Your second reading assignment is pp. 59-78. It deals with a major topic in economics, namely supply and demand. You need to have a thorough understanding of this material.

With respect to the presentation on page 59 and at the top of page 60, we could say that you have a demand for an item if you would be ready, willing, and able to buy it at some price. Demand is a theoretical construct. It consists of a set of hypothetical prices and the quantity demanded associated with each of those prices. This set of prices and quantities represents your demand for a particular item. If, for instance, you are someone who can't stand eating sardines and would not buy them no matter how low the price, then you simply have no demand for sardines. But if you would purchase sardines at some price, whether that be ten cents per can or one dollar per can, then you do have a demand for sardines.

The so-called law of demand is discussed on pp. 62-67. It is common sense to say that higher prices lead to a lower sales level and lower prices result in a higher sales level. That is, there is an inverse relationship between price and quantity demanded. This may be shown by a demand schedule, which is a simple table that lists various prices and the associated quantity demand. Assume the product is a large pepperoni pizza and the relevant consumer market is a small one, namely your family's monthly demand for pepperoni pizza. Perhaps the schedule looks like this:

At a price of $8 you're overdosing on pizza. At the higher price of $14 you maintain self control and only call in pizza twice each month. Make sure that you keep the law of demand in mind as you study supply and demand. It is a basic assumption of the analysis. In other words, it is assumed that there is an inverse relationship between price and quantity demanded.

The next thing to do is graph this demand schedule, that is, create a demand curve. Note that it is called a demand curve even though it is often shown as a straight line for convenience. A straight line demand curve is sometimes known as a linear demand curve. When setting up your demand curve, use the correct format: put the quantity on the horizontal axis and the price on the vertical axis. Use an evenly spaced scale for each axis. In this example, you could choose $4, 8, 12, and 16 as your price scale and 4, 8, 12, and 16 as the quantity scale. Label the vertical axis P and the horizontal axis Q. Now you are ready to plot the points: $8 and 14, $10 and 11, $12 and 9, and $14 and 6. Connect these points with a smooth line. You have just sketched a demand curve.

Note the negative slope of this curve. This is due to the inverse relationship between price and the sales level, which is indicated mathematically by a minus sign and negative slope. If a demand curve doesn't slope down from left to right, then something is wrong and you should check your work. Sketch the graph in the space below if you haven’t done so already.

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Although we are not yet ready to study the supply curve in detail, go ahead and sketch in a generic looking supply curve on the same graph you just created. You don’t have to plot specific points for this, just draw in an upward sloping supply curve as it moves from left to right. This will come in handy as a reference for the changes in demand we will study because the intersection of the demand and supply curves indicates the equilibrium price and quantity. Add a supply curve to your graph now.

Suppose we start at a price of $10 and then change the price to $12. The associated quantity changes from 11 (at $10) to 9 (at $12). The only reason for the change in quantity was the change in price. This may seem very elementary, but other reasons are possible, such as a change in household income. For instance, if your household income was cut by 25%, you might order pizza less often even if the price had stayed the same. But for now, we are holding all other factors constant. The only change is a change in the price of the product itself. This is referred to as a change in quantity demanded. This will soon be distinguished from a shift in demand (also known, confusingly, as a change in demand). For this price change from $10 to $12, you simply use the same demand curve you have already constructed. You don't need a new demand curve in a different position since only the product price changed and nothing else. Plot these two points on a graph and insert an arrow showing the movement along the demand curve.

A shift in demand results from some factor changing other than the price of the product itself. It is true that this factor will then lead to a different market price for the good, but the impetus for the new price was a factor such as a change in household income or a change in the price of a substitute or complementary good. In a sketch graph, no specific points are plotted on the graph. We are just looking at the tendencies for supply and demand curves to shift in response to certain changes. Sketch graphs are often used in economics and you should be comfortable with them. Draw a normal looking, downward sloping demand curve and then add a normal, upward sloping supply curve. The intersection of the two is the equilibrium point, labeled E. There is an associated price-quantity combination for this equilibrium point. When the demand or supply curve shifts to the right or left a new equilibrium point will result with a different price-quantity combination. A generic sketch graph looks like this, before the demand or supply curve shifts:

For changes in household income, we consider goods classified as normal which is the typical classification, or inferior, which is less common, but not rare. Most goods, such as a large pepperoni pizza, are considered normal goods because as income rises, you purchase more and as income falls, you buy less. That is, there is a direct, positive relationship between your household income and your demand for pizza. At least, for most income ranges this should hold true. If your income rises from $30,000 to $60,000 per year, you would order more pizza each month and if it fell from $30,000 to $15,000, then you would order less. Using the same set of prices contained in the original demand schedule, the associated quantity for each listed price would be more at a higher income and less at a lower income. At a higher income, your new set of associated quantities might be Q2 and at a lower income, the new set of quantities could be Q3. Go ahead and graph a new demand curve using the same prices along with Q2. This will result in a shift in demand to the right, known as an increase in demand. Now graph another demand curve (on the same graph as the original, by the way) using the original prices along with Q3. This is also a shift in demand, this time a decrease in demand.

It is possible that if your income doubled from $60,000 to $120,000, you might call in pizza less frequently due to certain substitutions in your food consumption. You might start buying more steak or more lobster or you might go out more frequently for quality restaurant meals. If this happens, your pizza consumption could actually diminish at higher incomes and now pizza would be considered an inferior good. An inferior good features an inverse relationship between income and demand: a higher income leads to a reduced demand and a lower income results in greater demand. Referring again to the demand schedule above, if a household has a high income, then a further increase could lead to Q3 (a decrease in demand) while a reduction in income might result in Q2, an increase in demand. But for the vast majority of families, it's fair to say that pizza would be classified as a normal good. If it is an inferior good, then an increase in income results in a decrease in demand; If it is a normal good, then an increase in income shifts the demand curve to the right. Draw sketch graphs to illustrate this. Your first sketch is for normal goods, income increases; Your second sketch is for inferior goods, income increases.