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Chapter 3
Demand (D),
Supply (S), and
Market Prices
Econ Quote of the Day
Teach a parrot the terms ‘supply and
demand’ and you’ve got an economist.
- Thomas Carlyle
Chapter 3 Objectives:
Upon completion of this lecture, you should understand and be able to answer these key questions:
1.
What are the basic decision-making units in the economy?
2.
What are the relationships between these basic units? How does a circular flow diagram
illustrate these relationships?
3.
What do we mean by ‘quantity demanded?’ What influences quantity demanded on the part
of households?
4.
What is the demand schedule for a product? What are the main features of a demand curve?
What is the law of demand and how is it illustrated by demand curves?
5.
What can change the demand for a product? How does the demand curve react to changes
in demand? What do we mean by normal goods? Inferior goods? Complementary goods?
Substitute goods?
6.
What is the law of supply? What influences the quantity supplied of a good? What are the
features of a supply curve? How do supply curves illustrate the law of supply? What factors
can cause the supply of a product to change and how are these changes reflected in the
supply curve?
7.
What is the equilibrium price for a product? What do we mean by a shortage? A surplus?
8.
How do changes in the supply or demand for a product affect its equilibrium price and
quantity?
Key Concepts
1.
2.
Circular flow model and markets
Demand (D)
a.
b.
c.
d.
3.
Supply (S)
a.
b.
c.
4.
D schedule, D curve, movement along D curve, law of D
Factors affecting D, shift of D curve
Individual and market D
Types of goods (normal, inferior, substitutes, complements)
S schedule, S curve, movement along S curve, law of S
Factors affecting S, shift of S curve
Individual and market S
Market interaction of S&D
a.
b.
Disequilibrium (excess demand, excess supply)
Equilibrium & equilibrium changes (due to shifts in D and/or S)
Some S & D Managerial Implications
1.
2.
Understand how P’s are determined in order to anticipate P
changes and capitalize with strategies related to:
- buying
- selling
- producing
- managing inventories
- staffing
- contracting
Understand how consumers and producers are likely to
respond or be motivated by P changes (i.e. how economic
activities are coordinated) in order to anticipate and capitalize
on those expected responses.
D Schedule
= a table showing the quantities
(physical amount or units) of an
item a buyer (or buyers) are willing
to buy at different prices, ceteris
paribus
D Curve
= a graph of a D schedule, normally with price
(P) units on the vertical axis.
P
D
Q
Q.
On a typical day, literally
millions of hamburgers are
purchased by individuals in
the U.S. What factors influence
the willingness and ability of
these consumers to buy
hamburgers?
Law of D
D
curves are downward sloping
ΔP
and ΔQd are in ‘opposite’
directions
Quote of the Day

“In this world, there are two ways to get rich:
#1. Produce something valuable and sell it to
others.
#2. Steal from those who are successful at
pursuing the first strategy.”
N. Gregory Mankiw
Fortune (June 12, 2000)
Factors That Affect D for X
1. PX = P of that product (or item) (note ΔP could be
caused by Δ supply)
2. P and/or availability of another item (e.g. Y)
a. Substitutes (PY   D for X)
b. Complements (PY   D for X)
3. Income (I)
a. Inferior (I  D for X)
b. Normal (I  D for X)
4. Type of Item
a. Luxury
b. Necessity
Factors That Affect D for X
5.
Buyer concerns or expectations
a.
b.
c.
6.
7.
8.
9.
10.
11.
12.
Safety
Health
Cost
Advertising
Tastes and preferences
No. of buyers or alternative uses
Govt. policy (e.g. tax)
Seasonality
Interest rates
Profitability of an input – derived demand
Graphical Impacts of D (for X) Factor s
1.
2.
ΔPX  movement along the D curve for X
(often called “Δ in quantity demanded”)
Δ any other factor  shift of the D curve for
X (called “Δ in demand”)
Shift to right   D
Change in “Quantity Demanded” of X
(Due to ΔPX = ΔP of THAT product)
PX
A to B: Increase in quantity demanded
A
10
B
6
D0
4
7
Q
Change in “Demand” for X
(Due to Δ other than ΔP of THAT product)
D0 to D1: Increase in Demand
PX
6
D1
D0
Q
7
13
S Schedule
= a table showing the quantities
(physical amount or units) of an
item a seller (or sellers) are willing
to sell at different prices, ceteris
paribus.
S Curve
= a graph of a S schedule, normally with price
(P) units on the vertical axis.
P
S
Q
Law of S
S
curves are upward sloping
 ΔP
and ΔQS are in the “same” direction
Q.
In a typical year recently, U.S.
farmers produce 9-11 billion
bushels of corn. What factors
influence the willingness and
ability of these producers to
produce corn?
Factors that Affect S of X
1.
2.
3.
4.
5.
PX = P of that product or item (note ΔP
could be caused ΔD)
P or profitability of an alternative production
item (e.g. Y) (PY  S of X)
P or cost of an input (e.g. Z) (PZ  S of X)
Taxes
Interest rates
Factors that Affect S of X
6.
7.
8.
9.
10.
Gov’t policies/regulations
Technology
Producer expectations
Weather
Number of producers
Graphical Impacts of S (of X) Factor Δs
1.
2.
ΔPX  movement along the S curve for X
(Often called ‘Δ quantity supplied”)
Δ any other factor  shift of the S curve for
X (often called “Δ in supply”)
Shift to right  S
Change in “Quantity Supplied” of X
(Due to ΔP = ΔP of THAT product)
PX
S0
B
20
10
A
Q
5
10
Change in Supply of X
(Due to Δ other thanΔP of THAT product)
PX
S0
S1
8
6
Q
5
7
Equilibrium Price =
Price for which QD = QS
P
(P=0+.01Q)
3.00
S
2.00*
← equilibrium point
(P=4-.01Q)
1.00
D
100
200*
300

In markets, people pursue their own self
interests by responding to price incentives.

Adam Smith (Wealth of Nations, 1776) noted
it’s almost as if individuals are being led by
an ‘invisible hand’, and this self-regulating
behavior actually promotes the best interests
of society as a whole.
Equilibrium Changes Over Time
P
P
P
S1
S2
D2
D1
Q
T1
S3
D3
Q
T2
Q
T3
Solving for Equilibrium P
Mathematically
Set S equation for P = D equation for P, and solve
for equilibrium Q
2.
Plug equilibrium Q back into either the S equation
or the D equation and solve for equilibrium P
Example:
S equation: P = 0 + .01Q
D equation: P = 4 - .01Q
 1) .01Q = 4 - .01Q  .02Q = 4  Q = 200
 2) P = 4 - .01Q  P = 4 - .01(200)  P = 2.00
1.
Q. What happens if a market price
is either above or below the
equilibrium value?
Disequilibrium price
 Prices for Qd ≠ QS
P
(P=0+.01Q)
Excess S
3.00
S
2.00
(P=4-.01Q)
Excess D
1.00
D
100
200
300
Q
Equilibrium Changes
Case
1. D
P

Q

2. D
3. S
4. S
5. D, S



?




6. D, S

?
7. D, S
8. D, S

?
?

Graph of Equilibrium Change,
Case #1 (DX)
 Shift of D curve for X to right caused by ΔD
factor other than ΔPX causes ΔPX which
causes ΔQS (movement along S curve)
PX
S1
P2
P1
D2
D1
QX
Graph of Equilibrium Change
Case #4 (SX)
Shift of S curve of X to left caused by ΔS
factor other than ΔPX causes ΔPX which
causes ΔQd (movement along D curve)
PX
S2
S1
P2
P1
D1
QX
Graph of Equilibrium Change
Case #6 (DX, SX)
PX
S2
S1
P2
P1
D2
D1
QX