Law of Supply and Market

Equilibrium
 

Supply:
Supply represents how much the
market can offer.
The quantity supplied refers to the
units of a certain good a producer is
willing to supply at a certain price.
 Market supply
• Market supply is the total quantities of a
good that sellers are willing and able to
sell at alternative prices in a given time
period (ceteris paribus), or simply the
combined willingness and ability of all
market suppliers to sell.
 Market supply
• must be both willingness and ability to sell
• not a statement of actual sales, that will
depend on the actual price
• given time period
• ceteris paribus
SUPPLY CURVE
Supply curve is upward sloping from left to right showing
positive relationship between quantity supplied and
price.
 Law of Supply
• Law of supply states that there is a
positive relation between price and
quantity supplied.
• If price goes up, quantity supplied goes
up; if price goes down, quantity supplied
goes down.
 Assumptions behind the market
supply curve
All the factors listed below are assumed to be
constant:
• cost of production
– input prices
– Technology
• number of sellers in the market
• Expectations(of future price)
• Price of related goods
• Excise tax rates
 Supply Schedule
Video Game Prices $ Quantity Supplied ( ‘000 )

100 200

150 250

200 300

250 350
 Exceptions to law of supply:
• Agricultural products (all agricultural
products are perishable, short run supply
change not possible)
• Perishable goods (dairy products, flowers,
fruits, vegetables etc)
• Supply of rare goods
• Disposal of old stock
• Non availability of resources
 Market supply curve
p (price)
s (supply)

0 q (quantity)
Market supply and demand curves:
MARKET EQUILIBRIUM
p
s

p*

q
0 q*
 Market equilibrium
• unique equilibrium of market supply and
demand
• equilibrium price ( p*) is price at which
quantity supplied = quantity demanded
(qs = qd)
• equilibrium quantity (q*) is quantity
corresponding to equilibrium price
 Disequilibrium—price p1 above
equilibrium price p* qs > qd
• excess supply or market surplus
Excess supply or market surplus
p

Excess Supply s

p1

p*

0 q
qd qs
1 1
 Equilibrating process
• competition between and among buyers
and sellers sets off equilibrium process
• Firms with excess inventories cut prices to
try to undersell their competition
• As price falls, quantity demanded rises,
and quantity supplied falls
• Process continues until p = p* and
(qs = qd)
Market returns to equilibrium
p
s

p*

q
0 q*
 Disequilibrium—price p1 below
equilibrium price p* qs < qd
• excess demand or market shortage
Excess demand or market shortage
p

p*

p1

Excess Demand q

0 q
qs qd
2 2
 Equilibrating process
• competition between and among buyers
and sellers sets off equilibrium process
• buyers competing with one another for
goods in short supply bid up price to try to
capture some of the good
• as price goes up, demand falls and supply
rises
• Process continues until p = p* and qs = qd
 Shift of supply curve
• shifts LEFTWARDS from:
– higher costs of production
• higher input prices
• technological decline
– Expectations that future price rises
– fewer sellers in the market
 Supply curve shifts in
Price
S1

S2
p1

p2

0 Quantity
q1 q2
 Shift of supply curve
• shifts RIGHTWARDS due to:
– lower costs of production
• lower input prices
• technological advance
– Expectations that price will fall in future
– more sellers in the market
 Supply curve shifts out
Price
S1

S2
p1

p2

0 Quantity
q1 q2
 Price elasticity of supply

• Price elasticity of supply (PES) measures the

responsiveness of quantity supplied to a
change in price. It is necessary for a firm to
know how quickly, and effectively, it can
respond to changing market conditions,
especially to price changes. The following
equation can be used to calculate PES.
 There are three cases of PES

• Perfectly elastic, where supply is infinite at

any one price.
• Perfectly inelastic, where only one quantity
can be supplied.
• Unit elasticity, which graphically is shown as
a linear supply curve coming from the origin.
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 Numericals
• Qd = 600-2P/ 1200-2P
• Qs = 3P
• Determine the equilibrium price and
equilibrium quantity.
• Qd=Qs
• Ep = 120/ Ep1 = 100/ Ep2 = 240
• Qd = Qs = 360, Eq = 400, Eq = 720
• Qd = 66-3P
• Qs = -4+2P
• 66-3P = -4+2P
• 70 =5P
• Determine the ep and eq.
• Ep = 14
• Eq = 24
• A local grocery store orders 200 cases of
Pepsi each week and sells them at a price
of $6.00 per case. At the end of the first
week, they have only sold 160 cases. What
economic situation is the grocery store
facing and what will have to happen to
price in order for equilibrium to be attained?
• Reduce the price, surplus.