Chapter 3

Demand, Supply, and

Market Equilibrium

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 Markets

• Bring together buyers and sellers

• Markets may be local, national or international
• Markets may be face-to-face or faceless
• Price is discovered in the interactions of buyers and
sellers
*We assume markets in this chapter have large no. of
independently acting buyers and sellers come together to
buy and sell standardized product (Highly competitive
market).

LO1 3-2
 Demand

• Demand schedule or demand curve

• Amount consumers are willing and able to
purchase at a given price
• Other things equal (ceteris paribus)

LO2 3-3
 Law of Demand

• Law of demand
• Other things equal, as price falls, the quantity
demanded rises, and as price rises, the quantity
demanded falls
• Explanations
• Price acts as an obstacle to buyers (common
sense)
• Law of diminishing marginal utility
• Income effect and substitution effect

LO2 3-4
 The Demand Curve
P
Individual 6
demand
for corn 5
P Qd
Price (per bushel) 4
$5 10

4 20 3

3 35 2

2 55 D
1

1 80
0 10 20 30 40 50 60 70 80
Q

Quantity demanded (bushels per week)

LO2 3-5
 Market Demand
Market Demand for Corn, Three Buyers

Quantity Demanded Total

Price Qd
per bushel Joe Jen Jay per week
$5 10 12 8 30
4 20 23 17 60
3 35 39 26 100
2 55 60 39 154
1 80 87 54 221

LO2 3-6
 Changes in Demand

P
Market Demand 6
for Corn,
200 Buyers, (D1) 5 Increase
P Qd in demand

Price (per bushel)

Increase in Demand
4
$5 2000

4 4000 3

3 7000 2
D2
2 11,000 Decrease
1 D1
Decrease
in demandin Demand
1 16,000 D3
0 Q
2 4 6 8 10 12 14 16 18
Quantity demanded (thousands of bushels per week)
LO2 3-7
 Changes in Demand
P
6 Change in demand

5
Price (per bushel)

4 Change in quantity
demanded
3

2
D2

1 D1
Decrease in Demand
D3
0
2 4 6 8 10 12 14 16 18 Q
Quantity demanded (thousands of bushels per week)

LO2 3-8
 Determinants of Demand

• Change in consumer tastes and preferences

• Change in the number of buyers
• Change in income
• Normal goods
• Consumer health care, holiday with 5 star hotel
• Inferior goods
• Supermarket own brand goods (Suave vs Bonia), bus
travel (more income, buy your own car), bundle cloth

LO2 3-9
 Determinants of Demand

• Change in prices of related goods

• Complementary good
• Printer and cartridge, automobiles and tyre/fuel
• Substitute good
• Glasses and contact lenses
• Change in consumer expectations
• Future prices
• Future income

LO2 3-10
 Determinants of Demand
Determinants of Demand: Factors That Shift the Demand Curve
Determinant Examples
Change in buyers’ tastes Physical fitness rises in popularity, increasing the demand
for jogging shoes and bicycles; cell phone popularity rises,
reducing the demand for land-line phones.

Change in the number of buyers A decline in the birthrate reduces the demand for
children’s toys.
Change in income A rise in incomes increases the demand for normal goods
such as restaurant meals, sports tickets, and necklaces
while reducing the demand for inferior goods such as
cabbage, turnips, and inexpensive wine.

Change in the prices of related goods A reduction in airfares reduces the demand for bus
transportation (substitute goods); a decline in the price of
DVD players increases the demand for DVD movies
(complementary goods).

Change in consumer expectations Inclement weather in South America creates an

expectation of higher future coffee bean prices, thereby
increasing today’s demand for coffee beans.
3-11
 Supply

• Supply schedule or a supply curve

• Amount producers are willing and able to sell
at a given price

LO3 3-12
 Law of Supply

• Law of supply
• Other things equal, as the price rises, the
quantity supplied rises and as the price falls,
the quantity supplied falls
• Explanation
• Price acts as an incentive to producers
• At some point, costs will rise (marginal cost
rises, diminishing marginal productivity)

LO3 3-13
 The Supply Curve
P S1
5
Supply
of Corn
4
P Qs
Price (per bushel)
$5 60 3

4 50 2

3 35
1
2 20
0
1 5 Q
10 20 30 40 50 60 70
Quantity supplied (bushels per week)

LO3 3-14
 Changes in Supply
P

$6 S3 S1
Market Supply
of Corn,
5
200 Producers, (S1) Decrease
P Qs S2
in supply
4
Price (per bushel)

$5 12,000
3
4 10,000

3 7000 2

2 4000 1 Increase
in supply
1 1000
0
Q
2 4 6 8 10 12 14 16
Quantity supplied (thousands of bushels per week)
LO3 3-15
 Changes in Supply
P
Change in quantity
$6 S3 S1
supplied
5
S2
4
Price (per bushel)

1 Change in supply

0
Q
2 4 6 8 10 12 14 16
Quantity supplied (thousands of bushels per week)
LO3 3-16
 Determinants of Supply

• A change in resource prices

• Increase production cost, squeeze profit, reduce incentive
to supply output at each price
• A change in technology
• Tech improve (techniques of production) enable firm to
produce units of output with fewer resources – lower
production cost – increase supply
• A change in the number of sellers
• More firms, greater market supply.

LO3 3-17
 Determinants of Supply

• A change in taxes and subsidies

• Taxes increase production cost, subsidies ‘taxes in reverse’
reduce production cost
• A change in prices of other goods
• Firm that can use their plant and equipment to produce
alternatives good. Increase in price of this ‘other goods’,
switch in production. E.g. producer of balls (soccer ball,
basketballs and volleyball)
• A change in producer expectations
• Expect future price increase, withhold production –
reduced supply
3-18
 Determinants of Supply
Determinants of Supply: Factors That Shift the Supply Curve
Determinant Examples
Change in resource prices A decrease in the price of microchips increases the supply of
computers; an increase in the price of crude oil reduces the
supply of gasoline.

Change in technology The development of more effective wireless technology increases

the supply of cell phones.
Change in taxes and subsidies An increase in the excise tax on cigarettes reduces the supply of
cigarettes; a decline in subsidies to state universities reduces the
supply of higher education.

Change in prices of other goods An increase in the price of cucumbers decreases the supply of
watermelons.
Change in producer expectations An expectation of a substantial rise in future log prices decreases
the supply of logs today.
Change in the number of suppliers An increase in the number of tattoo parlors increases the supply
of tattoos; the formation of women’s professional basketball
leagues increases the supply of women’s professional basketball
games.

3-19
 Market Equilibrium

• Equilibrium occurs where the demand curve and

supply curve intersect
• Equilibrium price and equilibrium quantity
• Surplus and shortage
• Rationing function of prices – the ability of
competitive forces of supply and demand to establish
a price where buying and selling decisions are
consistent
• Efficient allocation- at equilbrium

LO4 3-20
 Efficient Allocation

• Productive efficiency
• Producing goods in the least costly way
• Using the best technology
• Using the right mix of resources
• Allocative efficiency
• Producing the right mix of goods
• The combination of goods most highly
valued by society
LO4 3-21
 Market Equilibrium

6,000 bushel S
5 surplus
P Qd P Qs
Price (per bushel)

$5 2000 4
$5 12,000
4 4000 4 10,000
3
3 7000 3 7000
2 11,000 2
2 4000
1 16,000 7,000 bushel 1 1000
1 D
shortage

0 2 4 67 8 10 12 14 16 18

Bushels of corn (thousands per week)

LO4 3-22
 Changes in Demand and
Equilibrium

D increase: D decrease:
P, Q P, Q

P
P
S S

D2 D3

D1 D4

0 0

Increase in demand Decrease in demand

LO5 3-23
 Changes in Supply and Equilibrium

S increase: S decrease:
P, Q P, Q

P P
S1 S2 S4 S3

D
D

0 0

Increase in supply Decrease in supply

LO5 3-24
 Complex Cases
Effects of Changes in Both Supply and Demand
Effect on Equilibrium Effect on Equilibrium
Change in Supply Change in Demand Price Quantity
1. Increase Decrease Decrease Indeterminate
2. Decrease Increase Increase Indeterminate
3. Increase Increase Indeterminate Increase
4. Decrease Decrease Indeterminate Decrease

LO5 3-25
 Government Set Prices

• Price ceiling
• Argument – enable consumer to obtain some ‘essential’
good or services that couldn’t afford at equilibrium price.
• Set below equilibrium price
• Rationing problem – how Qs be apportioned among buyer
who want the greater amount Qd? – First-come first serve
basis, base on favoritism or ration coupon?
• Black markets – many buyers are willing to pay more than
Pc, also more profitable to seller if able to sell more than
Pc
• Example price ceiling on petrol

LO6 3-26
 Government Set Prices

P S

$3.50 P0 Ceiling

3.00 PC

D
Shortage

Q
Qs Q0 Qd

LO6 3-27
 Government Set Prices

• Price floor
• Prices are set above the market equilibrium price
• Normally apply when society feels free functioning of
market fail to provide sufficient income for certain groups
of resources suppliers or producers.
• Chronic surpluses
• Example is the minimum wage law

LO6 3-28
 Government Set Prices
P
S
Surplus
Floor

$3.00 Pf

2.00 P0

Q
Qd Q0 Qs
LO6 3-29
 Legal Market for Human Organs

• What if we created a legal market for human

organs?
• Positive effects
• Increase the incentive to donate
• Eliminate the persistent shortage of eyes,
livers, hearts, kidneys, etc.

3-30
 Legal Market for Human Organs

• Negative effects
• Diminishes the special nature of life by
commercializing it
• The market would leave out the poor and
uninsured
• Increases the cost of medical care
• Prohibition on market solution has resulted in
a $1 billion illegal market

3-31