The Market Forces

of Supply and
Demand
Prepared based on PowerPoint slides by Ron Cronovich
 •What factors affect buyers’ demand
for goods?
In this •What factors affect sellers’ supply of
chapter, look goods?
for the •How do supply and demand
determine the price of a good and the
answers to quantity sold?
these •How do changes in the factors that
affect demand or supply affect the
questions: market price and quantity of a good?
•How do markets allocate resources?
A market is a group of
buyers and sellers of a
particular product.
Describe a market
for one of your
favorite products.
Competitive Market
• A competitive market is one with many buyers and sellers, and each
has a negligible effect on price.
• In a perfectly competitive market:
• All goods are exactly the same
• Buyers and sellers are so numerous that no one can affect the
market price – each is a “price taker” (vs. price maker in monopoly
case)
• Perfect information
• There are no barriers to entry
• In this chapter, we assume markets are perfectly competitive.
Consider purchasing table
salt.
Which factors determine the
quantity of salt that you want
to buy?
Demand

The quantity demanded of Law of demand: the claim

any good is the amount of that the quantity
the good that buyers are demanded of a good falls
willing and able to when the price of the good
purchase. rises, other things equal
The Demand Schedule
Quantity
Price
•Demand schedule: of lattes
of lattes
A table that shows the relationship demanded
between the price of a good and $0.00 16
the quantity demanded. 1.00 14
Example: Helen’s demand for lattes. 2.00 12
3.00 10
• Notice that Helen’s preferences obey 4.00 8
the Law of Demand.
5.00 6
6.00 4
Helen’s Demand Schedule & Curve
Price of Quantity
Price
Lattes of lattes
of lattes
demanded
$0.00 16
1.00 14
2.00 12
3.00 10
4.00 8
5.00 6
6.00 4
Quantity
of Lattes
Market Demand versus Individual Demand
• The quantity demanded Price Helen’s Qd Ken’s Qd Market Qd
(Qd) in the market is the
$0.00 16 + 8 = 24
sum of the quantities
1.00 14 + 7 = 21
demanded by all buyers
at each price. 2.00 12 + 6 = 18
3.00 10 + 5 = 15
• Suppose Helen and Ken
are the only two buyers 4.00 8 + 4 = 12
in the Latte market. 5.00 6 + 3 = 9
6.00 4 + 2 = 6
The Market Demand Curve for Lattes
Qd
P P
(Market)
$0.00 24
1.00 21
2.00 18
3.00 15
4.00 12
5.00 9
6.00 6
Q
Demand Curve Shifters
•The demand curve shows how price affects quantity
demanded, other things being equal.
•These “other things” are non-price determinants of
demand (i.e., things that determine buyers’ demand
for a good, other than the good’s price).
•Changes in them shift the D curve…
Demand Curve Shifters:
number of Buyers

An increase in the
number of buyers causes
an increase in quantity
demanded at each price,
which shifts the demand
curve to the right.

This Photo by Unknown Author is licensed under CC BY-NC-ND

Demand Curve Shifters: number of Buyers
P Suppose the number
of buyers increases.
Then, at each price,
quantity demanded
will increase
(by 5 in this example).

Q
Demand Curve Shifters:
Income
• Demand for a normal good is positively
related to income.
• An increase in income causes an
increase in quantity demanded at
each price
• shifts the D curve to the right.
(Demand for an inferior good is
negatively related to income. An
increase in income shifts D curves for
inferior goods to the left.)
This Photo by Unknown Author is licensed under CC BY
Demand Curve Shifters: Prices of Related
Goods
• Two goods are substitutes if: an
increase in the price of one causes an
increase in demand for the other.
• Example: pizza and hamburgers.
• An increase in the price of pizza
increases demand for hamburgers,
shifting the hamburger demand
curve to the right.
Demand Curve Shifters: Prices of Related
Goods
Two goods are complements if: an
increase in the price of one causes a fall in
demand for the other.
Example: computers and software.
•The price of computers rises,
people buy fewer computers, and
therefore less software.
The software demand curve shifts left.
Demand Curve
Shifters: Tastes
Anything that causes a
shift in tastes toward a
good
• will increase demand for
that good
• shifts its D curve to the
right.
Demand Curve Shifters: Expectations
• Expectations affect consumers’ buying
decisions.
• Examples:
• If people expect their incomes to rise,
their demand for meals at expensive
restaurants may increase now.
• If the economy turns bad and people
worry about their future job security,
demand for new autos may fall now. This Photo by Unknown Author is licensed under CC BY
Summary: Variables That Influence Buyers
Variable A change in this variable…

Price …causes a movement

along the D curve
No. of buyers …shifts the D curve
Income …shifts the D curve
Price of
related goods …shifts the D curve
Tastes …shifts the D curve
Expectations …shifts the D curve
 Demand curve
Draw a demand curve for Spotify
subscriptions. What happens to
it in each of the following
scenarios? Why?
A. The price of smart devices falls
B. The price of a Netflix
subscription falls
B. The price of Apple Music falls.
A. The price of smart devices falls
Price of
Spotify
Subscription Spotify music streaming
service and smart devices
are complements.

P1
A fall in the price of smart
devices shifts the demand
curve for Spotify service to
the right.
D1 D2

Q1 Q2 Quantity of
Spotify
Subscriptions
22
B. The price of a Netflix subscription falls
Price of
Spotify
Subscription The D curve
does not shift.
Move down along
P1
curve to a point with
P2 lower P, higher Q.

D1

Q1 Q2 Quantity of
Spotify
Subscriptions
23
C. The price of Apple Music falls.
Price of
Spotify
Subscription
Spotify and Apple Music
services are substitutes.

P1
A fall in the price of Apple
Music subscription fees
shifts demand for Spotify
service to the left.
D2 D1

Q2 Q1 Quantity of
Spotify
Subscriptions
24
Supply

Law of supply: the claim

The quantity supplied of
that the quantity supplied
any good is the amount
of a good rises when the
that sellers are willing and
price of the good rises,
able to sell.
other things equal
Imagine you are a table
salt seller.
Which factors determine
the quantity of salt that
you want to sell?
The Supply Schedule
Price Quantity
• Supply schedule:
A table that shows the relationship of of lattes
between the price of a good and lattes supplied
the quantity supplied. $0.00 0
Example: 1.00 3
2.00 6
• Starbucks’ supply of lattes.
3.00 9
• Notice that Starbucks’ supply 4.00 12
schedule obeys the
Law of Supply. 5.00 15
6.00 18
Starbucks’ Supply Schedule & Curve
Price Quantity
P of of lattes
lattes supplied
$0.00 0
1.00 3
2.00 6
3.00 9
4.00 12
5.00 15
6.00 18
Q
Market Supply versus Individual
Supply
• The quantity supplied in
Price Starbucks Jitters Market Qs
the market is the sum of
the quantities supplied $0.00 0 + 0 = 0
by all sellers at each 1.00 3 + 2 = 5
price. 2.00 6 + 4 = 10
• Suppose Starbucks and 3.00 9 + 6 = 15
Jitters are the only two 4.00 12 + 8 = 20
sellers in this market. 5.00 15 + 10 = 25
(Qs = quantity supplied) 6.00 18 + 12 = 30
The Market Supply Curve
P
QS
P
(Market)
$0.00 0
1.00 5
2.00 10
3.00 15
4.00 20
5.00 25
Q 6.00 30
Supply Curve Shifters

The supply curve shows how price affects

quantity supplied, other things being equal.
These “other things” are non-price determinants
of supply.
Changes in them shift the S curve…
Supply Curve Shifters: input
prices
• Examples of input prices: wages,
prices of raw materials.
• A fall in input prices makes
production
• more profitable at each output
price,
• so firms supply a larger quantity
at each price,
• the S curve shifts to the right.
Supply Curve Shifters: Input Prices
P
Suppose the
price of milk falls.
At each price,
the quantity of
Lattes supplied
will increase
(by 5 in this
example).
Q
Supply Curve Shifters:
Technology
•Technology determines how much
inputs are required to produce a unit
of output.
•A cost-saving technological
improvement has same effect as a
fall in input prices,
shifts the S curve to the right.
Supply Curve Shifters:
Number of Sellers
•An increase in the number of
sellers
•increases the quantity
supplied at each price,
•shifts the S curve to the
right.

This Photo by Unknown Author is licensed under CC BY-NC-ND

Supply Curve Shifters:
Expectations
•Suppose a firm expects the price
of the good it sells to rise in the
future.
•The firm may reduce supply now,
to save some of its inventory to
sell later at the higher price.
•This would shift the S curve
leftward.
Summary: Variables That Affect Supply
Variable A change in this variable…

Price …causes a movement

along the S curve
Input prices …shifts the S curve
Technology …shifts the S curve
No. of sellers …shifts the S curve
Expectations …shifts the S curve
Supply curve

Draw a supply curve for tax preparation software.

What happens to it in each of the following scenarios?
A. Retailers cut the price of the software.
B. A technological advance allows the software to be
produced at a lower cost.
C. Professional tax preparers raise the price of the
services they provide.
A. Retailers cut the price of the software.
Price of tax
preparation The S curve
S1
software does not shift.
P1 Move down
along the curve
P2 to a lower P
and lower Q.

Q2 Q1 Quantity of tax
preparation
software
39
B. A technological advance allows the
software to be produced at a lower cost.
Price of tax
preparation The S curve
S1 S2
software shifts to the
right:
P1
at each price,
Q increases.

Q1 Q 2 Quantity of tax
preparation
software
40
C. Professional tax preparers raise the price
of the services they provide.
Price of tax
preparation
S1 This shifts the
software
demand curve for
tax preparation
software, not the
supply curve.

Quantity of tax
preparation
software
41
Supply and Demand Together
P Equilibrium:
D S
P has reached
the level where
quantity supplied
equals
quantity demanded

Q
Equilibrium price:
The price that equates quantity supplied
with quantity demanded
P
D S
P QD QS
$0 24 0
1 21 5
2 18 10
3 15 15
4 12 20
5 9 25
Q 6 6 30
Equilibrium quantity:
The quantity supplied and quantity
demanded at the equilibrium price
P
D S
P QD QS
$0 24 0
1 21 5
2 18 10
3 15 15
4 12 20
5 9 25
Q 6 6 30
Surplus:
when quantity supplied is greater
than quantity demanded
P
D Surplus S Example:
If P = $5,
then
QD = 9 lattes
and
QS = 25 lattes
resulting in a surplus
of 16 lattes
Q
Surplus:
when quantity supplied is greater
than quantity demanded
P
D Surplus S Facing a surplus,
sellers try to increase
sales by cutting the price.
This causes
QD to rise and QS to fall…
…which reduces the
surplus.

Q
Surplus:
when quantity supplied is greater
than quantity demanded
P
D Surplus S Facing a surplus,
sellers try to increase
sales by cutting the price.
Falling prices cause
QD to rise and QS to fall.
Prices continue to fall until
market reaches equilibrium.

Q
Shortage:
when quantity demanded is
greater than quantity supplied
P
D S Example:
If P = $1,
then
QD = 21 lattes
and
QS = 5 lattes
resulting in a
shortage of 16 lattes
Shortage Q
Shortage:
when quantity demanded is greater than
quantity supplied

P
D S Facing a shortage,
sellers raise the price,
causing QD to fall
and QS to rise.
Prices continue to rise
until market reaches
equilibrium.
Shortage
Q
Three Steps to Analyzing Changes in Equilibrium

To determine the effects of any event,

1. Decide whether event shifts S curve,
D curve, or both.
2. Decide in which direction curve shifts.
3. Use supply-demand diagram to see
how the shift changes eq’m P and Q.
EXAMPLE: The Market for Hybrid Cars
P
price of
S1
hybrid cars

P1

D1
Q
Q1
quantity of
hybrid cars
EXAMPLE 1: A Change in Demand
EVENT TO BE
ANALYZED: P
Increase in price of gas. S1
STEP 1: P2
D curve shifts
because
STEP 2:
price of gas P1
affects demand for
D shifts right
hybrids.
because
STEP 3: high gas
S curve does not D1 D2
price makes hybrids
The shift
shift, causes
because an
price
more attractive Q
increase
of gas doesin price
not Q1 Q2
relative to other cars.
and quantity
affect cost of of
hybrid cars.
producing hybrids.
EXAMPLE 1: A Change in Demand
Notice: P
When P rises,
S1
producers supply
a larger quantity P2
of hybrids, even
though the S curve P1
has not shifted.
Always be careful
D1 D2
to distinguish b/w
a shift in a curve Q
Q1 Q2
and a movement
along the curve.
Terms for Shift vs. Movement Along Curve
Change in supply: a shift in the S curve
• occurs when a non-price determinant of supply changes (like
technology or costs)
Change in the quantity supplied: a movement along a fixed S curve
• occurs when P changes
Change in demand: a shift in the D curve
• occurs when a non-price determinant of demand changes (like
income or # of buyers)
Change in the quantity demanded: a movement along a fixed D curve
• occurs when P changes
EXAMPLE 2: A Change in Supply
EVENT: New technology
reduces cost of producing P
hybrid cars. S1 S2
STEP 1:
S curve shifts
because
STEP 2:
event affects P
1
cost of production.
S shifts right P2
D curve does not
because
STEP 3: event
shift, because D1
reduces cost,
The shift causes
production technology
makes production Q
price
is not to
onefallof the Q1 Q2
more profitable at
and quantity
factors to rise.
that affect
any given price.
EXAMPLE 3: A Change in Both Supply and Demand
EVENTS:
price of gas rises AND P
new technology reduces S1 S2
production costs
STEP 1: P2
Both curves shift.
P1
STEP 2:
Both shift to the right.
STEP 3: D1 D2
Q rises, but effect Q
on P is ambiguous: Q1 Q2
If demand increases more
than supply, P rises.
EXAMPLE 3: A Change in Both Supply and Demand

EVENTS:
price of gas rises AND P
new technology reduces S1 S2
production costs

STEP 3, cont.
P1
But if supply
increases more P2
than demand,
D1 D2
P falls.
Q
Q1 Q2
Change in supply and demand
Use the three-step method to analyze the effects of each
event on the equilibrium price and quantity of music
downloads.
Event A: A fall in the price of compact discs
Event B: Sellers of music downloads negotiate a reduction in
the royalties they must pay for each song they sell.
Event C: Events A and B both occur.

58
Event A: A fall in the price of compact discs
P
S1
STEPS
1. D curve shifts P1
The market for
2. D shifts left P2 music downloads

3. P and Q both
fall.
D2 D1
Q
Q2 Q1

59
Event B: Sellers of music downloads negotiate a
reduction in the royalties they must pay for each
song they sell.
P
S1 S2
STEPS
1. S curve shifts P1 The market for
music downloads
2. S shifts right P2
(royalties are part
of sellers’ costs)
D1
3. P falls, Q
Q rises. Q1 Q2

60
Events A and B both occur.
STEPS
1. Both curves shift (see parts A & B).
2. D shifts left, S shifts right.
3. P unambiguously falls.
Effect on Q is ambiguous: The fall in demand reduces Q, the
increase in supply increases Q.
CONCLUSION:
How Prices Allocate Resources
•One of the Ten Principles from
Chapter 1: Markets are usually a
good way to organize economic
activity.
•In market economies, prices adjust to
balance supply and demand. These
equilibrium prices are the signals that
guide economic decisions and
thereby allocate scarce resources.
CHAPTER SUMMARY
•A competitive market has many buyers and sellers, each of
whom has little or no influence on the market price.
•Economists use the supply and demand model to analyze
competitive markets.
•The downward-sloping demand curve reflects the Law of
Demand, which states that the quantity buyers demand of a
good depends negatively on the good’s price.
CHAPTER SUMMARY
• Besides price, demand depends on buyers’ incomes, tastes,
expectations, the prices of substitutes and complements, and # of
buyers. If one of these factors changes, the D curve shifts.
• The upward-sloping supply curve reflects the Law of Supply, which
states that the quantity sellers supply depends positively on the
good’s price.
• Other determinants of supply include input prices, technology,
expectations, and the # of sellers. Changes in these factors shift
the S curve.
CHAPTER SUMMARY
•The intersection of S and D curves determines the market
equilibrium. At the equilibrium price, quantity supplied
equals quantity demanded.
•If the market price is above equilibrium, a surplus results,
which causes the price to fall.
•If the market price is below equilibrium, a shortage results,
causing the price to rise.
CHAPTER SUMMARY
We can use the supply-demand diagram to analyze the effects
of any event on a market:
•First, determine whether the event shifts one or both curves.
•Second, determine the direction of the shifts.
•Third, compare the new equilibrium to the initial one.
In market economies, prices are the signals that guide
economic decisions and allocate scarce resources.