Bell Ringer
 Explain the point that
this political cartoon is
making.
Demand, Supply, and Market
Equilibrium
CHAPTER 3
Supply and Demand
3
 Supply and demand is an economic model
 Designed to explain how prices are determined in certain types
of markets
 The price of a good or service is what must be given
in exchange for the good. Price measures the scarcity.
Prices provide our economy with incentives to use
scarce resources efficiently.
Why is the first car more expensive?
4
$105,000
1974 Pontiac Trans AM
$38,000
2009 Pontiac Solstice
Markets
5
 A market is a place (including the internet) where
buyers and sellers are brought together to trade
goods/services

What are some examples of markets?
Buyers and Sellers
6
 Buyers and sellers in a market can be
Households
 Business firms
 Government agencies
 All three can be both buyers and sellers in the same market,
but are not always
 Usually we simplify our examples by saying:
 In markets for consumer goods, we’ll view business firms
as the only sellers, and households as only buyers
 In most of our discussions, we’ll be leaving out the
“middleman”

Competition in Markets
7
 Perfectly
competitive markets have many small
buyers and sellers, e.g., farmer’s market, big city
hot dog market
Each is a small part of the market, and the
product is standardized, and each buyer and
seller takes the market price as a given
 Imperfectly competitive markets have just a few
large buyers and sellers, e.g., local electricity
company
The product of each seller is unique in some
way, each buyer or seller has some influence
over the price.
Using Supply and Demand
8
 Supply and demand model is designed to explain
how prices are determined in perfectly competitive
markets
Perfect competition is rare but many markets come
reasonably close
 Perfect competition is a matter of degree rather than an
all or nothing characteristic

 Supply and demand is one of the most versatile
and widely used models in the economist’s tool kit
Demand
9
 Demand is the specific amount of a good that all
buyers in the market are willing and able to buy
Is there demand if I want a $7000 T.V. but only have
$300 to spend?
 Is there demand if I have $5000 to spend on a fence but I
don’t need a new fence?

Quantity Demanded
10
 Implies a choice
 How much households would like to buy when they take into account
the opportunity cost of their decisions?
 Is hypothetical
 Makes no assumptions about availability of the good
 How much would households want to buy, at a specific price, given
real-world limits on their spending power?
 Stresses price
 Price of the good is one variable among many that influences
quantity demanded
 We’ll assume that all other influences on demand are held constant,
so we can explore the relationship between price and quantity
demanded
The Law of Demand
11
 States that when the price of a good rises and
everything else remains the same, the quantity of
the good demanded will fall (e.g., air travel,
magazines, education, etc)

The words, “everything else remains the same” are
important
In the real world many variables change simultaneously
 However, in order to understand the economy we must first
understand each variable separately
 Thus we assume that, “everything else remains the same,” in order
to understand how demand reacts to price

The Demand Schedule and The Demand
Curve
12
 Demand schedule
A
list showing the quantity of a good that
consumers would choose to purchase at different
prices, with all other variables held constant
 The demand curve shows the relationship
between the price of a good and the quantity
demanded , holding constant all other variables
that influence demand
 Each point on the curve shows the total buyers
would choose to buy at a specific price
 Law of demand tells us that demand curves
virtually always slope downward
Demand Schedule for Maple Syrup in U.S.A.
13
Price
(per bottle)
Quantity Demanded
(Bottles per Month)
$1.00
75,000
2.00
60,000
3.00
50,000
4.00
40,000
5.00
35,000
Figure 1: The Demand Curve
14
Price per
Bottle
When the price is $4.00
per bottle, 40,000
bottles are demanded
(point A).
$4.00
A
B
2.00
At $2.00 per bottle,
60,000 bottles are
demanded (point B).
D
40,000
60,000
Number of Bottles
per Month
Shifts vs. Movements Along
The Demand Curve
15
 A change in the price of a good causes a
movement along the demand curve
A increase in price would cause a movement to the
right along the demand curve
 A decrease in price will cause a movement to the left
along the demand curve

Movements Along The Demand Curve
16
Price
Price increase moves us
leftward along demand
curve
P2
Price decrease moves us
rightward along
demand curve
P1
P3
Q2
Q1
Q3
Quantity
Shifts vs. Movements Along The Demand Curve
17
 Changes such as more income and population
growth lead to the line shifting on the graph
 Example:


Demand curve has shifted to the right of the old curve as
income has risen
A change in any variable that affects demand—except for the
good’s price—causes the demand curve to shift
A Shift of The Demand Curve
18
Price
per
Bottle
An increase in income
shifts the demand curve for
maple syrup from D1 to D2.
At each price, more bottles
are demanded after the
shift
$2.00
B
C
D1
60,000
80,000
D2
Number of Bottles
per Month
Dangerous Curves: “Change in Quantity
Demanded” vs. “Change in Demand”
19
 Language is important when discussing demand
 “Quantity demanded” means
A particular amount that buyers would choose to buy at a specific
price
 It is a number represented by a single point on a demand curve
 When a change in the price of a good moves us along a demand
curve, it is a change in quantity demand


The term demand means
The entire relationship between price and quantity demanded—
and represented by the entire demand curve
 When something other than price changes, causing the entire
demand curve to shift, it is a change in demand

Income: Factors That Shift The Demand
Curve
20
 An increase in income has effect of shifting demand
for normal goods to the right


However, a rise in income shifts demand for inferior goods to
the left
Examples: housing, automobiles, health club memberships,
etc.
 A rise in income will increase the demand for a
normal good, and decrease the demand for an
inferior good (e.g. instant noodles).
Wealth: Factors That Shift The Demand
Curve
21
 Your wealth—at any point in time—is the total value
of everything you own minus the total dollar amount
you owe
 An increase in wealth will


Increase demand (shift the curve rightward) for a normal good
Decrease demand (shift the curve leftward) for an inferior
good
Prices of Related Goods: Factors that
Shift the Demand Curve
22
 Substitute—good that can be used in place of some
other good and that fulfills more or less the same
purpose, e.g., different types of meat

A rise in the price of a substitute increases the demand
for a good, shifting the demand curve to the right
 Complement—used together with the good we are
interested in, e.g., pancake mix and maple syrup

A rise in the price of a complement decreases the demand
for a good, shifting the demand curve to the left
Other Factors That Shift the Demand
Curve
23
 Population
 As the population increases in an area


Number of buyers will ordinarily increase
Demand for a good will increase
 Expected Price
 An expectation that price will rise (fall) in the future shifts the
current demand curve rightward (leftward)
 Tastes
 Combination of all the personal factors that go into determining how
a buyer feels about a good
 When tastes change toward a good, demand increases, and the
demand curve shifts to the right
 When tastes change away from a good, demand decreases, and the
demand curve shifts to the left
Shifts of The Demand Curve
24
Price
Entire demand curve shifts
rightward when:
• income or wealth ↑
• price of substitute ↑
• price of complement ↓
• population ↑
• expected price ↑
• tastes shift toward good
D2
D1
Quantity
Shifts of The Demand Curve
25
Price
Entire demand curve shifts
left when:
• income or wealth ↓
• price of substitute ↓
• price of complement ↑
• population ↓
• expected price ↓
• tastes shift toward good
D1
D2
Quantity
Supply
26
 Supply is the amount of a product that a
producer/supplier is willing and able to
produce
 If they want to produce it but don’t have
the factors of production, then they can’t
produce
 If they own the factors of production but
don’t want to produce then they won’t…
The Law of Supply
27
 States that when the price of a good rises and
everything else remains the same, the quantity of
the good supplied will rise

The words, “everything else remains the same” are
important
 In the real world many variables change simultaneously
 However, in order to understand the economy we must
first understand each variable separately
 We assume “everything else remains the same” in order
to understand how supply reacts to price
The Law of Supply
28
 Think about it this way…
 If
you raise the price of jeans and people are
knocking down the door to purchase them
still…are you going to make more or less of
them?
 If you drop the price what’s going to happen?
Why?
This is why we have clearance racks…
The Supply Schedule and The Supply
Curve
29
 Supply schedule—shows quantities of a good or
service firms would choose to produce and sell at
different prices, with all other variables held
constant
 Supply curve—graphical depiction of a supply
schedule

Shows quantity of a good or service supplied at various prices,
with all other variables held constant
The Supply Curve
30
Price
per
Bottle
When the price is $2.00
per bottle, 40,000 bottles
are supplied (point F).
$4.00
2.00
S
G
At $4.00 per bottle,
quantity supplied is
60,000 bottles (point G).
F
40,000
60,000
Number of Bottles
per Month
Movements Along the Supply Curve
31
 A change in the price of a good causes a movement
along the supply curve
A
rise (fall) in price would cause a rightward
(leftward) movement along the supply curve
Changes in Supply and in Quantity
Supplied
32
Price
S
Price increase moves
us rightward along
supply curve
P2
P1
Price decrease moves
us leftward along
supply curve
P3
Q3
Q1
Q2
Quantity
Shift in the Supply Curve
33
 A drop in transportation costs will cause a shift in the
supply curve itself

Supply curve has shifted to the right of the old curve as
transportation costs have dropped
 Input prices
 A fall (rise) in the price of an input causes an increase
(decrease) in supply, shifting the supply curve to the right (left)
 Price of Related Goods
 When the price of an alternate good rises (falls), the supply
curve for the good in question shifts rightward (leftward)
 Technology
 Cost-saving technological advances increase the supply of a
good, shifting the supply curve to the right
Factors That Shift the Supply Curve
34
 Number of Firms
 An increase (decrease) in the number of sellers—with no other
changes—shifts the supply curve to the right (left)
 Expected Price
 An expectation of a future price increase (decrease) shifts the
current supply curve to the left (right)
Factors That Shift the Supply Curve
35
 Changes in weather
 Favorable weather
Increases crop yields
 Causes a rightward shift of the supply curve for that crop


Unfavorable weather
Destroys crops
 Shrinks yields
 Shifts the supply curve leftward

 Other unfavorable natural events may effect all
firms in an area

Causing a leftward shift in the supply curve
A Shift of The Supply Curve
36
Price
per
Bottle
A decrease in transportation
costs shifts the supply curve for
maple syrup from S1 to S2.
S1
S2
At each price, more bottles
are supplied after the shift
$4.00
G
60,000
J
of Bottles
80,000 Numberper
Month
Changes in Supply and in Quantity
Supplied
37
Price
Entire supply curve shifts
rightward when:
• price of input ↓
• price of alternate good ↓
• number of firms ↑
• expected price ↑
• technological advance
• favorable weather
S1
S2
Quantity
Changes in Supply and in Quantity
Supplied
38
Price
Entire supply curve shifts
rightward when:
• price of input ↑
• price of alternate good ↑
• number of firms ↓
• expected price ↑
• unfavorable weather
S2
S1
Quantity
Equilibrium: Putting Supply and
Demand Together 39
 When a market is in equilibrium
 Both price of good and quantity bought and sold have
settled into a state of rest
 The equilibrium price and equilibrium quantity are
values for price and quantity in the market but, once
achieved, will remain constant

Unless and until supply curve or demand curve shifts
 The equilibrium price and equilibrium quantity
can be found on the vertical and horizontal axes,
respectively

At point where supply and demand curves cross
Market Equilibrium
40
Price
per
Bottle
S
E
$3.00
equilibrium price is $3.00
.
1.00
H
J
D
25,000 50,000 75,000
Number of Bottles
per Month
Excess Demand: Putting Supply and
Demand Together
41
 Excess demand
 At a given price, the excess of quantity demanded over
quantity supplied
 Price of the good will rise as buyers compete with
each other to get more of the good than is available
Market Equilibrium
42
Price
per
Bottle
2. causes the price
to rise . . .
3. shrinking the
excess demand . . .
S
E
$3.00
1.00
1. At a price of $1.00 per
bottle an excess demand of
50,000 bottles . . .
H
Excess Demand
4. until price reaches its
equilibrium value of
.
$3.00
J
25,000 50,000 75,000
D
Number of Bottles
per Month
Excess Supply: Putting Supply and
Demand43Together
 Excess Supply
 At a given price, the excess of quantity supplied over quantity
demanded
 Price of the good will fall as sellers compete with
each other to sell more of the good than buyers want
Excess Supply and Price Adjustment
44
Price
per
Bottle
1. At a price of $5.00 per
bottle an excess supply
of 30,000 bottles . . .
Excess Supply at $5.00 S
$5.00
2. causes the
price to drop,
3.00
3. shrinking the
excess supply . . .
L
K
E
4. until price reaches its
equilibrium value of
$3.00.
D
35,000 50,000 65,000
Number of Bottles
per Month
Income Rises: What Happens When
Things 45Change
 Income rises, causing an increase in demand
 Rightward shift in the demand curve causes rightward
movement along the supply curve
 Equilibrium price and equilibrium quantity both rise
 Shift of one curve causes a movement along the other
curve to new equilibrium point
When One Curve Shifts…
46
Price
per
Bottle
4. Equilibrium
price
increases
3. to a new
equilibrium.
S
F'
$4.00
3.00
2. moves us along
the supply
curve . . .
E
1. An increase in
demand . . .
D2
D1
5. and equilibrium
quantity increases too.
50,000 60,000
Number of Bottles of
Maple Syrup per
Period
An Ice Storm Hits: What Happens When
Things Change
47
 An ice storm causes a decrease in supply
 Weather is a shift variable for supply curve

Any change that shifts the supply curve leftward in a market will
increase the equilibrium price
 And decrease the equilibrium quantity in that market
Figure 10: A Shift of Supply and A New
Equilibrium
48
Price
per
Bottle
$5.00
3.00
S2
S1
E'
E
D
35,000 50,000
Number of Bottles
Both Curves Shift
49
 When just one curve shifts (and we know the
direction of the shift) we can determine the
direction that both equilibrium price and quantity
will move
 When both curves shift (and we know the direction
of the shifts) we can determine the direction for
either price or quantity—but not both

Direction of the other will depend on which curve shifts
by more
Changes in the Market for Handheld PCs
50
Price
3. moved the market to
per
a new equilibrium.
Handhel
d PC
4. Price
decreased . . .
2. and a decrease in
demand . . .
A
$500
B
$400
S2002
S2003
1. An increase in
supply . . .
D2002
5. and quantity
decreased as well.
D2003
2.45
3.33
Millions of Handheld PCs
per Quarter
The Three Step Process
51
 Key Step 1—Characterize the Market
 Decide which market or markets best suit problem being
analyzed and identify decision makers (buyers and sellers)
who interact there
 Key Step 2—Find the Equilibrium
 Describe conditions necessary for equilibrium in the
market, and a method for determining that equilibrium
 Key Step 3—What Happens When Things Change
 Explore how events or government polices change market
equilibrium
Using Supply and Demand: The
Invasion 52of Kuwait
 Why did Iraq’s invasion of Kuwait cause the price of
oil to rise?


Immediately after the invasion, United States led a worldwide
embargo on oil from both Iraq and Kuwait
A significant decrease in the oil industry’s productive capacity
caused a shift in the supply curve to the left

Price of oil increased
The Market For Oil
53
Price per
Barrel of
Oil
S2
S1
E'
P2
E
P1
D
Q2
Q1
Barrels of Oil
Using Supply and Demand: The
Invasion of Kuwait
54
 Why did the price of natural gas rise as well?
 Oil is a substitute for natural gas
 Rise in the price of a substitute increases demand for a good
 Rise in price of oil caused demand curve for natural gas to shift
to the right

Thus, the price of natural gas rose
The Market For Natural Gas
55
Price per
Cubic Foot of
Natural
Gas
S
F'
P4
P3
F
D2
D1
Q3
Q4
Cubic Feet
of Natural
Gas