Chapter 3

• Supply and Demand

• Equilibrium: How Supply and Demand

Determine Prices

3-1
 OBJECTIVES:
What will you learn?
• What the characteristics of a competitive market are.
• How to construct a demand curve.
• How to distinguish a shift in demand versus a
movement along the demand curve.
• How to construct a supply curve.
• How to distinguish a shift in supply versus a movement
along the supply curve.
• How demand and supply interact to bring markets to
equilibrium.
• How changes in supply and demand influence
equilibrium price and quantity.

3-2
 Markets
• A market refers to the buyers and sellers who trade a
particular good or service.
– Markets can be located locally, globally, or even virtually.
• One special class of markets is the competitive market.
• Four characteristics of perfectly competitive markets.

Standardized good No transaction costs

• In this Full information
chapter, Participants
markets are assumed areperfectly
to be price takers
competitive.

3-3
 Demand
• As a group, consumers determine the demand
for a product.
• The quantity demanded is the amount of a
particular good or service that buyers are
willing and able to purchase at a given price.
• The law of demand states that the lower the
price, the higher the quantity demanded, all
other things equal.

3-4
 The demand schedule
• A demand schedule Cell phones Price
(millions) ($)
displays the quantities
demanded at various 30 180

prices. 60 160

• This demand schedule 90 140

provides the quantity of 120 120

cellphones demanded at 150 100

specific prices. 180 80

• Notice that as price falls, 210 60

the quantity demanded 240 40
increases. 270 20

3-5
 The demand curve
The demand curve illustrates the relationship between the quantity demanded and the
price of the good, holding all of the other non-price determinants constant.
Price ($)
220
Cell phones Price
200 (millions) ($)
180 30 180
160 1. As the price decreases… 60 160
140 90 140
120
2. …the quantity demand
increases. 120 120
100 150 100
80
180 80
60
210 60
40
240 40
20
270 20
0
30 60 90 120 150 180 210 240 270
Quantity of cell phones (millions)
3-6
Active Learning: Constructing demand

Use the following demand schedule to construct the demand curve.

Price Quantity P
8
1 280 7
2 260 6
3 240 5
4 220 4
5 200 3
6 180 2
7 160 1
8 140 0
140 160 180 200 220 240 260 280 300 Q

3-7
Active Learning: Constructing demand

Use the following demand schedule to construct the demand curve.

Price Quantity P
8
1 280 7
2 260 6
3 240 5
4 220 4
5 200 3
6 180 2
7 160 1
8 140 0
140 160 180 200 220 240 260 280 300 Q

3-8
 Changes in demand
• The five most important non-price
determinants of demand are:
Preferences Number of buyers
Incomes Expectations
Price of related goods

• What happens when one of the non-price

determinants changes?
– If positive influence, demand increases.
– If negative influence, demand decreases.

3-9
 Shifting the demand curve
Price ($)
240 • When demand
200
increases, the
160
demand curve shifts
120
to the right.
80
DB • When demand
DA decreases, the
40
DC demand curve shifts
0
0 60 120 180 240 to the left.
Quantity of cell phones (millions)

3-10
 Shifts versus movements
There is an important difference between a shift in the demand
curve and a movement along the demand curve.
Price ($)
Price ($)
240
240

200 200

160 160

120 120
DB
80 80
DA D
40 40
DC
0 60 120 180 240 0 60 120 180 240
Quantity of cell phones (millions) Quantity of cell phones (millions)

If a non-price determinant changes, If the price decreases, then quantity

then the demand curve shifts with demanded increases and there is a
changes in the quantity demanded movement along the demand curve.
at every price.

3-11
Active Learning: Shifts vs. movements
Indicate whether a shift or movement occurs in
the market for cellphones when each of the
following determinants changes.
– Advertising causes individuals to prefer cellphones
over home phones.
– Cellphones go on sale.
– Cellphone calling plans become more expensive.

3-12
Active Learning: Shifts vs. movements
Advertising causes individuals to prefer
cellphones over home phones.
Price ($)
240 • Change in
200 preferences
160 towards the good.
120
DB • Increase in
80
DA demand.
40

0
• Demand curve
0 60 120 180
Quantity of cell phones (millions)
240 shifts right.

3-13
 Active Learning: Shifts vs. movements
Cellphones go on sale.
Price ($)
220

• Sales imply the

200

180

160 1. As the price decreases… price is going

140 down.
120
2. …the quantity demand

100
increases. • This causes a
80 movement along
60 the demand
40
curve.
20

0
30 60 90 120 150 180 210 240 270
Quantity of cell phones (millions)
3-14
Active Learning: Shifts vs. movements
Cellphone calling plans become more expensive.

Price ($) • Change in related good.

240
• Cellphone plans are
200 complements to
cellphones.
160
• Since the complement
120 becomes more
expensive, the demand
80 decreases.
DA
40 • Demand curve shifts
DB left.
0
0 60 120 180 240
Quantity of cell phones (millions)

3-15
 Supply
• As a group, producers determine the supply of
a product.
• The quantity supplied is the amount of a
particular good that producers are willing and
able to sell at a given price.
• The law of supply states that the higher the
price, the higher the quantity supplied, all
other things equal.

3-16
 The supply schedule
• A supply schedule
displays the Cell phones
(millions)
Price
($)
quantities supplied at
various prices. 270 180
240 160
• This supply schedule
provides the quantity 210 140
of cellphones 180 120
supplied at specific 150 100
prices. 120 80
• Notice that as price 90 60
increases, the 60 40
quantity supplied
increases. 30 20

3-17
 The supply curve
Price ($)
200 Cell phones Price
(millions) ($)
180 1. As price increases…
270 180
160 2. quantity supplied increases…
240 160
140
210 140
120
180 120
100
150 100
80
120 80
60
90 60
40
60 40
20
30 20
0
30 60 90 120 150 180 210 240 270
Quantity of cell
phones (millions)
3-18
 Active Learning: Constructing supply
Use the following supply schedule to construct the supply curve.

P
Price Quantity 8
1 130 7
2 260 6
3 390 5
4 520 4
5 650 3
6 780 2

7 910 1

8 1040 0
140 160 180 200 220 240 260 280 300 Q

3-19
 Active Learning: Constructing supply
Use the following supply schedule to construct the supply curve.

P
Price Quantity 8
1 130 7
2 260 6
3 390 5
4 520 4
5 650 3
6 780 2

7 910 1

8 1040 0
140 160 180 200 220 240 260 280 300 Q

3-20
 Changes in supply
• The five most important non-price
determinants of supply are:
Technology Number of producers
Price of Inputs Expectations
Price of related goods

• What happens when one of the non-price

determinants changes?
– If positive influence, supply increases.
– If negative influence, supply decreases.

3-21
 Shifting the supply curve

Price ($)
240
SC • When supply
200 SA increases, the supply
160 SB
curve shifts to the
120
right.
80
• When supply
decreases, the supply
40
curve shifts to the
0
0 60 120 180 240 300 left.
Quantity of cell phones (millions)

3-22
 Shifts versus movements
There is an important difference between a shift in the supply
curve and a movement along the supply curve.
Price ($) Price ($)
240 240
SC

200 SA 200
SA
160 SB 160

120 120

80 80

40 40

0 60 120 180 240 300 0 60 120 180 240 300

Quantity of cell phones (millions) Quantity of cell phones (millions)

If a non-price determinant changes, If the price decreases, then quantity

then the supply curve shifts with supplied decreases and there is a
changes in the quantity supplied at movement along the supply curve.
every price.

3-23
Active Learning: Shifts vs. movements
• Indicate whether a shift or movement occurs
in the market for cellphones when each of the
following determinants change.
– A new Chinese cellphone manufacturer enters the
market.
– Producers expect cellphones prices to rise.
– The price of calling over the Internet (e.g. Skype)
decreases.

3-24
Active Learning: Shifts vs. movements
A new Chinese cellphone manufacturer
enters the market.
Price ($)
240 • Increased
200
number of SA

160
sellers. SB

120 • Increase in
80 supply.
40 • Supply curve
0
0 60 120 180 240 300
shifts right.
Quantity of cell phones (millions)

3-25
Active Learning: Shifts vs. movements
Producers expect cellphones prices to rise.

• Change in
Price ($)
SB
240

200 SA expected
160 price.
120 • Supply
80 decreases.
40
• Supply curve
0
0 60 120 180 240 300 shifts left.
Quantity of cell phones (millions)

3-26
 Active Learning: Shifts vs. movements
The price of calling over the Internet decreases.

Price ($)
240 • Change in related goods.
200 • Calling over the Internet
160
is a substitute for
cellphones.
120
• Since the substitute
80
DA becomes less expensive,
40
DB
demand for cellphones
0
0 60 120 180 240
decreases.
Quantity of cell phones (millions) • No change in supply.

3-27
 Market equilibrium
Price ($) • The equilibrium is where
200 the supply curve
S intersects the demand
150 curve.
Equilibrium price At the market equilibrium
point, the quantity supplied
– At this point, consumers
100 equals the quantity are willing to buy exactly
demanded. what producers are
50 willing to sell.
D
Equilibrium quantity
• The equilibrium price is
0 50 100 150 200 250 300
$100.
Quantity of cell phones (millions) • The equilibrium quantity
is 150 M.

3-28
 Active Learning: Finding equilibrium
1) Graph the supply and demand curve and find the equilibrium.
2) Circle the market equilibrium price and quantity in the schedule.
P
Price QS QD 8
1 130 280 7
2 260 260 6
3 390 240 5
4 520 220 4

5 650 200 3

6 780 180 2

7 910 160 1
0
8 1040 140
140 160 180 200 220 240 260 280 300 Q

3-29
 Active Learning: Finding equilibrium
1) Graph the supply and demand curve and find the equilibrium.
2) Circle the market equilibrium price and quantity in the schedule.
P
Price QS QD 8
1 130 280 7
2 260 260 6
3 390 240 5
4 520 220 4

5 650 200 3
S
6 780 180 2

7 910 160 1 D
0
8 1040 140
140 160 180 200 220 240 260 280 300 Q

3-30
 Disequilibrium
• What happens when the market is not in
equilibrium?
• If the market price is not equal to the equilibrium
price, then quantity demanded is not equal to
quantity supplied.
– If the price is too high, excess supply occurs and there
is a surplus of the good or service.
• A lower price alleviates the surplus.
– If the price is too low, excess demand occurs and there
is a shortage of the good or service.
• A higher price alleviates the shortage.

3-31
 A surplus
Price ($)
200 Surplus • A surplus provides incentives for
(excess supply)
160
S the price to decrease.
Price is
too high • As the price decreases…
120
1) The quantity supplied
80 decreases.
2) The quantity
40
QD QS D demanded increases.
0 60 120 180 240 300 • The price continues to decrease
Quantity of cell phones (millions) until QS = QD = Q*.

3-32
 A shortage
Price ($)
200
• A shortage provides incentives for
S
160 the price to increase.
120
• As the price increases…
1) The quantity supplied
80
Price is
increases.
40
too low
2) The quantity demanded
Shortage Q D
QS(excess D
demand) decreases.
0 60 120 180 240 300 • The price continues to increase
Quantity of cell phones (millions)
until QS = QD = Q*.

3-33
 Active Learning: Excess supply
1) Find the quantity demanded and quantity supplied at a price of $3.
2) Quantify the excess supply (surplus).

P QS QD
1 130 280
2 260 260
3 390 240
4 520 220
5 650 200
6 780 180
7 910 160
8 1040 140

3-34
 Active Learning: Excess supply
1) Find the quantity demanded and quantity supplied at a price of $3.
2) Quantify the excess supply (surplus).

P QS QD • At a price of $3
1 130 280 – Quantity demanded is
2 260 260 240.
3 390 − 240 =150 – Quantity supplied is 390.
4 520 220 • The surplus is equal to the
5 650 200 difference between QS
6 780 180
and QD: 390 – 240 = 150
units.
7 910 160
8 1040 140
• 150 units are unsold.

3-35
 Active Learning: Excess demand
1) Find the quantity demanded and quantity supplied at a price of $1.
2) Quantify the excess demand (shortage).

P QS QD
1 130 280
2 260 260
3 390 240
4 520 220
5 650 200
6 780 180
7 910 160
8 1040 140

3-36
 Active Learning: Excess demand
1) Find the quantity demanded and quantity supplied at a price of $1.
2) Quantify the excess demand (shortage).

P QS QD • At a price of $1
1 130 280
– Quantity demanded is
2 260 260
280.
3 390 240
– Quantity supplied is 130.
4 520 220
5 650 200
• The shortage is equal to the
difference between QD and
6 780 180
QS: 280 – 130 = 150 units.
7 910 160
8 1040 140
• 150 units are demanded, but
none are available.

3-37
 Changes in market equilibrium
• The equilibrium price and quantity are determined by the
intersection of the demand and supply curves.
• If a non-price factor changes, this affects the market
equilibrium.
• To determine the effect on market equilibrium, there are
three questions that must be answered:
– Does the change affect demand? If so, how?
– Does the change affect supply? If so, how?
– What happens to equilibrium price and quantity?

3-38
 Shifts in demand
Suppose the price of land-line service suddenly
skyrockets.
Price ($) • Market for cellphones is in
200 equilibrium.
180 S2

160
• More expensive substitute
140 causes the demand to
120 increase.
100 • The demand curve shifts right.
80
60
• The market equilibrium
40
D2
changes.
20 D1 – Equilibrium price increases.
0
0 30 60 90 120 150 180 210 240 270 300
– Equilibrium quantity increases.
Quantity of cell phones (millions)

3-39
 Active Learning: Equilibrium effects from
shifts in demand
Suppose the demand curve shifts outward by 60 units. Update
the demand schedule and find the new equilibrium price and
quantity.
P QS QD Q’D
8 270 30
7 240 60
6 210 90
5 180 120
4 150 150
3 120 180
2 90 210
1 60 240

3-40
 Active Learning: Equilibrium effects from
shifts in demand
Suppose the demand curve shifts outward by 60 units. Update
the demand schedule and find the new equilibrium price and
quantity.
P QS QD Q’D • Update demand schedule
8 270 30 90 by increasing QD by 60.
7 240 60 120 • Find new equilibrium
6 210 90 150
where
5 180 120 180
QS = Q’D.
– New equilibrium price is
4 150 150 210 $5.
3 120 180 240 – New equilibrium quantity
2 90 210 270 is 180.
1 60 240 300

3-41
 Shifts in supply
Suppose there is a breakthrough in battery technology.

Price ($)
200
• Market for cellphones is
180 S1 initially in equilibrium.
160 • Increased technology causes
140 S2
the supply to increase.
120
100 • The supply curve shifts right.
80 • The market equilibrium
60
changes.
40
20 D1
– Equilibrium price decreases.
0 – Equilibrium quantity
0 30 60 90 120 150 180 210 240 270 300 increases.
Quantity of cell phones (millions)

3-42
 Active Learning: Equilibrium effects from
shifts in supply
Suppose the cost of sugar, an input for making ice cream,
increases. Identify whether supply, demand, or both shift(s)
and the new equilibrium price and quantity for ice cream.
P Ice Cream Market
S

P*

D
Q* Q
3-43
 Active Learning: Equilibrium effects from
shifts in supply
Suppose the cost of sugar, an input for making ice cream,
increases. Identify whether supply, demand, or both shift(s)
and the new equilibrium price and quantity for ice cream.
P Ice Cream Market S’
S
• The cost of an input
increases, causing a
decrease in supply.
P**
• The supply curve
P*
shifts left.
• The market
equilibrium changes.
– Equilibrium price
D
increases.
Q** Q* Q – Equilibrium quantity
decreases.
3-44
 Shifts in demand or supply
When either demand or supply changes, there is
an unambiguous effect on equilibrium price and
quantity.

Curve Change Price change Quantity change

Supply Decrease
Supply Increase
Demand Decrease
Demand Increase

3-45
 Shifts in both demand and supply
• It is possible for non-price factors that influence both
demand and supply at the same time.
• This leads to shifts in both demand and supply.
• The new equilibrium occurs at the new intersection.
• Suppose that landline phone service prices increase
and an input price to make cellphones decreases.
– Demand increases.
– Supply increases.
• What happens to equilibrium price and quantity?
– It depends on whether the demand or supply curve shifts
out more.

3-46
 Shifts in both demand and supply
(A) Demand increases more (B) Supply increases more
Price ($) Price ($)
200 200
180 S1 S 1
180
160 S2 160
140 140
120 E2 120
E1 E 1
100 S 2
100 E 2
80 D2 80
60 60 D2
40 40
20 D1 20 D1

0 30 60 90 120 150 180 210 240 270 300 0 30 60 90 120 150 180 210 240 270
Quantity of cell phones (millions) Quantity of cell phones (millions)

New equilibrium New equilibrium

– Quantity increases. – Quantity increases.
– Price increases. – Price decreases.
Conclusion: Quantity increases.
Price may increase or decrease (ambiguous).

3-47
 Shifts in demand and supply
When both supply and demand shift and the
magnitudes of change are unknown, the effect
on either price or quantity is known, but not
both.
Supply change Demand change Price change Quantity change
Decrease Decrease ?
Decrease Increase ?
Increase Increase ?
Increase Decrease ?

3-48
 Summary
• A market is the group of buyers and sellers
who trade.
– A competitive market exists if a large number of
buyers and sellers trade standardized goods and
services.
– Modeled using supply and demand.

3-49
 Summary
• Demand demonstrates consumers’ highest
willingness to pay for a given quantity.
• The law of demand states that the quantity
demanded increases as the price decreases.
– The demand curve has a negative slope.
• When one of the non-price determinants of
demand changes, the entire demand curve
shifts to the left or the right.

3-50
 Summary
• Supply demonstrates producers’ lowest price
that they must receive to sell a given quantity.
• The law of supply states that the quantity
supplied increases as the price increases.
– The supply curve has a positive slope.
• When one of the non-price determinants of
supply changes, the entire supply curve shifts
to the left or the right.

3-51
 Summary
• The equilibrium price and quantity are identified
when quantity supplied equals quantity
demanded. At this point:
– Producers sell all they desire at the equilibrium price.
– Consumers buy all they desire at the equilibrium price.
• If the market price is not equal to the equilibrium
price, then a surplus or shortage exists, and the
price adjusts until quantity demanded is equal to
quantity supplied.

3-52
 Summary
• When a non-price determinant changes, the
effect on equilibrium price and quantity can be
evaluated by:
– Determining whether supply, demand, or both are
affected.
– Determining the direction supply, demand, or both
shift(s).
– Comparing the new equilibrium to the initial
equilibrium to identify the effect on price and
quantity.

3-53
• Irregular weather patterns caused very poor
yields for orange farmers. Which factor of
supply would this change in the market for
orange juice?
• A. Technology
• B. Price of input
• C. Number of sellers
• D. Price of related good
• B

3-54
• The equilibrium price is sometimes called:
• A. the market-clearing price.
• B. the optimum price.
• C. the maximum.
• D. the quantity-clearing price.
• A

3-55
• A shortage will occur if:
• A. the quantity being supplied at a given price
is less than the quantity demanded at that
price.
• B. the quantity being supplied at a given price
exceeds the quantity demanded at that price.
• C. there are not enough buyers in the market.
• D. there are only inexperienced firms in the
market.
• A

3-56
• The term "surplus" refers to:
• A. a situation in which the quantity supplied is
less than the quantity demanded.
• B. a situation in which the quantity demanded
is less than the quantity supplied.
• C. a market that sells secondary goods.
• D. a signal that producers need to increase
the price of the good.
• B

3-57
• If producers incorrectly set the price of their
product too high:
• A. a shortage will result.
• B. a surplus will result.
• C. equilibrium will result.
• D. the industry will soon die out.
• B

3-58
• If producers incorrectly set the price of their
product too low:
• A. a shortage will result and consumers will bid
the price down to equilibrium.
• B. a surplus will result and excess goods in
inventory will signal the producers to lower their
prices.
• C. a shortage will result and consumers will bid
the price up to equilibrium.
• D. a surplus will result and excess goods in
inventory will signal the producers to restrict
output until sales increase.
• C
3-59
According to the table shown, if the price were
$0.50, what will total demand by Betty and Barney
be?

36

3-60
Assume the graph shown represents the market for bottles of wine
and was originally in equilibrium with D and S. Something changes
and demand shifts to D2. Which of the following is true?
A. Equilibrium price increased by $5. (A)
B. Equilibrium quantity increased by 20.

C. Equilibrium price increased by $15.

D. Equilibrium quantity increased by 30.

3-61