Supply and Demand
Since people want more of scarce goods than
is freely available, we need a way of rationing
the goods. Some possible criteria are:
 beauty
 popularity
 income
 first
come, first served
 the market or price (supply & demand)
Law of Demand
There is a negative relation between the price
of a good and the amount of the good that
buyers are willing to purchase.
example:
price
quantity demanded per month(QD)
13
400
12
450
11
500
10
550
9
600
8
650
7
700
price
13
12
11
10
9
8
7
quantity
400 450 500 550 600 650 700
price
13
12
11
10
9
8
7
Demand
quantity
400 450 500 550 600 650 700
The demand curve slopes down!
Law of Supply
There is a positive relation between the price
of a good and the amount of the good that
producers are willing to produce and sell.
example:
price
quantity supplied per month(Qs)
13
625
12
600
11
575
10
550
9
525
8
500
7
475
price
13
12
11
10
9
8
7
quantity
475 500 525 550 575 600 625
price
13
12
11
10
9
8
7
Supply
quantity
475 500 525 550 575 600 625
The supply curve slopes up!
price
13
12
11
10
9
8
7
price
QD
13
400
12
450
11
500
10
550
9
600
8
650
7
700
price
QD
Qs
13
400
625
12
450
600
11
500
575
10
550
550
9
600
525
8
650
500
7
700
475
price
QD
Qs
mkt. cond.
13
400 < 625 excess supply
12
450 < 600
11
500 <
575 excess supply
10
550
550
9
600
525
8
650
500
7
700
475
excess supply
price
QD
Qs
mkt. cond.
13
400
625 excess supply
12
450
600
11
500
575 excess supply
10
550
550
excess supply
9
600 > 525
excess demand
8
650 >
7
700 > 475 excess demand
500 excess demand
price
QD
Qs
mkt. cond.
13
400
625 excess supply
12
450
600
11
500
575 excess supply
10
550 =
excess supply
550 equilibrium
9
600
525
excess demand
8
650
500
excess demand
7
700
475
excess demand
When the quantity demanded is equal to
the quantity supplied, we have
equilibrium.
Equilibrium means that there is no
tendency for things to change. The
system is in balance.
price
QD
Qs
mkt. cond. price pressure
13
400
625
excess supply
down
12
450
600
excess supply
down
11
500
575
excess supply
down
10
550
550
equilibrium
9
600
525
excess demand
8
650
500
excess demand
7
700
475
excess demand
price
QD
Qs
mkt. cond. price pressure
13
400
625
excess supply
down
12
450
600
excess supply
down
11
500
575
excess supply
down
10
550
550
equilibrium
9
600
525
excess demand
up
8
650
500
excess demand
up
7
700
475
excess demand
up
price
QD
Qs
mkt. cond. price pressure
13
400
625
excess supply
down
12
450
600
excess supply
down
11
500
575
excess supply
down
10
550
550
equilibrium
none
9
600
525
excess demand
up
8
650
500
excess demand
up
7
700
475
excess demand
up
price
13
12
11
10
9
8
7
Demand
quantity
400 450 500 550 600 650 700
price
13
12
11
10
9
8
7
Supply
quantity
475 500 525 550 575 600 625
price
equilibrium
10
equilibrium
price
Supply
Demand
quantity
550
equilibrium quantity
The equilibrium is at the intersection of the
demand curve and the supply curve.
The equilibrium quantity can be read from
the horizontal axis.
The equilibrium price can be read from the
vertical axis.
Changes in Demand
& Changes in Quantity Demanded.
A change in the price of a product results in
a change in the quantity demanded or
a movement along the demand curve.
price
13
12
11
10
9
8
7
A
Suppose the price of a
product is initially $12.
The quantity demanded is
450. We are at point A.
Demand
quantity
400 450 500 550 600 650 700
price
13
12
11
10
9
8
7
B
If price decreases to $11,
quantity demanded increases to
500. We are now at point B
on the same demand curve.
Demand
quantity
400 450 500 550 600 650 700
price
13
12
11
10
9
8
7
A
B
The quantity demanded has
changed. We have moved
along a particular demand
curve from one point
to another.
Demand
quantity
400 450 500 550 600 650 700
price
13
12
11
10
9
8
7
If price increases from
$11 to $12, quantity
demanded decreases from
500 to 450.
Demand
quantity
400 450 500 550 600 650 700
The demand curve for a product does not shift
when the price of the product changes! We
simply move from one point on the curve to
another point on the same curve.
Do not confuse a change in the quantity
demanded with a change in demand!
change in quantity demanded:
move along the same curve
change in demand: entire curve moves
What is a change in demand?
A change in demand means that at each
price you want to purchase a different
amount than you did previously. The
entire demand curve moves when your
demand is affected by something other
than the price of the product.
What factors cause demand to change?
(a shift of the entire curve)



a change in income
a change in the price of a related good
a change in tastes for the good
A Change in Income.
Suppose you buy CDs. What happens if your
income increases?
If you had more income, you would consider
buying more CDs at each price level.
price
13
12
11
10
9
8
7
Before your income increased, if the
price was 12, you bought 450 CDs.
Now, perhaps if the price
is 12, you buy 500 CDs.
Demand
quantity
400 450 500 550 600 650 700
price
13
12
11
10
9
8
7
Before, if the price was 11, you
bought 500 CDs. Now, perhaps if
the price is 11, you buy 550 CDs.
Demand
quantity
400 450 500 550 600 650 700
price
13
12
11
10
9
8
7
Before, if the price was 10, you
bought 550 CDs. Now, perhaps if
the price is 10, you buy 600 CDs.
Demand
quantity
400 450 500 550 600 650 700
price
13
12
11
10
9
8
7
Connecting the new points, we see
that when your income increased,
you changed to an entirely
different demand curve.
New Demand
Demand
quantity
400 450 500 550 600 650 700
price
13
12
11
10
9
8
7
The new demand curve lies to the right
of the old curve, or the demand
curve has shifted to the right.
Demand increased.
New Demand
Demand
quantity
400 450 500 550 600 650 700
price
13
12
11
10
9
8
7
Similarly, if your income
decreased, the Demand
curve for CDs would shift
left. Demand decreases.
Demand
New Demand
quantity
400 450 500 550 600 650 700
Normal Goods and Inferior Goods
When your income increased, your
demand for CDs increased. When your
income decreased, your demand for
CDs decreased. Goods that behave
this way are called normal goods.
In general for normal goods:
When income increases, demand increases.
When income decreases, demand decreases.
Inferior goods work the opposite way.
Example: potatoes. People who have little
income eat lots of potatoes, because
potatoes are cheap and filling. When
income rises, people eat fewer potatoes.
When income falls, people eat more
potatoes.
In general for inferior goods:
When income increases, demand decreases.
When income decreases, demand increases.
price
When income increases,
demand for an inferior good
decreases.
Demand
New Demand
quantity
price
When income decreases, the
demand for an inferior good
increases.
New Demand
Demand
quantity
“Related Goods” fall into two categories:
substitute
goods
complementary goods
Two goods are substitutes if you can use one
good instead of the other good.
CDs and cassettes would be substitute goods.
If the price of cassettes increases, the
demand for CDs would increase.
If the price of cassettes decreases, the
demand for CDs would decrease.
In general:
If the price of a substitute good increases,
the demand for the other good increases.
If the price of a substitute good decreases,
the demand for the other good decreases.
price
When the price of a substitute
good increases, the demand
for the other good increases.
New Demand
Demand
quantity
price
When the price of a substitute
good decreases, demand for
the other good decreases.
Demand
New Demand
quantity
Two goods are complements
if you use them together.
CDs and CD players would be
complementary goods.
If the price of CD players increases, the
demand for CDs would decrease.
If the price of CD players decreases, the
demand for CDs would increase.
In general:
If the price of a complementary good
increases, the demand for the other good
decreases.
If the price of a complementary good
decreases, the demand for the other good
increases.
price
When the price of a
complementary good
increases, demand for the
other good decreases.
Demand
New Demand
quantity
price
When the price of a
complementary good
decreases, the demand for
the other good increases.
New Demand
Demand
quantity
Changes in tastes can also lead to
changes in demand.
Taste changes can take the form of fads
or responses to new health information
concerning a product.
price
A fad for hula hoops can
result in an increase in
demand for them.
New Demand
Demand
quantity
price
Findings about cancercausing effects of chewing
tobacco can reduce the
demand for that product.
Demand
New Demand
quantity
Changes in Supply
& Changes in Quantity Supplied.
Changes in Quantity Supplied
a change in the price of a product results in
a change in the quantity supplied or
a movement along the supply curve.
price
13
12
11
10
9
8
7
Supply
If price decreases
from $12 to $11,
quantity supplied
decreases from
600 to 575.
quantity
475 500 525 550 575 600 625
price
13
12
11
10
9
8
7
Supply
If price increases
from $11 to $12,
quantity supplied
increases from
575 to 600.
quantity
475 500 525 550 575 600 625
Do not confuse a change in the quantity
supplied with a change in supply!
change in supply: entire curve moves
change in quantity supplied:
move along the same curve
What is a change in supply?
A change in supply means that at each
price, producers are willing to produce and
sell a different amount than previously.
The entire supply curve moves when
supply is affected by something other than
the price of the product.
What factors cause supply to change?
(a shift of the entire curve)



a change in technology
a change in the price of an input
a change in taxes on production
Technological Advance
When there is a technological advance
that makes it cheaper to produce a
good, the supply of the good will
increase.
price
Supply
New Supply
When technology
improves, the supply of
good increases.
quantity
A Change in the Price of an Input
When the price of an input changes, the
supply of a good that uses that input
will change.
price
New Supply
Supply
When the price of an
input increases, the
supply of the good
decreases.
quantity
price
Supply
New Supply
When the price of an
input decreases, the
supply of the good
increases.
quantity
Production Tax Changes
When the tax on the production of a
good changes, the supply of the good
will change.
price
New Supply
Supply
When a tax on production
increases, the supply of the
good decreases.
quantity
price
Supply
New Supply
When a tax on production
decreases, the supply of
the good increases.
quantity
What happens to equilibrium
price and quantity when supply
or demand changes?
S1
price
S2
P1
P2
S increases:
P decreases &
Q increases.
D
quantity
Q1 Q2
S2
price
S1
P2
P1
S decreases:
P increases &
Q decreases.
D
quantity
Q2
Q1
price
S
P2
D increases:
P increases &
Q increases.
P1
D2
D1
quantity
Q1 Q2
price
S
P1
P2
D decreases:
P decreases &
Q decreases.
D1
D2
quantity
Q2 Q1
What happens to equilibrium price
and quantity when both supply
and demand change?
S increases &
D increases:
In this case,
Q increases &
P stays the same.
price
S1
S2
P2 = P1
D2
D1
Q1
Q2
quantity
S increases &
D increases:
In this case,
Q increases &
P increases.
price
S1
P2
P1
S2
D2
D1
Q1
Q2
quantity
S increases &
D increases:
In this case,
Q increases &
P decreases.
price
S1
S2
P1
P2
D2
D1
Q1
Q2
quantity
So....
If demand increases more than supply,
the price will increase.
If supply increases more than demand,
the price will decrease.
If supply and demand increase the same amount,
the price will stay the same.
In other words, what happens to the price
when both supply and demand increase
depends on the relative magnitudes of
the changes in supply and demand.
S decreases &
D decreases:
price
S2
P ? &
Q decreases
S1
P2 = P1
D1
D2
quantity
Q2
Q1
S increases &
D decreases:
price
S1
P decreases &
S2
P1
P2
Q?
D1
D2
quantity
Q1 = Q2
S decreases &
D increases:
price
S2
P increases &
P2
Q?
S1
P1
D2
D1
quantity
Q1 = Q2
Price Ceilings
and
Price Floors
Price Ceiling
A government imposed maximum legal
price.
Example: rent controls on apartments
Price Ceiling
price
S
Notice that Qd > Qs.
Thus, there is excess
demand or a shortage.
P1
Pc
D
quantity
Qs Q1 Qd
Price Floor
A government imposed minimum legal
price.
Examples:
minimum wages, agricultural price supports
Price Floor
price
S
Notice that Qs > Qd.
Thus, there is excess
supply or a surplus.
Pf
P1
D
quantity
Qd Q1 Qs