CHAPTER T W O

2
Demand, Supply and
Market Equilibrium
 Content

◼ Demand

◼ Supply

◼ Market Equilibrium

◼ Changes in Market Equilibrium

 Demand

◼ Demand is the quantity that buyers wish to

purchase at each conceivable price.

◼ Note the distinction between demand and the

quantity demanded

◼ Demand describes the behavior of buyers at

every price. At a particular price there is a

particular quantity demanded.
 Demand

◼ Demand is the quantity that buyers wish to

purchase at each conceivable price.

◼ Note the distinction between demand and the

quantity demanded

◼ Demand describes the behavior of buyers at

every price. At a particular price there is a

particular quantity demanded.
 Demand Function

◼ A function that shows the relationship

between the price of a good and the quantity
demanded.

◼ Demand Function

QD = f(P)
QD = aP + b (a < 0)

◼ Example: QD = - 4P + 12
 Demand Schedule

Demand schedule of chocolate

P ($) QD (no. of bars)

0 12
1 8
2 4
3 0
 Demand Curve
Price (P)
A graph of the relationship
3 between the price of a good
and the quantity demanded.
2

Quantity
4 8 12 Demanded (QD)
0

Because a lower price increases the quantity

demanded, the demand curve slopes downward.
 Law of Demand

Price
falls

Other things equal, the quantity

demanded of a good falls when
the price of the good rises.

Quantity
rises
 Supply

◼ Supply is the quantity of a good that sellers

wish to sell at each possible price.

◼ Note the distinction between supply and the

quantity supplied.
 Supply Function

◼ A function that shows the relationship between

the price of a good and the quantity supplied.

◼ Supply Function

QS = f(P)
QS = c*P + d (c > 0)

◼ Example: QS = 3P + 5
 Supply Schedule

Supply schedule of chocolate

P ($) QS (no. of bars)

0 5
1 8
2 11
3 14
 Supply Curve
Price (P)
A graph of the relationship
3
between the price of a good
and the quantity supplied.
2

0 8 11 14 Quantity Supplied (QS)

Because a higher price increases the quantity

supplied, the supply curve slopes upward.
Law of Supply

Price
falls

Other things equal, the quantity

supplied of a good rises when
the price of the good rises.

Quantity
falls
 Market Equilibrium
Price (P)
A situation in which the
3 market price has reached
the level at which quantity
2 supplied equals quantity
demanded
1

8 12 Quantity (Q)
0

At equilibrium: QS = QD
 Market Equilibrium

P ($) QD QS
0 12 5
1 8 8
2 4 11
3 0 14
 Surplus vs shortage
Price (P)
Surplus Surplus is a situation in
which quantity supplied
is greater than quantity
1 demanded (QS > QD)

0 8 Quantity (Q)

Surplus: QS > QD
 Surplus vs shortage
Price (P)

Shortage is a situation in
which quantity demanded is
1 greater than quantity
supplied (QS < QD)

Shortage

0 8 Quantity (Q)

Shortage: QS < QD
 Changes in Market Equilibrium

◼ A change in market equilibrium due to:

➢ Shift in Demand
➢ Shift in Supply
➢ Shift in both Demand and Supply
Shifts in Curves versus Movements along
Curves

◼ Changes in demand/supply make the entire

curves shift.

◼ Changes in quantity demanded/supplied cause

movements along curves.
 Shift in Demand

◼ Increase in demand
◼ Any change that increases the quantity demanded
at every price

◼ Demand curve shifts right

◼ Decrease in demand
◼ Any change that decreases the quantity demanded
at every price

◼ Demand curve shifts left

 Shift in Demand

◼ Income

◼ Prices of related goods

◼ Tastes

◼ Expectations

◼ Number of buyers
How about bus
rides if your
income rises?
 Income

◼ Demand for a normal good is positively related

to income.
◼ An increase in income leads to an increase in demand

◼ Demand for an inferior good is negatively related

to income.
◼ An increase in income leads to a decrease in demand
 Prices of related goods

◼ Substitutes, two goods

◼ An increase in the price of one

◼ Leads to an increase in the demand for the other

◼ Complements, two goods

◼ An increase in the price of one

◼ Leads to a decrease in the demand for the other

 Taste

◼ Anything that causes a shift in tastes toward a

good will increase demand for that good.
◼ The emphasis on health and fitness has increased the
demand for jogging equipment, healthy foods and sports
facilities.
 Expectation

◼ Expectations about the future may affect

demand for a good or service today.

◼ Example:

◼ Expect an increase in income

◼ Increase in current demand

◼ Expect higher prices

◼ Increase in current demand
 Number of buyers

◼ Increase in number of buyers

increases quantity demanded at each price.
 Shift in Supply

◼ Increase in supply
◼ Any change that increases the quantity supplied at
every price

◼ Supply curve shifts right

◼ Decrease in supply
◼ Any change that decreases the quantity supplied
at every price

◼ Supply curve shifts left

 Shift in Supply

◼ Input prices

◼ Technology

◼ Expectations

◼ Number of sellers

◼ Government policies
 Input prices

◼ Examples of input prices: wages, prices of

raw materials.

◼ A fall in input prices makes production

more profitable at each output price
◼ Firms supply a larger quantity at each price

◼ The S curve shifts to the right.

 Technology

◼ Technology determines how much inputs are

required to produce a unit of output.

◼ Advance in technology has the same effect

as a fall in input prices, shifts S curve to the
right.
 Expectation

◼ Suppose a firm expects the price of ice

cream to rise in the future.

◼ The firm may put some of its current

production into storage, and supply less to
the market today.

◼ This would shift the S curve to the left.

 Number of sellers

◼ An increase in the number of sellers

increases the quantity supplied at each price,
shifts S curve to the right.
 Government policies

◼ Government policies can affect the cost of

production and the supply curve through
taxes, regulations, and subsidies.
◼ Taxes raise the cost of production and decrease
supply.

◼ Subsidies reduce the cost of production and

increase supply.
Changes in Market Equilibrium

Price
S

P1
P0

D D’

Q0 Q1 Quantity (Q)

New equilibrium following shift in demand

 Changes in Market Equilibrium
S’
Price
S

P2
P0

Q2 Q0 Quantity (Q)

New equilibrium following shift in supply

 Changes in Market Equilibrium

Three steps for analyzing changes in equilibrium:

1. Decide whether the event shifts the supply or

demand curve (or perhaps both).

2. Decide in which direction the curve shifts.

3. Use the supply and demand diagram to see

how the shift changes the equilibrium price and
quantity.