Chapter 3
Demand, supply and the market
David Begg, Stanley Fischer and Rudiger Dornbusch, Economics,
8th Edition, McGraw-Hill, 2005
PowerPoint presentation by Alex Tackie and Damian Ward
Some key terms
• Market
– a set of arrangements by which buyers and sellers are in contact
to exchange goods or services
• Demand
– the quantity of a good buyers wish to purchase at each
conceivable price
• Supply
– the quantity of a good sellers wish to sell at each conceivable
price
• Equilibrium price
– price at which quantity supplied = quantity demanded
1
Catherine’s Demand Schedule
The demand schedule is a table that shows the relationship between the price of
the good and the quantity demanded.
Figure 1 Catherine’s Demand Schedule and Demand Curve
(The demand curve is a graph of the relationship between the price of a good and the quantity
demanded.)
Price of
Ice-Cream Cone
$3.00
2.50
1. A decrease
in price ...
2.00
1.50
1.00
0.50
0 1 2 3 4 5 6 7 8 9 10 11 12 Quantity of
Ice-Cream Cones
2. ... increases quantity
of cones demanded.
Copyright © 2004 South-Western
Changes in Quantity Demanded
Movement along the demand curve caused by a change in the price of
the product.
Price of IceCream
Cones
B
$2.00
A tax that raises the price
of ice-cream cones results
in a movement along the
demand curve.
A
1.00
D
0
4
8
Quantity of Ice-Cream Cones
Market Demand versus
Individual Demand
• Market demand refers to the sum of all
individual demands for a particular good or
service.
• Graphically, individual demand curves are
summed horizontally to obtain the market
demand curve.
Price
The Demand curve shows the relation between price and
quantity demanded holding other things constant
D
• “Other things” include:
– the price of related goods
– consumer incomes
– consumer preferences
• Changes in these other things
affect the position of the
demand curve
Quantity
6
Prices of related goods and Effect on Demand
Substitute Goods:
coffee for tea; train ride for driving your own auto; coal for natural
gas
If Price of coffee increases then Demand for tea increases
Complimentary Goods:
tea and sugar; coffee and milk; gas and car; coal and coal heaters
If Price of gas increases, then Demand for automobiles decreases
7
Effect of Consumer Income on Demand:
Normal Goods versus Inferior Goods
Normal Goods:
For normal goods, demand increases when consumer income
increases.
Most goods are normal goods.
Inferior Goods:
For inferior goods, demand decreases when consumer income
increases.
Second-hand cars, second-hand clothing, bus rides (versus driving your
own auto or cab rides)
8
Ben’s Supply Schedule
(The supply schedule is a table that shows the relationship between the price of
the good and the quantity supplied.)
Figure 5 Ben’s Supply Schedule and Supply Curve
(The supply curve is the graph of the relationship between the price of a good and the quantity
supplied.)
Price of
Ice-Cream
Cone
$3.00
1. An
increase
in price ...
2.50
2.00
1.50
1.00
0.50
0
1 2
3
4
5
6
7
8
9 10 11 12 Quantity of
Ice-Cream Cones
2. ... increases quantity of cones supplied.
Copyright©2003 Southwestern/Thomson Learning
Market Supply versus
Individual Supply
• Market supply refers to the sum of all
individual supplies for all sellers of a particular
good or service.
• Graphically, individual supply curves are
summed horizontally to obtain the market
supply curve.
Price
The Supply curve shows the relation between price and
quantity supplied holding other things constant
S
• “Other things” include:
– technology
– input costs
– government regulations
• Changes in these other things
affect the position of the
demand curve
Quantity
12
SUPPLY AND DEMAND TOGETHER
Demand Schedule
Supply Schedule
At $2.00, the quantity demanded
is equal to the quantity supplied!
Market equilibrium (1)
D0
S

P0
• Market equilibrium is at E0
where quantity demanded
equals quantity supplied
E0
– with price P0 and
quantity Q0
D0
S
Q0
Quantity
14
Market equilibrium and disequilibrium
D

P1
S
excess
supply
E


P0

P2
S

excess
demand
D
Q0
Quantity
• If price were below P0 there
would be excess demand
– consumers wish to
purchase more than
producers wish to supply
• If price were above P0
there would be excess
supply
– producers wish to
supply more than
consumers wish to
purchase
15
A shift in demand
D1
D0
If the price of a substitute
good decreases ...
S
P0
less will be demanded at
each price.
E0
P1
The demand curve shifts
from D0D0 to D1D1.
E1
S
D1
Q1 Q0
D0
Quantity
If price stayed at P0 there
would be excess supply.
So the market moves to a
new equilibrium at E1.
16
A shift in supply
S1
S0
D
E2
P1
P0
The supply curve
shifts to S1S1
E0
If price stayed at P0 there
would be excess demand
S1
D
S0
Q1 Q0
Suppose safety
regulations are tightened,
increasing producers’ costs
So the market moves to a
new equilibrium at E2
Quantity
17
Two ways in which demand may
increase (1)
• (1) A movement along the
demand curve from A to B
• represents consumer reaction
to a price change
• could follow a supply shift
A
P0
P1
B
D
Q0 Q1 Quantity
18
Two ways in which demand may
increase (2)
P0
P1
• (2) A movement of the
demand curve from D0 to D1
• leads to an increase in demand
at each price
• e.g. at P0 quantity demanded
increases from Q0 to Q2: at P1
quantity demanded increases
from Q1 to Q3
C
A
B
F
D0 D1
Q0 Q1 Q2 Q3
Quantity
19
A market in disequilibrium
• Suppose a disastrous harvest
moves the supply curve to SS
• government may try to protect
the poor, setting a price ceiling
at P1
• which is below P0, the
equilibrium price level
• The result is excess demand
S
D
P2
E
P0
P1
A
S
B
excess
demand
QS Q0
D
RATIONING is needed to
QD Quantity
cope with the resulting
excess demand
20
Price and quantity changes
• In practice, we cannot plot ex ante demand
curves and supply curves
• So we use historical data and the supposition that
the observed values are equilibrium ones
• Since other things are often not constant, some
detective work is required
• This is where our theory comes in useful
21
What, how and for whom
• The market:
– decides how much of a good should be produced
• by finding the price at which the quantity demanded equals the
quantity supplied
– tells us for whom the goods are produced
• those consumers willing to pay the equilibrium price
– determines what goods are being produced
• there may be goods for which no consumer is prepared to pay a
price at which firms would be willing to supply
22