Supply and Demand

Markets
● Market : A group of buyers and sellers of a particular good or service
● Economists use the term competitive market to describe a market in which there are so many
buyers and so many sellers that each has a negligible impact on the market price.
● Each seller of ice cream has limited control over the price because other sellers are offering
similar products.
● If a seller charges more than the going market price, buyers will make their purchases elsewhere.
● Similarly, no single buyer of ice cream can influence the price of ice cream because each buyer
purchases only a small amount.

(This chapter assumes perfectly competitive markets)

● (1) the goods offered for sale are all exactly the same, and (2) the buyers and sellers are so
numerous that no single buyer or seller has any influence over the market price.
● Because buyers and sellers in perfectly competitive markets must accept the price the market
determines, they are said to be price takers.
Demand for goods and services
● Demand to refer to the amount of some good or service consumers are willing and able to
purchase at each price. Demand is different from need and a want. Demand is a need or a want
for which one has theon ability to pay. If you cannot pay, you have no effective demand.
● What a buyer pays for a unit of the specific good or service is called price. The total number
of units purchased at that price is called the quantity demanded.
● An increase in the price of a good or service almost always decreases the quantity demanded
of that good or service. Conversely, a decrease in price will increase the quantity demanded.
When the price of a gallon of gasoline goes up, for example, people look
for ways to reduce their consumption by combining several errands,
commuting by carpool or mass transit, or taking weekend or vacation
trips closer to home. Economists call this inverse relationship between
price and quantity demanded the law of demand. The law of demand
assumes that all other variables that affect demand are held constant .
● The law of demand states that a higher price leads to a lower quantity demanded and that a
lower price leads to a higher quantity demanded.
● Demand curves and demand schedules are tools used to summarize the relationship between
quantity demanded and price.
Demand schedule and demand curve

● A demand schedule is a table that shows the quantity demanded at each price.
● A demand curve is a graph that shows the quantity demanded at each price.
Price (per gallon) Quantity demanded (millions of gallons)

$1.00 800

$1.20 700

$1.40 600

$1.60 550

$1.80 500

$2.00 460

$2.20 420
Demand curves will be somewhat different for each product. They may appear relatively steep or flat,
and they may be straight or curved. Nearly all demand curves share the fundamental similarity
that they slope down from left to right, embodying the law of demand: As the price increases, the
quantity demanded decreases, and, conversely, as the price decreases, the quantity demanded
increases.
Based on the number of consumers, demand is classified as individual demand and market demand.
Individual demand implies, the quantity of good or service demanded by an individual household, at
a given price and at a given period of time. For example, the quantity of detergent purchased by an
individual household, in a month, is termed as individual demand.

Market Demand implies the sum total of all individual demand for the commodity at each possible
price, over a period of time. For example, There are 10 consumers of detergent in the market, wherein
their monthly demand for detergent is 10kg, 5kg, 4kg, 6kg, 5kg, 3kg, 7kg, 12kg, 6kg and 4 kg
respectively. So, the market demand for detergent is 62kg.
Individual Demand Curve

An individual demand curve represents the quantity demanded by the

individual household at various prices. We can also say that it is the graphical
representation of the individual demand schedule. It can be constructed by
observing consumer behaviour when there is a change in price.
To analyze how markets work, we need to determine the market demand, the
sum of all the individual demands for a particular good or service.
Market demand as a sum of individual demand

Price of ice-cream Catherine Nicholas Market

cone

$0.00 12 + 7 = 19

0.50 10 6 16

1.00 8 5 13

1.50 6 4 10

2.00 4 3 7

2.50 2 2 4

3.00 0 1 1
A B A+B
Movement and Shift of
Demand Curve
Changes in demand/quantity demanded
Consider the following scenarios

Car dealership slashes the prices by 10%

Price of petrol increases

Price of public transport falls

State lowers vehicle registration fees

Recession leads to a fall in income

Consumers expect new car prices to rise next year

Movement along the demand curve
An increase in quantity demanded of a commodity is caused by a fall in it’s own price,
ceteris paribus. Graphically, this is shown as a downward movement along the same
demand curve. All other factors affecting demand remain constant (CP)
SHIFTS IN THE DEMAND CURVE

Because the market demand curve holds other things constant, it need not be stable over time.

For example, suppose the American Medical Association discovered that people who regularly eat ice
cream live longer, healthier lives. The discovery would raise the demand for ice cream. At any given
price, buyers would now want to purchase a larger quantity of ice cream, and the demand curve for
ice cream would shift.

shifts the demand curve to the right and is called an

increase in demand
Any change that reduces the quantity demanded at every price shifts the demand curve to the left
and is called a decrease in demand
There are many variables that can shift the demand curve.
There are many variables that can shift the demand curve.

Income What would happen to your demand for ice cream if you lost your job one summer? Most
likely, it would fall. A lower income means that you have less to spend in total, so you would have to
spend less on some—and probably most—goods. If the demand for a good falls when income falls,
the good is called a normal good.

Not all goods are normal goods. If the demand for a good rises when income falls, the good is called
an inferior good. An example of an inferior good might be bus rides. As your income falls, you are
less likely to buy a car or take a cab and more likely to ride a bus.
normal good

a good for which, other things equal, an increase in income leads to an increase in demand

inferior good

a good for which, other things equal, an increase in income leads to a decrease in demand
Prices of Related Goods Suppose that the price of frozen yogurt falls. The law of demand says that
you will buy more frozen yogurt. At the same time, you will probably buy less ice cream. Because ice
cream and frozen yogurt are both cold, sweet, creamy desserts, they satisfy similar desires. When a
fall in the price of one good reduces the demand for another good, the two goods are called
substitutes. Substitutes are often pairs of goods that are used in place of each other, such as hot dogs
and hamburgers, sweaters and sweatshirts, and movie tickets and video rentals.

Now suppose that the price of hot fudge falls. According to the law of demand, you will buy more hot
fudge. Yet in this case, you will buy more ice cream as well because ice cream and hot fudge are often
used together. When a fall in the price of one good raises the demand for another good, the two goods
are called complements. Complements are often pairs of goods that are used together, such as
gasoline and automobiles, computers and software, and peanut butter and jelly.
substitutes

two goods for which an increase in the price of one leads to an increase in the demand for the other

complements

two goods for which an increase in the price of one leads to a decrease in the demand for the other
Tastes The most obvious determinant of your demand is your tastes. If you like ice cream, you buy
more of it. Economists normally do not try to explain people's tastes because tastes are based on
historical and psychological forces that are beyond the realm of economics. Economists do, however,
examine what happens when tastes change.

Expectations Your expectations about the future may affect your demand for a good or service today.
For example, if you expect to earn a higher income next month, you may choose to save less now and
spend more of your current income buying ice cream. As another example, if you expect the price of
ice cream to fall tomorrow, you may be less willing to buy an ice-cream cone at today’s price.
Number of Buyers In addition to the preceding factors, which influence the behavior of individual
buyers, market demand depends on the number of these buyers. If Peter were to join Catherine and
Nicholas as another consumer of ice cream, the quantity demanded in the market would be higher at
every price, and market demand would increase.
Variable Effect on the demand curve

Price Movement along the demand curve

Income Shift of the demand curve

Price of related goods Shift of the demand curve

Tastes Shift of the demand curve

Expectations Shift of the demand curve

Number of buyers Shift of the demand curve

Public policymakers often want to reduce the amount that people smoke. There are two ways that
policy can attempt to achieve this goal.

One way to reduce smoking is to shift the demand curve for cigarettes and other tobacco products.
Public service announcements, mandatory health warnings on cigarette packages, and the prohibition
of cigarette advertising on television are all policies aimed at reducing the quantity of cigarettes
demanded at any given price. If successful, these policies shift the demand curve for cigarettes to the
left
Key differences between movement and shift

Change in quantity demanded Change in demand

Caused by a change in price, CP Cause by change in other factors, price

remains unchanged

Movement along the same demand curve Shift of the entire demand curve

At a lower price more/less in demanded At the same price more/less is demanded

Key differences between Extension and Increase in demand

Extension Right Shift in demand

Caused by a fall in price, CP Caused by a change in non-price factors.

Likely causes: a rise in income ( normal
good), favourable change in tastes.

Graphical representation of increase in Graphical representation of an increase in

quantity demanded demand

It is a downward movement along the It is a right (or an outward) shift of the

same demand curve entire demand curve
Key differences between contraction and decrease in demand

Contraction of demand Decrease in demand

Caused by an increase in price of the Caused by a change in non-price factors.

good, CP For example, a reduction in disposable
income.

A graphical representation of decrease in A graphical representation of decrease in

quantity demanded demand

An upward movement along the same An inside/left shift of the entire demand
demand curve curve
SUPPLY
The quantity supplied of any good or service is the amount that sellers are willing and able to sell.
There are many determinants of quantity supplied, but once again, price plays a special role in our
analysis. When the price of ice cream is high, selling ice cream is profitable, and so the quantity
supplied is large. Sellers of ice cream work long hours, buy many ice-cream machines, and hire many
workers. By contrast, when the price of ice cream is low, the business is less profitable, and so sellers
produce less ice cream. At a low price, some sellers may even choose to shut down, and their quantity
supplied falls to zero.
This relationship between price and quantity supplied is called the law of supply: Other things equal,
when the price of a good rises, the quantity supplied of the good also rises, and when the price falls,
the quantity supplied falls as well.

quantity supplied: the amount of a good that sellers are willing and able to sell at a given price

law of supply: the claim that, other things equal, the quantity supplied of a good rises when the price
of the good rises
The curve relating price and quantity supplied is called the supply curve. The supply curve slopes
upward because, other things equal, a higher price means a greater quantity supplied.
Individual and Market Supply
We sum the individual supply curves horizontally to obtain the market supply curve. That is, to find
the total quantity supplied at any price, we add the individual quantities, which are found on the
horizontal axis of the individual supply curves. The market supply curve shows how the total quantity
supplied varies as the price of the good varies, holding constant
SHIFTS IN THE SUPPLY CURVE
Because the market supply curve holds other things constant, the curve shifts when one of the factors
(except price)changes. For example, suppose the price of sugar falls. Sugar is an input into producing
ice cream, so the fall in the price of sugar makes selling ice cream more profitable. This raises the
supply of ice cream: At any given price, sellers are now willing to produce a larger quantity. The
supply curve for ice cream shifts to the right.
Any change that raises units supplied at every price, such as a fall in the price of sugar, shifts the
supply curve to the right and is called an increase in supply. Similarly, any change that reduces the
units supplied at every price shifts the supply curve to the left and is called a decrease in supply.

There are many variables that can shift the supply curve
Factors that cause a shift in the supply curve

Input Prices A supply curve shows how quantity supplied will change as the price rises and falls,
assuming ceteris paribus—no other economically relevant factors are changing. If other factors
relevant to supply do change, then the entire supply curve will shift. A shift in supply means a
change in the quantity supplied at every price.

Say we have an initial supply curve for a certain kind of car. Now imagine that the price of steel—an
important ingredient in manufacturing cars—rises so that producing a car becomes more expensive.

Changes in the prices of inputs in the production process will affect the cost of production and thus
the supply.
Natural conditions

In 2014, the Manchurian Plain in Northeastern China—which produces most of the country's wheat,
corn, and soybeans—experienced its most severe drought in 50 years. A drought decreases the supply
of agricultural products, which means that at any given price, a lower quantity will be supplied.
Conversely, especially good weather would shift the supply curve to the right.
Technology

When a firm discovers a new technology that allows it to produce at a lower cost, the supply curve
will shift to the right as well. For instance, in the 1960s, a major scientific effort called the Green
Revolution focused on breeding improved seeds for basic crops like wheat and rice. By the early
1990s, more than two-thirds of the wheat and rice in low-income countries around the world was
grown with these Green Revolution seeds—and the harvest was twice as high per acre. A
technological improvement that reduces costs of production will shift supply to the right, causing a
greater quantity to be produced at any given price.
Government policies

Government policies can affect the cost of production and the supply curve through taxes, regulations,
and subsidies. For example, the U.S. government imposes a tax on alcoholic beverages that collects
about $8 billion per year from producers. Taxes are treated as costs by businesses. Higher costs
decrease supply for the reasons discussed above. Another example of policy that can affect cost is the
wide array of government regulations that require firms to spend money to provide a cleaner
environment or a safer workplace; complying with regulations increases costs.
A government subsidy, on the other hand, is the opposite of a tax. A subsidy occurs when the
government pays a firm directly or reduces the firm’s taxes if the firm carries out certain actions. From
the firm’s perspective, taxes or regulations are an additional cost of production that shifts supply to the
left, leading the firm to produce a lower quantity at every given price. Government subsidies,
however, reduce the cost of production and increase supply at every given price, shifting supply to the
right.

Expectations

Number of sellers
Equilibrium
There is one point at which the supply and demand curves intersect. This point is called the market’s
equilibrium. The price at this intersection is called the equilibrium price, and the quantity is called
the equilibrium [Link], demand and supply determine the price and the quantity that
will be bought and sold in a market.

At the equilibrium price, the quantity of the good that buyers are willing and able to buy exactly
balances the quantity that sellers are willing and able to sell.

The equilibrium price is sometimes called the market-clearing price because, at this price, everyone in
the market has been satisfied: Buyers have bought all they want to buy, and sellers have sold all they
want to sell.
Equilibrium: a situation in which the market price has reached the level at which quantity supplied
equals quantity demanded

Equilibrium price: the price that balances quantity supplied and quantity demanded. This is the price
at which we would predict the market will operate.

Equilibrium quantity: the quantity supplied and the quantity demanded at the equilibrium price
The demand curve, D, and the supply curve, S, intersect at the equilibrium point E, with an equilibrium price of 1.4 dollars and an
equilibrium quantity of 600. The equilibrium is the only price where quantity demanded is equal to quantity supplied. At a price above
equilibrium, like 1.8 dollars, quantity supplied exceeds the quantity demanded, so there is excess supply. At a price below equilibrium,
such as 1.2 dollars, quantity demanded exceeds quantity supplied, so there is excess demand.
The equilibrium price is the only price where the plans of consumers and the plans of producers agree
—that is, where the amount consumers want to buy of the product, quantity demanded, is equal to the
amount producers want to sell, quantity supplied. This common quantity is called the equilibrium
quantity. At any other price, the quantity demanded does not equal the quantity supplied, so the
market is not in equilibrium at that price.

The word equilibrium means balance. If a market is at its equilibrium price and quantity, then it has no
reason to move away from that point. However, if a market is not at equilibrium, then economic
pressures arise to move the market toward the equilibrium price and the equilibrium quantity.
Shift in supply: good weather for salmon fishing

In the summer of 2000, weather conditions were excellent for commercial salmon fishing off the
California coast. Heavy rains meant higher than normal levels of water in the rivers, which helped the
salmon to breed. Slightly cooler ocean temperatures stimulated the growth of plankton—the
microscopic organisms at the bottom of the ocean food chain—providing everything in the ocean with
a hearty food supply. The ocean stayed calm during fishing season, so commercial fishing operations
did not lose many days to bad weather.

How did these climate conditions affect the quantity and price of salmon?
Original supply curve S0 shifts to the

Right to S1 denoting an increase

In supply at the same price

Due to favourable fishing

conditions.
newspapers and the internet

According to the Pew Research Center for People and the Press, more and more people—especially
younger people—are getting their news from online and digital sources. The majority of US adults
now own smartphones or tablets, and most of those Americans say they use these devices in part to
get the news. From 2004 to 2012, the share of Americans who reported getting their news from digital
sources increased from 24% to 39%.

How has this shift in behavior affected consumption of print news media and radio and television
news?
D0 shows the original demand

For print, radio and television.

Due to a rise in digital sources demand

Curve for conventional media

Decreases to D1.
Decrease in demand = Decrease in Supply
Original Equilibrium is determined
Original Equilibrium is determined at point E, when the original demand curve DD and the original
supply curve SS intersect each other. OQ is the equilibrium quantity and OP is the equilibrium price.

When decrease in demand is proportionately equal to decrease in supply, then leftward shift in
demand curve from D to D¹ is proportionately equal to leftward shift in supply curve from SS to S¹S¹ .
The new equilibrium is determined at E¹ As demand and supply decrease in the same pro­portion,
equilibrium price remains same at OP, but equilibrium quantity falls from OQ to OQ¹.

Equilibrium price remains unchanged, equilibrium quantity decreases

Decrease in Demand > Decrease in Supply
When decrease in demand is proportionately more than decrease in supply, then
leftward shift in demand curve from D to D¹ is proportionately more than
leftward shift in supply curve from S to S1

The new equilibrium is determined at E¹, equilibrium price falls from OP to OP¹
and equilibrium quantity falls from OQ to OQ¹

Both equilibrium price and quantity decrease

Increase in Demand < Increase in Supply:
When decrease in demand is proportionately less than decrease in supply, then
leftward shift in demand curve from D to D¹ is proportionately less than leftward
shift in supply curve from S to S¹. The new equilibrium is determined at E¹
equilibrium price rises from OP to OP¹ whereas, equilibrium quantity falls from
OQ to OQ¹.

Equilibrium price falls equilibrium quantity increases

Increase in Demand = Increase Supply Increase
Original Equilibrium is determined at point E, when the original demand curve DD and the original
supply curve SS intersect each other. OQ is the equilibrium quantity and OP is the equilibrium price

When increase in demand is proportionately equal to increase in supply, then rightward shift in
demand curve from D to D1 is proportionately equal to rightward shift in supply curve from S to S¹.
The new equilibrium is determined at E¹. As both demand and supply increase in the same proportion,
equilibrium price remains the same at OP, but equilibrium quantity rises from OQ to OQ¹.

Equilibrium price remains unchanged ,equilibrium quantity increases.

Increase in Demand > Increase in Supply
When increase in demand is proportionately more than increase in supply then
rightward shift in demand curve from D to D¹ is proportionately more than
rightward shift in supply curve from SS to S1S1. The new equilibrium is
determined at E1 equilibrium price rises from OP to OP¹ and equilibrium
quantity rises from OQ to OQ¹

Both equilibrium price and equilibrium quantity increase

Increase in Demand < Increase in Supply
When increase in demand is proportionately less than increase in supply, then
rightward shift in demand curve from D to D¹ is proportionately less than
rightward shift in supply curve from S to S¹. The new equilibrium is determined
at E¹ equilibrium price falls from OP to OP¹ whereas, equilibrium quantity rises
from OQ to OQ

Equilibrium price falls, equilibrium quantity increases

Increase in demand = Decrease in supply
Decrease in Demand > Increase in Supply
US Postal Service

In the real world, many factors affecting demand and supply

can change all at once. For example, more and more people are
using email, text, and other digital message forms such as
Facebook and Twitter to communicate with friends and others,
and at the same time, compensation for postal workers tends to
increase most years due to cost-of-living increases.
Labor compensation is a cost of production.
Effect on quantity: Higher postal worker labor compensation raises the cost of production of postal
services, which decreases the equilibrium quantity. A change in tastes away from "snail mail" also
decreases the equilibrium quantity. Since both shifts are to the left, the overall impact is a decrease
in the equilibrium quantity of postal service
Effect on price: The overall effect on price is more complicated. Higher postal worker labor
compensation raises the cost of production, increasing the equilibrium price. But, a change in tastes
away from "snail mail" decreases the equilibrium price. Since the two effects are in opposite
directions, the overall effect is unclear, unless we know the magnitudes of the two effects.
Questions
From August 2014 to January 2015, the price of jet fuel decreased roughly 47%. Using the four-step
analysis, how do you think this fuel price decrease affects the equilibrium price and quantity of air
travel?

A tariff is a tax on imported goods. Suppose the US government cuts the tariff on imported flat-screen
televisions. Using the four-step analysis, how do you think the tariff reduction will affect the
equilibrium price and quantity of flat-screen TVs?
Supply and demand for movie tickets in a city are shown in the table below. Graph demand and
supply and identify the equilibrium. Then, calculate in a table and graph the effect of the following
two changes:

● Three new nightclubs open. They all offer decent bands and have no cover charge, but they
make their money by selling food and drink. As a result, demand for movie tickets falls by 6
units at every price.
● The city eliminates a tax that it had been placing on all local entertainment businesses. The
result is that the quantity supplied of movies at any given price increases by 10%.
Price Q demanded Q supplied

$5 26 16

$6 24 18

$7 22 20

$8 21 21

$9 20 22
Key points

● There is a four-step process that allows us to predict how an event will affect the equilibrium price and
quantity using the supply and demand framework.
● Step one: draw a market model (a supply curve and a demand curve) representing the situation before
the economic event took place.
● Step two: determine whether the economic event being analyzed affects demand or supply.
● Step three: decide whether the effect on demand or supply causes the curve to increase (shift to the
right) or decrease (shift to the left) and to sketch the new demand or supply curve on the diagram.
● Step four: identify the new equilibrium price and quantity and then compare the original equilibrium
price and quantity to the new equilibrium price and quantity.
Laws enacted by the government to regulate prices are called price controls. Price controls come in
two flavors. A price ceiling keeps a price from rising above a certain level—the “ceiling”. A price
floor keeps a price from falling below a certain level—the “floor”.

● Price ceilings prevent a price from rising above a certain level.

● Price floors prevent a price from falling below a certain level.
Price Ceiling
In many markets for goods and services, demanders outnumber suppliers. Consumers, who are also potential
voters, sometimes unite to convince the government to hold down a certain price.

For example, when rents begin to rise rapidly in a city—perhaps due to rising incomes or a change in tastes
—renters may press political leaders to pass rent control laws, a price ceiling that usually works by stating
that rents can be raised by only a certain maximum percentage each year.

Let's expand this example by thinking about a hypothetical town. Rent was fairly stable. But then, the town
was featured on a top-ten-places-to-live article in a popular magazine. Eventually, rent control laws were
passed.
When the article inspired more people to want to move to our imaginary town, it shifted the demand
curve for rental housing to the right, as shown by the data in the table below and the shift from D0 to
D1 on the graph. In the new market, at the new equilibrium
E1, the price of a rental unit rose to $600 and the equilibrium quantity increased to 17,000 units.
Now, let's suppose that a bunch of residents were pretty unhappy with paying a 20% increase in their rent.
They pressured local politicians to pass a rent control law to keep the price at the original equilibrium of
$500 for a typical apartment.

In the demand and supply model above, the horizontal line at the price of $500 shows the legally fixed
maximum price set by the rent control law. However, the underlying forces that shifted the demand curve to
the right are still there. At the fixed maximum price of $500, the quantity supplied remains at the same
15,000 rental units, but the quantity demanded is 19,000 rental units. In other words, the quantity demanded
exceeds the quantity supplied, so there is a shortage of rental housing.
Price ceilings are enacted in an attempt to keep prices low for those who demand the product—be it housing,
prescription drugs, or auto insurance. But when the market price is not allowed to rise to the equilibrium
level, quantity demanded exceeds quantity supplied, and thus a shortage occurs.

Those who manage to purchase the product at the lower price given by the price ceiling will benefit, but
sellers of the product will suffer, along with those who are not able to purchase the product at all. Quality is
also likely to deteriorate.
Price floors

A price floor is the lowest legal price that can be paid in a market for goods and services, labor, or financial
capital. Perhaps the best-known example of a price floor is the minimum wage, which is based on the
normative view that someone working full time ought to be able to afford a basic standard of living. The
federal minimum wage at the end of 2014 was $7.25 per hour, which yields an income for a single person
slightly higher than the poverty line. As the cost of living rises over time, Congress periodically raises the
federal minimum wage.
Price floors are sometimes called price supports because they support a price by preventing it from falling
below a certain level. Around the world, many countries have passed laws to create agricultural price
supports. Farm prices, and thus farm incomes, fluctuate—sometimes widely. So even if, on average, farm
incomes are adequate, some years they can be quite low. The purpose of price supports is to prevent these
swings.
The example is hypothetical, but the concept plays out in the real world as well. If a government is willing to
purchase excess agricultural supply—or to provide payments for others to purchase it—then farmers will
benefit from the price floor, but taxpayers and consumers of food will pay the costs.
Minimum Support Price (MSP) is a form of market intervention by the Government of India to insure
agricultural producers against any sharp fall in farm prices. The minimum support prices are announced by
the Government of India at the beginning of the sowing season for certain crops on the basis of the
recommendations of the Commission for Agricultural Costs and Prices (CACP). MSP is price fixed by
Government of India to protect the producer - farmers - against excessive fall in price during bumper
production years. The minimum support prices are a guarantee price for their produce from the Government.
The major objectives are to support the farmers from distress sales and to procure food grains for public
distribution. In case the market price for the commodity falls below the announced minimum price due to
bumper production and glut in the market, government agencies purchase the entire quantity offered by the
farmers at the announced minimum price.