“ Don’t try just do it”

CHAPTER 2:
SUPPLY, DEMAND
AND MARKET
EQUILIBRIUM.
Instructor:
Dr. NGUYỄN THỊ THANH THÚY

Chapter 2: Supply, Demand, and Market Equilibrium

Objectives

- Understanding definitions and determinants of demand

and supply, draw the curves.

- Identify the market equilibrium and the shift of this

point.

- Analyze the impact of price ceiling, price floor, tax and

subsidy

- Solve quizzes

1
Chapter 2: Supply, Demand, and Market Equilibrium

1 Demand

2 Supply

3 Market Equilibrium

4 Government Intervention
on the market

1. Demand
1.1 Definitions
 The quantity demanded of any good is the amount of
the good that buyers are willing and able to purchase.

Ex: Lan has 60.000 VND and she is willing and able to
purchase 3 ice-cream cones at 20.000 VND per cone.

 The quantity demanded in a market is the sum of the

quantities demanded by all the buyers at each price.

2
 1. Demand
1.2 The Law of Demand
 A demand schedule is a table that shows the relationship
between the price of a good and the quantity demanded

Price of Ice-cream Quantity of cone

cone demanded
(1000 VND) (millions)
2 20
3 15
4 10
5 5

1. Demand

1.2 The Law of Demand

P (Price) • The demand curve, which
6 graphs the demand schedule,
5 illustrates how the quantity
4 demanded of the good changes
as its price varies.
3
• The characteristics of demand
2
curve:
1 + A straight line (simply)
0 Q (quantity + Downward slope
0 20 40
of demand)
Demand curve of ice-cream cone

3
 1. Demand

1.2 The Law of Demand

Demand’s equation (A straight line)
P = a.Q + b (with a <0)
The law of demand:

Other things equal, when the price of a good rises, the

quantity demanded of the good falls, and when the price
falls, the quantity demanded rises.

1. Demand
1.3 Shifts in the demand curve

Demand curve

shifts

Prices of
Numbers Tastes Expectations
Income related
of buyers
goods

4
 1. Demand
1.3 Shifts in the demand curve

P P
(D1) (D2)
P1 P1
(D2) (D1)

Q2 Q1 Q Q1 Q2 Q
Decrease in demand Increase in demand

1. Demand
1.3 Shifts in the demand curve
a. Income

normal good P
a good for which, other
things equal, an increase (D2)
in income leads to an P1
increase in demand (D1)

inferior good
a good for which, other
things equal, an increase Q1 Q2 Q
in income leads to a Income increases –
decrease in demand
Normal goods

5
 1. Demand
1.3 Shifts in the demand curve
b. Numbers of buyers
An increase in numbers of buyers leads to an increase in
demand
P

(D2)
P1
(D1)

Q1 Q2 Q
Numbers of buyers increase

1. Demand
1.3 Shifts in the demand curve
c. Prices of related goods

- Substitutes are similar - Complements are products

products and can be
substituted, meaning
consumers can choose when
to use them.
Ex: Ice-cream and frozen
yogurt
that are often used together,
without this product can not
use the other product, and
vice versa.
Ex: Automobile and gasoline

6
 1. Demand
1.3 Shifts in the demand curve
c. Prices of related goods
Substitutes:

The price of one of

the product increase - P

> quantity demanded

of substitute goods
(D)
will increase at all
(D)
prices -> the Q
A demand curve for ice-cream
demand curve will when the price of yogurt rise

shift to the right.

1. Demand
1.3 Shifts in the demand curve
c. Prices of related goods

Complements:
The price of one of the
P
product increase ->
quantity demanded of
other product will (D)

decrease at all prices -> (D’)

Q
the demand curve will
A demand curve for gasoline
shift to the left. when the price of
automobile rises

7
 1. Demand

1.3 Shifts in the demand curve

d. Tastes
• If someone likes a good or service, he/she will buy more of it
d. Expectations
• Expectations about the future may affect the demand for
a good or service today.

1. Demand

Shift in
demand
curve or
movement
along
demand
curve?

8
 1. Demand

1.4 Elasticity of Demand

a. The price elasticity of demand (ED )
 Price elasticity of demand is a measure of how much the
quantity demanded of a good responds to a change in the
price of that good, computed as the percentage change in
quantity demanded divided by the percentage change in
price
 Elasticity answers the question of how much the quantity
will change in percentage terms for a 1% change in the
price

1. Demand

1.4 Elasticity of Demand

a. The price elasticity of demand (ED )
 At one point
Q
Q Q P 1 P 1 P
ED       
P P Q P Q .......... .......... ....... Q
P Q Slope of demand curve
1 P
ED  
a Q

ED : The price elasticity of demand

Q : Quantity Q : Change in quantity demanded
P : Price at point 1 P : Change in price
a : belongs to equation: P = aQ + b

9
 1. Demand

1.4 The elasticity of demand

a. The price elasticity of demand (ED )
 Midpoint method (at two points)

ED 
Q 2  Q1  P1  P 2
P 2  P1 Q1  Q2

ED : The price elasticity of demand

Q1, Q2 : Quantities of demand at point 1 and 2
P1, P2 : Prices at point 1 and 2

1. Demand
1.4 The elasticity of demand
a. The price elasticity of demand (ED )
P P P

Q Q Q
| ED| < 1: Inelastic | ED| = 1: Unit | ED| > 1: Elastic
demand elastic demand demand

10
 1. Demand
1.4 The elasticity of demand
a. The price elasticity of demand (ED )

P P

Q Q
| ED| = 0: Perfectly | ED| = ∞: Perfectly Elastic
Inelastic demand demand

1. Demand

1.4 The elasticity of demand

b. The income elasticity of demand (EI )
The income elasticity of demand measures how the quantity
demanded changes as consumer income changes. It is calculated as
the percentage change in quantity demanded divided by the
percentage change in income.
Q
Q Q I
EI   
I I Q
Features: I

+ Normal goods have positive income elasticities (EI >0)

+ Inferior goods have negative income elasticities. (EI <0)

11
 1. Demand
1.4 The elasticity of demand
c. The cross-price elasticity of demand (EXY )
 The cross-price elasticity of demand measures how the
quantity demanded of one good responds to a change in the
price of another good.
Q X
QX Q X PY
E XY   
PY PY QX
Features: PY
+ EXY > 0 when X and Y are substitutes
+ EXY < 0 when X and Y are complements
+ EXY = 0 when X and Y are unrelated goods

2. Supply

2.1 Definitions

 The quantity supplied of any good or service is the

amount that sellers are willing and able to sell.

Ex: ABC company produces 60 ice-cream cones per day

and sell at 20.000 VND per cone.

 The quantity supplied in a market is the sum of the

quantities supplied by all the sellers at each price.

12
 2. Supply

2.2 The law of supply

 The supply schedule is a table that shows the relationship
between the price of a good and the quantity supplied.

Price Quantity of supply

(1000 VND/cone) (million)
3 5
4 10
5 15
6 20

2. Cung

2.2 The law of supply

• The supply curve
P (Price)
is a graph of the
7
relationship
6

5
between the price
4
of a good and the
3 quantity supplied
2 • Characteristics of
1 supply curve:
0
0 5 10 15 20 25
+ A straight line
Q (Quantity of (simply)
supply) + Upward slope
Supply curve of ice-cream cone

13
 2. Supply

2.2 The law of supply

Supply’s equation (A straight line)
P = a.Q + b (with a >0)
The law of supply:

Other things equal, when the price of a good rises, the

quantity supplied of the good also rises, and when the price
falls, the quantity supplied falls as well.

2. Supply
2.3 Shifts in supply curve
Supply curve

Shifts

Input Numbers
Expectations
Technology prices of
sellers

14
 2. Supply
2.3 Shifts in the supply curve

P P
(S2) (S1)
(S1) (S2)
P1 P1

Q1 Q2 Q Q1 Q2 Q

Decrease in supply Increase in supply

2. Supply
2.3 Shifts in the supply curve
a. Input price
When the price of inputs decreases, producing is more
profitable, and firms supply more => increase in supply
P
(S1)
(S2)
P1

Q1 Q2 Q
The price of input decreases

15
 2. Supply
2.3 Shifts in the supply curve
b. Technology
Technology advancement => reduce input prices => increase in
supply
P
(S1)
(S2)
P1

Q1 Q2 Q
Technology advancement

2. Supply

2.3 Shifts in the supply curve

c. Numbers of sellers
An increase in numbers of sellers leads to an
increase in supply
d. Expectations
Change in seller’s expectations can impact to
quantity of supply

16
 2. Supply

2.4 The Price Elasticity of Supply (ES )

Price elasticity of supply is a measure of how
much the quantity supplied of a good responds to a
change in the price of that good, computed as the
percentage change in quantity supplied divided by the
percentage change in price
Elasticity answers the question of how much the
quantity will change in percentage terms for a 1%
change in the price

2. Supply

2.4 The Price Elasticity of Supply (ES )

 At one point
Q
Q Q P 1 P 1 P
ES       
P P Q P Q Slope of supply curve
........................... Q
P Q
1 P
ES  
a Q
ES : The price elasticity of supply
Q : Quantity Q : Change in quantity supplied
P : Price at point 1 P : Change in price
a : belongs to equation: P = aQ + b

17
 2. Supply

2.4 The Price Elasticity of Supply (ES )

P P P

Q Q Q
ES < 1: : Inelastic ES = 1: Unit elastic ES > 1: Elastic
supply supply supply

2. Supply

2.4 The Price Elasticity of Supply (ES )

P P

Q Q
ES = 0: Perfectly ES = ∞: Perfectly elastic
Inelastic supply supply

18
 3. Market Equilibrium
3.1 Definition

Equilibrium is a situation in which the market price has

reached the level at which quantity supplied equals
quantity demanded.

This point is called the market’s equilibrium. The price at

this intersection is called the equilibrium price, and the
quantity is called the equilibrium quantity.

3. Market Equilibrium
3.1 Definition

Price Quantity of demand Quantity of supply

(P - 1.000 (QD - 1000 (QS - 1000
VND/pair) pair/month) pair/month)
100 100 600
80 200 450
60 300 300
40 400 150
20 500 0

The demand and supply of shoes market

19
 3. Market Equilibrium

3.1 Definition
P 120

100

80 Equilibrium
60 A
Pe
40

20

Equilibrium 0
price 0 100 200 300 400 500 600 700

Qe Q
Market equilibrium Equilibrium quantity

3. Market Equilibrium

3.1 Definition
Surplus – excess supply
P 120

100

80

60 A
Pe
40

20
Shortage – excess demand
0
0 100 200 300 400 500 600 700

Qe Q
Market equilibrium

20
 3. Market Equilibrium

3.2 A change in market equilibrium

1.Decide whether the event shifts the

supply or demand curve (or perhaps both).
Three Steps for
2. Decide in which direction Analyzing
the curve shifts. Changes
in Equilibrium
3. Use the supply-and demand
diagram to see how the shift changes
the equilibrium price and quantity.

3. Market Equilibrium
3.2 A change in market equilibrium
a. A shift in demand

(S)
P (D1) (S) P (D2)
P1 (D2) P2 (D1)

P2 P1

Q2 Q1 Q1 Q2
Q Q
Demand decrease Demand increase

21
 3. Market Equilibrium
3.2 A change in market equilibrium
b. A shift in supply

(S2) (S1)
P P (S2)
(D) (S1) (D)
P2 P1
P1 P2

Q2 Q1 Q1 Q2
Q Q
Supply decrease Supply increase

3. Market Equilibrium
3.2 A change in market equilibrium
c. A shift in both demand and supply

(D2) (S2)
P P (D2) (S2)
(D1) (S1)
(D1)
P2 P2 (S1)

P1 P1

Q2 Q1 Q Q1 Q2 Q
Large decrease in supply, Small decrease in supply,
small increase in demand large increase in demand

22
 4. Government intervention on the market
4.1 Price Ceilings (Maximum price control)
• This is a situation where the government sets a maximum
price, below the equilibrium price, which then prevents
producers from raising the price above it.
• Target: Protect consumers

(D) (S)
P

PE

PMax Maximum price

Shortage

QS QD Q

4. Government intervention on the market

4.2 Price Floors (Minimum price control)
• This is a situation where the government sets a minimum
price, above the equilibrium price, which then prevents
producers from reducing the price above it.
• Target: Protect workers and raise incomes for producers
P Surplus (S)

PMin Minimum price

PE

(D)

QD Q
QS

23
 4. Government intervention on the market
4.3 Tax
Suppose the local government passes a law requiring
sellers to send $ t to the government for each product they sell.
P o : Price sellers receive
P1 : Price without tax
P2 : Price buyers pay
(D) (S2)
P
Equilibrium with tax
P2 t (S1)
P1
P0
Equilibrium without tax

Q2 Q1 Q
A tax on seller

4. Government intervention on the market

4.3 Tax

24
4. Government intervention on the market
4.3 Tax

4. Government intervention on the market

4.4 Subsidy
Suppose the local government passes a law requiring
the government to pay $ s to the sellers for each product
they sell.
P1 : price without subsidy
P2 : price buyers pay
P3 : price sellers receive
(S1)
P (D)
s (S2)
P3
P1
P2
A subsidy to producers

Q1 Q2 Q

25
“ Don’t try just do it”

26