Demand and Supply

• Markets are the institutions that bring together buyers and sellers.

– Examples include: farmer’s markets, eBay, Amazon.com, and retail outlets.

1. DEMAND

Learning Objectives1. Define the quantity demanded of a good or service and illustrate it using

a demand schedule and a demand curve.2. Distinguish between the following pairs of concepts: demand and quantity

demanded, demand schedule and demand curve, movement along and shift in a demand curve.

3. Identify demand shifters and determine whether a change in a demand shifter causes the demand curve to shift to the right or to the left.

1.1 Price and the Demand Curve

• The quantity demanded is the quantity buyers are willing and able to buy of a good or service at a particular price during a particular period, all other things unchanged.

• A demand schedule is a table that shows the quantities of a good or service demanded at different prices during a particular period, all other things unchanged.

• A demand curve is a graphical representation of a demand schedule.

1.1 Price and the Demand Curve

• A change in quantity demanded is a movement along a demand curve that results from a change in price.

• The law of demand states that for virtually all goods and services, a higher price leads to a reduction in quantity demanded and a lower price leads an increase in quantity demanded.

A Demand Schedule and a Demand Curve

Price per pound ($) 9 8 7 6 5 4

Quantity demanded per month (millions of pounds)

10 15 20 25 30 35

25 million pounds of coffee per month are

demanded at a price of $6 per pound.

25 million pounds of coffee per month are

demanded at a price of $6 per pound.

30 million pounds of coffee per month are

demanded at a price of $5 per pound.

30 million pounds of coffee per month are

demanded at a price of $5 per pound.

The demand schedule lists points on the demand curve.

The demand schedule lists points on the demand curve.

• A change in demand is characterized by a shift in a demand curve.

• A demand shifter is a variable that can change the quantity of a good or service demanded at each price.

– Preferences– Prices of related goods and services

• Complements and Substitutes– Income

• Normal and Inferior goods– Demographic characteristics– Buyer expectations

1.2 Changes in Demand

Price Old quantity demanded

$9 10

8 15

7 20

6 255 30

4 35

New quantity demanded

20

25

30

3540

45

D1 D2

A A’

An Increase in Demand

Price Old quantity demanded

$9 10

8 15

7 20

6 255 30

4 35

New quantity demanded

0

5

10

1520

25

D1D3

AA’’

A Reduction in Demand

Complements and Supplements

Complements (coffee and doughnuts)

Reducing the price of one… Increases the demand for the other.

Increasing the price of one… Reduces the demand for the other.

Substitutes (coffee and tea)

Increasing the price of one… Increases the demand for the other.

Reducing the price of one… Reduces the demand for the other.

Changes in Price Versus Changes in Demand

A reduction in demandA reduction in demand

A change in price causes a movem

ent

Along the demand curve.

Demand curve

Shifts the demand curve to the right

Shifts the demand curve to the left

An increase in demand

An increase in demand

Pric

e pe

r un

it

Quantity per period

Learning Objectives1. Define the quantity supplied of a good or service and illustrate it using a supply

schedule and a supply curve.2. Distinguish between the following pairs of concepts: supply and quantity supplied,

supply schedule and supply curve, movement along and shift in a supply curve.3. Identify supply shifters and determine whether a change in a supply shifter causes

the supply curve to shift to the right or to the left.

2. Supply

• The quantity supplied is the quantity sellers are willing to sell of a good or service at a particular price during a particular period, all other things unchanged.

• A supply schedule is a table that shows quantities supplied at different prices during a particular period, all other things unchanged.

• A supply curve is a graphical representation of a supply schedule.• A change in quantity supplied is characterized by movement along the supply

curve caused by a change in price.

2.1 Price and the Supply Curve

A Supply Schedule and a Supply Curve

Price per pound ($) 4 5 6 7 8 9

Quantity supplied per month (millions of pounds)

15 20 25 30 35 40

25 million pounds of coffee per month are

supplied at a price of $6 per pound.

25 million pounds of coffee per month are

supplied at a price of $6 per pound.

30 million pounds of coffee per month are

supplied at a price of $7 per pound.

30 million pounds of coffee per month are

supplied at a price of $7 per pound.

The supply schedule lists points on the supply

curve.

The supply schedule lists points on the supply

curve.

• A change in supply is characterized by a shift in the supply curve.

• A supply shifter is a variable that can change the quantity of a good or service supplied at each price.

– Prices of factors of production– Returns from alternative activities– Technology– Seller expectations– Natural events– The number of sellers

2.2 Changes in Supply

Price Old quantity supplied

$4 15

5 20

6 257 30

8 35

9 40

New quantity supplied

25

30

3540

45

50

S1 S2

A A’

An Increase in Supply

Price Old quantity supplied

$4 15

5 20

6 257 30

8 35

9 40

New quantity supplied

5

10

1520

25

30

S1S3

AA’’

A Reduction in Supply

Changes in Price Versus Changes in Supply

A reduction in supply

A reduction in supply

A c

hang

e in

pric

e ca

uses

a m

ovem

ent

Alo

ng th

e su

pply

cur

ve.

Supply curve

Shi

fts th

e su

pply

cur

ve to

the

right

Shi

fts th

e su

pply

cur

ve to

the

left

An increase in supply

An increase in supply

Pric

e pe

r un

it

Quantity per period

3 Demand, Supply, and Equilibrium

Learning Objectives1. Use demand and supply to explain how

equilibrium price and quantity are determined in a market.

2. Understand the concepts of surpluses and shortages and the pressures on price they generate.

3. Explain the impact of a change in demand or supply on equilibrium price and quantity.

4. Explain how the circular flow model provides an overview of demand and supply in product and factor markets and how the model suggests ways in which these markets are linked.

3.1 The Determination of Price and Quantity

• The Equilibrium price (market clearing price) is the price at which quantity demanded equals quantity supplied.

• The Equilibrium quantity is the quantity demanded and supplied at the equilibrium price.

• A Surplus is the amount by which the quantity supplied exceeds the quantity demanded at the current price.

• A Shortage is the amount by which the quantity demanded exceeds the quantity supplied at the current price.

S

D

The Determination of Equilibrium Price and Quantity

Equilibrium price and quantity

Equilibrium price and quantity

At a price of $8 per pound, 35 million pounds of coffee are

supplied

At a price of $8 per pound, 35 million pounds of coffee are

supplied

At a price of $8 per pound,

15 million pounds of coffee are

demanded

At a price of $8 per pound,

15 million pounds of coffee are

demanded

Surplus at P = $8

At a price of $4 per pound, 35 million pounds of coffee are demanded

At a price of $4 per pound, 35 million pounds of coffee are demanded

At a price of $4 per pound,

15 million pounds of coffee are supplied

At a price of $4 per pound,

15 million pounds of coffee are supplied

Shortage at P = $4

3.2 Shifts in Demand and Supply

S1

D1D2 D2

3.2 Shifts in Demand and Supply

S1

D1

S2 S2

Simultaneous Decreases in Demand and Supply

S1

D1

S2

D2

Simultaneous Decreases in Demand and Supply

S1

D1

S2

D2

Simultaneous Decreases in Demand and Supply

S1

D1

S2

D2

Simultaneous Shifts in Demand and Supply

3.3 An Overview of Demand and Supply: The Circular Flow Model

• The circular flow model is a model that provides a look at how markets work and how they are related to each other.

• The Product markets are markets in which firms supply goods and services demanded by households.

• The Factor markets are markets in which households supply factors of production – labor, capital, and natural resources – demanded by firms.

D

S

Pric

e

Payments to firms for goods and services

Textile workers

Demand goods and services

Product markets

Supply goods and services

Demand factors

And supply factorsFactors markets

FirmsFirms HouseholdsHouseholds

D

S

Pric

e

Blue jeans

D

S

Pric

e

Haircuts

D

S

Pric

e

Apartments

D

S

Pric

e

Barbers

D

S

Pric

e

Apartment buildings

3.3 An Overview of Demand and Supply: The Circular Flow Model

Wages paid to household for labor