Demand, Supply, and Market Equilibrium

CHAPTE
3
Demand, Supply,
and Market Equilibrium
Prepared by: Fernando Quijano

and Yvonn Quijano
2004 Prentice Hall Business Publishing
Principles of Economics, 7/e
Karl Case, Ray Fair
C H A P T E R 3: Demand, Supply, and Market Equilibrium
Firms and Households:

The Basic Decision-Making Units
A firm is an organization that transforms
resources (inputs) into products
(outputs). Firms are the primary
producing units in a market economy.
An entrepreneur is a person who
organizes, manages, and assumes the
risks of a firm, taking a new idea or a
new product and turning it into a
successful business.
Households are the consuming units in
an economy.
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Input Markets and Output Markets:

The Circular Flow
The circular flow of

economic activity
shows how firms
and households
interact in input and
output markets.
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The Circular Flow
Product or output
markets are the markets
in which goods and
services are exchanged.
Input markets are the
markets in which
resourceslabor,
capital, and landused
to produce products, are
exchanged.
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The Circular Flow
Goods and services flow

clockwise. Firms provide
goods and services;
households supply labor
services.
Payments (usually money)
flow in the opposite
direction (counterclockwise)
as the flow of labor
services, goods, and
services.
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The Circular Flow
Input or factor markets are the
markets in which the resources used
to produce products are exchanged.
They include:
The labor market, in which
households supply work for wages
to firms that demand labor.
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The Circular Flow
They include:
The capital market, in which
households supply their savings,

for interest or for claims to future
profits, to firms that demand funds
to buy capital goods.
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The Circular Flow
They include:
The land market, in which
households supply land or other

real property in exchange for rent.
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The Circular Flow
Inputs into the production
process are also called
factors of production.
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Demand in Product/Output Markets

A households decision about the
quantity of a particular output to
demand depends on:
The price of the product in
question.
The income available to the
household.
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demand depends on:
The households amount of
accumulated wealth.
The prices of other products
(substitutes and complements)
available to the household.
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demand depends on:
The households tastes and
preferences.
The households expectations
about future income, wealth, and
prices.
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Quantity demanded is the

amount (number of units) of a
product that a household would
buy in a given time period if it
could buy all it wanted at the
current market price.
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Changes in Quantity Demanded Versus

Changes in Demand
The most important
relationship in individual
markets is that between
market price and quantity
demanded.
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Changes in Demand
We use the ceteris paribus or all
else equal device, to examine the
relationship between the quantity
demanded of a good per period of
time and the price of that good, while
holding income, wealth, other prices,
tastes, and expectations constant.
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Changes in Demand
Changes in price affect the
quantity demanded per period.
Changes in income, wealth,
other prices, tastes, or
expectations affect demand.
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Price and Quantity Demanded:

The Law of Demand
ANNA'S DEMAND
SCHEDULE FOR
TELEPHONE CALLS
PRICE
(PER CALL)
$
0
0.50
3.50
7.00
10.00
15.00
QUANTITY
DEMANDED
(CALLS PER
MONTH)
30
25
7
3
1
0
A demand schedule
is a table showing
how much of a given
product a household
would be willing to
buy at different prices.
Demand curves are
usually derived from
demand schedules.
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The Law of Demand
ANNA'S DEMAND
SCHEDULE FOR
TELEPHONE CALLS
PRICE
(PER
CALL)
$
0
0.50
3.50
7.00
10.00
15.00
QUANTITY
DEMANDED
(CALLS PER
MONTH)
30
25
7
3
1
0
The demand curve is

a graph illustrating
how much of a given
product a household
would be willing to buy
at different prices.
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The Law of Demand
The law of demand

states that there is a
negative, or inverse,
relationship between
price and the quantity
of a good demanded
and its price.
This means that
demand curves slope
downward.
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Other Determinants
of Household Demand
Income is the sum of all households
wages, salaries, profits, interest
payments, rents, and other forms of
earnings in a given period of time. It
is a flow measure.
Wealth, or net worth, is the total
value of what a household owns
minus what it owes. It is a stock
measure.
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Other Determinants
of Household Demand
Normal Goods are goods for which
demand goes up when income is
higher and for which demand goes
down when income is lower.
Inferior Goods are goods for which
demand falls when income rises.
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Other Determinants
of Household Demand
Substitutes are goods that
can serve as replacements for
one another; when the price of
one increases, demand for the
other goes up.
Perfect substitutes are
identical products.
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Other Determinants
of Household Demand
Complements are goods that
go together; a decrease in
the price of one results in an
increase in demand for the
other, and vice versa.
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Shift of Demand Versus

Movement Along a Demand Curve
A change in demand is not

the same as a change in
quantity demanded.
A higher price causes lower
quantity demanded and a
move along the demand
curve DA.
Changes in determinants of
demand, other than price,
cause a change in demand,
or a shift of the entire
demand curve, from DA to DB.
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A Change in Demand Versus

a Change in Quantity Demanded
To summarize:
Change in price of a good or service
leads to
Change in quantity demanded
(Movement along the curve).
Change in income, preferences, or
prices of other goods or services
leads to
Change in demand
(Shift of curve).
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The Impact of a Change in Income

Higher income
decreases the demand
for an inferior good
Higher income
increases the demand
for a normal good
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The Impact of a Change

in the Price of Related Goods
Demand for
complement
good
(ketchup)
shifts left
Price of hamburger rises

Quantity of hamburger
demanded per month falls
Demand for
substitute
good
(chicken)
shifts right
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From Household
Demand to Market Demand
Demand for a good or service can be
defined for an individual
household, or for a group of
households that make up a market.
Market demand is the sum of all the
quantities of a good or service
demanded per period by all the
households buying in the market for
that good or service.
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From Household
Demand to Market Demand
Assuming there are only two households in the
market, market demand is derived as follows:
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Supply in Product/Output Markets
Supply decisions depend

on profit potential.
Profit is the difference
between revenues and
costs.
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Supply in Product/Output Markets

CLARENCE BROWN'S
SUPPLY SCHEDULE
FOR SOYBEANS
PRICE
(PER
BUSHEL)
$
2
1.75
2.25
3.00
4.00
5.00
QUANTITY
SUPPLIED
(THOUSANDS
OF BUSHELS
PER YEAR)
0
10
20
30
45
45
Quantity supplied
represents the number of
units of a product that a
firm would be willing and
able to offer for sale at a
particular price during a
given time period.
A supply schedule is a
table showing how much
of a product firms will
supply at different prices.
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A supply curve is a graph illustrating how

much of a product a firm will supply per
period of time at different prices.
CLARENCE BROWN'S
SUPPLY SCHEDULE
FOR SOYBEANS
PRICE
(PER
BUSHEL)
$
2
1.75
2.25
3.00
4.00
5.00
QUANTITY
SUPPLIED
(THOUSANDS
OF BUSHELS
PER YEAR)
0
10
20
30
45
45
Price of soybeans per bushel ($)
Price and Quantity Supplied:

The Law of Supply
6
5
4
3
2
1
0
0
10
20
30
40
50
Thousands of bushels of soybeans

produced per year
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Price of soybeans per bushel ($)
Price and Quantity Supplied:

The Law of Supply
The law of supply
states that there is a
positive relationship
between price and
quantity of a good
supplied.
6
5
4
3
2
1
0
0
10
20
30
40
Thousands of bushels of soybeans

produced per year
50
This means that

supply curves typically
have a positive slope.
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Other Determinants of Supply

The price of the good or service.
The cost of producing the good,
which in turn depends on:
The price of required inputs
(labor, capital, and land),

The technologies that can be
used to produce the product,
The prices of related products.
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Shift of Supply Versus

Movement Along a Supply Curve
A higher price causes

higher quantity
supplied, and a
move along the
demand curve.
A change in determinants
of supply other than price
causes an increase in
supply, or a shift of the
entire supply curve, from
SA to SB.
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Shift of Supply Curve for Soybeans

Following Development of a New Seed Strain
In this example, since the
factor affecting supply is not
the price of soybeans but a
technological change in
soybean production, there is
a shift of the supply curve
rather than a movement
along the supply curve.
The technological advance means that
more output can be supplied for at any
given price level.
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Shift of Supply Versus

Movement Along a Supply Curve
To summarize:
Change in price of a good or service
leads to
Change in quantity supplied
(Movement along the curve).
Change in costs, input prices, technology, or prices of
related goods and services
leads to
Change in supply
(Shift of curve).
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From Individual
Supply to Market Supply
The supply of a good or service can
be defined for an individual firm, or
for a group of firms that make up a
market or an industry.
Market supply is the sum of all the
quantities of a good or service
supplied per period by all the firms
selling in the market for that good or
service.
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From Individual
Supply to Market Supply
As with market demand, market
supply is the horizontal summation
of individual firms supply curves.
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Market Equilibrium
Market equilibrium is
the condition that exists
when quantity supplied
and quantity demanded
are equal.
At equilibrium, there is no
tendency for the market
price to change.
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Market Equilibrium
Only in equilibrium is
quantity supplied
equal to quantity
demanded.
At any price level
other than P0, such as
P1, quantity supplied
does not equal
quantity demanded.
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Excess Demand
Excess demand, or
shortage, is the condition
that exists when quantity
demanded exceeds
quantity supplied at the
current price.
When quantity demanded
exceeds quantity supplied,
price tends to rise until
equilibrium is restored.
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Excess Supply
Excess supply, or surplus,
is the condition that exists
when quantity supplied
exceeds quantity demanded
at the current price.
When quantity supplied
exceeds quantity demanded,
price tends to fall until
equilibrium is restored.
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Changes in Equilibrium
Higher demand leads to

higher equilibrium price and
higher equilibrium quantity.
Higher supply leads to

lower equilibrium price and
higher equilibrium quantity.
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Changes in Equilibrium
Lower demand leads to

lower price and lower
quantity exchanged.
Lower supply leads to

higher price and lower
quantity exchanged.
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Relative Magnitudes of Change
The relative magnitudes of change in supply and demand

determine the outcome of market equilibrium.
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Relative Magnitudes of Change
When supply and demand both increase, quantity

will increase, but price may go up or down.
Karl Case, Ray Fair
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Review Terms and Concepts

capital market
income
perfect substitutes
complements,
complementary goods
inferior goods
product or output markets
input or factor markets
profit
demand curve
labor market
quantity demanded
demand schedule
land market
quantity supplied
entrepreneur
law of demand
shift of a demand curve
equilibrium
law of supply
substitutes
excess demand or shortage
market demand
supply curve
excess supply or surplus
market supply
supply schedule
factors of production
wealth or net worth
firm
movement along a
demand curve
households
normal goods
Karl Case, Ray Fair
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Demand, Supply, and Market Equilibrium

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CHAPTE

Prepared by: Fernando Quijano

2004 Prentice Hall Business Publishing

Principles of Economics, 7/e

Karl Case, Ray Fair

C H A P T E R 3: Demand, Supply, and Market Equilibrium

Firms and Households:

2004 Prentice Hall Business Publishing

Principles of Economics, 7/e

Karl Case, Ray Fair

C H A P T E R 3: Demand, Supply, and Market Equilibrium

Input Markets and Output Markets:

The circular flow of

2004 Prentice Hall Business Publishing

Principles of Economics, 7/e

Karl Case, Ray Fair

C H A P T E R 3: Demand, Supply, and Market Equilibrium

Input Markets and Output Markets:

2004 Prentice Hall Business Publishing

Principles of Economics, 7/e

Karl Case, Ray Fair

C H A P T E R 3: Demand, Supply, and Market Equilibrium

Input Markets and Output Markets:

2004 Prentice Hall Business Publishing

Goods and services flow

Karl Case, Ray Fair

C H A P T E R 3: Demand, Supply, and Market Equilibrium

Input Markets and Output Markets:

2004 Prentice Hall Business Publishing

Principles of Economics, 7/e

Karl Case, Ray Fair

C H A P T E R 3: Demand, Supply, and Market Equilibrium

Input Markets and Output Markets:

households supply their savings,

2004 Prentice Hall Business Publishing

Principles of Economics, 7/e

Karl Case, Ray Fair

C H A P T E R 3: Demand, Supply, and Market Equilibrium

Input Markets and Output Markets:

households supply land or other

2004 Prentice Hall Business Publishing

Principles of Economics, 7/e

Karl Case, Ray Fair

C H A P T E R 3: Demand, Supply, and Market Equilibrium

Input Markets and Output Markets:

2004 Prentice Hall Business Publishing

Principles of Economics, 7/e

Karl Case, Ray Fair

C H A P T E R 3: Demand, Supply, and Market Equilibrium

Demand in Product/Output Markets

2004 Prentice Hall Business Publishing

Principles of Economics, 7/e

Karl Case, Ray Fair

C H A P T E R 3: Demand, Supply, and Market Equilibrium

Demand in Product/Output Markets

2004 Prentice Hall Business Publishing

Principles of Economics, 7/e

Karl Case, Ray Fair

C H A P T E R 3: Demand, Supply, and Market Equilibrium

Demand in Product/Output Markets

2004 Prentice Hall Business Publishing

Principles of Economics, 7/e

Karl Case, Ray Fair