CHAPTER II

THE MARKET
FORCES
of
SUPPLY

DEMAND

CHAPTER II: THE MARKET FORCES OF SUPPLY AND DEMAND

Learning objectives:
By the end of this Chapter, students should be able to:
 Define demand and supply.
 Explain the factors that influence demand and supply.
 Derive a market demand curve and a market supply curve.
 Explain what is meant by ‘market equilibrium’.
 Distinguish a market shortage and a market surplus.
 Understand the rationale of government intervention in the market.
 Explain the mechanism of price controls and taxes.

Reading materials
Chapter 4,5,6; Principles of Economics (2021), N.Gregory Mankiw; South-
Western Cengage Learning 9th edition 2
 DEMAND

SUPPLY
OUTLINE

MARKET EQUILIBRIUM

GOVERNMENT POLICIES

Markets  Competition
• A market is a group of buyers and sellers of a particular product.
• A competitive market is one with many buyers and sellers,
each has a negligible effect on price.
• In a perfectly competitive market:
• All goods exactly the same
• Buyers & sellers so numerous that no one can affect market
price—each is a “price taker”
• In this chapter, we assume markets are perfectly competitive.

4
1. DEMAND
Definition
Demand means there has to be the willingness and ability to buy
a product.

The quantity demanded of any good is the amount of the good

that buyers are willing and able to purchase at a given price in a
given period of time, ceteris paribus.

The demand for a chocolate is 4 million bars per week at 0.4 dollar each

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.
5

The
demand
The function The
demand demand
schedule curve

Ways of
illustrating
demand

6
 Illustrating demand
The demand schedule
Price Quantity of
of ice Cones
cream demanded

Demand schedule is a table that $0 16

shows the relationship between the 1 14
price of a good and the quantity 2 12
demanded, ceteris paribus 3 10
4 8
5 6
6 4

Illustrating demand
The demand curve
P
Price of Quantity of
6 ice Cones
cream demanded
5
$0 16
4 Demand curve 1 14
3 2 12
3 10
2
4 8
1
5 6
0 4 6 8 10 12 14
6 4
Q
8
 Illustrating demand
The demand function

 General demand function

We can relate the quantity demanded to two or more determinants.

𝑸𝑫 = f (𝑿𝟏 , 𝑿𝟐 , 𝑿𝟑 ,…, 𝑿𝑵 )

 Simple demand function

Demand equations are often used to relate quantity demanded to just one determinant.

𝑸𝑫 = a + bP
 If the a term alone changed, there would be a parallel shift in the curve.
 If the b term changed, the slope of the curve would change.

Individual vs Market demand

• The market demand curve shows how the total quantity demanded of a
good varies as the price of the good varies, ceteris paribus.
• We sum the individual demand schedules horizontally to obtain the market
demand schedules.
Price Bill’s Qd Jill’s Qd Market Qd
$0 16 + 8 = 24
1 14 + 7 = 21
2 12 + 6 = 18
3 10 + 5 = 15
4 8 + 4 = 12
5 6 + 3 = 9
6 4 + 2 = 6 10
 P
Price of Quantity of
ice Cones
6 cream demanded

5 A $0 24

B 1 21
4 Market demand curve
2 18
3 3 15
C
2 4 12
1 5 9
6 6
0 6 9 12 15 18 21 24
Q

11

Determinants influencing demand

i) Price and the movement along the demand curve

A change in price leads to change in quantity demanded movement along a demand curve
An increase in price leads to a decrease in quantity demanded contraction of demand

A decrease in price leads to an increase in quantity demanded expansion of demand

12
 P Suppose the number of
$6.00
buyers increases.
• Then, at each P, Qd will
$5.00 increase (by 5 in this
$4.00 example).
$3.00
• The demand curve
shifts to the right
$2.00
$1.00

$0.00
Q
0 5 10 15 20 25 30

increase
in demand

decrease
in demand

D2
D1
D3

Q
14
 Determinants influencing demand
i) Price and the movement along the demand curve

A change in price leads to change in quantity demanded movement along a demand curve
An increase in price leads to a decrease in quantity demanded contraction of demand

A decrease in price leads to an increase in quantity demanded expansion of demand

ii) Non-price factors and shifts in the demand curve

A change in non-price determinants lead to change in quantity demanded at any given price

shift in the demand curve

Any change that increases the quantity demanded at every price shifts the demand curve to the right

increase in demand
Any change that reduces the quantity demanded at every price shifts the demand curve to the left
decrease in demand 15

(1) Income and Wealth

Income is the sum of all the wages, Wealth (net worth) is the total value of what
salaries, profits, interest payments, rents, a household owns minus what it owes at a
and other forms of earnings received by the given point in time.
household in a given period of time.

Normal goods Inferior goods

Goods for which demand goes Goods for which demand tends
up/down when income is higher/lower to fall when income rises

Include:
 necessity goods
 luxury goods

16
 (2) Prices of related goods

Substitutes Complements

 Substitutes are often pairs of  Complements are often pairs of

goods that are used in place of
each other.
 When a fall in the price of one
good reduces the demand for
another good, the two goods are
called substitutes.
goods that are used together.
 When a fall in the price of one good
raises the demand for another good,
the two goods are called
complements.

Because any one good may have many potential substitutes and complements at the
same time, a single price change may affect a household's demands for many goods
simultaneously

17

(3) Tastes and preferences

A favorable or unfavorable change in consumer tastes or preferences means more or less of a product is
demanded at each possible price. Trends, fashions, advertising, and new products can influence
consumer preferences to buy a particular good or service.

(4) Expectations of buyers

What you decide to buy today may depends on expectations about future changes in prices. If a buyer
predicts an increase in future price, the demand of such goods in the current time will increase; and
vice versus.

(5) Number of buyers

Market demand depends on the number of buyers. Population growth tends to increase the number of
buyers, which shifts the market demand curve for a good or service rightward. Conversely, a population
decline shifts most market demand curves leftward (a decrease in demand).

18
 SUMMARY

Non-price determinant of Relationship to changes in

Demand demand
1. Income and Wealth
a. Normal goods Direct
b. Inferior goods Inverse
2. Prices of related goods
a. Substitute goods Direct
b. Complementary goods Inverse
3. Tastes and preferences Direct
4. Expectations of buyers Direct
5. Number of buyers Direct
19

CHECK POINT: The demand curve

Draw the demand curve for orange juice, D1, and a point A (P1,
Q1) on the demand curve. What happens in each of the following
scenarios? Why?

A. The price of apple juice increases

B. The price of orange juice falls
C. Consumers’ income falls (and orange juice is a normal good)
2. SUPPLY
Definition
Supply means there has to be the willingness and ability to sell a
product.

The quantity supplied of any good is the amount of the good that
sellers are willing and able to sell at a given price in a given
period of time, ceteris paribus.

The supply for a chocolate is 4 million bars per week at 0.4 dollar each

The law of supply

Other things equal, when the price of a good rises, the quantity
supplied of the good rises, and when the price falls, the quantity
supplied falls.
21

Illustrating supply
The supply schedule
Price of Quantity of
ice Cones
cream supplied
Supply schedule is a table that $0 0
shows the relationship between the
1 3
price of a good and the quantity
supplied, ceteris paribus. 2 6
3 9
4 12
5 15
6 18

22
 Illustrating supply
The supply curve
P
6 Price of Quantity of
ice Cones
5 cream supplied
$0 0
4
1 3
3 2 6
2 3 9
1
4 12
5 15
0 6 18
3 6 9 12 15 18 Q

23

Illustrating supply
The supply function

 General supply function

We can relate the quantity supplied to two or more determinants.

𝑸𝑺 = f (𝑿𝟏 , 𝑿𝟐 , 𝑿𝟑 ,…, 𝑿𝑵 )

 Simple supply function

Supply equations are often used to relate quantity supplied to just one determinant.

𝑸𝑺 = a + bP
 If the a term alone changed, there would be a parallel shift in the curve.
 If the b term changed, the slope of the curve would change.

24
 Individual vs Market supply
• The market supply curve shows how the total quantity supplied of a good
varies as the price of the good varies, ceteris paribus.
• We sum the individual supply schedules horizontally to obtain the market
supply schedules.

Price Tom’s QS Jerry’s QS Market QS

$0 0 + 0 = 0
1 3 + 2 = 5
2 6 + 4 = 10
3 9 + 6 = 15
4 12 + 8 = 20
5 15 + 10 = 25
6 18 + 12 = 30 25

P Market supply curve

Price of Quantity of
6 ice Cones
cream supplied
5
$0 0
4 1 5
3 2 10
2 3 15
4 20
1
5 25
0 6 30
5 10 15 20 25 30 Q

26
 P
Price of Quantity of
$6.00 ice Cones
cream supplied
$5.00
$0 0
An
$4.00 increase in A movement 1 5
price… along the
$3.00 2 10
supply curve
3 15
$2.00
4 20
$1.00
5 25
$0.00 6 30
0 5 10 15 20 25 30 35 Q
… increases the quantity of ice cream cones supplied.

P
Suppose the price
$6.00
of oranges falls.
$5.00 • At each price, the
quantity of orange
$4.00
juice supplied will
$3.00 increase (by 5 in
this example).
$2.00
• The supply curve
$1.00 shifts to the right
$0.00
Q
0 5 10 15 20 25 30 35

28
 P
S3

S1
increase
in supply
S2
decrease
in supply

Q
29

Determinants influencing supply

i) Price and the movement along the supply curve

A change in price leads to change in quantity supplied movement along a supply curve
An increase in price leads to an increase in quantity supplied expansion of supply

A decrease in price leads to decrease in quantity supplied contraction of supply

ii) Non-price factors and shifts in the supply curve

A change in non-price determinants lead to change in quantity supplied at any given price

shift in the supply curve

Any change that increases the quantity supplied at every price shifts the supply curve to the right

increase in supply
Any change that reduces the quantity supplied at every price shifts the supply curve to the left
decrease in supply 30
 (1) Resource prices

Natural resources, labor, capital are all required to produce products, and the prices of these resources
affect supply. Any reduction in production cost caused by a decline in the price of resources will increase
supply, and vice versus.

(2) Technology

New, more efficient technologies reduce production costs and increase the supply of all sorts of goods
and services.

(3) Number of sellers

Market supply depends on the number of producers. When the number of sellers increase, the market
supply curve for a good or service shifts rightward. Conversely, a decline in the number of sellers shifts
the market supply curves leftward.

31

(4) Expectations of sellers

What firms decide to sell today may depends on expectations about future changes in prices. If a seller
predict an increase in future price, the supply of such goods in the current time will decrease; and vice
versus.

(5) Governmental policies

Regulations and policies of the Government affect the production costs of enterprises, making the
production of enterprises less or more expensive, thereby increasing or decreasing the supply of goods
and services.

32
 SUMMARY

Non-price determinant of Relationship to changes in

supply supply
1. Resource prices Inverse
2. Technology Direct
3. Number of sellers Direct
4. Governmental policies Direct and inverse
5. Expectations of sellers Inverse

33

CHECK POINT: The supply curve

Draw a supply curve for apple juice, S1, and a point A (P1, Q1) on
the supply curve. What happens to it in each of the following
scenarios? Why?
A. Grocery stores cut the price of apple juice.
B. A technological advance allows apple juice to be produced at
lower cost.
C. Grocery stores cut the price of orange juice.
1. A movement downward and to the right along a
demand curve is called a(n)
a) increase in demand.
b) increase in quantity demanded.
c) decrease in demand.
d) decrease in quantity demanded.
3. If something happens to alter the quantity
demanded at any given price, then
a) the demand curve becomes steeper.
b) the demand curve becomes flatter.
c) we move along the demand curve.
d) the demand curve shifts.
3. MARKET EQUILIBRIUM
P are willing and able to buy
D S
equilibrium price E Everyone in the market has been
Pe
equilibrium quantity Qe
2. Which of the following would not shift the demand
curve for smartphones?
a) a trend that makes smartphones more popular
b) a decrease in the price of smartphones
c) an increase in the price of digital music downloads, a
complement for smartphones
d) a decrease in the income
4. Which of the following might cause the supply
curve for a good to shift to the right?
a) an increase in input prices
b) a decrease in consumer income
c) an improvement in production technology that makes
production of the good more profitable
d) a decrease in the number of sellers in the market
35
At the equilibrium price,
the quantity of the good that buyers
exactly balances
the quantity that sellers are willing
and able to sell.
The market’s
equilibrium
satisfied: Buyers have bought all
they want to buy, and sellers have
sold all they want to sell.
Q
36
 EXERCISE SOLVING GUIDE: ANALYZING CHANGES IN EQUILIBRIUM

Decide whether the event shifts the

supply curve, the demand curve, or,
in some cases, both curves.

Decide whether the curve shifts to

the right or to the left

Use the supply-and-demand diagram

to compare the initial and the new
equilibrium
37

Market for hybrid cars

EVENT TO BE ANALYZED:
Increase in price of gas P
S1
STEP 1: P2
D curve shifts
because
STEP 2: price of gas P1
affects demand for
D curve shifts rightward
hybrids.
rightwards
STEP 3: does not
S curve
because high gas price D1 D2
The shift
shift, causes an
makes hybridsprice
because more Q
increase
of gas in price
does not Q1 Q2
attractive relative to
and quantity
affect cost of of
other cars.
hybrid cars.
producing hybrids.
EVENT: New technology reduces Market for hybrid cars
cost of producing hybrid cars
P
S1 S2
STEP 1:
S curve shifts
because
STEP 2: event affects P1
cost of production. P2
S curve shifts rightward
D curve does not
because event reduces
STEPbecause
shift, 3:
cost, D1
The shift
production
makes causes price
moreto fall
technology
production Q
and
is notquantity
oneat to rise.
ofany
the Q1 Q2
profitable given
factors that affect
price.
demand.
39

EVENTS: price of gas rises AND Market for hybrid cars

new technology reduces
P
production costs
S1 S2

STEP 1: P2
Both curves shift.
P1
STEP 2:
Both shift to the right.
STEP 3: D1 D2
Q rises, but effect Q
on P is ambiguous: Q1 Q2
If demand increases more
than supply, P rises.
40
EVENTS: price of gas rises AND Market for hybrid cars

new technology reduces

P
production costs
S1 S2

STEP 3, cont.
P1
But if supply
increases more P2
than demand,
D1 D2
P falls.
Q
Q1 Q2

41

1. What would happen to the equilibrium price and quantity of coffee if the wages of
coffee-bean pickers fell and the price of tea fell?
a) Price would rise, and the effect on quantity would be ambiguous.
b) Price would fall, and the effect on quantity would be ambiguous.
c) Quantity would fall, and the effect on price would be ambiguous.
d) Quantity would rise, and the effect on price would be ambiguous.

2. Which of the following events must cause equilibrium quantity to fall?

a) demand increases and supply decreases
b) demand decreases and supply increases
c) demand and supply both increase
d) demand and supply both decrease

42
Changes in equilibrium
P
D S
SHORTAGE
When quantity demanded is
greater than quantity supplied

Sellers can respond to the excess

demand by raising their prices
Pe
This causes QD to fall and QS to rise
P2
Prices continue to rise until market
P1
reaches equilibrium.
Shortage

Qs1 Qe Qd1 Q
43

Changes in equilibrium

P SURPLUS

When quantity supplied is

D Surplus S greater than quantity demanded

P1
Sellers can respond to the excess
supply by reducing their prices
Pe
This causes QD to rise and QS to fall

Prices continue to fall until market

reaches equilibrium.

Qd1 Qe Qs1 Q
44
1. Which of the following would cause price to increase?
a) a shortage of the good
b) an increase in supply
c) a decrease in demand
d) a surplus of the good

2. When a surplus exists in a market, sellers

a) raise price, which increases quantity demanded and decreases quantity supplied until the
surplus is eliminated.
b) lower price, which increases quantity demanded and decreases quantity supplied until the
surplus is eliminated.
c) lower price, which decreases quantity demanded and increases quantity supplied until the
surplus is eliminated.
d) raise price, which decreases quantity demanded and increases quantity supplied until the
shortage is eliminated.

45

4. GOVERNMENT POLICIES

 Direct control: Price controls

• Price ceiling: a legal maximum on the price of a good or

service

• Price floor: a legal minimum on the price of a good or service

 Indirect control: Taxes

 How Price Ceilings Affect Market Outcomes

P S
Price
Pc
ceiling
A price ceiling above the
equilibrium price is Pe E
not binding
– has no effect
on the market outcome.
D
Q

47

How Price Ceilings Affect Market Outcomes

P S

The equilibrium price is above

the ceiling and therefore illegal.
Pe E
The ceiling is a binding
constraint on the price, Price
Pc
causes a shortage. ceiling
shortage
D
Q

48
 Evaluating Price Ceilings
If the government merely sets prices and does not intervene further, the
shortages will lead to the following:
Allocation on a ‘first come, first served’ basis.
Discrimination according to seller bias.
The emergence of black markets.

The rationing mechanisms that develop under price ceilings are rarely efficient.

49

How Price Floors Affect Market Outcomes

P S

A price floor below the Pe E

equilibrium price is
Price
not binding Pf
floor
– has no effect
on the market outcome. D
Q

50
 How Price Floors Affect Market Outcomes

Surplus
P S
Price
Pf
The equilibrium price is below floor
the floor and therefore illegal.
Pe E
The floor is a binding
constraint on the price,
causes a surplus.

D
Q

51

Evaluating Price Floors

The surpluses resulting from price floors can cause:

Some sellers are unable to sell all they want at the market price.
High prices may cushion inefficiency. Firms may feel less need to find
more efficient methods of production to cut their costs.

When the government imposes a binding price floor on a competitive market, a surplus of
the good arises, and sellers must ration the scarce goods among the large number of
potential sellers. Again, the rationing mechanisms that develop under price floors
are undesirable.

52
 The Minimum Wage

Minimum wage laws do not affect

highly skilled workers.
Effective date: January 1, 2020
They do affect unskilled workers.
AREA MINIMUM WAGE
I 4.420.000 VND Studies:
A 10% increase in the minimum
II 3.920.000 VND
wage raises teen unemployment
III 3.430.000 VND by 1–3%.
IV 3.070.000 VND

53

The Minimum Wage

Minimum wage laws W unemployment

S
do not affect Minimum
highly skilled workers. Pf
wage
They do affect unskilled
workers. Pe
Studies:
A 10% increase
in the minimum wage
raises teen D
unemployment L
by 1–3%. Qd Qs

54
1. To say that a price ceiling is binding is to say that the
price ceiling
a) causes quantity demanded to exceed quantity 4. A nonbinding price floor
supplied. (i) causes a surplus
b) results in a surplus.
(ii) causes a shortage
c) is set above the equilibrium price.
(iii) is set at a price above the equilibrium price
d) All are correct.
(iv) is set at a price below the equilibrium price
2. If a binding price floor is imposed on the textbook a) (iii) only
market, then b) (iv) only
a) the quantity of textbooks demanded will decrease. c) (i) and (iii) only
b) the quantity of textbooks supplied will increase. d) (ii) and (iv) only
c) a surplus of textbooks will develop.
d) All are correct.
5. When a binding price ceiling is imposed on a market to
benefit buyers,
3. After the price ceiling becomes effective, a) no buyers actually benefit.
a) a smaller quantity of the good is demanded. b) some buyers benefit, but no buyers are harmed.
b) a larger quantity of the good is supplied. c) some buyers benefit, and some buyers are harmed.
c) a smaller quantity of the good is bought and sold. d) all buyers benefit.
d) the price rises above the previous equilibrium.
55

Taxes
• The government levies taxes on many goods & services to raise
revenue to pay for national defense, public schools, etc.
• The government can make buyers or sellers pay the tax.
• The tax can be a % of the good’s price, or a specific amount for
each unit sold.
• For simplicity, we analyze per-unit taxes only.

56
 EXAMPLE: The Market for Pizza

P
S1
E
Equilibrium without tax $10.00

D1

Q
500

57

A Tax on Buyers
The price buyers pay Effects of a $1.50 per unit tax
is now $1.50 higher than the on buyers
market price P. P
P would have to fall by $1.50 S1
to make buyers willing to buy
same Q as before.
$10.00
E.g., if P falls from $10.00 Tax
to $8.50, buyers still willing to
purchase 500 pizzas. $8.50
D1

Hence, a tax on buyers shifts the D2

Q
D curve down by the amount of 500
the tax.
58
 A Tax on Buyers
New equilibrium: Effects of a $1.50 per unit tax
on buyers
Q = 450 P
Sellers receive S1
PS = $9.50 PB = $11.00
Tax
Buyers pay $10.00
PB = $11.00 PS = $9.50

Difference between
D1
them
= $1.50 = tax D2
Q
450 500

59

A Tax on Sellers
The tax effectively raises sellers’ Effects of a $1.50 per unit tax
costs by $1.50 per pizza. on sellers
P S2
Sellers will supply $11.50
Tax S1
500 pizzas
only if
$10.00
P rises to $11.50,
to compensate for
this cost increase.
D1

Hence, a tax on sellers shifts the Q

S curve up by the amount of the 500
tax.
60
 A Tax on Sellers
New equilibrium: Effects of a $1.50 per unit tax
on sellers
Q = 450 P S2
Buyers pay S1
PB = $11.00 PB = $11.00
Tax
Sellers receive $10.00
PS = $9.50 PS = $9.50

Difference between
D1
them
= $1.50 = tax
Q
450 500

61

The Outcome Is the Same in Both Cases!

The effects on P and Q, and the tax incidence are the same whether the
tax is imposed on buyers or sellers!
P
* Buyers pay a S1
PB = $11.00
higher price. Tax
* Sellers receive a $10.00
lower price. PS = $9.50
* The size of the
market decreases. D1

Q
450 500

62
1. A tax imposed on the buyers of a good will lower the
a) effective price received by sellers and lower the
equilibrium quantity.
b) effective price received by sellers and raise the
equilibrium quantity.
c) price paid by buyers and lower the equilibrium quantity.
d) price paid by buyers and raise the equilibrium quantity.
2. When a tax is placed on the sellers of a good, the size of
the market
a) and the effective price received by sellers both decrease.
b) and the effective price received by sellers both increase.
c) increases, but the effective price received by sellers
decreases.
d) decreases, but the effective price received by sellers
increases.

3. If the government passes a law requiring buyers of
laptops to send $10 to the government for every laptops
they buy, then
a) the demand curve for laptops shifts downward by $10.
b) buyers of laptops pay $10 more per laptop than they
were paying before the tax.
c) sellers of laptops are unaffected by the tax.
d) All are correct
4. If the government wants to reduce smoking, it should
impose a tax on
a) whichever side of the market is less elastic.
b) buyers of cigarettes.
c) sellers of cigarettes.
d) either buyers or sellers of cigarettes.

63

EXERCISE

Demand and supply in a market are described by the equations:

𝐐𝐃 = 70 – 2P and 𝐐𝐒 = P – 5.
a. Solve for the equilibrium price and quantity.
b. If the government imposes Pc = $20, does a shortage or
surplus (or neither) develop? What are the price, quantity
supplied, quantity demanded, and size of the shortage or
surplus?
c. If the government imposes Pf = $30, does a shortage or
surplus (or neither) develop? What are the price, quantity
supplied, quantity demanded, and size of the shortage or
surplus?
64