Markets: Supply and Demand
Markets
• Market : A group of buyers and sellers of a
certain good or service
• Competitive Market : Many buyers and many
sellers so each has small if any impact on the
price
• Role of Price: information -“price signal”
• Perfectly Competitive Market: many buyers
and sellers – none have any influence over the
market price
• Everybody is a price taker
• Monopoly : only one seller, so sets the price
• Monopsony : only one buyer, so sets the price
• Other markets: somewhere between these
extremes
Demand
• Quantity demanded
– Amount of a good buyers are willing and
able to purchase at a certain price
• Law of demand
– Other things equal (ceteris paribus) when
the price of the good rises the quantity
demanded of a good falls
• Demand Schedule/Curve : one a table, the
other a graph
– Both represent the relationship between price and
quantity demanded
• Individual Demand : Demand of a single
individual
• We will focus on linear demand curves:
– A simplifying assumption
Sara’s Demand Schedule and Demand Curve
Price
Price of Coffee
Quantity Demanded
(cups)
$0.00
6
$0.50
5
$1.00
4
$1.50
3
$2.00
2
$2.50
1
$3.00
0
$3.00
$2.00
$1.00
1
2
3
4
5
Quantity
Note: we say price affects quantity – Q=f(P) but price is on “y” axis – comes from
historical perspective and fish markets – Marshal?
6
• Market Demand : Sum of all individuals’
demand in that market
• Market Demand Curve : Sum up individual
demand curves horizontally
Market Demand Schedule
Price of Coffee
Sara
David
Market
$0.00
6
12
18
$0.50
5
10
15
$1.00
4
8
12
$1.50
3
6
9
$2.00
2
4
6
$2.50
1
2
3
$3.00
0
0
0
Market Demand Curve Creation
Price
Sara’s
Demand
Price
$3.00
David’s
Demand
$3.00
Price
$3.00
$2.00
$2.00
$2.00
$1.00
$1.00
$1.00
4
6
Market
Demand
8
12
12
18
More on Demand Curves
• Shifts in Demand
– Increased Demand
• Anything that increases the quantity demanded at all
prices
• Curve shifts to the right
– Decreased Demand
• Anything that decreases the quantity demanded at all
prices
• Curve shifts to the left
• Note: Difference between change in quantity
demanded and shift in demand
P
Change in Demand vs Change in Quantity
Demanded
Increased
Demand
Change in
Demand
Change in quantity
demanded
Decreased
Demand
Q
• What things shift demand (change demand)
– Income
– Price of related goods
– Tastes
– Expectations
– Number of buyers
On Effect of Income
• Normal Good:
– When income goes up demand goes up
– When income goes down demand goes down
• Inferior Good:
– When income goes up demand goes down
– When income goes down demand goes up
On Effect of Related Goods
• Substitutes (need 2 goods):
– An increase in the price of one leads to an
increase in demand for the other
– A decrease in the price of one leads to an
decrease in demand for the other
• Compliments (need 2 goods):
– An increase in the price of one leads to an
decrease in demand for the other
– A decrease in the price of one leads to an
increase in demand for the other
• Tastes: Like it more, increase demand
• Expectations: What you think might happen in
the future (income, price changes) can affect
current demand
• Number of buyers: more buyers, increase
demand
Remember The Difference
• Change in price – Change in quantity
demanded (movement along demand curve)
• Change in all others (income, tastes, price of
other goods, etc.) – Change in demand (shift
in demand curve)
Example
Reducing Soda Consumption
• Tax sugar – will increase the price
– Leads to a movement along the demand curve
• Education On Healthy Diet – will change tastes
– Lead to a shift in the demand curve
P
Shift in
demand due
to change in
tastes
P’’
Movement along
demand due to
change in price
Tax
P’
Q’’’
Q’’
Q’
Q
Supply
• Quantity Supplied:
– Amount of the good that suppliers are willing and
able to supply at a specific price
• Law of Supply:
– All other things being equal, if price goes up
quantity supplied will go up
• Supply Schedule/Curve : one a table, the other
a graph
– Both represent the relationship between price and
quantity supplied
• Individual Supply : Supply of a single
individual/firm (seller)
• We will focus on linear supply curves:
– A simplifying assumption
Starbuck’s Supply Schedule and Supply Curve
Price
Price of Coffee
Quantity Supplied
(cups)
$0.00
0
$0.50
1
$1.00
2
$1.50
3
$2.00
4
$2.50
5
$3.00
6
$3.00
$2.00
$1.00
1
2
3
Quantity
4
5
6
• Market Supply : Sum of all suppliers individual
supply in that market
• Market Supply Curve : Sum up individual
supply curves horizontally
Market Supply Schedule
Price of Coffee
Starbucks
Seattle’s Best
Market
$0.00
0
0
0
$0.50
1
2
3
$1.00
2
4
6
$1.50
3
6
9
$2.00
4
8
12
$2.50
5
10
15
$3.00
6
12
18
Market Supply Curve Creation (sort of)
Price
Starbuck’s
Supply
Seattle’s
Supply
Price
$3.00
$3.00
Price
$3.00
$2.00
$2.00
$2.00
$1.00
$1.00
$1.00
2
6
Market
Supply
4
12
6
18
More on Supply Curves
• Shifts in Supply
– Increased Supply
• Anything that increases the quantity supplied at all
prices
• Curve shifts to the right
– Decreased Supply
• Anything that decreases the quantity supplied at all
prices
• Curve shifts to the left
• Note: Difference between change in quantity
supplied and change in supply
P
Change in Supply vs Change in Quantity
Supplied
Increased
Supply
Change in quantity
supplied
Decreased
Supply
Change in
Supply
Q
• What things shift supply curve (change supply)
– Price of inputs: input prices go up, supply goes
down
– Technology: better tech., increase in supply
– Expectations: beliefs about future can affect
current supply
– Number of sellers: more sellers increases supply
• Again remember difference between change
in supply (shift of curve) and change in
quantity supplied (movement on curve)
Equilibrium
• Market equilibrium: when markets “clear”,
quantity demanded = quantity supplied
• Equilibrium price: the price at which the
market clears
• Equilibrium quantity: the amount of the good
bought/sold at the equilibrium
Equilibrium Between Demand and Supply
P
Market Demand
Market Supply
Equilibrium Price
Equilibrium
$1.50
Equilibrium Quantity
9
Q
Out of Equilibrium
• Surplus: excess supply
– Quantity supplied > quantity demanded
– Downward pressure on price to clear market
• Shortage: excess demand
– Quantity demanded > quantity supplied
– Upward pressure on price to clear market
• Note difference between shortage and scarcity
Shortage and Surplus
Excess Supply
Excess Demand
P
Demand
Surplus
Supply
Supply
Price higher
than eq.
price
Price lower
than eq.
price
Demand
Shortage
Quantity
Demanded
Quantity
Supplied
Q
Quantity
Supplied
Quantity
Demanded
Changes to Equilibrium
• Analyzing Changes in the market after some
“shock” or change
• 1st is supply changed, is demand changed
• How is it changed
• Graphically make the change and determine
new equilibrium
• Beware of drawing conclusion based on scale
Example: Study finds eating ice-cream increases students GPA
What happens? – Demand increases, quantity supplied
increases
Demand
Increases
P’’
P’
New Eq.
Quantity
Supplied
Increases
Original Eq.
Q’
Q’’
Price increased in mkt
Quantity increased in mkt
Example: Study finds eating ice-cream increases students GPA
and price of sugar goes up
What happens? – Demand increases, Supply Decreases
Demand
Increases
New Eq.
Supply Decreases
P’’
P’
Price increased in mkt
Quantity increased in mkt
Original Eq.
But: b/c of scale
Q’
Q’’
Example: Study finds eating ice-cream increases students GPA
and price of sugar goes up
What happens? – Demand increases, Supply Decreases
P’’
New Eq.
Supply Decreases
Demand
Increases
P’
Original Eq.
Price increased in mkt
Quantity decreased in mkt
But: b/c of scale
Q’’ Q’
• So in analyzing market changes be careful of
possible ambiguous answers
• If supply and demand both change do their
changes have the same qualitative effect on
price/quantity
• If the same then effect is known
• If different the effect depends on which is
larger