Chapter 4
SUPPLY & DEMAND
1. The Market
A place where a product is being bought or sold.
All buyers and sellers for a product/service.
The demand that exists for a particular product/service.
The process by which a buyer and seller arrive at a mutually agreeable price and
quantity.
Question:
Answer:
Who determines the price (P) for goods/services in a market?
The market does by matching buyers and sellers of a particular
product/service.
Buyers want the price to be as low as possible and sellers would prefer
higher prices.
The price that is settled upon will be somewhere in between.
Prices can fluctuate quite a bit, depending on the good/service in
question.
2. Examining Demand
The quantity of a good or service that buyers will purchase at
various prices during a period of time.
The Law of Demand states quantity demanded (Qd) varies inversely with price
(P), ceteris paribus
In other words, the higher the price of a product, the less it will be purchased and
the lower the price, the more it will be purchased.
Why is this so?
o The Substitution Effect as the price of a good rises we tend to substitute
similar goods in place of it.
o The Income Effect the effect of price on quantity demanded that reflects
the change in real income due to the price change. From $1.00 to $1.10
no one cares. From $5 000 to $6 000 people might.
A demand schedule is a table that outlines quantity demanded for a good at any
given price. A demand curve can be drawn using this table.
A market demand schedule is the sum of all individual consumer demand
schedules, and we can then draw the market demand curve.
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Examining Supply
Supply: The quantities that sellers will offer for sale at various prices.
Sellers would obviously prefer higher prices because they are in business to
make a profit.
The Law of Supply states that the quantity supplied (Qs) will increase if price
increases and fall if price falls, ceteris paribus.
A supply schedule is a table that lists the relationship between price and
quantity supplied at that price. From this, a Supply curve can be drawn.
When the supply schedules for all individual sellers are combined we have a
market supply schedule and can draw a market supply curve.
Market Equilibrium
If we combine the demand and supply schedules, we will see there is only one
price at which Qd and Qs are equal. This is known as the Equilibrium Price.
If we were to graph the demand and supply curves together, we would see that
they intersect one another at this equilibrium.
Any price above equilibrium would generate a surplus because Qs > Qd.
Any price below equilibrium would generate a shortage because Qs < Qd.
Changes in Demand and Supply
Note:
Up to now, we have only considered the effects of price changes on
demand and supply. The only effect a P change has on demand or supply
is movement along the curve.
This movement creates surpluses and shortages in the market.
We have been looking at everything, ceteris paribus, thus only price has been
able to change.
Question:
What happens when non-price factors influence the market?
Answer:
We get shifts in the demand and supply curves because these
factors affect the Qs or Qd at every given price.
REMEMBER THIS:
The only way a curve can shift is via a change in one of the non price factors.
This is a change in Demand or Supply.
A change in price only results in movement along the curve. This is a change in Qs or
Qd ONLY!
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Factors Causing Changes (Shifts) in Demand
Changes in the following factors will cause shifts in the demand curve which, in
turn, will cause the Equilibrium point to change. A shift right is an increase in
demand and a shift left is a decrease.
INCOME
o An increase in incomes will cause Qd to be higher at every given price
level (an increase in demand) and vice-versa.
POPULATION
o A population increase/decrease will create the same situation as above.
Can you think of any examples?
TASTES & PREFERENCES
o Changes in taste for a product cause increases and decreases in demand
for it.
o These changes can be consumer generated or they can be generated via
advertising and/or publicity. Example?
EXPECTATIONS
o Consumer beliefs about the future can affect the demand in the present
market. Example?
PRICES OF RELATED GOODS
o Substitute Goods can affect the demand for one another. If the price of
good A goes up, the demand for good B will increase due to substitution,
and vice-versa. Example?
o Complement Goods are products that are sold, or used, in conjunction
with other goods. i.e. car/gas A fall in the price of either one will cause an
increase in the demand of the other & vice-versa.
Factors Causing Changes (Shifts) in Supply
Changes in the following factors will cause shifts in the supply curve which, in
turn, will cause the Equilibrium point to change. A shift right is an increase in
supply and a shift left is a decrease.
COSTS
o An increase/decrease in production costs will affect Qs at every given
price level, thereby changing supply.
NUMBER OF SELLERS
o If new producers enter an industry, the supply will increase and viceversa.
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TECHNOLOGY
o A technological innovation or simple use of a technology usually
decreases costs of production and increases supply.
NATURE & THE ENVIRONMENT
o Changes in weather, pollution, etc. can dramatically affect the supply in
many industries.
PRICES OF RELATED OUTPUTS
o The price of one item may affect the supply of another. i.e. If a farmer is
growing wheat and the price of corn rises significantly, that farmer will
want to switch to growing corn. This will decrease the supply of wheat.
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