Chapter 2 The Basics of Supply and Demand

Part One
Introduction: Markets and Prices

Chapter 1 Preliminaries
Chapter 2 The Basics of Supply and Demand
Chapter 2: The Basics of Supply and Demand
Supply-demand analysis is a fundamental and powerful tool that can be applied to a
wide variety of interesting and important problems.
We will find out how this analysis can be used:

• to describe the market mechanism
• to explain variations of price and quantity over time
• to show how markets respond to various events and government policies
Characteristics of demand and supply may differ from one market to another.
The Basics of Supply and Demand – Outline
2.1 Supply and Demand
2.2 The Market Mechanism
2.3 Changes in Market Equilibrium
2.4 Elasticities of Supply and Demand
2.5 Short-Run versus Long-Run Elasticities
*2.6 Understanding and Predicting the Effects of Changing Market Conditions
2.7 Effects of Government Intervention—Price Controls
The Supply Curve ( 供给曲线 )
Other Factors That Affect Supply
• The quantity that producers are willing to sell depends not only on the price they
receive but also on their production costs, including wages, the costs of raw
materials, etc.
Suppose production costs (e.g. the costs of raw materials) fall. How does this affect the
supply curve?
• Lower costs make production more profitable. Firms can expand production and
sell more. The quantity supplied increases at each price.
The supply curve shows the relationship between the quantity of a good that
producers are willing to sell and the price of the good.
Price Quantity P S
Note that the supply curve
1 5 4
slopes upward. In other
2 10 3
words, the higher the price,
the more that firms are
3 14 2
able and willing to produce
1
4 16 and sell.
4 8 12 16 Q
20
A change in price leads to a movement along the supply curve.
Lower production costs:
P S S’
Price Quantity
1 5 8 4
2 10 13 3
2
3 14 17
1
4 16 19
4 8 12 16 20 Q
This causes a shift of the supply curve itself.
The supply curve shifts to the right.
How should we describe these changes?
• When we move along the curve (as a result of a lower or higher price of the
product), we use the phrase “change in quantity supplied” ( 供给量的变动 ).
• When the supply curve shifts (for example as a result of lower or higher
production costs), we use the phrase “change in supply” ( 供给的变动 ).
The Demand Curve ( 需求曲线 )
The demand curve shows the relationship between the quantity of a good that
consumers are willing to buy and the price of the good.
Price Quantity P
Note that the demand
1 16 4
curve slopes downward. In
2 10 3
other words, consumers
are usually ready to buy
3 6 2
more if the price is lower.
1
4 4 D
4 8 12 16 20 Q
A change in price leads to a movement along the demand curve.
The quantity of a good that consumers are willing to buy can depend on other things
besides its price. Some of the most important variables are: consumers’ incomes and
the prices of related goods.
Suppose income levels increase. What happens to the demand curve?

• With higher incomes, consumers can spend more money. The quantity demanded
(usually) increases at each price.
Higher income levels:
Price Quantity P
1 16 19 4
2 10 13 3
3 6 9 2
1
4 4 7 D’
D
4 8 12 16 20 Q
This causes a shift of the demand curve itself.
The demand curve shifts to the right.
Substitute and Complementary Goods
Changes in the prices of related goods also affect demand. We have to distinguish two
kinds of relationships:
• Substitutes ( 替代品 ) – Consumers are willing to shift their purchases from one
product to another (replace one with another). Two goods are substitutes when an
increase in the price of one leads to an increase in the quantity demanded of the
other.
• Suppose the price of pork increases. What happens to the demand for beef?
• Assuming the price of beef hasn’t changed, consumers can replace expensive pork
with cheaper beef. The quantity demanded of beef increases at each price and the
demand curve shifts to the right.
Substitute and Complementary Goods
Changes in the prices of related goods also affect demand. We have to distinguish two
kinds of relationships:
• Complements ( 互补品 ) – Consumers tend to use two products together. Two
goods are complements when an increase in the price of one leads to a decrease
in the quantity demanded of the other.
• Suppose the price of cars increases. How is the demand for gasoline affected?
• Because higher price of cars leads to fewer cars being purchased, consumers also
buy less gasoline. The quantity demanded of gasoline decreases at each price and
the demand curve shifts to the left.
The next step is to put the supply curve and the demand curve together.
P S
3 Equilibrium ( 均衡 )
2
1
D
4 8 12 16 20 Q
The two curves intersect at the equilibrium price and equilibrium quantity.
In this situation, when the price is 2, the quantity supplied and the quantity demanded
are just equal (both are 10).
Equilibrium
• If the price is not at the equilibrium level, there is a tendency in a free market for
the price to change until the market “clears”, i.e. until the quantity supplied and
the quantity demanded are equal.
• Suppose the price is above the equilibrium level. Is the quantity supplied equal to
the quantity demanded?
• No, because producers will try to produce and sell more than consumers are
willing to buy, which results in a surplus ( 过剩 , quantity supplied > quantity
demanded).
• Such a surplus creates downward pressure on the price, until it decreases to the
equilibrium level.
• The opposite would happen if the price is below the equilibrium.
• Producers don’t want to produce as much as consumer want to buy, which results
in a shortage ( 短缺 , quantity supplied < quantity demanded).
• Such a shortage creates upward pressure on the price, until it increases to the
equilibrium level.
When Can We Use the Supply-Demand Model?
• We are assuming that at any given price, a given quantity will be produced and
sold. This assumption makes sense only if a market is at least roughly competitive.
• By this we mean that both sellers and buyers should have little or no market
power ( 市场势力 ), i.e. they are not individually able to affect the market price.
• If instead the market is not competitive (for example, when there is only one
producer – a monopolist), using supply-demand analysis is not appropriate.
Review
Explain how the following changes affect the demand curve:
• For beef, when the price of lamb decreases.
• For cars, when the average income decreases.
• For rice, when the price of rice decreases.
• For software, when the price of computers increases.
Review
Explain how the following changes affect the supply curve:
• For agricultural products, when the technology improves.
• For hamburgers, when the price of hamburger meat increases.
• For cars, when the costs of hiring workers increases.
• for smartphones, when the price of smartphones increases.
Review
When an industry's raw material costs increase, other things remaining the same,
A) the supply curve shifts to the left.
B) the supply curve shifts to the right.
C) output increases regardless of the market price and the supply curve shifts upward.
D) output decreases and the market price also decreases
Review
Assume that steak and potatoes are complements. When the price of steak goes up,
the demand curve for potatoes:
A) shifts to the left.
B) shifts to the right.
C) remains constant.
D) shifts to the right initially and then returns to its original position.
Review
You are analysing the demand for good X. Which of the following will result in a shift to
the right of the demand curve for X?
A) A decrease in the price of X
B) An increase in the price of a good that is a complement to good X
C) An increase in the price of a good that is a substitute for X
D) all of the above
Review
When the current price is above the equilibrium (market-clearing) level we would
expect:
A) quantity demanded to exceed quantity supplied.
B) quantity supplied to exceed quantity demanded.
C) a shortage.
D) greater production to occur during the next period.
Review
What is the equilibrium price of books?

A) 5
B) 10
C) 15
D) 20
The next step is to analyse how the equilibrium changes in response to shifts in the
supply and demand curves.
• First, suppose the supply curve shifts to the right (perhaps as a result of a decrease
in the price of raw materials). What happens to the equilibrium price and
quantity?
P S S’
The price decreases

and the quantity
P1 increases.
D
Q1 Q
• Instead, suppose the demand curve shifts to the right (perhaps as a result of an
increase in consumers’ incomes). What happens to the equilibrium price and
quantity?
P S
The price and quantity

both increase.
P1
D D’
Q1 Q
When both curves shift at the same time, the result depends on the direction of the
shifts but also its magnitude and the shape of the curves.
From 1970 to 2010, the real (constant-dollar) price of

eggs fell by 55 percent, while the real price of a
college education rose by 82 percent.
The mechanization of poultry farms sharply reduced
the cost of producing eggs, shifting the supply curve
to the right (downward).
The demand curve for eggs
shifted to the left as a more
health-conscious population
tended to avoid eggs. As a
result, the real price of eggs
declined sharply.
As for college education, increases in the costs of

equipping and maintaining modern classrooms,
laboratories, and libraries, along with increases in
faculty salaries, pushed the supply curve to the left
(upward).
The demand curve shifted to the right as a larger
percentage of a growing number of high
school graduates decided
that a college education
was essential. As a result,
the real price increased
significantly.
( 工资不平
Over the past等two
) decades, the wages of skilled high-income workers have grown
substantially, while the wages of unskilled low-income workers have fallen slightly.
While the supply of unskilled workers—people with limited educations—has grown
substantially, the demand for them has risen only slightly.
On the other hand, while the supply of skilled workers—e.g., engineers, scientists,
managers, and economists—has grown slowly, the demand has risen dramatically, pushing
wages up.
Exercise: Use this information to draw supply and demand curves and show how they have
shifted (for skilled workers and unskilled workers separately).
We already know whether quantity demanded and supplied increase or decrease in
response to a change in price of the product, but we also want to measure how much.
We use elasticities to measure this.
An Elasticity ( 弹性 ) measures the sensitivity of one variable to another. In general, it
is the percentage change in one variable resulting from a 1-percent increase in
another.
• Price Elasticity of Demand ( 需求的价格弹性 ) is the percentage change in
quantity demanded of a good resulting from a 1-percent increase in its price.
(2.1)
• The price elasticity of demand is usually a negative number (quantity demanded
falls as a result of an increase in price). Generally, the minus sign can be dropped.
• For example, when we say that the elasticity is 2 in magnitude, it means that a 1%
increase in price leads to a 2% decrease in quantity demanded.
• In this case, (i.e. the percentage decline in quantity is greater than the percentage
increase in price), we say the demand is “price elastic” ( 富有价格弹性的 ).
• If , we say the demand is “price inelastic” ( 缺乏价格弹性的 ).
Consider the following demand curve:
• Calculate the price elasticity of demand when the price is 1.

• Is the demand price elastic or inelastic at this point?
• In general, the price elasticity of demand for a good depends on the availability of
other goods that can be substituted for it, and whether the product is a necessity.
• Can you think of a product with high/low price elasticity of demand?
What determines price elasticity?
• Suppose the price of the following goods increases by 20%. For which good does
the quantity demanded decrease the most?
• Eggs vs. cabbage
• Cabbage has close substitutes so buyers can easily switch if the price rises.
• Eggs don’t have any close substitutes so a price increase would not affect
demanded quantity very much.
• Therefore, the demand for cabbage is more elastic than the demand for eggs.
What determines price elasticity?
• Suppose the price of the following goods increases by 20%. For which good does
the quantity demanded decrease the most?
• Insulin ( 胰岛素 , medicine for diabetics) vs. Caribbean cruises
• To millions of diabetics, insulin is a necessity. A rise in its price would cause little or
no decrease in demanded quantity.
• A cruise is a luxury. If the price rises, many people will forego it, demanded
quantity decreases significantly. Therefore, the demand for Caribbean cruises is
more elastic than the demand for insulin.
A Few Elasticities from the Real World
Linear Demand Curve ( 线性需求曲线 )
The price elasticity of demand must be measured at a particular point on the demand
curve and will generally change as we move along the curve.
𝑄=𝑎− 𝑏𝑃
• Infinitely elastic demand ( 完全弹性的需求 ) – Principle that consumers will buy as

much of a good as they can get at a single price, but for any higher price the
quantity demanded drops to zero, while for any lower price the quantity demanded
increases without limit.
• Completely inelastic demand ( 完全无弹性的需求 ) – Principle that consumers

will buy a fixed quantity of a good regardless of its price.
Other Demand Elasticities
Income elasticity of demand ( 需求的收入弹性 ) – Percentage change in the quantity
demanded resulting from a 1-percent increase in income.
(2.2)
Generally, higher income leads to an increase in quantity demanded of a product.
Therefore, income elasticity of demand is usually positive. Can it also be negative?
Other Demand Elasticities
Cross-price elasticity of demand ( 需求的交叉价格弹性 ) – Percentage change in the
quantity demanded of one good resulting from a 1-percent increase in the price of
another.
(2.3)
Cross-price elasticity will be positive when the two products are substitutes.
For complementary goods, it will be negative.
What is the relationship if the cross-price elasticity is zero?

Elasticities of Supply
Price elasticity of supply ( 供给的价格弹性 ) – Percentage change in quantity
supplied resulting from a 1-percent increase in price. This elasticity is usually positive.
It is also possible to measure elasticity of supply with respect to some other variables,
such as prices of materials, wages, etc.
Point versus Arc Elasticities
Until now, we have considered elasticities at a particular point - point elasticity ( 点弹
性 ). However, sometimes we want to calculate a price elasticity over some portion of
the demand/supply curve.
For example, when price increases from $8 to $10 and quantity demanded falls from 6
units to 4. How should we calculate the price elasticity of demand?
Arc elasticity of demand ( 弧弹性 ) – Price elasticity calculated over a range of prices.
(2.4)
where is the average of the initial and final quantity and is the average of the initial
and final price.
Calculate the price elasticity of demand:
1. At point A
2. At point B
𝑄=5 − 𝑃
3. Between point A and B P
A
3
B
2
D
2 3 Q
Wheat is an important agricultural commodity, and the wheat

market has been studied extensively by agricultural economists.
During recent decades, changes in the wheat market had major
implications for both American farmers and U.S. agricultural
policy. To understand what happened, let’s examine the
behaviour of supply and demand beginning in 1981.
By setting the quantity supplied equal to the quantity demanded, we can determine the
market-clearing price of wheat for 1981:
To find the market-clearing quantity, substitute this price of $3.46 into either the supply curve
equation or the demand curve equation. Substituting into the supply curve equation, we get
We use the demand curve to find the price elasticity of demand:
Thus demand is inelastic. We can likewise calculate the price elasticity of supply:
Because these supply and demand curves are linear, the price elasticities will vary as we move
along the curves.
When measuring elasticities, quantity demanded or supplied may respond to a change
in price with a significant lag. We must be clear about how much time is allowed to
pass before we measure the changes in the quantity – short run versus long run.
Demand
• For many goods, demand is much more elastic in the long run – people need more
time to change their consumption habits.
• However, for some durable goods ( 耐用品 , such as automobiles, refrigerators,
TVs, etc.) demand is more elastic in the short run than in the long run (people can
put off purchasing durable goods).
Income Elasticities
• Income elasticities also differ from the short run to the long run.
• For most goods and services—foods, beverages, fuel, entertainment, etc.— the
income elasticity of demand is larger in the long run than in the short run.
• For a durable good, the opposite is true. The short-run income elasticity of
demand will be much larger than the long-run elasticity.
– Suppose incomes rise sharply. As a result, more people can afford to buy a car. However, this doesn’t
mean they will keep buying a new car every year – future purchases will only be made to replace old
cars. Conversely, when incomes fall, many people put off buying a car.
– This causes the quantity demanded of durable goods to fluctuate more than the quantity of
nondurable goods.
Supply
• Elasticities of supply also differ in the short run and long run. For most products,
long-run supply is much more price elastic than short-run supply. Firms need time
to expand production, hire new workers, buy more equipment, build new
factories, etc.
Government intervention ( 政府干预 ) – Governments often regulate markets in a
variety of ways. One common form of government intervention is price controls ( 价格
控制 ).
• Suppose and are the equilibrium price and quantity. However, the government
has decided that is too high and imposes a ceiling on price,
( 最高限价 ). This means that no one is allowed to sell or buy the product at a
price higher than . P S
• This leads to a shortage.
Equilibrium
𝑷𝟎
𝑷 𝒎𝒂𝒙 ceiling
D
𝑸𝟎 Q
Price controls can be used to keep prices at lower levels, such as food, gas, electricity,
etc. However, not everyone benefits from lower prices.
Who do you think benefits/loses when prices are kept artificially low?
• Producers lose because they receive lower prices, and some have to leave the
industry.
• Some but not all consumers gain (some can buy the good at a lower price, but
others can’t buy it at all).
• (In chapter 9, we will learn a method to measure the gains and losses from price
controls.)
( 天然气 )
In 2007, The (free-market) wholesale price
of natural gas was $6.40 per mcf (thousand
cubic feet). Production and consumption of
gas were 23 Tcf (trillion cubic feet);
The government determines that the free-
market price of $6.40 is too high, and sets a
maximum price of $3.00. Quantity supplied
decreases to 20.6 Tcf, quantity demanded
increases to 29.1 Tcf.
Therefore, these price controls would create
a shortage (excess demand) of 29.1 − 20.6
= 8.5 Tcf.
Review
Which of the following would cause an unambiguous decrease in the real price a
product?
A) A shift to the right in the supply curve and a shift to the right in the demand curve
B) A shift to the right in the supply curve and a shift to the left in the demand curve
C) A shift to the left in the supply curve and a shift to the right in the demand curve
D) A shift to the left in the supply curve and a shift to the left in the demand curve
Review
Between points B and C, demand is:
A) small
B) inelastic, but not completely inelastic
C) infinitely elastic
D) elastic, but not infinitely elastic
Review
Which of the following best describes de demand curve in this figure?
A) Demand is infinitely elastic.
B) Demand is completely inelastic.
C) Demand becomes more inelastic the lower the price.
D) Demand becomes more elastic the lower the price
Review
Which of the following represents the income elasticity of demand?
A)
B)
C)
D)
Review
The cross-price elasticity of demand refers to:
A) a change in the demanded for two goods, following a change in the price of one
good.
B) the substitution of one good for another as the prices of two goods change.
C) the value of price elasticity at which supply crosses demand.
D) the percentage change in the quantity demanded of one good resulting from a 1-
percent increase in the price of another good.
Review
If two goods are substitutes, the cross-price elasticity of demand must be:
A) negative.
B) positive.
C) zero.
D) infinite.
Review
For U.S. consumers, the income elasticity of demand for fruit juice is 1.1. If the
economy enters a recession next year and consumer income declines by 2.5%, what is
the expected change in the quantity of fruit juice demanded next year?
A) -2.75%
B) +2.75%
C) -27.5%
D) +27.5%

Chapter 2 The Basics of Supply and Demand

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Chapter 2 The Basics of Supply and Demand

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Part One

Introduction: Markets and Prices

We will find out how this analysis can be used:

Suppose income levels increase. What happens to the demand curve?

What is the equilibrium price of books?

The price decreases

The price and quantity

From 1970 to 2010, the real (constant-dollar) price of

As for college education, increases in the costs of

• Calculate the price elasticity of demand when the price is 1.

• Infinitely elastic demand ( 完全弹性的需求 ) – Principle that consumers will buy as

• Completely inelastic demand ( 完全无弹性的需求 ) – Principle that consumers

What is the relationship if the cross-price elasticity is zero?

Wheat is an important agricultural commodity, and the wheat

We use the demand curve to find the price elasticity of demand:

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