Lec-05

Supply and Equilibrium Analysis

Nazrul Islam
Lecturer in Economics
Dept. of Humanities,RUET

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 Supply analysis

 Supply:
 If a firm supplies a good or service, the firm
1. Has the resources and technology to produce it.
2. Can profit from producing it.
3. Plans to produce it and sell it.

A supply is more than just having the resources and the technology to produce something. Resources and
technology are the constraints that limit what is possible.
 Quantity Supplied: The quantity supplied of a good or service is the amount that producers plan and able to
sell during a given time period at a particular price. Like the quantity demanded, the quantity supplied is
measured as an amount per unit of time.
 Law of supply: The law of supply states: Other things remaining the same, the higher the price of a good, the
greater is the quantity supplied; and the lower the price of a good, the smaller is the quantity supplied.
 Why does a higher price increase the quantity supplied? It is because marginal cost increases. As the
quantity produced of any good increases, the marginal cost of producing the good increases. When the price
of a good rises, other things remaining the same, producers are willing to incur a higher marginal cost, so
they increase production. The higher price brings forth an increase in the quantity supplied.

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 Supply schedule and curve

 Supply Curve and Supply Schedule : A supply curve shows the relationship between the quantity supplied of a good and its price
when all other influences on producers’ planned sales remain the same. Supply schedule is a table that shows the relationship
between the price and the quantity supplied of a good.

 The table shows the supply schedule of energy bars. For example, at a
price of $1.00, 6 million bars a week are supplied; at a price of $2.50,
15 million bars a week are supplied. The supply curve shows the
relationship between the quantity supplied and the price, other things
remaining the same. The supply curve slopes upward: As the price of a
good increases, the quantity supplied increases.
 A supply curve can be
read in two ways. For a given price, the supply curve tells us the
quantity that producers plan to sell at that price. For example, at a
price of $1.50 a bar, producers are planning to sell 10 million bars a
week. For a given quantity, the supply curve tells us the minimum
price at which producers are willing to sell one more bar. For example,
if 15 million bars are produced each week, the lowest price at which a
producer is willing to sell the 15 millionth bar is $2.50

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Market supply and individual supply
 Market Supply Curve:
 we sum the individual supply curves
horizontally to obtain the market supply
curve. That is, to find the total quantity
supplied at any price, we add the individual
quantities, which are found on the
horizontal axis of the individual supply
curves. The market supply curve shows how
the total quantity supplied varies as the
price of the good varies, holding constant all
the other factors beyond price that
influence producers’ decisions about how
much to sell.

 So, the quantity supplied in a market is the

sum of the quantities supplied by all the
sellers at each price. Thus, the market
supply curve is found by adding horizontally
the individual supply curves. At a price of
$2.00, Ben supplies 3 ice-cream cones, and
Jerry supplies 4 ice-cream cones. The
quantity supplied in the market at this price
is 7 cones.

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Change in supply and quantity
supplied

 Change in quantity supplied: The term quantity supplied refers to a point on a

supply curve—the quantity supplied at a particular price. Other things remaining
same, when quantity supplied changes due to changes of only price of the good.
Change in quantity supplied is marked by movement along the supply curve.
When the price of the good changes, there is a movement along the supply curve
and a change in the quantity supplied, shown by the blue arrows on supply curve
S0.

 Change in supply: The term supply refers to the entire relationship between the
price of a good and the quantity supplied of it. Supply is illustrated by the supply
curve and the supply schedule.
 Because the market supply curve holds other things constant, the curve shifts
when one of the factors changes. When supply changes due to other factors of
supply except price is called change in supply.

 When any other factor influence on selling plans changes, there is a shift of the
supply curve and a change in supply. An increase in supply shifts the supply curve
rightward (from S0 to S1), and a decrease in supply shifts the supply curve
leftward (from S0 to S2).
 Any change that raises quantity supplied at every price, shifts the supply curve to
the right and is called an increase in supply. Similarly, any change that reduces
the quantity supplied at every price shifts the supply curve to the left and is
called a decrease in supply.

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Change in supply

Reasons for change in supply: There are many variables that can
shift the supply curve. Here are some of the most important.
Six main factors bring changes in supply. They are changes in
o The prices of factors of production
o The prices of related goods produced
o Expected future prices
o The number of suppliers
o Technology The state of nature

 The prices of factors of production: The prices of the factors of

production used to produce a good influence its supply. For example,
during 2008, as the price of jet fuel increased, the supply of air travel
decreased. Similarly, a rise in the minimum wage decreases the supply of
hamburgers.

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Reasons for change in supply

 The prices of related goods produced : The prices of related goods that firms produce influence supply. For
example, if the price of normal coke rises, firm switch production from diet coke to normal coke. The supply
of energy diet coke decreases. Normal coke and diet coke are substitutes in production—goods that can be
produced by using the same resources. If the price of beef rises, the supply of cowhide increases. Beef and
cowhide are complements in production—goods that must be produced together.
 Expected future prices: If the expected future price of a good rises, the return from selling the good in the
future increases and is higher than it is today. So supply decreases today and increases in the future.
 The Number of Suppliers: The larger the number of firms that produce a good, the greater is the supply of
the good. As new firms enter an industry, the supply in that industry increases. As firms leave an industry,
the supply in that industry decreases.
 Technology: The term “technology” is used broadly to mean the way that factors of production are used to
produce a good. A technology change occurs when a new method is discovered that lowers the cost of
producing a good. For example, new methods used in the factories that produce computer chips have
lowered the cost and increased the supply of chips.
 The State of Nature: The state of nature includes all the natural forces that influence production. It includes
the state of the weather and, more broadly, the natural environment. Good weather can increase the supply
of many agricultural products and bad weather can decrease their supply. Extreme natural events such as
earthquakes, tornadoes, and hurricanes can also influence supply.

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Market equilibrium

 Market equilibrium: is a situation in which the market price has reached the
level at which quantity supplied equals quantity demanded
 equilibrium price: the price that balances quantity supplied and quantity
demanded. At the equilibrium price, the quantity of the good that buyers are
willing and able to buy exactly balances the quantity that sellers are willing
and able to sell.
 equilibrium quantity: the quantity supplied and the quantity demanded at
the equilibrium price.
 Surplus: a situation in which quantity supplied is greater than quantity
demanded.
 Shortage: a situation in which quantity demanded is greater than quantity
supplied.
 law of supply and demand: the claim that the price of any good adjusts to
bring the quantity supplied and the quantity demanded for that good into
balance.
 The Equilibrium of Supply and Demand: The equilibrium is found where the
supply and demand curves intersect. At the equilibrium price, the quantity
supplied equals the quantity demanded. Here the equilibrium price is $2.00:
At this price, 7 ice cream cones are supplied, and 7 ice-cream cones are
demanded.

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Numerical example

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Market not in equilibrium

 Markets Not in Equilibrium:

 In panel (a), there is a surplus. Because
the market price of $2.50 is above the
equilibrium price, the quantity supplied
(10 cones) exceeds the quantity
demanded (4 cones). Suppliers try to
increase sales by cutting the price of a
cone, and this moves the price toward its
equilibrium level.
 In panel (b), there is a shortage. Because
the market price of $1.50 is below the
equilibrium price, the quantity demanded
(10 cones) exceeds the quantity supplied
(4 cones). With too many buyers chasing
too few goods, suppliers can take
advantage of the shortage by raising the
price. Hence, in both cases, the price
adjustment moves the market toward the
equilibrium of supply and demand

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Change in equilibrium

THREE STEPS TO ANALYZING CHANGES IN EQUILIBRIUM :

The equilibrium price and quantity depend on the position of the supply and
demand curves. When some event shifts one of these curves, the equilibrium in
the market changes, resulting in a new price and a new quantity exchanged
between buyers and sellers. When analyzing how some event affects the
equilibrium in a market, we proceed in three steps.
First, we decide whether the event shifts the supply curve, the demand curve, or,
in some cases, both curves.
Second, we decide whether the curve shifts to the right or to the left.
Third, we use the supply-and-demand diagram to compare the initial and the new
equilibrium, which shows how the shift affects the equilibrium price and quantity.

 1. A Change in Market Equilibrium Due to a Shift in Demand : Here we see how

an Increase in Demand affects the Equilibrium. An event that raises quantity
demanded at any given price shifts the demand curve to the right. The
equilibrium price and the equilibrium quantity both rise. Here an abnormally
hot summer causes buyers to demand more ice cream. The demand curve
shifts from D1 to D2, which causes the equilibrium price to rise from $2.00 to
$2.50 and the equilibrium quantity to rise from 7 to 10 cones.

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Shifts in Both Supply and Demand 3. Shifts in Both Supply and Demand :
:

2. A Change in Market Equilibrium Due to a

Shift in Supply : An event that reduces
quantity supplied at any given price shifts the
supply curve to the left. The equilibrium
price rises, and the equilibrium quantity falls.
Here an increase in the price of sugar (an
input) causes sellers to supply less ice cream.
The supply curve shifts from S1 to S2, which
causes the equilibrium price of ice cream to
rise from $2.00 to $2.50 and the equilibrium
quantity to fall from 7 to 4 cones.

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Shift in equilibrium positions

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Consumer surplus
 Consumer Surplus:
 We don’t always have to pay as
much as we are willing to pay. We
get a bargain. When people buy
something for less than it is
worth to them, they receive a
consumer surplus. Consumer
surplus is the excess of the
benefit received from a good
over the amount paid for it. We
can calculate consumer surplus as
the marginal benefit (or value) of
a good minus its price, summed
over the quantity bought.
 So, consumer surplus is the
amount a buyer is willing to pay
for a good minus the amount the
buyer actually pays for it. Actually
area under the demand curve
and above equilibrium price is
consumer surplus.

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Producer surplus

 Producer Surplus:
 When price exceeds marginal
cost, the firm receives a
producer surplus. Producer
surplus is the excess of the
amount received from the sale
of a good or service over the
cost of producing it. We
calculate producer surplus as
the price received minus the
marginal cost (or minimum
supply-price), summed over
the quantity sold.
 So, producer surplus is the
amount a seller is paid for a
good minus the seller’s cost of
providing it.

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Market efficiency

Market efficiency:
efficiency is the property of a resource allocation of maximizing the total surplus
received by all members of society.
Consumer surplus and producer surplus are the basic tools that economists use to
study the welfare of buyers and sellers in a market. These tools can help us address a
fundamental economic question: Is the allocation of resources determined by free
markets desirable?

EVALUATING THE MARKET EQUILIBRIUM: The Figure shows consumer and producer
surplus when a market reaches the equilibrium of supply and demand. Recall that
consumer surplus equals the area above the price and under the demand curve and
producer surplus equals the area below the price and above the supply curve. Thus,
the total area between the supply and demand curves up to the point of equilibrium
represents the total surplus in this market. Is this equilibrium allocation of resources
efficient? That is, does it maximize total surplus? To answer this question, recall that
when a market is in equilibrium, the price determines which buyers and sellers
participate in the market. Those buyers who value the good more than the price
(represented by the segment AE on the demand curve) choose to buy the good;
buyers who value it less than the price (represented by the segment EB) do not.
Similarly, those sellers whose

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Evaluation of market equilibrium
costs are less than the price (represented by the segment CE on the supply curve) choose to produce and sell
the good; sellers whose costs are greater than the price (represented by the segment ED) do not. These
observations lead to two insights about market outcomes:
1. Free markets allocate the supply of goods to the buyers who value them most highly, as measured by
their willingness to pay.
2. Free markets allocate the demand for goods to the sellers who can produce them at the least cost.
Thus, given the quantity produced and sold in a market equilibrium, the social planner cannot increase
economic well-being by changing the allocation of consumption among buyers or the allocation of production
among sellers. But can the social planner raise total economic well-being by increasing or decreasing the
quantity of the good? The answer is no, as stated in this third insight about market outcomes:

3. Free markets produce the quantity of goods that maximizes the sum of consumer and producer surplus.

The figure in the next slide illustrates why this is true. To interpret this figure, keep in mind that the demand
curve reflects the value to buyers and the supply curve reflects the cost to sellers. At any quantity below the
equilibrium level, such as Q1, the value to the marginal buyer exceeds the cost to the marginal seller. As a
result, increasing the quantity produced and consumed raises total surplus. This continues to be true until the
quantity reaches the equilibrium level. Similarly, at any quantity beyond the equilibrium level, such as Q2, the
value to the marginal buyer is less than the

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Evaluation of market equilibrium

cost to the marginal seller. In this case, decreasing the

quantity raises total surplus, and this continues to be true
until quantity falls to the equilibrium level. To maximize
total surplus, the social planner would choose the
quantity where the supply and demand curves intersect.
Home Tasks-
 From a imaginary demand equation, make a demand
schedule, draw demand curve and explain your
process. From a imaginary supply equation, make a
supply schedule, draw supply curve and explain your
process.
 Combining both the equations, find out equilibrium
price , equilibrium quantity demanded, equilibrium
quantity supplied, consumer surplus.
 Suppose Tk. 2 tax/subsidy has been imposed/given
on/to buyers/sellers. Now, calculate equilibrium price
, equilibrium quantity demanded, equilibrium
quantity supplied, change in consumer & producer
surplus and dead weight loss.
 Show the whole scenario graphically.

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