Market Demand and

Supply

This ppt is just the sketch of what is

being covered, read the book
thoroughly and practise the
end-of-chapter exercises for complete
understanding of concepts
Topics

Supply and Demand

The Market Mechanism

Changes in Market Equilibrium

Elasticities of Supply and Demand

Short-Run versus Long-Run Elasticities,

Revenue and Elasticity

Effects of Government Intervention—Price Controls

PARAMITAM
The Basics of Supply and Demand

• Supply-demand analysis is a fundamental and

powerful tool

• Understanding and predicting how changing world

economic conditions affect market price and quantity

• Evaluating the impact of government price controls,

minimum wages, price supports and production
incentives

• Determining how taxes, subsidies affect consumers

and producers
 Role of Prices
Under free market conditions, price reflects scarcity
❖Price conveys critical economic information
❖ When resource prices are high, company has a
greater incentive to economize on its use
❖ When price of a good is high, firm has an
incentive to produce more
❖Thus, prices provide incentives to use scarce
resources effectively
It’s important to understand what determine prices

PARAMITAM
Market
A market is a group of buyers and sellers of a particular
good or service. The buyers as a group determine the
demand for the product, and the sellers as a group
determine the supply of the product.
Organized and scattered
Competition: Each buyer knows that there are several
sellers from which to choose, and each seller is aware that
his product is similar to that offered by other sellers. As a
result, the price and quantity of ice cream sold are not
determined by any single buyer or seller.
Competitive Market : there are so many buyers and so
many sellers that each has a negligible impact on the
market price
we assume that markets are perfectly competitive. To reach
this
highest form of competition, a market must have two
characteristics: (1) The goods offered for sale are all exactly
the same, and (2) the buyers and sellers are so numerous
that no single buyer or seller has any influence over the
market price.
PARAMITAM
Individual to Market
Demand
Individual consumers first decide to buy those goods
which maximise their utility (preferences, i.e.
benefits) subject to their budget constraint (price of
the goods and income, i.e. cost)
The individual demand may be different from one
consumer to the other as their preferences and
income are not same
The market demand of a particular good X is
obtained as the sum of all these individual demand
for good X.
We are dealing with market demand here

PARAMITAM
 The Demand Curve
● demand curve Relationship between the quantity of
a good that consumers are willing to buy and the
price of the good.

• Demand curve is derived from demand schedule

• Market demand schedule is the list of quantities of a

commodity that consumers are willing and able to
purchase at different prices while all other factors are
not changing

• The other factors are price of other related goods,

consumer’s income, tastes and preferences etc.
 Demand Schedule to Demand
Curve
Consider weekly demand for pizza (of a pizza store) in a locality

Change along B
the curve –
When own price
changes, quantity
Changes –
movement along the demand curve

PARAMITAM
Shift of the Demand Curve
The demand curve is
downward sloping;
holding other things
equal, consumers will
want to purchase more of
a good as its price goes
down.

Shifts in dd curve takes

place when there is a
change in any of these
other factors (say, price of
coffee increases; then
demand for tea will
increase – but own price
is not changing!! Hence,
there is a shift)

Caution: Change along the

curve and shift of the
PARAMITAM
 Shift of the Demand Curve
If consumers’ income
increases, this increase would
occur no matter what the
market price is, hence would
be a shift to the right of the
entire demand curve.

substitutes Two goods for

which an increase in the
price of one leads to an
increase in the quantity
demanded
● of the other.

complements Two goods

for which an increase in the
price of one leads to a
decrease in the quantity
demanded of the other.
PARAMITAM
Understanding Demand
Curve
Relationship between quantity demanded and
price as an equation: Q = Q(P)
Plot the following demand equation:
Q=400 – 8P
P=0, Q = 400
P=25, Q= 200
P= 50, Q= 0
Interpretation

PARAMITAM
From Data to Demand
Equation
How do we get the equations from real life data?

Q = a + bP

b = change in Q/ change in P =
-50/25 = -2

So, Q= a - 2P
Now, a = 150 + 2*200 = 550.
Demand eqn: Q = 550 – 2P

PARAMITAM
 Exception to Law of
Demand
❖Veblen Good
❖Giffen Good
❖Possibility of Future Rise in Prices
❖Highly Essential Good

PARAMITAM
 The Supply Curve
Relationship between the quantity of a good that
producers
● are willing to sell and the price of the good
assuming factors like technology, input prices are not
changing

The supply curve is

upward sloping: The higher
the price, the more firms
are able and willing to
produce and sell.

If production costs fall,

firms can produce the
same quantity at a lower
price or a larger quantity at
the same price. The supply
curve then shifts to the right
(from S to S’).
PARAMITAM
 Supply Schedule to Supply
Curve

Change
along
the curve

PARAMITAM
The Supply Curve : Change along the
Curve and Shift of Supply Curve

• The quantity that producers are willing to sell

depends not only on the price they receive but also on
their production costs, including wages, interest
charges, and the costs of raw materials.

• When production costs decrease, output increases.

The entire supply curve thus shifts to the right.

• Change along the curve : when movement of quantity

supplied is due to change in prices
• Shift of the Supply Curve: when quantity supplied
changes due to other factors than price of that good
Understanding Supply Curve
The supply curve is thus a relationship between the
quantity supplied and the price. We can write this
relationship as an equation: Q = Q(P)
Plot the following supply equation:
Q = 200 + 2P
P=0, Q = 200
P=100, Q=400
P=200, Q=600

PARAMITAM
 Exercise 1
1. Consider the quantity of McDonald’s chicken burger.
Specify: Movement along the curve or shift of the curve
and which curve - demand or supply of McBurger?
✔price of KFC’s chicken burger increases
✔ (shift of demand curve to the right - substitute)
✔Potato shortage is there, so price of french fries increases.
Assume most of the consumers combine chicken burger
with french fries.
✔(shift of demand curve to the left - complementary)
✔McDonald’s chicken supplier gets a hit due to bird flu
✔ (shift of both demand and supply to the left)
✔McDonald raises the price of chicken burger by Rs. 25.
✔ (demand will fall – change along the curve)
✔There is an agitation on sale of Coke/ Pepsi, so they stop
selling it. Assume 98% customers take cold drink with
chicken burger.
(shift of demand to the left)
PARAMITAM
Exercise 1………continued
2. Specify: substitutes/complements/ unrelated
a. Cucumber and pedicure
b. HP printers and Casio calculators
c. Amul Butter and Kissan strawberry jam
d. KFC chicken burger and chicken
e. Basmati Rice and Biriyani.
f. Parle Hide and Seek biscuit and Britannia Bourbon
biscuit

PARAMITAM
Exercise 1…… continued
For each of the following events, describe in words
what happens to the supply, demand, quantity
demanded and quantity supplied in the market for
new cars.
a. The auto workers get a large raise.
b. A new robotic technology is introduced in the
factory.
c. The government subsidizes bus tickets resulting in a
large reduction in the cost of a bus ticket.
d. Real income grow and new cars are normal good.
Ans: ss falls, ss increases, dd decreases, dd increases
PARAMITAM
Exercise 1 …….continued
Demand equation is Q= 1200 – 5P.
Interpret the intercept and the co-efficient
What is the maximum demand?
What is the maximum price one may charge?
Plot the demand equation

Supply equation is Q= 1200 + 5P.

Interpret the co-efficient of P.
Plot the supply equation

PARAMITAM
Exercise 1 continued…..
▪Owing to the Coronavirus pandemic, tourism industry
suffered. Can you explain this with the help of change/
shift of demand/ supply curves?

▪In 2021, coronavirus vaccines were not available and

there was a crunch. Is it change along the curve or the
shift of the supply curve? Why?

PARAMITAM
THE MARKET MECHANISM
In a free market, tendency for price to adjust till the market clears!!

Supply and Demand

The market clears at
price P0 and quantity
Q0.

At the higher price P1,

a surplus develops, so
price falls.

At the lower price P2,

there is a shortage, so
price is bid up.
Equilibrium

● equilibrium (or market clearing) price

Price that equates the quantity supplied to the
quantity demanded.

● market mechanism Tendency in a free market for price

to change until the market clears.

● surplus Situation in which the quantity supplied

exceeds the quantity demanded.

● shortage Situation in which the quantity demanded

exceeds the quantity supplied.
 Equilibrium
QD - QS

Excess
Demand

Excess
Supply

Equilibrium occurs at P=150, where Q=250

(DD=SS)
At P< 150, DD>SS implying shortage
At P> 150, SS>DD implying surplus

PARAMITAM
 Equilibrium
Dd: Q=400 – 8P
Ss: Q = 200 + 2P
Find out equilibrium price and quantity

Exercise
Demand function for chairs in a city is given as: Q = 4000-2P.
a.Draw the demand curve. How many chairs will be sold at a
price of 800? At 1000?
What is the price above which no chairs will be sold?
If the seller sells the chairs at free of cost, how many chairs will
be sold?
What does the slope of the demand function imply?
b. Supply function for chairs is: Q = 2400+ 6P. Plot supply curve.
c. Find out equilibrium quantity and price.

PARAMITAM
 Do It Yourself

PARAMITAM
 Changes in Equilibrium

PARAMITAM
New Equilibrium Following Shift in
Supply
When the supply
curve shifts to the
right, the market
clears at a lower
price P3 and
a larger quantity
Q3.

PARAMITAM
New Equilibrium Following Shift in
Demand
When the demand
curve shifts to the
right, the market
clears at a higher
price P3 and a
larger quantity Q3.

PARAMITAM
 Exercise 2 : Caselet 1

DIY
Pindyck & Rubinfeld, Chapter 2, Q2 of Questions for Review
2. Use supply and demand curves to illustrate how each of the following
events would affect the price of butter and the quantity of butter bought
and sold: (a) an increase in the price of margarine; (b) an increase in the
price of milk; (c) a decrease in average income levels.

(a) Demand for butter shifts to the right. P & Q increase.

(b) Supply of butter shifts to left. P increases, Q decreases.
(c) Demand shifts to the left. P and Q decrease.

PARAMITAM
Exercise 2
Suppose that the price of football tickets at your college is determined by market
forces. Currently, the demand supply schedules are as follows;
Price Quantity demanded Quantity Supplied
4 10000 8000
8 8000 8000
12 6000 8000
16 4000 8000
20 2000 8000
a. Draw the demand and supply curves. What is unusual about the supply curve?
Why might this be true?
b. What are the equilibrium price and quantity of tickets?
c. Your college plans to increase total enrolment next year by 5000 students. The
additional student will have the following demand schedule.
Price Quantity demanded
4 4000
8 3000
12 2000
16 1000
20 0
Now determine the new market demand schedule. What will be the equilibrium
price and quantity?
PARAMITAM
 Both demand and supply shift
Supply and
demand
curves shift over
time
as market
conditions
change.

In general, changes
in price and
quantity
depend on the
amount
by which each
curve
PARAMITAM
Some Other Possibilities
When DD and SS move in opposite direction, what
happens?

Think and draw on your own

Possibilities:
1. DD increases, SS increases
2. DD falls, SS falls
3. DD increases, SS falls
4. DD falls, SS increases

PARAMITAM
Lessons
When DD and SS shift in the same direction, effect on
Q is certain (in the same direction as both DD,SS shift!)

When DD and SS shift in the opposite direction, effect

on P is certain (in the same direction as DD shifts!)

PARAMITAM
 CHANGES IN MARKET EQUILIBRIUM :
EXAMPLE
From 1970 to 2007, price of eggs fell by 49 percent, while the
price
. of a college education rose by 105 percent.
Explanations
❖The mechanization of poultry farms sharply reduced the
cost of producing eggs, shifting the supply curve
downward. The demand curve for eggs shifted to the left as
a more health-conscious population tended to avoid eggs.
❖As for college, increases in the costs of equipping and
maintaining modern classrooms, laboratories, and libraries,
along with increases in faculty salaries, pushed the supply
curve up. The demand curve shifted to the right as a larger
percentage of a growing number of high school graduates
decided that a college education was essential

PARAMITAM
 Exercise 3: Caselet 1
Firewood prices in places from northern
California to Boston and suburban New Jersey
have remained steady even though the
supply of firewood has been diminished by
environmental restrictions on cutting. The
Wall Street Journal reports that sales of gas
fireplaces are outpacing sales of
wood-burning hearths and that "people are
burning less and less wood."
Use supply and demand analysis to show why
firewood prices are not rising while the quantity of
firewood burned is declining.
PARAMITAM
 Exercise 3 : Caselet 2
Construct a graph showing equilibrium in the market
for movie tickets. Label both axes and denote the
initial equilibrium price and quantity as P and Q. For
each of the following events, predict the impact of
the event on the market price of a movie ticket and
the number of tickets sold in the new equilibrium
situation:
a. There is another Movie theater that closed their
operation in the locality.
b. Cable television begins offering pay-per-view
movies.
c. The screenwriters' guild ends a 10-month strike.
d. Kodak reduces the price it charges movie producers
for motion picture film.
PARAMITAM
 Exercise 3 : Caselet 3
3. Consider the market for chocolate ice-cream in the
region of North America. A severe drought in the
Midwest causes dairy farmers to reduce the number
of milk-producing cattle in their herds by a third.
These dairy farmers supply cream that is used to
manufacture chocolate ice cream. At the same time,
the discovery of cheaper synthetic vanilla flavoring
lowers the price of vanilla ice cream. What would be
the impact of these on equilibrium price and quantity
on Chocolate ice-cream?
Explain your answer.

PARAMITAM
 Exercise 3.4: DIY
Consider the markets for DVDs, TV and tickets at
movie theatres.
For each pair, identify whether they are
complementary or substitutes:
DVDs and TV
DVDs and Movie tickets
TV and movie tickets
Suppose a technological advance reduces the cost of
manufacturing TV screens. Draw a diagram to show
what happens in the TV market.
Draw two more diagram to show how the change in
the market for TV screens affects the markets for DVDs
and movie tickets.

PARAMITAM
Demand Equation
Revisited
We may write the complete equation of demand as Q
depends on own price, price of related goods,
consumers’ income and other relevant factors. It may
look like this:
Q = 300 - 2P + 4I, where I is average income measured
in thousands of dollars.
The supply curve is Q = 3P - 50.
a. If I = 25, find the market-clearing price and quantity
for the product.
b. If I = 50, find the market-clearing price and quantity
for the product.

PARAMITAM
Exercise 4

PARAMITAM
DIY
Annual demand and supply for the Electronics
company is given by:
Qd=5000+0.5I+0.2A-100P and Qs=-5000+100P, where
Q is the quantity per year, P is the price, I is the income
per household, and A is the advertising expenditure.
a. If A=$10,000 and I=$25,000, what is the demand
curve?
b. Given the demand curve in part a, what is the
equilibrium price and quantity?
c. If consumer incomes increase to $30,000, what will
be the impact on equilibrium price and quantity?
Answer: a. Q=19500-100P. b. P=122.5, Q=7250. c.
P=8500, Q=135

PARAMITAM
 DIY

Price(¢) Quantity Supplied Quantity Surplus(+) or

Demanded Shortage(-)

15
16
17
18
19
20

PARAMITAM
 Consumer and Producer
Surplus
❖Measures benefits of consumers and producers
❖Measures changes in welfare of consumers / producers
❖Enables policy makers to gauge the effects of policies/
events

PARAMITAM
CONSUMER AND PRODUCER
SURPLUS
Consumer A would pay
$10 for a good whose
market price is $5 and
therefore enjoys a
benefit of $5.
Consumer B enjoys a
benefit of $2,
and Consumer C, who
values the good at
exactly the market
price, enjoys no
benefit.
Consumer surplus,
which measures the
total benefit to all
consumers, is the
yellow-shaded area
between the demand
curve and the market
CONSUMER AND PRODUCER
SURPLUS
Producer surplus
measures the total
profits of producers
(takes only variable
cost).
It is the green-shaded
area between the
supply curve and the
market price.
Together, consumer
and producer surplus
measure the welfare
benefit of a
competitive market.
Exercise 5
1. The
market demand function for a product is given by
Qd=300-2P. How much consumer surplus do they receive
when P=45? P=30?
2. The market supply curve for a product is given by
P=10+2Qs. How much producer surplus do they receive
when P=18, P=30?
3 Let the market supply and demand curves are given by
the equations :
P = 40 + 4Qs and P= 100 – 2Qd. What is the consumer and
producer surplus at the equilibrium price and quantity?

PARAMITAM
 Government Intervention

PARAMITAM
Government Intervention
Interfering with the market
Price ceiling (rent control)
Price floors (min. wage)
Breaks the signaling system and leads to wastage and inefficiency

Working through the market

Taxes
Subsidies
Influences demand/ supply, but market forces determine the price
and quantity

PARAMITAM
EFFECTS OF GOVERNMENT
INTERVENTION— PRICE CONTROLS
Without price controls, the market clears
at the equilibrium price
and quantity P0 and Q0.

If price is regulated to be
no higher than Pmax, the quantity
supplied falls to Q1, the
quantity demanded increases
to Q2, and a shortage develops.

Price ceiling leads to excess

demand!

PARAMITAM
Case study-Lines at the Gas
Pump

PARAMITAM
EFFECTS OF GOVERNMENT
INTERVENTION— PRICE CONTROLS
EXAMPLE
Price of Natural Gas

Natural gas prices rose sharply after 2000,

as did the prices of oil and other fuels.
PRICE CONTROLS – Measuring Excess
Demand
•Price of natural gas was regulated at $3
•The (free-market) wholesale price of natural gas was $6.40 per mcf
(thousand cubic feet);

•Production and consumption of gas were 23 Tcf (trillion cubic feet);

•The average price of crude oil (which affects the supply and demand
for natural gas) was about $50 per barrel.
Supply: Q = 15.90 + 0.72PG + 0.05PO
Demand: Q = 0.02 – 0.18PG + 0.69PO
Substitute $3.00 for PG in both the supply and demand equations
(keeping the price of oil, PO, fixed at $50).
You should find that the supply equation gives a quantity supplied of
20.6 Tcf and the demand equation a quantity demanded of 29.1 Tcf.
Therefore, these price controls would create an excess demand of
29.1 − 20.6 = 8.5 Tcf.
PARAMITAM
 Price controls: price floors
Equilibrium Price floor
Surplus
Price D S Price D S

4 4

3 3
Price
2 Ceiling
2

100 200 Quantity of Quantity of

100 200 600
lentils lentils

PARAMITAM
PARAMITAM
CONSUMER AND PRODUCER
SURPLUS: Changes
● welfare effects Gains and losses to consumers and producers.
Change in Consumer and Producer
Surplus from Price Controls ● deadweight loss Net loss of
total (consumer plus
The price of a good has been
regulated to be no higher than Pmax, producer) surplus = B+C
which is below the market-clearing
price P0.
The gain to consumers is the
difference between rectangle A and
triangle B.
The loss to producers is the sum of
rectangle A and triangle C.

Consumer’s gain: A-B

Producer’s gain: - (A+C)
Net gain= A- B –A –C=
- (B+C)
CONSUMER AND PRODUCER SURPLUS: Price Control
and Natural Gas Shortages

Supply: QS = 15.90 + 0.72PG + 0.05PO

Demand: QD = 0.02 − 0.18PG + 0.69PO

Effects of Natural Gas Price

Controls
The market-clearing price
of natural gas is $6.40
per mcf, and the
(hypothetical) maximum
allowable price is $3.00.
A shortage of 29.1 − 20.6
= 8.5 Tcf results.
The gain to consumers is
rectangle A minus
triangle B,
and the loss to producers
is rectangle A plus
triangle C.
The deadweight loss is
the sum of triangles B
plus C.
 Applications: Exercise 6
1 The government has set the prices of Covishield and
Covaxin in India. What kind of intervention is this?
What is the possible impact?
2 The government announces minimum support price
for various crops every year. What kind of
intervention is this?
3 Suppose the market demand and supply functions
are given by Qd=60-P and Qs=P-20. Determine the
consumer and producer surplus if a price ceiling of 32
is imposed in this market. What is the amount of dead
weight loss?
4 The domestic demand and supply and demand
curves for petrol are: Supply: P=50+Q; Demand:
P=200-2QWhat will be the consumer and producer
surplus if a price ceiling of 75 is imposed?
PARAMITAM
Exercise 6 continued
The rent control agency of New York City has found
that aggregate demand is QD = 160 - 8P. Quantity is
measured in tens of thousands of apartments. Price, the
average monthly rental rate, is measured in hundreds
of dollars. The agency also noted that the increase in Q
at lower P results from more three-person families
coming into the city from Long Island and demanding
apartments. The city’s board of realtors acknowledges
that this is a good demand estimate and has shown that
supply is QS = 70 + 7P.

a. If both the agency and the board are right about

demand and supply, what is the free-market price?
b. What is the change in city population if the agency
sets a maximum average monthly rent of $300 and all
those who cannot find an apartment leave the city?
PARAMITAM
Reference

Pindyck and Rubinfeld, Chapter 2

For Consumer and Producer surplus, Mankiw,
chapters 6, 7

PARAMITAM