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R. Larry Reynolds

Fall 97

Principles of

slide 1

Demand and Supply

Markets as allocative mechanism require:
nonattenuated property rights
[exclusive, enforceable, transferable]

voluntary transactions
Markets include all potential buyers and
sellers
behavior of buyers is represented by demand
[benefits side of model]

behavior of sellers is represented by supply

[cost side of model]

Fall 97

Principles of

slide 2

Markets, Supply and Demand

markets include all potential buyers
and sellers
geographic boundaries of market
markets defined by nature of product
and characteristics of buyers
conditions of entry into market
markets, competition and substitutes
Fall 97

Principles of

slide 3

Demand
Definition: A schedule of the quantities
of a good that buyers are willing and able
to purchase at each possible price during a
period of time, ceteris paribus. [all other
things held constant]
Demand can also be perceived as a schedule
of the maximum prices buyers are willing
and able to pay for each unit of a good.
Fall 97

Principles of

slide 4

Demand Function
Is the functional relationship between the
price of the good and the quantity of that
good purchased in a given time period [UT],
income, other prices and preferences being
held constant.
A change in income, prices of other goods
or preferences will alter [shift] the
demand function.
Fall 97

Principles of

slide 5

Quantity demanded
A change in the price of the good under
consideration will change the quantity demanded.
Q = f (P, holding M, Pr , preferences constant);
where: M = income
Pr = prices of related goods
P causes a change in X [Q], this is a change in
quantity demanded

Fall 97

Principles of

slide 6

Change in demand
If M, Pr, or preferences change, the demand
function [relationship between P and Q] will
change.
These are sometimes called demand shifters
Be sure to understand difference between a
change in demand and a change in quantity
demanded
change in demand --- shift of the function
change in quantity demanded --- move on the function

Fall 97

Principles of

slide 7

Law of Demand
Theory and empirical evidence
suggest that the relationship
between Price and Quantity is an
inverse or negative relationship
At higher prices, quantity purchased
is smaller, or at lower prices the
quantity purchased is greater.
Fall 97

Principles of

slide 8

An example of hot chocolate:

There is a coffee cart in the building that primarily serves the
individuals who work in the building. The market is defined to some
extent by the geography of the building. Individuals who buy the
hot chocolate rarely come from other buildings to purchase a cup.
During the time period [UT]under consideration [8:00-9:00am on
a week day ] the incomes and preferences of buyers are unlikely to
change. The prices of coffee, lattes, etc. can be controlled by the
vendor and the price of soft drinks from the machines remains
constant. The number of workers in the building remain at a
constant level.
Under these circumstances, we observe the number of cups of hot
chocolate [H] sold each morning as the price [P] is changed.
From these observations the demand relationship is estimated.

Fall 97

Principles of

slide 9

Cups of Hot Chocolate [H] purchased

eachday between 8-9am
price
per cup

cups
purchased

20 .

$ .50

15 .

$ . 75

12 . 5

$ 1. 00

$ 1. 25

7 .5

$ 1. 50

5.

$ 1. 75

2 .5

$ 2 . 00

P > 0
[+.75]

10 .

Q < 0
[-7.5]

The demand relationship

can be demonstrated as a
table:
Demand is a schedule of
quantities that will be
purchased at a schedule
of prices during a given
time period, cet. par.
As the price is increased,
the quantity purchased
decreases.

This demand relationship can be expressed as an equation:

P = 2 - .1Q or Q = 20 - 10P: [Q = f (P, . . .) but we graph P on
the Y axis and Q on the X axis.]

Fall 97

Principles of

slide 10

PRICE

The demand relationship can be expressed as a table

(previous slide) or an equation [either P = 2 - .1Q or Q = 20 - 10P]
The data from the table or equation can be graphed:
$

2.25
2.00
1.75
1.50
1.25
1.00

P = $2, Then Q = 0

..

.75

..

.50
.25
2

P = $1.75, then Q = 2.5

P = $1.50, then Q = 5
P = $1.25, Q = 7.5

..

10 12 14

P = $1, then Q = 10
P = 0, then Q = 20
Demand

16 18 20

22 24

QUANTITY
The demand function can be represented as a table, {CUPS/UT}

an equation or a graph.

Fall 97

Principles of

slide 11

The demand equation P = 2 - .1Q was graphed

PRICE

A change in quantity demanded is a movement on the demand

function caused by a change in the independent variable [ price].

P from $1.50 to $1 causes Q from 5 to 10 units

2.25
2.00
1.75

A change in quantity demanded is a move

from point A to B on the demand function
caused by a change in the price!

1.50
1.25
1.00

.75
.50

Demand [P = 2 - .1Q]

.25

QUANTITY
2

4 6

Fall 97

10 12 14 16 18 20 22 24

Principles of

{CUPS/ UT}

slide 12

The demand equation P = 2 - .1Q was graphed

A change in any of the parameters (income, price of related goods,

preferences, population of buyers, etc.) will cause a shift of the
demand function. In this example, the intercepts have changed,
PRICE

the slope has remained constant

2.50
2.25
2.00
1.75
1.50
1.25
1.00

ad
ec

.75

.50

an increase in demand
D [ P = 2.5 - .1Q]
re
ase
in
d

.25
2

em
a
8

Demand [P = 2 - .1Q]

nd
10 12 14

D`` [P`` = 1.5 - .1Q]

Fall 97

16 18 20 22 24

Principles of

QUANTITY
{CUPS/UT}

slide 13

PRICE

2.50
2.25
2.00
1.75
1.50
1.25
1.00
.75
.50
.25

buyers are more responsive to P

P` = 2- .048076923Q
buyers
a decrease in the
are less
slope
responsive an increase in
Demand [P = 2 - .1Q]
the
slope
to P
P = 2 - .25Q
2

10 12 14

16 18 20

22 24

QUANTITY
{CUPS/UT}

A change in the parameters [income, Pr, preferences, population,

etc.] might alter the relationship by changing the slope
A change in demand refers to a movement or shift of the entire
demand function

Fall 97

Principles of

slide 14

PRICE

2.50

An increase in demand

2.25
2.00
1.75

results in a larger quantity being

purchased at each price

increase

1.50
1.25
1.00

D2

.75
.50

[an increase in demand]

Demand [P = 2 - .1Q]

.25

Q = 7.5
2

10 12 14

16 18 20 22 24

QUANTITY

{CUPS/UT}
In this case, an increase in demand results
in an increase in the amount that will be purchased at a price of
$1.25. At this price the Quantity purchased increases from 7.5
to 18. An increase in demand!

Fall 97

Principles of

slide 15

PRICE

Effect of a change in the price of a

substitute

2.50
2.25
2.00
1.75
1.50
1.25
1.00
.75
.50
.25

D em
the and fo
r
pric
e of steak
chic incre
as
ken
incr es wh
e
ea s
es n

in dec
fo th re
r e as
st de e
ea m
k an
d
2

Demand [P = 2 - .1Q]

D2
8

10 12 14

16 18 20 22 24

If the price of a substitute, like chicken, increases

buyers will buy more steak at each price of steak

QUANTITY
[steak /UT]

If the price of chicken decreases, the buyers will want less steak at
each possible price of steak; the demand for steak decreases!

Fall 97

Principles of

slide 16

Complementary goods
Two goods may be complimentary, i.e. the two goods are
used together. [tennis rackets and tennis balls or CDs
and CD Players]
An increase in the price of CDs will tend to reduce the
demand [shift the demand function to the left] for CD Players

PCDs
P2

As people buy fewer

CDs, the demand for
CD players decreases.

Pplayers

As the price of CDs increases

from P1 to P2, the quantity of
CDs decreases from Y1
to Y.
Ppl

At the same price,

Ppl , the demand
is reduced
from Dto D.

Dplayer

Dcd

P1

Fall 97

Y1 CDs/UT

Principles of

Dplayer

X1 CD Players
per UT
slide
17

Compliments and
Substitutes
Substitutes:
if the price of a substitute increases, the
demand for the good increases.
if the price of a substitute decreases, the
demand for the good decreases.
Compliments:
if the price of a compliment increases, the
demand for the good decreases.
if the price of a compliment decreases, the
demand for the good increases.

Fall 97

Principles of

slide 18

Demand Summary
Law of Demand holds that usually as the
price of a good increases, individuals will buy
less of it.
The nature of this relationship is influenced
by a variety of other variables;
income, preferences, prices of related
goods, and other circumstances
as these circumstances change, the
demand relationship changes or shifts.
Fall 97

Principles of

slide 19

Demand Summary

[cont. . . ]

A change in demand means the relationship

between price and quantity was altered by a
change in some other variable [a demand shifter]
The demand shifts.
A change in quantity demanded is a change in the
quantity bought that was caused by a change in
the price of the good. There is a movement on the
demand function.

Fall 97

Principles of

slide 20

Supply
Supply is defined as a schedule of
quantities of a good that will be produced
and offered for sale at a schedule of
prices during a given time [UT], ceteris
paribus.
Generally, producers are willing to offer
greater quantities of a good for sale at
higher prices; a positive relationship
between price and quantity supplied.
Fall 97

Principles of

slide 21

Supply Schedule

Observation

Price

Quantity
Supplied

$1

$2

10

$3

14

$4

18

$5

22

The information can be represented

on a graph by plotting each
price quantity combination.

E
F

Both the graph and the table

represent a supply
relationship: Q = 2 + 4P

A supply schedule can be

displayed as a table.
Fall 97

P
$5

.
.

$4
$3
$1

Principles of

ly
p
p
su

$2

10 12 14

slide 22

Change in Quantity Supplied

A change in the price of the good
causes a change in the quantity
supplied.
The change in the price of the good
causes a movement on the supply
function, not a change or shift of
the supply function.
Fall 97

Principles of

slide 23

Supply Schedule

Observation

Price

Quantity
Supplied

$1
$1

$2

$3
$3

$4

A change in the price causes a

6
change in the quantity supplied.
10
CAUSES
QThis can be represented by a
movement on the supply
14
function in the graph
18

E
F

$5

22

This is a change in quantity

supplied. Not to be
confused with a change in
supply!
P from $1 to
$3

Fall 97

P
$5
$4

P causes the quantity supplied

to increase from 6 to 14.

y
l
p
sup

$3
$2
$1
2

Principles of

10 12

14 16

slide 24

Q
/ut

Change in Supply
A change in supply [like a change in demand]
refers to a change in the relationship
between the price and quantity supplied.
A change in supply is caused by a change
in any variable, other than price, that
influences supply
A change in supply can be represented by a
shift of the supply function on a graph
Fall 97

Principles of

slide 25

Change in Supply

[cont. . . ]

There are many factors that infuence the

willingness of producers to supply a good.
technology
prices of inputs
returns in alternative choices
taxes, expectations, weather, number of
sellers, . . .
Qs = fs (P, Pinputs, technology, . . .)

Fall 97

Principles of

slide 26

Change in Supply

[cont. . . ]

Qs = fs (P, Pinputs, technology, number of

sellers, taxes, . . .)
A change in the price [P] causes a change
in quantity supplied;
a change in any other variable causes a
change in supply

Fall 97

Principles of

slide 27

Supply Schedule

Given the supply schedule,

An increase in the prices
of inputs would make it
more expensive to produce
each unit of output,
therefore, the supply
decreases

Observation

Price

Quantity
Supplied

$1

$2

$3

$4

46
810
1214
16
18

$5

22
20

P
$5

a shift to the left

is a decrease in supply

$4
$3

ne

$2

ly
p
up
s
w

$1
2

Fall 97

10

on
i
t
nc
u
f

The decreased quantity

at each price shifts the
supply curve to the left!

y
l
p
sup The development of a new

e
s
a
re
c
n
i
an ply
sup

12 14

16

in

technology that reduces the

cost of production will shift
the supply function to the right

Principles of

slide 28

Equilibrium
Equilibrium: 1. a state of rest or balance due to
the equal action of opposing forces. 2. equal
balance between any powers, influences, [Websters
Encyclopedic Unabridged Dictionary of the English Language]

In a market an equilibrium is said to exist when

the forces of supply [sellers] and demand [buyers] are
in balance: the actions of sellers and buyers are
coordinated. The quantity supplied equals the
quantity demanded!

Fall 97

Principles of

slide 29

[Price]

Px

l
p
p
u
S

100
90
80
$70
70

y
Given a demand
function [which

represents the
behavior or choices
of buyers,

60
50
40
30
20

and a supply function

that represents the
behavior of
De
m sellers,

an

10
10

20

30

40

50 60

60

70

80

90 100 110 120 130

Qx/ UT

Where the quantity that people want to buy is equal to the quantity
that the producers want to sell, there is an equilibrium quantity.
The price that coordinates the preferences of the buyers and sellers
is the equilibrium price.
At the equilibrium price of $70, the quantity supplied is equal to
the quantity demanded.

Fall 97

Principles of

slide 30

When the price is greater than the equilibrium price, the

amount that sellers want to sell at that price [quantity supplied]
exceeds the amount that buyers are willing to purchase [quantity
demanded] at that price. The price is too high.

[Price]

At a Price of $90 the quantity supplied is 80, the quantity demanded is 35

surplus = 45

100

Su

90
$90

60
50
40
30
20
10
10

Fall 97

20

303540

At $90 there is a surplus

of 45 units [80-35=45]

equilibrium price
equilibrium quantity

Px

80
$70
70

l
p
p

50 60

60

Principles of

De
ma
nd
70

80
80

90 100 110 120 130

Qx/ UT
slide 31

ly
p
p
u
S

[Price]

surplus = 45

100

90
$90

lower
price

Px

80
$70
70
60
50
40
30
20

At a price of $90 a surplus

of 45 units exists

Suppliers have more to sell than

buyers will purchase at a price of $90.
To get rid of these unsold
units [inventory], the
Quantity
sellers lower
supplied
decreases
the price.
D

Quantity
demanded
increases

em

10
10

20

303540

50 60

60

70

80
80

90

an
d

100 110 120 130

Qx/ UT

As the price of the good is reduced, the quantity supplied decreases.

The quantity demanded increases as the price falls.
As the price moves toward equilibrium, quantity supplied and
quantity demanded are brought into equilibrium.

Fall 97

Principles of

slide 32

[Price]

Px

100

As a result of market forces

the market moves to

60
50
40
30
$30
20
10

equilibrium

90
80
$70
70

price
rises
quantity
supplied
increases
10 1520

30 40

ly
p
p
Su
At a price below equilibrium the
the quantity demanded exceeds
the quantity supplied.
At a price of $30 the quantity
demanded is 110. The quantity
supplied is 15.

quantity
demanded
decreases
shortage = 95
50

60
60

70

80

De
ma
nd

90 100 110
110 120 130

Qx/ UT

At a price of $30 the quantity demanded exceeds the quantity

supplied by 95 units [110 - 15 = 95]. This is a shortage.

Since the buyers cannot obtain all they want at a price of $30, some buyers will
offer to pay more. Some buyers will not pay the higher price, they buy less so the
quantity demanded decreases. At the higher price the quantity supplied increases

..

Fall 97

Principles of

slide 33

[Price]

100

Px

80
$70
70

90
$89

ly
p
p
u
S The market for good X is

demand
increases
price
rises

in equilibrium at

Px = $70

60
50
40
30
20

equilibrium
quantity
increases

De
ma
n

10

10 20 30 40 50 60
60 70 80
80 90 100 110 120 130

An increase in the price of a

substitute [good Y] causes the
demand for good X to increase.
As a result of the increased demand,
market forces push

Fall 97

Px up.

D2

Qx/ UT

The increase in the demand for

good X results in an increase in
both the equilibrium price and
quantity.
Identify other factors that could
increase demand!

Principles of

slide 34

[Price]

Px

ly
p
p
u
S Given a demand function,

100
90
80
70

an equilibrium is defined.

$70

A decrease in demand,
establishes a new equilibrium
at a lower price and
quantity.

60

$50.89
50
40
30
20

D1

10

De
ma
n

10 20 30 39.2
40 50 60
60 70 80 90 100 110 120 130

Demand might be reduced by:

a decrease in the price of a substitute,
an increase in the price of a compliment,
a change in income,
a change in the number of buyers
or their preferences, or, . . .
.

Fall 97

Principles of

Qx/ UT

A change in the
price of the good
does not change
demand! It changes
the quantity
demanded.

slide 35

[Price]

Px

l
p
p
u
S

100
90
80
$70
70

price
60 falls

S2

supply
increases

50
$50
40
30
20

De
ma
n

10

10 20 30 40 50 60
60 70 808690 100 110 120 130

Given an equilibrium
condition in a market,

an increase in supply will

increase the equilibrium
quantity and decrease
equilibrium P.

Fall 97

Quantity
increases

Principles of

Qx/ UT

Identify
1.
2.
3.
4.

factors that increase supply:

fall in price of inputs
improved technology
increase in number of sellers
fall in return in alternative
uses of inputs
5. or, . . .

slide 36

A decrease in supply causes the equilibrium price to increase

and equilibrium quantity to decrease. What forces might cause the

Px
100

$90
90
80
70

$70

price rises

supply to decrease?
1. an increase in the prices
of inputs
S1
in returns from
y 2. increase
l
alternative actions
p
p
decrease in supply
3. problems in technology
Su
[regulations, . . . ]
4. decrease in number of
sellers or producers

60
50
40
30
20

quantity
decreases

De
ma
nd

10

10 20 3035
40 50 60
60 70 80 90 100 110 120 130

Fall 97

Principles of

Qx/ UT
slide 37

P100
x
90
80
70

$70
60
50
40
30
20

demand
increases
price might
go up or down
or stay the same

supply
increases

10
10 20 30 40

and decrease
price

+P

-P

increase

results in
increase
a market
force to
results
in
aincrease
market Q
force to
increase Q

ly
p
p
u
S

S2 If both supply and

demand decrease,
the P will be
indeterminate and
the equilibrium Q
will decrease.

and
increase
price

D2
De
m

50 60
60 70 80 90 100
100 110 120 130

an
d

Qx/ UT

When demand and supply both shift, the resultant effect on either
equilibrium price or quantity will be indeterminate.

Both the increase in demand and supply increase quantity; equilibrium Q increases.
The increase in demand pushes price up. The increase in supply pushes price down.
The change in price may be positive or negative, it depends on the magnitude
of the shifts in and slopes of demand and supply.

Fall 97

Principles of

slide 38

A decrease in supply tends to increase P and reduce Q.

An increase in demand tends to increase both P and Q.
Result is that Price will rise, Quantity may increase, decrease or stay the same
depending on the magnitudes of the shifts and slopes of supply and demand.
In this example,
Price
the price
$105
increases to
100
$105.

90
When supply
80
increases and $70
70

demand
decreases,
the price will
fall but the
change in Q
will be
indeterminate!

S1
to push
price up

l
p
p
decrease in supply
u
S

pushes
price up

60
50
40
30
20

reducesand
quantityincrease
Q

an increase in
demand tends

D2
De
ma
nd

10
10 20 303540 49
50 60
60 70 80 90 100 110 120

Fall 97

the quantity decreases to 49

Principles of

Qx/ UT

slide 39

Supply and Demand Analysis

Supply and demand is a simplistic model that
provides insights into the effects of events that
are related to a specific market.
Whether an event will tend to cause the price of a
good to increase or decrease is of importance to
decision makers.
To estimate the magnitude of price and quantity
changes more sophisticated models are needed.

Fall 97

Principles of

slide 40