BECO1000 Principles of Microeconomics (010), 2023/2024-1

DEMAND AND SUPPLY (in goods markets)

(Textbook: Chapter 3)

Demand
Wants are the unlimited desires or wishes that people have for goods and services. Scarcity
means that some wants will never be satisfied.

Demand reflects a decision about which wants to satisfy. It is the entire relationship between
the price of a good or service and the quantity demanded of that good or service during a given
time period, other things remaining the same.

QUANTITY DEMANDED
The quantity demanded of a good or service is the amount that consumers (or households) plan
to buy (and are affordable to do so) during a given time period at a particular price.

PRICE
The price of a good or service reflects the households’ maximum willingness to pay, which
measures marginal benefit.

LAW OF DEMAND
The law of demand states that, other things remaining the same, the higher the price of a good
or service, the smaller is the quantity demanded, and vice versa. In other words, there is a
negative relationship between them.

A higher price reduces the quantity demanded for two reasons:

Substitution Effect
When the relative price (opportunity cost) of a good or service rises, people seek substitutes
for it, so the quantity demanded of the good or service decreases.

Income Effect
When the price of a good or service rises relative to income, people cannot afford all the things
they previously bought, so the quantity demanded of the good or service decreases.

DEMAND SCHEDULE
A demand schedule is a table that lists the quantity demanded of a good or service at each price
when all other things remain the same.

DEMAND CURVE
A demand curve is a graphical illustration of the demand schedule. The entire demand curve
shows demand.

1
 Demand schedule and demand curve for energy bars

CHANGE IN QUANTITY DEMANDED

When the price of a good or service changes, while other things remain the same, there will be
a change in the quantity demanded of that good or service, resulting in a movement along the
demand curve.

A fall in the price of a good or service results in an increase in the quantity demanded of it,
which is illustrated by a movement down along the demand curve. A rise in the price of a good
or service results in a decrease in the quantity demanded of it, which is illustrated by a
movement up along the demand curve.

Since the price of a good or service reflects the households’ maximum willingness to pay,
which measures marginal benefit, a demand curve is also a willingness-and-ability-to-pay
curve. The smaller the quantity available, the higher is the price that someone is willing to pay
for another unit.

CHANGE IN DEMAND
A change in any factor other than the price that influences the quantity demanded of a good or
service results in a change in demand, which corresponds to a shift of the demand curve.

An increase in demand means that the quantity demanded at each price is greater, that is, there
is a new demand schedule, resulting in a rightward shift of the demand curve. A decrease in
demand means that the quantity demanded at each price is smaller, that is, there is a new
demand schedule, resulting in a leftward shift of the demand curve.

2
INCOME
A household’s income is the sum of all earnings received by the household from selling its
factors of production in the factor market in a given period of time.

A normal good is one for which demand increases as income increases. An inferior good is
one for which demand decreases as income increases.

PRICES OF RELATED GOODS AND SERVICES

Substitutes are goods or services that can serve as replacements for one another. When the
price of one good or service increases, the demand for the other good or service will increase.

Complements are goods or services that are used in conjunction with one another. When the
price of one good or service increases, the demand for the other good or service will decrease.

EXPECTATIONS
Expectations about future changes (in prices, income, etc.) may affect the demand of a good
today.

If the expected future price of a good rises and if the good can be stored, the demand for the
good today will increase. When the expected future income increases, demand for a good today
may increase.

3
PREFERENCES
Preferences determine the value that people place on each good and service, which depend on
such things as the weather, information and fashion.

POPULATION
The larger the population, the greater is the demand for all goods and services.

Supply
Supply refers to the entire relationship between the price of a good or service and the quantity
supplied of that good or service during a given time period, other things remaining the same.

QUANTITY SUPPLIED
The quantity supplied of a good or service is the amount that firms plan to produce and sell
(and have the resources and technology to produce) during a given time period at a particular
price.

PRICE
The price of a good reflects the firms’ minimum willingness to sell in accordance with the
marginal cost.

LAW OF SUPPLY
The law of supply states that, other things remaining the same, the higher the price of a good
or service, the greater is the quantity supplied, and vice versa. In other words, there is a positive
relationship between them.

SUPPLY SCHEDULE
A supply schedule is a table that lists the quantity supplied of a good or service at each price
when all other things remain the same.

SUPPLY CURVE
A supply curve is a graphical illustration of the supply schedule. The entire supply curve shows
supply.

Supply schedule and supply curve for energy bars

4
CHANGE IN QUANTITY SUPPLIED
When the price of a good or service changes, while other things remain the same, there will be
a change in the quantity supplied of that good or service, resulting in a movement along the
supply curve.

A rise in the price of a good or service results in an increase in the quantity supplied of it,
which is illustrated by a movement up along the supply curve. A fall in the price of a good or
service results in a decrease in the quantity supplied of it, which is illustrated by a movement
down along the supply curve.

Since the price of a good reflects the firms’ minimum willingness to sell in accordance with
the marginal cost, a supply curve is also a minimum-supply-price curve. As the quantity
produced increases, marginal cost increases.

CHANGE IN SUPPLY
A change in any factor other than the price that influences the quantity supplied of a good or
service results in a change in supply, which corresponds to a shift of the supply curve.

An increase in supply means that the quantity supplied at each price is larger, that is, there is a
new supply schedule, resulting in a rightward shift of the supply curve. A decrease in supply
means that the quantity supplied at each price is smaller, that is, there is a new supply schedule,
resulting in a leftward shift of the supply curve.

5
COST OF PRODUCTION and TECHNOLOGY
If the price of a factor of production falls, the lowest price that producers are willing to accept
for that good or service will fall, that is, supply increases.

A technology change occurs when a new method is discovered that lowers the cost of
producing a good or service.

PRICES OF RELATED GOODS AND SERVICES

Substitutes in production are goods or services that can be produced by using the same
resources. When the price of one good or service rises, the supply for the other good or service
will decrease, and vice versa.

Complements in production are goods or services that must be produced together. When the
price of one good or service rises, the supply for the other good or service will increase, and
vice versa.

STATE OF NATURE
The state of nature includes all the natural forces that influence production. It includes the state
of the weather and, more broadly, the natural environment, and extreme natural events such as
earthquakes, tornadoes, and hurricanes.

EXPECTATIONS
Expectations about future changes (in prices, availability of inputs, etc.) may affect the supply
of a good today.

If the expected future price of a good rises, the supply for the good today will decrease and the
supply for the good in the future will increase.

NUMBER OF SUPPLIERS
The larger the number of firms that produce a good or service, the greater is the supply of the
good or service.

6
Market Equilibrium
The operation of the market depends on the interaction between buyers (demand) and sellers
(supply). The price adjusts to coordinate buying plans and selling plans.

At any moment, one of three conditions prevails in every market:

(1) EXCESS DEMAND (SHORTAGE)
A situation in which the quantity demanded exceeds the quantity supplied (QD > QS) at the
current price.

Price adjustment
There is a tendency for price to rise as buyers compete against one another for the limited
supply. As price rises, the quantity demanded falls as buyers drop out of the market, and
the quantity supplied increases as sellers find themselves receiving a higher price for their
good or service and increase in production.

This process continues until a price is reached at which the shortage is eliminated.

(2) EXCESS SUPPLY (SURPLUS)

A situation in which the quantity supplied exceeds the quantity demanded (QS > QD) at the
current price.

Price adjustment
There is a tendency for price to fall as sellers find themselves with unsold goods. As price
falls, the quantity demanded rises as buyers are attracted by the lower price, and the quantity
supplied decreases as some sellers are discouraged by the lower price and pull their goods
from the market. This process continues until a price is reached at which the surplus is
eliminated.

(3) EQUILIBRIUM
A situation in which the quantity demanded equals the quantity supplied (QD = QS) at the
current price. At the equilibrium, no tendency for price to change exists, which is called
the equilibrium price. The equilibrium quantity is the quantity bought and sold at the
equilibrium price.

7
Change in Market Equilibrium
CHANGE IN DEMAND
Increase in demand
The original equilibrium price is $1.50 an energy bar, and the equilibrium quantity is 10 million
energy bars a week. If more people join health clubs, the demand for energy bars increases.
When demand increases, the demand curve shifts rightward. The increase in demand creates a
shortage of 10 million energy bars at the original equilibrium price. To eliminate the shortage,
the price must rise. The equilibrium price rises to $2.50 an energy bar, and the equilibrium
quantity increases to 15 million energy bars a week. There is an increase in the quantity
supplied but no change in supply – a movement up along the supply curve.

Decrease in demand
If people switch to energy gel, a substitute for energy bars, the demand for energy bars
decreases. The decrease in demand shifts the demand curve leftward. At the original
equilibrium price, a surplus is created, which leads to a fall in price. The equilibrium price falls
and the equilibrium quantity decreases. There is a movement down along the supply curve.

8
CHANGE IN SUPPLY
Increase in supply
When energy bar producers switch to a new cost-saving technology, the supply of energy bars
increases and the supply curve shifts rightward. At the original equilibrium price, there is a
surplus in the market, which leads to a fall in the price. The equilibrium price falls and the
equilibrium quantity increases. There is an increase in the quantity demanded but no change in
demand – a movement down along the demand curve.

Decrease in supply
Suppose that the cost of labor or raw materials rises and the supply of energy bars decreases.
The decrease in supply shifts the supply curve leftward. At the original equilibrium price, there
is a shortage in the market, and the price must rise. The equilibrium price rises and the
equilibrium quantity decreases. The quantity demanded decreases and there is a movement up
along the demand curve.

9
Change in both demand and supply
Increase in supply & demand / Decrease in supply & demand
An increase (/ A decrease) in demand and an increase (/ a decrease) in supply increase (/
decrease) the equilibrium quantity. The change in equilibrium price is uncertain because the
increase (/ decrease) in demand raises (/ lowers) the price and the increase (/ decrease) in supply
lowers (/ raises) it. We need to know the magnitudes of the changes in demand and supply to
predict the effects on price.

Decrease in demand & increase in supply / Increase in demand & decrease in supply
A decrease (/ an increase) in demand and an increase (/ a decrease) in supply lowers (/ raises)
the equilibrium price. The change in equilibrium quantity is uncertain because the decrease
(/increase) in demand decreases (/ increases) the quantity and the increase (/ decrease) in supply
increases (/ decreases) it. We need to know the magnitudes of the changes in demand and
supply to predict the effects on quantity.

Summary
An increase in demand (P, Q)
A decrease in demand (P, Q)
An increase in supply (P, Q)
A decrease in supply (P, Q)
An increase in demand & an increase in supply (?P, Q)
A decrease in demand & a decrease in supply (?P, Q)
A decrease in demand & an increase in supply (P, ?Q)
An increase in demand & a decrease in supply (P, ?Q)

10
Algebra of Market Equilibrium
Demand function: QD = a - bP

Supply function: QS = c + dP

At the equilibrium, QD = QS = Q*,

that is, Q* = a – bP* and Q* = c + dP*
so that a – bP* = c + dP*
=> P* = (a – c)/(b + d)
Therefore, Q* = (ad + bc)/(b + d)

11