1. Chapter 3
Supply and Demand

2. WHAT YOU WILL LEARN IN THIS CHAPTER
What a competitive market is and how it is described by the supply and demand model
What the demand curve and supply curve are
The difference between movements along a curve and shifts of a curve
How the supply and demand curves determine a market’s equilibrium price and equilibrium quantity
In the case of a shortage or surplus, how price moves the market back to equilibrium
WHAT YOU
WILL LEARN
IN THIS CHAPTER

3. Supply and Demand A competitive market:
Many buyers and sellers
Same good or service
The supply and demand model is a model of how a competitive market works.
Five key elements:
Demand curve
Supply curve
Demand and supply curve shifts
Market equilibrium
Changes in the market equilibrium

4. Demand Schedule
A demand schedule shows how much of a good or service consumers will want to buy at different prices.
7.1
7.5
8.1
8.9
10.0
11.5
14.2
Price of cotton (per pound)
Quantity of cotton demanded (billions of pounds)
1.75
1.50
1.25
1.00
0.75
0.50
$2.00
Demand Schedule for Cotton

5. Price of cotton (per pound) Quantity of cotton (billions of pounds)
Demand Curve
Price of cotton (per pound)
A demand curve is the graphical representation of the demand schedule. It shows how much of a good or service consumers want to buy at any given price.
$2.00
Demand curve, D
1.75
1.50
1.25
1.00
Figure Caption:
Figure 3-1: The Demand Schedule and the Demand Curve
The demand schedule for cotton yields the corresponding demand curve, which shows how much of a good or service consumers want to buy at any given price. The demand curve and the demand schedule reflect the law of demand: As price rises, the quantity demanded falls. Similarly, a decrease in price raises the quantity demanded. As a result, the demand curve is downward sloping.
0.75
As price rises, the quantity demanded falls
0.50 7 9 11 13 15 17
Quantity of cotton (billions of pounds)

6. An Increase in Demand
An increase in population and other factors generate an increase in demand.
a rise in the quantity demanded at any given price
This is represented by the two demand schedules—one showing demand in 2007, before the rise in population, the other showing demand in 2010, after the rise in population.
Demand Schedules for Cotton
Quantity of cotton demanded (billions of pounds)
Price of cotton (per pound)
in 2007
in 2010
$2.00
7.1
8.5
1.75
7.5
9.0
1.50
8.1
9.7
1.25
8.9
10.7
1.00
10.0
12.0
0.75
11.5
13.8
0.50
14.2
17.0

7. Price of cotton (per pound) Quantity of cotton (billions of pounds)
An Increase in Demand
Price of cotton (per pound)
$2.00
Increase in population 
more cotton clothing users 2
1.75
Demand curve in 2010
1.50
1.25
1.00
0.75
Demand curve in 2007
0.50 D D 1
Figure Caption:
Figure 3-2: An increase in demand
An increase in the population and other factors generate an increase in demand—a rise in the quantity demanded at any given price. This is represented by the two demand schedules—one showing demand in 2007, before the rise in population, the other showing demand in 2010, after the rise in population—and their corresponding demand curves. The increase in demand shifts the demand curve to the right. 7 9 11 13 15 17
Quantity of cotton (billions of pounds)
A shift of the demand curve is a change in the quantity demanded at any given price, represented by the change of the original demand curve to a new position, denoted by a new demand curve.

8. Movement Along the Demand Curve
A movement along the demand curve is a change in the quantity demanded of a good that is the result of a change in that good’s price.
Price of cotton (per pound)
A shift of the demand curve…
$2.00
1.75
… is not the same thing as a movement along the demand curve A C
1.50
1.25 B
Figure Caption:
Figure 3-3: Movement Along the Demand Curve Versus Shift of the Demand Curve
The rise in quantity demanded when going from point A to point B reflects a movement along the demand curve: it is the result of a fall in the price of the good. The rise in quantity demanded when going from point A to point C reflects a shift of the demand curve: it is the result of a rise in the quantity demanded at any given price.
1.00
0.75
0.50 D D 1 2 7
8.1
9.7 10 13 15 17
Quantity of cotton (billions of pounds)

9. Shifts of the Demand Curve
An “increase in demand” means a rightward shift of the demand curve: at any given price, consumers demand a larger quantity than before. (D1D2)
A “decrease in demand” means a leftward shift of the demand curve: at any given price, consumers demand a smaller quantity than before. (D1D3)
Price
Increase in demand
Figure Caption:
Figure 3-4: Shifts of the Demand Curve
Any event that increases demand shifts the demand curve to the right, reflecting a rise in the quantity demanded at any given price. Any event that decreases demand shifts the demand curve to the left, reflecting a fall in the quantity demanded at any given price.
Decrease in demand D D D 3 1 2
Quantity

10. What Causes a Demand Curve to Shift?
Changes in the Prices of Related Goods
Substitutes: Two goods are substitutes if a fall in the price of one of the goods makes consumers less willing to buy the other good.
Complements: Two goods are complements if a fall in the price of one good makes people more willing to buy the other good.

11. What Causes a Demand Curve to Shift?
Changes in Income
Normal Goods: When a rise in income increases the demand for a good — the normal case — we say that the good is a normal good.
Inferior Goods: When a rise in income decreases the demand for a good, it is an inferior good.
Changes in Tastes
Changes in Expectations

12. Individual Demand Curve and the Market Demand Curve
The market demand curve is the horizontal sum of the individual demand curves of all consumers in that market.
(a)
Darla’s Individual Demand Curve
(b)
Dino’s Individual Demand Curve
(c)
Market Demand Curve
Price of blue jeans (per pair)
Price of blue jeans (per pair)
Price of blue jeans (per pair)
$30
$30
$30 D
Market
Figure Caption:
Figure 3-5: Individual Demand Curves and the Market Demand Curve
Darla and Dino are the only two consumers of blue jeans in the market. Panel (a) shows Darla’s individual demand curve: the number of pair of jeans she will buy per year at any given price. Panel (b) shows Dino’s individual demand curve. Given that Darla and Dino are the only two consumers, the market demand curve, which shows the quantity of blue jeans demanded by all consumers at any given price, is shown in panel (c). The market demand curve is the horizontal sum of the individual demand curves of all consumers. In this case, at any given price, the quantity demanded by the market is the sum of the quantities demanded by Darla and Dino. 1 1 1 D D
Darla
Dino 3 4 2 3 5 6 7
Quantity of blue jeans (pounds)
Quantity of blue jeans (pounds)
Quantity of blue jeans (pounds)

13. Supply Schedule for Cotton
Price of
cotton
(per pound)
Quantity of
supplied
(billions of pounds)
$2.00
11.6
1.75
11.5
1.50
11.2
1.25
10.7
1.00
10.0
0.75
9.1
0.50
8.0
A supply schedule shows how much of a good or service would be supplied at different prices.
Figure Caption:
Figure 3-6: The Supply Schedule and the Supply Curve
The supply schedule for cotton is plotted to yield the corresponding supply curve, which shows how much of a good producers are willing to sell at any given price. Just as the quantity of cotton that consumers want to buy depends on the price they have to pay, the quantity that producers are willing to produce and sell—the quantity supplied—depends on the price they are offered.

14. Price of cotton (per pound) Quantity of cotton (billions of pounds)
Supply Curve
Price of cotton (per pound)
A supply curve shows graphically how much of a good or service people are willing to sell at any given price.
Supply curve, S
$2.00
1.75
As price rises, the quantity supplied rises.
1.50
1.25
1.00
Figure Caption:
Figure 3-6: The Supply Schedule and the Supply Curve
The supply curve and the supply schedule reflect the fact that supply curves are usually upward sloping: the quantity supplied rises when the price rises.
0.75
0.50 7 9 11 13 15 17
Quantity of cotton (billions of pounds)

15. Supply Schedule for Cotton Quantity of cotton supplied
An Increase in Supply
The adoption of improved cotton-growing technology generated an increase in supply — a rise in the quantity supplied at any given price.
This event is represented by the two supply schedules — and their corresponding supply curves
one showing supply before the new technology was adopted
the other showing supply after the new technology was adopted
Supply Schedule for Cotton
Price of cotton
(per pound)
Quantity of cotton supplied
(billions of pounds)
Before new technology
After new technology
$2.00
11.6
13.9
1.75
11.5
13.8
1.50
11.2
13.4
1.25
10.7
12.8
1.00
10.0
12.0
0.75
9.1
10.9
0.50
8.0
9.6
Figure Caption:
Figure 3-7: An increase in supply
The adoption of new technology in the cotton growing business generated an increase in supply—a rise in the quantity supplied at any given price. This event is represented by the two supply schedules—one showing supply before technology adoption, the other showing supply after technology adoption—and their corresponding supply curves. The increase in supply shifts the supply curve to the right.

16. Price of cotton (per pound) Quantity of cotton (billions of pounds)
An Increase in Supply
Price of cotton (per pound) S 2 S 1
Technology adoption in cotton-growing business 
more cotton producers
$2.00
Supply curve before new technology
1.75
1.50
1.25
1.00
Supply curve
after
new technology
0.75
Figure Caption:
Figure 3-7: An increase in supply
The adoption of new technology in the cotton growing business generated an increase in supply—a rise in the quantity supplied at any given price. This event is represented by the two supply schedules—one showing supply before technology adoption, the other showing supply after technology adoption—and their corresponding supply curves. The increase in supply shifts the supply curve to the right.
0.50 7 9 11 13 15 17
Quantity of cotton (billions of pounds)
A shift of the supply curve is a change in the quantity supplied of a good at any given price.

17. Movement Along the Supply Curve
Price of cotton (per pound) S S 2
$2.00
A movement along the supply curve… 1
1.75
1.50 B
1.25 A
1.00 C
… is not the same thing as a shift of the supply curve
0.75
Figure Caption:
Figure 3-8: Movement Along the Supply Curve Versus Shift of the Supply Curve
The increase in quantity supplied when going from point A to point B reflects a movement along the supply curve: it is the result of a rise in the price of the good. The increase in quantity supplied when going from point A to point C reflects a shift of the supply curve: it is the result of an increase in the quantity supplied at any given price.
0.50 7 10
11.2 12 15 17
Quantity of cotton (billions of pounds)
A movement along the supply curve is a change in the quantity supplied of a good that is the result of a change in that good’s price.

18. Shifts of the Supply Curve
Any “decrease in supply” means a leftward shift of the supply curve: at any given price, there is a decrease in the quantity supplied. (S1 S3)
Any “increase in supply” means a rightward shift of the supply curve: at any given price, there is an increase in the quantity supplied. (S1 S2)
Price S S S 3 1 2
Increase in supply
Figure Caption:
Figure 3-9: Shifts of the Supply Curve
Any event that increases supply shifts the supply curve to the right, reflecting a rise in the quantity supplied at any given price. Any event that decreases supply shifts the supply curve to the left, reflecting a fall in the quantity supplied at any given price.
Decrease in supply
Quantity

19. What Causes a Supply Curve to Shift?
Changes in input prices
An input is a good that is used to produce another good.
Changes in the prices of related goods and services
Changes in technology
Changes in expectations
Changes in the number of producers

20. Individual Supply Curve and the Market Supply Curve
The market supply curve is the horizontal sum of the individual supply curves of all firms in that market.
(a)
Mr. Silva’s Individual Supply Curve
(b)
Mr. Liu’s Individual Supply Curve
(c)
Market Supply Curve
Price of cotton (per pound)
Price of cotton (per pound)
Price of cotton (per pound) S S S
Silva
Liu
Market $2 $2 $2 1 1 1
Figure Caption:
Figure 3-10: Individual Supply Curves and the Market Supply Curve
Panel (a) shows the individual supply curve for Mr. Silva, SSilva, the quantity of cotton he will sell at any given price. Panel (b) shows the individual supply curve for Mr. Liu, SLiu. The market supply curve, which shows the quantity of cotton supplied by all producers at any given price, is shown in panel (c). The market supply curve is the horizontal sum of the individual supply curves of all producers.
At any given price, the quantity supplied to the market is the sum of the quantities supplied by Mr. Silva and Mr. Liu. For example, at a price of $2 per pound, Mr. Silva supplies 3,000 pounds of cotton per year and Mr. Liu supplies 2,000 pounds per year, making the quantity supplied to the market 5,000 pounds.
Clearly, the quantity supplied to the market at any given price is larger with Mr. Liu present than it would be if Mr. Silva was the only supplier. The quantity supplied at a given price would be even larger if we added a third producer, then a fourth, and so on. So an increase in the number of producers leads to an increase in supply and a rightward shift of the supply curve. 1 2 3 1 2 1 2 3 4 5
Quantity of cotton (thousands of pounds)
Quantity of cotton (thousands of pounds)
Quantity of cotton (thousands of pounds)

21. Supply, Demand and Equilibrium
Equilibrium in a competitive market: when the quantity demanded of a good equals the quantity supplied of that good
The price at which this takes place is the equilibrium price (or market-clearing price)
Every buyer finds a seller and vice versa.
The quantity of the good bought and sold at that price is the equilibrium quantity.

22. Price of cotton (per pound) Quantity of cotton (billions of pounds)
Market Equilibrium
Price of cotton (per pound)
Market equilibrium occurs at point E, where the supply curve and the demand curve intersect.
Supply
$2.00
1.75
1.50
1.25
Equilibrium price E
Equilibrium
1.00
0.75
Figure Caption:
Figure 3-11: Market Equilibrium
Market equilibrium occurs at point E, where the supply curve and the demand curve intersect. In equilibrium, the quantity demanded is equal
to the quantity supplied. In this market, the equilibrium price is $1 per pound and the equilibrium quantity is 10 billion pounds per year.
0.50
Demand 7 10 13 15 17
Quantity of cotton (billions of pounds)
Equilibrium quantity

23. Price of cotton (per pound) Quantity of cotton (billions of pounds)
Surplus
Price of cotton (per pound)
There is a surplus of a good when the quantity supplied exceeds the quantity demanded. Surpluses occur when the price is above its equilibrium level.
Supply
$2.00
1.75
Surplus
1.50
1.25
1.00 E
0.75
Figure Caption:
Figure 3-12: Price Above Its Equilibrium Level Creates a Surplus
The market price of $1.50 is above the equilibrium price of $1. This creates a surplus: at a price of $1.50, producers would like to sell 11.2 billion pounds but consumers want to buy only 8.1 billion pounds, so there is a surplus of 3.1 billion pounds. This surplus will push the price down until it reaches the equilibrium price of $1.
0.50
Demand 7
8.1 10
11.2 13 15 17
Quantity of cotton (billions of pounds)
Quantity demanded
Quantity supplied

24. Price of cotton (per pound) Quantity of cotton (billions of pounds)
Shortage
Price of cotton (per pound)
There is a shortage of a good when the quantity demanded exceeds the quantity supplied. Shortages occur when the price is below its equilibrium level.
Supply
$2.00
1.75
1.50
1.25
1.00 E
0.75
Figure Caption:
Figure 3-13: Price Below Its Equilibrium Level Creates a Shortage
The market price of $0.75 is below the equilibrium price of $1. This creates a shortage: consumers want to buy 11.5 billion pounds, but
only 9.1 billion pounds are for sale, so there is a shortage of 2.4 billion pounds. This shortage will push the price up until it reaches the
equilibrium price of $1.
Shortage
0.50
Demand 7
9.1 10
11.5 13 15 17
Quantity of cotton (billions of pounds)
Quantity supplied
Quantity demanded

25. Equilibrium and Shifts of the Demand Curve
Price of cotton
An increase in demand…
Supply
… leads to a movement along the supply curve due to a higher equilibrium price and higher equilibrium quantity. E 2 P
Price rises 2 E 1 P 1 D
Figure Caption:
Figure 3-14: Equilibrium and Shifts of the Demand Curve
The original equilibrium in the market for cotton is at E1, at the intersection of the supply curve and the original demand curve, D1. A rise in
the price of polyester , a substitute, shifts the demand curve rightward to D2. A shortage exists at the original price, P1, causing both the price and quantity supplied to rise, a movement along the supply curve. A new equilibrium is reached at E2, with a higher equilibrium price, P2, and a higher equilibrium quantity, Q2. When demand for a good or service increases, the equilibrium price and the equilibrium quantity of the good or service both rise. 2 D 1 Q Q 1 2
Quantity of cotton
Quantity rises

26. Equilibrium and Shifts of the Supply Curve
Price of cotton S S 2 1
A decrease in supply… E 2 P 2
Price rises
… leads to a movement along the demand curve due to a higher equilibrium price and lower equilibrium quantity.
A drought causes a fall in the supply of cotton. How does this negative supply shock affect the market for cotton?
Figure Caption:
Figure 3-15: Equilibrium and Shifts of the Demand Curve
The original equilibrium in the market for cotton is at E1. A drought causes a fall in the supply of cotton and shifts the supply curve leftward from S1 to S2. A new equilibrium is established at E2, with a higher equilibrium price, P2, and a lower equilibrium quantity, Q2. P E 1 1
Demand Q Q
Quantity of cotton 2 1
Quantity falls

27. Technology Shifts of the Supply Curve
An increase in supply …
… leads to a movement along the demand curve to a lower equilibrium price and higher equilibrium quantity.
Price S2
Technological innovation: In the early 1970s, engineers learned how to put microscopic electronic components onto a silicon chip; progress in the technique has allowed ever more components to be put on each chip. E1 P1
Price falls E2 P2
Demand
Quantity Q1 Q2
Quantity increases

28. Simultaneous Shifts of Supply and Demand
(a) One Possible Outcome: Price Rises, Quantity Rises
Small decrease in supply
Price of cotton S S 2 1 E 2 P
The increase in demand dominates the decrease in supply.
Two opposing forces determining the equilibrium quantity. 2
Figure Caption:
Figure 3-16 (a) There is a simultaneous rightward shift of the demand curve and leftward shift of the supply curve. Here
the increase in demand is relatively larger than the decrease in supply, so the equilibrium price and equilibrium quantity both rise. E 1 P 1 D 2 D 1
Large increase in demand Q
Quantity of cotton 1 Q 2

29. Simultaneous Shifts of Supply and Demand
(b) Another Possible Outcome: Price Rises, Quantity Falls
Price of cotton
Large decrease in supply S 2 S 1
Two opposing forces determining the equilibrium quantity.
The decrease in supply dominates the increase in demand. E 2 P 2
Figure Caption:
Figure 3-16 (b) There is also a simultaneous rightward shift of the demand curve and leftward shift of the supply curve. Here the decrease in supply is relatively larger than the increase in demand, so the equilibrium price rises and the equilibrium quantity falls. E
Small increase in demand 1 P 1 D 2 D 1 Q Q
Quantity of cotton 2 1

30. Simultaneous Shifts of Supply and Demand
We can make the following predictions about the outcome when the supply and demand curves shift simultaneously:
Simultaneous Shifts of Supply and Demand
Supply Increases
Supply Decreases
Demand Increases
Price: ambiguous
Quantity: up
Price: up
Quantity: ambiguous
Demand Decreases
Price: down
Quantity: down

31. 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.

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33. SUMMARY
The supply and demand model illustrates how a competitive market, one with many buyers and sellers, none of whom can influence the market price, works.
The demand schedule shows the quantity demanded at each price and is represented graphically by a demand curve. The law of demand says that demand curves slope downward; that is, a higher price for a good or service leads people to demand a smaller quantity, other things equal.

34. SUMMARY
A movement along the demand curve occurs when a price change leads to a change in the quantity demanded. When economists talk of increasing or decreasing demand, they mean shifts of the demand curve—a change in the quantity demanded at any given price. An increase in demand causes a rightward shift of the demand curve. A decrease in demand causes a leftward shift.

35. SUMMARY There are five main factors that shift the demand curve:
• A change in the prices of related goods or services, such as substitutes or complements
• A change in income: when income rises, the demand for normal goods increases and the demand for inferior goods decreases.
• A change in tastes
• A change in expectations
• A change in the number of consumers

36. SUMMARY
The market demand curve for a good or service is the horizontal sum of the individual demand curves of all consumers in the market.
The supply schedule shows the quantity supplied at each price and is represented graphically by a supply curve. Supply curves usually slope upward.

37. SUMMARY
A movement along the supply curve occurs when a price change leads to a change in the quantity supplied. When economists talk of increasing or decreasing supply, they mean shifts of the supply curve—a change in the quantity supplied at any given price. An increase in supply causes a rightward shift of the supply curve. A decrease in supply causes a leftward shift.

38. SUMMARY There are five main factors that shift the supply curve:
• A change in input prices
• A change in the prices of related goods and services
• A change in technology
• A change in expectations
• A change in the number of producers
The market supply curve for a good or service is the horizontal sum of the individual supply curves of all producers in the market.

39. SUMMARY
The supply and demand model is based on the principle that the price in a market moves to its equilibrium price, or market-clearing price, the price at which the quantity demanded is equal to the quantity supplied. This quantity is the equilibrium quantity. When the price is above its market-clearing level, there is a surplus that pushes the price down. When the price is below its market-clearing level, there is a shortage that pushes the price up

40. SUMMARY
An increase in demand increases both the equilibrium price and the equilibrium quantity; a decrease in demand has the opposite effect. An increase in supply reduces the equilibrium price and increases the equilibrium quantity; a decrease in supply has the opposite effect.

41. SUMMARY
Shifts of the demand curve and the supply curve can happen simultaneously. When they shift in opposite directions, the change in equilibrium price is predictable but the change in equilibrium quantity is not. When they shift in the same direction, the change in equilibrium quantity is predictable but the change in equilibrium price is not. In general, the curve that shifts the greater distance has a greater effect on the changes in equilibrium price and quantity.

42. KEY TERMS Competitive market Quantity supplied Supply and demand model
Supply schedule
Demand schedule
Supply curve
Quantity demanded
Shift of the supply curve
Demand curve
Movement along the supply curve
Law of demand
Input
Shift of the demand curve
Individual supply curve
Movement along the demand curve
Equilibrium price
Substitutes
Equilibrium quantity
Complements
Market-clearing price
Normal good
Surplus
Inferior good
Shortage
Individual demand curve