Demand, Supply and
Market Equilibrium
The Basic Decision-Making Units
• A firm is an organization that transforms
resources (inputs) into products (outputs). Firms
are the primary producing units in a market
economy.
• An entrepreneur is a person who organizes,
manages, and assumes the risks of a firm, taking a
new idea or a new product and turning it into a
successful business.
• Households are the consuming units in an
economy.
Markets
• A market is any institutional structure, or mechanism,
that brings together buyers and sellers of particular
goods and services
• Markets exists in many forms
• They determine the price and quantity of a good or
service transacted
3
Input Markets and Output Markets
• Output, or product, markets
are the markets in which
goods and services are
exchanged.
• Input markets are the
markets in which resources—
labor, capital, and land—used
to produce products, are
• Payments flow in the opposite
exchanged.
direction as the physical flow of
resources, goods, and services
(counterclockwise).
Input Markets
Input markets include:
• The labor market, in which households supply work
for wages to firms that demand labor.
• The capital market, in which households supply their
savings, for interest or for claims to future profits, to
firms that demand funds to buy capital goods.
• The land market, in which households supply land or
other real property in exchange for rent.
Buyers and Sellers
• Buyers and sellers in a market can be
• Households
• Business firms
• Government agencies
• All three can be both buyers and sellers in the same market, but are
not always
• For purposes of simplification this lecture will usually follow these
guidelines
• In markets for consumer goods, we’ll view business firms as the
only sellers, and households as only buyers
Using Supply and Demand
• Supply and demand model is designed to explain how prices are
determined in perfectly competitive markets
• Perfect competition is rare but many markets come reasonably
close
• Perfect competition is a matter of degree rather than an all or
nothing characteristic
• Supply and demand is one of the most versatile and widely used
models in the economist’s tool kit
Demand
• A household’s quantity demanded of a good
• The various amounts of a product that consumers are willing and able to
purchase at various prices during some specific period
• Specific amount a household would choose to buy over some time
period, given
• A particular price that must be paid for the good
• All other constraints on the household
• Market quantity demanded (or quantity demanded) is the
specific amount of a good that all buyers in the market
would choose to buy over some time period, given
• A particular price they must pay for the good
• All other constraints on households
The Law of Demand I
• States that when the price of a good rises and everything
else remains the same, the quantity of the good
demanded will fall
• The words, “everything else remains the same” are important
• In the real world many variables change simultaneously
• However, in order to understand the economy we must first
understand each variable separately
• Thus we assume that, “everything else remains the same,” in order to
understand how demand reacts to price
The Law of Demand II
• The inverse relationship between the price and the quantity
demanded of a good or service during some period of time.
• That is, the slope of the demand curve is downwards.
It is based on:
1. Income effect P Q
2. Substitution effect P Q
3. Diminishing marginal utility
Income Effect
• At a lower price, consumers can buy more of a product without giving
up other goods. A decline in price increases the purchasing power of
money/real income
Substitution Effect
• At a lower price, consumers have the incentive to substitute the
cheaper good for similar goods that are now relatively more
expensive. (e.g. Plantain flour vs Yam Flour)
Diminishing Marginal Utility
• States that successive units of a given product yield less and less extra
satisfaction. Therefore, consumers will only buy more of a good if its
price is reduced.
11
The Demand Schedule and The
Demand Curve
• Demand schedule
I
• A list of table (price- quantity combination) showing the
quantity of a good that consumers would choose to purchase at
different prices, with all other variables held constant.
• The market demand curve (or just demand curve) shows the
relationship between the price of a good and the quantity
demanded , holding constant all other variables that influence
demand
• The demand curve is a graph illustrating how much of a given
product a household would be willing to buy at different prices.
• Demand curves are usually derived from demand schedules.
The Demand Schedule and The
Demand Curve II
ANNA'S DEMAND
SCHEDULE FOR
TELEPHONE CALLS
QUANTITY
PRICE DEMANDED
(PER (CALLS PER
CALL) MONTH)
$ 0 30
0.50 25
3.50 7
7.00 3
10.00 1
15.00 0
From Household to Market Demand
• Demand for a good or service can be defined
for an individual household, or for a group of
households that make up a market.
• Market demand is the sum of all the
quantities of a good or service demanded per
period by all the households buying in the
market for that good or service.
From Household Demand to Market
Demand
• Assuming there are only two households in the
market, market demand is derived as follows:
Deriving the market demand curve from individual
curves:
Deriving the market demand curve from individual
curves: continued
Determinants of Household Demand
A household’s decision about the quantity of a particular output to
demand depends on:
• The price of the product in question.
• The income available to the household.
• Normal or superior goods—demand varies directly with income
• Inferior goods—demand varies inversely with income
• The household’s amount of accumulated wealth.
• The prices of related products available to the household.
• Substitute goods
• Complementary goods
• Independent goods
• The household’s tastes and preferences.
• The household’s expectations about future income, wealth, and prices.
Changes in Quantity
Demand
• caused by changes in price only
• represented as movement along a demand curve
• other factors determining demand are held constant
19
Changes in Demand
• Caused by changes in one or other of the non-price
determinants of demand
• Represented as a shift of the demand curve either to the right
or left
• Represents a change in the quantity demand at every price, so
cannot be related to a change in price
20
Income: Factors That Shift The Demand Curve
• Normal Goods are goods for which demand goes up when
income is higher and for which demand goes down when
income is lower.
• Inferior Goods are goods for which demand falls when
income rises.
Related Goods and Services: Factors That Shift The
Demand Curve
• Substitutes are goods that can serve as replacements for one
another; when the price of one increases, demand for the other goes
up. Perfect substitutes are identical products.
• Complements are goods that “go together”; a decrease in the price of
one results in an increase in demand for the other, and vice versa.
Shift of Demand Versus Movement Along a
Demand Curve
• A change in demand is
not the same as a change
in quantity demanded.
• In this example, a higher
price causes lower
quantity demanded.
• Changes in determinants
of demand, other than
price, cause a change in
demand, or a shift of the
entire demand curve, from
DA to DB.
A Change in Demand Versus a Change in
Quantity Demanded
• When demand shifts to
the right, demand
increases. This causes
quantity demanded to be
greater than it was prior to
the shift, for each and
every price level.
A Change in Demand Versus a Change in
Quantity Demanded
To summarize:
Change in price of a good or service
leads to
Change in quantity demanded
(Movement along the curve).
Change in income, preferences, or
prices of other goods or services
leads to
Change in demand
(Shift of curve).
The Impact of a Change in
Income
• Higher income • Higher income
decreases the demand increases the demand
for an inferior good for a normal good
The Impact of a Change in
the Price of Related Goods
• Demand for complement good
(ketchup) shifts left
• Demand for substitute good (chicken)
shifts right
• Price of hamburger rises
• Quantity of hamburger
demanded falls
Dangerous Curves: “Change in Quantity Demanded”
vs. “Change in Demand”
• Language is important when discussing demand
• “Quantity demanded” means
• A particular amount that buyers would choose to buy at a specific
price (it is a number represented by a single point) on a demand curve
• When a change in the price of a good moves us along a demand
curve, it is a change in quantity demanded
• The term demand means
• The entire relationship between price and quantity demanded—and
represented by the entire demand curve
• When something other than price changes, causing the entire
demand curve to shift, it is a change in demand
Supply in Output Markets
CLARENCE BROWN'S • A supply schedule is a table
SUPPLY SCHEDULE showing how much of a product
FOR SOYBEANS
firms will supply at different
QUANTITY
SUPPLIED prices.
PRICE (THOUSANDS
(PER OF BUSHELS • Quantity supplied represents the
BUSHEL) PER YEAR)
$ 2 0 number of units of a product that
1.75 10
2.25 20
a firm would be willing and able to
3.00 30 offer for sale at a particular price
4.00
5.00
45
45
during a given time period.
The Supply Curve and
the Supply Schedule
• A supply curve is a graph illustrating how much
of a product a firm will supply at different prices.
CLARENCE BROWN'S 6
Price of soybeans per bushel ($)
SUPPLY SCHEDULE
FOR SOYBEANS 5
QUANTITY
SUPPLIED
4
PRICE (THOUSANDS
(PER OF BUSHELS
3
BUSHEL) PER YEAR) 2
$ 2 0
1.75 10 1
2.25 20
3.00 30 0
4.00 45
5.00 45 0 10 20 30 40 50
Thousands of bushels of soybeans
produced per year
The Law of Supply
Price of soybeans per bushel ($)
6 • The law of supply
5 states that there is a
4 positive relationship
3 between price and
2 quantity of a good
1 supplied.
0
• This means that supply
0 10 20 30 40 50
Thousands of bushels of soybeans curves typically have a
produced per year
positive slope.
Determinants of Supply
• The price of the good or service.
• The cost of producing the good, which in turn
depends on:
• The price of required inputs (labor, capital, and
land),
• The technologies that can be used to produce
the product,
• The prices of related products.
A Change in Supply Versus
a Change in Quantity Supplied
• A change in supply is
not the same as a
change in quantity
supplied.
• In this example, a higher
price causes higher
quantity supplied, and
a move along the
demand curve.
• In this example, changes in determinants of supply, other
than price, cause an increase in supply, or a shift of the
entire supply curve, from SA to SB.
A Change in Supply Versus
a Change in Quantity Supplied
• When supply shifts
to the right, supply
increases. This
causes quantity
supplied to be
greater than it was
prior to the shift, for
each and every price
level.
A Change in Supply Versus
a Change in Quantity Supplied
To summarize:
Change in price of a good or service
leads to
Change in quantity supplied
(Movement along the curve).
Change in costs, input prices, technology, or prices of
related goods and services
leads to
Change in supply
(Shift of curve).
From Individual Supply
to Market Supply
• The supply of a good or service can be defined for an
individual firm, or for a group of firms that make up a
market or an industry.
• Market supply is the sum of all the quantities of a
good or service supplied per period by all the firms
selling in the market for that good or service.
Market Supply
• As with market demand, market supply is the
horizontal summation of individual firms’ supply
curves.
Market Equilibrium
• The operation of the market
depends on the interaction
between buyers and sellers.
• An equilibrium is the condition
that exists when quantity supplied
and quantity demanded are equal.
• At equilibrium, there is no
tendency for the market price to
change.
Market Equilibrium
• Only in equilibrium is
quantity supplied equal
to quantity demanded.
• At any price level
other than P0, the
wishes of buyers
and sellers do not
coincide (tally again)
Market Disequilibria
• Excess demand, or shortage,
is the condition that exists
when quantity demanded
exceeds quantity supplied at
the current price.
• When quantity demanded
exceeds quantity
supplied, price tends to
rise until equilibrium is
restored.
Market Disequilibria
• Excess supply, or surplus, is
the condition that exists
when quantity supplied
exceeds quantity demanded
at the current price.
• When quantity supplied
exceeds quantity
demanded, price tends to
fall until equilibrium is
restored.
Increases in Demand and Supply
• Higher demand leads to higher • Higher supply leads to lower
equilibrium price and higher equilibrium price and higher
equilibrium quantity. equilibrium quantity.
Decreases in Demand and Supply
• Lower demand leads to • Lower supply leads to higher
lower price and lower price and lower quantity
quantity exchanged. exchanged.
Demand or Supply change
• Increase in D: P increases; Q Increases
• Decrease in D: P decreases; Q increases
• Increase in S: P decreases; Q increases
• Decrease in S: P increases; Q decreases
44
Contd..
• Short-run Market Equilibrium : fixed factor inputs remain constant.
( e.g use of more labour and raw materials will only increase outputs.
• Long-run Market Equilibrium : all factors can be varied, Why?
• Firms have enough time to alter plant size and change other factor
inputs.
• Also, new firms can come into the market which expands the market
supply.
• So the short-run market equilibrium is different from the long-run
market equilibrium.
Partial Equilibrium & General
Equilibrium
• Partial Equilibrium (Single Market)
• This studies the behavior of individual decision–making units
(household, a firm) and assume that the behavior of other units
(Market) remains constant.
• General Equilibrium
• This studies the behavior of individual decision-making units and all
other individual markets that exist in the system all together.
Market Equilibrium (Mathematical Analysis)
• Two ways to analyse equilibrium in a particular
market:
1. Solving demand and supply equation simultaneously
2. Use of the demand and supply curve.
• A market is in equilibrium when the price is such that
the quantity supplied is equal to quantity demanded.
• A market is in equilibrium when the price is such that
excess supply equals excess demand equals zero.
Excess supply and excess demand and price pressure
When the quantity demanded in the market
exceeds the quantity supplied at a given price,
QD (P) > QS (P)
there is excess demand,
and the price will tend to rise.
Excess demand and excess supply
and price pressure
When the price in the market rises,
quantity demanded falls
& quantity supplied rises
until an equilibrium is reached at which
quantity demanded equals quantity supplied.
Demand and Supply of Hamburger Patties
Quantity Quantity
Price (per lb) supplied demanded
0.3 1000 9800
0.60 2000 8600
0.90 3000 7400
1.20 4000 6200
1.50 5000 5000
1.80 6000 3800
2.10 7000 2600
2.40 8000 1400
2.50 9000 200
Excess supply and excess demand
Excess supply
At a given price, the excess of the
quantity supplied over the quantity demand
is called the excess supply.
Excess supply = QS (P) - QD (P)
Quantity Quantity
Price (per lb) supplied demanded
0.3 1000 9800
0.60 2000 8600
0.90 3000 7400
1.20 4000 6200
1.50 5000 5000
1.80 6000 3800
2.10 7000 2600
2.40 8000 1400
2.50 9000 200
At a price of $2.10, excess supply (QS (P) - QD (P) ) is given by
7,000 - 2,600 = 4,400
Quantity Quantity
Price (per lb) supplied demanded
0.3 1000 9800
0.60 2000 8600
0.90 3000 7400
1.20 4000 6200
1.50 5000 5000
1.80 6000 3800
2.10 7000 2600
2.40 8000 1400
2.50 9000 200
At a price of $0.90, excess demand (QD (P) - QS (P) ) is given by
7,400 - 3,000 = 4,400
Mathematical Determination
• The demand for computer monitors is given by the equation
Qd =700 – P, while the supply is given by the equation
Qs =100 + P
In both equations P denotes the market price. Fill in the following table.
For what price is the market in equilibrium—supply equals to the
demand?
P 200 250 300 350 400
Qd
Qs
Contd…
• The demand for computer memory chips is given by the equation
Qd = 500 – 2P, while the supply is given by the equation
Qs = 50 + P.
In both equations P denotes the market price. For what price is the
market in equilibrium— supply equals demand? What is the
equilibrium quantity?
P 50 100 150 200 250
Qd
Qs
