ITE lecture no.3 John Cubbin
Introduction to Economics
Microeconomics
Topic 2 (continued) Analysing markets:
supply and demand
The aim of this lecture is:
 To demonstrate the way in which
‘market forces’ operate to establish
equilibrium.
 To show how linear Qs and Qd
equations can be used to show
equilibrium price and quantity.
Required reading for this topic:
Sloman Chapter 2, Sections 2.1-2.3
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Key points from the last lecture…
 Qd = f(price, income, tastes, prices of
other goods and services…)
 A change in price will move a
consumer along their demand curve
 A change in any other variable will
cause the demand curve to shift.
 Qs = f(price, costs of production,
industry conditions…)
 A change in price will move the
industry along their supply curve
 A change in any other variable will
cause the supply curve to shift.
 In a private market, supply and
demand interact to establish an
equilibrium price i.e. where Qs = Qd
We perhaps did not say - but should have done that supply and demand analysis assumes
competitive markets
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ITE lecture no.3 John Cubbin
1a. Re-establishing equilibrium after a
shift in the demand curve
Effect of a shift in the demand curve:
Price
S
P
P
2
1
D2
D1
O
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1
Q2
e
Quantity
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ITE lecture no.3 John Cubbin
1b. Re-establishing equilibrium after a
shift in the supply curve
Effect of a shift in the supply curve
Price
S1
S2
P
P
1
2
D
O
Q
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Q
2
Quantity
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ITE lecture no.3 John Cubbin
2. Linear demand and supply analysis
Linear demand and supply curves can be
expressed as equations with an intercept
and a slope.
Supply curve
QS = IS + SS*P




QS is the amount of X supplied at price
P
IS is the intercept for the supply curve
SS is the slope of the supply curve
P is the price of X
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ITE lecture no.3 John Cubbin
Linear demand and supply analysis
Example of linear supply curve:
QS = -20 + 2P
100
Price
(P)
95
90
85
80
75
70
65
60
55
50
45
40
35
30
25
20
15
10
5
0
0
10
20
30
40
50
60
70
80
90 100 110 120 130 140 150 160 170 180 190 200 210 220 230
Quantity (Qs)
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ITE lecture no.3 John Cubbin
Demand curve
QD = ID + SD*P




QD is the amount of X demanded at
price P
ID is the intercept for the demand curve
SD is the slope of the demand curve
P is the price of X
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ITE lecture no.3 John Cubbin
Linear demand and supply analysis
Example of linear demand curve:
QD = 220 - 4P
Price
(P)
100
95
90
85
80
75
70
65
60
55
50
45
40
35
30
25
20
15
10
5
0
0
10 20 30 40 50 60 70 80 90 100 110 120 130 140 150 160 170 180 190 200 210 220 230
Quantity (Qd)
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ITE lecture no.3 John Cubbin
3. Linear demand and supply
analysis: equilibrium
Calculating the equilibrium point
QS = -20 + 2P
QD = 220 - 4P
In equilibrium, XS=XD, therefore
-20 + 2 P
= 220 – 4P
6P
= 240
P = 40
Substituting for P in the supply
equation,
QS = -20 + (2*40) = 60
Substituting for P in the demand
equation,
QD = 220 – (4*40) = 60
Giving the equilibrium position,
P = 40, and QS = QD = 60.
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ITE lecture no.3 John Cubbin
Linear demand and supply analysis:
plotting demand and supply curves
100
Supply
Price (P) 55
40
Demand
10
0
0
60
220
Quantity (Q)
The points marked are:
If QS = 0, P = 10
If QD=0, P = 55
If P = 0, QD = 220
If P = 40, Q = 60 (equilibrium)
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ITE lecture no.3 John Cubbin
4. Putting theory into practice:
 Economists use data
(e.g time series, cross-sectional) to
estimate demand and supply schedules
(econometrics)
 these may be represented as linear or
non-linear relationships, depending on
the data.
What is the relevance of demand and
supply analysis?
 Firms: interested in the factors
 determining demand as this affects
their revenue, investment
requirements
 Governments: essential to predict the
effects of policies aimed at increasing
or decreasing demand (e.g. subsidies,
taxes)
e.g. see discussion paper on demand
for long distance rail travel at:
http://www.city.ac.uk/economics/discussi
onpapers/index.html
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ITE lecture no.3 John Cubbin
5. Predicting the effect of a price
ceiling
Price
S
P
Pmax
D
Quantity
If the ceiling bites (i.e. is less than the
market equilibrium price) => excedss
demand
Examples of price ceilings:
Rent controls, any others?
But what about controlled prices such as
water, postal services?
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ITE lecture no.3 John Cubbin
6. Predicting the effect of a sales
tax
Note: if we do not get time to cover this in today’s lecture,
we will do so in forthcoming lectures.
e.g. a tax on cigarettes
Incidence = who ‘bears’ the tax?
Price
£1 per
unit tax
S2
S1
£6
£5.20
£5
D
80 85
Quantity
 Total tax revenue = 80 x £1 =
£80
 Tax paid by consumers = 80 x
(£6 - £5.20) = £64
 Tax paid by suppliers = 80 x (£5
- £5.20) = £16
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ITE lecture no.3 John Cubbin
Note: the incidence of a tax depends
on how ‘responsive’ demand and
supply are to price.
In the diagram above, demand is
‘unresponsive’ to price [the
demand curve is quite ‘steep’] so:
 Quantity demanded doesn’t change
much
 The govt. earns a lot of revenue
 Consumers bear most of the tax
burden
Test your understanding…
On a diagram, show the effects of a sales
tax where the demand curve is flat and the
supply curve is steep. Who bears the tax?
Why?
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