Weeks 3 & 4

Market Forces: Demand and Supply
Murat Issabayev, PhD, Associate Professor of Economics

Date: September 13 – 23, 2022
Demand
Supply and Demand
• Supply and demand analysis is a tool that managers can use to
visualize the “big picture” that are market trends and changes
on the horizon
• It is a qualitative forecasting tool you can use to predict trends
in competitive markets, including changes in the prices of your
firm’s products, related products (both substitutes and
complements), and the prices of inputs.
© 2017 by McGraw-Hill Education. All Rights Reserved. 2-2

Copyright © 2014 by the McGraw-Hill Companies, Inc. All rights reserved.
Demand
Demand
• Market demand curve
• Illustrates the relationship between the total quantity and
price per unit of a good all consumers are willing and able
to purchase, holding other variables constant.
• Law of demand
• The quantity of a good consumers are willing and able to
purchase increases (decreases) as the price falls (rises).
• Price and quantity demanded are inversely related.

Copyright © 2014 by the McGraw-Hill Companies, Inc. All rights reserved.
Demand
Market Demand Curve
Price ($)
$40
$30
$20
$10
Demand
0 20 40 60 80 Quantity
(thousands per year)
2-4
© 2017 by McGraw-Hill Education. All Rights Reserved.
Demand
Shift in Quantity Demanded versus a Shift in

Demand
• Changing only the “own price” leads to changes in quantity
demanded.
• This type of change is graphically represented by a
movement along a given demand curve, holding other
factors that impact demand constant.
• Changing factors other than the “own price” lead to changes
in demand.
• These types of changes are graphically represented by a
shift of the entire demand curve.
2-5
Demand
Changes in Demand
Price
A Increase
in
demand
Decrease
in
B
demand
D11
D2 D00
0 Quantity
2-6
Demand
Demand Shifters
• Income
- Normal good
- Inferior good
• Prices of related goods
- Substitute goods
- Complement goods
• Advertising and consumer tastes
- Informative advertising
- Persuasive advertising
• Population
• Consumer expectations
2-7
Demand
Advertising and the Demand for Clothing

Price of
high-style
clothing
Due to an
increase in
advertising
$50
$40
D2
D1
0 50,0000 60,000 Quantity of
high-style
clothing
2-8
Demand
The Demand Function
• The demand function for good X is a mathematical
representation describing how many units will be purchased at
different prices for X, the price of a related good Y, income M
and other factors H that affect the demand for good X.
• Symbolically, the demand function for good X can be written
as:
QXd =f(PX, PY, M, H)
2-9
Demand
The Linear Demand Function
• One simple, but useful, representation of a demand function is the linear
demand function:
𝑸𝑫
𝑿 = 𝜶𝟎 + 𝜶𝟏 𝑷𝑿 + 𝜶𝟐 𝑷𝒀 + 𝜶𝑴 𝑴 + 𝜶𝑯 𝑯
where:
• 𝑸𝑫
𝑿 is the number of units of good X demanded;
• 𝑷𝑿 is the price of good X;
• 𝑷𝑌 is the price of a related good Y;
• 𝑴 is the income;
• 𝑯 is the value of any other variable affecting demand.
2-10
Demand
Understanding the Linear Demand Function

• The signs and magnitude of the 𝜶 coefficients determine the impact
of each variable on the number of units of X demanded.
• For the linear demand
𝑸𝑫𝑿 = 𝜶𝟎 + 𝜶𝟏 𝑷𝑿 + 𝜶𝟐 𝑷𝒀 + 𝜶𝑴 𝑴 + 𝜶𝑯 𝑯
• 𝜶𝟏 < 𝟎 by the law of demand
>𝟎 if 𝑔𝑜𝑜𝑑 𝑌 is a substitute for good X
• 𝜶𝟐 ቊ
< 𝟎 if good Y is a complementary for good X
>𝟎 if good X is a normal good
• 𝜶𝑴 ቊ
< 𝟎 if good X is an inferior good
2-11
Demand
The Linear Demand Function in Action
2-12
Demand
Consumer Surplus
• Marketing strategies – like value pricing and price discrimination – rely
on understanding consumer value for products.
- Total consumer value is the sum of the maximum amount a consumer is willing
to pay at different quantities.
- Total expenditure is the per-unit market price times the number of units
consumed.
- Consumer surplus is the extra value that consumers derive from a good but do
not pay extra for.
2-13
Demand
Market Demand and Consumer Surplus in Action
Consumer Surplus
Price per
liter
Consumer Surplus (CS):
0.5($5 - $3)x(2-0) = $2
$5
Total Consumer Value (CS+E):
0.5($5 - $3)x2+(3-0)(2-0) = $8
$4
$3 Expenditures (E):
$(3-0) x (2-0) = $6
$2
$1 Demand
0 1 2 3 4 5 Quantity
in liters
2-14
Supply
Supply
• Market supply curve
- A curve indicating the total quantity of a good that all producers in a competitive
market would produce at each price, holding input prices, technology, and other
variables affecting supply constant.
• Law of supply
- As the price of a good rises (falls), the quantity supplied of the good rises (falls),
holding other factors affecting supply constant.
2-15
Supply
Changes in Quantity Supplied versus Changes in
Supply
• Changing only price leads to changes in quantity supplied.
- This type of change is graphically represented by a movement
along a given supply curve, holding other factors that impact
supply constant.
• Changing factors other than price lead to changes in supply.
- These types of changes are graphically represented by a shift
of the entire supply curve.
2-16
Supply
Changes in Supply
Price
S1 S0
B S2
Decrease
in supply
Increase
in supply
AA
0 Quantity
2-17
Supply
Supply Shifters
• Input prices
• Technology or government regulation
• Number of firms
- Entry
- Exit
• Taxes
- Excise tax: a tax on each unit of output sold, where tax revenue is
collected from the supplier
- Ad valorem tax: percentage tax
• Producer expectations
2-18
Supply
A Per Unit (Excise) Tax
Excise tax
Price
of S0+t
gasoline
$1.20 S0
t = 20¢
t
$1.00 t = per unit tax of 20¢
0 Quantity of
gasoline per
week
2-19
Supply
An Ad Valorem Tax
Price Ad valorem tax
of
backpacks
S1 = 1.20 x S0
$24
S0
$20
$12
$10
0 1,100 2,450 Quantity of

backpacks per
week
2-20
Supply
The Supply Function
• The supply function for good X is a mathematical
representation describing how many units will be produced at
alternative prices for X, alternative input prices W, and
alternative values of other variables that affect the supply for
good X.
2-21
Supply
The Linear Supply Function
• One simple, but useful, representation of a supply function is the linear
supply function:
𝑸𝑺𝑿 = 𝜷𝟎 + 𝜷𝑿 𝑷𝑿 + 𝜷𝑾 𝑷𝑾 + 𝜷𝒓 𝑷𝒓 + 𝜷𝑯 𝑯
• 𝑸𝑺𝑿 is the number of units of good X produced;

• 𝑷𝑿 is the price of good X;
• 𝑷𝑾 is the price of an input;
• 𝑷𝒓 is price of technologically related goods;
• H is the value of any other variable affecting supply.
2-22
Supply
Producer Surplus
• Producer surplus: the amount producers receive in
excess of the amount necessary to induce them to produce
the good.

Supply
Producer Surplus in Action
Price 𝟒𝟎𝟎 𝟏 𝑺
𝑷𝑿 = + 𝑸𝑿 Supply
𝟑 𝟑
$400
Producer surplus
$400
3
0 800 Quantity
2-24
Market Equilibrium
Market Equilibrium
• Competitive Market Equilibrium
- Determined by the intersection of the market demand and
market supply curves.
- A price and quantity such that there is no shortage or
surplus in the market.
- Forces that drive market demand and market supply are
balanced, and there is no pressure on prices or quantities to
change.
- The equilibrium price is the price that equates quantity
demanded with quantity supplied
2-25
Market Equilibrium
Market Equilibrium
Price Supply
Surplus
𝑷𝑯
𝑷𝒆
𝑷𝑳
Shortage
Demand
0 𝑸𝟎 𝑸𝒆 𝑸𝟏 280 Quantity
2-26
Market Equilibrium
Market Equilibrium in Action

• Consider a market with demand and supply functions, respectively, as
𝑸𝒅 = 𝟏𝟎 − 𝟐𝑷 and 𝑸𝑺 = 𝟐 + 𝟐𝑷
• A competitive market equilibrium exists at a price,𝑷𝒆 , such that
𝑸𝒅 𝑷𝒆 = 𝑸𝒔 (𝑷𝒆 ). That is,
𝟏𝟎 − 𝟐𝑷 = 𝟐 + 𝟐𝑷
𝑷𝒆 = $𝟐
𝑸𝒅 𝑷𝒆 = 𝟏𝟎 − 𝟐 $𝟐 = 𝟔 and 𝑸𝑺 𝑷𝒆 = 𝟐 + 𝟐 $𝟐 = 𝟔
𝑸𝒆 = 𝟔 𝒖𝒏𝒊𝒕𝒔
2-27
Price Restrictions and Market Equilibrium

• In a competitive market equilibrium, price and quantity freely
adjust to the forces of demand and supply.
• Sometime government restricts how much prices are permitted
to rise or fall.
- Price ceiling (the highest permissible price in the market,
like oil/gas price, set by the government due to scarcity)
- Price floor (the lowest permissible price in the market,
minimum wage)
2-28
A Price Ceiling
Price Supply
Social welfare Loss

Nonpecuniary price
𝑷𝑭
𝑷𝒆
𝑷𝒄 Priceceiling
Shortagee
Demand
0 𝑸𝒔 𝑸𝒆 𝑸𝒅 280 Quantity
2-29
Price Ceiling in Action

• Suppose the government views the equilibrium price, 𝑷𝒆 , to be too
high, and passes a law which prohibits firms to charge above 𝑷𝒄 , price
ceiling level.
• At 𝑷𝒄 there is a shortage of 𝑸𝒅 − 𝑸𝑺 as firms are not willing to
produce more than 𝑸𝑺 and consumers are willing to buy 𝑸𝒅 at 𝑷𝒄 .
• Not enough goods to satisfy all consumers. One way to do it is to sell
at “first come first served” basis. Thus, price ceilings discriminate
against people who have a high opportunity cost of time and do not like
to wait in lines.
2-30

• From graph we can see that consumers are willing to pay 𝑷𝑭 for
another unit of the good. However, by law they cannot pay more than
𝑷𝒄 .
• 𝑷𝑭 − 𝑷𝒄 is the price per unit the consumers are willing to pay by
waiting in line.
ด𝑭
𝑷 = 𝑷 ด𝒄 + ( 𝑷𝑭 − 𝑷𝒄 )
𝑭𝒖𝒍𝒍 𝑫𝒐𝒍𝒍𝒂𝒓 𝑵𝒐𝒏𝒑𝒆𝒄𝒖𝒊𝒏𝒊𝒂𝒓𝒚
𝒆𝒄𝒐𝒏𝒐𝒎𝒊𝒄 𝒑𝒓𝒊𝒄𝒆 𝒑𝒓𝒊𝒄𝒆 𝒑𝒓𝒊𝒄𝒆
• The last is not paid in dollars, but through opportunity cost.
• When lines develop due to a shortage, people with high opportunity
costs are hurt, while those with low opportunity costs may actually
benefit.
2-31
• During the gasoline shortage of the 1970s, many gas stations sold gas
only to customers who regularly used the stations
• Ceilings on loan interest rates, banks may allocate money only to
consumers who are relatively well-to-do
• Blackmarket!?
• The key point is that in the presence of a shortage created by a ceiling,
managers must use some method other than price to allocate the
goods. Depending on which method is used, some consumers will
benefit and others will be worse off.
2-32
A Price Floor
Price Supply
Surplus
𝑷𝑭 Pricefloor
𝑷𝒆 Cost of
purchasing
excess supply
Demand
0 𝑸𝒅 𝑸𝒆 𝑸𝒔 280 Quantity
2-33
Price Floor in Action
• One possibility is that the government purchases and discards the

surplus. This is the case with price floors on many agricultural
products, such as cheese (a price support)
2-34
Price Floor in Action

• Consider a market with demand and supply functions, respectively, as
𝑸𝒅 = 𝟏𝟎 − 𝟐𝑷 and 𝑸𝑺 = 𝟐 + 𝟐𝑷
• Suppose a $3.50 price floor is imposed on the market.
- 𝑸𝒅 = 𝟏𝟎 − 𝟐 $𝟑. 𝟓 = 𝟑 units
- 𝑸𝑺 = 𝟐 + 𝟐 $𝟑. 𝟓 = 𝟗 units
- Since 𝑸𝒔 > 𝑸𝒅 a surplus of 9-3=6 units exists
- The cost to the government of purchasing the surplus is $𝟑. 𝟓 × 𝟔 = $𝟐𝟏.
2-35

Comparative Statics
Comparative Statics
• Comparative static analysis
- The study of the movement from one equilibrium to another.
• Competitive markets, operating free of price restraints, will be analyzed
when:
- Demand changes
- Supply changes
- Demand and supply simultaneously change
2-36
Comparative Statics
Changes in Demand
• Increase in demand only
- Increase equilibrium price
- Increase equilibrium quantity
• Decrease in demand only
- Decrease equilibrium price
- Decrease equilibrium quantity
• Example of change in demand
- Suppose that consumer incomes are projected to increase 2.5% and the number
of individuals over 25 years of age will reach an all time high by the end of next
year. What is the impact on the rental car market?
2-37
Comparative Statics
Effect of a Change in Demand for Rental Cars

Price Supply
$49
$45
Demand1
Demand0
0 100 104 108 Quantity

(thousands
rented per day)
2-38
Comparative Statics
Changes in Supply
• Increase in supply only
- Decrease equilibrium price
- Increase equilibrium quantity
• Decrease in supply only
- Increase equilibrium price
- Decrease equilibrium quantity
• Example of change in supply
- Suppose that a bill before Congress would require all employers to provide health
care to their workers. What is the impact on retail markets?
2-39
Comparative Statics
Effect of a Change in Supply
Price Supply1
Supply0
𝟏
𝑷
𝑷𝟎
Demand
0 𝑸𝟏 𝑸𝟎 Quantity
2-40
Comparative Statics
Simultaneous Shifts in Supply and Demand

• Suppose that simultaneously the following events occur:
- An earthquake hit Kobe, Japan and decreased the supply of
fermented rice used to make sake wine.
- The stress caused by the earthquake led many to increase
their demand for sake, and other alcoholic beverages.
• What is the combined impact on Japan’s sake market?
2-41
Comparative Statics
Simultaneous Shifts in Supply and Demand in

Action
Japan’s Sake Market
Price
Supply2
C
𝑷𝟐
Supply1
B Supply0
𝟏
𝑷
A
𝑷𝟎
Demand1
Demand0
0 𝑸𝟐 𝑸𝟎 𝑸𝟏 Quantity
2-42
Comparative Statics
An example
• You are the manager of a firm that produces and markets a generic type
of soft drink in a competitive market. In addition to the large number of
generic products in your market, you also compete against major brands
such as Coca-Cola and Pepsi. Suppose that, due to the successful
lobbying efforts of sugar producers in the United States, Congress is
going to levy a $0.50 per pound tariff on all imported raw sugar—the
primary input for your product. In addition, Coke and Pepsi plan to
launch an aggressive advertising campaign designed to persuade
consumers that their branded products are superior to generic soft
drinks. How will these events impact the equilibrium price and quantity
of generic soft drinks?
2-43
Comparative Statics
Another example
• You are the manager of Fast & Easy Donuts. Almost all of your donut
sales are derived from the drive-through window. You know from
experience that coffee is a complement for your donuts. The morning
newspaper says that a major storm has just destroyed 50 percent of this
year's coffee bean crop. Will this affect how much flour you order? Will
it affect how many employees you schedule? What will happen to
prices?
Answer: Destruction of 50 percent of this year's coffee bean crop means a decrease in the supply
curve of coffee. The equilibrium price and quantity in the market for coffee are higher and lower,
respectively. As the price of a cup of coffee increases, the demand curve for its complement, donuts,
decreases. Hence, quantities sold in the donut market will be lowered. You should order less flour.
Also, you should hire fewer employees since prices and quantity sold are expected to be lower.
2-44
Interesting Research:
The Influence of Food Recommendations on Demand
• Assessing the impact of two types of recommendations
commonly observed in food settings: most popular and chef’s
choice.
• The best seller in the bakery vs. the baker’s recommended
cupcake.
• The most popular is the only recommendation that statistically
significantly increased consumers’ demand relative to a baseline
without recommendations.
• This effect only holds for subjects from outside the local region.
https://digitalcommons.chapman.edu/cgi/viewcontent.cgi?article=1343&context=esi_working_papers

Interesting Research:
CIA, Bin Laden and Vaccination Demand in Pakistan
• In July 2011, the Pakistani public learnt that the CIA had used a
vaccination campaign as cover to capture Osama Bin Laden.
• The Taliban leveraged on this information and launched an
anti-vaccine propaganda campaign to discredit vaccines and
vaccination workers.
• Vaccination rates declined 12 to 20% for people supporting
Islamist parties.
• Information discrediting vaccination campaigns can negatively
affect trust in health services and demand for immunization.
http://d.repec.org/n?u=RePEc:cge:wacage:544&r=&r=soc

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Market Forces: Demand and Supply

Murat Issabayev, PhD, Associate Professor of Economics

© 2017 by McGraw-Hill Education. All Rights Reserved. 2-2

© 2017 by McGraw-Hill Education. All Rights Reserved. 2-3

Shift in Quantity Demanded versus a Shift in

Advertising and the Demand for Clothing

Understanding the Linear Demand Function

The Linear Demand Function in Action

$1.00 t = per unit tax of 20¢

0 1,100 2,450 Quantity of

• 𝑸𝑺𝑿 is the number of units of good X produced;

© 2017 by McGraw-Hill Education. All Rights Reserved. 2-23

Market Equilibrium in Action

Price Restrictions and Market Equilibrium

Social welfare Loss

Price Ceiling in Action

Price Ceiling in Action

Price Ceiling in Action

Price Floor in Action

• One possibility is that the government purchases and discards the

Price Floor in Action

© 2017 by McGraw-Hill Education. All Rights Reserved.

Effect of a Change in Demand for Rental Cars

0 100 104 108 Quantity

Effect of a Change in Supply

Simultaneous Shifts in Supply and Demand

Simultaneous Shifts in Supply and Demand in

© 2017 by McGraw-Hill Education. All Rights Reserved. 2-45

© 2017 by McGraw-Hill Education. All Rights Reserved. 2-46

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