THE

MARKET
FORCES OF
SUPPLY AND
DEMAND
 From the desk of Ms Imrana Bano

2 MARKETS AND COMPETITION

• Market – a group of buyers and sellers of a particular good or service
• Competitive market – a market in which there are many buyers and
many sellers so that each has a negligible impact on the market price
 From the desk of Ms Imrana Bano

3 MARKET DEMAND VERSUS

INDIVIDUAL DEMAND
• The market demand is the sum of all of the individual demands for a particular good
or service
• The demand curves are summed horizontally – meaning that the quantities
demanded are added up for each level of price
• The market demand curve shows how the total quantity demanded of a good varies
with the price of the good, holding constant all other factors that affect how much
consumers want to buy
 MARKET DEMAND VERSUS INDIVIDUAL
From the desk of Ms Imrana Bano

4 DEMAND
• Suppose Helen and Ken are the only two buyers in the Latte market. (Qd =
quantity demanded)

Price Helen’s Qd Ken’s Qd Market Qd

$0.00 16 + 8 = 24
1.00 14 + 7 = 21
2.00 12 + 6 = 18
3.00 10 + 5 = 15
4.00 8 + 4 = 12
5.00 6 + 3 = 9
6.00 4 + 2 = 6
 THE MARKET DEMAND CURVE FOR
From the desk of Ms Imrana Bano

5 LATTES
Qd
P P
(Market)
$6.00
$0.00 24
$5.00
1.00 21
$4.00
2.00 18
$3.00 3.00 15
$2.00 4.00 12
$1.00 5.00 9
$0.00 Q 6.00 6
0 5 10 15 20 25
 From the desk of Ms Imrana Bano

6 MARKET SUPPLY VS. INDIVIDUAL

SUPPLY
• The market supply curve can be found by summing
individual supply curves
• Individual supply curves are summed horizontally at every
price
• The market supply curve shows how the total quantity
supplied varies as the price of the good varies
MARKET SUPPLY VERSUS INDIVIDUAL SUPPLY
From the desk of Ms Imrana Bano

7
• Suppose Starbucks and Jitters are the only two sellers in this market. (Qs =
quantity supplied)

Price Starbucks Jitters Market Qs

$0.00 0 + 0 = 0
1.00 3 + 2 = 5
2.00 6 + 4 = 10
3.00 9 + 6 = 15
4.00 12 + 8 = 20
5.00 15 + 10 = 25
6.00 18 + 12 = 30
 The Market Supply Curve
From the desk of Ms Imrana Bano

8
QS
P P
(Market)
$6.00
$0.00 0
$5.00 1.00 5
$4.00 2.00 10
$3.00 3.00 15
$2.00 4.00 20
$1.00
5.00 25
6.00 30
$0.00 Q
0 5 10 15 20 25 30 35
 SUPPLY AND DEMAND TOGETHER
From the desk of Ms Imrana Bano

9
• Equilibrium
• The point where the supply and demand
curves intersect is called the market’s
equilibrium
• Equilibrium – a situation in which the price
has reached the level where quantity supplied
equals quantity demanded
• Equilibrium price – the price that balances
quantity supplied and quantity demanded
• the equilibrium price is often called the
“market-clearing” price because both buyers
and sellers are satisfied at this price
• Equilibrium quantity – the quantity
supplied and the quantity demanded at the
equilibrium price
 From the desk of Ms Imrana Bano

10
 SUPPLY AND DEMAND TOGETHER
From the desk of Ms Imrana Bano

11

P Equilibrium:
$6.00 D S
P has reached
$5.00 the level where
$4.00 quantity supplied
$3.00
equals
quantity demanded
$2.00
$1.00
$0.00 Q
0 5 10 15 20 25 30 35
__________
EQUILIBRIUM
_____
PRICE:
From the desk of Ms Imrana Bano

12 The price that equates quantity supplied

with quantity demanded
P
$6.00 D S
P QD QS
$5.00 $0 24 0
$4.00 1 21 5
$3.00 2 18 10
$2.00 3 15 15
$1.00 4 12 20
5 9 25
$0.00 Q
0 5 10 15 20 25 30 35 6 6 30
__________
EQUILIBRIUM
________
QUANTITY:
From the desk of Ms Imrana Bano

13 The quantity supplied and quantity demanded at

the equilibrium price
P
$6.00 D S
P QD QS
$5.00 $0 24 0
$4.00 1 21 5
$3.00 2 18 10
$2.00 3 15 15
$1.00 4 12 20
5 9 25
$0.00 Q
0 5 10 15 20 25 30 35 6 6 30
 SUPPLY AND DEMAND TOGETHER
From the desk of Ms Imrana Bano

14

• If the actual market price is higher

than the equilibrium price, there
will be a surplus of the good
• Surplus – a situation in which
quantity supplied is greater than
quantity demanded
• To eliminate the surplus,
producers will lower the price
until the market reaches
equilibrium
 SURPLUS: From the desk of Ms Imrana Bano

15 when quantity supplied is greater than

quantity demanded
P
$6.00 D Surplus S Example:
If P = $5,
$5.00
then
$4.00 QD = 9 lattes
$3.00 and
$2.00 QS = 25 lattes

$1.00
resulting in a surplus of
16 lattes
$0.00 Q
0 5 10 15 20 25 30 35
 SURPLUS: From the desk of Ms Imrana Bano

16 when quantity supplied is greater than

quantity demanded
P
$6.00 D Surplus S Facing a surplus,
sellers try to increase sales
$5.00 by cutting the price.
$4.00 This causes
$3.00 QD to rise and QS to fall…

$2.00 …which reduces the

surplus.
$1.00
$0.00 Q
0 5 10 15 20 25 30 35
 SURPLUS: From the desk of Ms Imrana Bano

17
when quantity supplied is greater than
quantity demanded
P
$6.00 D Surplus S Facing a surplus,
sellers try to increase sales
$5.00 by cutting the price.
$4.00 Falling prices cause
$3.00 QD to rise and QS to fall.

$2.00 Prices continue to fall until

market reaches equilibrium.
$1.00
$0.00 Q
0 5 10 15 20 25 30 35
 From the desk of Ms Imrana Bano

18 SUPPLY AND DEMAND TOGETHER

• If the actual price is lower than the equilibrium

price, there will be a shortage of the good
• Shortage – a situation in which quantity
demanded is greater than quantity supplied.
• Sellers will respond to the shortage by raising the
price of the good until the market reaches
equilibrium
• Law of supply and demand – the claim that
the price of any good adjusts to bring the supply
and demand for that good into balance
 SHORTAGE: From the desk of Ms Imrana Bano

19 when quantity demanded is greater than

quantity supplied
P
$6.00 D S Example:
If P = $1,
$5.00
then
$4.00 QD = 21 lattes
$3.00 and
QS = 5 lattes
$2.00
resulting in a
$1.00 shortage of 16 lattes
$0.00 Shortage Q
0 5 10 15 20 25 30 35
 SHORTAGE: From the desk of Ms Imrana Bano

20
when quantity demanded is greater than
quantity supplied
P
$6.00 D S Facing a shortage,
sellers raise the price,
$5.00
causing QD to fall
$4.00 and QS to rise,
$3.00 …which reduces the
shortage.
$2.00
$1.00
Shortage
$0.00 Q
0 5 10 15 20 25 30 35
 SHORTAGE: From the desk of Ms Imrana Bano

21
when quantity demanded is greater than
quantity supplied
P
$6.00 D S Facing a shortage,
sellers raise the price,
$5.00
causing QD to fall
$4.00 and QS to rise.
$3.00 Prices continue to rise
$2.00
until market reaches
equilibrium.
$1.00
Shortage
$0.00 Q
0 5 10 15 20 25 30 35
 From the desk of Ms Imrana Bano

22 THREE STEPS TO ANALYZING

CHANGES IN EQUILIBRIUM
• Decide whether the event shifts the supply or
demand curve
• Decide in which direction the curve shifts
• Use the supply-and-demand diagram to see how the
shift changes the equilibrium price and quantity
• A shift in the demand curve is called a “change in
demand.” A shift in the supply curve is called a “change is
supply.”
• A movement along a fixed demand curve is called a
“change in quantity demanded.” A movement along a fixed
supply curve is called a “change in quantity supplied.”
 From the desk of Ms Imrana Bano

EXAMPLE: THE MARKET FOR HYBRID

23
CARS P
price of
S1
hybrid cars

P1

D1
Q
Q1
quantity of
hybrid cars
 EXAMPLE 1: A CHANGE IN DEMAND
From the desk of Ms Imrana Bano

24
EVENT TO BE
ANALYZED: P
Increase in price of gas. S1
P2
STEP 1: D curve shifts
because price of gas affects demand
P1
for hybrids.
S curve does not shift, because price
of gas does not affect cost of
producing hybrids. D1 D2
STEP 2: D shifts right Q
because high gas price makes hybrids more Q1 Q2
attractive relative to other cars.
STEP 3:
The shift causes an increase in price
and quantity of hybrid cars.
EXAMPLE 1: A CHANGE IN DEMAND
From the desk of Ms Imrana Bano

25
Notice: P
When P rises,
S1
producers supply
a larger quantity P2
of hybrids, even
though the S curve P1
has not shifted.
Always be careful
D1 D2
to distinguish b/w a
shift in a curve and Q
Q1 Q2
a movement along
the curve.
 SHIFT VS. MOVEMENT ALONG CURVE
From the desk of Ms Imrana Bano

• Change in supply: a shift in the S curve

26
• occurs when a non-price determinant of supply changes (like technology or costs)

• Change in the quantity supplied:

a movement along a fixed S curve
• occurs when P changes

• Change in demand: a shift in the D curve

• occurs when a non-price determinant of demand changes (like income or # of buyers)

• Change in the quantity demanded:

a movement along a fixed D curve
• occurs when P changes
 EXAMPLE 2: A CHANGE IN SUPPLY
From the desk of Ms Imrana Bano

27
EVENT: New technology
reduces cost of producing P
hybrid cars. S1 S2

STEP 1: S curve shifts

because event affects cost of
P1
production.
D curve does not shift, because P2
production technology is not one
of the factors that affect demand.
D1
STEP 2: S shifts right because
Q
event reduces cost, makes Q1 Q2
production more profitable at any
given price.
STEP 3: The shift causes price to fall
and quantity to rise.
 EXAMPLE 3: A CHANGE IN BOTH
From the desk of Ms Imrana Bano

28 SUPPLY
EVENTS:
price of gas rises ANDAND DEMAND
P
new technology reduces S1 S2
production costs
P2
P1
STEP 1: Both curves shift.
STEP 2:
Both shift to the right. D1 D2
STEP 3: Q
Q rises, but effect Q1 Q2
on P is ambiguous:
If demand increases more than
supply, P rises.
EXAMPLE 3: A CHANGE IN BOTH
From the desk of Ms Imrana Bano

29 SUPPLY
EVENTS: AND DEMAND
P
S1 S2
price of gas rises AND
new technology reduces
production costs
P1
P2
STEP 3, cont.

But if supply D1 D2
increases more Q
Q1 Q2
than demand,
P falls.
A C T I V E L E A R N I N G 3:
From the desk of Ms Imrana Bano

CHANGES
30 IN SUPPLY AND DEMAND

Use the three-step method to analyze the effects of each event on the
equilibrium price and quantity of music downloads.
Event A: A fall in the price of compact discs
Event B: Sellers of music downloads negotiate a reduction in the royalties they must
pay for each song they sell.
Event C: Events A and B both occur.

30
A C T I V E L E A R N I N G 3:
From the desk of Ms Imrana Bano

A.31FALL IN PRICE OF CDS

P
STEPS
S1

1. D curve shifts P1

2. D shifts left P2

3. P and Q both
D2 D1
fall. Q
Q2 Q1

The market for

music downloads 31
A C T I V E L E A R N I N G 3:
From the desk of Ms Imrana Bano

B.32FALL IN COST OF The market for

ROYALTIES P music downloads
S1 S2
STEPS
1. S curve shifts P1
(royalties are part
P2
of sellers’ costs)
2. S shifts
right
D1
3. P falls, Q
Q1 Q2
Q rises.
32
A C T I V E L E A R N I N G 3:
From the desk of Ms Imrana Bano

C.33FALL IN PRICE OF CDS

AND FALL IN COST OF ROYALTIES

STEPS
1. Both curves shift (see parts A & B).
2. D shifts left, S shifts right.
3. P unambiguously falls.
Effect on Q is ambiguous:
The fall in demand reduces Q,
the increase in supply increases Q.

33
 From the desk of Ms Imrana Bano

34 CONCLUSION:
HOW PRICES ALLOCATE RESOURCES
• One of the Ten Principles from Chapter 1: Markets are usually a good way
to organize economic activity.

▪ In market economies, prices adjust to balance

supply and demand. These equilibrium prices
are the signals that guide economic decisions
and thereby allocate scarce resources.