Demand curve and supply curve Demand curve: demand curve for a good represents the relationship between price of the good and its quantity demanded in the market. It shows how the quantity demanded of the good changes for a change in its price when all factors other than the price of the good unchanged. Law of demand: The law of demand says that as the price of a good falls, its quantity demanded increases; as the price of a good rises, its quantity demanded increases. The demand curve for a good that follows the law of demand is “downward sloping”, as shown in Diagram 1. Diagram 1 price demand curve p1 p2 quantity q1 q2 In Diagram 1, the demand curve for a good is drawn. The price of the good is taken in the vertical axis; the quantity demanded is taken on the horizontal axis. The demand curve is downward sloping, that is, as price goes up, quantity demanded falls and as price goes down, quantity demanded rises. This is illustrated by two different prices p1 and p2. At price p1, from the demand curve we can see the quantity demanded is q1. When price falls to p2, the quantity demanded increases from q1 to q2. Supply curve: supply curve for a good represents the relationship between price of the good and its quantity supplied in the market. It shows how the quantity supplied of the good changes for a change in its price when all factors other than the price of the good is unchanged. Law of supply: The law of supply says that as the price of a good falls, its quantity supplied decreases; as the price of a good rises, its quantity supplied increases. The supply curve for a good that follows the law of supply is “upward sloping”, as shown in Diagram 2. Diagram 2 price supply curve p1 p2 quantity q2 q1 In Diagram 2, the supply curve for a good is drawn. The price of the good is taken in the vertical axis; the quantity supplied is taken on the horizontal axis. The supply curve is upward sloping, that is, as price goes up, quantity supplied rises and as price goes down, quantity supplied falls. This is illustrated by two different prices p1 and p2. At price p1, from the supply curve we can see the quantity supplied is q1. When price falls to p2, the quantity demanded decreases from q1 to q2. Equilibrium price Equilibrium price is defined as price at which market clears, that is, quantity demanded equals quantity supplied. Equilibrium price corresponds to the point where demand and supply curves meet, as shown in Diagram 3. Diagram 3 price supply curve E pE qE demand curve quantity Observe from Diagram 3 that the demand curve and the supply curve meet at the point E. The price corresponding to point E is pE. Therefore equilibrium price is pE. At price pE, quantity demanded = quantity supplied = qE. What happens at a price that is not an equilibrium price? By definition, at equilibrium price: quantity demanded equals quantity supplied. Therefore at a price which is not equilibrium, we know quantity demanded does not equal quantity supplied. Thus, at any such price, either (a) quantity demanded is more than quantity supplied, or (b) quantity demanded is less than quantity supplied. Whether (a) or (b) happens, depends on whether a price is above or below the equilibrium price, as shown in Diagram 4. Diagram 4 price supply curve p1 demand curve pE p2 q1(d) q2(s) qE q1(s) q2(d) quantity Consider the price p1, which is above the equilibrium price pE. At price p1, quantity demanded is q1(d) and quantity supplied is q1(s). We can observe from Diagram 4 that q1(s) is more than q1(d). Thus, at price p1, quantity supplied is more than quantity demanded. So at price p1, there is “excess supply”. Consider the price p2, which is below the equilibrium price pE. At price p2, quantity demanded is q2(d) and quantity supplied is q2(s). We can observe from Diagram 4 that q2(d) is more than q2(s). Thus, at price p2, quantity demanded is more than quantity supplied. So at price p2, there is “excess demand”. In general: (a) at any price which is above equilibrium price, there is excess supply and (b) at any price which is below equilibrium price, there is excess demand. Linear demand curve, linear supply curve A linear demand curve is a demand curve that is a straight line. If the demand curve for a good is linear and it follows the law of demand, then the demand curve is a downward sloping straight line, as shown in Diagram 5. Diagram 5 price linear demand curve p1 p2 quantity q1 q2 In Diagram 5, the demand curve for a good is drawn. It is a linear demand curve. The demand curve is a downward sloping straight line, that is, as price goes up, quantity demanded falls and as price goes down, quantity demanded rises. This is illustrated by two different prices p1 and p2. At price p1, from the demand curve we can see the quantity demanded is q1. When price falls to p2, the quantity demanded increases from q1 to q2. A linear supply curve is a supply curve that is a straight line. If the supply curve for a good is linear and it follows the law of supply, then the supply curve is an upward sloping straight line, as shown in Diagram 6. Diagram 6 price linear supply curve p1 p2 quantity q2 q1 In Diagram 6, the supply curve for a good is drawn. It is a linear supply curve. The supply curve is an upward sloping straight line, that is, as price goes up, quantity supplied rises and as price goes down, quantity supplied falls. This is illustrated by two different prices p1 and p2. At price p1, from the supply curve we can see the quantity supplied is q1. When price falls to p2, the quantity supplied decreases from q1 to q2. Equilibrium price Recall that equilibrium price is defined as price at which market clears, that is, quantity demanded equals quantity supplied. Equilibrium price corresponds to the point where demand and supply curves meet, as shown in Diagram 7 (both demand and supply curves are linear). Diagram 7 price supply curve E pE demand curve qE quantity Observe from Diagram 7 that the demand curve and the supply curve meet at the point E. The price corresponding to point E is pE. Therefore equilibrium price is pE. At price pE, quantity demanded = quantity supplied = qE. Equation of a linear demand curve The general equation of a downward sloping linear demand curve is given by q = A – Bp where q is quantity demanded, p is price and A,B are positive numbers. Note that in the equation above, p is being multiplied by a negative number (– B). Because of this, a larger value of p gives a smaller value of A – Bp. Thus, as price (p) goes up, quantity demanded (q = A – Bp) falls. Similarly, as price goes down, quantity demanded rises. Equation of a linear supply curve The general equation of an upward sloping linear supply curve is given by q = C + Dp where q is quantity supplied, p is price and C,D are positive numbers. Note that in the equation above, p is being multiplied by a positive D. Because of this, a larger value of p gives a larger value of C + Dp. Thus, as price (p) goes up, quantity supplied (q = C + Dp) rises. Similarly, as price goes down, quantity supplied falls. Determining equilibrium price when both demand and supply curves are linear When demand and supply curves are both linear, if we know their equations, we can determine numerical value of equilibrium price. As an example, suppose demand curve is given by the equation q = 80 – 3p and supply curve is given by the equation q = 20 + p. Equilibrium price is defined as price at which quantity demanded = quantity supplied. Since quantity demanded at price p (given by the demand curve) is q = 80 – 3p and quantity supplied at price p (given by the supply curve) is q = 20 + p, at equilibrium price we have 80 – 3p = 20 + p which implies 80 – 20 = 3p + p, so that 60 = 4p or 4p = 60. So we have p = 60/4 = 15. For this example, equilibrium price is pE = 15. Taking p = 15 in either demand or supply curve gives us q = 35 (from demand curve: q = 80 – 3p = 80 – 3*15 = 80 – 45 = 35; from supply curve: q = 20 + p = 20 + 15 = 35). Therefore qE (equilibrium quantity) is 35. What happens at a price that is not an equilibrium price? By definition, at equilibrium price: quantity demanded equals quantity supplied. Therefore at a price which is not equilibrium, we know quantity demanded does not equal quantity supplied. Thus, at any such price, either (a) quantity demanded is more than quantity supplied, or (b) quantity demanded is less than quantity supplied. Whether (a) or (b) happens, depends on whether a price is above or below the equilibrium price, as shown in Diagram 8 (where both demand and supply curves are linear). Diagram 8 price supply curve p1 pE p2 demand curve q1(d) q2(s) qE q2(d) q1(s) quantity Consider the price p1, which is above the equilibrium price pE. At price p1, quantity demanded is q1(d) and quantity supplied is q1(s). We can observe from Diagram 8 that q1(s) is more than q1(d). Thus, at price p1, quantity supplied is more than quantity demanded. So at price p1, there is “excess supply”. Consider the price p2, which is below the equilibrium price pE. At price p2, quantity demanded is q2(d) and quantity supplied is q2(s). We can observe from Diagram 8 that q2(d) is more than q2(s). Thus, at price p2, quantity demanded is more than quantity supplied. So at price p2, there is “excess demand”. When demand and supply curves are both linear, we can determine the magnitude of excess demand or excess supply at any price. This is illustrated in the following example. Example Consider again the example with linear demand and supply curves given before where the demand curve is given by the equation q = 80 – 3p and supply curve is given by the equation q = 20 + p. We have already determined the equilibrium price: pE = 15. Consider the price p = 18 (this price is above the equilibrium price 15). At this price, the quantity demanded is given by q = 80 – 3p = 80 – 3*18 = 80 – 54 = 26. At this price, the quantity supplied is given by q = 20 + p = 20 + 18 = 38. Thus, at price p = 18, quantity supplied is more than quantity demanded. So there is excess supply and the magnitude of excess supply is 38 – 26 = 12. Consider the price p = 9 (this price is below the equilibrium price 15). At this price, the quantity demanded is given by q = 80 – 3p = 80 – 3*9 = 80 – 27 = 53. At this price, the quantity supplied is given by q = 20 + p = 20 + 9 = 29. Thus, at price p = 9, quantity demanded is more than quantity supplied. So there is excess demand and the magnitude of excess demand is 53 – 29 = 24.
