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Managerial Economics
Topic 3 - Supply, Demand and Equilibrium

Gary Tan, PhD

Head, School of Business – Group
BAC Education Group

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Subtopics Overview
3.1 The Law of Demand, Income/Substitution Effects, and Shift Factors
3.2 Changes in Demand vs. Change in Quantity Demanded
3.3 The Market Demand and Supply Curves; Supply Curve Shift Factors
3.4 Equilibrium; Price Effects of Supply and Demand Curve Shifts
3.5 Price Controls and Floors
3.6 The Market Allocates Goods and Resources

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3.1 The Law of Demand, Income/Substitution Effects, and Shift Factors

• Supply and Demand Diagram

(a) Vertical Axis – Price
(b) Horizontal Axis – Quantity

• Ceteris Paribus – “all other things

being unchanged or constant”

• Law of Demand states that a higher

price leads to a lower quantity
demanded and that a lower price
leads to a higher quantity
demanded (i.e., inverse relationship
between price and quantity).

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Income and Substitution Effect

• Why quantity demanded tends to fall when price rises?

• Income Effect – The increase in price reduces disposable

income and this lower income may reduce demand.

• Substitution Effect – The good is relatively more expensive than

alternative goods, and therefore people will switch to other
goods which are now relatively cheaper.

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3.2 Changes in Demand (D) vs. Change in Quantity Demanded (QD)

• Change in QD – movement
along the demand curve
(i.e., movement from Point
A to Point B on D1) and
price is the main driver.

• Change in D (i.e., decrease

in demand) – shift of the
demand curve (inward,
from D1 to D2) due to
decrease in income.

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Shift Factors (Demand)

• Changes in demand cause by change in:

(a) consumers’ tastes,

(b) population,
(c) disposable income,
(d) prices of substitute or complement goods,
(e) expectations about future conditions and prices.

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3.3 The Market Demand and Supply Curves; Supply Curve Shift Factors

• If the supply curve shifts to

the right, this is an increase
in supply; more is provided
for sale at each price

• If the supply curve moves

inwards, there is a decrease
in supply meaning that less
will be supplied at each
price
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Shift Factors (Supply)

• Changes in demand cause by change in:

(a) input prices,

(b) natural conditions,
(c) changes in technology,
(d) government taxes, regulations, or subsidies.

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3.4 Equilibrium; Price Effects of Supply

and Demand Curve Shifts

• Equilibrium is achieved at
the price at which
quantities demanded and
supplied are equal.
• We can represent a market
in equilibrium in a graph by
showing the combined
price and quantity at
which the supply and
demand curves intersect.

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3.5 Price Controls (Ceiling) and Floors

• Price Control (Ceiling) – impose a

maximum price on certain goods and
services. They are usually put in place
(i.e., below equilibrium point) to protect
vulnerable buyers, or in industries where
there are few suppliers. A good example
of this is the oil industry, where buyers can
be victimized by price manipulation.

• Price Floor – impose a minimum price on

certain goods and services. They are
usually put in place (i.e., above
equilibrium point) to protect vulnerable
suppliers. A good example of this is the
farming industry; small farmers are very
sensitive to changes in the price of farm
products, due to thin margins.

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3.6 The Market Allocates Goods and Resources

• What goods are produced? 

This is answered by the signals of the market prices. Those who have the most
dollar votes have the greatest influence on what goods are produced.
 
• For whom are goods produced? 
The power of the purse dictates the distribution of income and consumption. Those
with higher incomes end up with larger houses, more clothing, and longer
vacations. And backed up by cash, the most urgently felt needs get fulfilled through
the demand curve.

• How goods are produced?

The choice of technique depends on the prices of the factors of production (labor or
capital intensive).

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Final Thought
• Of course in business, it's all a gamble, but as a Chinese
philosopher once said chance favors the prepared mind, or in
this case chance favors the prepared micro economist.

• Please remember that economics is not something to memorize

but rather something to conceptualize. So as you study it, think
about it too.

• Next topic – Topic 4: Demand and Consumer Behavior with 5

subtopics.
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