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How Markets Work
Demand
Introduction
• Economics is about choices that people make to
face scarcity and how those choices are affected
by incentives.
• Prices act as incentives.
• The demand & supply model is the main tool of
Economics . It tells us how people respond to
prices and how prices are determined by
demand & supply.
• This model helps us to answer the economic
questions : What How , and for whom are goods
and services are produced?
Prices And Markets
• Prices of goods and services are determined by
demand and supply of these goods and services
in the markets.
• A market has two sides : buyers & sellers.
• Examples of goods and services:
• Some markets are physical places where buyers
& sellers meet.
• Some markets are groups of people around the
world who never meet , but connected through
Internet. Examples: E-commerce markets and
currency markets.
Money Prices & Relative Prices
• A Money Price of a good is the amount of
money must be paid in exchange of it.
• A Relative Price is the ratio of the price of one
good to another and it is an opportunity cost.
• Example :
• If the money price of coffee is 1 SR and the
money price of gum is 0.5 SR , then the relative
price of coffee to gum= 1 /0.5 = 2 : 1 and it is
the opportunity cost of a cup of coffee : To get
one cup of coffee ,you must give up two packs of
gum.
Demand
•
•
•
•
•
If you demand something that means:
You want it.
You can afford it ,and
Plan to buy it.
Demand reflect a choice : What wants to be
satisfied and by what goods and services.
The Quantity Demanded
• The quantity demanded of goods &
services is the amount that consumer
plan to buy during a period of time at a
particular price.
• Many factors influence buying plans and
price is one of them.
The Law of Demand
• Other things remain the same , the
higher the price of a good , the smaller
the quantity demanded and the lower
the price of a good , the greater the
quantity demanded.
Substitution Effect and Income Effect
• To explain why a higher price reduce the
quantity demanded ?
• For two reasons:
• Substitution Effect: When the price of a good
rises . Other things remaining the same, its
relative price ( the opportunity cost) rises.
As the opportunity cost of a good rises , the
incentive to reduce its use and switch to a
substitute becomes stronger.
Income Effect
• When the price of a good rises , Other
things remaining the same , people face a
higher price and an unchanged income.
They cannot pay for all goods and services
that they used to buy. So when the price of
a good rises , Other things remaining the
same , they must decrease the quantities of
some goods and services specially the good
whose price has increased.
The Demand Curve
• It shows the inverse relationship between
the quantity demanded of a good and its
price , other things that affect demand being
the same.
Price
Quantity Demanded
A Demand Schedule
• It lists the quantity demanded at each price
other things that influence demand being the
same. Example:
Point
Price
Quantity
demanded
A
0.5
22
B
1
15
C
1.5
10
D
2
7
E
2.5
5
The Demand Curve

2.5

2

1.5

1
0.5

2
4
6
8
10 12
14
16
18
20 22
How Markets Work
A Change in Demand
A Change in Demand
• When a factor that affects the buying plan
other than the price of the good changes ,
there is a change in demand.
• Increase in demand means movement of the
demand curve to the right and quantity
demanded increases at each price.
• Decrease in demand means movement of the
demand curve to the left and quantity
demanded decreases at each price.
Increase & Decrease of the Demand Curve
Increase in Demand
P
Decrease in Demand
P
Q
Q
Factors bring Changes in Demand
1. The Prices of Related Goods:
The related goods are:
Substitutes &Complement.
A substitute is a good that can be used in
place of another one. There is positive
relationship between the price of a substitute
and the demand for the good. If the price of
tea rises the demand for coffee increases and
vise versa.
Factors bring Changes in Demand
A complement is a good is used with
another one to satisfy the same needs.
There is negative relationship between the
price of a complement and the demand for
the good. If the price of sugar rises the
demand for tea decreases and vise versa.
Factors bring Changes in Demand
2. Expected Future Prices:
If the price of a good is expected to rise in
the future , and if the good can be stored ,
the demand for the good increases today
and vise versa. Examples.
Factors bring Changes in Demand
3. Income: Consumers’ income influences demand.
• When income increases , consumers buy more of
most goods and when income decreases ,
consumers buy less of most goods.
• The positive relationship between income and
demand for the good is true for most goods, they
are the normal goods. But the relationship
between income and demand for the good is
negative for few goods; the inferior goods.
• Example: air travel and long – distance bus trips.
Factors bring Changes in Demand
4. Expected Future Income & Credit:
When income is expected to increase in the
future . Or when credit is easy to obtain , the
demand might increase now. Example.
5. Population :
Demand depends on the size and the age
structure of the population .
The larger the population ,the greater the
demand for all goods and services and vise
versa.
Factors bring Changes in Demand
• Also ,the larger the proportion of the
population in a given age group , the greater
is the demand for the goods and services
used by that group. Example.
6. Preferences:
Demand depends on preferences .
Preferences determine the value that
people place on each good and service.
Preferences are affected by things such as
weather , information and fashion.
A change in the quantity demanded
• A change in the quantity demanded =
movement along the demand curve
• If the price of the good changes, but no other
influence on buying plans changes, that
means we have movement along the
demand curve ; there is a change in the
quantity demanded as price changes.
• Examples:
A Change in Demand
• If the price of a good remains constant ,but some
other influence on buyers’ plans changes, there is
a change in the demand of the good.
A Change in Demand =A Shift of the Demand Curve
Examples:
Table 3.1 p.62
• It summarizes what we have studied.
• The law of demand
• The change in the quantity demanded due to
the changes in the price of the good.
• Changes in demand happen as a result of the
change in the other factors except the price
of the good .
The Law of Demand:
The quantity of the good demanded
Decreases if:
The price of the
good rises.
Increases if:
The price of the good
falls.
Changes in Demand
The demand for the good
Decreases if :
Increases if :
1. The price of a
1. The price of a
substitute falls.
substitute rises.
2. The price of a
2. The price of a
complement rises.
complement falls.
3. The price of the
3. The price of the
good is expected to
good is expected to
fall.
rise.
Changes in Demand
The demand for the good
Decreases if :
4. Income falls.
5. Expected Income
falls or credit
becomes harder to
get.
6. The population
decreases.
Increases if :
4. Income rises.
5. Expected future
Income rises or credit
becomes easier to
get.
6. The population
increases.
How Markets Work
Supply
Supply
• If firm supplies a good or a service , the firm:
1. Has the resources and technology to
produce it ,
2. Can make profit from producing it , and
3. Plan to produce & sell it.
The Quantity Supplied
The quantity supplied of a good or a service
is the amount that producers plan to sell
during a given time period at a particular
price.
The Law of Supply
• The law of supply states:
• Other things remaining the same, the higher the
price , the greater is the quantity supplied; and
the lower the price , the smaller is the quantity
supplied.
• The reason for the positive relationship: When
price rises , other things remaining the same ,
producers can bear higher costs by increasing
the quantity supplied.
• Remember : Opportunity cost ( the cost of the
last unit produced of the good measured by the
decrease in the quantity of the other good )
increases as the production of the good
increases.
Supply Schedule
The supply schedule lists the quantity supplied
at each price when all other things that
affect producers’ planned sales remain the
same.
The supply curve shows the relationship
between the quantity supplied of a good and
its price when all other things that affect
producers’ planned sales remain the same.
The Supply Schedule of Energy Bar
Price
The Quantity Supplied
A
0.5
0
B
1
6
C
1.5
10
D
2
13
E
2.5
15
The Supply Curve of Energy Bar
Price
0.5
Quantity Supplied
How Markets Work
A Change in Supply
A Change in Supply
• When any other factor affecting supply of a
good other than its price changes , there is a
change in supply curve it would shift to the
right or to the left.
• We are going to study these factors and their
effects on the supply curve.
A Change in Supply
• The Prices of Factors of Production : If the
prices of factors of production rise , supply
decreases .The prices of factors of production
are costs of production , if they increase this
means higher costs and lower profits so
producers decrease production at each price
and supply curve shifts to the left.
A Change in Supply
• Prices of Related Goods Produced:
• If price of a substitute rises , firms switch
production from the good to the substitute
and supply decreases ,and vice versa. (
example: Energy bar & energy gel).
• If a price of a complement rises , the supply
of the good increases and vice versa.
• Example : Beef and cowhide are complements
in production ; they must be produced
together.
A Change in Supply
• Expected Future Price: If the price of the
good is expected to rise , supply decreases
today and increases in the future.
• The Number of Suppliers:
• The larger the number of suppliers , the
greater is the supply of the good. As firms
enter an industry , the supply increases.
A Change in Supply
• Technology:
• It means the way that factors of production
are used to produce a good.
• If technology improves and we use new
method that lowers costs of production ,
production of the good increases and supply
shifts to the right.
A Change in Supply
• The State of Nature :
• This includes all natural forces that influence
production.
• Good weather can increase the supply of
agricultural goods and vice versa.
• Extreme natural event such as earthquakes ,
tornados, and hurricanes can influence
supply.
A Change in Quantity Supplied VS.
a Change in Supply
• A change in quantity supplied means
movement along the curve and it happens
when the price of the good changes.
• a change in supply means that the entire
supply curve shifts, it happens when any of
the other factors that influence supply other
than the price of the good changes
A Change in Quantity Supplied VS.
a Change in Supply
P
S2
S
S1
P1
P2
Qd
q4 q2
q1
q3
Table 3.2 p. 67
The Law of Supply
The quantity of the good supplied
Decreases if:
The price of the good
falls.
Increases if:
The price of the good
rises.
Changes in Supply
The supply of the good
Decreases if :
1. The price o a factor of
production used to
produce it rises.
2. The price of a substitute
in production rises.
3. The price of a complement
in production falls.
4. The price of the good is
expected to rise.
Increases if :
1. The price o a factor of
production used to
produce it falls.
2. The price of a substitute
in production falls.
3. The price of a
complement in
production rises.
4. The price of the good is
expected to fall.
Changes in Supply
The supply of the good
Decreases if :
5. The number of
suppliers decreases.
6. A technology change
decreases production
of the good.
7. A natural event
decreases production
of the good .
Increases if :
5. The number of
suppliers increases.
6. A technology change
increases production
of the good.
7. A natural event
increases production
of the good
Market Equilibrium
Market Equilibrium
• Equilibrium in a market occurs when the
price balances the plans of buyers and plans
of sellers.
• The equilibrium price is the price at which
the quantity demanded equals the quantity
supplied.
• The equilibrium quantity is the quantity
bought & sold at the equilibrium price .
Price as a Regulator
• The price of a good regulates the quantity
demands and supplied.
• If price is too low , the quantity demanded >
the quantity supplied , and we have a
shortage . The shortage bids up price till we
reach equilibrium.
• If price is too high , the quantity supplied >
the quantity demanded , and we have a
surplus . The surplus e bids down the price till
we reach equilibrium.
A Figure Shows Equilibrium
P
P2
D
A Surplus
S
P*
P1
A Shortage
q*
Q
Market Equilibrium
Table p. 68 shows :
The equilibrium price at which Qd = Qs
Above the equilibrium price :
Qs > Qd
A surplus
Below the equilibrium price :
Qd > Qs
A shortage
Price per
unit
Qd
Qs
Shortage (−)
Or
Surplus (+)
millions of bars per week
0.5
22
0
− 22
1
15
6
−9
1.5
10
10
0
2
7
13
+6
2.5
5
15
+10
Price Adjustment
A shortage forces the price up:
• When there is a shortage ,producers raise
the price. When price rises Qd decreases and
Qs increases until we reach equilibrium.
A surplus forces the price down:
• When there is a surplus ,producers cut the
price. When price falls Qs decreases and Qd
increases until we reach equilibrium.
The Effects of changes in Demand
and Supply on Market Equilibrium
PP. 70-71
An Increase in Demand
• When number of consumers or income of
consumers increases ,or other things that
cause demand increases , the demand curve
shifts to the right . . Both the equilibrium
price and quantity increase.
Equilibrium price rises &
Equilibrium quantity increases
When demand increases
P
D1
D2
S
Q
A Decrease in Demand
• When number of consumers or income of
consumers decreases ,or other things that
cause demand decreases , the demand curve
shifts to the left . Both the equilibrium price
and quantity decrease.
Equilibrium price falls &
equilibrium quantity decreases
When demand decreases
P
D2 D1
S
Q
An Increase in Supply
• If costs of production fall or producers use a
new technology that cause increase in supply
, or other things happen that increase supply
, supply curve shifts to the right.
• The equilibrium price decreases and the
equilibrium quantity increases.
Equilibrium Price Falls &
Equilibrium Quantity Increases
When Supply Increases
P
D
S1
S2
Q
A Decrease in Supply
• If costs of production rise or producers switch to
a substitute, or other things happen that
decrease supply , supply curve shifts to the left.
• The equilibrium price rises and the equilibrium
quantity decreases.
Equilibrium Price Rises &
Equilibrium Quantity Decreases
When Supply Decreases
P
D
S2
S1
Q