Demand & Supply

Demand, Supply & Market Equilibrium

P

Q

D

S

Demand A relation between the price of a good and the

quantity that consumers are willing and able to buy during a given period, other things constant. Willing: you want to buy the product Able: you can afford the buy the product

Demand Schedule and Curve Demand curve:

a curve showing the relation between the price of a good and quantity demanded during a given period, other things constant.

Suppose we are making pizza.

Price of Good

Quantity Demand

ed

$3 200

$4 150

$5 100

$6 75

$7 50

Law of Demand States that a quantity of a good demanded

during a given period relates inversely to its price, other things constant.

Price increases Quantity Demanded decreases

Price decreases Quantity demanded increases

Creates a downward sloping demand curve

Why? Substitution Effect

Unlimited wants/scarce resources When the price of a good falls, consumers

substitute that good for other goods, which become relatively more expensive.

Reverse also holds true

Why? Income Effect

Money income: is simply the number of dollars received per period

Real income: your income measured in terms of what it can buy.

A fall in the price of a good increases consumers’ real income making consumers more able to purchase goods; for a normal good, the quantity demanded increases.

Demand Curve

Price

Quantity0

$3

$4

$5

$6

50 75 100 150 200

Demand

Point on the line that matches the schedule Every point on the line matches the schedule. It is a price/quantity demanded that consumers are willing and able to buy.

A curve showing the relation between the price of a good and the quantity demanded.

Movement Along the Demand Curve Caused by a change in price

Only a change in priceOnly a change in price Move from one point to another on the same

graph Called a

Change in quantity demanded.

Quantity

Price

0

$5

100

Demand

$6

75

Movement along the Demand Curve

A

B

Demand Individual demand

The demand of an individual consumer Market demand

Sum of individual demands of all consumers in the market

Shifts in the Demand Curve A demand curve isolates the relation between

prices of a good and quantities demanded when other factors that could affect demand remain unchanged.

Factors called assumptions or determinants

Determinants of Demand Changes in consumer income Changes in prices of related goods Changes in consumer expectations Changes in the number or composition of

consumers Changes in consumer tastes

Changes in determinants Results in changes to the RELATIONSHIP

BETWEEN PRICE AND QUANTITY DEMANDED.

At each and every price a DIFFERENT DIFFERENT quantity is demanded.

Results in a shift in the demand curve New curve must be drawn

Changes in Demand Increase in demand

At each and every price MOREMORE of the good is demanded

Shifts to the right

D1

$5

D2

A B

Price

Quantity100 150

P Qd1 Qd2

$4 150 200

$5 100 150

$6 75 100

Causes of Increase in Demand Increase in consumer

income Causes consumers to

buy more of the product at each and every price.

Normal goods Inferior goods

Change in consumer income Normal goods

A good for which demand increases as consumer income rise

Inferior goods A good which demand

increases as consumer income falls

Changes in Price of Related Goods Substitutes

Goods that are not consumed jointly

Goods that are related in such a way that an increase in the price of one shifts the demand curve for the other rightward.

Increase in price of Coke Increase in price of Coke leads to increase in leads to increase in demand for Pepsidemand for Pepsi

Changes in Price of Related Goods Substitutes

Suppose that the price of Coke rises from $1 to $1.50, then the demand for Pepsi will decrease from 75 to 100.

D2

$1

100

D1

75

Changes in the price of related goods Complements

Goods that are related in a such a way that an increase in the price of one shifts the demand of the other leftward

Two goods that are consumed jointly.

An decrease in the An decrease in the price of one will price of one will increase demand increase demand for the otherfor the other

Changes in Price of Related Goods Complements

An decrease in the price of DVD players, increases the demand for DVDs

Suppose that DVD players decrease in price from $145 to $100, now the demand for DVDs will decrease from 750 at $20 to 900.

D

$20

750 900

D2

Changes in Consumer Expectations Such as expectations in

Prices and income Affect how consumers

spend their money and their demand

If product cheaper today than tomorrow, then increase in demand

Changes in consumer tastes Consumer preferences

likes and dislikes in consumption assumed to be constant along a given demand curve assumed constant along a given demand curve

Changes in taste will cause a shift in the demand curve as different quantities are demanded at each and every price.

Changes in taste Consumers

prefer platform shoes.

At $50, demand increases from 100 to 200. D

$50

100

D2

200

Change in the number and composition of consumers The market demand curve is the sum of the

individual demand curves. If the number of consumers falls then the sum

will be smaller thus shifting the demand curve

Changes in Demand Decrease in demand

At each and every price LessLess of the good is demanded

Shifts to the Left

D2

$5

D1

A

B

Price

Quantity90 100

P Qd1 Qd2

$4 150 110

$5 100 90

$6 75 60

Causes of Decrease in Demand Decrease in consumer

income Causes consumers to

buy less of the product at each and every price.

Changes in Price of Related Goods Complements

An decrease in the price of DVD players, increases the demand for DVDs

Suppose that DVD players increase in price from $100 to $145, now the demand for DVDs will decrease from 900 at $20 to 750.

D2

$20

750 900

D1

Change in the number and composition of consumers The market demand curve is the sum of the

individual demand curves. If the number of consumers falls then the sum

will be smaller thus shifting the demand curve

Review of Demand A change in quantity demanded is not a change in

demand Change in quantity demanded is caused by a change

in price Change in quantity demanded is a movement along

the demand curve Change is demand is caused by a change in the

determinants Change in demand shifts the demand curve

Supply Producer’s side A relation between the price of a good and the

quantity that the producers are willing and able to offer for sale during a given period, other things constant.

Law of Supply The quantity of a good supplied during a

given period is usually directlydirectly related to the price of the good

Increase in price leads to increase in quantity supplied

Decrease in price leads to decrease in quantity supplied.

Creates upward sloping supply curve

Supply CurvePrice of Good

Quantity Demanded

$3 50

$4 75

$5 100

$6 150

$7 200

Supply

Quantity

Price

6

5

Movement along the supply curve A change in price and only in price Causes a movement along the supply curve Called a Change in Quantity Supplied

A$4

100

$6

150

Supply

B

Supply Individual supply

The supply of an individual producer Market supply

The sum of individual supplies of all producers in the market

Determinants for the Supply Curve Changes in technology Changes in prices of relevant resources Changes in the prices of alternative goods Changes in Producer Expectations Changes in the number of producers

Changes in Supply Caused by changes in the determinants to

the supply curve Results in changes to the relationship Results in changes to the relationship

between the price and quantity suppliedbetween the price and quantity supplied At each and every price a different

quantity is supplied New supply curve - shift in supply

Increase in Supply At each and every price moremore of the good

is supplied

400300

$6

S1S2

Causes of increase in Supply Improvements in Technology Changes in relevant resources

Decrease in the price of resources Lowers costs

Changes in price of alternative goods If price of alternative good increases, supply of

the good increases Changes in producers expectations

Changes in technology Technology is the economy’s stock of

knowledge about how to combine resources efficiently

Changes in Technology Improvements in technology

Causes an increase in supply More of the product is available at all prices

300

$6

S1S2

400

Changes in Relevant Resources Decrease in

resource prices Increases the

supply of the good at each and every price.

400300

$6

S1S2

Changes in prices of Alternative Goods Alternative goods

Other goods that use some or all of the same resources as the good in question

Beef and leather. If the price of beef

increases, producers will supply more beef thus increasing the supply of leather.

400300

$6

S1S2

Above is the market for the supply of leather

Q Leather

Price

Changes in Producers Expectations Expectation of future prices of resources or

their own product can cause producers to change what they offer at each individual price

Changes in the Number of Producers As the number of

producers change so does the supply of the product

A decrease in the number of producers will lead to a decrease in supply

Decrease in Supply At each and every price LESS LESS of the good is

supplied

5

600400

S1S2

Causes of Decrease in Supply Backward movement in Technology Changes in relevant resources

Increase in the price of resources Raises costs

Changes in price of alternative goods If price of alternative good decreases, supply of

the good decreases Changes in producers expectations

Changes in Relevant Resources Are those employed in

the production of the good in question

Increase in price of resources Results in decrease in

supply Less of the good is

available at all prices

$9

500 600

S1S2

Changes in prices of Alternative Goods Alternative goods

Other goods that use some or all of the same resources as the good in question

Beef and leather. If the price of beef

decreases, producers will supply less beef thus decreasing the supply of leather.

400300

$6

S1

Above is the market for the supply of leather

Q Leather

Price

Producer’s Expectation Nationalization

Expropriation

Supply Review Change in Quantity Supplied

Caused by a change in the price of the product Movement along the supply curve

Change in Supply Caused by change in the determinants Results in a shift in the supply curve

Market Equilibrium Market

Includes all the arrangements used to buy and sell

Reduce transaction costs

The place where buyers and sellers meet to determine price and quantity

Equilibrium At specific price where:

Quantity demanded = Quantity suppliedQuantity demanded = Quantity supplied Equilibrium price –

market clearing price Equilibrium quantity –

D = S

Equilibrium At specific

price where:

Quantity Quantity demandeddemanded

EqualsEquals

Quantity Quantity SuppliedSupplied

S

D

Q

P

$5

150

Equilibrium

Reaching Equilibrium

If market price is ABOVE equilibrium

Qs > QD

Economy is at a SURPLUS

Market price will fall

S

D

Q

P

150

$5

$6

100 200

Surplus

Reaching Equilibrium If the market

price is BELOW the equilibrium price

QD > Qs

Shortage exists Market price rises

to equilibrium

S

D

Q

P

150 100 200

$4

$5

Shortage

Shifts in Demand Demand increases

Equilibrium price increases

Equilibrium quantity increases

S

D

Q

P

150 100 200

D1

$4 A

B$6

Shifts in Demand

Decrease in demand decrease in price decrease in equilibrium

S

D

Q

P

100 200

D1

A

B$6

$5

Shifts in Supply Increase in supply

Decrease in equilibrium price

Increase in quantity

400300

$6

S1S2

Q Leather

Price

$5

Shifts in Supply Decrease in supply

Price increases Quantity decreases

Simultaneous Shifts in Supply and Demand The change in equilibrium price and quantity

depends on which curve shifts the most.

S

D

S1

D1

AB

200 300

4

5

Simultaneous Changes

Change in Supply

Change in Demand

Effect on Equilibrium

Price

Effect on Equilibrium

Quantity

Increase Decrease Decrease Indeterminate

Decrease Increase Increase Indeterminate

Increase Increase Indeterminate Increase

Decrease Decrease Indeterminate Decrease

Government Intervention Government enters

the economy Price Setting Subsidies

Government payments to reduce the cost of product or to limit production.

Price Floors A minimum

legal price below which a good or service cannot be sold

If above equilibrium causes surplus

S

D

Q150 100 200

Surplus

$7

$6

Price Ceilings A maximum legal

price above which a good or service cannot be sold

Below equilibrium price

Shortage occurs

S

D

Q

P

150 100 200

$5

Shortage