Microeconomics Chapter 3 – Market Demand

Things to Consider
- Why is milk always the same price in every corner store?
- Did you see that lineup at the gas station? What’s that all about?
- What factors influence how much of a good consumers want to buy?

Markets
Market:
- a group of buyers and sellers of a particular good or service.
- The terms supply and demand refer to the behaviour of people as they interact with one
another in markets.

Market demand
- refers to the sum of all individual demands for a particular good or service.

Market supply
- refers to the sum of all individual supplies of a particular good or service

There are different types of market structures. For the next while we’ll study what is often
considered the ideal:
- A perfectly competitive market:
o all goods are identical (homogeneous)
o firms can freely enter or exit the market
o buyers & sellers are so numerous that no individual consumer or firm can affect
the market price – each is a price take
Demand
- Quantity demanded, Qd: the amount of a good or service that consumers are willing and
able to buy at a given price, P.
- When the price of a good increases, you buy less of that good.
- We say price and Qd are negatively related.
- As P up, Qd down

The law of demand

- Other things bring equal (Ceteris Paribus), when the price of a good rises, the quantity
demanded of those good falls

Other Determinants of Demand

Income
- Normal good: when income increases, demand increases and vice versa.
o Example: most goods
- Inferior good: when income increases, demand decreases and vice versa.
o Example: thrift store clothes
Prices of related goods
- Substitutes: if the price of one good increases, the demand for the other good increases
and vice versa.
o Examples: chicken and turkey, Pepsi, and Coke
o Price of Pepsi, goes up, Demand of Coke goes up
- Complements: when the price of a good goes up, the demand for the other good
decreases.
o Examples: peanut butter and jam, cars, and gas
o Price of peanut butter goes up you will buy less of peanut butter and jam
demand would go down
- Tastes: you’ll buy more of things you like.
- Expectations: if you think the price will go up in the future, you’ll demand more of the
good today.
- Population: higher population means more consumers in general and higher demand
- Demand schedules are tables that show the relationship between price and quantity
demanded for a good.
- Demand curves are graphs of demand schedule

Market demand example:

The demand for candy bars
- Suppose there are only 2 consumers in the market for candy bars – Kylie and Jack.
- We assume that income, prices of related goods, tastes and expectations are held constant
– non-changing at this moment in time.
- Their demand schedules are as follow

- Notice that even though Qd depends on P, P is on the vertical axis.

- What we graph is the inverse demand function where we treat price as a function of
quantity.
- This representation will make later analysis simple and clear
- To get market quantity demanded, add up individual quantity demanded

Change in Quantity Demanded

- A change in quantity demanded: is movement along the demand curve due to a change in
the price of the good.
 - The demand curve itself: does NOT move quantity.

Change in Demand
- A change in demand is a shift of the demand curve when anything other than the price of
the good changes.
- An increase in demand: D shifts right
- A decrease in demand: D shifts left

Shift Factors for Demand

Consumer Income
- As income increases, the demand for a normal good will: shift D to the right
- As income increases, the demand for an inferior good will: shift D to the left

Prices of Related Goods

 - If 2 goods are substitutes in consumption: an increase in the price of one good will shift
the demand for the other good to the right
- If 2 goods are complements in consumption: an increase in the price of one good will
shift the demand of the other good to the left
- If 2 goods are complements in consumption: an increase in the price of one good will
shift the demand of the other good to the Right

- Changes in expectations and tastes will shift demand accordingly.

- Increases in population will shift demand to the right.

Market Supply I
Things to Consider
- What factors influence how much of a good is produced and offered for sale in a market?
- Why does the price of bread in Hamilton depend on the weather out West?
- How is the price we pay for perfectly competitive goods determined?

Supply
- Quantity supplied, Qs: the quantity of goods and services firms (sellers, suppliers,
producers) are willing and able to sell at any price, P.
- When the price of a good increases, ceteris paribus, selling that good becomes more
profitable and firms will want to offer more for sale.
- Price and Qs are positively related. As P up, Qs up

The Law of Supply

- Other things being equal (ceteris paribus), the quantity supplied of a good rise when the
price of the good rises
Other Determinants of Supply
Input Prices: when the price of an input into production (a factor of production, a resource) like
labour costs, raw materials, machinery, energy, etc. increases, producing the good becomes less
profitable and firms will offer fewer goods for sale at any price and vice versa.

Prices of Related Goods in Production

- If 2 goods are substitutes in production: an increase in the price of one good will
decrease supply of the other.
o Example: SUVs and trucks
o If selling price of trucks goes up, become more attractive and increase production
for trucks but not SUV
- If 2 goods are complements in production: an increase in the price of one good will
increase the supply of the other.
o Example: chicken breasts & chicken thighs
o If the breasts supply goes up, the thighs will have to go up too

Technology: a technology that lowers the cost of production will increase supply.

Expectations: if prices are expected to increase in the future, firms will hold off producing today
and supply today will decrease.

Number of Firms: more firms producing means supply will increase.

The supply schedule is a table that shows the relationship between the price of the good and the
quantity supplied. The supply curves are a graph of the supply schedule.

The Supply of Candy Bars

Let’s look at the supply schedule for Paul and John, the only 2 firms that sell candy bars in our
mark

Market Supply II and Market Equilibrium

A Change in Quantity Supplied

- A change in quantity supplied: is movement along the supply curve due to a change in the
price of the good.
- The supply curve itself: does NOT move
A Change in Supply
- A change in supply is a shift of the supply curve due to a change in anything other than
the price of the good.
- An increase in supply means a shift to the right.
- A decrease in supply means a shift to the left.
- If input prices increase, the supply curve shifts to the left (and vice versa).
- An increase in the price of a substitute good in production will decrease the supply of the
other good (shift it left).
- An increase in the price of a complement in production will increase the supply of the
other good (shift it right).
- Advances in technology and an increase in the number of firms will shift the supply
curve to the right.
- Expectations will shift supply according to the expectation
Market Equilibrium
- Equilibrium: is a situation in which there is no incentive for any individual to change
what they’re doing because they can’t make themselves any better off.
- In the market, this happens when Qd = Qs.
- The price is such that no buyers want to buy any more at that price and no sellers want to
sell any more at that price.
- No one goes without and no one has any extra: the market clears.

- The price at which Qd = Qs is the equilibrium price, also called the market clearing price.

- The quantity at which Qd = Qs is the equilibrium quantity.

- It is the quantity traded in the market (the quantity that is sold).

- Let’s find equilibrium for our candy bar market

Analyzing Market Equilibrium, I
Things to Consider
- What happens if a market is not in equilibrium?
- What can happen in a market to change the equilibrium market price?

Suppose that for some reason, the market price of candy bars was $2.50.
- At $2.50, consumers will only buy 5 bars, but firms will offer 25 bars for sale.
- There will be a surplus, or excess supply at a price above equilibrium price where Qs >
Qd.
- Firms will want to decrease inventory by lowering P.
- As P down, consumers purchase more of the good.
- Eventually we return to eqm. P where Qd = Qs with no further pressures on price
Suppose that for some reason, the market price of candy bars was $1.00.
- At $1.00, consumers will want to buy 20 bars, but firms will only offer 10 bars for sale.
- There will be a shortage, or excess demand at a price below equilibrium price where Qd
> Qs.
- Too many buyers will bid up P and firms will start to supply more.
- As P up, firms supply more, and consumers purchase less of the good.
- Eventually we return to eqm. P where Qd = Qs with no further pressures on price
 - When the market is not in equilibrium, the short side of the market dominates.
- This means that whichever is lower, Qd (in the case of a surplus) or Qs (in the case of a
shortage) is what is traded (sold) in the market.
o Example: if Qd = 20 and Qs = 100, only 20 will be traded because that’s all those
consumers want to buy at the current price. It doesn’t matter how much over 20
units of the good that firms produce, they’ll only be able to sell 20.

Law of Supply and Demand

- The price of any good adjusts to bring the market back to equilibrium if the market is left
to operate freely (with no intervention from outside parties, like a government, that would
force price to be kept at an artificial, non-equilibrium level)

Analyzing Market Equilibrium II

Analyzing Changes in Equilibrium
- Often, events can happen which will shift demand or supply or both.
- This will lead to a change in eqm. P and Q.
- We can use our diagrams to see what happens to equilibrium when curves shift (this is
called comparative statics)

Example: A change in demand.

Suppose advertising increases the demand for candy bars:

- D will shift right.
- New intersection of D and S
- Eqm. P up and Q up
- We have a change in demand and a change in quantity supplied (D shifts, but we move
up the S curve
Example: A change in supply
Suppose the price of sugar, A key input into candy bar production, rises
- Cost of production goes up, S goes down
- New intersection of D and S
- Eqm. P goes up, and Q goes down
- We have a change in supply and a change in quantity demanded (S shift movement up the
demand curve)

Changes in Both Demand and Supply

- When an event or events shift both D and S at the same time, what happens to eqm. P and
Q depends on the size of the relative shifts.
- For example, we have a simultaneous up in D and up in S
- Q will increase, but we don’t know what will happen to P – the change in P is ambiguous
and depends on the relative magnitudes of the shifts in D and S
Using Equations
- Most of the time, we will be representing demand and supply using equations.
- In first year, we simplify and assume that both demand and supply are linear equation

- EXAMPLE: The Popsicle Market

- The demand and supply equations for the popsicle market are:
Demand: Qd = 1600 – 300P
Supply: Qs = 800 + 700P
- In equilibrium, Qd = Qs
1600 - 300P = 800 + 700P
800 = 1000P
P* = .80 is eqm. Price

Substitute P* = .80 into either D or S equation to solve for eqm Q, denoted Q*: Qs = 800 +
700(.80) = 1360 = Qd = Q* = 1360

- Suppose for some reason the price of popsicles was currently $0.50
- Since price is below eqm. Pe, we know there will be excess demand for popsicles. Let’s
calculate the shortage:
o At P = .50,
o Qd = 1600 – 300(.50) = 1450
o Qs = 800 + 700(.50) = 1150
o Excess demand = Qd – Qs = 1450 – 1150 = 300
o There is a shortage of 300 popsicles

- Too many popsicle demanders will lead to upward pressure on price.

- Popsicle suppliers will supply more as price increases.
- We’ll end up at the original Pe and Qe.
- If the popsicle market is left to operate freely, eventually we’ll see a return to equilibrium
P and Q.
- Too many popsicle demanders will lead to upward pressure on price.
- Popsicle suppliers will supply more as price increases.
- We’ll end up at the original Pe and Qe.