Demand, Supply, and Market Equilibrium
Chapter 3 Outline
I. Markets are the source of unison for buyers, also known as “demanders,” and sellers, also known as “suppliers.”
A. Markets consist of numerous independently acting buyers and sellers of standardized products.
B. The prices at which products are sold are “discovered” through the decisions made between interacting buyers and sellers.
C. All markets involve demand, supply, price, and quantity.
II. Demand is a schedule (or curve) that illustrates the various amounts of a product that
consumers
are
willing and able to purchase at various prices in a given time. It basically shows the
quantities of a
product that may be purchased at various possible prices, other things equal.
A. Willing and able is stated because “willingness alone is not effective in the
market.”
(Pg. 45)
1. For instance, one may be willing to purchase a plasma television set; yet, this willingness is not enough. It must be
supported by the necessary amount of dollars needed to make the purchase.
B. It is important that the quantities at each price in which a product is sold is related to a specific period (a day, a week, a month, a
year).
1. This is used to determine whether the demand for a product is large or small.
a. Distinguish between the following: “A consumer will buy 12 bushels of wheat at $6 per bushel” and “A
consumer will buy 12 bushels of wheat per week at $6 per bushel.” As one can see, without a specific time
period, the statement is meaningless.
C. Law of Demand:
1. “All else equal, as price falls, the quantity demanded rises, and as price rises, the quantity demanded falls.” (Pg. 46)
a. This shows that there is a negative, or inverse, relationship between price and quantity demanded.
b. Other things equal is very crucial here because there are many other factors, other than the price of the
product, that can affect the amount purchased.
i. For instance, the quantity of Nikes purchased will depend on, not only the price of Nikes, but also
the price of other name brand sneakers (also known as substitutes) such as: Reeboks, Adidas,
New Balances etc. If the price of Nikes rises,
while the prices of the other sneakers remain
constant, the demand for Nikes will decrease
and less Nikes will be purchased. However, if
the prices of all the sneakers (including Nikes) increases, there is a possibility that consumers
may purchase more, less, or the same amount of Nikes (now depending on other factors such as
preference).
D. There are three explanations as to why there is an inverse relationship between price and quantity demanded.
1. People buy more of a product at a low price than at a high price. “Price is an obstacle that deters consumers from
buying.” (Pg. 46)
a. Simply stated: the higher the price, the less amount of product will be bought; the lower the price, the more
amount of product will be bought.
2. During specific times, the buyer of a product will obtain less satisfaction (whether in benefit or utility) from a certain
product being consumed.
a. For instance, when someone purchases a Whopper from Burger King for the first time, they love its taste
and will continue to purchase it. But after purchasing it a
second, third, or fourth time, the satisfaction just isn’t like that
first bite into that juicy Whopper.
b. This is known as diminishing marginal utility, where
eventually, consumers will only continue to purchase the product if it is at a lower price.
3. The law of demand can also be approached by using the income and substitution effects.
a. The income effect shows that lower prices increase the “purchasing power” of a buyer’s money income.
This allows the buyer to purchase more of a certain product than they did before.
b. The substitution effect shows that at a lower price, buyers now have the option to “substitute” what is now
a less expensive product for similar products (if the products they used to purchase before are now more
expensive).
E. The demand curve inversely illustrates the relationship between price and quantity demanded for any product.
1. Quantity is measured on the x-axis (horizontal), while price is measured on the y-axis (vertical).
2. “Its downward slope reflects the law of demand – people buy more of a product, service, or resource as its price
falls.” (Pg. 46)
3. The downward slope also indicated that the relationship between price and quantity demanded is inverse (or
negative).
F. Within a market demand, it is assumed that every buyer is willing and able to buy the same amounts at each possible price.
1.
A market demand table is calculated by adding the “quantity demanded” by each buyer for given time period. (Table
3.1 – Pg. 47)
2. A market demand curve is illustrated by drawing each individual curve, per buyer, then drawing one final graph that
combines (adds) the other graphs together and form it into one. (Figure 3.2 – Pg. 47)
G. Changes in the determinants of demand alter the demand data and shift the demand curve.
1. An increase in demand shifts the demand curve to the right.
a. Consumers buy more of a product at each possible price.
D  = Shift to 
2. A decrease in demand shifts the demand curve to the left.
a. Consumers buy less of a product at each possible price.
D  = Shift to 
3. Various determinants affect demand.
a. Tastes:
i
Demand will increase if the product is favorable, shifting the curve to the right.
ii
Demand will decrease if the product is unfavorable, shifting the curve to the left.
iii
For instance, when digital cameras were introduced, consumers who were willing and able to
purchase one would prefer this camera over a
disposable film camera. Therefore, with the
new digital cameras, the demand for
disposable film cameras greatly decreased.
b. Number of buyers:
i
Demand will increase if there is an increase in the number of buyers.
ii
Demand will decrease if there is a decrease in the number of buyers.
c. Income:
i
A rise in income will cause an increase in demand.
ii
A decline in income will cause a decrease in demand.
iii
“Products whose demand varied directly with the money income are called superior goods, or
normal goods.” (Pg. 48)
iv
Consumers usually buy more of a product, whether it is food, furniture, or electronic
equipment, as their income rises.
v
Yet, there are some exceptions. As income increases, the purchasing of used clothing and
used automobiles are no longer demanded. Because of high incomes, the consumer is now
able to purchase new versions of products. This causes a decline in the demand for those
specific products.
d. Prices of related goods:
i
“A substitute good is one that can be used in place of another good.” (Pg. 49) –Ex. Colgate
vs. Crest
ii
“A compliment good is one that is used together with another good.” (Pg. 49) –Ex. Cell
Phones and Cellular Service
iii
Unrelated Goods, also known as independent goods, have little or no effect on the demand
for the other. –Ex. Apples and alarm clocks
e. Consumer Expectations:
i
“A newly formed expectation of higher future prices may cause consumers to buy now in
order to ‘beat’ the anticipated price rises, thus increasing current demand.” (Pg. 49) –Ex.
Real estate markets
H. Changes in Demand vs. Changes in QUANTITY Demanded:
1. Change in demand is when the demand curve shifts to the right (increase in demand) or to the left (decrease in
demand), while a change in quantity demanded is “a movement from one point to another point – from pricequantity combination to another – on a fixed demand curve.” (Pg. 50)
III. Supply is a schedule (or curve) that illustrates the various amounts of a product that
producers are
willing and able to make available for sale at various prices in a given time. It basically shows
the quantities
of a product that will be supplied at various possible prices, other things equal.
A. Law of Supply:
1. “As price rises, the quantity supplied rises; as price falls, the quantity supplied falls.” (Pg. 50)
a. Firms will produce and offer for sale more of their products at a high price than at a low price (for higher
profit).
b. To a supplier, price represents revenue. The higher the price that a product is sold for, the higher the
supplier’s revenue.
2. The supply curve directly illustrates the correspondence with the price-quantity supplied data.
a. This shows that there is a positive, or direct, relationship between price and quantity supplied.
B.
A market supply is derived the same way as market demand, where the quantities at each price supplied by producers are
summed. The curve is obtained by “horizontally adding” the supply curves of the individual producers. (Table 3.4 and Figure 3.4
– Pg. 51)
C. Changes in the determinants of supply alter the supply data and shift the supply curve. Note that cost is a major factor that
affects the supply curve.
1. Resource Prices:
a. Prices of the resources used in the production process help determine the costs of productions earned by
firms.
b. Higher resource prices raise production costs and minimize profits.
c. Lower resource prices reduce production costs and increase profits. –Ex. Decrease in the price of flat panel
glass will increase the supply of big-screen TVs.
2. Technology:
a. With new and improved technology (“techniques of production”), firms are able to produce with fewer
resources.
b. Using fewer resources lowers production costs and increases supply.
3. Taxes and Subsidies:
a. Taxes are treated as costs.
b. An increase in taxes will increase production costs, reducing supply.
c. When subsidies to the production are made, the producers’ costs are lowered and supplies are increased.
4. Prices of Other Goods:
a. The higher prices of these “other goods” allow producers to switch production to those other goods to
increase profits. “This substitution in production results in a decline in the supply of products.” (Pg. 52) –Ex.
Producing soccer balls vs. producing basketballs and volleyballs
5. Producer Expectations:
a. This may affect the producer’s willingness to supply a specific product.
6. Number of Sellers:
a. The greater the number of sellers, the greater the market supply.
b. “As more firms enter the industry, the supply curve shifts to the right,” while “the smaller number of firms in
the industry, the less the market supply.” (Pg. 52) In this case, the curve shifts to the left.
D. Changes in Supply vs. Changes in QUANTITY Supplied:
1. Change in supply is when the supply curve shifts to the right (increase in supply) or to the left (decrease in supply),
while a change in quantity supplied is “a movement from one point to another point on a fixed supply curve.” (Pg.
53)
IV. Market equilibrium:
A. Equilibrium price refers to the point where a price set by buyers and sellers are equal.
1. “It is the price where quantity demanded equals quantity supplied.” (Pg. 53)
B. Equilibrium quantity refers to the quantity demanded and quantity supplied at the equilibrium price.
C. When graphing, this point is indicated where the supply curve and the demand curve intersect.
D. Competition amongst buyers and sellers tends to alter the price to the equilibrium price. Once there, it remains that way unless
they are “disturbed” by changes in demand or supply (shift of curves).
1. Anything above equilibrium price results in a surplus, or excess supply.
a. Surpluses drive prices down. Must get rid of products. –Ex. Clearance sales
2. Anything below equilibrium price results in a shortage, or excess demand.
a. Consumers desire more than are available. –Ex. Gasoline
E.
F.
Productive Efficiency vs. Allocative Efficiency:
1. Productive efficiency refers to producing something in the least costly way.
2. Allocative efficiency refers to producing a combination of goods and services most highly valued by society
(minimum-cost production assumed).
Demand reflects the marginal benefit (MB) of the good, while supply reflects the marginal cost (MC) of producing the good.
1.
2.
Markets make sure that firms produce units where MB exceeds MC and no units where MC exceeds MB.
At equilibrium, where the supply curve intersects with the demand curve, MB =MC.
G. Changes in Supply, Demand, and Equilibrium:
REFER TO: Table 3.7 - Pg. 57 [same as below]; Figure 3.7[graphical] – Pg. 57
Change in Supply
1. Increase
2. Decrease
3. Increase
4. Decrease
Change in Demand
Decrease
Increase
Increase
Decrease
Effect on Equilibrium
Price
Decrease
Increase
Indeterminate
Indeterminate
Effect on Equilibrium
Quantity
Indeterminate
Indeterminate
Increase
Decrease
H. Government Set Prices:
1. Price ceilings: the maximum legal price a seller may charge for a product or service. –Ex. Gasoline
2. Price floors: the minimum legal price set by the government
– Ex. Minimum wage
3. Black Market: when products are bought illegally for personal profit.