Chapter 2

DEMAND,
SUPPLY &
MARKET
EQUILIBRIUM

1
 Chapter Outline
1.1 Introduction: Market
and the Circular Flow
1.2 Demand (DD)
1.3 Supply (SS)
1.4 Market Equilibrium
1.5 Change in Equilibrium
(SS & DD)
1.6 SS/DD Analysis:
Example 2
 1.1 INTRODUCTION
Market & the circulation flow

Economics decision-making units

Demand &
supply
interaction

3
Markets
A market is a group of buyers and sellers
of a particular goods and services.
A market may be local, national or
international in scope.
This chapter concern purely competitive
market with a large number of
independent buyers and sellers.

4
 1.2 DEMAND
Howmanypacksofai
yubingwillstudent
Relationshipbetween buyatapriceofRM2?
price&quantitydemanded Whatifthepriceis
RM1.50?

Quantity consumers are both willing

and able to buy at each possible
price during a given time period, other
things constant.
can be defined as the purchase of
product 5
Law of Demand
Says that quantity demanded varies inversely, or
negatively, to the price, other things constant.
Negative relationship between price and quantity
demanded.
The higher the price, the smaller the quantity
demanded.

Figure: Price & Quantity

Demanded: The Law of
Demand

6
Demand Schedule & Demand
Curve
The demand schedule is a table that
shows the relationship between the price
of the good and the quantity demanded.

The demand curve is a graph of the

relationship between the price of a good
and the quantity demanded.

Downward sloping & to the right because

law of demand.

7
 Example
Mays Demand Schedule and
Demand Curve
Price of
Ice-Cream Cone
$3.00

2.50

1. A decrease
2.00
in price ...

1.50

1.00

0.50

0 1 2 3 4 5 6 7 8 9 10 11 12 Quantity of
Ice-Cream Cones
2. ... increases quantity
of cones demanded. 8
Individual Demand & Market
demand

The individual demand is the

relationship between the quantity
demanded by a single buyer and its
prices
The market demand is the relationship
between the total quantity demanded
by all consumers in the market and
its price.

9
 Example
The market demand curve is the horizontal
sum of the individual demand curves!
When the price is $2.00, When the price is $2.00, The market demand at
Catherine will demand 4 Nicholas will demand 3 $2.00 will be 7 ice-cream
ice-cream cones. ice-cream cones. cones.
Catherines Demand + Nicholass Demand = Market Demand

Price of Ice- Price of Ice- Price of Ice-

Cream Cone Cream Cone Cream Cone

2.00 2.00 2.00

1.00 1.00 1.00

3 5 7 13
4 8
Quantity of Ice-Cream Cones Quantity of Ice-Cream Cones Quantity of Ice-Cream Cones

When the price is $1.00, When the price is $1.00, The market demand at
Catherine will demand 8 Nicholas will demand 5 $1.00, will be 13 ice-
ice-cream cones. ice-cream cones. cream cones.
10
Changes in Quantity Demanded
& Changes in Demand

Changes in quantity demanded

result in movement along the
demand curve due a change in
price while other factors remain
constant. (upward/downward
movement)

Change in demand is the shift of

the demand curve due a change in
other factors while price remains
constant. (leftward/ rightward
11
shift)
 Changes in Quantity
Demanded
A tax on sellers of ice-
Price of Ice-
Cream cream cones raises
Cones
the price of ice-cream
B cones and results in a
$2.0
0
movement along the
demand curve.

1.00 A

D
0 4 8Quantity of12 Ice-Cream Cones
Change in Demand
A shift in the demand curve either to
the left or right caused by any
changes that alters the quantity
demanded at every price. Such as:
Income
Prices of related goods
Tastes
Expectations
Number of buyers

13
 Shifts in The Demand
Curve
Price of
Ice-Cream
Cone

Increase
in demand

Decrease
in demand
Demand
curve, D2
Demand
curve, D1
Demand curve, D3
0 Quantity of
14
Ice-Cream Cones
Changes in Consumer
Income
Goods can be classified into two
broad categories:
Normal goods: the demand
increases when income
increases and decreases when
income decreases
Inferior goods: the demand
decreases when income
increases and increases when
income decreases
15
Changes in Price of Related
Good
(i) Substitute Goods
(-) A product that can be used in
place of another product
(-) A change in the price of
substitute products affect the
demand for the product in the
same direction in which the
price change.
(-) E.g: tea vs coffee; a bus ride vs
an LRT ride
( Pcoffee Qdd coffee DDtea)
16
Changes in Price of Related
Good
(ii) Complementary Goods
- A product that is used in
conjunction with another
product.
- The change in the price of a
complementary product affects
the demand for the product in
the opposite direction to the
change price.
- E.g: a disk and computer, pen
and ink.
( Ppen Qdd pen DDink )
17
 Taste & Preference

Tastes and preferences of

consumers change significantly.
If a product become more
fashionable, the demand for it
will increase and if the same
product becomes outdated, the
demand for it will fall.
E.g: Changes in music, apparel or
recreation.
18
 Expectations

The higher the expected future

price of a product, the higher the
current demand for that product and
vice versa.

E.g: When the government plans to

increase the price of sugar the
following week, the demand for sugar
will immediately increase.

19
Population or Number of
Buyers

A larger population with a high

rate of growth creates greater
demand for goods and services.
E.g: An increase in the population
of UTAR would increase the
demand for houses, F & B, and
other goods and services.

20
Summary for Movement/Shift in
Demand

Taste / preference

21
1.3 SUPPLY

Supply indicates how much of a good

producers are willing and able to offer
for sale per period at each possible price,
other things constant
Law of supply states that the quantity
supplied is usually directly related to its
price, other things constant
The lower the price, the smaller the quantity
supplied
The higher the price, the greater the quantity
supplied
22
Supply Schedule & Supply
Curve

The supply schedule is a table

that showing how much of a
product firms will set at different
prices.
The supply curve is a graph
illustrating how much of a
product a firm will set at
different prices.
23
Bens Supply Schedule and
Supply Curve
Price of
Ice-Cream
Cone
$3.00

2.50
1. An
increase
in price ... 2.00

1.50

1.00

0.50

0 1 2 3 4 5 6 7 8 9 10 11 12 Quantity of
Ice-Cream Cones
24
2. ... increases quantity of cones supplied.
Individual Supply & Market
Supply

The individual supply is the

relationship between price of
good and the quantity an
individual producer is willing
and able to sell per period,
other things constant.
The market supply is the
sum of all that is supplied each
period by all producers of a
single product.
25
Market Supply Curve

26
 Changes in Quantity
Supplied & Changes in
Supplied
A changes in quantity
supplied result in the
movement along the supply
curve due a change in price
while other factors remain
constant.
Change in supply is shift of
supply curve resulting from a
change in one of the
determinants of supply other
27
 Change in Quantity
Supplied
Price of Ice-
Cream S
Cone
C
$3.0
0 A rise in the price
of ice cream
cones results in a
movement along
A the supply curve.
1.00

Quantity of
Ice-Cream
0 1 5 28 Cones
 Changed in Supply
A shift of the supply curve, either
to the left or right.
Determinants of supply other than
the price of the good
Cost of production
Technology
Prices of related goods
Expectation
Number of sellers 29
 Shifts in The Supply
Curve
Price of
Ice-Cream Supply
Cone curve, S3

Supply
Decrease curve, S1
in supply Supply
curve, S 2

Increase
in supply

0 Quantity of
30
Ice-Cream Cones
 The Cost of Production
Response to the factor of production
(labor, land, capita, energy, and so on).
Supply of a goods are negatively related
to the price of the inputs used to make
the good.
Objective is to maximize profit.
Example: to produce ice-cream, sellers use
various inputs such as cream, sugar, flavoring, ice-
cream machines. When price of one or more of
these inputs rises, producing ice-cream is less
profitable & firm supply less ice-cream.
31
 Technology
Represents the economys knowledge
about how to combine resources
efficiently.
If a better technology is discovered,
production costs will fall. Thus,
suppliers will be more willing & able to
supply the good at each price.
Example: when new technology are introduced
in the production of sushi, supply of sushi will
increase and shift the supply curve.

32
 Price of Related Goods
Substitutes Goods
If there is an increase in the price of
substitute goods in production, supply of a
good will decrease.
Example: Pepsi and Coke
( Ppepsi QSS pepsi SScoke )
Complementary Goods
An increase in the price of complementary
goods will increase the supply of a good &
vice versa.
Example: Pen and Ink
( Ppen QSS pen SSink )
33
 Expectations
Expectation of price in the
future could either increase or
decrease current supply.
Example: when government
announced an increase in the price of
petrol, current supply will decrease
because the supplier wants to sell after
the price hike to gain profit with new
price.
34
 Number of Sellers
Market supply sums the amount
supplied at each price by all
producers, market supply depends on
the number producers in the market.
Example: if there are more than one
economic rice shop at New Town, there will be
more economic rice supplied.

Shift of SS curve
35
Summary for
Movement/Shift in Supply

36
 1.4 MARKET EQUILIBRIUM
Output (Product) Market
Consumers Firms
DD & SS Interaction
(Demand) (Supply)
3 set of market condition / effect:

(a) The quantity (b) The quantity (c) The quantity

demanded equal demanded exceeds supplied exceeds
the quantity the quantity the quantity
supplied at the supplied at the demanded at the
current price. This current price. This current price. This
situation called situation called situation called
equilibrium excess demand excess supply
37
or shortage or surplus
 Equilibrium
Price of
Ice-Cream
Cone Supply

Equilibrium price Equilibrium

$2.00

Equilibrium Demand
quantity

0 1 2 3 4 5 6 7 8 9 10 11 12 13
Quantity of 38
Ice-Cream Cones
 Market Equilibrium
The condition that exists in a market
when the plans of buyers match those
of sellers, so quantity demanded equals
quantity supplied and the market
clears. There is no tendency for price to
change.
DD = SS
Equilibrium price
The price that balances quantity
supplied and quantity demanded.
Equilibrium quantity
The quantity supplied and the
39 quantity
 Excess Supply
(Surplus)
Price of
Ice-Cream Supply
Cone Surplus
$2.50

2.00

Demand

0 4 7 10 Quantity of
Quantity Quantity Ice-Cream
demanded supplied Cones
40
Excess Supply (Surplus)

When:
Price > Equilibrium Price,
then
Qs > Qd
- There is excess supply or a
surplus.
- Suppliers will lower the price
to increase sales, thereby
moving toward equilibrium.
41
Excess Demand
(Shortage)
Price of
Ice-Cream Supply
Cone

$2.00

1.50
Shortage

Demand

0 4 7 10 Quantity of
Quantity Quantity Ice-Cream
supplied demanded Cones
42
Excess Demand (Shortage)
When:
Price < Equilibrium Price, then
Qd > Qs
- There is excess demand or a
shortage.
- Suppliers will raise the price
due to too many buyers
chasing too few goods,
thereby moving toward
equilibrium.
43
 1.5 CHANGE IN
EQUILIBRIUM
The market equilibrium will
change when there is a shift in
the demand or supply curve.
We will see what happens
when:
The demand curve shifts and
supply remains constant.
The supply curve shifts and
demand remains constant.
Both the demand and supply 44
 Three Steps for Analyzing
Changes in Equilibrium
1. Decide whether the events
shifts the supply or demand
curve (or both)
2. Decide in which direction the
curve shifts.
3. Use the supply-and-demand
diagram to see how the shift
changes the equilibrium price
and quantity. 45
 Effect of Change in
Demand
Change in DD can arise from a
number of factors; change in
income, tastes, etc.
Supposethereisan
Price
SS increaseinthedemandfor
E1 Pilotpens,thedemand
E0 curvewillshift
D0D1 rightwards,toD1.
Quantity
Equilibriumpricewill
increase,andequilibrium
quantitywillalso
increase.
Note:Ifthereisadecreaseinthedemand,the
effectwillbeviceversa. 46
 Effect of Change in
Supply
Change in SS can arise from a
number of factors; change in
cost, technology, etc.
Price S0S1 Supposethereisan
E0 increaseinthesupplyfor
E1 Pilotpens,thesupply
curvewillshift
DD
Quantity
rightwards,toS1.
Equilibriumpricewill
decrease,andequilibrium
quantitywillincrease.
Note:Ifthereisadecreaseinthesupply,the
effectwillbeviceversa. 47
Effect of Changes in Both
Demand and Supply
As long as only one curve shifts, equilibrium
price and quantity will change.
If both curve shift, the outcome is obvious.
For example:

48
(a) Supply change > demand change (b) Supply change < demand change
 ?

1.6 ACTIVITY
49
 Supply and Demand Analysis

Question (i):
Proton Berhad decreases the price of its car
model, Proton Persona from P0 to P1. Explain
the law of demand and based on it, explain
what will happen to the quantity demanded
for Proton Persona car. Sketch a graph to
illustrate your explanation.

50
Question (ii):
What will happen to the Perodua
Nautica (substitutes) when the price
of Proton Persona car drop? Sketch
a graph to illustrate your
explanation

51
Question (iii):
Assume that Proton Persona cars
need a specific regular maintenance
service to bring out the performance
of the car. Based on situation in (a),
what will happen to the demand of
that specific regular maintenance
service?
52 End
THANK YOU

53