Demand, Supply, &

Market Equilibrium
Chapter 3

Demand
A schedule or curve that shows the
various amounts of a product that
consumers are willing and able to
purchase at each of a series of possible
prices during a specified period of time
A statement of a buyers plans, or
intentions, with respect to the purchase of
a product

Law of Demand
Other-Things-Equal Assumption
As the Price (P) falls, the Quantity
Demanded (QD) rises. (P QD )
As the Price (P) rises, the Quantity
Demanded (QD) falls. (P QD )
Thus, there is an inverse (or negative)
relationship between Price and Quantity
Demanded.

Law of Demand
Common Sense

People do buy more at low prices

Sales!!!

Diminishing Marginal Utility

Each additional unit of the product produces less

satisfaction (or benefit, or utility)

Income Effect

Lower prices increase the purchasing power of a

buyers income

Substitution Effect

Lower prices give buyers the incentive to substitute

similar products

Individual Demand
P6

P
$5

Qd
10

20

35

55

80

Price (per bushel)

Individual
Demand

4
3
2
1
0

D
10

20

30

40

50

60

70

80

Quantity Demanded (bushels per week)

Determinants of Demand
Tastes

Favorable change in consumer tastes (preferences) = More Demanded

at each price

Number of Buyers

Increase in number of buyers = Increase in Demand

Income

Normal (Superior) Goods Demand Varies Directly with Income

Inferior Goods Demand Varies Inversely with Income

Prices of Related Goods

Substitutes: Used in place of another good

Example: Leather vs. Cloth Coats

Complements: Used together with another good

Example: Computers & Software

Unrelated Goods: Not related at all

Example: Potatoes & Automobiles

Consumer Expectations

Determinants of Demand
Therefore, an Increase in Demand may be
caused by:

A favorable change in consumer tastes/preferences

An increase in the number of buyers
Rising incomes if the product is a normal good
Falling incomes if the product is an inferior good
An increase in the price of a substitute good
A decrease in the price of a complimentary good
A new consumer expectation that either prices or
income will be higher in the future

Individual Demand

Demand Can Increase or Decrease

P6

P
$5

Qd
10

20

35

55

80

Price (per bushel)

Individual
Demand

Increase in Demand

4
3
2
1
0

D2

Decrease in Demand
2

10

D1

D3
12

14

16

18 Q

Quantity Demanded (bushels per week)

Changes in Quantity Demanded

Not to be confused with Change in Demand
A shift of the demand curve to the right (increase in
demand) or to the left (decrease in demand)
Cause: A change in one or more determinants of
demand

Change in Quantity Demanded

A movement from one point to another point from
one price/quantity combination to another on a fixed
demand schedule/curve
Cause: An increase or decrease in the price of the
product under consideration

Individual Demand

Demand Can Increase or

An Increase in Demand
Decrease
P6
Means a Movement
P
$5

Qd
10

20

35

55

80

of the Line
5

Price (per bushel)

Individual
Demand

A Movement Between
Any Two Points on a
Demand Curve is
Called a Change in
Quantity
Demanded

4
3
2
1
0

D2

Decrease in Demand
2

10

D1

D3
12

14

16

18 Q

Quantity Demanded (bushels per week)

Supply
A schedule or curve showing the various
amounts of a product that producers are
willing and able to make available for sale
at each of a series of possible prices
during a specific period

Law of Supply
As the Price (P) falls, the Quantity Supplied (Qs)
falls. (P Qs )
As the Price (P) rises, the Quantity Supplied (Qs)
rises. (P Qs )
Thus, there is a direct (or positive) relationship
between Price and Quantity Supplied.
Remember, the supplier is on the receiving end
of the products price. Therefore, higher prices
dont pose the same obstacle on the supply side
as they do on the demand side.

Individual Supply
P6

P
$5

Qs
60

50

35

20

S1

Price (per bushel)

Individual
Supply

4
3
2
1
0

10

20

30

40

50

60

70

Quantity Supplied (bushels per week)

Determinants of Supply
Resource Prices
Higher Resource Prices raise production costs & squeeze profits
Lower Resource Prices reduce production costs & increase
profits

Technology
Improvements in technology enable firms to produce units of
output with fewer resources

Taxes & Subsidies

Businesses treat most taxes as costs.
Increase in sales or property taxes will increase production costs
& reduce supply
Subsidies are considered taxes in reverse
Thus, lower production costs/increase in supply

Determinants of Supply
Prices of other Goods

Substitution in Production
Example: Producing basketballs instead of soccer balls results
in a decline in the supply of soccer balls

Producer Expectations

Future Prices of Products

Number of Sellers in the Market

Other things equal, the larger the number of suppliers, the

greater the market supply
As more firms enter the industry, the supply curve shifts to the
right
The smaller the number of suppliers, the less the market supply
As more firms leave the industry, the supply curve shifts to the
left

Individual Supply
Supply Can PIncrease or Decrease
6

P
$5

Qs
60

50

35

20

S3
5

Price (per bushel)

Individual
Supply

S1
S2

4
3
2
1
0

10

12

14

Quantity Supplied (bushels per week)

Changes in Quantity Supplied

Not to be confused with Change in Supply

A change in the schedule & shift of the curve

An increase in supply shifts curve to the right
A decrease in supply shifts curve to the left
Cause: A change in one or more of the determinants
of supply

Change in Quantity Supplied

A movement from one point to another on a fixed
supply curve
Cause: A change in the price of the specific product
being considered

Individual Supply

Supply Can Increase or Decrease

P6 A Movement Between

P
$5

Qs
60

50

35

20

Price (per bushel)

Individual
Supply

Any Two Points on a

Supply Curve is Called
a Change in Quantity
Supplied

S3

S1
S2

4
3
2

An Increase in Supply
Means a Movement
of the Line

1
0

10

12

14

Quantity Supplied (bushels per week)

Market Equilibrium
Equilibrium Price (PE)
Market Clearing Price
The price where the intentions of buyers & sellers match
QD = Q S

Equilibrium Quantity

The quantity demanded & supplied at the equilibrium

price in a competitive market

Competition among buyers & sellers drives the

price to equilibrium
Surplus: Excess Supply
Shortage: Excess Demand

Market Equilibrium
200 Buyers & 200 Sellers

Market
Demand
200 Buyers

Qd

$5

2,000

4,000

7,000

11,000

16,000

6,000 Bushel
Surplus

Price (per bushel)

Market
Supply
200 Sellers

$4 Price Floor

4
3
3

$2 Price Ceiling

7,000 Bushel
Shortage

1
0

6 7 8

10

D
12

14

16

Bushels of Corn (thousands per week)

18

Qs

$5

12,000

10,000

7,000

4,000

1,000

Government-Set Prices
Price Ceilings
The maximum legal price a seller may charge for a product or
service
Prices at or below the ceiling are legal
Prices above are not
Examples: Rent Controls
Sometimes leads to black markets & political pressure to lower
prices

Price Floors

A minimum price fixed by the government

A price at or above the floor are legal
Prices below are not
Distort resource allocation

Efficient Allocation
Productive Efficiency
The production of any particular good in the least costly way
Example: Have $100 worth of resources
Can produce a bushel of corn using either $5 or $3 of those
resources, leaving either $95 or $97 remaining for alternative uses
Which is better?

Allocative Efficiency
The particular mix of goods & services most highly valued by
society (minimum cost production assumed)
Society wants iPods instead of cassette tapes
However, society also wants cell phones
Competitive markets help assign allocative efficiency

Equilibrium Price & Quantity

In competitive markets, produces an assignment
of resources that is right from an economic
perspective
Demand reflects MB based on utility received
Supply reflects MC of producing good
Remember:

MB>MC
MB<MC
MB=MC

Expand Output
Reduce Output
Optimal Output

Changes in Supply, Demand,

& Equilibrium
Changes in Demand

Supply Constant, Demand Increases

Raises PE and QE
See pg 57, Figure 3.7 a

Supply Constant, Demand Decreases

Reduces PE and QE
See pg 57, Figure 3.7b

Changes in Supply

Demand Constant, Supply Increases

Reduces PE, Increases QE
See pg 57, Figure 3.7c

Demand Constant, Supply Decreases

Increases PE, Reduces QE
See pg 57, Figure 3,7d

Changes in Supply, Demand,

& Equilibrium
Complex Cases: (See pg. 57, Table 3.7)
Supply Demand PE QE ?
Supply Demand PE QE ?
Supply Demand PE ? QE
Supply Demand PE ? QE