Lecture

2
DEMAND, SUPPLY, AND MARKET
EQUILIBRIUM
Overview
Demand
Law of Demand:
It states that as the price of the product increases,
the quantity demanded falls, ceteris paribus, and
vice-versa.
Demand
The Law of Demand can be represented
through:
1. Table : Demand Schedule 2. Graph : Demand Curve
Quantity P
Price (P)
Demanded (Qd) 5

0 100
1 80
2 60
3 40
4 20
5 0 0 100
Qd
Demand
3. Equation: Demand Equation
Using the slope-intercept form: 𝒚 = 𝒎𝒙 + 𝒃
where
y is the dependent variable
m is the slope (that gives the change in y per unit
change in x)
x is the independent variable
b is the y-intercept (it gives the value of y if x=0)
Demand
3. Equation: Demand Equation
Using the slope-intercept form: 𝒚 = 𝒎𝒙 + 𝒃
Quantity
Price (P)
Demanded (Qd) 𝑸𝒅 = 𝟏𝟎𝟎 − 𝟐𝟎𝑷
0 100 Intercept: 100, If Price is
1 80 zero, Qd is equal to 100
2 60 units
3 40
Slope: -20, As P ↑ by P1,
4 20
Qd↓ by 20 units, vice-
5 0
versa.
 The Demand Curve
Price
(P per unit)

P2

P1

Q1 Q2 Quantity
Non-Price Factors of Demand
§ Income
• Normal Products
• Inferior Products
§ Price of Related Products (Py)
• Substitutes
• Complements
§ Quality
§ Advertisements
§ Future price expectations (Pf)
§ Tastes and Preference
Shifts of the Demand Curve
P D D’

P2

P1

Q0 Q1 Q2 Q
Change in Quantity Demanded
versus Change in Demand
Change in Quantity Change in Demand
Demanded
§ It is caused by changes in §It is caused by changes in
the price of the product. the non-price determinants
of demand.
§ Graphically it is
represented by an §Graphically it is
upward or downward represented by a rightward
movement along a or a leftward shift of the
demand curve demand curve
 Change in Quantity Demanded
versus Change in Demand
D
P D’

A C
P2

B D
P1

Q0 Q1 Q2 Q
Supply
Law of Supply:
It states that as the price of the product increases,
the quantity supplied increases, ceteris paribus,
and vice-versa.
 The Supply Curve
Price S
(P per unit)

P2

P1

Q1 Q2 Quantity
Non-Price Factors of Supply
§ Production Costs
§ Profitability of Substitute Products
§ Technology
§ Taxes
§ Government Subsidies
§ Future Price Expectations
 Shifts of the Supply Curve
P
S S’

P1

P2

Q0 Q1 Q2 Q
Change in Quantity Supplied
versus Change in Supply
Change in Quantity Supplied Change in Supply
§ It is caused by changes in §It is caused by changes in
the price of the product. the non-price determinants
of supply.
§ Graphically it is
represented by an §Graphically it is
upward or downward represented by a rightward
movement along a or a leftward shift of the
supply curve supply curve
 Change in Quantity Supplied
versus Change in Supply
P
S S’

A B
P1

C D
P2

Q0 Q1 Q2 Q
The Market Equilibrium
The market mechanism is the tendency in a free
market for price to change until the market clears.
Markets clear when quantity demanded equals
quantity supplied at the prevailing price.

Market clearing price – price at which markets clear

The Market Equilibrium
Price S
(P per unit)

E
Pe

Qe Quantity
 Market Disequilibrium
Price
(P per unit) S

Surplus
P1

P0

QD Q0 QS Quantity
 Market Disequilibrium
Price
(P per unit)

P3

P2

Shortage D
QS Q3 QD Quantity
Changes in Market Equilibrium
Equilibrium prices are determined by the relative
level of supply and demand.
Changes in supply and/or demand will cause
change in the equilibrium price and/or quantity in a
free market.
 Changes in Market Equilibrium
P D
Situation: Decline in S
S’
production cost due to
the fall in petroleum
prices.
What will be the effect P1
on the market price and
P3
quantity?

Q1 Q3 Q2 Q
 Changes in Market Equilibrium
D D’
P
Situation: There was S
increase in the level of
income (assume the
product is a normal
P3
product).
P1
What will be the effect
on the market price and
quantity?

Q1 Q3 Q2 Q
Changes in Market Equilibrium
The following summarizes what can cause market
equilibrium to change.

Changes in Changes in
Changes both in Demand and Supply
Demand Supply

⬆D & k S ⬆S & k D ⬆ D = ⬆ S ⬇ D = ⬇ S ⬆ D = ⬇ S
⬇D & k S ⬇S & k D ⬆ D > ⬆ S ⬇ D > ⬇ S ⬆ D > ⬇ S
⬆ D < ⬆ S ⬇ D < ⬇ S ⬆ D < ⬇ S
Government Interventions
Price Ceiling is the legal maximum amount a seller
can charge for a product.

Price Floor is the legal minimum amount a seller

can charge for a product.
Price Ceiling
Price
S

Pe

Pmax
Shortage
D

QS Qe QD Quantity
Price Floor
Price
S
Surplus
Pmin

Pe

QD Qe QS Quantity