The Supply and Demand
Model
How are Market Outcomes (price
and quantity) Determined?
The components of the supply
and demand model:
1. Supply (description of
seller behavior)
2. Demand (description of
buyer behavior)
3. Resolution Rule (how are
seller and buyer plans
resolved)
Demand
Demand refers to the
relationship between the
amount of the commodity the
buyer would like to purchase
(the quantity demanded) and
the price of the commodity.
The quantity demanded is
measured in terms of units of
the commodity per unit of time
(e.g., 3 units per week) and
price is measured in terms of
units of money per unit of
commodity (e.g., $2/unit).
The Law of Demand
All else equal, the quantity
demanded varies inversely
with the price.
Why? Substitution and
income effects
Exceptions? (Giffen goods,
“status symbols”)
The Demand Curve
The demand curve is the graphical
representation of demand.
According to the law of demand,
the demand curve is downward
sloping.
Change in Quantity Demanded
vs.
Change in Demand
When the price of the commodity
changes, all else equal, buyers want
to change the amount of the
commodity they want to purchase:
The quantity demanded changes;
there is a movement along the
demand curve. (Demand has not
changed.)
When the amount that buyers want to
buy at a given price changes, then
the demand curve changes (shifts)
and there is a change in demand.
Sources of Changes in Demand
(for household goods and services)
• Changes in income (normal vs.
inferior goods)
• Changes in prices of other
goods (substitutes vs.
complements)
• Changes in tastes and
preferences
• Changes in expected future
price
• Changes in population
Supply
• Supply refers to the relationship
between the amount of the
commodity the seller would like to
sell (the quantity supplied) and the
price of the commodity.
• The quantity supplied is measured in
terms of units of the commodity per
unit of time (e.g., 3 units per week)
and price is measured in terms of
units of money per unit of
commodity (e.g., $2/unit).
The Law of Supply
All else equal, the quantity
supplied varies directly with the
price.
The Supply Curve
The supply curve is the graphical
representation of supply.
According to the law of supply,
the supply curve is upward
sloping.
Change in Quantity Supplied
vs.
Change in Suppy
When the price of the
commodity changes, all else
equal, sellers want to change the
amount of the commodity they
want to sell: The quantity
supplied changes; there is a
movement along the supply
curve. (Supply has not
changed.)
When the amount that sellers
want to sell at a given price
changes, then the supply curve
changes (shifts) and there is a
change in supply.
Sources of Changes in Supply
(for goods and services)
• changes in input prices
• changes in technology
• changes in number of
sellers
Closing the Model:
Equilibrium
The law of supply and
demand –
In the absence of external
barriers on price movements,
price will fall in response to
“excess supply” and rise in
response to “excess demand”,
settling at the equilibrium
price where quantity demanded
equal quantity supplied