Chapter 4

Demand and Supply

Chp. 4 1
Market Demand in Product/Goods Markets
• Demand is the relation between market price
and quantity demanded of the good or service at
a given time.

• Quantity demanded is the number of units of a

good or service that consumers are willing and
able to purchase in a given time period at a
specified price.

Chp. 4 2
 Law of Demand
 The relationship between the market price of the
good and its quantity demanded forms the basis for
the law of demand.
 The law of demand states other things remaining
the same (ceteris paribus),
• If the price of the good rises, the quantity
demanded of that good decreases.
• If the price of the good falls, the quantity
demanded of that good increases.
 There is an inverse relation between market price
and quantity demanded of the good.

Chp. 4 3
 Demand Curve
• Demand curve is a graph of the relationship
between the quantity demanded of a good and its
price when all other influences on buying plans
remain the same.
• Always graph price on the vertical axis and the
quantity demanded on the horizontal axis.
• The law of demand holds along the demand
curve and thus the demand curve is downward
sloping.

Chp. 4 4
 Things that Shift Demand
• There is a change in demand (the demand
curve shifts) if there is a change in anything that
affects potential buyers other than the price of
the product.
 An increase in demand will shift the demand
curve to the right
 A decrease in demand will shift the demand
curve to the left
• Recall that a change in the price of the product
causes a change in quantity demanded. It does
NOT change (shift) demand.

Chp. 4 5
 Things that Shift Demand
(1) Change in income or wealth
 An increase (decrease) in income will cause
demand for the good to rise (fall) if the good is a
normal good.
 An increase (decrease) in income will cause
demand for the good to fall (rise) if the good is an
inferior good.

Chp. 4 6
 Things that Shift Demand
(2) Change in price of a substitute
 Substitutes are goods that can serve as
replacements for one another.
 An increase (decrease) in price of a substitute
will cause demand for the good to rise (fall).

Examples: Diet Pepsi and Diet Coke; Dell and HP

laptops

Chp. 4 7
 Things that Shift Demand
(3) Change in price of a complement
 Complements or complementary goods are
goods that “go together”.
 An increase (decrease) in price of a complement
will cause demand for the good to fall (rise).

Examples: chips & salsa; coffee and coffee

creamer

Chp. 4 8
 Things that Shift Demand
(4) Changes in consumer tastes, preferences, or
fashion

Examples: individuals have become more health

conscious, so demand for Diet Pepsi has increased

Chp. 4 9
 Things that Shift Demand
(5) Changes in expectation of future income
 If consumers expect to earn higher (lower)
income in future, then current demand for the
good will increase (decrease).

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 Things that Shift Demand
(6) Changes in expectation of future price of the
good
 If consumers expect price of the good to rise in
future, they will stock up and current demand will
increase; If consumers expect price of the good
to fall in future, they will postpone their
purchases and current demand of the good will
decrease.

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 Things that Shift Demand
(7) Change in number of buyers
 An increase (decrease) in the number of buyers
will increase (decrease) the demand for the good

Example: number of households with single parent

or both parents working has increased, as a result
demand for daycare has increased.

Chp. 4 12
 Change in Quantity Demanded vs.
Change in Demand
• When the price of the good changes, there is a
change in the quantity demanded of the good
and a movement along the demand curve.

• When any influence other than the price of the

good changes, the demand for the good
changes and the demand curve shifts.

Chp. 4 13
Market Supply in Product/Goods Markets
• Supply is the relation between market price and
quantity supplied of the good or service at a
given time.

• Quantity supplied is the number of units of a

good or service that firms or producers are
willing and able to sell in a given time period at a
specified price.

Chp. 4 14
 Law of Supply
 The relationship between the market price of the good
and its quantity supplied forms the basis for the law of
supply.
 The law of supply states other things remaining the
same (ceteris paribus),
• If the price of the good rises, the quantity supplied
of that good increases.
• If the price of the good falls, the quantity supplied of
that good decreases.
 An increase in the price of the good with no change in
input costs makes it more profitable to produce and sell
the item; this causes firms to increase production
 There is a direct relation between market price and
quantity supplied of the good.

Chp. 4 15
 Supply Curve
• Supply curve is a graph of the relationship
between the quantity supplied of a good and its
price when all other influences on selling plans
remain the same.
• Always graph price on the vertical axis and the
quantity supplied on the horizontal axis.
• The law of supply holds along the supply curve
and thus the supply curve is upward sloping.

Chp. 4 16
 Things that Shift Supply
• There is a change in supply (the supply curve
shifts) if there is a change in anything that affects
potential sellers other than the price of the
product.
 An increase in supply will shift the supply curve to
the right
 A decrease in supply will shift the supply curve to
the left
• Recall that a change in the price of the product
causes a change in quantity supplied. It does
NOT change (shift) supply.

Chp. 4 17
 Things that Shift Supply
(1) Changes in Cost of Inputs (i.e. changes in input
prices)
 An increase (decrease) in cost will cause supply
of the good to fall (rise).

Chp. 4 18
 Things that Shift Supply
(2) Improvements in Production Technology
 Improved technology increases the efficiency of
production, thus increases supply.

Chp. 4 19
 Things that Shift Supply
(3) Nature and Natural Events
 Examples: Harvests, fire, flood, discoveries of
natural resources, etc.

Chp. 4 20
 Things that Shift Supply
(4) Change in number of producers or firms
 An increase (decrease) in the number of firms
will increase (decrease) the supply for the good

Chp. 4 21
 Change in Quantity Supplied vs.
Change in Supply
• When the price of the good changes, there is a
change in quantity supplied of the good and a
movement along the supply curve.

• When any influence on selling plans other than

the price of the good changes, then supply of
the good changes and the supply curve
shifts.

Chp. 4 22
 Market Equilibrium
• Trade or exchange takes place i.e. goods and
services are bought and sold when buyers and
sellers meet each other in goods markets.
• Market equilibrium is the condition that exists
when quantity supplied and quantity demanded
are equal – the point where demand and supply
curves intersect each other.
• Equilibrium price is the price at which the
quantity demanded equals the quantity supplied.
• Equilibrium quantity is the quantity bought and
sold at the equilibrium price.

Chp. 4 23
 Disequilibrium and adjustments
towards equilibrium
• When demand or supply curves shift (due to
the event of change in factors other than price
of the good) the equilibrium situation will be
disturbed i.e. a disequilibrium situation will
arise. Then the market will adjust towards a
new equilibrium.
• Two disequilibrium situations can arise
(1) Current market price is higher than equilibrium
price
(2) Current market price is lower than equilibrium
price

Chp. 4 24
Case 1: Current market price is higher than
equilibrium price
• This happens when either the supply curve shifts
right or the demand curve shifts left.
• Results in quantity supplied to be greater than
quantity demanded.
• When quantity supplied is greater than quantity
demanded at the current price then we say that
there is an excess supply or a surplus in the
market.

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Surplus and adjustment towards equilibrium

• A surplus causes producers to reduce market

price until new equilibrium is reached.
 As price falls producers reduce quantity supplied
 As price falls consumers increase quantity
demanded
 The market reaches equilibrium

Chp. 4 26
Case 2: Current market price is less than
equilibrium price
• This happens when either the supply curve shifts
left or the demand curve shifts right.
• Results in quantity demanded to be greater than
quantity supplied.
• When quantity demanded is greater than quantity
supplied at the current price then we say that
there is an excess demand or a shortage in the
market.

Chp. 4 27
Shortage and adjustment towards equilibrium

• A shortage causes producers to increase market

price until new equilibrium is reached.
 As price rises producers increase quantity
supplied
 As price rises consumers decrease quantity
demanded
 The market reaches equilibrium

Chp. 4 28
 Predicting Changes in Equilibrium
We can work out the effects of an event on
equilibrium price and quantity following the steps
discussed below:
1. First draw the graph of the market whose equilibrium has been
affected.
2. Has the event caused demand or supply curve to shift?
3. Once you shift the appropriate curve compare prices and
quantities at the new equilibrium point with the old equilibrium
point.

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 Price Rigidities
• Price adjustments bring market equilibrium.
• But sometimes prices do not adjust. What
happens then?
• Three reasons why price adjustment might not
occur are:
– Price floor
– Price ceiling
– Sticky price

Chp. 4 30
 Price Floor
• A price floor is a minimum price below which
the good should not be sold.
• A price floor is imposed when the equilibrium
price in the market is too low from the sellers’
viewpoint.
• The result of setting a price floor will be excess
supply, or higher quantity supplied than quantity
demanded.
Examples: government price floors such as farm
price supports, minimum wage laws.

Chp. 4 31
 Price Ceiling
• A price ceiling or price cap is a maximum price
that sellers may charge for a good.
• A price ceiling is imposed when the equilibrium
price in the market is too high from the buyers’
viewpoint.
• The result of setting a price ceiling will be excess
demand, or higher quantity demanded than
quantity supplied.
Examples: government price ceilings such as rent
control, caps on gasoline prices.

Chp. 4 32
 Sticky Price
• In some markets, a law might not restrict the
price.
• But either the buyer and seller agree on a price
for a fixed period or the seller sets a price that
changes infrequently.
• In these markets, prices adjust slowly and not
quickly enough to avoid shortages and
surpluses.

Chp. 4 33