Chapter 3

Supply and Demand

Can supply and demand be affected by a change
in price?

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 Learning Objectives: Understand

1.How the demand curve summarizes the behavior of buyers in the marketplace

2.Individual vs market demand curves

3.Determinants of demand

4.How the supply curve summarizes the behavior of sellers in the marketplace

5.Individual vs market supply curves

6.Determinants of Supply

7.How the supply and demand curves interact to determine the equilibrium price and
quantity.

8.How shifts in supply and demand curves cause prices and quantities to change.
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 Supply and Demand

 Supply and demand are the forces that make

market economies work. They determine
the quantity of each good produced and the
price at which it is sold.

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 Demand

 Demand is a relationship, not a number.

 Demand is the relationship between the

price of a good and the quantity demanded
of that good.

 Quantity demanded is the amount of a good

that buyers are willing and able to purchase.

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 The Law of Demand

 The law of demand states that, other things

equal, there is an inverse or negative
relationship between price and quantity
demanded.
 For buyers, price represents how the good is
valued.

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 Demand

$4

$2
D
Q
8 16

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 Demand Slopes Downward

 Substitution Effect
 As pizza becomes more expensive, a consumer
may switch to other foods that substitute for
pizza
 Income Effect
 A higherprice lowers the purchasing power of a
consumer, resulting in reduced consumption
 Diminishing marginal utility
 Additional units consumed derived less
satisfaction
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 Catherine’s Demand Schedule
and Demand Curve

 The demand curve, which graphs the

demand schedule, shows how the quantity
demanded of the good changes as price
varies.

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Catherine’s Demand Schedule
PRICE OF ICE-CREAM CONE QUANTITY OF CONES DEMANDED

$0.00 12

0.50 10

1.00 8

1.50 6

2.00 4

2.50 2

3.00 0

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Catherine’s demand curve
Price of
Ice-Cream
Cone

$3.00

2.50

2.00

1.50

1.00

0.50

0 1 2 3 4 5 6 7 8 9 10 11 12 Quantity of
Ice-Cream Cones

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Individual and Market Demand Schedules

PRICE OF ICE-CREAM CONE CATHERINE NICHOLAS MARKET

$0.00 12 + 7 = 19

0.50 10 6 16

1.00 8 5 13

1.50 6 4 10

2.00 4 3 7

2.50 2 2 4

3.00 0 1 1

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 Individual demands

Catherine's Demand + Nichola's Demand

Price of Price of
Ice-Cream Ice-Cream
Cone Cone

$3.00 $3.00

2.50 2.50

2.00 2.00

1.50 1.50

1.00 1.00

0.50 0.50

0 1 2 3 4 5 6 7 8 9 10 11 12 0 1 2 3 4 5 6 7 8 9 10 11 12 Quantity of
Quantity of
Ice-Cream Cones Ice-Cream Cones

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 Market Demand as the Sum of
Individual Demands
= Market Demand
Price of
Ice-Cream
Cone

$3.00

2.50

2.00

1.50

1.00

0.50

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 Quantity of
(=4 + 3) Ice-Cream Cones

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 Determinants of Demand

 Anything that shifts the demand curve is a

determinant of demand.

 The price of the good is not a determinant

of demand.

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We will discuss 5 determinants of demand:

 1.- Income

 2.- Price of related goods

 3.- Taste and preferences

 4.- Expectations

 5. Number of buyers
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 Income

 Other things equal, what happens to demand

if income increases? If income falls?

 To answer this question we need to distinguish

between normal and inferior goods...

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 Normal Goods

 A good for which, other things equal, an

increase in income leads to an increase in
it’s demand.

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 Inferior Goods

 A good for which, other things equal, an

increase in income leads to a decrease in it’s
demand.

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 Price of Related Goods

 The price of a related good is a determinant

of demand.
 How prices of related goods affect demand
depends on whether the goods are
substitutes or complements.

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 Substitutes

 Substitutes are goods that compete with

each other.

 Two goods are substitutes if, other things

equal, an increase in the price of one them,
leads to an increase in the demand for the
other.
 What else? 3 more different scenarios
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 Substitutes
COKE PEPSI

P P

5 5

D2
D
D1

0 0.5 1 0 1 1.5
Q Q

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 Complements

 Complements are goods that are jointly

consumed.
 Two goods are complements if, other things
equal, an increase in the price of one them,
leads to a decrease in the demand for the
other.
 What else? 3 more different scenarios

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 Complements

COFFEE CREAM

P P

1 0.5

D1
D
D2

0 0.5 1 0 0.5 1
Q Q

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 Taste and Preferences

 Taste and preferences are non-economics

determinants of demand. Other things
equal, if you like or prefer something you
will buy more of it. The opposite is true.

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 Expectations

 Expectations about future prices affect

your demand today. If you expect the
price of sugar to increase, other things
equal, you may buy more of it today.
 The demand curve is affected when a
change in expectation takes place.

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 Number of Buyers

 As the number of buyers increases, other

things equal, demand increases. The
opposite is true.

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 A Shift in Demand

 When demand increases, it shifts to the right.

 When demand decreases, it shifts to the left.

 An increase in demand means we are willing and

able to buy more at any given price.

 A decrease in demand means we are willing and

able to buy less at any given price.

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 Shift in Demand

D2

D1

D3
0 3 5 7
Q

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 Shift in the Demand Curve
Price of (A) a Shift in the Demand Curve
Cigarettes,
per Pack
A policy to discourage smoking
shifts the demand curve to the left.

$2.00 B A

D1

D2

0 10 20
Number of Cigarettes
Smoked per Day.
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Movement Along the Demand Curve
Price of
Cigarettes,
per Pack
A tax that raises the price of
cigarettes results in a movement
along the demand curve.
C
$4.00

$2.00 A

D1

0 10 20
Number of Cigarettes
Smoked per Day.

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 Supply

 Supply is a relationship, not a number.

 Supply is the relationship between the price

of a good and the quantity supplied.

 Quantity supplied is the amount of a good

that sellers are willing and able to sell.

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 The Law of Supply

 The law of supply states that, other things

equal, there is a direct or positive
relationship between price and quantity
supplied.
 For suppliers, in competitive markets, price
represent their cost.

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Interpreting the Supply Curve

P
S
$4

$2

Q
8 16

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 Supply Slopes Upward

 Because of increasing marginal cost.

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Ben’s Supply Schedule and Supply
Curve

 The supply curve, which graph the supply

schedule, shows how the quantity supplied
of the good changes as price varies.

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 Ben’s Supply Schedule
PRICE OF ICE-CREAM CONE QUANTITY OF CONES SUPPLIED

$0.00 0

0.50 0

1,00 1

1,50 2

2,00 3

2,50 4

3,00 5

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 Ben’s Supply Curve
Ben's Supply Curve
Price of
Ice-Cream
Cone

$3.00

2.50

2.00

1.50

1.00

0.50

0 1 2 3 4 5 6 7 8 9 10 11 12
Quantity of
Ice-Cream Cones

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Individual and Market Supply Schedules

PRICE OF ICE-CREAM
CONE BEN JERRY MARKET

+ =

$0.00 0 0 0

0.50 0 0 0

1,00 1 0 1

1,50 2 2 4

2,00 3 4 7

2,50 4 6 10

3,00 5 8 13

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Market Supply as the Sum of
Individual Supplies
Price of
Ice cream
Ben's Supply Curve + Price of Jerry's Supply Curve
cone Ice cream
cone
$3.00 $3.00

2.50 2.50

2.00 2.00

1.50 1.50

1.00 1.00

0.50 0.50

0 1 2 3 4 5 6 7 8 9 10 11 12 0 1 2 3 4 5 6 7 8 9 10 11 12
Quantity of Quantity of
Ice-Cream Cones Ice-Cream Cones

= Price of
Market Supply
Ice-Cream
Cone

$3.00

2.50

2.00

1.50

1.00

0.50

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 Quantity of
(=3 + 4 ) Ice-Cream Cones

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 Determinants of Supply

 Anything that shifts the supply curve is a

determinant of supply.

 The price of the good is not a determinant

of supply.

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 We will discuss 4 determinants of supply:

 1.- Input prices

 2.- Technology

 3.- Expectations

 4.- Number of sellers

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 Input Prices

 Supply of a good is negatively related to the

price of the inputs used to make the good.

 Thus, other things equal, if input prices fall,

supply increases. The opposite is true.

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 Technology

 Advance technology reduces firm’s costs

and allows speedy production. Better
technology allows production to increase as
workers produce more per a given period.
Other things equal, supply increases.

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 Expectations

 Expectations about future prices affect

supply today. If you expect price to
increase, you may sell less today and store
some for the future. Other things equal,
supply decreases.

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 Number of Sellers

 As more sellers enter the market, more

goods are offered. Other things equal, the
supply curve increases. Internet sales have
increase supply of many goods and
services.

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 A Shift in Supply
 When supply increases, it shifts to the right.

 When supply decreases, it shifts to the left.

 An increase in supply means sellers are willing and able to

supply more at any give price.

 A decrease in supply means sellers are willing and able to

supply less at any given price.

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 Changes in Supply
 Supply increases when sellers  Supply decreases when sellers
are willing to offer more for sale are willing to offer less for sale
at each possible price at each possible price
 Moves the entire supply  Moves the entire supply
curve to the right curve to the left

Supply of Pizzas Supply of Tuna

P P
S S*
S'
S
$2
$2

8 9 Q 8 9 Q

(000s of slices/day) (000s of cans/day)

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 Market Equilibrium

Quantity supplied equals
quantity demanded AND
P

Price is on supply and
S
demand curves

No tendency to change P
or Q $3
 Buyers are on their
D
demand curve Q
 Sellers are on their
12

supply curve

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 Excess Supply and Excess Demand

Excess Supply Excess Demand

 At $4, 16 units are supplied and 8  At $2, 8 units are supplied and
units are demanded 16 units are demanded

P P
Surplus
S S

$4
Shortage
$2
D D
Q Q
8 16 8 16

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 Analyzing Changes in
Equilibrium

 Change in demand.

 Change in supply.

 Change in both demand and supply.

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 Change in Demand

 A change in demand can be caused by any of the

five determinants discussed before.
 A hot summer affect our preferences. Other things
equal, we may buy more ice cream, shifting the
demand curve to………...
 Higher income also affects demand. Suppose
income goes up, other things equal, what has to be
true about ice cream in order for demand to
increase?

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 Change in Supply

 A change in supply can be caused by any of the

four determinants discussed before.

 Other things equal, increasing the price of milk, an

important input for making ice-cream, shifts the
supply to……….

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 How a Decrease in Supply
Affects Equilibrium
Price of
Ice-Cream s2 1.An earthquake reduces
Cone
the supply of ice cream

s1

$2.50 New
equilibrium

2.00 Initial equilibrium

2. ...resulting in
a higher price...

Demand

0 4 7
Quantity of
3. ... and a lower Ice-Cream Cones
quantity sold.

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 A Change in Both
Supply and Demand

 Assume that income goes up and leather

bags are normal goods. If at the same time
the price of leather (an important input in
the production of leather bags) increases,
what happens to equilibrium price and
equilibrium quantity assuming everything
else remains the same?

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 PANEL A
A Shift in Both Supply and Demand
(a) Price Rises, Quantity Rises
Price of
Ice-Cream
Cone
Large
increase in
demand
New
equilibrium s2

s1

P2

Small
decrease in
supply

P1 D2

Inital equilibrium

D1

0 Q1 Q2
Quantity of
Ice-Cream Cones

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 PANEL B
A Shift in Both Supply and Demand
(b) Price Rises, Quantity Falls
Price of
Ice-Cream
Cone
s2
Large
increase in
demand s1

P2 New equilibrium
Large
decrease in
supply

P1

Inital equilibrium

D2
D1

0 Q2 Q1 Quantity of
Ice-Cream Cones

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An Alternative to do the Same Analysis

P (a) (b)
P S1

S S

P1 P1

P* P*

D’
D
D

0 Q* Q1 Q 0 Q1 Q* Q

P Q P Q

Price increases in both cases but quantity is undetermined

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