THE MARKET

FORCES OF SUPPLY
AND DEMAND
MANKIW CH-4
 MARKETS AND COMPETITION

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.
WHAT IS A MARKET?

• A market is a group of buyers and sellers of a particular good

or service.

• The terms supply and demand refer to the behavior of people . .

. as they interact with one another in markets.
WHAT IS A MARKET?

• Buyers determine demand.

• Sellers determine supply.

WHAT IS COMPETITION?

A competitive market is a market

in which there are many buyers
and sellers so that each has a
negligible impact on the
market price.
WHAT IS COMPETITION?

• Competition: Perfect and Otherwise

• Perfect Competition
• Products are the same
• Numerous buyers and sellers so that each has no influence over price
• Buyers and Sellers are price takers

• Monopoly
• One seller, and seller controls price
WHAT IS COMPETITION?

• Competition: Perfect and Otherwise

• Oligopoly
• Few sellers
• Not always aggressive competition
• Monopolistic Competition
• Many sellers
• Slightly differentiated products
• Each seller may set price for its own product

The distinguishing feature between perfect and

imperfect markets is the absence of opportunity to
control price versus the opportunity to do the same.
DEMAND

• Quantity demanded is the amount of a good that buyers

are willing and able to purchase.

• 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.
 THE DEMAND CURVE: THE
RELATIONSHIP BETWEEN PRICE AND
QUANTITY DEMANDED

• Demand Schedule
• The demand schedule is a table that
shows the relationship between the
price of the good and the quantity
demanded.
 ARUN’S DEMAND SCHEDULE

Price of Ice Cream Quantity Demanded

0.00 12
0.50 10
1.00 8
1.50 6
2.00 4
2.50 2
3.00 0
 DEMAND CURVE

• The demand curve is a graph of

the relationship between the
price of a good and the quantity
demanded.
ARUN’S DEMAND SCHEDULE AND
DEMAND CURVE
Price of
Ice-Cream Cone
Re3.00

2.50

1. A decrease
2.00
in price ...

1.50

1.00

0.50

0 1 2 3 4 5 6 7 8 9 10 11 12 Quantity of
Ice-Cream Cones
2. ... increases quantity
of cones demanded.
 MARKET DEMAND VERSUS
INDIVIDUAL DEMAND
• Market demand refers to the sum of all
individual demands for a particular good or
service.

• Graphically, individual demand curves are

summed horizontally to obtain the market
demand curve.
 THE MARKET DEMAND CURVE

The market demand curve is the horizontal

sum of the individual demand curves!
Anup’s Demand + Becky’s Demand = Market Demand

Price of Ice- Price of Ice- Price of Ice-

Cream Cone Cream Cone Cream Cone

2.00 2.00 2.00

1.00 1.00 1.00

7 13
4 8 3 5

Quantity of Ice-Cream Cones Quantity of Ice-Cream Cones Quantity of Ice-Cream Cones

When the price is Re1.00, When the price is Re1.00, The market demand at
Anup will demand 8 ice- Becky’s will demand 5 ice- Re.1.00, will be 13 ice-
cream cones. cream cones. cream cones.
 DETERMINANTS OF DEMAND

• What are the factors affecting demand for a

product?
• There is not finite list of determinants of demand.
• Determinants of demand vary as per: (a) the nature
of the good and (b) the purpose of the purchase.
• Each determinant has a specific direction of
relationship with the quantity demanded.
 SHIFTS IN THE DEMAND
CURVE
• Change in Quantity Demanded
• Movement along the demand
curve.

• Caused by a change in the own

price of the product.
 CHANGES IN QUANTITY
DEMANDED
Price of Ice-
Cream
Cones
A tax on sellers of ice-
B cream cones raises the
price of ice-cream cones
Re.2.00
and results in a
movement along the
demand curve.

1.00 A

D
0 4 8 Quantity of Ice-Cream Cones
 SHIFTS IN THE DEMAND
CURVE
Determinants other than price
• Consumer income
• Prices of related goods
• Tastes
• Expectations
• Number of buyers
 SHIFTS IN THE DEMAND CURVE

• Change in Demand
• A shift in the demand curve, either to the left or right.

• Caused by any change that alters the quantity demanded at every price.

• To the right is called, “Increase in Demand”.

• To the left if called,“Decrease in Demand”.

 SHIFTS IN THE DEMAND CURVE

Price of
Ice-Cream
Cone

Increase
in demand

Decrease
in demand
Demand
curve, D2
Demand
curve, D1
Demand curve, D3
0 Quantity of
Ice-Cream Cones
 SHIFTS IN THE DEMAND CURVE

Consumer Income
• As income increases the demand
for a normal good will increase.

• As income increases the demand

for an inferior good will decrease.
 CONSUMER INCOME NORMAL GOOD

Price of Ice-
Cream Cone
Re3.00 An increase in
income...
2.50
Increase
2.00 in demand

1.50

1.00

0.50
D2
D1 Quantity of
Ice-Cream
0 1 2 3 4 5 6 7 8 9 10 11 12 Cones
CONSUMER INCOME INFERIOR GOOD

Price of Ice-
Cream Cone
$3.00

2.50 An increase in
income...
2.00
Decrease
1.50 in demand

1.00

0.50
Quantity of
D2 D1 Ice-Cream
Cones
0 1 2 3 4 5 6 7 8 9 10 11 12
SHIFTS IN THE DEMAND CURVE

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.
VARIABLES THAT INFLUENCE
BUYERS
 SUPPLY
• Quantity supplied is the amount of a good that sellers are willing
(Market conditions) and able (Cost Conditions) to sell.

• 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.
 THE SUPPLY CURVE: THE RELATIONSHIP
BETWEEN PRICE AND QUANTITY SUPPLIED

• Supply Schedule

• The supply schedule is a table

that shows the relationship
between the price of the good
and the quantity supplied.
 SUPPLY SCHEDULE
Price quantity
0.00 0
0.50 0
1.00 1
1.50 2
2.00 3
2.50 4
3.00 5
SUPPLY CURVE

• The supply curve is the

graph of the relationship
between the price of a good
and the quantity supplied.
 SUPPLY CURVE
Price of
Ice-Cream
Cone
Re3.00

2.50
1. An
increase
in price ... 2.00

1.50

1.00

0.50

0 1 2 3 4 5 6 7 8 9 10 11 12 Quantity of
Ice-Cream Cones
2. ... increases quantity of cones supplied.
 WHY SUPPLY CURVE IS
POSITIVELY SLOPED?
• Very low prices do not attract producers to devote
resources to produce a said product.

• Profitable prices enable entrepreneurs to add worker,

machines etc to produce & supply more.

• Describes price – supply relationship.

• Upward sloping supply curve reflects law of supply.

 MARKET SUPPLY VERSUS
INDIVIDUAL SUPPLY

• Market supply refers to the sum of

all individual supplies for all sellers of
a particular good or service.

• Graphically, individual supply curves

are summed horizontally to obtain
the market supply curve.
SUPPLY DETERMINANTS – GOOD’S
PRICE

• Higher money income required to induce producers to produce more.

• Higher the price, higher the potential to earn and more the incentive to
produce greater quantities.
SUPPLY DETERMINANTS – OTHER
GOOD’S PRICE

• Change in the price of related goods provoke producers to

move away from producing goods having a lower price to
producing goods attracting a higher price.
SUPPLY DETERMINANTS – FACTOR
PRICES

• Factor prices influence firm’s cost structure.

• Changes relative profitability of business.

• Changes amount supplied.

SUPPLY DETERMINANTS –
TECHNOLOGY LEVEL

• Two forms of technological advances:

1. Lower amount of inputs for same amount of output.

2. Same amount of inputs for higher amount of output.
 SHIFTS IN THE SUPPLY CURVE

• Input prices
• Technology
• Expectations
• Number of sellers
 SHIFTS IN THE SUPPLY CURVE

Change in Quantity Supplied

• Movement along the supply curve.

• Caused by a change in anything that

alters the quantity supplied at each
price.
 CHANGE IN QUANTITY SUPPLIED

Price of Ice-
Cream S
Cone
C
$3.00
A rise in the price of ice
cream cones results in a
movement along the
supply curve.

A
1.00

Quantity of
Ice-Cream
0 1 5 Cones
SHIFTS IN THE SUPPLY CURVE

Change in Supply

• A shift in the supply curve, either to

the left or right.

• Caused by a change in a determinant

other than price.
 SHIFTS IN THE SUPPLY CURVE

Price of
Ice-Cream Supply curve, S3
Supply
Cone
curve, S1
Supply
Decrease curve, S2
in supply

Increase
in supply

0 Quantity of
Ice-Cream Cones
VARIABLES THAT INFLUENCE
SELLERS
 SHIFTS IN CURVES VERSUS
MOVEMENTS ALONG CURVES

• A shift in the supply curve is called a change in

supply.
• A movement along a fixed supply curve is called a
change in quantity supplied.
• A shift in the demand curve is called a change in
demand.
• A movement along a fixed demand curve is called a
change in quantity demanded.
 SUPPLY AND DEMAND
TOGETHER

• Equilibrium refers to a situation in

which the price has reached the level
where quantity supplied equals
quantity demanded.
 SUPPLY AND DEMAND
TOGETHER
• 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.
SUPPLY AND DEMAND TOGETHER

Demand Schedule Supply Schedule

Price (Re.) Market Price (Re.) Market
0.00 19 0.00 0
0.50 16 0.50 0
1.00 13 1.00 1
1.50 10 1.50 4
2.00 7 2.00 7
2.50 4 2.50 10
3.00 1 3.00 13

At Re.2.00, the quantity

demanded is equal to the quantity
supplied!
 THE EQUILIBRIUM OF SUPPLY AND
DEMAND
Price of
Ice-Cream
Cone Supply

Equilibrium price Equilibrium

Re.2.00

Equilibrium Demand
quantity

0 1 2 3 4 5 6 7 8 9 10 11 12 13
Quantity of Ice-Cream Cones
 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.
 MARKETS NOT IN EQUILIBRIUM
(a) Excess Supply
Price of
Ice-Cream Supply
Cone Surplus

Re.2.50

2.00

Demand

0 4 7 10 Quantity of
Quantity Quantity Ice-Cream
demanded supplied Cones
• 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.
 MARKETS NOT IN EQUILIBRIUM
(b) Excess Demand
Price of
Ice-Cream Supply
Cone

Re.2.00

1.50
Shortage

Demand

0 4 7 10 Quantity of
Quantity Quantity Ice-Cream
supplied demanded Cones
LAW OF SUPPLY AND
DEMAND

• The claim that the price of any

good adjusts to bring the
quantity supplied and the
quantity demanded for that
good into balance.
THREE STEPS FOR ANALYZING
CHANGES IN EQUILIBRIUM
HOW AN INCREASE IN DEMAND AFFECTS
THE EQUILIBRIUM
Price of
Ice-Cream 1. Hot weather increases
Cone the demand for ice cream . . .

Supply

Re.2.50 New equilibrium

2.00
2. . . . resulting
Initial
in a higher
equilibrium
price . . .
D

0 7 10 Quantity of
3. . . . and a higher Ice-Cream Cones
quantity sold.
HOW A DECREASE IN SUPPLY AFFECTS THE
EQUILIBRIUM
Price of
Ice-Cream 1. An increase in the
Cone price of sugar reduces
the supply of ice cream. . .
S2
S1

New
Re.2.50 equilibrium

2.00 Initial equilibrium

2. . . . resulting
in a higher
price of ice
cream . . . Demand

0 4 7 Quantity of
3. . . . and a lower Ice-Cream Cones
quantity sold.
SHIFTS IN BOTH SUPPLY AND
DEMAND