Demand and Supply
Professor Heather Grob
ECN101
www.stmartin.edu
Two branches of economics: micro/macro
• Microeconomics – how individuals make
economic decisions
» How individuals react to prices and quantities
» Effects of taxes or incentives on behavior
• Macroeconomics – how economies behave and
perform
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Total output
Conditions of trade
Supply and demand for money
Fiscal and monetary policy
Plotting a line
GPA
Slope= rise/ run = ½ =.5
Rise=1
Run=2
Hours of study
DEMAND for a normal good
• Usually people buy less of a good when
the price goes up (law of demand)
• Price (p) and quantity demanded (QD)
are inversely related
p
D
Q
What explains the law of demand?
• Substitution effect: people substitute the
cheaper good
• Income effect: purchasing power
• Diminishing marginal utility: additional
amount purchased is less worthy.
• Exceptions to the law of demand: what do
people buy more of when the price is high?
SUPPLY of a normal good
• Amount of good or service a firm or
household is willing to sell at each
possible price
• Price is directly related to quantity
supplied
p
S
Q
What explains the law of supply?
• As price increases, the quantity
supplied increases (law of supply)
• Law of diminishing marginal physical
product: output decreases with each
additional input
• It costs more to produce more, so
employers can be induced to produce
more if the price rises
Equilibrium
• Supply and demand intersect: the
market clears at the equilibrium price
and the equilibrium quantity
p
S
P*
D
Q*
Q
Assumptions of equilibrium
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Perfect competition
Full employment of resources
Perfect information
Marginal utility falls
Everyone faces the same prices
Preferences cannot be imposed and can
be revealed
• Normal profit
Shortage vs. Surplus
• When prices are too low, there will be a
shortage of the good or service.
• When prices are too high, there will be
a surplus of the good or service.
How economists explain change:
Mechanistic vs. organic
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Things that shift the DEMAND curve
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Taste, preference, quality
Number of buyers
Consumer income
Prices of related goods
Expected future prices
Things that shift the SUPPLY curve
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Resource prices
Technology
Prices of other goods
Expected future prices
Taxes and subsidies
Number of suppliers
Shifts in demand in perfect competition
• When demand increases, equilibrium
price and quantity increase
• When demand decreases, price and
quantity decrease
p
S
D1 D2
Q
Shifts in supply in perfect competition
• Test yourself: An increase in supply
causes…
a) fall in equilibrium price and quantity
b) rise in equilibrium price and quantity
c) price will rise and quantity will fall
d) price will fall and quantity will rise
**The answer is d!
• A decrease in supply causes price to rise
and quantity to fall
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Quiz yourself
• When will supply of gasoline shift
leftward?
A) increase availability of crude oil
B) expect greater auto efficiency
C) technological improvements in production
D) lower prices of labor and capital
The answer is B! The producers pull back when
they expect less demand.
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Your turn!
• In-class exercise
• Apply shifts of supply and demand to
gasoline prices and nursing shortage
• As you read the economic news, try to
graph what you are reading in terms of
supply and demand
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