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Supply and Demand
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Supply and Demand is the essential issue of
economics.
Economic agents: Households
Economic agents: Business firms
Markets for Outputs (products)
Markets for Inputs (factors)
The framework of an economy
Households
Demand
Supply
Markets for
Outputs
(products)
Markets
for Inputs
(factors)
Demand
Supply
Business Firms
Price and Quantity
 Quantity
and Price
The most important information of
our interest in the market
Price and quantity demanded
 Quantity
demanded
is the number of units households
are willing to buy.
Price and Quantity Demanded
 “Law
of demand”
 We generally believe that there is an
inverse relationship between price
and quantity demanded. If price
goes up, then quantity demanded
goes down, and vice versa
 P ----→ Qd 
 P  ----→ Qd 
Demand schedule and
demand curve
 Demand
schedule and demand curve
shows the relationship between
quantities demanded and prices of a
good.
 It is in general downward sloping.
(Its slope is negative)
Demand curve
Find quantity demanded at each price
from the demand curve
P ($)
Demand for milk
1.50
1.00
0
2000
3000
Movement versus Shift in Demand


Movement along the demand curve
If there is a change in the own price, whereas
other determinants (shifters) of demand remain
unchanged, it just produces a movement along
the demand curve.
Shift in the demand curve
If instead there is a change in the
determinants (shifters) other than the price, then
at each price we observe that the quantity
demanded increases or decreases, which is a
shift in the demand curve.
Shifters of demand
 Income
 Consumer
preferences (taste)
 Prices of related goods (substitutes
and complements)
 Population size
 Expectations
Difference between
Demand and Quantity Demanded
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
Demand
refers to the entire demand curve
Quantity demanded
refers to a point on the demand
curve
Change in Demand: Shift
Change in Quantity demanded:
likely to be a movement
Supply
 Quantity
supplied
is the number of units firms are
willing to supply (sell).
 “Law of Supply”
 There is a direct relationship
between price and quantity supplied.
P  ----→ Qs 
P  ----→ Qs 
Supply curve
 The
supply curve shows the
relationship between quantities
supplied and prices of a good.
It is upward sloping (its slope is
positive)
Supply of milk
P ($)
Supply of Milk
S
1.50
1.00
0
3000
4500
Movement and Shift in Supply


Movement along the supply curve
If there is a change in the own price, whereas
other determinants (shifters) of quantity supplied
remain unchanged, it just produces a movement
along the supply curve.
Shifts of the supply curve
If instead there is a change in the
determinants (shifters) other than the price, then
at each price we observe that the quantity
supplied increases or decreases, which is a shift
in the supply curve.
Shifters of Supply
 Prices
of inputs
 Technological progress
 Changes in natural resource
endowment and production capacity
 Size of the industry
 Price of related outputs
Difference between
Supply and Quantity Supplied
 Supply
refers to the entire supply curve
 Quantity supplied
refers to a point on the supply
curve
 Change in Supply: Shift
 Change in Quantity supplied: likely
to be a movement
Place Supply and Demand together
 Analyze
how the supply and demand
together determines the market
price and quantity transacted.
The Supply and Demand Diagram
P
S
P*
D
0
Q*
Q
Equilibrium
 The
point where the supply and
demand curves intersect is called
equilibrium. At the point quantity
demanded equals quantity supplied.
 Equilibrium
is the state where quantity
demanded equals quantity supplied.
Equilibrium price and equilibrium
quantity
 Equilibrium
price and equilibrium
quantity
The price at the equilibrium is
called equilibrium price and the
quantity in the equilibrium is called
equilibrium quantity.
 Equilibrium price and quantity are
the prevailing price and quantity
transacted in the market.
Market forces push or pull the price to the
equilibrium level.
surplus
P
S
P=1.60
high
P*=1.00
D
0
2000
3000
4500
Q
Market forces push or pull the price to the
equilibrium level.
P
S
P*
P=0.70
low
shortage
0
1800
D
Q*
4000
Q
Market forces push or pull the price to the
equilibrium level.
P
S
P
high
P*
P
low
D
0
Q*
Q
An equilibrium state
 is
a situation in which there are no
inherent forces that produce change.
 Changes away from the equilibrium
position will occur only as a result of
"outside events" which disturb the
status quo.
Equilibrium State and Changes
 "Outside
events" and changes in
equilibrium price and quantity
 The supply and demand diagram.
is the most essential analytical
tool in economics.
 Examples
Case 1: Suppose the weather suddenly turns to be very
cold. What will happen to the equilibrium price and quantity
in the heating oil market?
P
S
P*
D
0
Q*
Q
Case 1: Suppose the weather suddenly turns to be very
cold. What will happen to the equilibrium price and quantity
in the heating oil market?
P
S
P’
P*
D’
D
0
Q*
Q’
Q
Case 2: Again, suppose the same outside event---the
weather suddenly turns to be very cold. What will happen
to the equilibrium quantity and equilibrium price in the ice
cream market?
P
S
P’
P*
D
0
Q*
Q
Case 2: Again, suppose the same outside event---the
weather suddenly turns to be very cold. What will happen
to the equilibrium quantity and equilibrium price in the ice
cream market?
P
S
P*
P’
D’
0
Q’
Q*
D
Q
Case 3: Suppose the cold weather brought a frost in
Florida, what happens to the equilibrium price and quantity
in the orange market?
P
S
P*
D
0
Q*
Q
Freeze Oranges in Florida
Jan 2010
Case 3: Suppose the cold weather brought a frost in
Florida, what happens to the equilibrium price and quantity
in the orange market?
S’
P
S
P’
P*
D
0
Q’
Q*
Q
Case 4: Suppose a technological innovation takes place in
manufacturing LCD TV sets. What happens to the
equilibrium price and quantity of the LCD TV sets?
P
S
P*
D
0
Q*
Q
Case 4: Suppose a technological innovation takes place in
manufacturing fax machines. What happens to the
equilibrium price and quantity of the fax machines?
P
S
S’
P*
P’
D
0
Q*
Q’
Q
Comparative Statics Analysis
 Comparative
statics analysis
is an analysis about how the
equilibrium price and quantity
change in response to changes in the
outside forces.
Steps to do the comparative static
analysis
 1.
Ask which curve shifts and to
which direction?
 2. Find the new equilibrium state and
new equilibrium price and quantity.
 3. Draw conclusions about changes
in equilibrium price and quantity.
Exercise
 The
drug BGH (bovine growth
hormone) dramatically increases the
milk output of dairy cows. Farmers in
Wisconsin, a big dairy state,
vigorously oppose licensing the drug,
fearing that excess supply and a
consumer reaction on the purity of
food issue will put many of them out
of business.
Exercise
 Which
graph in Figure 5-13 best
illustrates the farmers' fears?
 a. 1
b. 2
c. 3
d. 4
Exercise
 “A
severe drought has reduced the
supply of oranges and increased
their price. But the higher price will
reduce the demand for oranges and
push their price back toward the
original level.” True or false?
Comment too.