1. Chapter 3 Demand, supply and the market
David Begg, Stanley Fischer and Rudiger Dornbusch, Economics,
9th Edition, McGraw-Hill, 2005
PowerPoint presentation by Alex Tackie and Damian Ward 1

2. Some key terms
Market
a set of arrangements by which buyers and sellers are in contact to exchange goods or services
Demand
the quantity of a good buyers wish to purchase at each conceivable price
Supply
the quantity of a good sellers wish to sell at each conceivable price
Equilibrium price
price at which quantity supplied = quantity demanded
See Sections 3-1 and 3-2 in the main text. 2

3. Some key terms (2) Some goods are related to each other.
Substitutes: If the two goods fulfill similar needs they are called substitutes. E.g. Tea and Coffee.
Complements: If the two goods complete each other when consumed, they are called complements. E.g. Tea and sugar.
See Sections 3-1 and 3-2 in the main text. 3

4. Prices of Related Goods
Some Key Terms (3)
Prices of Related Goods
When a fall in the price of one good reduces the demand for another good, the two goods are called substitutes.
When a fall in the price of one good increases the demand for another good, the two goods are called complements.

5. Some Key Terms (4) Consumer Income
As income increases the demand for a normal good will increase. E.g. Cars
As income increases the demand for an inferior good will decrease. E.g Bread

6. The Demand curve shows the relation between price and quantity demanded holding other things constant
“Other things” include:
the price of related goods
consumer incomes
consumer preferences
Changes in these other things affect the position of the demand curve
Price
See Sections 3-3 and 3-4 in the main text. D
Quantity
Law of Demand: The quantity demanded of a good decreases as its prices increases, all other things equal. 6

7. The Supply curve shows the relation between price and quantity supplied holding other things constant S
“Other things” include:
technology
input costs
government regulations
Changes in these other things affect the position of the demand curve
Price
See Sections 3-3 and 3-6 in the main text.
Quantity
Law of Supply: The quantity supplied of a good increases as its prices increases, all other things equal. 7

8. Market equilibrium (1)  SD0
Price
Market equilibrium is at E0 where quantity demanded equals quantity supplied
with price P0 and quantity Q0 Q0 P0 E0 
See Section 3-2 in the main text.
Quantity 8

9. Market equilibrium and disequilibrium
If price were below P0 there would be excess demand
consumers wish to purchase more than producers wish to supply S P1 
excess supply D
Price E P0 
If price were above P0 there would be excess supply
producers wish to supply more than consumers wish to purchase P2 
excess demand
See Section 3-3 in the main text. S D Q0
Quantity 9

10. A shift in demand D0 S D1 Q1 P1 Q0 P0 S If the price of a substitute
good decreases ...
Price D0 S
The demand curve shifts
from D0D0 to D1D1. D1 Q1 P1
less will be demanded at
each price. E0 Q0 P0 E1
See Sections 3-4 and 3-5 in the main text.
So the market moves to a
new equilibrium at E1.
If price stayed at P0 there
would be excess supply. S
Quantity 10

11. Shift in demand (2)
Consumer income:
Normal goods: Demand shifts right if the income increases
Inferior goods: Demand shifts left if the income increases.
Preferences: If the change in preference is in favor of the good, the demand will shift to the right. E.g: Ice cream in summer.

12. Shift in demand (3)
Population increase shifts the market demand curve to the right.
Subsititutes: If a substitute good price increases, the other good’s demand will shift to the right.
Complements: If a complement good’s price increases, the other good’s demand will shift to the left.

13. A shift in supply S1 S0 D Q1 P1 E2 P0 E0 D Q0 Suppose safety
The supply curve
shifts to S1S1
Suppose safety
regulations are tightened,
increasing producers’ costs S0 D
Price Q1 P1 E2
So the market moves to a
new equilibrium at E2 P0 E0
If price stayed at P0 there
would be excess demand
See Sections 3-6 and 3-7 in the main text. D Q0
Quantity 13

14. Shift in supply (2)
Increase in input’s price shift the supply curve to the left.
Taxes shifts the supply curve to the left.
Expectation about future consumers shifts the supply curve to the right.
External conditions also shift the supply curve. E.g Weather conditions for agricultural products.

15. Two ways in which demand may increase (1)
(1) A movement along the demand curve from A to B
represents consumer reaction to a price change
could follow a supply shift
Price A P0 B P1 Q1
See Activity Box 3 in the main text. D Q0
Quantity 15

16. Two ways in which demand may increase (2)
(2) A movement of the demand curve from D0 to D1
leads to an increase in demand at each price
e.g. at P0 quantity demanded increases from Q0 to Q2: at P1 quantity demanded increases from Q1 to Q3
Price C D1 F Q2 Q3 P0 A P1 B
See Activity Box 3 in the main text. D0 Q0 Q1
Quantity 16

17. A market in disequilibrium
Suppose a disastrous harvest moves the supply curve to SS
government may try to protect the poor, setting a price ceiling at P1
which is below P0, the equilibrium price level
The result is excess demand
Price S D P2 E P0 A B P1
excess demand
You may wish to point out that:
1 Supply is actually reduced as a result of this policy;
2 There is a possible long-run effect on resource allocation arising because the incentives for producers are poor with prices held artificially low;
3 A price ceiling at P2 would be ineffective/irrelevant, given that the market could reach its equilibrium level.
See Section 3-8 in the main text. D S
RATIONING is needed to cope with the resulting excess demand QS Q0 QD
Quantity 17

18. What, how and for whom The market:
decides how much of a good should be produced
by finding the price at which the quantity demanded equals the quantity supplied
tells us for whom the goods are produced
those consumers willing to pay the equilibrium price
determines what goods are being produced
there may be goods for which no consumer is prepared to pay a price at which firms would be willing to supply
See Section 3-9 in the main text. 18