MARKET FORCES OF DEMAND AND
SUPPLY
• Forces that make market economies work.
• Theories of supply and demand - how buyers
and sellers behave and how they interact with
one another.
• Consumer preferences determine consumer
demand for commodities, while business costs
are the foundation of the supply of
commodities.
• Supply and demand - behaviour of people as they
interact with one another in competitive markets
• A market is a group of buyers and sellers of a
particular good or service.
• The buyers as a group determine the demand for
the product, and the sellers as a group determine
the supply of the product.
Competitive Market
• A market in which there are so many buyers and so
many sellers that each has a negligible impact on the
market price.
• Each seller has limited control over the price because
other sellers are offering similar products.
• Similarly, no single buyer can influence the price
because each buyer purchases only a small amount.
• Perfectly competitive market
(1)goods offered for sale are all exactly the same,
and
(2) the buyers and sellers are so numerous that no
single buyer or seller has any influence over the
market price.
• Price taker
DEMAND
• The quantity demanded of any good is the amount of
the good that buyers are willing and able to purchase
• Inverse relationship between price and quantity
demanded of a good. True for most goods in the
economy.
• Law of demand: Other things equal, when the price of
a good rises, the quantity demanded of the good falls,
and when the price falls, the quantity demanded rises.
• Demand schedule – a table that shows the
relationship between the price of a good and
the quantity demanded, holding constant
everything else that influences how much of
the good consumers want to buy.
• Demand curve - downward-sloping line
relating price and quantity demanded
Demand Schedule and Demand Curve
Price Price Quantity
0.0 12
3 0.5 10
1.0 8
2.5 1.5 6
2.0 4
2.5 2
2.0 3.0 0
1.5
1.0
.5
0 1 2 3 4 5 6 7 8 9 10 11 12 Quantity
• Market Demand - Sum of the quantities
demanded by all the buyers for a particular
good or service at each price.
• Graphically, the market demand curve is found
by adding horizontally the individual demand
curves.
Market demand as the sum of individual
demands
Person A’s
demand +
Person B’s
demand =
Market
demand
Price Price Price
3.00 DPerson A 3.00 3.00
Dperson B
2.50 2.50 2.50
2.00 2.00 2.00
1.50 1.50 1.50
DMarket
1.00 1.00 1.00
0.50 0.50 0.50
0 1 2 3 4 5 6 7 8 9 10 11 12 0 1 2 3 4 5 6 7 0 2 4 6 8 10 12 14 16 18
Quantity Quantity of Quantity
Shifts in the Demand Curve
• If the quantity demanded of a commodity alters at
any given price, the demand curve shifts.
• Decrease in demand
– Any change that decreases the quantity demanded at
every price
– Demand curve shifts left
• Increase in demand
– Any change that increases the quantity demanded at every
price
– Demand curve shifts right
Shifts in the demand curve
Price
Demand
Demand
Demand curve, D1
curve, D2
curve, D3
0
Quantity
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.
Variables that shift the demand curve
Income
– Demand falls when income falls.
– If the demand for a good falls when income falls, the good is called a
normal good.
– If the demand for a good rises when income falls, the good is called an
inferior good.
Prices of related goods
Substitutes
• Two goods where an increase in the price of one leads to an increase in
the demand for the other
Complements
• Two goods for which an increase in the price of one leads to a decrease in
the demand for the other.
Tastes
Expectations
Number of buyers
SUPPLY
• Law of Supply - The positive relationship between price and
quantity supplied
• Other things equal, when the price of a good rises, the
quantity supplied of the good also rises, and when the price
falls, the quantity supplied falls as well.
• Supply Schedule - a table that shows the relationship
between the price of a good and the quantity supplied, holding
constant everything else that influences how much producers
of the good want to sell.
• Supply curve The curve relating price and quantity supplied.
• Upward slopping
Supply Schedule and Supply Curve
Price Quantity
Price
0.0 0
0.5 2
1.0 4
3.00
1.5 6
2.0 8
2.50 2.5 10
3.0 12
2.00
1.50
1.00
0.50
0 1 2 3 4 5 6 7 8 9 10 11 12 Quantity
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• Market supply - sum of all the individual
supplies of all sellers of a good or service.
• Graphically, individual supply curves are
summed horizontally to obtain the market
supply curve.
Market supply - sum of individual supplies
A’s B’s Market
supply + supply = supply
Price Price Price
SA
3.00 3.00 3.00 SMarket
SB
2.50 2.50 2.50
2.00 2.00 2.00
1.50 1.50 1.50
1.00 1.00 1.00
0.50 0.50 0.50
0 1 2 3 4 5 6 7 8 9 10 11 12 0 1 2 3 4 5 6 7 0 2 4 6 8 10 12 14 16 18
Quantity Quantity Quantity
Shifts in the supply curve
Price Supply Supply Supply
curve, S3 curve, S1 curve, S2
0
Quantity
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.
Variables that can shift the supply curve
- Input Prices
- Technology
- Expectations about future
- Number of sellers
Supply and Demand Together – Equilibrium
• Market Equilibrium - Point at which market
supply and demand curves intersect
• Equilibrium price - The price that balances
quantity supplied and quantity demanded
• Market-clearing price
• Equilibrium quantity - Quantity supplied and
demanded at the equilibrium price
• Market demand and supply schedules
Demand Supply
Price Buyer A Buyer B Market Seller A Seller B Market
0 12 7 19 0 0 0
0.5 10 6 16 0 0 0
1 8 5 13 1 0 1
1.5 6 4 10 2 2 4
2 4 3 7 3 4 7
2.5 2 2 4 4 6 10
3 0 1 1 5 8 13
Equilibrium of supply and demand
Price
Supply
2.00
Demand
0 1 2 3 4 5 6 7 8 9 10 11 12 13
Quantity
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• Case 1 –Shortage
• Price < equilibrium price; quantity demanded >
quantity supplied.
• Excess demand or a shortage.
• Market demand and supply schedules
Demand Supply State of Pressure
Price Buyer A Buyer B Market Seller A Seller B Market Market on Price
0 12 7 19 0 0 0 Shortage Upward
0.5 10 6 16 0 0 0 Shortage Upward
1 8 5 13 1 0 1 Shortage Upward
1.5 6 4 10 2 2 4 Shortage Upward
2 4 3 7 3 4 7 Equilibrium Neutral
2.5 2 2 4 4 6 10 Surplus Downward
3 0 1 1 5 8 13 Surplus Downward
Figure 9 Markets Not in Equilibrium
Excess Demand
Price
Supply
2.00
1.50
Demand
0 4 7 10 Quantity
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• Case 2 - Excess supply in the market
• Price > equilibrium price; quantity supplied >
quantity demanded.
• Excess supply or a surplus.
From Surplus to Equilibrium
Excess Supply
Price
Supply
2.50
2.00
Demand
0 4 7 10 Quantity
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• Movement along demand/ supply curve - price
change - change in quantity demanded / change in
quantity supplied
• Shifts in demand/ supply - Changes in factors
other than a good’s own price– change in demand/
supply
– i.e., increase or decrease in demand or supply at each
price
FigureIncrease
10 How in
andemand
Increase and Equilibrium
in Demand Affects the Equilibrium
Case 1- Increase in Demand (Shift in demand) & change in quantity supplied
(movement along supply curve)
Price
Supply
2.50 New equilibrium
2.00
Initial
equilibrium
0 7 10 Quantity
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• Consumers’ desire to buy at any given price
is altered, and thereby shifts the demand curve
to the right
• The increase in demand/ excess demand
causes the equilibrium price to rise. When the
price rises, the quantity supplied rises. This
increase in quantity supplied is represented by
the movement along the supply curve.
• Case 2- Change in Supply (Shift in Supply
curve) & Decrease in Quantity demanded
(Movement along demand curve)
• For example, a rise in the price of an input
• The demand curve does not change
• The supply curve shifts to the left
Figure 11 How a Decrease in Supply Affects the Equilibrium
Price
S2
S1
New
2.50 equilibrium
2.00 Initial equilibrium
Demand
0 4 7 Quantity
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A shift in both supply and demand
Price Rises, Quantity Rises
Price
Price Rises, Quantity Rises
S2 S1
A small decrease in supply,
P2
and a large increase in
D2 demand results in rise in
P1
both price (from P1 to P2)
and quantity (from Q1 to
Q2)
D1
0 Q1 Q2 (The rise in price is greater
Quantity
than the rise in quantity)
A shift in both supply and demand
Price Price Rises, Quantity Falls
S2
Price Rises, Quantity Falls S1
A large decrease in supply, P2
and a small increase in
demand results in a rise the P1
price (from P1 to P2) and a D2
fall in the quantity (from Q1 D1
to Q2)
0 Q2 Q1
Quantity
ELASTICITY AND ITS APPLICATION
• Elasticity - a numerical measure of the responsiveness
of quantity demanded or quantity supplied to a change
in one of its determinants
Price Elasticity of Demand
• How much the quantity demanded responds to a change
in price.
• Elastic Demand - If the quantity demanded responds
substantially to changes in the price.
• Inelastic Demand - If the quantity demanded responds
only slightly to changes in the price.
Determinants of Price Elasticity of Demand
• Availability of Close Substitutes
• Necessities versus Luxuries
• Percentage of income
• Time Horizon
• Definition of the Market
• Demand tends to be more elastic :
– the larger the number of close substitutes.
– if the good is a luxury.
– If a large share of income is spent on the good
– the more narrowly defined the market.
– the longer the time period.
Computing the Price Elasticity of Demand
ED = Percentage change in quantity demanded ÷ Percentage change
in price
Δ Q /Q ÷ ΔP/ P
Point A: Price = 90 & quantity = 240
Point B: Price = 110 & quantity 160
Elasticity from Point A to B
ΔP/P = 20/100 = 20%
Δ Q /Q = (-)80/200 = 40%
ED = 40/20 = 2
ED = ΔQ/ (Q 1 + Q 2)/2 ÷ ΔP/ (P1+ P2)/2
• 1. Positive value or absolute value.
• 2. Midpoint Method
– Elasticity from Point A to B = 1.5
– Elasticity from Point B to A = 2.7
(100 - 50)
Computing the Price Elasticity of Demand (100 50)/2
ED
(4.00 - 5.00)
(4.00 5.00)/2
Price
67 percent
5 3
22 percent
4
Demand Elasticity is reported as positive
value
0 50 100 Quantity
Demand is price elastic
Varieties of Demand Curves
• Demand curves classified according to their
elasticity.
• Price-elastic Demand
• Price-inelastic Demand
• Unit-elastic Demand
• Price elasticity of demand is closely related to the
slope of the demand curve.
Demand is perfectly inelastic, and demand curve is vertical.
Regardless of the price, the quantity demanded stays the same.
(a) Perfectly Inelastic Demand: Elasticity Equals 0
Price
Demand
0 100 Quantity
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Figure 1 The Price Elasticity of Demand
(b) Inelastic Demand: Elasticity Is Less Than 1
Price
4
Demand
0 90 100 Quantity
Figure 1 The Price Elasticity of Demand
(c) Unit Elastic Demand: Elasticity Equals 1
Price
4
Demand
0 80 100 Quantity
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Figure 1 The Price Elasticity of Demand
(d) Elastic Demand: Elasticity Is Greater Than 1
Price
4 Demand
0 50 100 Quantity
Figure 1 The Price Elasticity of Demand
(e) Perfectly Elastic Demand: Elasticity Equals Infinity
Price
4 Demand
0 Quantity
Elasticity of a Linear Demand Curve
P
200%
30 EP = = 5.0
40%
67%
20 EP = = 1.0
67%
40%
10 EP = = 0.2
200%
0 Q
0 20 40 60
• Slope of a linear demand curve is constant, but its
elasticity is not.
• Along a straight-line demand curve, the price
elasticity varies from zero to infinity
• But, the elasticity at a given point may be
considered as closely related to the slope of the
demand curve.
Total Revenue and the Price Elasticity of
Demand
• Total revenue - The amount paid by buyers (for a
good), and received by sellers of the good.
• Total revenue = Price * Quantity
R=P*Q
Figure 2 Total Revenue
Price
P × Q = 400
P
(revenue) Demand
0 100 Quantity
Q
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• Total revenue along the demand curve - price
elasticity of demand.
• Change in Price and Revenue:
– Higher price means more revenue on each unit
sold. (Price Effect)
– But fewer units are sold due to Law of Demand.
(Quantity Effect)
Case 1 – Inelastic demand
• % change in Q < % change in P
• Total Revenue rises.
Figure 3 How Total Revenue Changes When Price Changes:
Inelastic Demand
Inelastic Demand
An increase in price from 1 to 3 results in an increase in revenue from 100 to 240.
Price Price
Revenue = 240
1
Revenue = 100 Demand Demand
0 100 Quantity 0 80 Quantity
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Case 2 – Elastic Demand
• % change in Q > % change in P
• Total Revenue falls
Figure 4 How Total Revenue Changes When Price Changes:
Elastic Demand
Price Price
Demand
Demand
Revenue = 200 Revenue = 100
0 50 Quantity 0 20 Quantity
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• Elasticity and Total Revenue along a Linear
Demand Curve
OTHER DEMAND ELASTICITIES
• Income Elasticity of Demand measures how
much the quantity demanded of a good responds
to a change in consumers’ income.
• EI = Percentage change in quantity demanded ÷
Percentage change in income
• EI = Δ Q /Q ÷ ΔI/ I
• EI = ΔQ/ (Q 1 + Q 2)/2 ÷ ΔI/ (I1+ I2)/2
• Normal goods - positive income elasticities.
• Inferior goods - negative income elasticities.
• Necessities.
• Luxuries
• Cross-price elasticity of demand - a measure of
how much the quantity demanded of one good
responds to a change in the price of another good
• EXY = Percentage change in quantity demanded
of good X ÷ Percentage change in the price of
good Y
• EXY = Δ QX /QX ÷ ΔPY/ PY
• EXY = ΔQ X / (QX2 + QX1)/2 ÷ ΔPY2 / (PY2 +PY1)/2
• Complements – negative
• Substitutes – positive
ELASTICITY OF SUPPLY
• Price elasticity of supply measures how much the
quantity supplied of a good responds to a change
in the price of that good.
• Elastic
• Inelastic
Determinants of price elasticity of supply
• Availability of inputs.
• Flexibility of the production process.
• Adjustment time
Price elasticity of supply
• ES = Percentage change in quantity supplied ÷
Percentage change in price
• Δ Q /Q ÷ ΔP/ P
– Point A: Price = 4 & quantity = 50
– Point B: Price = 5 & quantity = 100
Elasticity from Point A to B (Midpoint Method)
ΔP/P = 1/4.5 = .22
Δ Q /Q = 50/75 = .67
ES = .67/.22 = 3
• ES = ΔQ/ (Q 1 + Q 2)/2 ÷ ΔP/ (P1+ P2)/2
Figure 6 The Price Elasticity of Supply
(a) Perfectly Inelastic Supply:
Elasticity Equals 0
Price
Supply
0 100 Quantity
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Figure 6 The Price Elasticity of Supply
(b) Inelastic Supply:
Elasticity Is Less Than 1
Price
Supply
5
0 100 110 Quantity
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Figure 6 The Price Elasticity of Supply
(c) Unit Elastic Supply:
Elasticity Equals 1
Price
Supply
5
0 100 125 Quantity
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Figure 6 The Price Elasticity of Supply
(d) Elastic Supply:
Elasticity Is Greater Than 1
Price
Supply
0 100 200 Quantity
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Figure 6 The Price Elasticity of Supply
(e) Perfectly Elastic Supply:
Elasticity Equals Infinity
Price
4 Supply
0 Quantity
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Price Elasticity of Supply Can Vary over the Curve
P Initial stages of production –
S 67% increase in quantity
supplied at 29% increase in
15 price.
Later stages of production–
12 supply curve becomes inelastic -
5 % increase in quantity supplied
is smaller than the 22 % increase
in price.
4
3
Q
100 200 500 525
• Paradox of the Bumper Harvest - Can Good
News for Farming Be Bad News for Farmers?
• Bumper harvest - supply curve shifts to the right.
• Demand curve remains the same
• Does the bumper harvest make farmers better off?
Figure 8 An Increase in Supply in the Market for Wheat
Price
S1
S2
Then, why do
farmers adopt Demand
new
0 100 110 Quantity
technologies
that increase
output?
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• OPEC and Price of Oil
• How supply and demand behaves differently in
the short run and in the long run
• In the short run, both the supply and demand for
oil are relatively inelastic
• Source:
• Mankiw, N. Gregory. 2012. Principles of
Economics, Mason: South-Western Cengage
Learning
• South-Western Cengage Learning
