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Chapter 3
Supply and Demand

Chapter Outline
Market demand Market supply Market equilibrium Comparative statics analysis Supply, demand, and price

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Learning Objectives
Define supply, demand, and equilibrium price List and provide specific examples of the non-price determinants of supply and demand Distinguish between the short-run rationing function and long-run guiding function of price Illustrate how the concepts of supply and demand can be used in management decisions about price and allocations of resources. Use supply and demand diagrams to determine price in the short and long run

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Market Demand
The demand for a good or service is defined as:
Quantities of a good or service that people are ready, willing and able to buy at various prices within some given time period. (Other factors besides price held constant.)

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Market Demand
Ready implies that consumers are prepared to buy a good or service both because they are:
Willing: Consumers have a preference for it. Able: Consumers have the income to support this preference.

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Market Demand
Market demand is the sum of all the individual demands. Individuals may have distinct demand curves, and they sum to the overall demand in the market.
Example: demand for pizza

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Market Demand
There is an inverse relationship between price and the quantity demanded of a good or service.

This is called the Law of Demand.

Thus, the demand curve is downward sloping.
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Market Demand
Graphical Representation of Demand

Algebraic Representation of Demand Qd=700-100P

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Market Demand
Changes in price result in changes in the quantity demanded
This is shown as movement along the demand curve.

Changes in non-price factors result in changes in demand

This is shown as a shift in the demand curve.
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Market Demand

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Market Demand
Non-price determinants of demand-result is a shift in the demand curve.
tastes and preferences income prices of related products future expectations number of buyers

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Market Supply
The supply of a good or service is defined as quantities that people are ready to sell at various prices within some given time period (Other factors besides price held constant)

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Market Supply
Changes in price result in changes in the quantity supplied
shown as movement along the supply curve

Changes in non-price determinants result in changes in supply

shown as a shift in the supply curve

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Market Supply

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Market Supply
Non-price determinants of supply-results in a shift in the supply curve.
costs and technology prices of other goods or services offered by the seller future expectations number of sellers weather conditions

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Market Equilibrium
Equilibrium price: the price that equates the quantity demanded with the quantity supplied Equilibrium quantity: the amount that people are willing to buy and sellers are willing to offer at the equilibrium price level

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Market Equilibrium
Shortage: a market situation in which the quantity demanded exceeds the quantity supplied
shortage occurs at a price below the equilibrium level

Surplus: a market situation in which the quantity supplied exceeds the quantity demanded
surplus occurs at a price above the equilibrium level
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Market Equilibrium

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Comparative Statics Analysis

Comparative statics is a form of sensitivity (or what-if) analysis
Commonly used method in economic analysis

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Comparative Statics Analysis

Process of comparative statics analysis:
state all the assumptions needed to construct the model begin by assuming that the model is in equilibrium introduce a change in the model, so a condition of disequilibrium is created find the new point of equilibrium compare the new equilibrium point with the original one

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Comparative Statics Analysis

Step 1
assume all factors except the price of pizza are constant buyers demand and sellers supply are represented by lines shown

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Comparative Statics Analysis

Step 2 begin the analysis in equilibrium as shown by Q1 and P1

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Comparative Statics Analysis

Step 3 assume that a new study shows pizza to be the most nutritious of all fast foods consumers increase their demand for pizza as a result
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Comparative Statics Analysis

Step 4 the shift in demand results in a new equilibrium price (P2) and a new equilibrium quantity (Q2)

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Comparative Statics Analysis

Step 5 comparing the new equilibrium point with the original one, we see that both equilibrium price and quantity have increased

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Comparative Statics Analysis

The short run is the period of time in which:
sellers already in the market respond to a change in equilibrium price by adjusting variable inputs buyers already in the market respond to changes in equilibrium price by adjusting the quantity demanded for the good or service

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Comparative Statics Analysis

Short run changes show the rationing function of price
The rationing function of price is the change in market price to eliminate the imbalance between quantities supplied and demanded.

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Comparative Static Analysis: Short-run

an increase in demand causes equilibrium price and quantity to rise

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Comparative Static Analysis: Short-run

a decrease in demand causes equilibrium price and quantity to fall

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Comparative Static Analysis: Short-run

an increase in supply causes equilibrium price to fall and equilibrium quantity to rise

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Comparative Static Analysis: Short-run

a decrease in supply causes equilibrium price to rise and equilibrium quantity to fall

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Comparative Static Analysis: Long-run

The long run is the period of time in which:
new sellers may enter a market existing sellers may exit from a market existing sellers may adjust fixed factors of production buyers may react to a change in equilibrium price by changing their tastes and preferences

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Comparative Static Analysis: Long-run

Long run changes show the allocating function of price The guiding or allocating function of price is the movement of resources into or out of markets in response to a change in the equilibrium price.

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Comparative Static Analysis: Long-run

initial change: decrease in demand from D1 to D2 result: reduction in equilibrium price and quantity (to P2, Q2) follow-on adjustment:
movement of resources out of the market leftward shift in the supply curve to S2 equilibrium price and quantity (to P3, Q3)

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Long-run Analysis
initial change: increase in demand from D1 to D2 result: increase in equilibrium price and quantity (to P2, Q2) follow-on adjustment: movement of resources into the market rightward shift in the supply curve to S2 equilibrium price and quantity (to P3, Q3)
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Summary: Short-Run and Long-Run Changes in the Market

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Supply, Demand, and Price

In the extreme case, the forces of supply and demand are the sole determinants of the market price, not any single firm.
this type of market is perfect competition

In many cases, individual firms can exert market power over price because of their:
dominant size ability to differentiate their product through advertising, brand name, features, or services
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Supply, Demand, and Price

Discussion of changes in the computer industry
Makers of PCs, notebooks and jump drives are facing slower growth in the demand for their products as technology is changing. What impact do you think cloud computing will have on the demand for stand-alone applications such as Microsoft Office or storage devices for computers?
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Global Application
What are the implications of rising demand for oil among developing counties?

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Global Application

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Global Application

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Summary
The law of demand states that, other factors held constant, the quantity demanded is inversely related to price. The law of supply states that, other factors held constant, the quantity supplied is directly related to price. Non-price factors may shift the curves. Price serves a short-run rationing function and a long-run guiding function in the marketplace.
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