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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)
Market Equilibrium
P
S
P*
D
0
Q*
Q
Mathematical form of
The equilibrium state
 Equilibrium
is the state where
quantity demanded equals quantity
supplied
 Qd = Qs
 Demand and supply can be
represented by equations
Example
Suppose the TV market is described as
follows:
 The Demand Function
Qd = 95 - 50 P
 The Supply Function
Qs = - 10 + 100 P
 Find equilibrium price and quantity
Equilibrium Math Form
Qd = Qs
By substitution,
95 - 50 P = - 10 + 100 P
105 = 150 P
P = 0.70 (Equilibrium price)
Q = 95 - 50 X 0.7 = 60
(Equilibrium quantity)
Comparative static analysis in the
equation form
 “Outside
force” change the equation.
 Example, income changes causes the
shift in the demand function to
Qd = 120 - 50 P
 Then we solve for the new
equilibrium price and equilibrium
quantity
 Draw conclusions
CONTROLS ON PRICES
 Are
usually enacted when
policymakers believe the market
price is unfair to buyers or sellers.
 Result in government-created price
ceilings and floors.
CONTROLS ON PRICES
 Price
Ceiling
– A legal maximum on the price at which
a good can be sold.
 Price
Floor
– A legal minimum on the price at which a
good can be sold.
How Price Ceilings Affect
Market Outcomes
 If
the price ceiling is set set below
the equilibrium price (called binding),
leading to a shortage.
A Market with a Price Ceiling
Rent of
Apartment
Supply
Equilibrium
price
$2000
800
Price
ceiling
Shortage
Demand
0
7500
Quantity
supplied
12500
Quantity
demanded
Apartments available
For rent
How Price Ceilings Affect
Market Outcomes
A
(binding) price ceiling creates
– Shortages because QD > QS.
 Example:
Gasoline shortage of the 1970s
 Example: Usury law and interest rate
control
 Shortage and repressed inflation in CPEs
– Nonprice rationing
 Examples:
sellers
Long lines, discrimination by
CASE STUDY: Lines at the Gas
Pump
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In 1973, OPEC raised the price of
crude oil in world markets. Crude
oil is the major input in gasoline,
so the higher oil prices reduced the
supply of gasoline.
What was responsible for the long
gas lines?
 Economists blame government
regulations that limited the
price oil companies could
charge for gasoline.
How Price Floors Affect Market
Outcomes
 When
the government imposes a
price floor floor above the
equilibrium price, leading to a
surplus.
A Market with a Price Floor
Price of
Wheet
Supply
Surplus
$4
Price
floor
3
Equilibrium
price
Demand
0
Quantity of wheet
Quantity Quantity Thousands of bushels
demanded supplied
80
120
How Price Floors Affect Market
Outcomes
A
binding price floor causes . . .
– a surplus because QS > QD.
– nonprice rationing is an alternative
mechanism for rationing the good, using
discrimination criteria.
 Examples:
The minimum wage, agricultural
price supports
 Examples: Agricultural products
CASE STUDY: The Minimum
Wage
 An
important example
of a price floor is the
minimum wage.
 Minimum wage laws
dictate the lowest
price possible for
labor that any
employer may pay.
How the Minimum Wage Affects
the Labor Market
Wage
Labor surplus
(unemployment)
Labor
Supply
Minimum
wage
Equilibrium wage
Labor
demand
0
Quantity
demanded
Quantity
supplied
Quantity of
Labor
A Can of Worms
 Favoritism
and corruption
 Unenforceability
 Limit of volume of transactions
 Misallocation of resources and
inefficiency