05-Sep-16

SS 132: Microeconomics

Demand-Supply Model

Dr Arshad Ali Bhatti

Fall 2016

In this lecture you will…

• Learn the nature of a competitive market.
• Examine what determines the demand for
a good in a competitive market.
• Examine what determines the supply of a
good in a competitive market.
• See how supply and demand together set
the price of a good and the quantity sold.
• Consider the key role of prices in
allocating scarce resources.

Dr Arshad Ali Bhatti/ Fall 2016 Chapter 4: Page 2

1
 05-Sep-16

THE MARKET FORCES OF

SUPPLY AND DEMAND
• Supply and Demand are the two
words that economists use most
often.
• Supply and Demand are the forces
that make market economies work!
• Modern microeconomics is about
supply, demand, and market
equilibrium.

Dr Arshad Ali Bhatti/ Fall 2016 Chapter 4: Page 3

MARKETS AND COMPETITION

• The terms supply and demand refer

to the behaviour of people. . .
• . . .as they interact with one another
in markets.
• A market is a group of buyers and sellers
of a particular good or service.
– Buyers determine demand...
– Sellers determine supply…

Dr Arshad Ali Bhatti/ Fall 2016 Chapter 4: Page 4

2
 05-Sep-16

Competitive Markets

• A Competitive Market is a market

with many buyers and sellers so that
each has a negligible impact on the
market price.

Dr Arshad Ali Bhatti/ Fall 2016 Chapter 4: Page 5

Competition: Perfect or Otherwise

Perfectly Competitive:
Homogeneous Products
Buyers and Sellers are Price Takers
Monopoly:
One Seller, controls price
Oligopoly:
Few Sellers, not aggressive competition
Monopolistic Competition:
Many Sellers, differentiated products

Dr Arshad Ali Bhatti/ Fall 2016 Chapter 4: Page 6

3
 05-Sep-16

DEMAND

• Quantity Demanded refers to the

amount (quantity) of a good that
buyers are willing to purchase at
alternative prices for a given period.

Dr Arshad Ali Bhatti/ Fall 2016 Chapter 4: Page 7

Determinants of Demand

• What factors determine how much ice

cream you will buy?
• What factors determine how much you
will really purchase?
1) Product’s Own Price
2) Prices of Related Goods
3) Income of the Consumer
4) Number of Consumers
PINTEO
5) Tastes
6) Expectations
7) Other (Weather, Ads etc.)
Dr Arshad Ali Bhatti/ Fall 2016 Chapter 4: Page 8

4
 05-Sep-16

1) Own Price

Law of Demand
– The law of demand states that,
other things equal, the quantity
demanded of a good falls when
the price of the good rises.
– Examples?

Dr Arshad Ali Bhatti/ Fall 2016 Chapter 4: Page 9

2) Prices of Related Goods

Prices of Related Goods

– When a fall in the price of one
good reduces the demand for
another good, the two goods are
called substitutes.
– When a fall in the price of one
good increases the demand for
another good, the two goods are
called complements.
Dr Arshad Ali Bhatti/ Fall 2016 Chapter 4: Page 10

5
 05-Sep-16

3) Income

• As income increases the

demand for a normal good will
increase.

• As income increases the

demand for an inferior good will
decrease.

Dr Arshad Ali Bhatti/ Fall 2016 Chapter 4: Page 11

4) Number of Consumers/ Buyers

• As the number of consumers increase, the
demand for a good increases or vice
versa.

• Example:
• Immigration of software engineers and
demand for software

Dr Arshad Ali Bhatti/ Fall 2016 Page 12

6
 05-Sep-16

5) Taste
• People may improve their tastes for
certain goods over time.
• Improvement in tastes for any good may
lead to increased demand for that good.

• Examples
• Historical movies
• Coffee
• Use of Kindle/ iPad in Education

Dr Arshad Ali Bhatti/ Fall 2016 Page 13

6) Expectations
• Expectations usually play an important
role in the demand for good/service.
• Price
– Expectation: The price of a Sony laptop
is likely to decrease by 25% next month
– Effect on current buying of laptops???
• Income
– Expectation: Govt. is going to increase
income tax by 10% next month.
– Effect on current buying of a good???

Dr Arshad Ali Bhatti/ Fall 2016 Page 14

7
 05-Sep-16

7) Others

• Weather
• Earthquakes
• Wars
• Advertisements etc

Dr Arshad Ali Bhatti/ Fall 2016 Chapter 4: Page 15

The Demand Schedule and the

Demand Curve
The demand schedule is a table that
shows the relationship between the
price of the good and the quantity
demanded.
The demand curve is a graph of the
relationship between the price of a
good and the quantity demanded.
Ceteris Paribus: “Other thing being
equal”

Dr Arshad Ali Bhatti/ Fall 2016 Chapter 4: Page 16

8
 05-Sep-16

Table 1: Hamza’s Demand Schedule

Price of Ice-cream Quantity of cones

Cone ($) Demanded
0.00 12
0.50 10
1.00 8
1.50 6
2.00 4
2.50 2
3.00 0

Dr Arshad Ali Bhatti/ Fall 2016 Chapter 4: Page 17

Figure 1: Hamza’s Demand Curve

Price of Ice-
Cream Cone

$3.00

2.50

2.00

1.50

1.00

0.50

0 2 4 6 8 10 12 Quantity of Ice-
Cream Cones

Dr Arshad Ali Bhatti/ Fall 2016 Chapter 4: Page 18

9
 05-Sep-16

Market Demand Schedule

• Market demand is the sum of all individual

demands at each possible price.

• Graphically, individual demand curves are

summed horizontally to obtain the market
demand curve.
• Assume the ice cream market has two
buyers as follows…

Dr Arshad Ali Bhatti/ Fall 2016 Chapter 4: Page 19

Table 2: Market demand as the Sum of

Individual Demands
Price of Ice-cream
Hamza Noor Market
Cone ($)

0.00 12 + 7 = 19

0.50 10 6 16

1.00 8 5 13

1.50 6 4 10
2.00 4 3 7

2.50 2 2 4

3.00 0 1 1

Dr Arshad Ali Bhatti/ Fall 2016 Chapter 4: Page 20

10
 05-Sep-16

• Market Demand Curve is flatter than the

individual demand curves of Hamza and
Noor???

Dr Arshad Ali Bhatti/ Fall 2016 Page 21

Figure 3: Shifts in the Demand Curve

Price of
Ice-Cream
Cone

Increase in
demand

Decrease
in demand

D2
D1

D3
Quantity of Ice-
Cream Cones

Dr Arshad Ali Bhatti/ Fall 2016 Chapter 4: Page 22

11
 05-Sep-16

Table 3: The Determinants of Quantity

Demanded

Dr Arshad Ali Bhatti/ Fall 2016 Chapter 4: Page 23

Shifts in the Demand Curve versus

Movements Along the Demand Curve

Dr Arshad Ali Bhatti/ Fall 2016 Chapter 4: Page 24

12
 05-Sep-16

Figure 4 a): A Shifts in the Demand Curve

it doses not change due to price it chang due to policy
Price of
Cigarettes,
per Pack.
A policy to discourage
smoking shifts the demand
curve to the left.

B A
$2.00

D1

D2
0 10 20 Number of Cigarettes
Smoked per Day

Dr Arshad Ali Bhatti/ Fall 2016 Chapter 4: Page 25

Figure 4 b): A Movement Along the Demand

Curve
Price of
Cigarettes,
per Pack.
C A tax that raises the price
of cigarettes results in a
$4.00
movements along the
demand curve.

A
$2.00

D1
it change
due to price
0 12 20 Number of Cigarettes
Smoked per Day

Dr Arshad Ali Bhatti/ Fall 2016 Chapter 4: Page 26

13
 05-Sep-16

Points to Remember
• Market demand curve is flatter than the
individual demand curves of consumers

• Bandwagon Effect will lead to an even

flatter market demand curve

• Snob Effect will lead to a steeper market

demand curve.

Dr Arshad Ali Bhatti/ Fall 2016 Page 27

SUPPLY

• Quantity Supplied refers to the

amount (quantity) of a good that
sellers are willing to make available
for sale at alternative prices for a
given period.

Dr Arshad Ali Bhatti/ Fall 2016 Chapter 4: Page 28

14
 05-Sep-16

Determinants of Supply

• What factors determine how much ice

cream you are willing to offer or produce?

1) Product’s Own Price

2) Prices of Related Goods
3) Input prices
4) Number of sellers/ firms
5) Technology PINTEO
6) Expectations
7) Other (Corporate Taxes etc.)

Dr Arshad Ali Bhatti/ Fall 2016 Chapter 4: Page 29

1) Own Price

Law of Supply
– The law of supply states that,
other things equal, the quantity
supplied of a good rises when the
price of the good rises.

Dr Arshad Ali Bhatti/ Fall 2016 Chapter 4: Page 30

15
 05-Sep-16

2) Prices of Related Goods

• Say as a seller/ producer you sell two
related goods: CDs and Cassettes

• If the price of CDs increases in the market,

what is about your supply or sale of
Cassettes?
• Does your supply curve of Cassettes
shifts downward? Why?

Dr Arshad Ali Bhatti/ Fall 2016 Page 31

3) Input Prices
• Increase in input prices leads to increased
cost of production.

• Example:
• Manufacturing of CDs
• What is if the prices of plastic increase?
• What is if the wages of labor in CDs
Industry increase?
• These factors will increase the cost of
production and shift the supply curve

Dr Arshad Ali Bhatti/ Fall 2016 Page 32

16
 05-Sep-16

4) Number of Sellers/ Firms

• Increased number of sellers/ firms will
increase the supply of goods/ services

• Examples:
• Production of CDs
• Production of Mobile Phones
• Telephony Services
• Education industry >> number of business
schools in Islamabad

Dr Arshad Ali Bhatti/ Fall 2016 Page 33

5) Technology
• Technological advancement may improve
the production processes
– Efficiency
• Cost of production decreases
• Supply increases >> Supply curve shifts
• Examples:
• Production of Books
• Production of Movies
• ???

Dr Arshad Ali Bhatti/ Fall 2016 Page 34

17
 05-Sep-16

6) Expectations
• Imagine you are a seller/ producer of NICE
RICE, a special brand of rice in Pakistan.

• You expect that the price of your product

will go up by 20% next month.
• You expect that the labor in your firm will
go on strike next month following the
nationwide labor strikes.
• Do you see any impact of these events on
your current supply of NICE RICE.

Dr Arshad Ali Bhatti/ Fall 2016 Page 35

7) Others
• Think about any other event or factor that
may affect your supply of goods/ services

• Floods?
• Earthquakes?
• Nationwide strikes?
• Political chaos?
• Uncertain corporate policies?
• ???

Dr Arshad Ali Bhatti/ Fall 2016 Page 36

18
 05-Sep-16

The Supply Schedule and the

Supply Curve
The supply schedule is a table that
shows the relationship between the
price of the good and the quantity
supplied.
The supply curve is a graph of the
relationship between the price of a
good and the quantity supplied.
Ceteris Paribus: “Other thing being
equal”

Dr Arshad Ali Bhatti/ Fall 2016 Chapter 4: Page 37

Table 4: Nomi’s Supply Schedule

Price of Ice-cream Quantity of cones

Cone ($) Supplied
0.00 0
0.50 0
1.00 1
1.50 2
2.00 3
2.50 4
3.00 5

Dr Arshad Ali Bhatti/ Fall 2016 Chapter 4: Page 38

19
 05-Sep-16

Figure 5: Nomi’s Supply Curve

Price of
Ice-Cream
Cone
$3.00

2.50

2.00

1.50

1.00

0.50

0 1 2 3 4 5 6 8 10 12 Quantity of Ice-
Cream Cones

Dr Arshad Ali Bhatti/ Fall 2016 Chapter 4: Page 39

Market Supply Schedule

• Market supply is the sum of all individual

supplies at each possible price.

• Graphically, individual supply curves are

summed horizontally to obtain the market
demand curve.
• Assume the ice cream market has two
suppliers as follows…

Dr Arshad Ali Bhatti/ Fall 2016 Chapter 4: Page 40

20
 05-Sep-16

Table 5: Market supply as the Sum of

Individual Supplies
Price of Ice-cream
Nomi Ali Market
Cone ($)

0.00 0 + 0 = 0
0.50 0 0 0

1.00 1 0 1

1.50 2 2 4

2.00 3 4 7

2.50 4 6 10

3.00 5 8 13

Dr Arshad Ali Bhatti/ Fall 2016 Chapter 4: Page 41

• Market Supply Curve is flatter than the

individual supply curves of Nomi and
Ali???

Dr Arshad Ali Bhatti/ Fall 2016 Page 42

21
 05-Sep-16

Figure 7: Shifts in the Supply Curve

Price of S3
Ice-Cream
Cone
S1 S2

Decrease
in supply

Increase in
supply

Quantity of Ice-
Cream Cones

Dr Arshad Ali Bhatti/ Fall 2016 Chapter 4: Page 43

Table 6: The Determinants of Quantity

Supplied

Dr Arshad Ali Bhatti/ Fall 2016 Chapter 4: Page 44

22
 05-Sep-16

SUPPLY AND DEMAND

TOGETHER

• Equilibrium refers to a situation in which

the price has reached the level where
quantity supplied equals quantity
demanded.

Dr Arshad Ali Bhatti/ Fall 2016 Chapter 4: Page 45

Equilibrium

• Equilibrium Price
– The price that balances quantity supplied and
quantity demanded.
– On a graph, it is the price at which the supply
and demand curves intersect.
• Equilibrium Quantity
– The quantity supplied and the quantity
demanded at the equilibrium price.
– On a graph it is the quantity at which the
supply and demand curves intersect.

Dr Arshad Ali Bhatti/ Fall 2016 Chapter 4: Page 46

23
 05-Sep-16

Equilibrium

Demand Schedule Supply Schedule

At $2.00, the quantity demanded

is equal to the quantity supplied!
Dr Arshad Ali Bhatti/ Fall 2016 Chapter 4: Page 47

Figure 8: The Equilibrium of Supply and

Demand
Price of
Ice-Cream
Cone

Supply

Equilibrium price Equilibrium

$2.00

Demand

Equilibrium quantity

0 1 2 3 4 5 6 7 8 9 10 11 Quantity of Ice-
Cream Cones

Dr Arshad Ali Bhatti/ Fall 2016 Chapter 4: Page 48

24
 05-Sep-16

Equilibrium

• Surplus
– When price > equilibrium price, then quantity
supplied > quantity demanded.
• There is excess supply or a surplus.
• Suppliers will lower the price to increase sales,
thereby moving toward equilibrium.
• Shortage
– When price < equilibrium price, then quantity
demanded > the quantity supplied.
• There is excess demand or a shortage.
• Suppliers will raise the price due to too many buyers
chasing too few goods, thereby moving toward
equilibrium.

Dr Arshad Ali Bhatti/ Fall 2016 Chapter 4: Page 49

Figure 9 a): Excess Supply

Price of Ice-
Cream Cone

Surplus
Supply
$2.50

$2.00

Demand

0 1 2 3 4 5 6 7 8 9 10 11 Quantity of Ice-
Cream Cones
Qd Qs

Dr Arshad Ali Bhatti/ Fall 2016 Chapter 4: Page 50

25
 05-Sep-16

Figure 9 b): Excess Demand

Price of Ice-
Cream Cone

Supply

$2.00

$1.50

Shortage
Demand

0 1 2 3 4 5 6 7 8 9 10 11 Quantity of Ice-
Cream Cone
Qs Qd

Dr Arshad Ali Bhatti/ Fall 2016 Chapter 4: Page 51

Three Steps To Analyzing

Changes in Equilibrium
• Decide whether the event shifts the
supply or demand curve (or both).
• Decide whether the curve(s) shift(s)
to the left or to the right.
• Use the supply-and-demand diagram
to see how the shift affects
equilibrium price and quantity.
• Example: A Heat Wave

Dr Arshad Ali Bhatti/ Fall 2016 Chapter 4: Page 52

26
 05-Sep-16

What is a Trading Curve?

• Parts of demand and supply curves on
which actual trade Occurs.

• Think
• Class discussion

Dr Arshad Ali Bhatti/ Fall 2016 Page 53

Figure 10: How an Increased Demand Affects

the Equilibrium [Hot weather]
Price of Ice-
Cream Cone
1. Hot weather increases the
demand for ice cream…
Supply
$2.50 New equilibrium

$2.00
Initial D2
2. … equilibrium
resulting in
a higher
price …

D1

0 1 2 3 4 5 6 7 10 11 Quantity of Ice-
Cream Cone
3. … and a higher
quantity sold.

Dr Arshad Ali Bhatti/ Fall 2016 Chapter 4: Page 54

27
 05-Sep-16

Figure 11: How a Decreased Demand Affects

the Equilibrium [Earthquake]
Price of Ice- S2
Cream Cone
1. An earthquake reduces the
supply of ice cream…
S1
$2.50 New equilibrium

$2.00 Initial equilibrium

2. …
resulting in
a higher
price …

Demand

0 1 2 3 4 7 10 11 Quantity of Ice-
Cream Cones
3. … and a lower
quantity sold.

Dr Arshad Ali Bhatti/ Fall 2016 Chapter 4: Page 55

Figure 12 a): A Shift in Both Supply and

Demand
Price of Ice- Large
Cream Cone increase in
demand
New
S2
equilibrium S1
P2
Small
decrease in
supply

P1 D2
Initial equilibrium

D1

0 Q1 Q2 Quantity of Ice-
Cream Cone

Dr Arshad Ali Bhatti/ Fall 2016 Chapter 4: Page 56

28
 05-Sep-16

Figure 12 b): A Shift in Both Supply and

Demand
Price of Ice- Small increase
Cream Cone in demand
New S2
equilibrium
S1
P2

Large
decrease in
supply

P1 Initial equilibrium

D2

D1

0 Q2 Q1 Quantity of Ice-
Cream Cone

Dr Arshad Ali Bhatti/ Fall 2016 Chapter 4: Page 57

Table 8: What Happens to Price and

Quantity when Supply or Demand Shifts

Dr Arshad Ali Bhatti/ Fall 2016 Chapter 4: Page 58

29
 05-Sep-16

Class Exercise
• Go through these examples of events that would shift either
the demand or supply of #2 lead pencils:
– an increase in the income of consumers
– an increase in the use of standardized
exams (using opscan forms)
– a decrease in the price of graphite (used
in the production of pencils)
– a decrease in the price of ink pens
– the start of a school year
– new technology that lowers the cost of
producing pencils
Dr Arshad Ali Bhatti/ Fall 2016 Page 59

Class Exercise
• Think of different goods and formulate
similar problems

• You may present on the board

Dr Arshad Ali Bhatti/ Fall 2016 Page 60

30
 05-Sep-16

Concluding Remarks…

• Market economies harness the

forces of supply and demand. . .
• Supply and Demand together
determine the prices of the
economy’s different goods and
services. . .
• Prices in turn are the signals that
guide the allocation of resources.

Dr Arshad Ali Bhatti/ Fall 2016 Chapter 4: Page 61

Announcement
• Problem Set-1
• To be handed in on September ??, 2016
(TUE)

Dr Arshad Ali Bhatti/ Fall 2016 Page 62

31
 05-Sep-16

Summary

• Economists use the model of supply and

demand to analyze competitive markets.
• In a competitive market, there are many
buyers and sellers, each of whom has little
or no influence on the market price.

Dr Arshad Ali Bhatti/ Fall 2016 Chapter 4: Page 63

Summary
• The demand curve shows how the
quantity of a good depends upon the
price.
– According to the law of demand, as the price
of a good falls, the quantity demanded rises.
Therefore, the demand curve slopes
downward.
– In addition to price, other determinants of how
much consumers want to buy include income,
the prices of complements and substitutes,
tastes, expectations, and the number of
buyers.
– If one of these factors changes, the demand
curve shifts.
Dr Arshad Ali Bhatti/ Fall 2016 Chapter 4: Page 64

32
 05-Sep-16

Summary
• The supply curve shows how the quantity of a
good supplied depends upon the price.
– According to the law of supply, as the price of
a good rises, the quantity supplied rises.
Therefore, the supply curve slopes upward.
– In addition to price, other determinants of how
much producers want to sell include input
prices, technology, expectations, and the
number of sellers.
– If one of these factors changes, the supply
curve shifts.

Dr Arshad Ali Bhatti/ Fall 2016 Chapter 4: Page 65

Summary
• Market equilibrium is determined by the
intersection of the supply and demand
curves.
• At the equilibrium price, the quantity
demanded equals the quantity supplied.
• The behavior of buyers and sellers
naturally drives markets toward their
equilibrium.

Dr Arshad Ali Bhatti/ Fall 2016 Chapter 4: Page 66

33
 05-Sep-16

The End

Dr Arshad Ali Bhatti/ Fall 2016 Chapter 4: Page 67

34