Chapter 2.

Supply and Demand

2.1 Demand

 Demand function: the correspondence between quantity demanded for the good or service on
one hand and, on the other hand, the factors that affect it, including its price, prices of substitute
and complementary products, consumers’ income, etc. 
the price of coffee, p





Suppose the quantity of coffee demanded, Qd , varies with the price of sugar, ps
 

consumers’

income, Y
The coffee demand function, D, is:

• A general form:
Qd = D(p, ps , Y ) (1)

– It does not tell specifically how each argument affects Q.

• A specified, estimated form:

Qd = 8.56 − p − 0.3ps + 0.1Y (2)

– Economists derive it from real world data with the help of econometric techniques.

∂Qd

 = −1: Each unit increase in p leads to a fall in Qd by 1
 ∂p



∂Qd
 ∂ps
= −0.3: Each unit increase in ps leads to a fall in Qd by 0.3.


 ∂Q
 d = 0.1: each unit increase in Y leads to a rise in Qd by 0.1.

∂Y

In case we want to focus on the relationship between Qd and p, hold the other factors constant

– ps : $0.20 per lb

– Y : $35

Then equation (2) becomes

Qd = 8.56 − p − 0.3ps + 0.1Y

= 8.56 − p − 0.3 × 0.20 + 0.1 × 35
(3)
= 12 − p (specified form)
= D(p) (general form)

1
◦ Demand curve: A graphical representation of the demand function

Qd = 12 − p
14

12

10

P
6

0
0 2 4 6 8 10 12 14
Q

◦ The law of demand: p ↓ ⇒ Qd ↑ or p ↑ ⇒ Qd ↓, given that other factors are constant.

– Graphically: The demand curve slopes downward.

dQd
– Mathematically: dp
<0
dQd
For equation (6), dp
= −1 ⇒ Hence, the law of demand holds.

◦ A shift of the demand curve

Suppose the average income increases by $15 to $50 from $35.

Then equation (2) becomes

Qd = 8.56 − p − 0.3ps + 0.1Y

= 8.56 − p − 0.3 × 0.20 + 0.1 × 50 (4)
= 13.5 − p

16

14

12

10

8
P

0
0 2 4 6 8 10 12 14 16
Q

At any price, Qd is now larger by 1.5. Why?

2
→ From the demand function (2), we have

∂Qd
= 0.1
∂Y
which means each unit increase in Y leads to an increase in Qd by 0.1.

Then, the income rise by $15 leads to an increase in Qd by 0.1 × 15 = 1.5.

 Summing Demand Functions (total demand function)

“The total demand function = sum of individual demand functions”

Suppose a market with n consumers. Suppose

• the demand function for consumer 1: Qd1 = D1 (p)

• the demand function for consumer 2: Qd2 = D2 (p)

• ···

• the demand function for consumer n: Qdn = Dn (p)

• then, the total demand function: Qd = Qd1 + Qd2 + · · · + Qdn = D1 (p) + D2 (p) + · · · + Dn (p)

2.2 Supply

 The Supply Function: the correspondence between the quantity supplied on one hand and, on
the other hand, the factors that affect it, including its price
 and others.
the price of coffee, p

Suppose the quantity of coffee supplied, Qs , varies with
the price of cocoa, p

c

• A general form
Qs = S(p, pc )

• An estimated form
Qs = 9.6 + 0.5p − 0.2pc (5)

 ∂Qs

= 0.5: Each unit increase in p leads to a rise in Qs by 0.5
∂p
 ∂Qs

= −0.2: Each unit increase in pc leads to a fall in Qs by 0.2.
∂pc

In case we want to focus on the relationship between Qs and p, hold the other factors constant

3
 – pc : $3 per lb

Then equation (5) becomes

Qs = 9.6 + 0.5p − 0.2pc
= 9.6 + 0.5p − 0.2 × 3 (6)
= 9 + 0.5p

◦ A shift of the supply curve

Suppose pc rises by $3 per pound. Then equation (5) becomes

Qs = 9.6 + 0.5p − 0.2 × 6 = 8.4 + 0.5p (7)

2.3 Market Equilibrium

Qd = 12 − p
Qs = 9 + 0.5p

The equilibrium is obtained when Qd = Qs :

12 − p = 9 + 0.5p

• Equilibrium price: p = $2

• Equilibrium quantity: Qd = 12 − 2 = 10 or Qs = 9 + 0.5 × 2 = 10