Introduction to Economics
Eco-101
Lecture # 02
THE PRICE MECHANISM
Demand and Supply Analysis
Instructor: Farhat Rashid
Demand
• Demand indicates how much amount of a
product consumers are both willing and able
to buy at each possible price during a given
time period.
• Emphasis on individual being both willing
and able to buy is called demand.
Demand, Wants, and Needs
• Consumer demand and wants are not the
same thing
– Wants ignore the importance of ability
to buy as expressed by a person’s
budget
• Nor is demand the same as need
– Need focuses on the willingness and
again ignores the ability to purchase
3
Law of Demand
• A fundamental characteristic of demand is
this : All else equal , as price falls , the quantity
demanded rises , and as price rises the
quantity demanded falls.
• In short there is negative or inverse
relationship between price and quantity
demanded.
• Economists call this relationship the law of
demand.
Individual Demand
P
6
Individual
Demand
$5
Qd
10
4
20
3
35
2
55
1
80
Price (per bushel)
P
5
4
3
2
1
0
D
10
20
30
40
50
60
70
80
Quantity Demanded (bushels per week)
Q
Shifts of the Demand Curve
• Demand curve focuses on the relationship
between the price of a good and the quantity
demanded when other factors that could affect
demand remain unchanged
–
–
–
–
–
Money income of consumers
Prices of related goods
Consumer expectations
Number and composition of consumers in the market
Consumer tastes
6
Changes in Consumer Income
• Goods can be classified into two broad
categories depending on how the demand for
the good responds to changes in money income
– Normal goods: the demand increases when income
increases and decreases when income decreases
– Inferior goods: the demand decreases when income
increases and increases when income decreases
NOTE:As income increases, consumers tend to switch from
consuming these goods to consuming normal goods
7
Changes in the Prices of Related Goods
• The prices of other goods are another of the
factors assumed constant along a given demand
curve
• Two general relationships
– Two goods are substitutes if an increase in the price of
one shifts the demand for the other rightward and,
conversely, if a decrease in the price of one shifts the
demand for the other good leftward
– Two goods are complements if an increase in the price
of one shifts the demand for the other leftward and a
decrease in the price of one shifts the demand for the
other rightward
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Changes in Consumer Expectations
• A change in consumer expectations with respect
to future prices and future incomes is another of
the factors which shifts demand
• Changes in income expectations
– If individuals expect income to increase in the future,
current demand increases and vice versa
– If individuals expect prices to increase in the future,
current demand increases and decreases if future
prices are expected to decrease
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Changes in Consumer Tastes
• Tastes are nothing more than a person’s
likes and dislikes as a consumer
• Difficult to say what determines tastes but
clearly they are important
• And whatever factors change taste will
clearly change demand
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Demand Can Increase or Decrease
An Increase in Demand
Means a Movement
of the Line
P
6
Individual
Demand
Qd
10
4
Price
P
$5
A Movement Between
Any Two Points on a
Demand Curve is Called a
Change in Quantity
Demanded
5
3
4
20
3
35
2
2
55
1
1
80
0
D2
Decrease in Demand
2
4
6
8
10 12
Quantity Demanded
D3
14 16 18
D1
Q
Reminder
• Remember the distinction between a movement
along a demand curve and a shift of a demand
curve
• A change in price, other things constant, causes
a movement along a demand curve, changing
the quantity demanded contraction/expansion)
• A change in one of the determinants of demand
other than the price causes a shift of the demand
curve  changing demand (rise/fall)
12
Individual Demand Market Demand
• Individual demand :refers to the demand of an
individual consumer
• Market demand :is the sum of the individual
demands of all consumers in the market
13
From Household Demand to Market
Demand
• Assuming there are only two households in the
market, market demand is derived as follows:
Supply
• Supply indicates how much of a good producers
are willing and able to offer for sale per period
at each possible price, other things constant
• Law of supply states that the quantity supplied is
usually directly related to its price, other things
constant
– The lower the price, the smaller the quantity
supplied
– The higher the price, the greater the quantity
supplied
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Law of Supply
• Two reasons producers tend to offer more for
sale when the price rises
• First, as the price increases, other things
constant, a producer becomes more willing to
supply the good
– Prices act as signals to existing and potential suppliers
about the rewards for producing various goods 
higher prices attract resources from lower-valued
uses
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Determinants of supply
•
•
•
•
•
Resource prices
Technology
Taxes and subsidies
Number of sellers
Producers expectations
Individual Supply and Market Supply
• Individual supply refers to the
supply of an individual producer
• Market supply is the sum of
individual supplies of all
producers in the market
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Market Supply
• As with market demand, market supply is the
horizontal summation of individual firms’
supply curves.
Reminder
• Remember the distinction between a
movement along a supply curve and a shift
of a supply curve
• A change in price, other things constant,
causes a movement along a supply curve,
changing the quantity supplied
• A change in one of the determinants of
supply other than the price causes a shift
of the supply curve  changing supply
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Equilibrium
• When the quantity that consumers are willing
and able to pay equals the quantity that
producers are willing and able to sell, the market
reaches equilibrium  the independent plans of
both buyers and sellers exactly match  market
forces exert no pressure to change price or
quantity
21
Disequilibrium Prices
• Markets do not always reach equilibrium quickly
and during the time required for adjustment, the
market is in disequilibrium
• Disequilibrium is usually temporary as the
market gropes for equilibrium
• Sometimes, as a result of government
intervention in markets, disequilibrium can last a
long time
22
Market Disequilibria
• Excess demand, or
shortage, is the condition
that exists when quantity
demanded exceeds quantity
supplied at the current
price.
•
When quantity demanded
exceeds quantity supplied, price
tends to rise until equilibrium is
restored.
Market Disequilibria
• Excess supply, or surplus, is
the condition that exists
when quantity supplied
exceeds quantity demanded
at the current price.
•
When quantity supplied exceeds
quantity demanded, price tends to
fall until equilibrium is restored.
Change in Market Equilibrium
• Changes in Demand
• Changes in Supply
• Changes in Equilibrium
Changes in Equilibrium
• Once a market reaches equilibrium, that price
and quantity will prevail until one of the
determinants of demand or supply changes
• A change in any one of these determinants will
usually change equilibrium price and quantity in
a predictable way
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Increases in Demand and Supply
• Higher demand leads to higher • Higher supply leads to lower
equilibrium price and higher
equilibrium price and higher
equilibrium quantity.
equilibrium quantity.
Shifts of the Supply Curve
• An increase in supply  a rightward shift of the
supply curve reduces the equilibrium price but
increases equilibrium quantity
• On the other hand, a decrease in supply  a
leftward shift of the supply curve increases
equilibrium price but decreases equilibrium
quantity
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Decreases in Demand and Supply
• Lower demand leads to
lower price and lower
quantity exchanged.
• Lower supply leads to
higher price and lower
quantity exchanged.
Summary
• If demand and supply shift in opposite
directions, we can say what will happen to
equilibrium price
– It will increase if demand increases and supply
decreases
– It will decrease if demand decreases and supply
increases
• Without reference to the size of the shifts, we
cannot say what will happen to equilibrium
quantity
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ASSIGNMENT # 1:
SHOW THESE SIMULTANEOUS SHIFTS IN DEMAND AND
SUPPLY WITH THE HELP OF GRAPHS.
D >
in D >
in D >
in D >
in D =
in D =
in D =
in D =
in D <
in
in S
in S
in S
in S
in S
in S
in S
in S
I in S
in D <
in D <
in D <
in S
in S
in S
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