Principles of MicroPrinciples of Micro

Chapter 4: “Chapter 4: “THE MARKET FORCES OF THE MARKET FORCES OF SUPPLY AND DEMANDSUPPLY AND DEMAND””

by Tanya Molodtsova, Fall 2005

III. III. Supply and Demand Supply and Demand Together: EquilibriumTogether: Equilibrium The point where the supply The point where the supply

and demand curves and demand curves intersect is called the intersect is called the market’s equilibriummarket’s equilibrium..

equilibriumequilibrium: a situation in : a situation in which the price has which the price has reached the level where reached the level where quantity supplied equals quantity supplied equals quantity demanded.quantity demanded.

III. III. Supply and Demand Supply and Demand Together: EquilibriumTogether: Equilibrium

equilibrium priceequilibrium price: the price that : the price that balances quantity supplied and balances quantity supplied and quantity demanded.quantity demanded.

On a graph, it is the price at which On a graph, it is the price at which the supply and demand curves the supply and demand curves intersect.intersect.

equilibrium quantityequilibrium quantity: the quantity : the quantity supplied and the quantity supplied and the quantity demanded at the equilibrium price.demanded at the equilibrium price.

On a graph it is the quantity at On a graph it is the quantity at which the supply and demand which the supply and demand curves intersect.curves intersect.

III. III. Supply and Demand Supply and Demand TogetherTogether

At $2.00, the quantity demanded is equal to the

quantity supplied!

Demand Schedule

Supply Schedule

The Equilibrium of Supply and The Equilibrium of Supply and DemandDemand

Price ofIce-Cream

Cone

0 1 2 3 4 5 6 7 8 9 10 11 12Quantity of Ice-Cream Cones

13

Equilibriumquantity

Equilibrium price Equilibrium

Supply

Demand

$2.00

III. III. Supply and Demand Supply and Demand TogetherTogether When market price > the When market price > the

equilibrium price equilibrium price there will be there will be a surplus of the good.a surplus of the good.

surplussurplus: a situation in which : a situation in which quantity supplied > quantity quantity supplied > quantity demanded.demanded.

To eliminate the surplus, To eliminate the surplus, producers will lower the price producers will lower the price until the market reaches until the market reaches equilibrium.equilibrium.

III. III. Supply and Demand Supply and Demand TogetherTogether

Price of

Ice-Cream

Cone

0

Supply

Demand

(a) Excess Supply

Quantity

demanded

Quantity

supplied

Surplus

Quantity of

Ice-Cream

Cones

4

$2.50

10

2.00

7

III. III. Supply and Demand Supply and Demand TogetherTogether When price < equilibrium price When price < equilibrium price

then then there will be a shortage of there will be a shortage of the good.the good.

shortageshortage: a situation in : a situation in which quantity demanded > which quantity demanded > quantity supplied.quantity supplied.

Sellers will respond to the Sellers will respond to the shortage by raising the price of shortage by raising the price of the good until the market the good until the market reaches equilibrium.reaches equilibrium.

III. III. Supply and Demand Supply and Demand TogetherTogether

Price of

Ice-Cream

Cone

0

Supply

Demand

(a) Excess Supply

Quantity

demanded

Quantity

supplied

Surplus

Quantity of

Ice-Cream

Cones

4

$2.50

10

2.00

7

III. III. Supply and Demand Supply and Demand TogetherTogether Law of Supply and Law of Supply and

DemandDemand: the claim that : the claim that the price of any good the price of any good adjusts to bring the adjusts to bring the supply and demand for supply and demand for that good into balance.that good into balance.

Three Steps to Three Steps to Analyzing Changes in Analyzing Changes in EquilibriumEquilibrium::

1.1. Decide whether the event Decide whether the event shifts the supply or demand shifts the supply or demand curve (or both).curve (or both).

2.2. Decide in which direction the Decide in which direction the curve shifts.curve shifts.

3.3. Use the supply-and-demand Use the supply-and-demand diagram to see how the shift diagram to see how the shift changes the equilibrium changes the equilibrium price and quantity.price and quantity.

Shifts in Curves vs. Shifts in Curves vs. Movements Along Movements Along CurvesCurves 1.1. A shift in the demand curve is A shift in the demand curve is

called a "change in demand." called a "change in demand." A shift in the supply curve is A shift in the supply curve is called a "change in supply."called a "change in supply."

2.2. A movement along a fixed A movement along a fixed demand curve is called a demand curve is called a "change in quantity "change in quantity demanded." A movement demanded." A movement along a fixed supply curve is along a fixed supply curve is called a "change in quantity called a "change in quantity supplied."supplied."

How an Increase in Demand How an Increase in Demand Affects the EquilibriumAffects the Equilibrium

Price ofIce-Cream

Cone

0 Quantity of Ice-Cream Cones

Supply

Initialequilibrium

D

D

3. . . . and a higherquantity sold.

2. . . . resultingin a higherprice . . .

1. Hot weather increasesthe demand for ice cream . . .

2.00

7

New equilibrium$2.50

10

How a Decrease in Supply How a Decrease in Supply Affects the EquilibriumAffects the Equilibrium

Price ofIce-Cream

Cone

0 Quantity of Ice-Cream Cones

Demand

Newequilibrium

Initial equilibrium

S1

S2

2. . . . resultingin a higherprice of icecream . . .

1. An increase in theprice of sugar reducesthe supply of ice cream. . .

3. . . . and a lowerquantity sold.

2.00

7

$2.50

4

A Change in Both A Change in Both Supply and DemandSupply and Demand

if you do not know the if you do not know the relative sizes of these shifts, relative sizes of these shifts, the end effect on either the end effect on either equilibrium price or equilibrium price or equilibrium quantity will be equilibrium quantity will be ambiguous.ambiguous.

The outcome depends on The outcome depends on the relative sizes of the the relative sizes of the shifts in supply and demand shifts in supply and demand