CHAPTER 2:
DEMAND, SUPPLY, MARKET
EQUILIBRIUM
I. MARKET.
A. Defined: A market is a formal or informal
arrangement in which people exchange goods,
services, or productive resources.
1) Formal (organized)
2) Informal (unorganized)
B.
Competitive Markets
1) Defined: Many buyers and sellers of a
relatively homogenous product.
2) Examples:
 Markets for agricultural products
 Stocks
 Bonds
 Precious Metals
 Foreign currencies
II. DEMAND SIDE OF MARKET.
A. Generalized Demand function
1) Defined: Shows the relationship between
quantity demanded and product price, as
well as the five other independent variables
that affect quantity demanded.
2) Qd =
(P, M, PR, T , Pe, N) where:
Qd = Quantity demanded of a good or
service.
P = Price of the good or service.
M = Consumer’s income (generally
per capita).
PR = Price of related products.
T = Taste patterns of consumers.
Pe = Expected price of the good in
some future period.
N = Number of consumers in the
market.
f
B. Generalized demand function in linear form
1)
Qd = a + bP + cM + dPR + e T + fPe + gN
2) Parameters
a) Intercept Parameter: Shows the value of
Qd when all other variables are 0.
b) Slope Parameters: Measure the effect on
Qd of changing one of the independent
variables while holding the rest of the
independent variables constant.
c) For example:
b=
ΔQ
ΔP
ceteris paribus or b =
σQ d
σP
.
d) Expected signs of parameters: Table 2.1
C. Demand function (ordinary demand function)
1) Qd = f (P) “ceteris paribus”
2) To derive the demand function from a
generalized demand function, the other five
independent variables in the generalized
demand function must have fixed values.
3)
Hypothetical Example:
Qd = f (P,M',P'R)
Qd = 1800 - 20P + .6M - 50 PR
Qd = 1800 - 20P + .6(20,000) - 50(250)
Qd = 1800 - 20P + 12000 – 12500
Qd = 1300 - 20P
Interpretation of Intercept Parameter:
The amount of the good that the consumer
will demand if the price is 0.
4) Points to note.
a) Law of demand.
b) Demand schedule: Table 2.2
c) Demand curve: Figure 2.1
5) Inverse Demand Function
P = f (Qd)
P = 65 – 1/20 Qd
6) Determinants of Demand
a. M = Consumer’s income
1. Normal Good
2. Inferior Good
b. PR = Price of related goods
1. Complements
2. Substitutes
c. T = Consumer Tastes
d. Pe = Expected price in future
e. N = Number of consumers in the
market
(Figure 2.2: Demand shifts)
7) Summary of Demand Shifts and signs of slope
parameters. (Table 2.4)
8) Change in Demand vs. Change in Quantity
Demanded.
III. SUPPLY SIDE OF THE MARKET
A. Generalized supply function.
1) Defined: Shows the relationship between
quantity supplied and product price, as well
as the other five independent variables that
affect supply.
2) Qs =
f
(P, Pi, Pr, T, Pe, F)
Where:
Qs = Quantity supplied of a good or service
P = Price of the good.
PI = Price of the inputs used to produce the
good.
Pr = Price of goods related in production.
T = Level of available technology
Pe = Expectations of producers concerning
future price of the product
F = Number of firms producing the good,
or productive capacity.
B. Generalized supply function in linear form
1) Qs = h + kP +lPi + mPr + nT + rPe + sF
2) Parameters
a) Intercept Parameter: Shows the value of
Qs when all of the independent variables
have a value of 0.
b) Slope Parameters: Measure the affect on
Qs of changing one of the independent
variables while holding the rest of the
independent variables constant. k, l, m,
n, r and s are slope parameters.
For example: k =
ΔQ s
ΔP
Ceteris Parabus
Q s
k = P
c) Expected signs of Parameter (Table 2.5)
C. Supply function (ordinary supply function)
1) Qs = f (P), “ceteris parabus”
2) To derive the supply function from a
generalized supply function, the other five
independent variables in the generalized
supply function must have fixed values.
Hypothetical Example:
Qs = f(P,P'I,F')
Qs = 50 + 10P - 8Pi + 5F
Qs = 50 + 10P - 8(50) + 5(90)
Qs = 100 + 10P
3) Points to note:
a) Relationship between Qs and P is direct.
b) A point on the supply schedule indicates
the maximum amount of a good or
service that will be offered at a specific
price, or the supply price, the minimum
amount necessary to induce producers to
voluntarily offer a given amount for sale.
c) Supply schedule: Table 2.6
d) Supply curve: Figure 2.3
4) Inverse Supply Function
P = f (Qs)
P = -10 +1/10 Q
5) Determinants of supply
a. Pi = Price of inputs
b. Pr = Price of goods related in production
c. T = State of technology
d. Pe = Expected Price
e. F = Number of firms in industry
(Figure 2.4 Supply Shifts)
6) Summary of Sign Shifts and Slope
Parameters. (Table 2.8)
7) Change in Supply vs. Change in Quantity
Supplied.
IV. MARKET EQUILIBRIUM
A. Intuitive explanation
1) Equilibrium: General Definition
2) Equilibrium price Qd = Qs,
a. Only stable price in the market.
b. Actual price < equilibrium price
Shortage & upward pressure on price.
c. Actual price > equilibrium price
Surplus & downward pressure on price.
B. Equilibrium from table: (Table 2.9)
C. Equilibrium from graph: (Figure 2.5)
Equilibrium algebraically:
Qd = 1300 - 20P
Qs = 100 + 10P
1300 - 20P = 100 + 10P
30P = 1200
P = $40
Qd = 1300 - 20(40) = 500
Qs = 100 + 10(40) = 500
E. Changes in Equilibrium
1) Qualitative Forecast: A forecast that predicts
only the direction in which an economic
variable will change.
Example:
Technical Questions 14 & 15
2) Quantitative Forecast: A forecast that
predicts both the direction and magnitude in
which an economic variable will change.
Example:
13d and 13e
V. PRICE CEILINGS & PRICE FLOORS
A. Price ceiling: The maximum legal price that the
government permits sellers to charge for a good
when this price is below equilibrium, a shortage
occurs.
1) Figure 2.11 a (A shortage occurs)
2) Examples of Price ceilings
B. Price floor: The minimum legal price that the
government permits sellers to charge for a good
when this price is above equilibrium a surplus
occurs.
1) Figure 2.11 b (A surplus occurs)
2) Examples of Price Floors
Chapter 2 Assignment
Technical Problems: 1, 2, 6, 7, 9, 10, 11, 13, 14, 15
Applied Problems: 1, 2, 11