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10/09/2023
FOUNDATIONS OF MICROECONOMICS
Topic 2: The Market Forces of Demand and Supply
Baye and Prince, Chapter 2
Professor Fátima Barros
2023/2024
Some facts
https://www.ft.com/video/69cd8024-475b-4d6e-8f2c-
1df1ac8b3e67
“Asian thermal coal prices hit a new record this month, driven by
growing demand in Europe after the region banned imports of the fuel
from Russia.
[…]
European countries are preparing to burn more coal this winter, and
some have switched on mothballed coal plants, as the continent braces
for energy shortages caused by the absence of Russian gas and coal.
[…]
Due to high gas prices, Europe is already burning more coal in power
stations. In Germany, coal-fired power generation was up 31 per cent
between January and August compared with the same period last year”
Financial Times, September 7, 2022
Foundations of Microeconomics Fátima Barros 2
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Some Facts
“The owner of Primark has raised its profit outlook for

the year as sales at the value chain were lifted by strong
demand for summer clothes and higher prices.
…
The update comes after rival Next last week said that
warmer weather and wage increases encouraged
shoppers to spend more on their summer wardrobes and
lifted its profit guidance.”
Financial Times, June 2003
Some Facts
For years, wholesale gas prices in Britain were steady and cheap, hovering at
about 50 pence per therm between 2010 and 2021. This changed in the summer of
that year, with economies reopening as the coronavirus pandemic eased and
Russia started to squeeze supplies. Prices then leapt after Russian troops poured
over the border with Ukraine, surging as much as 11-fold to 640 pence per therm
in August 2022. By January 2023, Ofgem’s price cap, which usually governs how
much a typical household pays and is reset every three months to reflect changing
wholesale costs, had reached £4,279 per year — almost four times higher than in
2021. By then the government had stepped in with a subsidy, known as the energy
price guarantee, that limited the typical annual bill to £2,500 at an estimated cost
to taxpayers of £29.4bn. But as the cap drops below that level most support for
households will end. Following a relatively mild winter and efforts across Europe to
reduce demand, wholesale prices have fallen back but are still well above the
prewar average.
Rachel Millard, Financial Times, June 3, 2023
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Introduction
• What factors affect buyers’ demand for goods?
• What factors affect sellers’ supply of goods?
• How do supply and demand determine the price of a good
and the quantity sold?
• How do changes in the factors that affect demand or supply
affect the market price and quantity of a good?
• How do we measure consumer and producer surplus?
Markets and Competition
• A market is a group of buyers and sellers of a particular

product.
• A competitive market is one with many buyers and sellers,

where each has a negligible effect on price.
• In a perfectly competitive market:

– All goods are exactly the same (homogeneity)
– Buyers & sellers are so numerous that no one can affect
market price—each is a “price taker”
• For now, we assume markets are perfectly competitive.
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1. Market Demand
Demand
• The quantity demanded of any good is the

amount of the good that buyers are willing and
able to purchase at a given price.
• Mathematically, the demand function or curve

is the relation between the quantities demanded
and prices: 𝑄 𝐷 = 𝑓(𝑝)
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1.1 The Demand Schedule
• Demand schedule: a table that shows

Quantity
the relationship between the price of a Price
of coffee
of coffee
good and the quantity demanded demanded
𝑄 𝐷 = 𝑓(𝑝) € 0.00 16
€ 1.00 14
• Example: Helen’s demand for coffee
€ 2.00 12
(per week).
€ 3.00 10
Helen’s preferences can be represented by
€ 4.00 8
the following equation:
€ 5.00 6
𝑄 𝐻 = 16 − 2𝑝 € 6.00 4
Example: Helen’s Demand Schedule & Curve
Price of Quantity
Price
coffee of coffee
of coffee (€)
demanded
€$6.00 0.00 16
€$5.00 1.00 14
2.00 12
$4.00
€
3.00 10
€$3.00 4.00 8
$2.00
€ 5.00 6
6.00 4
$1.00
€
€$0.00
Quantity of
0 5 10 15 coffee
10
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1.2 Law of Demand
• The demand curve is downward sloping.
Price
8
6
5
4
3
2
1
0
0 4 6 8 10 12 14 16 Quantity
11
Law of demand: the claim that

the quantity demanded of a good
falls when the price of the good
rises, other things equal (coeteris Market Demand
paribus).
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Inverse Demand Function
• Price as a function of quantity demanded.

• Example:
Demand Function:
𝑄𝑥𝐷 = 16 – 2𝑝𝑥
Inverse Demand Function:
2𝑝𝑥 = 16– 𝑄𝑥𝐷
𝑝𝑥 = 8 − 0.5𝑄𝑥𝐷
Indicates the maximum value the consumer is

willing to pay for a certain amount of the good
13
Market Demand versus Individual Demand

• The quantity demanded in the market is the sum of the quantities
demanded by all buyers at each price.
• Suppose Helen and Ken are the only two buyers in the coffee 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
14
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The Market Demand for Coffee (1)
P QD
P
€$6.00
Horizontal aggregation (Market)
of demand curves
0.00 24
€$5.00
1.00 21
€$4.00 2.00 18
€$3.00 3.00 15
Ken
4.00 12
€$2.00
5.00 9
$1.00
€
6.00 6
Helen
€$0.00 Q
0 5 10 15 20 25
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The Market Demand for Coffee (2)
The same example with algebra

• Helen’s demand is given by 𝑄𝐻 = 16 – 2𝑝
• Ken’s demand is 𝑄𝐾 = 8 – 𝑝
• Market demand is found adding up the quantities demanded for
any given price
𝑄𝐻 + 𝑄 𝐾 = 𝑄𝑀𝑎𝑟𝑘𝑒𝑡 = 24 – 3𝑝
Another example: Market Demand with 100 Helens and 50

Kens
𝑄𝑀𝑎𝑟𝑘𝑒𝑡 = 1600– 200𝑝 + 400 − 50𝑝 ⇔ 𝑄𝑀𝑎𝑟𝑘𝑒𝑡 = 2000 − 250𝑝
Inverse Market Demand is 𝑝 = 8 − 0.004 𝑄𝑀𝑎𝑟𝑘𝑒𝑡

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1.3 Determinants of Demand
Determinants of Demand
• Consumers’ Income
– Normal good
– Inferior good
• Prices of Related Goods
– Prices of substitutes
– Prices of complements
• Advertising and consumer tastes
• Population
• Consumer expectations
• Cultural aspects
Foundations of Microeconomics
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Fátima Barros 17
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Normal Good and Inferior Good
• Normal Good: A good for which an increase

(decrease) in income leads to an increase
(decrease) in the demand for that good;
• Inferior Good: A good for which an increase

(decrease) in income leads to a decrease
(increase) in the demand for that good
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Substitutes and Complements
• Substitute Goods
• Two goods are substitutes if an increase in the price of one
causes an increase in the demand for the other.
Examples: Coke and Pepsi, Ryanair and Easyjet, Uber and Taxi
• Complement Goods
• Two goods are complements if an increase in the price of one
causes a fall in the demand for the other.
Example: cars and tires, Ryanair and Airbnb…
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The Demand Function
• A linear equation representing the demand curve
• Example:
𝑄𝑋𝐷 = 100 − 2𝑷𝑿 + 0.5𝑷𝒀 + 3𝑴+2𝑯
𝑄𝑋𝐷 = quantity demanded of good X.

𝑃𝑋 = price of good X.
𝑃𝑌 = price of a related good Y.
𝑀 = income.
𝐻 = any other variable affecting demand.
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The Linear Demand Function
Example:
𝑄𝑋𝐷 = 100 − 2𝑷𝑿 + 0.5𝑷𝒀 + 3𝑴
Relationship between quantity demanded and all

variables:
𝑷𝑿 : coeficient negative (− ) by the law of demand
𝑷𝒀 : coeficient positive (+ ) means good Y is a
substitute for good X
𝑴: coeficiente Positive (+ ) means good X is a
normal good
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In general terms:
𝑄𝑋𝐷 = 𝛼0 + 𝛼𝑋 𝑷𝑿 + 𝛼𝑌 𝑷𝒀 + 𝛼𝑀 𝑴
The signs and magnitude of α coefficients determine
the impact of each variable on the number of units
of 𝑋 demanded.
𝛼𝑋 < 0 by the law of demand
𝛼𝑌 > 0 if good Y is a substitute for good X
𝛼𝑌 < 0 if good Y is a complement for good X
𝛼𝑀 > 0 if good X is a normal good
𝛼𝑀 < 0 if good X is an inferior good
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In our previous example:

𝑄𝑋𝐷 = 100 − 2𝑃𝑋 + 0.5𝑃𝑌 + 3𝑀
𝜶𝑿 = −𝟐 by the law of demand

𝜶𝒀 = +𝟎. 𝟓 then good Y is a substitute for good X
𝜶𝑴 = +𝟑 then good X is a normal good
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1.4 Demand Curve Shifters
• The demand curve shows how price affects quantity

demanded, other things being equal.
𝑸𝑫 = 𝒇(𝒑)
• These “other things” (X) are non-price determinants of

demand (i.e., things that determine buyers’ demand for
a good, other than the good’s price).
𝑸𝑫 = 𝒇(𝒑; 𝑿)
• Changes in them shift the D curve…
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Example
Consider the demand function

𝑄𝑋𝐷 = 100 − 2𝑃𝑋 + 0.5𝑃𝑌 + 3𝑀
Assume that 𝑃𝑌 = 40 and 𝑀 = 20

Then the demand curve is given by
𝑄𝑋𝐷 = 100 − 2𝑃𝑋 + 0.5 40 + 3 20
𝑄𝑋𝐷 = 𝟏𝟖𝟎 − 2𝑃𝑋
And the inverse demand curve is
𝑃𝑋 = 𝟗𝟎 − 0.5𝑄𝑋𝐷
If M decreases to M’=10 then 𝑄𝑋𝐷 = 𝟏𝟓𝟎 − 2𝑃𝑋
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Change in Demand
Price D0 to D1: Decrease in Demand

90
75 D0 : 𝑄𝑋𝑑 = 𝟏𝟖𝟎 − 2𝑃𝑋
D1 ∶ 𝑄𝑋𝑑 = 𝟏𝟓𝟎 − 2𝑃𝑋
and the Inverse demand

functions are
D0 : 𝑃𝑋 = 𝟗𝟎 − 0.5𝑄𝑋𝑑
10
D1
D1 : 𝑃𝑋 = 𝟕𝟓 − 0.5𝑄𝑋𝑑
Quantity
130 160
Foundations of Microeconomics 26Fátima Barros 26
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Changes in Quantity Demanded
• Changing only price leads to changes in quantity

demanded.
– This type of change is graphically represented by a
movement along a given demand curve, holding other
factors that impact demand constant.
• Changing factors other than price leads to changes
in demand.
– These types of changes are graphically represented by a
shift of the entire demand curve.
27
Change in Quantity Demanded
𝑄𝑋𝑑 = 𝟏𝟖𝟎 − 2𝑃𝑋

Price
90 And the Inverse demand curve:
𝑃𝑋 = 𝟗𝟎 − 0.5𝑄𝑋𝑑
A A to B: price decreases and quantity
10
demanded increases
B
8
Movement along
the demand curve
D0
160 164 Quantity
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Change in Demand
Price
90 D0 to D1: Decrease in Demand

D0 to D2: Increase in Demand
75
10
D1 D0 D2
Quantity
130 160
Foundations of Microeconomics 29Fátima Barros 29
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Demand Curve Shifters: # of buyers
What happens to the demand curve D if the number of

buyers increases (demographic effect)?
• Increase in # of buyers increases quantity

demanded at each price, shifts D curve to the right.
30
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Demand Curve Shifters: # of buyers
P Suppose the number of

€$6.00 buyers increases.
Then, at each P,
€$5.00 QD will increase
(by 5 in this example).
$4.00
€
€$3.00
€$2.00
$1.00
€
€$0.00 Q
0 5 10 15 20 25 30
31
Demand Curve Shifters: Income
• Demand for a normal good is positively related to

income.
– An increase in income causes increase in quantity

demanded at each price, shifts D curve to the right.
• Demand for an inferior good is negatively related to

income.
– An increase in income shifts D curves for inferior

goods to the left. Typically low quality goods are inferior
goods.
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Demand Curve Shifters: Prices of Related Goods
• If two goods are substitutes an increase in the price of one

causes a shift to the right of the demand for the other.
Example: An increase in the price of Coke increases demand for

Pepsi, shifting the Pepsi demand curve to the right.
• If two goods are complements an increase in the price of one

causes a shift to the left of the demand for the other.
Example: An increase in the price of cars decreases the demand

for cars, shifting the tires demand to the left.
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Demand Curve Shifters: Tastes
• Anything that causes a shift in tastes toward a good will

increase demand for that good and shift its D curve to the right.
• Examples:
The discovery that the pigments in red wine might be good for
health led to an increase in the demand for red wine in some
countries
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Demand Curve Shifters: Expectations
• Expectations affect consumers’ buying decisions.
• Examples:
– If people expect taxes on cars to increase they will

anticipate the decision to buy a new car and the demand
for new cars will increase.
– If the economy is not growing and people worry about their

future job security, demand for new cars may fall now.
35
Summary: Variables that Influence Buyers
Variable A change in this variable…
Price …causes a movement

along the D curve
# of buyers …shifts the D curve
Income …shifts the D curve
Price of
related goods …shifts the D curve
Tastes …shifts the D curve
Expectations …shifts the D curve
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2. Market Supply
37
Supply
• Market supply curve

– relationship between the total quantity all
producers are willing and able to produce at
alternative prices, holding other factors
affecting supply constant.
• Law of supply
– As the price of a good rises (falls), the
quantity supplied of the good rises (falls),
holding other factors affecting supply
constant.
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2.1 Law of Supply
P
€$6.00
€$5.00 The supply curve has a

positive slope
€$4.00
€$3.00
€$2.00
$1.00
€
€$0.00 Q
0 5 10 15
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The Supply Schedule
• Supply schedule: A table that shows

the relationship between the price of a Quantity
Price
of coffee
good and the quantity supplied. of coffee
supplied
0.00 0
• Example: Starbucks’ supply of coffee.
1.00 3
Notice that Starbucks’ supply schedule
2.00 6
obeys the law of supply. 3.00 9
4.00 12
• Supply is 𝑄𝑆 = 3𝑝.
5.00 15
6.00 18
40
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Starbucks’ Supply Curve
P
€$6.00 Price Quantity
of coffee of coffee
€$5.00
€0.00 0
€$4.00
1.00 3
€$3.00 2.00 6
€$2.00 3.00 9
4.00 12
$1.00
€
5.00 15
€$0.00 Q 6.00 18
0 5 10 15
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2.2 Inverse Supply Function
• Price as a function of quantity supplied.

• Example:
Supply Function
𝑄𝑥𝑠 = 3𝑝𝑥
Inverse Supply Function:
3𝑝𝑥 = 𝑄𝑥𝑠
𝑄𝑥𝑠
𝑝𝑥 =
3
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Market Supply versus Individual Supply

The quantity supplied in is the sum of the quantities supplied by all
sellers at each price. Suppose Starbucks and Jeronymo are the only
two sellers in this market.(Qs=quantity supplied)
Price (€) Starbucks Jeronymo 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
QMarket=QS+QJ  QMarket=3p+2p=5p  QMarket=5p
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The Market Supply Curve

Jeronymo
Starbucks
P Market QS
P
$6.00
€ (Market)
0.00 0
$5.00
€
1.00 5
$4.00
€ 2.00 10
$3.00
€ 3.00 15
4.00 20
$2.00
€
5.00 25
$1.00
€ 6.00 30
$0.00
€ Q 𝑝 = 𝑄𝑆𝑠 𝑄𝐽𝑠
𝑆 𝑝𝐽 =
3 2
0 5 10 15 20 25 30 35
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2.3 Supply Shifters
• Input prices
• Technology or government regulations
• Number of firms
– Entry
– Exit
• Substitutes in production
• Taxes
– Per unit tax
– Ad valorem tax
• Producer expectations
45
The Supply Function
• An equation representing the supply curve :
𝑄𝑋𝑠 = 100 + 3𝑃𝑋 − 1.5𝑊 − 0.5𝑅
𝑄𝑋𝑠 = quantity supplied of good X.

𝑃𝑋 = price of good X.
𝑊 = price of inputs (e.g., wages).
𝑅 = other variable affecting supply (ex: regulatory
costs).
46
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The Linear Supply Function
The signs and magnitude of β coefficients determine

the impact of each variable on the number of units
of X produced.
For example:
𝑄𝑋𝑠 = 𝛽0 + 𝛽𝑋 𝑃𝑋 + 𝛽𝑊 𝑊 + 𝛽𝑟 𝑅
𝛽𝑥 > 0 by the law of supply

𝛽𝑤 < 0 increasing input price
𝛽𝑟 < 0 regulatory costs
47
The Linear Supply Function
An example:
𝑄𝑋𝑠 = 50 + 2𝑃𝑋 − 4𝑊 − 0.5𝑅
If W= 60 and 𝑅=20 we get
If W increases to W’=65 then
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Change in Supply
Price S0 to S1 : Decrease in supply
S1
S0
110
100
Quantity
49
Changes in Quantity Supplied
• Changing only price leads to changes in quantity

supplied.
– This type of change is graphically represented by a
movement along a given supply curve, holding other
factors that impact supply constant.
• Changing factors other than price lead to changes in
supply.
– These types of changes are graphically represented by a
shift of the entire supply curve.
50
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Change in Quantity Supplied
Price A to B: Increase in quantity supplied
S0
B
20
Movement along
the supply curve
A
10
5 10 Quantity
51
Change in Supply
Price S0 to S1: Increase in supply

S0 to S2: Decrease in supply
S2 S0
S1
3 5 7 Quantity
52
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Impact of a Per Unit Tax
53
Impact of an Ad Valorem Tax
54
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Supply Curve Shifters: Input Prices
• Examples of input prices: wages, price of energy, prices of

raw materials.
• A fall in input prices makes production more profitable, so

firms supply a larger quantity at each price, and the S curve
shifts to the right.
55
Supply Curve Shifters: Input Prices
Suppose the price

P of coffee grain
$6.00
€ falls.
At each price, the
€$5.00
quantity of coffee
$4.00
€ supplied will
increase (by 5 in
$3.00
€ this example).
$2.00
€
$1.00
€
$0.00
€ Q
0 5 10 15 20 25 30 35
56
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Supply Curve Shifters: Technology
• Technology determines the quantities of inputs required to

produce a unit of output.
• A cost-saving technological improvement has the same

effect as a fall in input prices, shifts S curve to the right.
Example: energy or labor-saving devices.
57
Supply Curve Shifters: # of Sellers
• An increase in the number of sellers increases the

quantity supplied at each price, shifts S curve to the right.
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Supply Curve Shifters: Expectations
• Example:
– War events lead to expectations of higher oil prices in the

near future.
– In response, Russian oil companies reduce supply now,

save some inventory to sell later at the higher price.
– S curve shifts left.

• In general, sellers may adjust supply* when their expectations
of future prices change.
(*If good not perishable)
59
Summary: Variables that Influence Sellers
Variable A change in this variable…

Price …causes a movement
along the S curve
Input Prices …shifts the S curve
Technology …shifts the S curve
# of Sellers …shifts the S curve
Expectations …shifts the S curve
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Active Learning
Market Demand and Market

Supply
61
Active Learning 1
Consider the market for electric cars Price of
P electric cars
EVENT TO BE
ANALYZED:
Increase in price of
gasoline.
D shifts right
because electric cars
are substitutes of other
cars that use gasoline. D1 D2
High gas prices make Q
electric cars more
attractive. quantity of
electric cars
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Active Learning 1
What is the impact in Price of

P gas cars
the market for gas-
powered cars?
D shifts left P1
because gas is a
complement of gas-
powered cars.
Therefore high gas D2 D1
price reduces the Q
demand for gas- Q2 Q1
powered cars. quantity of
gas-powered
cars
63
Active Learning 1
Consider again the market for electric cars
Price of
P electric cars
EVENT: consumers
expect Government to
increase subsidies to
stimulate the purchase
of electric cars.
P1
D shifts left
because consumers
that plan to buy a car D1
D2
will postpone the
decision given the Q
Q2 Q1
expectation of
government support quantity of
electric cars
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Active Learning 2
When people need personal transportation with a driver (rides) they

call a taxi but there are alternatives. For example they can call Uber.
How did Uber and others like it change the market supply of rides?
Show that using supply curves.
65
Active Learning 2
Price of S0 to S1: Increase in supply

Rides
S0
S1
P1
Q1 Q2 Quantity of Rides
66
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Active Learning 3
When it comes time to fill out income

taxes, people can choose to do it
themselves (perhaps using software) or,
instead, hire professionals. Consider the
market for tax return preparation
software. What happens to it in each of
the following scenarios?
A. Retailers cut the price of

the software.
B. A technological advance allows the
software to be produced at lower cost.
C. Professional tax return preparers raise the price of the
services they provide.
67
Active Learning 3
A. Fall in price of tax return software
Price of
tax return S curve does
S1
software not shift.
Move down
P1 along the curve
to a lower P
P2 and lower Q.
Q2 Q1 Quantity of tax
return software
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Active Learning 3
B. Fall in cost of producing software
Price of
S curve shifts to
tax return
S1 S2 the right:
software
at each price,
P1 Q increases.
Q1 Q2 Quantity of tax
return software
69
Active Learning 3
C. Professional preparers raise their price
Price of
tax return This shifts the
software demand curve for tax
preparation software,
not the supply curve.
D1 D2
Quantity of tax
return software
70
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Consumer Surplus
71
Consumer Surplus:
•The value consumers

get from a good but do
not have to pay for.
•Difference between the Consumer surplus will prove

value consumers are particularly useful in
willing to pay for a good marketing and other
and the price they disciplines emphasizing
strategies like value pricing
actually pay.
and price discrimination.
Foundations of Microeconomics 72
Fátima Barros 72
72
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Consumer Surplus: The Discrete Case
Suppose
Consumer Surplus: Themarket price isCase
Discrete p=2
Price Consumer Surplus:
The value received but not
10
paid for. Consumer surplus =
8 (8-2) + (6-2) + (4-2) = $12.
2 Market Price
D
1 2 3 4 5 Quantity
73
Consumer Surplus: The Continuous Case
Suppose market price is p=2

Price $
10
Consumer Value
8 of 9 units = $54
Surplus =
$54 - $18 = = ($10-$2)x9/2+9x$2
$36
6
4 Expenditure on 9 units =
$2 x 9 = $18
2 P=2
CS= triangle area D
=(10-2)x9/2=36
1 2 3 4 5 6 7 8 9 Quantity
74
37
10/09/2023
Consumer Surplus: an example

Consider a market where the demand is 𝑄𝑋𝑑 = 90 − 0.5𝑃𝑋 . If the
price in the market is P=40 what is the consumer surplus?
Price The inverse demand function is 𝑃𝑋 = 𝟏𝟖𝟎 − 2𝑄𝑋𝑑
180
(180 − 40) × 70
𝐶𝑆 = = 4.900
2
40 market price
D0
70 Quantity
75
Consumer Surplus
If the market price increases to P=60 what is the impact in the
consumer surplus?
Price New Consumer (180 − 60) × 60
Surplus 𝐶𝑆 = = 3.600
180 2
Loss in consumer surplus
60 new market price
40 market price
D0
60 70 Quantity
76
38
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Producer Surplus
77
Producer Surplus
Producer Surplus
The amount producers receive in excess
of the amount necessary to induce them
to produce the good.
Price Producer surplus is the
area of the triangle
S0
Market price
P*
Q* Quantity
78
39
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Producer Surplus: an example

Consider the inverse supply function: 𝑃 = 10 + 2𝑄 and
assume that market price is P=50. What is the producer
surplus?
(50 − 10) × 20
𝑃𝑆 = = 400
2
Price
S0
Market price
50
10
20 Quantity
79
Producer Surplus
Suppose now that the market price increases to P=60.
What is the impact in the producer surplus?
(60 − 10) × 25
𝑃𝑆 = = 625
2
Price Gain in Producer Surplus
S0
60 new market price
market price
50
10
20 25 Quantity
80
40
10/09/2023
Market Equilibrium
81
Market Equilibrium
82
82
41
10/09/2023
Market Equilibrium
• Competitive market equilibrium: determined by

the interactions of the market demand and
market supply for the good.
• The Price (P) that balances supply and demand
𝑸 𝒙𝑺 = 𝑸 𝒙𝒅
• No shortage or surplus
• Steady-state: forces that drive market demand
and market supply are balanced, and there is no
pressure on prices or quantities
to change.
83
Market Equilibrium
Price 𝑄𝐷 = 24 – 3𝑝
S
𝑄𝑆 = 5𝑝
P*=3
Quantity
Q*=15
84
42
10/09/2023
If price is too low…

Price S
7
6
Shortage D
12 - 6 = 6
6 12 Quantity
Quantity Quantity
Supplied Demanded
85
If price is too high…
Surplus
Price
14 - 6 = 8 S
9
6 8 14 Quantity
Quantity Quantity
Demanded Supplied
86
43
10/09/2023
Price Restrictions
• In a competitive market equilibrium, price and quantity

freely adjust to the forces of demand and supply.
• Sometime government restricts how much prices are
permitted to rise or fall.
• Price Ceilings
– The maximum legal price that can be charged.
– Examples:
• Gasoline prices until early 00’s in Portugal (70’s in US).
• Tuition fees in public universities
• Price Floors
– The minimum legal price that can be charged.
– Examples:
• Minimum wage.
• Agricultural price supports.
87
Market without Government intervention

Price
S
Consumer
Surplus
P* Q d= Q s
Producer D
surplus
Q* Quantity
88
44
10/09/2023
Impact of a Price Ceiling
Price S
P*
P Ceiling
Shortage D
Qs Q* Qd Quantity
Quantity Quantity
Supplied Demanded
89
Price S
E CS=E+B
B PS=A+C+D
P*
A C
P Ceiling
D
Shortage D
Qs Q* Qd Quantity
Quantity Quantity
Supplied Demanded
90
45
10/09/2023

Price
S
New CS=A+E Deadweight loss
E
Consumers gain:
B
ΔCS=+A-B
P*
Producers loose:
A C ΔPS=-A-C
ΔCS+ΔPS = -B-C
P Ceiling
D
D
Shortage
New PS=D
Qs Q* Qd Quantity
Quantity Quantity
Supplied Demanded
91
Impact of a Price Floor

Price Surplus
S
PFl oor
25
22
6 12 15 Quantity
Quantity Quantity
Demanded Supplied
92
46
10/09/2023
Price Surplus
E
S
PFl oor
25
A B
22 CS=A+B+E
C
PS=D+C
D
6 12 15 Quantity
Quantity Quantity
Demanded Supplied
93

Price
New CS=E Surplus
S
E
PFl oor
25
A A
Consumers loose:
B
ΔCS=-A-B
22 Producers gain:
C ΔPS=+A-C
D ΔCS+ΔPS=-B-C
D
New PS=A+D
6 12 15 Quantity
94
47
10/09/2023
Price Surplus S
PFl oor Consumers loose:
25
ΔCS=-A-B
B
Producers gain:
22 ΔPS=+A-C
C ΔCS+ΔPS=-B-C
6 12 15 Quantity
95
Price S’
E
S
t=1
Inverse Demand: 𝑃 = 10 − 𝑄
7,5 B
7 Inverse Supply: 𝑃 = 4 + 𝑄
C
6,5 With tax
5 Inverse Supply: 𝑃 = 4 + 𝑡 + 𝑄
t=1
D
4
2,5 3 Quantity
96
48
10/09/2023
Price S’
E
S
t=1
𝑃 = 7,5 is the price
7,5 B consumers pay
7
t=1 𝑃 = 6,5 is the price firms
C
6,5 receive
5
D
4
2,5 3 Quantity
97
Price S’ S
E
7,5 B
7 Tax Revenue
A Tax Revenue=(7,5-6,5)x2,5
B
C
6,5 A+B= Deadweight Loss
5
D
4
2,5 3 Quantity
98
49
10/09/2023
Three Steps to Analysing Changes in

Equilibrium
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.
99
Example: The Market for Electric Cars
P
price of
S1
electric cars
P1
D1
Q
Q1
quantity of
electric cars
100
50
10/09/2023
Example 1: A Shift in Demand

EVENT TO BE
ANALYZED: P
Increase in price of S1
gasoline.
P2
STEP 2: P1
D shifts right
because high gas price
makes electric cars D1 D2
more attractive relative
Q
to other cars. Q1 Q2
quantity of
electric cars
101
Example 1: A Shift in Demand

Notice:
P
When P rises,
producers supply S1
a larger quantity P2
of electric cars, even
though the S curve
has not shifted. P1
Always be careful to
D1 D2
distinguish b/w a shift
in a curve and a Q
movement along the Q1 Q2
curve.
102
51
10/09/2023
Example 2: A Shift in Supply

EVENT: New technology
reduces cost of producing P
electric cars. S1 S2
STEP 1:
S curve shifts
because event affects P1
STEP
cost of2:
production.
P2
D curve right
S shifts does not shift,
because
STEP 3: event reduces
because production
cost,
technology is not price
The shift causes one of D1
makes
the
to fall production
factors more
that affect
and quantity to Q
profitable
demand.
rise. at any given Q1 Q2
price.
103
Example 3: A Shift in Both Supply and

Demand
EVENTS:
Price of gas rises AND P
new technology reduces S1 S2
production costs
STEP 1: P2
Both curves shift.
P1
STEP 2:
Both shift to the right.
D1 D2
STEP 3: Q
Q rises, but effect on P is Q1 Q2
ambiguous: If demand increases
more than supply, P rises.
104
52
10/09/2023
Example 4:
Impact of Airbnb in rental housing
market
EVENTS:
Airbnb’s appearance shifts P
total demand for rental S1
housing up
Demand curve
increases, supply curve P2
stays the same, quantity
increases and P P1
increases.
D1 D2
What happens in the Q
long term rental segment Q1 Q2
of the market?
105
Example 5:
Impact of Uber in market for rides
EVENTS:
Uber’s appearance shifts P
S1
total supply of rides up
S2
Supply curve increases, D1

demand curve stays the
P1
same, quantity increases
and P decreases. P2
What happens in the taxi

segment of the market? Q
Q1 Q2
106
53
10/09/2023
Conclusion:
How Prices Allocate Resources
• One of the seven 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.
107
Summary
• A competitive market has many buyers and sellers, each of

whom has little or no influence on the market price.
• Economists use the supply and demand model to analyze

competitive markets.
• The downward-sloping demand curve reflects the law of

demand, which states that the quantity buyers demand of a
good depends negatively on the good’s price.
108
54
10/09/2023
Summary
• Besides price, demand depends on buyers’ incomes, tastes,

expectations, the prices of substitutes and complements, and
number of buyers. If one of these factors changes, the D curve
shifts.
• The upward-sloping supply curve reflects the Law of Supply,

which states that the quantity sellers supply depends positively
on the good’s price.
• Other determinants of supply include input prices, technology,

expectations, and the # of sellers. Changes in these factors shift
the S curve.
109
Summary
• The intersection of S and D curves determines the market

equilibrium. At the equilibrium price, quantity supplied equals
quantity demanded.
• If the market price is above equilibrium, a surplus results,

which causes the price to fall. If the market price is below
equilibrium, a shortage results, causing the price to rise.
110
55
10/09/2023
Summary
• We can use the supply-demand diagram to analyze the

effects of any event on a market: First, determine whether the
event shifts one or both curves. Second, determine the
direction of the shifts. Third, compare the new equilibrium to
the initial one.
• In market economies, prices are the signals that guide

economic decisions and allocate scarce resources.
111
56

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10/09/2023

Topic 2: The Market Forces of Demand and Supply

Baye and Prince, Chapter 2

Professor Fátima Barros

Foundations of Microeconomics Fátima Barros 2

“The owner of Primark has raised its profit outlook for

Foundations of Microeconomics Fátima Barros 3

Rachel Millard, Financial Times, June 3, 2023

Foundations of Microeconomics Fátima Barros 4

• What factors affect buyers’ demand for goods?

• What factors affect sellers’ supply of goods?

• How do supply and demand determine the price of a good

and the quantity sold?

• How do changes in the factors that affect demand or supply

affect the market price and quantity of a good?

• How do we measure consumer and producer surplus?

Foundations of Microeconomics Fátima Barros 5

Markets and Competition

• A market is a group of buyers and sellers of a particular

• A competitive market is one with many buyers and sellers,

• In a perfectly competitive market:

Foundations of Microeconomics Fátima Barros 6

• The quantity demanded of any good is the

• Mathematically, the demand function or curve

Foundations of Microeconomics Fátima Barros 8

1.1 The Demand Schedule

• Demand schedule: a table that shows

Foundations of Microeconomics Fátima Barros 9

Example: Helen’s Demand Schedule & Curve

Foundations of Microeconomics Fátima Barros 10

1.2 Law of Demand

• The demand curve is downward sloping.

Foundations of Microeconomics Fátima Barros 11

Law of demand: the claim that

Foundations of Microeconomics Fátima Barros 12

Inverse Demand Function

• Price as a function of quantity demanded.

Indicates the maximum value the consumer is

Market Demand versus Individual Demand

Price (€) Helen’s QD Ken’s QD Market QD

Foundations of Microeconomics Fátima Barros 14

The Market Demand for Coffee (1)

Foundations of Microeconomics Fátima Barros 15

The Market Demand for Coffee (2)

The same example with algebra

Another example: Market Demand with 100 Helens and 50

Inverse Market Demand is 𝑝 = 8 − 0.004 𝑄𝑀𝑎𝑟𝑘𝑒𝑡

1.3 Determinants of Demand

Normal Good and Inferior Good

• Normal Good: A good for which an increase

• Inferior Good: A good for which an increase

Foundations of Microeconomics Fátima Barros 18

Substitutes and Complements

Example: cars and tires, Ryanair and Airbnb…

Foundations of Microeconomics Fátima Barros 19

The Demand Function

• A linear equation representing the demand curve

𝑄𝑋𝐷 = quantity demanded of good X.

Foundations of Microeconomics Fátima Barros 20