2
SUPPLY AND DEMAND I: HOW MARKETS WORK
The Market Forces of
Supply and Demand
4
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MARKETS AND COMPETITION
• 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.
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MARKETS AND COMPETITION
• Buyers determine demand.
• Sellers determine supply
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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.
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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.
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Catherine’s Demand Schedule
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The Demand Curve: The Relationship
between Price and Quantity Demanded
• Demand Curve
• The demand curve is a graph of the relationship
between the price of a good and the quantity
demanded.
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Figure 1 Catherine’s Demand Schedule and Demand
Curve
Price of
Ice-Cream Cone
$3.00
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.
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Shifts in the Demand Curve
• Change in Quantity Demanded
• Movement along the demand curve.
• Caused by a change in the price of the product.
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Changes in Quantity Demanded
Price of Ice-
Cream A tax that raises the
Cones
price of ice-cream
B cones results in a
$2.00
movement along the
demand curve.
1.00 A
D
0 4 8 Quantity of Ice-Cream Cones
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Shifts in the Demand Curve
• Consumer income
• Prices of related goods
• Tastes
• Expectations
• Number of buyers
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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.
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Figure 3 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
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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.
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Consumer Income
Normal Good
Price of Ice-
Cream Cone
$3.00 An increase
2.50 in income...
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
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Consumer Income
Inferior Good
Price of Ice-
Cream Cone
$3.00
2.50 An increase
2.00
in income...
Decrease
1.50 in demand
1.00
0.50
D2 D1 Quantity of
Ice-Cream
0 1 2 3 4 5 6 7 8 9 10 11 12 Cones
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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.
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Table 1 Variables That Influence Buyers
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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.
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SUPPLY
• Quantity supplied is the amount of a good that
sellers are willing and able 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.
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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.
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Ben’s Supply Schedule
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The Supply Curve: The Relationship between
Price and Quantity Supplied
• Supply Curve
• The supply curve is the graph of the relationship
between the price of a good and the quantity
supplied.
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Figure 5 Ben’s Supply Schedule and Supply Curve
Price of
Ice-Cream
Cone
$3.00
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.
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Shifts in the Supply Curve
• Input prices
• Technology
• Expectations
• Number of sellers
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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.
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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
A the supply curve.
1.00
Quantity of
Ice-Cream
0 1 5 Cones
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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.
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Figure 7 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
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Table 2 Variables That Influence Sellers
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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.
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SUPPLY AND DEMAND
TOGETHER
• Equilibrium refers to a situation in which the
price has reached the level where quantity
supplied equals quantity demanded.
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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.
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SUPPLY AND DEMAND
TOGETHER
Demand Schedule Supply Schedule
At $2.00, the quantity demanded
is equal to the quantity supplied!
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Figure 8 The Equilibrium of Supply and Demand
Price of
Ice-Cream
Cone Supply
Equilibrium price Equilibrium
$2.00
Equilibrium Demand
quantity
0 1 2 3 4 5 6 7 8 9 10 11 12 13
Quantity of Ice-Cream Cones
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Figure 9 Markets Not in Equilibrium
(a) Excess Supply
Price of
Ice-Cream Supply
Cone Surplus
$2.50
2.00
Demand
0 4 7 10 Quantity of
Quantity Quantity Ice-Cream
demanded supplied Cones
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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.
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Equilibrium
• 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.
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Figure 9 Markets Not in Equilibrium
(b) Excess Demand
Price of
Ice-Cream Supply
Cone
$2.00
1.50
Shortage
Demand
0 4 7 10 Quantity of
Quantity Quantity Ice-Cream
supplied demanded Cones
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Equilibrium
• 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.
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Three Steps to Analyzing Changes in
Equilibrium
• Decide whether the event shifts the supply or
demand curve (or both).
• Decide whether the curve(s) shift(s) to the left
or to the right.
• Use the supply-and-demand diagram to see how
the shift affects equilibrium price and quantity.
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Figure 10 How an Increase in Demand Affects the
Equilibrium
Price of
Ice-Cream 1. Hot weather increases
Cone the demand for ice cream . . .
Supply
$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.
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Three Steps to Analyzing Changes in
Equilibrium
• 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.
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Figure 11 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
$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.
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Table 4 What Happens to Price and Quantity When Supply
or Demand Shifts?
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