Econ 200 Chapter 8: The Supply and Demand Model
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The supply and demand model is what economists use to explain how prices are
determined in a market.
The supply and demand model consist of three elements:
o Demand: Describing the behavior of consumers in the market
o Supply: Describing the behavior of firms in the market
o Market Equilibrium: Connecting the supply and demand and describing how
consumers and firms interact in the market.
8.1 Demand
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Demand: A relationship between price and quantity demanded.
o The price of a particular good and the quantity of that good that consumers are
willing to buy at that price during a specific time period.
Price: The amount of money or other good that one must pay to obtain a particular good
Quantity Demanded: The quantity of a good that people want to buy at a given price
during a specific time period.
Ceteris Paribus is appended to the definition of demand because the quantity that
consumers are willing to buy depends on many other things besides the price of the good.
Demand Schedule: A tabular presentation of demand showing the price of quantity
demanded for a particular good, all else being equal.
Law of Demand: The tendency for the quantity demanded of a good in a market decline
as its price rises.
o Price and quantity are negatively related.
The Demand Curve
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Demand Curve: A graph of demand showing the downward-sloping relationship between
price and quantity demanded.
The demand curve has a downward slope because they hold constant the price of other
goods
Shifts in Demand
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Price is not the only thing that affects the quantity of a good that people buy.
An increase in demand shifts the demand curve to the right, quantity demanded with
increase
A decrease in demand shifts the demand curve to the left, quantity demanded will
decrease
The demand curve shows how the quantity of a good is related to the price of the good,
all other things being equal.
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The shift can be attributed to one of the several sources
o Consumers’ preferences
 A change in people’s tastes or preferences for a product compared
with other products will change the amount of the product they
purchase at any given price
o Consumers’ information
 Ex: when there was an E.coli outbreak in spinach, demand for spinach
in grocery stores decreased.
o Consumers’ incomes
 If people’s income change, then their purchases of goods usually
change.
 Normal Goods: A good for which demand increases when income
rises and decreases when income falls.
 Ex: shoes, clothing
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Inferior goods: A good for which demand decreases when income rises
and increases when income falls.
 This happens because people can afford more attractive goods.
o Ex: instant ramen
o Number of consumers in the market
 Demand is a relationship between price and the quantity demanded by
all consumers in the market.
 If the number of consumers increase, then demand will increase and
vice versa.
o Consumers’ expectations of future prices
 Demand increases if people expect the future price of a good to rise.
 Demand decreases if people expect the future price of the good to fall.
o Price of related goods
 Substitute: A good that has many of the same characteristics as, and
can be used in place of, another good.
 Ex: Butter and margarine
 Demand for a good will increase if the price of a substitute for the
good rises, and the demand for a good will decrease if the price of a
substitute falls.
 Complement: A good that usually is consumed or used together with
another good.
 Gasoline and SUVs are complements
Movements Along vs. Shifts of the Demand Curve
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A movement along the demand curve occurs when the quantity demanded changes
because of a change in the price of the good.
o An increase in demand is a shift to the right of the demand curve.
o A decrease in a demand is a shift to the left of the demand curve
A shift of the demand curve, on the other hand, occurs when a change is caused by any
source except the price.
o The term demand refers to the entire curve or schedule relating price and quantity
demanded
o The term quantity demanded refers to a single point of the demand curve
o A shift in demand is called change in demand.
8.2 Supply
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Supply: A relationship between price and quantity supplied.
o Two variables: The price of a particular good and the quantity of the good that
firms are willing to sell at that price
 2nd variable is called quantity supplied: the quantity of a good that firms
are willing to sell at a given price.
Supply Schedule: A tabular presentation of supply showing the price and quantity
supplied of a particular good, all else being equal.
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Law of Supply: The tendency for the quantity supplied of a good in a market to increase
as its price rises.
o The price and quantity supplied are positively related, all other things being equal.
The Supply Curve
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Supply curve: A graph of supply showing the upward-sloping relationship between price
and quantity supplied.
o The supply curve shows that the price and the quantity supplied by firm are
positively related.
o Firms are more willing to sell more of that good if the price has increased.
Shifts in Supply
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Shifts in the supply curve may shift if the price and the quantity supplied is changed.
(Other than the goods price)
o If something decreased, the supply curve would shift to the left. If something
increases, the supply curve would shift to the right.
o Ex: Technology, weather conditions, the price of inputs used in production, etc.
Technology
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Anything that changes the amount a firm can produce with a given amount of inputs to
production can be considered a change in technology.
o This improvement in technology would correspond to an increase in supply, a
shift in the supply curve to the right.
Weather Conditions
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Weather conditions like droughts, hurricanes and earthquakes may have an affect on
certain goods produced.
The Price of Inputs Used in Production
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If the price of inputs to production- raw materials, labor, and capital-increase, then it
becomes more costly to produce goods, and firms will produce less at any given price.
o In this case, supply curve will shift to the left
The Number of Firms in the Market
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If the number of firms increases, then more goods will be produced at each price: supply
increases, and the supply curve shifts to the right.
Expectations of Future Prices
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If firms expect the price of the good they produce to rise in the future, then they will hold
off selling at least part of their production until the price rises
Expectations of future price increases tend to reduce supply and vice versa.
Government Taxes, Subsidies, and Regulations
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Government has the ability to affect the supply of particular goods produced by firms.
o The supply curve shifts to the left when a tax on what firms sell in the market
increases.
The government also makes payments-subsidies- to firms to encourage those firms to
produce certain goods.
o An increase subsidies reduces firms’ costs and increases the supply.
o Ex: If the government provided subsidies for corn production to encourage the use
of ethanol, this would increase corn production
o Ex: On the other hand, when the U.S. government imposes a tax on cigarettes, the
supply of cigarettes will decrease.
Governments also regulate firms
o Regulations can change the firms’ costs of production or their ability to produce
goods and thereby affect supply.
Movements Along vs. Shifts of the Supply Curve
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A movement along the supply curve occurs when the quantity supplied changes as a
result of a change in the price of the good.
A shift of the supply curve occurs when a change in something (other than the price)
affects the amount of a good that firms are willingly to supply.
8.3 Market Equilibrium: Combining Supply and Demand
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