Demand, Supply, and Market Equilibrium
Chapter Outline
1. The Circular Flow Diagram
2. Demand
a. Definitions
b. Law of Demand
c. Changes in Quantity Demand vs. Changes in Demand
d. Determinants of Demand
3. Supply
a. Definitions
b. Law of Supply
c. Changes in Quantity Supply vs. Changes in Supply
d. Determinants of Supply
4. Market Equilibrium
a. Excess Demand / Supply
$
b. Changes in Equilibrium
$
INCOMES
COSTS
RESOURCE
MARKET
Circular Flow Diagram
On Right.
RESOURCES
INPUTS
Demand
Quantity Demanded – the amount
of a good that a consumer is
HOUSEBUSINESS
HOLDS
willing and able to purchase at
the current market price.
Demand – the amount of a good
GOODS &
GOODS &
SERVICES
SERVICES
that a consumer is willing and
able to purchase at all market
PRODUCT
prices, holding all else
MARKET
constant.
$
$
Demand Schedule – a table
CONSUMPTION
REVENUE
showing how much a
consumer is willing and able to purchase at different market prices.
Demand Curve – a graph showing how much a consumer is willing and able to purchase at
different market prices.
Law of Demand – All else equal, as price falls the quantity demanded rises and vice versa.
Determinants of Demand
1. Income
2. Price of Related Goods
a. Substitute Goods
b. Complementary Goods
3. Tastes and Preferences
4. Expectations
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Normal Good – the higher your income the more you consume
Examples: Sports Tickets, Cars, and Luxury Goods
↑Income
consume more at each P
↑D
Inferior Good – as income rises you consume less
Examples: Ramen Noodles, Potatoes
↑Income
consume other products
↓D
Substitute Goods – two goods in which a consumer will consume one good or the other
Examples: Pepsi or Coke, Rent Movie or Go to Theater, SUV or Mini Van
↑Price of Pepsi
drink less Pepsi
purchase more Coke
↑D
Complementary Goods – two goods consumed together
Examples: Pizza and Pop, DVD Player and Movie, Cookies and Milk
↑Price of pizza
consume less pizza
consume less pizza and pop
↓D
Tastes / Preference
New tastes for the product
Consume more
↑D
Expectations
↑Price tomorrow
buy today instead of tomorrow
↑D
Supply
Quantity Supplied – the amount of a good that a firm is willing and able to offer for sale at the
current market price.
Supply – the amount of a good that a firm is willing and able to offer for sale at all market prices,
holding all else constant.
Supply Schedule – a table showing how much a firm is willing and able to offer for sale at
different market prices.
Supply Curve – a graph showing how much a firm is willing and able to offer for sale at different
market prices.
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Law of Supply – All else equal, as price falls the quantity supplies falls and vice versa.
Determinants of Supply
1. Cost of Production
a. Prices of required inputs
b. Technologies used in production
2. Price of Related Products
Prices of required inputs
↑Price of labor
hire less people
produce less at current P
↓S
Technologies used in production
New technology
produce output for less
higher profit on output
produce more at current P
↑S
Price of Related Products
- book only mentions this.
Market Equilibrium
Shortage (Excess Demand) – a shortage occurs when the quantity demanded is greater
than the quantity supplied at a particular price.
Surplus (Excess Supply) – a shortage occurs when the quantity demanded is less than the
quantity supplied at a particular price.
Market Equilibrium – occurs when there is no incentive for prices to change (a steady
state). This occurs when there is no surplus or shortage (when QS = QD).
Example: Suppose that we are analyzing the market for chocolate. What will happen to
the market price and sales of chocolate if consumer’s income increases?
Example: Suppose that the actor’s guild lost a lawsuit filed by the movie studios. After
the lawsuit the wages fall in the industry. What will happen to the market equilibrium for
movie theater tickets?
Example: Suppose that Cox Communications increases the price of cable service.
1. What will happen to the price and sales of Direct TV systems?
2. What will happen the equilibrium price and quantity of televisions sold?
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