Chapter 2
Demand and Supply
Outline
▪ Describe the nature of demand and analyze the factors
that affect it
▪ Summarize the nature of supply and analyze the factors
that affect it
▪ Explain how markets reach equilibrium – the point at
which demand and supply meet
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Teach a parrot to say demand and supply, and
you’ve created an economist.
- Old Joke
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What Is Demand?
Demand is the relationship between price and quantity
demanded
o It is shown by a schedule or curve.
o Price and quantity demanded are inversely related.
o Market demand is the sum of quantities demanded by all
consumers in a market.
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The Individual Demand Curve
The demand curve D depicts the inverse relationship between price
and quantity demanded.
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Deriving Market Demand
The market demand
curve Dm is found by
horizontally summing all
the demand curves in
the market.
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Changes in Demand
Changes in demand:
▪ are shown by shifts in the demand curve
▪ are caused by changes in demand factors
A change in the number of buyers in a market shifts the demand curve D in the
same direction.
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Demand Factors
Demand factors include the following:
▪ The number of buyers
o More buyers shifts D to the right.
▪ Income
o For normal products, higher income shifts D to the right.
o For inferior products, higher income shifts D to the left.
▪ Prices of other products
o For substitute products, a higher price for the other product shifts D to the
right.
o For complementary products, a higher price for the other product shifts D
to the left.
▪ Consumer preferences
o Changes may shift D right or left.
▪ Consumer expectations
o Expected higher future prices shift D to the right.
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Changes in Quantity Demanded
Changes in quantity demanded:
o are shown by movements along the demand curve
o are caused by price changes
A change in quantity demanded is shown by the movement from points a to b in the left
graph while a change in demand is shown by the shift from D0 to D1 in the right graph.
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What Is Supply?
Supply is the relationship between price and quantity
supplied
o It is shown by a schedule or curve.
o Price and quantity supplied are directly related.
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The Supply Curve
A supply curve S depicts the direct relationship between price and
quantity supplied.
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Changes in Supply
Changes in supply:
o are shown by shifts in the supply curve
o are caused by changes in supply factors
A change in the number of producers in a market shifts the supply curve S in the
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same direction.
Supply Factors
Supply factors include the following:
▪ Number of producers
o More producers shifts S to the right.
▪ Resource prices
o Higher resource prices shift S to the left.
▪ State of technology
o A technological improvement shifts S to the right.
▪ Prices of related products
o Changes in their prices may shift S right or left.
▪ Changes in nature
o Changes in nature may shift S right or left.
▪ Producer expectations
o Expected higher future prices shift S to the left
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Changes in Quantity Supplied
Changes in quantity supplied:
o are shown by movements along the supply curve
o are caused by price changes
A change in the quantity supplied is shown by the movement from points a to b in the left
graph while a change in supply is shown by the shift from S0 to S1 in the right graph.
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Market Equilibrium
▪ When a product is in surplus:
→ there is excess supply
→ P is pushed down
▪ When a product is in shortage:
→ there is excess demand
→ P is pushed up
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Reaching Market Equilibrium
Regardless of where price starts, it is pushed towards the equilibrium point e.
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Effect of a Demand Increase
When D increases and S stays the same, equilibrium P and Q both rise.
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Effect of a Supply Increase
When S increases and D stays the same, equilibrium P falls and equilibrium Q rises.
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Effect of an Increase in Demand and Supply
When D and S both increase, Q rises and the effect on P depends on the sizes
of the two shifts. P rises with a bigger shift in D and falls with a bigger shift in S.
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Effect of a Demand Increase and Supply
Decrease
When D increases and S decreases, P rises and the effect on Q depends on the sizes
of the two shifts. Q rises with a bigger shift in D and falls with a bigger shift in S.
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Spoilt for Choice
William Stanley Jevons:
o assumed measurable utility
o outlined the law of
diminishing marginal utility
o showed how this law can be
illustrated using the
downward-sloping marginal
utility graph
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Total and Marginal Utility
As consumption of an item rises, the consumer’s marginal utility falls while total
utility rises by smaller increments.
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The Utility-Maximizing Rule
Jevons devised the utility-maximizing rule:
o This rule states a consumer should reach the same marginal utility
per dollar for all products consumed.
o It can be shown in mathematical terms:
MU1
MU2
=
P1
P2
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Applying the Rule
To make marginal utility per dollar (MU ÷ P) the same for both items, this
consumer maximizes utility by consuming two cups of cappuccino and one pastry.
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