Chapter Two

Supply and Demand

 Chapter Outline

1. Demand.
2. Supply.
3. Market Equilibrium.
4. Shocking the Equilibrium.
5. Effects of Government
Interventions.
6. When to Use the Supply-and-
Demand Model.

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 Demand: determinants of demand.

 The following factors determine the

demand for a good:
 Price of the good
 Tastes
 Information
 Prices of related goods
 Complements and substitutes
 Income
 Government rules and regulations
 Other

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 Demand: the demand curve

 Quantity demanded - the amount of a

good that consumers are willing to buy
at a given price, holding constant the
other factors that influence purchases.
 Demand curve - the quantity demanded
at each possible price, holding constant
the other factors that influence
purchases

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 Figure 2.1 A Demand Curve
Law of Demand
p, $ per kg

14.30 consumers demand

more of a good the
Demand curve for Lamb, D1 lower its price, holding
constant all other
factors that influence
consumption
4.30
3.30
2.30

0 200 220 240 286

Q, Million kg of Lamb per year

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 Figure 2.2 A Shift of the
Demand Curve
p, $ per kg

Effect of a 60¢ increase in the price of beef

3.30

D2
D1

0 176 220 232

Q, Million kg of Lamb per year
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 The Demand Function

 The processed Lamb demand function is:

Q = D(p, pb, pc, Y)

 where Q is the quantity of Lamb demanded

 p is the price of Lamb (dollars per kg)
 pb is the price of beef (dollars per kg)
 pc is the price of chicken (dollars per kg)
 Y is the income of consumers (thousand
dollars)
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 From the Demand Function to the
Demand Curve
 Estimated demand function for Lamb:

Q = 171−20p + 20pb + 3pc + 2Y

 Using the values pb = 4, pc = 3.33 and Y =

12.5, we have
Q = 286−20p

 which is the linear demand function for Lamb.

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 From the Demand Function to the
Demand Curve
Q = 286−20p
p, $ per kg

14.30
If p = 0, then
Demand curve for pork, D1 Q = 286

4.30
3.30
2.30

0 200 220 240 286

Q, Million kg of pork per year

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 Solved Problem 2.1

 How much would the price have to fall

for consumers to be willing to buy 1
million more kg of Lamb per year?

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 Solved Problem 2.1: Answer

1. Express the price that consumers are

willing to pay as a function of quantity.

Q = 286−20p

20p = 286 - Q

p = 14.30 − 0.05Q

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 Solved Problem 2.1: Answer
2. Use the inverse demand curve to determine
how much the price must change for
consumers to buy 1 million more kg of Lamb
per year.

Δp = p2 − p1
= (14.30 − 0.05Q2) − (14.30 − 0.05Q1)
= –0.05(Q2 − Q1)
= –0.05ΔQ.

 The change in quantity is ΔQ = Q2 − Q1 = (Q1 +

1)−Q1 = 1, so the change in price is Δp = –0.05.

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 Application: Aggregating the
Demand for Broadband Service

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 Supply: determinants of supply.

 The following factors determine the

supply for a good:
 Price of the good
 Costs
 Government rules and regulations

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 Supply: the demand curve

 Quantity supplied - the amount of a

good that firms want to sell at a given
price, holding constant other factors that
influence firms’ supply decisions, such
as costs and government actions
 Supply curve - the quantity supplied at
each possible price, holding constant
the other factors that influence firms’
supply decisions

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 Figure 2.3 A Supply Curve
An increase in the
price…
p, $ per kg

5.30 Supply curve, S1

3.30

causes a movement
along the curve….

0 176 220 300

and a decrease in the Q, Million kg of pork per year

quantity supplied….
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 Figure 2.4 A Shift of a Supply
Curve
p, $ per kg A $0.25 increase in the
price of hogs….. shifts the supply curve
to the left
S2
S1

3.30

reducing the quantity

supplied at the previous
price.

0 176 205 220

Q, Million kg of po rk per year

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 The Supply Function

 The processed Lamb supply function is:

Q = S(p, ph)

 where Q is the quantity of Lamb supplied

 p is the price of Lamb (dollars per kg)
 ph is the price of a hog (dollars per kg)

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 From the Supply Function to the
Supply Curve
 Estimated demand function for Lamb:

Q = 178 + 40p−60ph

 Using the values ph = $1.50 per kg

Q = 88 + 40p.

 What happens to the quantity supplied if the

price of processed Lamb increases by Δp =
p2−p1?

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 Figure 2.5 Total Supply: The Sum
of Domestic and Foreign Supply

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 Solved Problem 2.2

 How does a quota set by the United

States on foreign steel imports of Q
affect the total American supply curve
for steel given the domestic supply, Sd in
panel a of the graph, and foreign supply,
Sf in panel b?

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 Solved Problem 2.2

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 Market Equilibrium

 Equilibrium - a situation in which no

one wants to change his or her
behavior.
 excess demand the amount by which the
quantity demanded exceeds the quantity
supplied at a specified price.
 excess supply the amount by which the
quantity supplied is greater than the
quantity demanded at a specified price

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 Figure 2.6 Market Equilibrium
At a price above
equilibrium….
p, $ per kg

Excess supply
Market equilibrium = 39
point!
S
3.95
e
3.30

2.65

Excess demand = 39
At a price below D
equilibrium…. is below the quantity
is below the quantity
supplied
demanded

0 176 194 207 220 233 246

Q, Million kg of pork per year
the quantity supplied….
the quantity demanded….
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 Using Math to Determine the
Equilibrium
 Demand: Qd = 286 − 20p
 Supply: Qs = 88 + 40p
 Equilibrium:
Qd = Qs
286 − 20p = 88 + 40p
60p = 198
P = $3.30
Q = 286 – 20(3.3) = 220

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 Equilibrium: Practice Problem

 The demand function for a good is

Q = a−bp, and the supply function is
Q = c + ep, where a, b, c, and e are
positive constants. Solve for the
equilibrium price and quantity in
terms of these four constants.

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 Shocking the Equilibrium

The equilibrium changes only if a shock

occurs that shifts the demand curve or the
supply curve. These curves shift if one of
the variables we were holding constant
changes.

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 Figure 2.7a Equilibrium Effects of a
Shift of a Demand Curve
A $0.60 increase in the price of

p, $ per kg
beef shifts the demand outward

Which puts an
upward pressure in
the price to a new
e2
equilibrium.
S
3.50
3.30 D2
e1

D1
At the original price
Excess demand = 12 there is now an
excess demand….

0 176 220 228 232

Q, Million kg of Lamb per year

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 Figure 2.7b Equilibrium Effects of
a Shift of a Supply Curve
A $0.25 increase in the price of hogs
shifts the supply curve to the left

p, $ per kg Which puts an upward

pressure in the price to
a new equilibrium.
S2
e2
3.55 S1
3.30
e1
D
At the original price
Excess demand = 15
there is now an
excess demand….
0 176 205 215 220
Q, Million kg of Lamb per year

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 Solved Problem 2.3

 Mathematically, how does the

equilibrium price of Lamb vary as the
price of hogs changes if the variables
that affect demand are held constant at
their typical values?

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 Solved Problem 2.3: Solution
1. Solve for the equilibrium price of Lamb in
terms of the price of hogs.
Qd = 286−20p
Qs = 178 + 40p−60ph
286−20p = 178 + 40p−60ph
60p = 108 – 60ph
p = 1.8 – ph

2. Show how the equilibrium price of Lamb

varies with the price of hogs.

 Since Δp = Δph, any increase in the price of hogs

causes an equal increase in the price of
processed Lamb.
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 Solved Problem 2.4

 In the first few weeks after the U.S. ban,

the quantity of beef sold in Japan fell
substantially, and the price rose. In
contrast, three weeks after the first
discovery, the U.S. price in January
2004 fell by about 15% and the quantity
sold increased by 43% over the last
week in October 2003. Use supply-and-
demand diagrams to explain why these
events occurred.
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 Solved Problem 2.4

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 Figure 2.8 A Ban on Rice Imports
Raises the Price in Japan
p, Pr ice of r ice per pound
– A ban on rice imports
S (ban)
shifts the total supply of
rice in Japan… S (no ban)

p2 e2

which causes the

p1 e1 equilibrium to change
and the price to
increase.

D
Q2 Q1 Q, Tons of rice per year

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 Solved Problem 2.5

 What is the effect of a United States

quota on steel of Q on the equilibrium in
the U.S. steel market? Hint: The answer
depends on whether the quota binds (is
low enough to affect the equilibrium).

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 Solved Problem 2.5

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 Figure 2.9 Price Ceiling on
Gasoline
p, $ per gallon Supply shifts to the S2 S1
left….

but gas stations

must continue to
charge a price of
P1…..

e1
p1 = p–p1 Price ceiling

Qs Q1= Qd
which creates an
excess demand. Q, Gallons of gasoline per month
Excess demand
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 Figure 2.10 Minimum Wage

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 Why Supply Need Not Equal Demand

 The quantity that firms want to sell and

the quantity that consumers want to buy
at a given price need not equal the
actual quantity that is bought and sold.
 Example: price ceiling.

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 Perfectly competitive markets

 Everyone is a price taker.

 Firms sell identical products.

 Everyone has full information about the

price and quality of goods.

 Costs of trading are low.

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 Figure 2A.1 Regression

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