Market Supply and Demand

• Key Concepts • Summary • Practice Quiz

What is the Law of Demand?
The principle that there is an inverse relationship between the price of a good and the quantity buyers are willing to purchase in a defined time period, ceteris paribus

What does “ceteris paribus” mean?
All else remains the same

What is a demand curve?
Depicts the relationship between price and quantity demanded

Rs20 Rs15 Rs10 Rs5

P

Individual’s Demand Curve for Compact Discs

A B C

Individuals Buyer’s Demand Schedule for Compact Discs Point Price per compact disk Quantity demanded (per year)

A B C D

Rs 20 Rs 15 Rs 10 Rs 5

4 6 10 16
7

D
Demand Curve

4

8

12 16

Q

Why do demand curves have a negative slope?
At a higher price consumers will buy fewer units, and at a lower price they will buy more units

What is a demand schedule?
Shows the specific quantity of a good or service that people are willing and able to buy at different prices

What is market demand?
The summation of the individual demand schedules

IMPORTANT KNOW THE DIFFERENCE BETWEEN A CHANGE IN THE QUANTITY DEMANDED AND A CHANGE IN DEMAND

When price changes what happens?
The curve does not shift there is a change in the quantity demanded

Increase in Quantity Demanded Decrease in Price

P
Rs20 Rs15 Rs10 Rs5

Rahul’s Demand Curve

D1
1 2 3 4 5 6 7 8 9 Q

P
Rs20 Rs15 Rs10 Rs5

Mohan’s Demand Curve

D2
1 2 3 4 5 6 7 8 9 Q

P
Rs20 Rs15 Rs10 Rs5

Market Demand Curve

D3 Q
3 4 5 6 7 8 9 101112

P
Rs20 Rs15

P
Rahul’s Demand Curve

Rs20 Rs15 Rs10

Mohan’s Demand Curve

Rs10

Rs5
Rs5

D1
1 2 3 4 5 6 7 8 9 Q
12

D2
1 2 3 4 5 6 7 8 9 Q
13

P
Rs20 Rs15 Rs10 Rs5

Market Demand Curve

D3 Q
3 4 5 6 7 8 9 10 11 12
14

Market Demand Schedule for Compact Discs
Price Fred Mary Total Demanded

Rs25 Rs20 Rs15 Rs10 Rs5

1 + 0 = 2 1 3 3 4 5 5 7

1 3 6 9 12

Rs20 Rs15 Rs10

P

A change in price causes a change in the quantity demanded

A B

Rs5

D

Q 10 20 30 40 50

When something changes other than price, what happens?
The whole curve shifts,there is a change in demand

Rs20 Rs15 Rs10

P

When the ceteris paribus assumption is relaxed, the whole curve can shift

A

B

Rs5

D D12
10 20

30 40 50

Q

Increase in demand Change in nonprice determinant

What can cause a shift in a demand curve?
• Tastes and preferences • Number of buyers in the market • Income • Expectations of consumers • Prices of related goods

Decrease in quantity demanded Upward movement along the demand curve Price increases

Increase in quantity demanded Downward movement along the demand curve Price decreases

Decrease or increase in demand Leftward or rightward shift in the demand curve Nonprice determinant

What is a normal good?
Any good for which there is a direct relationship between changes in income and its demand curve

What is an inferior good?
Any good for which there is an inverse relationship between changes in income and its demand curve

What are substitute goods?
Goods that compete with one another for consumer purchases

What happens when the price increases for a good that has a substitute?
The demand curve for the substitute good increases

What happens when the price decreases for a good that has a substitute?
The demand curve for the substitute good decreases

The two move in the same direction

What does a direct relationship between price and quantity mean?

What are complementary goods?
Goods that are jointly consumed with another good

What happens when the price increases for a good that has a complement?
The demand curve for the complements good decreases

What happens when the price decreases for a good that has a complement?
The demand curve for the complements good increases

What does an inverse relationship between price & quantity mean?
It means that the two move in opposite directions

What is the law of supply?
The principle that there is a direct relationship between the price of a good and the quantity sellers are willing to offer for sale in a defined time period, ceteris paribus

Why do supply curves have a positive slope?
Only at a higher price will it be profitable for sellers to incur the higher opportunity cost associated with supplying a larger quantity

P
Rs20 Rs15 Rs10

A company’s Supply Curve for Compact Discs

Supply Curve

A B

Rs5

C
10 20 30 40

Q

An Individual Seller’s Supply for Compact Discs

Point

Price

Quantity

A B C

Rs20 10 6

40 30 20

What is a market?
Any arrangement in which buyers and sellers interact to determine the price and quantity of goods and services exchanged

What is market supply?
The horizontal summation of all the quantities supplied at various prices that might prevail in the market

P
Rs25 Rs20 Rs15 Rs10

Market Supply Curve

S total

40 45

55 60

Q

P
Rs 25 Rs20 Rs15 Rs10

Super Sound Supply Curve

S1

10 15

20 25

Q

P
Rs25 Rs20 Rs15 Rs10

High Vibes Supply Curve

S2

20 25

30 35

Q

Market Supply Schedule for Compact Discs
Price Super Sound High Vibes Total

Rs25 Rs20 Rs15 Rs10 Rs5

25 + 35 = 20 30 15 25 10 20 5 15

60 50 40 30 20

IMPORTANT KNOW THE DIFFERENCE BETWEEN A CHANGE IN THE QUANTITY SUPPLIED AND A CHANGE IN SUPPLY

When price changes, what happens?
The curve does not shift there is a change in the quantity supplied

A change in price causes a change in the quantity Rs20 supplied
Rs15 Rs10

P

Supply Curve

A B

Rs5

C
10 20 30 40

Q

Increase in Quantity Supplied Increase in Price

When something changes other than price, what happens?
The whole curve shifts - there is a change in supply

Rs20 Rs15 Rs10

P

When the ceteris paribus assumption is relaxed, the whole curve can shift

S1

S2

Rs5

10

20

30

40

Q

Increase in supply Change in nonprice determinant

What can cause a shift in a supply curve?
1. Number of sellers in the market 2. Technology 3. Resource prices 4. Taxes and subsidies 5. Expectations of producers 6. Prices of other goods the firm could produce

Rs1200

P

The Supply & Demand for Tennis Shoes

Rs900

S
Surplus Shortage

Rs600

Rs300

D

1,000 2,000 3,000 4,000

Q

What is an equilibrium?
A market condition that occurs at any price for which the quantity demanded and the quantity supplied are equal

What is the price system?
A mechanism that uses the forces of supply and demand to create an equilibrium through rising and falling prices

Cross Price Elasticity
• Suppose that the Intel microprocessor chips (Pentium, etc.) increases in price by about 10%. What will happen to Microsoft software? • If the price of one product rises and the quantity demanded of another product falls, then we say the products are complements.

Cross Price Elasticity
• Suppose that Coca-Cola raises its price by 10%. • What happens to sales of Pepsi? • If the price of one product rises and the quantity demanded of another product rises, we say the products are substitutes.

Utility Max: Marginal
• Suppose you could measure happiness from consumption of apples, then, suppose that the following situation exists:
• Unit 1 = 8 units of happiness • Unit 2 = 6 units of happiness • Unit 3 = 4 units of happiness • Unit 4 = 2 units of happiness

Utility Max: Marginal
• The total amount of happiness depends on how much of the good we have.
Units Unit 1 Unit 2 Unit 3 Unit 4 Total Happiness 6 units of happiness 14 18 20

Utility Max: Marginal
The total amount of happiness depends on how much of the good we have. Units Total Happiness Marginal Unit 1 6 6 Unit 2 14 8 Unit 3 18 4 Unit 4 20 2

MU

10 8 6 4 2

The first Unit gives us 6 units of happiness

Total utility 20 15 10 5 1 2 3 4 5 6 Quantity of Good or Activity

MU

10 8 6 4 2

The second unit gives us 8 units of happiness

Total utility
20 15 10 5
1 2 3 4 5 6

The first two units then are providing a total of 14 units of happiness Quantity of Good or Activity

MU

10 8 6 4 2 Total utility 15 10 5
1

Even though MU is falling, total utility continues to rise until .....

Quantity of Good or Activity

2

3

4

5

6

MU 10 8 6 4 2 Total utility 15 10 5
1 2

MU reaches zero. Zero MU means MAX Total Utility. Any more consumption and MU is negative so total utility declines

Quantity of Good or Activity

3

4

5

6

Key Concepts
• • • • • •

What is the law of demand? What is a demand curve? Why do demand curves have a negative slope? When price changes, what happens? When something changes other than price, what happe What can cause a shift in a demand curve?

Key Concepts

Key Concepts cont.
• • • • • • •

What is the law of supply? Why do supply curves have a positive slope? When price changes, what happens? When something changes other than price, what happe What can cause a shift in a supply curve? What is a market? What is an equilibrium?

Summary

68

The law of demand states there is an inverse relationship between the price and the quantity demanded, ceteris paribus. A market demand curve is the horizontal summation of individual demand curves.

69

Rs20 Rs15 Rs10

P

Individual’s Demand Curve for Compact Discs

A B C

Individuals Buyer’s Demand Schedule for Compact Discs Point Price per compact disk Quantity demanded (per year)

A B C D

Rs 20 Rs 15 Rs 10 Rs 5

4 6 10 16
7

Rs5

D
Demand Curve

4

8

12 16

Q

A change in quantity demanded is a movement along a stationary demand curve caused by a change in price. When any of the nonprice determinants of demand changes, the demand curve responds by shifting. An increase in demand (rightward shift) or a decrease in demand (leftward shift) is caused by a change in one of the nonprice determinants.
71

Rs20 Rs15 Rs10

P

When the ceteris paribus assumption is relaxed, the whole curve can shift

A

B

Rs5

10 20

30 40 50

D2 D1 Q

Nonprice determinants of demand: a. the number of buyers, b. tastes and preferences. c. income (normal and inferior). d. expectations of future p;rice and income changes, and e. prices of related goods (substitutes and complements)
73

The law of supply states there is a direst relationship between the price and the quantity supplied, ceteris paribus. The market supply curve is the horizontal summation of individual supply curves.

74

A change in quantity supplied is a movement along a stationary supply curve caused by a change in price. When any of the nonprice determinants of supply changes, the supply curve responds by shifting. An increase in supply (rightward shift) or a decrease in supply (leftward shift) is caused by a change in one of the nonprice determinants.
75

P
Rs20 Rs15 Rs10

A company’s Supply Curve for Compact Discs

Supply Curve

A B

Rs5

C
10 20 30 40

Q

Rs20 Rs15 Rs10

P

When the ceteris paribus assumption is relaxed, the whole curve can shift

S1

S2

Rs5

10

20

30

40

Q

Nonprice determinants of supply: a. the number of sellers. b. technology c. resource prices. d. taxes and subsidies. e. expectations of future price changes, f. prices of other goods.
78

A surplus or shortage exists at any price where the quantity demanded and the quantity supplied are not equal. When the price of a good is greater than the equilibrium price, there is an excess quantity supplied called a surplus. When the price is less than the equilibrium price, there is an excess quantity demanded called a shortage.
79

Equilibrium is the unique price and quantity established at the intersection of the supply and the demand curves. Only at equilibrium does quantity demanded equal quantity supplied.

80

Rs120

P

The Supply & Demand for Tennis Shoes

Rs90 Rs60 Rs30

S
Surplus Shortage

D

1,000 2,000 3,000 4,000

Q

The price system is the supply and demand mechanism that establishes equilibrium through the ability of prices to rise or fall.

82

Quiz that all of you love

1. If the demand curve for good X is downwardsloping, this means that an increase in the price will result in a. an increase in the demand for good X. b. a decrease in the demand for good X. c. no change in the quantity demanded for good X. d. a larger quantity demanded for good X. e. a smaller quantity demanded for good X.

Answer 1

E. When price changes there is a opposite change in the quantity demanded as measured on the horizontal axis.

2. The law of demand states that the quantity demanded of a good changes, other things being equal, when a. the price of the good changes. b. consumer income changes. c. the prices of other goods change. d. a change occurs in the quantities of other goods purchased.

Answer 2

A. A “change in demand” means that the whole curve shifts, but a “change in the quantity demanded” means that there is movement along a stationary curve.

3. Which of the following is the result of a decrease in the price of tea, other things being equal? a. A leftward shift in the demand curve for tea. b. A downward movement along the demand curve for tea. c. A rightward shift in the demand curve for tea. d. An upward movement along the demand curve for tea.

Answer 3

B. Because demand curves have a negative slope, as the price declines, the quantity demanded will increase.

4. Which of the following will cause a movement along the demand curve for X? a. A change in the price of a close substitute. b. A change in the price of good X. c. A change in consumer tastes and preferences for good X. d. A change in consumer income.

Answer 4 B. Movement along a given demand curve always occurs when the price changes, if anything other than price changes, then the whole curve will shift.

5. Assuming that beef and chicken are substitutes, a decrease in the price of chicken will cause the demand curve for beef to a. shift to the left as consumers switch from chicken to beef. b. shift to the right as consumers switch from chicken to beef. c. remain unchanged, since beef and chicken are sold in separate markets. d. none of the above.

Answer 5

A. With a decrease in the price of chicken people will want to buy more chicken; because beef and chicken are substitutes, they will buy less beef.

6. Assuming that coffee and tea are substitutes, a decrease in the price of coffee, other things being equal, results in a (an) a. downward movement along the demand curve for tea. b. leftward shift in the demand curve for tea. c. upward movement along the demand curve for tea. d. rightward shift in the demand curve for tea.

Answer 6

B. With a decrease in the price of coffee people will want to buy more coffee; because coffee and tea are substitutes, they will buy less at possible prices for tea.

7. Assuming steak and potatoes are complements, a decrease in the price of steak will a. decrease the demand for steak. b. increase the demand for steak. c. increase the demand for potatoes. d. decrease the demand for potatoes.

Answer 7

C. With a decrease in the price of steak people will want to buy more steak; because steak and potatoes are complements, they will buy more potatoes as well.

8. Assuming that steak is a normal good, a decrease in consumer income, other things being equal, will a. cause a downward movement along the demand curve for steak. b. shift the demand curve for steak to the left. c. cause an upward movement along the demand curve for steak. d. shift the demand curve for steak to the right.

Answer 8

B. Normal goods are goods that people will buy more of as their incomes increase and less of as their income decreases.

9. An increase in consumer income, other things being equal, will a. shift the supply curve for a normal good to the right. b. cause an upward movement along the demand curve for an inferior good. c. shift the demand curve for an inferior good to the left. d. cause a downward movement along the supply curve for a normal good.

Answer 9

C. Inferior goods are goods that people will buy less of at possible prices as their income increases.

10. Yesterday, seller A supplied 400 units of a good X at Rs10 per unit. Today, seller A supplies the same quantity of units at Rs5 per unit. Based on this evidence, seller A has experienced a (an) a. decrease in supply. b. increase in supply. c. increase in the quantity supplied. d. decrease in the quantity supplied. e. increase in demand.

Answer 10

B. A shift to the right of a supply curve along a stationary demand curve will result in a lower price as illustrated on the next page.

Rs20 Rs15 Rs10

P

When the ceteris paribus assumption is relaxed, the whole curve can shift

S1

S2

Rs5

10

20

30

40

Q

11. An improvement technology causes a (an) a. leftward shift of the supply curve. b. upward movement along the supply curve. c. firm to supply a larger quantity at any given price. d. downward movement along the supply curve.

Answer 11
C. When price changes, the supply curve itself does not change, but when other things change, the whole curve will shift. A change in technology is an example of what can cause the supply curve to shift.

12. Suppose auto workers receive a substantial wage increase. Other things being equal, the price of autos will rise because of a (an) a. increase in the demand for autos. b. rightward shift of the supply curve for autos. c. leftward shift of the supply curve for autos. d. reduction in the demand for autos.

Answer 12
C. A change in costs for a business is a factor that will shift the supply curve. If costs go up, as in the case of having to pay higher wages, the supplier has less of an ability to supply cars.

13. Assuming that soybeans and tobacco can both be grown on the same land, an increase in the price of tobacco, other things being equal, causes a (an) a. upward movement along the supply curve for soybeans. b. downward movement along the supply curve for soybeans. c. rightward shift in the supply for soybeans. d. leftward shift in the supply for soybeans.

Answer 13
D. With an increase in the price of tobacco farmers will want to grow more tobacco to take advantage of the higher price. Farmers will therefore plant soybeans on land they used to use for tobacco.

14. If Qd = quantity demanded and Qs = quantity supplied at a given price, a shortage in the market results when a. Qd is greater than Qs. b. Qs equals Qd. c. Qs is less than or equal to Qd. d. Qs is greater than or equal to Qd.

Answer 14
A. When there are more units of something being demanded than being supplied, a shortage will result.

15. Assume that the equilibrium price for a good is Rs10. If the market price is Rs5, a a. shortage will cause the price to remain at Rs5. b. surplus will cause the price to remain at Rs5. c. shortage will cause the price to rise toward Rs10. d. surplus will cause the price to rise toward Rs10.

Answer 15
C. When the price of a good is below the market price, there are less units being supplied than being demanded. The result is a shortage and consumers will bid the price up toward the equilibrium price.

P
Rs2.00 Rs1.50 Rs1.00

Supply & Demand Exhibit

S D
100 200 300 400

Rs.50

Q

16. In the market shown in the previous graph, the equilibrium price and quantity of good X are
Previous graph

a. Rs0.50, 200. b. Rs1.50, 300 c. Rs2.00, 100 d. Rs1.00, 200

Answer 16
D. The equilibrium price and equilibrium quantity are at the point where the quantity demanded equals the quantity supplied. This is the price toward which the economy tends.

17. In the previous graph, at a price of Rs2.00, the market for good X will experience a a. shortage of 150 units. b. surplus of 100 units. Previous graph c. shortage of 100 units. d. surplus of 200 units.

Answer 17
D. At a price of Rs2.00 the quantity demanded is 100 and the quantity supplied is 300; 300 units minus 100 equals 200 units.

18. In the previous graph, if the price of good X moves from Rs1.00 to Rs2.00, the new market condition will put Previous graph a. upward pressure on price. b. no pressure on price to change. c. downward pressure on price. d. upward pressure on price.

Answer 18
C. Anytime the price is above the equilibrium price a surplus will result. Suppliers will therefore lower price to get rid of the surplus.

END

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