Ch.

2: The Mechanics of the Market

Demand and Supply

Learning Outcomes
Explain the meaning of demand, law of demand
and market demand.
Explain why a demand curve is downward sloping.
Distinguish between a change in quantity demanded
and a change in demand.
Describe the factors that cause a change in the demand
curve.

Learning Outcomes
Explain the meaning of supply, law of
supply and market supply.
Explain the reasons that supply curve slope
upward.
Distinguish between a change in quantity
supplied and a change in supply.
Describe the factors that cause a change in the
supply curve.

Learning Outcomes
Explain Market Equilibrium and
Disequilibrium.

Demand
Demand: the (1) willingness and ability of buyers
to purchase different quantities of a good (2) at
different prices (3) during a specific period of
time.
Law of Demand: as the price of a good rises,
quantity demanded of that good falls; as the price
of a good falls, quantity demanded of that good
rises, ceteris paribus.

Thinking In Terms Of the

Ceteris Paribus Assumption
It is important to realize that most economic
theoriesindeed, most theories of any nature
implicitly or explicitly utilize the ceteris paribus
condition.
From the Latin, ceteris paribus means all other
things held constant.
It is used in a theory to separate out the effects of
that which we want to observe from that which we
do not.

Four Ways to Represent The Law

Of Demand
In Words: As price
rises, quantity
demanded falls
In Symbols: PQd
In a Demand Schedule
In a Demand Curve

The Demand Curve & Demand

Schedule

Prices
In economics, there are two (2) prices:
1) Absolute Prices.
2) Relative Prices.

1)Absolute Price
) the price of a good in monetary terms.
) i.e. The absolute price of a new car is RM300,000.
The absolute price of a computer is RM20,000.

Prices
2) Relative Price:
the price of a good in terms of another good.
Relative price is calculated by dividing the absolute
price of one product with the absolute price of another
product.
i.e.The absolute price of a new car is RM300,000.
The absolute price of a computer is RM20,000.
The relative price of the car is 15 computers. ( or An
opp. costs to buy 1 car is 15 computers.)
Absolute price of car
Relative price of cars = --------------------------------Absolute price of computer

Prices
As the absolute price of a
good
increases,
if
nothing else changes, the
relative price of a good
increases (if the absolute
price of a car increase to
RM40,000
and
the
absolute
price
of
computer
remain
at
RM20,000.
The relative price of the
car is 20 computers.

Why Quantity Demanded Goes

Down As Price Goes Up
Two reasons:
1) Substitution Effect.
2) The Law of Diminishing Marginal Utility.
1)Substitution Effect.
) People substitute lower-priced goods for higherpriced goods.

Why Quantity Demanded Goes

Down As Price Goes Up
2) The Law of Diminishing Marginal Utility
for a given time period, the marginal (additional)
utility or satisfaction gained by consuming equal
successive units of a good will decline as the
amount consumed increases.
Individuals obtain less utility from additional units
of a goods.
Therefore, they will only buy larger quantities of a
good at lower prices.
The more (less) utility you receive from a unit of s
goods, the higher (lower) the price you are willing
to pay for it.

Individual Demand Curve and

Market Demand Curve
Individual demand curve represents the
price-quantity combinations of a particular
good for a single buyer.
Market demand curve represents the
price-quantity combinations of a particular
good for all buyers.

Deriving a Market Demand Schedule and a

Market Demand Curve

Change in Quantity Demanded

versus a Change in Demand
Change in Quantity Demanded: a
movement from one point to another point
on the same demand curve caused by a
change in the price of the good (own price).
Change in Demand: a shift in the demand
curve
Increase in demand: a shift to the right
Decrease in demand: as shift to the left

Shifts in the Demand Curve

Causes of Change in the

Demand Curve
Five (5) factors cause of change/ shift in the
demand curve:
1) Income
2) Preferences
3) Prices of Related Goods
4) Number of Buyers
5) Expectations of Future Price

Causes of Change in the

Demand Curve

1) Income
) A persons income change, demand for a particular
good may increase, decrease or remain constant.
) The demand for a good increases if people are
willing and able to buy more of the good at all prices.
) A normal good is a good that as income rises (falls),
the demand for a good will rises (falls).
) An inferior good is a good that as income rises
(falls), the demand for a good falls (rises ).
) A neutral good is a good that as income rises or
falls, the demand for which does not change.

Causes of Change in the

Demand Curve
2) Preferences
Preferences affect the amount of a good they
are willing to buy at a particular price (Ex:
favorite food, favorite author).
A change in preferences in favour of a goods
will shifts the demand curve to rightward.
A change in preferences away from the goods
will shifts the demand curve to leftward.

Causes of Change in the Demand

Curve
3) Prices of Related Goods.
There are two types of related goods:
1) Substitutes goods
- two goods that satisfy similar needs / desires.
- If the demand for product X increases as the price for Y
increases, and the demand for product X falls as the price for Y
falls, X and Y are substitutes (i.e. Coke and Pepsi).
2) Complements goods
- two goods that are consumed jointly.
- If the price of product A falls as the demand for product B
rises, and the price of product A rises as the demand for product
B falls, A and B are complements (i.e. Ketchup and Hot Dog
Buns).

Causes of Change in the

Demand Curve
4) Number of Buyers
More Buyers, More Demand.
Fewer Buyers, Less Demand.
5) Expectations of Future Price
Buyers who expect a price to be higher next month
buy the good this month, increasing demand.
Buyers who expect a price to be lower next month
wait to buy the good next month, reducing demand.
i.e. if the house prices are expected to fall in a
months, a potential house buyer may hold off
purchase of a house for a few months.

will
will
few
her

Supply
Supply is the (1) willingness and ability of
sellers to produce and offer to sell different
quantities of a good (2) at different prices (3)
during a specific period of time.
Law of Supply:
- As the price of a good rises, the quantity
supplied of the good rises; and as the price of a
good falls, the quantity supplied of the good
falls ceteris paribus.

The Supply Curve

Supply curve
is upward
sloping from
left to right.

Why Supply Curves Slope

Upwards
An Upward-sloping supply curve
reflects the fact that under certain
conditions:
1) a higher price is an incentive to
producers to produce more of a
good.
2) the law of increasing opportunity
costs.
- the opportunity costs rise when
more units of are good is produced,
so a higher price is necessary to
elicit more output.

Market Supply Curve

The Market Supply Curve represents the
price-quantity combinations for all sellers
of a particular good.
An Individual supply curve represents the
price-quantity combinations for a single
seller.

Deriving a Market Supply Schedule and a

Market Supply Curve

Changes in Quantity Supplied

versus Changes in Supply
Changes in Quantity Supplied:
- a movement along the supply curve.
Changes in Supply:
a shift in the supply curve.
Increase in supply: a shift to the right.
Decrease in supply: a shift to the left.

Factors Which Can Shift the

Supply Curve
Six (6) factors that can change/ shift the supply
curve:
1) Price of a relevant resources
2) Technology
3) Number of sellers
4) Expectations of future price
5) Taxes and subsidies
6) Government restrictions

Factors Which Can Shift the

Supply Curve
1) Price of a relevant resources
) If the price of a relevant resource changes, the
supply curve will shift.
) i.e. the wood prices increase, cost of a new
house increases as well, supply of house will
decrease and supply curve will shift to left.

Factors Which Can Shift the

Supply Curve
2) Technology
Technology - can increase the quantity supplied
by producing more of a product with the same
quantity of resources supplied, thus reducing
per unit production costs.
i.e. An advance in technology able to produce
more output cost per unit production reduce
quantity supply of the good at each price to
increase

Factors Which Can Shift the

Supply Curve
3) Number of sellers
If the number of sellers increase, the supply curve will
shift to right.
If the number of sellers decrease, the supply curve will
shift to left.
4) Expectations of future price
If the price of a good is expected to be higher in the
future, the supply curve will shift to the left.
If the price of a good is expected to be lower in the
future, the supply curve will shift to the right.

Factors Which Can Shift the

Supply Curve
5) Taxes and subsidies
Taxes increase, the unit costs will increase, supply shift
to left.
Whereas subsidies have the opposite effect, the quantity
supply will shift to right.
6) Government restrictions
Government restrictions can change the supply curve
by increasing or limiting production.
i.e. An import quota on foreign goods such as Japanese
TV sets supply curve for MAL shift to right.

Factors Which Can Shift the

Supply Curve
A Change in the Supply Curve is a shift in the Supply
Curve, not merely moving up and down the same curve.

A Change in Supply versus a Change in

Quantity Supplied

The Market
Putting Supply and Demand Together

Market Language
1) Surplus or excess supply.
2) Shortage or excess demand.
3) Equilibrium.
4) Equilibrium price, or the market-clearing price.
5) Equilibrium quantity.
6) Disequilibrium.
7) Disequilibrium price.
8) Disequilibrium quantity.

Market Language
1) Surplus or excess supply
) If the quantity supplied is greater than the quantity
demanded, the good has a surplus or excess supply.
2) Shortage or excess demand.
) If quantity demanded is greater than quantity supplied, a
shortage or excess demand.
3) Equilibrium.
) A market in which quantity demanded equals quantity
supplied is said to be in equilibrium.

Market Language
4) Equilibrium price, or the market-clearing price.
The price at which a quantity demanded equals the
quantity supplied is the equilibrium price.
5) Equilibrium quantity.
The quantity that corresponds to the equilibrium price is
the equilibrium quantity.
6) Disequilibrium.
A market that exhibits either a surplus or a shortage is
said to be in disequilibrium.

Market Language
7) Disequilibrium price.
Any price at which quantity demanded is
not equal to quantity supplied is a
disequilibrium price.
8) Disequilibrium quantity.
The quantity that corresponds to the
disequilibrium price is the disequilibrium
quantity.

Moving to Equilibrium
Why does the price fall when there is a surplus?
Why does the price rise when there is a shortage?
Mutually beneficial trade drives the market towards
equilibrium.

Viewing Equilibrium In Terms of

Consumers and Producers Surplus
Consumers Surplus:
the difference between the maximum or highest
amount buyers would be willing to pay and the
price they actually pay.
Producers Surplus:
the difference between the price sellers receive for
the good and the minimum or lowest price they
would be willing to sell the good for.
Total Surplus = Consumers Surplus + Producers
Surplus

Consumers and Producers Surplus

Equilibrium, Consumers Surplus,

and Producers Surplus

What Can Change Equilibrium

Price and Quantity
Whenever demand or supply changes or both
change, equilibrium price and quantity change.
Demand rises and supply is constant:
Equilibrium price rises, Equilibrium quantity rises.
Demand falls, supply is constant: Equilibrium
price falls, Equilibrium quantity falls.
Supply rises, demand is constant: Equilibrium
price falls, Equilibrium quantity rises.
Supply falls, demand is constant: Equilibrium
price rises, Equilibrium quantity falls.

What Can Change Equilibrium

Price and Quantity
Demand rises and supply falls by an equal
amount: Equilibrium price rises, Equilibrium
quantity is constant.
Demand falls and supply rises by an equal
amount: Equilibrium price falls, Equilibrium
quantity is constant.
Demand rises by a greater amount than supply
falls: Equilibrium price and quantity rise.
Demand rises by a lesser amount than supply
falls: Equilibrium price rises, Equilibrium quantity
falls.

Equilibrium Price and Quantity Effects of

Supply Curve Shifts and Demand Curve Shifts

Price Controls

There are two types of price controls: price ceilings

and price floors.
Price Ceiling: a government mandated maximum
price above which legal trades may not be made.
-

For example, the Domestic Trade and Consumer Affairs

Ministry in this country mandates the maximum price
for chillies at RM9 per kilo.

1)
2)

Price Ceilings may cause:

Shortages: Qty. demanded > qty. supplied
Fewer Exchanges: it prevents mutually
advantageous trades from being realized.
As long as the supply curve is not vertical, the quantity of
goods sold will be less with a ceiling than would have been true
at the equilibrium price.

Price Controls
3)

4)

5)

Non-price Rationing Devices : price ceilings prevent

price from rising to the level sufficient to ration goods
fully. As a result, some nonprice rationing device exists
such as first-come-first-served or ration stamps.
Buying and Selling at a Prohibited Price : both buyers
and sellers may regularly circumvent a price ceiling by
making their exchange under the table. This gives rise to
black markets. The consumers who are willing to pay a
price above the ceiling, to be assured of getting the good,
can arrange illicit transactions.
Tie in Sales : a sale whereby one good can be purchased
only if another good is also purchased. For example, to
evade rent control, many landlords require potential
tenants to rent furniture (uncontrolled price) along with
their (price-controlled) apartment.

Price Controls
A price floor is a government mandated
minimum price below which legal trades
cannot be made.
Price floors can cause Surpluses and Fewer
Exchanges. As long as the demand curve is
not vertical, the quantity of goods sold will
be less with a floor than would have been
true at the equilibrium price.

Price Ceiling vs. Price Floor