Week 5

BUSINESS
ECONOMICS
Chapter 2: Supply and Demand
BUSINESS ECONOMICS 2024 AHMAD HASSANI

READING
GLS - Chapter 2
2
OUTLINE
2.1 Markets and Models
2.2 Demand
2.3 Supply
2.4 Market Equilibrium
2.5 Elasticity
3
EXAM PROBLEM (2021)
Suppose the demand for vodka is given by 𝑄 ! = 300 − 𝑃, and the supply
of vodka is given by 𝑄 " = 0.5𝑃, where P is the price per bottle of vodka in
DKK and Q is the number of bottles sold per month, in thousands.
4
EXAM PROBLEM (2021)
a) Derive and graph the inverse demand and supply curves for vodka.
b) Solve for the equilibrium price and quantity of vodka (i.e., 𝑃 # and 𝑄 # ).
Then show the equilibrium point, price, and quantity on your graph.
c) Calculate the price elasticity of demand (i.e., 𝐸 ! ) and the price
elasticity of supply (i.e., 𝐸 " ) at the equilibrium price and quantity.
5
EXAM PROBLEM (2021)
A new article by American Cancer Society on 9th June 2020 states that
“Alcohol use is one of the most important preventable risk factors for
cancer, along with tobacco use and excess body weight.” Therefore,
individuals have gradually declined their alcohol consumption since the
publication of the article, and hence, the new demand for vodka has
become 𝑄 ! = 240 − 𝑃.
6
EXAM PROBLEM (2021)
d) Derive the new demand curve for vodka and add (graph) that to your
figure in question (a).
e) Solve for the new equilibrium price and quantity of vodka (i.e., 𝑃$# and
𝑄$# ). Then show the new equilibrium point, price, and quantity on your
graph.
f) Calculate the consumer surplus before and after the shift in demand
curve. Then calculate the magnitude of change in consumer surplus
due to the shift in demand curve.
7
OUTLINE
2.2 Demand
2.3 Supply
2.5 Elasticity
8
MARKETS AND MODELS
What is a market?
• Place where producers and consumers meet for transactions
• Defined by the specific product being bought and sold (e.g.,
bananas), a particular location (e.g., a grocery store, a city,
etc.), and a point in time (e.g., March 15th).
What is the supply and demand for a good?

• Supply: the combined amount of a good that all producers in a
market are willing to sell
• Demand: the combined amount of a good that all consumers in
a market are willing to buy
9
MARKETS AND MODELS
Supply and demand model: 4 key assumptions:
1. Supply and demand in a single market.
2. All goods sold in the market are identical (= homogeneous)
3. All goods sold in the market sell for the same price, and
everyone has the same information.
4. There are many producers and consumers in the market

(price-takers)
10
THE AVOCADO MARKET IN 2017
“Avocado prices have risen to a record due to …
reduced harvests from major producers Mexico,
Peru and California.”
“A 10-kilogram box of Hass avocados from Mexico's major wholesale
producer sells for around $27.89”
“That is more than double last year's price” (Source: BBC)
Effect on demand?
Source: Bloomberg
11
OUTLINE
2.2 Demand
2.3 Supply
2.5 Elasticity
12
DEMAND
Demand = Combined output that all consumers want
to buy
What factors influence the demand for a good?
1. Price
2. Number of consumers
3. Consumer income or wealth
4. Consumer tastes
5. Prices of other, related goods
‒ Complements and substitutes
13
DEMAND
• Focus on effect of price
• Demand curve: describes the relationship between quantity of a

good that consumers demand and the good’s price, holding all
other factors constant
Demand choke
price At $5, consumers demand no tomatoes.
‒ This is known as the demand choke
price.
As the price drops, consumers demand a

greater quantity of tomatoes.
We draw a demand curve that connects all

the observed price-quantity combinations.
14
DEMAND
Mathematical description:
The demand curve to the right is

given as
QD = 1,000 − 200P
• QD is the quantity of tomatoes

demanded (in pounds)
• P is the price of tomatoes
($/pound).
Inverse demand curve

P = 5 − 0.005QD
15
DEMAND
• The demand curve is graphed in two dimensions; all other
factors are assumed constant.
‒ Change in quantity demanded: a movement along the demand
curve that occurs as a result of a change in the good’s price
What about the other factors that influence demand?
• If another factor changes, the demand curve will shift.

− Change in demand: a shift of the entire demand curve caused
by a change in a determinant of demand other than the
good’s own price
16
DEMAND
Change in quantity demanded
17
DEMAND
Change in demand
18
DEMAND
Special role for price in demand:
• Price is important factor affecting demand
(recall strong relationship on Avocado market)
• Price is easy to change in most markets, and changes
often
• Price also important factor that influences quantity
supplied of good, and thereby forms link between both
sides of market
Next we consider supply…
19
OUTLINE
2.2 Demand
2.3 Supply
2.5 Elasticity
20
SUPPLY
Supply = Combined output that all producers want to
sell
What factors influence the supply of a good?
1. Price
2. Number of producers
3. Production costs: Includes the processes used to make,

distribute, and sell a good (production technology)
4. Producers’ outside options: Price of good in other markets and
prices of other, related goods
21
SUPPLY
Again, focus on effect of price
Supply curve: describes the relationship between quantity of a
good that producers supply and the good’s price, holding all other
factors constant
At the price of $1 per pound or less, suppliers find
it unprofitable to sell any tomatoes so they are
unwilling to supply any.
- This is known as the supply choke price.
As the price increases beyond $2, suppliers will
provide more and more tomatoes to the market.
Supply choke
price Just as with demand, we connect the observed
price-quantity combinations using a supply curve.
22
SUPPLY
Mathematical description:
QS = 200P − 200
• QS is the quantity of tomatoes

supplied (in pounds)
• P is the price of tomatoes
($/pound).
Inverse supply curve is given as
P = 0.005QS +1
23
SUPPLY
• The supply curve is also graphed in two dimensions; all
other factors are assumed constant.
‒ Change in quantity supplied: a movement along the
supply curve that occurs as a result of a change in the
good’s price
What about the other factors that influence supply?

• If another factor changes, the supply curve will shift.
‒ Change in supply: a shift of the entire supply curve
caused by a change in a non-price factor that affects
supply
24
SUPPLY
Change in quantity supplied
25
SUPPLY
Change in supply
26
OUTLINE
2.2 Demand
2.3 Supply
2.5 Elasticity
27
MARKET EQUILIBRIUM
Important and powerful economic concept to analyze markets
• How to determine equilibrium?
• Why is it equilibrium?
• Effects on equilibrium from

shifts in demand and supply
28
MARKET EQUILIBRIUM
Both supply and demand relate the price of a good to the quantity,
so we can draw them on the same graph.
The point at which the supply and demand curves cross is called
the market equilibrium.
• Equilibrium quantity: (𝑄$ ) occurs when the price of a good results in

the quantity demanded (𝑄 % ) equaling the quantity supplied (𝑄 & )
• Equilibrium price: (𝑃$ ) the only price at which the quantity demanded
equals the quantity supplied
29
MARKET EQUILIBRIUM
Graphically, the intersection of supply and demand curves
Equilibrium price: $3.00 per pound

of tomatoes
Equilibrium quantity: 400 pounds of

tomatoes
30
MARKET EQUILIBRIUM
The market equilibrium can be identified mathematically.
Returning to the tomatoes example:

QD = 1,000 − 200P and QS = 200P − 200
Solve for the equilibrium price, Pe , by setting demand equal to

supply (QD = QS):
1,000 − 200Pe = 200Pe − 200
Rearranging yields:
1,200= 400Pe , Pe = $3
To find the equilibrium quantity, Qe , substitute Pe = 3 into either
equation. Both should yield: Q e = 400
31
MARKET EQUILIBRIUM
Why markets move toward equilibrium
First, if P > Pe, quantity supplied will exceed quantity demanded,

resulting in Excess Supply: QS > QD
• Excess supply is also referred to as a surplus.

• To sell their products, producers must lower prices.
‒ As prices fall, quantity demanded increases and quantity
supplied decreases until the market reaches an equilibrium
at a lower price.
32
MARKET EQUILIBRIUM
Describing excess supply graphically
At a price of Phigh, QShigh pounds are supplied,

but only QDhigh are demanded.
‒ There is an excess supply of:
QShigh – Qdhigh
To reach the equilibrium, prices must fall,

leading to
1. a decrease in the quantity supplied
2. an increase in the quantity
demanded.
‒ The equilibrium is reached at a price of Pe,

where both quantity demanded and
quantity supplied equal Qe per pound.
33
MARKET EQUILIBRIUM
Why markets move toward equilibrium
Likewise, if P < Pe, quantity demanded will exceed

quantity supplied, resulting in Excess Demand: QD > QS
• Excess demand is also referred to as a shortage.

• The shortage will induce buyers to bid up the price.
‒ As prices rise, quantity demanded will fall and quantity
supplied will rise until the market reaches equilibrium at
a higher price.
34
MARKET EQUILIBRIUM
Describing excess demand graphically
At a price of Plow, QSlow pounds are supplied, but

QDlow pounds are demanded.
‒ There is an excess demand of
QDlow – QSlow
To reach the equilibrium, prices must rise,

leading to
1. a decrease in the quantity demanded
2. an increase in the quantity supplied.
‒ The equilibrium is reached at a price of Pe,

where both quantity demanded and quantity
supplied equal Qe per pound.
35
MARKET EQUILIBRIUM
What happens to the market equilibrium when there is a
shift in demand or supply?
Remember the factors that can shift the demand curve:

• Number of consumers
• Wealth or income
• Consumer tastes
• Prices of related goods (complements or substitutes)
And those that shift the supply curve:
• Number of producers
• Costs of production
• Producer outside options
36
MARKET EQUILIBRIUM
Example: Avocado market in 2017
Droughts reduce supply…
• In 2016, equilibrium
at E.
• Inward supply shift
gives excess demand
at old price (E <--> F)
• Price and supplied
quantity rise to reach
new equilibrium (G).
• Supply shift gives
movement along
demand curve.
37
MARKET EQUILIBRIUM
Recent “global hunger” for avocados increases its demand…
In 2016, equilibrium at E.
• Outward demand shift
gives excess demand
at old price (E <--> H)
• Price and supplied
quantity rise to
new equilibrium (I).
• Demand shift gives
movement along
supply curve to reach
new equilibrium
(from E to I).
38
MARKET EQUILIBRIUM
Summary of the effect of a shift in supply or demand on

market equilibrium
Impact on
Curve that Impact on
Direction of Shift Equilibrium:
Shifts Equilibrium: Quantity
Price
Demand Out (increase in D) ↑ ↑
Curve
In (decrease in D) ↓ ↓
Supply Curve Out (increase in S) ↓ ↑
In (decrease in S) ↑ ↓
39
MARKET EQUILIBRIUM
Recently, avocado supply contraction due to e.g. drought,
and demand expansion from e.g. hipster demand.
Shifts of supply and
demand give:
• reinforcing price effects
• conflicting quantity effects
New demand and supply are:
𝑄$% = 15 − 5𝑃 and 𝑄$& = 5𝑃 − 5.
Verify that quantity stays 5
(as in E1) and new price is $ 2.00
40
MARKET EQUILIBRIUM
General rule: when both curves shift at
same time, direction of change of either
equilibrium price or quantity is unambiguous,
but never both.
41
MARKET EQUILIBRIUM
What determines the magnitude of the change in
equilibrium price and quantity?
Two important parameters:
1. Size of the shift
2. Slope of the curves
‒ If demand shifts, the slope of the supply curve determines
the size of the change in equilibrium price and quantity, and
vice versa.
‒ The size of the change in price is inversely related to the size
of the change in quantity.
42
MARKET EQUILIBRIUM
Consider an outward shift in demand (increase)
Panel (a): Supply has

relatively shallow slope: The
same shift in demand results in
small change in price and
large change in quantity
exchanged.
Panel (b): Supply has

relatively steep slope: Shift in
demand results in large
change in price and small
change in quantity exchanged.
43
MARKET EQUILIBRIUM
Consider an outward shift in supply (increase)
Panel (c): Demand has relatively

shallow slope: The same shift in
supply results in small change in
price and large change in quantity
exchanged.
Panel (d): Demand has relatively

steep slope: Shift in supply
results in large change in price
and small change in quantity
exchanged.
44
OUTLINE
2.2 Demand
2.3 Supply
2.5 Elasticity
45
ELASTICITY
The slopes of the supply and demand curves determine
how markets respond to shifts in supply and demand.
• Steep curves: large changes in price and small changes in

quantity, all else equal
• Shallow curves: small changes in price and large changes in

quantity, all else equal
46
ELASTICITY
Elasticity
• Measure that describes the sensitivity of quantity

demanded or supplied to changes in price, income, or
price of related goods.
• Percentage change in one variable (e.g., quantity) divided
by the percentage change in another (e.g., price)
• Elasticities are unit-free (i.e. just a number)
47
ELASTICITY
Price elasticity of demand: percentage change in
quantity demanded divided by percent change in price
%∆*" ∆*" /*" ∆*" +

• for discrete changes 𝐸% = = = %
%∆+ ∆+/+ ∆+ *"
% -*" + -.(0)
• for continuous changes 𝐸 = % with = 𝑓′(𝑥)
-+ *" -0
Price elasticity of supply: percentage change in

quantity supplied divided by percent change in price
S
% DQ
ES =
%DP
48
ELASTICITY
Markets with large price elasticities of demand…
• Relatively small increases in price result in relatively large drops
in quantity demanded (e.g. fruit/vegetables)
Markets with less price-responsive elasticities of
demand…
• Relatively large increases in price result in relatively small drops
in quantity demanded (e.g. medicine)
Markets with large price elasticities of supply…
• Relatively small increases in price result in relatively large
increases in quantity supplied (e.g. software)
Markets with low price elasticities of supply…
• Relatively large increases in price result in relatively small
increases in quantity supplied (e.g. Wimbledon finals)
49
ELASTICITY
50
ELASTICITY
What variables affect the elasticity of demand?
1. Availability of close substitutes
2. Breadth of the market
3. Type of product
‒ Necessity or luxury item
4. Percentage of income spent on the good
5. Time horizon of the analysis
What variables affect the elasticity of supply?

1. The ease at which production capacity can be expanded
2. Time horizon of the analysis
51
ELASTICITY
Terminology
• Inelastic: Demand is inelastic if 0 < |ED| < 1
• Unit elastic: Demand is unit elastic if |ED| = 1
• Elastic: Demand is elastic if |ED| > 1
• Perfectly elastic: Demand is perfectly elastic if |ED| = ∞
• Perfectly inelastic: Demand is perfectly inelastic if |ED| = 0
Important: Elasticities do not have units attached.

• Allows for the comparison across different goods and
services in different markets
• Above also used to describe supply.
52
ELASTICITY
Elasticities and Linear Demand and Supply
Often we assume demand and supply to be linear
The equation for price elasticity (demand or supply):
%ΔQ ΔQ / Q
E= or E=
%ΔP ΔP / P
Moving up or down an inverse linear supply or demand curve, the

ratio ΔQ/ΔP is equal to 1/slope. Rewriting the formula above:
DQ / Q DQ P 1 P
E= = • = •
DP / P DP Q slope Q
53
ELASTICITY
Price Elasticity of Demand for a Linear Demand Curve
As we move down the demand

curve, the ratio between price
and quantity (P/Q) falls, reducing
the magnitude of the price
elasticity of demand.
à Demand becomes less elastic
as we move down the demand
curve
Note: The slope of the linear

demand curve does not change
as we move down the demand
curve, so the falling P/Q ratio
decreases the elasticity of
demand.
54
ELASTICITY
Income elasticity of demand: the ratio of the percentage
change in the quantity demanded to the corresponding
percentage change in consumer income:
D D D
%ΔQ ΔQ / Q
EID = =
%ΔI ΔI / I
The sign of 𝐸%! depends on the type of product:
• 𝐸%! is negative for inferior goods.

‒ Consumption decreases with increases in income.
• 𝐸%! is positive for normal goods.

‒ Consumption increases with increases in income.
• Luxury Goods: 𝐸%! > 1
55
ELASTICITY
Cross-price elasticity of demand: The ratio of the percentage
change in one good’s quantity demanded (e.g.,, good X) to the
percentage change in the price of another good (e.g.,, good Y) :
D %ΔQXD ΔQXD / QXD

E XY = =
%ΔPY ΔPY / PY
%
where X and Y are different products that may be related. The sign of 𝐸23
depends on the relationship between the products:
!
• 𝐸&' is negative for complements
‒ Consumption of good X decreases with an increase in the price of a related
good Y, and vice versa.
!
• 𝐸&' is positive for substitutes
‒ Consumption of good X increases with an increase in the price of a related
good Y, and vice versa.
56
SUMMARY
Demand function is downward-sloping relationship between
quantity demanded and price of good
● Price change gives movement along demand curve
● Change in other factor for buyer shifts demand curve
Supply function is upward-sloping relationship between quantity

supplied and price of good
● Price change gives movement along supply curve
● Change in other factor for seller shifts supply curve
57
SUMMARY
Equilibrium: neither excess supply nor excess demand
Shift of demand curve moves equilibrium point along supply curve,

and vice versa. This determines direction of change.
Size of change in equilibrium depends on size of curve shift, and

slope of other curve
Elasticity measures effect of changes independent of units
58
READING AND OUTLOOK
Reading: GLS - Chapter 2
Next: Market analysis

Consumer surplus and producer surplus (Section 3.1)
Effects of Price regulations (Section 3.2)
Effects of Taxes (Section 3.4)
59
IN ST IT U T FO R Ø KO N O M I
AA R H U S U N IV ER SITET

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BUSINESS

BUSINESS ECONOMICS 2024 AHMAD HASSANI

BUSINESS ECONOMICS 2024 AHMAD HASSANI

BUSINESS ECONOMICS 2024 AHMAD HASSANI

BUSINESS ECONOMICS 2024 AHMAD HASSANI

BUSINESS ECONOMICS 2024 AHMAD HASSANI

BUSINESS ECONOMICS 2024 AHMAD HASSANI

BUSINESS ECONOMICS 2024 AHMAD HASSANI

BUSINESS ECONOMICS 2024 AHMAD HASSANI

What is the supply and demand for a good?

BUSINESS ECONOMICS 2024 AHMAD HASSANI

1. Supply and demand in a single market.

2. All goods sold in the market are identical (= homogeneous)

4. There are many producers and consumers in the market

BUSINESS ECONOMICS 2024 AHMAD HASSANI

BUSINESS ECONOMICS 2024 AHMAD HASSANI

BUSINESS ECONOMICS 2024 AHMAD HASSANI

BUSINESS ECONOMICS 2024 AHMAD HASSANI

• Demand curve: describes the relationship between quantity of a

As the price drops, consumers demand a

We draw a demand curve that connects all

BUSINESS ECONOMICS 2024 AHMAD HASSANI

The demand curve to the right is

• QD is the quantity of tomatoes

Inverse demand curve

BUSINESS ECONOMICS 2024 AHMAD HASSANI

What about the other factors that influence demand?

• If another factor changes, the demand curve will shift.

BUSINESS ECONOMICS 2024 AHMAD HASSANI

BUSINESS ECONOMICS 2024 AHMAD HASSANI

BUSINESS ECONOMICS 2024 AHMAD HASSANI

Next we consider supply…

BUSINESS ECONOMICS 2024 AHMAD HASSANI

BUSINESS ECONOMICS 2024 AHMAD HASSANI

3. Production costs: Includes the processes used to make,

BUSINESS ECONOMICS 2024 AHMAD HASSANI

BUSINESS ECONOMICS 2024 AHMAD HASSANI

• QS is the quantity of tomatoes

Inverse supply curve is given as

BUSINESS ECONOMICS 2024 AHMAD HASSANI

What about the other factors that influence supply?

BUSINESS ECONOMICS 2024 AHMAD HASSANI

BUSINESS ECONOMICS 2024 AHMAD HASSANI

BUSINESS ECONOMICS 2024 AHMAD HASSANI

BUSINESS ECONOMICS 2024 AHMAD HASSANI

• How to determine equilibrium?

• Effects on equilibrium from

BUSINESS ECONOMICS 2024 AHMAD HASSANI

• Equilibrium quantity: (𝑄$ ) occurs when the price of a good results in

BUSINESS ECONOMICS 2024 AHMAD HASSANI

Equilibrium price: $3.00 per pound

Equilibrium quantity: 400 pounds of

BUSINESS ECONOMICS 2024 AHMAD HASSANI

Returning to the tomatoes example:

Solve for the equilibrium price, Pe , by setting demand equal to

BUSINESS ECONOMICS 2024 AHMAD HASSANI

First, if P > Pe, quantity supplied will exceed quantity demanded,

• Excess supply is also referred to as a surplus.

BUSINESS ECONOMICS 2024 AHMAD HASSANI

At a price of Phigh, QShigh pounds are supplied,

To reach the equilibrium, prices must fall,

‒ The equilibrium is reached at a price of Pe,

BUSINESS ECONOMICS 2024 AHMAD HASSANI

Likewise, if P < Pe, quantity demanded will exceed

%∆" ∆" /" ∆" +