Supply and Demand
Chapter 4
Demand
• Buyers or Consumers are sometimes
called demanders.
• Consumers are said to “demand”
products in the market place.
• Demand refers to the consumption
behavior of buyers in the market.
• Demand also means the willingness to
pay of consumers at various prices
and quantities.
Demand
• Prices are the tools by which the
market coordinates individual
desires.
The Law of Demand
• Quantity demanded rises as price
falls, other things held constant
(such as income or the prices of
competitive products).
• Quantity demanded falls as prices
rise, other things constant.
• Therefore, there is an inverse or
negative relationship between price
and quantity demanded.
The Law of Demand
• What accounts for the law of
demand?
• People tend to substitute for goods
whose price has gone up
The Demand Curve
• The demand curve is the graphic
representation of the law of demand.
• The demand curve slopes downward
and to the right.
• As the price goes up, the quantity
demanded goes down.
The Demand Curve
• The slope tells us that quantity
demanded varies indirectly—in the
opposite direction—with price.
• The slope of the demand curve is
negative because the relationship
between price and quantity is inverse.
• A simple equation of demand in slopeintercept form is
Qd = a - mP
Slope is negative
Assumption :Other Things
Constant
• Other things constant means that all
other factors that affect the
analysis are assumed to remain
constant, whether they actually
remain constant or not.
• These factors may include changing
tastes, prices of other goods, the
income of the buyers, even the
weather.
Price (per unit)
A Sample Demand Curve
PA
A
D
0
QA
Quantity demanded (per unit of time)
Shifts in Demand
Versus
Movements Along a Demand Curve
• Demand refers to a schedule of
quantities of a good that will be
bought per unit of time at various
prices, other things constant.
• Graphically, “demand” refers to the
entire demand curve.
Shifts in Demand
Versus
Movements Along a Demand Curve
• Quantity demanded refers to a
specific amount that will be
demanded per unit of time at a
specific price.
• Graphically, it refers to a specific
point on the demand curve.
Shifts in Demand
Versus
Movements Along a Demand Curve
• A movement along a demand curve is
the graphical representation of the
effect of a change in price on the
quantity demanded.
Shifts in Demand
Versus
Movements Along a Demand Curve
• A shift in demand is the graphical
representation of the effect of
anything other than price on demand.
• The original curve will move to the
right or to the left.
Price (per unit)
Change in Quantity
Demanded
$2
B
Change in quantity demanded
(a movement along the curve)
$1
A
D1
0
100
200
Quantity demanded (per unit of time)
Price (per unit)
Shift in Demand
Change in demand
(a shift of the curve – in this
case a decrease in demand)
$2
$1
B
A
D0
D1
250
100
200
Quantity demanded (per unit of time)
Shift Factors of Demand
• Shift factors of demand are those
that cause shifts in the demand
curve to the right or left.
Shift Factors of Demand
• Shift factors of demand include—but
are not limited—to the following:
–
–
–
–
Society's income
The prices of other goods
Tastes
Expectations
Shift Factors of Demand
• A rise in income will increase demand
for goods.
• When the prices of substitute goods
fall, you will consume less of the good
whose price has not changed.
• A change in taste will change demand
with no change in price.
Shift Factors of Demand
• If you expect your income to rise,
you may consume more now.
• If you expect prices to fall in the
future, you may put off purchases
today.
The Demand Table
• The demand table assumes all the
following:
– As price rises, quantity demanded
declines.
– Quantity demanded has a specific time
dimension to it.
– All the products involved are identical in
shape, size, quality, etc.
– The schedule assumes that everything
else is held constant.
From a Demand Table
to a Demand Curve
• Plot each point in the demand table
on a graph and connect the points to
derive the demand curve.
• The demand curve graphically
conveys the same information that is
on the demand table.
• The curve represents the maximum
price that you will for various
quantities of a good—you will happily
pay less.
From a Demand Table
to a Demand Curve
A Demand Table
A
B
C
D
E
$0.50
1.00
2.00
3.00
4.00
9
8
6
4
2
Price per cassette (in dollars)
Price per Cassette rentals
cassette demanded per
week
A Demand Curve
$6.00
5.00
4.00
3.50
3.00
E
D
2.00
C
1.00
.50
0
F
Demand for
cassettes
B
A
1 2 3 4 5 6 7 8 9 10 11 12 13
Quantity of cassettes demanded (per week)
Individual and Market
Demand Goods
• A market demand curve is the
horizontal sum of all individual
demand curves.
• The market demand curve is
determined by adding the individual
demand curves of all the demanders.
Individual and Market
Demand Goods
• Real world sellers do not add up
individual demand curves.
• They estimate total market demand
for their product which becomes
smooth and downward sloping curve.
Individual and Market
Demand Goods
• The demand curve is downward
sloping for the following reasons:
– At lower prices, existing demanders buy
more.
– At lower prices, new demanders enter
the market.
From Individual Demands
to a Market
A $.0.50
B
1.00
C
1.50
D
2.00
E
2.50
F
3.00
G
3.50
H
4.00
9
8
7
6
5
4
3
2
6
5
4
3
2
1
0
0
(2)
Cathy’s
demand
1
1
0
0
0
0
0
0
(3)
Market
demand
16
14
11
9
7
5
3
2
$4.00
Price per cassette (in dollars)
(1)
(2)
(3)
Price per Alice’s Bruce’s
cassette demand demand
3.50
G
F
3.00
E
2.50
D
2.00
C
1.50
B
1.00
0.50
A
Cathy
0
2 4
Bruce Alice
6 8 10 12 14 16
Quantity of cassettes demanded per week
Supply
• Individuals control the factors of
production.
– Factors of production are the
resources or inputs, necessary to
produce goods or services.
• Individuals supply factors of
production to intermediaries or
firms.
Supply
• The analysis of the supply of
produced goods has two parts:
– An analysis of the supply of the factors
of production to firms.
– An analysis of why firms transform
those factors of production into final
goods and services.
The Law of Supply
• Quantity supplied rises as price
rises, other things constant.
• Quantity supplied falls as price falls,
other things constant.
• Thus, there is a direct or positive
relationship between price and
quantity supplied.
The Law of Supply
• The law of supply is accounted for by two
factors:
– When prices of their product rise, firms
arrange their activities to supply more of the
good to the market, substituting production of
that good for the production of other goods.
– Assuming firms' costs are constant, a higher
price means higher profits.
– Or, assuming firms’ costs rise as production
increases, they must raise price to cover their
cost increase.
The Supply Curve
• The supply curve is the graphic
representation of the law of supply.
• The supply curve slopes upward to the
right.
• The slope tells us that the quantity
supplied varies directly—in the same
direction—with the price.
• A simple equation of supple is
Qs = a + mP
Slope is positive
Price (per unit)
A Sample Supply Curve
S
PA
0
A
QA
Quantity supplied (per unit of time)
Shifts in Supply
Versus
Movements Along a Supply Curve
• Supply refers to a schedule of
quantities a seller is willing to sell per
unit of time at various prices, other
things constant.
Shifts in Supply
Versus
Movements Along a Supply Curve
• If the amount supplied is affected by
anything other than a change in price,
there will be a shift in supply.
– Shift in supply -- the graphic
representation of the effect of a change
in a factor other than price on supply.
Shifts in Supply
Versus
Movements Along a Supply Curve
• Quantity supplied refers to a
specific amount that will be supplied
at a specific price.
Shifts in Supply
Versus
Movements Along a Supply Curve
• Changes in price causes changes in
quantity supplied represented by a
movement along a supply curve.
Shift in Supply
S0
Price (per unit)
S1
$15
A
B
Shift in Supply
(a shift of the curve
– in this case an
increase in supply)
1,250
1,500
Quantity supplied (per unit of time)
Change in Quantity
Supplied
Price (per unit)
S0
B
$15
A
Change in quantity
supplied (a movement
along the curve)
1,250
1,500
Quantity supplied (per unit of time)
Shift Factors of Supply
• Shift factors of supply are those
factors that cause shifts in the
entire supply curve to the left or
right.
Shift Factors of Supply
• The following are shift factors of
supply:
– Changes in the prices of inputs used in
the production of a good
– Changes in technology
– Changes in suppliers' expectations
– Changes in taxes and subsidies
Shift Factors of Supply
• Changes in the prices of inputs used
in the production of a good.
– If costs go up, then profits go down, and
the incentive to supply also goes down.
– If costs go up substantially, the firm
may even shut down.
Shift Factors of Supply
• Technology makes costs go down,
profits go up, thus the incentive to
supply also goes up.
– This is especially true when technology
replaces labor.
Shift Factors of Supply
• If they expect prices to rise in the
future, suppliers may store today's
production for an expected windfall
later.
• If they expect prices to fall in the
future, suppliers may sell off more of
their inventories today.
Shift Factors of Supply
• If taxes go up, costs also go up, and
profits go down, leading suppliers to
reduce output.
• If government subsidies go up, costs
go down, and profits go up, leading
suppliers to increase output.
From a Supply Table
to a Supply Curve
• To derive a supply curve from a supply
table, you plot each point in the supply
table on a graph and connect the points.
• The supply curve represents the set of
minimum prices an individual seller will
accept for various quantities of a good.
• Competing suppliers’ entry into the
market places a limit on the price any
supplier can charge.
From a Supply Table
to a Supply Curve
• Competing suppliers’ entry into the
market places a limit on the price any
supplier can charge.
Individual and Market
Supply Curves
• The market supply curve is derived
by horizontally adding the individual
supply curves of each supplier.
From Individual Supplies
to a Market Supply
(1)
(2)
(3)
(4)
(5)
Quantities
Price
Ann's Barry's Charlie's Market
Supplied (in dollars) Supply Supply Supply Supply
A
B
C
D
E
F
G
H
I
$0.00
0.50
1.00
1.50
2.00
2.50
3.00
3.50
4.00
0
1
2
3
4
5
6
7
8
0
0
1
2
3
4
5
5
5
0
0
0
0
0
0
0
2
2
0
1
3
5
7
9
11
14
15
Price per cassette (in dollars)
From Individual Supplies
to a Market Supply
$4.00
Charlie
Barry
Ann
Market Supply
3.50
H
3.00
G
2.50
F
2.00
E
1.50
D
1.00
0.50
0 A
I
C
B
CA
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
Quantity of cassettes supplied (per week)
The Dynamic Laws of
Supply and Demand
• Supply and demand come together to
determine equilibrium quantity and
equilibrium price.
Excess Supply
and
Excess Demand
• Excess supply – prices tend to fall if
quantity supplied is greater than quantity
demanded.
• Excess demand – prices tend to rise if
quantity demanded is greater than quantity
supplied.
Price Adjusts
• The larger the difference between
quantity demanded and quantity
supplied, the greater the pressure
for prices to rise (if there is
excess demand) or fall (if there is
excess supply.
• When quantity demanded equals
quantity supplied, prices have no
tendency to change.
Price per cassette (in dollars)
The Marriage of Supply
and Demand
$5.00
S
Excess supply
4.00
3.50
A
3.00
Excess supply
B
E
2.50
C
2.00
1.50
Excess demand
1.00
1
D
2 3 4 5 6 7 8 9 10 11 12
Quantity of cassettes supplied and demanded
(per week)
Market Equilibrium
• Equilibrium is a concept in which
opposing dynamic forces pushing
cancel each other out.
• In supply and demand analysis,
equilibrium means that the upward
pressure on price is exactly offset
by the downward pressure on price.
Equilibrium
• Equilibrium price is the price toward
which the invisible hand drives the
market.
• Equilibrium quantity is the amount
bought and sold at the equilibrium
price.
Equilibrium is not…
• A state of the world—it is a
characteristic of the static model we
use to examine the world.
• Neither good or bad—but simply a
state in which dynamic pressures
offset each other.
• Equilibrium exists at a particular
moment in time.
Desirable Characteristics
of Supply/Demand
Equilibrium
• Consumer surplus – the distance between
the demand curve and the price the
demander pays is net benefit to
consumers.
Desirable Characteristics
of Supply/Demand
Equilibrium
• Producer surplus – if a producer
receives more than the price he
would be willing to sell it for, he
receives a net benefit.
Desirable Characteristics
of Supply/Demand
Equilibrium
• What's good about equilibrium is
that it makes the combination of
consumer and producer surplus as
large as it can be.
Desirable Characteristics
of Supply/Demand
Equilibrium
• Markets allow trade, thereby leading
to an increase in the combination of
consumer and producer surplus.
Consumer and Producer
Surplus
$10
9
Consumer Surplus
8
Lost
7
Surplus
6
5
4 Producer
3 Surplus
2
1
0
1 2 3 4 5 6 7 8
Quantity
Supply
Demand
9 10
Supply and Demand
End of Chapter 4