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Demand and Supply Analysis
A market is a group of buyers and sellers that
interact to exchange a good or service.
Markets differ in their degree of organization
(e.g., securities markets, housing markets
with multiple listing services, farmer's
market, lawn care, Ebay).
market. However, there are numerous
examples where geography is relatively
unimportant in determining the buyers and
sellers that interact. Examples include the
markets for many financial services and
assets as well as personal computers.
property that goods and services are
exchanged and prices are determined. It is the
interaction of buyers and sellers in the
marketplace that determines price and
quantity.
Markets are classified according to their
degree of competition.
goods sold by all firms are identical and there
are sufficient numbers of buyers and sellers
so that each has a negligible effect on the
market price (i.e., each is a price taker).
.A market is monopolistically competitive if
there are many sellers selling slightly
differentiated products. In this case, sellers
have some control over price.
.Oligopoly refers to a market where there are
only a few sellers who may not compete
aggressively.
.Monopoly refers to the case where there is a
single seller that sets the price.
We first consider the case of perfect
competition. The following relates to the
behavior of buyers.
good that a buyer is (buyers are) willing and
able to purchase during a specified period of
time. Quantity demanded refers to a
particular number of units.
change in the quantity of the good that a
buyer is (buyers are) willing and able to
purchase. This is a change in the number of
units.
What determines the quantity demanded? The
quantity demanded by a consumer will
depend upon the following factors:
The good's own price.
The consumer's income.
The prices of related goods.
The tastes and preferences of the consumer.
Expectations and other special influences
(e.g., weather).
(Think of these factors in the context of a
particular good.)
of related products, tastes, special influences)
where Qd is the quantity demanded and f(.) is
the notation used to represent a function; the
quantity demanded is a function of the good’s
own price, … .
First consider the relationship between the
quantity demanded and the good's own price,
ceteris paribus (i.e., other things being equal).
Vanessa's Demand Schedule
for video rentals (per month)
price
A demand schedule is a table representation
of the relationship between the price of a
good and the quantity demanded, other things
equal.
A demand curve is a graphical
representation of the relationship between the
price of a good and the quantity demanded,
ceteris paribus.
The law of demand states that there is an
inverse or negative relationship between a
good's price and the quantity demanded, other
things constant.
The law of demand is reflected in demand
curves being downward sloping. This has the
following implications:
When the price of a good rises, the quantity
demanded falls, other things equal.
When the price of a good falls, the quantity
demanded increases, other things equal.
In summary, demand is the relationship
between the price of a good or service and the
quantity demanded, other things held
constant.
Market demand is the relationship between
the price of a good or service and the quantity
demanded by all buyers in the market, ceteris
paribus.
The market demand curve is obtained by
horizontally summing the demand curves for
all buyers in the market. See the following
example.
An implication is that an increase in the
number of buyers, ceteris paribus, will result
in an increase in demand.
Now consider what happens if "other things"
change, rather than remain constant?
more of the determinants of the quantity
demanded, other than price, might lead to
case B where, at each price, the quantity
demanded is lower than in case A. This is an
example of a change in the demand
relationship.
relationship between the quantity demanded
and price, resulting from a change in some
determinant other than the good's price. A
change in demand is reflected in a shift of the
demand curve.
Possible demand shifts:
reduction in demand: at each price, the
quantity demanded decreases.
increase in demand: at each price, the
quantity demanded increases.
curve. (Remember, change in demand refers
to a shift in the demand curve.) Rather, such a
price change results in a movement along a
given demand curve. A change in the price
of a good results in a change in the
quantity demanded but not a change in
demand.
addition, a change in the number of buyers
will also lead to change in market demand,
even if the demands of individual buyers
remain unchanged. Example: Think about the
effects of the baby-boom generation on the
demand for various products.
The causes of a change in market demand are
as follows:
.Change in income.
the good is positively related to income; for
example, an increase in income leads to an
increase in the demand for the good.
Example?
the good is negatively (inversely) related to
income; for example, an increase in income
results in a decrease in demand for the good.
Example?
.Change in the prices of related goods.
one is positively related to the price of the
other (e.g., if a fall in the price of one good
leads to a reduction in the demand for the
other).
Goods will often be substitutes when they
serve similar purposes (e.g., butter and
margarine).
Two goods are compliments if the demand
for one is inversely related to the price of the
other (e.g., a fall in the price of one good
leads to an increase the demand for the other.)
Goods will often be complements when they
are used together (e.g., bread and butter,
gasoline and tires).
Some goods are unrelated in that a change in
the price of one does not affect the demand
for the other.
.Changes in tastes.
Examples: baseball caps, tattoos, oat bran,
baseball caps (worn backward)
D. Changes in other influences.
Example: expectations regarding future prices
and income, and weather.
Exercise 1: Show (graphically) how the
demand for CD's is likely to be affected by
each of the following: A decrease in the
price of CD's.
A fall in the price of cassette tapes.
An increase in the price of CD players.
A decrease in the price of digital tape
recorders.
An increase in the price of milk.
A new government program is implemented
which gives every college student a payment
of $1000 per month.
There is increased interest in listening to live
music, rather than recordings.
Exercise 2: Show graphically and explain
what will happen to the demand for gasoline
when:
The price of air travel increases.
The price of automobiles fall.
Income rises.
Highway tolls rise.
Better public transportation becomes
available.
The price of gasoline rises.
Exercise 3: List various examples of factors
that would cause a change in the demand for
eggs.
Now consider the supply side of a market.
The quantity supplied is the quantity of a
good a seller is (sellers are) willing and able
to make available in the market over a given
period of time.
Quantity supplied refers to a particular
quantity.
change in the quantity of the good that a
supplier is (suppliers are) willing and able to
make available in the market over a given
period, often as a result of a change in the
good's price.
The quantity supplied of a good will depend
upon the following factors:
The good's own price.
Prices of inputs used to produce the good.
The technology regarding the transformation
of inputs into the output.
The prices of other goods the seller (sellers)
could supply.
Expectations.
In summary, Qs = g(own price, prices of
inputs, technology, price of alternative
products, expectations)
of a good and the quantity supplied, holding
other factors constant. This relationship can
be represented in a supply schedule or a
supply curve.
Law of Supply: There is a direct or positive
relationship between a good's price and the
quantity supplied, other things equal.
The law of supply is reflected in supply
curves being upward sloping. An implication
is that the quantity supplied will be larger the
higher is the good's price, ceteris paribus.
Market supply is the relationship between
the price of a good or service and the quantity
supplied by all sellers in the market, ceteris
paribus.
(horizontally) summing the supply curves for
all sellers in the market. For example, in the
following diagram, S is the horizontal
summation of S1, S2 and S3.
A change in supply is a change in the
relationship between the quantity supplied
and price that results from a change in a
determinant other than the good’s price.
Examples of supply shifts:
increase in supply: at each price, the quantity
supplied increases.
reduction in supply: at each price, the
quantity supplied decreases.
supply relationship reflected in a supply
curve). Rather, such a price change results in
a movement along a given supply curve. The
change in the price of a good results in a
change in the quantity supplied, but not a
change in supply.
A change in supply can result from each of
the following:
Changes in the prices of inputs necessary to
produce and sell the good.
Changes in technology.
Changes in expectations.
Changes in the prices of other goods that the
seller could supply.
Exercise 4:
Explain and show graphically how the supply
of personal computers is affected by each of
the following:
1. There is an increase in the wages paid to
workers having the skills needed to build
computers.
2. There is a decline in the prices of computer
components.
3. There are improvements in knowledge of
how to assemble computers.
4. The market price of trucks increases.
5. IBM decides to stop making personal
computers.
6. The market price of personal computers
declines.
Exercise 5:
Think of various examples of factors that
would cause a change in the supply of eggs.
Interaction of Supply and Demand
Now consider how demand and supply
interact to determine the market price as well
as the quantity transacted.
Digression:
Equilibrium is the state of balance between
opposing forces. In equilibrium, the system is
in a state of rest as there is no tendency for
change. Example: children on a see-saw.
In economics, there is an “equilibrium”
when economic forces are in balance. In such
a case, economic variables will have no
tendency to change.
Suppose that the market demand and supply
of eggs are as follows:
Market Demand and Supply for Eggs
quantity
Price
demanded quantity
6,000
5,000
6,000
7,000
8,000
9,000
4,000
5,000
surplus
surplus
surplus
surplus
shortage
upward
none none 4,000
downward 3,000
downward 2,000
downward 1,000
downward
at a given price, the quantity demanded
exceeds the quantity supplied. For example,
at a price of $0.50 per dozen there is a
shortage of 4000 units (i.e., dozens of eggs).
A shortage (excess demand) results in
upward pressure on price.
given price, the quantity demanded is less
than the quantity supplied. In the above
example, if the price of eggs was $1.75 per
dozen, there would be a surplus of 6000
dozen eggs.
A surplus (excess supply) results in
downward pressure on price.
When the quantity demanded equals the
quantity supplied, demand and supply
forces will be in balance so that there will
be no tendency for price to change.
A market equilibrium exists when the price
of a good is such that the quantity demanded
is equal to the, quantity supplied.
because the quantity demanded equals the
quantity supplied; the number of units that
buyers are willing and able to purchase
exactly equals the number of units that sellers
are willing and able to sell.
The terms equilibrium price and
equilibrium quantity are used to denote the
price and quantity that correspond to the
market equilibrium.
Law of demand and supply: The market
price of a good will adjust so that supply and
demand forces will be in balance.
market. Consider an oral auction with an
auctioneer. Even though there are no
auctioneers in most competitive markets, the
markets tend to be self-equilibrating because
of the competition between buyers and
sellers.
attained. Furthermore, if the market demand
and supply curves remain unchanged, there
will be no tendency for price and quantity
traded in the market to change. Only if there
is a change in demand or supply, or both, will
the equilibrium price and quantity change.
Consider how equilibrium price and
equilibrium quantity change as a result of
changes in demand or supply, or both.
A. An increase in demand, ceteris paribus,
will result in equilibrium price and
quantity both increasing.
With demand and supply curves D1 and S,
respectively (shown below) the initial
equilibrium is at price P1 and quantity Ql.
price, P1, there is now an excess demand of
Q3 – Q1 units. Reflecting this excess demand,
market forces will cause the price to rise. The
new equilibrium will be at price P2 and
quantity Q2. Note that both the equilibrium
price and quantity both have increased.
eliminates this excess demand. The increase
in price from P1 to P2 results in an increase in
the quantity supplied from Q1 to Q2
(movement along the supply curve S) and a
reduction in the quantity demanded from Q3
to Q2 (movement along the new demand
curve, D2). In this way, the increase in price
leads to the elimination of the shortage.
NOTE: The increase in demand results in an
increase in the quantity supplied, but not an
increase in supply.
B. A decrease in demand, ceteris paribus,
will result in decreases in both the
equilibrium price and the equilibrium
quantity.
Exercise: Write out an explanation similar to
that in case A, explaining how a decrease in
demand from D1 to D5 causes the equilibrium
price and equilibrium quantity to fall.
C. An increase in supply, ceteris paribus,
will result in reduction in the equilibrium
price and an increase in the equilibrium
quantity.
With demand and supply curves D and Sa,
respectively, the initial equilibrium is at price
P1 and quantity Q1.
reduction in price results in an increase in the
quantity demanded (movement along the
demand curve D) and a reduction in the
quantity supplied (movement along the new
supply curve, Sb). These changes lead to a
reduction in, and ultimately the elimination
of, the initial excess supply. The new
equilibrium will be at price P2 and quantity
Q2. Note that the equilibrium price has fallen
and the equilibrium quantity has increased.
D. A decrease in supply, ceteris paribus, will
result in an increase in the equilibrium price
and a reduction in the equilibrium quantity.
in supply will result in an increase in the
equilibrium price and a reduction in the
equilibrium quantity. Write an explanation
similar to those above, explaining your
analysis in detail.
Now consider combinations of changes in
demand and supply.
increase in the equilibrium quantity. The
equilibrium price could rise, fall or remain
unchanged - depending on the relative
magnitudes of the shifts in demand and
supply. This can be seen by considering the
changes in demand and supply one at a time.
In each of the following two diagrams,
demand increases from D1 to D2 and supply
increases from S1 to S2.
remained at the initial level, P1, there would
be a shortage (excess demand), which result
in an increase in market price (P1 to P2).
Thus, in this case, the changes in demand and
supply together result in an increase in the
equilibrium price.
relatively to the increase in demand results in
there being an excess supply at P1 (given the
new demand and supply curves). This leads to
a fall in the market price.
rises, falls or remains unchanged depends
upon whether the change in demand or the
change in supply is larger (at the initial
equilibrium price).
Note: with increases in both demand and
supply the equilibrium quantity always
increases.
the equilibrium price. The equilibrium
quantity could rise, fall or remain unchanged
- depending on the relative magnitudes of the
shifts in demand and supply. Again, this can
be seen by considering the changes in
demand and supply one at a time.
Effects of an increase in demand
together with a decrease in supply
equilibrium demand effect supply effect
net effect quantity
up down ?
price up up up
showing the pre- and post-change equilibria
and demonstrate that the equilibrium price
must rise but that the equilibrium quantity
could increase or fall.
the demand effect or the supply effect
dominates. This will be determined by
whether (after the changes in demand and
supply) there is an excess demand or an
excess supply at the pre-change equilibrium
price.
increase in supply will result in a decrease in
the equilibrium price. The equilibrium
quantity could rise, fall or remain unchanged
- depending upon the relative magnitudes of
the shifts in demand and supply.
Effects of an decrease in demand
together with a increase in supply
equilibrium demand effect supply effect
net effect quantity
down up ?
price down down down
decrease in supply will result in a decrease in
the equilibrium quantity. The equilibrium
price could rise, fall or remain unchanged,
depending upon the relative magnitudes of
the shifts in demand and supply.
Effects of an decrease in demand
together with a decrease in supply
equilibrium demand effect supply effect
net effect quantity
down down
down price down up ?
A four-step analysis can be used to work
through how various changes affect
equilibrium price and quantity.
1. Characterize the initial equilibrium (e.g.,
identify the equilibrium price and quantity).
.Determine whether the events being
considered result in changes in demand
and/or supply.
.If so, determine whether the events result in
an increase or decrease in demand and/or
supply.
.Given the changes in demand and/or supply,
determine how the equilibrium price and
quantity change.
Examples:
Consider the market for detached single
family housing and analyze the effects of the
following changes:
The incomes of households increase.
There is an aging of the population; babyboomers become senior citizens.
New construction technologies are developed.
Due to increased restrictions on logging in
National Forests, the price of lumber
increases.
A hurricane destroys 10 percent of a region's
housing stock.
quantity in a market change as a result of
changes in factors external (exogenous) to the
market. (Remember that demand and supply
interact to determine the price and quantity
traded in a market. However, there are a
variety of factors external to the market that
can affect demand and/or supply.)
quantity that would result from changes in the
determinants of demand and supply, consider
what changes in the determinants of supply
and demand could possibly explain observed
changes in a good's equilibrium price and
quantity.
in the equilibrium quantity accompanied by
very large reductions in equilibrium price.
How can such a change from point a to b
explained in terms of changes in demand and
supply?
The above comparative static analyses of how
changes in demand and supply affect
equilibrium price and equilibrium quantity
are applicable for all competitive markets.
rate per year
Borrowers lenders labor
hour worked wage per hour Firms
individuals foreign exchange yen
dollars per yen those wanting yen those
wanting to liquidate yen crude oil crude oil
dollars per barrel refiners oil field
owners personal computer personal
computers dollars per computer
Individuals computer companies