Lecture two
© copyright：qinwang 2013
Qinwang@mail.shufe.edu.cn
SHUFE school of international business
Demand, Supply, and Market
Equilibrium
 Demand and demand function
 Supply and supply function
 Market equilibrium
Demand and supply
1、Demand
2、Supply
 Demand definition
 Supply definition
 Demand and
 Supply and
influences
influences
 Demand function
 Supply function
 Demand curve (firm  Supply curve (firm
and industry)
and industry)
 The rule of demand
 The rule of supply
 Shift of demand
 Shift of supply
Demand
 Quantity demanded (Qd)
 Amount of a good or service consumers
are willing & able to purchase during a
given period of time
 Demand is different from need
General Demand Function
 Some variables that influence Qd
 Price of good or service (P)
 Incomes of consumers (M)
 Prices of related goods & services (PR)
 Taste patterns of consumers (T)
 Expected future price of product (Pe)
 Number of consumers in market (N)
• General demand function
Qd = f(P, M, PR, T, Pe , N)
General Demand Function
Qd = a + bP + cM + dPR + eT + fPe + gN
 b, c, d, e, f, & g are slope parameters
 Measure effect on Qd of changing one of the
variables while holding the others constant
 Sign of parameter shows how variable
is related to Qd
 Positive sign indicates direct relationship
 Negative sign indicates inverse relationship
General Demand Function
Relation to Qd
Variable
Sign of Slope Parameter
b = Qd/P is negative
P
Inverse
M
c = Qd/M is positive
Direct for normal goods
Inverse for inferior goods c = Qd/M is negative
PR
Direct for substitutes
Inverse for complements
d = Qd/PR is positive
d = Qd/PR is negative
T
Direct
e = Qd/T is positive
Pe
Direct
f = Qd/Pe is positive
N
Direct
g = Qd/N is positive
Direct Demand Function
 The direct demand function, or simply
demand, shows how quantity demanded,
Qd , is related to product price, P, when
all other variables are held constant

Qd = f(P)
 Law of Demand
 Qd increases when P falls, all else constant
 Qd decreases when P rises, all else constant
 Qd/P must be negative
Demand curve
firm1
Q1
firm2
Q2
Q3=Q2+Q1
industry
Q3
Graphing Demand Curves
 Change in quantity demanded
 Occurs when price changes
 Movement along demand curve
 Change in demand
 Occurs when one of the other variables,
or determinants of demand, changes
 Demand curve shifts rightward or
leftward
Supply
 Six variables that influence Qs






Price of good or service (P)
Input prices (PI )
Prices of goods related in production (Pr)
Technological advances (T)
Expected future price of product (Pe)
Number of firms producing product (F)
 General supply function
 Qs = f(P, PI, Pr, T, Pe, F)
General Supply Function
Variable
Relation to Qs
P
Direct
Sign of Slope
Parameter
k = Qs/P is positive
PI
Inverse
l = Qs/PI is negative
Inverse for substitutes
Direct for complements
m = Qs/Pr is negative
m = Qs/Pr is positive
T
Direct
n = Qs/T is positive
Pe
Inverse
r = Qs/Pe is negative
F
Direct
s = Qs/F is positive
Pr
Direct Supply Function
 The direct supply function, or simply
supply, shows how quantity supplied,
Qs , is related to product price, P, when
all other variables are held constant

Qs = f(P)
 Law of Supply
 Qs increases when P rises, all else constant
 Qs decreases when P falls, all else constant
 Qs/P must be positive
Supply curve
firm1
Q1
firm2
Q2
Q3=Q2+Q1
industry
Q3
 Supply curve of labor
labor
Graphing Supply Curves
 Change in quantity supplied
 Occurs when price changes
 Movement along supply curve
 Change in supply
 Occurs when one of the other variables,
or determinants of supply, changes
 Supply curve shifts rightward or leftward
Market Equilibrium
 Equilibrium price & quantity
are determined by the
intersection of demand &
supply curves
 At the point of
intersection, Qd = Qs
 Consumers can purchase
all they want & producers
can sell all they want at
the “market-clearing” or
“equilibrium” price
Market Equilibrium
 Excess demand (shortage)
 Exists when quantity demanded
exceeds quantity supplied
 Excess supply (surplus)
 Exists when quantity supplied
exceeds quantity demanded
Value of Market Exchange
 Economic value
 Maximum amount any buyer in the market is willing to
pay for the unit, which is measured by the demand
price for the unit of the good
 Consumer surplus
 Difference between the economic value of a good (its
demand price) & the market price the consumer must
pay
 Producer surplus
 For each unit supplied, difference between market price
& the minimum price producers would accept to supply
the unit (its supply price)
 Social surplus
 Sum of consumer & producer surplus
 Area below demand & above supply over the relevant
range of output
Changes in Market Equilibrium
 Qualitative forecast
 Predicts only the direction in which an
economic variable will move
 Quantitative forecast
 Predicts both the direction and the
magnitude of the change in an
economic variable
Case 1

Demand Shifts (Supply
Constant)
– D increase, ?
– D decrease, ?
Case two

Supply Shifts (Demand
Constant)
– Supply increase, ?
– Supply decrease, ?
Case three
 When demand &
supply increase
simultaneously
 Quantity?
 Price?
Case four
 When demand &
supply decrease
simultaneously
 Quantity,?
 Price,?
Case five
 Supply increase，
demand decrease
 Quantity?
 Price?
Case six
 Supply decrease，
demand increase
 Quantity ?
 Price?
Example: House leasing
 In a competitive market of house
leasing, analyze the following market
(other factors are given) :
 Consumers income increased
 Levy rent tax for $100/unit/month
 An regulation: the rent is no more than
2000/unit/month.
Ceiling & Floor Prices
 Ceiling price
 Maximum price government permits
sellers to charge for a good
 When ceiling price is below equilibrium, a
shortage occurs
 Floor price
 Minimum price government permits
sellers to charge for a good
 When floor price is above equilibrium, a
surplus occurs
Ceiling & Floor Prices
Px
Sx
2
1
Price (dollars)
Px
Sx
3
2
Dx
Dx
22
50 62
Quantity
Panel A – Ceiling price
Qx
32 50
84
Quantity
Panel B – Floor price
Qx
Cobweb Theorem
Elasticity




Elasticity and its calculation
Price Elasticity of Demand (Ep)
Income elasticity of demand(Em)
Cross elasticity of demand(Exr)
Elasticity
• Measures responsiveness or sensitivity of
dependant variable Y to independent
variable X
 
E
 X
 X & Y are related variables,The larger
the absolute value of E, the more
sensitive Y are to a change in X
Calculating Elasticity
 Point elasticity
 Y Y / Y Y X
E


  X  X/ X  X Y
 Interval (arc) elasticity
Y Average X
E

X Average Y
Price Elasticity of Demand (E)
• Measures responsiveness or sensitivity of
consumers to changes in the price of a
good
 Q Q P
E

 P P Q
 P & Q are inversely related by the law
of demand so E is always negative
 The larger the absolute value of E, the more
sensitive buyers are to a change in price
Case：Levy Jeans
Demand of Levy Jeans in Sears
$price（/unit）
Sales(unit/week)
20
19
18
17
16
12
11
12
14
16
18
20
28
30
Price Elasticity of Demand (E)
Table
Elasticity
Responsiveness
E
Elastic
%∆Q> %∆P E> 1
Unitary Elastic
%∆Q= %∆P E= 1
Inelastic
%∆Q< %∆P E< 1
Price Elasticity & Total Revenue
Elastic
Unitary elastic
Inelastic
%∆Q> %∆P%∆Q= %∆P%∆Q< %∆P
Quantityeffect
dominates
Price
rises
Price
falls
No dominant
effect
TR falls
No change in TR
TR
rises
No change in TR
Price-effect
dominates
TR
rises
TR falls
Case：Basketball shoes’ pricing
N is a company of basketball shoes. It
sells 10000 pairs of shoes per month
(shoes price is $100). Its competitor
reduces the price of basketball shoes. After
that N company’s sale reduce to 8000 pairs.
According to experience, the Ep in such
range of price and quantity is about -2.00。
If N company want increase its sale to
10000 pairs per month，what price would N
company set?
Ep of some goods in US economy
Industry
Ep
Elastic
Finished food
2.27
Metal
1.52
Furniture 、wood 1.25
Auto
1.14
Logistics
1.03
Inelastic
Gas、power、water
Oil
Chemical
Drinks
Tobacco
Food
House/
Clothes
Book, magazine, newspaper
Meat
0.92
0.91
0.89
0.78
0.61
0.58
0.55
0.49
0.34
0.20
Demand & Marginal Revenue
 When inverse demand is linear,
P = A + BQ (A > 0, B < 0)
 Marginal revenue is also linear, intersects
the vertical (price) axis at the same
point as demand, & is twice as steep as
demand
MR = A + 2BQ
Linear Demand, MR, & Elasticity
MR, TR, & Price Elasticity
Marginal
revenue
Total revenue
MR > 0
TR increases as
Q increases
(P decreases)
MR = 0
MR < 0
TR is maximized
TR decreases as
Q increases
(P decreases)
Price
elasticity of
demand
Elastic
(│E│> 1)
Unit Elastic
(│E│= 1)
Inelastic
(│E│< 1)
Marginal Revenue & Price Elasticity
 For all demand & marginal revenue
curves, the relation between marginal
revenue, price, & elasticity can be
expressed as
1

MR  P  1  
E

Example：Price strategy of telecom
Fixed-line toll：increase
International telephone fee
decrease
：
Example：Tax for luxuries
The government want to levy tax
on luxuries to narrow the gap between
the poor and rich?
Income Elasticity
 Income elasticity (EM) measures the
responsiveness of quantity demanded to
changes in income, holding the price of
the good & all other demand
determinants constant
 Positive for a normal good
 Negative for an inferior good
 Qd Qd M
EM 


 M M Qd





EM >1：high-grade products
0< EM <=1：normal product
EM <0：inferior
EM ＝0：
EM ＝1：
EP And EM in US
product
EP
EM
Food
-0.21
0.28
Auto
-1.20
3.00
Petrol
-0.54
1.06
Power
-1.14
0.61
Beer
-1.13
0.93
Flour
Marijuana
-0.36
-1.50
0
Engel's Coefficient
1989
US
Japan
France
Brazilian India
13
16
16
35
52
China
1964
1985
1990
1992
1994
1999
2009
City
59.2
53.3
54.2
52.9
50
41.9
37
Rural
68.5
57.7
58
56.8
57
52.6
43
Cross-Price Elasticity
 Cross-price elasticity (EXR) measures the
responsiveness of quantity demanded of
good X to changes in the price of related
good R, holding the price of good X & all
other demand determinants for good X
constant
 Positive when the two goods are substitutes
 Negative when the two goods are complements
E XR
 QX QX PR



 PR PR QX
 EXR >0：substitute
 EXR <0)：complement
 EXR =0：
EXR In US
Goods Y
Goods X
EXR
power
gas
0.20
pork
beef
0.14
Orange
from
california
Orange
from fo
0.14
EXR and decision
Substitutes and Complements
 Questions?