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Topic 1: Supply and Demand
Consider the following market. Let market demand and supply be given by the following
schedule.
Price
0
50
100
150
200
250
300
Quantity Demanded
12
10
8
6
4
2
0
Quantity Supplied
0
2
4
6
8
10
12
The following graph depicts the supply and demand curve.
Supply and Demand
300
250
Price
200
Quantity Demanded
150
Quantity Supplied
100
50
0
0
2
4
6
8
10
12
Quantity
The demand curve is downward sloping, indicating that consumers would be willing to
buy less as the price increases. The supply curve is upward sloping, indicating that
consumers would be willing to supply more as the price rises. The equilibrium point is Q
= 6 and P = 150. If the price is above the equilibrium price (say, at 200), then quantity
demanded is 4, quantity supplied is 8, and a surplus of 4 results. If the price is below the
equilibrium price (say, at 100), then quantity demanded is 8, quantity supplied is 4, and a
shortage of 4 results. If there is a shortage or a surplus, then there will be pressure to
move toward the equilibrium price level.
Factors that affect the Demand Curve
1.
Price (slide along the demand curve)
2.
Income (shifts the demand curve)
If the good is normal, then an increase in income increases demand (and a
decrease in income decreases demand):
Price

D1
D2
Quantity
However, if the good is inferior, then an increase in income decreases
demand (and a decrease in income increases demand):
Price

D2
D1
Quantity
Examples of inferior good for some consumers are macaroni and cheese,
bologna, and Roman noodles.
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3.
Prices of related goods (shifts the demand curve)
If the price of a substitute increases, then the demand curve will shift to the
right:
Price

D1
D2
Quantity
But if the price of a complement increases, then the demand curve will shift to
the left:
Price

D2
D1
Quantity
An example of substitutes is mountain dew and mellow yellow and an
example of complements is milk and cheerios.
4.
Tastes and preferences (shifts the demand curve).
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Factors that affect the Supply Curve
1.
Price (slide along the supply curve)
2.
Input prices (shifts the supply curve)
If the cost of an input increases, then the supply curve will shift to the left:
Price
S2
S1

Quantity
This would occur, for example, if the wages paid to a labor input increased.
3.
Technology (shifts the supply curve)
If there is an advance in technology such that output can be produced more
efficiently, then the supply curve will shift to the right:
Price
S1
S2

Quantity
4
4.
Number of firms (shifts the supply curve).
If the number of firms increases, then the supply curve will shift to the right:
Price
S1
S2

Quantity
A “slide” along a curve occurs when there is a price change (or a change in a variable
being graphed on one of the two axes). A “shift” of a curve occurs when a factor not
explicitly being graphed (such as income, prices of related goods, etc.) changes.
Now, consider the market for heroin. How can we reduce the market-clearing quantity of
heroin?
Factors decreasing demand will shift the demand curve to the left:
Price

D2
D1
Quantity
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Factors decreasing supply will shift the supply curve to the left:
Price
S2
S1

Quantity
Billions have been spent trying to stop illegal drugs at the boarder, yet this has only made
a small dint in the flow of drugs. Why? Economics can explain. When drug interdiction
confiscates drugs, this shifts the supply curve back, consequently raising price. As the
price goes up, this raises the reward for dealing drugs, and more drug producers are
attracted to the industry. This shifts the supply curve back to the left.
Price
S
p*2
p*1
D
0
q*2
q*1
Quantity
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Thus, economists have suggested focusing on reducing demand. When demand is
reduced (through changes in tastes and preferences), the demand curve shifts back but
price falls.
Price
S
p*1
p*2
D
0
q*2 q*1
Quantity
Another alternative is to legalize drugs. A high fraction of all the violent crimes
committed in the United States are drug-related. One major reason is that the price of
drugs are so high that addicts must steal to get the money that drug traffickers require,
and drug traffickers are willing to kill to protect their highly profitable business.
If drugs were legal, then drugs might become vastly cheaper. This would reduce drugrelated crimes. For example, have you ever heard of a gang killing connected with the
distribution of cigarettes?
Of course, if the price of drugs fell with legalization, then consumers would be willing to
buy more drugs and drug-use would increase, producing more addicts. This is because
legalizing drugs would shift the supply curve to the right (by reducing the price of inputs
or by increasing the number of firms) but would not necessarily shift the demand curve.
This would lower the price, but the equilibrium quantity would increase, as explained
above: at lower prices, consumers would be willing to buy more.
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Price Ceiling – A legal maximum on the price at which a good can be sold.
Price Floor – A legal minimum on the price at which a good can be sold.
New York is the only major city in the US that has had rent controls continuously since
WWII. The objective of rent control is, of course, to protect the consumer from high
rents. The figure below depicts the situation in New York.
Rental Housing in New York City
3600
3200
2800
Rent
2400
Quantity Demanded
2000
Quantity Supplied
1600
Price Ceiling
1200
800
400
0
0
0.5
1
1.5
2
2.5
3
3.5
4
4.5
Dw ellings (in millions)
As we would expect, rent controls have spawned a lively black market in New York. The
black market raises the effective price of rent-controlled apartments in many ways,
including bribes, key money paid to move up the waiting list, and requiring prospective
tenants to purchase worthless furniture at inflated prices.
Landlords, discouraged by the low rents, have converted apartment buildings into office
space. Other apartments have been inadequately maintained. After all, rent controls
create a shortage, which makes even dilapidated apartments easy to rent.
Why do rent controls persist? People do not understand the problem. Landlords are
unpopular. And, those who benefit from rent controls (those who have housing) only pay
a fraction of what they would pay on the open market. They are quite happy and don’t
want any change.
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Another example of price controls: the market for gasoline.
Price of
Gas
0.90
1.00
1.10
1.20
1.30
Quantity of Gas
Demanded
160
140
120
100
80
Quantity of Gas
Supplied
40
60
80
100
120
Now, impose a price ceiling. Describe the effects.
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Problem Set 1: Supply and Demand
1.
Suppose that the price of Vanderbilt football tickets is determined by market
forces. Currently, the demand and supply schedules are as follows:
Price
8
16
24
32
40
a)
b)
c)
d)
e)
Quantity Demanded Quantity Supplied
50,000
42,000
42,000
42,000
34,000
42,000
26,000
42,000
18,000
42,000
Graph the demand and supply curves.
What is unusual about this supply curve? Why might this be true?
What is the equilibrium price and quantity of Vanderbilt football tickets?
Suppose that Vanderbilt University sells its football tickets for a price of
$32.00. What will be the quantity supplied and demanded? Will there be a
shortage or a surplus?
Now suppose that the NFL’s Titans move to Nashville. Describe in words
how you think that this will affect your graph. Then, indicate the effect of the
Titan’s presence in Nashville on:
i.
ii.
iii.
iv.
the quantity of Vanderbilt football tickets demanded
the quantity of Vanderbilt football tickets supplied
the equilibrium price of Vanderbilt football tickets
the equilibrium quantity of Vanderbilt football tickets
Hint: the Titans won’t necessarily have an effect on all of these items.
f)
g)
Are Vanderbilt tickets a normal good or an inferior good? In drafting an
answer to this question, define normal good and inferior good.
Now suppose that the average income of all people in Nashville increases by
$10,000. Graphically, show the effect of this increase in income on the
market for Vanderbilt football tickets.
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2.
Suppose the supply and demand schedules for Japanese cars in the United States
are as follows:
Price
8
10
12
14
16
18
20
Table 2
Quantity Demanded
2.75
2.50
2.25
2.00
1.75
1.50
1.25
Quantity Supplied
1.25
1.50
1.75
2.00
2.25
2.50
2.75
a) Graph these curves and show the equilibrium price and quantity.
b) Now suppose that a rise in anti-Japanese sentiment in the U.S. reduces the
quantity demanded at each price by 500,000 (0.5 million cars). What is the new
equilibrium price and quantity? Show this solution graphically. Explain why the
quantity falls by less than 500,000 cars per year.
c) Suppose instead that anti-American sentiment in Japan induces the Japanese to
reduce their shipments to the U.S. by 500,000 cars per year (at each price). Find
the new equilibrium price and quantity, and show it graphically. Explain again
why quantity falls by less than 500,000.
d) What is the equilibrium price and quantity if the shifts described in parts b and c
happen at the same time?
3.
Table 3 below summarizes information about the market for principles of
economics textbooks.
Table 3
Price
Quantity Demanded
Quantity Supplied
20
30
40
50
60
2000
1000
500
250
125
0
200
500
900
1400
a) What is the market equilibrium price and quantity of textbooks?
b) In order to quell outrage over tuition increases, the college places a $30.00 limit
on the price of textbooks. How many textbooks will be sold now?
c) While the price limit is still in effect, automated publishing increases the
efficiency of textbook production. Show graphically the likely effect of this
innovation on the market quantity.
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4.
In a recent attempt to lower the price of energy in California, Senator Barbara
Boxer suggested that the Bush Administration impose a price ceiling. When the
administration did not respond affirmatively, Boxer commented that she was appalled
that Bush did not consider price caps. She went on to note that Bush and Cheney are
former oil company executives. Vice President Cheney later responded that capping
energy prices would not increase the supply of energy or reduce demand.
a) In a carefully labeled supply and demand diagram, indicate the equilibrium price
and quantity for energy assuming the market initially clears.
b) Then, impose a binding price ceiling. Note the quantity supplied and demanded
at the price cap.
c) According to your diagram, what benefits do price caps provide, if any?
d) What are the drawbacks of price controls, if any?
e) Cheney suggested that increasing the supply of energy would reduce market
prices. Is this true?
f) What are the four factors that affect the supply curve?
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Answer Key 1: Supply and Demand
Answer to question 1:
Price
Supply
$16
Demand
42,000
50,000 Quantity
Vanderbilt football tickets
a)
b)
c)
d)
e)
f)
g)
Graphed above.
The supply curve is perfectly inelastic. This is because football stadiums are
of a fixed size.
The equilibrium price is $16.00 per seat and the equilibrium quantity is
42,000.
There would be a surplus because the quantity demanded would only be
26,000 but the stadium (supply) would still be 42,000. The size of the surplus
would be 16,000 empty seats.
The Titans would reduce the quantity of Vanderbilt football tickets demanded.
As demand shifts left, the equilibrium price falls but the equilibrium quantity
remains at 42,000. This is because supply remains at 42,000.
A normal good is one where demand increases when income increases. With
an inferior good, if income increases, demand decreases. Assume Vanderbilt
football tickets are a normal good.
If income increases, the demand for Vanderbilt football tickets will increase
and the demand curve will shift to the right. Note that the opposite would
occur if Vanderbilt football tickets are an inferior good.
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Price
Supply

$16
D1
42,000
50,000
D2
Quantity
Answer to question 2:
a)
b)
The equilibrium price is 14 and the equilibrium quantity is 2 million.
The graph is shown below in Figure 2.
See Table 2B. The equilibrium price will be 12 and the equilibrium
quantity will be 1.75 million. The new demand curve will be D2 in
Figure 2. The quantity falls by less than .5 million because the price
decreases, which mitigates the effect.
Price
8
10
12
14
16
18
20
c)
Table 2B
Quantity Demanded
2.25
2
1.75
1.5
1.25
1
.75
Quantity Supplied
1.25
1.5
1.75
2
2.25
2.5
2.75
See Table 2C. The equilibrium price will be 16 and the equilibrium
quantity will be 1.75 million. The new supply curve is S2 in Figure 2.
The quantity falls by less than .5 million because the price increases,
mitigating the effect.
14
Price
8
10
12
14
16
18
20
d)
Table 2C
Quantity Demanded
2.75
2.5
2.25
2
1.75
1.5
1.25
Quantity Supplied
0.75
1
1.25
1.5
1.75
2
2.25
See Table 2D. The equilibrium price will be 14 and the equilibrium
quantity will be 1.5 million.
Price
8
10
12
14
16
18
20
Table 2D
Quantity Demanded
2.25
2
1.75
1.5
1.25
1
.75
Quantity Supplied
0.75
1
1.25
1.5
1.75
2
2.25
Figure 2
S2
Price
S1
c
16
14
12
D
A
B
D1
D2
1.5 1.75
2
Quantity
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Answer to question 3:
e)
f)
g)
The equilibrium price is 40 and the equilibrium quantity is 500.
With a $30 price limit, 1000 are demanded and 200 are supplied, so
only 200 are sold. There is a shortage of 800.
A reduction in the cost of production makes suppliers willing to
produce more textbooks at any given price because efficiency has
increased. This shifts the supply curve to the right, and increases the
number of textbooks sold (S2 in Figure 3).
Figure 3
Price
S1
S2
40
30
D
200
500
1000
Quantity
Answer to question 4:
a)
At a market-clearing equilibrium, the market price is p* and the market
quantity is q*.
b)
Now, impose a price ceiling. A Price Ceiling is a legal maximum at which a
good can be sold. Let Boxer’s price ceiling be given by the horizontal, dotted
line below. At the price cap, the quantity supplied is QS and the quantity
demanded is QD.
c)
The benefit of the price regulation is that the price of energy cannot legally
rise above the price ceiling. Those who can buy energy get to do so at a lower
price.
d)
The drawback is a shortage of QD – QS. As a result, some people who would
have been willing to pay p* for energy are unable to make such a purchase,
which means that many Californians would be without electricity
e)
Yes. If the supply curve shifts to the right, then the market-clearing price will
go down and the market-clearing quantity will increase. There will be no
shortages.
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f)
The factors that affect the supply curve are (i) the price, (ii) the cost of inputs,
(iii) technology, and (iv) the number of firms.
Price
Supply
P*
Price Ceiling
QS
Q*
Demand
QD California Energy
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