BASICS OF SUPPLY AND
DEMAND
REFERENCE:
R.S. Pindyck, D.L. Rubinfeld and P.L. Mehta, Microeconomics, Pearson Education.
N.G. Mankiw, Principles of Microeconomics, 8th ed., Cengage Publications, 2018.
Outline
1. Supply and Demand
2. The Market Mechanism
3. Changes in Market Equilibrium
The Basics of Supply and Demand
Supply-demand analysis is a fundamental and powerful tool that can be applied to a wide
variety of interesting and important problems. To name a few:
•Understanding and predicting how changing world economic conditions affect market
price and production
•Evaluating the impact of government price controls, minimum wages, price supports,
and production incentives
•Determining how taxes, subsidies, tariffs, and import quotas affect consumers and
producers
Demand
• Quantity Demanded: The amount of a good that buyers are willing and able to purchase
• Law of demand: Other things being equal, the quantity demanded of a good falls when the
price of the good rises.
• Demand schedule: A table that shows the relationship between the price of a good and the
quantity demanded.
• Demand curve: A graph of the relationship between the price of a good and the quantity
demanded.
The Demand Curve
• Demand curve: Relationship between the quantity of a good that consumers are willing
to buy and the price of the good.
We can write this relationship between quantity demanded and price as an equation:
QD = QD(P)
Catherine’s Demand Schedule and Demand Curve
Examples:
Mobile Phones in India:
• Consider the Indian smartphone market.
• When Xiaomi entered the market with its competitively priced smartphones, the demand
for its products surged.
• As Xiaomi offered feature-rich phones at lower prices compared to competitors like
Apple and Samsung, more consumers in India chose Xiaomi, illustrating the Law of
Demand in action.
Market Demand versus Individual Demand
• The demand curve in previous figure shows an individual’s demand for a product.
• To analyze how markets work, we need to determine the market demand, the sum of all the
individual demands for a particular good or service.
Market demand as the sum of individual
demands
Shifts in the Demand Curve
• Any change that raises the quantity that
buyers wish to purchase at any given
price shifts the demand curve to the right.
Any change that lowers the quantity that
buyers wish to purchase at any given
price shifts the demand curve to the left.
Determinants of Demand and Shift in the Demand
Curve
• The demand curve, labeled D, shows how the
quantity of a good demanded by consumers
depends on its price. The demand curve is
downward sloping; holding other things
equal, consumers will want to purchase more
of a good as its price goes down.
• The quantity demanded may also depend on
other variables, such as income, the weather,
and the prices of other goods. For most
products, the quantity demanded increases
when income rises.
• A higher income level shifts the demand curve
to the right (from D to D’).
Variables that shift the demand curve
➢ Income of the consumer
➢ Prices of related goods:
Substitutes: Two goods for which an increase in the price of one leads to an increase in the quantity
demanded of the other.
Complements Two goods for which an increase in the price of one leads to a decrease in the
quantity demanded of the other.
➢ Tastes
➢ Expectations: Expectation of higher income in the future might increase your current demand.
Expectation about a decrease in price tomorrow will lower the quantity demanded of a good now.
➢ Number of buyers: Shifts the market demand curve
Normal goods and Inferior goods
• Normal Good: • Inferior good
• A good for which, other things being • A good for which, other things being
equal, an increase in income leads to an equal, an increase in income leads to a
increase in demand. decrease in demand.
Variables that influence buyers
Factors that Affect the Demand for Electric Vehicles
• Efficiency: EVs are more efficient than gasoline-powered cars, traveling 2.6 to 4.8 times farther per
mile.
• Running costs: EVs cost about Rs 1 to 1.5 per kilometer to run, while small petrol cars cost around
Rs 7-8 per kilometer.
• Upfront costs: The upfront cost of EVs is a barrier to adoption in some countries, such as the UK
and the US. However, the cost of EVs is expected to be similar to petrol and diesel cars by 2025 or
2027.
• Government policies: Governments can incentivize the adoption of EVs by: Increasing the
penetration of renewable energy (solar panels used for generating electricity); Tax and financial
benefits (registration fee and road tax on purchasing EVs are lesser that petrol or diesel vehicles).
• Price of related goods: The quantity demanded of petrol cars decreases when the price of electric
vehicles (EVs) decreases. (Substitutes); Electricity and EVs are complementary, meaning that when
electricity prices fall, EV penetration increases.
Movement along the demand curve
Shifts in Demand Curve versus Movement
along the Demand Curve
• If warnings on cigarette packages convince
smokers to smoke less, the demand curve for
cigarettes shifts to the left.
• In panel (a), the demand curve shifts from D1 to
D2.
• At a price of $4.00 per pack, the quantity
demanded falls from 20 to 10 cigarettes per day,
as reflected by the shift from point A to point B.
• By contrast, if a tax raises the price of cigarettes,
the demand curve does not shift. Instead, we
observe a movement to a different point on the
demand curve.
• In panel (b), when the price rises from $4.00 to
$8.00, the quantity demanded falls from 20 to
12 cigarettes per day, as reflected by the
movement from point A to point C.
SUPPLY
• Quantity supplied: The amount of a good that sellers are willing and able to sell.
• Law of supply: Other things being equal, the quantity supplied of a good rises when the
price of the good rises.
• Supply schedule: A table that shows the relationship between the price of a good and the
quantity supplied.
• Supply curve: A graph of the relationship between the price of a good and the quantity
supplied.
Ben’s Supply Schedule and Supply Curve
Price of ice-cream cones Quantity of ice cream
cones supplied
$0.00 0
0.50 0
1.00 1
1.50 2
2.00 3
2.50 4
3.00 5
Market supply as the sum of individual
supplies
The Supply Curve
• Supply curve: Relationship between the quantity of a good that producers are willing to
sell and the price of the good.
• The supply curve, labeled S in the figure,
shows how the quantity of a good offered
for sale changes as the price of the good
changes. The supply curve is upward
sloping: The higher the price, the more
firms are able and willing to produce and
sell.
• If production costs fall, firms can produce
the same quantity at a lower price or a
larger quantity at the same price. The
supply curve then shifts to the right (from
S to S’).
Shifts in the Supply Curve
• Because the market supply curve is drawn holding other things constant, when one of
these factors changes, the supply curve shifts.
• Any change that raises quantity supplied at every price, such as a fall in the price of
sugar, shifts the supply curve to the right and is called an increase in supply.
• Any change that reduces the quantity supplied at every price shifts the supply curve to
the left and is called a decrease in supply.
Shifts in Supply Curve
Variables that shift a supply curve
• Input Prices
• To produce their output of ice cream, sellers use various inputs: cream, sugar, flavoring, ice-
cream machines, the buildings in which the ice cream is made, and the labor of workers who
mix the ingredients and operate the machines.
• When the price of one or more of these inputs rises, producing ice cream is less profitable, and
firms supply less ice cream.
• If input prices rise substantially, a firm might shut down and supply no ice cream at all. Thus,
the supply of a good is negatively related to the price of the inputs used to make the good.
• Technology
• Expectations
• For example, if a firm expects the price of ice cream to rise in the future, it will put some of its
current production into storage and supply less to the market today.
• Number of Sellers:
• Market supply depends on the number of these sellers.
Factors affecting the supply of electric
vehicles:
• Here are some factors that can increase the supply of electric vehicles (EVs):
• Improved battery technology
• As battery technology improves, EVs can travel longer distances between charges. This
makes EVs more practical for people with longer commutes.
• Increased reliability
• EVs have fewer moving parts than traditional vehicles, making them more reliable.
• Government subsidies
• Government subsidies paid directly to consumers can increase the demand for EVs.
• Industrial demand
• The demand for new EVs from industries and corporations can increase the supply.
• Other factors that can affect the supply of EVs include:
• Charging infrastructure
• The availability of public charging stations is a major barrier to EV adoption.
• Raw material shortages
• Shortages of key metals like lithium, cobalt, nickel, and copper can increase the cost or
reduce the quality of EV batteries.
Equilibrium
• Equilibrium (or market clearing) price: Price that equates the quantity supplied to the
quantity demanded.
Market mechanism: Tendency in a free market for price to change until the market
clears.
Surplus: Situation in which the quantity supplied exceeds the quantity
demanded.
Shortage: Situation in which the quantity demanded exceeds the quantity supplied.
Equilibrium price: The price that balances quantity supplied and quantity demanded.
Equilibrium quantity: The quantity supplied and the quantity demanded at the equilibrium
price.
The Equilibrium of Supply and Demand
The Market Mechanism
• Supply and Demand
The market clears at price P0 and
quantity Q0.
At the higher price P1, a surplus
develops, so price falls.
At the lower price P2, there is a
shortage, so price is bid up.
Three steps for analyzing changes in
equilibrium
1. Decide whether the event shifts the supply or demand curve (or perhaps 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.
Changes in Market Equilibrium
• New Equilibrium Following Shift in
Supply
• When the supply curve shifts to the right,
the market clears at a lower price P3 and
a larger quantity Q3.
Changes in Market Equilibrium
New Equilibrium Following Shift in
Demand
When the demand curve shifts to the right,
the market clears at a higher price P3 and a
larger quantity Q3.
How an increase in demand affects equilibrium
• An event that raises quantity demanded
at any given price shifts the demand
curve to the right.
• The equilibrium price and the equilibrium
quantity both rise.
• Here an abnormally hot summer causes
buyers to demand more ice cream.
• The demand curve shifts from D1 to D2,
which causes the equilibrium price to rise
from $2.00 to $2.50 and the equilibrium
quantity to rise from 7 to 10 cones.
How a decrease in supply affects the
equilibrium
• An event that reduces quantity supplied
at any given price shifts the supply curve
to the left.
• The equilibrium price rises, and the
equilibrium quantity falls.
• Here an increase in the price of sugar (an
input) causes sellers to supply less ice
cream.
• The supply curve shifts from S1 to S2,
which causes the equilibrium price of ice
cream to rise from $2.00 to $2.50 and the
equilibrium quantity to fall from 7 to 4
cones.
The effect of price and quantity on different
demand and supply shifts
Changes in Market Equilibrium
New Equilibrium Following Shifts in
Supply and Demand
• Supply and demand curves shift over time
as market conditions change.
• In this example, rightward shifts of the
supply and demand curves lead to a
slightly higher price and a much larger
quantity.
• In general, changes in price and quantity
depend on the amount by which each
curve shifts and the shape of each curve.
The Market for Eggs
• From 1970 to 2010, the real (constant-dollar)
price of eggs fell by 55 percent.
• The supply curve for eggs shifted downward as
production costs fell; the demand curve shifted
to the left as consumer preferences changed.
• As a result, the real price of eggs fell sharply
The mechanization of poultry farms sharply reduced the
and egg consumption rose.
cost of producing eggs, shifting the supply curve
downward. The demand curve for eggs shifted to the left
as a more health-conscious population tended to avoid
eggs.
The Market for College Education
• The real price of a college education rose by 82 percent.
• For college, increases in the costs of equipping and maintaining
modern classrooms, laboratories, and libraries, along with
increases in faculty salaries, pushed the supply curve up. The
demand curve shifted to the right as a larger percentage of a
growing number of high school graduates decided that a college
education was essential.
• The supply curve for a college education shifted up as the costs of
equipment, maintenance, and staffing rose.
• The demand curve shifted to the right as a growing number of
high school graduates desired a college education. As a result,
both price and enrollments rose sharply.
Changes in Market Equilibrium: A shift in both
supply and demand
• Here we observe a simultaneous increase in demand and decrease in supply. Two outcomes are
possible. In panel (a), the equilibrium price rises from P1 to P2, and the equilibrium quantity rises from
Q1 to Q2. In panel (b), the equilibrium price again rises from P1 to P2, but the equilibrium quantity
falls from Q1 to Q2.
What happens to price and quantity when
supply or demand shifts?
