Demand, Supply,

Equilibrium, &
Elasticity

Chapter 2: The Basics of Supply and Demand Slide 1

Supply and Demand

• The Supply Curve

• The supply curve shows how much of a good producers
are willing to sell at a given price, holding constant other
factors that might affect quantity supplied
• This price-quantity relationship can be shown by the
equation:

Qs  Qs (P)
Chapter 2: The Basics of Supply and Demand Slide 2
Supply and Demand
The Supply
Curve Graphically
Price
($ per unit) S

P2
The supply curve slopes
P1 upward demonstrating that
at higher prices, firms
will increase output

Q1 Q2 Quantity
Chapter 2: The Basics of Supply and Demand Slide 3
Supply and Demand
Change in Supply
P
S S’
• The cost of raw
materials falls
• At P1, produce Q2
P1
• At P2, produce Q1
• Supply curve shifts right P2
to S’
• More produced at any
price on S’ than on S
Q0 Q1 Q2 Q
Chapter 2: The Basics of Supply and Demand Slide 4
Supply and Demand

• The Demand Curve

• The demand curve shows how much of a good consumers
are willing to buy as the price per unit changes holding
non-price factors constant.
• This price-quantity relationship can be shown by the
equation:

Q D  Q D (P)
Chapter 2: The Basics of Supply and Demand Slide 5
Supply and Demand
Price
($ per unit) The demand curve slopes
downward demonstrating
that consumers are willing
to buy more at a lower price

Quantity
Chapter 2: The Basics of Supply and Demand Slide 6
Supply and Demand
Change in Demand
P D D’

• Income Increases P2
• At P1, purchase Q2
• At P2, purchase Q1 P1
• Demand Curve shifts right
• More purchased at any price
on D’ than on D

Q0 Q1 Q2 Q
Chapter 2: The Basics of Supply and Demand Slide 7
The Market Mechanism

Price
($ per unit) S

The curves intersect at

equilibrium, or market-
clearing, price. At P0 the
quantity supplied is equal
P0
to the quantity demanded
at Q0 .

Q0 Quantity
Chapter 2: The Basics of Supply and Demand Slide 8
The Market Mechanism

Price
S
($ per unit)
Surplus
P1
Assume the price is P1 , then:
1) Qs : Q2 > Qd : Q1
2) Excess supply is Q2 – Q1.
P2 3) Producers lower price.
4) Quantity supplied decreases
and quantity demanded
increases.
5) Equilibrium at P2Q3

Q1 Q3 Q2 Quantity
Chapter 2: The Basics of Supply and Demand Slide 9
The Market Mechanism

Price
($ per unit)
S

Assume the price is P2 , then:

1) Qd : Q2 > Qs : Q1
2) Shortage is Q2 – Q1.
P3 3) Producers raise price.
4) Quantity supplied increases
and quantity demanded
decreases.
P2 5) Equilibrium at P3, Q3

Shortage
D

Q1 Q3 Q2 Quantity
Chapter 2: The Basics of Supply and Demand Slide 10
Changes In Market Equilibrium

• Income Increases & raw P D D’ S S’

material prices fall
• The increase in D is greater
than the increase in S
P2
• Equilibrium price and P1
quantity increase to P2, Q2

Q1 Q2 Q
Chapter 2: The Basics of Supply and Demand Slide 11
Example 1: Market for Eggs

Prices fell until

P S1970 a new equilibrium
(1970 was reached at $0.26
dollars per and a quantity
dozen) of 5,300 million dozen

S1998

$0.61

$0.26

D1970
D1998
5,300 5,500 Q (million dozens)
Chapter 2: The Basics of Supply and Demand Slide 12
Example 2: Market for a College Education
P S1995 Prices rose until
(annual cost a new equilibrium
in 1970
was reached at $4,573
dollars)
and a quantity
of 12.3 million students
$4,573
S1970

$2,530

D1995
D1970

7.4 12.3 Q (millions of students enrolled))

Chapter 2: The Basics of Supply and Demand Slide 13
Changes In Market Equilibrium

Chapter 2: The Basics of Supply and Demand Slide 14

Changes In Market Equilibrium

Chapter 2: The Basics of Supply and Demand Slide 15

Changes In Market Equilibrium

Chapter 2: The Basics of Supply and Demand Slide 16

 Elasticities of Supply and Demand
Price Elasticity of Demand

• Measures the sensitivity of quantity demanded to price

changes.
• It measures the % change in the quantity demanded for a
good or service that results from a one percent change in
the price.
• The price elasticity of demand is:

E P  (%  Q)/(%  P)
Chapter 2: The Basics of Supply and Demand Slide 17
 Elasticities of Supply and Demand
Price Elasticity of Demand

• The % change in a variable is the absolute change in the

variable divided by the original level of the variable. So the
price elasticity of demand is also:

 Q/Q P Q
EP  
 P/P Q P

Chapter 2: The Basics of Supply and Demand Slide 18

Elasticities of Supply and Demand

• Interpreting Price Elasticity of Demand Values

1) Because of the inverse relationship between P and Q; EP is
negative.
2) If |EP| > 1, the % change in quantity demanded is greater
than the % change in price. We say demand is price elastic.
3) If |EP| < 1, the % change in quantity demanded is less
than the % change in price. We say demand is price
inelastic.

Chapter 2: The Basics of Supply and Demand Slide 19

Price Elasticities of Demand
Price
EP  -  The lower portion of
4 a downward sloping
demand curve is less elastic
Q = 8 - 2P than the upper portion.

Ep = -1
2
Linear Demand Curve
Q = a - bP
Q = 8 - 2P

Ep = 0

4 8 Q
Chapter 2: The Basics of Supply and Demand Slide 20
 Elasticities of Supply and Demand
Other Demand Elasticities

• Income elasticity of demand measures the % change in

quantity demanded resulting from a one percent change in
income. The income elasticity of demand is:

 Q/Q I Q
EI  
 I/I Q I

Chapter 2: The Basics of Supply and Demand Slide 21

 Elasticities of Supply and Demand
Other Demand Elasticities

• Cross price elasticity of demand = the % change in the

quantity demanded of one good that results from a one
percent change in the price of another good.
• The cross price elasticity for substitutes is positive, while that
for complements is negative. For example, consider the
substitute goods, butter and margarine.

 Q b /Q b P m  Q b
E Q bP m  
 P m /P m Q b  P m

Chapter 2: The Basics of Supply and Demand Slide 22

Elasticities of Supply and Demand
Elasticities of Supply

• Price elasticity of supply measures the % change in quantity

supplied resulting from a 1% change in price.
• The elasticity is usually positive because price and quantity
supplied are positively related (Higher price gives producers
an incentive to increase output)
• We can refer to elasticity of supply with respect to interest
rates, wage rates, and the cost of raw materials.

Chapter 2: The Basics of Supply and Demand Slide 23

SR Versus LR Elasticities
Price Elasticity of Demand
• Price elasticity of demand varies with the amount of time
consumers have to respond to a price.
• Most goods and services:
• Short-run elasticity is less than long-run elasticity (e.g. gasoline).
People tend to drive smaller and more fuel efficient cars in the long-run

• Other Goods (durables):

• Short-run elasticity is greater than long-run elasticity (e.g.
automobiles). People may put off immediate consumption, but
eventually older cars must be replaced.

Chapter 2: The Basics of Supply and Demand Slide 24

SR Versus LR Elasticities
Income Elasticities

• Most goods and services:

• Income elasticity is greater in the long-run than in the short
run. For example, higher incomes may be converted into
bigger cars so the income elasticity of demand for gasoline
increases with time.
• Other Goods (durables):
• Income elasticity is less in the long-run than in the short-
run. For example, consumers will initially want to hold
more cars. Later, purchases will only to be to replace old
cars.

Chapter 2: The Basics of Supply and Demand Slide 25

SR Versus LR Elasticities

Price Elasticity of Supply

• Most goods and services:

• Long-run price elasticity of supply is greater than short-run price
elasticity of supply. Due to limited capacity, firms are output
constrained in the short-run. In the long-run, they can expand.

• Other Goods (durables, recyclables):

• Long-run price elasticity of supply is less than short-run price elasticity
of supply. For example, consider the secondary copper market. Copper
price increases provide an incentive to convert scrap copper into new
supply. In the long-run, this stock of scrap copper begins to fall.

Chapter 2: The Basics of Supply and Demand Slide 26

SR Versus LR Elasticities: Coffee

Chapter 2: The Basics of Supply and Demand Slide 27

Understanding and Predicting the Effects
of Changing Market Conditions

1. We must learn how to “fit” linear demand and supply

curves to market data.
2. We determine numerically how a change in one variable
will cause supply or demand to shift and so affect the
equilibrium price and quantity.
3. Assume the Available Data are:
• Equilibrium Price, P*
• Equilibrium Quantity, Q*
• Price elasticity of supply, ES, and demand, ED.

Chapter 2: The Basics of Supply and Demand Slide 28

Understanding and Predicting the Effects
of Changing Market Conditions
Price
Supply: Q = c + dP
a/b

ED = -bP*/Q*
P* ES = dP*/Q*

-c/d Demand: Q = a - bP

Q* Quantity
Chapter 2: The Basics of Supply and Demand Slide 29
Understanding and Predicting the Effects
of Changing Market Conditions

• Let’s begin with the equations for supply and demand, and
the elasticities:
Demand: QD = a - bP
Supply: QS = c + dP

E  (P/Q)(  Q/  P)

Chapter 2: The Basics of Supply and Demand Slide 30

Understanding and Predicting the Effects
of Changing Market Conditions

• Note: for linear demand curves, ∆Q/ ∆P is constant (equal to

the slope of the curve).
• Substituting the slopes for each into the formula for elasticity,
we get:

E D  - b(P * /Q*)

E S  d(P * /Q*)
Chapter 2: The Basics of Supply and Demand Slide 31
Understanding and Predicting the Effects
of Changing Market Conditions

• Suppose we have values for ED, ES, P*, and Q*, we can then
solve for b & d, and a & c.

* *
Q D  a  bP
* *
Q S  c  dP

Chapter 2: The Basics of Supply and Demand Slide 32

 Example: The Copper Market

• Suppose we want to derive the long-run supply and demand

for copper:
• The data are:

• Q* = 7.5 mmt/yr.
• P* = 75 cents/pound
• ES = 1.6
• ED = -0.8

Chapter 2: The Basics of Supply and Demand Slide 33

Understanding and Predicting the Effects
of Changing Market Conditions
Price
Supply: QS = -4.5 + 16P
1.69 = a/b

.75

+.28 = -c/d Demand: QD = 13.5 - 8P

7.5 Mmt/yr
Chapter 2: The Basics of Supply and Demand Slide 34
Example 1: Real versus Nominal Prices of Copper 1965 - 1999

Chapter 2: The Basics of Supply and Demand Slide 35

Chapter 2: The Basics of Supply and Demand Slide 36
Declining Demand and the Behavior of
Copper Prices

• The relevant factors leading to a decrease in the demand for

copper are:
1) A decrease in the growth rate of power generation
2) The development of substitutes: fiber optics and
aluminum
• We will try to estimate the impact of a 20% decrease in the
demand for copper.
• Recall the equation for the demand curve:
Q = 13.5 - 8P
Chapter 2: The Basics of Supply and Demand Slide 37
Real versus Nominal
Prices of Copper 1965 - 1999
• Multiply the demand equation by 0.80 to get the new equation. This
gives:
Q = (0.80)(13.5 - 8P) = 10.8 - 6.4P
• Recall the equation for supply:
Q = -4.5 + 16P
• The new equilibrium price is:
-4.5 + 16P = 10.8 - 6.4P
-16P + 6.4P = 10.8 + 4.5
P = 15.3/22.4 = 68.3 cents/pound

Chapter 2: The Basics of Supply and Demand Slide 38

Example 2: Government Intervention -
Price Controls
• If the government decides that the equilibrium price is
too high, they may establish a ceiling price.
• Natural Gas Market: In 1954, the federal government
began regulating the wellhead price of natural gas.
• In 1962, the ceiling prices that were imposed became
binding and shortages resulted.
• Price controls created an excess demand of 7 trillion
cubic feet.
• Price regulation was a major component of U.S. energy
policy in the 1960s and 1970s, and it continued to
influence the natural gas markets in the 1980s.

Chapter 2: The Basics of Supply and Demand Slide 39

Effects of Price Controls

Price
S

If price is regulated to
be no higher than Pmax,
quantity supplied falls
P0 to Q1 and quantity
demanded increases to
Q2. A shortage results.
Pmax

D
Excess demand
Q1 Q0 Q2 Quantity
Chapter 2: The Basics of Supply and Demand Slide 40
"Ini Pergerakan Harga Pangan pada Musim Hujan“
Kompas.com - 27/02/2017, 14:30 WIB

JAKARTA, KOMPAS.com — Beberapa komoditas pangan pokok, seperti beras dan cabai, beberapa hari terakhir tengah
mengalami pergerakan harga, ada yang alami kenaikan akibat musim hujan dan ada juga yang alami penurunan. Deputi Bidang
Statistik Distribusi dan Jasa Badan Pusat Statistik (BPS) Sasmito Hadi Wibowo mengatakan, banjir merupakan fenomena
musiman yang berulang setiap tahun. "Walau banjir antar tahun bervariasi besarannya, tetapi petani tampaknya sudah terbiasa
dan cukup antisipatif," ujar Sasmito kepada Kompas.com, Senin (27/2/2017). Seperti turunnya harga beras, Sasmito menilai hal
itu merupakan fenomena yang wajar karena sedang puncak panen padi pada Februari hingga Maret. Menurut dia, komoditas
yang masih sensitif terhadap cuaca adalah komoditas cabai. Akibatnya, harga cabai tengah melonjak. "Cabai masih bandel
karena lebih sensitif terhadap curah hujan yang tinggi. Harga cabai rawit masih bertahan. Kemudian cabai merah yang biasanya
berlawanan arah dengan cabai rawit, sekarang ikut naik," papar Sasmito. Pengamat pertanian Institut Pertanian Bogor (IPB) Dwi
Andreas mengungkapkan, ada beberapa faktor utama yang memengaruhi terhadap naik turunnya harga pangan pada saat ini.
"Pertama, karena produk pertanian sifatnya musiman, jadi sesuai musim, ada puncak-puncak di mana produksi tinggi lalu ada
waktu-waktu terjadi paceklik atau tidak ada produksi itu yang salah satunya menyebabkan harga pangan itu selalu fluktuatif,"
ujar Andreas. Menurut dia, faktor kedua adalah sifat dari produk pertanian yang sebagian besar mudah rusak dan tidak tahan
lama. "Karena mudah rusak otomatis, tidak memiliki daya simpan yang lama sehingga harus cepat dijual, maka ada kondisi-
kondisi tertentu stok menurun. Kalau cepat dijual kemudian harga turun, tetapi ketika tidak terjual lagi mungkin dalam satu
sampai dua minggu harga naik enggak karuan," paparnya. Selain itu, persoalan harga pangan juga dipengaruhi oleh elastisitas
permintaan atau price elasticity of demand (PED) adalah ukuran respons perubahan jumlah permintaan barang terhadap
perubahan harga. Berdasarkan pusat informasi harga pangan strategis (PIHPS) nasional, harga telur ayam ras di Jakarta Rp
19.400 per kilogram, bawang merah Rp 45.250 per kilogram, cabai merah keriting Rp 45.000 per kg, dan cabai rawit hijau Rp
73.750 per kilogram. Selain itu, cabai rawit merah Rp 155.000 per kilogram, gula pasir Rp 14.750 per kilogram, minyak goreng
curah Rp 13.650 per kilogram, dan daging sapi Rp 123.750 per kilogram.

Penulis : Pramdia Arhando Julianto

Chapter 2: The Basics of Supply and Demand Slide 41