ECO 2013
Chapter 3: Demand, Supply, & Market Equilibrium
Demand:
 A relation between the price of a good and the quantity
that consumers are willing and able to buy during a
given period, other things constant.
o WILLING: you want to buy the product
o ABLE: you can afford the buy the product
 Is a schedule or a curve that shows the various
amounts of a product that consumers are willing and
able to purchase at each of a series of possible prices
during a specific period of time.
Price
$1.00
$1.25
$1.50
$2.00
Quantity
Demanded
100
80
70
50
 Law of Demand:
o States that a quantity of a good demanded during
a given period relates inversely to its price, other
things constant
o Price increases then Quantity demanded decreases
o Price decreases then Quantity demanded increases
o Results in downward sloping demand curve
o Why?
 The law of demand is consistent with
common sense
 Substitution Effect:
Created by Maria Mari
Fall 2007
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ECO 2013
Chapter 3: Demand, Supply, & Market Equilibrium
 Unlimited wants and scarce resources
cause this.
 It is when the price of a good falls,
consumers substitute that good for
other goods, which become relatively
more expensive.
 Income Effect:
 Money income: is simply the number of
dollars received per period.
 Real income: your income measured in
terms of what it can buy
 A fall in the price of good increases’
consumers’ real income making
consumers more able to purchase
goods: for a normal good, the quantity
demanded increases.
 Demand Schedule and Curve
o Demand curve: a curve showing the relation
between the price of a good and the quantity
demanded during a given period, other things
constant
o Suppose we produce pizza, here is the
demand schedule
Created by Maria Mari
Fall 2007
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Price of
Good
Quantity
Demanded
$3
200
$4
150
$5
100
ECO 2013
Chapter 3: Demand, Supply, & Market Equilibrium
$6
75
$7
50
Notice that as the price increases, quantity
demanded decreases.
Drawing the curve:
The demand curve is downward
sloping due to the inverse
relationship between price and
$6
Notice:
every point onA the line matches the schedule. It is a
quantity demanded.
price/quantity demanded that consumers are willing and able to buy.
$5
B
Price
$4
o Movement along the Demand Curve
$3 o Caused by a change in price and ONLY a change
in price
$2
o You will move form one point to another on the
Demand
$1
same graph.
o Such as in the above graph we go from $5 to $4, the
$0 quantity demand increases from 75 to 150 units.
50
75
100 150
200
Quantity
o When a price changes then we have a Change in
Quantity Demanded.
o Determinants of Demand
o These are the other things constant
o They are
 Consumers’ tastes
 Number of buyers in the market
 Consumers’ income
 The price of related goods
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Fall 2007
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ECO 2013
Chapter 3: Demand, Supply, & Market Equilibrium
 Consumer expectations
o Changes in Demand
Extremely
important
!!!
o A demand curve isolates the relation between prices
of a good and quantities demanded when other
factors that could affect demand remain unchanged.
o
o Called ASSUMPTIONS OR DETERMINANTS
 Change in consumer income
 Change in prices of related goods
 Changes in consumer expectations
 Changes in the number of consumers
 Changes in consumer tastes or preferences
o Changes in determinants
 Results in changes to the relationship between
PRICE and QUANTITY DEMANDED
 At each and every price a DIFFERENT quantity
is demanded.
 Results in a shift in the demand curve.
Increase in Demand
 at each and every price MORE of the good
is demanded
 consumers are willing to purchase more
quantities of the good at each price.
 shifts the demand curve to the right
P
Qd1
Qd2
$4
150
200
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Fall 2007
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ECO 2013
Chapter 3: Demand, Supply, & Market Equilibrium
$5
100
150
$6
75
100
Note: Qd1 is the demand schedule that originally existed for
the product. After a change in one of the determinants that
resulted in an increase in DEMAND, a new demand schedule
Qd2 is created. At each and every price more of the good is
demanded. Check out price of $5.
Price
The demand curve shifts to the
right.
What causes an increase in demand?
o Increase in consumer income
o Consumers have more money, they spend on
$5
more of everything
Qd2
o Normal goods
 A good for which
Qd1 demand increases as
consumer income rise
o Inferior goods
Quantity
 A good which demand increases as consumer
100falls
150
income
 Bus
o Change in Price of Related goods
o Some goods are related to other goods in that
consumption of one affects the consumption of the
other good
o Substitutes:
 goods that are not consumed jointly
 such as coke and Pepsi
 goods that are related in such a way than an
increase in the price of one increases the
demand for the other
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Fall 2007
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ECO 2013
Chapter 3: Demand, Supply, & Market Equilibrium
 increase in the price of Pepsi, increase
the demand for Coke
o Complements
 Goods that are related in such a way that an
decrease in the price of one will increase the
demand for the other
 DVD player and DVDs
 Decrease in the price of DVD players,
increases demand for DVDs
 Must be consumed jointly
o Changes in consumer tastes or preferences
o Consumer preferences: likes or dislikes in
consumption are assumed not to change along the
demand curve
o But if taste change so does demand
o VHS, platform shoes
o Changes in Consumer Expectations
o As prices and income
o Affect how consumers spend their money and
their demand
o If we think that the product will be more
expensive tomorrow, we will buy today
o Changes in the number and composition of consumers
o The market demand curve is the sum of the
individual demand curves
o If the number of consumers fall then demand falls
Decrease in Demand
 at each and every price LESS of the good
is demanded
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Fall 2007
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ECO 2013
Chapter 3: Demand, Supply, & Market Equilibrium
 no matter what price, consumers buy less
quantities
 shifts the demand curve to the right
P
Qd1
Qd2
$4
150
130
$5
100
90
$6
75
60
Note: Qd1 is the demand schedule that originally existed for
the product. After a change in one of the determinants that
resulted in a decrease in DEMAND, a new demand schedule
Qd2 is created. At each and every price less of the good is
demanded. Check out price of $5.
Price
The demand curve shifts to the
left.
What causes a decrease in demand?
$5
o Decrease in consumer income
Qd1
o Consumers have less money, they spend less of
Qd2
everything
100
Quantity
o Change in90Price of Related
goods
o Some goods are related to other goods in that
consumption of one affects the consumption of the
other good
o Substitutes:
 goods that are not consumed jointly
 such as Coke and Pepsi
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Fall 2007
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ECO 2013
Chapter 3: Demand, Supply, & Market Equilibrium
 goods that are related in such a way than an
decrease in the price of one increases the
demand for the other
 therefore an decrease in the price of
Pepsi will reduce the demand for Coke
o Complements
 Goods that are related in such a way that an
increase in the price of one will decrease the
demand for the other
 DVD player and DVDs
 Increase in price of DVD players will
decrease demand for DVDs
 Must be consumed jointly
o Changes in consumer tastes or preferences
o Consumer preferences: likes or dislikes in
consumption are assumed not to change along the
demand curve
o But if taste change so does demand
o Vinyl, Tape, CD, iPod
o Changes in Consumer Expectations
o As prices and income
o Affect how consumers spend their money and
their demand
o If we think that the product will be less expensive
tomorrow, we will buy tomorrow
o Changes in the number and composition of consumers
o The market demand curve is the sum of the
individual demand curves
o If the number of consumers rises then demand
rises
Created by Maria Mari
Fall 2007
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A change in quantity
demanded is NOT a
change in demand.
Change in quantity
ECO 2013
Chapter 3: Demand, Supply, & Market Equilibrium
Supply
 The producer’s side
 A relation between the price of a good and the quantity
that the producers are willing and able to offer for sale
during a given period other things constant.
 Law of Supply”
o The quantity of a good supplied during a given
period is usually directly related to the price of the
good.
o An increase in the price of the good causes an
increase in the quantity supplied.
o A decrease in price leads to decrease in quantity
supplied
o Creates an upward sloping supply curve
Price of
Good
$3
$4
$5
$6
$7
Quantity
Demanded
Price
 Movement along the supply
$7
curve
o Caused by a change in
$6
50
price and only in price
75
$5
o Causes a movement
100
$4 along the supply curve
o Called a Change in
150
$3 Quantity Supplied
o Suppose that the price
200
changes from $4 to $3
$0
then quantity supplied
100
150
goes from 75 to 50
 Determinants for the Supply Curve
o Change in technology
Created by Maria Mari
Fall 2007
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Supply
ECO 2013
Chapter 3: Demand, Supply, & Market Equilibrium
o
o
o
o
Change in the prices of relevant resources
Changes in the prices of alternative goods
Changes n producer expectations
Changes in the number of producers
 Changes in Supply
o Caused by changes in the determinants to the
supply curve
o Results in changes to the relationship between the
price and quantity supplied.
o At each and every price a DIFFERENT quantity is
supplied.
o Results in a new supply curve: a shift in the curve
Increase in Supply
 At each and every price MORE of the good is
supplied
P
Qs1
Qs2
$4
150
180
$5
100
200
$6
75
100
Price
Qs1
Qs2
$5
Created by Maria Mari
Fall 2007
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Quantity
100
200
ECO 2013
Chapter 3: Demand, Supply, & Market Equilibrium
What causes an increase in supply?
 Improvements in technology
o Increases in efficiency and productivity at each
and every price
 Changes in relevant resources
o Are those employed in the production of the good
in question
o Decrease in the price of resources
 Results in an increase in supply.
 Producers are willing to produce more at
lower price since their costs have fallen
 Changes in the prices of alternative goods
o Other goods that use some or all of the same
resources as the good in question
o Beef and leather
o If the price of beef increases, producers supply
more beef, results in more leather at lower prices
 Changes in producers expectations
o Expectation of increase in future prices of
resources may cause producers to offer more
today
 Changes in the number of producers
o As the number of producers change so does the
supply of the product
o A increase in the number of producers will lead to
an increase in supply
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Fall 2007
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ECO 2013
Chapter 3: Demand, Supply, & Market Equilibrium
Decrease in Supply
 At each and every price LESS of the good is
supplied
P
Qs1
Qs2
$4
180
150
$5
200
100
$6
100
80
Price
Qs2
Qs1
$5
Quantity
100
200
What causes a decrease in supply?
 Changes in relevant resources
o Are those employed in the production of the good
in question
o Increase in the price of resources
 Results in a decrease in supply.
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Fall 2007
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ECO 2013
Chapter 3: Demand, Supply, & Market Equilibrium
 Producers are willing to produce less at lower
price since their costs have risen
 Changes in the prices of alternative goods
o Other goods that use some or all of the same
resources as the good in question
o Beef and leather
o If the price of beef decreases, producers supply
less beef, results in less leather at all prices
 Changes in producers expectations
o Expectation of decrease in future prices of
resources may cause producers to offer less today
 Changes in the number of producers
o As the number of producers change so does the
supply of the product
o A decrease in the number of producers will lead to
an decrease in supply
A change in quantity
supplied is NOT a change
in supply.
Change in quantity
supplied is caused by a
change in PRICE
Change in supply is
caused by a change in
the DETERMINANTS
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Fall 2007
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ECO 2013
Chapter 3: Demand, Supply, & Market Equilibrium
Market Equilibrium
 Market
o Includes all the arrangements used to buy and
sell
o Reduces transaction costs
o The place where buyers and sellers meet to
determine price and quantity
 Equilibrium
o A specific price where the quantity demanded is
equal to the quantity supplied.
o QUANTITY DEMANDED = QUANTITY SUPPLIED
o Equilibrium Price = the market clearing price
o Equilibrium Quantity where Demand = Supply
 The intersection of the demand and supply
curves
Price
Supply
Equilibrium
 Reaching
Equilibrium
Price
o Competition among buyers and among sellers
drives the price to the equilibrium price
 $6
Once there, it remains unless it isEQUILIBRIU
M in
subsequently disturbed by changes
demand or supply
o When a product enters the market, it may be
Demand
placed at a price too high or too low for
equilibrium. If such, then the market moves
Quantity
toward equilibrium
150
o Price Above Equilibrium:
 If the market price is above equilibrium:
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Fall 2007
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ECO 2013
Chapter 3: Demand, Supply, & Market Equilibrium
 Market price > Equilibrium Price
 Quantity supplied > Quantity demanded
 The economy has a surplus
 To reduce the surplus, the producers lower
the price until they reach equilibrium.
Surplus
Qs > Qd
Price
Supply
o Price Below Equilibrium:
 $7
If the market price is below equilibrium
Price drops
 Market price < Equilibrium Price
from $7 to
$6 to
$6  Quantity supplied < Quantity demanded
 The economy has a shortage reduce the
surplus
 then quantity supplied will be less than
quantity demanded.
 To reduce the shortage and get the products
that they want, consumers will bid up the Demand
price until they reach equilibrium.
100
145
Price
170
Supply
The market will always move toward equilibrium if left alone.
 Rationing function of prices
 $6
Productive efficiency
Price rises from $4
to $6 to eliminate
 Allocative efficiency
the shortage
$4
Shortage
Qd > Qs
Demand
Shifts in Demand and Supply & Equilibrium
76
82
98
 Demand increases, what happens to equilibrium
o Equilibrium price and quantity increases
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Fall 2007
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ECO 2013
Chapter 3: Demand, Supply, & Market Equilibrium
Price
Supply
New Eq
$7
$6
 Demand
decreases, what happens to equilibrium
o Equilibrium price and quantity decreases
D2
Demand
Price
Supply
100 109
New Eq:
Price is $7
Supply$6 increases, what happens to
and Qequilibrium
=
109
o Equilibrium price decreases and quantity
$7

increases
D2
Price
100 109
D1
S1
S2

New Eq:
$5
Supply decreases, what happens Price
to isequilibrium
Quantity is
$5
o Equilibrium
price increases and 109.
quantity decreases
$6
Price
New Eq
Price = $6
Q100
= 100109
Demand
S2
 Simultaneous shifts in supply ad demand
Supply
o the change in equilibrium price and quantity
$6
depends
on which curve shifts the most
$5
o Supply increases, demand decreases
 Both decrease price
Demand
 Greater drop than one alone
100 109
 Quantity
 Supply increases quantity
 Demand decreases quantity
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Fall 2007
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ECO 2013
Chapter 3: Demand, Supply, & Market Equilibrium
 Depend on the relative size of each
change
o Supply decreases, demand increases
 Both increase price
 Greater increase than one alone
 Quantity
 Supply decreases quantity
 Demand increases quantity
 Depend on the relative size of each
change
o Supply increases, demand increases
 Price
 Demand increases price
 Supply decreases price
 If increase in supply is greater than the
increase in demand, the equilibrium
price will fall.
 Quantity will increase
 Supply increases quantity
 Demand increases quantity
 Increase by an amount greater than
each individually
o Supply decreases, demand decreases
 If the decrease in supply is greater than
the decrease in demand, equilibrium
price will rise
 Reverse is true
 Quantity
 Supply decreases quantity
 Demand decreases quantity
 Greater reduction
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Fall 2007
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ECO 2013
Chapter 3: Demand, Supply, & Market Equilibrium
Change in
Supply
Change in
Demand
Effect on
Equilibrium
Price
Effect on
Equilibrium
Quantity
Increase
Decrease
Decrease
Indeterminate
Decrease
Increase
Increase
Indeterminate
Increase
Increase
Indeterminate Increase
Decrease
Decrease
Indeterminate Decrease
Government Intervention in the Economy
 Government enters into the economy when market
failure occurs
 Two types of intervention
o Price setting
o Subsidies
 Government payments to reduce the cost of
production or to limit production
 Agricultural products
Price Setting
 Government sometimes concludes that supply and
demand will produce prices that are unfairly high for
buyers or unfairly low for sellers
 So government may place legal limits on how high or
low a price or prices may go.
 Price Floors
o A minimum legal price below which a good or
service cannot be sold.
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Fall 2007
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ECO 2013
Chapter 3: Demand, Supply, & Market Equilibrium
o
o
o
o
o
Fixed by government
A price below is not legal
A price above is legal
If above equilibrium causes surplus
Agricultural goods
Price
If market in equilibrium at $6
and 100 units. Then gov’t
sets price at $8, producers
supply 125 units and
consumer demands 75 units
there is a permanent surplus
in the market. Price cannot
drop
Supply
$8
Price Floor
$6
$5
Demand
75
100
125
Surplus of 50 units
 Price Ceiling
o A maximum legal price above which a good or
service cannot be sold
o A price at or below the ceiling is legal
o A price above the ceiling is not legal
o If above equilibrium causes shortage
o Rent control
Price
Supply
$8
$6
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Fall 2007
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Price Ceiling
$5
Demand
8 9 10
If market in
equilibrium at $6
and 9 units.
Then gov’t sets
price at $5,
producers supply
8 units and
consumer
demands 10
units there is a
permanent
shortage in the
market. Price