Applied Economics

Supply and Demand

Lecture 2
Chapter 4

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Syllabus
1. Introduction / Economic principles
2. Supply and demand
3. Elasticities
4. Firm behaviour
5. Production, pricing and market structures (I)
6. Production, pricing and market structures (II)
7. … Reading Week…
8. Consumer Theory
9. Behavioural Economics & Policy
10.Macro Aggregates - Aggregate demand/supply
11.Unemployment & Inflation
12.Fiscal, monetary and supply-side policies
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 Economic Models

§ The economy is complicated and interlinked

§ Economists use models to learn about the economy

§ Model: a representation of some aspect of the economy

§ But very simplified (with less detail)

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 Market forces of Supply & Demand
§ Two key components in any market economy are:
(a) Demand, and
(b) Supply
§ These determine the quantity of each good produced
and the price at which it is sold
§ Price = amount of money a buyer/consumer has to pay to
buy something
§ Cost = refers to payment to factor input in production (eg
labour cost, cost of resources, etc)

§ Demand and supply are two of the words economists

use the most!! 4 of 38
Markets and Competition
§ Market = group of sellers and buyers of a particular good/service
§ Sellers = determine the supply of a product
§ Buyers = determine the demand of a product

§ Buyers and sellers don’t have to meet (physically) to make a deal

§ Markets exist in many forms

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Different types of markets
§ Competition = 2 or more firms are rivals for customers
Characteristics of a perfectly competitive market:
1. Homogenous goods (buyers have no preference between sellers)
2. Price takers (numerous buyers and sellers, each unable to influence
prices)
3. Free entry and exit from the market
4. Full information is available to both consumers and producers

§ Monopoly: One seller (who sets the price) or one buyer (eg:
local water company)
§ Oligopoly: A few sellers not always aggressively competing with
each other (eg: airlines)
§ Monopolistic competition: Many sellers each offering a slightly
different product (eg: magazines, IT producers)
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The Demand Curve:
The Relationship Between Price & Quantity Demanded

§ The quantity demanded of any good is the

amount of the good that buyers are willing and
able to purchase at each price
§ Law of demand: other things being equal
(ceteris paribus), when the price of a good rises,
the quantity demanded of the good falls
• This is because you can buy less at a higher price.
• And the revese: when the price falls, the quantity
demanded rises
§ A demand schedule is a table that shows the
relationship between the price of a good
and the quantity demanded
§ The downward sloping line relating price
and quantity demanded is called
the demand curve

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The Demand Curve – downward sloping

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The Demand Curve
§ The market demand = is the (horizontal) sum of
all the individual demands for a particular good or
service

MOVEMENT OF THE DEMAND CURVE

§ A movement along the demand curve occurs
only when there is a change in Price
§ A shift of the demand curve is caused by factors
affecting demand other than a change in Price

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Movement along the Demand Curve
§P => Q

If P , => two reasons for Q

1. Income effect = If income constant and P =>
buyers can afford to buy more with their income =>
Demand increases
2. Substitution effect = buyers will choose to
substitute the more expensive good with cheaper
one => Demand increases

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Causes of Shifts in the Demand Curve
§ Income
• Normal goods: Income => D and vice and versa
• Inferior: Income => D and vice and versa
§ Prices of related goods, a and b:
• Substitutes: if Pa => Db and vice and versa
• Complements: if Pa => Db and vice and versa
§ Tastes
§ Expectations
§ Size and structure of the population:
§ a larger population will mean a higher demand for goods and
services
§ A change in the age distribution of the population influences
demand 11 of 38
 The Supply Curve:
The Relationship Between Price & Quantity Supplied

§ The quantity supplied of any good or

service is the amount that sellers are willing
and able to sell
§ Law of supply: other things being equal
(ceteris paribus), when the price of a good
rises, the quantity producers are willing to
supply also rises.
• This is because it is profitable to sell at a
higher price.
• Vice versa: when the price falls the quantity
supplied also falls.
§ The supply schedule is a table showing
the relationship between the price of
a good and the quantity supplied
§ The supply curve is a graphical display of
the supply schedule

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The Supply Curve for a seller
– upward sloping

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The Supply Curve for the market
§ Market supply = is the (horizontal) sum of the
supplies of all sellers
• The behaviour of one single business may be different
from the whole industry

MOVEMENT OF THE SUPPLY CURVE

§ A movement along the supply curve is caused
only by a change in Price!!
§ A shift of the supply curve is caused by factors
affecting supply other than a change in Price
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Causes of Shifts in the Supply Curve
§ Input prices
§ Cheaper inputs => S

§ Technology
§ More advanced technology increases productivity with fewer input
=> cost decreases => S
§ Expectations
§ Expectations for an increase in prices in the future => product in
stock and S
§ Number of sellers
§ More sellers= S
§ Natural / social factors
Bad weather will reduce the supply of crops S

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 Demand & Supply Together

§ Equilibrium is a situation where the price has reached the level where quantity
supplied equals quantity demanded.
• This price is called the equilibrium price

§ Drawing a horizontal line from the equilibrium point where the supply and
demand curves intersect provides the equilibrium price
§ Drawing a vertical line from where the supply and demand curves intersect
provides the equilibrium quantity bought and sold 16 of 38
 Demand & Supply Together II

• If the market price was above the equilibrium price there would be a surplus
(higher supply compared to demand) – that is, excess supply
• If the market price was set below the equilibrium price there would be a shortage
(lower supply compared to demand) – that is, excess demand
• The law of supply and demand claims that price adjusts so that the equilibrium
point is reached 17 of 38
Changes in the equilibrium
3 steps:
1. Determine whether there is a shift in the supply curve or the demand
curve
2. Is this shift to the right or to the left?
3. Use the diagram to show how the new equilibrium afftects quantity
and price?

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