Principles of

Economics 3e
Chapter 3 DEMAND AND SUPPLY
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Ch.3 OUTLINE
• Demand and its determinants
• Supply and its
• Equilibrium in Markets for Goods and Services ,Changes in Equilibrium
Price and Quantity: The Four-Step Process
• Price Ceilings and Price Floors
• Demand, Supply, and Efficiency
Why Does It Cost More?

Organic vegetables and fruits that are grown and sold within a specific geographical region should, in theory, cost less than
conventional produce because the transportation costs are less. That is not, however, usually the case. This is caused by
demand and supply.
(Credit: modification of "Old Farmers' Market" by NatalieMaynor/Flickr, CC BY 2.0)
Demand and its determinants
• Demand - the amount of some good or service consumers are willing and
able to purchase at each price.

• Price - what a buyer pays for a unit of the specific good or service.

• Quantity demanded - the total number of units of a good or service

consumers are willing to purchase at a given price

• Law of demand - keeping all other variables that affect demand constant,

• if price goes , then quantity demanded goes

• if price goes , then quantity demanded goes

Demand Schedule & Curve
• Demand schedule - a table that shows a range of prices for a certain
good or service and the quantity demanded at each price.

• Demand curve - a graphic representation of the relationship between

price and quantity demanded of a certain good or service, with
quantity on the horizontal axis and the price on the vertical axis.
Graphing the Demand

• The points of a demand schedule are graphed, and the line connecting them is the
demand curve (D).

• The downward slope of the demand curve again illustrates the law of demand - the
inverse relationship between prices and quantity demanded.
Shifts in Demand
• Ceteris paribus - Latin phrase meaning “other things being equal”

• Any given demand or supply curve is based on the ceteris paribus

assumption that all else is held equal.
Demand Curve

• The demand curve can be used to identify how much consumers

would buy at any given price.
Shifting the Demand Curve
Figure A Figure B

If income increases:

• Consumers will purchase larger quantities, pushing demand to the

right (figure A).
• Thus, causing the demand curve to shift right (figure B).
Shifting the Demand Curve

• Increased demand means that at every given price, the quantity demanded is
higher, so that the demand curve shifts to the right from D0 to D1.
• Decreased demand means that at every given price, the quantity demanded is
lower, so that the demand curve shifts to the left from D0 to D2.
What Factors Affect Demand?
• A shift in demand happens when a change in some economic factor (other
than price) causes a different quantity to be demanded at every price.

• Factors that affect demand:

• Income
• Changing tastes or preferences
• Changes in the composition of the population
• Price of substitute or complement changes
• Changes in expectations about future
How Factors Affect Demand

(a) A list of factors that can cause an increase in demand from D 0 to D1.
(b) The same factors, if their direction is reversed, can cause a decrease in demand from D 0 to D1.
Types of Goods & Services
• Normal good - A product whose demand rises when income rises, and vice
versa.

• Inferior good - A product whose demand falls when income rises, rises, and
vice versa.

• Substitute - a good or service that we can use in place of another good or

service.

• Complements - goods or services that are often used together so that

consumption of one good tends to enhance consumption of the other.
Supply of Goods and Services and its determinants
• Supply - the amount of some good or service a producer is willing to
supply at each price.

• Quantity supplied - the total number of units of a good or service

producers are willing to sell at a given price.

• Law of supply - assuming all other variables that affect supply are held
constant,

• if price goes , then quantity supplied goes

• if price goes , then quantity supplied goes

Supply Schedule & Curve
• Supply schedule - a table that shows the quantity supplied at a range
of different prices.

• Supply curve - a graphic illustration of the relationship between price,

shown on the vertical axis, and quantity, shown on the horizontal axis.
Graphing the Supply

• The supply curve (S) is created by graphing the points from a supply schedule and
then connecting them.

• The upward slope of the supply curve illustrates the law of supply - that a higher
price leads to a higher quantity supplied, and vice versa.
Supply Curve

• The supply curve can be used to show the minimum price a firm will
accept to produce a given quantity of output.
Supply Price

• The cost of production and the desired profit equal the price a firm
will set for a product.
Changing the Price

• Because the cost of production and the desired profit equal the price
a firm will set for a product,
• If the cost of production , the price for the product will also need to .
Shifting the Supply Curve

• When the cost of production increases, the supply curve shifts up to a

new price level.
Shifting the Supply Curve

• Decreased supply means that at every given price, the quantity supplied is
lower, so that the supply curve shifts to the left, from S0 to S1.
• Increased supply means that at every given price, the quantity supplied is
higher, so that the supply curve shifts to the right, from S0 to S2.
What Factors Affect Supply?
• Shift in supply - when a change in some economic factor (other than
price) causes a different quantity to be supplied at every price.

• Inputs or factors of production - the combination of labor, materials,

and machinery that is used to produce goods and services.

• Factors that affect supply:

• Natural conditions
• Input prices
• Technology
• Government policies
How Factors Affect Supply

(a) A list of factors that can cause an increase in supply from S 0 to S1.
(b) The same factors, if their direction is reversed, can cause a decrease in supply from S 0 to S1.
Equilibrium - Where Demand and Supply Intersect
• Equilibrium - the combination of price and quantity where there is no
economic pressure from surpluses or shortages that would cause price or
quantity to change
quantity demanded = quantity supplied

• Equilibrium price - the price where quantity demanded is equal to quantity

supplied
• Equilibrium quantity - the quantity at which quantity demanded and
quantity supplied are equal for a certain price level.
• Surplus or excess supply - at the existing price, quantity supplied exceeds
the quantity demanded.
• Shortage or excess demand - at the existing price, the quantity demanded
exceeds the quantity supplied.
Equilibrium - Where Demand and Supply Intersect

• The demand curve (D) and the supply curve (S) intersect at the equilibrium point E.
• The equilibrium price is the only price where,
quantity demanded = quantity supplied
• At a price above equilibrium, quantity supplied > quantity demanded, so there is excess
supply.
• At a price below equilibrium, quantity demanded > quantity supplied, so there is excess
demand.
Changes in Equilibrium Price and Quantity: The Four-Step Process

Four-step process to determining how an economic event affects equilibrium

price and quantity:

• Step 1. Draw a demand and supply model before the economic change took
place.

• Step 2. Decide whether the economic change affects demand or supply.

• Step 3. Decide whether the effect causes a curve shift to the right or to the left,
and sketch the new curve on the diagram.

• Step 4. Identify the new equilibrium and then compare to the original.
Example: Shift in Supply

• Discussion Question: Using the 4-step approach, how did excellent

weather conditions during the summer affect the quantity and price
of salmon?
Example: Shift in Demand

• Discussion Question: From 2004 to 2012, the share of Americans who

reported obtaining their news from digital sources increased from 24% to
39%. Using the 4-step approach, how has this affected the consumption of
traditional sources, such as print news media, and radio and television news?
A Combined Example
• Discussion Question: Using the 4-step approach, what does an increase in labor compensation,
as well as an increase in digital communication suggest about the continued viability of the
Postal Service?

(a) Higher labor compensation causes a leftward shift in the supply curve, a decrease in the equilibrium quantity, and an
increase in the equilibrium price.
(b) A change in tastes away from Postal Services causes a leftward shift in the demand curve, a decrease in the equilibrium
quantity, and a decrease in the equilibrium price.
A Combined Example

• Superimposing the previous two diagrams one on top of the other, we

see that supply and demand shifts cause changes in equilibrium price
and quantity.
Movements vs. Shifts
• Movements are different than shifts.

• A shift in one curve never causes a shift in the other curve. Rather, a shift in
one curve causes a movement along the second curve.
Price Ceilings and Price Floors
• Price controls - laws that governments enact to regulate prices.

• Price ceiling -

• keeps a price from rising above a certain level

• a legal maximum price that one pays for some good or service

• Price floor -

• keeps a price from falling below a given level.

• is the lowest price that one can legally pay for some good or service.
A Price Ceiling Example - Rent Control

• The original intersection of demand and supply occurs at E0.

• If demand shifts from D0 to D1, the new equilibrium would be at E1 - unless a price ceiling prevents the
price from rising.

• If the price is not permitted to rise, the quantity supplied remains at 15,000. However, after the change
in demand, the quantity demanded rises to 19,000, resulting in a shortage.
A Price Floor Example - European Wheat Prices

• The intersection of demand (D) and supply (S) would be at the equilibrium point E 0.
• However, a price floor set at Pf holds the price above E 0 and prevents it from falling.
• The result of the price floor is that the quantity supplied Q s exceeds the quantity
demanded Qd. There is excess supply, also called a surplus.
Demand, Supply, and Efficiency
• Consumer surplus -
• the amount that individuals would have been willing to pay minus the amount that they
actually paid.
• the area above the market price and below the demand curve.
• Producer surplus -
• the price the producer actually received minus the price the producer would have been
willing to accept.
• the area between the market price and the segment of the supply curve below the
equilibrium.

• Social surplus/economic surplus/total surplus =

consumer surplus + producer surplus
• Deadweight loss - the loss in social surplus that occurs when a market produces
an inefficient quantity
Consumer and Producer Surplus

• The somewhat triangular area labeled by F shows the area of consumer surplus, which shows
that the equilibrium price in the market was less than what many of the consumers were willing
to pay.

• The somewhat triangular area labeled by G shows the area of producer surplus, which shows
that the equilibrium price received in the market was greater than what many of the producers
were willing to accept for their products.
Efficiency and Price Floors and Ceilings

(a) The original equilibrium price is $600 with a quantity of 20,000. Consumer surplus is T + U, and producer surplus is V + W
+ X. A price ceiling is imposed at $400, so firms in the market now produce only a quantity of 15,000. As a result, the new
consumer surplus is T + V, while the new producer surplus is X.
(b) The original equilibrium is $8 at a quantity of 1,800. Consumer surplus is G + H + J, and producer surplus is I + K. A price
floor is imposed at $12, which means that quantity demanded falls to 1,400. As a result, the new consumer surplus is G, and
the new producer surplus is H + I.