Notes on the Construction of

Demand & Supply Schedules

Leigh Tesfatsion
Prof. of Econ, Math and ECpE
Iowa State University
Ames, IA 50011-1070
http://www.econ.iastate.edu/tesfatsi/
Latest Revision: 10 June 2010
1

Clarification of Terminology

In market analyses:

Ordinary supply and demand schedules give quantity

for each (per unit) price: Q = So(P); Q = Do(P)
Inverse supply and demand schedules give (per unit)
price for each quantity: P = S(Q); P = D(Q).

In this class we will stress price-setting agents who

determine price for each quantity bought/sold, so we

focus on inverse supply/demand functions.

The exact relationship between ordinary/inverse

supply and demand is illustrated at the end of these
notes.

EXAMPLE 1:
Seller S1 Supply Schedule
Inverse Form P = S1(Q)
90

S1

Let Q = Apple Amount (in bushels)

Let P = Per-unit price of apples
(i.e., dollars $ per bushel)

70

Given any Q, the function P=S1(Q) gives

Seller S1s minimum per-unit sale price
($/bushel) for the last unit supplied at
this Q.

50

Bushel Unit

30
10
0

1
2
3
4
5
6

Seller S1 Min Sale Price

$20
$30
$60
$80
$90

Seller S2 Supply Schedule

Inverse Form P = S2(Q)
90

S2

Given any Q, the function P=S2(Q)

gives Seller S2s minimum per-unit
sale price ($/bushel) for the last
unit supplied at this Q.

70

50

Bushel Unit

30

1
2
3
4

Seller S2 Min Sale Price

$10
$50
$90

10
0

Total Supply Schedule (Sellers S1 & S2)

Inverse Form P = S(Q)
90

S1
S1

Bushel Unit Min Seller Price

70

S1

S1

30

1
2
3
4
5
6
7
8
9

S2

50

10

S2

S1
S2

$10
$20
$30
$50
$60
$80
$90
$90

(S2)
(S1)
(S1)
(S2)
(S1)
(S1)
(S1/S2)
(S2/S1)

Q
5

Buyer B1 Demand Schedule

Inverse Form P = D1(Q)

90

Given any Q, the function

P=D1(Q) gives Buyer B1s
maximum per-unit purchase
price ($/bushel) for the last
unit purchased at this Q.

70

50

Bushel Unit

Buyer B1s Max

Per-Unit Price

30

1
2
3
4

$84
$76
$70
$0

10
0

D1
2

Buyer B2 Demand Schedule

Inverse Form P = D2(Q)
P

70

Given any Q, the function P=D2(Q)

gives Buyer B2s maximum per-unit
purchase price ($/bushel) for the
last unit purchased at this Q.

50

Bushel Unit

90

30
10
0

D2
2

1
2
3
4

Buyer B2s Max

Per-Unit Price
$50
$30
$20
$0

Buyer B3 Demand Schedule

Inverse Form P = D3(Q)

90

P
Given any Q, the function
P=D3(Q) gives Buyer B3s
maximum per-unit purchase
price ($/bushel) for the last
unit purchased at this Q.

70

50

Bushel Unit

30
10
0

D3
2

1
2
3

Buyer B3s Max

Per-Unit Price
$90
$80
$0

Q
8

Total Demand Schedule (Buyers B1,B2,& B3)

Inverse Form P = D(Q)

90

B3

B1

B3
B1

Bushel Unit

B1

70

50

B2

30

B2

10
0

1
2
3
4
5
6
7
8
9

B2

Max Buyer
Per-Unit Price
$90
$84
$80
$76
$70
$50
$30
$20
0

(B3)
(B1)
(B3)
(B1)
(B1)
(B2)
(B2)
(B2)

CMC Points (S=D)

P
90

B3
B1

B3

Bushel Unit MaxBuyPrice MinSellPrice

B1

1
2
3
4
5
6
7
8

S1

60
S2

50

B2

S1

30

CMC Pts: Q*=5, $60 P* $70

S1

B1

70

10

S1 S2

B2

S1

B2

S2

D
2

$90
$84
$80
$76
$70
$50
$30
$20
0

$10
$20
$30
$50
$60
$80
$90
$90

10

Remark: Inframarginal (traded) units versus

extramarginal (non-traded) units at CMC Pts
P
90

B3

S1

B1

B3

B1

Bushel Unit MaxBuyPrice MinSellPrice

B1
S1

60

S2

50

B2

S1

30

CMC Pts: Q*=5, $60 P* $70

S1

70

10

S2

B2

S1

B2

S2

D
2

1
2
3
4
5

$90
$84
$80
$76
$70

$10
$20
$30
$50
$60

6
7
8

$50
$30
$20

$80
$90
$90

11

Total Net Surplus at CMC Points

(invariant to particular choice of CMC Point)
90

CMC Pts: Q*=5, $60 P* $70

Bushel Unit MaxBuyPrice MinSellPrice

70

60
50

30

10
0

1
2
3
4
5

$90
$84
$80
$76
$70

$10
$20
$30
$50
$60

6
7
8

$50
$30
$20

$80
$90
$90

12

Total Net Surplus at CMC Points

90

CMC Pts: Q*=5, $60 P* $70

Net
BushelUnit MaxBuyP MinSellP Surplus

70

1
2
3
4
5

60
50

- $10 = $80
- $20 = $64
- $30 = $50
- $50 = $26
- $60 = $10

TOTAL NET SURPLUS:

30
10
0

$90
$84
$80
$76
$70

$230

13

Net Buyer/Seller Surplus at CMC Points

(surplus division DOES depend on CMC point)
90
70

50

EXAMPLE: Q*=5, P*= $65

Bushel Unit MaxBuyPrice MinSellPrice

Buyer

Seller

30

10
0

1
2
3
4
5

$90
$84
$80
$76
$70

$10
$20
$30
$50
$60

6
7
8

$50
$30
$20

$80
$90
$90

14

Net Buyer/Seller Surplus at CMC Points

90
70

50

EXAMPLE: Q*=5, P*= $65

BushelUnit MaxBPrice P*=65

1
2
3
4
5

Buyer

$90
$84
$80
$76
$70

$65
$65
$65
$65
$65

=
=
=
=
=

NET BUYER SURPLUS:

Seller

10
0

1
2
3
4
5

$65
$65
$65
$65
$65

$10
$20
$30
$50
$60

$25
$19
$15
$11
$5

$75

BushelUnit P*=65 MinSPrice

30

BuySurplus

=
=
=
=
=

SellSurplus
$55
$45
$35
$15
$5

NET SELLER SURPLUS: $155

15

Market Efficiency (ME)

90

CMC Pts: Q*=5, $60 P* $70

TOTAL NET SURPLUS (TNS): $230

70
60

MARKET EFFICIENCY (ME) =

50
100%

30
10
0

Max Possible TNS

How could ME be
less than 100% ?

D
2

Actual Extracted Surplus

16

ME < 100% under What Conditions?

Some inframarginal quantity unit FAILS to
trade
Or some extramarginal quantity unit
SUCCEEDS in being traded

NOTE: If the price received by the seller of

some quantity unit is LESS than the price paid
by the buyer of this quantity unit (so some net
surplus is extracted by a third party), then
Buyer Net Surplus + Seller Net Surplus < 100%
ISOs in wholesale power markets !
17

Market Power:
more

90
70

50

Ability of a trader to extract

surplus than he would get at CMC Point

EXAMPLE: Q*=5, P*= $65

BushelUnit MaxBPrice P*=65

1
2
3
4
5

Buyer

$90
$84
$80
$76
$70

$65
$65
$65
$65
$65

=
=
=
=
=

NET BUYER SURPLUS:

Seller

10
0

1
2
3
4
5

$65
$65
$65
$65
$65

$10
$20
$30
$50
$60

$25
$19
$15
$11
$5

$75

BushelUnit P*=65 MinSPrice

30

BuySurplus

=
=
=
=
=

SellSurplus
$55
$45
$35
$15
$5

NET SELLER SURPLUS: $155

18

Does seller S1 below have

any market power?
90

B3

S1

B1

B3

B1

70
60

S1

10
0

Bushel Unit MaxBuyPrice MinSellPrice

S2

B2

S1

30

CMC Pts: Q*=5, $60 P* $70

S1
B1

50

S2

B2

S1

B2

S2

D
2

1
2
3
4
5

$90
$84
$80
$76
$70

$10
$20
$30
$50
$60

6
7
8

$50
$30
$20

$80
$90
$90

19

Market power of seller S1 ?

90

B3

S1

B1

B3

76

B1
S1
S2

50

CMC Price P*=$70, Q*=5

B2

S1

30

Suppose S1 REPORTS a reservation

value on his 3rd unit equal to $70?

B1

60

Q*=5, P*= $60

S1s Net Seller Surplus = $70

S1

70

10

S Example: CMC Pt:

S2

S1s Net Seller Surplus = $100 !

($10 extra on each unit sold)

B2

S1

B2

S2

D
2

20

Market power of seller S1 ?

90

B3

S1

B1

B3

76

Suppose S1 REPORTS a reservation

value on his 3rd unit equal to $80
and on his 2nd unit equal to $76?

S1
S2

50

B2

S1

30

B1

Q*=5, P*= $60

S1s Net Seller Surplus = $70

S1
B1

60

10

S EX: CMC Pt:

S2

B2

S1

B2

S2

D
2

21

Market power of seller S1?

90

B3

S1

B1

B3

76

B1

B2

50
S1

30

Suppose S1 REPORTS a reservation

value on his 3rd unit equal to $80
and on his 2nd unit equal to $76?

S1
S2

Q*=5, P*= $60

S1s Net Seller Surplus = $70

S1
B1

60

10

S EX: CMC Pt:

S2

At CMC price $76, S1 only sells his

first two units, but his net seller
surplus on these two units alone
increases to $102 = [$56+$46] !

B2

S1

B2

S2

D
2

22

More on CMC Points:

Illustrative Example 2
S

Unique CMC Pt: Q*=4, P*= $20

Bushel Unit MaxBuyPrice MinSellPrice

$30

B1

B1 B1

S3

$25

S1

$20

S2

$15
$10
$5
0

1
2
3
4
5
6
7
8

B1

S1

B2
S1

B2

S1

$30
$30
$30
$30
$10
$10
0
0

$5
$5
$15
$20
$20
$25

23

More on CMC Points:

Illustrative Example 3
90

70

CMC Points:
P*=$60, 4 Q* 5

50

30

10
0

24

More on CMC Points:

Illustrative Example 4
90

B3

S1

B1

B3

S2

CMC Pts: Q*=5, $60 P* $70

S1

B1

Bushel Unit MaxBuyPrice MinSellPrice

B1

70

1
2
3
4
5
6
7
8

S1
S2

50
S1

30
10
0

B2

B2

S1

B2

S2

D
2

$90
$84
$80
$76
$70
$50
$30
$20
0

$10
$20
$30
$50
$60
$80
$90
$90

25

Relationship of Inverse to Ordinary

Supply and Demand Schedules
In

all of the previous inverse supply and

demand examples, the minimum per-unit sale
prices (i.e., the sale reservation prices) and
the maximum per-unit purchase prices (i.e.,
the purchase reservation prices) were given
for each successive quantity unit 1, 2, 3,

Conversely,

for ordinary supply and demand,

the maximum sale and purchase quantities are
given for each successive per-unit price
$1, $2, $3,

26

Illustrative Comparison of Inverse and Ordinary Supply:

Supply Schedule for Seller S1

Inverse Form P = S1(Q)

S1

Supply Unit

Seller S1 Min
per-Unit Sale Price

0
1
2
3
4
5
6

$0
$2
$4
$5

1
0

27

Supply Schedule for Seller S1 Re-Expressed in

Ordinary Form Q1 = So(P)

S o1

Q = So1(P) = Maximum amount of Q

that Seller S1 is willing to supply at
the per-unit sale price P

8
7

Seller S1 Max
Supply

6
5
4
3
2
1
0

0
0
1
1
2
3
3
3
3
3

Per-Unit
Sale Price
$0
$1
$2
$3
$4
$5
$6
$7
$8
$9

28

Supply Schedule for Seller S2

Inverse Form P = S2(Q)

S2

Supply Unit

8
7

0
1
2
3
4
5
6
7
8
9

6
5
4
3
2
1
0

Seller S2 Min
Per-Unit Sale Price
$0
$1
$1
$2
$2
$3
$4
$4
$5

Q
29

Supply Schedule for Seller S2 Re-Expressed in

Ordinary Form Q = So2(P)

S o2

Q = So2(P) = Maximum amount

of Q that Seller S2 is willing to
supply at per-unit sale price P

8
7

Seller S2 Max
Supply

6
5
4
3
2
1
0

0
2
4
5
7
8
8
8
8
8

Per-Unit
Sale Price
$0
$1
$2
$3
$4
$5
$6
$7
$8
$9

30

Total Supply Schedule (Sellers S1 & S2)

Inverse Form P = S(Q)

8
7
6
1,2

1,2,2

3
2
1
0

1,2,2
2,2

10

P = S(Q) = Minimum per-unit sale

price a seller (either Seller S1 or
Seller S2) is willing to accept for
the last unit supplied at Q

Supply Unit Min Per-Unit Sale Price

1
$1 (S2)
2
$1 (S2)
3
$2 (S1/S2/S2)
4
$2 (S1/S2/S2)
5
$2 (S1/S2/S2)
6
$3 (S2)
7
$4 (S1/S2/S2)
8
$4 (S1/S2/S2)
9
$4 (S1/S2/S2)
10
$5 (S1/S2)
Q 11
$5 (S1/S2)
31
12 14 16
12

Total Supply Schedule (Sellers S1 & S2) Re-Expressed

in Ordinary Form Q = So(P) = [So1(P) + So2(P)]
9

So

Q = So(P) = Maximum total amount

of Q that Sellers S1 and S2 are
willing to supply at the per-unit
sale price P

8
7
6
5

1,2,2

3
2
1
0

1,2

1,2,2
2,2

12

16

Max Supply

Unit Sale Price

Q=Q1+Q2
0=0+0
2=0+2
5=1+4
6=1+5
9=2+7
11=3+8
11=3+8
11=3+8
11=3+8
11=3+8

$0
$1
$2
$3
$4
$5
$6
$7
$8
$9

32