Chapter 3-Supply and Demand (ECON 610)

Chapter 3
Supply and
Demand
Chapter Outline
• Market demand
• Market supply
• Market equilibrium
• Comparative statics analysis
• Supply, demand, and price: The managerial

challenge.
Copyright ©2014 Pearson Education, Inc. All rights reserved. 1-2

Learning Objectives
• Define supply, demand, and equilibrium price.
• List and provide specific examples of the non-price

determinants of supply and demand.
• Distinguish between the short-run rationing function

and long-run guiding function of price.
• Illustrate how the concepts of supply and demand

can be used in management decisions about price
and allocations of resources.
• Use supply and demand diagrams to determine

price in the short and long run.
Market Demand
• The demand for a good or service is defined

as:
Quantities of goods or services that people are
ready, willing and able to buy at various prices
within some given time period.
(Other factors besides price held constant)

Market Demand
• “Ready” implies that consumers are prepared to

buy a good or service because they are both:
 Willing: Consumers have a preference for it.
 Able: Consumers have the income supporting

thier preference.
• Market demand is the sum of all the individual

demands.
• Individuals may have distinct demand curves, and

they sum to the overall demand in the market.
Market Demand
Example: Demand for pizza
Price QD1 QD2 QD3 QDM

$7.00 0 0 0 0
6.00 20 50 30 100
5.00 40 100 60 200
4.00 60 140 100 300
3.00 80 180 140 400
2.00 100 220 180 500
1.00 120 250 230 600
0.00 140 280 280 700

Market Demand
• There is an inverse P ($)

relationship between 8
price and the 7
quantity demanded
6
of a good or service.
5
D
• This is called the 4
Law of Demand. 3
2
• Thus, the demand
curve is downward 1
sloping. 0
100 200 300 400 500 600 700 Q

Market Demand
• Graphical
Representation of
Demand
• Algebraic Representation
of Demand (demand
Function):
Qd=a-bP
Qd=700-100P

Market Demand
• Changes in price result in changes in the quantity

demanded
 This is shown as movement along the demand

curve.
• Changes in non-price factors result in changes in

demand
 This is shown as a shift in the demand curve.

Market Demand
P ($)
8
5
Increase
4
3 Decrease
1 D3 D1 D2
0
100 200 300 400 500 600 700 800 Q

Market Demand
• Non-price determinants of demand-result is a shift

in the demand curve.
 Tastes and preferences
 Income
 Prices of related products
 Future expectations
 Number of buyers

Market Supply
• The supply of a good or service is defined

as:
Quantities that people are ready to sell at various

prices within some given time period.
(Other factors besides price held constant)

Market Supply
• Changes in price result in changes in the

quantity supplied.
 Shown as movement along the supply curve.
• Changes in non-price determinants result in

changes in supply.
 Shown as a shift in the supply curve.

Market Supply
Example: Supply of pizza
Price QS1 QS2 QS3 QSM

$7.00 250 120 230 600
6.00 200 100 200 500
5.00 150 80 170 400
4.00 100 60 140 300
3.00 50 40 110 200
2.00 0 20 80 100
1.00 0 0 0 0

Market Supply
P ($)
• There is a direct
8
positive relationship
between price and 7
the quantity 6
supplied of a good or 5 S
service. 4
3
• Thus, the Supply 2
curve is upward 1
(positive) sloping.
0
-100 100 200 300 400 500 600 700 Q

Market Supply
• Graphical
Representation of
Supply
• Algebraic Representation
of Supply (Supply
function):
• Qs=a + bP
Qs=-100 +100P

Market Supply
P ($)
S3
8
7
S1
6 S2
5 Decrease
4
Increase
3
0
-100 100 200 300 400 500 600 700 Q

Market Supply
• Non-price determinants of supply-results in a shift

in the supply curve.
 Costs and technology
 Prices of other goods or services offered by the

seller
 Future expectations
 Number of sellers
 Weather conditions.

Market Equilibrium
• Equilibrium price:
The price that equates the quantity demanded
with the quantity supplied.
• Equilibrium quantity:
The amount that people are willing to buy, and
sellers are willing to offer at the equilibrium
price level.

Market Equilibrium
• Supply and Demand for Pizza
Price Qd Qs
$7.00 0 600
Surplus 6.00 100 500
5.00 200 400
P 4.00 300 Q 300
3.00 400 200
Shortage 2.00 500 100
1.00 600 0
0.00 700 -100

Market Equilibrium
• Shortage:
A market situation in which the quantity demanded
exceeds the quantity supplied.
 Shortage occurs at a price below the
equilibrium level.
• Surplus:
A market situation in which the quantity supplied
exceeds the quantity demanded.
 Surplus occurs at a price above the equilibrium
level.

Market Equilibrium
P ($)
8
7 S
6
Surplus
5
4
P1 3
2 Shortage
1 D
0
-100 100 200 300 400 500 600 700 800 Q
Q1

Comparative Statics Analysis
• Comparative statics: is a form of sensitivity

(or what-if) analysis
 Commonly used method in economic
analysis.

• Process of comparative statics analysis:

 State all the assumptions needed to construct
the model
 Begin by assuming that the model is in
equilibrium
 Introduce a change in the model, so a condition
of disequilibrium is created
 Find the new point of equilibrium
 Compare the new equilibrium point with the
original one

Step 1
• Assume all factors
except the price of
pizza are constant
• Buyers’ demand and

sellers’ supply are
represented by lines
shown

Step 2
• Begin the analysis
in equilibrium as
shown by Q1 and P1

Step 3
• Assume that a new
study shows pizza to
be the most nutritious
of all fast foods
• Consumers increase
their demand for pizza
as a result

Step 4
• the shift in demand
results in a new
equilibrium price (P2)
• and a new equilibrium

quantity (Q2)

Step 5
• Comparing the new
equilibrium point with
the original one, we
see that both
equilibrium price and
quantity have
increased

• The short run is the period of time in which:

 Sellers already in the market respond to a change in
equilibrium price by adjusting variable inputs
 Buyers already in the market respond to changes in
equilibrium price by adjusting the quantity demanded for the
good or service
• Short run changes show the rationing function of

price:
 The rationing function of price is the change in market price
to eliminate the imbalance between quantities supplied and
demanded.

Comparative Static Analysis:
Short-run
• An increase in
demand causes
equilibrium price
and quantity to rise.

Short-run
• A decrease in
demand causes
quantity to fall.

Short-run
• An increase in
supply causes
equilibrium price
to fall and
equilibrium
quantity to rise.

Short-run
• A decrease in
supply causes
equilibrium price to
rise and equilibrium
quantity to fall.

Long-run
• The long run is the period of time in which:

 New sellers may enter a market
 Existing sellers may exit from a market
 Existing sellers may adjust fixed factors of
production
 Buyers may react to a change in equilibrium price
by changing their tastes and preferences

Long-run
• Long run changes show the allocating

function of price.
• The guiding or allocating function of

price is the movement of resources into or
out of markets in response to a change in
the equilibrium price.

Long-run
• Initial change: decrease

in demand from D1 to D2
• Result: reduction in
quantity (to P2, Q2)
• Follow-on adjustment:
 Movement of resources out
of the market
 Leftward shift in the supply
curve to S2
 Equilibrium price and

Long-run Analysis
• Initial change: increase in
demand from D1 to D2
• Result: increase in
• Follow-on adjustment:
 Movement of resources into
the market
 Rightward shift in the
supply curve to S2
 Equilibrium price and

Summary: Short-Run and Long-Run
Changes in the Market

Supply, Demand, and Price
• In the extreme case, the forces of supply

and demand are the sole determinants of
the market price, not any single firm.
 This type of market is called ‘perfect competition’
• In many cases, individual firms can exert

market power over price because of their:
 Dominant size
 Ability to differentiate their product through
advertising, brand name, features, or services.

Supply, Demand, and Price
• Discussion: Changes in the computer

industry
 Makers of PCs, notebooks and jump drives are
facing slower growth in the demand for their
products as technology is changing.
 What impact do you think cloud computing will
have on the demand for stand-alone
applications such as Microsoft Office or storage
devices for computers?

Global Application
What are the implications of rising demand for
oil among developing counties?

Global Application

Summary
• The law of demand states that, other factors held

constant, the quantity demanded is inversely related to
price.
• The law of supply states that, other factors held constant,

the quantity supplied is directly related to price.
• Non-price factors may shift the curves.
• Price serves a short-run rationing function and a long-run

guiding function in the marketplace.

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Chapter 3

• Comparative statics analysis

• Supply, demand, and price: The managerial

Copyright ©2014 Pearson Education, Inc. All rights reserved. 1-2

• Define supply, demand, and equilibrium price.

• List and provide specific examples of the non-price

• Distinguish between the short-run rationing function

• Illustrate how the concepts of supply and demand

• Use supply and demand diagrams to determine

• The demand for a good or service is defined

Copyright ©2014 Pearson Education, Inc. All rights reserved. 1-4

• “Ready” implies that consumers are prepared to

 Willing: Consumers have a preference for it.

 Able: Consumers have the income supporting

• Market demand is the sum of all the individual

• Individuals may have distinct demand curves, and

Example: Demand for pizza

Price QD1 QD2 QD3 QDM

Copyright ©2014 Pearson Education, Inc. All rights reserved. 1-6

• There is an inverse P ($)

Copyright ©2014 Pearson Education, Inc. All rights reserved. 1-7

Copyright ©2014 Pearson Education, Inc. All rights reserved. 1-8

• Changes in price result in changes in the quantity

 This is shown as movement along the demand

• Changes in non-price factors result in changes in

 This is shown as a shift in the demand curve.

Copyright ©2014 Pearson Education, Inc. All rights reserved. 1-9

Copyright ©2014 Pearson Education, Inc. All rights reserved. 1-10

• Non-price determinants of demand-result is a shift

 Tastes and preferences

 Prices of related products

Copyright ©2014 Pearson Education, Inc. All rights reserved. 1-11

• The supply of a good or service is defined

Quantities that people are ready to sell at various

(Other factors besides price held constant)

Copyright ©2014 Pearson Education, Inc. All rights reserved. 1-12

• Changes in price result in changes in the

• Changes in non-price determinants result in

Copyright ©2014 Pearson Education, Inc. All rights reserved. 1-13

Example: Supply of pizza

Price QS1 QS2 QS3 QSM

Copyright ©2014 Pearson Education, Inc. All rights reserved. 1-14

Copyright ©2014 Pearson Education, Inc. All rights reserved. 1-15

Copyright ©2014 Pearson Education, Inc. All rights reserved. 1-16

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• Non-price determinants of supply-results in a shift

 Costs and technology

 Prices of other goods or services offered by the

Copyright ©2014 Pearson Education, Inc. All rights reserved. 1-18

Copyright ©2014 Pearson Education, Inc. All rights reserved. 1-19

Copyright ©2014 Pearson Education, Inc. All rights reserved. 1-20

Copyright ©2014 Pearson Education, Inc. All rights reserved. 1-21

Copyright ©2014 Pearson Education, Inc. All rights reserved. 1-22

• Comparative statics: is a form of sensitivity

Copyright ©2014 Pearson Education, Inc. All rights reserved. 1-23

• Process of comparative statics analysis:

Copyright ©2014 Pearson Education, Inc. All rights reserved. 1-24

• Buyers’ demand and

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• and a new equilibrium

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Copyright ©2014 Pearson Education, Inc. All rights reserved. 1-29