Chapter 4
Supply and Demand
– An Initial Look
The free enterprise system is absolutely too important to be left
to the voluntary action of the marketplace.
RICHARD KELLY
The Invisible Hand
• Invisible hand
– Adam Smith
– People pursue own self-interests
– “Led by an invisible hand”
– Promote wellbeing of community
2
Demand and Quantity Demanded
• Quantity demanded
– Number of units
– Consumers
• Willing
• Can afford to buy
– Specified period of time
3
Demand and Quantity Demanded
• Quantity demanded
– Depends on price
– Also depends on
• Population size
• Consumer incomes
• Tastes
• Prices of other products
4
Demand and Quantity Demanded
• Demand schedule - Table
– Period of time
– Quantity demanded changes
• As price changes
• All other determinants – constant
• All other determinants constant
– As price rises
• Quantity demanded falls
– As price falls
• Quantity demanded rises
5
Table 1
Demand schedule for beef
Price per pound
Quantity demanded Label in Figure 1
$7.50
45
A
7.40
50
B
7.30
55
C
7.20
60
E
7.10
65
F
7.00
70
G
6.90
75
H
6
Demand and Quantity Demanded
• Demand curve
– Graphical depiction of demand schedule
– Quantity demanded – changes
• Price – changes
– Period of time
– All other determinants – constant
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Figure 1
Demand curve for beef
D
$7.50
A
B
Price per Pound
7.40
C
7.30
E
7.20
F
7.10
G
7.00
H
6.90
D
0
45
50
55
60
65
70
75
Quantity Demanded in Millions of Pounds per Year
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Demand and Quantity Demanded
• Change in price
– Movement along demand curve
• Change in other determinants
– Shifts entire demand curve
– Consumers - buy more (any & all prices)
• Demand curve – shifts right/outward
– Consumers – buy less (any & all prices)
• Demand curve – shifts left/inward
9
Figure 2
Movement along versus shift of a demand curve
D1
Price per Pound
D0
C
$7.30
F
7.10
D0
0
D1
Quantity Demanded in Millions of Pounds per Year
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Demand and Quantity Demanded
• Consumer income - increase
– Demand – increase
• Outward shift
• Population – increase
– Demand – increase
• Outward shift
• Consumer preferences – in favor
– Demand – increase
• Outward shift
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Figure 3
Shifts of the demand curve
D0
D1
S
D2
E
Price
Price
D0
M
D0
D0
Quantity demanded
(a)
D1
S
D2
Quantity
(b)
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Demand and Quantity Demanded
• Prices & availability of related goods
– Price of substitutes – increase
• Demand – increase
– Shift right
– Price of complements – increase
• Demand – decrease
– Shift left
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Supply and Quantity Supplied
• Quantity supplied
– Number of units
– Sellers - want to sell
– Specified period of time
• All other determinants constant
– As price rises
• Quantity supplied rises
– As price falls
• Quantity supplied falls
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Supply and Quantity Supplied
• Supply schedule - Table
– Period of time
– Quantity supplied changes
• As price changes
• All other determinants – constant
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Table 2
Supply schedule for beef
Price per pound
Quantity supplied
Label in Figure 4
$7.50
90
a
7.40
80
b
7.30
70
c
7.20
60
e
7.10
50
f
7.00
40
g
6.90
30
h
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Supply and Quantity Supplied
• Supply curve
– Graphical depiction of supply schedule
– Quantity supplied – changes
• Price – changes
– Period of time
– All other determinants – constant
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Figure 4
Supply curve for beef
S
$7.50
a
b
Price per Pound
7.40
7.30
c
7.20
e
7.10
f
7.00
g
6.90
h
S
0
30
40
50
60
70
80
90
Quantity Supplied in Millions of Pounds per Year
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Supply and Quantity Supplied
• Change in price
– Movement along supply curve
• Change in other determinants
– Shifts entire supply curve
• Size of industry
• Technological progress
• Prices of inputs
• Prices of related outputs
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Figure 5
Movement along versus shift of a supply curve
Price per Pound
S0
S1
c
$7.30
7.10
f
S0
0
S1
Quantity Supplied in Millions of Pounds per Year
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Supply and Quantity Supplied
• Size of industry
– Increase
• New firms - enter
• Existing firms - expand
– Supply – increase
• Outward shift
• Technological progress
– Reduces costs
– Supply – increase
• Outward shift
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Figure 6
Shifts of the supply curve
D
S1
Price
S0
Price
S2
S0
V
U
E
S2
S0
S0
S1
D
Quantity
Quantity
(a)
(b)
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Supply and Quantity Supplied
• Prices of inputs – increase
– Supply – decrease
• Inward shift
• Prices of related outputs - change
– Supply – shift
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Supply and Demand Equilibrium
• Supply-demand diagram
– Graph: Supply & Demand curves
– Determines
• Equilibrium price
• Equilibrium quantity
• Shortage
– Excess quantity demanded
• Over quantity supplied
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Supply and Demand Equilibrium
• Surplus
– Excess quantity supplied
• Over quantity demanded
• Equilibrium
– No inherent forces that produce change
• Equilibrium change
– “Outside events”
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Table 3
Determination of equilibrium price & quantity of beef
Price
per pound
Quantity
Demanded
Quantity
Supplied
Surplus or
Shortage
Price
Direction
$7.50
45
90
Surplus
Fall
7.40
50
80
Surplus
Fall
7.30
55
70
Surplus
Fall
7.20
60
60
Neither
Unchanged
7.10
65
50
Shortage
Rise
7.00
70
40
Shortage
Rise
6.90
75
30
Shortage
Rise
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Figure 7
Demand curve for beef
D
$7.50
S
A
a
Price per Pound
7.40
7.30
E
7.20
7.10
g
7.00
G
6.90
D
S
0
30
40
50
60
70
80
90
Quantity in Millions of Pounds per Year
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Supply and Demand Equilibrium
• Law of Supply and Demand
– Free market
– Forces: supply & demand
• Push the price - equilibrium level
– Quantity supplied = quantity demanded
– May be disobeyed
• Long term
– Shortages
– Surpluses
– Prices - fail to move toward equilibrium
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Demand shifts & supply-demand equilibrium
• Demand curve - shift outward / right
– Supply curve – no change
– Equilibrium price – rise
– Equilibrium quantity – rise
• Demand curve - shift inward / left
– Supply curve – no change
– Equilibrium price – fall
– Equilibrium quantity – fall
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Figure 8
D1
D0
S
T
$7.30
E
Price per pound
Price per pound
The effects of shifts of the demand curve
D0
S
D2
E
L
R
$7.20
7.20
D1
S
D0
60 70 75
Quantity
(a)
7.10
M
S
D2
D0
45 50 60
Quantity
(b)
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Supply shifts & supply-demand equilibrium
• Supply curve - shift outward / right
– Demand curve – no change
– Equilibrium price – fall
– Equilibrium quantity – rise
• Supply curve - shift inward / left
– Demand curve – no change
– Equilibrium price – rise
– Equilibrium quantity – fall
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Figure 9
D
S2
D
S0
S0
V
S1
E
$7.20
I
J
7.10
Price per pound
Price per pound
The effects of shifts of the supply curve
$7.40
E
U
7.20
S2
S0
D
S1
D
S0
60 65
Quantity
(a)
78
50
37.5
Quantity
(b)
60
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Application: Who really pays that tax?
• New tax on product: 10 cents gasoline tax
per gallon
– Firms
• Decrease supply
• Pay part of tax
– Consumers
• Pay part of tax
• What if consumers have an inelastic
demand for gasoline?
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Figure 10
Price per gallon
Who pays for a new tax on products?
S1
D
M
$2.64
E1
2.60
2.54
S0
S1
E0
S0
D
Q2
Q1
30
50
Millions of gallons per year
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The Market Fights Back
• Battling the invisible hand
• Legally imposed constraints on prices
– Price ceilings
• Legal maximum
• Equilibrium price – above it
– Price floors
• Legal minimum
• Equilibrium price – below it
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Price Ceilings
• Keep price – below free-market level
• Consequences
– Shortage – persistent
• Quantity demanded > quantity supplied
– Illegal or “black” market
– Black market prices – higher
– Portion of revenues – illicit supplier
– Investment – dries up
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Case study: Rent controls in New-York city
• Rent control
– To protect consumers
– Long run - worse off
– Shortage – long waiting list, high search
cost
– Poor maintenance
– Black market – bribes
– Only some benefit, and they defend the
rent control
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Figure 11
Supply-demand diagram for rental housing
Rent per month
D
$2,000
1,200
S
E
Market rent
B
Rent ceiling
C
D
S
2.5
3
3.5
Millions of dwellings rented per month
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Price Floors
• Keep price – above free-market level
• Symptoms
– Surplus
– Problem of disposal for regulated goods
– Motivate sellers provide disguised and
unwanted discounts
– Overinvestment in industry
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Case study: Farm price supports; Sugar prices
• Farm price supports
– Introduced 1933 - “temporary”
– Prices – inflated
– Surplus – unsellable
• Purchases by government
• Taxpayer pays
– Higher prices
– Taxes
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Case study: Farm price supports; Sugar prices
• Sugar industry
– Producers
• Low-interest loans
• Enforced price floor
– Limit domestic production
– Limit foreign imports
– Supply curve – left shift
• Industry – benefits
• Consumers – pay
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Figure 12
Supporting the price of sugar
S1
S0
Price
D
50¢
25¢
S1
D
S0
Quantity
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Summary
• Movement along the D or S curve vs.
shift of the whole curve
• Supply meets demand → equilibrium
• Price control is a bad idea
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