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Demand, Supply
and Market Equilibrium
dr Magdalena Klimczuk-Kochańska
Market – definitions
• A place where buyers and sellers meet to trade
• Represent the interaction of buyers and sellers for goods and
services
• Markets bring together buyers (“demanders”) and sellers
(“suppliers”).
• Some markets are local while others are national or international.
• Markets help to determine the prices and quantities bought and
sold of millions of goods and services.
• Example:
 Automobile market
 Health care market
 Labor market
 Stock market
Ceteris Paribus
• „Other things being equal”
• Price changes along the demand / supply
curve – but other things do not change
• Other things e.g.:
Tastes
Incomes
Prices of other goods
New information
Availability of credit
Expectations
Demand - definitions
• Demand is a schedule or curve that shows the
various amounts of a product that consumers
will buy at each of a series of possible prices
during a specific period.
• A curve illustrating the inverse relationship
between the price of a product and the
quantity demanded of it, other things equal, is
the demand curve.
The Individual Demand Schedule
The Individual Demand Curve
• The demand curve is a graph
illustrating how much of a
given product a household
would be willing to buy at
different prices.
• Quantity demanded is
inversely related to price,
holding other factors constant.
• Price #
Qd $
• Price $
Qd #
• The Law of Demand states
that, all else equal, as price
falls, the quantity demanded
rises, and vice versa.
Individual and Market Demand
• Individual demand is the demand schedule or
curve of a single consumer.
• Market demand is the sum of all the
individual demands.
The demand of all consumers in the marketplace
for a particular good or service
Summation at each price of the quantity
demanded by each individual
The Horizontal Summation of Two Demand
Curves
The Horizontal Summation
of Two Demand Curves
Determinants of Demand
- Changes in Goods’ Own Price
• A change in a good’s own
price leads to a change in
quantity demanded.
• A change in quantity
demanded is a movement
from one point to another
point on a fixed demand
curve.
• The cause of such change
is an increase or decrease
in the price of the product
under consideration.
• A change in a good’s own
price is a movement along
the same curve.
Non-price Determinants
of Demand
Determinants of demand are factors other than price that locate the position of a
demand curve.
• Income
• Tastes and preferences
• The prices of related goods
 Substitutes - Two goods are substitutes when a change in the price of one
causes a shift in demand for the other in the same direction as the price
change.
 Complements - Two goods are complements when a change in the price of
one causes an opposite shift in the demand curve for the other.
• Expectations
 Future prices
 Income
 Product availability
• Market size (number of buyers)
Non-price Determinants of Demand
Figure 04.06b
• A change in one or more
of the non-price
determinants will lead to
a change in demand.
• This is a shift of the
whole curve.
• A change in demand is a
shift of the demand
curve to the right (an
increase in demand), or
to the left (a decrease in
demand).
• Shifts are cause by a
change in one or more of
the determinants of
demand.
Change in Income
• Income is the sum of all households wages,
salaries, profits, interest payments, rents, and
other forms of earnings in a given period of
time. It is a flow measure.
• The effects of changes in income vary
depending on the type of product demanded.
• When income rises, all else equal, the demand
for normal goods increases, while the demand
for inferior goods decreases.
Shifts in Demand – Normal Good
• Normal goods are
goods for which
demand goes up
Increase in income when income is
increases demand
higher and for
which demand goes
down when income
is lower.
Price
Decrease in income
decreases demand
D3
D1
D2
Q/Units
Shifts in Demand – Inferior Good
• Inferior Goods are
goods for which
demand falls when
income rises.
Price
Decrease in income
decreases demand
D2
D1
Q/Units
Shifts in Demand – Tastes and
Preference
Price
Hybrid vehicles
• Increase in demand
SUVs
• Decrease in demand
D3
D1
D2
Q/Units
Prices of Related Goods
• When two goods are related (as substitutes or complements), a
change in the price of one good may either increase or decrease the
demand for the other product.
• A substitute good is one that can be used in place of another good.
• Substitutes are goods that can serve as replacements for one
another.
• When the price of one increases, demand for the other goes up.
Perfect substitutes are identical products.
• A complementary good is one that is used together with another
good.
• Complements are goods that „go together”. A decrease in the price
of one results in an increase in demand for the other, and vice versa.
Prices of Related Goods
• Most goods are unrelated to one another. For these
independent goods, a change in the price of one will
have virtually no effect on the demand for the other.
Shifts in Demand – Prices of Related
Goods: Substitutes
Price
Butter and Margarine
• Price of both = $2/lb
• Price of margarine
increases to $3/lb
• Demand for butter
increases
D1
D2
Q/Butter
Example: Kids Give Barbie Dolls
and Legos the Boot
• Barbie dolls and Lego building blocks were
among the most popular toys for many years.
• Since the early 2000s, annual purchases of
such toys have fallen by as much as 25%.
• At the same time, prices of substitute forms of
entertainment, such as video games and
computer software, have increased.
Shifts in Demand – Price od Related
Goods: Complements
Price
Speakers and Amplifiers
• Decrease the relative
price of amplifiers
• Demand for speakers
increases
Speakers and Amplifiers
• Increase the relative
price of amplifiers
• Demand for speakers
decreases
D3
D1
D2
Q/Speakers
Shifts in Demand – Expectations:
Income, Future Prices
Price
A higher income or
expectations of a higher future
price will increase demand
A lower income or
expectations of a lower future
price will decrease demand
D3
D1
D2
Q/Units
Shifts in Demand – Market Size
(Number of Buyers)
Price
Increase in the
number of buyers
increases demand
Decrease in the
number of buyers
decreases demand
D3
D1
D2
Q/Units
Shift of Demand - Resume
• A change in demand is not
the same as a change in
quantity demanded.
• A higher price causes lower
quantity demanded and vice
versa.
• Changes in determinants of
demand, other than price,
cause a change in demand,
or a shift of the entire
demand curve, from DA to
DB.
Supply - Definition
• Schedule showing relationship between price and
quantity supplied for a specified time period, other
things being equal
• The amount of a product or service that firms are
willing to sell at alternative prices
• Supply is a schedule or curve showing the amounts of
a product that producers will make available for sale at
each of a series of possible prices during a specific
period.
• A curve illustrating the positive, or direct relationship
between the price of a product and the quantity
supplied of it, other things equal, is the supply curve.
The Individual Producer’s Supply Schedule and
Supply Curve for Flash Memory Pen Drives
The Individual Producer’s Supply Schedule and
Supply Curve for Flash Memory Pen Drives
• The Law of Supply states
that, all else equal, as price
rises, the quantity supplied
rises, and vice versa.
• The price of a product or
service and the quantity
supplied are directly
related.
• P # Qs #
• P $ Qs $
Horizontal Summation of Supply
Curves
Horizontal Summation of Supply
Curves
• As with market demand market supply is
the horizontal summation of individual
firms’ supply curve.
Changes in Supply – Non-price
Determinants
• Cost of inputs (resources prices)
• Technology and productivity
• Taxes and subsidies
• Price expectations
• Number of firms in industry (numer of sellers in
the market)
Shift of supply curve
31
Shifts in Supply - Cost of Inputs
Price
Increase in cost
decreases supply
S3
S1
• The cost of
producing the good
S2
depends on:
Decrease in cost
increases supply
Q/Units
 The price of required
inputs (labor, capital,
and land)
 The technologies
that can be used to
produce the product
Shifts in Supply – Technology and
Productivity
Price
S3
S1
S2
Decreases in productivity
decrease supply
Improvements in technology or
increases in productivity
increase supply
Q/Units
Shifts in Supply – Taxes and Subsidies
Price
S3
S1
S2
Increases in taxes or
decreases in subsidies
decrease supply
Decreases in taxes or
increases in subsidies
increase supply
Q/Units
Shifts in Supply – Price Expectations
Price
Expectations of higher
future prices decrease
supply
S3
S1
S2
Expectations of lower
future prices increase
supply
Q/Units
Shifts in Supply – Number of Firms in
Industry
Price
Decrease in the
number of firms
decreases supply
S3
S1
S2
Increase in the
number of firms
increases supply
Q/Units
A Change in Supply Versus
a Change in Quantity Supplied
• A change in supply is
not the same as a
change in quantity
supplied.
• A higher price causes
higher quantity
supplied, and a move
along the demand
curve.
• Changes in determinants of supply, other than price, cause
an increase in supply, or a shift of the entire supply
curve, from SA to SB.
Putting Demand
and Supply Together
• The operation of the market depends on the
interaction between buyers and sellers.
• In competitive markets, buyers and sellers
have no control over prices. When buyers and
sellers interact in a free competitive market,
the equilibrium price and equilibrium quantity
is determined by the intersection of the
demand and supply curves.
Market Equilibrium
• An equilibrium is the condition that exists when quantity supplied and
quantity demended are equal.
• At equilibrium, there is no tendency for the market price to change.
• The equilibrium price, or market-clearing price, is the price at which
the intentions of buyers and sellers match.
– The price that clears the market
– The price at which quantity demanded equals quantity supplied
– The price where the demand curve intersects the supply curve
• The equilibrium quantity is the quantity demanded and quantity
supplied that occurs at the equilibrium price in a competitive market.
Putting Demand and Supply Together
– At a $3 price there is
market clearing
equilibrium
Putting Demand and Supply Together
•
Surplus
•
•
•
At a $4 price more is being supplied (8
millions of Pen Drives) than demanded (4
millions of Pen Drives)
Any price above the equilibrium price
would create a surplus, or excess supply;
quantity supplied exceeds quantity
demanded.
Surpluses drive prices down to
equilibrium.
– As prices fall, the incentive to
produce declines and the incentive
for consumers to buy increases
Surpluses
– The situation when quantity supplied
is greater than quantity demanded
Qd < Qs
– Exist at any price above the market
clearing price
Putting Demand and Supply Together
•
•
•
Shortage
•
At a $2 price more is being
demanded (8 millions of Pen Drives)
than supplied (4 millions of Pen
Drives)
Any price below the equilibrium price
would create a shortage, or excess
demand; quantity demanded
exceeds quantity supplied.
Shortages push prices up equilibrium.
– As prices rise, the incentive to
produce increases and the
incentive for consumers to buy
decreases.
Shortages
– The situation when quantity
demanded is greater than
quantity supplied
Qd > Qs
– Exist at any price below the
market clearing price
Putting Demand and Supply Together
Surplus
Shortage
Putting Demand and Supply Together
How Do Markets Reach Equilibrium?
• Excess demand – prices tend to rise
• Excess supply – prices tend to fall
Changes in Demand,
Supply, and Equilibrium
• Changes in Demand: When supply is constant,
an increase in demand will result in a higher
equilibrium price and quantity. If demand
falls, equilibrium price and quantity decrease.
• Changes in Supply: With a constant demand,
if supply increases, equilibrium price falls
while equilibrium quantity rises. If supply
decreases, equilibrium price rises, and
equilibrium quantity falls.
Market Equilibrium - A shift in demand
D1
D0
P1
P0
E0
S
Q0 Q 1
Example:
• If the price of a substitute
S
good increases …
• more will be demanded at
each price
E1
• the demand curve shifts from
D0 to D1
• The market moves to a new
equilibrium at E1.
D1 • Higher demand leads to
D0
higher equilibrium price and
higher equilibrium quantity.
Quantity
Market Equilibrium - A shift in supply
S1
S0
D
E2
P1
P0
E0
S1
S0
D
Q1 Q0
Quantity
Example:
• Suppose safety regulations
are tightened increasing
producers’ costs …
• The supply curve shifts to
S1
• If price stayed at P0 there
would be excess demand
• So the market moves to a
new equilibrium at E2
• Lower supply leads to
higher equilibrium price and
lower equilibrium quantity.
Changes in Demand,
Supply, and Equilibrium
When both supply and demand change, the
effect is a combination of the individual
effects.
The relative sizes of the change in demand
and supply will determine the effect on
equilibrium price and quantity.
– In some cases, the effect is certain; in others the
effect depends on the size of the shifts.
Relative Magnitudes of Change
• The relative magnitudes of change in supply and
demand determine the outcome of market equilibrium.
Relative Magnitudes of Change
• When supply and demand both increase, quantity
will increase, but price may go up or down.
Changes in Demand,
Supply, and Equilibrium
Change in
Supply
Change in
Demand
Change in
Price
Increases
Decreases
↓
Decreases
Increases
↑
Increases
Increases
Decreases
Decreases
↑, ↓, or no
change
↑, ↓, or no
change
Change in
Quantity
↑, ↓, or no
change
↑, ↓, or no
change
↑
↓
Government-Set Prices
• In most markets, prices are free to rise or fall
with changes in demand and supply.
• However, sometimes the resulting price in a
market is „too high” or „too low”.
– Government may place legal limits on how high or
how low a price or prices may go.
– High prices may be unfair to buyers whereas low
prices may be unfair to sellers.
Price Ceiling
• If the price of a product is unfairly high, the
government can set a price ceiling, or a legal
maximum price a seller may charge for a
product.
• This purportedly enables consumers to obtain
some „essential” good or service that they
could not afford at the equilibrium price;
however, it also creates a shortage of the
good.
A market in disequilibrium – Price
Ceilling
S
P2
E
P0
A
P1
B
Shortage
D
S
Q1
Q0
Quantity
• Suppose a disastrous harvest
moves the supply curve to
SS
• government may try to
protect the poor, setting a
price ceiling at P1
• which is below P0, the
equilibrium price level
• RATIONING is needed to
cope with the resulting
excess demand
Price Floor
• When the price of a good or service is “too
low”, the government can set a price floor, or a
minimum fixed price that sellers can charge.
• The goal is to provide a sufficient income for
certain groups of resource suppliers, or
producers who would otherwise receive very
low incomes at the equilibrium price.
However, a surplus of the good is created.
Price Floor Example
•
S
Support Price
– The governmentally established
price floor
Surplus
• Associated with agricultural
products
P2
E
P0
•
A
P1
B
Used to be associated with the
Common Agricultural Policy of EU
– Wheat, barley, potatoes,
cauliflower, broccoli, wine, sugar
D
S
Q1
Q0
Quantity
– Now being phased out for many
crops