Demand and Supply

Market and the Economy

Demand
The Demand Curve
Demand versus Quantity Demanded
Supply
Supply versus Quantity Supplied
Market Equilibrium
Changes in Market Equilibrium
 Specialization and Trade
In a market economy people can trade what they
have (or have produced) for economic resources or
goods they would like to have. Places, institutions,
or mechanisms at or through which these trades take
palace are called markets.
• Money as a medium of exchange, standard of value,
and store of vale facilitates trade.
• Trade allows people to specialize, resulting in
greater efficiency in production.
The Circular Flow Model
Markets and Prices

>
Inputs Input Markets Inputs
Income Exp
V

Households Firms

A Rev
Exp
Products Product Markets Products
<
 The Role of Price in the Market
Price is in essence the means of
communication in the market. By offering
higher prices buyers signal their desire to buy
more of a good or a resource to sellers.
Sellers, on the other hand, communicate the
information about the cost of a good or a
resource to buyers through price.
• If too much of a good is produced => Price
• If not enough of a good is produced => Price
A Network of Markets
A market economy functions through a vast
network of individual markets bringing together
buyers and sellers of various goods and services as
well as resources; e.g., the corner grocery store,
the McDonald's restaurant, the New York Stock
Exchange, The Chicago Mercantile Exchange
In each market it is the interaction of demand and
supply that determines the price.
Competitive Markets

A competitive market is characterized by:

• Many sellers and many buyers
• Free (unhindered) entry and free exit
• Full information
• Homogenous products
No individual buyer or seller’s decisions
would have a noticeable impact on the
market price.
DEMAND
Demand and its Determinants:
A General Definition:
Demand is the quantity of a good or resource
that buyers (or demanders) are willing and
able to buy under a given set of conditions
over a given period of time.
Conditions: price, income, taste, prices of
related goods, expected prices, number of
buyers, etc.
Demand and Price

Demand and Price, Ceteris Paribus:

A Narrower (More Specific) Definition
Demand is a schedule or a curve showing
the various amounts of a good or a service
consumers (buyers) are willing and able to
buy at various prices, ceteris paribus, over a
specified period of time.
 DEMAND SCHEDULE FOR MILK
Price per Quart Quantity Demanded
$1.50 45
1.40 50
1.30 55
1.20 60
1.10 65
1.00 70
0.90 75

NOTE: Quantity is in billions of quarts per year.

C opyri ght  2000 by Harc ourt, Inc . Al l ri ght s rese rved .
Law of Demand

Other things unchanged, as price rises, the

quantity demanded decreases, and as price
falls, the quantity demanded increases; the
relationship between price and the quantity
demanded is negative.
The Demand Curve:A graphical
representation of the demand schedule
The demand curve is a line or a curve showing the
relationship between price and quantity demanded;
it is a curve plotted in a two-dimensional space
with price measured along the vertical axis and the
quantity demanded measured along the horizontal
axis.
A demand curve shows the relationship between
price and quantity demanded only; all (other)
factors affecting demand are assumed to remain
unchanged along a demand curve.
 DEMAND CURVE FOR MILK
D A
$1.50
B
1.40
C
Price per Quart

1.30
E
1.20
F
1.10
G
1.00
H
.90
D
0 45 50 55 60 65 70 75
Quantity Demanded
in Billions of Quarts per Year
C op y ri g ht  20 0 0 by Harc ou rt, Inc . Al l ri g ht s rese rv ed .
The Reasons Behind the Law of
Demand
• The price a consumer pays for a good is, in
fact, the opportunity cost of having it
• The principle of diminishing marginal
utility
• Income and substitution effects
Individual Demand and Market
Demand
An individual demand curve reflects the
quantities of a good a consumer is willing
and able to purchase at a range of possible
prices, ceteris paribus, during a given
period of time. A market demand (curve) is
the (horizontal) sum of individual demands.
Demand (Curve) versus Quantity
Demanded
By “demand”or “demand curve” we mean a
range of quantities corresponding to various
prices reflected along a line or a curve. By
“quantity demanded” we mean a specific
quantity demanded corresponding to a
specific price.
Changes in Demand versus
Changes in Quantity Demanded
• A change in price, ceteris paribus, results in
a change in quantity demanded; that is a
movement along the curve not a change in
demand.

• A change in demand (curve) results from

changes in factors other than price. Such
changes cause shifts of the demand curve.
Factors causing changes (shifts)
in demand (curve):
• Changes in income
• taste
• prices of related goods (substitutes or
complementary goods)
• expectations about future prices,
• number of buyers
• Other non-self-price factors
 MOVEMENT ALONG A DEMAND CURVE
VERSUS SHIFT BETWEEN DEMAND CURVES
D1
An increase in income
D0
Price per Quart

D2
C
A decrease in income
$1.30

F
1.10

D1
D2 D0
Quantity Demanded in Billions of Quarts per year
C op yri ght  2000 by Harc ourt, Inc . Al l ri ght s rese rved.
Supply
A General Definition: Supply is the
quantity of a good or resource that sellers
(or suppliers) are willing and able to offer
to the market for sale under a given set of
conditions over a specific period of time.
Determinants of Supply

Factors affecting supply of a good

include price, prices of inputs,
technology, prices of related
goods, taxes, expectations, number
of firms, etc.
Supply and Price: A Narrower
Definition
Supply (or a supply curve) is a
schedule or curve showing the
quantities of a product a firm (or
firms) is (are) willing and able to
produce and offer to the market for
sale at a range of possible prices,
ceteris paribus, over a certain
period of time.
Supply Curve
The supply curve is a line or a curve showing the
relationship between price and quantity supplied; it
is a curve plotted in a two-dimensional space with
price measured along the vertical axis and the
quantity supplied measured along the horizontal
axis.
A supply curve shows the relationship between
price and quantity supplied only; all (other)
factors affecting supply are assumed to remain
unchanged along a supply curve.
 SUPPLY CURVE FOR MILK
a
$1.50 S
b
1.40
c
Price per Quart

1.30
e
1.20
f
1.10
g
1.00
h
.90
S
0 30 40 50 60 70 80 90
Quantity Supplied
in Billions of Quarts per Year
C opy ri ght  20 00 by Harc ou rt, Inc . Al l ri g ht s rese rved .
Law of Supply

Other things remaining constant, as

the price of a good rises, the
corresponding quantity supplied
increases, and as the price falls the
quantity supplied decreases; the
relationship between price and the
quantity supplied is positive.
The Reason Behind the Law of
Supply
As more and more of a good is
produced, beyond some production
level, the costs of producing
additional units begin to rise. In order
for a firm to produce more of that
good it has to charge (or be offered)
higher prices.
 Individual Supply and Market
Supply
An individual supply curve reflects the
quantities of a good a producer (a firm) is
willing and able to produce and offer for
sale at a range of possible prices, ceteris
paribus, during a given period of time. A
market supply (curve) is the (horizontal)
sum of individual supply curves.
Supply (Curve) versus Quantity
Supplied
By Supply or supply curve we mean
a range of quantities corresponding
to various prices reflected along a
line or a curve. By quantity supplied
we mean a specific quantity supplied
corresponding to a specific price.
 Supply and Quantity supplied
• A change in price (ceteris paribus) results in a change in
quantity supplied ( a movement along the curve), not a
change in supply.
• A change in supply (or the supply curve) is caused by
changes in factors other than price. Such changes cause
shifts of the supply curve.
• Changes in resource prices, technology, prices of related
goods (substitutes or accompanying products),
expectations, number of firms, etc. will result in changes
in (market) supply or shifts of the supply curve.
 MOVEMENT ALONG A SUPPLY CURVE
VERSUS SHIFT BETWEEN SUPPLY CURVES
S0
S1

1.30
c
Price per Quart

f
1.10
S0

S1

Quantity Supplied
in Billions of Quarts per Year
C opy ri ght  20 00 by Harc ou rt, Inc . Al l ri g ht s rese rved .
 SHIFTS BETWEEN SUPPLY CURVES

S1
S0

Price
Price

S1 V S0

U E

S0 S1
S1 S0
Quantity Quantity
(a) (b)
C opy ri ght  20 00 by Harc ou rt, Inc . Al l ri g ht s rese rved .
Market Equilibrium
Market equilibrium is a condition under which the
quantity supplied is equal to the quantity demanded;
when a market is in equilibrium, there is no tendency
for change.
The equilibrium price is the price at which the quantity
demanded is equal to the quantity supplied.
Shortages occur when price is below the equilibrium
price; shortages cause the price to rise.
Surpluses occur when price is above the equilibrium
price; surpluses cause the price to fall.
 DETERMINATION OF THE EQUILIBRIUM
PRICE AND QUANTITY OF MILK
Price Quantity Quantity Surplus or Price
per Quart Demanded Supplied Shortage? Direction

$1.50 45 90 Surplus Fall

1.40 50 80 Surplus Fall
(i$ - iY) = p
1.30 55 70 Surplus Fall
1.20 60 60 Neither Unchanged
1.10 65 50 Shortage Rise
1.00 70 40 Shortage Rise
0.90 75 30 Shortage Rise

NOTE: Quantity is in billions of quarts per year.

Copyright  2000 by Harcourt, Inc. All rights reserved.
 SUPPLY-DEMAND EQUILIBRIUM
D S
A a
$1.50

1.40

1.30
Price per Quart

E
1.20

1.10
g G
1.00
D
.90
S

0 30 40 50 60 70 80 90
Quantity
in Billions of Quarts per Year
C opy ri ght  20 00 by Harc ou rt, Inc . Al l ri g ht s rese rved .
 THE EFFECT OF
SHIFTS OF THE DEMAND CURVE

D1
D0 S D0 S

Price per Quart

T D2
$1.30 E E
1.20 R $1.20 L M
1.10

D1 D0
S D0 S D2
60 70 75 45 50 60
Quantity Quantity

C opy ri ght  20 00 by Harc ou rt, Inc . Al l ri g ht s rese rved .

 THE EFFECTS OF SHIFTS
OF THE SUPPLY CURVES
S2
D D
V
$1.40 S0
S0
E U E
$1.20 S1 1.20
J
1.10
S0 S2
S1 S0
D D
60 65 78 37.5 50 60
Quantity Quantity

C opy ri ght  20 00 by Harc ou rt, Inc . Al l ri g ht s rese rved .

 Changes in the Market
Equilibrium
Changes (shifts) in the market
supply and/or the market demand
result in changes in the market
equilibrium.
Using the S&D Tool to Address
Some Policy Questions
• Who pays the excise taxes?
• Rent control
• Subsidies for farmers
• Minimum wage
 WHO PAYS FOR A NEW TAX ON GAS?
P

D
S1
Price per Gallon

M
$1.14
X
E1 /gallon
1.10 t =.10 S0
1.04
S1
E0

D
S0 Q2 Q1
30 50 Q
Quantity
C opy ri ght  20 00 by Harc ou rt, Inc . Al l ri g ht s rese rved .
 SUPPLY-DEMAND DIAGRAM FOR RENTAL
Ren t p e r Mo n th HOUSING

D S

Market
rent E
$2,000
Rent
ceiling C B
1,200

D
S
0 2.5 3 3.5
Millions of Dwellings
Rented per Month
C opy ri ght  20 00 by Harc ou rt, Inc . Al l ri g ht s rese rved .
The Minimum Wage Controversy
Wage
Surplus
S
7.00

6.00

5.25

Labor
0
 SUPPORTING THE PRICE OF SUGAR

S1
D
S0

$1.30
Price

$.90

S1
S0 D