In this chapter, look for the answers to these
questions:
• What factors affect buyers’ demand for goods?
• What factors affect sellers’ supply of goods?
• How do supply and demand determine the
price of a good and the quantity sold?
• How do changes in the factors that affect
demand or supply affect the market price and
quantity of a good?
• How do markets allocate resources?
© 2007 Thomson South-Western
© 2007 Thomson South-Western
What Is a Market?
MARKETS AND COMPETITION
• Supply and demand are the two words that
economists use most often.
• Supply and demand are the forces that make
market economies work.
• Modern microeconomics is about supply,
demand, and market equilibrium.
• A market is a group of buyers and sellers of a
particular good or service.
• The terms supply and demand refer to the
behavior of people . . . as they interact with one
another in markets.
• Buyers determine demand.
• Sellers determine supply.
• A competitive market is a market in which there
are many buyers and sellers so that each has a
negligible impact on the market price.
© 2007 Thomson South-Western
© 2007 Thomson South-Western
What Is Competition?
DEMAND
• Competition: Perfect and Otherwise
• Perfect Competition
• Products are the same
• Numerous buyers and sellers so that each has no influence over price
• Buyers and Sellers are price takers
• Monopoly
• Quantity demanded is the amount of a good
that buyers are willing and able to purchase.
• Law of Demand
– The law of demand states that, other things equal,
the quantity demanded of a good falls when the
price of the good rises.
• One seller, and seller controls price
• Oligopoly
• Few sellers
• Not always aggressive competition
• Monopolistic Competition
• Many sellers
• Slightly differentiated products
• Each seller may set price for its own product
© 2007 Thomson South-Western
© 2007 Thomson South-Western
1
The Demand Curve: The Relationship
between Price and Quantity Demanded
The Demand Curve: The Relationship
between Price and Quantity Demanded
• Demand Schedule
• Demand Curve
• The demand schedule is a table that shows the
relationship between the price of the good and the
quantity demanded.
• The demand curve is a graph of the relationship
between the price of a good and the quantity
demanded.
© 2007 Thomson South-Western
Figure 1 Catherine’s Demand Schedule and Demand Curve
Price of
Ice-Cream Cone
Market Demand versus Individual Demand
• Market demand refers to the sum of all
individual demands for a particular good or
service.
• Graphically, individual demand curves are
summed horizontally to obtain the market
demand curve.
$3.00
2.50
1. A decrease
in price ...
© 2007 Thomson South-Western
2.00
1.50
1.00
0.50
0 1 2 3 4 5 6 7 8 9 10 11 12 Quantity of
Ice-Cream Cones
2. ... increases quantity
of cones demanded.
© 2007 Thomson South-Western
© 2007 Thomson South-Western
The market demand curve is the horizontal sum
of the individual demand curves!
Catherine’s Demand
Price of IceCream Cone
+
2.00
2.00
1.00
1.00
4
8
Quantity of Ice-Cream Cones
=
Nicholas’s Demand
Price of IceCream Cone
Shifts in the Demand Curve
The market demand at
$2.00 will be 7 ice-cream
cones.
When the price is $2.00,
When the price is $2.00,
Nicholas
will demand 3
Catherine will demand
4
ice-cream cones. ice-cream cones.
Market Demand
• Change in Quantity Demanded
• Movement along the demand curve.
• Caused by a change in the price of the product.
Price of IceCream Cone
2.00
1.00
3
5
Quantity of Ice-Cream Cones
When the price is $1.00, When the price is $1.00,
Catherine will demand 8 Nicholas will demand 5
ice-cream cones.
ice-cream cones.
7
13
Quantity of Ice-Cream Cones
The market demand at
$1.00, will be 13 icecream cones.
© 2007 Thomson South-Western
© 2007 Thomson South-Western
2
Shifts in the Demand Curve
Changes in Quantity Demanded
A tax on sellers of icecream cones raises the
price of ice-cream
cones and results in a
movement along the
demand curve.
Price of IceCream
Cones
B
$2.00
A
1.00
D
0
4
8
• Change in Demand
• A shift in the demand curve, either to the left or
right.
• Caused by any change that alters the quantity
demanded at every price.
• Consumer income
• Prices of related goods
• Tastes
• Expectations
• Number of buyers
Quantity of Ice-Cream Cones
© 2007 Thomson South-Western
© 2007 Thomson South-Western
Figure 3 Shifts in the Demand Curve
Shifts in the Demand Curve
Price of
Ice-Cream
Cone
• Consumer Income
• As income increases the demand for a normal good
will increase.
• As income increases the demand for an inferior
good will decrease.
Increase
in demand
Decrease
in demand
Demand curve, D3
Demand
curve, D1
Demand
curve, D2
Quantity of
Ice-Cream Cones
0
© 2007 Thomson South-Western
© 2007 Thomson South-Western
Consumer Income Inferior Good
Consumer Income Normal Good
Price of IceCream Cone
Price of IceCream Cone
$3.00
$3.00
An increase
in income...
2.50
2.50
Increase
in demand
2.00
An increase
in income...
2.00
Decrease
in demand
1.50
1.50
1.00
1.00
0.50
D1
0 1
2 3 4 5 6 7 8 9 10 11 12
D2
Quantity of
Ice-Cream
Cones
© 2007 Thomson South-Western
0.50
0 1
D2
D1
2 3 4 5 6 7 8 9 10 11 12
Quantity of
Ice-Cream
Cones
© 2007 Thomson South-Western
3
Shifts in the Demand Curve
Table 1 Variables That Influence Buyers
• Prices of Related Goods
• When a fall in the price of one good reduces the
demand for another good, the two goods are called
substitutes.
• When a fall in the price of one good increases the
demand for another good, the two goods are called
complements.
© 2007 Thomson South-Western
© 2007 Thomson South-Western
The Supply Curve: The Relationship
between Price and Quantity Supplied
SUPPLY
• Quantity supplied is the amount of a good that
sellers are willing and able to sell.
• Law of Supply
• Supply Schedule
• The supply schedule is a table that shows the
relationship between the price of the good and the
quantity supplied.
– The law of supply states that, other things equal,
the quantity supplied of a good rises when the
price of the good rises.
© 2007 Thomson South-Western
The Supply Curve: The Relationship
between Price and Quantity Supplied
• Supply Curve
• The supply curve is the graph of the relationship
between the price of a good and the quantity
supplied.
© 2007 Thomson South-Western
Figure 5 Ben’s Supply Schedule and Supply Curve
Price of
Ice-Cream
Cone
$3.00
1. An
increase
in price ...
2.50
2.00
1.50
1.00
0.50
0
1 2
3
4
5
6
7
8
9 10 11 12 Quantity of
Ice-Cream Cones
2. ... increases quantity of cones supplied.
© 2007 Thomson South-Western
© 2007 Thomson South-Western
4
Market Supply versus Individual Supply
Shifts in the Supply Curve
• Market supply refers to the sum of all
individual supplies for all sellers of a particular
good or service.
• Graphically, individual supply curves are
summed horizontally to obtain the market
supply curve.
• Change in Quantity Supplied
• Movement along the supply curve.
• Caused by a change in anything that alters the
quantity supplied at each price.
© 2007 Thomson South-Western
Shifts in the Supply Curve
Change in Quantity Supplied
Price of IceCream
Cone
• A shift in the supply curve, either to the left or right.
• Caused by a change in a determinant other than
price.
C
A rise in the price
of ice cream
cones results in a
movement along
the supply curve.
A
0
• Change in Supply
S
$3.00
1.00
© 2007 Thomson South-Western
1
Quantity of
Ice-Cream
Cones
5
•
•
•
•
Input prices
Technology
Expectations
Number of sellers
© 2007 Thomson South-Western
© 2007 Thomson South-Western
Figure 7 Shifts in the Supply Curve
Table 2: Variables That Influence Sellers
Price of
Ice-Cream
Cone
Supply curve, S3
Decrease
in supply
Supply
curve, S1
Supply
curve, S2
Increase
in supply
0
Quantity of
Ice-Cream Cones
© 2007 Thomson South-Western
© 2007 Thomson South-Western
5
SUPPLY AND DEMAND TOGETHER
SUPPLY AND DEMAND TOGETHER
• Equilibrium refers to a situation in which the
price has reached the level where quantity
supplied equals quantity demanded.
• Equilibrium Price
– The price that balances quantity supplied and
quantity demanded.
– On a graph, it is the price at which the supply and
demand curves intersect.
• Equilibrium Quantity
– The quantity supplied and the quantity demanded
at the equilibrium price.
– On a graph it is the quantity at which the supply
and demand curves intersect.
© 2007 Thomson South-Western
© 2007 Thomson South-Western
Figure 8 The Equilibrium of Supply and Demand
SUPPLY AND DEMAND TOGETHER
Demand Schedule
Supply Schedule
Price of
Ice-Cream
Cone
Supply
Equilibrium
Equilibrium price
$2.00
At $2.00, the quantity demanded
is equal to the quantity supplied!
Equilibrium
quantity
0
1
2
3
4
5
6
7
8
Demand
9 10 11 12 13
Quantity of Ice-Cream Cones
© 2007 Thomson South-Western
© 2007 Thomson South-Western
Equilibrium
Figure 9 Markets Not in Equilibrium
(a) Excess Supply
• Surplus
• When price > equilibrium price, then quantity
supplied > quantity demanded.
• There is excess supply or a surplus.
• Suppliers will lower the price to increase sales, thereby
moving toward equilibrium.
Price of
Ice-Cream
Cone
Supply
Surplus
$2.50
2.00
Demand
0
4
Quantity
demanded
7
10
Quantity
supplied
Quantity of
Ice-Cream
Cones
© 2007 Thomson South-Western
© 2007 Thomson South-Western
6
Equilibrium
Figure 9 Markets Not in Equilibrium
(b) Excess Demand
• Shortage
• When price < equilibrium price, then quantity
demanded > the quantity supplied.
• There is excess demand or a shortage.
• Suppliers will raise the price due to too many buyers
chasing too few goods, thereby moving toward
equilibrium.
Price of
Ice-Cream
Cone
Supply
$2.00
1.50
Shortage
Demand
0
4
Quantity
supplied
7
10
Quantity of
Quantity
Ice-Cream
demanded
Cones
© 2007 Thomson South-Western
© 2007 Thomson South-Western
Equilibrium
Table 3: Three Steps for Analyzing Changes in Equilibrium
• Law of supply and demand
• The claim that the price of any good adjusts to bring
the quantity supplied and the quantity demanded for
that good into balance.
© 2007 Thomson South-Western
Figure 10 How an Increase in Demand Affects the Equilibrium
Price of
Ice-Cream
Cone
1. Hot weather increases
the demand for ice cream . . .
Supply
2.00
2. . . . resulting
in a higher
price . . .
Initial
equilibrium
D
D
7
0
3. . . . and a higher
quantity sold.
10
Three Steps to Analyzing Changes in
Equilibrium
• Shifts in Curves versus Movements along
Curves
New equilibrium
$2.50
© 2007 Thomson South-Western
Quantity of
Ice-Cream Cones
• A shift in the supply curve is called a change in
supply.
• A movement along a fixed supply curve is called a
change in quantity supplied.
• A shift in the demand curve is called a change in
demand.
• A movement along a fixed demand curve is called a
change in quantity demanded.
© 2007 Thomson South-Western
© 2007 Thomson South-Western
7
Figure 11 How a Decrease in Supply Affects the Equilibrium
Price of
Ice-Cream
Cone
S2
The Market for Hybrid Cars
EXAMPLE:
1. An increase in the
price of sugar reduces
the supply of ice cream. . .
S1
New
equilibrium
$2.50
P
price of
hybrid cars
S1
P1
Initial equilibrium
2.00
2. . . . resulting
in a higher
price of ice
cream . . .
D1
Demand
Q
Q1
0
4
7
3. . . . and a lower
quantity sold.
EXAMPLE 1:
quantity of
hybrid cars
Quantity of
Ice-Cream Cones
© 2007 Thomson South-Western
A Change in Demand
Event to be analyzed:
Increase in price of gas
(change in price of a
complement)
© 2007 Thomson South-Western
EXAMPLE 1: A Change in Demand
P
• STEP 1:
S1
– D curve shifts
because price of gas affects demand for hybrids.
– S curve does not shift, because price of gas does not
affect cost of producing hybrids.
P2
P1
• STEP 2:
D1
– D shifts right
because high gas price makes hybrids more attractive
relative to other cars.
D2
Q
Q1 Q2
• STEP 3:
– The shift causes an increase in price
and quantity of hybrid cars.
© 2007 Thomson South-Western
EXAMPLE 1:
A Change in Demand
Notice:
When P rises,
producers supply
a larger quantity
of hybrids, even
though the S curve
has not shifted.
Always be careful
to distinguish b/w
a shift in a curve
and a movement
along the curve.
© 2007 Thomson South-Western
EXAMPLE 2:
A Change in Supply
EVENT: New
technology
reduces cost of
producing hybrid
cars.
P
S1
P2
P1
P
S1
S2
P1
P2
D1
Q1 Q2
D2
D1
Q
© 2007 Thomson South-Western
Q1 Q2
Q
© 2007 Thomson South-Western
8
EXAMPLE 3:
EXAMPLE 2: A Change in Supply
A Change in Both Supply
and Demand
EVENTS:
P
price of gas rises
AND
new technology P2
reduces productionP1
costs
• STEP 1:
– S curve shifts
because event affects cost of production.
– D curve does not shift, because production
technology is not one of the factors that affect
demand.
• STEP 2:
S1
– S shifts right
because event reduces cost,
makes production more profitable at any given price.
D1
Q1
• STEP 3:
S2
D2
Q
Q2
– The shift causes price to fall
and quantity to rise.
© 2007 Thomson South-Western
© 2007 Thomson South-Western
Changes in supply and demand
EXAMPLE 3: A Change in Both Supply and Demand
Use the three-step method to analyze the
effects of each event on the equilibrium
price and quantity of music downloads.
• STEP 1:
– Both curves shift.
• STEP 2:
Event A: A fall in the price of compact discs
– Both shift to the right.
• STEP 3:
Event B: Sellers of music downloads negotiate a
reduction in the royalties they must pay
for each song they sell.
– Q rises, but effect
on P is ambiguous:
– If demand increases more than supply, P rises.
Event C: Events A and B both occur.
But if supply increases more than demand,
P falls.
51
© 2007 Thomson South-Western
A. fall in price of CDs
P
B. fall in cost of royalties
The market for
music downloads
P
S1
STEPS
1. S curve shifts
(royalties are part
of sellers’ costs)
P2
2. D shifts left
3. P and Q both
fall.
The market for
music downloads
S1
STEPS
P1
1. D curve shifts
© 2007 Thomson South-Western
S2
P1
P2
2. S shifts right
D2
Q2 Q1
D1
D1
Q
52
© 2007 Thomson South-Western
3. P falls, Q rises.
Q1 Q2
Q
53
© 2007 Thomson South-Western
9
C. fall in price of CDs AND fall in cost of
royalties
Table 4: What Happens to Price and Quantity When Supply
or Demand Shifts?
STEPS
1. Both curves shift (see parts A & B).
2. D shifts left, S shifts right.
3. P unambiguously falls.
Effect on Q is ambiguous:
The fall in demand reduces Q,
the increase in supply increases Q.
54
© 2007 Thomson South-Western
© 2007 Thomson South-Western
10