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Chapter 3

Supply and
Demand
Chapter Outline

Market demand
Market supply
Market equilibrium
Comparative statics analysis
Supply, demand, and price

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Learning Objectives

Define supply, demand, and equilibrium price


List and provide specific examples of the non-price
determinants of supply and demand
Distinguish between the short-run rationing function
and long-run guiding function of price
Illustrate how the concepts of supply and demand
can be used in management decisions about price
and allocations of resources.
Use supply and demand diagrams to determine
price in the short and long run

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Market Demand

The demand for a good or service is defined


as:
Quantities of a good or service that people are
ready, willing and able to buy at various prices
within some given time period. (Other factors
besides price held constant.)

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Market Demand

Ready implies that consumers are


prepared to buy a good or service both
because they are:

Willing: Consumers have a preference for it.

Able: Consumers have the income to support this


preference.

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Market Demand

Market demand is the sum of all the individual


demands.
Individuals may have distinct demand curves,
and they sum to the overall demand in the
market.
Example: demand for pizza

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Market Demand

There is an inverse
relationship between
price and the quantity
demanded of a good or
service.

This is called the Law


of Demand.

Thus, the demand


curve is downward
sloping.

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Market Demand

Graphical
Representation of
Demand

Algebraic
Representation of
Demand
Qd=700-100P

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Market Demand

Changes in price result in changes in the


quantity demanded

This is shown as movement along the demand


curve.

Changes in non-price factors result in


changes in demand

This is shown as a shift in the demand curve.

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Market Demand

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Market Demand

Non-price determinants of demand-result is


a shift in the demand curve.

tastes and preferences


income
prices of related products
future expectations
number of buyers

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Market Supply

The supply of a good or service is defined as


quantities that people are ready to sell at
various prices within some given time period

(Other factors besides price held constant)

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Market Supply

Changes in price result in changes in the


quantity supplied

shown as movement along the supply curve

Changes in non-price determinants result in


changes in supply

shown as a shift in the supply curve

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Market Supply

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Market Supply

Non-price determinants of supply-results in


a shift in the supply curve.

costs and technology


prices of other goods or services offered by the
seller
future expectations
number of sellers
weather conditions

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Market Equilibrium

Equilibrium price: the price that equates


the quantity demanded with the quantity
supplied

Equilibrium quantity: the amount that


people are willing to buy and sellers are
willing to offer at the equilibrium price level

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Market Equilibrium

Shortage: a market situation in which the


quantity demanded exceeds the quantity
supplied
shortage occurs at a price below the equilibrium
level

Surplus: a market situation in which the


quantity supplied exceeds the quantity
demanded
surplus occurs at a price above the equilibrium
level

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Market Equilibrium

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Comparative Statics Analysis

Step 1
assume all factors
except the price of
pizza are constant

buyers demand and


sellers supply are
represented by lines
shown

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Comparative Statics Analysis

Step 2
begin the analysis
in equilibrium as
shown by Q1 and P1

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Comparative Statics Analysis

Step 3
assume that a new
study shows pizza
to be the most
nutritious of all fast
foods

consumers increase
their demand for
pizza as a result

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Comparative Statics Analysis

Step 4
the shift in demand
results in a new
equilibrium price
(P2)

and a new
equilibrium quantity
(Q2)

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Comparative Statics Analysis

Step 5
comparing the
new equilibrium
point with the
original one, we
see that both
equilibrium price
and quantity have
increased

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Comparative Statics Analysis

The short run is the period of time in


which:

sellers already in the market respond to a change


in equilibrium price by adjusting variable inputs

buyers already in the market respond to changes


in equilibrium price by adjusting the quantity
demanded for the good or service

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Comparative Static Analysis:
Short-run
an increase in
demand causes
equilibrium price and
quantity to rise

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Comparative Static Analysis:
Short-run
a decrease in demand
causes equilibrium
price and quantity to
fall

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Comparative Static Analysis:
Short-run
an increase in
supply causes
equilibrium price
to fall and
equilibrium
quantity to rise

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Comparative Static Analysis:
Short-run
a decrease in
supply causes
equilibrium price
to rise and
equilibrium
quantity to fall

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Comparative Static Analysis:
Long-run

The long run is the period of time in which:


new sellers may enter a market
existing sellers may exit from a market
existing sellers may adjust fixed factors of
production
buyers may react to a change in equilibrium price
by changing their tastes and preferences

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Comparative Static Analysis:
Long-run

Long run changes show the allocating


function of price

The guiding or allocating function of


price is the movement of resources into or
out of markets in response to a change in
the equilibrium price.

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Comparative Static Analysis:
Long-run
initial change: decrease in
demand from D1 to D2
result: reduction in
equilibrium price and
quantity (to P2, Q2)
follow-on adjustment:
movement of resources out
of the market
leftward shift in the supply
curve to S2
equilibrium price and
quantity (to P3, Q3)

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Long-run Analysis

initial change: increase in


demand from D1 to D2
result: increase in
equilibrium price and
quantity (to P2, Q2)
follow-on adjustment:
movement of resources
into the market
rightward shift in the
supply curve to S2
equilibrium price and
quantity (to P3, Q3)

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Summary: Short-Run and Long-Run
Changes in the Market

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Supply, Demand, and Price

In the extreme case, the forces of supply


and demand are the sole determinants of
the market price, not any single firm.
this type of market is perfect competition

In many cases, individual firms can exert


market power over price because of their:
dominant size
ability to differentiate their product through
advertising, brand name, features, or services

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