Lecture 4:
Demand, Supply and Equilibrium
Required Text: Chapter 2
Law of Demand


When price of a good goes up, people buy less of that good
Leads to downward sloping demand curve
Individual Consumer’s demand for coffee
Quantity
Demanded (cups)
0.50
5
0.75
4
1.00
3
1.25
2
1.75
1.50
1.25
Price ($)
Price
($/cup)
1.00
0.75
0.50
0.25
1.50
1
1
2
3
4
Quantity Demanded (cups per day)
5
Demand versus Quantity Demanded

Quantity Demanded


Amount of a good consumed at a given price
Change in price means a change in quantity
demanded


Movement along the demand curve
Demand

A family of numbers that lists the quantity
demanded corresponding to each possible price


Demand Schedule
Demand Curve
Demand Schedule and Demand Curve

Demand Schedule - Refers to the demand table that
shows quantity demanded at each price

Demand Curve - Graph illustrating demand Graphical representation of the demand schedule
 Price on the vertical axis
 Quantity demanded on the horizontal axis

Demand Equation

Qd = (price, income, tastes and preferences,
expectations, and prices of other goods)
Changes in Demand


Price change does not lead to change in demand
Change in anything other than price lead to demand changes
- Entire curve shifts
 Income
 Price of related goods
 Substitutes
 Complements
 Taste (preference)
 Sales Tax
 Number of consumers
Shifting Demand

Fall in Demand



Decision made by demanders to buy a smaller
quantity at each given price
Leftward shift of demand curve
Rise in Demand


Decision made by demanders to a buy a larger
quantity at each given price
Rightward shift of demand curve
Sales Tax Example

Sales Tax – A tax imposed on consumers



Paid directly to the government
Does not affect the price
Consumers pay “Price plus sales tax”

Less desirable to buy the taxed good or service at every
given price

Demand shifts downward and to the left
Effect of a Sales Tax on Demand

A new law requires $0.25 sales tax per cup of coffee
Change in demand due to sales tax
Price
($/cup)
Quantity (cups)
before Tax
Quantity (cups)
after tax
1.75
0.50
5
4
0.75
4
3
1.00
3
2
Price ($)
1.50
1.25
1.00
0.75
D
1.25
2
1
0.50
1.50
1
0
0.25
D'
0
1
2
3
Quantity (cups per day)
4
5
Shape of the Demand Curve

Steeply-sloped demand curve


Flat demand curve


Large change in price leads to small change in
quantity demanded
Small change in price leads to large change in
the quantity demanded
Important to producers of goods and services
Econometrics

Statistical techniques used by economist to resolve
questions about slopes of various demand curves

Based on direct observations in marketplace
 Ex. Demand for murder
 Ex. Demand for reckless driving

Wide scope of economics
 Allows for other investigations as well
Market (Aggregate) Demand

Aggregate quantity of a good demanded by all
consumers in a community (market) at each given
price

The aggregate or market demand is obtained by the
horizontal summation of all individual consumer’s
demand curves.

Similar to the individual demand curve - Slopes
downward
Market (Aggregate) Demand


Suppose, there are 10,000 SB coffee consumers in Lubbock
Each individual consumer’s demand for SB coffee is the same
Aggregate (market) demand for coffee
Ind. Quantity
(cups)
Ag. Quantity
(cups)
0.50
5
50,000
0.75
4
40,000
1.00
3
30,000
1.25
2
20,000
1.75
1.50
Price ($/cup)
Price
($/cup)
1.25
1.00
0.75
0.50
0.25
0.00
1.50
1
10,000
10,000
20,000
30,000
40,000
50,000
Agg. Quantity Demanded (cups per day)
Law of Supply


When the price of a good goes up, the quantity supplied goes up
Leads to a upward sloping supply curve
Supply of Coffee
0.25
1.75
Quantity
(cups)
0
1.50
Price ($/cup)
Price ($)
1.25
1.00
0.50
100
0.75
200
1.00
300
0.25
1.25
400
0.00
1.50
500
0.75
0.50
0
100
200
300
400
Quantity Supplied (cups per day)
500
Supply versus Quantity Supplied

Quantity Supplied
 Amount of a good that suppliers will provide at a given
price
 Changes if the price changes
 Movement along the curve

Supply
 Family of numbers giving the quantities supplied at each
price
 Change in anything other than price changes supply
 Shifts the entire curve
Changes in Supply

Supply Equation
 Qs =  (price, expectations, input prices, prices of other
goods, technological change, number of producers)

Rise in Supply
 Increase in quantities that supplier will provide at each price
 Rightward shift of supply

Fall in Supply
 Decrease in quantities that supplier will provide at each price
 Leftward shift of supply
Changes in Supply


Price change does not lead to change in supply
Factors that lead to supply changes - Entire curve shifts
 Production costs
 Improvement in production technology
 Change in the wage rate
 Changes in the Prices of other goods (subs. or
comps.)
 Excise Tax
 Number of Producers
Excise Tax Example

The government imposes a tax on producers


Producers pay the tax directly to the
government
Price does not change, but the cost

Less desirable to produce the taxed good or service at
every given price

Supply shifts to the left and upward
Effect of an Excise Tax on Supply

An excise tax of $0.25 per cup of coffee
Change in Supply due to Excise Tax
Quantity
Supplied
before tax
Quantity
Supplied
after tax
0.25
0
0
0.50
100
0
0.75
200
100
1.00
300
200
1.25
400
300
1.50
500
400
1.75
S'
1.50
Price ($/cup)
Price
($/cup)
S
1.25
1.00
0.75
0.50
0.25
0.00
0
100
200
300
400
Quantity (cups per day)
500
Market (Aggregate) Supply

Aggregate quantity of a good supplied by all producers
in a community (market) at each given price

The aggregate or market supply is obtained by the
horizontal summation of all individual producer’s supply
curves.

Similar to the individual producer’s supply curve –
Market supply curve slopes upward
Market (Aggregate) Supply

Suppose, there are 10 SB coffee sellers in Lubbock
Each individual seller’s supply for SB coffee is the same
Price
($/cup)
Ind. Quantity
(cups)
Ag. Quantity
(cups)
0.50
1,000
10,000
0.75
2,000
20,000
1.00
3,000
Market (Aggregate) Supply Curve
1.75
Price ($/cup)

1.50
1.25
1.00
30,000
0.75
1.25
4,000
40,000
1.50
5,000
50,000
0.50
0.25
10,000
20,000
30,000
40,000
50,000
Quantity Supplied (cups per day)
Market Equilibrium

Actual price and Quantity determined by interactions
between demanders (consumers) and suppliers
(sellers)


Demanders cannot purchase more than
suppliers willing to sell
Suppliers cannot sell more than demanders
willing to buy
Equilibrium Point

Point where the market demand and supply
curves intersect


Price at which quantity demanded equals
quantity supplied
Demanders and suppliers are satisfied

Able to behave as one wants to, taking market
prices as given
Market Equilibrium for SB Coffee


Equilibrium price – $1.00 per cup
Equilibrium quantity – 30,000 cups per day
Equilibrium in the Market
Price
($/cup)
Ag. Quantity
Demanded
Ag. Quantity
Supplied
0.50
50,000
10,000
0.75
40,000
20,000
1.00
30,000
30,000
1.25
20,000
40,000
Price ($/cup)
1.75
1.50
1.25
1.00
0.75
0.50
0.25
1.50
10,000
50,000
10,000
20,000
30,000
40,000
Quantity (cups per day)
50,000
Changes in the Equilibrium Point

The only way that anything can affect the equilibrium
price and quantity is by causing a shift in either the
supply curve or the demand curve
 Never look at price and quantity
 Look at the effect of the change has on demand curve
and/or supply curve

The factors that shifts the demand and supply curves
affect the equilibrium price and quantity
The Effects of
Supply and
Demand Shifts
Landsburg, Price Theory and
Applications, 7th edition
Effect of Sales Tax

Sales tax of x¢ per item causes equilibrium
price to fall by some amount less than x¢ per
item

Price to suppliers not same as price to
demanders (price plus sales tax)
Effect of Excise Tax

Excise tax of x¢ per item causes the
equilibrium price to rise by some amount
less than x¢ per item

Price to suppliers (price minus excise tax)
not same as price to demanders
Comparing Two Taxes


Economic Incidence – the division of a tax burden
according to who actually pays the tax
Legal Incidence – the division of a tax burden
according to who is required under the law to pay
the tax

The economic incidence of a tax independent of its
legal incidence

Ex. Social Security tax
A Sales Tax versus an Excise Tax
Landsburg, Price Theory and
Applications, 7th edition
Aggregated Effects of a Demand Curve
Shift (for example change in income)
Price
D
S
D’
P1
P0
Q
Q0
Q1
Firm’s response to increased demand


What steps could a firm manager take to react to a shift in the
demand curve to the right for an agricultural/food product?
For a competitive (atomistic) firm manager




Knowledge of the increase in demand is first seen by a noticed increase
in price received.
Usual reaction is to increase output.
Other firm managers see that above normal profits are being
earned and enter the market thus putting some upward pressure
on input costs.
The increased production lower prices to an equilibrium price
(where price = average cost) that is somewhat higher than the
initial price.
Firm’s response to increased demand …

For the firm in monopolistic competition
 the firm manager (remember the firm is a price maker)
would first be aware of the increase in demand by an
increase in sales or product orders.

The firm’s reaction would be to increase output and/or increase price.

Seeing the above normal profits, other firms would enter and
increase the supply.

The firm would experience a weakened demand for its
product with the resulting equilibrium price a little higher
that the initial price.

This higher price is due to the increased average costs.
Firm’s response to increased demand

For the oligopolistic firm manager
 The increase in demand would be recognized by an
increase in sales/orders.
 Reaction would be to increase output and price.
 Entry is possible, but more difficult.
 With entry, demand would weaken. The resulting price
is not predictable.
Impacts of Large Decline in Demand in
Alternative Market Models
Situations
Atomistic
First
indication
Price falls
First
Reaction
Cut output
Long run
Many firms
exit
Price raises
Impact of
Exits
Monopolist
Competition
Orders/Sales
decline
Oligopoly
Cut output,
change
promotion
A few firms exit
Cut output,
change
promotion
Possibly an
exit
Increase sales
Increase sales
Orders/Sales
decline
Domestic Demand vs. Export Demand

Consideration of demand for the farm commodity must
consider total demand where total demand equals domestic
demand plus export demand.

Domestic food demand is fairly stable with little change
from year to year. However, droughts and other disasters
that occur in foreign countries can create large swings in
foreign demand from year to year.

Question

What can be the major result of these often-unexpected shifts in
foreign demand?
Agricultural/Food Sector Trends




Moving from atomistic markets towards monopolistic
competition:
How: creating differentiation: regional (California fruit),
branding (Dole, green giant, Del Monte)
Why: more alternative marketing strategies
For example rice, bananas, tomatoes, lettuce, beef?