MICROECONO Prof.

Mani Govil

MICS School of Commerce

MODULE 2-SUPPLY, DEMAND
& EQUILIBRIUM
TO BE DONE:
Assumptions of the competitive market model: all agents are price takers,
homogeneous products.
Demand & supply: determinants of demand & supply, demand & supply curves,
consumer and producer surplus, divisibility, the “laws” of demand and supply,
movements along versus shifts of demand and supply curves.
Normal & inferior goods, complements & substitutes, individual demand and
supply vs market demand and supply
Equilibrium prices and quantities, price as a mechanism for equilibration.
Determination of equilibrium price and quantity.
SUPPLY AND DEMAND
ANALYSIS CAN:
Help us understand and predict how real world economic conditions affect market
price and production
Analyze the impact of government price controls, minimum wages, price supports,
and production incentives on the economy
Determine how taxes, subsidies, tariffs and import quotas affect consumers and
producers.
 BASICS OF DEMAND
By definition, demand is the ability and willingness of a consumer to buy or purchase a particular
product. 
To an economist, the term ‘demand’ refers to a specific relationship of various quantities (of a
particular product) per unit of time (say a day, a week, a month or a year) to such variable as the
price of the product under consideration, income of the buyer(s), prices of substitutes, prices of
comple­ments, expected future conditions, seasonal factors, availability of consumer credit and
various other factors.
The Demand curve is the relationship between the Price and Quantity Demanded.
The demand curve indicates the quantity of a good that people are willing to buy as the price per
unit changes.
Mathematically, this relationship can be written in the form of an equation as :

 The equation explains that the demand is a function of the price of the product.
DEMAND FUNCTION
LAW OF DEMAND
Law of Demand-The consumer buys more unit of the good when the price is low
and fewer units when the price increases. In other words, demand is a negative
function of the price. Graphically, demand is a downward sloping curve labeled
as “D”
Assumptions of the law of demand :
The law is valid only when the following assumptions hold:
 (a) The price of the related goods remains the same.
 (b) The income of the consumers remains unchanged.
 (c) Tastes and preferences of the consumers remain the same. (d) All the units of the goods are
homogeneous.
 (e) Commodity should be a normal good..
DEMAND CURVE
The graphical representation of the demand function is called a demand curve. The demand curve
also represents the average revenue function for the product. It is because aver­age revenue is the
same as the price of a product.
The demand curve usually slopes downward from left to the right. 
The independent variable (price) is measured along the y-axis and dependent variable (quantity)
is measured along the x-axis. T
If the income of the buyer increases, the consumer will buy more of the same commodity even at
the same price. 
A change in the price of a related good or a change in the tastes and preferences of buyers is
likely to have the same effect.
Factors other than price are conceived as demand curve shifters — forces that move the price-
quantity relation­ship, left or right. Changes in demand imply such shifts of demand curves.
REASONS BEHIND
DOWNWARD SLOPE OF THE
DEMAND CURVE
a)Law of Diminishing Marginal Utility.
b)Substitution Effect.
Substitution effect means with fall in the price of a good, consumer feels a rise in
relative price of other goods, which in turn leads to more demand for the good.
(c) Income Effect.
(d) New Consumers Creating Demand.
 INDIVIDUAL AND MARKET DEMAND CURVE

The individual demand curve for good X is the quantities of good X demanded by one
participant in the market for good X.

The market demand curve for good X includes the quantities of good X demanded by all
participants in the market for good X. The market demand curve is found by taking the horizontal
summation of all individual demand curves.
CHANGE IN QUANTITY DEMANDED (MOVEMENT) VS.
CHANGE IN DEMAND (SHIFT) OF DEMAND CURVE

Movement: Change in Quantity Demanded

A movement along the demand curve is caused by a change in the price of the good,
other things remaining constant. Movement along a demand curve can bring about:
(a) Expansion of demand, or (b) Contraction of demand
Shift: Change in Demand
A shift of the demand curve is caused by changes in factors other than price of the
good. A shift of the demand curve can bring about: (a) Increase in demand, or (b)
Decrease in demand.

80 d2
 A SHIFT OF DEMAND CURVE VERSUS MOVEMENT
ALONG THE DEMAND CURVE

 The shift in the demand curve is caused by factors other than price. This is referred as the change
in demand.
 In contrast, change in quantity demanded, is shown by a movement along the curve due to price
changes (keeping other factors constant).
 DEMAND EQUATION
Qd = a – b(P)

Q = quantity demand (the dependent variable)

a = all factors affecting demand other than price (e.g. income, fashion)
1/b = slope of the demand curve. P
P = Price of the good. (an independent variable)
Q P
40 0 Q-ve `Q
38 1
36 2
34 3
32 4
Q=60- 2P
30 5 Q=20-2P
28 6
26 7 60
20
0 20
15

10

D2
D1

Q2 Q1 Q3
Q= 40-2P or P=20-0.5Q
What is the quantity demanded at Rs. 8?
How does the demand curve change when a increases from 40 to 50?
How does the demand curve change when b decreases from 2 to 1?
What happens at b=0 and b= infinity?
What is P intercept?
What is Q intercept?
What is the slope of the equation? 40
What happens to the linear demand curve if income increases/ decreases?
 SUPPLY ANALYSIS
Supply of a good in economics means the quantity produced and supplied of the
good per period by its producer-firm(s) at any particular price of the good.
However, supply depends on many things other than the price of the good.

The Supply Curve

The relationship between the quantity of a good that producers are willing to sell and
the price of the good.

It Measures quantity on the x-axis and price on the y-axis.

SUPPLY EQUATION
Qs=-c+dP
c is the Q intercept and d is price coefficient of supply.
d is the inverse of the slope.
d is change in Q/ change in P
Higher the d, more responsive producers are to price, flatter the curve.
Find the supply equation by the following supply schedule P Qs
1 0
2 20
3 50
4 80
5 110
6 140
7 170
THE SUPPLY CURVE

Po
 FACTORS AFFECTING SUPPLY CURVE
Just like demand which is effected by internal and external Factors. So is the Supply.

1.Costs of Production

•Cost of Production
Labor
Capital
Raw Materials

Lower costs of production allow a firm to produce more at each price and vice versa i.e the supply curve shifts.
2. Technology

3. Subsidies/ Taxes

4. Price of other goods

5. Expectation about prices
6. Size of the market

Change in Supply and Change in Quantity Supplied

 Movement along the curve caused by a change in price. In other words, thee is only a change in Quantity Supplied when prices
changes. Or Factors within the Graph (Price).
Change in Supply

Shift of the curve caused by a change in something other than the price of the good would result in a change in Supply. Just like we
described Technology and cost of Production that effect Supply Curve other than Price.
 60
SUPPLY EQUATION
-60
60 80
Example of linear supply curve
15
P = 30+ 0.5(Qs) or Q=-60+2P
Shift in slope of supply curve `P Q
Qs P 30
P = 30+ 1.2(Qs) 0 30 35
10 35 40
20 40 45
50
30 45
40 50
50 55
60 60
LAW OF SUPPLY
There is a positive relation between price and quantity supplied.
ASSUMPTIONS
Competitive market
Increase in marginal cost due to diminishing returns
Aim at maximum profits or sales revenue
Technology remains constant
Input prices are constant
QUESTIONS
What happens to the supply curve if non price determinants of supply change?
Show the effect on supply curve if supply equation changes from Qs= -40+30P to
Qs= -20+30P
What will be the new c and d? will the slope change?
If supply equation becomes Qs=-40+50P, what will happen to the slope of the new
curve?
Can you draw the new supply curve?

-40 -20
SHIFT IN THE SUPPLY CURVE

P = 0 + 1.2 (Qs) shifts the supply curve downwards so it

starts at the 0,0

Shift and movement

EFFECT OF SPECIFIC TAX ON
SUPPLY EQUATION
If supply equation is Qs= -c+dP, P= (c+Qs)/d.
If specific tax T is imposed, new equation is P= T+(c+Qs)/d
Example: P = 0 +2Q. Suppose specific tax is 5 Rs. per unit.
A specific tax will shift supply curve upwards by 5. After tax. The supply curve will
be
P = 5+2Q
An Indirect tax will shift supply curve upwards by a certain percentage. e.g. VAT =
20%
P = 0+2Q. After VAT will be P = 0+(2Q * 1.2)
EFFECT OF SUBSIDY ON
SUPPLY EQUATION
Suppose we have supply curve
P = 30+0.5Q
After subsidy of 10
P = 20+0.5Q
30

20
 MARKET EQUILIBRIUM
When the demand for good X equals the supply of good X, the market for good X is
said to be in equilibrium.
The determination of equilibrium quantity and price, known as equilibrium
analysis
Equilibrium quantity of good X.
The equilibrium price for good X- clearing price
At the higher price P1, a surplus develops, so price falls. (Role of price as an
invisible hand).
At the lower price P2, there is a shortage, so price is bid up.
SHIFTS IN DEMAND AND
SUPPLY CURVES
How to determine the effect of any event:

1. Does the event affect the demand or supply side

in the market
2. What is happening to the demand or supply
curves in the market
3. How does the change impact the market
equilibrium.
 s2
P2 E2 S1
P1 E1
E3 E1
P1
P2 E2

Q1 D1
Q2 D2
Q2
Q1
S
S2
S
P2
E2 S1
40 E

P1 E1

Q2 5000 Q1
DETERMINATION OF EQUILIBRIUM
PRICE AND QUANTITY
Let us suppose we have two simple supply and demand equations
Qd = 20 – 2P ii.) Suppose a subsidy of Rs.2.
Qs = -10 + 2P new supply eqn: P=0.5Qs+5, P=0.5(20-2P)+3, P=6.5 , Q=7
To find where QS = Qd we put the two equations together
20-2P = -10 + 2P
20+10= 4P
30/4=P
P = 7.5
To find Q, we just put this value of P into one of the equations
Q = 20 – (2×7.5)
Q= 5
 Qd = 20 – 2P Qs = -10 + 2P

P Qd QS
0 20 -10
1 18 -8
2 16 -6
3 14 -4
4 12 -2
5 10 0
6 8 2
7 6 4
7.5 5 5
8 4 6
9 2 8
10 0 10
11 -2 12
12 -4 14
 PRICE CEILING & PRICE
FLOOR
A price ceiling keeps a price from rising above a certain level (the “ceiling”), while
a price floor keeps a price from falling below a certain level (the “floor”). 
CONSUMER SURPLUS
Individual consumer surplus is the difference between the maximum amount that a
consumer is willing to pay for a good and the amount that the consumer actually
pays.
It is the benefit from the consumption of a product less the total cost of purchasing
it.
It is measured by the area below an individual's demand curve and above the market
price of the product. s1

s2

q1
 PRODUCER SURPLUS
A producer surplus is a difference between how much of a good the producer is
willing to supply versus how much he receives in the trade.
It is measured as the area above a producer’s supply curve and below the market
price.
It is also defined as the difference between the firm’s revenue and its total variable
cost.
D S
CS
E
P3 F

A
ECONOMIC WELFARE
With consumer and producer surplus, we can evaluate the
welfare effects of a government intervention in the market.

In market analysis economic welfare at equilibrium

can be calculated by adding consumer and producer
P1 surplus.

Welfare analysis considers whether economic

decisions by individuals, organisations, and the
government increase or decrease economic welfare.
CHANGE IN CONSUMER AND
PRODUCER SURPLUS FROM
PRICE CONTROLS
Consumers gain an area of A and lose an area of B.

Producers lose areas C and A NET GAIN IN CONSUMER SURPLUS= A-B

NET LOSS IN PRODUCER SURPLUS= A+C
NET LOSS IN TOTAL MARKET SURPLUS=
A+C- (A-B)
=B+C= DWL
Consumers lose an area of A and lose an area of C.
Producers increase an area of A and lose B
B and C is dead weight loss NET LOSS IN CONSUMER SURPLUS= A+C
NET GAIN IN PRODUCER SURPLUS= A-B
NET LOSS IN TOTAL SURPLUS= A+C- (A-B)
=B+C= DWL
DEAD WEIGHT LOSS
The loss in producer and consumer surplus due to an inefficient level
of production perhaps resulting from market failure or government
failure. https://www.youtube.com/watch?
v=U0nfsAoCyA0&list=RDCMUCqfPqpkvs1gaDNfrmwtlUpA&inde
x=5
 EFFECT OF TAXES
Government levies a $3 gas tax on producers
Supply curve will shift up by $3.
Producers do not receive $5, they now only receive $2, as $3 has to be sent to the government.
Consumers responds by decreasing the quantity demanded for the higher priced good. 
https://www.youtube.com/watch?v=jBz2cAGzaDM
Before
The market surplus before the tax has not been shown, as the process should be routine. Ensure you understand how
to get the following values:
Consumer Surplus = $4 million
Producer Surplus  = $8 million
Market Surplus = $12 million
After
The market surplus after the policy can be calculated in reference to Figure
Consumer Surplus (Blue Area) = $1 million
Producer Surplus (Red Area)= $2 million
Government Revenue (Green Area) = $6 million
Market Surplus = $9 million
PRACTICE QUESTIONS
 S

Price Quantity demanded Quantity Supplied

4 10000 8000
8 8000 8000
12 6000 8000
16 4000 8000
20 2000 8000 q
Draw the demand and supply curves. What is unusual about the supply curve? Why
might this be true?
What are the equilibrium price and quantity of tickets?

Price Quantity demanded

4 4000
8 3000
12 2000
16 1000
20 0

Now determine the new market demand schedule. What will be the equilibrium price and
quantity?
Annual demand and supply for the Electronics company is given by:
Qd=5000+0.5I+0.2A-100P and Qs=-5000+100P, where Q is the quantity per year, P
is the price, I is the income per household, and A is the advertising expenditure.
A. If A=$10,000 and I=$25,000, what is the demand curve?, Qd=19500-100P
B. Given the demand curve in part a, what is the equilibrium price and quantity?
C. If consumer incomes increase to $30,000, what will be the impact on equilibrium
price and quantity?
1. Industry demand and supply curve are; QD=1000 – 2P and Qs = 3P
 What is the equilibrium price and quantity?, 1000-2P=3P, P=200, Q=600
 Plot the demand and supply curve and show the equilibrium point.
 At a price of Rs. 100, will there be a shortage or a surplus, how large will it be? Qd=800, Qs=300, Qd>Q,
shortage, =500
 At a price of Rs. 300, will there be a shortage or a surplus, how large will it be? Show in the diagram.
Qd=400, Qs=900, surpus=500

2. The market demand function for a product is given by Qd=300-2P. How much consumer
150
surplus do they receive when
P=45? 45 B
30
P=30? 210 240 300
3. Suppose the market demand and supply functions are given by Qd=60-P and Qs=P-20.
Determine the consumer and producer surplus if a price ceiling of 32 is imposed in this
market. What is the amount of dead weight loss?
QD=1000 – 2P AND QS = 3P
P QD QS
100 800 300 500
200 600 600
300 400 900 400
400 200 1200 300
500 0 1500
200

100
0 200 400 600 800 1000 1200 1400
Qd=300-2P, CS= ½*210*105= 105*105=
CS= ½*240*120= 120*120
150

45
30
210 240 300
Qd=60-P and Qs=P-20., 60A
Q=20, P=40
48 B
P=32
40 F
CS= ABCD D C
32
PS= CDE E 20
DWL= BCF 12 20 28
CS= 264
PS= 72
DWL= 64
 60

CS= 12*(48-32)+1/2*12*12= 264

48
PS= ½*12*(32-20)= 72
40 E
32
PS
20

12 20
Consider the supply and demand diagram below. Assume no
externalities.

If a price floor of $20 is introduced, then which area will represent the deadweight loss?
a) e.
b) e + d.
c) e + b + d.
d) The deadweight loss will be zero.
QUES 252
150
dwl
126
Demand fn: P=252-2Q
102
Supply fn: P=2Q
New supply eqn: P=2Q+50
Dwl= old surplus- new surplus 51 63
Old surplus= 2*63*63=7938
New surplus=51*51+51*51+ 51*48=7650
Dwl=7938-7650=288
What is the equilibrium price and quantity
What is the value of consumer and producer surplus? CS= 63*63, PS=63*63

Suppose tax imposed is Rs. 50 per unit on sellers, find the dead weight loss.