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Chapter 5
Price: The Role of
Supply and Demand
© 2001 South-Western College Publishing
Law of Demand
The quantity purchased of a good or
service is inversely related to the
price, all other things being equal
2
Quantity Demanded vs. Demand
Quantity Demanded:
The quantities of a good or service that people
will purchase at a specific price over a given
period of time.
Demand:
A schedule of the total quantities of a good or
service that purchasers will buy at different
prices at a given time
3
Demand
Individual demand:
– quantity of a good or service that an
individual or firm stands ready to buy at
various prices at a given time
Market demand:
– sum of the individual demands in the
marketplace
4
Demand Schedule/Demand Curve
 Demand Schedule:
– table showing the various quantities
of a good or service that will be
purchased at various prices
 Demand Curve:
– curve that indicates the number of
units of a good or service that
consumers will buy at various prices
at a given time
5
Demand Curve for Internet Time
$1.5
5
1.50
per
1.45
1.40
Price
Hour
1.35
1.30
1.25
1.20
1.15
D
1.10
1.05
0
8
1
9
2
3
4
5
10 Quantity
11
12
13
(millions
of hours)
6
7
6
Changes in Demand
 Change in Quantity Demanded:
– Movement along the demand curve
that occurs because the price of the
product has changed
 Change in Demand:
– Change in the amounts of the product
that would be purchased at the same
given prices; a shift in the entire
demand curve
7
Demand Curves for Internet Time
$1.5
5
1.50
per
1.45
1.40
Price
Hour
1.35
1.30
1.25
1.20
D1
1.15
D
1.10
D2
1.05
0
8
1
9
2
3
4
5
10 Quantity
11
12
13
(millions
of hours)
6
7
8
Supply
 Supply: The total quantities of a good or
service that sellers stand ready to sell at
different prices at a given time
 Individual Supply: Quantities offered for
sale at various prices at a given time by
an individual seller
 Market Supply: Sum of the individual
supply schedules in the marketplace
9
Supply
 Supply Schedule: Table showing the
various quantities of a good or service
that sellers will offer at various prices at
a given time
 Supply Curve: Line showing the number
of units of a good or service that will be
offered for sale at different prices at a
given time
10
Law of Supply
The quantity offered by sellers of a
good or service is directly related to
price, all things being equal.
11
Changes in Supply
 Change in the Quantity Supplied:
Movement along the supply curve that
occurs because the price of the product
has changed
 Change in Supply: A change in the
amount of the product that would be
offered for sale at the same given price;
a shift of the entire supply curve
12
Supply Curves for Internet Time
$1.5
5
S2
1.50
S
S1
per
1.45
1.40
Price
Hour
1.35
1.30
1.25
1.20
1.15
1.10
1.05
0
8
1
9
2
3
4
5
10 Quantity
11
12
13
(millions
of hours)
6
7
13
Determinants of Supply
Changes in the cost of resources
Technology
Expectations of future prices
Prices of related products
14
Equilibrium Price
The price at which the quantity
demanded equals the quantity
supplied
15
Demand, Supply, and Market Price
for Internet Time
$1.5
5
Demand
Supply
1.50
per
1.45
1.40
Price
Hour
1.35
1.30
E
1.25
1.20
1.15
1.10
1.05
0
8
1
9
2
3
4
5
10 Quantity
11
12
13
(millions
of hours)
6
7
16
Surplus, Shortage, and Equilibrium
for Internet Time
$1.5
5
Demand
Supply
1.50
per
1.45
1.40
Surplus
Price
Hour
1.35
1.30
E
1.25
1.20
1.15
1.10
Shortage
1.05
0
8
1
9
2
3
4
5
10 Quantity
11
12
13
(millions
of hours)
6
7
17
Alternate Supply and Demand Positions
P
P
S
S
D1
D
D
Q/t
Demand Increases
(D becomes D1 )
Demand Decreases
(D1 becomes D)
S1
Q/t
Supply Increases
(S becomes S1 )
Supply Decreases
(S1 becomes S)
18
Price Ceiling
Government mandated maximum
price that can be charged for a good
or a service
19
Effects of a Price Ceiling
on Rental Housing
Monthly Price
($)
S
E
700
500
Shortage
0
18,000
30,000
D
40,000
Quantity (housing
units)
20
Price Floor
Government mandated minimum
price that can be charged for a good
or a service
21
Effects of a Price Floor on Wheat
S
Surplus
Price per
bushel ($)
3.00
2.00
D
0
75,000 100,000 115,000
Quantity
(bushels)
22
Price Elasticity of Demand
Measure of the sensitivity or
responsiveness of quantity
demanded to a change in price
– Formula method
– Total revenue method
23
Demand Curve Showing Different Elasticities
$13
12
11
D1
D2
D
Price
10
9
8
7
D1
6
5
4
D
3
2
1
0
D2
1,600
2,000
2,400
Quantity/Time
24
Formula Method
Price elasticity 
percentage change in quantity demanded
percentage change in price
Q 2  Q1
(Q1  Q2 )/2

P2  P1
(P1  P2 )/2
25
Unit Elastic Demand
Demand that exists when a
percentage change in price causes an
equal percentage change in quantity
demanded
– has an elasticity coefficient equal
to 1.0
26
Elastic Demand
Demand that exists when a
percentage change in price causes a
greater percentage change in
quantity demanded
– has an elastic coefficient greater
than 1.0
27
Inelastic Demand
Demand that exists when a
percentage change in price causes a
smaller percentage change in
quantity demanded
– has an elasticity coefficient less
than 1.0
28
Total Revenue Method
 If price changes and total revenue is
constant, unit elasticity of demand exists
 If price changes and total revenue moves
in the opposite direction, demand is elastic
 If price changes and total revenue moves
in the same direction, demand is inelastic
29
Characteristics Affecting Price
Elasticity of Demand
Trend Toward
Elastic Demand
 Luxuries
 Large expenditures
 Durable goods
 Substitute goods
 Multiple uses
Trend Toward
Inelastic Demand
 Necessities
 Small expenditures
 Perishable goods
 Complementary goods
 Limited uses
30
Three Demand Curves Showing Different
Elasticities
(a)
(c)
(b)
P
P
Perfectly
Elastic
P
D2
Perfectly
Inelastic
D1
Perfectly
Unit
Elastic
D3
Q/t
Q/t
Q/t
31
Demand Curve Showing Different Elasticities
$12
11
Price
10
9
8
7
6
5
4
3
2
1
0
80
10
90
20
100
30
110
40
120
50
60
70
Quantity/Time
32
Other Types of Elasticity
Cross elasticity of demand
Income elasticity of demand
Price elasticity of supply
33
Cross Elasticity of Demand
Measure of the responsiveness of the
quantity demanded of one product as a
result of a change in the price of another
product
Cross elasticity of demand 
percentage change in quantity demanded of B
percentage change in price of A
34
Income Elasticity of Demand
Measure of the responsiveness of the
quantity demanded to a change in income
Income elasticity of demand 
percentage of change in quantity
percentage change in income
35
Price Elasticity of Supply
Measure of the responsiveness of the
quantity supplied to a change in price
Price elasticity of supply 
percentage change in quantity supplied
percentage change in price
36
Time and Elasticity of Supply Intermediate
P
S
P1
P2
D1
D
Q
Q/t
37
Time and Elasticity of Supply Short Run
P
S
P2
P
D1
D
Q
Q2
Q/t
38
Time and Elasticity of Supply Long Run
P
S
P3
P
D1
D
Q
Q3
Q/t
39
Effects of a Tax on Cigarettes
S + $1
S + $1
S
3.2
5
e
e
3.7
R
3.0
0
S
R
5
3.0
D
0
D
40
50
48
50
Quantity (millions of
packs)
Quantity (millions of
packs)
40