03

Demand, Supply, and Market Equilibrium

McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
 Markets
• Interaction between buyers and
sellers (demanders and suppliers)
• Markets may be
• Local
• National
• International
• Price is discovered in the interactions
of buyers and sellers

LO1 3-2
 Demand

• Schedule or curve
• Amount consumers are willing and
able to purchase at various possible
prices
• Other things equal
– The quantity of Nikes purchased will depend not only on the
price of Nikes but also on the prices of such substitutes as
Reeboks, Adidas, and New Balances

LO1 3-3
 Demand

• Individual demand
• Market demand: adding the quantities
demanded by all consumers at each
of the various possible prices, we can
get from individual demand to market
demand

LO1 3-4
 Law of Demand

• Other things equal, as price falls the

quantity demanded rises, and as
price rises the quantity demanded
falls
• There is a negative or inverse
relationship between price and
quantity demanded.

LO1 3-5
 Why ？

• Reasons
• Common sense
• Price is an obstacle that deters consumers from
buying.
• Businesses have “sales” to clear out unsold items
is evidence of their belief in the law of demand.
• Law of diminishing marginal utility
• Income effect and substitution effects

LO1 3-6
 Why ？

• Reasons
• Law of diminishing marginal utility
• Each buyer of a product will derive less satisfaction
(or benefit, or utility) from each successive unit of
the product consumed.
• Consumers will buy additional units only if the price
of those units is progressively reduced.
• Income effect and substitution effects

LO1 3-7
 Why ？

• Reasons
• Income effect and substitution effects
• The income effect indicates that a lower price
increases the purchasing power of a buyer’s money
income, enabling the buyer to purchase more of the
product than be- fore.
• The substitution effect suggests that at a lower price
buyers have the incentive to substitute what is now a
less expensive product for other products that are
now relatively more expensive.
• A decline in the price of chicken

LO1 3-8
 Determinants of demand

• Other factors can and do affect purchases

• When any of these determinants changes, the demand curve will
shift to the right or left. For this reason, determinants of demand are
sometimes referred to as demand shifters.
– Consumers’ tastes (preferences)
– The number of buyers in the market
– Consumers’ incomes
– The prices of related goods
– Consumer expectations

LO1 3-9
 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 A reduction in airfares reduces the demand for bus
goods 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.
LO1 3-10
 Substitutes

• When two products are substitutes, an

increase in the price of one will increase
the demand for the other. Conversely, a
decrease in the price of one will decrease
the demand for the other.

LO1 3-11
 Complements

• Because complementary goods (or, simply,

complements) are used together, they are
typically demanded jointly.

• If the price of a complement (for example,

computers) goes up, the demand for the
related good (software) will decline.

LO1 3-12
 Changes in Quantity Demanded

• a change in quantity demanded is a movement

from one point to another point—from one price-
quantity combination to another—on a fixed demand
curve.

LO1 3-13
 The Demand Curve

P
6

Price (per bushel)

P Qd
4
$5 10

4 20 3

3 35 2

2 55 1 D

1 80
0 10 20 30 40 50 60 70 80 Q
Quantity Demanded (bushels per week)

LO1 3-14
 Changes in Demand

P
6 Change in Demand

5
Price (per bushel)

4 Change in Quantity
Demanded
3

2
D2

1 D1
D3
0
2 4 6 8 10 12 14 16 18 Q
Quantity Demanded (bushels per week)

LO1 3-15
 Supply

• Schedule or curve
• Amount producers are willing and able
to sell at a series of possible prices
during a specific period
• Individual supply
• Market supply
– Sum the quantities supplied by each producer
at each price.

LO2 3-16
 Law of Supply

• Other things equal, as the price rises

the quantity supplied rises, and as the
price falls the quantity supplied falls
（ directly related ）

LO2 3-17
 Law of Supply

• Reasons
• Price acts as an incentive to producers
• To a supplier, price represents revenue, which serves
as an incentive to produce and sell a product. The
higher the price, the greater this incentive and the
greater the quantity supplied.
• At some point, costs will rise
• Increases in marginal cost—the added cost of
producing one more unit of output.
• The firm will not produce the more costly units unless it
receives a higher price for them.

LO2 3-18
 The Supply Curve

P
S
5
Supply of Corn
Price Qs
4

Price (per bushel)

per per
Bushel Week
3
$5 60
4 50 2
3 35
1
2 20
1 5
0
Q
10 20 30 40 50 60 70
Quantity supplied (bushels per week)

LO2 3-19
 Determinants of Supply

• If one of them does change, a change in supply

will occur, meaning that the entire supply curve will
shift either right or left.
• Resource prices
• Technology
• Taxes and subsidies
• Prices of other goods
• Producer expectations
• The number of sellers in the market

LO2 3-20
 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.

LO2 3-21
 Changes in Supply
P
Change in Quantity
$6
Supplied S3 S1

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)

LO2 3-22
 Changes in Quantity Supplied

• a change in quantity supplied is a movement

from one point to another on a fixed supply
curve. The cause of such a movement is a
change in the price of the specific product being
considered.

LO2 3-23
 Market Equilibrium

• Equilibrium occurs where the demand curve and supply curve

intersect.

• The equilibrium price (or market-clearing price) is the price where

the intentions of buyers and sellers match. It is the price where
quantity demanded equals quantity supplied.

• The market is in equilibrium, meaning “in balance” or “at rest.”

LO3 3-24
 Market Equilibrium

6 6,000 Bushel
Surplus (excess supply)
S
5
P Qd P Qs
Price (per bushel)

$5 2,000 4
$5 12,000
4 4,000 4 10,000
3
3 7,000 3 7,000
2 11,000 2
2 4,000
1 16,000 7,000 Bushel 1 1,000
1 D
Shortage (excess demand)

0 2 4 67 8 10 12 14 16 18
Bushels of Corn (thousands per week)

LO3 3-25
 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

LO4 3-26
 Changes
Changesin
inDemand
Supply
` and
andEquilibrium
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

LO4 3-27
 Application: Government-Set Prices

• Price Ceilings: Gasoline

– A price ceiling sets the maximum legal price a seller may charge
for a product or service. A price at or below the ceiling is legal; a
price above it is not.
– Enable consumers to obtain some “essential” good or service
that they could not afford at the equilibrium price.
• Set below equilibrium price

LO5 3-28
 Government-Set Prices
The rapidly rising price of gasoline greatly burdens low- and moderate-income households, which pressure government

to “do something.”

P
S

$3.50 P0
Ceiling

3.00 PC

D
Shortage

Q
Qs Q0 Qd

LO5 3-29
 Application: Government-Set Prices

• Price Ceilings: Gasoline

• Rationing problem
• The government must establish some formal system for rationing it to consumers
• Coupons: purchase a fixed amount of gasoline per month
• Black markets
• Many buyers are willing to pay more than the ceiling price
• It is more profitable for gasoline stations to sell at prices above the ceiling.
• Black markets in which gasoline is illegally bought and sold at prices above the legal
limits will flourish

• Counterfeiting of ration coupons

• Face political pressure to set the price even lower.

LO5 3-30
 Government-Set Prices

• Price Floors
– A price floor is a minimum price fixed by the government. A price at or above the price floor
is legal; a price below it is not.

– The free functioning of the market system has not provided a sufficient income for certain
groups of resource suppliers or producers.

• Prices are set above the market price

• Example: Minimum wage laws or wheat

LO5 3-31
 Government-Set Prices
P
S
Surplus
Floor

$3.00 Pf

2.00 P0

Q
Qd Q0 Qs

LO5 3-32
 Government-Set Prices

• Farmers will be willing to produce and offer for sale more than private buyers are

willing to purchase at the price floor.

• Without the price floor, the $2 equilibrium price of wheat would cause financial

losses and force high-cost wheat producers to plant other crops or abandon farming

altogether. But the $3 price floor allows them to continue to grow wheat and remain

farmers. So society devotes too many of its scarce resources to wheat production

and too few to producing other, more valuable, goods and services. It fails to

achieve allocative efficiency.

LO5 3-33
 Government-Set Prices

• Consumers of wheat-based products pay higher prices because of the price floor.

Taxpayers pay higher taxes to finance the government’s purchase of the surplus.

Also, the price floor causes potential environmental damage

• The higher price also prompts imports of wheat; undermine the price floor

• keep the foreign wheat out by increasing tariff

• Other countries

LO5 3-34