Module

Principles of Microeconomics

Unit 2
SUPPLY AND DEMAND

Phạm Xuân Nam

nampx@neu.edu.vn
 Objectives

Markets

Demand Supply
(buyers’ behavior) (sellers’ behavior)

Market Equilibrium

Equilibrium Price Equilibrium Quantity

Unit 2: Supply and Demand Slide 2

 Contents

1 2
Demand Supply

3
Market
44
Market
Equilibrium Efficiency
Unit 2: Supply and Demand Slide 3
 Market
Market is any arrangement that enables buyers and sellers to get
information and to do business with each other.

Unit 2: Supply and Demand Slide 4

 Market
In a market, the participants (sellers and buyers) make the decisions
themselves based on analyzing their own benefits and opportunity
costs.

Unit 2: Supply and Demand Slide 5

1
DEMAND
 Demand

Demand is the amount of a good that buyers are willing and able to
purchase across a range of prices, ceteris paribus.

Q Quantity D Demand

P Price QD Quantity Demanded

Unit 2: Supply and Demand Slide 7

 Quantity Demanded

Quantity demanded is the amount of a good that buyers are willing

and able to purchase at a specific price, ceteris paribus.

Unit 2: Supply and Demand Slide 8

 Demand Schedule

Unit 2: Supply and Demand Slide 9

 Demand Curves

Unit 2: Supply and Demand Slide 10

 Demand Function
• Expression of demand as a mathematical function:

𝑄𝐷 = 𝑓 ( 𝑃 )
• Special Case: Linear demand function:

𝑄 𝐷 =𝑎 − 𝑏 𝑃

Unit 2: Supply and Demand Slide 11

 Individual Demand and Market Demand

Unit 2: Supply and Demand Slide 12

 Individual Demand and Market Demand
Suppose Spencer and Kate are the only two demanders of lemonade. Each month, Spencer
buys six glasses of lemonade when the price is $1.00 per glass, and he buys four glasses when
the price is $1.50 per glass. Each month, Kate buys four glasses of lemonade when the price is
$1.00 per glass, and she buys two glasses when the price is $1.50 per glass. Which of the
following points is on the market demand curve?

A. Q = 2; P = 1,5

B. Q = 4; P = 2,5

C. Q = 10; P = 1

D. Q = 16; P = 2,5

Unit 2: Supply and Demand Slide 13

 Price (P)
P
The Law of Demand
The claim that, other things
being equal, the quantity
demanded of a good falls
when the price of the good
rises.

A change in price cause a

movement along the
demand curve.
Q

Unit 2: Supply and Demand Slide 14

 Determinants of Demand
A movement along the A shift of the demand
demand curve curve

Unit 2: Supply and Demand Slide 15

 Determinants of Demand
A movement along the A shift of the demand
demand curve curve
Caused by a change in Caused by a determinants
price. of demand other than the
price of the goods itself.
Change the quantity
demanded at any given
price.

Unit 2: Supply and Demand Slide 16

 Income (I)

Normal Good
Demand increases when income increases.
shifts to the right
shifts to the left

Inferior Good
Demand decreases when income increases.
shifts to the right
shifts to the left

Unit 2: Supply and Demand Slide 17

 Prices of Related Goods (Px,PY)
Substitutes
two goods for which an increase in
the price of one leads to an
increase in the demand for the
other
shifts to the right

Hàng hóa bổ sung

two goods for which an increase in
the price of one leads to a
decrease in the demand for the
other
shifts to the left

Unit 2: Supply and Demand Slide 18

 Number of buyers (N)

Size of the market

market demand depends on how
many of these buyers there are
The number of buyers
increases shifts to the right

Unit 2: Supply and Demand Slide 19

 Tastes (T)
The personal preference
of consumers for goods
and services
Determinants
• Age
• Gender
• Traditions
• Habits
• Advertisements

Unit 2: Supply and Demand Slide 20

 Expectations (E)

What people think will

happen in the future

Expectations on future income

Expectations on future prices

Unit 2: Supply and Demand Slide 21

 Variables That Influence Buyers
Represents a
movement
along the Price of the good itself
demand curve

Income
Prices of related goods
Shifts the
demand curve
Tastes
Expectations
Number of buyers

Unit 2: Supply and Demand Slide 22

2
SUPPLY
 Supply

Supply is the amount of a good that sellers are willing and able
to sell across a range of prices, ceteris paribus.

Q Quantity S Supply

P Price QS Quantity Supplied

Unit 2: Supply and Demand Slide 24

 Quantity Supplied
Quantity supplied is the amount of a good that sellers are willing
and able to sell at a specific price, ceteris paribus.

Supply represents the relationship between quantity supplied

and price, ceteris paribus.

Unit 2: Supply and Demand Slide 25

 Supply Schedule and Supply Curve

Unit 2: Supply and Demand Slide 26

 Supply Function
• Expression of supply as a mathematical function:

𝑄 𝑆= 𝑓 ( 𝑃 )
• Special Case: Linear supply function:

𝑄 𝑆 =𝑎 +𝑏𝑃

Unit 2: Supply and Demand Slide 27

 Individual Supply and Market Supply

Unit 2: Supply and Demand Slide 28

 Individual Supply and Market Supply
Suppose that the market for toothpaste only consists of 2 sellers,
which are PS with the inverse supply function , and CloseUp with
the inverse supply function . Determine the market supply function
for toothpaste.

Unit 2: Supply and Demand Slide 29

 Price (P)
The Law of Supply
The claim that, other things
being equal, the quantity
supplied of a good rises
when the price of the good
rises

A change in price cause a

movement along the supply
curve.

Unit 2: Supply and Demand Slide 30

 Determinants of Supply

Unit 2: Supply and Demand Slide 31

 Technology

Technological advances help

increase productivity and
reduce producers’ costs →
increase in quantity supply
at any prices → the supply
curve shifts to the right.

Unit 2: Supply and Demand Slide 32

 Input Prices
Directly affects the production
costs
Input Prices increase →
Production Costs increase →
Supply decreases (shifts to
the left)

Unit 2: Supply and Demand Slide 33

 Number of Sellers

The market supply curve is

the sum of all the individual
sellers’ supply curves. Higher
number of sellers will
increases market supply.

Unit 2: Supply and Demand Slide 34

 Taxes and Subsidies

Changes in the level of taxes

and subsidies directly affect
the firms’ production cost,
therefore shifting the supply
curve.

Taxes and subsidues are

used by the government to
regulate the behaviors of the
sellers.

Unit 2: Supply and Demand Slide 35

 Taxes and Subsidies
Suppose that the market demand function for toothbrushes is .
a. The government imposes a tax of $5/toothbrush. Determine the new demand
function.
b. The government imposes a subsidy of $5/toothbrush. Determine the new
demand function.

Unit 2: Supply and Demand Slide 36

 Expectations (E)

What people think will

happen in the future

Expectations on market demand

Expactations on policy changes

Unit 2: Supply and Demand Slide 37

 Variables That Influence Sellers
Represents a
movement along Price of the good itself
the supply curve

Input Prices
Technology
Shifts the supply
curve
Taxes and Subsidies
Number of Sellers
Expectations

Unit 2: Supply and Demand Slide 38

 3
MARKET EQUILIBRIUM
 Market Equilibrium

Surplus

Shortage

Unit 2: Supply and Demand Slide 40

 Market Equilibrium
Market equilibrium is a situation in which the market price has
reached the level at which the quantity supplied equals the
quantity demanded

Equilibrium price is the price that balances the quantity supplied

and the quantity demanded

Equilibrium quantity is the quantity supplied and the quantity

demanded at the equilibrium price
Unit 2: Supply and Demand Slide 41
 Market Equilibrium
Invisible The price of any good adjusts to bring the quantity supplied and
Hand
the quantity demanded of that good into balance

Unit 2: Supply and Demand Slide 42

 Market Equilibrium
Surplus

A situation in which the

quantity supplied is
greater than the quantity
demanded

A surplus will create

pressure to lower the
market price.

Unit 2: Supply and Demand Slide 43

 Market Equilibrium
Shortage

A situation in which the

quantity demanded is
greater than the quantity
supplied

A shortage will create

pressure to raise the
market price.

Unit 2: Supply and Demand Slide 44

 Market Equilibrium

There are 100 identical sellers and 80 identical buyers in a

certain market. The sellers all have their individual supply
functions as and the buyers all have their individual
demand function as .
1. Determine the market demand and market supply functions.
2. Determine the equilibrium price and quantity of the market.

Unit 2: Supply and Demand Slide 45

 Analyxing Changes in Equilibrium

1 Decide if the event shifts the supply or demand curve (or

perhaps both).

2 Decide in which direction the curve shifts.

3 Use a supply-and-demand diagram to see how the shift

changes the equilibrium price and quantity.

Unit 2: Supply and Demand Slide 46

 Analyxing Changes in Equilibrium

1 There is an article in Kenh14.vn praising the health

benefits of eating salmon.

Unit 2: Supply and Demand Slide 47

 Analyxing Changes in Equilibrium

Unit 2: Supply and Demand Slide 48

 Analyxing Changes in Equilibrium

2 Prolonged draught reduces the reprodutive rate of

salmon both in the wild and in aquaculture farms.

Unit 2: Supply and Demand Slide 49

 Analyxing Changes in Equilibrium

Unit 2: Supply and Demand Slide 50

 Analyxing Changes in Equilibrium

3 Both events (1) and (2) happen at the same time.

Unit 2: Supply and Demand Slide 51

 Analyxing Changes in Equilibrium

Unit 2: Supply and Demand Slide 52

 Analyxing Changes in Equilibrium

Unit 2: Supply and Demand Slide 53

 Analyxing Changes in Equilibrium

Unit 2: Supply and Demand Slide 54

 4
MARKET EFFICIENCY
 Welfare Economics
• The study of how the allocation of resources affects
economic well-being
• The equilibrium of supply and demand in competitive
markets maximizes the total benefits received by all
buyers and sellers combined

Unit 2: Supply and Demand Slide 56

 Price and the Willingness to Pay
• WTP is the maximum amount that a buyer will pay for a
good
• Measures how much buyer values the good
• Price < Willingness to pay: Buyer would be eager to buy
• Price > Willingness to pay: Buyer would refuse to buy
• Price = Willingness to pay: Buyer would be indifferent about
buying

Unit 2: Supply and Demand Slide 57

 The Willingness to Pay of Four Possible Buyers

Buyer Willingness to Pay

Whitney $1,000

Ella 800

Mariah 700

Karen 500

Unit 2: Supply and Demand Slide 58

 Consumer Surplus
• Amount a buyer is willing to pay for a good minus
amount the buyer actually pays
• Measures the benefit buyers receive from participating in
a market
• Closely related to the demand curve

Unit 2: Supply and Demand Slide 59

 Using the Demand Curve to Measure Consumer Surplus

• At any quantity, the price given by the demand curve

shows the willingness to pay of the marginal buyer
• Marginal buyer
• The buyer who would leave the market first if the price were any
higher
• Total consumer surplus
• Area below the demand curve and above the price
• Measures the consumer surplus in a market

Unit 2: Supply and Demand Slide 60

 Using the Demand Curve to Measure Consumer Surplus

Price Buyers Quantity Demanded

More than $1,000 None 0
$800 to $1,000 Whitney 1
$700 to $800 Whitney, Ella 2
$500 to $700 Whitney, Ella, Mariah 3
$500 or less Whitney, Ella, Mariah, Karen 4

Unit 2: Supply and Demand Slide 61

 Using the Demand Curve to Measure Consumer Surplus

Unit 2: Supply and Demand Slide 62

 Using the Demand Curve to Measure Consumer Surplus

Unit 2: Supply and Demand Slide 63

 What Does Consumer Surplus Measure?
• Consumer surplus
• Measures the benefit that buyers derive from a market as the
buyers themselves perceive it
• Good measure of economic well-being if policymakers want to
satisfy buyers’ preferences

Unit 2: Supply and Demand Slide 64

 Cost and the Willingness to Sell
• Cost is the value of everything a seller must give up to
produce a good including opportunity cost
• Measure of willingness to sell
• Price > Cost: Seller would be eager to sell
• Price < Cost: Seller would refuse to sell
• Price = Willingness to sell: Seller would be indifferent about
selling

Unit 2: Supply and Demand Slide 65

 The Costs of Four Possible Sellers

Seller Cost

Vincent $3,600

Claude 3,200

Pablo 2,400

Andy 2,000

Unit 2: Supply and Demand Slide 66

 Producer Surplus
• Amount a seller is paid for a good minus the seller’s cost
of providing it
• Measures the benefit sellers receive from participating in
a market
• Closely related to the supply curve

Unit 2: Supply and Demand Slide 67

Using the Supply Curve to Measure Producer Surplus
• Supply curve
• Reflects sellers’ costs
• Used to measure producer surplus
• Total producer surplus
• Area below the price and above the supply curve
• Measures the producer surplus in a market

Unit 2: Supply and Demand Slide 68

 Using the Supply Curve to Measure Producer Surplus

Price Sellers Quantity Supplied

$3,600 or more Vincent, Claude, Pablo, Andy 4
$3,200 to $3,600 Claude, Pablo, Andy 3
$2,400 to $3,200 Pablo, Andy 2
$2,000 to $2,400 Andy 1
Less than $2,000 None 0

Unit 2: Supply and Demand Slide 69

Using the Supply Curve to Measure Producer Surplus

Unit 2: Supply and Demand Slide 70

Using the Supply Curve to Measure Producer Surplus

Unit 2: Supply and Demand Slide 71

 Benevolent Social Planners
• Benevolent social planners
• Hypothetical committee: all-knowing, all-powerful, well-
intentioned
• Want to maximize the economic well-being of everyone in
society
• Total surplus is a natural variable to consider when
judging a market’s allocation of resources
• Total surplus = Value to buyers − Cost to sellers
Unit 2: Supply and Demand Slide 72
 Maximizing Total Surplus
• If an allocation of resources maximizes total surplus, the
allocation exhibits efficiency
• Efficiency
• Property regarding a resource allocation of maximizing the total surplus
received by all members of society

• Equality
• Property of distributing economic prosperity uniformly among the
members of society

Unit 2: Supply and Demand Slide 73

 Consumer and Producer Surplus in the Market Equilibrium

Total surplus—the sum of

consumer and producer
surplus—is the area
between the supply and
demand curves up to the
equilibrium quantity.

Unit 2: Supply and Demand Slide 74

 Evaluating the Market Equilibrium
• The equilibrium outcome is an efficient allocation of
resources
1. Competitive markets allocate the supply of goods to the buyers
who value them most, as measured by their willingness to pay
2. Competitive markets allocate the demand for goods to the
sellers who can produce them at the lowest cost
3. Competitive markets produce the quantity of goods that
maximizes the sum of consumer and producer surplus

Unit 2: Supply and Demand Slide 75

 The Efficiency of the Equilibrium Quantity

• At quantities less than the equilibrium

quantity, such as Q1, the value to buyers
exceeds the cost to sellers.
• At quantities greater than the
equilibrium quantity, such as Q2, the cost
to sellers exceeds the value to buyers.
• Therefore, the market equilibrium
maximizes the sum of producer and
consumer surplus.

Unit 2: Supply and Demand Slide 76

 Markets are Efficient
• To conclude that markets are efficient, assumptions were
made about how markets work
• Assumptions
1. Markets are perfectly competitive
2. Outcome in a market matters only to the buyers and sellers in
that market

Unit 2: Supply and Demand Slide 77

 Are Markets Perfectly Competitive?
• Competition is far from perfect
• Ability to influence prices is called market power
• Market power can make markets inefficient by keeping
price and quantity away from equilibrium

Unit 2: Supply and Demand Slide 78

 Do Outcomes Matter only to the Buyers and Sellers?
• Decisions of buyers and seller affect bystanders
• Externalities
• The welfare implications of market activity depend on more
than just the value realized by buyers and the cost incurred by
sellers
• If externalities are ignored, the equilibrium in a market can be
inefficient from the standpoint of society as a whole

Unit 2: Supply and Demand Slide 79

 Market Failures
• The inability of some unregulated markets to allocate
resources efficiently
• When markets fail, public policy can potentially remedy the
problem and enhance economic efficiency

Unit 2: Supply and Demand Slide 80