Demand, Supply and Market Equilibrium

Demand

Demand is the amount of a product that people are willing and able to purchase at each possible price during a given period of time.

The quantity demand is the amount of a product that people are willing and able to purchase at one, specific price.

The Law of Demand

Law of demand there is an inverse relationship between price and quantity demanded (ceteris paribus).

Quantity demanded rises as price falls, other things constant.Quantity demanded falls as prices rise, other things constant.Why?

Price per DVDs (in dollars) A Demand CurveQuantity of DVDs demanded (per week)123456789101112 13$6.005.00 4.00 3.00 2.00 1.00 .50 03.50From a Demand Table to a Demand Curve

Change in Quantity DemandedD1

Change in Demand250

Shift Factors of Demand

IncomeThe prices of other goodsTastesExpectationsNumber of Buyers

Consumer IncomeNormal Good$3.002.502.001.501.000.50213456789101211Price of Ice-Cream ConeQuantity of Ice-Cream Cones0Increasein demandAn increase in income...D1D2

Consumer IncomeInferior Good$3.002.502.001.501.000.50213456789101211Price of Ice-Cream ConeQuantity of Ice-Cream Cones0Decreasein demandAn increase in income...D1D2

Prices of Related GoodsSubstitutes & ComplementsWhen a fall in the price of one good reduces the demand for another good, the two goods are called substitutes.When a fall in the price of one good increases the demand for another good, the two goods are called complements.

Consumer TasteIf there is a change in taste in favor of a commodity, the demand for that commodity will increase and demand curve will shift to the right, and vice versa.

A taste can be affected by advertisement

Expectation and PopulationIf consumer expect that prices will rise in future, the current demand will increase .

The market demand for a product is also influenced by changes in the size and composition of the population.

Other Factors - Weather - Health Scares

Individual and Market Demand CurvesA market demand curve is the horizontal sum of all individual demand curves.This is determined by adding the individual demand curves of all the demanders.

From Individual Demandsto a Market Demand CurveMarket demand

SupplyQuantity supplied is the amount of a good that sellers are willing and able to sell.

The Law of SupplyThere is a direct relationship between price and quantity supplied (ceteris paribus).

Quantity supplied rises as price rises, other things constant.

Quantity supplied falls as price falls, other things constant.

Why?

Supply Curve$3.002.502.001.501.000.50213456789101211Price of Ice-Cream ConeQuantity of Ice-Cream Cones0

Quantity supplied refers to a specific amount that will be supplied at a specific price.Changes in price causes changes in quantity supplied represented by a movement along a supply curve.A movement along a supply curve the graphic representation of the effect of a change in price on the quantity supplied.

Shifts in Supply Versus Movements Along a Supply Curve

Change in Quantity Supplied1 5Price of Ice-Cream ConeQuantity of Ice-Cream Cones0S 1.00ACA rise in the price of ice cream cones results in a movement along the supply curve.

If the amount supplied is affected by anything other than a change in price, there will be a shift in supply.Shift in supply the graphic representation of the effect of a change in a factor other than price on supplyShifts in Supply Versus Movements Along a Supply Curve

Change in SupplyPrice of Ice-Cream ConeQuantity of Ice-Cream Cones0S1

Shift Factors of SupplyOther factors besides price affect how much will be supplied:

Prices of ResourcesPrices of Other GoodsTechnologySuppliers expectationsGovernment RegulationsNumber of Suppliers

From Individual Supplies to a Market Supply

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16From Individual Supplies to a Market SupplyPrice per DVDQuantity of DVDs supplied (per week)$4.003.50 3.00 2.50 2.00 1.50 1.00 0.50 0

Equilibrium

In a free market, the forces of supply and demand interact to determine equilibrium quantity and equilibrium price.

When the market is not in equilibrium, you get either excess supply or excess demand, and a tendency for price to change.

Excess Supply, Excess DemandExcess supply a surplus, the quantity supplied is greater than quantity demandedPrices tend to fall.Excess demand a shortage, the quantity demanded is greater than quantity suppliedPrices tend to rise.

Price AdjustsThe greater the difference between quantity supplied and quantity demanded, the more pressure there is for prices to rise or fall.

When quantity demanded equals quantity supplied, prices have no tendency to change.

The Interaction of Demand and Supply

Price (per DVD)

Quantity Supplied

Quantity Demanded

Surplus (+) Shortage (-)

$3.50

7

3

+4

$2.50

5

5

0

$1.50

3

7

-4

The Interaction of Demand and SupplyPrice per DVD$5.00 4.00 3.50 3.00 2.50 2.00 1.50 1.00SDQuantity of DVDs supplied and demanded123456789101112

Shifts in Supply and DemandShifts in either supply or demand change equilibrium price and quantity.

An increase in demand creates excess demand at the original equilibrium price.

The excess demand pushes price upward until a new higher price and quantity are reached.

Price (per DVDs)AS0Quantity of DVDs (per week)$2.502.2509810Increase in DemandD0

Decrease in SupplyA decrease in supply creates excess demand at the original equilibrium price.

The excess demand pushes price upward until a new higher price and lower quantity are reached.

ADecrease in SupplyPrice (per DVDs)Quantity of DVDs (per week)$2.502.2509810D0S0

Price Ceiling

Price Floor

The Demand Function

A general equation representing the demand curve Qxd = f(Px , PY , M, H) Qxd = quantity demand of good X. Px = price of good X. PY = price of a related good Y. Substitute good. Complement good. M = income. Normal good. Inferior good. H = any other variable affecting demand.

Inverse Demand Function

Price as a function of quantity demanded.Example: Demand Function Qxd = 10 2PxInverse Demand Function: 2Px = 10 Qxd Px = 5 0.5Qxd

The Supply Function An equation representing the supply curve: Qxs = f(Px , PR ,W, H,)

QxS = quantity supplied of good X. Px = price of good X. PR = price of a production substitute. W = price of inputs (e.g., wages). H = other variable affecting supply.

Inverse Supply FunctionPrice as a function of quantity supplied.

Example: Supply Function Qxs= -10 + 2Px

Inverse Supply Function: 2Px = 10 + Qxs Px = 5 + 0.5Qxs

Market EquilibriumDemand Function Q = 10 2PSupply Function Q = -5 + 3P

What is Equilibrium P and Q ?

Market EquilibriumDemand Function Qd = 10 2PSupply Function Qs = -5 + 3P

Equilibrium P and Q ? P = 3 and Q = 4

***15Use the Cold Soda example from page 64-65 in the Instructors Manual. Shows very nicely the two different demand curves. *25*25*25*29*30*30**