Supply and Demand Guide

To solve the homework problems do the following:

1. Identify the determinant change

2. Shift the appropriate curve in the correct direction

3. Change price appropriately

4. Move along the other curve (the one that did not shift) in response to the price change.

The following information will tell you the determinants and how the change, as well as definitions of the key terms.

Demand

Demand: The amount that consumers are willing and able to purchase at various prices.

Law of Demand: Price and Quantity Demanded vary inversely.

Quantity Demanded: The amount that consumers are willing and able to buy at a particular price.

Change in Quantity Demanded: Changes in price change the quantity demanded. This is a Movement Along a Demand Curve in Response to a Price Change.

Change in Demand: This is a shift in the position of the demand curve, either upward or downward. If the curve shifts upward, consumers are saying they will pay more for all quantities of the good or service. If it shifts downward, consumers are saying they will pay less for all quantities of the good or service.

Determinants of Demand: The Demand Curve will shift only when one (or more) of the Determinants of Demand changes. These determinants are:

1. Size of Market: the number of consumers in the market for the good or service. If this factor increases, the curve shifts upward (increase in demand). If this decreases, the curve shifts downward (decrease in demand).

2. Consumer Tastes and Preferences: if these shift in favor of a product, the demand curve shifts upward (demand increases); if these shift against a product, the demand curve shifts downward (demand decreases).

3. Consumer Income: as the income of consumers increase, consumers purchase more of all normal goods (assume all the goods in the homework are normal goods), this shifts the demand curve upward (demand increases); if income decreases, then consumers buy less of all normal goods, this shifts the demand curve downward (demand decreases).

4. Prices of Related Goods:

a. Complimentary Goods: These are goods that are used to together like peanut butter and jelly. If the price of peanut butter goes up, the Quantity Demanded of peanut butter will decrease (a movement along a demand curve in response to a price change). However, the Demand for jelly will decline (decrease in demand) as fewer people buy it to go with the peanut butter, since they are buying less peanut butter.

b. Substitute Goods: These are goods that are used in place of each other. If the price of Coke Cola goes up, the Quantity Demanded of Coke does down (a movement along the demand curve). But the Demand for Pepsi - the substitute good - goes up as people substitute the lower priced Pepsi for the higher priced Coke (the Pepsi demand curve shifts upward).

5. Expectations about the Future: If people have a positive view of the future they will consumer more and save less. This shifts the demand curve for all normal goods upward. If people have a negative view of the future, they will consume less and save more, this shifts the demand curve for all normal goods downward.

Supply

Supply: The amount that producers are willing and able to bring to market at various prices.

Law of Supply: Price and Quantity Supplied vary directly.

Quantity Supplied: The amount that producers are willing and able to bring to market at a particular price.

Change in Quantity Supply: Changes in price change the quantity supplied. This is a Movement Along a Supply Curve in Response to a Price Change.

Change in Supply: This is a shift in the position of the supply curve, either upward (inward) or downward (outward). If the curve shifts upward, producers are saying they will bring less to market at all prices. If it shifts downward, producers are saying they will bring more to market at all prices.

Determinants of Supply: The Supply Curve will shift only when one (or more) of the Determinants of Supply changes. These determinants are:

1. Number of Firms in the Industry: If the number of firms in an industry increases, the more the industry can produce - this shifts the supply curve downward (outward) - this is an increase in supply. If the number of firms in an industry decreases, the industry can produce less output - this shifts the supply curve upward (inward) - this is a reduction in supply.

2. Relative Price of Alternative Outputs: If a firm can produce Product A or Product B with the same resources (inputs), it will produce the product with the higher price. If the price of Product A increases relative to Product B, then the firm will produce more of A and less of B. This causes the Supply Curve for A to shift outward (increase in supply) and the Supply Curve for B to shift upward (decrease in supply).

3. Costs of Production*: The costs of production is the primary determinant of supply. If the costs of production increase, then supply decreases - the Supply Curve shifts inward (a decrease in supply). If the costs of production decrease, then supply increases - the Supply Curve shifts outward (an increase in supply).

4. Expectations About the Future: If firms have a positive view of the future, they will increase production which is an increase in supply - the curve shifts outward. If firms have a negative view about the future, they will decrease production and the supply curve will shift upward - a decrease in supply.

* The Costs of Production include:

• Prices of inputs - the Factors of Production

• Business Taxes

• Complying with regulations

• Less any Subsidies the firm may receive

In equilibrium, the quantity supplied equals the quantity demanded.

Graph A

When one or more of the determinants of demand (see above) change such that the demand for a good increases, that shows that consumers are willing to pay more for all possible quantities of the good. The upward shift in the demand curve causes an increase in price. Suppliers respond to the higher market price by bringing a greater quantity supplied to market - recall the Law of Supply.

Graph B

When one or more of the determinants of demand (see above) change such that the demand for that good decreases. The demand curve reflects this by shifting downward, showing the consumers are willing to pay less for all possible quantities of the good. This causes a decrease in price. Suppliers respond to the price change by bringing a lesser quantity supplied to market - recall the Law of Supply.

Graph C

When one or more of the determinants of supply (see above) change such that the supply for that good increases, the supply curve shifts outward showing that suppliers can bring more product to market at lower prices for all possible quantities. This causes a decrease in price. Demanders will respond to the price change with a greater quantity demanded - recall the Law of Demand.

Graph D

When one or more of the determinants of supply (see above) change such that the supply for that good decreases, the supply curve shifts inward showing the suppliers can bring fewer products to market at higher prices for all possible quantities. This causes an increase in price, and demanders are willing to buy a lesser quantity demanded - recall the Law of Demand.