Chapter 3
Demand, Supply, and Market
Equilibrium
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Markets
• Interaction between buyers and sellers
• Markets may be
• Local
• National
• International
• Price is discovered in the interactions of
buyers and sellers
LO1
3-2
Demand
• Demand
• Demand schedule or demand curve
• Amount consumers are willing and able to
purchase at a given price
• Other things equal
• Individual demand
• Market demand
LO2
3-3
Law of Demand
• Law of demand
• Other things equal, as price falls, the
quantity demanded rises, and as price rises,
the quantity demanded falls
• Explanations
• Price acts as an obstacle to buyers
• Law of diminishing marginal utility
• Income effect and substitution effect
LO2
3-4
The Demand Curve
P
6
P
$5
Qd
10
4
20
3
35
2
55
1
80
Price (per bushel)
5
4
3
2
D
1
0
10
20
30
40
50
60
70
80
Q
Quantity demanded (bushels per week)
LO2
3-5
Market Demand
Market Demand for Corn, Three Buyers
Quantity Demanded
Total
Qd
per week
Price
per bushel
Joe
Jen
Jay
$5
10
12
8
30
4
20
23
17
60
3
35
39
26
100
2
55
60
39
154
1
80
87
54
221
LO2
3-6
Changes in Demand
P
6
P
Qd
$5
2000
4
4000
3
7000
2
1
11,000
Price (per bushel)
5
Increase
in demand
4
3
2
1
16,000
D2
Decrease
in demand
D1
D3
0
2
4
6
8
10
12
14
16
18
Q
Quantity demanded (thousands of bushels per week)
LO2
3-7
Changes in Demand
P
6
Change in demand
Price (per bushel)
5
Change in quantity
demanded
4
3
2
D2
1
0
D1
D3
2
4
6
8
10
12
14
16
18 Q
Quantity demanded (thousands of bushels per week)
LO2
3-8
Determinants of Demand
•
•
•
•
LO2
Determinants of demand
Change in consumer tastes and preferences
Change in the number of buyers
Change in income
• Normal goods
• Inferior goods
3-9
Determinants of Demand
• Change in prices of related goods
• Complementary good
• Substitute good
• Change in consumer expectations
• Future prices
• Future income
LO2
3-10
Determinants of Demand
Determinants of Demand: Factors That Shift the Demand Curve
Determinant
Examples
Change in buyers’ tastes
Physical fitness rises in popularity, increasing the demand
for jogging shoes and bicycles; cell phone popularity rises,
reducing the demand for land-line phones.
Change in the number of buyers
A decline in the birthrate reduces the demand for
children’s toys.
Change in income
A rise in incomes increases the demand for normal goods
such as restaurant meals, sports tickets, and necklaces
while reducing the demand for inferior goods such as
cabbage, turnips, and inexpensive wine.
Change in the prices of related goods
A reduction in airfares reduces the demand for bus
transportation (substitute goods); a decline in the price of
DVD players increases the demand for DVD movies
(complementary goods).
Change in consumer expectations
Inclement weather in South America creates an
expectation of higher future coffee bean prices, thereby
increasing today’s demand for coffee beans.
3-11
Supply
• Supply
• Supply schedule or a supply curve
• Amount producers are willing and able to sell
at a given price
• Individual supply
• Market supply
LO3
3-12
Law of Supply
• Law of supply
• Other things equal, as the price rises, the
quantity supplied rises and as the price falls,
the quantity supplied falls
• Explanation
• Price acts as an incentive to producers
• At some point, costs will rise
LO3
3-13
The Supply Curve
P
S1
5
Qs
$5
60
4
50
3
35
Price (per bushel)
P
4
3
2
1
2
1
20
5
0
10
20
30
40
50
60
70
Q
Quantity supplied (bushels per week)
LO3
3-14
Changes in Supply
P
$6
5
Qs
$5
12,000
4
10,000
3
7000
2
4000
1
1000
4
Price (per bushel)
P
S3
S1
Decrease
in supply
S2
3
2
Increase
in supply
1
0
2
4
6
8
10
12
14
16
Q
Quantity supplied (thousands of bushels per week)
LO3
3-15
Changes in Supply
P
Change in quantity
S3
supplied
$6
S1
5
S2
Price (per bushel)
4
3
2
Change in supply
1
0
2
4
6
8
10
12
14
16
Q
Quantity supplied (thousands of bushels per week)
LO3
3-16
Determinants of Supply
•
•
•
•
•
•
•
LO3
Determinants of supply
A change in resource prices
A change in technology
A change in the number of sellers
A change in taxes and subsidies
A change in prices of other goods
A change in producer expectations
3-17
Determinants of Supply
Determinants of Supply: Factors That Shift the Supply Curve
Determinant
Examples
Change in resource prices
A decrease in the price of microchips increases the supply of
computers; an increase in the price of crude oil reduces the
supply of gasoline.
Change in technology
The development of more effective wireless technology increases
the supply of cell phones.
Change in taxes and subsidies
An increase in the excise tax on cigarettes reduces the supply of
cigarettes; a decline in subsidies to state universities reduces the
supply of higher education.
Change in prices of other goods
An increase in the price of cucumbers decreases the supply of
watermelons.
Change in producer expectations
An expectation of a substantial rise in future log prices decreases
the supply of logs today.
Change in the number of suppliers
An increase in the number of tattoo parlors increases the supply
of tattoos; the formation of women’s professional basketball
leagues increases the supply of women’s professional basketball
games.
3-18
Market Equilibrium
• Equilibrium occurs where the demand curve
and supply curve intersect
• Equilibrium price and equilibrium quantity
• Surplus and shortage
• Rationing function of prices
• Efficient allocation
LO4
3-19
Efficient Allocation
• Productive efficiency
• Producing goods in the least costly way
• Using the best technology
• Using the right mix of resources
• Allocative efficiency
• Producing the right mix of goods
• The combination of goods most highly
valued by society
LO4
3-20
Market Equilibrium
6
5
Qd
$5
2000
4
4000
3
7000
2
11,000
1
16,000
Price (per bushel)
P
6,000 bushel
surplus
S
4
3
2
7,000 bushel
shortage
1
0
2
4
67
8
10
D
12
14
16
P
Qs
$5
12,000
4
10,000
3
7000
2
4000
1
1000
18
Bushels of corn (thousands per week)
LO4
3-21
Rationing Function of Prices
• The ability of the competitive forces of
demand and supply to establish a price at
which selling and buying decisions are
consistent
LO4
3-22
Changes in Demand and
Equilibrium
D increase:
P, Q
D decrease:
P, Q
P
P
S
S
D2
D3
D1
0
0
Increase in demand
LO5
D4
Decrease in demand
3-23
Changes in Supply and Equilibrium
S increase:
P, Q
S decrease:
P, Q
P
P
S1
S4
S2
D
D
0
0
Increase in supply
LO5
S3
Decrease in supply
3-24
Complex Cases
Effects of Changes in Both Supply and Demand
Change in Supply
Change in Demand
Effect on Equilibrium
Price
Effect on Equilibrium
Quantity
1. Increase
Decrease
Decrease
Indeterminate
2. Decrease
Increase
Increase
Indeterminate
3. Increase
Increase
Indeterminate
Increase
4. Decrease
Decrease
Indeterminate
Decrease
LO5
3-25
Government Set Prices
• Price ceiling
• Set below equilibrium price
• Rationing problem
• Black markets
• Example is rent control
LO6
3-26
Government Set Prices
S
P
$3.50 P0
Ceiling
3.00 PC
D
Shortage
Qs
LO6
Q0
Qd
Q
3-27
Government Set Prices
• Price floor
• Prices are set above the market price
• Chronic surpluses
• Example is the minimum wage law
LO6
3-28
Government Set Prices
P
S
Surplus
Floor
$3.00 Pf
2.00 P0
D
Q
LO6
Qd
Q0
Qs
3-29
Legal Market for Human Organs
• What if we created a legal market for human
organs?
• Positive effects
• Increase the incentive to donate
• Eliminate the persistent shortage of eyes,
livers, hearts, kidneys, etc.
3-30
Legal Market for Human Organs
• Negative effects
• Diminishes the special nature of life by
commercializing it
• The market would leave out the poor and
uninsured
• Increases the cost of medical care
• Prohibition on market solution has resulted in
a $1 billion illegal market
3-31