Econ 102: Supply, Demand, and Competitive

Equilibrium
2/12/2021
 Outline
• Demand Curve
– Consumer surplus
– Shifts of demand curve
• Supply Curve
– Producer surplus
– Shifts of supply curve
• Competitive Equilibrium
– How supply and demand determine market price and quantity
– Efficiency of competitive equilibrium
– Effects of supply and demand shifts
 Demand Curve
• Shows relationship between price of good and how much
people want to buy

• Quantity on x-axis, price on y-axis

– Marshallian demand

• Example: Market for oil

Demand Curve
 Law of Demand
• Demand curve is downward sloping
– As prices fall, people consume more
• Known as the law of demand
• Why?
– Oil: Not all uses of oil equally valuable
• Jet fuel vs. Plastic bottles
– Pizza: Not all slices of pizza equally valuable
• First piece of pizza vs. Eighth piece of pizza
• Key insight: demand curve represents benefit of
additional consumption
 Consumer Surplus
• Consumer surplus equal to difference between
consumer’s value for a good and the price they pay for it
– Example: If my value of having an iPhone is $1500 and I pay
$1000 for it, I have a consumer surplus of $500
– Measures consumer’s gains from trade
• Total consumer surplus: sum of all individual consumer
surplus
– In graph, area between price and demand curve
Consumer Surplus
 Demand Curve Shifters
• Demand curve shows effect of price on quantity
demanded
• Other determinants of demand shift demand curve
– Shift can be increase or decrease in demand
– Income
• Normal vs. Inferior Good
– Price of related goods
• Complements vs. substitutes
– Tastes
– Expectations
– Number of buyers
Demand Curve Shifters
 Supply Curve

• Shows relationship between price of good and how much

people want to sell

• Quantity on x-axis, price on y-axis

– Just like demand

• Market for oil again

Supply Curve
 Law of Supply

• Supply curve is upward sloping

– As prices rise, people want to sell more
• Known as the law of supply
• Why?
– Oil: Not all oil equally costly to extract
• Saudi oil vs. Oklahoma oil
• Key insight: supply curve represents the cost of additional
production
 Producer Surplus

• Producer surplus equal to difference between price and

producer’s cost to make a good
– Example: If designing and producing an iPhone costs Apple
$500 and they sell it for $1000, Apple’s producer surplus is
$500
– Measures producer’s gains from trade
• Total producer surplus: sum of all individual producer
surplus
– In graph, area between price and supply curve
Producer Surplus
 Supply Curve Shifters

• Supply curve shows effects of price on quantity supplied

• Other determinants of supply shift supply curve
– Shift can be increase or decrease in supply
– Price of inputs
– Technology
– Expectations
– Number of suppliers
Supply Curve Shifters
 Competitive Equilibrium
• Price and quantity where supply equals demand
– Prediction about what will happen in market
• If price is below equilibrium price:
– Quantity demanded exceeds quantity supplied
– Shortage
• If price is above equilibrium price:
– Quantity supplied exceeds quantity demanded
– Surplus
Competitive Equilibrium
 Total Surplus

• Total surplus is sum of consumer and producer surplus

– TS = CS + PS
– Equal to total gains from trade
• Notice that TS = Benefit to Consumers – Cost to Producers
– Measure of total societal welfare
• In competitive equilibrium TS is area between supply and
demand curve
Total Surplus
 Markets and Welfare
• Social planner
– Basically a dictator
• But not evil
• Wants to make society as a whole as best off as possible
• Tries to maximize total surplus
• Can social planner improve on market outcome?
– No!
– Why not? Market equates benefit of additional consumption
and cost of additional production
Markets and Welfare
Example: Market for Gasoline and Iraq Invasion

• U.S. Invaded Iraq in March 2003

Market for Gasoline in 2003

1.700 16000
Price
1.650
Quantity 15500
1.600

Millions of Gallons
Dollars Per Gallon

15000
1.550

• Caused price of oil to increase 1.500

1.450
14500

14000
1.400

1.350 13500
2003-01-01 2003-02-01 2003-03-01 2003-04-01 2003-05-01 2003-06-01 2003-07-01

Month

• Supply shock: price of inputs

Example: Housing Market and Fed Funds Rate

• Demand shock: priceFedof complement

Housing
FundsFed
Rate
Market
1.40
Funds
and2016-2017
Rate
Home Prices

5800000
1.20 Home Sales 200.00
200.00
Fed Funds Rate
1.20 198.00
5700000 Case-Shiller Index
1.00 Case-Shiller Index 196.00
195.00
1.00 5600000
194.00
0.80
5500000 192.00
190.00
0.80

Number of Units

Index Value
0.60
5400000 190.00

Index Value
Percent
0.60
Percent
188.00
185.00
5300000
0.40
186.00
0.40
5200000 180.00
184.00
0.20
0.20 5100000 182.00
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