a When people’s preferences change so that they want to read more books, the demand curve for books shifts rightward.
- d The equilibrium quantity increases if the in- crease in demand is larger than the decrease in
D E M A N D A N D S U P P L Y 5 7
Short Answer Problem 3
0
6 8 10 12 14
F I G U R E 3. 1 1
16 Quantity (millions of comic books per month)
Price (dollars per comic book)
S
D 1 D (^2)
c. The new demand curve is plotted in Figure 3. as D 2. The new equilibrium price is $4, and the new equilibrium quantity is 13 million.
Short Answer Problem 4
F I G U R E 3. 1 2
Price (thousands of dollars per new car)
Quantity (millions of new cars per year)
0 8 9 10 11 12 13
17
18
19
20
21
S
D (^1)
D (^2)
- Because new cars are a normal good, an increase in income increases the demand for them. Hence the demand curve shifts rightward, as shown in Figure 3.12. As a result, the equilibrium price rises (from $19,000 to $20,000 in the figure) and the equilib- rium quantity also increases (from 10 million a year to 11 million in the figure).
Short Answer Problem 5
F I G U R E 3. 1 3
Price (dollars per record)
Quantity (thousands of records per month)
0 10 20 30 40 50 60
2
4
6
8
10
S
D (^1)
D (^2)
- The fall in the price of a used compact disc, a sub- stitute for used records, decreases the demand for used records. This change means the demand curve for used records shifts leftward, as shown in Figure 3.13. As a result, the price of a used record falls, (from $8 a record to $6 in the figure) and the quantity decreases (from 40,000 per month to 30,000 in the figure). Note that it is the shift in the demand curve that changed the price and that the shift in the demand curve did not shift the supply curve.
- In order for both the equilibrium price and quantity of peanut butter to increase, the demand for peanut butter must have increased. The increase in demand leads to a rise in the price and an increase in the quantity of peanut butter. The observation that both the price rose and the quantity increased is not at all inconsistent with the law of demand. The law of demand states that “other things remaining the same, the higher the price of a good, the smaller is the quantity de- manded.” A key part of this law is the “other things remaining the same” clause. When the demand curve for peanut butter shifts rightward, something else that increased the demand for peanut butter changed. Hence “other things” have not remained the same and by changing have resulted in a higher price and increased quantity of peanut butter.
5 8 C H A P T E R 3
Short Answer Problem 7
F I G U R E 3. 1 4
Price (cents per gallon of gasoline)
Quantity (millions of gallons of gasoline a month)
D
S (^1) S (^2)
0 8 9 10 12 13
50
60
70
80
90
11
- Lower wages reduce the price of a resource (labor) used to produce gasoline. As a result, the supply of gasoline increases. This change is illustrated in Fig- ure 3.14, where the supply curve shifts rightward from S 1 to S 2. The increase in supply lowers the price of gasoline (from 80 cents a gallon to 70 cents in the figure) and increases the quantity (from 10 million gallons a month to 11 million).
Short Answer Problem 8
F I G U R E 3. 1 5
Price (cents per liter of benzene)
Quantity (millions of liters of benzene a month)
D
S (^1) S (^2)
0 8 9 10 12 13
50
60
70
80
90
11
- New technology increases the supply, so the supply curve shifts rightward. Then, as Figure 3.15 shows, the price falls (from 80 cents a liter to 70 cents in
the figure) and the equilibrium quantity increases from (10 million liters of benzene a month to 11 million). This answer and the figure are virtually the same as those in problem 7. Even though a fall in wages and the development of new technology appear dissimi- lar, the demand and supply model reveals that both have the same effect on the price and quantity of the product. This model can easily accommodate these quite different changes. For this reason the demand and supply model is a very important economic tool.
Short Answer Problem 9
F I G U R E 3. 1 6
Price (dollars per computer)
Quantity (thousands of computers per month)
D 1 D^2
S (^1)
S (^2)
500
1,
1,
2,
2,
0 8 9 10 11 12 13
- Personal computers have fallen in price although the demand for them has increased because the supply has increased even more rapidly. Figure 3.16 illus- trates this situation. From one year to the next the demand curve shifted from D 1 to D 2. But over the year the supply curve shifted from S 1 to S 2. Because the supply has increased more than the demand, the price of a personal computer fell (in the figure, from $1,500 for a personal computer to $1,000). The quantity increased (from 9,000 personal computers a month to 11,000 in the figure).
- a. With the change in people’s preferences — so that they want more chicken wings and hence more chickens — the demand for chickens in- creases. The increase in the demand for chickens means that the demand curve for chickens shifts rightward. Figure 3.17 (on the next page) shows this change. As it demonstrates, the equilibrium
6 0 C H A P T E R 3
shift. Because the supply shift is larger, the equi- librium quantity decreases to 250 million chick- ens. So unless you know which shift is larger, you cannot determine whether the quantity in- creases (when the demand shift is larger); de- creases (when the supply shift is larger); or stays the same (when both shifts are the same size). However, regardless of the relative sizes, Figures 3.19 and 3.20 show that the price will unambi- guously rise, coincidentally to $5 in both figures.
You’re the Teacher
- “The distinction between a ‘shift in a curve’ and a ‘movement along a curve’ is really crucial. Let’s think about the demand curve; once you understand the difference for the demand curve, understanding it for the supply curve is easier. Take movies, OK? A lot of things affect how many movies we see in a month: the ticket price, our income, and so on. Start with the price. Obviously, if the price of a movie ticket rises, we’ll buy fewer. The slope of a demand curve shows this effect. For the demand curve in Figure 3.21, when the price rises from $ to $6 for a movie, the movement is from point a on the demand curve to point b. Our quantity de- manded decreases from 5 movies a month to 4. So the rise in the price of the product has lead to a movement along the demand curve. The negative slope of the demand curve shows the negative effect that higher prices have on the quantity demanded. “Now, let’s suppose that our incomes fall and that as a result we’re going to go to fewer movies. The demand curve’s slope can’t show us this effect be- cause the slope indicates the relationship between the price and the quantity demanded. Instead, the whole demand curve is going to shift. That is, at any price we’ll buy fewer tickets. Look at Figure 3.22 for instance. If the price stays at $6 a movie, the quan- tity we demand decreases from 4 movies a month to 2. “But the same is true if the price is $5: If the price stays at $5 the quantity we demand decreases from 5 movies a month to only 3. Now, I don’t mean to say that the price has to stay at $6 or at $5. All I’m saying is that at any possible price, the number of movies we’ll see has decreased and I’m just using $ and $5 as examples. So we’re going to decrease the quantity demanded at $6 and at $5, and at every
You’re the Teacher Question 1
F I G U R E 3. 2 1
Price (dollars per movie)
Quantity (movies per month)
4 D
5
6
7
8
0 1 2 3 4 5 6
a
b
You’re the Teacher Question 1
F I G U R E 3. 2 2
Price (dollars per movie)
Quantity (movies per month)
D (^1) D (^2)
4
5
6
7
8
0 1 2 3 4 5 6
other possible price. That means that we can draw a new demand curve ( D 2 )to show how much we demand at every price after our incomes fall. So, the drop in income has shifted the demand curve from D 1 to D 2. And, that’s all there is to the difference between a ‘movement along the demand curve’ and a ‘shift in the demand curve.’ ”
- “You’re missing a key point about the demand and supply model. This model predicts what happens to relative prices, not money prices. You’re certainly right when you say that we don’t often see a money
D E M A N D A N D S U P P L Y 6 1
price fall. We live in inflationary times and most money prices usually rise. But when the demand and supply model says that the price falls, it means that the relative price falls. A good’s relative price can fall even though its money price rises. For in- stance, if the money price of some product rises by 2 percent when the money prices of all other goods are rising by 4 percent, the first product’s relative price has fallen. That is, its money price relative to
every other money price is lower. If you think about it, relative prices change all the time, and at least half the time relative prices fall. Drops in relative prices aren’t rare; they’re common. So, don't be too hasty to throw away the demand and supply model. Not only are we going to see it on tests in this class, but it also works well to help us understand what happens to a product’s (relative) price and quantity whenever there’s a change in a relevant factor.”
