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Combining Supply and Demand
• How do supply and demand create balance in the
marketplace?
• What are differences between a market in equilibrium
and a market in disequilibrium?
Chapter 6
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Balancing the Market
The point at which quantity demanded and quantity
supplied come together is known as equilibrium.
Finding Equilibrium
Equilibrium Point
Combined Supply and Demand Schedule
$3.50
$2.50
$2.00
Equilibrium
Price
$1.50
$1.00
$.50
Supply
0
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50
a
Equilibrium
Quantity
Price per slice
$3.00
Demand
100 150 200 250 300
Slices of pizza per day
Section
Price of
a slice
of pizza
Quantity
demanded
Quantity
supplied
$ .50
300
100
$1.00
250
150
$1.50
200
200
$2.00
150
250
$2.50
100
300
$3.00
50
350
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Result
Shortage from
excess demand
Equilibrium
Surplus from
excess supply
Market Disequilibrium
If the market price or quantity supplied is anywhere but
at the equilibrium price, the market is in a state called
disequilibrium. There are two causes for disequilibrium:
Excess Demand
Excess Supply
• Excess demand occurs when
quantity demanded is more
than quantity supplied.
• Excess supply occurs when
quantity supplied exceeds
quantity demanded.
• Ex: beanie babies
• Ex: today’s housing market
Interactions between buyers and sellers will
always push the market back towards
equilibrium.
Chapter 6
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Sec. 2
Changes in Market Equilibrium
• How do shifts in supply affect market equilibrium?
• How do shifts in demand affect market equilibrium?
• How can we use supply and demand curves to analyze
changes in market equilibrium?
Chapter 6
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Shifts in Supply
• Understanding a Shift
– A change in supply will lead the market to a new equilibrium
price and quantity sold.
• Excess Supply
– If a surplus occurs, producers reduce prices to sell their
products. This creates a new market equilibrium.
• A Fall in Supply
– The opposite occurs: As supply decreases, producers will
raise prices and demand will decrease.
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Shifts in Demand
• Excess Demand creates a “shortage”
– A shortage is a situation in which quantity demanded is
greater than quantity supplied.
• A Fall in Demand
– When demand falls, suppliers respond by cutting prices, and a
new market equilibrium is found.
Chapter 6
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Analyzing Shifts in Supply and Demand
Graph A: A Change in Supply
Graph B: A Change in Demand
$800
$60
a
Supply
$50
b
Original
supply
$40
c
Price
Price
$600
$400
c
$30
a
b
$20
$200
New
supply
Demand
New
demand
Original
demand
$10
0
1
2
3
4
5
0
100
Output (in millions)
200
300
400
500
600
700
Output (in thousands)
• Graph A shows how the market finds a new equilibrium
when there is an increase in supply.
• Graph B shows how the market finds a new equilibrium
when there is an increase in demand.
Chapter 6
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800
900
The Great Tortilla Crisis:
• A sharp rise in the price of tortillas, a staple food of Mexico’s poor,
which had gone from 25 cents a pound to between 35 and 45 cents a
pound in just a few months in early 2007.
Why were tortilla prices soaring?
• It was a classic example of what happens to equilibrium prices when
supply falls. Tortillas are made from corn; much of Mexico’s corn is
imported from the United States, with the price of corn in both
countries basically set in the U.S. corn market. And U.S. corn prices
were rising rapidly thanks to surging demand in a new market: the
market for ethanol.
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Demand and Supply Shifts at Work
in the Global Economy
• A recent drought in Australia reduced the amount of grass on
which Australian dairy cows could feed, thus limiting the
amount of milk these cows produced for export.
• At the same time, a new tax levied by the government of
Argentina raised the price of the milk the country exported,
thereby decreasing Argentine milk sales worldwide.
• These two developments produced a supply shortage in the
world market, which dairy farmers in Europe couldn’t fill
because of strict production quotas set by the European
Union.
Chapter 6
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Sec. 3
The Role of Prices
• What role do prices play in a free market system?
• What advantages do prices offer?
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The Role of Prices in a Free Market
Prices serve a vital role in a free market economy:
• Prices help move land, labor, and capital into the hands
of producers, and finished goods into the hands of
buyers.
• Prices create an efficient way to allocate (“distribute”)
resources for producers
•
Create a language that both consumers and producers
can use.
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Advantages of Prices
Prices provide a language for buyers and sellers.
1. Prices work as an Incentive
Prices communicate to both buyers and sellers whether goods or
services are scarce or easily available. Prices can encourage or
discourage production.
2. Signals
Think of prices as a traffic light. A relatively high price is a green light
telling producers to make more. A relatively low price is a red light
telling producers to make less.
3. Flexibility
In many markets, prices are much more flexible than production levels.
They can be easily increased or decreased to solve problems of
excess supply or excess demand.
4. Price System is "Free"
Unlike central planning, a distribution system based on prices costs
nothing to administer.
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