Chapter 3

Demand, Supply, and

Prices: Basic Concepts
 1. Markets
• Conditions for the existence of a
market
1.At least one buyer
2.At least one seller
3.A product or a service
4.A price for the product or service
• Markets play an important role in
the allocation of resources

3-2
 2. Demand(1)
• Demand: the quantities of a product
or a service that consumers are
willing and able to buy at different
prices during a specific period.
• NB:
– Not actual purchases
– A flow concept
– A hypothetical relationship, not actual
quantity demanded and price
 Demand(2)
• The relationship between quantity
demanded and price can be
expressed in different ways
– Mathematically: the demand
equation
– In a table: demand schedule
– Graphically: the demand curve
https://www.economicshelp.org/blog/glossary/demand-curv
e-formula/
 Demand(3)
• Distinction
• Demand: the inverse
relationship between various
prices and quantities
• Quantity demanded: the
amount a product that
consumers wish and are able
to buy at a specific price

3-5
3.The Law of Demand(1)
• States that as the price of a product
decreases the quantity demanded of
the product increases, other things
being equal
• Reasons for the negative
relationship:
1.The market-size effect: as price
decreases the number of customer
for the product increases

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The Law of Demand(2)
2. The income effect: as price
decreases the purchasing power of
income increases
3. The substitution effect: as price
decreases, the product becomes
relatively inexpensive

3-7
 4. The Demand Curve
• A graphical representation of the
inverse relationship between quantity
demanded and price
• Can be linear or non-linear

Copyright  2012 Pearson Canada Inc. LO 3.2 3-8

 The Demand Curve
• Quantity demanded: a point on
the demand curve
• Demand: the entire curve

3-9
 5. Variables Affecting Demand(1):
Income
• Income affects the demand for a
product
– For most products, as the income of
consumers increases, the demand for a
product increases
– Normal good: a product whose demand
increases as income increases

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Variables Affecting Demand: Income

– Inferior product: a product whose

demand decreases as income
increases
• Example: non-brand products

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 Variables Affecting Demand(2):
Prices of Related Products
• Substitutes : products that
fulfill the same needs
– Pepsi or Coke
– Pizza or hamburger
• As the price of one product
increases the demand for its
substitute increases

3-12
 Variables Affecting Demand:
Prices of Related Products

• Complements: jointly used

products
– Shoes and socks
– Car and gasoline
– As the price of a product
increases, the demand for its
complement decreases

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 Variables Affecting Demand(3):
Tastes and Preferences
• Consumers’ preferences for a
product
• A number of variables influence
people’s preferences
– Culture
– Age
– Gender
– Advertisement
– Fashions and fads
 Variables Affecting Demand(4):
Expectations
• What consumers expect future
economic conditions to be
• Expectations could relate to the price
of a product
– An expected price increase will
increase current demand and vice
versa.
• Expectations may also relate to the
economy at large
– If consumers expect that their
income will increase, they may
undertake major expenditures.

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 Variables Affecting Demand(5):
Population
• The potential buyers of a product
depends on the country’s population
• International trade extends the
number of potential buyers beyond a
country’s population
• The demand for a product depends on
certain demographic characteristics

3-16
 6. A Change in Demand versus a
Change in Quantity Demanded
• A change in quantity
demanded is the
result of a change in
price
• Graphically, it leads to
a movement along the
demand curve

3-17
 7. A Change in Demand versus a
Change in Quantity Demanded
• A change in
demand is caused
by changes in the
variables other
than price, at each
price level,
quantity demanded
of the product
changes

3-18
A Change in Demand versus a
Change in Quantity Demanded
• Graphically, it
leads to a shift
in the demand
curve
• An increase in
Demand: a shift
to the right
• A decrease in
demand: a shift
to the left
LO 3.4 3-19
 A Shift in Demand
• The demand curve shifts if the
following variables change
1.Income
2.The price of a substitute
3.The price of a complement
4.Tastes and preferences
5.Expectations
6.Population

3-20
A Shift in Demand

Copyright  2012 Pearson Canada Inc. LO 3.4c 3-21

 8. Supply
• Supply: the quantities of a product
that sellers are willing and able to sell
at various prices during a specific
period
• NB:
– Not actual sales
– A flow concept
– A hypothetical relationship, not actual
quantity supplied and price

3-22
 Supply
• The relationship between
quantities supplied and price can
be expressed in a number of
ways
– Mathematically: the supply equation
– Graphically: the supply curve
– In a table: the supply schedule
• Shows the direct relationship
between price and quantity
supplied
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 9. The Law of Supply
States that as the
price of a
product
increases, other
things remaining
the same, the
quantity
supplied of the
product
increases.
 10. The Law of Supply
• Reasons for the positive
relationship:
– Suppliers sell products to earn profits
– As the price a product increases,
assuming costs remain unchanged,
profits will increase
– So, price acts as an incentive to
increase production

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 11. The Supply Curve
• A graph showing a direct
relationship between price and
quantity supplied
• Can be linear or non-linear
• Quantity supplied: a point on the
supply curve
• Supply: the entire curve
12. Determinants of Supply

1. The number of producers

As the number of producers
increases, the supply of the
product increases

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Determinants of Supply
2. Price of related goods
– Substitutes in production
• Alternatives in production
• GM can produce more sedans or
vans
– Complements in production
• Jointly produced goods
• Producing one product results in
producing the other
• Chicken wings and chicken
breasts

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Determinants of Supply
3. Technology
– improvement in technology
increases supply
4. Producer expectations
– producers’ expectation of future
prices
5. Cost of production
– changes in the cost of inputs

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 Supply and Quantity
Supplied
• A change in
the price of
the product
leads to a
change in
quantity
supplied

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 Supply and Quantity
Supplied
A change in
supply results
from changes in
the variables
other than price

3-31
 Changes in Supply
Changes in the following variables
will result in a change in supply
1.The number of producers
2.The price of the substitute
3.The price of the complement
4.Improvement in technology
5.Producers’ expectations
6.The costs of production

. 3-32
Changes in Supply

Copyright  2012 Pearson Canada Inc. LO 3.8 3-33

 Equilibrium Price and
Quantity
• Equilibrium is a state of equality
• A competitive market: a market
in which D and S determine price
• Market condition: a comparison
between quantity demanded and
quantity supplied of a product in
a market

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 Equilibrium Price and
Quantity
• When QD > QS : shortage or
excess quantity demanded
– Price increases
• When QD < QS : surplus or
excess quantity supplied
– Price decreases
• When QD = QS : equilibrium
– Equilibrium price and quantity (PE
and QE) 3-35
PE : Graphically

3-36
 Changes in PE and QE
• An increase in D and a decrease
in S of the same amount, results
in a higher PE but same QE
• An increase in S and a decrease
in D of the same amount results
in a lower PE but same QE

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 Changes in PE and QE
An increase in
D results in a
higher PE and
a higher QE
(and vice
versa)
 Changes in PE and QE
An increase in
S results in
a lower PE
and a higher
QE (and vice
versa)

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Changes in PE and QE
When both curves move in the same
direction, QE is known, but PE depends on
the magnitude of the shifts.

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Changes in PE and QE
When both curves move in opposite
directions, PE is known, but QE
depends on the magnitude of the
shifts.

Copyright  2012 Pearson Canada Inc. LO 3.9 3-41