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Chapter 4
Price: The Role of
Demand and Supply
© 2003 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
Schedule of the total quantities of a good or service
that purchasers will buy at different prices at a given
time
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Demand
Individual demand
The quantity of a good or service that an
individual or firm stands ready to buy at
various prices at a given time
Market demand
The sum of the individual demands in the
marketplace
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Demand Schedule/Demand Curve
Demand schedule
Table showing the various quantities of a good or
service that will be demanded at various prices
Demand Curve
A curve that indicates the number of units of a good
or service that consumers will buy at various prices
at a given time
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Demand Curve for Internet Time
$1.55
1.50
Table 4-1 provides the detail for
the demand curve presented here
1.45
1.40
Price per
Hour
1.35
1.30
1.25
1.20
1.15
1.10
D
1.05
0
1
2
3
4
5
6
7
8
9
10 11
12 13
Quantity (millions of hours)
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
Shift from D to D1 is an increase in
demand  more will be purchased
at each price
Price per Hour
1.50
1.45
1.40
Shift from D to D2 is a
decrease in demand  less
will be purchased at each
price
1.35
1.30
1.25
1.20
D1
1.15
D
1.10
D2
1.05
0
1
2
3
4
5
6
7
8
9
10 11
12 13
Quantity (millions of hours)
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Determinants of Demand
Changes in income
Higher incomes  increase in demand
Lower incomes  decrease in demand
Changes in tastes and preferences
Change in consumer expectations
9
Determinants of Demand
Changes in the prices of other goods
Substitutes  Increase in the price of
substitutes  increase in demand
Complements  Increase in the price of
complements  decrease in demand
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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
11
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
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Law of Supply
The quantity offered by sellers of a
good or service is directly related to
price, all things being equal.
13
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
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Supply Curves for Internet Time
$1.55
Price per Hour
1.50
1.45
1.40
1.35
Shift from S to S2 is
decrease in demand S2
 smaller amount
offered for sale at
each price
S
S1
Shift from S to S1 is
increase in demand
 larger amount
offered for sale at
each price
1.30
1.25
1.20
1.15
1.10
1.05
0
1
2
3
4
5
6
7
8
9
10 11
12 13
Quantity (millions of hours)
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Determinants of Supply
Changes in the cost of resources
Increase in the cost of resources  decrease in
supply
Technology
Improvements  increase in supply
Expectations of future prices
Prices of related products
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Equilibrium Price
The price at which the quantity
demanded equals the quantity
supplied
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Demand, Supply, and Market Price
for Internet Time
$1.55
Demand
Supply
1.50
Price per Hour
1.45
1.40
1.35
1.30
E
1.25
1.20
1.15
At a price of $1.20, 6 million
hours of internet time will
be offered for sale and an
equal amount purchased
1.10
1.05
0 1
2 3
4 5 6 7 8 9
10 11 12 13
Quantity (millions of hours)
18
Surplus of Internet Time
At a price of $1.30, 7.8 million hours will be offered for sale
but consumers are only willing to purchase 4.2 million
hours  Qs > Qd 
surplus of internet hours
Supply
Demand
$1.55
1.50
Price per Hour
1.45
1.40
Surplus
1.35
Rather than hold on to these
hours sellers will offer to sell
at lower prices with the result
that more consumers enter the
market  price moves toward
$1.20
1.30
1.25
E
1.20
1.15
1.10
1.05
0
1
2
3
4
5
6
7
8
9
10
11 12 13
Quantity (millions of hours)
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Shortage of Internet Time
At a price of $1.10, buyers want to buy 8.5 million hours but
sellers are willing to offer only 3.6 million hours  Qd >Q 
shortage
$1.55
1.50
1.45
Price per Hour
1.40
Some buyers will be willing
to pay more with the result
that the price will increase
and sellers will increase the
amount they offer for sale 
move toward $1.20
1.35
1.30
1.25
E
1.20
1.15
1.10
1.05
Shortage
0
1
2
3
4
5
6
7
8
9 10
11 12 13
Quantity (millions of hours)
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Alternate Supply and Demand Positions
P
P
S
S
D1
D
Q/t
Demand increases from D to D1:
price and quantity both increase
Demand decreases from D1 to D:
price and quantity both decrease
S1
D
Q/t
Supply increases from S to S1:price
declines and quantity increases
Supply decreases from S1 to S: price
increases and quantity declines
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General Guidelines
Increase in demand relative to supply 
higher price
 Decrease in demand relative to supply 
lower price
 Increase in supply relative to demand 
lower price
 Decrease in supply relative to demand 
higher price

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Price Ceiling
Government mandated maximum
price that can be charged for a good
or a service
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Effects of a Price Ceiling
on Rental Housing
Monthly Price ($)
S
E
700
500
Shortage
0
18,000
The effect of the
price ceiling on
rental housing is to
cause a shortage
and reduce housing
opportunities to
those families they
are intended to
accommodate
D
30,000 40,000
Quantity (housing units)
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Price Floor
Government mandated minimum
price that can be charged for a good
or a service
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Effects of a Price Floor on Wheat
S
Price per bushel ($)
Surplus
Impact of the price
floor is to cause a
surplus  the
government must then
buy and store the
surplus that is created
by the price floor
3.00
2.00
D
0
75,000 100,000 115,000
Quantity (bushels)
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Price Elasticity of Demand
Measure of the sensitivity or
responsiveness of quantity
demanded to a change in price
Formula method
Total revenue method
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Formula Method
Price elasticity 
percentage change in quantity demanded
percentage change in price
Q 2  Q1
(Q1  Q 2 )/2

P2  P1
(P1  P2 )/2
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Demand Curve Showing Different Elasticities
$13
12
11
D1
D2
D
Unit elastic
10
Price
9
Elastic demand
8
7
D1
6
5
4
Inelastic demand
D
3
2
D2
1
0
1,600
2,000
2,400
Quantity/Time
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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
Demand curve DD in Figure 4-9
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Elastic Demand
Demand that exists when a
percentage change in price causes a
greater percentage change in
quantity demanded
Has an elasticity coefficient greater
than 1.0: Demand curve D1 in Figure
4-9
31
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  Demand curve D2 in Figure
4-9
32
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
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Characteristics Affecting Price
Elasticity of Demand
Trend Toward
Trend Toward
Inelastic Demand
Elastic Demand
Necessities
Luxuries
Large expenditures Small expenditures
Perishable goods
Durable goods
Complementary goods
Substitute goods
Limited uses
Multiple uses
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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
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Demand Curve Showing Different Elasticities
Elasticity changes
along the demand
curve from elastic at
the top to inelastic at
the bottom
$12
11
10
Price
9
8
7
6
5
4
3
2
1
0 10 20 30 40 50 60 70 80 90 100 110 120
Quantity/Time
36
Other Types of Elasticity
 Cross
elasticity of demand
 Income
 Price
elasticity of demand
elasticity of supply
37
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
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Cross Elasticity of Demand
Substitute goods
Functionally equivalent goods
Complementary goods
Goods that are used together
Change in the price of one product, if it is
substitute or complement can affect the
demand for the other
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Cross Elasticity of Demand
Coefficient of cross elasticity can be
positive or negative
Positive in the case of substitutes
Negative in the case of complements
The larger the coefficient, the greater the
cross elasticity
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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
41
Income Elasticity of Demand
Normal goods
Positive coefficient
Demand varies in the same direction as
income
Inferior goods
Negative coefficient
Demand varies inversely with changes in
income
42
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
43
Time and Elasticity of Supply –
Immediate
P
Demand increases from D to
D1 and because the sellers
cannot adjust the quantity
supplied on such short
notice, the only impact is an
increase in price
S
P1
P
D1
D
Q
Q/t
44
Time and Elasticity of Supply Short Run
P
In the short run, the
seller has sufficient
time to vary some
productive resource
 supply becomes
more elastic and the
quantity supplied
increases and price
Increases
S
P2
P
D1
D
Q
Q2
Q/t
45
Time and Elasticity of Supply Long Run
P
S
P3
P
D1
D
Q
Q3
Over the long
run, the supply
curve becomes
still more elastic
because
producers can
vary all
productive
resources and
make use of new
technology
Q/t
46
Effects of a Tax on Cigarettes
S + $1
S + $1
S
e
e
3.25
S
3.75
R
R
3.00
3.00
D
D
40 50
Quantity (millions of packs)
48 50
Quantity (millions of packs)
Note that the same $1 tax has a much larger impact on quantity
when demand is more elastic than when it is inelastic
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