3 | Demand and Supply – Week 1
• Demand, Supply, and Equilibrium in Markets for Goods and Services
• Shifts in Demand and Supply for Goods and Services
• Changes in Equilibrium Price and Quantity: The Four-Step Process
• Price Ceilings and Price Floors
Demand, Supply, and Equilibrium in Markets for
Goods and Services
The Demand for a Good or a Service
Economists use the term individual or household demand to refer to the amount of some good
or service a household or consumer is willing and able to purchase at each price. The market
demand is the horizontal sum of all individual demands. All demand is based on needs and
wants. But, simply wanting something alone is not good enough to qualify as a demand.
Demand is also constrained by one’s ability to pay. If you cannot pay for a good, you have no
effective demand for the good. A young boy may really want a new BMW, but most do not have
enough buying power to actually buy it and be part of the demand for BMWs.
People who correctly use the term “demand” mean a curve showing the maximum amount of
“quantity demanded” for a given price assuming all other factors are held constant. It is the
price and those “all other factors” that determine the demand for a good.
(LEFT) - This is demand in tabular form –
it shows the maximum quantity
demanded at various prices…note that
there are no other factors affecting
demand that are shown in the table…they
are being held constant
(RIGHT) - This is demand in graphical form
– it shows the maximum quantity
demanded at various prices…again note
that there are no other factors affecting
demand that are shown in the
graph…they are being held constant
“Demand” is a curve, while “quantity demanded” is a point on the horizontal axis. Changes in price
cannot shift demand but can alter the quantity demanded. A lower price raises the quantity demanded,
but it does not increase demand. The distinction is very important. Neither a change in P not a change in
Q can shift demand – one merely moves along a stationary demand curve.
Exogenous variables held constant –
the ceteris paribus assumptions
A demand curve is a relationship between two, and only two, variables: quantity on the horizontal axis and
price on the vertical axis. The assumption behind a stationary demand curve is that no relevant economic
factors, other than the product’s price and quantity, are changing, even hypothetically. Economists call this
assumption ceteris paribus, a Latin phrase meaning “other things being equal.” Any given demand is based
on the ceteris paribus assumption that all else is held constant.
Demand-side ceteris paribus variables being held constant by assumption
Income, Wealth, and Taxes
Quality of the Good or Service
Advertising
Substitute Prices
Complement Prices
Weather
Expectations of future price
Tastes and Preferences
Size and Structure of the Population
Foreign Exchange Rate
Interest Rate
Supply of a Good or a Service
When economists talk about the supply of a firm, they mean a curve showing the quantities, at various
hypothetical prices, that if produced and sold will maximize the profits of the firm, holding all other
variables constant. The market supply is the horizontal sum of the individual supplies of all the firms in the
industry.
Note how that as price changes from $3 to $4, the
quantity supplied changes from 100 units/ time to 120
units/time. This shows that neither price nor quantity
can shift supply. The same is true for demand. Only
the ceteris paribus variables can shift supply or
demand.
Exogenous variables held constant –
the ceteris paribus assumptions
A supply curve is a relationship between two, and only two, variables: quantity on the horizontal axis and
price on the vertical axis. No relevant economic factors, other than the product’s price and quantity, are
changing, even hypothetically. Any given supply is based on the ceteris paribus assumption that all else is
held constant.
Supply-side ceteris paribus variables being held constant by assumption
Money wages
Number of firms in the industry
Other productive factor prices
Quality of the good or service
Foreign exchange rate
Weather
Expectations of future price
Individual Supply versus Market Supply
Firm 1
Firm 2
Firm 3
Market
To arrive at the market supply (regardless of the industry, one simply adds together the individual
supplies of the firms HORIZONTALLY. What would happen if the individual supplies of the firms were
exactly the same curve?
Equilibrium in the Market