Turn to

page 30

2.1.2 Interaction of Demand and Supply

b. Equilibrium price and equilibrium quantity
c. Changes in demand and supply leading to
changes in market equilibrium
 Recall
MARKET

a place where there is interaction

between buyers and sellers

Buyers (consumers) Sellers (producers)

Theory of Demand Theory of Supply

 Recall

PRICES DETERMINED BY BRINGING

TOGETHER DEMAND & SUPPLY

LAW OF DEMAND LAW OF SUPPLY

Price Price
S

D
0 0
Quantity Quantity
 Recall

Market forces of DD and SS

PricePrice DD S
Price
S
Q

D
D
0 0
Quantity Quantity
0 Quantity

Market Equilibrium
 Recall
Page 8
Market Equilibrium

• Equilibrium
– situation where there’s no tendency to change
– determined by interaction of DD & SS
• DD curve cuts SS curve
– at equilibrium, Qdd = Qss
– Eqm P and Q will change when
non-P factors affecting DD and/or SS change
 Recall
Page 9
FIG 1: EQUILIBRIUM PRICE AND OUTPUT
Price/kg
Supply

3 Qdd = Qss
E Market eqm is point E
2
Eqm P is $2 and Eqm Q= 60

Demand
30 60 90 Quantity/month
 Page 30
How do you think it
will affect the demand
for lettuce?

HEADLINE NEWS!!

lettuce
 Page 30

HEADLINE NEWS!!

lettuce

• Health-conscious consumers’ taste and

preference change in favour of lettuce
• DD rise  Impact on eqm P and eqm Q?
How do we use DD/SS diagram to explain?
∆ in Mkt Equilibrium - ∆ in DD only Page 30

• Taste and preference change in favour of healthy

lettuce  DD ↑ (rightward shift from DD0 to DD1)
Price
SS0
P1

P0
shortage
DD1
DD0

Qty of
Qss Q
= 0Q0 Q1 Qdd = Q2 lettuce

1. At original price P0, shortage of Q0Q2 results

2. shortage causes P↑ from P0 to P1
3. Qss ↑ and Qdd ↓ until Qdd = Qss again
4. new higher eqm Q at Q1 and higher eqm P at P1
 Page 31
HEADLINE NEWS!!

• Technologically advanced methods of farming  rise in

productivity fall in unit COP  rise in profits  profit-
maximising producers have more incentive to produce
• SS rise  Impact on eqm P and eqm Q?
How do we use DD/SS diagram to explain?
 ∆ in Mkt Equilibrium - ∆ in SS only Page 30

• Technologically advanced methods of farming  SS ↑

(rightward shift from SS0 to SS1)
Price
SS0
SS1

surplus
P0

P1

DD0

Qty of
Qdd=QQ
00 Q1 Qss = Q2 lettuce

1. at original price P0, surplus Q0Q2 results

2. surplus causes P↓ to P1
3. Qdd ↑ and Qss ↓ until Qdd = Qss again
4. new higher eqm Q at Q1 and lower eqm P at P1
 Page 31

∆ in Mkt Equilibrium – ∆ in both DD & SS

• In reality, there is often ∆ in both DD & SS
at the same time
- e.g. greater taste and preference for
healthy lettuce and technological
advancement in growing lettuce
- cause both DD and SS to rise

– Will eqm P rise or fall?

– Will eqm Q rise or fall?
 Page 31
RISE IN BOTH DD AND SS
Eqm Q Eqm P
Higher DD, cp (1) increase increase
Higher SS, cp (2) increase decrease
Effect of both higher increase uncertain
DD and SS (1+2)

Q0
 Page 31
RISE IN BOTH DD AND SS
Eqm Q Eqm P
Higher DD, cp increase increase
Higher SS, cp increase decrease
Effect of both higher increase uncertain
DD and SS (1+2)

Eqm Q will increase.

Whether eqm P rise or fall depends on magnitude

of shift of DD and SS.
1.Increase in DD > increase in SS
2.Increase in DD < increase in SS
3.Increase in DD = increase in SS
 Page 32
∆ in Mkt Equilibrium - ∆ in both DD & SS
• if both DD & SS ↑ (shift right)
Price
SS0 SS1

P1
P0

DD1
DD0

Qty
Scenario 1 Q0 Q1

– DD ↑ > SS ↑ (DD shifts more than SS)

– eqm P ↑, eqm Q ↑
 Page 32
∆ in Mkt Equilibrium - ∆ in both DD & SS

• if both DD & SS ↑ (shift right)

Price
SS0
SS2

P0
P2

DD2

DD0
Scenario 2 Q0 Q2
Qty

– DD ↑ < SS ↑ (DD shifts less than SS)

– eqm P ↓, eqm Q ↑
 Page 32
∆ in Mkt Equilibrium - ∆ in both DD & SS
• if both DD & SS ↑ (shift right)
Price
SS0
SS3

P3 = P0

DD3
DD0

Scenario 3 Q0 Q3
Qty

– DD ↑ = SS ↑ (DD shifts by same extent as SS)

– eqm P is unchanged, eqm Q ↑
∆ in Mkt Equilibrium – Rise in both DD & SS
Eqm Q Eqm P
Higher DD, cp (1) increase increase
Higher SS, cp (2) increase decrease
Effect of both higher increase uncertain
DD and SS (1+2)

3 scenarios Eqm Q Eqm P

↑DD > ↑SS increase increase
↑DD < ↑SS increase decrease
↑DD = ↑SS increase same
 Page 34

∆ in Mkt Equilibrium – fall in DD + rise in SS

Eqm Q Eqm P
Lower DD, cp (1) decrease decrease
Higher SS, cp (2) increase decrease
Effect of both fall in DD and
uncertain decrease
rise in SS (1+2)
 Page 34
∆ in Mkt Equilibrium – fall in DD + rise in SS

Eqm Q Eqm P
Lower DD, cp (1) decrease decrease
Higher SS, cp (2) increase decrease
Effect of both fall in DD
uncertain decrease
and rise in SS (1+2)

Eqm P will decrease.

Whether eqm Q rise or fall depends on magnitude of

shift of DD and SS.
1.Decrease in DD > increase in SS
2.Decrease in DD < increase in SS
3.Decrease in DD = increase in SS
 Page 34

Supply curve shift to the

right
Scenario 1
 Demand decrease > Supply increase

Demand curve shift to the left

Price
SS0

P0

DD0
0 Q0 Quantity
 Page 34
∆ in Mkt Equilibrium - ∆ in both DD & SS
Scenario 1
• ↓ DD (shift left) > SS ↑ (shift right)
Price
SS0 SS1

Po

P1
DD0

DD1
Qty
Q1 Q0

• eqm P↓ , eqm Q ↓
 Page 34

Supply curve shift to the

right
Scenario 2
 Demand decrease < Supply increase

Demand curve shift to the left

Price
SS0

P0

DD0
0 Q0 Quantity
 Page 34
∆ in Mkt Equilibrium - ∆ in both DD & SS
Scenario 2
• ↓ DD (shift left) < SS ↑ (shift right)
Price SS1
SS0

Po

P1
DD0
DD1
Qty
Q0 Q1

• eqm P ↓, eqm Q ↑
 Page 34

Supply curve shift to the

right
Scenario 3
 Demand decrease = Supply increase

Demand curve shift to the left

Price
SS0

P0

DD0
0 Q0 Quantity
 Page 34
∆ in Mkt Equilibrium - ∆ in both DD & SS
Scenario 3
• ↓ DD (shift left) = SS ↑ (shift right)
Price SS1
SS0

Po

P1

DD0
DD1
Qty
Q0
• eqm P ↓, eqm Q remains the same
 Page 34
∆ in Mkt Equilibrium – fall in DD + rise in SS

Eqm Q Eqm P
Lower DD, cp decrease decrease
Higher SS, cp increase decrease
Effect of both
higher DD and uncertain decrease
SS (1+2)
Eqm P will decrease.

Whether eqm Q rise or fall depends on extent of shift of DD and SS

If ↓DD>↑SS  eqm Q falls
If ↓DD<↑SS  eqm Q rises
If ↓DD=↑SS  eqm Q remains unchanged
Test yourself at home Page 35
SWEETENERS USED IN A FRUIT DRINK HAVE BEEN FOUND TO
CAUSE CANCER IN RATS. WHAT WILL HAPPEN TO EQUILIBRIUM
PRICE AND QUANTITY?

A. Both equilibrium price and quantity rise

B. Both equilibrium price and quantity fall
C. Equilibrium price rises and equilibrium
quantity falls
D. Equilibrium price falls and equilibrium
quantity rises
 Page 39

What is Consumer Surplus?

 Consumer surplus is the difference between
what the consumer is willing to pay for a
good and what he actually pays for it
DD curve shows consumers’ If the final transacted
ability and willingness to pay price is $4,
$8
for the good. how many sandwiches
7 will you buy and how
Qty Willingness to 6 much do you pay?
pay (MU/MB)
5
1st $7
2nd $6 4

3rd $5 3

4th $4 2

5th $3 1
D
0
1 2 3 4 5 6 7 8
Subways per month
You will buy 4
$8
sandwiches and pay $4
for each sandwiches. 7

Qty Willing Actual 5

to pay payment
4

3
1st $7 $4
2
2nd $6 $4
1
3rd $5 $4 D
0
4th $4 $4 1 2 3 4 5 6 7 8
Subways per month
What is the consumer surplus
(willing to pay – actual payment)? $8

Qty Willing Actual CS 6

to pay paid 5

1st $7 $4 $3 3

2
2nd $6 $4 $2
1
3rd $5 $4 $1
D
4th $4 $4 $0 0
1 2 3 4 5 6 7 8
Subways per month
 Page 38

Price Willing to
pay 0ABQ

A S Actual paid
(consumer 0PBQ
expenditure)
P B Consumer ABP
surplus

D
0 Q Qty
Consumer surplus is represented by the area below the
demand curve but above the market equilibrium price
 Page 39

What is Producer Surplus?

 The difference between the amount that
a producer is willing to be paid for a
good and the amount he actually
receives.
 If the final transacted price
SS curve shows producers’ is $4, how many
ability and willingness to sell $8 sandwiches will you sell and
for the good. how much do you get?
7
S
Qty Willing to 6
sell
5
1st $2
4
2nd $3
3
3rd $4
2
4th $5
1
5th $6
0
1 2 3 4 5 6 7 8
Subways per month
You will sell 3 sandwiches
and get $4 for each $8 S
sandwiches. 7

6
Qty Willing Actual
5
to sell payment
4

1st $2 $4 3

2
2nd $3 $4
1
3rd $4 $4
0
1 2 3 4 5 6 7 8
Subways per month
What is the producers surplus S
$8
(willing to sell – amt receive)?
7

Qty Willing Amt PS 6

to sell received 5

3
1st $2 $4 $2
2
2nd $3 $4 $1
1
3rd $4 $4 $0
0
1 2 3 4 5 6 7 8
Subways per month
 Page 39

Price Willing to
0REQ
sell
A S Actual sold
and received 0PEQ
E (producer
P revenue)
Producer RPE
surplus
R D

0 Q Qty
Producer surplus is represented by the area above the
supply curve but below the market equilibrium price
Allocative efficiency is achieved when there is maximum
welfare in the economy.
Maximum welfare = total welfare = sum of both CS and PS