Demand and Supply

MICROECONOMICS
PROF. RUSHEN CHAHAL

Prof. Rushen Chahal

Learning Objectives
y 1. Understand the economic definitions of supply

and demand. y 2. Understand what demand shift is and why it happens. y 3. Describe how the market reaches equilibrium price and quantity. y 4. Describe how shifts in demand and supply cause equilibriums to change. y 5. Describe what happens to an equilibrium if demand and supply shift and the same time.

Prof. Rushen Chahal

y y y y y y y y y y y y

Definitions Demand Quantity Demanded Law of Demand Shifting the Demand Curve Supply Quantity Supplied Law of Supply Shifting the Supply Curve Market Demand and Supply Market Equilibrium Changes in Market Equilibrium

Prof. Rushen Chahal

Demand
y Demand relates the quantity of a good that

consumers would purchase at each of various possible prices, over some period of time, ceteris paribus.
y In other words:  For ALL possible prices, demand consists of the quantities that people want in a defined amount of time.  On a graph, demand is many points.

Prof. Rushen Chahal

Demand
A demand schedule a table that shows possible prices and their quantities demanded.

Price per pizza ($) 2 4 6 8 10

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Quantity of pizzas per month 13 10 7 4 1

Demand
Individual Demand Curve for pizza (monthly): Price
$10 8 6 4 2 1
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D
Quantity
4 7 10 13

A demand curve the graph of a demand schedule. Notice that the demand curve slopes down and to the right. This is a negative slope.

Quantity Demanded
y Quantity demanded the quantity that consumers

would purchase at a given price.

y In other words:  For ONE (and only ONE) price, quantity demanded is the amount that people want.  On a graph, quantity demanded is ONE point.

Prof. Rushen Chahal

Quantity Demanded
y A change in price causes the quantity demanded to

change. y When this happens, we move ALONG the demand curve (the demand curve does NOT move).

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Quantity Demanded
Demand Curve for pizza (monthly): Price
$10 8 6 4 2 1
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D
Quantity
4 7 10 13

If the price changes from $8 to $4, we move ALONG the demand curve. The price change caused a change in the quantity demanded. The demand curve did NOT move.

Law of Demand
y Law of Demand as price falls, the quantity demanded

increases.
  

If your favorite car cost 720,000 RMB, how many would you buy? What if it cost 72,000 RMB? What if it cost 72 RMB?

y What happens to quantity demanded if price rises?  Quantity demanded falls.

Prof. Rushen Chahal

Shifting the Demand Curve

y We do NOT move ALONG the demand curve.

Instead, we move the demand curve.

y An INCREASE in demand: demand shifts to the

RIGHT.
y A DECREASE in demand: demand shifts to the

LEFT.

Prof. Rushen Chahal

Shifting the Demand Curve

$
An increase in demand is represented by a rightward shift in the demand curve. 10 8 6 4 2 50
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D21

D1
100 125 150 175 200

Shifting the Demand Curve

$
Conversely, a decrease in demand will cause a leftward shift on the demand curve. Hence, fewer units will be demanded at every given price. 10 8 6 4 2

D1 D2
50 100 125 150 175 200

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Shifting the Demand Curve

y Shift factors (cause a change in demand):  Tastes and preferences  Substitutes  Complements  Income
Normal goods

and inferior goods

 

Population Expectation of future price

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Shifting the Demand Curve

y Substitutes something that takes the place of

something else, such as one brand of cola for another.

y Examples:  You always drink green tea. The price of green tea doubles. You change to black tea (demand for black tea increases). Black tea is a substitute for green tea.

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Shifting the Demand Curve

y Compliments goods or services that go well with

each other, such as cream with coffee.

y Example:  You ketchup with french fries. The cost of french fries goes down by half. This causes you to eat more ketchup (demand for ketchup increases). Ketchup is a compliment of french fries.

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Shifting the Demand Curve

y Normal goods demand for these goods varies

directly with income.

y In other words:  If you have more money, you buy MORE normal goods (demand increases). y Examples:  Housing, jewelry, new clothes.

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Shifting the Demand Curve

y Inferior goods demand for these goods varies

inversely with income.

y In other words:  If you have more money, you buy LESS inferior goods (demand decreases). y Examples:  Cold showers, bad tasting cheap food, old clothes.

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Demand Shifts RIGHT When:

Shifting the Demand Curve

Price

D2 D1

Quantity
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Prices of substitutes increase Prices of complements decrease Normal good-income goodincreases Inferior good-income gooddecreases Population increases Tastes & preferences turn in favor of the product It is believed that prices will rise in the future

Demand Shifts LEFT When:

Prices of substitutes decrease Prices of complements increase Normal good-income gooddecreases Inferior good-income goodincreases Population decreases Tastes & preferences turn against the product It is believed that in the future prices will fall
Prof. Rushen Chahal

Shifting the Demand Curve

Price

D1 D2

Quantity

Supply
y Supply relates the quantity of a good that will be

offered for sale at each of various possible prices, over some period of time, ceteris paribus.
y In other words:  For ALL possible prices, supply consists of the quantities that people will produce in a defined amount of time.  On a graph, supply is many points.

Prof. Rushen Chahal

Supply
Price per Quantity box of supplied Cigarettes (millions ($) of boxes per year) 5 10 4 8 3 2 1 6 4
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A supply schedule a table that shows possible prices and their quantities supplied.

Supply
A supply curve the graph of a supply schedule. Notice that the supply curve slopes up and to the right. This is a positive slope.
Supply Curve for cigarettes (daily): (daily): Price
$5 4 3 2 1 2 4 6 8 10

Qs

Quantity

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Quantity Supplied
y Quantity supplied the quantity that will be offered

for sale at a given price.

y In other words:  For ONE (and only ONE) price, quantity supplied is the amount that people will sell.  On a graph, quantity supplied is ONE point.

Prof. Rushen Chahal

Quantity Supplied
y A change in price causes the quantity supplied to

change. y When this happens, we move ALONG the supply curve (the supply curve does NOT move).

Prof. Rushen Chahal

Quantity Supplied
Supply Curve for cigarettes (daily): (daily): Price
$5 4 3 2 1 2 4 6 8 10

If the price changes from $2 to $5, we move ALONG the supply curve. The price change caused a change in the quantity supplied. The supply curve did NOT move.
Prof. Rushen Chahal

Qs

Quantity

Law of Supply
y Law of Supply as price rises, the quantity

supplied increases.


If your tutor someone in English for 10RMB per hour, how many hours will you work?  What if it pays 100 RMB per hour?  What if pays 1000 RMB per hour?
y What happens to quantity supplied if price falls?  Quantity supplied falls.

Prof. Rushen Chahal

Shifting the Supply Curve

y We do NOT move ALONG the supply curve.

Instead, we move the supply curve.

y An INCREASE in supply: supply shifts to the

RIGHT.
y A DECREASE in supply: supply shifts to the LEFT.

Prof. Rushen Chahal

Changes in Supply vs. Changes in Quantity Supplied

Price ($s)

Supply
5 4 3 2 1 0 1 2 3 Increase Movement ALONG the supply curve 4 5 Quantity Decrease

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Shifting the Supply Curve

y Shift Factors:

Prices of Inputs Technological Change Government or Union Restrictions (pollution) Prices of Substitutes in Production (would you make more money if you made a different good?) Prices of Jointly Produced Goods (beef and leather) Expected Future Prices Number of sellers (suppliers)

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Changes in Supply - Decrease

Supply Shifts LEFT When:
Sellers expect price to rise in future. Price of labor or any input rises. Government or union restrictions increase cost. Price of substitute in production rises. Price of product produced jointly falls. Number of sellers declines Prof. Rushen Chahal
$ S2

S1

Quantity

Changes in Supply - Increase

$ S1 S2

Quantity

Supply Shifts RIGHT When: Sellers expect price to decline in future. Price of labor or any input falls. Technological change lowers cost. Price of substitute in production falls. Price of product produced jointly rises. Number of sellers increases

Prof. Rushen Chahal

Market Demand and Supply

y The market is made up of individual firms

(businesses) as well as individual costumers. y How do you thing we measure market supply and demand? y Market demand is the horizontal summation of each individuals demand curve. y Market supply is the horizontal summation of the supply of each sellers supply curve.

Prof. Rushen Chahal

Market Demand
Price ($) 5 4 3 2 1 0 Jack's Quantity Demanded mark's Quantity DemandedMarket Q Demanded 1 0 1 2 1 3 3 2 5 4 3 7 4 9 5 6 5 11

Demand can be one individuals or the market as a whole

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Individual A s Demand Curve

Price ($)
Marks Quantity

6 5 4 3 2 1 0

At a price of $5 Mark' quantity demanded is 0 pails of water

5 4 3 2 1 0 At a price of $1 Mark' quantity demanded is 4 pails of water

Demanded 0 1 2 3 4 5

Jills Demand

1
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10 11 Quantity

Individual B s Demand Curve

At a price of $5 Jacks quantity demanded is 1 pails of water Price ($) Jacks Quantity Demanded 5 1 4 2 3 3 2 4 1 5 0 6 At a price of $1 Jill' quantity demanded is 4 pails of water

6 5 4 3 2 1 0 1
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Jacks Demand

10 11 Quantity

Market Demand Curve (Individual A and B s demand curves together)

6 5 4 3 2 1 0 1
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At a price of $5, the market quantity demanded is 1+0=1 pail of water.

Market Demand

At a price of $1, the market quantity demanded is 5+4=9 pails of water.

10 11 Quantity

Market Supply
Price ($) 5 4 3 2 1 0 Coke's Quantity Supplied 4 3 2 1 0 0 Pepsi's Quantity Supplied Market Q Supplied 5 9 4 7 3 5 2 3 1 1 0 0

Supply can be from one firm or all firms in the market.

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Company A s Supply Curve

Cokes Supply

5 4 3 2 1 0
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At a price of $5 DaZhong supplies 4 Pails of water

At a price of $1 Coke supplies 0 pails of water

7 8 9 Quantity

Company B s Supply Curve

Wandas Supply

5 4 3 2 1 0
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At a price of $5 Pepsi supplies 5 pails of water.

At a price of $1 Pepsi supplies 1 pails of water.

7 8 9 Quantity

Market Supply Curve (Individual A and B s supply curves together)

At a price of $5, the market quantity supplied is 4+5=9 pails of water.

5
Four by Coke

Five by Pepsi

4 3 2 1 0
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Market Supply
At a price of $1, the market quantity supplied is 0+1=1 pails of water.

7 8 9 Quantity

Market Equilibrium

y Market Equilibrium a situation in which there is

no tendency for either price or quantity to change.

y In other words:  The quantity supplied equals the quantity demanded.  There is only one price where this happens; we say the market clears.

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Market Equilibrium
y Surplus the excess of quantity supplied over

quantity demanded, which occurs when price is ABOVE equilibrium.

y Shortage the excess of quantity demanded over

quantity supplied, which occurs when price is BELOW equilibrium.

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Market Equilibrium
Price ($) 5 4 3 2 1 0 Quantity Demanded 1 3 5 7 9 11 Quantity Supplied 9 7 5 3 1 0 Surplus or Shortage 8 4 0 -4 -8 -11

There is only one price that clears the market, meaning that the quantity supplied equals the quantity demanded.
Prof. Rushen Chahal

Market Equilibrium
Market equilibrium occurs where demand and supply intersect.
Producers compete for customers, lowering the price

5
Too High 4

Surplus of 4 Pails

Supply

P* 3
Too Low 2 Shortage of 4 Pails

1 0
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Costumers compete for the product, raising the price

Demand

Q*

8 9 Pails of Water

Changes in Market Equilibrium

o Adjustment from one equilibrium to

the next can be thought of as a four step process:

For some reason, a shift occurs in either supply or demand. o The price that had been equilibrium now causes either a surplus or shortage. o If there is a surplus, price adjusts down; if a shortage, price adjusts up. o In response to changes in price, consumers adjust their quantities demanded and producers their quantity supplied until the two are equal and the market is again in Prof. Rushenequilibrium. Chahal
o

Changes in Market Equilibrium

S Snew
A

P*
B

D
Q*

Quantity

Step #1 - Supply shifts to the right. Step #2 A surplus occurs at the starting price. Step #3 Competition among the producers causes the price to fall. Step #4 - As price falls, the quantity demanded increases and the quantity supplied decreases until the two become equal, after which there is no more tendency for either price or quantity to change.

Price ($s)

An increase in supply.
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Changes in Market Equilibrium

Snew
Step #1 - Supply shifts to the left. Step #2 A shortage occurs at the starting price. Step #3 Competition among the consumers causes the price to rise. Step #4 - As price rises, the quantity demanded decreases and the quantity supplied increases until the two become equal, after which there is no more tendency for either price or quantity to change.
Prof. Rushen Chahal

Snew

Price ($s)

P* B

D
Q*

Quantity

A decrease in supply.

Changes in Market Equilibrium

Price ($s)

S
C

Price ($s)

S
B A

P* P* A B

D
Q*

Dnew
Q*

D Dnew
Quantity

Quantity An increase or decrease in demand.

Prof. Rushen Chahal

Changes in Market Equilibrium

Case 1 2 3 4 Demand No change No change Right Left Supply Right Left No change No change Equilibrium P Fall Rise Rise Fall Equilibrium Q Rise Fall Rise Fall

Note: In Cases 1-4 only one of the two curves is shifting.

Prof. Rushen Chahal

Changes in Market Equilibrium

Price ($s)

S Snew
Same Equilibrium Price

P*

Dnew D
Q*

Quantity

Higher equilibrium quantity

Shift in demand equal to shift in supply

Prof. Rushen Chahal

Changes in Market Equilibrium

Price ($s)

S Snew

P*

New Equilibrium Price

Dnew D
Q*

Quantity

Higher equilibrium quantity

Shift in demand less than shift in supply

Prof. Rushen Chahal

Changes in Market Equilibrium

Price ($s)

S Snew
New Equilibrium Price

P*

Dnew D
Q*

Quantity

Higher equilibrium quantity

Shift in demand greater than shift in supply

Prof. Rushen Chahal

Changes in Market Equilibrium

Case 5 6 7 8 Demand Shifts right Shifts left Shifts right Shifts left Supply Shifts right Shifts left Shifts left Shifts right Equilibrium P Direction uncertain Direction uncertain Rises Falls Equilibrium Q Rises Falls Direction uncertain direction uncertain

Note: In Cases 5-8 both of the curves are shifting.

Prof. Rushen Chahal