Chapter 2: Demand, Supply, and
Market Equilibrium
Lecture2
Markets


A market is a meeting place where
buyers and sellers are able to trade with
each other.
At market economy, the price of a
good is determined by the interaction of
demand and supply
I.

Demand
A relationship between price and
quantity demanded in a given time
period, ceteris paribus.
Law of demand
An inverse relationship exists between
the price of a good and the quantity
demanded in a given time period,
(ceteris paribus assumption).
The Demand curve
The Demand Curve shows how much
the buyers are willing to buy at different
prices of goods.
Person Demand
demand
P
6
5
4
3
2
1
0
0
20
40
60
80
Q 100
Quantity
demanded
Price/kilogram
10
5 ryal
20
4
35
3
55
2
80
1
Market Demand
Price
(ryal)
5
Buyer one
4
20
23
43
3
35
39
74
2
55
60
115
1
80
87
167
10
Buyer 2
+
12
Market
Demand
=
22
5
5
4
4
3
3
2
2
1
1
0
0
0
20
35
40
60
80
0
10
20
30
3940
50
60
Market Demand
5
5
4
4
3
3
2
2
1
1
0
0
20
40
60
70
80
Q
Q
P
P
Person 2 demand
P
Person 1 demand
80
74
100
120
140
Q
160
90
Market demand curve
Market demand is the horizontal
summation of individual consumer
demand curves.
Determinants of demand


tastes and preferences
prices of related goods and services





Complementary goods: goods that are typically
consumed together.
Substitute goods: goods that can be used instead
of each other
income
number of consumers
expectations of future prices and income
Tastes and preferences

Effect of fads:
Price of related goods


substitute goods – an increase in the
price of one results in an increase in the
demand for the other.
complementary goods – an increase in
the price of one results in a decrease in
the demand for the other.
Change in the price of a
substitute good

Price of coffee rises:
Change in the price of a
complementary good

Price of DVDs rises:
Income and demand: normal goods

A good is a normal good if an increase in
income results in an increase in the demand
for the good.
Income and demand: inferior goods

A good is an inferior good if an increase in
income results in a reduction in the demand
for the good.
Demand and the number of buyers

An increase in the number of buyers results
in an increase in demand.
Expectations


A higher expected future price will
increase current demand.
A lower expected future price will
decrease current demand.
II. Supply
The relationship that exists between
the price of a good and the quantity
supplied in a given time period, ceteris
paribus.
Law of supply
A direct relationship exists between the
price of a good and the quantity
supplied in a given period of time,
(ceteris paribus assumption).
Reason for law of supply



The price is a Revenue for the
producers.
High prices are necessary to
encourage offers and production
high prices are necessary to cover
production costs.
Person Supply
6
5
P
4
3
2
1
0
0
10
20
30
40
50
60
Q
Quantity
supplied
Price
60
5
50
4
35
3
20
2
5
1
Change in supply vs. change
in quantity supplied
Change in supply
Change in quantity supplied
Individual firm and market
supply curves
The market supply curve is the horizontal
summation of the supply curves of
individual firms. (This is equivalent to the
relationship between individual and
market demand curves.)
Determinants of supply





the price of resources,
technology and productivity,
the expectations of producers,
the number of producers, and
the prices of related goods and services
Price of resources
As the price of a resource rises, profitability
declines, leading to a reduction in the
quantity supplied at any price.
Technological improvements
Technological improvements (and any
changes that raise the productivity of labor)
lower production costs and increase
profitability.
Expectations and supply
An increase in the expected future price
of a good or service results in a
reduction in current supply.
Increase in number of sellers
Prices of other goods



Firms produce and sell more than one
commodity.
Firms respond to the relative profitability of
the different items that they sell.
The supply decision for a particular good is
affected not only by the good’s own price but
also by the prices of other goods and services
the firm may produce.
III. Market equilibrium
A market is in equilibrium ?
the intersection between the supply
and demand curves in one diagram get
an equilibrium point .
Equilibrium price and equilibrium
quantity
P*
Q*
Equilibrium Price

The equilibrium price of a good is:
a price at which quantity supplied equals
quantity demanded.
 a price at which excess demand equals
zero.

At the equilibrium price there is no net
tendency for price to change.
Equilibrium quantity

The equilibrium quantity of a good is:

a quantity that is bought and sold when
there is an equilibrium in the market.
How to find the equilibrium
mathematically


Example:
Supply and Demand can be written as
mathematical functions:


Qs =85 + 30p
Qd = 185 -20p
Example (continued)





We now want to find the price, p* that
makes Qs = Qd
85+30p* = 185 – 20p*
30p* + 20p* = 185 -85
50p* = 100
P* =2
Example (continued)






Q* =?
Q* = 85 +30*p*
Q* = 85 +30*2 =145
OR
Q* = 185 – 20*2
Q* = 145
Excess demand and supply

Excess demand exists when, at the

Excess supply exists when, at the
current price, the quantity demanded is
greater than quantity supplied.
current price, the quantity supplied is
greater than the quantity demanded.
Excess supply = Qs - QD
price
EXCESS SUPPLY
supply
P
demand
QD
QS
Q
Excess demand = QD - QS
price
supply
EXCESS DEMAND
P
demand
QS
QD
Q
Demand rises
price increases from p1 to p2 and
quantity demanded rises from q1 to
q2
p2
p1
q1
q2
Demand rises

When there is EXCESS DEMAND for a
good, price will tend to rise.
 Consumers rises price to p2,
 QS increases and QD decreases,
 The new equilibrium is attained at
p2,q2.
Demand falls
price decreases from p1 to p2 and
quantity demanded decreases from
q1 to q2
p1
p2
q2
q1
Demand falls

Producers decides to decrease the price in
p2,
QD rises and Qs
falls

And the new equilibrium is attained at p2,q2.

Supply rises
price decreases from p1 to p2 and
quantity supplied increases from q1
to q2
Supply rises

When there is EXCESS SUPPLY of a good,
price will tend to fall.
 Producers falls the price to p2,
 QD increases and QS decreases,
 And the new equilibrium is attained at
p2,q2
Supply falls
price increases from p1 to p2 and
quantity supplied decreases from q1
to q2
Supply falls



Consumers rises price to p2,
QS increases and QD decreases,
And the new equilibrium is attained at p2,q2