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ECON 1023 SPRING 2012
Instructor: Gibson Nene
Lecture Notes: Demand and Supply and Market Equilibrium
Source: Microeconomics Brief Edition, First Edition by McConnell, Brue and
Flynn.
This handout has 29 printed pages.
Markets Defined
A.
A market is an institution or mechanism that brings together buyers (demanders) and sellers (suppliers) of particular goods and services.
1.
A market may be local, national, or international in scope.
2.
Some markets are highly personal, face-to-face exchanges; others are impersonal and remote.
3.
Product market involves goods and services.
4.
Resource market involves factors of production.
B.
The goal of the chapter is to explain the way in which markets adjust to changes and the role of prices in determining how much markets will produce.
Demand
A.
Demand is a schedule or curve that shows the various amounts of a product that consumers will purchase at each of several possible prices during a specified time period .

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An example of an individual’s demand schedule for orange juice per month
Price($ per gallon)
7
6
Quantity demanded (gallons)
2
4
5
4
3
2
1
6
8
10
12
14
1.
The schedule shows how much gallons of orange juice the buyer is willing and able to purchase at seven possible prices per month.
2.
The demand schedule alone does not tell us the market price ; that depends on both demand and supply .
3.
To be meaningful, the demand schedule must have a period of time associated with it.
B.
Law of demand is a fundamental characteristic of demand behavior.
1.
All else equal (all other things equal) as price increases , the corresponding quantity demanded falls . a.
In other words, there is an __________ relationship between price and quantity demanded.

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2.
Note the “other-things-equal” assumption refers to consumer income and tastes, prices of related goods , and other things besides the price of the product being discussed.
3.
The law of demand is consistent with common sense and observed behaviors.
C.
The demand curve:
1.
Illustrates the inverse relationship between price and quantity
(see latte example, Figure 3.1).
2.
The downward slope indicates lower quantity (horizontal axis) at higher price (vertical axis), higher quantity at lower price, reflecting the Law of Demand .

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D.
Individual demand versus market demand:
1.
Transition from an individual to a market demand schedule is accomplished by summing individual quantities at various price levels .
2.
Market curve is a ____________ sum of individual curves.
Intentionally left blank

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The market demand curve
Market demand for orange juice, for three individuals
6
7
Price,
$
Quantity demanded
Gibson
2
4
+ 1
2
+
Jacob
+
+
0
1
Mike
Total
5
6
+
4 + 2
3
2
4
8
10
+
+
6
8
+
+
4
6
12 + 10 + 8
1 14 12 10
+ +
Note: we are assuming a market with only three orange juice consumers above. The three consumers are Gibson, Jacob and Mike.

The market demand curve for the three individuals
6

7
3
2
5
4
1
7
6
Suppose, if we sum all the various monthly orange juice demanded by consumers for a specific month in New York, we arrive at the demand schedule below.
The market demand curve for orange juice for the city of
New York
Price($ per gallon) Quantity demanded(millions of gallons)
100
200
300
400
500
600
700

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Changes in demand
There are several determinants of demand or the “other things,” besides price, which affect demand. Changes in these determinants cause changes in demand and shift the demand curve.
Increase and decrease in demand illustration
Determinants of demand a.
Consumer tastes
—-favorable changes lead to increases in demand; unfavorable changes decrease demand. b.
Number of buyers
—more buyers lead to an increase in demand; fewer buyers lead to a decrease. c.
Income
—more leads to an increase in demand; less leads to decrease in demand for normal (or superior) goods. Goods

9 whose demand varies inversely with income are called inferior goods. d. Prices of related goods also affect demand . i. Substitute goods are those that can be used in place of each other. ii. Complementary goods are those that are used together like ____________________ . If the price of _______ increases , demand for ___________ should decrease . e. Expectations—consumer views about future prices, product availability, and income can shift demand. These expectations can also become a self-fulfilling prophecy – buyers attempting to stock up goods in anticipation of a price increase may cause or contribute to that price increase.
1.
A summary of what can cause an increase in demand: a.
Favorable change in consumer tastes. b.
Increase in the number of buyers. c.
Rising income if product is a normal good. d.
Falling incomes if product is an inferior good. e.
Increase in the price of a substitute good. f.
Decrease in the price of a complementary good. g.
Consumers expect higher prices or incomes in the future.

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2.
A summary of what can cause a decrease in demand: a.
Unfavorable change in consumer tastes. b.
Decrease in number of buyers. c.
Falling income if product is a normal good. d.
Rising income if product is an inferior good. e.
Decrease in price of a substitute good. f.
Increase in price of a complementary good. g.
Consumers’ expectations of lower prices or incomes in the future.
A change in quantity demanded versus a change in demand
A change in quantity demanded is caused by a price change and a change in demand is caused by change in determinants .
A change in quantity demanded:

The demand schedule remains the same.

Involves a movement along a fixed or the original demand curve.
A change in demand:

The demand schedule changes.

The demand curve shifts .
Intentionally left blank

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Supply
A.
Supply is a schedule that shows amounts of a product that producers will make available for sale at each of a series of possible prices during a specific period .
A supply schedule for Forbes, an individual orange juice producer
Price($ per gallon) Quantity Supplied (gallons)
7
6
5
4
80
70
60
50
3
2
40
30
1 20
1.
The schedule shows what quantities will be offered at various prices or what price will be required to induce various quantities to be offered .
B.
Law of supply:
1.
Producers will produce and sell more of their product at a high price than at a low price.
2.
Restated: There is a _______ relationship between price and quantity supplied .
3.
Given product costs, a higher price means greater profits and thus an incentive to increase the quantity supplied .

Forbes’s individual supply curve:
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3
2
4
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Market supply
Market supply is derived from individual supply by “horizontally adding” the supply curves of the individual producers.
Market supply for orange juice, for three individuals in New York
6
7
Price,
$
Quantity supplied
80
Forbes
+
70
Peter
+
70 60
+
+
60
50
Jack
Total
5 60
+
50
+
40
50
+
40
+
30
40
30
+
+
30
20
+
+
20
10
1 20 10 0
+ +

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Note: we are assuming a market with only three orange juice producers above. The three consumers are Forbes, Peter and Jack.
Market demand curve for orange juice for the three individuals

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Suppose, if we sum all the various monthly orange juice supplied by producers for a specific month in New York, we arrive at the supply schedule below.
Market supply curve for orange juice in New York
Price($ per gallon) Quantity supplied(millions of gallons)
7
6
5
1300
1100
900
2
1
4
3
700
500
300
100

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A change in supply, an illustration
Determinants of supply:
1.
A change in any of the supply determinants causes a change in supply and a shift in the supply curve. An increase in supply involves a rightward shift , and a decrease in supply involves a leftward shift . Many supply shifts involve changes in production costs, so another way to sort out the effect of a particular change is to ask,
“How does this affect the cost of production?”

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Six basic determinants of supply, other than price a.
Resource prices
—a rise in resource prices will cause a decrease in supply or leftward shift in the supply curve; a decrease in resource prices will cause an increase in supply or rightward shift in the supply curve. b.
Technology
—a technological improvement means more efficient production and lower costs, so an increase in supply, or rightward shift in the curve, results. c.
Taxes and subsidies
—a business tax is treated as a cost, so decreases supply; a subsidy lowers cost of production, so increases supply. d.
Prices of related goods
—if price of substitute production good rises, producers might shift production toward the higher priced good, causing a decrease in supply of the original good. Note that these are substitutes from the sellers’ perspective that may not be strong substitutes from a buyers’ perspective. e.
Expectations
—expectations about the future price of a product can cause producers to increase or decrease current supply. (These expectations can also become a selffulfilling prophecy – firms reducing supply in anticipation of a price increase may cause or contribute to that price increase.)
f. Number of sellers
—generally, the larger the number of sellers the greater the supply.

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A change in quantity supplied versus a change in supply
A change in quantity supplied is due to price changes and a change or shift in supply due to change in determinants of supply .
A change in quantity supplied:

The supply schedule remains the same.

Involves a movement along a fixed or the original supply curve.
A change in supply:

The supply curve changes.

The demand curve changes or shifts.
Supply and Demand: Market Equilibrium
A. The equilibrium price and equilibrium quantity represent where the intentions of buyers and sellers match.
Intentionally left blank

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Demand and supply schedules for orange juice in New York
Quantity supplied(millions of gallons)
Price($ per gallon)
Quantity demanded(millions of gallons)
Surplus
(+) or shortage
(-)
1300 7 100 +1200
1100
900
700
6
5
4
200
300
400
+900
+600
+300
500
300
3
2
500
600
0
-300
100 1 700 -600
At what price and quantity is quantity supplied equal to quantity demanded?
Price= $3, Quantity=500 million gallons
What is the equilibrium price and quantity in the New York orange juice market?
Price= $3, Quantity=500 million gallons

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Excess supply and excess quantity demanded (shortage)
1. Excess supply occurs at prices above the market equilibrium.
2. An excess quantity demanded or shortage occurs at prices below the market equilibrium.
The market clearing or market price is another name for equilibrium price.
Graphically
The equilibrium price and quantity are where the supply and demand curves intersect. It is the point where quantity demanded equals quantity supplied.

Very important****: It is NOT correct to say supply equals demand!
Changes in Supply and Demand, and Equilibrium
A. Changing demand with supply held constant:
1.
An increase in demand with supply held constant
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2.
Decrease in demand with supply held constant
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Changing supply with demand held constant:
1. An increase in supply will have effect of decreasing equilibrium ________ and increasing ___________ .

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2.
Decrease in supply will have effect of increasing equilibrium
________ and decreasing _____________ .

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What happens when both supply and demand shift?
1. If supply increases and demand decreases, _______ declines, but the new equilibrium ____________ depends on the relative sizes of shifts in demand and supply .

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2.If supply decreases and demand increases, _________ rises , but the new equilibrium ___________ depends again on the relative sizes of shifts in demand and supply .

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3.
If supply and demand change in the same direction (both increase or both decrease), the change in equilibrium quantity will be in the direction of the _____ but the change in equilibrium _____ now depends on the relative shifts in demand and supply .

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Government-Set Prices (Ceilings and Floors)
A.
Government-set prices prevent the market from reaching the equilibrium price and quantity, usually because the government has been persuaded that market prices are unfairly high to buyers, or unfairly low to sellers.
B.
Applying the Analysis: Price ceilings on Gasoline
1.
A price ceiling sets a maximum legal price that a seller may charge, typically placed ________ equilibrium .
2.
If the equilibrium price of gasoline is $3.50, a price ceiling of
$3 will result in persistent shortages as quantity demanded exceeds quantity supplied at the $3 price.
3.
Shortages would change the rationing mechanism from price to some other system (first-come, first served; rationing coupons; favoritism), and may result in the emergence of black markets (illegal selling above the government set price).

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C. Applying the Analysis: Price Floors on Wheat
1. A price floors sets a minimum legal price a seller may charge, typically placed _______ the equilibrium price .
2. If the equilibrium price for wheat is $2, a price floor of $3 will result in persistent surpluses, as quantity supplied exceeds quantity demanded at the $3 price.
3. Government may attempt to rectify this excess supply of wheat by restricting supply, stimulating demand in the private sector, or purchasing the wheat themselves.
4. Price floors of wheat cause society to misallocate resources, both in terms of an inefficient mix of products, and the environmental damage resulting from brining land into production. marginal

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