Chapter 2 – Supply and DemandOverview: In this chapter, we will cover the following

topics.

1. Demand and Supply Analysis.

Determinants of Demand and Supply.

Equilibrium Quantity and Price.

Adjustment to Equilibrium.

2. Taxes.

1. Demand and Supply Analysis.

Demand and Supply Analysis: is a basic

tool for analyzing market outcomes, i.e.

price and quantity.

Required Conditions:

◦ Need a “well defined” market.

Simple Definition: A market consists of the buyers

and sellers of a good or service.

◦ Perfect Information.

1. Demand and Supply Analysis.

Demand Curve.

◦ Describe the relationship between price and

quantity demanded (from the buyer’s

perspective).

◦ (Most of the time is) downward sloping.

Law of Demand: The quantity demanded rises as the

price of the product falls.

What types of products that exhibit upward sloping

demand curves?

Giffen Good (Inferior Goods that have no close substitute)

Luxury (Veblen) Good (perception of high status products)

1. Demand and Supply Analysis.

Determinants of Demand – Factors that Shift the Demand Curve

◦ Incomes – Positive relationship Income Elasticity of Demand.

◦ Tastes/Preference. – Positive relationship. ◦ Ex: major research study discovers that drinking coffee

daily reduce chance of getting cancer by ½.

◦ Prices of Substitutes and Complements Cross Price Elasticity of Demand Substitutes: Negative relationship. Ex: A Safeway’s flyer shows that Fuji Apple is 30% off normal

price. What happens to the demand for Gala Apples at Safeway.

Complements: Positive relationship.

1. Demand and Supply Analysis.

Determinants of Demand – Factors that Shift

the Demand Curve.

◦ Expectations – Positive relationship.

◦ Ex: It’s about a month away from Black Friday,

BestBuy will have huge door crash event. Many

electronic products will be on sale.

◦ Population – Positive relationship.

1. Demand and Supply Analysis.

Supply Curve.

◦ Describe the relationship between price and

quantity supplied (from the seller’s

perspective).

◦ Upward sloping.

Law of Supply: the quantity supplied rises as the

price of a product rises..

1. Demand and Supply Analysis.

Determinants of Supply.

◦ Technology –Positive relationship.

◦ Weather – Positive relationship.

◦ Factor Prices – Negative relationship.

Ex: Price of raw peanut goes up due to a long dry

summer that hammers raw peanut production.

What will happen to the supply of peanut butter?

◦ Number of Suppliers – Positive relationship.

I. Demand and Supply Analysis.

Equilibrium

PS

CS

Consumer Surplus (CS):

the difference between

consumers’ willingness to

pay and what they actually

pay.

Producer Surplus (PS):

the difference between the

product’s market price and

the cost of producing

them.

Social Surplus (SS): is the

Sum of CS and PS.

I. Demand and Supply Analysis.

Market Equilibrium.

◦ The most efficient market allocation (Pareto

efficient).

Example: Problem 5 p.50

Using diagrams, show what changes in equilibrium price and

quantity exchanged in the following markets in the

situations described.

Crude Oil: Petroleum reserves decreases.

Air Travel: Worries about air travel safety.

Milk: A drop in milk production costs.

I. Demand and Supply Analysis.

Market Equilibrium

◦ Any intervention (rent control, price ceiling,

price floor, tax, etc.) may result in efficiency

loss or deadweight loss (DWL).

I. Demand and Supply Analysis.

Excess

Demand

Excess

Supply

Equilibrium

PS

CSD

W

L

Price Floor

Price Ceiling

2. Tax and other Interventions.

Consider the case of Constant Unit Tax (or

constant tax per unit of output or excise tax).

◦ Seller’s share of the tax:

◦ Buyer’s share of the tax: tb = 1 – ts

◦ In general, the tax burden depends on the shapes of

the supply and demand schedule.

◦ The effect of the tax on the equilibrium quantity and

price is insensitive to whom the tax is applied.

Tax

2. Tax and other Interventions.

Examples: Problem 7 p.51

◦ Suppose demand for seats at Winless University

football games is given by P=1900 -1/5Q and supply is

fixed at Q=9000 seats.

Find the equilibrium price and quantity of seats for a football

game.

Suppose a new govt. policy prohibits selling college football

ticket more than $50 (price ceiling). How large is excess

demand?

Suppose the next game is a major rivalry, and so demand

jumps to P = 2100 – 1/5Q. How large is the excess demand

for this game?

How do the distortions of this price ceiling differ from the

more typical case of upward sloping supply curve?