2

Partial Equilibrium
Analysis of Markets
• LEARNING OUTCOMES
• Show prices and quantities exchanged are
determined by demand and supply.
• Analyse changes in demand and supply
• Explain the difference between demand/ supply
and quantity demanded/ supplied
• Differentiate between a movement along a
demand/ supply curve and a shift of a
demand/supply curve
• explain the determinants of quantity demanded.
• Explain how the equilibrium price and quantity
are determined.
 Supply and Demand
• Supply and Demand are tools for economic
analysis.
• Supply and demand are the two words that
economists use most often.
• Supply and demand are the forces that make
market economies work.
• Modern microeconomics is about supply,
demand, and market equilibrium.
 Markets and competition
• Buyers determine demand.

• Sellers determine supply

 Forces of Supply

and Demand

HOW DO INDIVIDUAL MARKETS WORK?

Market:- is any arrangement which
facilitates purchase and sale of goods,
services or resources.
 Basic decision making units
• Firms and households

firms – primary producing unit in the

economy producing either goods or
services.
- make decisions in order to
maximize profits.
H/holds - the consuming units in an
economy.
- decision based on preferences and
tastes.
 Circular flow model of income and
expenditure

• A complex, interrelated web of decision

making and economic activity.
 Circular flow diagram

GOODS MARKETS
Goods and services
Payments for

services
Goods and

FIRMS
(producers)
HOUSEHOLDS
(consumers)

factor services

FACTOR MARKETS Factors services

Payments for
 DEMAND IN PRODUCT MARKET
What is Quantity demanded :- is the amount of
a good that buyers are willing and able to
purchase.
Law of Demand:- Price and Quantity Demanded
– The law of demand states that, the price of a
product and quantity demanded are negatively
related, other things equal.
 Demand curve: relationship between price
and quantity demanded

• Demand schedule
Economists can observe quantity demanded
and price and come up with a demand
schedule.
– The demand schedule is a table that shows the
relationship between the price of the good and
the quantity demanded.
Demand curve: relationship between
price and quantity demanded

• Demand Curve
– The demand curve is a graphical representation of
the relationship between the price of a good and
the quantity demanded.
 Demand Schedule and Demand Curve

Price of
Mealie
meal
$3.00

2.50

1. A decrease
2.00
in price ...

1.50

1.00

0.50

0 1 2 3 4 5 6 7 8 9 10 11 12 Quantity of Mealie mea

2. ... increases quantity

of mealie meal demanded.
 Properties of the demand curve
• The demand curve slopes downwards. Why?
a) Income and substitution effect
Income effect – higher prices make people poorer. A
decline in price of a product will increase the
purchasing power of one’s income.
Substitution effect – households tend to choose cheaper
alternatives.
b) Diminishing marginal utility – consuming successive
units of a particular product yields less and less extra
satisfaction. Hence consumers will only buy additional
units if and only if the price is reduced.
Market Demand versus Individual Demand

• Market demand refers to the sum of all

individual demands for a particular good or
service.
• Graphically, individual demand curves are
summed horizontally to obtain the market
demand curve.
 Determinants of Demand
• Product’s own price
• Average disposable income
• Tastes and preferences
• Prices of related goods and services
• Distribution of income
• Number of consumers
• Expectations of future prices and income
 Shifts in the Demand Curve

• Change in Quantity Demanded

– Movement along the demand curve.
– Caused by a change in the price of the product.
 Changes in Quantity Demanded
Price bread
A tax that raises the
price of bread results
B in a movement along
$2.00
the demand curve.

1.00 A

D
0 4 8 Quantity of bread
 of Curve
• Consumer income
• Prices of related goods
• Tastes
• Expectations
• Number of buyers
• A change in these factors will shift the
demand curve, either to the right or left.
It is a shift in the location of the demand curve.
– They alters the quantity demanded at
every price.
 Shifts in the Demand Curve

Price bread

Increase
in demand

Decrease
in demand
Demand
curve, D2
Demand
curve, D1
Demand curve, D3
0 Quantity of bread
 Shifts in the Demand Curve

• How changes in each determinant affect

demand?
 Effects of Average income on demand
• Consumer Income
– As income increases the demand for a normal
good will increase.
– normal goods are any goods for which demand
increases when income increases, and falls when
income decreases but price remains constant.
– As income increases the demand for an inferior
good will decrease, e.g dried capenta
– an inferior good is a good that decreases in
demand when consumer income rises (or rises in
demand when consumer income decreases),
 Consumer Income
Normal Good
Price of bread

$3.00 An increase
2.50 in income...
Increase
2.00 in demand

1.50

1.00

0.50
D2
D1 Quantity of
bread
0 1 2 3 4 5 6 7 8 9 10 11 12
 Consumer Income
Inferior Good
Price of sweet
potatoes
$3.00

2.50 An increase
2.00
in income...
Decrease
1.50 in demand

1.00

0.50

D2 D1 Quantity of
sweet
0 1 2 3 4 5 6 7 8 9 10 11 12 potatoes
The effects of price of related goods on demand

• Prices of Related Goods

– When a fall in the price of one good increases the
demand for another good, the two goods are
called complements.
The effects of price of related goods
on demand: substitute
– When a fall in the price of one good reduces the demand
for another good, the two goods are called substitutes, eg
coffee and tea.
– Substitutes are goods which can be used instead of the
good in question.
• Price of coffee rises:
 The effects of price of related
gccccomplements
– When a fall in the price of one good increases the
demand for another good, the two goods are
called complements, DVDs and DVD players. Price
of DVDs rises:
– Complements are goods that are used jointly
 The effects of expectations of buyers
on demand
• A higher expected future price will
increase current demand.
• A lower expected future price will
decrease current demand.
• A higher expected future income will
increase the demand for all normal
goods.
• A lower expected future income will
reduce the demand for all normal goods
•
The effects of remaining factors
Taste and preferences- can have a positive or
negative impact on the quantity demanded
• Number of buyers
• Distribution of income
Analyse on your own.
Variables That Influence Buyers
 Exceptional cases to the law of
demand
• What does the law of demand say?
a) Speculative demand: people tend to buy more goods if they
anticipate that there will be a further increase in demand
b) Snob demand: goods wanted not for the intrinsic satisfaction
it gives but because they are expensive, e.g. Expensive cars,
‘labels’ on clothing.
c) Giffen goods: a Giffen good is a product that people
consume more of as the price rises and vice versa.
d) Judging quality by price: some consumers may mistakenly
judge quality by price. When the price of a certain good falls,
consumers may mistakenly assume that the quality has
fallen.
 SUPPLY
• What is Quantity supplied is the amount of a
good that sellers are willing and able to sell
during some time period.
• Law of Supply:
– The law of supply states that, the price of a
product and the quantity supplied are positively
related, other things equal. the higher the price
the more its producers will supply, vice versa.
 The Supply Curve: The Relationship between
Price and Quantity Supplied
• Supply Schedule
– The supply schedule is a table that shows the
relationship between the price of the good and
the quantity supplied.
 Lobel’s Supply Schedule

Price of bread Quantity of bread

$0.00 0

0.50 0

1.00 1

1.50 2

2.00 3

2.50 4

3.00 5
 The Supply Curve: The Relationship between Price
and Quantity Supplied

• Supply Curve
– The supply curve is the graph of the relationship
between the price of a good and the quantity
supplied.
 Lobel’s Supply Schedule and Supply Curve

Price of bread Price of Quantity

bread of bread
$3.00 $0.00 0
0.50 0
2.50
1. An 1.00 1
increase
2.00 1.50 2
in price ...
2.00 3
1.50 2.50 4
3.00 5
1.00

0.50

0 1 2 3 4 5 6 7 8 9 10 11 12 Quantity of bread

2. ... increases quantity of bread supplied.

 Properties of supply curve
• It is upward sloping. Why?
a) Holding costs constant, higher prices means
higher profit margin.
b) The law of supply is the result of the law of
increasing cost.
– As the quantity of a good produced rises, the
marginal opportunity cost rises.
– Sellers will only produce and sell an
additional unit of a good if the price rises
above the marginal opportunity cost of
producing the additional unit.
Market Supply versus Individual Supply
• Market supply refers to the sum of all
individual supplies for all sellers of a particular
good or service.
• Graphically, individual supply curves are
summed horizontally to obtain the market
supply curve.
 Determinants of supply
These are factors affecting supply;
• Price of product
• Resource prices
• The technology
• Prices of other goods
• Expectations of the seller
• Number of sellers in the market
• Government taxes and subsidies
• Prices of related products and joint products
 Shifts in the Supply Curve

• Change in Quantity Supplied

– Movement along the supply curve.
– Caused by a change in anything that alters the
quantity supplied at each price.
 Change in Quantity Supplied
Price of Ice-
bread S
C
$3.00
A rise in the price
of bread results in
a movement
along the supply
A curve.
1.00

Quantity of
bread
0 1 5
 Shifts in the Supply Curve
• Input prices
• Technology
• Expectations
• Number of sellers
• A change in these factors will shift the
supply curve, either to the right or left.
It is a shift in the location of the supply curve.
They alters the quantity supplied at every price.
 Shifts in the Supply Curve

Price of
bread Supply curve, S3
Supply
curve, S1
Supply
Decrease curve, S2
in supply

Increase
in supply

0 Quantity of bread
 Shifts in the Supply Curve

• How changes in each determinant affect

supply?
• Technology- Technological improvements help
reduce production cost and increase profit,
thus stimulate higher supply.
• Number of sellers- More sellers in the market
increase the market supply.
• Expectation for future prices - If producers
expect future price to be higher, they will try
to hold on to their inventories and offer the
products to the buyers in the future, thus they
can capture the higher price.
• Taxes and Subsidies- Taxes reduces profits, an
increase in taxes reduce supply, whilst a
decrease in taxes increase supply. Subsidies
reduce the burden of production costs on
suppliers, thus increasing the profits.
Therefore increase in subsidies increase
supply and decrease in subsidies decrease
supply.
• Prices of Joint Products- When two or more
goods are produced in a joint process and the
price of any of the product increases, the
supply of all the joint products will be
increased and vice versa. For example,
increase in price of meat will increase the
supply of leather.
Variables That Influence Sellers
 The determination of market price:
Market Equilibrium
• How do the two forces of supply and demand
interact to determine price?
 SUPPLY AND DEMAND TOGETHER
Demand Schedule Supply Schedule

Price of bread Market Price of bread Market

$0.00 19 $0.00 0
0.5 16 0.5 0
1.00 13 1.00 1
1.50 10 1.50 4
2.00 7 2.00 7
2.50 4 2.50 10
3.00 1 3.00 13

At $2.00, the quantity demanded is

equal to the quantity supplied!
 The Graphical Analysis

Price of
bread
Supply

Equilibrium price Equilibrium

$2.00

Equilibrium Demand
quantity

0 1 2 3 4 5 6 7 8 9 10 11 12 13
Quantity of bread
• Equilibrium refers to a situation in which the price has reached
the level where quantity supplied equals quantity demanded
• Equilibrium Price or market clearing price
– The price that balances quantity supplied and quantity
demanded, no excess ss or dd.
– On a graph, it is the price at which the supply and demand
curves intersect.
• Equilibrium Quantity
– The quantity supplied and the quantity demanded at the
equilibrium price.
– On a graph it is the quantity at which the supply and
demand curves intersect.
 Markets Not in Equilibrium

(a) Excess Supply

Price of
bread Supply
Surplus
$2.50

2.00

Demand

0 4 7 10 Quantity of
Quantity Quantity bread
demanded supplied
 At P2 – price above equilibrium
Qs > Qd Excess supply or surplus
• Firms will find themselves with unwanted inventory of
goods.
• Would prompt competing sellers to bid down price to
encourage buyers to take this surplus off their hands
• Price goes down, buyer take more of the product, and
firms use a smaller amount of resources in production
• Process of bidding down prices continuous until
equilibrium is reached at $2.00.
 Markets Not in Equilibrium

(b) Excess Demand

Price of
bread Supply

$2.00

1.50
Shortage

Demand

0 4 7 10 Quantity of
Quantity Quantity bread
supplied demanded

Copyright©2003 Southwestern/Thomson Learning

 At P1 – price below equilibrium

• Qs< Qd excess demand or Shortage

• Shortages of goods causes competition among
buyers
• Buyers bid up prices for the limited goods
• The rise in price will force firms to commit
more resources in production .thus production
increases
• The process continues until equilibrium is
reached at $2.00
• The ability of the competitive forces of SS and
DD to establish price where selling and buying
decisions are coordinated is called the
rationing function of price
• once equilibrium is established, it will persist
until it is disturbed by changes in market
conditions.
 Changes in market prices
• Adjustment process
• The methodical approach of market analysis
• Three steps
 Three Steps to Analyzing Changes in
Equilibrium
STEP 1:
• Demand or Supply? Does the event impacts the
DD or SS side of the market?
STEP 2:
• Shift or Movement? If so in which direction.
STEP 3:
• Adjustment to new equilibrium. Did the shock
caused excess DD or excess SS at initial price.
In which direction will price adjust.
 The four effects of DD and SS curve
shifts
• Four laws of DD and SS
a) An ↑DD causes an ↑ in both equil P and Q.
b) A ↓ DD causes a ↓in both equil P and Q.

c) An ↑SS causes a ↓in equil P and ↑ Q.

d) A ↓SS causes an ↑ in equil P and ↓ Q.

 How an Increase in Demand Affects Equilibrium

Price of
bread 1. Income increases
the demand for bread. . .

Supply

$1.50 New equilibrium

1.00
2. . . . resulting
Initial
in a higher
equilibrium Excess demand
price . . .
D

0 7 10 Quantity of
3. . . . and a higher bread
quantity sold.
 How a Decrease in Supply Affects Equilibrium

Price of
1. Bad weather affect wheat
bread
price of flour increases reduces
the supply of bread. . .
S2
S1

New
$1.50 equilibrium

1.00 Initial equilibrium

2. . . . resulting
in a higher
price of bread
... Demand

shortages
0 4 7 Quantity of
3. . . . and a lower bread
quantity sold.
What Happens to Price and Quantity When
Supply or Demand Shifts?
 Summary
• Economists use the model of supply and
demand to analyze competitive markets.
• In a competitive market, there are many
buyers and sellers, each of whom has little or
no influence on the market price.
 Summary
• The demand curve shows how the quantity of a good
depends upon the price.
– According to the law of demand, as the price of a good
falls, the quantity demanded rises. Therefore, the demand
curve slopes downward.
– In addition to price, other determinants of how much
consumers want to buy include income, the prices of
complements and substitutes, tastes, expectations, and
the number of buyers.
– If one of these factors changes, the demand curve shifts.
 Summary
• The supply curve shows how the quantity of a
good supplied depends upon the price.
– According to the law of supply, as the price of a good
rises, the quantity supplied rises. Therefore, the
supply curve slopes upward.
– In addition to price, other determinants of how much
producers want to sell include input prices,
technology, expectations, and the number of sellers.
– If one of these factors changes, the supply curve
shifts.
 Summary
• Market equilibrium is determined by the
intersection of the supply and demand curves.
• At the equilibrium price, the quantity
demanded equals the quantity supplied.
• The behavior of buyers and sellers naturally
drives markets toward their equilibrium.
 Summary
• To analyze how any event influences a market,
we use the supply-and-demand diagram to
examine how the even affects the equilibrium
price and quantity.
• In market economies, prices are the signals
that guide economic decisions and thereby
allocate resources.