The Market Forces

Demand and Supply

Dr.B.Venkatraja
Associate Professor-Economics
SDMIMD

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 Demand
▪ The quantity demanded of any good is the
amount of the good that buyers are willing and able
to purchase.
✓Desire to purchase
✓Ability to purchase
✓Willingness to purchase
▪ Law of demand: the claim that the quantity
demanded of a good falls when the price of the
good rises or vice-versa, other things being equal.
✓ Inverse relationship between price & demand.
✓ Qd = f(P)
✓ Qd=a-bP
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 The Demand Schedule
Price Quantity
▪ Demand schedule: of of apples
A table that shows the apple($) demanded
relationship between the 1.00 14
price of a good and the 2.00 12
quantity demanded. 3.00 10
▪ Example: 4.00 8
Helen’s demand for apples. 5.00 6
6.00 4
▪ Notice that Helen’s
preferences obey the
Law of Demand.
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 Helen’s (Individual) Demand Schedule &
Curve
Price of Price Quantity
apples of of apples
apples demanded
$6.00
1.00 14
$5.00
2.00 12
$4.00 3.00 10
$3.00 4.00 8
5.00 6
$2.00
6.00 4
$1.00
$0.00 Quantity
0 5 10 15 of apples
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 Market Demand versus Individual Demand
▪ The quantity demanded in the market is the sum of
the quantities demanded by all buyers at each price.
▪ Suppose Helen and Ken are the only two buyers in
the apple market. (Qd = quantity demanded)
Price Helen’s Qd Ken’s Qd Market Qd

1.00 14 + 7 = 21
2.00 12 + 6 = 18
3.00 10 + 5 = 15
4.00 8 + 4 = 12
5.00 6 + 3 = 9
6.00 4 + 2 = 6
 The Market Demand Curve for Apples

Qd
P P
(Market)
$6.00
1.00 21
$5.00 2.00 18
$4.00 3.00 15

$3.00
4.00 12
5.00 9
$2.00
6.00 6
$1.00

$0.00 Q
0 5 10 15 20 25

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 Exception to Law of Demand
▪ Necessities of life
▪ Luxuries
▪ Conspicuous consumption (demonstration
effect) = people buy more of a costlier
commodity to impress others i.e. Veblen effect
▪ In case of scarcity
▪ Inferior goods

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 Determinants of Demand
(Shift Factors)
▪ The demand curve shows how price affects quantity
demanded, other things being equal.
▪ These “other things” are things that determine
buyers’ demand for a good, other than the good’s
price. They are:
✓Number of buyers
✓Income
✓prices of related goods
✓Tastes
✓expectations
▪ Changes in them shift the D curve…
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 Shift in Demand Curve
Factor 1: # of buyers
▪ An increase in the number of buyers causes
an increase in quantity demanded at each price,
which shifts the demand curve to the right.

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 P Suppose the number
$6.00 of buyers increases.
Then, at each price,
$5.00
quantity demanded
$4.00 will increase
(by 5 in this example).
$3.00
$2.00
$1.00
$0.00 Q
0 5 10 15 20 25 30
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 Factor 2: income
▪ Demand for a normal good is positively related to income.
• An increase in income causes increase
in quantity demanded at each price, shifting the D curve to
the right.
(Demand for an inferior good is negatively related to income.
An increase in income shifts D curves for inferior goods to the
left.)

P1

Price

D2
D1
Quantity
Q2 Q1 10
Factor 3: prices of related goods

▪ Two goods are substitutes if

an increase in the price of one causes
an increase in demand for the other.
▪ Example: pizza and hamburgers.
An increase in the price of pizza
increases demand for hamburgers,
shifting hamburger demand curve to the right.
▪ Other examples: Coke and Pepsi,
laptops and desktop computers,
compact discs and music downloads
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▪ Two goods are complements if
an increase in the price of one causes
a fall in demand for the other.
▪ Example: computers and software.
If price of computers rises, people buy fewer
computers, and therefore less software.
Software demand curve shifts left.

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Factor 4: tastes, preferences & fashion
▪ Anything that causes a shift in tastes toward a
good will increase demand for that good
and shift its D curve to the right.
▪ Sometimes people prefer some goods as they are
popular not because they are cheaper=
Bandwagon effect
▪ Some rich don’t buy popular goods. To prove
extraordinary they prefer rare products during use=
Snob effect

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Factor 5: expectations
▪ Expectations affect consumers’ today’s buying
decisions.
▪ Examples:
• If people expect their income to rise, their
demand for meals at expensive restaurants
may increase now.
• If the economy turns bad and people worry
about their future job security, demand for new
autos may fall now.

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Summary: Variables That Affect Demand
Variable A change in this variable…

Price …causes a movement

along the D curve
No. of buyers …shifts the D curve
Income …shifts the D curve
Price of
related goods …shifts the D curve
Tastes …shifts the D curve
Expectations …shifts the D curve
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ACTIVE LEARNING:
Demand curve
Draw a demand curve for music downloads.
What happens to it in each of the following
scenarios? Why?
A. The price of iPods
falls
B. The price of music
downloads falls
C. The price of compact
discs (loaded music
CDs ) falls
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ACTIVE LEARNING:
A. price of iPods falls

Price of Music downloads

music and iPods are
down- complements.
loads
A fall in price of
P1 iPods shifts the
demand curve for
music downloads
to the right.
D1 D2

Q1 Q2 Quantity of
music downloads
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ACTIVE LEARNING:
B. price of music downloads falls

Price of
music
down- The D curve
loads does not shift.
Move down along
P1
curve to a point with
P2 lower P, higher Q.

D1

Q1 Q2 Quantity of
music downloads
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ACTIVE LEARNING:
C. price of CDs falls

Price of CDs and

music music downloads
down- are substitutes.
loads
A fall in price of CDs
P1 shifts demand for
music downloads
to the left.

D2 D1

Q2 Q1 Quantity of
music downloads
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 Supply
▪ Supply comes from the behavior of sellers.
▪ The quantity supplied of any good is the
amount that sellers are willing and able to sell.
▪ Law of supply: the claim that the quantity
supplied of a good rises when the price of the
good rises, other things being equal
▪ Qs=f (P)
▪ Qs = a+bp
▪ Price & quantity supplied are positively related
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 The Supply Schedule

▪ Supply schedule: Price

Quantity
of
A table that shows the of apples
apple
relationship between the supplied
s
price of a good and the
$0.00 0
quantity supplied.
1.00 3
▪ Example: 2.00 6
Starbucks’ supply of apples. 3.00 9
4.00 12
▪ Notice that Starbucks’ 5.00 15
supply schedule obeys the
6.00 18
Law of Supply.
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 Starbucks’ Supply Schedule & Curve

Price Quantity
P of of apples
$6.00 apples supplied
$5.00
$0.00 0
$4.00 1.00 3
$3.00 2.00 6
$2.00 3.00 9
4.00 12
$1.00
5.00 15
$0.00 Q 6.00 18
0 5 10 15
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 Market Supply versus Individual Supply
▪ The quantity supplied in the market is the sum of
the quantities supplied by all sellers at each price.
▪ Suppose Starbucks and Jitters are the only two
sellers in this market. (Qs = quantity supplied)
Price Starbucks Jitters Market Qs
$0.00 0 + 0 = 0
1.00 3 + 2 = 5
2.00 6 + 4 = 10
3.00 9 + 6 = 15
4.00 12 + 8 = 20
5.00 15 + 10 = 25
6.00 18 + 12 = 30
 The Market Supply Curve
QS
P
(Market)
P
$6.00 $0.00 0
1.00 5
$5.00
2.00 10
$4.00 3.00 15
$3.00 4.00 20
$2.00 5.00 25
6.00 30
$1.00
$0.00 Q
0 5 10 15 20 25 30 35
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 Exceptions to the Law of Supply
▪ Labour Market
▪ Rare Collection
▪ Recession

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 Determinants of Supply
(Shift Factors)
▪ The supply curve shows how price affects
quantity supplied, other things being equal.
▪ These “other things” are non-price determinants
of supply. They are:
✓ input prices
✓technology
✓# of sellers
✓expectations
▪ Changes in them shift the S curve…

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 Shift in Supply Curve
Factor 1: input prices
▪ Examples of input prices:
wages, prices of raw materials.
▪ A fall in input prices makes production
more profitable at each output price,
so firms supply a larger quantity at each price,
and the S curve shifts to the right.

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 Supply Curve Shifters: input prices

P Suppose the
$6.00 price of milk falls.
At each price,
$5.00
the quantity of
$4.00 Lattes supplied
will increase
$3.00
(by 5 in this
$2.00 example).
$1.00
$0.00 Q
0 5 10 15 20 25 30 35
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Factor 2: technology
▪ Technology determines how much inputs are
required to produce a unit of output.
▪ A cost-saving technological improvement
has same effect as a fall in input prices,
shifts the S curve to the right.

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Factor 3: # of sellers

▪ An increase in the number of sellers increases

the quantity supplied at each price,
shifts the S curve to the right.

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Factor 4: expectations

Suppose a firm expects the price of the good it

sells to rise in the future…….
▪ The firm may reduce supply now, to save some
of its inventory to sell later at the higher price.
▪ This would shift the S curve leftward.

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Summary: Variables That Affect Supply
Variable A change in this variable…
…causes a movement
Price along the S curve
Input prices …shifts the S curve
Technology …shifts the S curve
No. of sellers …shifts the S curve
Expectations …shifts the S curve

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A C T I V E L E A R N I N G 2:
Supply curve
Draw a supply curve for tax
return preparation software.
What happens to it in each
of the following scenarios?
A. Retailers cut the price of
the software.
B. A technological advance
allows the software to be
produced at lower cost.
C. Professional tax return preparers raise the
price of the services they provide.
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ACTIVE LEARNING 2:
A. fall in price of tax return software
Price of
tax return The S curve
S1
software does not shift.
P1 Move down
along the curve
P2 to a lower P
and lower Q.

Q2 Q1 Quantity of tax
return software
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ACTIVE LEARNING 2:
B. fall in cost of producing the software
Price of
tax return The S curve
S1 S2
software shifts to the
right:
P1
at each price,
Q increases.

Q1 Q2 Quantity of tax
return software
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ACTIVE LEARNING 2:
C. professional preparers raise their price
Price of
tax return
S1 This shifts the
software
demand curve for
tax preparation
software, not the
supply curve.

Quantity of tax
return software
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 Equilibrium in the Market

P Equilibrium:
$6.00 D S
P has reached
$5.00 the level where
$4.00 quantity supplied
$3.00
equals
quantity demanded
$2.00
$1.00
$0.00 Q
0 5 10 15 20 25 30 35
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 Equilibrium price:
The price that equates quantity supplied
with quantity demanded
P
$6.00 D S
P QD QS
$5.00 $0 24 0
$4.00 1 21 5

$3.00 2 18 10
3 15 15
$2.00
4 12 20
$1.00
5 9 25
$0.00 Q 6 6 30
0 5 10 15 20 25 30 35
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 Equilibrium quantity:
The quantity supplied and quantity demanded
at the equilibrium price
P
$6.00 D S
P QD QS
$5.00 $0 24 0
$4.00 1 21 5

$3.00 2 18 10
3 15 15
$2.00
4 12 20
$1.00
5 9 25
$0.00 Q 6 6 30
0 5 10 15 20 25 30 35
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 Disequilibrium : case 1-Surplus
when quantity supplied is greater than
quantity demanded
P
$6.00 D Surplus S Example:
If P = $5,
$5.00
then
$4.00 QD = 9 apples
$3.00 and
QS = 25 apples
$2.00
resulting in a surplus
$1.00
of 16 apples
$0.00 Q
0 5 10 15 20 25 30 35
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 Surplus:
when quantity supplied is greater than
quantity demanded
P
$6.00 D Surplus S Facing a surplus,
sellers try to increase
$5.00 sales by cutting the price.
$4.00 This causes
$3.00 QD to rise and QS to fall…

$2.00 …which reduces the

surplus.
$1.00
$0.00 Q
0 5 10 15 20 25 30 35
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 Surplus:
when quantity supplied is greater than
quantity demanded
P
$6.00 D Surplus S Facing a surplus,
sellers try to increase
$5.00 sales by cutting the price.
$4.00 Falling prices cause
$3.00 QD to rise and QS to fall.

$2.00 Prices continue to fall until

market reaches equilibrium.
$1.00
$0.00 Q
0 5 10 15 20 25 30 35
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 Case 2 - Shortage:
when quantity demanded is greater than
quantity supplied
P
$6.00 D S Example:
If P = $1,
$5.00
then
$4.00 QD = 21 apples
$3.00 and
QS = 5 apples
$2.00
resulting in a
$1.00 shortage of 16 apples
$0.00 Shortage Q
0 5 10 15 20 25 30 35
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 Shortage:
when quantity demanded is greater than
quantity supplied
P
$6.00 D S Facing a shortage,
sellers raise the price,
$5.00
causing QD to fall
$4.00 and QS to rise,
$3.00 …which reduces the
shortage.
$2.00
$1.00
Shortage
$0.00 Q
0 5 10 15 20 25 30 35
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 Shortage:
when quantity demanded is greater than
quantity supplied
P
$6.00 D S Facing a shortage,
sellers raise the price,
$5.00
causing QD to fall
$4.00 and QS to rise.
$3.00 Prices continue to rise
$2.00
until market reaches
equilibrium.
$1.00
Shortage
$0.00 Q
0 5 10 15 20 25 30 35
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Effect of Shift in Demand & Supply on Eq’m

To determine the effects of any event,

1. Decide whether event shifts S curve,
D curve, or both.
2. Decide in which direction curve shifts.
3. Use supply-demand diagram to see
how the shift changes eq’m P and Q.

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 EXAMPLE: The Market for Hybrid Car

P
price of
S1
hybrid cars

P1

D1
Q
Q1
Ex: Toyota Prius, Honda Insight, plus hybrid
versions of the Ford Escape, Honda Accord,
quantity of
Toyota Highlander, Lexus RX400h SUV hybrid cars
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EXAMPLE 1: A Change in Demand
EVENT TO BE
ANALYZED: P
Increase in price of gas. S1
STEP 1: P2
D curve shifts
because
STEP 2: price of gas P1
affects demand for
D shifts right
hybrids.
because
STEP 3: high gas
S curve
price doeshybrids
makes not D1 D2
The shift
shift, causes
because an
price
more attractive Q
increase
of gas in price
does not cars. Q1 Q2
relative to other
and quantity
affect cost of of
hybrid cars.
producing hybrids.
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EXAMPLE 2: A Change in Supply
EVENT: New technology
reduces cost of P
producing hybrid cars. S1 S2
STEP 1:
S curve shifts
because event affects P
STEP 2: 1
cost of production.
S shifts right P2
D curve does not
because
STEP 3: event
shift, because
reduces cost, D1
production
The shift causestechnology
makes production Q
is not to
price one fallof the Q1 Q 2
more profitable at
factors that affect
and quantity to rise.
any given price.
demand.
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EXAMPLE 3: A Change in Both Supply
EVENTS:
and Demand
price of gas rises AND P
new technology reduces S1 S2
production costs
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.
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EXAMPLE 3: A Change in Both Supply
and Demand
P
S1 S2

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

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