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CHAPTER 4:
Demand and Supply
Analysis
CHAPTER CHECKLIST
1. Distinguish between quantity demanded and
demand and explain what determines demand.
2. Distinguish between quantity supplied and supply
and explain what determines supply.
3. Explain how demand and supply determine price
and quantity in a market and explain the effects of
changes in demand and supply.
4. Explain how price ceilings, price floors, and sticky
prices cause shortages, surpluses, and
unemployment.
LECTURE TOPICS
Demand
Supply
Market Equilibrium
Price Rigidities
MARKETS
A market is any arrangement that bring buyers and sellers
together.
MARKETS
In this chapter, we study a simple model of a market: a
market that has so many buyers, all small relative to the
size of the market, and so many sellers, all small relative to
the size of the market, that no individual buyer or seller can
influence the price by their individual actions.
This is called a “perfectly competitive market.”
4.1 DEMAND
Quantity demanded
The amount of a good, service, or resource that people
are willing and able to buy during a specified period at a
specified price.
The quantity demanded is an amount per unit of time.
For example, the amount per day or per month.
How much people want to buy, given the price.
4.1 DEMAND
The Law of Demand
Other things remaining the same, [“ceteris paribus”]
• If the price of a good rises, the quantity
demanded of that good decreases.
• If the price of a good falls, the quantity
demanded of that good increases.
• I.e., if something becomes more expensive,
people want to buy less of it; if it becomes
cheaper, people want to buy more of it.
4.1 DEMAND
Demand Schedule and Demand Curve
Demand
The relationship between the quantity demanded and
the price of a good when all other influences on buying
plans remain the same.
Demand is a list of quantities at different prices and is
illustrated by the demand curve.
“Demand” means all the amounts people will want to
buy at all possible different prices, everything else
unchanged; it is the relationship between price and how
much people want to buy.
4.1 DEMAND
Demand schedule
A list of the quantities demanded at each different
price when all the other influences on buying plans
remain the same.
Demand curve
A graph of the relationship between the quantity
demanded of a good and its price when all other
influences on buying plans remain the same; i.e. the
graph of the good’s own-price and how much people
want to buy at each own-price.
4.1 DEMAND
Economists have their own traditions ….
It is usual to draw graphs with the dependent
variable on the y (vertical) axis and the
independent variable on the x (horizontal) axis
Economics does it the other way round in
demand and supply diagrams -- own-price
determines the amount buyers want to buy, but
own-price is on the vertical [y] axis.
Why?
Economists started drawing [and publishing in
books] supply and demand diagrams in the 19th
century, before the standard y = f(x) convention
was strongly established
The standard supply and demand diagrams are
so firmly established, nobody dares try to
change them to conform to what is standard in
math, science, and engineering
4.1 DEMAND
Changes in Demand
Change in the quantity demanded
A change in the quantity of a good that people plan to
buy that results from a change in the price of the good.
Change in demand
A change in the quantities that people plan to buy [at
various prices] when any influence other than the ownprice of the good changes. In other words, a shift or
change in the relationship between the price of the
good and how much of it people want to buy.
4.1 DEMAND
When demand
changes, the
demand curve shifts.
1. When demand
decreases, the
demand curve shifts
leftward from D0 to D1.
2. When demand
increases, the demand
curve shifts rightward
from D0 to D2.
4.1 DEMAND
The main influences on buying plans that change
demand are:
• Prices of related goods
• Income
• Expectations
• Number of buyers
• Preferences
Make a Mnemonic to remember:
Economists use “Y” for income a lot; so
Prices of related goods
Y -- income of [potential] buyers
Number of [potential] buyers
Tastes [preferences] of [potential] buyers
Expectations about the future
4.1 DEMAND
Prices of Related Goods
Substitute
A good that can be consumed in place of another
good. For example, apples and oranges.
The demand for a good increases, if the price of one
of its substitutes rises.
The demand for a good decreases, if the price of
one of its substitutes falls.
4.1 DEMAND
Complement
A good that is consumed with another good. For
example, ice cream and fudge sauce.
The demand for a good increases, if the price of
one of its complements falls.
The demand for a good decreases, if the price of
one of its complements rises.
4.1 DEMAND
Income
The demand for a normal good increases if income
increases.
The demand for an inferior good decreases if
income increases.
4.1 DEMAND
Expectations
Expected future income and expected future prices
influence demand today.
For example, if the price of a computer is expected to
fall next month, the demand for computers today
decreases.
Number of Buyers
The greater the number of buyers in a market, the
larger is the demand for any good.
4.1 DEMAND
Preferences
When preferences change, the demand for one item
increases and the demand for another item (or items)
decreases.
Preferences change when:
• People become better informed, or new
information becomes available.
• New goods become available.
• Fashions [opinions] shift for some reason.
• Advertisers succeed in influencing tastes.
4.1 DEMAND
Demand: A Summary
4.2 SUPPLY
Quantity supplied
The amount of a good, service, or resource that people
are willing and able to sell during a specified period at a
specified price – how much people want to sell at the
given price.
The Law of Supply
Other things remaining the same,
• If the price of a good rises, the quantity supplied
of that good increases. When price rises, people
will want to sell more.
• If the price of a good falls, the quantity supplied of
that good decreases. If the good’s price falls,
people will want to sell less.
4.2 SUPPLY
Supply Schedule and Supply Curve
Supply
The relationship between the quantity supplied of a good
and the price of the good when all other influences on
selling plans remain the same.
Supply is a list of quantities at different prices and is
illustrated by the supply curve, just like demand and the
demand curve.
4.2 SUPPLY
Supply schedule
A list of the quantities supplied at each different price
when all other influences on selling plans remains
the same.
Supply curve
A graph of the relationship between the quantity
supplied and the good’s own-price when all other
influences on selling plans remain the same. As with
demand, this is the relationship between the
amounts sellers will want to sell and the price of the
good, other things constant.
4.2 SUPPLY
4.2 SUPPLY
Changes in Supply
Change in quantity supplied
A change in the quantity of a good that suppliers plan
to sell that results from a change in the price of the
good.
Change in supply
A change in the quantities that suppliers plan to sell at
all different prices when any influence on selling plans
other than the own-price of the good changes; i.e. a
change in the relationship between own-price and how
much sellers want to sell caused by some change in
something other than the good’s price.
4.2 SUPPLY
4.2 SUPPLY
When supply changes,
the supply curve shifts.
1. When supply
decreases, the supply
curve shifts leftward
from S0 to S1.
2. When supply
increases, the supply
curve shifts rightward
from S0 to S2.
4.2 SUPPLY
The main influences on selling plans that change supply
are:
• Prices of related goods
• Prices of resources and other Inputs
• Expectations
• Number of sellers
• Productivity
Things that shift supply ..
Prices of inputs used to make the good and
of related outputs;
Expectations about future prices
Supplier numbers
Technology
4.2 SUPPLY
Prices of Related Goods
A change in the price of one good can bring a change in the
supply of another good.
Substitute in production
A good that can be produced in place of another good. For
example, a truck and an SUV in an auto factory.
• The supply of a good increases if the price of one of its
substitutes in production falls.
• The supply a good decreases if the price of one of its
substitutes in production rises.
4.2 SUPPLY
Complement in production
A good that is produced along with another good. For
example, straw is a complement in production of wheat.
Manufacturing examples are hard to find except in
things like metal-refining.
• The supply of a good increases if the price of one
of its complements in production rises.
• The supply a good decreases if the price of one of
its complements in production falls.
4.2 SUPPLY
Prices of Resources and Other Inputs
Resource and input prices influence the cost of
production. And the more it costs to produce a good,
the smaller will be supply of that good.
Expectations
• Expectations about future prices influence supply.
• Expectations of future input prices also influence
supply.
4.2 SUPPLY
Number of Sellers
The greater the number of sellers in a market, the
larger is supply.
Productivity
Productivity is output per unit of input.
An increase in productivity lowers costs and increases
supply.
4.2 SUPPLY
 Supply: A Summary
Supply and Market Structure
Remember, we ONLY talked about markets
where there are many suppliers, all small
compared to the market
With other market structures, there may not be a
‘supply curve’ in a meaningful sense; ECO 2023
will deal with those cases
4.3 MARKET EQUILIBRIUM
Market equilibrium
When the quantity demanded equals the
quantity supplied—when buyers’ and sellers’
plans are consistent.
Equilibrium price
The price at which the quantity demanded
equals the quantity supplied.
Equilibrium quantity
The quantity bought and sold at the equilibrium
price.
4.3 MARKET EQUILIBRIUM
Figure 4.5 shows the
equilibrium price and
equilibrium quantity.
1. Market equilibrium is
at the intersection of
the demand curve and
the supply curve.
2. The equilibrium
price is $1 a bottle.
3. The equilibrium
quantity is 10 million
bottles a day.
4.3 MARKET EQUILIBRIUM
Price: A Market’s Automatic Regulator
Law of market forces
• When there is a shortage, the price tends to rise.
• When there is a surplus, the price tends to fall.
Surplus or Excess Supply
The quantity supplied exceeds the quantity demanded.
Shortage or Excess Demand
The quantity demanded exceeds the quantity supplied.
4.3 MARKET EQUILIBRIUM
Figure 4.6(a) market
achieves equilibrium.
At $1.50 a bottle:
1. Quantity supplied is 11
bottles.
2. Quantity demanded is 9
bottles.
3. There is a surplus.
4. Price falls until the
market is in equilibrium.
4.3 MARKET EQUILIBRIUM
Figure 4.6(b) market
achieves equilibrium.
At 75 cents a bottle:
5. Quantity demanded is
11 bottles.
6. Quantity supplied is 9
bottles.
7. There is a shortage.
8. Price rises until the
market is in equilibrium.
4.3 MARKET EQUILIBRIUM
Figure 4.7(a) shows the
effects of an increase in
demand.
1. An increase in demand
shifts the demand curve
rightward.
2. The price rises to restore
market equilibrium.
3. Quantity supplied increases
along the supply curve.
4. Equilibrium quantity
increases.
4.3 MARKET EQUILIBRIUM
Figure 4.7(b) shows the
effects of a decrease in
demand.
1. A decrease in demand shifts
the demand curve leftward.
2. The price falls to restore
market equilibrium.
3. Quantity supplied decreases
along the supply curve.
4. Equilibrium quantity
decreases.
4.3 MARKET EQUILIBRIUM
Effects of Changes in Demand
When demand changes:
• The supply curve does not shift.
• But there is a change in the quantity supplied –
sellers change how much they want to sell,
because price changes.
• Price and quantity change in the same direction as
the change in demand.
4.3 MARKET EQUILIBRIUM
Figure 4.8(a) shows the
effects of an increase in
supply.
1. An increase in supply shifts
the supply curve rightward.
2. The price falls to restore
market equilibrium.
3. Quantity demanded
increases along the supply
curve.
4. Equilibrium quantity
increases.
4.3 MARKET EQUILIBRIUM
Figure 4.8(b) shows the
effects of a decrease in supply.
1. A decrease in supply shifts
the supply curve leftward.
2. The price rises to restore
market equilibrium.
3. Quantity demanded
decreases along the supply
curve.
4. Equilibrium quantity
decreases.
4.3 MARKET EQUILIBRIUM
 Effects of Changes in Supply
When supply changes:
• The demand curve does not shift.
• But there is a change in the quantity demanded – buyers
change how much they want to buy, because the price
changes.
• Price changes in the same direction as the change in
supply.
• Quantity changes in the opposite direction to the change in
supply.
4.3 MARKET EQUILIBRIUM
Figure 4.9(a) shows the
effects of an increase in
both demand and supply.
An increase in demand
shifts the demand curve
rightward and an increase
in supply shifts the supply
curve rightward.
1. Quantity increases.
2. Price might rise or fall.
4.3 MARKET EQUILIBRIUM
Increase in Both Demand and Supply
• Increases the equilibrium quantity.
• The change in the equilibrium price is ambiguous
because the:
Increase in demand raises the price.
Increase in supply lowers the price.
4.3 MARKET EQUILIBRIUM
Figure 4.9(b) shows the
effects of a decrease in
both demand and supply.
A decrease in demand
shifts the demand curve
leftward and a decrease in
supply shifts the supply
curve leftward.
3. Quantity decreases.
4. Price might rise or fall.
4.3 MARKET EQUILIBRIUM
Decrease in Both Demand and Supply
• Decreases the equilibrium quantity.
• The change in the equilibrium price is ambiguous
because the:
Decrease in demand lowers the price
Decrease in supply raises the price.
4.3 MARKET EQUILIBRIUM
Figure 4.10(a) shows the
effects of an increase in
demand and a decrease in
supply.
An increase in demand
shifts the demand curve
rightward, and a decrease
in supply shifts the supply
curve leftward.
1. Price rises.
2. Quantity might increase,
decrease, or not change.
4.3 MARKET EQUILIBRIUM
Increase in Demand and Decrease in Supply
• Raises the equilibrium price.
• The change in the equilibrium quantity is
ambiguous because the:
Increase in demand increases the quantity.
Decrease in supply decreases the quantity.
4.3 MARKET EQUILIBRIUM
Figure 4.10(b) shows the
effects of a decrease in
demand and an increase
in supply.
A decrease in demand
shifts the demand curve
leftward, and an increase
in supply shifts the supply
curve rightward.
3. Price falls.
2. Quantity might increase,
decrease, or not change.
4.3 MARKET EQUILIBRIUM
Decrease in Demand and Increase in Supply
• Lowers the equilibrium price.
• The change in the equilibrium quantity is
ambiguous because the:
Decrease in demand decreases the quantity.
Increase in supply increases the quantity.
Kinds of Equilibrium
Unstable
Neutral
Stable
Market Equilibrium
 One of the neat things about the market is that the
Demand and Supply model shows that market
equilibrium is generally stable
 I.e., it is like
 If the ball moves a little, it will go back where it
started; if conditions don’t change, but price is
perturbed [moved] a little from equilibrium, it will go
back where it started.
4.4 PRICE RIGIDITIES
Price adjustments bring market equilibrium.
But sometimes prices do not adjust. What happens
then?
Three reasons why price adjustment might not occur
are:
• Price ceiling
• Price floor
• Sticky price
4.4 PRICE RIGIDITIES
Price Ceiling
Price Ceiling
The highest price at which it is legal to trade a particular
good, service, or factor of production.
Rent Ceiling
A law that makes it illegal for landlords to charge a rent
that exceeds a set limit.
4.4 PRICE RIGIDITIES
Figure 4.11 shows a rental
apartment market.
1. Market equilibrium is
determined by demand and
supply.
2. The equilibrium rent is $550
a month.
3. The equilibrium quantity is
4,000 apartments.
4.4 PRICE RIDIGITIES
Figure 4.12 shows a rental
apartment market.
The rent ceiling is introduced
below the equilibrium rent at
$400 a month.
The quantity of apartments
supplied decreases to 3,000.
The quantity for apartments
demanded increases to 6,000.
There is a shortage of 4,000
apartments.
4.4 PRICE RIGIDITIES
Price Floor
Price floor
The lowest price at which it is legal to trade a particular
good, service, or factor of production.
Minimum wage law
A government regulation that makes hiring labor for less
than a specified wage illegal.
4.4 PRICE RIGIDITIES
Figure 4.13 shows a market
for fast food servers.
1. Market equilibrium is
determined by demand and
supply.
2. The equilibrium wage
rate is $5 an hour.
3. The equilibrium quantity
is 5,000 servers.
4.4 PRICE RIGIDITIES
Figure 4.14 shows how a
minimum wage creates
unemployment.
The minimum wage rate is
set at $7 an hour.
1. The quantity demanded
decreases to 3,000 workers.
2. The quantity supplied
increases to 7,000 workers.
3. A surplus of workers occurs
and 4,000 are unemployed.
4.4 PRICE RIGIDITIES
Sticky Price
In most markets, a law does not restrict the price.
But in some markets, either the buyer and seller agree
on a price for a fixed period or the seller sets a price
that changes infrequently.
In these markets, prices adjust slowly and not quickly
enough to avoid shortages and surpluses.
Methodology
How to use Demand and Supply:
Identify the Ceteris Paribus variable(s)
that changed.
Shift the Demand and/or Supply curve.
Find the new Equilibrium.
Make your prediction.
It will be qualitative – direction of
change, not how much.