EC 101

PRINCIPLES OF MICROECONOMICS

Ch4. The Market Forces of Supply

and Demand
Agenda
 Define “market”
 Classify 3 types of markets (competitive, oligopoly,
monopoly)
• Focus on “perfectly competitive markets”
 Discuss determinants of the demand for a good in a
competitive market.
 Discuss determinants of the supply for a good in a
competitive market.
 Talk how supply and demand together set the price of a
good and the quantity sold.
 Talk the key role of prices in allocating scarce resources in
market economies.
Markets and Competition, Part 1
 Market
• A group of buyers and sellers of a particular good or
service
 Market for wheat
 Market for cars
 Market for newspapers
 Market for TL
 Academic job market
• Buyers as a group
 Determine the demand for the product
• Sellers as a group
 Determine the supply of the product
Markets and Competition, Part 2
 Competitive market
• Market in which there are many buyers and
many sellers
 Each has a small impact on market price
 Perfectly competitive market
• Buyers and sellers are infinitely many
 No single buyer or seller has any influence over
the market price
 Example
• Market for wheat
Markets and Competition, Part 3
 Monopoly
• Only one seller in the market
 Decides the price
• Example
 Water supply to our homes
 Oligopoly
• Market dominated by a few sellers
 The sellers have some control over price
• Between perfect competition and monopoly
• Examples
 Oil
 Most media outlets
 Commercial airplane manufacturing
Demand, Part 1
 Quantity demanded
• Amount of a good that buyers are willing and
able to purchase
Demand, Part 2
 Demand function
• Relationship between the price of a good and
quantity demanded
 Demand schedule: a table
 Demand curve: a graph
– Price on the vertical axis
– Quantity on the horizontal axis

 Law of demand
• When the price of a good rises, the quantity
demanded of the good falls
Figure 1. Catherine’s Individual Demand Schedule
and Demand Curve
Price of Quantity of
Ice-Cream Cones
Cone Demanded

$0.00 12 cones
0.50 10
1.00 8
1.50 6
2.00 4
2.50 2
3.00 0
Demand, Part 3
 Can analyze demand at different levels
• Individual demand
 An individual’s demand for a product
• Market demand
 Sum of all individual demands for a good or service
 Market demand curve
• Sum the individual demand curves horizontally
Figure 2. Market Demand as the Sum of Individual
Demands, Part 1

Price of Ice- Catherine Nicholas Market

Cream Cone

0.0 dollar 12 7 19 cones

0.5 dollar 10 6 16 cones
1.0 dollar 8 5 13 cones
1.5 dollars 6 4 10 cones
2.0 dollars 4 3 7 cones
2.5 dollars 2 2 4 cones
3.0 dollars 0 1 1 cone
The quantity demanded in a market is the sum of the quantities demanded by all the buyers at
each price. Thus, the market demand curve is found by adding horizontally the individual
demand curves. At a price of $2.00, Catherine demands 4 ice-cream cones and Nicholas
demands 3 ice-cream cones. The quantity demanded in the market at this price is 7 cones.
Figure 2. Market Demand as the Sum of Individual
Demands, Part 2
Demand, Part 4
 Shifts in the demand curve
• Increase in demand
 Any change that increases the quantity demanded at
every price
 Demand curve shifts right
• Decrease in demand
 Any change that decreases the quantity demanded at
every price
 Demand curve shifts left
Figure 3 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.
Demand, Part 5
 Variables that can shift the demand curve
• Income
• Prices of related goods
• Tastes
Demand, Part 6
 Income
• Normal good
 Other things constant, an increase in income leads to
an increase in demand
 Examples
• Inferior good
 Other things constant, an increase in income leads to
a decrease in demand
 Examples
Demand, Part 7
 Prices of related goods
• Substitutes, two goods
 An increase in the price of one leads to an increase in
the demand for the other
 Examples
• Complements, two goods
 An increase in the price of one leads to a decrease in
the demand for the other
 Examples
Example
 https://www.economist.com/graphic-detail/2019/08/16/legal-weed-is-linked-to-higher-junk-
food-sales?fsrc=gp_en?fsrc=scn/tw/te/bl/ed/
legalweedislinkedtohigherjunkfoodsalespotbelly
Example
Demand, Part 8
 Tastes
• Change in tastes: changes the demand
 Expectations about the future
• Expect an increase in income
 Increase in current demand
• Expect higher prices
 Increase in current demand
 Number of buyers, increases
• Market demand increases
Table 1 Variables That Influence Buyers

Variable A change in this variable

Price of the good itself Represents a movement along the
demand curve
Income Shifts the demand curve
Prices of related goods Shifts the demand curve
Tastes Shifts the demand curve
Expectations Shifts the demand curve
Number of buyers Shifts the demand curve

This table lists the variables that affect how much of any good consumers
choose to buy.
Notice the special role that the price of the good plays: A change in the good’s
price represents a movement along the demand curve, whereas a change in
one of the other variables shifts the demand curve.
Two ways to reduce the quantity
of smoking demanded, Part 1
1. Try to raise the price of cigarettes
2. Shift the demand curve for cigarettes

“What is the best way to

stop this?”
Two ways to reduce the quantity of smoking
demanded, Part 2
1. Try to raise the price of cigarettes
– Tax the manufacturer: higher price
– Movement along demand curve
• 10% ↑ in price → 4% ↓ in smoking
• Teenagers: 10% ↑ in price → 12% ↓ in smoking
Figure 4 Shifts in the Demand Curve versus
Movements along the Demand Curve (a)

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.
Two ways to reduce the quantity of smoking
demanded, Part 3

2. Shift the demand curve for cigarettes and

other tobacco products
– Public service announcements
– Mandatory health warnings on cigarette
packages
– Prohibition of cigarette advertising on television
• If successful
– Shift demand curve to the left
Figure 4 Shifts in the Demand Curve versus
Movements along the Demand Curve (b)

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.
Supply, Part 1
 Quantity supplied
• Amount of a good sellers are willing and able to
sell
 Law of supply
• When the price of a good rises, the quantity
supplied of the good also rises
Supply, Part 2
 Supply Function
• Relationship between the price of a good and
the quantity supplied
 Supply schedule: a table
 Supply curve: a graph
– Price on the vertical axis
– Quantity on the horizontal axis
Figure 5 Ben’s Supply Schedule and Supply Curve

Price of Quantity
Icecream Of
Cone Cones
Supplie
d
$0.00 0 cones
0.50 0
1.00 1
1.50 2
2.00 3
2.50 4
3.00 5
Supply, Part 3
 Can analyze at different levels
• Individual supply
 A seller’s individual supply
• Market supply
 Sum of the supplies of all sellers for a good or service
 Market supply curve
• Sum of individual supply curves horizontally
Figure 6 Market Supply as the Sum of Individual
Supplies, Part 1

Price of ice- Ben Jerry Market

cream cone
0.0 dollar 0 0 0 cone
0.5 dollar 0 0 0 cone
1.0 dollar 1 0 1 cone
1.5 dollars 2 2 4 cones
2.0 dollars 3 4 7 cones
2.5 dollars 4 6 10 cones
3.0 dollars 5 8 13 cones
Figure 6 Market Supply as the Sum of Individual
Supplies, Part 2
Supply, Part 4
 Shifts in supply
• Increase in supply
 Any change that increases the quantity supplied at
every price
 Supply curve shifts right
• Decrease in supply
 Any change that decreases the quantity supplied at
every price
 Supply curve shifts left
Exhibit 7 Shifts in the Supply Curve

Any change that raises the quantity that sellers wish to produce at any given price shifts the
supply curve to the right.
Any change that lowers the quantity that sellers wish to produce at any given price shifts the
supply curve to the left.
Supply, Part 5
 Variables that can shift the supply curve
• Input prices
• Technology
• Expectations about future
• Number of sellers
Supply, Part 6
 Input prices
• Supply is negatively related to prices of inputs
• Higher input prices: decrease in supply
 Technology
• Advance in technology: reduces firms’ costs:
increase in supply
Supply, Part 7
 Expectations about future
• Expected higher prices
 Decrease in current supply
 Number of sellers, increases
• Market supply increases
Table 2 Variables That Influence Sellers
Variable A change in this
variable
Price of the good itself 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

This table lists the variables that affect how much of any good producers choose to sell.
Notice the special role that the price of the good plays: A change in the good’s price
represents a movement along the supply curve, whereas a change in one of the other
variables shifts the supply curve.
Supply and Demand Together, Part 1
 Equilibrium
• A situation in which market price has reached
the level where
 Quantity supplied = Quantity demanded
• Supply and demand curves intersect
Supply and Demand Together, Part 2
 Equilibrium price
• Balances quantity supplied and quantity
demanded
 Equilibrium quantity
• Quantity supplied and quantity demanded at the
equilibrium price
Figure 8 The Equilibrium of Supply and Demand

The equilibrium is found where the supply and demand curves intersect. At the equilibrium
price, the quantity supplied equals the quantity demanded.
Here the equilibrium price is $2.00: At this price, 7 ice-cream cones are supplied and 7 ice-
cream cones are demanded.
Figure 9 Markets Not in Equilibrium

In panel (a), there is a surplus. Because the market price of $2.50 is above the equilibrium price,
the quantity supplied (10 cones) exceeds the quantity demanded (4 cones). Suppliers try to
increase sales by cutting the price of a cone, and this moves the price toward its equilibrium level.
Supply and Demand Together, Part 3
 Surplus
• Quantity supplied > Quantity demanded
• Excess supply
• Downward pressure on price
 Movements along the demand and supply curves
 Increase in quantity demanded
 Decrease in quantity supplied
Figure 9 Markets Not in Equilibrium

In panel (b), there is a shortage. Because the market price of $1.50 is below the equilibrium price,
the quantity demanded (10 cones) exceeds the quantity supplied (4 cones). With too many buyers
chasing too few goods, suppliers can take advantage of the shortage by raising the price. Hence, in
both cases, the price adjustment moves the market toward the equilibrium of supply and demand.
Supply and Demand Together, Part 4
 Shortage
• Quantity demanded > Quantity supplied
• Excess demand
• Upward pressure on price
 Movements along the demand and supply curves
 Decrease in quantity demanded
 Increase in quantity supplied
Supply and Demand Together, Part 5
 Law of supply and demand
• The price of any good adjusts to bring the
quantity supplied and the quantity demanded for
that good into balance
• In most markets surpluses and shortages are
temporary
Supply and Demand Together, Part 6
Three steps to analyzing changes in equilibrium
1. Decide whether the event shifts the supply
curve, the demand curve, or, in some cases,
both curves
2. Decide whether the curve shifts to the right or
to the left
3. Use the supply-and-demand diagram
 Compare the initial and the new equilibrium
 Effects on equilibrium price and quantity
Supply and Demand Together, Part 7
A change in market equilibrium due to a shift
in demand
• One summer, very hot weather
• Effect on the market for ice cream?
1. Hot weather: shifts the demand curve (tastes)
2. Demand curve shifts to the right
3. Higher equilibrium price; higher equilibrium
quantity
Figure 10 How an Increase in Demand Affects the
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 D 1 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.
Supply and Demand Together, Part 9

A change in market equilibrium due to a shift

in supply
• One summer, a hurricane destroys part of the
sugarcane crop: higher price of sugar
• Effect on the market for ice cream?
1. Change in price of sugar: supply curve
2. Supply curve: shifts to the left
3. Higher equilibrium price; lower equilibrium
quantity
Figure 11 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 S 1 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.
Supply and Demand Together, Part 10

Shifts in both supply and demand

• One summer: hurricane and heat wave
1. Heat wave shifts the demand curve; hurricane
shifts the supply curve
2. Demand curve shifts to the right; Supply curve
shifts to the left
3. Equilibrium price raises
– If demand increases substantially while supply falls just a
little: equilibrium quantity rises
– If supply falls substantially while demand rises just a
little: equilibrium quantity falls
Figure 12 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 P 1 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.
How Prices Allocate Resources
 The idea that markets coordinate production (supply) and
consumption (demand) of goods through prices one of the
most profound ideas in social sciences
• Many producers and consumers
• Each one makes his own production or consumption decision just
looking at one number: price
 All the communication takes place through one number
• Somehow, at the end of the day, this communication through price
makes sure total production equals total consumption
• We wil also prove, under certain conditions, the allocations that the
coordination achieved through prices maximizes total happiness of
the society!
 Hayek
• https://www.econlib.org/library/Essays/hykKnw.html
 Not responsible
PRACTICE QUESTIONS
Q1
 What happens to price of oranges when
frost hits Antalya?
Q2
 What happens to hotel prices in Bodrum
when weather gets warm in İzmir?
Q3
 When a war breaks out in the Middle East,
what happens to price of gasoline? Price
of used Cadillac?