3

DEMAND, SUPPLY AND MARKET EQUILIBRIUM

MARKETS AND COMPETITION

Supply and demand are the two words that

economists use most often.
Supply and demand are the forces that make
market economies work.
◦Buyers determine demand.
◦Sellers determine supply.

2
 The Demand Curve: The Relationship
between Price and Quantity Demanded
Quantity demanded is the amount (number
of units) of a product that a household
would buy in a given period at the current
market price. It is a single quantity at a single
price.
Demand schedule is a table that shows the
relationship between the price of the good
and the quantity demanded.

3
 Price of milk per Quantity of milk
litre (€) demanded (litres
per month)
0.00 20
Lara’s
0.10 18
demand
schedule for 0.20 16
0.30 14
milk
0.40 12
0.50 10
0.60 8
0.70 6
0.80 4
0.90 2
4
Lara’s demand for milk

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Demand: The relationship between price and
quantity demanded

◦ The demand curve is a graph of the relationship

between the price of a good and the quantity
demanded, ceteris paribus.

QD = QD(P)
◦ Note that we measure quantity demanded (QD) on the
x-axis and price (P) on the y-axis in a graph (not
intuitive but has a reason).
Ceteris paribus: the assumption of “holding other
factors constant”
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Law of Demand is the observation/claim that,
ceteris paribus, the quantity demanded of a good
falls when the price of the good rises.
The actual shape of an individual household
demand curve—whether it is steep or flat, whether
it is bowed in or bowed out—depends on the
unique tastes and preferences of the household
and other factors.

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Demand vs quantity demanded

Change in quantity demanded

◦ Movement along the demand curve caused by a
change in price- this is a movement from one
point to another on the demand curve.
Change in demand
◦ A shift or change of the entire demand curve
caused by something other than price (like a
change in income or taste)

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 Change in quantity demanded
Price of milk
An increase in the price
of milk results in a
B movement from point A
€1.20
to point B

A
€0.60

D
0 4 8 Quantity of milk

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 Changes in demand
Price of
milk

Increase
in demand

Decrease
in demand
Demand
curve,D2
Demand
curve,D1
Demand curve,D3
0 Quantity of milk

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²A shift in the demand curve, to the left or right (not
Shifts
necessarily in theis Demand
parallel) caused byCurve
a change that alters
the quantities demanded at different prices.
²Shifts are caused by factors other than price. Most
prominent factors are changes in:
• Consumer income and wealth
• Prices of related goods (substitutes and
complements)
• Tastes and fashion
• Number of buyers (population)
• Expectations of consumers (about prices, income,
wealth)

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Income: The sum of all a household’s wages,
salaries, profits, interest payments, rents, and
other forms of earnings in a given period of
time. It is a flow measure: we measure it over
an interval of time—income per month or per
year .
Wealth (or net worth): The total value of what a
household owns minus what it owes. It is a
stock measure: It is measured at a given point in
time.

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 Shifts in the Demand Curve
Effect of income changes:

◦As income increases, the demand for a

normal good will increase.
◦As income increases, the demand for an
inferior good will decrease.

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 Normal Good
Price of milk
An increase
€ 1.20
in income
1.00 causes...
… an increase
0.80 in demand.

0.60

0.40

0.20
D2
D1
Quantity of
0 1 2 3 4 5 6 7 8 9 10 11 12 milk

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 Inferior Good
Price of
inferior good
€ 1.50 An increase
in income
causes...
1.00
… a decrease
in demand.
0.50

D2 D1 Quantity of
inferior
0 1 2 3 4 5 6 7 8 9 10 11 12 good

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Prices of Related Goods Curve

◦ When an increase (decrease) in the price of one

good increases (decreases) the demand for
another good, the two goods are called
substitutes.
◦ Ex.: An increase in the price of Coca-Cola is likely
to cause an increase in the demand for Pepsi Cola.
◦ Ex.: A decrease in the price of contact lenses is
likely to decrease the demand for eyeglasses.

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Prices of Related Goods Curve

◦ When a decrease (increase) in the price of one

good increases (decreases) the demand for
another good, the two goods are called
complements.
◦ Ex.: A decrease in the price of cartridges is likely
to increase the demand for printers.
◦ Ex.: An increase in the price of gas (“benzin”) is
likely to decrease the demand for cars.

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18
 Market Demand versus Individual Demand
Market demand refers to the sum of all
individual demands for a particular good or
service.
Graphically, individual demand curves are
summed horizontally to obtain the market
demand curve.

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 FIGURE 3.5 Deriving Market Demand
from Individual Demand Curves

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Point to think about:

ØWhat do you think demand for insulin looks like?

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SUPPLY

Quantity supplied is the amount of a good that

sellers are willing to (and able to) sell at a given
price.
The supply schedule is a table that shows the
relationship between the price of the good and the
quantity supplied.

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 Price of milk per Quantity of milk
litre (€) supplied (litres per
month)
0.00 0
0.10 0
0.20 2
Richard’s 0.30 4
Supply 0.40 6
Schedule 0.50 8
0.60 10
0.70 12
0.80 14
0.90 16
1.00 18
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Supply: The relationship between price
and quantity supplied

The supply curve is the graph of the relationship

between the price of a good and the quantity
supplied, ceteris paribus.

Q S = Q S (P)
We measure quantity supplied (QS) on the x-axis
and price (P) on the y-axis.

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Richard’s supply curve

25
Law of supply is the observation/claim that,
ceteris paribus, the quantity supplied of a
good rises when the price of the good rises.

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Supply vs quantity supplied

Change in quantity supplied

◦ Movement from one point on the curve to
another point on the curve because of a change
in price
Change in supply
◦ Shift of the supply curve caused by a change in
something other than the price of the good, like
a change in costs of production.

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 Change in Quantity Supplied
Price of
milk S
C
€1.50
A rise in the
price milk
results in a
movement from
A point A to point
€0.60
C on the supply
curve.
Quantity of
milk
0 1 5
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 Shifts in the supply curve (changes in supply)

Price
of milk Supply curve,S3
Supply
curve,S1
Supply
Decrease curve,S2
in supply

Increase
in supply

0 Quantity of milk

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Price changes affect quantity supplied, not supply.
Some variables affecting supply:
◦ Labor, capital and land prices
◦ Changes in technology: Lower costs of production
allow a firm to produce more at each price.
◦ Expectations
◦ Number of sellers (for market supply)
◦ The prices of related products (related in production).

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Market Supply

Graphically, individual supply curves are summed

horizontally to obtain the market supply curve.

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Deriving Market Supply from Individual Firm Supply Curves
32
Point to think about:

ØWhat do you think the supply of a rare painting

(like Mona Lisa) looks like?

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Demand and Supply meet: the Market

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The Market

A market is a group of buyers and sellers of a

particular good or service. This is where supply and
demand meet.

Question: Does a market have to be a physical

place?

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A perfectly competitive market is a market in which
there are many buyers and sellers so that each has a
negligible impact on the market price. In this type of
market the good is homogeneous, so that buyers are
indifferent between the goods sold by various sellers.

This is a very important concept for most economic

outcomes, so we will come back to it later.

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SUPPLY AND DEMAND TOGETHER
Equilibrium Price
◦ The price that balances quantity supplied and quantity
demanded.
◦ On a graph, it is the price at which the supply and demand
curves intersect.

Equilibrium Quantity
◦ The quantity supplied and the quantity demanded at the
equilibrium price.
◦ On a graph it is the quantity at which the supply and demand
curves intersect.

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The Market Mechanism

The market mechanism is the tendency in a free

market for price to change until the market clears.
A market clears when quantity demanded equals
quantity supplied at the prevailing price.
Market clearing price: price at which a market
clears

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Price of milk Quantity Quantity
supplied demanded
0.00 0 20
0.05 0 19
0.10 0 18
0.15 1 17
0.20 2 16
0.25 3 15
0.30 4 14
0.35 5 13
0.40 6 12
0.45 7 11 At €0.55, the quantity
0.50 8 10 demanded is equal to
0.55 9 9 the quantity supplied
0.60 10 8 in this example. This is
0.65 11 7 the equilibrium price.
0.70 12 6 The equilibrium
0.75 13 5
quantity is 9.
0.80 14 4
0.85 15 3
0.90 16 2
0.95 17 1
1.00 18 0 39
 P
1
0.95 S
0.9
0.85
0.8
0.75
D
0.7
0.65
0.6
0.55
0.5
0.45
0.4
0.35
0.3
0.25
0.2
0.15
0.1
0.05
0 Q
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18

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What happens if the market is not in equilibrium?
What is the current price is something other than
the equilibrium price?

The market mechanism works to bring the market

to equilibrium.

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A market which is not in equilibrium:
Price is € 0.70
(a) Surplus (excess supply)
Price
of milk Supply
Surplus

€ 0.70

0.60

Demand

0 4 7 10 Quantity of milk
Quantity Quantity
demanded supplied

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SurplusEquilibrium
◦ When price > equilibrium price, then quantity
supplied > quantity demanded.
◦ There is excess supply or a surplus.
◦ Suppliers will lower the price to increase sales,
thereby moving toward equilibrium.
◦ If there is no control* on price, it will fall until
equilibrium price is reached.

*The government sometimes uses price controls and

prevents the price from reaching equilibrium levels.
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 Price is P2

Price
($ per unit)
S
1. At P2, price is
below the
market clearing
price
2. QD > QS
(shortage)
P3 3. Price rises to
the market-
clearing price
P2 4. Market adjusts
to equilibrium

Shortage D
QS Q QD Quantity
3

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 Equilibrium
Shortage
◦ When price < equilibrium price, then quantity
demanded > the quantity supplied.
◦ There is excess demand or a shortage.
◦ Suppliers will raise the price due to too many
buyers chasing too few goods, thereby moving
toward equilibrium.
◦ If there is no control over price, it will increase until
equilibrium price is reached.

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Equilibrium

The market clears in equilibrium:

◦ There is no shortage
◦ There is no surplus
◦ Quantity supplied equals quantity demanded
◦ Anyone who wants to (and has the money to) buy at
the current price can and all producers who want to
(and are able to) sell at that price can

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Changes in Market Equilibrium

Equilibrium prices are determined by supply and

demand.
Changes in supply and/or demand will cause
changes in the equilibrium price and/or quantity in
a free market.

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 An increase in supply

P D
Original eq. at Q1, P1 S
S’
Raw material prices fall
◦ S shifts to S’ (supply
increases)
P1
◦ Surplus at P1 equal to
P3
(Q2 - Q1)
◦ Price adjusts to equilibrium
at Q3, P3

Q1 Q3 Q2 Q

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 A decrease in supply
Price of
milk 1. An increase in the
animal feed price reduces
the supply of milk. .
S2
S1

New
€ 0.80 equilibrium

0.60 Initial equilibrium

2. . . . resulting
in a higher
Demand
price of milk

0 4 7 Quantity of milk
3. . . . and a lower
quantity sold.

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 An increase in demand
Price
of milk 1. Hot weather increases
the demand for milk. . .

Supply

€ 0.80 New equilibrium

0.60
2. . . . resulting Initial
in a higher equilibrium
price . . .
D

0 7 10 Quantity of
3. . . . and a higher milk
quantity sold.

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A decrease in demand

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Simultaneous shifts in supply and
demand
When supply and demand change
simultaneously, the impact on the equilibrium
price and quantity is determined by:
1. The relative sizes and direction of the
changes
2. The shape of the supply and demand curves

52
 Ex.: Both demand and supply increase
Income increases (normal good)
and raw material prices fall:
P D
D’ S
ØDemand increases S’

ØSupply increases
ØQuantity increases for sure, as
both of these changes force P2
P1
quantity upwards
ØIn this case (shown in the graph)
price also increases. It could have
decreased or stayed the same if
the amount of shift in the curves
were different, though. Q1 Q2 Q

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The Price of a College Education

The real price of a college education rose 55

percent from 1970 to 2002.
Increases in costs of modern classrooms and wages
increased costs of production, which led to a
decrease in supply.
Due to a larger percentage of high school graduates
attending college, demand increased.

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 Market for a College Education
P S2002
(annual cost
in 1970 New
dollars)
equilibrium
was reached at
$3,917 $3,917 and a
S1970 quantity of 13.2
million
students

$2,530

D1970 D2002

Q (millions enrolled))
8.6 13.2
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What Happens to Price and Quantity When
Supply or Demand Shifts?

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Copyright©2014 Cengage
DEMAND AND SUPPLY
USING ALGEBRA
Example

QD = 32 – 2P
QS = 20 + 4P
Which is supply? Which is demand? Can you plot
supply and demand using these equations?
What is the equilibrium price in the market?
What is the quantity traded in the market
(equilibrium quantity)?

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4.5
P
4

3.5

3 S
2.5

1.5

1 D
0.5

0
24 25 26 27 28 29 30 31 32
Q

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