Supply, Demand, and
Equilibrium
Today: An introduction to supply
and demand, and how they relate
to equilibrium
Who is very hungry and likes
bananas?
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All the bananas you care to eat for one
person (up to however many I have)
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NOT extra credit, since you get free bananas
You are eating bananas at your own risk
You are not allowed to share bananas with
anyone else
Please report to me how many bananas you
eat in about 40 minutes
Previously
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The 7 Core Principles
Thinking like an economist
Marginal cost and benefit
Working with graphs
Today: Markets
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Supply, demand, and equilibrium
What causes shifts in supply and
demand?
What happens when supply and/or
demand shifts?
Central organization versus
Markets
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Central economic organization is rare
today
Most economic activity today occurs in
markets
Markets do fail sometimes, but this is
the focus of other chapters (e.g.
Chapters 8 and 10)
Markets
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Markets consist of buyers and sellers
Assume many buyers and many sellers
Fractional amounts of goods can be
produced
We will talk about supply and demand
for most markets
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Exceptions will be dealt with accordingly as
we get to them
Core principle related to
demand
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Cost-benefit analysis
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Recall energy drinks example
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Think “reservation price” when you think
“willingness to pay” (“WTP”)
Demand
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Demand states how much of a good
that buyers are willing to purchase
given each price
Demand is typically shown on a graph,
but it is occasionally displayed on a
table
Demand
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A fundamental characteristic of demand is
that as the price of a good increases, demand
typically goes down (all else constant)
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Recall that WTP for energy drinks decreases as
you consume more
Thus, each demand curve is downward
sloping if we graphed it
By convention, quantity is on the horizontal
axis and price on the vertical axis
Core principles related to
supply
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Increasing opportunity cost
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We want to produce at the lowest cost for
each additional unit
Also called “low-hanging-fruit” principle
Incentive principle
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Businesses will supply less when some
units are not profitable
Businesses will supply more when
producing more could lead to higher profits
Supply
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Supply states how much of a good that
sellers are willing to sell given each
price
Similar to demand, supply is typically
shown on a graph
Supply
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Low-cost sellers typically enter a market
before high-cost sellers
Thus, we would expect that the sellers
with lowest cost to sell a particular
good
Supply is then assumed to be upward
sloping
Discrete versus continuous
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Although many products can only be
purchased in discrete amounts, we usually
assume continuous curves
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Why? (Come to class to find out)
In this class, most common curve used is
linear
We will typically ignore the “discreteness”
problem in supply/demand analysis
Graphing supply and demand
Equilibrium principle
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Another core principle
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“No cash on the table”  “stable”
Nobody can be made better off by
changing her/his decision
Does not address potential actions that
groups of people can make
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Later topic, especially with market failure
Equilibrium: 4 units
purchased, at a price of 6
Why is a price of 6
equilibrium?
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To show that 6 is the equilibrium price,
we will show that prices above and
below are not in equilibrium
We will prove by contradiction that this
price could not be equilibrium
Suppose that a price (P) of 4 is
equilibrium
At P = 4: Quantity demanded
is 6, quantity supplied is 3.33
At P = 4: Quantity demanded
is 6, quantity supplied is 3.33
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When P is 4, people are demanding a
quantity that is higher than what is
supplied
Is this an equilibrium?
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No, this is not stable
Someone can increase their production
slightly, and sell at a price of 5 to make
more profits
Now suppose that P = 9 is an
equilibrium
Now suppose that P = 9 is an
equilibrium
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Quantity supplied is 6
Quantity demanded is 1
This is not stable either
Someone not selling
their entire stock can
sell for P = 7 to make
more money
A change in supply versus a
movement along the supply curve
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A change in supply leads to a shift of the
entire supply curve
A movement along the supply curve can
occur when the supply curve does not move
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Movement occurs when there is a change in price
Similar ideas apply for changes in demand
versus a movement along demand curves
What causes shifts in
demand?
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Price changes of complements and
substitutes
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Example of complements: baseballs and
baseball bats
Example of substitutes: two different
brands of cola
What causes shifts in
demand?
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Income changes
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Most goods are normal goods, meaning
that when income increases, the demand
curve shifts to the right
Some goods are inferior, meaning that
when income increases, the demand curve
shifts to the left
Changes in preferences, population,
and expected future prices
What is happening here?
What is happening here?
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The demand curve
shifts to the right
There is a
movement along the
supply curve, since
supply does not
change
What is happening here?
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Note that at any price,
a higher quantity is
demanded on curve D2
than on D1
The new equilibrium
price (P) and quantity
(Q) are higher when
demand shifts from D1
to D2
What causes shifts in supply?
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Anything that changes the cost of
production
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If the cost of production decreases, supply
shifts to the right
If the cost of production increases, supply
shifts to the left
A change in number of suppliers
Expectations of future prices
What happens when both
supply and demand shift?
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An example: Both supply and demand
shift right
Shift in supply…
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…causes Q to increase and P to decrease
Movement from A to B
A
B
Shift in demand…
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…causes Q to increase and P to increase
Movement from B to C
C
B
What can we conclusively say
about changes in Q and P?
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Change in supply causes Q to increase
and P to decrease
Change in demand causes Q to increase
and P to increase
The only conclusion when both supply
and demand shift right is that Q
increases
Now that we have talked
about supply and demand…
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…let’s talk about bananas
How many bananas did our volunteer
eat today?
Why not any more?
We will talk about what happened here
on Monday
Summary
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The intersection of demand and supply
curves determines equilibrium
Equilibrium is stable
Change in S or D causes the curve to shift
A movement along the supply curve can
occur when the supply curve does not move
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Same with demand
Both supply and demand can shift, but be
careful of your conclusions