THE MARKET FORCES OF
DEMAND AND SUPPLY
• Market is wherever buyers and sellers
exchange goods and services, mostly for
money.
• Wherever an economic transaction takes
place—it’s a market.
In Economics, demand means your
willingness to buy backed by your
purchasing power.
Demand must satisfy two conditions:
(a) willingness to buy a good, and
(b) ability to buy that good
• Law of demand says that, ceteris paribus
(other things equal), the quantity
demanded (Qd) of a good falls when the
price of the good rises, and vice versa.
Quantity demanded (Qd) means the
amount of a good that buyers are
willing and able to purchase at different
prices
Quantity demanded is negatively related to
price. This implies that the demand curve is
downward sloping.
• Demand schedule is a table that shows the relationship
between the price of a good and the quantity demanded.
• In one column we show price and in another column we
show quantity demanded
Points
A.
B.
C.
D.
E.
F.
G.
Price
$0.0
0.50
1.00
1.50
2.00
2.50
3.00
Qd
12
10
8
6
4
2
0
• Demand curve is a graphical representation
of the demand schedule—
• Like demand schedule, demand curve shows
the relationship between the price of a good
and the quantity demanded.
• The following figure translates the demand schedule for ice-cream cones
into a graph.
•
Quantity demanded is negatively
related to price. This implies that the
demand curve is downward sloping.
The market demand
• The market demand curve shows, ceteris
paribus, the total quantity demanded of a
good in the market at various prices.
• Ceteris Paribus means everything
remaining constant or unchanged.
else
• The market demand is the sum of all of the
individual demands for a particular good or
service.
• That means, individual demand curves are
summed
up
horizontally—that
the
quantities demanded by individuals are
added up for each level of price.
Suppose there are only three customers—Bob, Helen and Art. The
market demand is the sum of Bob, Helen and Art’s individual demands
for videos at different prices.
The Market Demand Schedule and Curve for Videos
The market demand is
shown in a graph.
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5
Shifts in the Demand Curve
• An increase in demand can be represented
by a shift of the demand curve to the right.
• A decrease in demand can be represented
by a shift of the demand curve to the left.
Shifts in the Demand Curve/Change
in Quantity Demanded
Determinants of Demand—
• any non-price factor can shift demand—
that means shift of the entire demand
curve—to the right or to the left.
• But change in price cannot shift the
demand curve—it can cause changes in Qd
only
Any Change in Non-Price factors, as
mentioned below, can shift demand curve:
•
•
•
•
•
Income
Price of Related goods
Tastes and Preferences
Expectations
Number of Buyers
A. Income
• Normal Goods--an increase in income
leads to an increase in demand.
• Inferior Goods— an increase in income
leads to a decrease in demand.
B. Price of Other Goods
• Substitutes--an increase in the price of one
good leads to an increase in the demand
for the other.
• Complements--an increase in the price of
one good leads to a decrease in the
demand for the other.
C. Tastes and Preferences of people change all the
time—that changes demand for goods and
services. If people prefer diet goods, demand
curve for diet food will shift to the right.
D. Expectations--Positive versus Negative
Expectations. People’s expectation about job,
market and economy is positive—demand curve
will shift to the right.
E. Number of Buyers –The more buyers, the larger is
the demand, and demand curve will shift to the
right.
A Change in Demand and a Change in the Quantity Demanded
Supply Schedule and Supply Curve for Videos
Price increases, supply of
video also increases.
Price and Quantity
Supplied move in the
same direction
The Market Supply Schedule and Curve for Videos
Suppose there are only three firms in the market—MGA, Motown and Blockmaster.
The Market Supply Curve is found by summing up individual supplies of MGA, Motown
and Blockmaster at various prices.
The Market Supply Curve for Videos
A Shift of the Supply Curve
Supply Curve shifts
to the right or to the
left, depending on
changes in the
following non-price
factors:
A. Cost of
Production
B. Change in
technology
C. People’s
expectations
D. Profit
considerations
E. Capacity
utilization
A Shift of the Supply Curve
Supply Curve shifts to the
right means supply has
increased
A Change in Supply and a Change in the Quantity Supplied
A Shift of the Supply Curve
to the left means supply
has decreased
Equilibrium of Demand and Supply
Market is at equilibrium when Qd equals Qs, and market
is cleared. In this graph market is at equilibrium when
price is $3, and Qd and Qs are at 66 units.
The Effects of a Shift of the Demand Curve
If supply remains
constant, but demand
shifts to the left, price
will fall and less
quantity will be
demanded.
The Effects of a Shift of the Supply Curve
If demand remains constant, but
supply shifts to the left, price will
go up and less will be supplied.
EQUILIBRIUM WITH AND WITHOUT
GOVERNMENT INTERVENTION
Dr. Dowlah
Spring 2009
29
• Market equilibrium is a point where the
supply and demand curves intersect—it is
a situation in which the price has reached
the level where quantity supplied equals
quantity demanded.
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• Equilibrium price is the price that
balances quantity supplied and
quantity demanded.
• The equilibrium price is often called the
"market-clearing" price because both
buyers and sellers are satisfied at this
price.
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• Equilibrium quantity is the quantity
supplied and the quantity demanded
at the equilibrium price.
32
The graph shows equilibrium price and quantity in the market for IceCream Cones. The market is at equilibrium at price $2, when 7 ice-cream
cones will be demanded and supplied.
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• Surplus and Shortage in Market
• Surplus is a situation in which quantity
supplied is greater than quantity
demanded.
• Shortage is a situation in which quantity
demanded is greater than quantity
supplied.
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Shortage
Surplus Qs is
greater than Qd.
When price is
$2.50, Qd is 4, Qs
is 10.
Theref0re,
market
has
a
surplus of 6 units
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Shortage
Shortage
means
Qd
is
greater
than Qs.
When price is $1.50, Qd
is 10, Qs is 4.
Theref0re, market has
a shortage of 6 units
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• The Invisible Hand of Market
•
Whenever a market is in disequilibrium,
in a market economy the invisible hands
of market brings the demand and supply
to an equilibrium.
• The concept of invisible hands of market
was first explained by Adam Smith.
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Figure 8: Equilibrium
In a market economy,
the forces of demand
and supply bring market
to an equilibrium point.
If Price is above the
equilibrium,
sellers
reduce price, and cut
down output. As prices
go down, buyers demand
more,
and
market
returns to equilibrium.
If
price
is
below
equilibrium, sellers raise
price
and
increase
output, as price goes up,
buyers
demand
less
quantity. Finally, market
restores equilibrium.
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13
38
Figure 9: The Effects of a Shift of the Demand Curve
If
supply
remains
constant,
but
demand
decreases, price
and Qd will fall.
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14
39
Figure 10: The Effects of a Shift of the Supply Curve
If demand remains
constant, but supply
decreases, price will
increase, but Qd will
fall.
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15
40
Government Intervention in Market
• Governments, however, often try to address
the problems of shortages and surpluses
through something called Price Controls.
• Common forms of government control of
prices are known as Price Ceiling and Price
Floor.
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Price Floor
•
• A price floor is a legal minimum on the price of a good
or service.
• If the price floor is above the equilibrium price, the
quantity supplied exceeds the quantity demanded.
• Because of the resulting surplus, buyers’ demands for
the good or service must in some way be rationed
among sellers.
•
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Minimum Wage
• An example is the Minimum Wage Legislation
•
• The market for labor looks like any other market:
downward-sloping demand, upward-sloping supply,
equilibrium price (called a wage), and equilibrium quantity
of labor hired.
• If the minimum wage is fixed above the equilibrium wage in
the labor market, a surplus of labor will develop.
• As the minimum wage is a binding constraint, employers
will be able to discriminate workers.
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Effects of Minimum Wage Legislation
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Price Ceiling
• A price ceiling is a legal maximum on the price of
a good or service.
• If the price ceiling is below the equilibrium price,
the quantity demanded exceeds the quantity
supplied.
• Because of the resulting shortage, sellers must in
some way ration the good or service among
buyers.
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Rent Control Legislations
The Market for Apartments in the Absence
of Government Controls
Without government intervention, the market for apartments reaches
equilibrium at point E with a market rent of $1,000 per month and 2
million apartments rented.
3
46
Effects of Rent Control laws
The Effects of a Price Ceiling
4
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Evaluations of Price Control
• Most economists feel that markets are usually a good way to organize
economic activity, and most of them oppose the use of price ceilings and
floors.
• If prices are set by laws, they obscure the signals that efficiently allocate
scarce resources in a market economy.
• Price ceilings and price floors often hurt the people they are intended to
help.
• Rent controls create a shortage of quality housing and provide
disincentives for building maintenance.
• Minimum wage laws create higher rates of unemployment for teenage
and low skilled workers.
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Other forms of Government control
• Subsidizing socially necessary products and
services
• Taxing socially harmful products and services
• Nationalization of Industries
• Controlling money supply, and interest rates
• Use of fiscal policies—taxation and revenue
policies
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