Ch. 3: Demand and Supply
Objectives
 Determinants of demand and supply
 Use demand and supply to understand how
markets determine prices and quantities
 Use demand and supply to make predictions
about changes in prices and quantities
Markets and Prices
• Market
– any arrangement that enables buyers and sellers to get
information and do business with each other.
• Competitive market
– a market that has many buyers and many sellers
– no single buyer or seller can influence the price.
• Money price of a good
– the amount of money needed to buy it.
• Relative price of a good
– ratio of its money price to the money price of the next best
alternative good
– the opportunity cost of the good expressed in units of the other
good.
Demand
• Quantity demanded of a good or service
– the amount that consumers plan to buy during a
particular time period at a particular price.
• The Law of Demand
– Other things remaining the same, the higher
the price of a good, the smaller is the quantity
demanded.
– The law of demand results from
• a substitution effect
• an income effect
– Normal versus inferior good
Demand
Demand
– the entire relationship between the price of
the good and quantity demanded of the good.
Demand curve
– shows the relationship between the QD of a
good and its price, ceteris parabus
Demand
• This figure shows a
demand curve for
gasoline
• A rise in the price,
ceteris paribus, brings
a decrease in the QD
and a movement
along the demand
curve.
Price
D
# gallons per week
Demand
A D-curve is also
– Willingness-to-pay
curve.
– Willingness to pay
measures marginal
benefit.
Price
D
# gallons per week
Demand
• A Change in Demand
 Quantity of the good that people plan to buy
changes at each and every price
 Shift of demand curve.
 When demand increases,
– QD increases at each and every price
– the demand curve shifts rightward.
 When demand decreases,
– QD decreases at each and every price
– the demand curve shifts leftward.
Demand
Change in Demand vs. Change in Quantity Demanded
Factors that change demand
1. Prices of related goods
 substitute in consumption
 complement in consumption
2. Income
 Normal good
 Inferior good
 Luxury good
3. Expected future prices
4. Population
5. Taxes on buyers
6. Consumer preferences
Supply
Quantity supplied (QS) of a good or service
• the amount that producers plan to sell during a given
time period at a particular price.
The Law of Supply
• Other things remaining the same, the higher the price
of a good, the greater is the quantity supplied.
 results from tendency for the marginal cost of
producing a good or service to increase as the
quantity produced increases (more later)
 Producers are willing to supply only if they at least
cover their marginal cost of production.
Supply
– Supply
• the entire relationship between the quantity
supplied and the price of a good.
– Supply curve
• shows relationship between QS and price of a
good, ceteris paribus.
Supply Curve
•A supply curve for
gasoline.
•A rise in the price,
ceteris paribus,
brings an increase
in QS and a
movement along
the supply curve.
$ per gallon
S
Gallons per day
Supply
–A supply curve is
also a minimumsupply-price curve.
–The greater the
quantity produced,
the higher is the price
that producers must
be offered to be
willing to produce
that quantity.
S
Gallons per day
Supply
• A Change in Supply
 occurs when the quantity of the good that
producers plan to sell changes at each and
every price, so there is a new supply curve.
 When supply increases,
• QS increases at each and every price
• supply curve shifts rightward.
 When supply decreases,
• QS decreases at each and every price
• supply curve shifts leftward.
Supply
Change in supply vs. change in quantity supplied
Factors that change supply.
1. Prices of inputs
2. Prices of related goods produced
 Substitutes in production
 Complements in production
3.
4.
5.
6.
Expected future prices
Number of sellers
Taxes on Sellers
Technology
Market Equilibrium
Equilibrium
 situation in which opposing forces balance
each other.
 occurs when the price balances the plans of
buyers and sellers.
Equilibrium price
 price at which the quantity demanded equals
the quantity supplied.
Equilibrium quantity
 quantity bought and sold at the equilibrium
price.
Market Equilibrium
Price Adjustments
If P>Pequil:
– a surplus forces the price
down.
If P<Pequil:
– a shortage forces the
price up.
At the equilibrium price,
– QS=QD
– and the price doesn’t
change.
S
D
Predicting Changes in Price and Quantity
Illustrate Effect on Equilibrium Price and Quantity if:
a. Demand increases
b. Supply increases
c. Demand and supply simultaneously increase.
Practice with Supply/Demand to:
a. Predict effect of “shock” to market.
b. Understand the type of “shock” that might have
caused an observed change in P & Q.
Price controls
1. A price ceiling is a maximum allowable
price.
• Results in a continuing shortage if ceiling is
BELOW equilibrium price.
2. A price floor is a minimum allowable price.
 Results in a continuing surplus if floor is ABOVE
equilibrium price.