LECTURE 3

DEMAND, SUPPLY AND

EQUILIBRUM PRICE
LEARN IT BECAUSE YOUR LIVES
REVOLES AROUND THIS NASTY
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Natalya Brown 2010
ECON 1007 Introduction to Economics II
Demand, Supply and Market
Equilibrium
IGCSE : Economics (0455)
Natalya Brown 2008
LECTURE 3
Demand,
Supply and
Market
Equilibrium
Overview
Demand & Supply
Shifts in a Demand/Supply Curve and
Movements Along a Demand/Supply Curve.
Market Equilibrium
The Four laws of Demand and Supply
Effect of a Sales Tax
Elasticities of Demand and Supply
Natalya Brown 2008
LECTURE 3
Demand,
Supply and
Market
Equilibrium
Quantity Demanded
Quantity demanded is the total amount of
any good or service that consumers wish
to purchase in some time period at a
particular price.
The total amount consumers wish to
purchase may differ from what is actually
purchased.
Quantity demanded is an example of a
flow variable.
Natalya Brown 2008
LECTURE 3
Demand,
Supply and
Market
Equilibrium
Demand
Demand is the quantity of a good or service
that buyers wish to purchase at each given
price.
Note the distinction between demand and
quantity demanded. Demand describes the
behaviour of buyers at every price, where as
quantity demanded describes behaviour at a
particular price.
Natalya Brown 2008
LECTURE 3
Demand,
Supply and
Market
Equilibrium
Quantity Demanded and Price
The Law of Demand: the basic hypothesis is
that other things being equal the price of a
product and the quantity demanded are
negatively related. That is, the lower the price,
the higher the quantity demanded and vice
versa.
This relationship between price and quantity
demanded is true for most goods in the
economy.

LECTURE 3
Demand Curve and Demand
Schedule
Price ($) Quantity
Demanded
800 200
1200 160
1600 120
1800 100
2000 80
2200 60
2400 40
2800 0
Monthly Demand of Sony VAIO Laptops in Noida, UP, India.
Demand Schedule
P
r
i
c
e

Quantity Demanded
2800

2400

2000

1600

1200

800

400
40 60 80 100 120 140 160 180 200
Demand
Curve
LECTURE 3
Graphing Linear Demand Curves
Notice that price is on the y-axis and quantity on the x-axis.
Quantity
Price
Q
D
= 100 - 2p
10 20 30 40 50 60 70 80 90 100 110
50

40

30

20

10

0
Sometimes it is easier
to use the inverse
demand curve price
as a function of
quantity demanded.
2p = 100 Q
D
p = 50 (1/2)Q
D
p= 50, Q
D
= 0
p= 0, Q
D
=100
The same method can be used for linear supply curves.
Natalya Brown 2008
LECTURE 3
Demand,
Supply and
Market
Equilibrium
Changes in Demand
Demand curves are drawn assuming that all factors
affecting demand for a commodity other than the
price of the commodity are held constant. If these
other factors change, then we get a shift of the
demand curve, called a change in demand.
Other factors:
Consumer incomes and distribution of income
Tastes and Networks
The prices of related goods
Expectations about the future
Population and Demographic changes.
LECTURE 3
A rightward shift in the
demand curve from D
0
to
D
1
indicates an increase
in demand.
0 Quantity Demanded
P
r
i
c
e

D
2
D
0
D
1

A leftward shift from D
0
to
D
2
indicates a decrease
in demand.
LECTURE 3
A change in demand is a change in quantity demanded at
every price. That is, a change in demand is a shift of the
entire demand curve.
A change in quantity
demanded refers to a
movement from one
point on a demand
curve to another
point, either on the
same demand curve
or on a new one.
p
3

p
2

p
0

q
3
q
0
q
2
q
1

D
1

D
0

Quantity
Change in quantity
demanded
Change in demand
Natalya Brown 2008
LECTURE 3
Demand,
Supply and
Market
Equilibrium
Quantity Supplied
Quantity supplied is the total amount of
any good or service that producers wish to
sell in some time period at a particular
price.
The total amount producers wish to sell
may differ from what is actually sold.
Quantity supplied is also an example of a
flow variable.
Natalya Brown 2008
LECTURE 3
Demand,
Supply and
Market
Equilibrium
Supply
Supply is the quantity of a good or service
that producers wish to sell at each given price.
The distinction between supply and quantity
supplied is the same as the distinction
between demand and quantity demanded.
The Law of Supply: the basic hypothesis is
that other things being equal the price of a
product and the quantity supplied are positively
related. That is, the higher the price, the higher
the quantity supplied.
LECTURE 3
Supply Curve and Supply Schedule
Price ($) Quantity
Supplied
800 0
1200 0
1600 40
1800 60
2000 80
2200 100
2400 120
2800 160
Monthly Supply of VAIO Laptops in Noida, UP, India by SONY
Supply Schedule
P
r
i
c
e

Quantity Supplied
2800

2400

2000

1600

1200

800

400
40 60 80 100 120 140 160 180 200
Supply
Curve
Natalya Brown 2008
LECTURE 3
Demand,
Supply and
Market
Equilibrium
Changes in Supply
Supply curves are drawn assuming that all factors
affecting the supply of a commodity other than the
price of the commodity are held constant. If these
other factors change, then we get a shift of the
supply curve, called a change in supply.
Other factors:
Technology
Input costs
Competing Products
Number of Suppliers
Expectations about the future
LECTURE 3
A change in supply is a change in quantity supplied at
every price. That is, a change in supply is a shift of the
entire supply curve.
A change in quantity supplied refers to a movement from
one point on a supply curve to another point, either on the
same supply curve or on a new one.
Natalya Brown 2008
LECTURE 3
Demand,
Supply and
Market
Equilibrium
Market Equilibrium

market is a set of arrangements where by buyers and
sellers exchange goods and services at various prices.
The equilibrium price clears the market, so it is
sometimes called the market-clearing price because at
this price what the producer wants to sell is exactly
matched with what consumer wants to buy. It is the
price at which the quantity demanded equals the
quantity supplied.
Excess Supply: this exists when the quantity supplied
exceeds the quantity demanded at the current price.
Excess Demand: this exists when the quantity demanded
exceeds the quantity supplied at the current price.
LECTURE 3
Market Equilibrium
Price
($)
Qty.
Demanded
Qty.
Supplied
800 200 0
1200 160 0
1600 120 40
1800 100 60
2000 80 80
2200 60 100
2400 40 120
2800 0 160
The Market for VAIO Laptops in Noida, UP, India.
P
r
i
c
e

Quantity
2800

2400

2000

1600

1200

800

400
40 60 80 100 120 140 160 180 200
Demand
Curve
Supply
Curve
Excess Supply
Excess Demand
LECTURE 3
Changes in Market Prices
There are four laws of supply and demand.
1. An increase in demand
causes an increase in both
the equilibrium price and
equilibrium quantity.
S
D
1
D
0



q
0
q
1

p
1

p
0

Quantity
2. A decrease in demand
causes a decrease in both
equilibrium price and
equilibrium quantity.
E
1

E
0

LECTURE 3
3. An increase in supply
causes a decrease in the
equilibrium price and an
increase in the equilibrium
quantity.
4. A decrease in supply
causes an increase in
the equilibrium price and
a decrease in the
equilibrium quantity.
S
1
S
0

D

q
1
q
0

p
0

p
1

Quantity

E
1

E
0

LECTURE 3
Exercise 1
Suppose that the demand function for
some product is given by:
And that the supply function for some
product is given by:
Q
D
= 100 - 4p
Q
S
= p
LECTURE 3
Equilibrium: Q
D
=Q
S
Price
Quantity
10
20
30
40
10 20 30 40 50 60 70 80 100
Q
S
=p
Q
D
= 100 - 4p
Graphically:
LECTURE 3
Numerically,
Q
D
= Q
S
implies that
100 4p = p
100 = 5p
p* = 20
Q* = p* = 20
or Q* = 100 4p* = 20

Natalya Brown 2008
LECTURE 3
Demand,
Supply and
Market
Equilibrium
Effect of a Sales Tax
After the imposition of a sales tax, the price paid by consumers is
higher, whereas the price received by producers is lower. The new
equilibrium quantity is less than the quantity before the tax was
imposed.
Let p
c
denote the price paid by consumers, and p
s
denote the
price received by suppliers.
The difference between the consumer and seller prices is equal to
the tax (i.e. tax = p
c
p
s
).
The effect of sales tax on equilibrium price and quantity is the
same regardless of whether it is levied on producers or
consumers.
LECTURE 3
Quantity
P
r
i
c
e

S
0
D
0
D
tax
p
s
p

p
c
tax
Quantity
P
r
i
c
e

S
0
D
0
p
s
p

p
c
S
tax
tax
In this case, the tax is
levied on consumers and
the demand decreases.
In this case, the tax is
levied on producers and
the supply decreases.
tax = p
c
p
s

q
1
q
0
q
1
q
0
LECTURE 3
Price Elasticity of Demand
Price elasticity of demand measures the
degree of responsiveness of quantity
demanded to a good by the consumer in
response to a change in the price of that
good. It is symbolized by the Greek letter eta:
.

percentage change in quantity demanded
percentage change in price
=
LECTURE 3
Since demand curves have negative slopes, price and
quantity demanded move in opposite directions along
the demand curve.
Because the changes in price and quantity have opposite
signs, demand elasticity is negative.
However, economists usually ignore the negative sign
and speak of the measure as a positive number that
is, they emphasize the absolute value.


LECTURE 3
Determinants of Price Elasticity of Demand
Availability of close substitutes: goods with close substitutes tend
to have more elastic demand because it is easier for consumers to
switch from that good to others.

Necessities vs. Luxuries: necessities tend to have inelastic demands
whereas luxuries have elastic demands.

Definition of the Market: narrowly-defined markets tend to have
more elastic demand than broadly-defined markets because it is
easier to find close substitutes for narrowly-defined goods.

Time Horizon: goods tend to have more elastic demand over longer
time horizons.
LECTURE 3
Exercise 2
If the price of a commodity increases by 3% and quantity
demanded decreases by 6%, then the price elasticity of
demand is 2.



If the price elasticity of demand for a commodity is 0.5, a 10%
decrease in price leads to a 5% increase in quantity
demanded.
=
% change in Q
D
% change in P
= 6% = 2
3%
= 0.5 =
% change in QD
% change in P
= 5% = 0.5
10%
LECTURE 3
Elastic:
If the percentage change in quantity demanded
is greater than the percentage change in price,
then demand is elastic and > 1.
Unit
Elastic:
If the percentage change in quantity demanded is
equal to the percentage change in price, then
demand is unit elastic and = 1.
Inelastic:
If the percentage change in quantity demanded is
less than the percentage change in price, then
demand is inelastic and 0 < < 1.
=
= 0 = 1
LECTURE 3
Price Elasticity of Supply
Price elasticity of supply measures the degree
of responsiveness of the quantity supplied to
a change in the products own price. It is
denoted by
s
, and is defined as:

S
=
percentage change in quantity supplied
percentage change in price
LECTURE 3
Determinants of Price Elasticity of Supply
The price elasticity of supply will depend on the flexibility
of sellers to change the amount of the good they
produce.
Technical ease of substitution in production: if it is easy
for firms to switch inputs from the production of one
good to another, then supply will be more elastic.
Time horizon: supply is usually more elastic in the long
run than in the short run
The nature of production costs: if production costs rise
sharply as firms output increases, then supply will tend
to be inelastic.
LECTURE 3
Income Elasticity of Demand
The income elasticity of demand measures
the degree of responsiveness of quantity
demanded to a change in income.


Normal goods: Higher the income higher will
be the quantity demanded.

Inferior goods: Higher income lowers the
quantity demanded.

Y
=
percentage change in quantity demanded
percentage change in income

Y
> 0

Y
< 0
Sign
Matters
LECTURE 3
The more necessary an item is in the consumption
pattern of consumers, the lower its income elasticity.
Income elasticities for any one product also vary with the level
of a consumers income.
The distinction between luxuries and necessities also helps to
explain differences in income elasticities between countries.
Determinants of Income
Elasticity of Demand
LECTURE 3
Cross-Price Elasticity of Demand
The cross-price elasticity of demand measures how
the quantity demanded of one good changes as the
price of another good changes.

XY
=
percentage change in quantity demanded of good X
percentage change in price of good Y
Substitutes are goods that are typically used in place of one
another (e.g. margarine and butter). Complements are goods
that are typically used together (such as computers and
software).
If
XY
> 0, then X and Y are substitutes. (+ value)
If
XY
< 0, then X and Y are complements.(- value)
Sign
Matters
LECTURE 3
Elasticity of formula in alternative forms
A. Elasticity of demand

Q P where d = demand elasticity
d = ------ . --- Q = change in quantity demanded
P Q P = change in price
P = original price
Q= original quantity demanded
B. Elasticity of Supply

Q P where s = supply elasticity
s = ------ . --- Q = change in quantity demanded
P Q P = change in price
P = original price
Q= original quantity demanded


LECTURE 3
INCOME ELASTICITY

Q Y where Y = income elasticity
Y = ------ . --- Q = change in Quantity
Y Q Y= change in income
Y = original income
Q= original quantity

CROSS PRICE ELASTICITY

Qx Py where C = cross elasticity
C = -------- . ---- Qx = change in Quantity of X
Py Qx Py= change in price of Y
Py = original price of Y
Qx= original quantity of X



LECTURE 3
Exercises:
Price Quantity
demanded/month Revenue
$1.60 4000
$1.20 8000
$0.80 12000

1. Calculate total revenue at each price.

2. If a product has a price elasticity of 1.3, what would happen to total revenue if the
price decreased?

3. Price Quantity Revenue Find the dollar value of total revenue at
$ 6 0 each of the six prices. At what price will
$ 5 1 total revenue be the greatest? How many
$ 4 2 will sell at that price?
$ 3 3
$ 2 4
$ 1 5

4. The market supply of a product is 1000 units at $8 and 1,200 units at $9. Calculate
elasticity of supply.

LECTURE 3
5. When price of a product rises from 60 to 90, demand contracts from 800
to 600. Calculate Ed, what type of Ed is this?
6. A consumer buys 80 units of a good at a price of $4 per unit. When the
price falls he buys 100 units. If price elasticity of demand is -1, find out
the new price.

Elasticity of demand and expenditure on the
product


1. Price of a product falls, but expenditure on the product by the consumer
falls! What idea do you get about the elasticity of demand of that product?
2. Price of a product falls, but expenditure on the product rises! What sort
of elasticity does the product have?
3. Price of the product rises, expenditure rises too! d=.
4. Price of the product rises, expenditure fall, d=.
LECTURE 3