Chapter 2. Supply and Demand
Supply
Supply
• Factors determining supply
– Price of the good
– Costs of production (Technology advance)
– Government rules and regulations
Supply curve
Effects of other variables on supply
Hot Topic: Supply Curve in the News
$50.00
$45.00
$40.00
$35.00
Switchgrass $30.00
farmgate
$25.00
price
($/ton)
$20.00
$15.00
$10.00
$5.00
$0.00
0.00
10.00
20.00
30.00
Switchgrass Supply (million tons/yr)
*Also available at the State and county level
National supply curves* for Energy crops
(POLYSYS output), ORNL
Supply function
•
•
•
•
•
Q=S(p,ph)
Q=178+40p-60ph
At price of hogs fixed at $1.50 per kg
Q=88+40p
P=1/40Q-88/40 -> P=0.025Q-2.2
– Two points on x and y axis (p=0,Q=88), (Q=0,p=-88/40)
• Δp=$1 cause the quantity supplied to
increase ΔQ=40 million kg per year
Equilibrium
• Equilibrium (in general)
– The condition of a system in which competing influences are
balanced
• Genetic equilibrium (in biology)
– Theoretical state in which a population is not evolving
• Chemical equilibrium (in chemistry)
– The state in which the concentrations of the reactants and
products have no net change over time
• Social equilibrium (in sociology)
– A system in which there is a dynamic working balance among its
interdependent parts
Equilibrium in Economics
• Equilibrium
– A situation in which no one wants to change
his or her behavior
• Market equilibrium
– All traders are able to buy and sell as much
as they want and no deviation is needed
Market equilibrium
Using math to determine the
equilibrium
• Demand function
• Qd=286-20p
• Supply function
• Qs=88+40p
• We want to find p at which Qd=Qs=Q, the
equilibrium quantity
• 286-20p=88+40p
• 198=60p
• P=$3.30, Q=220
Shocking the equilibrium
Policies that cause demand to differ from supply
(Price Ceiling)
Economic Analysis about Price Ceiling
•
“The Welfare Costs of Rationing by Waiting”
by Deacon, Robert T and Sonstelie, Jon (1989, Economic Iquiry)
•
Abstract: With price controls and rationing by waiting, rational consumers
increase the quantity bought per purchase. This individually rational
response is socially wasteful and the cost of making it is a deadweight loss.
This cost plus the value of time spent in queues may exceed the total rent
transferred from suppliers to consumers by price controls, i.e., the value of
resources spent competing for the rent may exceed the rent itself. This point
is illustrated by an empirical application to gasoline price controls. Rent
seeking exhausts an estimated 116 percent of the rent transferred.
•
Interpretation: Every dollar consumers save for the price ceiling during
the oil shock in 1972, they lost $1.16 in waiting time and other factors.
How shapes of demand curves
matter
Sensitivity of quantity demanded to
price
• Importance of sensitivity of quantity
demanded to price
• Price elasticity of demand
– Percentage change in the quantity demanded
in response to a given percentage change in
the price

Percentage change in quantity demanded Q / Q

Percentage changein price
p / p

Q / Q Q p

p / p p Q
Price elasticity of demand

Q / Q Q p

p / p p Q
Q  a  bp

Q / Q
p
b
p / p
Q
Q  286  20 p, given p  3.3 and Q  220
b
p
3.30
 20 
 0.3
Q
220
• 1% increase in price of pork leads to 0.3% decrease in the quantity
demanded
– A price increase causes a less than proportionate fall in the
quantity of pork demanded
Quiz #2
1. Draw supply curve for the supply function for the processed pork,
Q=88+40p (or P=1/40Q-88/40), Find two points on x and y axis (when p=0,
Q=?; when Q=0, p=?) and connect the two points
2. What happens to the supply curve for the processed pork if hog price
increases?
•
Using a linear downward-sloping demand curve and a linear upward-sloping
supply curve for gasoline:
3. Illustrate the effect of reduction of supply of crude oil in the gasoline market
(Graph new supply curve, find new equilibrium point, and explain).
4. If the government issues price ceiling at the original price before the
reduction of supply of crude oil, illustrate the effect on the graph and
explain.
Quiz #2
1. Draw supply curve for the supply function for the processed pork,
Q=88+40p (or P=1/40Q-88/40), Find two points on x and y axis (when p=0,
Q=?; when Q=0, p=?) and connect the two points
Answer)
2. What happens to the supply curve for the processed pork if hog price
increases?
Answer)
•
Using a linear downward-sloping demand curve and a linear upward-sloping
supply curve for gasoline:
3. Illustrate the effect of reduction of supply of crude oil in the gasoline market
(Graph new supply curve, find new equilibrium point, and explain).
Answer: The supply curve for the gasoline shifts from S1 to S2. Without
governmental intervention, new equilibrium from e1 to e2 will be achieved
and equilibrium quantity will be down and the equilibrium price will be up to
p2.
4. If the government issues price ceiling at the original price before the
reduction of supply of crude oil, illustrate the effect on the graph and
explain.
Answer: Government prohibited gasoline price greater than pbar. So, at the
pbar, supply will be at Qs and demand will be at Qd. As a result, there
would be Qd-Qs, excess demand. With excess demand, the price goes up
normally because consumers are willing to pay more to get gasoline.
However, at the price is arbitrarily controlled at pbar. Gas station can’t sell
the gasoline more than pbar, causing the excess demand continues. We
call this shortage of gasoline, a persistent excess demand. At this
circumstance, suppliers would make decision who gets gasoline, eg.,
friends, old customers, and others do not.