Chapter 3
Supply, Demand, and the Market
Process
1
Overview
1. Demand

the demand curve

consumer surplus

quantity demanded vs. demand

shifters of demand
2. Supply
 the supply curve
 producer surplus
 quantity supplied vs. supply
 shifters of supply
2
Overview
3. Market Equilibrium
 Efficiency
 Single and double shifts of supply and
demand
4. The invisible hand
3
The Demand Curve
Law of demand: There is an inverse
(negative) relationship between the price
of a good and the quantity that buyers are
willing to purchase
Results in a downward sloping demand
curve.
4
The Demand Curve
Ex. Deriving the Demand Curve
*Note*: As price increases, quantity
demanded decreases.
5
The Demand Curve
The height of the demand curve at any
quantity shows the maximum price that
consumers are willing to pay for an
additional unit.
Notice that when consumers have more of
the good they value it less.
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Consumer surplus
Consumer surplus: The difference
between the maximum amount consumers
would be willing to pay and the amount
that they actually pay.
Consumer surplus is the area below the
demand curve but above the price.
ex. What happens if price falls? rises?
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Demand vs. Quantity Demanded
Change in quantity demanded: A
movement along the curve
Caused by: a change in the price of that
good
 Increase in quantity demanded:
movement down the curve (to the right)
 Decrease in quantity demanded:
movement up the curve (to the left)
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Demand vs. Quantity Demanded
Change in demand: a shift of the curve
Caused by: a change in anything that affects
demand other than the price of the good


Increase in demand: curve shifts right
Decrease in demand: curve shifts left
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Shifters of Demand
1. Change in consumer income
A. Normal goods (Steak)
B. Inferior goods
Ramen Noodles
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Shifters of Demand
2. Change in number of consumers
Ex. Change in class size
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Shifters of Demand
3. Change in the price of a related good
A. Substitutes (Beef and Chicken)
B. Compliments (Milk and Cereal)
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Shifters of Demand
4. Change in expectations
A. Expected change in price
B. Expected change in income
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Shifters of Demand
5. Change in consumer tastes and
preferences.
Ex. What do you think will happen to the
demand for Kanye West posters?
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Shifting Demand: change in
consumer tastes and preferences
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Examples
What would happen to demand?
1.
2.
3.
What would happen to the demand for
Beef if the price of chicken increased?
What would happen to your demand for
shrimp (a normal good) if your income
decreased?
What would happen to the demand for
milk if the price of milk fell?
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The Supply Curve
The law of supply: There is a direct
(positive) relationship between the price
of a good or service and the amount that
suppliers are willing to produce
Results in an upward sloping supply curve
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The Supply Curve
Ex. Deriving the Supply Curve
*Note*: As price increases, quantity
supplied increases.
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The Supply Curve
The height of the supply curve indicates the
minimum price necessary to induce
producers to supply that additional unit
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Producer Surplus
Producer surplus: The difference between
the minimum price suppliers are willing to
accept and the price they actually receive.
Producer surplus is the area above the
supply curve but below price.
ex. What happens if price falls? Rises?
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Example of consumer and
producer surplus
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Supply vs. Quantity Supplied
Change in quantity supplied: a
movement along the curve
Caused by a change in the price of that
good:
 Increase in quantity supplied: Movement
up the curve (to the right)
 Decrease in quantity supplied: Movement
down the curve (to the left)
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Supply vs. Quantity Supplied
Change in supply: A shift of the curve
Caused by a change in anything that affects
supply other than the price of the good


Increase in supply: curve shifts right
Decrease in supply: curve shifts left
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Shifters of Supply
1. A change in resource price
ex. An increase in the price of steel
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Shifters of Supply
2. A change in technology
ex. The printing press
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Shifters of Supply
3. Changes in nature and politics
ex. Crop Freeze
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Shifters of Supply
4. Changes in taxes
ex. Yacht tax
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Elasticity
1. Elasticity of Demand
A. Inelastic Demand: Quantity demanded is NOT
sensitive to changes in price.
(inelastic demand curves are steeper)
B. Elastic Demand: Quantity demanded is
sensitive to changes in price.
(elastic demand curves are flatter)
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Elasticity
2. Elasticity of Supply
A. Inelastic Supply: Quantity supplied is NOT
sensitive to changes in price.
(inelastic supply curves are steeper)
B. Elastic Supply: Quantity supplied is sensitive to
changes in price.
(elastic supply curves are flatter)
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Market Equilibrium!
A state in which the conflicting forces of
supply and demand are in balance.
Occurs where the demand curve intersects
the supply curve.
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Market Equilibrium!
In market equilibrium:



all trades that generate more benefit then costs
are undertaken
No trades where costs exceed benefits are
undertaken
The combined area of consumer and producer
surplus is maximized
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Market Equilibrium!
The market equilibrium is economically
efficient.
Efficient: no excess supply or excess
demand
 Excess supply: quantity supplied >
quantity demanded
 Excess demand: quantity demanded >
quantity supplied
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Changes in Demand
Demand changes:
 Price: moves in same direction
 Quantity: moves in same direction
ex. Demand increases
 Price increases
 Quantity increases
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Changes in Supply
Supply changes:
 Price: moves in opposite direction
 Quantity: moves in same direction
ex. Supply increases
 Price decreases
 Quantity increases
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Changes In Both?
What happens if supply and demand both
increase at the same time?
35
Invisible Hand Principle
The tendency for people, while pursuing
their own interests, to promote the
economic well-being of society.
ex. Lines at Walmart
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Prices and Market Order
1. Prices communicate information to
decision makers
2. Prices coordinate the actions of market
participants
3. Prices motivate economic players
37
The Invisible Hand!
38
Review
1. Know why supply curve is upward sloping
and demand curve is downward sloping
2. Find producer and consumer surplus
3. What are the shifters of demand
4. What are the shifters of supply
5. Know the characteristics of market equilibrium
6. Be able to do single and double shifts of
demand and supply curves
7. Know the invisible hand principle
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