Chapter 4

Demand, Supply,
and Equilibrium

© 2015 Pearson Education, Ltd.

4.1 Markets

Market is a way of connecting people who mutually benefit by exchanging

goods and services through a process of buying and selling

Markets are,
• Reciprocated: Unlike gifts and theft, in a market one person's
transfer of a good or service to another is directly reciprocated by a
transfer in the other direction
• Voluntary: The exchange should be beneficial for both parties

• The market price is the price at which buyers and sellers conduct
transactions.
© 2015 Pearson Education, Ltd.
4.1 Markets: Competitive Markets

• If all sellers and all buyers face the same price, it is referred to as the
market price
• A Price taker is a buyer or seller who accepts the market price

• In a perfectly competitive market

• every buyer pays and every seller charges the same market price,
and no buyer or seller is big enough to influence that market price,
• all sellers sell an identical good or service.

© 2015 Pearson Education, Ltd.

4.2 How Do Buyers Behave?

How much more

gasoline would
people buy if its
price were lower?

© 2015 Pearson Education, Ltd.

4.2 How Do Buyers Behave?

Quantity Demanded
The amount of a good that buyers are willing to
purchase at a given price.

Demand Schedule
A table that reports the quantity demanded at
different prices, holding all else equal.

Demand Curve
Plots the quantity demanded at different prices.

Ceteris Paribus
Every thing else in the economy is held constant

© 2015 Pearson Education, Ltd.

4.2 How Do Buyers Behave?

If two variables move in opposite direction they are Negatively Related

Law of Demand: In almost all cases the quantity demanded rises when the price falls
(ceteris paribus)

© 2015 Pearson Education, Ltd.

4.2 How Do Buyers Behave?
Willingness to Pay
• Demand curve is negatively sloped: When the price of a
good increases, buyers demand a smaller amount of it.

• Willingness to pay is the highest price that a buyer is

willing to pay for an extra unit of a good

• Diminishing marginal benefit: As you consume more of a

good, your willingness to pay for an additional unit
declines.

© 2015 Pearson Education, Ltd.

4.2 How Do Buyers Behave?
From Individual Demand Curves to Aggregated Demand Curves

The process of adding up individual behaviors is referred to

as aggregation

Market Demand Curve

The sum of the individual demand curves of all the potential
buyers. The market demand curve plots the relationship
between the total quantity demanded and the market price,
holding all else equal.

© 2015 Pearson Education, Ltd.

4.2 How Do Buyers Behave?
From Individual Demand Curves to Aggregated Demand Curves
4.2 How Do Buyers Behave?
A Real Life Example: Demand for Oil

© 2015 Pearson Education, Ltd.

4.2 How Do Buyers Behave?
Shifting the Demand Curve

Shifts of the Demand Curve

occur when one of the following changes:

1. tastes and preferences

2. income and wealth
3. availability and prices of related goods
4. number and scale of buyers
5. buyers’ expectations about the future

© 2015 Pearson Education, Ltd.

4.2 How Do Buyers Behave? Shifting the Demand Curve: Examples

1. Tastes and preferences

• When people start to care about global warming more, they start to switch to
more environmentally friendly ways of transportation, so the oil demand curve
shifts to the left.

2. Income and wealth

• If people start earning more, then their consumption of oil will increase at each
price level, thus oil demand curve shifts to the right.
• For a normal good, an increase in income shifts the demand curve to right
(ceteris paribus)
• For an inferior good, an increase in income causes the demand curve to shift to
the left (ceteris paribus)

© 2015 Pearson Education, Ltd.

4.2 How Do Buyers Behave? Shifting the Demand Curve: Examples
3. Availability and prices of related goods
• If the price of another vehicle energy source (like electricity) falls, then the
demand for oil decreases at each price level – the market demand curve for oil
shifts to the left.
• Two goods are substitutes when the fall in the price of one leads to a left shift
in the demand curve for the other.
• Two goods are complements when the fall in the price of one, leads to a right
shift in the demand curve for the other

4. Number and scale of buyers

• Suppose that a town receives an influx of new residents due to recent job
openings. Because of that, the number of potential oil consumers in this town
increases, and the town’s oil market demand curve shifts to the right.

5. Buyers’ expectations about the future

• If people fear that they are going to lose their jobs in the near future, then they
start to cut down their spending and save from today. Because of that demand
for oil decreases, and the demand curve shifts to the left.

© 2015 Pearson Education, Ltd.

4.2 How Do Buyers Behave?
Shifting the Demand Curve
Exhibit 4.4 Shifts of the Demand Curve vs. Movement Along the Demand Curve

The demand curve shifts when the quantity demanded changes at a given price.
If a good’s own price changes and its demand curve hasn’t shifted, the own price change
produces a movement along the demand curve.
© 2015 Pearson Education, Ltd.
What Would Happen If the Government Tried to Dictate the Price of
Gasoline

Evidence-Based Economics Example:

How much
more gasoline
would people
buy if its price
were lower?

© 2015 Pearson Education, Ltd.

4 What Would Happen If the Government Tried to Dictate the Price of
Gasoline

Exhibit 4.5 The Quantity of Gasoline Demanded (per person) and the Price of
Gasoline in Brazil, Mexico, and Venezuela

© 2015 Pearson Education, Ltd.

4.3 How Do Sellers Behave?
Quantity Supplied
The amount of a good that sellers are willing to sell at a given price.

Supply Schedule
A table that reports the quantity supplied at different prices.

Supply Curve
Plots the quantity supplied at different prices.

© 2015 Pearson Education, Ltd.

Exhibit 4.6 ExxonMobil’s Supply Schedule for Oil and Supply Curve for
Oil

• Two variables are positively related if the variables move in the

same direction
• Law of supply: In almost all cases, the quantity supplied rises when
the price rises (ceteris paribus)
4.3 How Do Sellers Behave?

Willingness to accept
is the lowest price that a seller is willing to get paid to sell an
extra unit of a good.

Market Supply Curve

Plots the relationship between the total quantity supplied and
the market price, holding all else equal.

© 2015 Pearson Education, Ltd.

4.3 How Do Sellers Behave?
From the Individual Supply to the Market Supply Curve

© 2015 Pearson Education, Ltd.

4.3 How Do Sellers Behave?
Shifting the Supply Curve

Shifts of the Supply Curve

occur when one of the following changes:

1. input prices (an input is a good or service used to

produce another good or service)
2. technology
3. number and scale of sellers
4. sellers’ expectations about the future

© 2015 Pearson Education, Ltd.

4.3 How Do Sellers Behave?
Shifting the Supply Curve
1. Changes in input prices
• If the wage paid to workers who work in the extraction of oil, increases, then oil
production becomes more expensive. Therefore, now suppliers are willing to
extract a smaller amount of oil at each price level – the oil market supply curve
shifts to the left.
2. Changes in technology
• Oil production becomes less expensive if a less costly oil extraction technology
is invented. In this case, suppliers tend to be willing to supply a higher amount
at each price level – the oil market supply curve shifts to the right.
3. Changes in the number and scale of sellers
• If new companies start to extract and sell oil, then the total amount of oil
supplied at each price level increases – the market supply curve for oil shifts to
the right.
4. Changes in seller’s beliefs about the future
• Natural gas producer’s store the majority of the gas that they extract in the
summer due to expectations about gas price hikes in the winter. Such kind of an
expectation about a future price increase may reduce current supply – shift the
market supply curve to the left.
© 2015 Pearson Education, Ltd.
4.3 How Do Sellers Behave?
Shifting the Supply Curve

• The supply curve shifts only when the quantity supplied changes at a given price.
• If a good’s own price changes and its supply curve hasn’t shifted, the own price change
produces a movement along the supply curve.

© 2015 Pearson Education, Ltd.

4.4 Supply and Demand in Equilibrium
Competitive Equilibrium
The point at which the market comes to an agreement about
what the price will be (competitive equilibrium price) and
how much of a good or service will be exchanged (competitive
equilibrium quantity) at that price.

Excess Demand
Occurs when consumers want more than the amount that
suppliers provide at a given price. This situation results in a
shortage.

Excess Supply
Occurs when suppliers provide more than the amount that
consumers want at a given price. This situation results in a
surplus.
© 2015 Pearson Education, Ltd.
4.4 Supply and Demand in Equilibrium

Exhibit 4.10 Demand Curve and Supply Curve for Oil

When the market is at equilibrium, there is no incentive (on the part of

buyers or sellers) for the price to change.

© 2015 Pearson Education, Ltd.

4.4 Supply and Demand in Equilibrium
Exhibit 4.11 Excess Supply

As oil inventories start building up, producers realize that they need to lower
the price to encourage consumers to buy—they have an incentive to change
(lower) price.
© 2015 Pearson Education, Ltd.
4.4 Supply and Demand in Equilibrium

Exhibit 4.12 Excess Demand

But consumers will start competing with each other, bidding the price up
until there is no longer any incentive to do so—i.e., until the excess demand
is eliminated.
© 2015 Pearson Education, Ltd.
4.4 Supply and Demand in Equilibrium
Curve Shifting in Competitive Equilibrium

© 2015 Pearson Education, Ltd.

4.4 Supply and Demand in Equilibrium
Curve Shifting in Competitive Equilibrium

© 2015 Pearson Education, Ltd.

4.4 Supply and Demand in Equilibrium
Curve Shifting in Competitive Equilibrium

Both the Demand Curve and Supply Curve Shift Right

© 2015 Pearson Education, Ltd.

4.4 Supply and Demand in Equilibrium
Curve Shifting in Competitive Equilibrium

Both the Demand Curve and the Supply Curve Shift Left

© 2015 Pearson Education, Ltd.

4.4 Supply and Demand in Equilibrium
Curve Shifting in Competitive Equilibrium

The Demand Curve Shifts Right and

the Supply Curve Shifts Left

© 2015 Pearson Education, Ltd.

4.4 Supply and Demand in Equilibrium
Curve Shifting in Competitive Equilibrium

The Demand Curve Shifts Left and

the Supply Curve Shifts Right

© 2015 Pearson Education, Ltd.

4.4 Supply and Demand in Equilibrium
Curve Shifting in Competitive Equilibrium

Effects of Shifts of Demand and Supply

Change in Demand
Incr. Demand Decr. Demand
Change in Supply

Incr. Supply Equil. P ? Equil. P ↓

Equil. Q ↑ Equil. Q ?
Decr. Supply Equil. P ↑ Equil. P ?
Equil. Q ? Equil. Q ↓

© 2015 Pearson Education, Ltd.

4.5 Unintented Consequences of Fixing Market Prices

© 2015 Pearson Education, Ltd.