Principles of Economics
Principles of Economics

Principles of Economics

Lead Author(s): Stephen Buckles

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Stephen Buckles, Principles of Economics, Only One Edition needed

Cengage

N. Gregory Mankiw, Principles of Economics, 8th Edition

Pearson

Case, Fair, Oster, Principles of Economics, 12th Edition

McGraw-Hill

McConnell, Brue, Flynn, Principles of Microeconomics, 7th Edition

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All-in-one Platform

Access to additional questions, test banks, and slides available within one platform

Pricing

Average price of textbook across most common format

Top Hat

Stephen Buckles, Principles of Economics, Only One Edition needed

Up to 40-60% more affordable

Lifetime access on any device

Cengage

N. Gregory Mankiw, Principles of Economics, 8th Edition

$130

Hardcover print text only

Pearson

Case, Fair, Oster, Principles of Economics, 12th Edition

$175

Hardcover print text only

McGraw-Hill

McConnell, Brue, Flynn, Principles of Microeconomics, 7th Edition

$140

Hardcover print text only

Always up-to-date content, constantly revised by community of professors

Constantly revised and updated by a community of professors with the latest content

Top Hat

Stephen Buckles, Principles of Economics, Only One Edition needed

Cengage

N. Gregory Mankiw, Principles of Economics, 8th Edition

Pearson

Case, Fair, Oster, Principles of Economics, 12th Edition

McGraw-Hill

McConnell, Brue, Flynn, Principles of Microeconomics, 7th Edition

In-book Interactivity

Includes embedded multi-media files and integrated software to enhance visual presentation of concepts directly in textbook

Top Hat

Stephen Buckles, Principles of Economics, Only One Edition needed

Cengage

N. Gregory Mankiw, Principles of Economics, 8th Edition

Pearson

Case, Fair, Oster, Principles of Economics, 12th Edition

McGraw-Hill

McConnell, Brue, Flynn, Principles of Microeconomics, 7th Edition

Customizable

Ability to revise, adjust and adapt content to meet needs of course and instructor

Top Hat

Stephen Buckles, Principles of Economics, Only One Edition needed

Cengage

N. Gregory Mankiw, Principles of Economics, 8th Edition

Pearson

Case, Fair, Oster, Principles of Economics, 12th Edition

McGraw-Hill

McConnell, Brue, Flynn, Principles of Microeconomics, 7th Edition

All-in-one Platform

Access to additional questions, test banks, and slides available within one platform

Top Hat

Stephen Buckles, Principles of Economics, Only One Edition needed

Cengage

N. Gregory Mankiw, Principles of Economics, 8th Edition

Pearson

Case, Fair, Oster, Principles of Economics, 12th Edition

McGraw-Hill

McConnell, Brue, Flynn, Principles of Microeconomics, 7th Edition

About this textbook

Lead Authors

Stephen Buckles, Ph.DVanderbilt University

Stephen Buckles is a Senior Lecturer at Vanderbilt University, where he also received his Ph.D. in Economics. Buckles has been the recipient of numerous awards, including Madison Sarratt Prize for Excellence in Undergraduate Teaching (Vanderbilt, 2008), Kenneth G. Elzinga Distinguished Teaching Award (Southern Economic Association, 2006), and the Dean’s Award for Excellence in Teaching (Vanderbilt, 2007). His course pack, which this text is based on, has been used by thousands of students and engages the concepts of active learning.

PJ Glandon, PhDKenyon College

PJ Glandon joined Kenyon College as an Associate Professor of Economics after completing his Ph.D. at Vanderbilt University.

Contributing Authors

Benjamin ComptonUniversity of Tennessee

Caleb StroupDavidson College

Chris CotterOberlin College

Cynthia BenelliUniversity of California

Daniel ZuchengoDenver University

Dave BrownPennsylvania State University

John SwintonGeorgia College

Michael MathesProvidence College

Li FengTexas State University

Mariane WanamakerUniversity of Tennessee

Rita MadarassySanta Clara University

Ralph SonenshineAmerican University

Zara LiaqatUniversity of Waterloo

Susan CarterUnited States Military Academy

Julie HeathUniversity of Cincinatti

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Chapter 4: Demand, Supply, and Markets

Figure 4.1​: A Croatian fresh food market. [1]

An effort to decrease pollution associated with cars in the U.S. led to more expensive bacon. Why would changing the formula of gasoline to include up to 10% ethanol make the cost of bacon increase?

By the end of this chapter, you should be able to explain why two seemingly unrelated goods could have an impact on each other’s prices. This is just one example of how we will use supply and demand to understand how markets and the interactions of millions of buyers and sellers establish prices and determine the amount of goods and services produced.

4.1 Chapter Objectives

After working through this chapter, you will be able to:

  • Explain the role of markets in determining prices.
  • Explain how prices determine what and how much we produce.
  • Use the concepts of supply and demand to predict the consequences of a number of possible events for market prices and quantities.
  • Detail the process of moving from one market equilibrium to another.

Many of the fruits, vegetables, and grain we eat in the U.S. come from Florida, California, and the Midwest. Other produce comes from the Caribbean and Mexico. Clothing we wear comes to shelves in our local clothing stores from all over the world. Automobiles are produced in Michigan, California, South Carolina, Tennessee, Germany, Japan, and many other places before being sent to dealers in your hometown. Who decides how many bananas to produce? Who decides where to ship the automobiles? Who decides how much to charge? The food you eat, the clothing you wear, the cars you drive, the buses and subways you ride, and the movies you watch are all produced by this marvelous economy that somehow convinces millions of businesses to produce what we want the most. Every day in our economy, businesses, large and small, make decisions about what to produce and what resources to use in the process. Markets then help determine who gets the resulting goods and services. Almost all of those decisions result from buyers and sellers coming together in markets.

A gathering of produce vendors selling vegetables to locals in an empty parking lot on a downtown street corner is a market. Specifically, it is a farmers’ market. The New York Stock Exchange is located in a classic, early 20th-century building on Wall Street, which serves as the physical location for an international market for stocks and bonds. A market also may be non-geographical – a website such as eBay, for example, brings together potential buyers and sellers from all over the world. Markets can be local, such as the neighborhood gym, or worldwide, such as the market for automobiles. In essence, a market is a collection of places, institutions, and means that allow individuals and businesses to buy and sell goods and services, labor, financial assets, and anything else that people want to exchange. We have labor markets and money markets, as well as markets for fish, vegetables, housing, automobiles, stocks, virtual currencies, criminal and medical services.

In this chapter, we will build an economic model of markets. We will begin by examining the behavior of buyers. We will then explore what influences businesses to produce goods and services. And finally, we will put the buyers and sellers together. The resulting economic model will help us see how prices and the quantities bought and sold are determined as well as how and why they change.

4.2 Demand: An Analysis of Buyers

Question 4.01

Question 4.01

When you buy songs online, many factors influence your decision. Make a list of the characteristics that might affect how many songs you, as a consumer, purchase in a typical month. If you do not purchase music, list the characteristics that determine how many books or magazines you buy or movies you attend.

Hover here to see the hint for Question 4.01. 
Click here to see the answer to Question 4.01. 

4.2.1 What Factors Determine Buyer Behavior?

You might have suggested a number of influences. The price of a song, your income, and how much you enjoy music are all possibilities. There can be a long list of factors that determine how many songs buyers will want to purchase over a specific period of time. In putting together a model that describes how buyers make decisions, we will look at each of those possible determinants. To make the model as easy as possible to understand and use, we will discuss one determinant at a time and make the simplifying assumption that all other possible determinants do not change. The formal term for this type of assumption is ceteris-paribus. Later in the chapter, we will examine markets in which several events occur simultaneously.

4.2.2 Price

Question 4.02

Question 4.02

If the price of individual songs online were to increase, how would your decision about how many songs to buy change? Do you buy more music? Do you buy less? Why?

Hover here to see the hint for Question 4.02.
Click here to see the answer to Question 4.02.

If the price changes and everything else stays the same, many consumers react to a price increase by reducing the quantity they buy. There are a number of potential reasons, but we will focus on one primary reason. As the price of a good increases, some of us look around for a similar good that will come close to serving the same purpose. Perhaps we look for a monthly streaming service such as Spotify. If we can find that substitute good, we may switch from the more expensive good to the now relatively less expensive good. Or we may simply decide to switch to seemingly unrelated goods. For example, instead of buying more music, we might decide to spend more on movies.

In this situation, as the price of a good increases and all other influencing factors stay the same, the quantities that buyers are willing and able to buy decreases. This is the law of demand. It also works in reverse. As the price of a good falls, some of us are likely to buy more of it.

What is the highest surge price you have experienced when looking for an Uber or Lyft ride? Most people have seen a surge price and decided not to purchase the ride. The price may be high enough that an individual decides to call a friend and wait half an hour for them to arrive. If the price of rides stays high enough for several weekends in a row, people may start to use the bus instead.

The primary reason for the behavior of consumers in response to price changes is that substitutes exist for many goods and services. When the price of a good increases, individuals substitute relatively less expensive goods. When the price of a good decreases, consumers substitute purchases of that good for purchases of the now relatively more expensive goods. This was shown in the analysis above.

A second reason that we react so consistently to price changes is due to our incomes. When the price of a good increases and our income does not change, we have to do less of something – either less consumption of the higher-priced good, less buying of another good, or less saving. That “doing less of something” often includes buying less of the good with the increased price. If a price decreases instead, we can afford to buy more of the good (and other goods). Substitution of goods and services in response to price changes is reinforced by changes in our abilities to afford those goods and services.

The law of demand is called a law because it works almost all of the time. If you can think of an exception, then you are probably wrong. The most likely error you are making is that you are not holding everything else constant. What about exceptions? Suggest some, but be careful.

Question 4.03

Question 4.03

Can you think of exceptions to the law of demand?

Hover here to see the hint for Question 4.03.
Click here to see the answer to Question 4.03.

A good that is an absolute necessity may be an exception. Prescribed medicine, particularly when paid for by insurance, may be an example. Drugs that help save the lives of people suffering from diabetes or cancer are unlikely to be curtailed as prices increase. Similarly, patients will be unlikely to use more of the drugs if prices fall. As prices increase or decrease, the amount people buy of these necessities does not change. In essence, there are no viable substitutes.

Luxury goods may seem to be an apparent exception. The high price of a luxury good is sometimes interpreted as indicative of the high quality of the good. An example might be higher-priced cars. An expensive car may be thought to be better than a cheaper car. Given this assumption, a price increase may actually make a car more attractive to buyers. Similarly, you might buy a $300 stereo system as opposed to a $250 one sitting right next to it, because you think the sound system must be superior. However, these examples are not actual violations of the law of demand. Something else is changing along with the prices, so everything else is not truly held constant. The higher-priced car and the higher-priced stereo system are perceived as being of higher quality. The higher quality, not the higher price, is causing buyers to want to buy more.

4.2.3 Preferences

Tastes and preferences change over time, and those changes affect the kinds and quantities of goods that consumers want to buy. For example, as more people began to like hip-hop music, more people purchased hip-hop music. If many consumers like a specific good or service, there will be many buyers. If tastes change so that buyers like a particular good less and everything else related to buying that good stays the same, there will be fewer buyers. A decade ago, a popular band may have sold millions of copies of a single – but if tastes have changed, hardly anyone may want to purchase their new songs.

Question 4.04

Question 4.04

Can you think of a recent example of how changing tastes affected demand?

Hover here to see the hint for Question 4.04.
Click here to see the answer to Question 4.04.

There are countless examples that you might see every day and not even think about. Look at the automobiles on the street today and you will see many more sports utility vehicles than could be seen even a few years ago. This may seem like a strange trend because they are expensive to maintain and do not have the best gas mileage. However, sports utility vehicles are very fashionable. Tastes have changed. Consumers want to buy more of them.

4.2.4 Income

As consumers’ incomes increase and all other influencing factors do not change, many will buy more of most goods. Individuals with greater incomes tend to take more vacations, buy more and better cars, and rent larger apartments than consumers with lower incomes.

However, an increase in income might reduce how much individuals want to buy of some other goods. Can you think of a good that someone might buy less of if his or her income increases?

Question 4.05

Question 4.05

Can you think of a good that someone might buy less of if his or her income increases?

Hover here to see the hint for Question 4.05.
Click here to see the answer to Question 4.05.

Some consumers whose incomes are increasing might start eating fewer hamburgers and more lobster. Others whose incomes are rising may buy fewer used cars and be more likely to buy new cars. The vast majority of goods and services are such that more are purchased as consumers’ income rise. Those goods, the lobsters and new cars of the world, are called normal goods (if lobsters can be described as normal). In the examples above, hamburgers and used cars are known as inferior goods. Other types of inferior goods include ramen noodles, bus rides, and SPAM. Inferior goods are characterized by this process: as income increases, demand for the good decreases because consumers would rather consume other goods. These goods are perceived by some consumers as inferior to other possible choices, and if incomes increase, consumers will turn to those alternatives. This categorization is relative, however. A person who has been eating only macaroni and cheese may switch to hamburgers as a result of an increase in income. For that person, hamburgers are normal goods.

Question 4.06

Question 4.06

Sometimes changes in income will not increase or decrease the quantity of a good or service purchased. Can you think of an example?

Hover here to see the hint for Question 4.06.
Click here to see the answer to Question 4.06.

Consumption of necessities that add up to a small percentage of most people’s incomes is not normally influenced by income changes. Salt and toilet paper are inexpensive for most of us, and we will not buy more (or less) as income increases. The reasoning behind this logic is that a good that a consumer really needs before a change of income will still be a necessity after a change in income. Therefore, an increase in income will not necessarily change the amount of the good the consumer wants to purchase.

Another more serious example is a patient who needs a heart transplant. He will need it regardless of his income. If the transplant is paid for by insurance, the level of income will not affect whether or not a patient demands a heart transplant. Without insurance, demand may be affected by large changes in income.

Most goods and services are normal; fewer are inferior goods, and fewer still are relatively independent of income.

4.2.5 Prices of Related Goods

In some cases, changes in the prices of related goods can affect how much consumers want to buy. Think about the market for sweaters. An increase in the prices of wool sweaters may make people more likely to buy cotton sweaters. An increase in the price of wool sweaters causes an increase in the demand for cotton sweaters. If this relationship between the price of one good and the purchases of another good exists, the goods are substitute goods. It works in the opposite direction as well. In our example, if the prices of wool sweaters were to fall, some people would switch their consumption away from cotton sweaters. Can you think of other examples of substitute goods?

If the price of oranges remains the same, but the price of nectarines decreases, one person may buy fewer oranges. As the price of nectarines decreases, you may substitute nectarines for oranges. If the price of a Toyota Camry increases, you can be sure that some consumers will shift over to similar cars made by Ford, Honda, or other manufacturers. Purchases of substitute automobiles rise. But if the price of a Jaguar convertible increases, very few consumers would switch to Chevy trucks. Perhaps Jaguars and Chevy trucks are not substitute goods for most people.

Complementary goods are goods that are often used together. Coffee and cream, tennis rackets and tennis balls, bicycles and bicycle helmets, smartphones and earbuds, and gasoline and automobiles are examples.

Now try to think of how a change in price of one of the goods, such as tennis balls, might affect purchases for its complement, tennis rackets. Why does that relationship exist?

Question 4.07

How will an increase in the price of DVDs affect the demand for DVD players? Why?

A

Quantity demanded of DVD players increases

B

Demand for DVD players increases

C

Quantity demanded of DVD players decreases

D

Demand for DVD players decreases

As the price of DVDs increases, the cost of enjoying DVDs increases. Consumers might consider alternatives, such as using personal computers or downloading music. Thus, the purchases of DVD players will decrease. If the price of bicycles falls, consumers will buy more bicycles. Because many people consider bicycles and bicycle helmets as necessary to use together, purchases of bicycle helmets should rise.

4.2.6 Expectations

Expectations of future changes also affect the quantities of goods and services consumers will want to buy today. If consumers expect prices to be higher in the future and all other influencing factors are the same, demand for a good will increase.

Question 4.08

What will happen to current purchases if people expect lower prices in the future? What will happen with expectations of higher incomes?

A

Demand increases; demand increases

B

Demand decreases; demand increases

C

Demand increases; demand decreases

D

Demand decreases; demand decreases

If you expect higher prices in the future, current buying will increase, as people who plan on buying the good at some time in the future will buy now to avoid paying higher prices later. In some markets, people may buy now in order to make a profit by selling the good at a higher price later on.

If you expect to receive a higher income in the near future, then your current spending may increase. For example, if you expect to receive a job offer in the fall, you may rent a larger apartment in the summer than if you did not expect to have a job in the fall.

4.2.6.1 Potential Number of Buyers

An increase in the number of potential buyers, holding all other influencing factors the same, means there are more consumers wanting to buy products. An increase in the number of potential buyers can be viewed in much the same manner as an increase in income for normal goods. On the other hand, a smaller number of potential buyers will consume fewer goods. Thus, demand increases as the number of potential buyers grows and decreases as the number of potential buyers shrinks.

Question 4.09

Question 4.09

What are the key influences on buyers’ decision-making? Summarize the demand discussion in your own words.

Hover here to see the hint for Question 4.09.
Click here to see the answer to Question 4.09.

4.3 How do you Construct Demand Schedules and Curves?

An economic model of demand simplifies the buyers’ side of an actual market by making the assumption that only one determinant of buyers’ behavior will change at a time. We have discussed a number of possible influences on consumer decisions. Now we will focus on the relationship between the price of a good and how much consumers want to purchase, with all other determinants remaining unchanged. That relationship between prices and the amounts consumers want to purchase can be shown in tables and on two-dimensional graphs. This process will let us summarize a great deal of data and better understand markets.

4.3.1 Examine Changes in Quantities Demanded 

Assume that tastes, income, prices of related goods, expectations, and the number of potential buyers do not change. The law of demand tells us that if all of these potential influences remain the same, an increase in price will cause a decrease in the quantity demanded (and vice-versa). That relationship is often described as an inverse relation between price and the quantity demanded. Our model highlights the prices of goods and services because they are so central to the functioning of markets. One of the challenges of understanding and using this economic model is in learning the very specific language that economists use in describing what is happening in a market. The quantity demanded is the quantity of a good or service that consumers are willing and able to purchase during a given time period at a certain price.

Table 4.1: An individual's demand schedule for oranges.​

Consider a market for oranges. An example set of data appears in Table 4.1. If you really like oranges and the price is 50 cents, you might buy about five per week. If prices were a lot lower, you would probably buy more oranges – that is, substitute oranges for other kinds of fruit. At a price of 10¢ per orange, you might buy as many as eight per week. At a price of $1 each, you would reconsider. Now, you may switch to other fruit and perhaps buy as few as four oranges each week. If prices were to increase to even higher amounts, the law of demand tells us that you would be likely to reduce your consumption even further.

We will refer to this table, showing prices and the corresponding quantities demanded, as demand. It is the listing of quantities demanded that will exist in the market at each price. Demand is the quantity of a good that buyers will buy at each price, assuming that everything else remains constant. Demand is the entire table, the entire schedule – in other words, it includes all of the quantities demanded at each price.

These same data are shown in a graphical form in Figure 4.2. (If using graphs in this manner is new to you or you need a review, make sure you have read the appendix to Chapter 2: An Economic Model) We can draw the relationship between prices and quantities demanded and create a demand curve. We will refer to the demand curve as demand. It is the same as a demand schedule in that it shows the quantities demanded at each price. It simply shows this information on a graph instead of in a table.

With prices plotted along the vertical axis and the quantities demanded at each price along the horizontal axis, the demand curve will look like the line drawn in Figure 4.2. Points A, B, C, D, and E correspond to the prices and quantities demanded in the demand schedule shown in Table 4.1. Lines are drawn between each of the points on the assumption that if the price of oranges were between two of the listed prices, the quantity demanded would be between the two quantities demanded.

Figure 4.2: A demand curve for oranges.​

The demand curve and the demand schedule both represent demand. The demand curve and the data in the schedule also both reflect the law of demand. As price falls, the quantity demanded increases. For example, as price falls from $3.00 to $2.00 (point A to point B in Figure 4.2), the quantity demanded increases from one orange per week to two oranges per week. We describe that change as a movement along the demand curve or a change in the quantity demanded. This particular example also means that the graphical interpretation of the law of demand is a demand curve that is downward sloping, as we go from left to right.

Table 4.2: An individual’s demand schedule for oranges – after an announcement about the health benefits of oranges.​

Consider that demand may actually shift. A change in one of the determinants (other than price) of how much consumers want to buy will change the entire demand relationship. If your preferences for oranges change due to medical studies reminding you about the health benefits of Vitamin C, you might buy more at each price. This is an increase in demand, or a shift in the demand curve.

The medical study that described the benefits of oranges reflects a change in tastes and preferences. At each price level, you will choose to consume more oranges. When price alone changed, the result was described as a change in the quantity demanded and a movement along a demand curve. Your demand for oranges, given your refreshed knowledge about the health benefits of oranges, might now look something like the data shown in the third column of Table 4.2. The quantities demanded at each price are now greater than the original quantities demanded at the same prices. 

Graphing Question 4.01

Draw these new data on the graph below, which shows the initial demand curve.

You should have a new demand curve that has shifted to the right and looks like Figure 4.3. An increase in demand is represented on a graph as a shift of the demand curve to the right. The quantities demanded at each price are now greater than before the increase in demand.

Figure 4.3: An increase in demand following a favorable health announcement.​
Table 4.3: An individual’s demand schedule for oranges – after the fall in tangerine prices.​

Demand could shift in the opposite direction. Think back to the discussion of prices of substitute goods. For instance, if the price of tangerines were to fall dramatically, the demand for oranges would decrease. This means that at each price level for oranges, the quantity demanded of oranges would decrease, as suggested.

Graphing Question 4.02

Draw these points and the new curve on the graph below.

Your new demand curve should look like Figure 4.4; it shifts to the left to show a decrease in demand.

Figure 4.4: A decrease in demand for oranges.​

4.3.2 Remember How the Changes Work

A change in any of the factors influencing how much consumers want to buy, other than the price of the good itself, will cause a change in the quantities consumers are willing and able to purchase at each price. The shifts are caused by changes in income, tastes (in the previous example, this is represented by perceived health benefits), the number of potential buyers, expectations, and prices of substitute and complementary goods. A change in price alone is shown by movement along a specific demand curve, and in that case, demand itself does not change.

Do not be casual about the use of the terms “quantity demanded” and “demand.” The most common difficulty for those new to market models is confusion between quantity demanded and demand. Demand is not the same as quantity demanded. The quantity demanded is how much buyers are willing and able to buy at each specific price. Demand is the whole table, the whole schedule, and the whole curve. It is a list of prices and the quantities demanded at each individual price. A change in price does not change demand. It changes the quantity demanded. It is represented as a movement along a single demand curve. Do not use the two concepts interchangeably.

When we first considered demand, we discussed one person’s demand for oranges (Table 4.1). 

Question 4.10

What would the demand in the entire market be if there were 1000 individuals, each with demand schedules identical to that depicted in Table 4.1? Fill in the schedule for the market.

question description
Premise
Response
1

A

A

2000

2

B

B

4000

3

C

C

8000

4

D

D

1000

5

E

E

5000

Graphing Question 4.03

The new market demand schedule should be like the one shown in Table 4.4 below and drawn as a curve in Figure 4.5. The new schedule and the curve are derived by adding all of the individual quantities demanded at each price. In this case, because all the individuals’ demands are identical, the quantities demanded at each price are multiplied by 1,000.

Table 4.4: A demand schedule for a market with 1000 buyers.​​


Figure 4.5: A market demand curve for oranges.​

4.4 Section Review Questions

Graphing Question 4.04

Question 4.11

"Some people predict, however, that the prices of chocolate will increase drastically in about three years because of some unhealthy crops." Given this expectation for the future, what will happen to the demand for chocolate now? What will the demand do?

A

Decrease as people switch to substitute goods

B

Increase as consumers buy more now to avoid higher prices later

C

Decrease; when prices increase, demand decreases

D

Stay the same as consumers plan to adjust to the prices in the future

Question 4.12

Consider the markets for ball-point pens and the market for "rollerball" pens. Suppose that, due to an increased cost of the metal that is used in "rollerball" pens, the prices of "rollerball" pens and ball-point pens increase. There are no other changes. This is true because the two products have a unique relationship. What is the likely relationship between "rollerball" pens and ball-point pens? What are they?

A

Complementary goods

B

Substitute goods

C

Normal goods

D

Inferior goods

Question 4.13

Consider the markets for ball-point pens and "rollerball" pens. Suppose that, due to an increased cost of the metal that is used in "rollerball" pens, the prices of "rollerball" pens increase. There are no other changes. What would happen to the demand schedules of both products? The demand curve for ball-point pens would ______________ ; the demand curve for "rollerball" pens would ______________.

A

Increase; not change

B

Increase; increase

C

Decrease; not change

D

Decrease; increase

E

Not change; decrease

Question 4.14

A decrease in income will cause which of the following to happen to the demand for used cars? Assume used cars are inferior goods.

A

The demand for used cars will increase.

B

The demand for used cars will decrease.

C

The quantity demanded for used cars will increase.

D

The quantity demanded for used cars will decrease.

Question 4.15

An increase in the number of potential buyers will most likely cause which of the following?

A

An increase in demand

B

A decrease in demand

C

An increase in the quantity demanded

D

A decrease in the quantity demanded

4.5 Supply: An Analysis of Sellers and Producers

Buyers are only one half of a market. The other, equally important part of any market is made up of the producers and sellers of goods and services – the supply side of the market. To begin our thinking about supply, let’s envision a scenario. What do you think people in your class or dorm or a group of your friends would do if you offered to buy every used smartphone they would bring to you? Say at a price of $20 each? At $50 each? At $100? At $200?

Question 4.16

Question 4.16

Predict what would happen if you offered to purchase used smartphones from your fellow students for $20, $50, $100, or even $200.

Hover here to see the hint for Question 4.16.
Click here to see the answer to Question 4.16.

The suppliers of used smartphones (your classmates, dorm residents, or friends) would likely bring a few smartphones at a price of $20, more at $50, even more at $100, and the most at $200. That relationship between price and the amount of suppliers (in this case, your friends) bring to the market is the fundamental characteristic of the supply side of the market. Let’s look at why.

Most businesses are started and continue to grow due to owners’ and managers’ efforts to earn profits – the difference between revenues from selling goods and the costs of producing those goods. Anything that changes revenues or costs will affect incentives and thereby be likely to influence how much a business produces. A change that increases revenues (a higher price, perhaps) or decreases costs (less costly raw materials) will result in increased production. If revenues decline or costs increase, production will decrease. In our analysis of producers, we will focus on prices a business can receive for its products, the prices of resources used in producing its goods along with other costs, and the available technology or the methods a business uses to produce goods.

4.5.1 What Determines Production?

In thinking about business decision-making, we will proceed in a manner much like we did in the discussion of buyers and demand. We will explore how changes in each determinant will change output and when we assume that all of the other factors remain the same. Then we will put all of the factors together into a model of supply – one that parallels our model of demand.

4.5.1.1 Price

If the price of a good or service being produced increases, businesses will normally respond by increasing output of that good or service. Production will decrease if the price of the good decreases. Remember, we are assuming that no other possible influences change at the same time.

Higher prices provide incentives for producers to switch from production of one good to another. A car manufacturer, for example, may have the capability to produce convertibles or trucks, among other possibilities. An increase in the price of trucks will increase the incentive to produce trucks and reduce the incentive to produce convertibles and other automobiles. A decrease in prices will work in exactly the opposite fashion. A decrease in truck prices will decrease the incentives to produce trucks and result in a reduction in the output of trucks.

The same concept works with the supply of labor and most other resources. Why are some recent college graduates convinced that they should enter software development, business, or law instead of teaching at elementary and secondary schools? The higher salaries, that is, the higher prices for labor, in those professions attract more college graduates. In essence, more software designers, business students, and pre-law majors are produced, and fewer teachers are produced.

A second reason that prices and production change in the same direction is based on the concept of increasing costs that we discussed in Chapter 1: Introduction to Economic Analysis. As production increases, eventually the cost of producing additional output will increase. Most resources are best suited to specific uses. Dry, hot land can produce a lot of wheat. Wet, rich soil is effective to grow corn. Rice grows best in extremely wet conditions. Wheat farmers will use the dry land first. As wheat production is expanded, wetter soil will eventually have to be used. And that soil will not produce as much wheat. The cost of the additional production will eventually begin to increase. In order to pay the higher costs associated with the increased production and thereby convince farmers to grow more wheat, prices will have to increase.

The same is true when we think of work decisions made by individuals. Individuals who enjoy using their quantitative skills make good engineers and computer programmers. Others with superior writing and speaking skills often make good lawyers. An accountant is better at manipulating and analyzing numbers than the typical carpenter. The average carpenter is better at building houses than the accountant. If we try to expand the production of accounting services and we do so by hiring carpenters as accountants, they will not be as productive as people who have the skills necessary to be accountants. Or to make the carpenters productive, they may have to be trained. In either case, costs of producing accounting services will likely increase as more individuals are hired. Therefore, in order to get more accounting services and pay the higher costs, prices may have to rise. Again, we find that higher prices are necessary to attract more output.

Question 4.17

Question 4.17

In your own words, explain how and why changes in prices cause the amounts supplied by producers to change.

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The key to understanding supply is to think about why businesses are producing goods. The most common reason is to earn a profit. If prices increase, a business can earn more profit by switching from other lines of business to producing more of the good with the now higher price. Thus, the amount of the good produced increases. On the other hand, if the price falls, the typical firm will have less of an incentive to produce the good, and will likely cut back production.

4.5.1.2 Prices of Inputs

All goods and services sold in the marketplace are produced in processes that use labor, land, and capital resources (buildings, machines, computers, and other tools). The prices of these inputs include wages, prices of raw materials and supplies, rent, and utilities. Even taxes and tariffs are a part of the cost of producing goods and services. An increase in the prices of any of the inputs will lead to a decrease in profits. Thus, there is a decrease in the incentives to produce and as a result a decrease in production. On the other hand, a decrease in the price of any of the inputs will increase profits, increase the incentives to produce, and result in more of the good being brought to the market, ceteris-paribus (holding any changes to other variables constant). It should be noted that sellers (retailers) do not physically produce goods; rather, they bring to market goods that are produced by other firms. If there is an increase in the price of inputs that makes it more expensive to produce goods, it becomes more expensive for sellers to buy those goods and bring them to market.

Falling prices of microprocessors, for example, have meant increased profits and incentives to produce many new products that use microprocessors. The result is an increase in production of those goods.

4.5.1.3 Technology 

If new ways of producing goods are created so that fewer resources are used to produce the same output, the effect is similar to a decrease in the price of an input. Profits will increase, and businesses will be willing to expand production. Creation of new software has enabled many manufacturers to reduce the number of workers needed to manage supplies and to respond to orders. This, in turn, has reduced the resources necessary to produce goods and resulted in increased profits and increased incentives to expand production.

Question 4.18

How does an decrease in input costs affect suppliers?

A

Demand increases

B

Demand decreases

C

Supply increases

D

Supply decreases

4.5.1.4 Other Possible Factors

What about expectations? If producers expect prices to increase in the future, the amount of the good produced or brought to market in the present may decrease. For example, an oil company may withhold production from the market now in anticipation of higher prices next month. The reverse is true as well. The owner of bonds or stocks may offer more for sale now if she expects prices to fall in the near future. Expectations of future prices and incomes are another determinant.

Current prices of related goods can also affect supply of a good. In our discussion of the relationship between the amount produced and prices of the good, we looked at the prices of trucks. We said that as truck prices increase, automobile manufacturers would shift from producing convertibles to producing trucks. So, an increase in truck prices may cause a decrease in the production of convertibles. An increase in price of one good that a manufacturer can produce may reduce the production of other goods that the manufacturer could produce. In the case of a decrease in the price of one good, the manufacturer may increase the production of the alternative good.

The number of firms or sellers in the market is another determinant. If the number of firms or sellers in an industry increases, the amount of production or goods provided to a market will increase. If some firms leave the industry, the amount produced or brought to market will decrease. The effect is really a simple one. Think of the existing firms as continuing to produce or bring to market the same number of goods. New firms will add to total production in the market, and fewer firms will mean less production in the market. Every time a new coffee shop opens in town, total production of coffee increases. If coffee shops close, fewer total cups of coffee are produced.

A number of other events can change abilities or willingness to produce. Extraordinarily good or bad weather affects the production of agricultural products. Legislation can affect costs – for example, consider requirements that businesses change production techniques to reduce pollution in a manner that increases costs. Costs will rise, incentives to produce or bring goods to market will fall, and production or the number of goods sellers bring to market will be reduced.

Similarly, an increase in the price of corn will increase incentives to produce corn, and some farmers will switch land use from soybeans to corn. This will mean a greater production of corn and indirectly cause a decrease in the production of soybeans.

The expectation of higher future prices may cause a farmer to withhold production from the current market (if that can be done) in order to increase the sale of goods in the future. Thus the future supply to the market will increase, but the current amount of the product available on the market will decrease.

Question 4.19

Question 4.19

Suppose a farmer has a choice between planting soybeans and planting corn. If the price of corn increases, what will happen to the eventual production of soybeans and corn? Why?

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Question 4.20

Question 4.20

Assume that homeowners can sell their house whenever they want and they don’t have to worry about finding a new job. How will a homeowner’s decision to sell their home change if they expect housing prices to increase? What will happen to the number of houses in the market?

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4.6 How do You Construct Supply Schedules and Curves?

In our discussion of demand, we created an economic model of buyers’ behavior by assuming that a single influencing factor (price) would change and that all other potential influences (preferences, incomes, prices of related goods, expectations, and the number of potential buyers) would stay the same. We will do the same with producers’ decisions.

Account for changes in quantities supplied. We begin by considering how changes in the price of a good affect the quantity supplied of a good when all other possible determinants do not change. The quantity supplied is the quantity of a good or service that a producer will produce or bring to market at a specific price during a given period of time. It is a parallel concept to quantity demanded. This table shows a hypothetical example of the number of oranges a producer might bring to a market at each price level. The table shows that as prices of oranges increase, the quantities supplied increase. It also shows the reverse. As prices decline, a producer will reduce the quantity supplied. Can you explain why?​

Table 4.5: Supply schedule for oranges.​

Question 4.21

Question 4.21

Why does the quantity supplied decrease as prices fall?

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4.6.1 Understand Supply 

As we did with demand, we will use the term supply to mean the entire list of quantities that will be supplied at each price. That list is often called a supply schedule. It is simply a table listing a variety of prices and the quantities that will be supplied at each of those prices. A single supply schedule or table, such as the one shown in Table 4.5, shows the relationship between the market price and how much a producer is willing to produce or bring to market at each price assuming that everything else stays the same. Prices of resources, other costs, and the technology of producing do not change for a given supply.

The table summarizing the prices and how much businesses will produce or bring to market is also labeled simply as supply. When we put the same data on a graph, we describe the line as a supply curve, or again, simply supply. 

Assume that each potential supplier of oranges has the supply schedule shown in Table 4.5.

Graphing Question 4.05

The supply curve you draw should look like the one shown in Figure 4.6. The combinations of prices and quantities supplied are plotted first. Then the points are connected under the assumption that prices between those shown in the table will be associated with quantities supplied that are also between those shown in the table. The supply curve shows that as price increases, the quantities supplied by the producer increase. A change in price causes a movement along the supply curve. For example, in Figure 4.6, a movement from point A to point B is a result of a change in price.

Figure 4.6: Market demand curve for oranges.​
Question 4.22

What if another business of the same size as the first entered the market? Construct the new supply schedule for the market for oranges by matching the price to the quantity supplied per week.

Premise
Response
1

10¢

A

400

2

50¢

B

2¸400

3

$1.00

C

3¸000

4

$2.00

D

1¸000

5

$3.00

E

1¸600

The first supply schedule shows the following quantities supplied at each of the prices: 10 cents, 200 oranges; 50 cents, 500 oranges; $1.00, 800 oranges; $2.00, 1,200 oranges; and $3.00, 1,500 oranges. The market supply schedule with two firms is found by adding the quantities supplied by each of the two firms. Thus, the market quantities supplied should be 400, 1,000, 1,600, 2,400 and 3,000 oranges, respectively.

Graphing Question 4.06

4.6.2 Notice Shifts in Supply Curves

Changes in prices alone, with every other possible influencing factor staying the same, cause a movement along the supply curve, that is, a change in the quantity supplied. If any one of those other determinants changes, the entire relationship changes. There is a change in supply, and there will be a shift of the supply curve. For example, if an innovation in the orange industry made it possible to grow oranges in colder climates, the market for oranges would change. At each price, more oranges would be offered for sale in the market. Figure 4.7 shows the supply curve shifting to the right, representing an increase in supply.​

Figure 4.7: An increase in the supply of oranges.​



​Graphing Question 4.07

This change would cause a shift to the left of the supply curve - a decrease in supply - and would look like the new supply curve in Figure 4.8.

Figure 4.8: The effect of a hurricane on the supply of oranges.​



Question 4.23

Question 4.23

What are the key determinants of supply? Summarize in your own words how changes in each affect supply and quantity supplied.

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What can you conclude about changing demand and supply?

Question 4.24

Which of the following does not cause a change in demand?

A

Tastes and preferences

B

Income

C

Prices of related goods – substitutes and complements

D

Price of the good

E

The number of potential buyers

Question 4.25

Match the economic change to its associated effect on demand, supply, quantity demanded, or quantity supplied.

Premise
Response
1

Change in technology

A

Supply changes

2

Price of the good sold by a firm

B

Demand and supply change

3

Number of sellers

C

Demand changes

4

Tastes and preferences

D

Quantity supplied changes

5

Price of related goods

E

Supply changes

4.7 Section Review Questions

Graphing Question 4.08


Question 4.26

Indicate which of the following will cause a movement along a supply curve. Which will shift the supply curve to the left? Which will shift the supply curve to the right? Will supply increase or decrease?

Premise
Response
1

A decrease in the price of an input¸ such as wages for labor

A

Shift the supply curve to the left; a decrease in supply

2

A decrease in the price of another good that firms in the industry could produce

B

Shift the supply curve to the left; a decrease in supply

3

A decrease in the price of the good itself

C

Shift the supply curve to the right; an increase in supply

4

A tax on the land used by the producer

D

A movement along a supply curve; no change in supply

5

Expectations of rising prices of the good in the near future

E

Shift the supply curve to the right; an increase in supply

Question 4.27

An increase in the cost of an input will cause which of the following?

A

An increase in supply and a shift to the right of the supply curve

B

An increase in supply and a shift to the left of the supply curve

C

A decrease in supply and a shift to the right of the supply curve

D

A decrease in supply and a shift to the left of the supply curve

Question 4.28

Expectations of lower prices in the near future may cause some producers to do what?

A

Increase the quantity supplied of the good now

B

Increase the supply of the good now

C

Decrease the supply of the good now

D

Decrease the quantity supplied of the good now

Question 4.29

Six months ago, the cost of an important input in an industry increased. Then, three months later another change occurred. Production engineers invented a new method that uses fewer raw materials for the same level of production. If these were the only two events that influenced production in the last six months, what has been the influence on the supply?

A

Six months ago the supply curve shifted to the left, and then three months ago the quantity supplied at each price fell.

B

The first event caused production to decrease and supply to drop, but the second event increased supply above what it had been originally.

C

The influences of both events had equal effects on the supply, only one was negative and the other positive so that they perfectly balanced out.

D

The event of six months ago caused added costs to production and then lowered supply. The event of three months ago allowed more to be produced at each price, so the supply increased. Overall, the shift in supply is uncertain.

Question 4.30

Consider the market for peaches. Suppose that the conditions for growing peaches in the southeast become unfavorable, and many of the southeastern peach farmers decide to leave the industry and look for other jobs. With this migration of farmers, what will happen to the supply of peaches from the southeast?

A

Increase

B

Decrease

C

Not change

Question 4.31

Using the information provided in the previous question, in which direction will the demand curve for peaches shift? The information is repeated for you below:

Consider the market for peaches. Suppose that the conditions for growing peaches in the southeast become unfavorable, and many of the southeastern peach farmers decide to leave the industry and look for other jobs.

A

Left

B

Right

C

Not change

Question 4.32

Consider an increase in the number of potential buyers. Select whether this change will affect either the supply or demand of apples and whether this change will cause it to increase, decrease or not change.

A

Supply

B

Demand

C

Increase

D

Decrease

E

Neither

F

Cannot tell

Question 4.33

Consider a decrease in the cost of land used in apple orchards. Select whether this change will affect either the supply of apples or the demand for apples and whether this change will cause it to increase, decrease or not change.

A

Supply

B

Demand

C

Increase

D

Decrease

E

Neither

F

Cannot tell

4.8 Supply and Demand Together in a Market 

​A famous economist, Alfred Marshall, once described supply and demand as the two halves of a pair of scissors. By themselves, the halves are not very useful, and one could never really determine which half does the cutting. But when they are combined, we have a powerful tool to cut paper. And when we combine the concepts of supply and demand, we have a powerful tool to analyze markets. Just as the combination of two scissor blades cuts a piece of paper, supply and demand together determine market outcomes.

4.8.1 Changes in Market Prices

The final step in building our model of markets is to put supply and demand together into an economic model of a market. We should then be able to understand just how prices and the amounts of goods and services exchanged in markets are determined and be able to use the model to explain the effects of a series of changes in a market.

Our demand schedule and our supply schedule for oranges are shown in Table 4.6.

Table 4.6: The market supply and demand schedules for oranges.​

If the price in the market were 10 cents per orange, what would be the quantity supplied and the quantity demanded? Again, compare the two numbers and predict what might happen.

Question 4.34

What is the quantity supplied?

Question 4.35

What is the quantity demanded?

Question 4.36

Question 4.36

Compare the two numbers. Can you predict what will happen?

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4.8.1.1 How Does a Shortage Cause Prices to Increase? 

There will be a shortage of 6,000 oranges at a price of $0.10. A shortage simply means that buyers want to buy more (8,000) than sellers want to sell (2,000). Some buyers who cannot get oranges at a price of 10 cents may offer to pay more. The demand schedule tells us that at a price of $0.50 apiece, buyers wish to purchase 5,000 oranges. Some sellers, seeing an opportunity to increase profits, will raise their prices. Thus, because of the shortage, there will be upward pressure on prices.

Think of a sold-out concert or a world-championship sporting event. If there is a shortage of tickets, scalpers may raise the price and, some buyers may even advertise that they are willing to pay a higher price. When auto parts maker Takata announced a recall on 28 million airbags, individuals were asked not to use their cars. This caused a large shortage of rental cars available in the market and led to dealerships paying more for rental cars to provide to their customers.

As the market price increases, two things happen simultaneously. The quantity demanded will begin to decrease as some buyers turn to substitute goods or find they can no longer afford to buy as much of a product as they did before. The quantity supplied will begin to increase as suppliers see the increased incentives and realize they can pay the higher costs of producing. But if there is still a shortage, the price of a good will continue to increase (and as a result quantity demanded decreases and quantity supplied increases) until the quantity supplied is equal to the quantity demanded. At that point, there will no longer be any reason for prices to rise. In the example in Table 4.6, the price goes from 10 cents to 50 cents per orange. The quantity supplied increases from 2,000 to 5,000 oranges, and the quantity demanded decreases from 8,000 to 5,000. The process stops when the quantity supplied equals the quantity demanded at a quantity of 5,000 oranges.

At a price of $3.00, compare the quantity demanded with the quantity supplied. What is the difference? What do you think might happen in a market if this were the case? Go ahead. See if you can explain the process of adjustment.

Question 4.37

Question 4.37

If the price of oranges were $3.00, what would happen in the market depicted in Table 4.6? Explain the process.

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4.8.1.2 How Does a Surplus Cause Prices to Decrease? 

At a price of $3.00 per orange, the quantity supplied is 15,000 and the quantity demanded is 1,000 oranges. We define this difference as a surplus. A surplus means that sellers are producing more than buyers are willing to buy at the going market price. Since sellers cannot sell all they would like at the market price, some will likely offer to lower the price (perhaps run a sale) to get rid of the excess production. Some aggressive buyers might offer less, seeing that sellers are producing too much. As the price begins to come down, say to $2.00, two things happen simultaneously. First, the quantity demanded increases (from 1,000 to 2,000, for example) as buyers switch from substitute goods and can more easily afford the now less expensive oranges. Second, businesses begin to cut back production (from 15,000 to 12,000, for example) because at the lower price there is less of an incentive to grow oranges or to ship them to this market.

Even if the price fell to $1.00, however, there would still be a surplus. This process of the surplus shrinking, prices being lowered by sellers and buyers, and the surplus shrinking further continues until the quantity demanded equals the quantity supplied. In this example, the quantity demanded would equal the quantity supplied at a price of $ .50 per orange.

4.8.2 What Is an Equilibrium in a Market?

The adjustment processes in the case of a shortage and in the case of a surplus end with the shortage and surplus eliminated. At that point, there are no longer pressures for prices to change or for the quantities demanded and supplied to change. The market will then be in equilibrium, meaning that given the current supply and demand conditions in the market, price and quantity will not change. The market pressures of supply and demand are balanced.

This market price, where the quantity supplied equals the quantity demanded, is described as the equilibrium price, and the quantities demanded and supplied in the market are equal to the equilibrium quantity. The equilibrium price and quantity will not change unless something else changes. Changes in any of the factors that influence demand, or any of the factors that determine supply, will cause a new shortage or a surplus. Those changes will create a new equilibrium, and the forces of supply and demand will cause market prices and quantities to move toward that new equilibrium.

The adjustment process of moving from one equilibrium to another is often described as the law of supply and demand. The law means that given a change in supply or demand conditions, prices and quantities will tend to move toward equilibrium levels, where the quantities supplied and demanded are equal.

Figure 4.9: An equilibrium of supply and demand.​

What would happen in the market if income increases? We will assume that oranges are normal goods and that nothing other than income changes. Figure 4.10 shows a new demand curve that has shifted to the right, an increase in demand. Individuals now with higher incomes can afford to buy more of many goods, including oranges. At the current price of 50 cents, the new quantity demanded is 12,000 oranges, and there is now a shortage of oranges in the market. Given that the price has not changed, the quantity supplied is still 5,000. The resulting shortage is equal to 7,000 oranges (12,000 – 5,000). Some buyers may offer more in order to get oranges and surely grocery stores will begin to raise their prices. Grocers will see the opportunity to increase profits as they can sell all they have and more at the current prices. As prices increase, the quantity supplied will begin to increase. Remember that a higher price increases incentives to grow and ship oranges to this market. The quantity demanded will begin to decrease from the new higher amount as some consumers will switch to substitutes as the price of oranges rises. The shortage will get smaller. Figure 4.10 shows that if the price increases to $1.00, the shortage will still be about 2,000 oranges (10,000 – 8,000). But the process continues as long as there is a shortage.

Figure 4.10: How market forces shrink a shortage.​

Both the new equilibrium price (about $1.25) and the new equilibrium quantity (about 9,000 oranges) will be higher than before the increase in income. See Figure 4.11.

Figure 4.11: New equilibrium after a change in demand.​

A second application focuses on supply. Suppose a new fertilizer enables producers to grow more oranges in cooler climates. The enhanced technology allows producers to increase supply. The result is shown in Figure 4.12.

Figure 4.12: The effect of an increase in supply in the market for oranges.​

The increase in supply causes the new quantity supplied (13,000 oranges) to be greater than the quantity demanded (9,000 oranges) at the current market price of about $1.25. The surplus is shown as the difference between the new quantity supplied and the original quantity demanded – 4,000 oranges. Businesses cannot sell all they want to sell at the going market price. In order to sell their excess production, businesses will begin to lower prices. (Some savvy consumers might offer to pay a lower price once they notice that individual business have surpluses.) Two things happen as a result of the decrease in the market price. First, the quantity demanded increases; consumers substitute oranges for other goods. Second, the quantity supplied decreases; at the lower prices, some producers eventually decide to grow fewer oranges or perhaps to ship oranges to other markets. But as long as the surplus exists, prices continue to fall and the surplus gets smaller. The process stops when the quantity demanded equals the quantity supplied, at a new lower price ($.75) and a new higher equilibrium quantity (11,000 oranges).

The processes are the same with all other changes in demand or supply. First, identify whether a surplus or shortage is created. Then, determine the direction of the change in price. Next, think about what happens to quantity demanded and supplied and eventually to the equilibrium price and quantity. A favorable change in tastes, an increase in income (if the good is normal), increases in the prices of substitute goods, decreases in the prices of complementary goods, and increases in the number of potential buyers will all cause the equilibrium prices and equilibrium quantities of the good to increase. Changes in the opposite directions will have the opposite effects on equilibrium price and quantity. A decrease in the prices of inputs, an improvement in technology, and an increase in the number of firms in the industry will cause the equilibrium price to decrease and the equilibrium quantity to increase. Once again, changes in the opposite directions will have the opposite effects on equilibrium prices and quantities.

Go ahead and outline the steps in the adjustment process if there is an unfavorable change in tastes and an increase in the prices of inputs. Do each change in turn and then put the effects together.

Question 4.38

Question 4.38

How would a market equilibrium change if people decided they didn’t like a good anymore?

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Question 4.39

Question 4.39

Analyze the process following an increase in the prices of the inputs used to produce the good.

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The explanation in each case should begin with the change in the determinant of demand or supply and how it affects demand or supply. A decrease in tastes decreases demand. That creates a surplus at the current price level. That surplus causes the market price to begin to fall. You should be able to explain why, just as we did in the explanation of the surplus above. As prices fall, the quantity demanded begins to rise, and quantity supplied begins to fall. Explain why again. This process will continue until there is no longer a surplus. Finally, a new lower equilibrium price and lower equilibrium quantity are reached.

The increase in prices of inputs will decrease supply and result in a shortage. The creation of a shortage will cause prices to begin to rise. The quantity demanded will fall; the quantity supplied will rise. The new equilibrium will be a higher price and a lower quantity.

4.9 How Can You Remember the Distinction Between Demand and Quantity Demanded?

The importance of the distinction between quantity supplied and supply and quantity demanded and demand is illustrated by the following logic described in a Wall Street Journal article.

   “Demand for coffee increased. As a result, prices soared. The rapidly rising
   prices, in turn, caused demand to come back down. Thus, prices fell.”

So what was the final result? Does an increase in demand not cause higher prices as we have argued?

Question 4.40

Question 4.40

Is the Wall Street Journal analysis correct?

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Figure 4.13: The effect of an increase in demand in the market for coffee.​​

Figure 4.13 shows an increase in the demand for coffee. As a result of the increase in demand, the quantity demanded at a price of $400 per ton has increased from 600 tons to 1,200 tons. There is upward pressure on the price. As the price increases from $400 per ton to $600 per ton of coffee, the quantity demanded decreases from 1,200 tons to 1,000 tons. The equilibrium price will then stay at $600 until something else changes.

Graphing Question 4.09

4.9.1 Summarize the Results

A summary of the results of changes in supply and demand is shown in Table 4.7 – but a word of caution is appropriate. Students who do well in the study of economics do not memorize a table like Table 4.7. You will be much more successful if you work on understanding and explaining the processes behind the changes in the equilibrium prices and quantities. You will then be able to analyze any of the possible changes.

Table 4.7: The effects of only supply and demand shifting in a market.​
Table 4.8: The effects of changes in the market for oranges.​

A special challenge comes when there are simultaneous changes in supply and demand, such as an increase in demand for desktop computers at the same time as an increase in supply. What will be the result?

The way to approach such a problem is to think of the changes one at a time. The increase in demand will cause a shortage. Consumers will offer a higher price to make sure they get the good and firms will offer a higher price to maximize profit. This results in an increase in quantity supplied and a decrease in quantity demanded. This entire process repeats until a new equilibrium price is reached where the equilibrium price is higher and the equilibrium quantity has increased. The increase in supply will cause a surplus. Consumers will offer a lower price and firms will offer a lower price as they notice their inventory increasing. This results in a decrease in quantity supplied and an increase in quantity demanded. The entire process will repeat until a new equilibrium is reached where the equilibrium price has decreased and the equilibrium quantity has increased. Notice that even though the increase in supply and the increase in demand occur simultaneously, we can analyze each change individually to find the total effect.

We know that the equilibrium quantity will definitely increase because the effects of both the increase in demand and the increase in supply are to increase the equilibrium quantity. However, we cannot provide a definitive answer about the equilibrium price. The increase in demand raises prices and the increase in supply causes prices to fall. The combined effect on price is indeterminate unless we know whether the change in supply or the change in demand has the greatest effect on prices. For example, if the change in demand were quite large and the increase in supply were much smaller, then we should expect that the net effect would be an increase in the equilibrium price. Table 4.8 summarizes the results when both supply and demand change. Again, the word of caution about trying to memorize those results holds.

Question 4.41

Question 4.41

Consider a hypothetical situation where there is a simultaneous change in demand and supply. How will the equilibrium quantity and price change as a result of the possible combination of changes to supply and demand in demand and in supply? Explain why.

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Table 4.9: Effects of simultaneous changes in supply and demand on equilibrium prices and quantities.​

Graphing Question 4.10


​The quantity supplied of parking spaces is fixed at 5,000, which should be represented by a vertical supply curve drawn on the graph, as shown in Figure 4.14. Given that the quantity cannot be quickly changed, variations in price will not affect the quantity supplied. This type of supply curve is different from any we have seen or discussed. The quantity supplied does not change as price changes. We often find this type of supply relationship when we consider supply conditions over very brief periods of time or with goods that by their very nature take a long time to change the amount that is produced. Building a new parking lot does take time and in most cases cannot be done in a few days or weeks.

At a price of $150, the quantity of parking spaces demanded exceeds the quantity supplied by 2,000. Because the quantity demanded exceeds quantity supplied (a shortage), some students (and maybe even faculty) would be willing to pay a higher price. If the university wants to reduce the shortage, they could raise prices. That is what would happen in most markets. (Over an extended time frame, they could also build more parking.) As the administration raises prices, some consumers would decide to drop out of the market as they decide to park elsewhere or walk. Eventually, an equilibrium would be reached at a higher price, but the quantity will not have changed because of the fixed number of parking spots.

Figure 4.14: Supply and demand for college parking.​

Question 4.42

Question 4.42

Lady Gaga performed at the 2017 Super Bowl halftime show for free (The NFL covered production costs). Why would an artist who regularly grosses $1.3 million dollars per concert agree to perform for free?

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Question 4.43

Question 4.43

Describe the resulting situation. Nintendo released a limited supply of their original system, a product that many people wanted to buy. Due to a misestimate of potential demand, there were significantly more people that wanted the system than there were systems available for sale.

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Question 4.44

Question 4.44

Oprah Winfrey made comments about the possibility of contracting mad-cow disease from eating beef. Some observers said that those comments had negative effects on the beef market. In the same period of time, changes in rate of production may have been the real culprit. How and why would an increase in beef production, “oversupply,” and weak exports affect prices?

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Question 4.45

Question 4.45

How would “high feed costs” cause a fall in prices? Is this what one would expect with most goods? With cattle?

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Question 4.46

Question 4.46

What would you need to know to prove that a celebrity’s advice to fans not to eat meat hurt the cattle industry? How would you defend her?

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4.9.2 What Conclusions Can We Make About Demand, Supply, and Markets?

Supply and demand analysis provides us with a powerful set of tools. Remember the examples mentioned at the beginning of the chapter about the increased use of ethanol in gasoline causing prices of bacon to increase? Supply and demand analysis can explain these seemingly unrelated events. An increase in demand for corn, the main input for ethanol production, led to a large increase in the price of corn. Corn is also a major component of feed used to raise hogs. As we learned in this chapter, one of the input prices in bacon production increased, which led to the increase in bacon prices.

Markets are our economy’s primary method of allocating resources. As consumers increase the amount of fruit and vegetables in their diets, the demand for both increase. As a result, fruit and vegetable prices begin to rise, incentives to produce more fruit and vegetables increase, and, like magic, more fruit and vegetables are eventually brought to the market. The economy responds to our changing tastes by producing what we want the most and are willing to buy. The prices that the market generates even help determine who gets the fruit and vegetables once they are produced – whoever is able and willing to pay the market price.

Who makes the millions of decisions each day that determine how we use our scarce resources? Who answers the questions of what to produce, how to produce, and for whom to produce? The forces of supply and demand coming together in markets organize all of those efforts. Understanding these forces and developing an ability to use that understanding is important if you are to do well in the study of economics. In the next chapter, we will use these concepts in a variety of situations and applications. You will find hundreds of applications constantly in daily newspapers, on web pages, and on the evening television news.

4.10 Summary

  • Markets allocate scarce resources. How much of a good or service is produced, what resources are used, and who gets the goods and services are all largely determined by markets in our economy.
  • Increases in market prices cause the quantity demanded by buyers to decrease. Decreases in prices cause the quantity demanded to increase.
  • Changes in tastes and preferences, incomes, prices of related goods, expectations, and the number of potential buyers are factors that change demand and shift demand curves.
  • Higher prices normally result in a higher quantity supplied in a market. Lower prices cause quantity supplied to decrease.
  • Changes in prices of inputs and technology cause supply to change and shift the supply curve. Changes in expectations, prices of other goods firms could produce, the number of firms, weather, and other costs can also cause changes in supply.
  • Market prices and the quantities exchanged are determined by both supply and demand. Changes in supply and demand create surpluses and shortages, which in turn cause prices and quantities to adjust to new equilibrium levels.
  • A market is in equilibrium when the quantity demanded at the current market price is equal to the quantity supplied at that price. There are no pressures on either buyers or sellers to change prices or quantities. The price is described as an equilibrium price. The quantity is the equilibrium quantity.
  • An increase in demand will cause the equilibrium price and quantity to increase. A decrease in demand will cause the equilibrium price and quantity to decrease.
  • An increase in supply will cause the equilibrium price to decrease and the equilibrium quantity to increase. A decrease in supply will cause the equilibrium price to increase and the equilibrium quantity to decrease.
Question 4.47

Suppose the U.S. supply and demand schedules for computers manufactured in Japan are in the table below. What is the equilibrium price?

question description
A

$5

B

$9

C

$11

D

$13

E

$15

Question 4.48

Suppose that a change in U.S. attitudes toward goods made abroad reduces the quantity demanded at each price by a half-million computers per year. What is the new equilibrium price?

question description
A

$5

B

$9

C

$11

D

$13

E

$15

Question 4.49

Suppose that a tariff is established on computers made abroad. The equilibrium price will ______________ and the equilibrium quantity will ______________.

question description
A

Increase; increase

B

Increase; decrease

C

Decrease; increase

D

Decrease; decrease

Question 4.50

Assume that the tariff posed in the previous question still holds. How will that same tariff affect the market for domestic computers? The equilibrium price of domestic computers will ______________ and the equilibrium quantity of domestic computers will ______________.

A

Increase; increase

B

Increase; decrease

C

Decrease; increase

D

Decrease; decrease

Question 4.51

Indicate how an increase in tastes for apples will affect the equilibrium price and the equilibrium quantity in the market for apples.

A

Increase; increase

B

Increase; decrease

C

Decrease; decrease

D

Decrease; increase

Question 4.52

Indicate how a decrease in the cost of producing oranges (a substitute for apples) will affect the equilibrium price and the equilibrium quantity in the market for apples.

A

Increase; increase

B

Increase; decrease

C

Decrease; decrease

D

Decrease; increase

Question 4.53

Recently, stores have been reporting increased sales of DVD players and a reduction in their prices. In accordance with this trend, one might predict that there has been a(n) ______________ in demand and a(n) ______________ in supply.

A

Increase; no change

B

No change; increase

C

Decrease; no change

D

No change; decrease

Question 4.54

What does a single point on the supply curve represent?

question description
A

The cost of producing the given quantity of film

B

The amount of profit the producer hopes to receive

C

The cost, at the current level of production, of producing one more roll of film

D

The price the consumers are willing to pay for a roll of film

Question 4.55

What does a single point on the demand curve represent?

question description
A

The value of film to the consumer as judged by the producer

B

The value of consuming one more roll of film

C

The amount of film the consumer demands

D

The cost of producing film at that quantity

Question 4.56

At what level of output is each additional roll of film worth more to consumers than it costs to produce?

question description
A

50

B

100

C

150

4.11 Key Concepts

Markets and Allocation of Resources

Demand

      Quantity Demanded

      Law of Demand

      Shifts in Demand

Supply       

      Quantity Supplied

      Normal Supply

      Shifts in Supply

Equilibrium Price and Quantity

      The Law of Supply and Demand

      Shifts in Supply and Demand and Movement to Equilibrium

4.12 Key Term Glossary

Capital: The buildings and physical improvements, machines, and tools that business use to produce goods and services.

Complementary goods: Goods that are used together. When the price of one good increases, the demand for its complementary good decreases.

Demand: A table or graph showing the quantity of a good demanded at each price, assuming that all possible influencing factors other than price remain constant.

Economic model: A simplified explanation of a part of the economy. Economic models often focus on specific relationships and make assumptions about other possible influences remaining constant. 

Equilibrium price: The price at which quantity supplied is equal to quantity demanded. The market is in equilibrium, that is, equilibrium price will not change until something else changes. 

Equilibrium quantity: The quantity of a good bought and sold when quantity supplied equals quantity demanded. The equilibrium quantity will not change until something else changes.

Equilibrium: A market is in equilibrium, with an equilibrium price and an equilibrium quantity, when the quantity demanded equals the quantity supplied.

Inferior goods: A good is inferior if, in response to an increase in income, individuals decrease their consumption of the good.

Inputs: The resources - labor, land, and capital - businesses use in producing goods and services. Those resources are often described as factors of production.

Law of demand: The principle that price and quantity demanded are inversely related. A decrease in price, assuming nothing else changes, will cause an increase in the quantity demanded and an increase in price will cause a decrease in the quantity demanded. The law of demand implies a negatively sloped demand curve.

Law of supply and demand: The market price and the quantity exchanged in a perfectly competitive market will move toward the price and quantity where quantity supplied is equal to quantity demanded.

Markets: Means for individuals and businesses to exchange goods, services, assets, and labor.

Movements along a demand curve: A change in quantity demanded caused by a change in a good's price.

Movements along a supply curve: A change in quantity supplied caused by a change in a good's price.

Normal goods: A good is normal if, in response to an increase in income, individuals increase their consumption of the good.

Quantity demanded: The quantity of a good or service that consumers intend to purchase throughout a given time period at a certain price.

Quantity supplied: The quantity of a good or service that producers intend to sell throughout a given time period at a certain price.

Shift in the demand curve: A change in the quantities consumers are willing and able to purchase at each price. The shift is caused by changes other than a change in price. For instance, changes in income, tastes, expectations, the number of potential buyers, and prices of substitute and complementary goods may lead to shifts in demand.

Shift in the supply curve: A change in the quantities producers are willing and able to sell at each price. The shift is caused by changes other than a change in price. For instance, rising labor costs (a price of an input) cause a shift to the left of the supply curve (a decrease in supply). Changes in prices of other inputs or changes in technology will also shift the supply curve.

Shortage: At a single price, the quantity demanded is greater than the quantity supplied.

Substitute goods: Goods that can used in place of one another. When the price of one increases, the demand for a substitute good increases.

Supply: A table (schedule) or graph (curve) showing the quantity of a good that producers are willing to supply at each price, assuming that all possible influencing factors other than price remain constant.

Surplus: At a single price, the quantity supplied is greater than the quantity demanded.





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Answer Keys:

Answer to Question 4.01

There are a variety of possibilities. Continue reading the discussion in the next section for specific examples. 

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Answer to Question 4.02

In almost every case, individuals will buy less music if the price increases. Consumers have to decide what they will spend their money on; if music becomes more expensive, that would mean they could buy less of other goods if the quantity of music they purchase stays the same.

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Answer to Question 4.03

This is very rare, but if individuals are very poor and a food, such as instant noodle soup, becomes more expensive, individuals may buy more of it because they are unable to afford any other type of food. Let’s say an individual must eat 7 dinners in a week. Currently, they purchase 5 dinners of instant noodle soup (inexpensive meal) and 2 meals of grilled chicken salad (More expensive meal). If the price of instant noodle soup increases, it could mean the individual cannot afford to buy their usual mix of dinners. In order to continue to eat 7 meals a week, they drop one of the grilled chicken dinners and buy another instant noodle soup meal. (Other examples similar to this are correct. Remember that this is a very rare occurrence.)

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Answer to Question 4.04

Chipotle had two cases of E-coli at the end of 2015. Even though the majority of their stores were unaffected, sales nationwide decreased. Many people’s regard for the foods (tastes for Chipotle) had decreased.

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Answer to Question 4.05

Bus rides. If income increases, most individuals will choose to buy a car and no longer ride the bus.

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Answer to Question 4.06

An individual’s consumption of water does not change much with income. Individuals typically consume and use the same amount of water for drinking, cooking, and bathing.

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Answer to Question 4.09

Prices, tastes and preferences, income, price of related goods, expectations, and the number of potential buyers. The law of demand states that as prices of specific goods and services increase, quantity demanded will decrease. However, demand refers to the quantity of goods that individuals want to purchase at every price level. Prices only influence the quantity demanded while tastes and preferences, income, price of related goods, expectations, and the number of potential buyers affect demand.

Explanation: Your summary should include a listing of the factors that influence buyers – prices, tastes and preferences, incomes, prices of related goods, expectations, and the number of potential buyers. A complete answer would have a brief description of each of those relationships, perhaps with an emphasis on the law of demand.

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Answer to Question 4.16

As the price increased, more individuals would bring you more and more cell phones. This is no different than multinational firms reacting to higher prices by producing more.

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Answer to Question 4.17

A firm is always trying to maximize profit. If prices increase, there is an increased benefit to producing more output. Therefore, firms have an incentive to increase production to earn more profit.

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Answer to Question 4.19

Eventually, the farmer will produce fewer soybeans and more corn. The opportunity cost of growing soybeans increases. The farmer is giving up more and more revenue by not planting corn and growing more soybeans. To maximize profit, the farmer will increase corn production and decrease soybean production.

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Answer to Question 4.20

If homeowners expect higher prices in the future, they may decide to delay listing their house for sale. The future supply of houses for sale will be larger, but the supply in the present will shrink.

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Answer to Question 4.21

As the price falls (assuming everything else remains the same), there is less of an incentive to produce goods. Therefore, companies will produce less.

Explanation: Your answer should include the following ideas: as prices fall, assuming everything else remains the same, profits will fall, incentives to produce will be less, and companies will reduce their production.

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Answer to Question 4.23

Your summary should include the principal factors that influence supply and explanations of how changes in each will change business decisions regarding how much to produce. Increases in prices of inputs will increase the cost of producing, decrease supply, and shift the supply curve to the left. Decreases in prices of inputs and improvements in technology will decrease costs, increase supply, and shift the supply curve to the right. Changes in the price of the good alone will cause a change in the quantity supplied and a movement along a supply curve. The analysis is similar for the other three factors that shift supply: Number of firms, changes in technology, future expectations of prices, and prices of related goods.

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Answer to Question 4.36

There will be a shortage. Since there aren’t enough oranges to satisfy quantity demanded, consumers may offer to pay more and firms will accept a higher price. Price will increase as a shortage persists.

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Answer to Question 4.37

There will be a surplus of 14,000 oranges. Firms will try to get rid of their inventory, so they will lower prices to attract more buyers. Buyers will also notice the surplus and offer a lower price. At the lower price, firms have less incentive to produce, so quantity supplied decreases and consumers will increase their quantity demanded as explained by the law of demand. There will still be a surplus, and these steps will continue until a new equilibrium is reached. Price decreases as a result of a surplus.

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Answer to Question 4.38

This is a change in tastes and preferences. As a result of tastes and preferences turning negative for a product, demand will decrease. This leads to a surplus that firms and consumers recognize. Consumers will offer a lower price and firms will offer to sell at a lower price. At the lower price, quantity demanded increases and quantity supplied decreases. There will still be a surplus. This whole process will continue until quantity supplied is equal to quantity demanded. The market will have a lower price and a smaller quantity exchanged.

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Answer to Question 4.39

If the prices of inputs increase, producers will no longer be able to earn a profit and will reduce the amount of production at each market price.  A decrease in supply means there is a shortage (quantity supplied is smaller than quantity demanded) at the current price. Both the firms and consumers recognize there is a shortage. Consumers will offer a higher price to make sure they get the good and firms will charge a higher price upon recognizing the shortage in order to earn more profit. At a higher price, quantity demanded decreases and the incentive to produce increases, leading to a larger quantity supplied. There will still be a shortage, but this process with continue until a new equilibrium with a higher market price and small quantity of goods exchanged

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Answer to Question 4.40

Something (changing tastes, income, or prices of other goods) caused demand to increase in the first place. The increase in demand created a shortage at the existing price. As businesses increased prices and buyers offered higher prices, the quantity supplied would have increased and quantity demanded would have decreased from its new higher level. However, the writer of the above excerpt confuses demand and quantity demanded. The “rapidly rising prices” cause quantity demanded to fall, not demand. If prices did eventually fall, another change in demand (or an increase in supply) must have occurred. Remember, it is not the “rapidly rising prices” that cause demand to fall.

Figure 4.13 shows an increase in the demand for coffee. As a result of the increase in demand, the quantity demanded at a price of $400 per ton has increased from 600 tons to 1,20