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Lecture 3

Demand and Supply

Outline

• Supply– the supply schedule and the supply

curve; – The law of supply– factors influencing quantity supplied; – changes in supply vs. changes in

quantity supplied• Putting Demand and Supply together

– Equilibrium price and quantity*

Supply

• What is Supply?

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Supply

• Willingness and ability of suppliers to sell quantities of goods and services at given prices, over a given period of time

• Hypothetical• Quantity supplied

– Depends on the price• assume other things constant• explore the relationship between price and

quantity supplied*

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The Law of Supply

• When the price of a good rises, and everything else remains the same, the quantity of the good supplied will rise

• Ceteris paribus assumption• many variables change simultaneously

– we assume “everything else remains the same” • understand how supply reacts to price

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Supply Schedule

• Supply schedule• list of different quantities supplied at

different prices, ceteris paribus

Price (per bottle) Quantity Supplied (bottles per month)

1 25,000

2 40,000

3 50,000

4 60,000

5 65,000

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Supply Curve

• Supply curve– relationship between the price of a good

and the quantity supplied, with all other variables held constant

– Each point on the curve• total quantity that sellers would choose to

sell at a specific price– Slopes upward

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The Supply Curve

F

G

2.00

S

40,000 60,000

$4.00

Number of Bottles per Month

Price per Bottle

• The Supply Curve – movement along the supply curve

When the price is Ghc2.00per bottle, 40,000 bottlesare supplied

At Ghc4.00 per bottle,quantity supplied is60,000 bottles

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Movements Along the Supply Curve

• A change in the price of a good causes a movement along the supply curve, ceteris paribus– Graphical illustration

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Shifts of the Supply Curve

• A change in any variable that affects supply—except for the good’s price— causes the supply curve to shift.– Sell a greater quantity at any price

• The supply curve shifts rightward (increase in supply)

– Sell a smaller quantity at any price• The supply curve shifts leftward (decrease

in supply)

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Shifts of the Supply Curve

S2

G J

S1

60,000

$4.00

80,000 Number of Bottles per Month

Price per Bottle

• A Shift of the Supply Curve

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Factors that Shift the Supply Curve

• What are some factors that would cause a shift of the supply curve?

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Factors that Shift the Supply Curve

1. Input Prices– A fall in the price of an input

• lower cost of production• increase in supply (rightward shift)

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Factors that Shift the Supply Curve

2. Price of Alternatives– Other goods that a firm could produce– A rise in the price for an alternative

• decrease in supply (leftward shift)

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Factors that Shift the Supply Curve

3. Technology– What is technology?– technological advances

• increase the supply of a good

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Factors that Shift the Supply Curve

4. Number of Firms– An increase in the number of sellers

• increase supply

5. Expected price– An expected rise in price

• decrease the current supply (leftward shift)

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Factors that Shift the Supply Curve

6. Changes in Weather/Other Natural Events

– Favorable weather• increases crop yields• increases the supply (rightward shift)

– Unfavorable weather• destroys crops, shrinks yields, • decreases the supply (leftward shift)

Terminology:Change in Supply vs. Change in Quantity Supplied

• Change in Quantity Supplied– Change in price– Movement along the supply curve

• Change in Supply– Change in other factors, other than price– Shift of entire supply curve

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Movement along the Supply Curve• The Supply Curve – A summary

Q

P

P1A

BP2

Q1Q2 Q

P

P2B

AP1

Q2Q1

a) Price ↓Move leftward along the supply curve

b) Price ↑Move rightward along the supply curveS S

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Shift of Supply Curve• The Supply Curve – A summary

c) The Supply curve shifts rightward

Q

P S1

S2

Price of input ↓Price of alternatives ↓Number of firms ↑Expected price ↓Technological advanceFavorable weather

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Shift of Supply Curve• The Supply Curve – A summary

d) The Supply curve shifts leftward

Q

P S2

S1

Price of input ↑ Price of alternatives ↑Number of firms ↓Expected price ↑Unfavorable weather

DEMAND AND SUPPLY COMBINED

Demand and Supply Together

• Buyers and seller willing and able to trade have different agenda– Buyers: Pay the lowest price possible– Sellers: Charge the highest price

possible• In market, there is a price where both

parties willing to trade

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Supply and Demand Together

• Equilibrium - a situation– Various forces are in balance– A situation in which market price has

reached the level where• Quantity supplied = quantity demanded

– Supply and demand curves intersect

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Supply and Demand

• Equilibrium price and quantity– once achieved - remain constant – until either the demand curve or supply

curve shifts

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Demand Schedule

Price of Coke (Ghc) Quantity Demanded (bottles per month)

Quantity Supplied (bottles per month)

1 75,000 25,000

2 60,000 40,000

3 50,000 50,000

4 40,000 60,000

5 35,000 65,000

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Equilibrium

E

1.00

Ghc3.00

D

S

50,000Number of Bottles

per Month

Price per Bottle

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Excess Demand

• Price lower than equilibrium price• Excess Demand

– The amount by which quantity demanded exceeds quantity supplied - at a given price

– Buyers compete with each other to get more of the good than is available

– The price will rise – Equilibrium is reached

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Excess Demand

E

H J1.00

Ghc3.00

D

S

50,000 75,00025,000Number of Bottles

per Month

Price per Bottle

• Excess Demand Causes Price to Rise

Excess Demand

1. At a price of Ghc1.00 perBottle, an excess demandof 50,000 bottles . . .

2. causes the priceto rise . . .

3. shrinking the excessdemand until pricereaches its equilibriumvalue of Ghc3.00

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Excess Supply

• The amount by which quantity supplied exceeds quantity demanded - at a given price– Sellers compete with each other to sell

more than buyers want – The price will fall – Equilibrium is reached

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Excess Supply

K L

E3.00

D

S

Ghc5.00

50,00035,000 65,000

Excess Supply

Number of Bottles per Month

Price per Bottle

• Excess Supply Causes Price to Fall

1. At a price of Ghc5.00 perbottle an excess supplyof 30,000 bottles . . .

2. causes the price to drop…

3. shrinking the excess supply . . .

4. until price reachesits equilibrium value of Ghc3.00

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Markets Not in Equilibrium

Price

Quantity0

Demand

7

$2.50

(a) Excess Supply (b) Excess demand

2.00

Supply Surplus

4

Quantitydemanded

10

Quantitysupplied

Price

Quantity 0

Demand

7

1.50

$2.00

Supply

Shortage

4

Quantitysupplied

10

Quantitydemanded

Supply and Demand Together

• Law of supply and demand– The price of any good adjusts

• To bring the quantity supplied and the quantity demanded for that good into balance

– In most markets• Surpluses and shortages are temporary

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What happens when things Change?

• Three steps to analyzing changes in equilibrium1. Decide whether the event shifts the

supply curve, the demand curve, or, in some cases, both curves

2. Decide whether the curve shifts to the right or to the left

3. Use the supply-and-demand diagram• Compare the initial and the new equilibrium• Effects on equilibrium price and quantity

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What Happens When Things Change

• Income rises– normal good

• What curve shifts? What direction?– (Take-home exercise: repeat analysis for

inferior good)

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What Happens When Things Change

• Income rises• normal good• the demand increases (rightward shift of

the demand curve)– Rightward movement along the supply

curve– Equilibrium price rises– Equilibrium quantity rises

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Income rises, causing an increase in D

E

E'

3.00

D1

D2

S

Ghc4.00

50,000 60,000 Number of Bottles of Coke per Period

Price per Bottle

• A Shift in Demand and a New Equilibrium

1. An increasein demand . . .

2. moves us alongthe supply curve…

3. to a newequilibrium

4. equilibrium price increases

5. equilibrium quantityincreases too

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What Happens When Things Change

• Increase in minimum wage– What curve shifts? In what direction?

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What Happens When Things Change

• Increase in minimum wage– Increase in input costs will shift the

supply curve• decrease in supply (the supply curve

shifts leftward)– Equilibrium price rises– Equilibrium quantity falls

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Bad weather hits, decreasing the S

E'

E3.00

D

$5.00

50,00035,000

S2 S1

Number of Bottles

Price per Bottle

• A Shift of Supply and a New Equilibrium

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Both Curves Shift

• Just one curve shifts (D or S)– we can determine the direction that

BOTH equilibrium price AND quantity will move

• Both curves shift (D and S) – we can determine the direction that

EITHER equilibrium price OR equilibrium quantity will move

– direction of the other – which curve shifts by more

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Income rises and Minimum wage rises

E'

E3.00

D1

$6.00

S2 S1

Number of Bottles

Price per Bottle

• A Shift in Both Curves and a New Equilibrium

D2

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What Happens to Price and Quantity When Supply or Demand Shifts?

Take-home Questions (1)

• Consider the market for mini-vans. For each of the events listed below, identify which of the determinants of demand or supply are affected. Also indicate whether demand increases or decreases. Then draw a diagram to show the effect on the price and quantity of minivans– People decide to have more children– A strike by steelworkers raises steel price– Engineers develop new automated machinery

for the production of minivans– The price of sports utility vehicles (SUVs) rises– A stock-market crash lowers people’s wealth

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Take-home questions (2)

• Over the past 20years, technological advances have reduced the cost of computer chips. How do you think this affected the market for computers? For computer software? For typewriters?

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Next Class

• Elasticity of Demand and Supply

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