Supply, Demand, and
Equilibrium
Today: An Introduction to supply
and demand, and how they relate
to equilibrium
Today: Markets



Supply, demand, and equilibrium
What causes shifts in supply and
demand?
What happens when supply and/or
demand shifts?
Supply and Demand
Equilibrium


When you think of equilibrium, think
“stable”
Stability comes from nobody having an
incentive to change their decisions,
given the decisions of others
Market Equilibrium

Market equilibrium
is a situation in which,
at the current market
price, quantity
supplied equals
quantity demanded.
 When the market is in
equilibrium, there is
no tendency for the
price to increase or
decrease.
Equilibrium: 4 units
purchased, at a price of 6
Why is a price of 6 equilibrium?



To show that 6 is the equilibrium price,
we will show that prices above and
below are not in equilibrium
We will prove by contradiction that this
price could not be equilibrium
Suppose that a price (P) of 4 is
equilibrium
Shortage: excess quantity demanded

Excess Demand
(Shortage) : A
situation in which
consumers are willing
to buy more than
producers are willing to
sell. It occurs when
market price is lower
than equilibrium price.

An increase in the Price eliminates the shortage by
changing both quantity demanded and quantity supplied until
the original equilibrium is established
At P = 4: Quantity demanded
is 6, quantity supplied is 3.3
At P = 4: Quantity demanded
is 6, quantity supplied is 3.33


When P is 4, people are demanding a
quantity that is higher than what is
supplied
Is this an equilibrium?


No, this is not stable
Someone can increase their production
slightly, and sell at a price of 5 to make
more profits
Surplus: excess quantity supplied
 Excess
Supply
(Surplus): A
situation in which
producers are willing
to sell more than
consumers are willing
to buy. It occurs when
market price is above
equilibrium price.

A decrease in the Price eliminates excess supply by
changing both quantity demanded and quantity supplied until
the original equilibrium is established
Now suppose that P = 9 is an
equilibrium




Quantity supplied is 6
Quantity demanded is 1
This is not stable either
Someone not selling
their entire stock can
sell for P = 7 to make
more money
A change in supply versus a
movement along the supply curve


A change in supply is a shift of the entire
supply curve
A movement along the supply curve can occur
when the supply curve does not move


Movement occurs when there is a change in
price
Similar ideas apply for changes in demand
versus a movement along demand curves
What causes shifts in demand?
The main determinants of demand
include:
 The price of the product
 Consumer income
 The price of related goods—substitutes
and complements
 The number of consumer
 Consumer preferences—tastes and
advertising
 Consumer expectations about future
prices
What is happening here?


The demand curve
shifted to the right
There is a movement
along the supply
curve, since supply
does not change
What is happening here?


Note that at any
price, a higher
quantity is
demanded on curve
D2 than on D1
The new equilibrium
P and quantity (Q)
are higher when
demand shifts from
D1 to D2
What causes shifts in supply?
The main determinants of supply include:

The price of the product

The cost of inputs
Anything that changes the cost of
production



If the cost of production decreases, supply
shifts to the right
If the cost of production increases, supply
shifts to the left
What causes shifts in supply?

The state of production technology

A change in number of suppliers/ producers

Producer expectations about future prices

Taxes or subsidies from the government
What happens when both
supply and demand shift?

An example: Both supply and demand
shift right
Shift in supply…


…causes Q to increase and P to decrease
Movement from A to B
A
B
Shift in demand…


…causes Q to increase and P to increase
Movement from B to C
C
B
What can we conclusively say
about changes in Q and P?



Change in supply causes Q to increase
and P to decrease
Change in demand causes Q to increase
and P to increase
The only conclusion when both supply
and demand shift right is that Q
increases
Summary





The intersection of demand and supply
curves determines equilibrium
Equilibrium is stable
Change in S or D causes the curve to shift
A movement along the supply curve can
occur when the supply curve does not move
Both supply and demand can shift, but be
careful of your conclusions