Market Force: Demand

and Supply
Dr. Gong Jie

Agenda
I. Market Demand Curve
The Demand Function
Demand Drivers

II. Market Supply Curve

The Supply Function
Supply Shifters

III. Market Equilibrium

IV. Comparative Statics

What is a Market?
vA market consists of buyers (consumers) and sellers
(producers) that communicate with one another for
voluntary exchange of goods or services.
vExamples
The weekly market for fresh durians in Singapore
The market for smart phones in the world in 2013

Competitive Market
vSmall and numerous sellers and buyers
vGoods produced by different sellers are highly
homogeneous.
vIdentical technology and perfect information
vNo single buyer or seller can influence the market
price: everyone is a price-taker.
vExample: agricultural goods

Market Demand
vMarket Demand: tells us how the quantity of a good
demanded by the sum of all consumers in the market
depends on the price and various other factors.
My demand for beef is two kilograms: Wrong!!!
Two kilograms is the quantity demanded at a
certain price instead of demand.

vDemand Curve shows the amount of a good that

consumers are willing to buy at different prices,
holding other factors constant.
vLaw of Demand: demand curve is downward-sloping.

Price
5
4
3
2
1

10

Quantity

Demand Function
vExample: linear demand curve
Qxd = 10 2Px
vInverse demand function: Price as a function of
quantity demanded:
2Px = 10 Qxd
Px = 5 0.5Qxd

Determinants of Demand
vThe price of the product
vOther factors that may change consumers
willingness to buy
Income

Normal goods and inferior goods

Prices of related goods

Substitutes and complements

Advertising and consumer tastes

Consumer expectations

Inferior Good
vWhat is an inferior good? Low-quality good?
The label of inferior good does not mean low quality.
Inferior good are products that consumers purchase less of
when their income rises.

Examples: generic jeans, fast food, public transportation?

vBeer industry in recession-plagued Japan:

Top Japanese breweries (Kirin and Sapporo) experienced
sharp declines in domestic sales; while Asahi Beer had
double-digit growth in sales.

Asashi beer can be an inferior good to Japanese beer drinkers.

Substitutes and Complements

vOne good is a substitute of another good, if
consumers tend to consume one in place of the other.
Different brands of the same type of product
vOne good is a complement of another good if
consumers tend to consume the products together.
Coffee and cream; operating system and
applications; DVD players and DVDs.

Interpreting Demand Functions

vMathematical representations of demand curves.
vExample:
d

QX = 10 - 2 PX + 3PY - 2M
vX and Y are substitutes (coefficient of PY is positive).
vX is an inferior good (coefficient of M is negative).

Movement along Demand Curve vs. Shift

in Demand Curve
vA goods own price changes induces changes in
quantity demanded, which is represented by a
movement along the demand curve.
vChanges in demand occur when factors other than the
goods own prices change, which is represented by
shifts in demand curve.
Other factors: income, advertisement, prices of
related goods

Movement along Demand Curve

Price
A to B: Increase in quantity demanded
10

A
B

D0
4

Quantity

Change in Demand: Shift in Demand Curve

vIncrease in Demand
If the change increases consumers willingness to
acquire the good, the demand curve shifts right.
vDecrease in Demand
If the change decreases consumers willingness to
acquire the good, the demand curve shifts left.

Change in Demand: Shift in Demand Curve

Price

D0 to D1: Increase in Demand

6
D1
D0
7

13

Quantity

Market Supply
vMarket Supply tells us how the quantity of a good
supplied by the sum of all producers in the market
depends on the price and other factors.
vSupply vs. Quantity Supplied
The market supply of beef is two tons. Wrong!

Market Supply Curve

vThe market supply curve plots the total quantity of
goods that their suppliers are willing to sell at
different prices, holding other factors fixed.
vLaw of Supply: the supply curve is upward-sloping.
Price

S0

Quantity

Supply Function
vExample: linear Supply Function
Qxs = 10 + 2Px
vInverse Supply Function: Price as a function of
quantity supplied.
Px = -5 + 0.5Qxs

Determinants of Supply
vThe price of the product
vOther factors that change producers willingness to sell
Input prices
Technology or government regulations
Number of firms

Entry and Exit

Taxes
Producer expectations

Movement along Supply Curve vs. Shift

in Supply Curve
vA movement along the supply curve for a good tells
us how quantity supplied changes when triggered by
a change in the price of that good.
vShifts in the supply curve tell us how quantity
changes with respect to changes in factors other than
price of that good. (e.g. input price)

Movement along Supply Curve

Price

A to B: Increase in quantity supplied

S0
B

20
A
10

10

Quantity

Change in Supply: Shift in Supply Curve

vIncrease in Supply
If the change increases producers willingness to
offer the good at the same price, the supply curve
shifts right.
vDecrease in Supply
If the change decreases producers willingness to
offer the good at the same price, the supply curve
shifts left.

Change in Supply: Shift in Supply Curve

S0 to S1: Increase in supply

Price

S0
S1
8
6
5

Quantity

Market Equilibrium
vBalancing supply and demand

QxS = Qxd
vSteady-state: When the market is in equilibrium, the
quantity demanded is the same as the quantity
supplied for the prevailing market price.
This price is called market clearing price.

The Determination of Equilibrium

Price
At price P*, the quantity demanded is
Price

equal to the quantity supplied.

S0
P*

D0
Q*

Quantity

If price is too low

Price

7
6
5
Excess Demand: Shortage
12 - 6 = 6

12

D
Quantity

If price is too high

Excess Supply: Surplus
14 - 6 = 8

Price

9
8
7

D
6

14

Quantity

Comparative Static Analysis

vComparative static analysis examines how a change
in an exogenous variable will affect the level of an
endogenous variable in the model.
vUse this tool to show how the equilibrium price and
quantity will change when a determinant of supply or
demand changes.

Demand Shift
vA recent scientific study revealed that the
consumption of apple reduces the hazard of heart
attack.
vWhat would happen to the apple market?
Demand increase
What happens to the equilibrium price and
quantity?

Demand Shift:
Price
S0
P2
P1
Increase in Demand

Higher price,
higher quantity

D1
D0
Q1 Q2

Quantity

Supply Shift
vThe benign weather brought North America a bumper
crop.
vWhat would happen to agricultural market?
Supply increase
What happens to the equilibrium price and
quantity?

Change in Supply: Shift of Supply Curve

Price

Increase in supply
S0
S1

P1
P2
Lower price,
higher
quantity

D0
Q1

Q2

Quantity

Simultaneous Shifts in Demand and

Supply
vManagers may encounter events that lead to
simultaneous shifts in both demand and supply.
vA tragic example:
In late 1990s, an earthquake hit Kobe, Japan.
The earthquake damaged Japans sake wine industry.
People drank to relieve the stress caused by the earthquake.
What happened to the market?

Simultaneous Shift
Price

P2

Decrease in supply
S1
S0

P1
Higher price,
but the effect
on quantity is
uncertain.

Increase in Demand
D1
D0
Quantity

Takeaway
vDemand and supply curves tell us the relationship
between the price and quantity of a good
demanded or supplied.
vMarket clears at the equilibrium price and
quantity.
vWe can use the interplay between demand and
supply to predict the impact of a shock on
equilibrium prices and quantities.