Chapter 3 Demand, Supply and Market Equilibrium

CHAPTER 3
Demand, Supply,
and Market Equilibrium
Prepared by: Fernando Quijano

and Yvonn Quijano
© 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair
Topics will be Discussed
C H A P T E R 3: Demand, Supply, and Market Equilibrium
• Basics Decision Making Units &

The Circular Flow
• Demand in Product/Output Markets

• The Law of Demand
• Supply in Product/Output Markets

• The Law of Supply
• Market Equilibrium
© 2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair 2 of 49
Firms and Households:
The Basic Decision-Making Units

• A firm is an organization that transforms
resources (inputs) into products (outputs).
Firms are the primary producing units in a
market economy.
• An entrepreneur is a person who organizes,

manages, and assumes the risks of a firm,
taking a new idea or a new product and
turning it into a successful business.
• Households are the consuming units in an

economy.
Input Markets and Output Markets:
The Circular Flow
• The circular flow of

economic activity
shows how firms and
households interact in
input and output markets.
The Circular Flow
• Product or output markets are

the markets in which goods and
services are exchanged.
• Input markets are the markets in

which resources—labor, capital,
and land—used to produce
products, are exchanged.
The Circular Flow
• Goods and services flow

clockwise. Firms provide
goods and services;
households supply labor
services.
• Payments (usually money)
flow in the opposite
direction (counterclockwise)
as the flow of labor
services, goods, and
services.
The Circular Flow
• Input or factor markets are the

markets in which the resources
used to produce products are
exchanged. They include:
• The labor market, in which
households supply work for wages
to firms that demand labor.
The Circular Flow

markets in which the resources used
to produce products are exchanged.
They include:
• The capital market, in which
households supply their savings, for
interest or for claims to future
profits, to firms that demand funds
to buy capital goods.
The Circular Flow

markets in which the resources used
to produce products are exchanged.
They include:
• The land market, in which
households supply land or other real
property in exchange for rent.
The Circular Flow
• Inputs into the production

process are also called
factors of production.
Demand in Product/Output Markets
• A household’s decision about the

quantity of a particular output to
demand depends on:
• The price of the product in
question.
• The income available to the

household.

quantity of a particular output to
demand depends on:
• The household’s amount of
accumulated wealth.
• The prices of other products

(substitutes and complements)
available to the household.

quantity of a particular output to demand
depends on:
• The household’s tastes and

preferences.
• The household’s expectations about

future income, wealth, and prices.
• Quantity demanded is the

amount (number of units) of a
product that a household would
buy in a given time period if it
could buy all it wanted at the
current market price.
Changes in Quantity Demanded
Versus Changes in Demand
• The most important relationship

in individual markets is that
between market price and
quantity demanded.
• We use the ceteris paribus or “all

else equal” device, to examine the
relationship between the quantity
demanded of a good per period of
time and the price of that good,
while holding income, wealth, other
prices, tastes, and expectations
constant.
• Changes in price affect the

quantity demanded per period.
• Changes in income, wealth,

other prices, tastes, or
expectations affect demand.
Price and Quantity Demanded:
The Law of Demand
ANNA'S DEMAND • A demand schedule

SCHEDULE FOR is a table showing
TELEPHONE CALLS
how much of a given
QUANTITY
DEMANDED
product a household
PRICE (CALLS PER would be willing to
(PER CALL) MONTH)
$ 0 30
buy at different prices.
0.50 25
3.50 7 • Demand curves are
7.00 3
10.00 1 usually derived from
15.00 0 demand schedules.
The Law of Demand
ANNA'S DEMAND
SCHEDULE FOR
• The demand curve is
TELEPHONE CALLS a graph illustrating
QUANTITY
PRICE DEMANDED how much of a given
(PER (CALLS PER
CALL) MONTH) product a household
$ 0 30
0.50 25 would be willing to buy
3.50 7
7.00 3 at different prices.
10.00 1
15.00 0
The Law of Demand
• The law of demand

states that there is a
negative, or inverse,
relationship between
price and the quantity
of a good demanded
and its price.
• This means that

demand curves slope
downward.
Other Determinants
of Household Demand
• Income is the sum of all households

wages, salaries, profits, interest
payments, rents, and other forms of
earnings in a given period of time. It is
a flow measure.
• Wealth, or net worth, is the total value

of what a household owns minus what
it owes. It is a stock measure.
Other Determinants
of Household Demand
• Normal Goods are goods for

which demand goes up when
income is higher and for which
demand goes down when income
is lower.
• Inferior Goods are goods for
which demand falls when income
rises.
Other Determinants
of Household Demand
• Substitutes are goods that can
serve as replacements for one
another; when the price of one
increases, demand for the other
goes up.
• Perfect substitutes are identical

products.
Other Determinants
of Household Demand
• Complements are goods that

“go together”; a decrease in the
price of one results in an
increase in demand for the
other, and vice versa.
Shift of Demand Versus
Movement Along a Demand Curve

• A change in demand is not
the same as a change in
quantity demanded.
• A higher price causes lower
quantity demanded and a
move along the demand
curve DA.
• Changes in determinants of
demand, other than price,
cause a change in demand,
or a shift of the entire
demand curve, from DA to DB.
A Change in Demand Versus
a Change in Quantity Demanded
To summarize:
Change in price of a good or service
leads to
Change in quantity demanded

(Movement along the curve).
Change in income, preferences, or

prices of other goods or services
leads to
Change in demand
(Shift of curve).
The Impact of a Change in Income
• Higher income • Higher income

decreases the demand increases the demand
for an inferior good for a normal good
The Impact of a Change
in the Price of Related Goods
• Demand for
complement
good
(ketchup)
shifts left
• Demand for
substitute
good
(chicken)
• Price of hamburger rises shifts right
• Quantity of hamburger
demanded per month falls
From Household
Demand to Market Demand
• Demand for a good or service can be

defined for an individual household,
or for a group of households that
make up a market.
• Market demand is the sum of all the

quantities of a good or service
demanded per period by all the
households buying in the market for
that good or service.
From Household
Demand to Market Demand
• Assuming there are only two households in the

market, market demand is derived as follows:
Supply in Product/Output Markets
• Supply decisions depend on

profit potential.
• Profit is the difference

between revenues and costs.
Supply in Product/Output Markets
CLARENCE BROWN'S • Quantity supplied

SUPPLY SCHEDULE represents the number of
FOR SOYBEANS units of a product that a
QUANTITY firm would be willing and
SUPPLIED able to offer for sale at a
PRICE (THOUSANDS
(PER OF BUSHELS particular price during a
BUSHEL) PER YEAR) given time period.
$ 1 0
1,75 10 • A supply schedule is a
2,25 20
3,00 30
table showing how much
4,00 45 of a product firms will
5,00 45 supply at different prices.
Price and Quantity Supplied:
The Law of Supply

• A supply curve is a graph illustrating how
much of a product a firm will supply per
period of time at different prices.
Price of soybeans per bushel ($)

CLARENCE BROWN'S 6
SUPPLY SCHEDULE
FOR SOYBEANS 5
QUANTITY
SUPPLIED 4
PRICE (THOUSANDS
(PER OF BUSHELS 3
BUSHEL) PER YEAR)
$ 1 0 2
1,75 10
2,25
3,00
20
30
1
4,00 45
5,00 45
0
0 10 20 30 40 50
Thousands of bushels of soybeans
produced per year
Price and Quantity Supplied:
The Law of Supply
• The law of supply

Price of soybeans per bushel ($)
6
5 states that there is a
4 positive relationship
3
between price and
2
1
quantity of a good
0
supplied.
0 10 20 30 40 50
Thousands of bushels of soybeans • This means that
produced per year
supply curves typically
have a positive slope.
Other Determinants of Supply
• The price of the good or service.
• The cost of producing the good,

which in turn depends on:
• The price of required inputs

(labor, capital, and land),
• The technologies that can be
used to produce the product,
• The prices of related products.
Shift of Supply Versus
Movement Along a Supply Curve
• A higher price causes

higher quantity
supplied, and a
move along the
demand curve.
• A change in determinants
of supply other than price
causes an increase in
supply, or a shift of the
entire supply curve, from
SA to SB.
Shift of Supply Curve for Soybeans
Following Development of a New Seed Strain
• In this example, since the

factor affecting supply is not
the price of soybeans but a
technological change in
soybean production, there is
a shift of the supply curve
rather than a movement
along the supply curve.
• The technological advance means that more

output can be supplied for at any given price
level.
Shift of Supply Versus
Movement Along a Supply Curve

To summarize:
Change in price of a good or service
leads to
Change in quantity supplied

(Movement along the curve).
Change in costs, input prices, technology, or prices of
related goods and services
leads to
Change in supply
(Shift of curve).
From Individual
Supply to Market Supply
• The supply of a good or service can

be defined for an individual firm, or
for a group of firms that make up a
market or an industry.
• Market supply is the sum of all the

quantities of a good or service
supplied per period by all the firms
selling in the market for that good or
service.
From Individual
Supply to Market Supply
• As with market demand, market

supply is the horizontal summation
of individual firms’ supply curves.
Market Equilibrium
• Market equilibrium is the

condition that exists when
quantity supplied and quantity
demanded are equal.
• At equilibrium, there is no
tendency for the market price to
change.
Market Equilibrium
• Only in equilibrium is
quantity supplied
equal to quantity
demanded.
• At any price level
other than P0, such as
P1, quantity supplied
does not equal
quantity demanded.
Excess Demand
• Excess demand, or
shortage, is the condition
that exists when quantity
demanded exceeds
quantity supplied at the
current price.
• When quantity demanded
exceeds quantity supplied,
price tends to rise until
equilibrium is restored.
Excess Supply
• Excess supply, or surplus,

is the condition that exists
when quantity supplied
exceeds quantity demanded
at the current price.
• When quantity supplied
exceeds quantity demanded,
price tends to fall until
equilibrium is restored.
Changes in Equilibrium
• Higher demand leads to • Higher supply leads to

higher equilibrium price and lower equilibrium price and
higher equilibrium quantity. higher equilibrium quantity.
Changes in Equilibrium
• Lower demand leads to • Lower supply leads to

lower price and lower higher price and lower
quantity exchanged. quantity exchanged.
Relative Magnitudes of Change
• The relative magnitudes of change in supply and demand

determine the outcome of market equilibrium.
Relative Magnitudes of Change
• When supply and demand both increase, quantity

will increase, but price may go up or down.
Review Terms and Concepts
capital market income perfect substitutes

complements, inferior goods product or output
complementary goods markets
input or factor markets
demand curve profit
labor market
demand schedule quantity demanded
land market
entrepreneur quantity supplied
law of demand
equilibrium shift of a demand curve
law of supply
excess demand or substitutes
shortage market demand
supply curve
excess supply or surplus market supply
supply schedule
factors of production movement along a
demand curve wealth or net worth
firm
normal goods
households
Tugas # 3
• Sebutkan dua unit pengambil keputusan

yang utama dalam perekonomian ?
• Bagaimana mereka berinteraksi dalam

pasar (pasar output, pasar input) ?
• Jelaskan hukum permintaan !
• Jelaskan hukum penawaran !
• Jelaskan tentang keseimbangan pasar !


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CHAPTER 3

Prepared by: Fernando Quijano

• Basics Decision Making Units &

• Demand in Product/Output Markets

• Supply in Product/Output Markets

The Basic Decision-Making Units

• An entrepreneur is a person who organizes,

• Households are the consuming units in an

The Circular Flow

• The circular flow of

The Circular Flow

• Product or output markets are

• Input markets are the markets in

The Circular Flow

• Goods and services flow

The Circular Flow

• Input or factor markets are the

The Circular Flow

• Input or factor markets are the

The Circular Flow

• Input or factor markets are the

The Circular Flow

• Inputs into the production

• A household’s decision about the

• The income available to the

• A household’s decision about the

• The prices of other products

• A household’s decision about the

• The household’s tastes and

• The household’s expectations about

• Quantity demanded is the

Versus Changes in Demand

• The most important relationship

Versus Changes in Demand

• We use the ceteris paribus or “all

Versus Changes in Demand

• Changes in price affect the

• Changes in income, wealth,

The Law of Demand

ANNA'S DEMAND • A demand schedule

The Law of Demand

The Law of Demand

• The law of demand

• This means that

• Income is the sum of all households

• Wealth, or net worth, is the total value

• Normal Goods are goods for

• Perfect substitutes are identical

• Complements are goods that

Movement Along a Demand Curve

Change in quantity demanded

Change in income, preferences, or

• Higher income • Higher income

in the Price of Related Goods

Demand to Market Demand

• Demand for a good or service can be

• Market demand is the sum of all the

Demand to Market Demand

• Assuming there are only two households in the

• Supply decisions depend on

• Profit is the difference

CLARENCE BROWN'S • Quantity supplied

The Law of Supply

Price of soybeans per bushel ($)