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The Market Forces of
“This lecture material has been produced and published expressly for
Supply and Demand
lecture purposes in support of a Yonsei University course. This material
cannot be used for any other purposes and cannot be shared with others.
Individuals who violate these terms and restrictions are legally
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ⓒ 2009 South-Western, a part of Cengage Learning, all rights reserved 1

Markets and Competition Demand

 A market is a group of buyers and sellers of a  The quantity demanded of any good is the
particular product. amount of the good that buyers are willing and
able to purchase.
 A competitive market is one with many buyers
and sellers, each has a negligible effect on price.  Law of demand: the claim that the quantity
demanded of a good falls when the price of the
 In a perfectly competitive market:
good rises, other things equal
 All goods exactly the same
 Buyers & sellers so numerous that no one can
affect market price – each is a “price taker”
 In this chapter, we assume markets are perfectly
competitive.
THE MARKET FORCES OF SUPPLY AND DEMAND 2 THE MARKET FORCES OF SUPPLY AND DEMAND 3
 The Demand Schedule Helen’s Demand Schedule & Curve
Price of Price Quantity
 Demand schedule: Price Quantity
Lattes
of of lattes of of lattes
a table that shows the lattes demanded
lattes demanded $6.00
relationship between the
$5.00 $0.00 16
price of a good and the $0.00 16
1.00 14
quantity demanded 1.00 14 $4.00
2.00 12
 Example: 2.00 12 $3.00 3.00 10
Helen’s demand for lattes. 3.00 10
$2.00 4.00 8
4.00 8
5.00 6
 Notice that Helen’s 5.00 6
$1.00
6.00 4
preferences obey the 6.00 4 $0.00
Law of Demand. Quantity
0 5 10 15 of Lattes
THE MARKET FORCES OF SUPPLY AND DEMAND 4 THE MARKET FORCES OF SUPPLY AND DEMAND 5

Market Demand versus Individual Demand The Market Demand Curve for Lattes
 The quantity demanded in the market is the sum of the Qd
quantities demanded by all buyers at each price. P P
(Market)
 Suppose Helen and Ken are the only two buyers in $6.00
$0.00 24
the Latte market. (Qd = quantity demanded) $5.00 1.00 21
Price Helen’s Qd Ken’s Qd Market Qd $4.00 2.00 18
$0.00 16 + 8 = 24 3.00 15
$3.00
1.00 14 + 7 = 21 4.00 12
$2.00
2.00 12 + 6 = 18 5.00 9
3.00 10 + 5 = 15 $1.00 6.00 6
4.00 8 + 4 = 12 $0.00 Q
5.00 6 + 3 = 9 0 5 10 15 20 25
6.00 4 + 2 = 6 6 7
THE MARKET FORCES OF SUPPLY AND DEMAND
 Demand Curve Shifters Demand Curve Shifters: # of Buyers
 The demand curve shows how price affects  Increase in # of buyers
quantity demanded, other things being equal. increases quantity demanded at each price,
shifts D curve to the right.
 These “other things” are non-price determinants
of demand (i.e., things that determine buyers’
demand for a good, other than the good’s price).
 Changes in them shift the D curve…

THE MARKET FORCES OF SUPPLY AND DEMAND 8 THE MARKET FORCES OF SUPPLY AND DEMAND 9

Demand Curve Shifters: # of Buyers Demand Curve Shifters: Income

P Suppose the number  Demand for a normal good is positively related

$6.00 of buyers increases. to income.
Then, at each P,  Increase in income causes
$5.00
Qd will increase increase in quantity demanded at each price,
$4.00 (by 5 in this example). shifts D curve to the right.
$3.00
(Demand for an inferior good is negatively
$2.00 related to income. An increase in income shifts
$1.00 D curves for inferior goods to the left.)
$0.00 Q
0 5 10 15 20 25 30
THE MARKET FORCES OF SUPPLY AND DEMAND 10 THE MARKET FORCES OF SUPPLY AND DEMAND 11
Demand Curve Shifters: 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,
CDs and music downloads
THE MARKET FORCES OF SUPPLY AND DEMAND
Demand Curve Shifters: Tastes
 Anything that causes a shift in tastes toward a
good will increase demand for that good
and shift its D curve to the right.
 Example:
The Atkins diet became popular in the ’90s,
caused an increase in demand for eggs,
shifted the egg demand curve to the right.
THE MARKET FORCES OF SUPPLY AND DEMAND
Demand Curve Shifters: Prices of
Related Goods
 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.
 Other examples: college tuition and textbooks,
bagels and cream cheese, eggs and bacon
12 THE MARKET FORCES OF SUPPLY AND DEMAND 13
Demand Curve Shifters: Expectations
 Expectations affect consumers’ buying decisions.
 Examples:
 If people expect their incomes to rise,
their demand for meals at expensive
restaurants may increase now.
 If the economy sours and people worry about
their future job security, demand for new
autos may fall now.
14 THE MARKET FORCES OF SUPPLY AND DEMAND 15
 Summary: Variables That Influence Buyers ACTIVE LEARNING 1
Variable A change in this variable…
Demand Curve
Draw a demand curve for music downloads.
Price …causes a movement What happens to it in each of
along the D curve the following scenarios? Why?
# of buyers …shifts the D curve
A. The price of iPods
Income …shifts the D curve falls
Price of B. The price of music
related goods …shifts the D curve downloads falls
Tastes …shifts the D curve C. The price of CDs falls
Expectations …shifts the D curve
THE MARKET FORCES OF SUPPLY AND DEMAND 16 17

ACTIVE LEARNING 1 ACTIVE LEARNING 1

A. Price of iPods falls B. Price of music downloads falls
Music downloads
Price of and iPods are Price of
music music The D curve
down- complements. down- does not shift.
loads A fall in price of loads
Move down along
iPods shifts the curve to a point with
P1 demand curve for P1
lower P, higher Q.
music downloads P2
to the right.
D1 D2 D1

Q1 Q2 Quantity of Q1 Q2 Quantity of
music downloads music downloads
18 19
 ACTIVE LEARNING 1 Supply
C. Price of CDs falls  The quantity supplied of any good is the
Price of CDs and amount that sellers are willing and able to sell.
music music downloads
down- are substitutes.
 Law of supply: the claim that the quantity
loads supplied of a good rises when the price of the
A fall in price of CDs
good rises, other things equal
P1 shifts demand for
music downloads
to the left.

D2 D1

Q2 Q1 Quantity of
music downloads
20 THE MARKET FORCES OF SUPPLY AND DEMAND 21

The Supply Schedule Starbucks’ Supply Schedule & Curve

Price Quantity Price Quantity
 Supply schedule:
of of lattes P of of lattes
A table that shows the lattes supplied lattes supplied
$6.00
relationship between the
$0.00 0 $0.00 0
price of a good and the $5.00
1.00 3 1.00 3
quantity supplied. $4.00
2.00 6 2.00 6
 Example: 3.00 9 $3.00 3.00 9
Starbucks’ supply of lattes. 4.00 12 $2.00 4.00 12
5.00 15 5.00 15
 Notice that Starbucks’ $1.00
6.00 18 6.00 18
supply schedule obeys the $0.00 Q
Law of Supply. 0 5 10 15
THE MARKET FORCES OF SUPPLY AND DEMAND 22 THE MARKET FORCES OF SUPPLY AND DEMAND 23
 Market Supply versus Individual Supply The Market Supply Curve
 The quantity supplied in the market is the sum of P
QS
the quantities supplied by all sellers at each price. (Market)
P
 Suppose Starbucks and Jitters are the only two $6.00 $0.00 0
sellers in this market. (Qs = quantity supplied) 1.00 5
$5.00
2.00 10
Price Starbucks Jitters Market Qs $4.00 3.00 15
$0.00 0 + 0 = 0
$3.00 4.00 20
1.00 3 + 2 = 5
$2.00 5.00 25
2.00 6 + 4 = 10
6.00 30
3.00 9 + 6 = 15 $1.00
4.00 12 + 8 = 20 $0.00 Q
5.00 15 + 10 = 25 0 5 10 15 20 25 30 35
6.00 18 + 12 = 30 24 25
THE MARKET FORCES OF SUPPLY AND DEMAND

Supply Curve Shifters Supply Curve Shifters: Input Prices

 The supply curve shows how price affects
quantity supplied, other things being equal.
 These “other things” are non-price determinants
of supply.
 Changes in them shift the S curve…
 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.

THE MARKET FORCES OF SUPPLY AND DEMAND 26 THE MARKET FORCES OF SUPPLY AND DEMAND 27
Supply Curve Shifters: Input Prices Supply Curve Shifters: Technology
 Technology determines how much inputs are
P Suppose the
required to produce a unit of output.
$6.00 price of milk falls.
At each price,  A cost-saving technological improvement has
$5.00
the quantity of the same effect as a fall in input prices,
$4.00 Lattes supplied shifts S curve to the right.
will increase
$3.00
(by 5 in this
$2.00 example).
$1.00

$0.00 Q
0 5 10 15 20 25 30 35
THE MARKET FORCES OF SUPPLY AND DEMAND 28 THE MARKET FORCES OF SUPPLY AND DEMAND 29

Supply Curve Shifters: # of Sellers Supply Curve Shifters: Expectations

 An increase in the number of sellers increases Example:

the quantity supplied at each price,
shifts S curve to the right.
THE MARKET FORCES OF SUPPLY AND DEMAND
 Events in the Middle East lead to expectations of
higher oil prices.
 In response, owners of Texas oilfields reduce
supply now, save some inventory to sell later at
the higher price.
 S curve shifts left.
In general, sellers may adjust supply* when their
expectations of future prices change.
(*If good not perishable)
30 THE MARKET FORCES OF SUPPLY AND DEMAND 31
Summary: Variables that Influence Sellers ACTIVE LEARNING 2
Supply Curve
Variable A change in this variable…
Draw a supply curve for tax
Price …causes a movement return preparation software.
along the S curve What happens to it in each
Input Prices …shifts the S curve of the following scenarios?
A. Retailers cut the price of
Technology …shifts the S curve
the software.
# of Sellers …shifts the S curve B. A technological advance
Expectations …shifts the S curve allows the software to be
produced at lower cost.
C. Professional tax return preparers raise the
price of the services they provide.
THE MARKET FORCES OF SUPPLY AND DEMAND 32 33

ACTIVE LEARNING 2 ACTIVE LEARNING 2

A. Fall in price of tax return software B. Fall in cost of producing the software
Price of Price of
tax return S curve does tax return S curve shifts
S1 S1 S2
software not shift. software to the right:
Move down at each price,
P1 P1
along the curve Q increases.
P2 to a lower P
and lower Q.

Q2 Q1 Quantity of tax Q1 Q2 Quantity of tax

return software return software
34 35
 ACTIVE LEARNING 3 Supply and Demand Together
C. Professional preparers raise their price
Price of P
tax return D S Equilibrium:
S1 This shifts the $6.00
software P has reached
demand curve for $5.00 the level where
tax preparation
software, not the $4.00 quantity supplied
supply curve. $3.00
equals
quantity demanded
$2.00
$1.00

Quantity of tax $0.00 Q

return software 0 5 10 15 20 25 30 35
36 THE MARKET FORCES OF SUPPLY AND DEMAND 37

Equilibrium price: Equilibrium quantity:

the price that equates quantity supplied the quantity supplied and quantity demanded
with quantity demanded at the equilibrium price
P P
$6.00 D S P QD QS $6.00 D S P QD QS
$5.00 $0 24 0 $5.00 $0 24 0
$4.00 1 21 5 $4.00 1 21 5

$3.00
2 18 10 $3.00
2 18 10
3 15 15 3 15 15
$2.00 $2.00
4 12 20 4 12 20
$1.00 5 9 25 $1.00 5 9 25
$0.00 Q 6 6 30 $0.00 Q 6 6 30
0 5 10 15 20 25 30 35 0 5 10 15 20 25 30 35
THE MARKET FORCES OF SUPPLY AND DEMAND 38 THE MARKET FORCES OF SUPPLY AND DEMAND 39
 Surplus (a.k.a. excess supply): Surplus (a.k.a. excess supply):
when quantity supplied is greater than when quantity supplied is greater than
quantity demanded quantity demanded
P Example: P
$6.00 D Surplus S $6.00 D Surplus S Facing a surplus,
If P = $5, sellers try to increase
$5.00 then $5.00 sales by cutting price.
$4.00 QD = 9 lattes $4.00 This causes
$3.00 and $3.00 QD to rise and QS to fall…
QS = 25 lattes
$2.00 $2.00 …which reduces the
resulting in a surplus.
$1.00 surplus of 16 lattes $1.00

$0.00 Q $0.00 Q
0 5 10 15 20 25 30 35 0 5 10 15 20 25 30 35
THE MARKET FORCES OF SUPPLY AND DEMAND 40 THE MARKET FORCES OF SUPPLY AND DEMAND 41

Surplus (a.k.a. excess supply): Shortage (a.k.a. excess demand):

when quantity supplied is greater than when quantity demanded is greater than
quantity demanded quantity supplied
P P
$6.00 D Surplus S Facing a surplus, $6.00 D S Example:
sellers try to increase If P = $1,
$5.00 sales by cutting price. $5.00
then
$4.00 This causes $4.00 QD = 21 lattes
$3.00 QD to rise and QS to fall. $3.00 and
Prices continue to fall QS = 5 lattes
$2.00 $2.00
until market reaches resulting in a
$1.00 equilibrium. $1.00 shortage of 16 lattes
$0.00 Q $0.00 Shortage Q
0 5 10 15 20 25 30 35 0 5 10 15 20 25 30 35
THE MARKET FORCES OF SUPPLY AND DEMAND 42 THE MARKET FORCES OF SUPPLY AND DEMAND 43
 Shortage (a.k.a. excess demand): Shortage (a.k.a. excess demand):
when quantity demanded is greater than when quantity demanded is greater than
quantity supplied quantity supplied
P P
$6.00 D S Facing a shortage, $6.00 D S Facing a shortage,
sellers raise the price, sellers raise the price,
$5.00 $5.00
causing QD to fall causing QD to fall
$4.00 and QS to rise, $4.00 and QS to rise.
$3.00 …which reduces the $3.00 Prices continue to rise
shortage. until market reaches
$2.00 $2.00
equilibrium.
$1.00 $1.00
Shortage Shortage
$0.00 Q $0.00 Q
0 5 10 15 20 25 30 35 0 5 10 15 20 25 30 35
THE MARKET FORCES OF SUPPLY AND DEMAND 44 THE MARKET FORCES OF SUPPLY AND DEMAND 45

Three Steps to Analyzing Changes in Eq’m EXAMPLE: The Market for Hybrid Cars

P
To determine the effects of any event, price of
S1
hybrid cars
1. Decide whether event shifts S curve,
D curve, or both.
P1
2. Decide in which direction curve shifts.

3. Use supply-demand diagram to see

how the shift changes eq’m P and Q. D1
Q
Q1
quantity of
hybrid cars
THE MARKET FORCES OF SUPPLY AND DEMAND 46 THE MARKET FORCES OF SUPPLY AND DEMAND 47
EXAMPLE 1: A Shift in Demand EXAMPLE 1: A Shift in Demand
EVENT TO BE
Notice:
ANALYZED: P P
When P rises,
Increase in price of gas. S1 S1
producers supply
STEP 1: P2 a larger quantity P2
D curve shifts of hybrids, even
because
STEP 2: price of gas P1 though the S curve P1
affects demand for has not shifted.
D shifts right
hybrids.
because
STEP high gas
3: does Always be careful
S curve
price makes not
hybrids D1 D2 D1 D2
to distinguish b/w
The
shift,shift causes an
more because
attractiveprice Q a shift in a curve Q
increase
of gas does in price
not cars. Q1 Q2 Q1 Q2
relative to other and a movement
and quantity
affect cost of of
along the curve.
hybrid cars.
producing hybrids.
THE MARKET FORCES OF SUPPLY AND DEMAND 48 THE MARKET FORCES OF SUPPLY AND DEMAND 49

Terms for Shift vs. Movement Along Curve EXAMPLE 2: A Shift in Supply
 Change in supply: a shift in the S curve EVENT: New technology
occurs when a non-price determinant of supply reduces cost of P
changes (like technology or costs) producing hybrid cars. S1 S2

 Change in the quantity supplied: STEP 1:

a movement along a fixed S curve S curve shifts
occurs when P changes because
STEP 2: event affects P1
cost of production.
 Change in demand: a shift in the D curve S shifts right P2
D curve
because does
event not shift,
occurs when a non-price determinant of demand STEP 3: production
because
reduces cost, D1
changes (like income or # of buyers) The shift causes
technology is not one
makes production Q
 Change in the quantity demanded: price
of to fall
the profitable
factors that Q1 Q2
more at
and quantity
affect demand. to rise.
a movement along a fixed D curve any given price.
occurs when P changes
50 THE MARKET FORCES OF SUPPLY AND DEMAND 51
EXAMPLE 3: A Shift in Both Supply EXAMPLE 3: A Shift in Both Supply
EVENTS: and Demand EVENTS: and Demand
price of gas rises AND P price of gas rises AND P
new technology reduces S1 S2 new technology reduces S1 S2
production costs production costs
STEP 1: P2
Both curves shift. STEP 3, cont.
P1 P1
STEP 2: But if supply
increases more P2
Both shift to the right.
than demand,
STEP 3: D1 D2 D1 D2
P falls.
Q rises, but effect Q Q
on P is ambiguous: Q1 Q2 Q1 Q2
If demand increases more
than supply, P rises.
THE MARKET FORCES OF SUPPLY AND DEMAND 52 THE MARKET FORCES OF SUPPLY AND DEMAND 53

ACTIVE LEARNING 3 ACTIVE LEARNING 3

Shifts in supply and demand A. Fall in price of CDs
Use the three-step method to analyze the effects of The market for
STEPS
each event on the equilibrium price and quantity of P music downloads
music downloads. 1. D curve shifts
S1
Event A: A fall in the price of CDs 2. D shifts left
P1
Event B: Sellers of music downloads negotiate a 3. P and Q both
fall. P2
reduction in the royalties they must pay
for each song they sell.
Event C: Events A and B both occur.
D2 D1
Q
Q2 Q1
54 55
 ACTIVE LEARNING 3 ACTIVE LEARNING 3
B. Fall in cost of royalties C. Fall in price of CDs and
The market for
fall in cost of royalties
STEPS
P music downloads
1. S curve shifts STEPS
S1 S2
(Royalties are part 1. Both curves shift (see parts A & B).
of sellers’ costs) P1
2. D shifts left, S shifts right.
2. S shifts right
P2
3. P unambiguously falls.
3. P falls,
Q rises. Effect on Q is ambiguous:
The fall in demand reduces Q,
D1 the increase in supply increases Q.
Q
Q1 Q2
56 57

CONCLUSION:
How Prices Allocate Resources
 One of the Ten Principles from Chapter 1:
Markets are usually a good way
to organize economic activity.
 In market economies, prices adjust to balance
supply and demand. These equilibrium prices
are the signals that guide economic decisions
and thereby allocate scarce resources.

THE MARKET FORCES OF SUPPLY AND DEMAND 58