1. Demand, Supply & Market Equilibrium
ECO 2013
Chapter 3
Prof M. Mari
Fall 2007 D Q

2. 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

3. 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 Demanded $3
200 $4
150 $5
100 $6 75 $7 50

4. 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

5. 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

6. 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.

7. Demand Curve
A curve showing the relation between the price of a good and the quantity demanded.
Price $6 $5
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. $4 $3
Demand
Quantity
200 50 75
100
150

8. Movement Along the Demand Curve
Caused by a change in price
Only a change in price
Move from one point to another on the same graph
Called a
Change in quantity demanded.

9. Movement along the Demand Curve
Price B $6 $5 A
Demand 75
100
Quantity

10. Demand Individual demand Market demand
The demand of an individual consumer
Market demand
Sum of individual demands of all consumers in the market

11. 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

12. 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

13. Changes in determinants
Results in changes to the RELATIONSHIP BETWEEN PRICE AND QUANTITY DEMANDED.
At each and every price a DIFFERENT quantity is demanded.
Results in a shift in the demand curve
New curve must be drawn

14. Changes in Demand Increase in demand P Qd1 Qd2 $4 150 200 $5 100 $6 75
At each and every price MORE of the good is demanded
Shifts to the right
Price P
Qd1
Qd2 $4
150
200 $5
100 $6 75 A B $5 D2 D1
Quantity
100
150

15. 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

16. 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

17. 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 leads to increase in demand for Pepsi

18. 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. $1 D2 D1 75
100

19. 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 price of one will increase demand for the other

20. 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.
$20 D2 D
750
900

21. 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

22. 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.

23. Changes in taste Consumers prefer platform shoes.
At $50, demand increases from 100 to 200.
$50 D2 D
100
200

24. 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

25. Changes in Demand Decrease in demand P Qd1 Qd2 $4 150 110 $5 100 90 $6
At each and every price Less of the good is demanded
Shifts to the Left
Price P
Qd1
Qd2 $4
150
110 $5
100 90 $6 75 60 B $5 A D1 D2
Quantity 90
100

26. Causes of Decrease in Demand
Decrease in consumer income
Causes consumers to buy less of the product at each and every price.

27. 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.
Decrease in price of Coke leads to Decrease in demand for Pepsi

28. Changes in Price of Related Goods
Substitutes
Suppose that the price of Coke drops from $1 to $0.50, then the demand for Pepsi will decrease from 100 to 75. $1 D D2 75
100

29. 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 increase in the price of one will decrease demand for the other

30. 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.
$20 D1 D2
750
900

31. Changes in Consumer Expectations
Such as expectations in
Prices and income
Affect how consumers spend their money and their demand
If product more expensive today than tomorrow, then decrease in demand

32. 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.

33. 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

34. 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

35. 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.

36. Law of Supply
The quantity of a good supplied during a given period is usually directly 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

37. Supply Curve 5 Price of Good Quantity Demanded $3 50 $4 75 $5 100 $6
150 $7
200 6
Supply 5
Quantity

38. 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
Supply $6 B $4 A
100
150

39. Supply Individual supply Market supply
The supply of an individual producer
Market supply
The sum of individual supplies of all producers in the market

40. 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

41. Changes in Supply
Caused by changes in the determinants to the supply curve
Results in changes to the relationship between the price and quantity supplied
At each and every price a different quantity is supplied
New supply curve - shift in supply

42. Increase in Supply
At each and every price more of the good is supplied S1 S2 $6
300
400

43. 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

44. Changes in technology
Technology is the economy’s stock of knowledge about how to combine resources efficiently

45. Changes in Technology Improvements in technology
Causes an increase in supply
More of the product is available at all prices S1 S2 $6
300
400

46. Changes in Relevant Resources
Decrease in resource prices
Increases the supply of the good at each and every price. S1 S2 $6
300
400

47. Changes in prices of 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.
Price S1 S2 $6
Q Leather
300
400
Above is the market for the
supply of leather

48. 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

49. 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

50. Decrease in Supply
At each and every price LESS of the good is supplied 5 S1 S2
400
600

51. 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

52. 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 S1 S2
500
600

53. Changes in prices of 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.
Price S1 $6
Q Leather
300
400
Above is the market for the
supply of leather

54. Producer’s Expectation
Nationalization
Expropriation

55. Supply Review Change in Quantity Supplied Change in Supply
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

56. 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

57. Equilibrium At specific price where:
Quantity demanded = Quantity supplied
Equilibrium price –
market clearing price
Equilibrium quantity –
D = S

58. Equilibrium At specific price where: Quantity demanded Equals
Quantity Supplied S $5
Equilibrium D Q
150

59. Reaching Equilibrium If market price is ABOVE equilibrium Qs > QD
Economy is at a SURPLUS
Market price will fall P
Surplus S $6 $5 D Q
100
150
200

60. Reaching Equilibrium
If the market price is BELOW the equilibrium price
QD > Qs
Shortage exists
Market price rises to equilibrium P S $5 $4 D
Shortage Q
100
150
200

61. Shifts in Demand Demand increases Equilibrium price increases
Equilibrium quantity increases P S $6 B $4 A D1 D Q
100
150
200

62. Shifts in Demand Decrease in demand decrease in price
decrease in equilibrium S $6 B $5 A D1 D Q
100
200

63. Shifts in Supply Increase in supply Decrease in equilibrium price
Increase in quantity
Price S1 S2 $6 $5
Q Leather
300
400

64. Shifts in Supply
Decrease in supply
Price increases
Quantity decreases

65. Simultaneous Shifts in Supply and Demand
The change in equilibrium price and quantity depends on which curve shifts the most. S S1 5 A B 4 D1 D
200
300

66. Effect on Equilibrium Price Effect on Equilibrium Quantity
Simultaneous Changes
Change in Supply
Change in Demand
Effect on Equilibrium Price
Effect on Equilibrium Quantity
Increase
Decrease
Indeterminate

67. Government Intervention
Government enters the economy
Price Setting
Subsidies
Government payments to reduce the cost of product or to limit production.

68. Price Floors
A minimum legal price below which a good or service cannot be sold
If above equilibrium causes surplus
Surplus S $7 $6 D Q
100
150
200

69. Price Ceilings
A maximum legal price above which a good or service cannot be sold
Below equilibrium price
Shortage occurs P S $5 D
Shortage Q
100
150
200