1. Theory of Supply and Demand
How supply and demand determine the price of a good and the quantity sold in the market?
Role of prices in allocating resources in the market economy

2. Types of markets
Market is a group of buyers and sellers of a particular good or service
Buyers determine the demand for a product and sellers determine the supply of the product
Competitive market is a market in which there are many buyers and many sellers in the market so that each has a negligible impact on the market price
We assume perfectly competitive markets when we study the theory of demand and supply

3. Types of Markets
Perfectly competitive markets have the following two characteristics:
Goods being sold are all the same
Both Buyers and sellers are price takers
Monopoly is characterized by:
One seller and many buyers
Seller sets the price
Oligopoly is characterized by
Few sellers without rigorous competition
The sellers get together to set a price
Monopolistic competition is characterized by
Many sellers, each selling a differentiated product
Sellers have some ability to set the price for their own product

4. Law of Demand Price and quantity demanded are negatively related
Other things equal, the quantity demanded of a good falls when the price of the good rises.
Price and quantity demanded are negatively related
Quantity demanded is the amount of the good that buyers are willing to purchase

5. Determinants of Demand
Determinants of quantity demanded:
Income (normal, inferior)
Prices of related goods (substitutes, complements)
Tastes
Expectations
Number of buyers (Market demand curve)
Demand schedule and Demand curve
Demand schedule is a table that shows the relationship between the price of a good and the quantity demanded
Demand curve graphs the demand schedule. The demand curve slopes downward

6. Market Versus Individual Demand
Market demand is the horizontal sum of all individual demands for a particular good or service
Market demand is derived from individual demands and thus depends on all those factors that determine individual demand (income, expectations, etc)
In our case, market demand curve shows the variations in the quantity demanded of a good as price changes

7. Shifts Versus Movements Along the Demand Curve
Any change that varies the quantity that buyers wish to buy at a given price shifts the demand curve
Changes in price that varies the quantity that buyers wish to buy is represented as a movement along the demand curve
To summarize: Demand curve shows what happens to the quantity demanded of a good when its price varies, holding constant all other determinants of quantity demanded. When one of these determinants changes, the demand curve shifts.

8. Application of law of Demand: Policy to Reduce Smoking
Option #1: Raise prices of cigarettes by levying a tax
Option #2: Introduce a public awareness program regarding ill effects of smoking
Policy impact on substitutes
Policy impact on complements

9. SUPPLY
Quantity supplied of any good is the amount that sellers are willing to sell in the market
Determinants of supply:
Price
Input prices
Technology
Expectations
Number of sellers (Market supply curve)

10. Law of Supply
Other things equal, the quantity supplied of a good rises when the price of the good rises.
Quantity supplied is positively related to the price of the good
Supply schedule is a table that shows the relationship between the price of a good and the quantity supplied
Supply curve graphs the supply schedule. It is upward sloping

11. Market Versus Individual Supply
Market supply is derived by horizontally summing the individual supply curves
Market supply curve shows how the quantity supplied varies as the price of the good varies
Any change that varies the quantity supplied at a given price shifts the supply curve
Changes in price that varies the quantity supplied in the market is represented as a movement along the supply curve

12. SUPPLY AND DEMAND
How do supply and demand combined together determine the quantity and price of a good sold in the market?
Supply and demand curves intersect. At this equilibrium price quantity supplied equals quantity demanded
Equilibrium is a situation in which supply equals demand
Equilibrium price is also called as the market clearing price as quantity supplied equals quantity demanded

13. SUPPLY AND DEMAND
What happens when market price is not equal to the equilibrium price?
Excess supply- surplus in the market
Excess demand- shortage in the market
Free markets reach equilibrium through the interaction of buyers and sellers and price is the tool through which the market is cleared

14. LAW OF SUPPLY AND DEMAND
Other things remaining same, the price of any good adjusts to bring the supply and demand for that good into balance.
Shifts versus movements along curves
Change in quantity supplied and change in quantity demanded is represented as a movement along the fixed supply and demand curves respectively
Change in supply and change in demand is represented as shifts in supply and demand curves respectively

15. Analyzing Changes in Equilibrium: Application
Change in demand- shifts in the demand curve
Change in supply- shifts in the supply curve
Changes in both supply and demand- Change in equilibrium quantity and price
A simple application

16. Analyzing Changes in Equilibrium: Summary
DEMAND/
SUPPLY
No change in Supply
Increase in supply
Decrease in supply
No change in demand
P same
Q same
P down
Q up
P up
Q down
Increase in demand
P ambiguous
Q ambiguous
Decrease in demand

17. How Prices allocate Resources
Prices act as signals that guide the allocation of scarce resources in a market economy
Prices in turn are determined by forces of supply and demand