CHAPTER
4
Supply, Demand, and
Market Equilibrium
Prepared by: Fernando and Yvonn Quijano
© 2006 Prentice Hall Business Publishing
Economics: Principles and Tools, 4/e
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C H A P T E R 4: Supply, Demand, and Market
Equilibrium
Perfectly Competitive Market
• supply and demand—the most important
tool of economic analysis—the simplest!
• The model of supply and demand explains
how a perfectly competitive market
operates.
• A perfectly competitive market is a market
has a very large number of firms, each of which
produces the same standardized product in
amounts so small that no individual firm can
affect the market price.
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C H A P T E R 4: Supply, Demand, and Market
Equilibrium
The Demand Curve
• Here is a list of variables that affect
the individual consumer’s decision,
using the pizza market as an
example:
• The price of the product, for example,
the price of pizza
• The consumer’s income
• The price of substitute goods such as
pasta or satay
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C H A P T E R 4: Supply, Demand, and Market
Equilibrium
The Demand Curve
• Here is a list of variables that affect
the individual consumer’s decision,
using the pizza market as an
example:
• The price of complementary goods
such as beer or lemonade
• The consumer’s tastes and advertising
that may influence tastes
• The consumer’s expectations about
future prices
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C H A P T E R 4: Supply, Demand, and Market
Equilibrium
The Individual Demand Curve and
the Law of Demand
Table 4.1 Al’s Demand Schedule for Pizza
Price
Quantity of pizzas per month
$2
13
4
10
6
7
8
4
10
1
• The demand schedule is a table that shows
the relationship between price and quantity
demanded by an individual consumer, ceteris
paribus (everything else held fixed).
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C H A P T E R 4: Supply, Demand, and Market
Equilibrium
The Individual Demand Curve
and the Law of Demand
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• The individual demand
curve is a graphical
representation of the
demand schedule.
• LAW OF DEMAND: The
higher the price, the
smaller the quantity
demanded, ceteris paribus
(everything else held fixed).
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C H A P T E R 4: Supply, Demand, and Market
Equilibrium
The Individual Demand Curve
and the Law of Demand
• Quantity demanded is the
amount of a good an
individual consumer or
consumers as a group are
willing to buy.
• A change in quantity
demanded is a change in
the amount of a good
• In this case, an increase in
demanded resulting from a
price causes a decrease in
change in the price of the
quantity demanded, and a
good.
movement upward along the
individual’s demand curve.
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C H A P T E R 4: Supply, Demand, and Market
Equilibrium
From Individual to Market Demand
• The market demand curve shows the
relationship between price and quantity
demanded by all consumers together,
ceteris paribus (everything else held fixed).
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C H A P T E R 4: Supply, Demand, and Market
Equilibrium
The Supply Curve
• Here are the variables that affect the
decisions of sellers, using the market
for pizza as an example:
• The price of the product—in this case, the
price of pizza.
• The cost of the inputs used to produce the
product, for example, wages paid to
workers, the cost of dough and cheese, and
the cost of the pizza oven.
• The state of production technology, such as
the knowledge used in making pizza.
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C H A P T E R 4: Supply, Demand, and Market
Equilibrium
The Supply Curve
• Here are the variables that affect the
decisions of sellers, using the market
for pizza as an example:
• The number of producers—in this case, the
number of pizzerias.
• Producer expectations about the future price
of pizza.
• Taxes paid to the government or subsidies
received from the government.
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C H A P T E R 4: Supply, Demand, and Market
Equilibrium
The Individual Supply Curve
and the Law of Supply
Table 4.2 Nora’s Schedule for Pizza
Price
Quantity of pizzas per month
$4
100
6
200
8
300
10
400
12
500
• A firm’s supply schedule is a table that
shows the relationship between price and
quantity supplied, ceteris paribus
(everything else held fixed).
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C H A P T E R 4: Supply, Demand, and Market
Equilibrium
The Individual Supply Curve
and the Law of Supply
© 2006 Prentice Hall Business Publishing
• The individual supply
curve is a graphical
representation of the
supply schedule. Its
positive slope reflects the
law of supply.
• LAW OF SUPPLY: The
higher the price, the larger
the quantity supplied,
ceteris paribus.
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C H A P T E R 4: Supply, Demand, and Market
Equilibrium
The Individual Supply Curve
and the Law of Supply
• Quantity supplied is the
amount of a good an
individual firm or firms as a
group are willing to sell.
• A change in quantity
supplied is a change in the
amount of a good supplied
resulting from a change in
• In this case, an increase in
the price of the good;
price causes an increase in
represented graphically by
quantity supplied and a
a movement along the
movement upward along
supply curve.
the supply curve.
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C H A P T E R 4: Supply, Demand, and Market
Equilibrium
Why is the Individual Supply
Curve Positively Sloped?
• To determine how much to produce, the
individual firm chooses the quantity of
output that satisfies the marginal principle.
Marginal PRINCIPLE
Increase the level of an activity if its
marginal benefit exceeds its marginal cost;
reduce the level of an activity if its marginal
cost exceeds its marginal benefit. If
possible, pick the level at which the
activity’s marginal benefit equals its
marginal cost.
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C H A P T E R 4: Supply, Demand, and Market
Equilibrium
The Marginal Principle and
the Output Decision
• The marginal benefit of
selling a pizza is the price
received when the pizza is
sold.
• Marginal cost is the cost of
producing an additional
pizza.
• The marginal cost of producing
the first 299 pizzas is less than
the $8 marginal benefit. The
marginal principle is satisfied
when 300 pizzas are produced.
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C H A P T E R 4: Supply, Demand, and Market
Equilibrium
The Marginal Principle and
the Output Decision
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• An increase in the price
shifts the marginal benefit
curve upward and
increases the quantity at
which the marginal
principle is satisfied.
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C H A P T E R 4: Supply, Demand, and Market
Equilibrium
From Individual Supply
to Market Supply
• The market supply curve shows the relationship
between price and quantity supplied by all producers
together, ceteris paribus (everything else held fixed).
• If there are 100 identical pizzerias, market supply
equals 100 times the quantity supplied by a single
firm at each price level.
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C H A P T E R 4: Supply, Demand, and Market
Equilibrium
Market Equilibrium
© 2006 Prentice Hall Business Publishing
• Market equilibrium is
a situation in which
the quantity of a
product demanded
equals the quantity
supplied, so there is
no pressure to change
the price.
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C H A P T E R 4: Supply, Demand, and Market
Equilibrium
Excess Demand Causes
the Price to Increase
• Excess demand is a
situation in which, at
the prevailing price,
consumers are willing
to buy more than
producers are willing
to sell.
• The market moves upward along the demand curve,
decreasing quantity demanded, and upward along the
supply curve, increasing quantity supplied.
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C H A P T E R 4: Supply, Demand, and Market
Equilibrium
Excess Supply Causes
the Price to Drop
• Excess supply is a
situation in which, at
the prevailing price,
producers are willing
to sell more than
consumers are willing
to buy.
• The market moves downward along the demand
curve, increasing quantity demanded, and downward
along the supply curve, decreasing quantity supplied.
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C H A P T E R 4: Supply, Demand, and Market
Equilibrium
Market Effects of
Changes in Demand
Change in Quantity Demanded versus Change in Demand
• A change in price
causes a change in
quantity demanded.
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• A change in demand
(caused by changes in
something other than the
price of the good) shifts
the entire demand curve.
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C H A P T E R 4: Supply, Demand, and Market
Equilibrium
Increases in Demand
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• An increase in demand
shifts the market demand
curve to the right.
• At the initial price of $8,
there is now excess
quantity demanded.
• Equilibrium is restored at
point n, with a higher
equilibrium price and a
larger equilibrium quantity.
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C H A P T E R 4: Supply, Demand, and Market
Equilibrium
Causes of an Increase in Demand
• An increase in demand can occur
for several reasons:
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• An increase in income (for a normal
good). A normal good is a good that
consumers buy more of when their
income increases. Most goods fall in
this category.
• A decrease in income (for an inferior
good). An inferior good is the
opposite of a normal good. Consumers
buy more of inferior goods when their
income decreases.
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C H A P T E R 4: Supply, Demand, and Market
Equilibrium
Causes of an Increase in Demand
• An increase in demand can occur
for several reasons:
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• An increase in the price of a substitute
good. When to goods are
substitutes, an increase in the price
of one good increases the demand for
the other good.
• A decrease in the price of a
complementary good. Two goods are
complements when an increase in
the price of one good decreases the
demand for the other good.
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C H A P T E R 4: Supply, Demand, and Market
Equilibrium
Causes of an Increase in Demand
• An increase in demand can occur
for several reasons:
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• An increase in population
• A shift in consumer tastes
• Favorable advertising
• Expectations of higher future
prices
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C H A P T E R 4: Supply, Demand, and Market
Equilibrium
Decreases in Demand
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• A decrease in demand
shifts the demand curve to
the left.
• At the initial price of $8,
there is now an excess
supply.
• Equilibrium is restored at
point n, with a lower
equilibrium price ($6) and a
smaller equilibrium quantity
(20,000 pizzas).
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C H A P T E R 4: Supply, Demand, and Market
Equilibrium
Decreases in Demand
• A decrease in demand can occur
for several reasons:
• A decrease in income
(for a normal good)
• A decrease in the price
of a substitute good
• A decrease in population
• A shift in consumer tastes
• Favorable advertising
• Expectations of lower future
• An increase in the price
prices
of a complementary
good
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C H A P T E R 4: Supply, Demand, and Market
Equilibrium
Market Effects of
Changes in Demand
Table 4.3 Changes in Demand Shift the Demand Curve (pg. 1)
An increase in demand shifts
the demand curve to the
right when:
A decrease in demand shifts
the demand curve to the left
when:
The good is normal and income
increases
The good is normal and income
decreases
The good is inferior and income
decreases
The good is inferior and income
increases
The price of a substitute good
increases
The price of a substitute good
decreases
The price of a complementary
good decreases
The price of a complementary
good increases
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C H A P T E R 4: Supply, Demand, and Market
Equilibrium
Market Effects of
Changes in Demand
Table 4.3 Changes in Demand Shift the Demand Curve (pg. 2)
An increase in demand shifts
the demand curve to the
right when:
A decrease in demand shifts
the demand curve to the left
when:
Population increases
Population decreases
Consumer tastes shift in favor
of the product
Consumer tastes shift away
from the product
Consumers expect a higher
price in the future
Consumers expect a lower
price in the future
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C H A P T E R 4: Supply, Demand, and Market
Equilibrium
Market Effects of
Changes in Supply
Change in Quantity Supplied versus Change in Supply
• A change in price
causes a change in
quantity supplied.
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• A change in supply
(caused by changes in
something other than the
price of the good) shifts
the entire supply curve.
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C H A P T E R 4: Supply, Demand, and Market
Equilibrium
Increases in Supply
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• An increase in supply shifts
the market supply curve to
the right.
• At the initial price of $8,
there is now excess supply.
• Equilibrium is restored at
point n, with a lower
equilibrium price and a
larger equilibrium quantity.
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C H A P T E R 4: Supply, Demand, and Market
Equilibrium
Causes of an Increase in Supply
• An increase in supply can occur for
several reasons:
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• A decrease in input costs.
• An increase in the number of
producers.
• Expectations of lower future prices.
• Product is subsidized.
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C H A P T E R 4: Supply, Demand, and Market
Equilibrium
Decreases in Supply
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• A decrease in supply shifts
the supply curve to the left.
• At the initial price of $8,
there is now an excess
demand.
• Equilibrium is restored at
point n, with a higher
equilibrium price ($10) and
a smaller equilibrium
quantity (23,000 pizzas).
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C H A P T E R 4: Supply, Demand, and Market
Equilibrium
Causes of a Decrease in Supply
• A decrease in supply can occur for
several reasons:
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• An increase in input costs.
• A decrease in the number of producers.
• Expectations of higher future prices.
• Taxes. If a tax per unit is imposed,
which will make the product less
profitable, firms will produce less.
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C H A P T E R 4: Supply, Demand, and Market
Equilibrium
Market Effects of
Changes in Supply
Table 4.4 Changes in Supply Shift the Supply Curve
An increase in supply shifts
the supply curve to the right
when:
A decrease in supply shifts
the supply curve to the left
when:
The cost of an input decreases
The cost of an input increases
A technological advance
decreases production cost
The number of firms increases
The number of firms decreases
Producers expect a lower price
in the future
Producers expect a higher price
in the future
Product is subsidized
Product is taxed
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C H A P T E R 4: Supply, Demand, and Market
Equilibrium
Market Effects of Simultaneous
Changes in Supply and Demand
• Both the equilibrium price
and the equilibrium quantity
will increase.
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• The equilibrium price will
decrease and the equilibrium
quantity will increase.
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C H A P T E R 4: Supply, Demand, and Market
Equilibrium
Using the Model to Predict
Changes in Price and Quantity
Predicting the Effects of Changes in Demand
• An increase in university enrollment will • A report of pesticide residue on apples
increase the demand for apartments,
decreases the demand for apples, shifting
shifting the demand curve to the right.
the demand curve to the left. Both the
Both the equilibrium price and the
equilibrium price and the equilibrium
equilibrium quantity will increase.
quantity will decrease.
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C H A P T E R 4: Supply, Demand, and Market
Equilibrium
Using the Model to Predict
Changes in Price and Quantity
Predicting the Effects of Changes in Supply
• Technological innovation decreases
• Bad weather decreases the supply of
production costs, shifting the supply
coffee beans, shifting the supply curve to
curve to the right. The equilibrium price
the left. The equilibrium price increases,
decreases, and the equilibrium quantity
and the equilibrium quantity decreases.
increases.
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C H A P T E R 4: Supply, Demand, and Market
Equilibrium
Explaining Changes in
Price or Quantity
• At the same time the quantity
• At the same time the price decreased, the
increased, the price decreased.
quantity decreased. Therefore, the
Therefore, the increase in consumption
decrease in price was caused by a
resulted from an increase in supply, not
decrease in demand, not an increase in
an increase in demand.
supply.
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C H A P T E R 4: Supply, Demand, and Market
Equilibrium
The Market of Love
• How many are looking for true love?
Value of
Love
S
agape
phileo
eros
D
Opportunities for Love
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C H A P T E R 4: Supply, Demand, and Market
Equilibrium
Key Terms
perfectly competitive market
change in quantity supplied
demand schedule
market supply curve
individual demand curve
market equilibrium
quantity demanded
excess demand
law of demand
excess supply
change in quantity demanded
change in demand
substitution effect
normal good
income effect
substitute good
market demand curve
complementary good
supply schedule
inferior good
quantity supplied
change in supply
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