Week 2

SUPPLY AND DEMAND
Market Demand
 Demand for a good or service is defined as quantities
of a good or service that people are ready (willing and
able) to buy at various prices within some given time
period, other factors besides price held constant.
Market Demand
Market demand is the sum of all the individual
demands.
Example demand for pizza:

Market Demand
The inverse
relationship
between price and
the quantity
demanded of a
good or service is
called the Law of
Demand.
Market Demand
 Changes in price result in changes in the quantity
demanded.
 This is shown as movement along the demand curve.
 Changes in non-price determinants result in changes
in demand.
 This is shown as a shift in the demand curve.
Market Demand
 Nonprice determinants of demand
 Tastes and preferences
 Income
 Prices of related products
 Future expectations
 Number of buyers
Market Supply
 The supply of a good or service is defined as quantities
of a good or service that people are ready to sell at
various prices within some given time period, other
factors besides price held constant.
Market Supply
 Changes in price result in changes in the quantity
supplied.
 This is shown as movement along the supply curve.
 Changes in non-price determinants result in changes
in supply.
 This is shown as a shift in the supply curve.
Market Supply
 Nonprice determinants of supply
 Costs and technology
 Prices of other goods or services offered by the seller
 Future expectations
 Number of sellers
 Weather conditions
Market Equilibrium
 Equilibrium price: The price that equates the
quantity demanded with the quantity supplied.
 Equilibrium quantity: The amount that people are
willing to buy and sellers are willing to offer at the
equilibrium price level.
Market Equilibrium
 Shortage: A market situation in which the
quantity demanded exceeds the quantity supplied.
 A shortage occurs at a price below the equilibrium level.
 Surplus: A market situation in which the quantity
supplied exceeds the quantity demanded.
 A surplus occurs at a price above the equilibrium level.
Market Equilibrium
Comparative Statics Analysis
 A commonly used method in economic analysis: a form of
sensitivity, or what-if analysis
 Process of comparative statics analysis
 State all the assumptions needed to construct the model.
 Begin by assuming that the model is in equilibrium.
 Introduce a change in the model. In so doing, a condition of
disequilibrium is created.
 Find the new point at which equilibrium is restored.
 Compare the new equilibrium point with the original one.
Comparative Statics: Example
Step 1
 Assume all factors
except the price of
pizza are constant.
 Buyers’ demand and
sellers’ supply are
represented by lines
shown.
Step 2
 Begin the analysis in
equilibrium as shown
by Q1 and P1.
Step 3
 Assume that a new
study shows pizza to
be the most
nutritious of all fast
foods.
 Consumers increase
their demand for
pizza as a result.
Step 4
 The shift in demand
results in a new
equilibrium price, P2 ,
and quantity, Q2.
Step 5
 Comparing the new
equilibrium point with
the original one we see
that both equilibrium
price and quantity have
increased.
 The short run is the period of time in which:
 Sellers already in the market respond to a change in
equilibrium price by adjusting variable inputs.
 Buyers already in the market respond to changes in
equilibrium price by adjusting the quantity
demanded for the good or service.
 The rationing function of price is the change in
market price to eliminate the imbalance between
quantities supplied and demanded.
Short-run Analysis
 An increase in demand
causes equilibrium
price and quantity to
rise.
Short-run Analysis
 A decrease in demand
causes equilibrium
price and quantity to
fall.
Short-run Analysis
 An increase in supply
causes equilibrium
price to fall and
equilibrium quantity to
rise.
Short-run Analysis
 A decrease in supply
causes equilibrium
price to rise and
equilibrium quantity to
fall.
 The long run is the period of time in which:
 New sellers may enter a market
 Existing sellers may exit from a market
 Existing sellers may adjust fixed factors of production
 Buyers may react to a change in equilibrium price by
changing their tastes and preferences or buying
preferences
 The guiding or allocating function of price is the
movement of resources into or out of markets in
response to a change in the equilibrium price.
Long-run Analysis
 Initial change: decrease in
demand from D1 to D2
 Result: reduction in
equilibrium price and
quantity, now P2,Q2
 Follow-on adjustment:
 movement of resources out of
the market
 leftward shift in the supply
curve to S2
 Equilibrium price and
quantity now P3,Q3
Long-run Analysis
 Initial change: increase in
demand from D1 to D2
 Result: increase in
equilibrium price and
quantity, now P2,Q2
 Follow-on adjustment:
 movement of resources into
the market
 rightward shift in the supply
curve to S2
 Equilibrium price and
quantity now P3,Q3
Supply, Demand, and Price:
The Managerial Challenge
 In the extreme case, the forces of supply and
demand are the sole determinants of the market
price.
 This type of market is “perfect competition”
 In other markets, individual firms can exert
market power over their price because of their:
 dominant size.
 ability to differentiate their product through advertising,
brand name, features, or services
Exercise 1: Using the schedules below, answer the
following questions.
Quantity supplied
Quantity demanded Price (grams of rice)
Price
(grams of rice)
$4.20 125,000 $4.20 230,000
4.00 150,000 4.00 220,000
3.80 175,000 3.80 210,000
3.60 200,000 3.60 200,000
3.40 225,000 3.40 190,000
3.20 250,000 3.20 180,000
3.00 275,000 3.00 170,000

1. Plot the demand curve and the supply curve on the graph paper.
Label the axes and indicate for each axis the units being used to
measure price and quantity.
2. Give the equilibrium price and quantity for rice.
3. Indicate the equilibrium price and quantity on the graph paper by
drawing lines from the intersection of the supply and demand curves
to the price and quantity axes.
4. If the Malaysian government decided to support the price of rice at
$4.00 per grams, tell whether there would be a surplus or shortage
and how much it would be.
5. Demonstrate your answer to part (iv) on your graph paper and being
sure to label the quantity you designated as the shortage or surplus.
Exercise 2: Elasticities
The following data in the table below shows the relationship
between price and quantity demanded at four different prices for
a product.
Using the midpoint formula, what is the price elasticity of demand

between (shows your working) A and B, B and C, C and D, D and
E, and finally, E and F? Indicate whether the demand is elastic or
inelastic for each case?
E F
A B C D
3 1
Price ($) 11 9 7 5
Quantity
16 24 32 40 48 56
Demand

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SUPPLY AND DEMAND

Example demand for pizza:

$4.20 125,000 $4.20 230,000

4.00 150,000 4.00 220,000

3.80 175,000 3.80 210,000

3.60 200,000 3.60 200,000

3.40 225,000 3.40 190,000

3.20 250,000 3.20 180,000

3.00 275,000 3.00 170,000

Using the midpoint formula, what is the price elasticity of demand

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