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Ch. 4 Handouts: Demand and Supply
Demand (D): explains the overall relationship between the quantity of a good or service that
consumers buy and the various factors that influence their decisions.

These factors include (see Demand and Supply Review Handout)
o Selling price (P)
o Income (I)
o Price of Complements and Substitutes
o Interest Rates (R)
o Tastes and Preferences (quality, size, color, availability, brand,
advertising, etc)
o Expectations about future prices
o Expectations about future income

Demand is represented by an entire curve showing the overall relationship between
price and the quantity purchased holding these factors constant.
Quantity Demanded (Qd): is the amount of a good or service that consumers are willing and
able to buy at a given price holding all other factors constant.


Matches one price with one quantity intended to purchase
Each point along the demand curve represents Qd
Basic Inverse Demand and Demand Equations:
 Market for Digital Cameras
 Current values include I=$20,000, Price of computer=$1,000, Price of printer=$150.
Price of Digital Camera
$400
$300
$200

Quantity Demanded
500
650
800
Plot points to sketch a rough demand curve:

Get the inverse demand equation: P=a +bQ
o Get value for “b” or slope= __________________________________
o
o Get value for “a” by using any P, Q combo in table and substituting into
above. For example: when P=$400 we know Q=500.
o
o
o
o
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on graph above show y intercept as “735”

interpret the meaning as the “reservation price”—

get demand equation Q=f(P); basically rearrange to have Quantity on the left-hand
side
o
o
o Q=
o Now that Q is on left, the intercept value “a” is for the horizontal axis or
“Q” axis. Show on graph above.
o Interpret the new intercept “a” as the amount a firm would give away if
the product were free (P=0).
o The “b” in the equation is the inverse slope (Δx/Δy) or (ΔQd/ΔP)
o This is the coefficient from excel we saw yesterday.
Multiple Variable Analysis
Demand equation for coke with all variables:
Qcoke=f (Pcoke, Ppepsi, Income, POPulation, etc).
Ppepsi=$1.25
Income=$20,000
Population=10,000
Ex: in excel given some data you find that: Qc= -50000Pc +200Pp + 1.5I + 4 POP

This can be simplified to a basic demand curve for coke by substituting in current values
for everything other than the price of the good (coke)
Qc= -50,000Pc + 200(1.25) + 1.5(20,000) + 4(10,000)
Qc=-50,000Pc + 250 + 30,000+ 40,000
Qc=-50,000Pc + 70,250
demand equation
Plot this demand equation: Qc=-50,000Pc + 70,250
o need y-intercept or “reservation price”: the price at which consumers will buy zero
(Qd=0)
o need x-intercept: when the price is zero how many units will be theoretically
purchased:
Graph:
What information does this basic demand equation provide?
1.What price the firm should charge to get rid of excess inventory (surplus)?
If Q=20,000 units to sell:
2. If we decide to set our price at $1.20, estimate sales (Qc):
3. If we expect the median income to increase from $20,000 to $30,000 and still intent to
charge a price of $1.20, what will our sales (Qd) be?
o this represents a shift in demand with income
o at the same price, consumers are buying more
o plot on demand graph
4. The sign of the variables tells you about the relationship between the independent variable
and the dependent variable:
Original Ex: Qc= -50000Pc +200Pp + 1.5I + 4 POP
o the negative Pc means as price of coke increases (decreases), the quantity
demanded of coke, Qc, decreases (increases).

o the positive Pp means as the price of pepsi increases (decreases), the demand for
coke increases (decreases).

o The positive Income, I, means as income increases (decreases), demand for coke
increases (decreases).

o The positive POPulation means as the population increases (decreases) demand for
coke increases (decreases).
5. The magnitude of the coefficient of each independent variable tells you the affect on the
dependent variable for a one unit change in the independent variable:
o -50,000Pc: a $1.00 increase in the price of coke leads to a 50,000 drop in Qd of
coke.
o 1.5I (Income): a $1.00 increase in income leads to a 1.5 unit increase in the
Quantity of coke.
o Likewise, a $10.00 increase in the income leads to a 1.5(10)=15 unit increase in
the Quantity of coke.
Updating the demand equation:
o Demand data changes every day with economic indicators, consumer preferences, etc.
Firms cannot update equations every day and change prices in response to all changes
in the market.
o Most firms will adopt a demand equation that may be used for various time periods
(depending on the nature of the firm) and recognize that the equation may not be a
perfect representation of real world values at all times (or even most of the time)
o Updates may not come in a form in which you can just replace coefficients directly in
your equation:
o You may not always have raw data that tells you that income is expected to
increase from $20,000 to $30,000. You may be given % estimates from the
government, local economic agencies, etc.
o Ex:
Supply (S): explains the overall relationship between the quantity of a good or service that
sellers are willing to produce and sell at a given price depending on various factors that affect
their cost and profitability.
 These factors include (see Demand and Supply Review Handout)
o Selling price (P)
o Cost of Land, Labor, Capital, Materials
o Interest Rates (R)
o Business Taxes
o Subsidies
o Prices of Related Goods (other products they can shift production to)

Supply is represented by an entire curve showing the overall relationship between
price and the quantity produced and sold holding these factors constant.
Quantity Supplied (Qs): is the amount of a good or service that producers are willing and able
to sell at a given price holding all other factors constant.


Matches one price with one quantity intended to sell
Each point along the SUPPLY curve represents Qs
Basic Inverse Supply and Supply Equations:
Price
$150
$200
$250
Qs
900
1800
2700
o Determine inverse supply equation P=fQ)
o
o
o
o Find “c” by plugging in any P,Q combo; for example when P=150 Q=900.
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inverse supply equation is: P=100 +0.055Q
plot on graph; show “c” as “minimum selling price”—the lowest price
at which a firm will begin production and sale of a good.
Find the supply equation Q=f(p) by rearranging
o P=100 +0.055Q
o
o

-18 or “e” is the inverse slope (Δx/Δy) or (ΔQs/ΔP)
Market supply has multiple variables
Q=f(Price, Wage rate/cost of employees, materials cost, interest rates, etc).
The same analysis applies here as with demand.
You may estimate the equation by using regression analysis
Each coefficient tells you the impact on the quantity the firm will produce and sell for a 1 unit
change in the independent variable.
For example: Qs=-200 +57P -100wage – 2.57r
o coefficient for wage cost is -100.
o For every $1 increase in wage rate production will decrease by 100 units.
o Since the Illinois minimum wage increased on July 1st to $8.00 from 7.75 then
determine the impact on production quantity or supply:
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Market Equilibrium: occurs at the price at which Qd=Qs.
o No surplus (Qs > Qd)
o No shortage (Qd > Qs)
1. Plot:
Qd=40-0.2P
Qs=-10 + 0.1P
a. Demand x intercept 40
o
o
b. Demand y intercept:
o y intercept is when Qd=0
c. Supply x intercept -10 (as given by “c” in our equation or set Qd=0)
d. Supply y intercept
Graph:
2. Find the equilibrium price, Pe, and the equilibrium quantity, Qe.
Set Qd=Qs
40-0.2P= -10 +0.1P
50=0.3P
P=$166.67
Qd=40-1/5(166.67)=6.67
Qs=-10+1/10(166.67)6.67
Plot on graph above
3. If prices are artificially high (above Pe), say $175.00 determine the amount of the surplus or
shortage:
o Expect prices to fall to reach equilibrium price of $166.67
o When prices fall, Qd will increase and Qs will decrease until there is no longer a surplus.
Changes in Market Equilibrium:
o Occurs when either underlying factors affecting demand and/or supply change and thus
shift one or more curves.
o Ex: market for US cars ; show Pe, Qe. Suppose OPEC reduces oil production. Show
impact on both markets.
o Supply of gasoline decreases; shifts supply leftward
o
o Demand for cars will decrease (price of complement, gasoline, increases) so
demand will shift to the left
o
o Ex2: Show the impact on the car market when the price of gasoline increases (as above) and
simultaneously the government provides a subsidy (bailout) to car producers.
o
o
Graphing: eventually you MUST show the two together as the total impact on the car
industry.
o demand side:
o supply side:
o overall impact:
o overall impact:
Graph: