Lecture 6: Market Equilibrium,

Demand and Supply Shifts

EC101 DD & EE / Manove Supply & Demand p1

A firm is willing and able to produce and sell a

larger quantity of goods at higher prices…

EC101 DD & EE / Manove p2

 Market Equilibrium
A system is in equilibrium when there is no
tendency for change.
A competitive market is in equilibrium at
the market price if the quantity supplied
equals the quantity demanded.
We will show that in this equilibrium, the price
and quantity have no tendency to change.
At the market equilibrium, the price is called
the equilibrium price, …
…and the quantities supplied and demanded
are called the equilibrium quantity.
EC101 DD & EE / Manove Supply & Demand>Market Equilibrium p3

Example: The Market for Milk

In the market for milk described previously,
market supply and demand are as follows.

The market equilibrium is described by ____.

EC101 DD & EE / Manove Supply & Demand>Market for Milk>Equilibrium p4

 Equilibrium in the Market for Milk
on a Graph

EC101 DD & EE / Manove Supply & Demand>Market for Milk>Graph>Equilibrium p5

Movement towards Market Equilibrium

If the price is above the equilibrium price,
quantity supplied > quantity demanded,
 excess supply.
Sellers cannot sell as much as they want,
so they will tend to offer buyers a lower price.

Therefore, the price will tend to move

downwards towards the equilibrium price.

EC101 DD & EE / Manove Supply & Demand>Excess Supply p6

If the price is below the equilibrium price,
quantity demanded > quantity supplied
 excess demand,
buyers will not be able to buy all they want to
buy,
so they will tend to offer sellers a higher price.

Therefore, the price will tend to move pwards

towards the equilibrium price.

EC101 DD & EE / Manove Supply & Demand>Excess Demand p7

Which of the following

prices leads to ….?

EC101 DD & EE / Manove p8

 Movement Towards Equilibrium in
the Market for Milk

Excess Supply

Excess Demand

EC101 DD & EE / Manove Supply & Demand>Movement Towards Equilibrium p9

The Effect of Price Changes

Suppose the price is at $4…
Price ($)
…so that a buyer is at point A on his demand curve.

6 If Price changes to $3…

D
5
…the quantity demanded changes from 40 to 60,
Price
4
A …so the buyer moves ALONG his original
demand curve to point B, …
3 B
…because the same demand curve
2 yields the quantity demanded at
Quantity every reasonable price.
1 Demanded D
0 Quantity
40 60 120
Likewise, if price changes, a seller will MOVE ALONG her original
supply curve, because the same supply curve yields the quantity
supplied at every reasonable price.
EC101 DD & EE / Manove Supply & Demand>Price Changes p 10
 Demand-Curve Shifts
Changes in some demand-related factors affect
the quantities demanded at every price:
Consumer preferences
Income of consumers
Prices of other consumer goods
Expectations about the future
Such changes can affect demand in general,…
…and they can change the position of the
entire demand curve.
But those factors usually do NOT affect the
position of the supply curve.
EC101 DD & EE / Manove Supply & Demand>Demand-Curve Changes p 11

Changes in Consumer Preferences

 Consumer preferences change for many reasons.
New information

Fashion

Experience

 These changes can shift demand.

EC101 DD & EE / Manove Supply & Demand>Demand-Curve Changes p 12

 Example: Preference for Milk
New evidence emerges that milk
cures baldness in men.
Price More milk demanded
8 at every price.

D D’ S
6

B
4 New market equilibrium:
Higher price
A Larger quantity
2

Quarts of Milk
0 10 20 30 40

EC101 DD & EE / Manove Supply & Demand>Demand-Curve Shifts>Baldness p 13

Example 2: Preference for Milk

New evidence shows that milk
[is good for people]
Price
…but too much milk [is bad].
8

D D’ D’ S
6 Another
Slope possibility
increases
4 because
of narrow A In new equilibrium:
range of Lower price
desirable
quantities Smaller quantity
2 B (but that depends on
where the curves cross)
Quantity
0 10 20 30 40

EC101 DD & EE / Manove Supply & Demand>Demand-Curve Shifts>Complexion p 14

 Suppose a medical study demonstrates that
red wine is good for the heart…

EC101 DD & EE / Manove p 15

Income and Demand

Demand is affected by a person’s income.
Normal goods: demand increases as income rises.

Inferior goods: demand increases as income falls.

EC101 DD & EE / Manove Elasticity of Demand>Income p 16

 Example: Large Apartments and Income
in Washington DC
Government salaries increase.
Price
8 Large apartments
S are normal goods,…
D D’
6 but the supply curve
B is almost vertical,…
4 because it takes a long time
to supply more apartments.
A In new equilibrium:
2
Much higher price
Slightly larger quantity
Large
0 10 20 30 40 Apartments

EC101 DD & EE / Manove Supply & Demand>Demand-Curve Shifts>Apartments p 17

Substitutes
Two goods are substitutes if you can use one of
them instead of the other.

Demand for a good (chicken) increases when

the price of a substitute (hamburger) rises,…

because consumers want to buy less of the

substitute,…
and consume more of the first good instead—
at every price.
Supply DD
EC101 & Demand>Demand-Curve
& EE / Manove Shifts>Substitutes p 18
 Example: Car rentals and Airfares
Suppose airfares are rising sharply.
(And the quality of air travel is falling.)
Price
8
Road travel is a substitute for
D’ air travel, so demand for rental
D
6 S cars will increase.

B
4 In new equilibrium:
Higher price
More car rentals
A
2

Car Rentals
0 10 20 30 40

EC101 DD & EE / Manove Supply & Demand>Demand-Curve Shifts>Car Rentals p 19

Complements
 Two goods are complements in demand
if you normally use both of them together.

Demand for a good decreases when the price

of a complement rises,…
because if the complement is too expensive,
the first good is less useful.

EC101 DD & EE / Manove Supply & Demand>Demand-Curve Shifts>Complements p 20

 Example: Motel Rooms
and Gasoline Prices
Price
Suppose gasoline prices increase.
80
D S Motel rooms and
D’ gasoline are
60
complements.
A
40 In new equilibrium:
Much lower price
B Somewhat fewer
20 rooms rented

Rooms rented
0 100 200 300 400

EC101 DD & EE / Manove Supply & Demand>Demand-Curve Shifts>Motel Rooms p 21

Supply-Curve Changes
 Changes in some supply-related factors will
affect the quantities supplied at every price:
Prices of Inputs
Technology
Economic Environment
taxes
government regulations
weather
 Changes in these factors affect supply in general,…
 …and they can shift the entire supply curve.
 But they usually do NOT affect the position of the
demand curve.
EC101 DD & EE / Manove Supply & Demand>Supply-Curve Changes p 22
 Example: Supply of Milk
and Mad Cows
Price
Mad-cow disease kills
8 many cows.
D S’ S
In new equilibrium:
6 Higher price
B
Lower quantity
4 A

Quarts of Milk
0 100 200 300 400

EC101 DD & EE / Manove Supply & Demand>Supply-Curve Shifts>Cows p 23

Example: Supply of Milk

and Hormones
BST is discovered.
Price
D
8
S S’
Causes each cow to
give much more milk.
6 A
In new equilibrium:
4 B Lower price
Higher quantity

Quarts of Milk
0 100 200 300 400

EC101 DD & EE / Manove Supply & Demand>Supply-Curve Shifts>Hormones p 24

 Example: Opium
and the Taliban
Price In 2001, after the
80 D S S’ Afghan Taliban
regime fell,...
60 A restrictions on
opium production
40 B were relaxed.
In new equilibrium:
20 Lower price
Higher quantity

Opium Output
0 100 200 300 400

EC101 DD & EE / Manove Supply & Demand>Supply-Curve Shifts>Opium p 25

If household incomes increase,…

EC101 DD & EE / Manove p 26

 End of File

EC101 DD & EE / Manove End of File p 27