Chapter 2

Chapter 2
The Basics of
Supply and
Demand
Topics to Be Discussed
Supply and Demand
The Market Mechanism
Changes in Market Equilibrium
Elasticities of Supply and Demand
Short-Run Versus Long-Run Elasticities
Topics to Be Discussed
Understanding and Predicting the Effects

of Changing Market Conditions
Effects of Government Intervention--Price

Controls
Introduction
Applications of Supply and Demand

Analysis
Understanding
and predicting how world

economic conditions affect market price and
production
Analyzing
the impact of government price

controls, minimum wages, price supports,
and production incentives
Introduction
Applications of Supply and Demand

Analysis
Analyzing
how taxes, subsidies, and import

restrictions affect consumers and producers
Supply and Demand
The Supply Curve

The
supply curve shows how much of a good

producers are willing to sell at a given price,
holding constant other factors that might
affect quantity supplied
Supply and Demand
The Supply Curve

This
price-quantity relationship can be shown

by the equation:
Qs QS (P )
Supply and Demand

The
TheSupply
Supply
Curve
CurveGraphically
Graphically
Price
($ per unit)
Vertical axis measures
price (P) received
per unit in dollars
Horizontal axis measures

quantity (Q) supplied in
number of units per
time period
Quantity
Supply and Demand

Price
($ per unit)
The
TheSupply
Supply
Curve
CurveGraphically
Graphically
P2
The supply curve slopes
upward demonstrating that
at higher prices firms
will increase output
P1
Q1
Q2
Quantity
Supply and Demand
Non-price Determining Variables of

Supply
Costs
of Production
Labor
Capital
Raw Materials
Supply and Demand

Change
Changein
inSupply
Supply
The cost of raw

materials falls
At P1, produce Q2
At P2, produce Q1
Supply curve shifts right

to S
P1
P2
More produced at any

price on S than on S
Q0
Q1
Q2
Supply and Demand
Supply - A Review
Supply
is determined by non-price supplydetermining variables as such as the cost of

labor, capital, and raw materials.
Changes
in supply are shown by shifting the

entire supply curve.
Supply and Demand
Supply - A Review
Changes
in quantity supplied are shown by

movements along the supply curve and are
caused by a change in the price of the
product.
Supply and Demand
The Demand Curve

The
demand curve shows how much of a

good consumers are willing to buy as the
price per unit changes holding non-price
factors constant.
This
price-quantity relationship can be shown

by the equation:
QD QD(P)
Supply and Demand

Price
($ per unit)
Vertical axis measures
price (P) paid
per unit in dollars
Horizontal axis measures

quantity (Q) demanded in
number of units per
time period
Quantity
Supply and Demand

Price
($ per unit)
The demand curve slopes

downward demonstrating
that consumers are willing
to buy more at a lower price
as the product becomes
relatively cheaper and the
consumers real income
increases.
D
Quantity
Supply and Demand
Non-price Determining Variables of

Demand
Income
Consumer
Price
Tastes
of Related Goods
Substitutes
Complements
Supply and Demand

Change
Changein
inDemand
Demand
Income Increases
P2
At P1, produce Q2
At P2, produce Q1
Demand Curve shifts right P1
More purchased at any

price on D than on D
Q0
Q1
Q2
Shifts in Supply and Demand
Demand - A Review
Demand
is determined by non-price demanddetermining variables, such as, income, price

of related goods, and tastes.
Changes
in demand are shown by shifting

the entire demand curve.
Changes
in quantity demanded are shown by

movements along the demand curve.

Price
($ per unit)
S
The curves intersect at
equilibrium, or marketclearing, price. At P0 the
quantity supplied is equal
to the quantity demanded
at Q0 .
P0
D
Q0
Quantity
Characteristics of the equilibrium or

market clearing price:
QD
= QS
No
shortage
No
excess supply
No
pressure on the price to change

Price
($ per unit)
S
Surplus
P1
If price is above equilibrium:

1) Price is above the
market clearing price
2) Qs > Qd
3) Price falls to the
market-clearing price
P0
D
Q0
Quantity

A
ASurplus
Surplus
The market price is above equilibrium

There
is excess supply
Producers
lower prices
Quantity
demanded increases and quantity

supplied decreases
The
market continues to adjust until the

equilibrium price is reached.

Price
($ per unit)
Surplus
P1
Assume the price is P1 , then:

1) Qs : Q1 > Qd : Q2
2) Excess supply is Q1:Q2.
3) Producers lower price.
4) Quantity supplied decreases
and quantity demanded
increases.
5) Equilibrium at P2Q3
P2
D
Q1
Q3
Q2 Quantity

Surplus
Surplus -- Review:
Review:
The market price is above equilibrium:

There
is excess supply
Producers
lower prices
Quantity
demanded increases and quantity

supplied decreases
The
market continues to adjust until the

equilibrium price is reached

Price
($ per unit)
P3
P2
Shortage
Q1
Q3
Assume the price is P2 , then:

1) Qd : Q2 > Qs : Q1
2) Shortage is Q1:Q2.
3) Producers raise price.
4) Quantity supplied increases
and quantity demanded
decreases.
5) Equilibrium at P3, Q3
D
Q2 Quantity

Shortage
Shortage
The market price is below equilibrium:

There
is a shortage
Producers
raise prices
Quantity
demanded decreases and quantity

supplied increases
The
market continues to adjust until the new

equilibrium price is reached.
Market Mechanism Summary

1) Supply and demand interact to
determine the market-clearing price.
2) When not in equilibrium, the market
will
adjust to alleviate a shortage or
surplus and return the market to equilibrium.
3) Markets must be competitive for the
mechanism to be efficient.
Changes In Market Equilibrium
Equilibrium prices are determined by the

relative level of supply and demand.
Supply and demand are determined by

particular values of supply and demand
determining variables.
Changes in any one or combination of these

variables can cause a change in the
equilibrium price and/or quantity.
Raw material prices

fall
S shifts to S
Surplus
@ P1 of Q1,
Q2
Equilibrium
P1
P3
@ P3, Q3
Q1 Q3 Q2
Income Increases
Demand
Shortage
shifts to D1
@ P1 of Q1, Q2 P3
Equilibrium
@ P3 , Q 3
P1
Q2 Q1 Q3
Income Increases &

raw material prices fall
increase in D is
greater than the
increase in S
The
P2
P1
Equilibrium
price and
quantity increase to P2,
Q2
Q1
Q2
Shifts in Supply and Demand
When supply and demand change

simultaneously, the impact on the
equilibrium price and quantity is
determined by:
1) The relative size and direction of the
change
2) The shape of the supply and demand
models
The Price of Eggs and the Price

of a College Education Revisited
The real price of eggs fell 59% from 1970

to 1998.
Supply increased due to the increased

mechanization of poultry farming and the
reduced cost of production.
Demand decreased due to the increasing

consumer concern over the health and
cholesterol consequences of eating eggs.
Market for Eggs

P
Prices fell until

a new equilibrium
was reached at $0.26
and a quantity
of 5,300 million dozen
S1970
(1970
dollars per
dozen)
S1998
$0.61
$0.26
D1970
5,300 5,500
D1998
Q (million dozens)
The Price of a College Education
The real price of a college education rose

68 percent from 1970 to 1995.
Supply decreased due to higher costs of

equipping and maintaining modern
classrooms, laboratories and libraries, and
higher faculty salaries.
Demand increased due a larger

percentage of a larger number of high
school graduates attending college.
Market for a College Education

P
S1995
(annual cost
in 1970
dollars)
$4,248
Prices rose until

a new equilibrium
was reached at $4,573
and a quantity
of 12.3 million students
S1970
$2,530
D1970
8.6
14.9
D1995
Q (millions of students enrolled))
Wage Inequality in the United States

Real
after-tax income from 1977 to 1999:
Rose 40+% for the top 20% of the income

distribution
Fell 10+% for the bottom 20%
Question
Why
did the income distribution become

more unequal for 1977 to 1999?
Consumption & Price of Copper

1880-1998
The Long-Run Behavior

of Natural Resource Prices
Observations
Consumption
of copper has increased about

a hundred fold from 1880 through 1998
indicating a large increase in demand.
The
real price for copper has remained

relatively constant.

Price
S1900
S1950
S1998
Long-Run Path of
Price and Consumption
D1900
D1950
D1998
Quantity
Conclusion
Decreases
in the costs of production have

increased the supply by more than enough to
offset the increase in demand.
Observation
To accurately
predict the future price of a

product or service, it is necessary to consider
the potential change in supply and demand.
1970
predictions for oil and other minerals

proved incorrect because they only
considered the demand side of the market.
Generally, elasticity is a measure of the

sensitivity of one variable to another.
It tells us the percentage change in one

variable in response to a one percent
change in another variable.

Price
PriceElasticity
Elasticityof
ofDemand
Demand
Measures the sensitivity of quantity

demanded to price changes.
It
measures the percentage change in the

quantity demanded for a good or service that
results from a one percent change in the
price.
The price elasticity of demand is:
EP (%Q)/(%P)

Price
PriceElasticity
Elasticityof
ofDemand
Demand
The percentage change in a variable is

the absolute change in the variable
divided by the original level of the
variable.

Price
PriceElasticity
Elasticityof
ofDemand
Demand
So the price elasticity of demand is also:
Q/Q P Q
EP
P/P Q P
Interpreting Price Elasticity of Demand

Values
1) Because of the inverse relationship
between P and Q; EP is negative.
2) If EP > 1, the percent change in quantity is
greater than the percent change in
price.
We say the demand is price
elastic.
Interpreting Price Elasticity of Demand

Values
3) If EP < 1, the percent change in
quantity is less than the percent
change in price. We say the demand
is price inelastic.

Price
PriceElasticity
Elasticityof
ofDemand
Demand
The primary determinant of price

elasticity of demand is the availability of
substitutes.
Many
Few
substitutes demand is price elastic
substitutes demand is price inelastic
Price Elasticities of Demand

Price
4
EP -
Q = 8 - 2P
The lower portion of

a downward sloping
demand curve is less elastic
than the upper portion.
Ep = -1
2
Linear Demand Curve

Q = a - bP
Q = 8 - 2P
Ep = 0
4

Price
Infinitely Elastic Demand
P*
EP -
Quantity

Price
Completely Inelastic Demand
EP 0
Q*
Quantity

Other
OtherDemand
DemandElasticities
Elasticities
Income elasticity of demand measures

the percentage change in quantity
demanded resulting from a one percent
change in income.

Other
OtherDemand
DemandElasticities
Elasticities
The income elasticity of demand is:
Q/Q
I Q
EI
I/I
Q I

Other
OtherDemand
DemandElasticities
Elasticities
Cross elasticity of demand measures the

percentage change in the quantity
demanded of one good that results from
a one percent change in the price of
another good.
For example consider the substitute

goods, butter and margarine.
The cross elasticity of demand is:
Qb/Qb Pm Qb
EQbPm
Pm/Pm Qb Pm
The cross elasticity for substitutes is positive,

while that for complements is negative.

Elasticities
Elasticitiesof
ofSupply
Supply
Price elasticity of supply measures the

percentage change in quantity supplied
resulting from a 1 percent change in price.
The elasticity is usually positive because

price and quantity supplied are directly
related.

Elasticities
Elasticitiesof
ofSupply
Supply
We can refer to elasticity of supply with

respect to interest rates, wage rates, and the
cost of raw materials.

The
TheMarket
Marketfor
forWheat
Wheat
1981 Supply Curve for Wheat

QS
= 1,800 + 240P
1981 Demand Curve for Wheat

QD
= 3,550 - 266P

The
TheMarket
Marketfor
forWheat
Wheat
Equilibrium: Q S = Q D
1,800 240 P 3,550 266 P

506 P 1,750
P 3.46 / bushel
Q 1,800 (240)(3.46) 2,630 million bushels
Chapter 2: The Basics of Supply and Demand
Slide 63

The
TheMarket
Marketfor
forWheat
Wheat
P QD
3.46
E
(2.66) .035 Inelastic

Q P
2,630
D
P
P QS
3.46
E
(2.40) .032 Inelastic

Q P 2,630
S
P
Chapter 2: The Basics of Supply and Demand
Slide 64

The
TheMarket
Marketfor
forWheat
Wheat
Assume the price of wheat is $4.00/bushel

QD 3,550 ( 266)(4.00) 2,486
4.00
Q
( 266) 0.43
2,486
D
P
Changes in the Market: 1981-1998

The
TheMarket
Marketfor
forWheat
Wheat
Supply (Qs) Demand (QD)
Equilibrium Price (Qs = QD)
1981
1800 + 240P
3550 - 266P
1800+240P = 3550-266P
506P = 1750
P1981 = $3.46/bushel
1998
1,944 + 207P
3,244 - 283P
1,944+207P = 3,244-283P
P1998 = $2.65/bushel
Short-Run Versus
Long-Run Elasticities
Demand
Demand
Price elasticity of demand varies with the

amount of time consumers have to
respond to a price.
Short-Run Versus
Demand
Demand
Most goods and services:

Short-run
elasticity is less than long-run

elasticity. (e.g. gasoline, Drs.)
Other Goods (durables):

Short-run
elasticity is greater than long-run

elasticity (e.g. automobiles)
Gasoline: Short-Run and

Long-Run Demand Curves
Price
DSR
People tend to
drive smaller and
more fuel efficient
cars in the long-run
Gasoline
DLR
Quantity
Automobiles: Short-Run and

Long-Run Demand Curves
Price
DLR
People may put
off immediate
consumption, but
eventually older cars
must be replaced.
Automobiles
DSR
Quantity
Short-Run Versus
Income
IncomeElasticities
Elasticities
Income elasticity also varies with the

amount of time consumers have to
respond to an income change.
Short-Run Versus
Income
IncomeElasticities
Elasticities

Income
elasticity is greater in the long-run

than in the short run.
Higher incomes may be converted into

bigger cars so the income elasticity of
demand for gasoline increases with time.
Short-Run Versus
Income
IncomeElasticities
Elasticities
Other Goods (durables):

Income
elasticity is less in the long-run than

in the short-run.
Originally, consumers will want to hold

more cars.
Later, purchases will only to be to replace

old cars.
Short-Run Versus
The
TheDemand
Demandfor
for
Gasoline
Gasolineand
andAutomobiles
Automobiles
Gasoline and automobiles are

complementary goods.
Short-Run Versus
The
TheDemand
Demandfor
for
Gasoline
Gasolineand
andAutomobiles
Automobiles
Gasoline
The
long-run price and income elasticities

are larger than the short-run elasticities.
Automobiles
The
long-run price and income elasticities

are smaller than the short-run elasticities.
Short-Run Versus
The
TheDemand
Demandfor
forGasoline
Gasoline
Years Following Price or Income Change

Elasticity
Price
-0.11 -0.22 -0.32 -0.49 -0.82 -1.17
Income
0.07 0.13
0.20
0.32
0.54
0.78
Short-Run Versus
The
TheDemand
Demandfor
forAutomobiles
Automobiles
Years Following Price or Income Change

Elasticity
Price
Income
-1.20 -0.93 -0.75 -0.55 -0.42 -0.40

3.00 2.33
1.88
1.38
1.02
1.00
Short-Run Versus
The
TheDemand
Demandfor
for
Gasoline
Gasolineand
andAutomobiles
Automobiles
Data Explains:
1) Why the price of oil did not continue to
rise above $30/barrel even though it
rose very rapidly in the early 1970s.
2) Why automobile sales are so sensitive
to the business cycle.
Short-Run Versus
Supply
Supply

Long-run
price elasticity of supply is greater

than short-run price elasticity of supply.
Other Goods (durables, recyclables):

Long-run
price elasticity of supply is less

than short-run price elasticity of supply
Short-Run Versus
Primary
and
PrimaryCopper:
Copper:Short-Run
Short-Run
and
Long-Run
Elasticities
Long-Run
Long-RunSupply
SupplyCurves
Curves
Price
SSR
SLR
Due to limited
capacity, firms
are limited by
output constraints
in the short-run.
In the long-run, they
can expand.
Quantity
Short-Run Versus
Secondary
Copper:
and
Secondary
Copper:Short-Run
Short-Run
and
Long-Run
Elasticities
Long-Run
Long-RunSupply
SupplyCurves
Curves
Price
SLR
SSR
Price increases
provide an incentive
to convert scrap
copper into new supply.
In the long-run, this
stock of scrap copper
begins to fall.
Quantity
Short-Run Versus
Supply
Supplyof
of Copper
Copper
Price Elasticity of:
Short-run
Long-run
Primary supply
0.20
1.60
Secondary supply
0.43
0.31
Total supply
0.25
1.50
Short-Run Versus
Weather
Weatherin
in Brazil
Brazil and
and
the
theprice
priceof
of Coffee
Coffee
in
inNew
New York
York
Elasticity explains why coffee prices are

very volatile.
Due
to the differences in supply elasticity in

the long-run and short run.
Price of Brazilian Coffee
Short-Run Versus
Coffee
Coffee
S S
Price
A freeze or drought
decreases the supply
of coffee
P1
P0
Short-Run
1) Supply is completely inelastic
2) Demand is relatively inelastic
3) Very large change in price
D
Q1
Q0
Quantity
Short-Run Versus
Coffee
Coffee
Price
P2
P0
Intermediate-Run
1) Supply and demand are
more elastic
2) Price falls back to P2.
3) Quantity falls to Q2
D
Q2 Q0
Quantity
Short-Run Versus
Coffee
Coffee
Price
Long-Run
1) Supply is extremely elastic.
2) Price falls back to P0.
3) Quantity increase to Q0.
P0
D
Q0
Quantity

First, we must learn how to fit linear

demand and supply curves to market
data.
Then we can determine numerically how

a change in a variable will cause supply
or demand to shift and thereby affect the
market price and quantity.

Available Data
Equilibrium
Price, P*
Equilibrium
Quantity, Q*
Price
elasticity of supply, ES, and

demand, ED.

Price
Supply: Q = c + dP
a/b
ED = -bP*/Q*
ES = dP*/Q*
P*
-c/d
Demand: Q = a - bP
Q*
Quantity

Lets begin with the equations for supply

and demand:
Demand: QD = a - bP
Supply:
QS = c + dP
We must choose numbers for a, b, c,

and d.

Step 1:
Recall:
E (P/Q)( Q/P)

For linear demand curves, the change in

quantity divided by the change in price is
constant (equal to the slope of the curve).

Substituting the slopes for each into the

formula for elasticity, we get:
ED - b(P * /Q*)
ES d(P * /Q*)

Since we will have values for ED, ES, P*,

and Q*, we can solve for b & d, and a &
c.
QD a bP
QS c dP

Deriving the long-run supply and demand

for copper:
The
relevant data are:
Q* = 7.5 mmt/yr.
P* = 75 cents/pound
ES = 1.6
ED = -0.8

Es = d(P*/Q*)
Ed = -b(P*/Q*)
1.6 = d(75/7.5)
= 0.1d
-0.8 = -b(.75/7.5)
= -0.1b
d = 1.6/0.1 = 16
b = 0.8/0.1 = 8

Supply = QS* = c + dP*
Demand = QD* = a -bP*
7.5 = c + 16(0.75)
7.5 = a -(8)(.75)
7.5 = c + 12
7.5 = a - 6
c = 7.5 - 12
a = 7.5 + 6
c = -4.5
a =13.5
Q = -4.5 + 16P
Q = 13.5 - 8P

Setting supply equal to demand gives:

Supply = -4.5 + 16p = 13.5 - 8p = Demand
16p + 8p = 13.5 + 4.5
p = 18/24 = .75

Price
Supply: QS = -4.5 + 16P
a/b
.75
-c/d
Demand: QD = 13.5 - 8P
7.5
Mmt/yr

We have written supply and demand so

that they only depend upon price.
Demand could also depend upon income.
Demand would then be written as:
Q a bP fI

We know the following information

regarding the copper industry:
I
= 1.0
P*
= 0.75
Q*
= 7.5
=8
Income
elasticity: E = 1.3

f can be found by substituting known

values into the income elasticity formula:
E ( I / Q)(Q / I )
and
f Q / I

Solving for f gives:

1.3 = (1.0/7.5)f
f = (1.3)(7.5)/1.0 = 9.75

Solving for a gives:
Q a bP fI
*
7.5 = a - 8(0.75) + 9.75(1.0)

a = 3.75
Declining Demand and the

Behavior of Copper Prices
The relevant factors leading to a

decrease in the demand for copper are:
1) A decrease in the growth rate of power
generation
2) The development of substitutes: fiber
optics and aluminum
Real versus Nominal

Prices of Copper 1965 - 1999
Real versus Nominal

We will try to estimate the impact of a 20

percent decrease in the demand for
copper.
Recall the equation for the demand

curve:
Q = 13.5 - 8P
Real versus Nominal

Multiply this equation by 0.80 to get the

new equation. This gives:
Q = (0.80)(13.5 - 8P)
Q = 10.8 - 6.4P
Recall the equation for supply:

Q = -4.5 + 16P
Real versus Nominal

The new equilibrium price is:

-4.5 + 16P = 10.8 - 6.4P
-16P + 6.4P = 10.8 + 4.5
P = 15.3/22.4
P = 68.3 cents/pound
Real versus Nominal

The twenty percent decrease in demand

resulted in a reduction in the equilibrium
price to 68.3 cents from 75 cents, or 10
percent.
Price of Crude Oil
Upheaval in the World Oil Market
We can predict numerically the impact of

a decrease in the supply of OPEC oil.
In 1995:
P*
= $18/barrel
World
demand and total supply = 23 bb/yr.
OPEC
supply = 10 bb/yr.
Non-OPEC
supply = 13 bb/yr
Price Elasticity Estimates

Short-Run Long-Run
World Demand:
Competitive Supply
(non-OPEC)
-0.05
-0.40
0.10
0.40
Short-Run Impact of a stoppage of Saudi

Production equal to 3 bb/yr.
Short-run
D = 24.08 - 0.06P
Short-run
Demand
Competitive Supply
SC = 11.74 + 0.07P
Short-Run Impact of a stoppage of Saudi

Production equal to 3 bb/yr.
Short-run
Total Supply--before supply

reduction (includes OPEC, 10bb/yr)
ST = 21.74 + 0.07P
Short-run
Total Supply--after supply reduction
ST = 18.74 + 0.07P
New Price After Reduction

Demand = Supply
24.08 - 0.06P = 18.74 + 0.07P
P = 41.08
Impact of Saudi Production Cut

SC
D ST ST
Price 45
($ per
barrel) 40
Short-Run
Effect
35
30
25
20
18
15
10
5
0
10
15
20 23 25
30
Quantity
35 (billions barrels/yr)
Long-Run Impact of a stoppage Saudi

Production equal to 3 bb/yr..
Long-run
D = 32.18 - 0.51P
Long-run
Demand
Total Supply
S = 17.78 + 0.29P
New Price is found setting long-run

supply equal to long-run demand:
32.18 - 0.51P = 14.78 + 0.29P
P = 21.75
Impact of Saudi Production Cut

Price 45
SC
($ per
barrel) 40
ST ST
Long-run Effect
Due to the elasticity
of the long-run
supply and demand
curves, the long-run
effect of a cut
in production is
much less.
35
30
25
20
18
15
10
5
0
10
15
20 23 25
30
35
Quantity
(billions barrels/yr)
Effects of Government Intervention

--Price Controls
If the government decides that the

equilibrium price is too high, they may
establish a maximum allowable ceiling
price.
Effects of Price Controls

Price
S
If price is regulated to
be no higher than Pmax,
quantity supplied falls
to Q1 and quantity
demanded increases to
Q2. A shortage results
P0
Pmax
D
Excess demand
Q0
Quantity
Price Controls and

Natural Gas Shortages
In 1954, the federal government began

regulating the wellhead price of natural
gas.
In 1962, the ceiling prices that were

imposed became binding and shortages
resulted.
Price Controls and

Price controls created an excess demand

of 7 trillion cubic feet.
Price regulation was a major component

of U.S. energy policy in the 1960s and
1970s, and it continued to influence the
natural gas markets in the 1980s.
Price Controls and

The
TheData:
Data: Natural
NaturalGas
Gas
PES 0.2
Cross elasticity of supply for oil 0.1
D
PE
0.5
Cross elasticity of demand for oil 1.5

Supply : Q 14 2 PG .25 PO
Demand : Q 5 PG 3.75 PO
Supply Demand @ $2/TcF
Price Controls and

The
TheData:
Data: Natural
NaturalGas
Gas
1975 regulated price $1.00

At $1.00/TcF
QS 18 TcF and Q 25 TcF
Shortage 7 TcF/yr
Summary
Supply-demand analysis is a basic tool of

microeconomics.
The market mechanism is the tendency

for supply and demand to equilibrate, so
that there is neither excess demand nor
excess supply
Summary
Elasticities describe the responsiveness of

supply and demand to changes in price,
income, and other variables.
Elasticities pertain to a time frame.
If we can estimate the supply and demand

curves for a particular market, we can
calculate the market clearing price.
Summary
Simple numerical analysis can often be

done by fitting linear supply and demand
curves to data on price and quantity and
to estimates of elasticities.
End of Chapter 2
The Basics of
Supply and
Demand

Chapter 2

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Chapter 2

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Chapter 2

Supply and Demand

The Market Mechanism

Changes in Market Equilibrium

Elasticities of Supply and Demand

Short-Run Versus Long-Run Elasticities

Understanding and Predicting the Effects

Effects of Government Intervention--Price

Applications of Supply and Demand

and predicting how world

the impact of government price

Applications of Supply and Demand

how taxes, subsidies, and import

Supply and Demand

The Supply Curve

supply curve shows how much of a good

Supply and Demand

The Supply Curve

price-quantity relationship can be shown

Supply and Demand

Horizontal axis measures

Supply and Demand

Supply and Demand

Non-price Determining Variables of

Supply and Demand

The cost of raw

Supply curve shifts right

More produced at any

Supply and Demand

is determined by non-price supplydetermining variables as such as the cost of

in supply are shown by shifting the

Supply and Demand

in quantity supplied are shown by

Supply and Demand

The Demand Curve

demand curve shows how much of a

price-quantity relationship can be shown

Supply and Demand

Horizontal axis measures

Supply and Demand

The demand curve slopes

Supply and Demand

Non-price Determining Variables of

Supply and Demand

Demand Curve shifts right P1

More purchased at any

Shifts in Supply and Demand

is determined by non-price demanddetermining variables, such as, income, price

in demand are shown by shifting

in quantity demanded are shown by

The Market Mechanism

The Market Mechanism

Characteristics of the equilibrium or

pressure on the price to change

The Market Mechanism

If price is above equilibrium:

The Market Mechanism

The market price is above equilibrium

demanded increases and quantity

market continues to adjust until the

The Market Mechanism

Assume the price is P1 , then:

The Market Mechanism