4/24/2023

CHAPTER 2
SUPPLY AND DEMAND
1. Demand
2. Supply
3. Market Mechanism
4. Government’s policies

1. Demand
1.1. Definition
1.2. Law of demand
1.3. Illustrating demand
1.4. Determinants of demand
1.5. Movement and shift of demand curve

1.1. Definition
• Demand (D) describes the quantity of goods/services that
consumers are willing to buy and afford to buy at various
price levels in a certain time, ceteris paribus.
• Quantity demanded (QD) describes the quantity of goods and
services that consumers are willing to buy and afford to buy at
a price level in a certain time, ceteris paribus.
 Demand describes the relationship of price and quantity
demanded

1
 4/24/2023

Ex: A’s demand for milk tea

Price of milk tea Quantity of milk tea demanded

(thousand VND/cup) (cup(s)/day)
30 2
60 1

Question: Demand = ∑𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑑𝑒𝑚𝑎𝑛𝑑𝑒𝑑 = 3?

1.2. Law of demand

• Law of demand: the claim that other things equal, the
quantity demanded (Qd) of a good falls when the price (P) of
the good rises, and vice versa.
P  Qd
P  Qd
• Reason:

1.3. Illustrating demand

• Demand schedule
• Demand curve
• Demand equation

2
 4/24/2023

1.3. Illustrating demand

Demand schedule: a table that shows the relationship between the price
of a good and the quantity demanded
Ex: A’s demand for milk tea

1.3. Illustrating demand

P
Demand curve: a
60
downward-sloping
curve that shows the
30
relationship between
the price of a good and
the quantity demanded

0 Qd
1 2

1.3. Illustrating demand

• Demand equation describes the relationship of price and
quantity demanded
Qd = a.P + b
• Where:
a, b = parameter;
a = ∆Qd/∆P  a < 0;
a: slope of demand curve

Ex: Finding demand equation of A

3
 4/24/2023

Individual demand – Market demand

• The quantity demanded in the market is the sum of the quantities
demanded by all buyers at each price.
The milk tea market
P
QD QD
(thousand Market QD
(A) (B)
VND/cup)
30 2 + 4 = 6
60 1 2 3

Individual demand – Market demand

Market demand curve

P P P
60 60 60

30 30 30

DB DMK
DA

Qd
0 1 2 3 Qd 0 2 4 Qd 0 3 6

1.4. Determinants of Demand

• Price of related goods (Pr)
• Income (I)
• Number of buyers (N)
• Taste (T)
• Expectation (E)

4
 4/24/2023

1.4. Determinants of Demand

• Price of related goods (Pr):

Hàng thay thế: P↑→D↑ (P↓→D↓)
Hàng bổ sung: P↑→D↓ (P↓→D↑)

• Income (I):
Hàng thông thường: I↑→ D↑ (I↓ → D↓)
Hàng thứ cấp: I↑→ D↓ (I↓→ D↑)

1.4. Determinants of Demand

• Taste (T): T↑→ D↑ (T↓→ D↓)

• Number of buyers (N): N↑→ D↑ (N↓→ D↓)

• Expectation (E): E↑→ D↑ (E↓→ D↓)

1.5. Movement and shift of demand curve

• Moving along D curve when price changes  D curve

unchanged
• Shifting D curve when non-price determinants change
D↑→ D curve shifts to the right
D↓→ D curve shifts to the left

5
 4/24/2023

Movement along D curve

P increases Qd decreases
point A moves to point B (D
curve unchanged)

P decreaes Qd increases
point A moves to point C (D
curve unchanged)

Shifting D curve
D1 Shifting D curve when
P
non-price determinants
change
D↓ D
P1

D3 D2

0 Q1 Q2 Qd
Q3

D curve shifts to …?
• N↑
• Pr↑ (Complements)
• Pr↑ (Substitutes)
• T↓
• E↑
• I↑
• P↑

6
 4/24/2023

2. Supply
2.1. Definition
2.2. Law of supply
2.3. Illustrating supply
2.4. Determinants of supply
2.5. Movement and shift of supply curve

2.1. Definition
• Supply (S) describes the quantity of goods/services that
______ are willing to sell and afford to ______at
________________ in a certain time, ceteris paribus.
• Quantity supplied (Qs) describes the quantity of goods and
services that sellers are willing to sell and afford to sell
at____________in a certain time, ceteris paribus.
 Supply describes the relationship of supply and quantity
supplied

2.2. Law of supply

• Law of supply: the claim that other things equal, the quantity
supplied of a good rises when the price of the good rises, and
vice versa.
P  Qs
P  Qs
• Reason:

7
 4/24/2023

2.3. Illustrating supply

• Supply schedule
• Supply curve
• Supply equation

2.3. Illustrating supply

Supply schedule: a table that shows the relationship between
the price of a good and the quantity supplied.
Supply schedule
Price of face mask Quantity of masks supplied
(thousand VND/box) (box(es)/day)
30 100

40 150
50 200

2.3. Illustrating supply

P Supply curve: a upward-
50 sloping curve that shows
40 the relationship between
+
30
the price of a good and
the quantity supplied

+
0 Qs
100 150 200

8
 4/24/2023

2.3. Illustrating supply

• Supply equation describes the relationship of price and quantity
supplied
Qs = c.P + d
• Where:
c, d = parameter;
c = ∆Qs/∆P  c > 0;
c: slope of supply curve

Individual supply – Market supply

The quantity supplied in the market is the sum of the quantities supplied
by all sellers at each price.

P
Qs Qs
(thousand Market Qs
(Firm A) (Firm B)
VND/box)
30 100 + 110 = 210
40 150 160 310
50 200 210 410

Individual supply – Market supply

Market supply curve

P (SA) P (SB) P (SMK)

50 50 50
40 40 40

30 30 30

Qs
0 100 150 200 Qs 0 110 160 210 Qs 0 210 310 410

9
 4/24/2023

2.4. Determinants of Supply

• Input prices (Pi)
• Technology (Te)
• Number of sellers (Ns)
• Tax (Ta)
• Expectation of sellers (Es)

2.4. Determinants of Supply

• Input prices (Pi): Pi↑→S↓ (Pi↓→S↑)

• Techonology (Te): Te↑→ S↑ (Te↓→ S↓)

2.4. Determinants of Supply

• Tax (Ta): Ta ↑→ S↓ (Ta↓→ S↑)

• Number of sellers (Ns): Ns↑→ S↑ (Ns↓→ S↓)

• Expectation of sellers (Es): Es↑→ S↓ (E↓→ S↑)

10
 4/24/2023

2.5. Movement and shift of supply curve

• Moving along S curve when price changes  S curve
unchanged
• Shifting S curve when non-price determinants change
S↑ → S curve shifts to the right
S↓ → S curve shifts to the left

Movement along S curve

P increases  Qs increases 
point A moves to point B (S
curve unchanged)

P decreases Qs decreases 
point A moves to point C (S
curve unchanged)

Shifting S curve
S3
P
D
50 Shifting S curve when
40 non-price determinants
D
30 change
S1 S2

0 Qs
100 150 200

11
 4/24/2023

3. Market mechanism
3.1. Market equilibrium, surplus and shortage
3.2. Changes in equilibrium

Market equilibrium

Equilibrium quantity Qd = Qs at PE

Market equilibrium
P
Equilibrium (S)
Equilibrium
price
E
15

(D)

Equilibrium
quantity
0 Q
3

12
 4/24/2023

Market surplus and shortage

• Surplus (a.k.a. excess supply): when quantity supplied is greater than
quantity demanded
P
$6.00 D Surplus S
$5.00 then
$4.00 QD = 9 lattes
$3.00 and
QS = 25 lattes
$2.00
resulting in a
$1.00 surplus of 16 lattes
$0.00 Q
0 5 10 15 20 25 30 35

Market surplus and shortage

Shortage (a.k.a. excess demand): 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

3.2. Changes in equilibrium

Market equilibrium changes when S/D curve shifts or S+D shift
Three Steps to Analyzing Changes in Eq’m
To determine the effects of any event,

1. Decide whether the event shifts S curve,

D curve, or both.
2. Decide in which direction curve shifts.
3. Use supply—demand diagram to see
how the shift changes eq’m P and Q.

13
 4/24/2023

3.2. Changes in equilibrium

Ex: When D shifts to the right, S curve unchanged

• Event: Taste of milk tea

increases
• D shifts right
• New e’m: P↑, Q↑

3.2. Changes in equilibrium

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 CDs
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.

4. Government’ policies

4.1. Price controls

4.2. Tax policy

14
 4/24/2023

4.1. Price controls

P
(S)
• Price ceiling: a legal
maximum on the price of
Pc
a good or service
Shortage
(D)
• Price ceiling is for the sake
of consumers
0 Q

4.1. Price controls

P • Price floor: a legal
(S)
Pf
Surplus minimum on the price of
a good or service.
• Price floor is for the sake of
(D) suppliers

0 Q

4.2. Tax policy

• The govt levies taxes on many goods & services to raise
revenue to pay for national defense, public schools, etc.
• The govt can make buyers or sellers pay the tax.
• The tax can be a % of the good’s price, or a specific
amount for each unit sold.
• For simplicity, we analyze only:
Tax on suppliers
Per-unit tax

15
 4/24/2023

4.2. Tax policy

Step 1: Decide whether the event shifts S curve, D curve, or both.

• D curve unchanged

• Increase in tax  Increase in sellers’ costs  S curve shifts

4.2. Tax policy

Step 2: Decide in which direction curve shifts

A tax on sellers shifts the S curve up by the amount of the tax (to
compensate for this cost increase).

Step 3: Using the diagram

The tax effectively raises sellers’ costs Effects of a $1.50 per
unit tax on sellers
by $1.50 per pizza. P S2
$11.50 Tax S
Sellers will supply 1

500 pizzas only if $10.00

P rises to $11.50,
to compensate for
this cost increase. D1

Q
500
Hence, a tax on sellers shifts the
S curve up by the amount of the
tax.

16
 4/24/2023

4.2. Tax policy

New eq’m: Effects of a $1.50 per
unit tax on sellers
P
Q = 450 S2
S1
PB $11.00 Tax
Buyers pay =
$10.00
PB = $11.00 PS = $9.50

Sellers receive D1
PS = $9.50
Q
Difference between them 450 500
= $1.50 = tax

17