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Demand, Supply, &
Market Equilibrium
Chapter 3
Demand
A schedule or curve that shows the
various amounts of a product that
consumers are willing and able to
purchase at each of a series of possible
prices during a specified period of time
A statement of a buyer’s plans, or
intentions, with respect to the purchase of
a product
Law of Demand
Other-Things-Equal Assumption
As the Price (P) falls, the Quantity
Demanded (QD) rises. (P↓ QD ↑)
As the Price (P) rises, the Quantity
Demanded (QD) falls. (P↑ QD ↓)
Thus, there is an inverse (or negative)
relationship between Price and Quantity
Demanded.
Law of Demand
Common Sense
– People do buy more at low prices
– Sales!!!
Diminishing Marginal Utility
– Each additional unit of the product produces less
satisfaction (or benefit, or utility)
Income Effect
– Lower prices increase the purchasing power of a
buyer’s income
Substitution Effect
– Lower prices give buyers the incentive to substitute
similar products
Individual Demand
P
6
P
$5
Qd
10
4
20
3
35
2
55
1
80
5
Price (per bushel)
Individual
Demand
4
3
2
1
0
D
10
20
30
40
50
60
70
80
Quantity Demanded (bushels per week)
Q
Determinants of Demand
Tastes
– Favorable change in consumer tastes (preferences) = More Demanded
at each price
Number of Buyers
– Increase in number of buyers = Increase in Demand
Income
– Normal (Superior) Goods – Demand Varies Directly with Income
– Inferior Goods – Demand Varies Inversely with Income
Prices of Related Goods
– Substitutes: Used in place of another good
Example: Leather vs. Cloth Coats
– Complements: Used together with another good
Example: Computers & Software
– Unrelated Goods: Not related at all
Example: Potatoes & Automobiles
Consumer Expectations
Determinants of Demand
Therefore, an Increase in Demand may be
caused by:
–
–
–
–
–
–
–
A favorable change in consumer tastes/preferences
An increase in the number of buyers
Rising incomes if the product is a normal good
Falling incomes if the product is an inferior good
An increase in the price of a substitute good
A decrease in the price of a complimentary good
A new consumer expectation that either prices or
income will be higher in the future
Individual Demand
Demand Can Increase or Decrease
P
6
P
$5
Qd
10
4
20
3
35
2
55
1
80
5
Price (per bushel)
Individual
Demand
Increase in Demand
4
3
2
1
0
D2
Decrease in Demand
2
4
6
8
10
D1
D3
12
14
16
18 Q
Quantity Demanded (bushels per week)
Changes in Quantity Demanded
Not to be confused with Change in Demand
– A shift of the demand curve to the right (increase in
demand) or to the left (decrease in demand)
– Cause: A change in one or more determinants of
demand
Change in Quantity Demanded
– A movement from one point to another point – from
one price/quantity combination to another– on a fixed
demand schedule/curve
– Cause: An increase or decrease in the price of the
product under consideration
Individual Demand
Demand Can Increase or Decrease
An Increase in Demand
Means a Movement
of the Line
P
6
P
$5
Qd
10
4
20
3
35
2
55
1
80
5
Price (per bushel)
Individual
Demand
A Movement Between
Any Two Points on a
Demand Curve is
Called a Change in
Quantity
Demanded
4
3
2
1
0
D2
Decrease in Demand
2
4
6
8
10
D1
D3
12
14
16
18 Q
Quantity Demanded (bushels per week)
Supply
A schedule or curve showing the various
amounts of a product that producers are
willing and able to make available for sale
at each of a series of possible prices
during a specific period
Law of Supply
As the Price (P) falls, the Quantity Supplied (Qs)
falls. (P↓ Qs ↓)
As the Price (P) rises, the Quantity Supplied (Qs)
rises. (P↑ Qs ↑)
Thus, there is a direct (or positive) relationship
between Price and Quantity Supplied.
Remember, the supplier is on the receiving end
of the product’s price. Therefore, higher prices
don’t pose the same obstacle on the supply side
as they do on the demand side.
Individual Supply
P
6
P
$5
Qs
60
4
50
3
35
2
20
1
5
S1
5
Price (per bushel)
Individual
Supply
4
3
2
1
0
10
20
30
40
50
60
70
Quantity Supplied (bushels per week)
Q
Determinants of Supply
Resource Prices
– Higher Resource Prices raise production costs & squeeze profits
– Lower Resource Prices reduce production costs & increase
profits
Technology
– Improvements in technology enable firms to produce units of
output with fewer resources
Taxes & Subsidies
– Businesses treat most taxes as costs.
– Increase in sales or property taxes will increase production costs
& reduce supply
– Subsidies are considered “taxes in reverse”
– Thus, lower production costs/increase in supply
Determinants of Supply
Prices of other Goods
– Substitution in Production
– Example: Producing basketballs instead of soccer balls results
in a decline in the supply of soccer balls
Producer Expectations
– Future Prices of Products
Number of Sellers in the Market
– Other things equal, the larger the number of suppliers, the
greater the market supply
– As more firms enter the industry, the supply curve shifts to the
right
– The smaller the number of suppliers, the less the market supply
– As more firms leave the industry, the supply curve shifts to the
left
Individual Supply
Supply Can PIncrease or Decrease
6
P
$5
Qs
60
4
50
3
35
2
20
1
5
S1
5
Price (per bushel)
Individual
Supply
S3
S2
4
3
2
1
0
2
4
6
8
10
12
14
Quantity Supplied (bushels per week)
Q
Changes in Quantity Supplied
Not to be confused with Change in Supply
–
–
–
–
A change in the schedule & shift of the curve
An increase in supply shifts curve to the right
A decrease in supply shifts curve to the left
Cause: A change in one or more of the determinants
of supply
Change in Quantity Supplied
– A movement from one point to another on a fixed
supply curve
– Cause: A change in the price of the specific product
being considered
Individual Supply
Supply Can Increase or Decrease
P
6
P
$5
Qs
60
4
50
3
35
2
20
1
5
5
Price (per bushel)
Individual
Supply
A Movement Between
Any Two Points on a
Supply Curve is Called
a Change in Quantity
Supplied
S3
S1
S2
4
3
2
An Increase in Supply
Means a Movement
of the Line
1
0
2
4
6
8
10
12
14
Quantity Supplied (bushels per week)
Q
Market Equilibrium
Equilibrium Price (PE)
– Market Clearing Price
– The price where the intentions of buyers & sellers
match
– QD = QS
Equilibrium Quantity
– The quantity demanded & supplied at the equilibrium
price in a competitive market
Competition among buyers & sellers drives the
price to equilibrium
Surplus: Excess Supply
Shortage: Excess Demand
Market Equilibrium
200 Buyers & 200 Sellers
Market
Demand
200 Buyers
Qd
$5
2,000
4
4,000
3
7,000
2
11,000
1
6
6,000 Bushel
Surplus
5
Price (per bushel)
P
Market
Supply
200 Sellers
S
P
Qs
$5
12,000
4
10,000
3
7,000
$2 Price Ceiling 2
4,000
1
1,000
$4 Price Floor
4
3
2
16,000
7,000 Bushel
Shortage
1
0
2
4
6 7 8
10
D
12
14
16
18
Bushels of Corn (thousands per week)
Government-Set Prices
Price Ceilings
– The maximum legal price a seller may charge for a product or
service
– Prices at or below the ceiling are legal
– Prices above are not
– Examples: Rent Controls
– Sometimes leads to black markets & political pressure to lower
prices
Price Floors
–
–
–
–
A minimum price fixed by the government
A price at or above the floor are legal
Prices below are not
Distort resource allocation
Efficient Allocation
Productive Efficiency
– The production of any particular good in the least costly way
Example: Have $100 worth of resources
Can produce a bushel of corn using either $5 or $3 of those
resources, leaving either $95 or $97 remaining for alternative uses
Which is better?
Allocative Efficiency
– The particular mix of goods & services most highly valued by
society (minimum cost production assumed)
– Society wants iPods instead of cassette tapes
– However, society also wants cell phones
– Competitive markets help assign allocative efficiency
Equilibrium Price & Quantity
In competitive markets, produces an assignment
of resources that is “right” from an economic
perspective
Demand reflects MB based on utility received
Supply reflects MC of producing good
Remember:
– MB>MC Expand Output
– MB<MC Reduce Output
– MB=MC Optimal Output
Changes in Supply, Demand,
& Equilibrium
Changes in Demand
– Supply Constant, Demand Increases
Raises PE and QE
See pg 57, Figure 3.7 a
– Supply Constant, Demand Decreases
Reduces PE and QE
See pg 57, Figure 3.7b
Changes in Supply
– Demand Constant, Supply Increases
Reduces PE, Increases QE
See pg 57, Figure 3.7c
– Demand Constant, Supply Decreases
Increases PE, Reduces QE
See pg 57, Figure 3,7d
Changes in Supply, Demand,
& Equilibrium
Complex Cases: (See pg. 57, Table 3.7)
– Supply ↑ Demand ↓ PE ↓ QE ?
– Supply ↓ Demand ↑ PE ↑ QE ?
– Supply ↑ Demand ↑ PE ? QE ↑
– Supply ↓ Demand ↓ PE ? QE ↓