Demand, Supply and

Market Equilibrium
PROF. VANITA SINGH
MDI, GURGAON
Corporate Decision Making : The Toyota Prius
• Economics in introducing “Prius”, first
hybrid car
• How the public would react to design and
performance – Consumer preferences,
demand and pricing dynamics
• Cost of manufacturing, profit-maximizing
output, cost of inputs and raw material
affecting the total cost
• Pricing strategy and competitors
Public Policy Design: Fuel Efficiency Standards
for the Twenty-First Century
In 1975, the U.S. government imposed regulations designed to improve the average
fuel economy of domestically-sold cars and light trucks. The CAF E (Corporate Average
Fuel Economy) standards have become increasingly stringent over the years.
A number of important decisions have to be made when designing a fuel efficiency
program, and most of those decisions involve economics.
First, the government must evaluate the monetary impact of the program on
consumers. – Cost of achieving higher fuel economy – who will bear that cost?
Before imposing CAF E standards, it is important to estimate the likely impact those
standards will have on the cost of producing cars and light truck.
Quick Recap
• You had 50,000 rupees deposited in your bank account and you were getting
interest on the same. You decided to put this money in share market.
• What is the opportunity cost for your investment decision?

• You have 50 rupees and you can buy five slices of one small pizza. With pizza
you want to have coke (10 rs.), what will be your trade-off?
• If opportunity cost of producing one additional unit of good A is less for a
country it has a …………………….advantage
• To produce 10 more units of honey, country A has to give up 15 units of Maple
syrup while country B has to give up on 10 units of maple syrup. Which country
has comparative advantage in production of honey
Topics for today
• Where prices come from?
• Demand side of the market
• Supply side of the market
• Interaction of demand and supply
• Market equilibrium
Market
• Supply and demand are the forces that make market economies work
• A market is a group of buyers and sellers of a particular good or service.
• A competitive market is a market in which there are many buyers and sellers so
that each has a negligible impact on the market price.
Market Structures – At a Glance
Conditions for Perfect Competition
• 1) For an industry to be perfectly competitive, it must contain many producers,
none of whom have a large market share.
• A producer’s market share is the fraction of the total industry output represented by
that producer’s output.

• 2) An industry can be perfectly competitive only if consumers regard the

products of all producers as equivalent.
• A good is a standardized product, also known as a commodity, when consumers
regard the products of different producers as the same good.
Assumption for Competitive Markets
• The model of supply and demand which leads to this ‘efficient’ outcome is
based on the following:
• Many buyers and sellers.
• Perfect information for all buyers and sellers.
• Freedom of entry and exit.
• Identical goods.
• Buyers and sellers act in self interest.
Law of Demand
• Quantity demanded is the amount of a good that buyers are willing and able to
purchase.
• Law of Demand is the claim that, other things equal, the quantity demanded of a
good falls when the price of the good rises.
• Demand schedule: A table that shows the relationship between the price of a
product and the quantity of the product demanded.
What Explains Law of Demand
• Assume the price of milk falls.
• More will be demanded because of the income and substitution effects.
• The income effect. Assume that incomes remain constant then a fall in the
price of milk means that consumers can now afford to buy more with their
income. Increased purchasing power will lead consumers to purchase larger
quantity of good.
• The substitution effect. Milk is lower in price compared to other similar
products so some consumers will choose to substitute the more expensive
drinks with the now cheaper milk.
Demand Curve
Individual Demand Vs Market Demand- Exercise
• Scenario 1: You are a consumer of goods
Product Individual Market
for sale in our classroom "store". You have Quantities Quantities
a total income of $5 to spend on goods. Choco-bar
You may buy any number of the products [$1]
that you desire (as long as you spend only Chips [$1]
$5) and you certainly don’t have to Coke [$1]
purchase all of the products, but you must
spend all of your income. The prices of
the products for sale are listed in the table.
• *Only enter individual quantities
Individual Demand Vs Market Demand- Exercise
• Scenario 2: You have a total income
Product Individual Market
of $5 to spend on goods. You may Quantities Quantities
buy any number of the products that Choco-bar
[$2]
you desire (as long as you spend
Chips [$1]
only $5) and you certainly don’t
Coke [$1]
have to purchase all of the products,
but you must spend all of your
income. The prices of the products
for sale are listed in the table.
• *Only enter individual quantities
Individual Demand Vs Market Demand- Exercise
Product Individual Market
• Scenario 3/4: You received scholarship Quantities Quantities
support and now, you have a total Choco-bar
[$1]
income of $8 to spend on goods. You may
Chips [$1]
buy any number of the products that you
Coke [$1]
desire (as long as you spend only $8) and
you certainly don’t have to purchase all of
Product Individual Market
the products, but you must spend all of Quantities Quantities
your income. The prices of the products Choco-bar
[$2]
for sale are listed in the table.
Chips [$1]
• *Only enter individual quantities
Coke [$1]
Group Exercise
• Get in your groups, and determine the "Market Quantities" for situation 1, 2, 3
and situation 4 only (simply sum the quantities demanded for each product at
each price level over all individuals) and log the values in the spaces provided
(market quantities) above.
• Draw the demand curve for situation 1-2 and situation 3-4
Shifts Versus Movements Along The Demand
Curve
• Ceteris paribus - other factors affecting demand are held constant so that we can
analyze the effect of a change in price on demand.
• A shift in the demand curve is caused by a factor affecting demand other than a
change in price.
• Movement along the demand curve.
• Caused by a change in the price of the product.
 Movement Along the Curve: Changes In Quantity
Demanded
Price of milk

A tax that raises the

price milk results in a
B movement along the
€1.20
demand curve.

A
€0.60

D
0 4 8 Quantity of milk
 Shifts in the Demand Curve
Price of
milk

Increase
in demand

Decrease
in demand
Demand
curve, D2
Demand
curve, D1
Demand curve, D3
0 Quantity of milk
 Shifts in the Demand Curve
• A shift in the demand curve, to the left or right.
• Caused by any change that alters the quantity demanded at every given
price.
• Shifts caused by factors other than price.
1) Prices of related goods (substitutes and complements)
• Substitutes: two goods for which an increase in the price of one good leads
to an increase in the demand for the other.
• ? Perk Chocolate bar vs Kitkat
• Complements: two goods for which an increase in the price of one good
leads to a decrease in the demand for the other.
• ? Bread and Butter
Shifts in the Demand Curve
2) Income
• If the demand for a good falls when income falls or rises as income rises, the
good is called a normal good.
• If the demand for a good rises when income falls, the good is called an
inferior good.
3) Tastes. More people may like something
4) Population and Demographics
5) Expected Future Prices where demand is influenced by expectations of
future income and future prices
 Effect of Consumer Income- Normal
Good
Price of milk

€ 1.20 An increase
1.00 in income...
Increase
0.80 in demand

0.60

0.40

0.20
D2
D1 Quantity of
milk
0 1 2 3 4 5 6 7 8 9 10 11 12
 Effect of Consumer Income-
Inferior Good
Price inferior
good
€ 1.50

An increase
1.00
in income...
Decrease
in demand
0.50

D2 D1 Quantity of
inferior
0 1 2 3 4 5 6 7 8 9 10 11 12 good
Supply Side of the Market
• Quantity supplied is the amount of a good that sellers are willing and able to sell.
• Law of supply is the claim that, other things equal, the quantity supplied of a good rises
when the price of the good rises.
• Supply Schedule
• The supply schedule is a table that shows the relationship between the price of the good
and the quantity supplied
• Supply Curve
• The supply curve is the graph of the relationship between the price of a good and the
quantity supplied.
 Market Supply versus
Individual Supply
• Market supply refers to the sum of all individual
supplies for all sellers of a particular good or service.
The Market Supply

• Graphically, individual supply curves are summed

horizontally to obtain the market supply curve.
Shifts in Supply Curve
• Changes in supply can be caused
by changes in,
• Production Technology
• The prices of inputs/resources used
in production
• The prices of alternative goods
• Producer expectations
• The number of producers
Market Equilibrium
• Equilibrium Price
• The price that balances quantity
supplied and quantity demanded.
• On a graph, it is the price at which the
supply and demand curves intersect.
• Equilibrium Quantity
• The quantity supplied and the quantity
demanded at the equilibrium price.
• On a graph it is the quantity at which
the supply and demand curves intersect.
Markets Move Toward Equilibrium
• An economic situation is in equilibrium when no individual would be better off
doing something different.
• Anytime there is a change, the economy will move to a new equilibrium.
• In market economies, prices are the signals that guide economic decisions and
thereby allocate resources.
• Ex.: What happens when a new checkout line opens at a busy supermarket?
 Analyzing Changes in Equilibrium

① Decide whether the event shifts the supply or demand curve (or both).
② Decide whether the curve(s) shift(s) to the left or to the right.
③ Use the supply and demand diagram to see how the shift affects equilibrium price and
quantity.
What Happens to Price and Quantity When Supply
or Demand Shifts?
Moving Away from Equilibrium
•Surplus
• When price > equilibrium price, then quantity supplied > quantity demanded.
• There is excess supply or a surplus.
• Suppliers will lower the price to increase sales, thereby moving toward equilibrium.

•Shortage
• When price < equilibrium price, then quantity demanded > the quantity supplied.
• There is excess demand or a shortage.
• Suppliers will raise the price due to too many buyers chasing too few goods, thereby moving
toward equilibrium.
Prices Allocate Resources in Market Economies
• Luxury of living by the beach
• Who gets this resource?
• Are market economies fair in allocation of resources??
Making the Connection
• Decrease in price will cause an increase in demand
• Is this correct?
• The decrease in price will cause a movement along with demand curve, but not
an increase in demand.
• Why? The demand curve already describes how much of the good consumers
want to buy, at any given price.
• When the price change occurs, we just look at the demand curve to see what
happens to how much consumers want to buy.
Problems and Applications
• There is drought in a region and the prices of fruits rises in that region
• Market for smartphones
• Effect of technological advances

• Market for chocolate bars:

• Qd = 1600 – 300P
• Qs = 1400 +700P
• Calculate equilibrium price and equilibrium quantity
Thank You!!