Demand, Supply, and Market Equilibrium

03

McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

Markets

• Interaction between buyers and

sellers

• Markets may be:

• Local

• National

• International

• Price is discovered in the interactions

of buyers and sellers

LO1 3-2

Demand

• Schedule or curve

• Amount consumers are willing and

able to purchase at a given price

• Other things equal

• Individual demand

• Market demand

LO1 3-3

Law of Demand

• Other things equal, as price falls, the

quantity demanded rises, and as

price rises, the quantity demanded

falls.

• Reasons:

• Common sense

• Law of diminishing marginal utility

• Income effect and substitution effects

LO1 3-4

6

5

4

3

2

1

0 10 20 30 40 50 60 70 80

Quantity Demanded (bushels per week)

Pri

ce (

per

bu

sh

el)

P Qd

$5

4

3

2

1

10

20

35

55

80

P

Q

D

The Demand Curve

LO1

The Demand Curve

3-5

Market Demand

LO1

Market Demand for Corn, Three Buyers

Price

per bushel

Quantity Demanded Total

Qd

per week Joe Jen Jay

$5 10 12 8 30

4 20 23 17 60

3 35 39 26 100

2 55 60 39 154

1 80 87 54 221

3-6

Changes in Demand

LO1

6

5

4

3

2

1

0

Quantity Demanded (bushels per week)

Pri

ce (

per

bu

sh

el)

P

Q

D1

2 4 6 8 10 12 14 16 18

D2

D3

3-7

Changes in Demand

LO1

6

5

4

3

2

1

0

Quantity Demanded (bushels per week)

Pri

ce (

per

bu

sh

el)

P

Q

D1

2 4 6 8 10 12 14 16 18

D2

D3

Change in Demand

Change in Quantity

Demanded

3-8

Determinants of Demand

• Change in consumer tastes and

preferences

• Change in number of buyers

• Change in income

• Normal goods

• Inferior goods

LO1 3-9

Determinants of Demand

• Change in prices of related goods

• Complements

• Substitutes

• Change in consumers’ expectations

• Future prices

• Future income

LO1 3-10

Determinants of Demand

LO1

Table 3.1 Determinants of Demand: Factors That Shift the Demand Curve

Determinant Examples

Change in buyers’ tastes Physical fitness rises in popularity, increasing the

demand for jogging shoes and bicycles; cell phone

popularity rises, reducing the demand for land-line

phones.

Change in the number of buyers A decline in the birthrate reduces the demand for

children’s toys.

Change in income A rise in incomes increases the demand for normal

goods such as restaurant meals, sports tickets, and

necklaces while reducing the demand for inferior

goods such as cabbage, turnips, and inexpensive

wine.

Change in the prices of related

goods

A reduction in airfares reduces the demand for bus

transportation (substitute goods); a decline in the price

of DVD players increases the demand for DVD movies

(complementary goods).

Change in consumer expectations Inclement weather in South America creates an

expectation of higher future coffee bean prices,

thereby increasing today’s demand for coffee beans. 3-11

Supply

• Schedule or curve

• Amount producers are willing and

able to sell at a given price

• Individual supply

• Market supply

LO2 3-12

Law of Supply

• Other things equal, as the price rises,

the quantity supplied rises and as the

price falls, the quantity supplied falls.

• Reason:

• Price acts as an incentive to

producers

• At some point, costs will rise

LO2 3-13

The Supply Curve

LO2

5

4

3

2

1

0

Pri

ce (

per

bu

sh

el)

Quantity supplied (bushels per week)

S

10 20 30 40 50 60 70

Supply of Corn

Price

per

Bushel

Qs

per

Week

$5 60

4 50

3 35

2 20

1 5

P

Q

3-14

Changes in Supply

LO2

$6

5

4

3

2

1

0

Pri

ce (

per

bu

sh

el)

S1

Quantity supplied (thousands of bushels per week)

2 4 6 8 10 12 14 16

P

Q

S2

S3

Increase

in supply

Decrease

in supply

3-15

Changes in Supply

LO2

$6

5

4

3

2

1

0

Pri

ce (

per

bu

sh

el)

S1

Quantity supplied (thousands of bushels per week)

2 4 6 8 10 12 14 16

P

Q

S2

S3

Change in Quantity

Supplied

Change in Supply

3-16

Determinants of Supply

• A change in resource prices

• A change in technology

• A change in the number of sellers

• A change in taxes and subsidies

• A change in prices of other goods

• A change in producer expectations

LO2 3-17

Determinants of Supply

LO2

Table 3.2 Determinants of Supply: Factors That Shift the Supply Curve

Determinant Examples

Change in resource prices A decrease in the price of microchips increases the

supply of computers; an increase in the price of crude

oil reduces the supply of gasoline.

Change in technology The development of more effective wireless

technology increases the supply of cell phones.

Change in taxes and subsidies An increase in the excise tax on cigarettes reduces the

supply of cigarettes; a decline in subsidies to state

universities reduces the supply of higher education.

Change in prices of other goods An increase in the price of cucumbers decreases the

supply of watermelons.

Change in producer expectations An expectation of a substantial rise in future log prices

decreases the supply of logs today.

Change in the number of suppliers An increase in the number of tattoo parlors increases

the supply of tattoos; the formation of women’s

professional basketball leagues increases the supply

of women’s professional basketball games.

3-18

Market Equilibrium

• Equilibrium occurs where the demand

curve and supply curve intersect.

• Surplus and shortage

• Rationing function of prices

• Efficient allocation

• Productive efficiency

• Allocative efficiency

LO3 3-19

Market Equilibrium

LO3

6

5

4

3

2

1

0 2 4 6 8 10 12 14 16 18

Bushels of Corn (thousands per week)

Pri

ce (

per

bu

sh

el)

P Qd

$5

4

3

2

1

2,000

4,000

7,000

11,000

16,000

P Qs

$5

4

3

2

1

12,000

10,000

7,000

4,000

1,000

7

3

D

S 6,000 Bushel

Surplus

7,000 Bushel

Shortage

3-20

Rationing Functions of Prices

• The ability of the competitive forces of

demand and supply to establish a

price at which selling and buying

decisions are consistent.

LO3 3-21

Efficient Allocation

• Productive efficiency

• Producing goods in the least costly way

• Using the best technology

• Using the right mix of resources

• Allocative Efficiency

• Producing the right mix of goods

• The combination of goods most highly

valued by society

LO3 3-22

` Changes in Demand and Equilibrium

LO4

0

P

D4

D3

` Changes in Demand and Equilibrium

LO4

0

P

D1

D2

S

Increase in demand

D increase:

P, Q

D decrease:

P, Q

Decrease in demand

S

3-23

` Changes in Demand and Equilibrium

LO4

0

P

D

S4

` Changes in Supply and Equilibrium

LO4

S3

0

P

D

S2 S1

Increase in supply

S increase:

P, Q

S decrease:

P, Q

Decrease in supply

3-24

Complex Cases

LO4

TABLE 3.3 Effects of Changes in Both Supply and Demand

Change in Supply Change in Demand

Effect on

Equilibrium Price

Effect on

Equilibrium

Quantity

1. Increase Decrease Decrease Indeterminate

2. Decrease Increase Increase Indeterminate

3. Increase Increase Indeterminate Increase

4. Decrease Decrease Indeterminate Decrease

3-25

Government Set Prices

• Price Ceilings

• Set below equilibrium price

• Rationing problem

• Black markets

• Example: Rent control

LO5 3-26

Government Set Prices

LO5

S P

Q

D

P0

PC

Q0

Shortage

Qd Qs

ceiling $3.50

3.00

3-27

Government Set Prices

• Price Floors

• Prices are set above the market

price

• Chronic surpluses

• Example: Minimum wage laws

LO5 3-28

Government Set Prices

LO5

S

P

Q

D

P0

Pf

Q0

Surplus

Qs Qd

floor

2.00

$3.00

3-29

Legal Market for Human Organs

• What if we created a legal market for

human organs?

• Positive effects

• Increase the incentive to donate

• Eliminate the persistent shortage of

eyes, livers, hearts, kidneys, etc.

3-30

Legal Market for Human Organs

• Negative effects

• Increases the cost of medical care

• Diminishes the special nature of life

by commercializing it

3-31