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CHAPTER
4

The Market Forces of

Demand and Supply

Arjun Madan Ph D

Managerial / Micro Economics

look for the answers to these questions:

What factors affect buyers demand for goods?

What factors affect sellers supply of goods?
How do supply and demand determine the price
of a good and the quantity sold?
How do changes in the factors that affect demand
or supply affect the market price and quantity of
a good?
How do markets allocate resources?
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Markets and Competition

A market is a group of buyers and sellers of a
particular product.
A competitive market is one with many buyers
and sellers, each has a negligible effect on price.
In a perfectly competitive market:
All goods exactly the same
Buyers & sellers so numerous that no one can affect
market price each is a price taker
In this chapter, we assume markets are perfectly
competitive.

Markets and Competition

Markets as allocative mechanism require:
Nonattenuated [exclusive, enforceable, transferable]
property rights, and
voluntary transactions

Markets include all potential buyers and sellers

behavior of buyers is represented by demand
[benefits side of model]

behavior of sellers is represented by supply [cost

side of model]
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Demand
A schedule of the quantities of a good that buyers
are willing and able to purchase at each possible
price during a period of time, ceteris paribus. [all
other things held constant]
Law of demand
Other things being equal, the higher the price of
the commodity, less is the quantity demanded and
lower the price, more is the quantity demanded.

Demand

Demand may be viewed as ex-ante, i.e.

intended demand (potential demand) or ex-
post, i.e. which is already purchased (actual
demand).

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Types of Demand
Direct / Autonomous Demand
Demand for goods meant for final consumption

Derived Demand
Demand is derived from the demand for final
commodity

Recurring and Replacement Demand

Consumer goods and Durables

Types of Demand
Competitive Demand
Demand for substitutes

Joint or Complementary Demand

Two or more goods consumed together

Composite Demand
Commodities which have several uses

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The Demand Schedule

Price Quantity
Demand schedule: of of coffee
a table that shows the coffee demanded
relationship between the
$0.00 16
price of a good and the
quantity demanded 1.00 14
2.00 12
Example: 3.00 10
Hitens demand for coffee.
4.00 8
5.00 6
Notice that Hitens preferences 6.00 4
obey the Law of Demand.

Hitens Demand Schedule & Curve

Price of Price Quantity
Coffee of of coffee
$6.00 coffee demanded
$0.00 16
$5.00
1.00 14
$4.00 2.00 12
$3.00 3.00 10
$2.00 4.00 8
5.00 6
$1.00
6.00 4
$0.00
Quantity
0 5 10 15 of Coffee

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Market Demand versus Individual Demand

The quantity demanded in the market is the sum of
the quantities demanded by all buyers at each price.
Suppose Hiten and Ketan are the only two buyers in
the Coffee market. (Qd = quantity demanded)
Price Hitens Qd Ketans Qd Market Qd
$0.00 16 + 8 = 24
1.00 14 + 7 = 21
2.00 12 + 6 = 18
3.00 10 + 5 = 15
4.00 8 + 4 = 12
5.00 6 + 3 = 9
6.00 4 + 2 = 6
10

The Market Demand Curve for Coffee

Qd
P P
(Market)
$6.00
$0.00 24
$5.00 1.00 21
$4.00 2.00 18
3.00 15
$3.00
4.00 12
$2.00
5.00 9
$1.00 6.00 6
$0.00 Q
0 5 10 15 20 25

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Demand Function
Is the functional relationship between the price of
the good and the quantity of that good purchased in
a given time period [UT], income, other prices and
preferences being held constant.
Individual demand function can be expressed as:
Q = f (PX, I, Pr , P, A); where:
I = income, Pr = prices of related goods, P = preferences
A = Advertisement
Q = f (PX, holding I, Pr , P, A, etc. constant);
Thus, an individual demand function would be:
Q = f (PX)
12

Linear Demand Function

The individual demand function does not show
how much qty demanded will change following a
unit change in price. We need a specific form of
demand function.

Generally demand function is considered to be of a

linear form. This is written as:

Qd = a b Px
Where,
a is a constant intercept term
b is the coefficient showing the slope of demand curve.
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Linear Demand Function

However, demand function must be stated in
explicit form showing the precise effect on demand
of changes in various individual variables. Thus,

Qd = a + b1Px+b2P1+b3P2+b4I+b5A+b6

The coefficient b1,b2,b3,b4,b5,b6 shows the changes in

qty demanded caused by one unit change in the
associates variables.

Linear Demand Function: An Example

Thus, annual demand for sugar at various price

may be Qd = 70 5P

Interpreted as a one rupee fall in price of sugar

will cause its qty to increase by 5 units.

5 is the demand multiplier for change in demand

corresponding to a unit change in price.

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An example of hot chocolate:

There is a coffee cart in the building that primarily serves the
individuals who work in the building. The market is defined to
some extent by the geography of the building. Individuals who
buy the hot chocolate rarely come from other buildings to
purchase a cup. During the time period [UT] under
consideration [8:00-9:00am on a week day ] the incomes and
preferences of buyers are unlikely to change. The prices of
coffee, lattes, etc. can be controlled by the vendor and the
price of soft drinks from the machines remains constant. The
number of workers in the building remain at a constant level.

Under these circumstances, we observe the number of cups

of hot chocolate [H] sold each morning as the price [P] is
changed.
From these observations the demand relationship is
estimated.
16

Cups of Hot Chocolate [H] purchased

eachday between8-9am
price cups The demand relationship
per cup purchased can be demonstrated as a
table:
A 0 20 .

B $ . 50 15 . Demand is a schedule of
quantities
C $ . 75 12 . 5 that will be
DP > 0 DQ < 0 purchased
D $ 1. 00 [+.75] 10 . [-7.5]
at a schedule
E $ 1. 25 7.5 of prices during a given
F $ 1. 50 5. time period, cet. par.

G $ 1. 75 2.5
As the price is increased,
the quantity purchased
H $ 2 . 00 0 decreases.

This demand relationship can be expressed as an equation: = axis.]

Q = 20 - 10P
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The demand relationship can be expressed as a table

(previous slide) or an equation Q = 20 - 10P] [either P = 2 - .1Q or
PRICE The data from the table or equation can be graphed:
$

2.25
P = $2, Then Q = 0 P = $1.75, then Q = 2.5
2.00
1.75 . . P = $1.50, then Q = 5
1.50
1.25 . . P = $1.25, Q = 7.5

P = $1, then Q = 10

..
1.00
.75 P = 0, then Q = 20
.50
.25 Demand

2 4 6 8 10 12 14 16 18 20 22 24 QUANTITY
The demand function can be represented as a table, {CUPS/UT}
an equation or a graph.

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Market Demand Function

Mathematically, market demand function can be
expressed in general form as:
Q = f (PX, I, Pr , P, A, N);
And in specific form as:
Qd = C + b1Px+b2I+b3PY+b4T+b5A+b6N
C is a constant term showing the intercept of
market demand curve
The coefficient b1,b2,b3,b4,b5,b6 shows the
quantitative relationship of various independent
variables.

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An Illustration

A fruit seller want to sell 20 kgs of apples. He

want to fix a price. There are three customers and
their individual demand function is as follows:

D1 = 25 1.0P

D2 = 20 0.5P

D3 = 15 0.5P

Determine market demand equation, and selling

price
20

Solution
Market demand is the sum of individual demands:
Dm = (25 1.0P)+(20 0.5P)+(15 0.5P)
Dm = 60 2.0P
Quantity to be sold 20 kgs, so the price should be
set such that demand is for 20 kgs
Dm = 60 2.0P
20 = 60 2.0P
P = 20
Thus, demand by each buyer would be
D1 = 5 , D2 = 10 and D3 = 5
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Practice Problem
Suppose the estimated demand function for shirts
in a departmental store is as follows:

Q = 300 1.5 P

What would be the demand for shirts at Rs 90,

and at Rs 100.

At what price demand would be zero?

Practice Problem 1
At Rs 90, the demand for shirt is estimated to be:
Q = 300 1.5 (90)
= 300 135
= 165 shirts
At Rs. 100, then the demand would be:
Q = 300 1.5 (100)
= 300 150
= 150 shirts
At what price demand would be zero?
Qd = 300 1.5P
let us put Qd = 0
300 1.5P = 0
1.5P = 300
P = 300 / 1.5 = Rs. 200

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Practice Problem 2

The demand function for beer in the city is

Qd = 400 4 P

Qd = quantity of beer (in 000 bottles per week)

a) Construct a demand curve assuming price Rs. 10,
12, 15, 20 and 25 per bottle.
b) At what price the demand would be zero?
c) If the producer want to sell 3,80,000 bottles per
week, what price should he charge ?

Practice Problem

a)
P = 10: Qd = 400 - 4 x 10 = 360
P = 12: Qd = 400 4 X 12 = 352
P = 15: Qd = 400 4 X 15 = 340
P = 20: Qd = 400 4 X 20 = 320
P = 25: Q = 400 4 X 25 = 300

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Practice Problem
b) Qd = 400 4 P, c) Qd = 400 - 4P
let us put Qd = 0 Let Qd = 380
400 4P = 0
380 = 400 4 P
4P = 400
By manipulation
P = 400 / 4 = 100
4P = 400 380 = 20
At price Rs 100 per P = 20 / 4 = 5
bottle, the demand will be To sell 3,80,000 he
zero should charge Rs 5 per
bottle

Illustration
Demand for a goods is given by the equation:
DX = 1500 - 10PX + 4Y 15PY.
Find the demand equation for good X in terms of
price for P(PX) when
Y = 500, and
PY = 60

Solution !
DX = 1500 - 10PX+ 4Y 15PY
1500 10PX + 4(500) 15(60)
= 2600 10PX
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Illustration
Truett and Ruett (1980) described the following demand function for
a brand X of microwave ovens
Qx = f (Px, Pz, Nw, Y, A)
Where Qx = quantity demanded per year for brand X of microwave
ovens in a city,
Px = price of X brand
Pz = price of Z brand
Nw= number of working women
Y = mean annual household income
A = annual advertising expenditure
Assuming hypothetical data, we may state the demand estimation
as under :
Qx = 11,93,200 100Px + 20 Pz + 0.002 Nw + 1.8Y + 0.3A
On this basis, given that Px = 8000, Pz = 9000, Nw = 800,000 in a
city, Y = 100,000 A = 60,000 28

Solution
Qx = 11,93,200 (100 x 8000) + (20 x 9000) +
(0.002 x 800,000) + (1.8 x 100,000) + (0.3 x 60,000)
= 11,93,200 (800,000 + 180,000 + 1600 + 180,000
+ 18000)
= 11,93,200 11,79,600
= 13,600

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Determinants of Demand
Price of the Product
Income
Consumer tastes, preferences, needs, etc.
Availability and Price of related goods
substitutes and compliments
Fashion
Advertisements
Population- size, composition, density, and Income
distribution,
Future expectations of consumers

Exceptions
1. Giffen Goods (Inferior Goods)

2. Prestige Goods/Articles of Snob Appeal

Also called the Veblen Effect

(named after the American economist Thorstein Veblen)

3. Speculation/Future Expectation

4. Consumers Psychological Bias

5. Ignorance on part of consumers

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Two Rules for Movements vs. Shifts

Rule One
When an independent variable changes and that
variable does not appear on the graph, the curve on
the graph will shift.

Rule Two
When an independent variable does appear on the
graph, a movement along the existing curve will
occur.

Change in Quantity Demanded versus

Change in Demand

Change in Quantity Demanded

Movement along the demand curve.
Caused by a change in the price of
the product.

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Changes in Quantity Demanded

Price of
Cigarettes
per Pack
A tax that raises the price
of cigarettes results in a
B movement along the
4.00
demand curve.

2.00 A

D1

0
12 20 Number of Cigarettes
Smoked per Day

Change in Quantity Demanded versus

Change in Demand

Change in Demand
A shift in the demand curve, either to the
left or right.
Caused by a change in a determinant other
than the price.

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Consumer Income
Normal Good
Price of Ice-
Cream Cone

$3.00 An increase
2.50 in income...
Increase
in demand
2.00

1.50

1.00

D2
0.50
D1

Quantity of
0 1 2 3 4 5 6 7 8 9 10 11 12 Ice-Cream
Cones

Consumer Income
Inferior Good
Price of Bus
ticket

$3.00

2.50 An increase
2.00
A1
A in income...

1.50

1.00
Decrease
0.50 in demand

D2 D1
Quantity of
0 1 2 3 4 5 6 7 8 9 10 11 12 Bus rides

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Summary: Variables That Influence Buyers

Variable A change in this variable

Price causes a movement

along the D curve
# of buyers shifts the D curve
Income shifts the D curve
Price of
related goods shifts the D curve
Tastes shifts the D curve
Expectations shifts the D curve

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Supply
The quantity supplied of any good is the amount
that sellers are willing and able to sell.
Law of supply: the claim that the quantity
supplied of a good rises when the price of the good
rises, other things equal

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The Supply Schedule

Supply schedule: Price Quantity
of of coffee
A table that shows the
coffee supplied
relationship between the
price of a good and the $0.00 0
quantity supplied. 1.00 3
2.00 6
Example:
3.00 9
Starbucks supply of coffee.
4.00 12
5.00 15
Notice that Starbucks
6.00 18
supply schedule obeys the
Law of Supply.

40

Starbucks Supply Schedule & Curve

Price Quantity
P of of coffees
$6.00 coffee upplied
$0.00 0
$5.00
1.00 3
$4.00
2.00 6
$3.00 3.00 9
$2.00 4.00 12
5.00 15
$1.00
6.00 18
$0.00 Q
0 5 10 15

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Market Supply versus Individual Supply

The quantity supplied in the market is the sum of
the quantities supplied by all sellers at each price.
Suppose Starbucks and Jitters are the only two
sellers in this market. (Qs = quantity supplied)
Price Starbucks Jitters Market Qs
$0.00 0 + 0 = 0
1.00 3 + 2 = 5
2.00 6 + 4 = 10
3.00 9 + 6 = 15
4.00 12 + 8 = 20
5.00 15 + 10 = 25
6.00 18 + 12 = 30 42
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The Market Supply Curve

QS
P
(Market)
P
$6.00 $0.00 0
1.00 5
$5.00
2.00 10
$4.00 3.00 15
$3.00 4.00 20
$2.00 5.00 25
6.00 30
$1.00
$0.00 Q
0 5 10 15 20 25 30 35

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Determinants of Supply
Price of the commodity
Cost of production
State of technology
Number of firms
Government policies

44

Supply Function
Sx = f(Px, C, T, G, N)
Px, = price of the product
C, = cost of production
T, = state of technology
G, = government policies
N = number of firms
Holding other factors constant, supply function
would be : Sx = f(P)

A linear supply function would be:

Qs = c + dP 45

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Supply Schedule
Observation Price Quantity
Supplied
The information can be represented
A $1 6
on a graph by plotting each
B $2 10 price quantity combination.
C $3 14
D $4 18

E
F $5 22

P
Both the graph and the table $5
.
represent a supply
relationship: Q = 2 + 4P
$4
$3
. .
A supply schedule can be $2
displayed as a table or a curve.$1 .
2 4 6 8 10 12 14 Q
46

Change in Quantity Supplied

A change in the price of the good causes a

change in the quantity supplied.

It signify a movement on the supply function,

and not a shift of the supply function.

47

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Supply Schedule

Observation Price Quantity

Supplied
A change in the price causes a
A $1
$1 6change in the quantity supplied.
B $2 DP CAUSES
10 DQThis can be represented by a
C $3
$3 14 movement on the supply
D $4 18 function in the graph
E
F $5 22

This is a change in quantity P

supplied. Not to be $5 DP causes the quantity supplied
confused with a change in to increase from 6 to 14.
$4
supply!
$3
DP from $1 to $2
$3
$1

2 4 6 8 10 12 14 16 Q
/ut
48

Change in Supply
A change in supply is caused by a change in any
variable, other than price, that influences supply.

A change in supply can be represented by a shift of

the supply function on a graph.

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Supply Schedule
Given the supply schedule,
Observation Price Quantity
An increase in the prices Supplied
of inputs would make it A $1 46
more expensive to produce
B $2 810
each unit of output,
C $3 1214
therefore, the supply
decreases D $4 1618

E
F $5 20
22
P a shift to the left
$5 is a decrease in supply
The decreased quantity
$4
at each price shifts the
$3 supply curve to the left!
$2 The development of a new
technology that reduces the
$1
cost of production will shift
2 4 6 8 10 12 14 16 the supply function to the right
Q
50

Change in Quantity Supplied

versus Change in Supply
Variables that
Affect Quantity Supplied A Change in This Variable . . .
Price Represents a movement along
the supply curve
Input prices Shifts the supply curve
Technology Shifts the supply curve
Expectations Shifts the supply curve
Number of sellers Shifts the supply curve

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Equilibrium
A state of rest or balance due to the equal action of
opposing forces.
Equal balance between any power or influence [Websters
Encyclopedic Unabridged Dictionary of the English Language]

In a market an equilibrium is said to exist when

the forces of supply [sellers] and demand [buyers]
are in balance: the actions of sellers and buyers are
coordinated.
The quantity supplied equals the quantity
demanded!

Market Equilibrium

Market for Denim Pants

Price of Denim Pants Quantity Demanded Quantity Supplied

per month per month
(No. of pairs) (No. of pairs)
0 8 0
50 7 1
Equilibrium
Price=200 100 6 2
150 5 3
200 4 4
250 3 5
300 2 6
350 1 7
400 0 8

Equilibrium Quantity=4

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What would happen if the market

equilibrium is disturbed?

654

Market Equilibrium
At prices above the equilibrium price, quantity
supplied is greater than quantity demanded,
resulting in a temporary surplus.
In a surplus situation, producers will try to reduce price to
entice consumers to buy more denim pants. Actions by
both producers and the public will wipe out the temporary
surplus.

At prices below the equilibrium price, consumers

desire to buy more denim pants than are available,
creating a temporary shortage.
Consumers will try to outbid each other, thus pushing up
the price. As price rises, firms increase their production
while some consumers reduce their purchases.

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100
90 Given a demand
80 function [which
$70
70 represents the
behavior or choices
60 of buyers,
50 and a supply function
40 that represents the
30 behavior of
20 sellers,
10

10 20 30 40 50 60
60 70 80 90 100 110 120 130
Qx/ UT
Where the quantity that people want to buy is equal to the quantity
that the producers want to sell, there is an equilibrium quantity.
The price that coordinates the preferences of the buyers and sellers
is the equilibrium price.
At the equilibrium price of $70, the quantity supplied is equal to
the quantity demanded.

When the price is greater than the equilibrium price, the

[quantity supplied] exceeds the [quantity demanded] at that price.
The price is too high.

At a Price of $90 the quantity supplied is 80, the quantity demanded is 35

surplus = 45
100
$90
90
80 At $90 there is a surplus
equilibrium price of 45 units [80-35=45]
$70
70
equilibrium quantity

60
50
40
30
20
10

10 20 30 3540 50 60 808090 100 110 120 130

60 70
Qx/ UT

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surplus = 45
100
$90
90
80
$70
70
60
lower
price
. At a price of $90 a surplus
of 45 units exists
Suppliers have more to sell than
buyers will purchase at a price of $90.
50 To get rid of these unsold
40 Quantity units [inventory], the
Quantity
30
demanded
supplied sellers lower
increases
20
decreases the price.

10

10 20 30 35
40 50 60
60 70 8090
80 100 110 120 130
Qx/ UT
As the price of the good is reduced, the quantity supplied decreases.
The quantity demanded increases as the price falls.
As the price moves toward equilibrium, quantity supplied and
quantity demanded are brought into equilibrium.

As a result of market forces

100 the market moves to equilibrium
90
80
$70
70
60 price
. At a price below equilibrium the
the quantity demanded exceeds
the quantity supplied.
At a price of $30 the quantity
50 rises
demanded is 110.The quantity
40 supplied is 15.
$30
30 quantity quantity
20 supplied demanded
10
increases decreases
shortage = 95
10 1520 30 40 50 60 90 100 110 110
60 70 80 120 130
Qx/ UT
At a price of $30 the quantity demanded exceeds the quantity
supplied by 95 units [110 - 15 = 95]. This is a shortage.

Since the buyers cannot obtain all they want at a price of $30, some buyers will
offer to pay more. Some buyers will not pay the higher price, they buy less so the
quantity demanded decreases.
At the higher price the quantity supplied increases

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Shift in Demand and Supply Function

660

100 demand
increases
90
$89 The market for good X is
80 price in equilibrium at Px = $70
rises
$70
70
60
50
40
30 equilibrium
quantity
20 increases
10

10 20 30 40 50 60
60 70 808090 100 110 120 130 Qx/ UT
An increase in the price of a
substitute [good Y] causes the The increase in the demand for
demand for good X to increase. good X results in an increase in
both the equilibrium price and
As a result of the increased demand, quantity.
market forces push Px up.

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100
90 Given a demand function,
80 an equilibrium is defined.
$70
70
A decrease in demand,
60
establishes a new equilibrium
$50.89
50
at a lower price and
40
quantity.
30
20
10

10 20 30 40 6 070 80 90 100 110 120 130

39.250 60 Qx/ UT
Demand might be reduced by: A change in the
a decrease in the price of a substitute, price of the good
an increase in the price of a compliment, does not change
a change in income, demand! It changes
a change in the number of buyers the quantity
or their preferences, or, . . . demanded.

100
90 S2
80 supply
$70
70 increases
price
60 falls
50
$50
40
30
20
10

6070 80 86
10 20 30 40 50 60 90 100 110 120 130
Qx/ UT
Given an equilibrium
condition in a market, Quantity Identify factors that increase supply:
1. fall in price of inputs
an increase in supply will increases 2. improved technology
increase the equilibrium 3. increase in number of sellers
quantity and decrease 4. fall in return in alternative
equilibrium P. uses of inputs
5. or, . . .

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A decrease in supply causes the equilibrium price to increase

and equilibrium quantity to decrease.
What forces might cause the
supply to decrease?
1. an increase in the prices
S1 of inputs
2. increase in returns from
100 alternative actions
decrease in supply 3. problems in technology
$9090
[regulations, . . . ]
80 price rises
4. decrease in number of
$7070 sellers or producers
60
50 quantity
40 decreases
30
20
10

10 20 3035 6 070 80 90 100 110 120 130

40 50 60
Qx/ UT

100 demand
increases S2If both supply and
90 and decrease
80 demand decrease,
price might price
+DP and the DP will be
$70
70 go up or down increase indeterminate and
60 or stay the same -DP price the equilibrium Q
increase
will decrease.
50 results in
increase
a market
40
supply force to
results in
D2
30
increases aincrease
market Q
20
force to
10 increase Q

10 20 30 40 50 60 6 070 80 90 100100 110 120 130 Qx UT /

When demand and supply both shift, the resultant effect on either
equilibrium price or quantity will be indeterminate.
Both the increase in demand and supply increase quantity; equilibrium Q increases.
The increase in demand pushes price up. The increase in supply pushes price down.
The change in price may be positive or negative, it depends on the magnitude
of the shifts in and slopes of demand and supply.

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A decrease in supply tends to increase P and reduce Q.

An increase in demand tends to increase both P and Q.
Result is that Price will rise, Quantity may increase, decrease or stay the same
depending on the magnitudes of the shifts and slopes of supply and demand.
In this example,
the price Price
increases to $105100
S1
$105. decrease in supply
to push
90
price up
When supply 80 pushes
increases and $70
70 price up
demand
decreases, 60
an increase in
the price will 50 demand tends D2
fall but the 40 reduces and
change in Q quantity increase
30 Q
will be
20
indeterminate!
10

10 20 30 3540 49
50 60
60 70 80 90 100 110 120 Qx/ UT
the quantity decreases to 49

Illustration
Demand for wrist watches by Beyond Time Ltd.
for the year 2012 was given by
Qd = 1000 P and
supply is given by : Qs = 100 +4P
What is the equilibrium price?
What is the excess demand or supply if the price
is:
a) Rs 500
b) Rs100

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Solution
At equilibrium quantity Qd = quantity supplied Qs
Therefore, 1000 P = 100 + 4P
5P = 1000 100
P = 180
A) when price is Rs 500
Qd = 1000 500 = 500,
Qs = 100 + 4(500) = 2100
Therefore, excess supply = 2100 500 = 1600
B) when price is Rs 100
Qd = 1000 100 = 900
Qs = 100 + 4(100) = 500
Excess demand is 900 500 = 400 68

Illustration
Demand for X is given as
Dx = 1500 10Px + 4Y 15Py
Where Y = consumers income, and
Py is the price of related goods
Find demand equation for X in terms of price of X
(Px) when Y is Rs 500 and Py is Rs 60.
Supply function is given by the equation
Sx = 800 + 2Px
Find equilibrium price and quantity.

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Solution
Demand function by substituting the values of Y and Py
Dx = 1500 10Px + 4Y 15Py
1500 10Px + 4 (500) 15 (60) = 2600 10Px
Given the supply function:
Sx = 800 + 2Px equilibrium will occur when Dx = Sx
2600 10Px = 800 + 2Px
12Px = 2600 800
Px = 150
Equilibrium quantity is Dx = 2600 10Px
2600 10 (150)
Dx = 1100
70

Three Steps To Analyzing Changes

in Equilibrium

Decide whether the event shifts the supply

or demand curve (or both).

Decide whether the curve(s) shift(s) to the

left or to the right.

Examine how the shift affects equilibrium

price and quantity.

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EXAMPLE 1: A Shift in Demand

EVENT TO BE
ANALYZED: P
Increase in price of S1
gas.
STEP 1: P2
D curve shifts
because
STEP 2: price of gas P1
affects demand for
D shifts right
hybrids.
because
STEP high gas
3: does
S curve
price makes not
hybrids D1 D2
The
shift,shift causes an
more because
attractiveprice Q
increase
of gas does in price
not cars. Q1 Q2
relative to other
affect cost of of
and quantity
hybrid cars.
producing hybrids.
72

EXAMPLE 1: A Shift in Demand

Notice: P
When P rises,
S1
producers supply
a larger quantity P2
of hybrids, even
though the S curve P1
has not shifted.
Always be careful
to distinguish b/w D1 D2
a shift in a curve Q
Q1 Q2
and a movement
along the curve.

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Terms for Shift vs. Movement Along Curve

Change in supply: a shift in the S curve
occurs when a non-price determinant of supply
changes (like technology or costs)
Change in the quantity supplied:
a movement along a fixed S curve
occurs when P changes
Change in demand: a shift in the D curve
occurs when a non-price determinant of demand
changes (like income or # of buyers)
Change in the quantity demanded:
a movement along a fixed D curve
occurs when P changes
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74

EXAMPLE 2: A Shift in Supply

EVENT: New
technology reduces cost P
of producing hybrid S1 S2
cars.
STEP 1:
S curve shifts
because
STEP 2: event affects P1
cost of production.
S shifts right P2
D curve
because does not
3: event
STEPbecause
shift,
reduces cost, D1
The shift causes
production technology
makes production Q
price
is not to fallof the
one Q1 Q2
more profitable at
and quantity
factors that to rise.
affect
any given price.
demand.
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EXAMPLE 3: A Shift in Both Supply

EVENTS:
and Demand
price of gas rises AND P
new technology reduces S1 S2
production costs
STEP 1: P2
Both curves shift.
P1
STEP 2:
Both shift to the right.
STEP 3: D1 D2
Q rises, but effect Q
on P is ambiguous: Q1 Q2
If demand increases more
than supply, P rises.
76

EXAMPLE 3: A Shift in Both Supply

EVENTS: and Demand
price of gas rises AND P
new technology reduces S1 S2
production costs

STEP 3, cont.
P1
But if supply
increases more P2
than demand,
D1 D2
P falls.
Q
Q1 Q2

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CONCLUSION:
How Prices Allocate Resources
One of the Ten Principles from Chapter 1:
Markets are usually a good way
to organize economic activity.

In market economies, prices adjust to balance

supply and demand. These equilibrium prices
are the signals that guide economic decisions
and thereby allocate scarce resources.

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