Microeconomics
II
RABIA LIAQAT
VISITING LECTURER,
DEPARTMENT OF MANAGEMENT STUDIES,
BAHRIA UNIVERSITY ISLAMABAD
Word of Wisdom – Determination
Rocks, Pebbles, and Sand
Identify your priorities in life rather than wasting your time and effort on unnecessary
aspects of life.
Rabia Liaqat CHAPTER 2 2
Books
Rabia Liaqat CHAPTER 2 3
Chapter 2
THE BASICS OF SUPPLY
AND DEMAND
Introduction
What are supply and demand?
What is the market mechanism?
What are the effects of changes in market equilibrium?
What are elasticities of supply and demand?
Rabia Liaqat CHAPTER 2 5
Supply and Demand
The Supply Curve
◦ The relationship between the quantity of a good that producers
are willing to sell and the price of the good
◦ Measures quantity on the x-axis and price on the y-axis
Q S Q S(P)
Rabia Liaqat CHAPTER 2 6
The Supply Curve
Price S
($ per unit)
The Supply Curve,
Graphically Depicted
P2
The supply curve slopes
P1 upward, demonstrating that
at higher prices firms
will increase output
Q1 Q2 Quantity
Rabia Liaqat CHAPTER 2 7
The Supply Curve
Other Variables Affecting Supply
◦ Technology
◦ Costs of Production
◦ Labor
◦ Capital
◦ Raw Materials
◦ Lower costs of production allow a firm to produce more at
each price and vice versa
Rabia Liaqat CHAPTER 2 8
Change in Supply
The cost of raw materials P S
S’
falls
◦ Produced Q1 at P1 and Q0 at
P2
◦ Now produce Q2 at P1 and Q1
at P2 P1
◦ Supply curve shifts right to S’
P2
Draw supply Curve
showing oil price shock
Q0 Q1 Q2 Q
Rabia Liaqat CHAPTER 2 9
The Supply Curve
Change in Quantity Supplied
◦ Movement along the curve caused by a change in price
Change in Supply
◦ Shift of the curve caused by a change in something other than
the price of the good
◦ Change in costs of production
Rabia Liaqat CHAPTER 2 10
Supply and Demand
The Demand Curve
◦ The relationship between the quantity of a good that
consumers are willing to buy and the price of the good
◦ Measures quantity on the x-axis and price on the y-axis
Q D Q D (P)
Rabia Liaqat CHAPTER 2 11
The Demand Curve
Price
($ per unit) The demand curve slopes
downward, demonstrating
that consumers are willing
to buy more at a lower price
as the product becomes
relatively cheaper.
P2
P1
Q1 Q2 Quantity
Rabia Liaqat CHAPTER 2 12
The Demand Curve
Other Variables Affecting Demand
◦ Income
◦ Increases in income allow consumers to purchase more
at all prices
◦ Consumer Tastes
◦ Price of Related Goods
◦ Substitutes
◦ Complements
Rabia Liaqat CHAPTER 2 13
Change in Demand
D
Income Increases P D’
◦ Purchased Q0, at P2 and Q1 at
P1 P2
◦ Now purchased Q1 at P2 and
Q2 at P1
◦ Same for all prices P1
◦ Demand curve shifts right
Draw Demand Curve showing
increase in price of substitute tea
and coffee
Q0 Q1 Q2 Q
Rabia Liaqat CHAPTER 2 14
The Demand Curve
Changes in quantity demanded
◦ Movements along the demand curve caused by a change in
price
Changes in demand
◦ A shift of the entire demand curve caused by something other
than price
◦ Income
◦ Preferences
Rabia Liaqat CHAPTER 2 15
The Market Mechanism
The market mechanism is the tendency in a free market for
price to change until the market clears
Markets clear when quantity demanded equals quantity
supplied at the prevailing price
Market clearing price – price at which markets clear
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The Market Mechanism
Price S
($ per unit)
The curves intersect at
equilibrium, or market-
clearing, price.
Quantity demanded
P0 equals quantity
supplied at P0
Q0 Quantity
Rabia Liaqat CHAPTER 2 17
The Market Mechanism
In equilibrium
◦ There is no shortage or excess demand
◦ There is no surplus or excess supply
◦ Quantity supplied equals quantity demanded
◦ Anyone who wants to buy at the current price can and all
producers who want to sell at that price can
Rabia Liaqat CHAPTER 2 18
Market Surplus
The market price is above equilibrium
◦ There is excess supply - surplus
◦ Downward pressure on price
◦ Quantity demanded increases and quantity supplied
decreases
◦ The market adjusts until new equilibrium is reached
Rabia Liaqat CHAPTER 2 19
The Market Mechanism
Price
($ per unit) S
1. At P1, price is
Surplus
above the
P1 market clearing
price
2. Qs > Q D
P0
3. Price falls to
the market-
clearing price
4. Market adjusts
to equilibrium
D
QD Q0 QS Quantity
Rabia Liaqat CHAPTER 2 20
The Market Mechanism
The market price is below equilibrium:
◦ There is excess demand - shortage
◦ Upward pressure on prices
◦ Quantity demanded decreases and quantity supplied
increases
◦ The market adjusts until the new equilibrium is reached
Rabia Liaqat CHAPTER 2 21
The Market Mechanism
Price
($ per unit)
S
1. At P2, price is
below the
market
clearing price
2. QD > Q S
3. Price rises to
P3
the market-
clearing price
4. Market adjusts
P2 to equilibrium
Shortage D
QS Q3 QD Quantity
Rabia Liaqat CHAPTER 2 22
