w2 Topic 2a.mechanics of MKT-DD & Ss

TOPIC 2A
MECHANICS OF
MARKET:
Supply and Demand
Theory
©2016 Cengage Learning. All Rights Reserved. May not be scanned,

copied or duplicated, or posted to a publicly accessible website, in
whole or in part.
Learning Outcomes
• Explain the meaning of demand, law of demand
and market demand.
• Distinguish between a change in quantity demanded and a

change in demand.
• Describe the factors that cause a change in the demand

curve.
MARKET
● Any place people come together to trade
Trade or exchange
may take place at a
physical or virtual
location
©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
DEMAND - A DEFINITION
The willingness and ability of buyers:

● to purchase different quantities of a good
● at different prices
● during a specific time period.
LAW OF DEMAND
As the price of a good rises, the

quantity demanded of the good falls,
and as the price of a good falls, the
quantity demanded of the good rises,
ceteris paribus
Price Quantity
CETERIS PARIBUS
A Latin term meaning “all other things constant”

or “nothing else changes.”
Ceteris paribus is an assumption used to

examine the effect of one influence on an
outcome while holding all other influences
Constant.
Four Ways to Represent The Law
Of Demand
• In Words: “As price
rises, quantity
demanded falls”
• In Symbols: PQd
• In a Demand Schedule
• In a Demand Curve
DOWNWARD SLOPPING DEMAND
CURVE
The graphical representation of the demand
schedule and law of demand.
DEMAND - SCHEDULE AND GRAPH
WHY DOES QUANTITY DEMANDED GO DOWN AS
PRICE GOES UP?
Why are demand curves downward sloping?
 1.Substitution effect （替代效应） :

people substitute lower priced goods
for higher priced goods.
WHY DOES QUANTITY DEMANDED
GO DOWN AS PRICE GOES UP?
 2. Law of diminishing marginal utility, which
states that for a given time period, the marginal (or
additional) utility or satisfaction gained by
consuming equal successive units of a good will
decline as the amount consumed increases.
 Individuals obtain less utility from additional units of a goods.
 Therefore, they will only buy larger quantities of a good at
lower prices.
 The more (less) utility you receive from a unit of a good, the
higher (lower) the price you are willing to pay for it.
INDIVIDUAL DEMAND CURVE VS
MARKET DEMAND CURVE
● An Individual Demand Curve represents the price-
quantity combination of a particular single buyer.
● For example an Individual demand curve could show
the Jones’s demand for CDs.
● A Market demand curve represents the price-quantity

combination of a particular good for all buyers.
● In this case, the demand curve would show all buyers
demand for CDs.
DERIVATION OF MARKET DEMAND
SCHEDULE
DERIVATION OF MARKET DEMAND
CURVE
QUANTITY DEMANDED – A
DEFINITION
● Quantity Demanded is the number of units
(say 100 units of a good) that individuals are
willing and able to buy at a particular price
(say, $10 per unit) during a time period.
● This is different from demand which speaks
to the willingness and ability of buyers to buy
different quantities of a good at different
prices.
Change in Quantity Demanded
versus a Change in Demand
• Change in Quantity Demanded: a
movement from one point to another point
on the same demand curve caused by a
change in the price of the good (own price).
• Change in Demand: a shift in the demand
curve caused by 5 factors.
– Increase in demand: a shift to the right
– Decrease in demand: as shift to the left
INCREASE IN DEMAND
DECREASE IN DEMAND
FACTORS CAUSING A SHIFT IN THE
DEMAND CURVE
 Income
 Preferences
 Prices of related goods.
 Number of buyers
 Expectations of future prices
DEMAND CURVE - INCOME
Normal Good - A good the demand for which
rises (falls) as income rises (falls).
Inferior Good - A good the demand for which
falls (rises) as income rises (falls).
Neutral Good – A good the demand for which
does not change as income rises or falls.
DEMAND CURVE - PREFERENCES
Preferences
People’s preferences affect the amount of a good they
are willing to buy at a particular price.
A change in preferences in favor of a good shifts the
demand curve rightward.
A change in preferences away from the good shifts the
demand curve leftward.
For example, if people to favor Korean food more than
previously, the demand for Korean food increases, and
the demand curve shifts rightward.
DEMAND CURVE – PRICES OF
RELATED GOODS
Substitutes
Two goods that satisfy similar needs or desires.
If two goods are substitutes, the demand for one rises as
the price of the other rises (or the demand for one falls as
the price of the other falls). Eg Coke and Pepsi
Complements
Two goods that are used jointly in consumption.
If two goods are complements, the demand for one rises as
the price of the other falls (or the demand for one falls as
the price of the other rises). Eg Ketchup and hotdog
DEMAND CURVE – NUMBER OF
BUYERS
Number of Buyers
The demand for a good in a particular market area is
related to the number of buyers in the area.
More buyers, Higher demand;
Fewer buyers, Lower demand.
The number of buyers may increase owing to a heightened

birthrate, increased immigration, the migration of people from one
region of the country to another, and so on. The number of buyers
may decrease owing to an increased death rate, war the migration of
people from one region of the country to another, and so on.
DEMAND CURVE – EXPECTATIONS
OF FUTURE PRICE
Expectations of Future Price
Buyers who expect the price of a good to be higher next
month may buy it now, thus increasing the current (or
present) demand for the good.
Buyers who expect the price of a good to be lower next

month may wait until the next month to buy it, thus
decreasing the current (or present) demand for the
good.
Egs. Prices of houses; handphones.
A CHANGE IN DEMAND VERSUS A
CHANGE IN QUANTITY DEMANDED
SUPPLY
The willingness and ability of sellers to produce

and offer to sell different quantities of a good at
different prices during a specific time period.
LAW OF SUPPLY
As the price of a good rises, the quantity

supplied of the good rises, and as the price of a
good falls, the quantity supplied of the good
falls, ceteris paribus.
Price Quantity
SUPPLY CURVE
The graphical representation of the law of

supply, which states that price and quantity
supplied are directly related, ceteris paribus.
Why Supply Curves Slope
Upwards
• An Upward-sloping supply curve
reflects the fact that under certain
conditions:
1) a higher price is an incentive to
producers to produce more of a
good.
2) the law of increasing opportunity
costs.
- the opportunity costs rise when
more units of are good is produced,
so a higher price is necessary to
elicit more output.
Market Supply Curve
• The Market Supply Curve represents the
price-quantity combinations for all sellers
of a particular good.
• An Individual supply curve represents the
price-quantity combinations for a single
seller.
DERIVING A MARKET SUPPLY
CURVE
CHANGES IN SUPPLY
SHIFTS IN SUPPLY
 The supply of a good can rise or fall. An
increase in the supply of a good means that
suppliers are willing and able to produce and
offer to sell more of the good at all prices.
 The supply of a good decreases if sellers are
willing and able to produce and offer to sell
less of the good at all prices.
FACTORS THAT CAUSE THE SUPPLY
CURVE TO SHIFT
 Prices of relevant resources
 Technology
 Number of sellers
 Expectation of future prices
 Taxes and subsidies
 Government restrictions
SUPPLY CURVE – PRICES OF
RELEVANT RESOURCES
 Resources Price  Production Cost  Profit 

= Supply
 Resources Price  Production Cost  Profit 

= Supply
 Eg effect of price of wood on supply of new

houses.
FACTORS CAUSING A SHIFT IN THE
SUPPLY CURVE – TECHNOLOGY
 Improvements in technology (technique of

production) enable firms to produce units of
output with fewer resources.
 Advance in technology
 Because resources are costly, using fewer of
them lower production costs and increases
supply.
SUPPLY CURVE – NUMBER OF
SELLERS
 The larger the number of suppliers (more

firms enter an industry), the greater the
market supply.
 The supply curve will shift right.
 Vice versa.
SUPPLY CURVE – EXPECTATION OF
FUTURE PRICE
 If the price of a goods is expected to be

higher in the future, producers may hold back
some of the product today. Then, they will
have more to sell at the higher future price.
Therefore, the current supply curve shifts
leftward. Vice versa
SUPPLY CURVE – TAXES AND
SUBSIDIES
 An increase in sales taxes will increase

production cost and reduce supply. Supply
curve will shift left.
 If the government subsidizes the production

of a good, it in effect lowers the producers’
costs and increase supply. Supply curve will
shift right.
SUBSIDY – A DEFINITION
► Subsidies are a monetary payment by

government to a producer of a good or
service
► For example, suppose the government
subsidizes the production of corn by
paying corn farmers $2 for every bushel
they produce. Because of the subsidy, the
quantity supplied of the corn is greater at
each point, and the supply curve of the
corn shifts rightward. The removal of the
subsidy shifts the supply curve of corn
leftward.
SUPPLY CURVE – GOVERNMENT
RESTRICTIONS
 Sometimes government acts to reduce supply.

 An import quota (quantitative restriction on
foreign goods), and import licences reduce
the supply of particular good.
 Eg imported cars.
CHANGE IN SUPPLY
► A Change in any of these (shift)

factors can cause a change in supply.
► SS curve shift left or right.
1. Prices of Relevant Resources
2. Technology
3. Number of sellers
4. Expectations of Future Price
5. Taxes and Subsidies
6. Government Restrictions
CHANGE IN QUANTITY SUPPLIED
 A change in quantity supplied refers to a

movement along a supply curve.
 The only factor that can directly cause a
change in the quantity supplied of a good is a
change in the price of the good, or own price.
CHANGE IN QUANTITY SUPPLIED
► A change in this (movement)

factor will cause a change in
quantity supplied:
► 1. (A good’s) own price
A Change in Supply versus a Change in
Quantity Supplied
MARKET EQUILIBRIUM
 Equilibrium in a market is the price quantity

combination from which there is no tendency
for buyers or sellers to move away.
 Graphically, equilibrium is the intersection
point of the supply and demand curves.
PUTTING SUPPLY AND DEMAND
TOGETHER
The Market
Putting Supply and Demand Together
SURPLUS AND SHORTAGE
Surplus (Excess Supply) - A condition in

which quantity supplied is greater than
quantity demanded. Surpluses occur only at
prices above equilibrium price.
Shortage (Excess Demand) - A condition in
which quantity demanded is greater than
quantity supplied. Shortages occur only at
prices below equilibrium price.
EQUILIBRIUM
Equilibrium Price (Market- Clearing Price)

The price at which quantity demanded of the good
equals quantity supplied
Equilibrium Quantity
The quantity that corresponds to equilibrium price.
The quantity at which the amount of the good that
buyers are willing and able to buy equals the amount
that sellers are willing and able to sell, and both equal
the amount actually bought and sold.
DISEQUILIBRIUM
Disequilibrium
A state of either surplus or shortage in the
market
Disequilibrium Price
A price other than equilibrium price. A price at
which the quantity demanded does not equal the
quantity supplied.
Moving to Equilibrium
• Why does the price fall when there is a surplus?
• Why does the price rise when there is a shortage?
• Mutually beneficial trade drives the market towards
equilibrium.
MOVE TO MARKET EQUILIBRIUM
Why Does Price Fall When There is a Surplus?
 When there is a surplus, suppliers will not able to

sell all they had hoped to sell at equilibrium price.
As a result, their inventories will grow beyond the
level they hold in preparation for demand changes.
 Seller will want to reduce their inventories. Some
will lower prices to do so, some will cut back on
production, other will do a little of both. Finally,
there is a tendency for price and output to fall until
equilibrium is achieved.
MOVE TO MARKET EQUILIBRIUM
Why Does Price Fall When There is a Surplus?
 When there is a surplus, suppliers will not able to

sell all they had hoped to sell at equilibrium price.
As a result, their inventories will grow beyond the
level they hold in preparation for demand changes.
 Seller will want to reduce their inventories. Some
will lower prices to do so, some will cut back on
production, other will do a little of both. Finally,
there is a tendency for price and output to fall until
equilibrium is achieved.
MOVING TO EQUILIBRIUM
Why Does Price Rise when there is Shortage?
 When there is shortage, buyers will not be able to

buy all they had hoped to buy at equilibrium price.
 Some buyers will bid up the price to get sellers to
sell to them instead of to other buyers. Some sellers,
seeing buyers clamour for the goods, will realize that
they can raise the price on the goods they have for
sale. Higher prices will also call forth added output.
 Thus, there is a tendency for price and output to rise
until equilibrium is achieved.
What Can Change Equilibrium
Price and Quantity
• Whenever demand or supply changes or both
change, equilibrium price and quantity change.
• Demand rises and supply is constant:
Equilibrium price rises, Equilibrium quantity rises.
• Demand falls, supply is constant: Equilibrium
price falls, Equilibrium quantity falls.
• Supply rises, demand is constant: Equilibrium
price falls, Equilibrium quantity rises.
• Supply falls, demand is constant: Equilibrium
price rises, Equilibrium quantity falls.
Equilibrium Price and Quantity Effects of
Supply Curve Shifts and Demand Curve Shifts
Price Controls
• There are two types of price controls: price ceilings
and price floors.
• Price Ceiling: a government mandated maximum
price above which legal trades may not be made.
- For example, the Domestic Trade and Consumer Affairs
Ministry in this country mandates the maximum price
for chillies at RM9 per kilo.
• Price Ceilings may cause:
1) Shortages: Qty. demanded > qty. supplied
2) Fewer Exchanges: it prevents mutually
advantageous trades from being realized.
Price Controls
• A price floor is a government mandated
minimum price below which legal trades
cannot be made.
• Price floors can cause Surpluses and Fewer
Exchanges.
• Qty supplied > Qty demanded.

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TOPIC 2A

©2016 Cengage Learning. All Rights Reserved. May not be scanned,

• Distinguish between a change in quantity demanded and a

• Describe the factors that cause a change in the demand

● Any place people come together to trade

The willingness and ability of buyers:

As the price of a good rises, the

A Latin term meaning “all other things constant”

Ceteris paribus is an assumption used to

 1.Substitution effect （ 替代效应 ） :

● A Market demand curve represents the price-quantity

The number of buyers may increase owing to a heightened

Buyers who expect the price of a good to be lower next

The willingness and ability of sellers to produce

As the price of a good rises, the quantity

The graphical representation of the law of

 Resources Price  Production Cost  Profit 

 Resources Price  Production Cost  Profit 

 Eg effect of price of wood on supply of new

 Improvements in technology (technique of

 The larger the number of suppliers (more

 If the price of a goods is expected to be

 An increase in sales taxes will increase

 If the government subsidizes the production

► Subsidies are a monetary payment by

 Sometimes government acts to reduce supply.

► A Change in any of these (shift)

 A change in quantity supplied refers to a

► A change in this (movement)

 Equilibrium in a market is the price quantity

Surplus (Excess Supply) - A condition in

Equilibrium Price (Market- Clearing Price)

Why Does Price Fall When There is a Surplus?

 When there is a surplus, suppliers will not able to

Why Does Price Fall When There is a Surplus?

 When there is a surplus, suppliers will not able to

Why Does Price Rise when there is Shortage?

 When there is shortage, buyers will not be able to

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 1.Substitution effect （替代效应） :