University of Khartoum

M.Sc. in Health Economics PROGRAM

Microeconomics
Lecture ()

Theory of Supply and Demand

Prepared by : Dr. Mohammed Elhaj

1
 REVISION
 Market (who, what, how)
 Supply and demand is an economic model
– Designed to explain how prices are
determined in certain types of markets
 What you will learn in this part of the course
– How the model of supply and demand works
and how to use it
1. The law of demand
2. The law of supply
3. The determination of market equilibrium
4. Factors shifting demand or supply curves

2 2
 Markets
 In economics, a market is not a place but
rather a group of buyers and sellers with
the potential to trade with each other
– Market is defined not by its location but by its
participants
– First step in an economic analysis is to define
and characterize the market or collection of
markets to analyze
 Economists think of the economy as a
collection of individual markets

3 3
How Broadly Should We Define The Market
 Defining the market often requires
economists to group things together
– Aggregation is the combining of a group of
distinct things into a single whole
 Markets can be defined broadly or narrowly,
depending on our purpose
– How broadly or narrowly markets are defined is
one of the most important differences between
Macroeconomics and Microeconomics

4 4
Defining Macroeconomic Markets
 Goods and services are aggregated to
the highest levels
– Macro models lump all consumer goods
into the single category “consumption
goods”
– Macro models will also analyze all capital
goods as one market
– Macroeconomists take an overall view of
the economy without getting bogged down
in details
5 5
Defining Microeconomic Markets
 Markets are defined narrowly
– Focus on models that define much more
specific commodities
 Always involves some aggregation
– But not reach the highest level of generality
that macroeconomics investigates

6 6
Buyers and Sellers
 Buyers and sellers in a market can be
– Households
– Business firms
– Government agencies
» All three can be both buyers and sellers in the same
market, but are not always
 For purposes of simplification this text will
usually follow these guidelines
– In markets for consumer goods, we’ll view business
firms as the only sellers, and households as only
buyers

7 7
Using Supply and Demand
 Supply and demand model is designed to
explain how prices are determined in
perfectly competitive markets
– Perfect competition is rare but many markets
come reasonably close
– Perfect competition is a matter of degree
rather than an all or nothing characteristic

 Supply and demand is one of the most

flexible and widely used models in the
economist’s tool kit

8 8
 Meanings and Definition of Demand
The word 'demand' is so common and familiar with every one of
us that it seems superfluous to define it.
The need for precise definition arises simply because it is
sometimes confused with other words such as desire, wish, want,
etc.
 Demand in economics means a desire to possess a
good or a service supported by willingness and ability to
pay for it.
If your have a desire to buy a certain commodity, say a car, but
you do not have the adequate means to pay for it, it will simply be
a wish, a desire or a want and not demand.
Demand is an effective desire, i.e., a desire which is backed by
willingness and ability to pay for a commodity in order to obtain
it. In the words of Prof. Hibdon:
 "Demand means the various quantities of goods that would be
purchased per time period at different prices in a given market". 9
Characteristics of Demand:

There are thus three main characteristic's of demand in

economics.
(i) Willingness and ability to pay. Demand is the amount
of a commodity for which a consumer has the willingness
and also the ability to pay.
(ii) Demand is always at a price. If we talk about demand
without reference to a price, it will be meaningless. The
consumer must know both the price and the commodity.
(iii) Demand is always per unit of time. The time may be a
day, a week, a month, or a year.

10
 The Law of Demand
 In economics, the law of demand states that, all else being
equal, as the price of a product increases (↑), quantity
demanded falls (↓); likewise, as the price of a product
decreases (↓), quantity demanded increases (↑).
 The law of demand says that the higher the price, the lower
the quantity demanded, because consumers’ opportunity cost
to acquire that good or service increases, and they must
make more tradeoffs to acquire the more expensive product.

11 11
 Ceteris Paribus
Ceteris paribus is a Latin phrase that
means all variables other than the
ones being studied are assumed to be
constant. Literally, ceteris paribus
means “other things being equal.”

The demand curve slopes downward because, ceteris paribus, lower

prices imply a greater quantity demanded!

 Assumptions of the law of Demand
• According to Prof. Stigler and Boulding There are
three main assumptions of the Law:
 There should not be any change in the tastes of the
consumers for goods .
 The purchasing power of the typical consumer must
remain constant .
 The price of all other commodities should not vary .
 Price
The law of demand
Quantity demanded
16
17
 Individual's Demand Curve
• Demand curve is a graphic representation  of  the demand
schedule.
• According to Lipsey:
"The curve, which shows the relation between the price
of a commodity and the amount of that commodity the
consumer wishes to purchase is called demand curve".
• It is a graphical representation of the demand schedule.
19
 Limitations/Exceptions of Law of Demand
Though as a rule when the prices of normal goods rise, the demand
them decreases but there may be a few cases where the law may not

 Prestige goods: There are certain commodities like diamond,

operate.
sports cars etc., which are purchased as a mark of distinction

in society. If the prices of these goods rise, the demand for

them may increase instead of falling. 

Price expectations: If people expect a further rise in the price of

particular commodity, they may buy more in spite of rise in price. The

violation of the law in this case is only temporary.

 Ignorance of the consumer: If the consumer is ignorant about the rise

in price of goods, he may buy more at a higher price.

Giffen goods: If the prices of basic goods, (potatoes, sugar, etc) on which the poor
spend a large part of their incomes declines, the poor increase the demand for

superior goods, hence when the price of Giffen good falls, its demand also falls.

There is a positive price effect in case of Giffen goods.

 Market Demand Schedule (Table)
• The horizontal summation of individuals demand for a commodity
will be the market demand for a commodity as is illustrated in the
following schedule:

• In the above schedule, the amount of commodity demanded by four buyers

(which we assume constitute the entire market) differs for each price. When the
price of a commodity is $10, the total quantity demanded is 4C thousand units
per week. At price of $2, the total quantity demanded increases to 180
thousand units.              
 Market Demand Curve

Market demand curve for a Commodity is the horizontal summation of individual

demand curves of all the buyers in a market. This is illustrated with the help of the

market
The demand
market schedule
demand given DD/
curve above.
for a

commodity, like the individual demand

curve is negatively sloped, (see figure 4.2).

It shows that under the assumptions

(ceteris paribus) other things remaining the

same, there is an inverse relationship

between the quantity demanded and its

price.

At price of $10, the quantity demanded in

the market is 40 thousand units. At price of

$2.0 it increases to 180 thousand units. In.

 Demand Function
 The demand function for good X can be
expressed as follows :
XD = f(PX, Ps, Pc, I, T&P, Pop, W)
Where:
XD = quantity demanded
PX = X’s price
Ps = the price of substitutes
Pc = the price of complements
I=income
T&P=tastes and preferences
Pop=population in market or market size
W = Wealth 23
Summary: Variables That Influence Buyers
Variable A change in this variable…
Price …causes a movement

along the D curve

# of buyers …shifts the D curve

Income …shifts the D curve

Price of

related goods …shifts the D curve

Tastes …shifts the D curve

TH

Expectations …shifts the D curve MA

RK

ET
Population …shifts the D curve FO

RC
24
24
EPL
25
Movements Along and Shifts of The
Demand Curve
Price

Price increase moves us leftward along

demand curve

P
2
Price decrease moves us rightward along
demand curve

P
1

P
3

Q Q Q Quantity
2 1 3

26 26
The Shifts of The Demand Curve
Price
Entire demand curve shifts
rightward when:

• income or wealth ↑

• price of substitute ↑

• price of complement ↓

• population ↑

• expected price ↑

• tastes shift toward good

D
2
D
1

Quantity

27 27
The Shifts of The Demand Curve
Price
Entire demand curve shifts
leftward when:

• income or wealth ↓

• price of substitute ↓

• price of complement ↑

• population ↓

• expected price ↓

• tastes shift toward good

D
1
D
2

Quantity

28 28
29
Shift of Demand Versus Movement Along a Demand Curve

• A change in demand is not the same

as a change in quantity demanded.

• In this example, a higher price causes

lower quantity demanded.

• Changes in determinants of demand,

other than price, cause a change in

demand, or a shift of the entire

demand curve, from D to D .

A B

30
A Change in Demand Versus a Change in Quantity
Demanded

• When demand shifts to the right,

demand increases. This causes

quantity demanded to be greater than

it was prior to the shift, for each and

every price level.

31
Example “The Impact of a Change in Income

• Higher income decreases the • Higher income increases the

demand for an inferior good demand for a normal good

32
Example 2 : The Impact of a Change in the Price of
Related Goods

• Demand for complement good (ketchup) shifts left

• Demand for substitute good (chicken) shifts right

• Price of hamburger rises

• Quantity of hamburger demanded falls

33
The Demand Curve (Equation)
XD = 40 - P 15 = 40 - 25
 Mathematically, the
demand curve is an
equation that shows a P
D

negative relation
between price (P) and
quantity (X) for all 25

positive prices and

quantities.
 Beware of the equation
and the graph of
demand.
15 Q

34
 Demand equation
 Question 1: Suppose that the total market demand for a product
comprises the demand of three individuals with identical demand
equations.

Solution. The market demand curve is the horizontal summation of the

individual demand curves. The market demand equation is

35
The diagrammatic solution to problem in previous slide
Suppose that the total market demand for a product consists of the demands of individual 1 and individual 2. The demand equations of the two individuals are

given by the following equations:

 Supply
 A firm’s quantity supplied of a good is the
specific amount its managers would choose
to sell over some time period, given
– A particular price for the good
– All other constraints on the firm
 Market quantity supplied (or quantity
supplied) is the specific amount of a good
that all sellers in the market would choose to
sell over some time period, given
– A particular price for the good
– All other constraints on firms

38 38
39
40
The Law of Supply
 States that when the price of a good rises
and everything else remains the same, the
quantity of the good supplied will rise
– The words, “everything else remains the same”
are important
» In the real world many variables change
simultaneously
» However, in order to understand the economy we
must first understand each variable separately
» We assume “everything else remains the same” in
order to understand how supply reacts to price

41 41
42
43
 Price increases; QS increases
Direct
Price decreases; QS decreases
.

“S” refers to the “whole supply curve” and refers to what

producers will supply at “different prices”.

“QS” refers to a “point on the curve” and refers to what

producers will supply at a “particular price”.

P2 Change in “QS”
More of you would

supply your labor 1. Price change

for $12 than if labor 2. Movement
were getting just $6
(up/down “S” curve)
an hour.
P1 3. Point to point

(along “S” curve)

Producers want the

highest price possible.

QS1 QS2

Reasons For Upsloping “S” Curve

1. There is increasing opportunity cost if you don’t produce.

2. Current producers produce more [overtime/more shifts]

3. New producers are attracted to the market. 44

51
52
53
54
55
56
57
58
 Supply Function
 The supply function for good X can be
shown as follow:
XS = g(PX, Pfop, Poc, S&T, N)

Where:
XS = quantity supplied
PX = X’s price
Pfop = prices of factors of production
Poc = opportunity costs (alternatives in productions)
S&T = science and technology
N = number of firms in the market
59
Movements vs. Shifts
 A movement along the supply curve for
X would be caused by a change in Px.
 A shift of the entire supply curve would
be caused by a change in one of the
“ceteris paribus” supply variables.
– This would be referred to as an increase or
decrease in supply.

60
Change in the Quantity
Supplied
 A change in the
quantity supplied Price

is a movement Supply

along the supply

curve. 25

 At price = 10, the quantity

supplied = 16.

10

16 31 Quantity

61
Increase in Supply
 When supply Supply Curve
Original Increased
increases, the Price Supply Supply
quantity 0 6 11
supplied is 5 11 16
greater at every 10 16 21
15 21 26
price.
20 26 31
25 31 36
30 36 41
35 41 46
40 46 51

62
Increase in Supply
 An increase in
supply is a Price

rightward shift in Supply

the entire curve.

 More is supplied 25

at every price
 At price = 25, the quantity

supplied = 36 after the

increase.
New Supply

31 36 Quantity

63
Decrease in Supply
 When supply Supply Curve
Original Decreased
decreases, the Price Supply Supply
quantity 0 6
supplied is lower 5 11 1
at every price. 10 16 6
15 21 11
20 26 16
25 31 21
30 36 26
35 41 31
40 46 36

64
Decrease in Supply
 A decrease in
supply is a Price

leftward shift in New Supply Supply

the entire curve.

 Less is supplied 25

at every price
 At price = 25, the
quantity supplied
= 21 after the
decrease.
21 31 Quantity

65
 A Change in Supply Versus
a Change in Quantity Supplied

• A change in supply is not the same

as a change in quantity supplied.

• In this example, a higher price

causes higher quantity supplied,

and a move along the demand

curve.

• In this example, changes in determinants of supply, other than price, cause an increase

in supply, or a shift of the entire supply curve, from S to S .

A B

66
 A Change in Supply Versus
a Change in Quantity Supplied

To summarize:

Change in price of a good or service

leads to

Change in quantity supplied

(Movement along the curve).

Change in costs, input prices, technology, or prices of related goods and services

leads to

Change in supply

(Shift of curve).

67
The Supply Curve (Equation)
 Mathematically, the XS = 6 + P 31 = 6 + 25
supply curve is an S

equation that shows a P

positive relation
between price (P) and 25

quantity (X) for all

positive prices and
quantities.
 Beware of the equation
and the graph of supply.
31 Q

68
Changes in Supply and in Quantity
Supplied
Price increase moves
Price S
us rightward along
supply curve

P
2

P
1 Price decrease moves us
leftward along supply curve
P
3

Q Q Q Quantity
3 1 2

69 69
Individual Supply Can Increase or Decrease
Change in Supply [shift in supply curve]

1. Increase in resource cost

2. Alt. output price increase

3. Technological decrease
P
4.6Decrease in # of suppliers

5. Producer exp. of price increase

S
Individual 3
6. Decrease in subsidies S
7.5Increase in taxes
1
Supply S
2
P Q
s

Price (per bushel)

4

$5 60

3
4 50

2
3 35

2 20 1
1. Decrease in resource cost

2. Alt. output price decrease

1 5 3. Technological change
0
2 4. Increase
4 6 in # of
8 suppliers
10 12 14 Q
Quantity Supplied
5. Producer exp. (bushels per week)
of price decrease

6. Increase in subsidies

7. Decrease in taxes
Figure 6(b): Changes in Supply
and in Quantity Supplied
Price
Entire supply curve shifts S
1
S
rightward when: 2

• price of input ↓

• price of alternate good ↓

• number of firms ↑

• expected price ↑

• technological advance

• favorable weather

Quantity
71 71
Figure 6(c): Changes in Supply
and in Quantity Supplied
Price
Entire supply curve shifts S
2
rightward when: S
1

• price of input ↑

• price of alternate good ↑

• number of firms ↓

• expected price ↑

• unfavorable weather

Quantity
72 72
Market Equilibrium (Verbal)
 The equilibrium price and quantity in a
market occur at the price where the
quantity demanded equals the
quantity supplied.
 Example: for the demand and supply
curves used above, the equilibrium
price is 17, where the quantity
demanded, 23, equals the quantity
supplied, 23.
74
Market Equilibrium (Table)
 At a price of 17, Market Equilibrium
Quantity Quantity
the quantity Price Demanded Supplied
demanded is 0 40 6
equal to the 5 35 11
quantity 10 30 16
15 25 21
supplied, as the
17 23 23
table to the right 20 20 26
illustrates. 25 15 31
30 10 36
35 5 41
40 0 46

75
Market Equilibrium (Graph)
 The market
equilibrium Price
Demand

occurs at the Supply

intersection of
the supply and
demand curves.
 At price = 17, the 17

quantity supplied
= quantity
demanded = 23.

23 Quantity

76
Market Equilibrium (Equations)
 The equilibrium price and quantity satisfy
both the demand and supply equations
simultaneously.
 To find P*, set XD = XS .
– Recall: XD = 40 - P and XS = 6 + P
– So… (40 - P*) = (6 + P*)
– 34 = 2P* or P* = 34/2 so... P*=17
– To find X*, plug P* into either the demand or
supply equation.
– X*=23 = 40 - 17 or X*=23 = 6 + 17

77
Bushels Bushels D S
Demanded Corn Price Supplied
$5
26 $5 46

32 $4 41
$3
37 $3 37 $2

43 $2 32

48 $1 29
26 32 37 43 46

61. Equilibrium price will be ($1/$2/$3/$4/$5).

62. If the price in this market were $2, farmers

(would/would not) be able to sell all their corn.

63. If the price were initially $5, we would expect

the price of corn supplied to (increase/decrease)

as a result of the price change.

 Comparative Statics
 Using the model to make predictions.
 Something changes in the market.
 Compare one market equilibrium with
another market equilibrium and see what
happens to P* and X*
 Compare two equilibria - compare two static
situations - comparative statics!

79
Market Equilibrium
Increased Demand
 The increased
demand Price

intersects the Demand New Demand

Supply

original supply
curve to the
right of the
original
22

equilibrium. 17

 Price = 22 and quantity

supplied = quantity

demanded = 28

23 28 Quantity

80
Summary: Market Equilibrium
Increased Demand
 Increased demand is indicated by a greater
quantity demanded at every price.
 The demand curve shifts right and a
movement along the supply curve results.
 When demand increases:
– Equilibrium price increases
– Equilibrium quantity increases
– Note the movement in the same direction

81
 Market Equilibrium Decreased Demand

 The decreased
demand Price
Demand

intersects the Supply

original supply
curve to the left
of the original
equilibrium. 17

14.5

 Price = 14.5 and quantity

supplied = quantity demanded

= 20.5
New Demand

20.5 23 Quantity

82
Summary: Market Equilibrium Decreased Demand

 Decreased demand is indicated by a smaller

quantity demanded at every price.
 The demand curve shifts left and a
movement along the supply curve results.
 When demand decreases:
– Equilibrium price decreases
– Equilibrium quantity decreases
– Note the movement in the same direction

83
Increase in Supply
 An increase in
supply is a Price

rightward shift of Supply

the entire curve.

25

 More is supplied at every

price.

 At price = 25, the quantity

supplied = 36
New Supply

31 36 Quantity

84
Market Equilibrium
Increased Supply
 The increased
supply intersects Price
Demand

the original Supply

demand curve to
the right of the
original
equilibrium. 17

14.5

 Price = 14.5 and quantity

supplied = quantity demanded

New Supply
= 25.5

23 25.5 Quantity

85
Summary: Market Equilibrium
Increased Supply
 Increased supply is indicated by a greater
quantity supplied at every price.
 The supply curve shifts right and a movement
along the demand curve results.
 When supply increases:
– Equilibrium price decreases
– Equilibrium quantity increases
– Note the movement in opposite directions

86
Summary: Market Equilibrium Decreased Supply

 Decreased supply is indicated by a smaller

quantity supplied at every price.
 The supply curve shifts left and a movement
along the demand curve results.
 When supply decreases:
– Equilibrium price increases
– Equilibrium quantity decreases
– Note the movement in opposite directions

87
 Examples: Changes in Demand

 An increase in family income increases

the demand for automobiles.
 An increase in the price of software
decreases the demand for computers.

88
 Automobile Market
 Increased family
income increases Price
O
ld
Ne
w
D De
the demand for em
an
d
m
an
d
fo
Supply of Autos

fo
automobiles. r Au
to
s
rA
ut
os

 New price = P* and new quantity

supplied = new quantity demanded

P*
= X*.
P

 Equilibrium price and quantity both

rise.

X X* Quantity

89
Computer Market
 An increase in the
price of software Price
O
ld
D
em

decreases the
an Supply of Computers
d
fo
rC
om
demand for pu
te
r s
computers.

N
ew
D
em
an
d
 New price = P* and new quantity

fo
rC
om
pu
supplied = new quantity demanded

t
er
s
P
= X*.

P*

 Equilibrium price and quantity

both fall.

X* X Quantity

90
 Explanation of Computer Example

 Software is an example of good that is

demand “complementary” with
computers. When the price of a
complementary good (software) rises,
the demand for the good itself
(computers) decreases.
 The market moves down the supply
curve.

91
Examples: Changes in Supply
 A flood in Sudan in August decreases
the supply of Vegetables.
 A decrease in the price of energy
increases the supply of steel.
 An increase in the wage rate for
engineers decreases the supply of new
microprocessors.

92
Vegetables Market
 The decreased
supply intersects the Price De
m
original demand Ve
ge
ta
an
d
fo
r

curve to the left of the

b le
s

of
y
pl

of
original equilibrium.

y
Su

pl
s
le

p
ew

Su

s
ab

le
N

et

ab
ld
g

et
Ve

g
Ve
 New price = P* and new quantity
P*
supplied = quantity demanded = X*.

 Equilibrium price rises and

equilibrium quantity falls.

X* X Quantity

93
Explanation of Vegetables
Example
 Flood conditions reduce the cultivated
areas. Thus, the supply of vegetables
is reduced because of reduced
production at all prices.
 The market retreats along the demand
curve.

94
Steel Market
 The decreased
price of energy Price
D
increases the
em
St an
ee d
l fo

el
supply of steel.
r

e
St
of
 New price = P* and new quantity

ly
pp
Su

el
ld

e
supplied = quantity demanded =

St
of
ly
pp
X*.

Su
ew
N
P

P*
 Equilibrium price falls and

equilibrium quantity rises.

X X* Quantity

95
Explanation of Steel Example
 Energy is a factor in the production of
steel. When the price of energy falls, it
becomes less costly to produce steel.
Thus the supply of steel increases at all
prices.
 The market moves down the demand
curve.

96
Microprocessor Market
 The decreased D
em
an
supply intersects the Price d
fo
r M
ic
original demand ro
p ro

y
c

pl
es

p
curve to the left of the so

Su
rs

ew
N

y
original equilibrium.

ppl
Su
ld
O
P*

 New price = P* and new quantity

supplied = quantity demanded = X*.

P

 Equilibrium price rises and

equilibrium quantity falls.

X* X Quantity

97
Explanation of Microprocessor Example

 Engineers are a one of the types of labor

used to design new microprocessors.
When engineers become more expensive,
the cost of designing microprocessors
rises and supply falls at all prices.
 The market moves up the demand curve.

98
Thank you

99