Demand, Supply and Market
Equilibrium
 Demand reflects buyer’s decision making
 Supply reflects seller’s decision making
 Put supply and demand together, we have a
market
Demand
 The amount of a good or service that
consumers are willing and able to purchase
during a given period of time is called
quantity demanded.
 We will simplify demand analysis by
focusing on six critical factors that
influence quantity demanded.
Two Types of Demand Functions
 Generalized Demand Functions – which
show how quantity demanded is influenced
by the price of the product and five other
factors.
 Ordinary Demand Functions – which focus
on the relationship between price and
quantity demanded, holding other factors
constant.
Generalized Demand Functions
Qd  f (P, M , PR , T , Pe , N )
Nature of the Relationship
 All six jointly determine quantity
demanded.
 If want individual effects, must hold others
constant - ceteris paribus condition
Price and Quantity Demanded
  or   or  


Qd  f ( P, M , PR , T , Pe , N )
Price and quantity demanded are inversely related. If
price increases, holding other factors constant,
quantity demanded decreases. This inverse
relationship is often referred to as the Law of
Demand.
Demand and Income
  or   or 



Qd  f ( P, M , PR , T , Pe , N )
 For normal goods, income and demand are
positively related.
 For inferior goods, income and demand are
inversely related.
Demand and Price of Related
Goods
  or   or  


Qd  f ( P, M , PR , T , Pe , N )
 For complements, PR and demand are
inversely related.
 For substitutes, PR and demand are
positively related.
 When are two goods substitutes?
Complements?
Demand and Tastes
  or   or  


Qd  f ( P, M , PR , T , Pe , N )
 For this one, I have assumed that an
increase in tastes is an indication that
consumers perceive the product more
favorably and thus are willing and able to
purchase more.
Demand and Price Expectations
  or   or  


Qd  f ( P, M , PR , T , Pe , N )
 If consumers perceive that an increase in
prices is likely in the future, the current
level of demand will increase.
Demand and Number of Buyers
  or   or  


Qd  f ( P, M , PR , T , Pe , N )
 If the number of buyers increase, demand
will increase.
Abbreviated Demand Model
 Drop tastes – not measurable and not
always relevant
– Tastes for telephones
 Drop number of buyers – often doesn’t
change during time period of analysis
 Drop price expectations – difficult to
measure and only relevant for some goods
– Expect price of toilet paper to increase
– Expect price of telephone service to increase
Demand Functions
 Demand or the demand function is the
relationship between price and quantity
demanded, holding other factors constant.
– Table: see slide following
– Graph: see slide following
– Equation: Qd=2000-20P
Demand Schedule
Price
Qd=2000-20P
0
2000
25
1500
50
1000
75
500
100
0
Demand Curve
P
Q = 2000-20P
100
50
1000
2000
Qd
Changes in Demand vs Changes
in Quantity Demanded
 A change in the price of the product, results
in a movement along the demand curve and
is said to result in a change in quantity
demanded.
 A change in any of the other (five) factors in
the demand function , results in a shift in
the demand curve and is said to result in a
change in demand.
Supply
 Quantity supplied is the amount of a good
or service offered for sale in a market
during a given period of time.
 The quantity of a good offered for sale is
based on six factors.
Factors Influencing Supply
Decisions
 Price +
 Input prices  Prices of related goods in production
– – for substitutes (wheat and corn)
– + for complements (oil and gas)
 Technology +
 Price expectations  Number of sellers +
see Table 2.5
Generalized Supply Function
 Relationship depicting how all six factors
jointly determine quantity supplied.
Qs=g(P, PI,Pr,T,Pe,F)
Supply Function
 Shows the relationship between Q and P,
holding constant the other 5 factors.
 These other factors are called the
determinants of supply.
Change in Supply versus Change
in Quantity Supplied
 A change in price causes a change in
quantity supplied and is reflected by a
movement along a fixed supply function.
 A change in any of the determinants of
supply causes a change in supply and is
reflected by a shift in the supply function.
Supply Schedule
 A table showing a list of all possible prices
and the corresponding quantities supplied.
Price
65
60
50
40
30
20
10
Q Supplied
750
700
600
500
400
300
200
Supply Curve
 A graph showing relationship between price
and quantity supplied
P
S
Q
Supply Shifts – Increase Versus
Decrease
P
S0
Q
Market Equilibrium
S
P*
D
Q*
Excess Supply-Surplus
S
P1
P*
D
Q*
Excess Demand - Shortage
S
P*
P2
D
Q*
Market Equilibrium-Changes in
Demand
S
P*
D
Q*
Market Equilibrium-Changes in
Supply
S
P*
D
Q*
Market EquilibriumSimultaneous Changes in S & D
S
Indeterminate?
P*
D
Q*
Qualitative versus Quantitative
Market Forecasting
 Qualitative – only direction is predicted
 Quantitative – direction and magnitude is
forecasted
Price Fixing
 Price Ceiling
– Maximum price is mandated
– Shortages result
– Potential for Black Market
 Price Floor
– Minimum price is mandated