Demand, Supply and Prices

Chapter 7
DEMAND, SUPPLY
AND PRICES
Introduction
• Households & Firms interact in:
– Factor markets
– Good markets
• In the Goods markets:

– Firms supply goods & services
– Households demand goods & services
Chapter 7 Demand, supply and prices 2

© Van Schaik Publishers
Figure 7-1 The interaction between households and
firms

Demand
• Definition:
– Planned quantities of G&S that
– Prospective buyers are willing & able to
– Purchase during a certain period (flow)
• # from quantity actually bought
• Can be expressed using:
– Words; - Schedules, - Curves; -Equations

Determinants of demand (1)
• Individual demand:
– Price of the product
– Prices of related products: Complements &
Substitutes
– Income of the consumer: Normal & Inferior
– Taste of the consumer
– Size of the household

Determinants of demand (2)
• Market demand:
– Prices of related products: Complements &
Substitutes
– Income of the consumer: Normal & Inferior
– Taste of the consumer
– Population
– Expected future price of the product
– Distribution of income
Expressions of Demand (1)
• Words:
– The qty of a good demanded by an individual in a
particular period depends on the price of the
good, the prices of related goods, the income of
the individual, taste, the size of the household
and any other possible influence.
– Law of demand: Ceteris paribus, the higher the
price of a good, the lower is the quantity
demanded

Expression of Demand (2)
Equation
Qd  f ( Px , Py , Y , T , N ,...)
Dependent variable: Qd
Independent variables: Px, Py, Y, T, N
Qd  f ( Px , Py ,Y , T , N ,...)

Expressions of Demand (3)
• Demand schedule: Assume all other
influences on planned purchases are held cst.
Possibility Price Quantity demanded

A 1 6
B 2 5
C 3 4
D 4 3
E 5 2

Expression of Demand (4)
Demand curve

Demand & Qty Demanded
• Quantity demanded:
– Planned purchase at a given price
• Demand:
– Entire relationship between the quantity
demanded and the price of a good or
service, under the ceteris paribus condition

Movement Along &
Shift of a Demand Curve
• Movement along:
– Change in quantity demanded
– Due to change in the price of the product
• Shift:
– Change in demand
– Due to change in factors other than the
price of the product

Figure 7-4 A movement along a demand curve

Figure 7-5 Two substitutes: butter and margarine

Figure 7-6 Two complements: video cassette
recorders (VCRs) and video cassettes

Figure 7-7 A change in the quantity demanded
versus a change in demand

Reasons for the
Law of Demand
• Using relative prices
• Substitution Effect: Always towards
the goods which have become relatively
cheaper
• Income Effect: due to change in real
income

Supply
• Definition:
– Quantities of a G&S that
– Producers plan to sell at
– Each possible price, during
– A certain period (flow)
• # from quantity actually sold
• Can be expressed using: words, supply
schedule, supply curve, supply equation
Determinants of the
Quantity supplied (1)
• Individual Supply:
– Prices of alternative products
– Prices of factors of production
– Expected future prices
– State of technology

Figure 7-8 Johnny’s annual supply of tomatoes

Determinants of the
Quantity supplied (2)
• Market Supply:
– Price: product, alternative products, factors
– Expected future prices & State of technology
– Number of firms supplying the product
– Government policy
– Natural disasters
– Joint products & by-products
– Productivity

Movements Along &
Shifts of a Supply Curve
• Movements along:
– Change in the quantity supplied
– Due to change in the price of the product
• Shift:
– change in supply
– Due to change in factors other than the
price of the product

Figure 7-9 A movement along a supply curve: a
change in the quantity supplied

Figure 7-10 Shifts of the supply curve: changes in
supply

Market Equilibrium
• Equilibrium in the market:
– Qd = Qs not when Demand = Supply
– at equilibrium price: Pe
• Disequilibrium in the market:
– Qd ≠≠ Qs:
• Excess demand: market shortage
• Excess supply: market surplus

Figure 7-11 Demand, supply and market equilibrium

Functions of Prices
in a Market Economy
• Rationing function:
– ration the scarce supplies of G&S
– to those who place the highest value on them and
– can afford to pay for them
• Allocative function:
– Signals to direct factors of production
– ‘money votes’

Consumer Surplus
• Consumer surplus: #ce between what
consumers pay and the value they receive.
• Why?:
– For the last unit:
• Consumers are willing to pay more per unit
• Market price usually lower than the value received by
consumers
• Value received: highest prices consumers are willing
to pay
Figure 7-12 The consumer surplus

Producer Surplus
• Producer surplus involves the idea of
producers being willing to supply units
of the product at less than the market
price
• Positive difference between:
– Lowest prices producers are willing to
accept
– The price they actually receive
Figure 7-13 The producer surplus

Figure 7-14 Consumer surplus and producer
surplus at market equilibrium

Appendix 7-1
Algebraic analysis of demand and supply


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Chapter 7

• In the Goods markets:

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Possibility Price Quantity demanded

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