4
The Market Forces of Supply and
Demand
In this chapter, look for the answers to
these questions:
What factors affect buyers demand for goods?
PRINCIPLES OF
What factors affect sellers supply of goods?
How do supply and demand determine the price of
ECONOMICS
a good and the quantity sold?
FOURTH EDITION
How do changes in the factors that affect demand
N. G R E G O R Y M A N K I W
or supply affect the market price and quantity of a
good?
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2008 update
Modified by Joseph Tao-yi Wang
How do markets allocate resources?
CHAPTER 4
2008 South-Western, a part of Cengage Learning, all rights reserved
Markets and Competition
Markets and Competition
A perfectly competitive market:
A market is a group of buyers and sellers of a
all goods exactly the same
buyers & sellers so numerous that no one can
particular product.
A competitive market is one with many buyers
and sellers, each has a negligible effect on price.
In modern economics,
A market is a group of buyers and sellers of a
In modern economics,
and sellers so you can always switch
No one can affect market price each is a
price taker (since others can always switch)
A competitive market is one where buyers and
In this chapter, we assume markets are perfectly
sellers have a negligible effect on price because
there are substitutes on either side.
THE MARKET FORCES OF SUPPLY AND DEMAND
affect market price each is a price taker
There are perfect substitutes for both buyers
particular product trading under certain rules.
CHAPTER 4
competitive.
2
The Demand Schedule
Demand
The quantity demanded of any good is the
Demand schedule:
amount of the good that buyers are willing and
able to purchase.
A table that shows the
relationship between the
price of a good and the
quantity demanded.
Law of demand: the claim that the quantity
demanded of a good falls when the price of the
good rises, other things equal
Example:
Helens demand for lattes.
Notice that Helens
preferences obey the
Law of Demand.
CHAPTER 4
THE MARKET FORCES OF SUPPLY AND DEMAND
THE MARKET FORCES OF SUPPLY AND DEMAND
CHAPTER 4
Price Quantity
of
of lattes
lattes demanded
$0.00
16
1.00
14
2.00
12
3.00
10
4.00
5.00
6.00
THE MARKET FORCES OF SUPPLY AND DEMAND
Helens Demand Schedule & Curve
Market Demand versus Individual Demand
Price Quantity
of
of lattes
lattes demanded
Price of
Lattes
$6.00
$0.00
16
1.00
14
$4.00
2.00
12
$3.00
3.00
10
$5.00
4.00
$2.00
0
CHAPTER 4
Suppose Helen and Ken are the only two buyers in
Quantity
15 of Lattes
10
THE MARKET FORCES OF SUPPLY AND DEMAND
Price
Helens Qd
$0.00
16
24
1.00
14
21
2.00
12
18
3.00
10
15
4.00
12
5.00
6.00
The Market Demand Curve for Lattes
P
Qd
(Market)
$0.00
24
$5.00
1.00
21
$4.00
2.00
18
$3.00
3.00
15
4.00
12
5.00
6.00
P
$6.00
$2.00
$1.00
$0.00
(Qd = quantity demanded)
the Latte market.
6.00
$0.00
the quantities demanded by all buyers at each price.
5.00
$1.00
The quantity demanded in the market is the sum of
Kens Qd
Market Qd
Demand Curve Shifters
The demand curve shows how price affects
quantity demanded, other things being equal.
These other things are non-price determinants
of demand (i.e., things that determine buyers
demand for a good, other than the goods price).
Changes in them shift the D curve
Q
0
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10
15
20
25
THE MARKET FORCES OF SUPPLY AND DEMAND
Demand Curve Shifters: # of buyers
CHAPTER 4
THE MARKET FORCES OF SUPPLY AND DEMAND
Demand Curve Shifters: # of buyers
Increase in # of buyers
Suppose the number
of buyers increases.
Then, at each P,
Qd will increase
(by 5 in this example).
increases quantity demanded at each price,
shifts D curve to the right.
$6.00
$5.00
$4.00
$3.00
$2.00
$1.00
$0.00
0
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THE MARKET FORCES OF SUPPLY AND DEMAND
10
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10
15
20
25
30
THE MARKET FORCES OF SUPPLY AND DEMAND
11
Demand Curve Shifters: income
Demand Curve Shifters:
Demand for a normal good is positively related
prices of
related goods
Two goods are substitutes if
to income.
an increase in the price of one causes
an increase in demand for the other.
Increase in income causes
increase in quantity demanded at each price,
shifts D curve to the right.
Example: pizza and hamburgers.
An increase in the price of pizza
increases demand for hamburgers,
shifting hamburger demand curve to the right.
(Demand for an inferior good is negatively
related to income. An increase in income shifts
D curves for inferior goods to the left.)
Other examples: laptops and desktop computers,
compact discs and music downloads,
In the news: Fresh and Frozen Vegetables after a typhoon
CHAPTER 4
THE MARKET FORCES OF SUPPLY AND DEMAND
Demand Curve Shifters:
12
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THE MARKET FORCES OF SUPPLY AND DEMAND
13
Demand Curve Shifters: tastes
prices of
related goods
Anything that causes a shift in tastes toward a
Two goods are complements if
good will increase demand for that good
and shift its D curve to the right.
an increase in the price of one causes
a fall in demand for the other.
Example:
Example: computers and software.
The organic diet became popular recently,
caused an increase in demand for organic food,
shifted the organic demand curve to the right.
If price of computers rises, people buy fewer
computers, and therefore less software.
Software demand curve shifts left.
Other examples: college tuition and textbooks,
bagels and cream cheese, eggs and bacon
In the news: gasoline and cars
CHAPTER 4
THE MARKET FORCES OF SUPPLY AND DEMAND
14
Demand Curve Shifters: expectations
CHAPTER 4
THE MARKET FORCES OF SUPPLY AND DEMAND
Summary: Variables That Affect Demand
Expectations affect consumers buying
Variable
decisions.
If people expect their incomes to rise,
their demand for meals at expensive
restaurants may increase now.
If the economy turns bad and people worry
about their future job security, demand for
new autos may fall now.
THE MARKET FORCES OF SUPPLY AND DEMAND
16
A change in this variable
Price
causes a movement
along the D curve
No. of buyers
shifts the D curve
Income
shifts the D curve
Price of
related goods
shifts the D curve
Tastes
shifts the D curve
Expectations
shifts the D curve
Examples:
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15
CHAPTER 4
THE MARKET FORCES OF SUPPLY AND DEMAND
17
ACTIVE LEARNING
1:
ACTIVE LEARNING
Demand curve
1:
A. price of iPods falls
Draw a demand curve for music downloads.
What happens to it in each of the following
scenarios? Why?
Music
Music downloads
downloads
and
and iPods
iPods are
are
complements.
complements.
A
A fall
fall in
in price
price of
of
iPods
iPods shifts
shifts the
the
demand
demand curve
curve for
for
music
music downloads
downloads
to
to the
the right.
right.
Price of
music
downloads
A. The price of iPods
falls
P1
B. The price of music
downloads falls
D2
D1
C. The price of
compact discs falls
Q2
Q1
Quantity of
music downloads
18
19
1:
B. price of music downloads falls
ACTIVE LEARNING
Price of
music
downloads
Price of
music
downloads
ACTIVE LEARNING
The
The D
D curve
curve
does
does not
not shift.
shift.
Move
Move down
down along
along
curve
curve to
to aa point
point with
with
lower
lower P,
P, higher
higher Q.
Q.
P1
P2
CDs
CDs and
and
music
music downloads
downloads
are
are substitutes.
substitutes.
A
A fall
fall in
in price
price of
of CDs
CDs
shifts
shifts demand
demand for
for
music
music downloads
downloads
to
to the
the left.
left.
P1
D1
Q1
Q2
1:
C. price of CDs falls
D1
D2
Q2
Quantity of
music downloads
Q1
Quantity of
music downloads
20
21
The Supply Schedule
Supply
Supply schedule:
The quantity supplied of any good is the
A table that shows the
relationship between the
price of a good and the
quantity supplied.
amount that sellers are willing and able to sell.
Law of supply: the claim that the quantity
supplied of a good rises when the price of the
good rises, other things equal
Example:
Starbucks supply of lattes.
Notice that Starbucks
supply schedule obeys the
Law of Supply.
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THE MARKET FORCES OF SUPPLY AND DEMAND
22
CHAPTER 4
Price
of
lattes
Quantity
of lattes
supplied
$0.00
1.00
2.00
3.00
4.00
12
5.00
15
6.00
18
THE MARKET FORCES OF SUPPLY AND DEMAND
23
Starbucks Supply Schedule & Curve
P
$6.00
$5.00
$4.00
$3.00
$2.00
$1.00
$0.00
Market Supply versus Individual Supply
Price
of
lattes
Quantity
of lattes
supplied
$0.00
1.00
2.00
3.00
4.00
12
5.00
15
6.00
18
The quantity supplied in the market is the sum of
the quantities supplied by all sellers at each price.
Suppose Starbucks and Jitters are the only two
sellers in this market.
Q
0
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10
15
24
THE MARKET FORCES OF SUPPLY AND DEMAND
(Qs = quantity supplied)
Market Qs
Price
Starbucks
Jitters
$0.00
1.00
2.00
10
3.00
15
4.00
12
20
5.00
15
10
25
6.00
18
12
30
Supply Curve Shifters
The Market Supply Curve
P
$6.00
QS
(Market)
$0.00
1.00
2.00
10
$4.00
3.00
15
$3.00
4.00
20
$2.00
5.00
25
6.00
30
$5.00
$1.00
The supply curve shows how price affects
quantity supplied, other things being equal.
These other things are non-price determinants
of supply.
Changes in them shift the S curve
$0.00
0
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10 15
20 25 30
35
THE MARKET FORCES OF SUPPLY AND DEMAND
26
Supply Curve Shifters: input prices
CHAPTER 4
THE MARKET FORCES OF SUPPLY AND DEMAND
27
Supply Curve Shifters: input prices
Examples of input prices:
Suppose the
price of milk falls.
At each price,
the quantity of
Lattes supplied
will increase
(by 5 in this
example).
wages, prices of raw materials.
$6.00
A fall in input prices makes production
$5.00
more profitable at each output price,
so firms supply a larger quantity at each price,
and the S curve shifts to the right.
$4.00
$3.00
$2.00
$1.00
$0.00
0
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THE MARKET FORCES OF SUPPLY AND DEMAND
28
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10 15
20 25 30
35
THE MARKET FORCES OF SUPPLY AND DEMAND
29
Supply Curve Shifters: technology
Supply Curve Shifters: # of sellers
Technology determines how much inputs are
An increase in the number of sellers increases
required to produce a unit of output.
the quantity supplied at each price,
A cost-saving technological improvement has
shifts S curve to the right.
the same effect as a fall in input prices,
shifts S curve to the right.
CHAPTER 4
THE MARKET FORCES OF SUPPLY AND DEMAND
30
Variable
Example:
Events in the Middle East lead to expectations of
higher oil prices.
In response, owners of Texas oilfields reduce
supply now, save some inventory to sell later at
the higher price.
S curve shifts left.
supply*
In general, sellers may adjust
when their
expectations of future prices change.
(*If good not perishable.)
THE MARKET FORCES OF SUPPLY AND DEMAND
ACTIVE LEARNING
32
2:
31
A change in this variable
Price
causes a movement
along the S curve
Input prices
shifts the S curve
Technology
shifts the S curve
No. of sellers
shifts the S curve
Expectations
shifts the S curve
CHAPTER 4
THE MARKET FORCES OF SUPPLY AND DEMAND
33
A C T I V E L E A R N I N G 2:
A. fall in price of photo imaging software
Supply curve
Draw a supply curve for
photo imaging software.
What happens to it in each
of the following scenarios?
A. Retailers cut the price of
the software.
B. A technological advance
allows the software to be
produced at lower cost.
THE MARKET FORCES OF SUPPLY AND DEMAND
Summary: Variables That Affect Supply
Supply Curve Shifters: expectations
CHAPTER 4
CHAPTER 4
Price of
photo
imaging
software
S1
P1
P2
S
S curve
curve does
does
not
not shift.
shift.
Move
Move down
down
along
along the
the curve
curve
to
to aa lower
lower P
P
and
and lower
lower Q.
Q.
Picture source: Wikipedia
Q2 Q1
C. Professional photoshops raise the price of
the services they provide.
34
Quantity of
photo imaging
software
35
2:
B. fall in cost of producing the software
2:
C. professional photoshops raise their price
ACTIVE LEARNING
Price of
photo
imaging
software
S1
Q2
Price of
photo
imaging
software
S
S curve
curve shifts
shifts
to
to the
the right:
right:
at
at each
each price,
price,
Q
Q increases.
increases.
S2
P1
Q1
ACTIVE LEARNING
Quantity of
photo imaging
software
$5.00
$4.00
$3.00
$2.00
Equilibrium:
P has reached
the level where
quantity supplied
equals
quantity demanded
QS
$5.00
$0
24
$4.00
21
$3.00
18
10
15
15
12
20
25
30
$2.00
$1.00
$0.00
$0.00
Q
5
CHAPTER 4
10 15 20 25 30 35
38
Equilibrium quantity:
The quantity supplied and quantity demanded
at the equilibrium price
P
D
S
$6.00
D
S
P
24
$5.00
$4.00
21
$4.00
$3.00
18
10
$3.00
15
15
12
20
25
$1.00
30
$0.00
$1.00
Q
0
CHAPTER 4
THE MARKET FORCES OF SUPPLY AND DEMAND
and
QS = 25 lattes
resulting in a surplus
of 16 lattes
Q
0
40
39
then
QD = 9 lattes
$2.00
10 15 20 25 30 35
THE MARKET FORCES OF SUPPLY AND DEMAND
10 15 20 25 30 35
Surplus:
when quantity supplied is greater than
quantity demanded
P
Example:
D Surplus
S
$6.00
If P = $5,
$0
$2.00
CHAPTER 4
$5.00
$0.00
Q
0
THE MARKET FORCES OF SUPPLY AND DEMAND
37
Equilibrium price:
The price that equates quantity supplied
with quantity demanded
P
D
S
$6.00
D
$1.00
This
This shifts
shifts the
the
demand
demand curve
curve for
for
photo
photo imaging
imaging
software,
software, not
not the
the
supply
supply curve.
curve.
Quantity of
photo imaging
software
36
Supply and Demand Together
$6.00
S1
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10 15 20 25 30 35
THE MARKET FORCES OF SUPPLY AND DEMAND
41
Surplus:
when quantity supplied is greater than
quantity demanded
P
D Surplus
S Facing a surplus,
$6.00
sellers try to increase
$5.00
sales by cutting price.
Surplus:
when quantity supplied is greater than
quantity demanded
P
D Surplus
S Facing a surplus,
$6.00
sellers try to increase
$5.00
sales by cutting price.
$4.00
This causes
QD to rise and QS to fall
$4.00
which reduces the
surplus.
$2.00
$3.00
$2.00
$1.00
$0.00
5
CHAPTER 4
Prices continue to fall until
market reaches equilibrium.
$1.00
$0.00
Q
0
This causes
QD to rise and QS to fall.
$3.00
10 15 20 25 30 35
Q
0
THE MARKET FORCES OF SUPPLY AND DEMAND
42
CHAPTER 4
10 15 20 25 30 35
THE MARKET FORCES OF SUPPLY AND DEMAND
Shortage:
when quantity demanded is greater than
quantity supplied
P
Example:
D
S
$6.00
If P = $1,
$5.00
then
$4.00
QD = 21 lattes
and
$3.00
QS = 5 lattes
$2.00
resulting in a
$1.00
shortage of 16 lattes
Shortage:
when quantity demanded is greater than
quantity supplied
P
Facing a shortage,
D
S
$6.00
sellers raise the price,
$0.00
$0.00
Shortage
0
CHAPTER 4
10 15 20 25 30 35
44
Shortage:
when quantity demanded is greater than
quantity supplied
P
Facing a shortage,
D
S
$6.00
sellers raise the price,
$2.00
$1.00
$2.00
$1.00
Shortage
CHAPTER 4
10 15 20 25 30 35
THE MARKET FORCES OF SUPPLY AND DEMAND
45
To
To determine
determine the
the effects
effects of
ofany
anyevent,
event,
1.
1. Decide
Decide whether
whetherevent
eventshifts
shifts SScurve,
curve,
DDcurve,
curve,or
orboth.
both.
2.
2. Decide
Decide in
in which
which direction
direction curve
curve shifts.
shifts.
Prices continue to rise
until market reaches
equilibrium.
$3.00
$3.00
Three Steps to Analyzing Changes in Eqm
causing QD to fall
and QS to rise.
$4.00
causing QD to fall
and QS to rise,
which reduces the
shortage.
$4.00
THE MARKET FORCES OF SUPPLY AND DEMAND
$5.00
$5.00
43
3.
3. Use
Use supply-demand
supply-demand diagram
diagram to
to see
see
how
the
shift
changes
eqm
P
how the shift changes eqm Pand
and Q.
Q.
Shortage
$0.00
Q
0
CHAPTER 4
10 15 20 25 30 35
THE MARKET FORCES OF SUPPLY AND DEMAND
46
CHAPTER 4
THE MARKET FORCES OF SUPPLY AND DEMAND
47
EXAMPLE:
The Market for Hybrid Cars
EXAMPLE 1: A Change in Demand
EVENT TO BE
ANALYZED:
price of
hybrid cars
Increase in price of gas.
S1
STEP 1:
D curve shifts
because
STEP 2: price of gas
affects demand for
D shifts right
hybrids.
because
high gas
STEP
3: does
S
curve
not
price
makes
hybrids
The shift causes
an
shift,
more because
attractiveprice
increase
in price
of
gas
does
not
relative to other cars.
and quantity
affect
cost of of
hybrid cars.
producing
hybrids.
P1
D1
Q
Q1
quantity of
hybrid cars
CHAPTER 4
48
THE MARKET FORCES OF SUPPLY AND DEMAND
CHAPTER 4
D2
D1
Q1 Q2
occurs when a non-price determinant of supply
S1
changes (like technology or costs)
Change in the quantity supplied:
P2
a movement along a fixed S curve
occurs when P changes
P1
Change in demand: a shift in the D curve
occurs when a non-price determinant of
D2
D1
demand changes (like income or # of buyers)
Q
Q1 Q2
Change in the quantity demanded:
a movement along a fixed D curve
occurs when P changes
50
THE MARKET FORCES OF SUPPLY AND DEMAND
EXAMPLE 2: A Change in Supply
EXAMPLE 3: A Change in Both Supply
EVENT: New technology
P
reduces cost of
producing hybrid cars.
EVENTS:
price of gas rises AND
new technology reduces
production costs
and Demand
S1
S2
STEP 1:
S curve shifts
because
STEP 2: event affects P1
cost of production.
P2
S shifts right
D
curve does
not
because
event
STEPbecause
3:
shift,
reduces
cost,
The shift causes
production
technology
makes production
price
to
fallof the
is
not
one
more profitable at
and quantity
to rise.
factors
thatprice.
affect
any given
demand.
CHAPTER 4
49
THE MARKET FORCES OF SUPPLY AND DEMAND
Change in supply: a shift in the S curve
Always be careful
to distinguish b/w
a shift in a curve
and a movement
along the curve.
P1
Terms for Shift vs. Movement Along Curve
EXAMPLE 1: A Change in Demand
Notice:
When P rises,
producers supply
a larger quantity
of hybrids, even
though the S curve
has not shifted.
CHAPTER 4
S1
P2
STEP 1:
Both curves shift.
P
S1
S2
P2
P1
STEP 2:
Both shift to the right.
STEP 3:
D1
Q1 Q2
THE MARKET FORCES OF SUPPLY AND DEMAND
Q rises, but effect
on P is ambiguous:
If demand increases more
than supply, P rises.
52
CHAPTER 4
D1
Q1
Q2
THE MARKET FORCES OF SUPPLY AND DEMAND
D2
Q
53
3:
Changes in supply and demand
EXAMPLE 3: A Change in Both Supply
ACTIVE LEARNING
and Demand
EVENTS:
price of gas rises AND
new technology reduces
production costs
STEP 3, cont.
But if supply
increases more
than demand,
P falls.
P
S1
Event A: A fall in the price of compact discs
P1
Event B: Sellers of music downloads negotiate a
reduction in the royalties they must pay
for each song they sell.
P2
D2
D1
Q1
CHAPTER 4
Use the three-step method to analyze the effects of
each event on the equilibrium price and quantity of
music downloads.
S2
Q2
Event C: Events A and B both occur.
54
THE MARKET FORCES OF SUPPLY AND DEMAND
3:
ACTIVE LEARNING
A. fall in price of CDs
P
ACTIVE LEARNING
B. fall in cost of
royalties
The market for
music downloads
S1
STEPS
1. D curve shifts
P1
2. D shifts left
P2
55
The market for
music downloads
S1
STEPS
3. P and Q both
fall.
D2
Q2 Q1
3:
1. S curve shifts
(royalties are part
2. S shifts right
of sellers costs)
3. P falls,
Q rises.
D1
S2
P1
P2
D1
Q1 Q2
56
57
CONCLUSION:
3:
C. fall in price of CDs
AND fall in cost of royalties
ACTIVE LEARNING
How Prices Allocate Resources
One of the Ten Principles from Chapter 1:
Markets are usually a good way
to organize economic activity.
STEPS
STEPS
1.
1. Both
Both curves
curves shift
shift (see
(see parts
parts AA && B).
B).
In market economies, prices adjust to balance
2.
2. D
D shifts
shifts left,
left, SS shifts
shifts right.
right.
supply and demand. These equilibrium prices
are the signals that guide economic decisions
and thereby allocate scarce resources.
3.
3. PP unambiguously
unambiguously falls.
falls.
Effect
Effect on
on Q
Q is
is ambiguous:
ambiguous:
The
The fall
fall in
in demand
demand reduces
reduces Q,
Q,
the
increase
in
supply
the increase in supply increases
increases Q.
Q.
58
CHAPTER 4
THE MARKET FORCES OF SUPPLY AND DEMAND
59
CHAPTER SUMMARY
A competitive market has many buyers and
CHAPTER SUMMARY
Besides price, demand depends on buyers
sellers, each of whom has little or no influence
on the market price.
incomes, tastes, expectations, the prices of
substitutes and complements, and # of buyers.
If one of these factors changes, the D curve shifts.
Economists use the supply and demand model to
The upward-sloping supply curve reflects the Law
analyze competitive markets.
of Supply, which states that the quantity sellers
supply depends positively on the goods price.
The downward-sloping demand curve reflects the
Law of Demand, which states that the quantity
buyers demand of a good depends negatively on
the goods price.
CHAPTER 4
Other determinants of supply include input prices,
technology, expectations, and the # of sellers.
Changes in these factors shift the S curve.
60
THE MARKET FORCES OF SUPPLY AND DEMAND
CHAPTER SUMMARY
The intersection of S and D curves determine
CHAPTER 4
61
THE MARKET FORCES OF SUPPLY AND DEMAND
CHAPTER SUMMARY
We can use the supply-demand diagram to
analyze the effects of any event on a market:
First, determine whether the event shifts one or
both curves. Second, determine the direction of
the shifts. Third, compare the new equilibrium to
the initial one.
the market equilibrium. At the equilibrium price,
quantity supplied equals quantity demanded.
If the market price is above equilibrium,
a surplus results, which causes the price to fall.
If the market price is below equilibrium,
a shortage results, causing the price to rise.
In market economies, prices are the signals that
guide economic decisions and allocate scarce
resources.
CHAPTER 4
62
THE MARKET FORCES OF SUPPLY AND DEMAND
Seeing the Invisible Hand
CHAPTER 4
63
THE MARKET FORCES OF SUPPLY AND DEMAND
Seeing the Invisible Hand
Seeing the Invisible Hand
Seeing the Invisible Hand
12
10
9
10
8
7
Demand
Price
Price
6
6
Supply
4
4
3
2
1
0
0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
Quantity
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
Quantity
Seeing the Invisible Hand
Seeing the Invisible Hand
Seeing the Invisible Hand
Seeing the Invisible Hand
12
12
10
10
Demand
Supply
Price
Price
Demand
4
2
2
0
1
10
Quantity
11
13
15
17
19
Quantity
Seeing the Invisible Hand
Seeing the Invisible Hand
Seeing the Invisible Hand
12
10
10
Supply
Price
Price
Seeing the Invisible Hand
12
Demand
Supply
0
1
10
Quantity
Summary
Supply, Demand, and Equilibrium
Step 1: Identify which curve shifts (or both)
Step 2: Identify what direction did it shift
Step 3: Use the S/D graph to find how
equilibrium price and quantity change
Homework: Mankiw, p. 85-87, Problem 4,
7, 8, 12, 13
Quantity
10
