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R. Larry Reynolds 
Fall ‘ 97
Principles of Microeconomics
slide 1
Demand and Supply
· Markets as allocative mechanism require:
· nonattenuated property rights
[exclusive, enforceable, transferable]
· “voluntary” transactions
· Markets include all “potential buyers and
sellers”
· behavior of buyers is represented by “demand”
[benefits side of model]
· behavior of sellers is represented by “supply”
[cost side of model]
Fall ‘ 97
Principles of Microeconomics
slide 2
Markets, Supply and Demand
· markets include all potential buyers
and sellers
· geographic boundaries of market
· markets defined by nature of product
and characteristics of buyers
· conditions of entry into market
· markets, competition and substitutes
Fall ‘ 97
Principles of Microeconomics
slide 3
Demand
· Definition: “A schedule of the quantities
of a good that buyers are willing and able
to purchase at each possible price during a
period of time, ceteris paribus. [all other
things held constant]”
· Demand can also be perceived as a schedule
of the maximum prices buyers are willing
and able to pay for each unit of a good.
Fall ‘ 97
Principles of Microeconomics
slide 4
Demand Function
· Is the functional relationship between the
price of the good and the quantity of that
good purchased in a given time period [UT],
income, other prices and preferences being
held constant.
· A change in income, prices of other goods
or preferences will alter [‘shift’] the
demand function.
Fall ‘ 97
Principles of Microeconomics
slide 5
Quantity demanded
· A change in the price of the good under
consideration will change the “quantity demanded.”
· Q = f (P, holding M, Pr , preferences constant);
where: M = income
Pr = prices of related goods
 DP causes a change in X [DQ], this is a “change in
quantity demanded”
Fall ‘ 97
Principles of Microeconomics
slide 6
Change in demand
· If M, Pr, or preferences change, the demand
function [relationship between P and Q] will
change.
· These are sometimes called “demand shifters”
· Be sure to understand difference between a
“change in demand” and a “change in quantity
demanded”
· change in demand --- shift of the function
· change in quantity demanded --- move on the function
Fall ‘ 97
Principles of Microeconomics
slide 7
“Law of Demand”
· Theory and empirical evidence
suggest that the relationship between
Price and Quantity is an inverse or
negative relationship
· At higher prices, quantity purchased
is smaller, or at lower prices the
quantity purchased is greater.
Fall ‘ 97
Principles of Microeconomics
slide 8
An example of hot chocolate:
There is a coffee cart in the building that primarily serves the
individuals who work in the building. The market is defined to some
extent by the geography of the building. Individuals who buy the
hot chocolate rarely come from other buildings to purchase a cup.
During the time period [UT]under consideration [8:00-9:00am on
a week day ] the incomes and preferences of buyers are unlikely to
change. The prices of coffee, lattes, etc. can be controlled by the
vendor and the price of soft drinks from the machines remains
constant. The number of workers in the building remain at a
constant level.
Under these circumstances, we observe the number of cups of hot
chocolate [H] sold each morning as the price [P] is changed.
From these observations the demand relationship is estimated.
Fall ‘ 97
Principles of Microeconomics
slide 9
Cupsof Hot Chocolate[H] purchased
eachdaybetween8-9am
price
per cup
cups
purchased
A
0
20 .
B
$ .50
15 .
C
$ .75
12 . 5
D
$ 1. 00
E
$ 1. 25
7.5
F
$ 1. 50
5.
G
$ 1. 75
2.5
H
$ 2 . 00
0
DP > 0
[+.75]
10 .
DQ < 0
[-7.5]
The demand relationship
can be demonstrated as a
table:
Demand is a schedule of
quantities that will be
purchased at a schedule
of prices during a given
time period, cet. par.
As the price is increased,
the quantity purchased
decreases.
This demand relationship can be expressed as an equation:
P = 2 - .1Q or Q = 20 - 10P: [Q = f (P, . . .) but we graph P on
the Y axis and Q on the X axis.]
Fall ‘ 97
Principles of Microeconomics
slide 10
PRICE
The demand relationship can be expressed as a table
(previous slide) or an equation [either P = 2 - .1Q or Q = 20 - 10P]
The data from the table or equation can be graphed:
$
2.25
2.00
1.75
1.50
1.25
P = $2, Then Q = 0
..
1.00
.75
..
.50
.25
2
4
6
8
P = $1.75, then Q = 2.5
P = $1.50, then Q = 5
P = $1.25, Q = 7.5
..
10 12 14
P = $1, then Q = 10
P = 0, then Q = 20
Demand
16 18 20
22 24
QUANTITY
The demand function can be represented as a table, {CUPS/UT}
an equation or a graph.
Fall ‘ 97
Principles of Microeconomics
slide 11
The demand equation P = 2 - .1Q was graphed
PRICE
A change in “quantity demanded” is a movement on the demand
function caused by a change in the independent variable [ price].
DP from $1.50 to $1 causes DQ from 5 to 10 units
2.25
.
2.00
1.75
A change in quantity demanded is a move
from point A to B “on the demand function”
caused by a change in the price!
A
1.50
1.25
.
B
1.00
.75
Demand [P = 2 - .1Q]
.50
.25
QUANTITY
2
Fall ‘ 97
4 5 6
8
10 12 14 16 18 20 22 24
Principles of Microeconomics
{CUPS/ UT}
slide 12
The demand equation P = 2 - .1Q was graphed
A change in any of the parameters (income, price of related goods,
preferences, population of buyers, etc.) will cause a “shift of the
demand function.” In this example, the intercepts have changed,
PRICE
the slope has remained constant
2.50
2.25
2.00
1.75
an increase in demand
D’ [ P’ = 2.5 - .1Q]
1.50
1.25
1.00
.75
Demand [P = 2 - .1Q]
.50
.25
2
4
6
8
10 12 14
16 18 20 22 24
D`` [P`` = 1.5 .1Q]
Fall ‘ 97
Principles of Microeconomics
QUANTITY
{CUPS/UT}
slide 13
PRICE
2.50
2.25
2.00
1.75
buyers are more responsive to DP
1.50
P` = 2- .048076923Q
1.25
1.00
.75
.50
.25
buyers
a decrease in the
are less
slope
responsive an increase in
Demand [P = 2 - .1Q]
the slope
to DP
P = 2 - .25Q
2
4
6
8
10 12 14
16 18 20
22 24
QUANTITY
{CUPS/UT}
A change in the parameters [income, Pr, preferences, population,
etc.] might alter the relationship by changing the slope
A change in demand refers to a movement or shift of the entire
demand function
Fall ‘ 97
Principles of Microeconomics
slide 14
PRICE
2.50
An increase in demand
2.25
2.00
1.75
results in a larger quantity being
purchased at each price
increase
1.50
1.25
D2
1.00
[an increase in demand]
.75
Demand [P = 2 - .1Q]
.50
.25
Q = 7.5
2
4
6
8
10 12 14
16 18 20 22 24
QUANTITY
{CUPS/UT}
In this case, an increase in demand results
in an increase in the amount that will be purchased at a price of
$1.25. At this price the Quantity purchased increases from 7.5
to 18. An increase in demand!
Fall ‘ 97
Principles of Microeconomics
slide 15
PRICE
Effect of a change in the price of a
substitute
2.50
2.25
2.00
1.75
1.50
1.25
1.00
.75
.50
D2
.25
2
4
6
8
10 12 14
Demand [P = 2 - .1Q]
16 18 20 22 24
If the price of a substitute, like chicken, increases
buyers will buy more steak at each price of steak
QUANTITY
[steak /UT]
If the price of chicken decreases, the buyers will want less steak at
each possible price of steak; the demand for steak decreases!
Fall ‘ 97
Principles of Microeconomics
slide 16
Complementary goods
Two goods may be complimentary, i.e. the two goods are
“used together. [tennis rackets and tennis balls or CD’s
and CD Players]
An increase in the price of CD’s will tend to reduce the
demand [shift the demand function to the left] for CD Players
PCD’s
P2
As people buy fewer
CD’s, the demand for
CD players decreases.
Pplayers
As the price of CD’s increases
from P1 to P2, the quantity of
CD’s decreases from Y1
to Y.
Ppl
At the same price,
Ppl , the demand
is reduced
from Dto D’.
D’player
Dcd
P1
Y
Fall ‘ 97
Y1 CD’s/UT
Principles of Microeconomics
X
Dplayer
X1 CD Players
per
UT17
slide
Compliments and Substitutes
· Substitutes:
· if the price of a substitute increases, the
demand for the good increases.
· if the price of a substitute decreases, the
demand for the good decreases.
· Compliments:
· if the price of a compliment increases, the
demand for the good decreases.
· if the price of a compliment decreases, the
demand for the good increases.
Fall ‘ 97
Principles of Microeconomics
slide 18
Demand Summary
· “Law of Demand” holds that usually as the
price of a good increases, individuals will
buy less of it.
· The nature of this relationship is
influenced by a variety of other variables;
· income, preferences, prices of related
goods, and other circumstances
· as these circumstances change, the
demand relationship changes or “shifts.”
Fall ‘ 97
Principles of Microeconomics
slide 19
Demand Summary [cont. . . ]
· A “change in demand” means the relationship
between price and quantity was altered by a
change in some other variable [a demand “shifter”]
The demand “shifts.”
· A “change in quantity demanded” is a change in the
quantity bought that was caused by a change in
the price of the good. There is a movement on the
demand function.
Fall ‘ 97
Principles of Microeconomics
slide 20
Supply
· Supply is defined as a schedule of
quantities of a good that will be produced
and offered for sale at a schedule of
prices during a given time [UT], ceteris
paribus.
· Generally, producers are willing to offer
greater quantities of a good for sale at
higher prices; a positive relationship
between price and quantity supplied.
Fall ‘ 97
Principles of Microeconomics
slide 21
Supply Schedule
Observation
Price
Quantity
Supplied
A
$1
6
B
$2
10
C
$3
14
D
$4
18
$5
22
The information can be represented
on a graph by plotting each
price quantity combination.
E
F
Both the graph and the table
represent a supply
relationship: Q = 2 + 4P
A supply schedule can be
displayed as a table.
Fall ‘ 97
P
$5
.
.
$4
$3
.
$2
$1
2
4
Principles of Microeconomics
6
8
10 12 14
slide 22
.
Q
Change in Quantity Supplied
· A change in the price of the good
causes a change in the “quantity
supplied.”
· The change in the price of the good
causes a “movement on the supply
function,” not a change or “shift of
the supply function.”
Fall ‘ 97
Principles of Microeconomics
slide 23
Supply Schedule
Observation
A
B
C
D
Price
Quantity
Supplied
A change in the price “causes” a
$1
6
$1
change in the “quantity supplied.”
$2 DP “CAUSES”
10
DQThis can be represented by a
“movement” on the supply
$3
14
$3
function in the graph
$4
18
E
F
$5
22
This is a change in “quantity
supplied.” Not to be
confused with a “change in
supply!”
DP from $1 to
$3
Fall ‘ 97
P
$5
$4
DP “causes” the quantity supplied
to increase from 6 to 14.
$3
$2
$1
2
4
6
Principles of Microeconomics
8
10 12
14 16
slide 24
Q
/ut
“Change in Supply”
· A change in supply [like a change in demand]
refers to a change in the relationship
between the price and quantity supplied.
· A change in supply is “caused” by a change
in any variable, other than price, that
influences supply
· A change in supply can be represented by a
shift of the supply function on a graph
Fall ‘ 97
Principles of Microeconomics
slide 25
“Change in Supply” [cont. . . ]
· There are many factors that infuence the
willingness of producers to supply a good.
·
·
·
·
technology
prices of inputs
returns in alternative choices
taxes, expectations, weather, number of
sellers, . . .
· Qs = fs (P, Pinputs, technology, . . .)
Fall ‘ 97
Principles of Microeconomics
slide 26
“Change in Supply” [cont. . . ]
· Qs = fs (P, Pinputs, technology, number of
sellers, taxes, . . .)
· A change in the price [P] causes a “change
in quantity supplied;”
· a change in any other variable causes a
“change in supply”
Fall ‘ 97
Principles of Microeconomics
slide 27
Supply Schedule
Given the supply schedule,
An increase in the prices
of inputs would make it
more expensive to produce
each unit of output,
therefore, the supply
decreases
Observation
Price
Quantity
Supplied
A
$1
B
$2
C
$3
D
$4
46
810
1214
16
18
$5
22
20
E
P
$5
F
a shift to the left
is a decrease in supply
The decreased quantity
at each price “shifts” the
supply curve to the left!
$4
$3
$2
$1
2
4
Fall ‘ 97
6
8
10
12 14
16
Q
The development of a “new”
technology that reduces the
cost of production will “shift”
the supply function to the right
Principles of Microeconomics
slide 28
Equilibrium
· Equilibrium: 1. a state of rest or balance due to
the equal action of opposing forces. 2. equal
balance between any powers, influences, [Webster’s
Encyclopedic Unabridged Dictionary of the English Language]
· In a market an equilibrium is said to exist when
the forces of supply [sellers] and demand [buyers] are
in balance: the actions of sellers and buyers are
coordinated. The quantity supplied equals the
quantity demanded!
Fall ‘ 97
Principles of Microeconomics
slide 29
100
Given a demand
function [which
90
80
represents the
behavior or choices
of buyers,
$70
70
60
50
and a supply function
that represents the
behavior of
sellers,
40
30
20
10
10
20
30
40
50 60
60
70
80
90 100 110 120 130
Qx/ UT
Where the quantity that people want to buy is equal to the quantity
that the producers want to sell, there is an equilibrium quantity.
The price that coordinates the preferences of the buyers and sellers
is the equilibrium price.
At the equilibrium price of $70, the quantity supplied is equal to
the quantity demanded.
Fall ‘ 97
Principles of Microeconomics
slide 30
When the price is greater than the equilibrium price, the
amount that sellers want to sell at that price [quantity supplied]
exceeds the amount that buyers are willing to purchase [quantity
demanded] at that price. The price is “too high.”
At a Price of $90 the quantity supplied is 80, the quantity demanded is 35
surplus = 45
100
90
$90
$70
70
60
50
40
30
20
10
10
Fall ‘ 97
At $90 there is a surplus
of 45 units [80-35=45]
equilibrium price
equilibrium quantity
80
20
303540
50 60
60
70
80
80
Principles of Microeconomics
90 100 110 120 130
Qx/ UT
slide 31
surplus = 45
100
90
$90
.
lower
price
80
$70
70
60
Suppliers have more to sell than
buyers will purchase at a price of $90.
To get rid of these unsold
units [inventory], the
Quantity
sellers lower
supplied
decreases
the price.
50
40
Quantity
demanded
increases
30
20
At a price of $90 a surplus
of 45 units exists
10
10
20
303540
50 60
60
70
80
80
90
100 110 120 130
Qx/ UT
As the price of the good is reduced, the quantity supplied decreases.
The quantity demanded increases as the price falls.
As the price moves toward equilibrium, quantity supplied and
quantity demanded are brought into equilibrium.
.
Fall ‘ 97
Principles of Microeconomics
slide 32
100
As a result of market forces
the market moves to
.
equilibrium
90
80
$70
70
60
50
40
30
$30
20
10
price
rises
quantity
supplied
increases
10 1520
30 40
At a price below equilibrium the
the quantity demanded exceeds
the quantity supplied.
At a price of $30 the quantity
demanded is 110. The quantity
supplied is 15.
quantity
demanded
decreases
shortage = 95
50
60
60
70
80
90 100 110
110 120 130
Qx/ UT
At a price of $30 the quantity demanded exceeds the quantity
supplied by 95 units [110 - 15 = 95]. This is a shortage.
Since the buyers cannot obtain all they want at a price of $30, some buyers will
offer to pay more. Some buyers will not pay the higher price, they buy less so the
quantity demanded decreases. At the higher price the quantity supplied increases
..
Fall ‘ 97
Principles of Microeconomics
slide 33
100
90
$89
80
$70
70
demand
increases
The market for good X is
price
rises
in equilibrium at Px = $70
60
50
40
equilibrium
quantity
increases
30
20
10
10 20 30 40 50 60
60 70 80
80 90 100 110 120 130
An increase in the price of a
substitute [good Y] causes the
demand for good X to increase.
As a result of the increased demand,
market forces push Px up.
Fall ‘ 97
Qx/ UT
The increase in the demand for
good X results in an increase in
both the equilibrium price and
quantity.
Identify other factors that could
increase demand!
Principles of Microeconomics
slide 34
100
90
80
70
$70
60
$50.89
50
40
30
Given a demand function,
an equilibrium is defined.
A decrease in demand,
establishes a new equilibrium
at a lower price and
quantity.
20
10
10 20 30 39.2
40 50 660
0 70 80 90 100 110 120 130
Demand might be reduced by:
a decrease in the price of a substitute,
an increase in the price of a compliment,
a change in income,
a change in the number of buyers
or their preferences, or, . . .
.
Fall ‘ 97
Principles of Microeconomics
Qx/ UT
A change in the
price of the good
does not change
demand! It changes
the quantity
demanded.
slide 35
100
S2
90
80
$70
70
price
60 falls
supply
increases
50
$50
40
30
20
10
10 20 30 40 50 60
60 70 8086
90 100 110 120 130
Given an equilibrium
condition in a market,
an increase in supply will
increase the equilibrium
quantity and decrease
equilibrium P.
Fall ‘ 97
Quantity
increases
Qx/ UT
Identify
1.
2.
3.
4.
Principles of Microeconomics
factors that increase supply:
fall in price of inputs
improved technology
increase in number of sellers
fall in return in alternative
uses of inputs
5. or, . . .
slide 36
A decrease in supply causes the equilibrium price to increase
and equilibrium quantity to decrease. What forces might cause the
S1
100
decrease in supply
$90
90
80
price rises
70
$70
supply to decrease?
1. an increase in the prices
of inputs
2. increase in returns from
alternative actions
3. problems in technology
[regulations, . . . ]
4. decrease in number of
sellers or producers
60
50
40
quantity
decreases
30
20
10
10 20 3035
40 50 6
600 70 80 90 100 110 120 130
Fall ‘ 97
Principles of Microeconomics
Qx/ UT
slide 37
demand
increases
100
90
80
70
$70
60
price might
go up or down
or stay the same
50
40
30
20
supply
increases
10
10 20 30 40
and decrease
price
+DP
-DP
increase
S2 If both supply and
and
increase
price
results in
increase
a market
force to
results
in
increase
a market Q
demand decrease,
the DP will be
indeterminate and
the equilibrium Q
will decrease.
D2
force to
increase Q
50 660
100 110 120 130
0 70 80 90 100
Qx/ UT
When demand and supply both shift, the resultant effect on either
equilibrium price or quantity will be indeterminate.
Both the increase in demand and supply increase quantity; equilibrium Q increases.
The increase in demand pushes price up. The increase in supply pushes price down.
The change in price may be positive or negative, it depends on the magnitude
of the shifts in and slopes of demand and supply.
Fall ‘ 97
Principles of Microeconomics
slide 38
A decrease in supply tends to increase P and reduce Q.
An increase in demand tends to increase both P and Q.
Result is that Price will rise, Quantity may increase, decrease or stay the same
depending on the magnitudes of the shifts and slopes of supply and demand.
In this example,
Price
the price
$105
increases to
100
$105.
90
When supply
80
increases and $70
70
demand
60
decreases,
the price will
50
fall but the
40
change in Q
30
will be
20
indeterminate!
S1
to push
price up
decrease in supply
pushes
price up
reducesand
quantityincrease
Q
an increase in
demand tends
D2
10
10 20 303540 49
50 60
60 70 80 90 100 110 120
Fall ‘ 97
the quantity decreases to 49
Principles of Microeconomics
Qx/ UT
slide 39
Supply and Demand Analysis
· Supply and demand is a simplistic model that
provides insights into the effects of events that
are related to a specific market.
· Whether an event will tend to cause the price of a
good to increase or decrease is of importance to
decision makers.
· To estimate the magnitude of price and quantity
changes more sophisticated models are needed.
Fall ‘ 97
Principles of Microeconomics
slide 40