Demand, supply, market equilibria and

surplus
The law of demand
The law of demand states that there is an inverse relationship between price (P) and the quantity
demanded (Q
D
).
Demand
Demand is a graphical representation of the law of demand. It is a curve with a negative slope
showing the relationship between price and quantity demanded.
Demand is the quantity of a good or service that consumers are willing and able to purchase at a
given price in a given time period. It is a graphical representation of the law of demand.
Effective demand consumers must have the financial means to buy a product, the ability to buy it.
The paradox of water and diamonds
Why are diamonds infinitely more expensive than water, even if we need water infinitely more than
diamonds? Because diamonds are so SCARCE!
Quantity demanded
The Q
D
is just a number representing the amount of a good.
Determination of the demand curve
1. Income (I) is the sum of all households wages, salaries, profits, interest payments, rents and
other forms of earnings in a given period of time. It is a flow measure.
If I grows by >100%
a) Q
D
grows by >100% luxury good (rhinestones,)
b) Q
D
grows by <100% or not at all necessary good (food,)
c) Q
D
decreases inferior good (box wine,)

2. Wealth or net worth is the total value of what a household owns, minus what it owes. It is a
stock measure.
3. Change of preference
4. Government policy
5. Seasonal changes
6. Physical hindrances - dont know the good or physically cannot buy it
7. The price of other goods
If P of another good grows by >100%
normal
goods
a) Q
D
of good grows substitutes (because the good replaces the other one) (ie. rum and
vodka)
b) Q
D
of good falls complement (because the goods always go together) (ie. phone and
phone bill)

8. Change in size of population, age distribution etc. (demographic effect)
9. Wealth distribution
Exceptions
Giffen goods - upward sloping demand more goods demanded at a higher price
all Giffen goods are inferior goods
there is no available supplement at a given price
Veblen goods - (conscious consumption) upward sloping demand
a good that is bought to show off ones wealth
iPhones
From Households to Market Demand
Demand for a good or service can be defined for an individual household, or for a group of
households that make up a market.
Market demand = the sum of all the quantities of a good or service
The (linear) demand function
Demand functions represent graphically the demand curve
Qd = a bP
- a simple demand function relating the quantity demanded for a product to the price of the product
Qd = quantity demanded
P = price
a = the quantity that would be
demanded if the price was zero (change in
the position)
b = sets the slope of the curve
Notice that x and y axes are inverted!!!


The law of supply
Direct proportionality between quantity supplied (Q
S
) and Price (P).
positive slope
Supply
Supply is the willingness and ability of producers to produce a quantity of a good or service at a
given price in a given time period
Effective supply - producers must have the financial means to supply the product, the ability to
suppl
Supply schedule - a table showing how much of a product firms will supply at different prices
(willingness and ability)
Quantity supplied represents the number of units of a product that a firm would be willing and able
to offer for sale at a particular price during a given time period
The non-price determinants of supply
1. The price of the good or service (moving along the curve)
2. The cost of factors of production (price of required inputs - labour, capital and land) (moves
curve to left or right)
3. The price of other products, which the producer could produce instead of the existing
product
4. The price of related products
5. The state of technology
a. improvements lead to increase in supply (shift of the supply curve to the right)
6. Expectations
7. Government intervention

A change in the price of the good itself leads to a movement along the existing supply curve.
A change in any of the other determinants of supply will always lead to a shift of the supply
curve to either the left or right.
Qs = c + dP

Qs ............................................ quantity supplied
P ............................................ price
c ............................................ the quantity that would be supplied if the price was zero
d ...................................... sets the slope of the curve
If there is a limited amount of the good, the function can become vertical at one point.
Market equilibrium
( http://img.sparknotes.com/figures/0/039bab1e6f1ef2a65b5f4c8ddc66073a/eq.gif)
An equilibrium occurs when the Q
s
= Q
D
.
At equilibrium, there is no tendency for the market price to change.
Changes in equilibria
The change in price depends on the slope of the supply.
When demand and supply both grow, the Q will increase, but the P may or may not increase.
Market disequilibria
1. EXCESS DEMAND/SHORTAGE
Occurs when Q
D
> Q
S
at the set price.

(
http://ingrimayne.com/econ/DemandSupply/Figure4.10.
gif)
2. EXCESS SUPPLY/SURPLUS
Occurs when Q
s
> Q
D
at the set price.

(http://upload.wikimedia.org/wikipedia/en/thumb/e/e9/Surplus_from_P
rice_Floor.svg/400px-Surplus_from_Price_Floor.svg.png)
Consumer and producer surplus
(http://theincidentaleconomist.com/wordpress/wp-content/uploads/2010/05/350px-Economic-surpluses.svg.png)
Consumer surplus (CS) = (how much the consumer was willing to spend) (how much he actually
spent)
Producer surplus (PS) = (for how much the producer actually sold it) (for how much the producer
was willing to sell it)