Chapter 4

Demand, Supply,

and Markets

© 2009 South-Western/Cengage Learning

22

Demand

Demand:a demand schedule (curve, function) shows the quantities buyers are willing and able to buy at various prices for a given time period

Price:amount of money given up to purchase 1 unit of the good

3

Law of Demand

• Law of demand

– Quantity demanded varies inversely with price, other things constant• Higher price: lower quantity demanded

4

Law of Demand

• Substitution effect– shows the change in consumption

resulting from the change in the relative price of the good

– lower price• lower relative price• buy more of the relatively cheaper good and

less of the relatively more expensive good

5

Law of Demand

• Income effect– shows the change in consumption

resulting from the change in the purchasing power of the consumer’s income

– lower price• Greater real income• Increase ability to purchase all goods

6

Demand Schedule and Demand Curve

• Demand schedule– Possible prices

– Quantity demanded at each price

– Law of demand

• Demand curve– Downward slope

– Law of demand

7

Demand Shifters

1. Consumer incomenormal good (I increases Qd increases )

inferior good (I increases Qd decreases)

2. Prices of other goodssubstitutes (Py increases Qx increases)

complements (Py increases Qx decreases)

3. Consumer expectations

4. Population

5. Consumer tastes / preferences

8

Supply

Supply:a supply schedule (curve, function) shows the quantities producers will produce at various prices for a given time period.

9

Law of Supply

• Law of supply?– Quantity supplied is directly related to its

price, other things constant• usually upward sloping

– Higher price: higher quantity supplied• Higher reward, profit

– More willing to increase quantity supplied

• Can afford to cover the marginal costs– Increasing opportunity cost– More able to increase quantity supplied

10

Supply Shifters

1. Technology

2. Input prices

3. Prices of related goods

4. Producer expectations

5. Number of producers in the market

6. Government policies

7. Natural disastersweather, earthquakes, floods, etc.

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Market Equilibrium• An equilibrium exists when all who wish to buy may

do so and all who wish to sell may do so (at the existing price)

Qd = Qs

• Surplus: Qd < Qs

– Downward pressure on price• Decrease quantity supplied• Increase quantity demanded

• Shortage: Qd > Qs

– Upward pressure on price• Increase quantity supplied• Decrease quantity demanded

If Demand shifts

Increase in Demand:

(shift right)

increase P*

increase Q*

Decrease in Demand:

(shift left)

decrease P*

decrease Q*

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If Supply shifts

Increase in Supply:

(shift right)

decrease P*

increase Q*Decrease in Supply:

(shift left)

increase P*

decrease Q*13

If both Supply and Demand shift

• Who can tell what will happen??– depends on the magnitude and direction

of the shifts

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Exhibit 9Effects of both demand and supply

15

Demand increases

Demand decreases

SupplyIncreases

Equilibrium price change is indeterminate.

Equilibrium quantity increases.

Equilibrium price falls.

Equilibrium quantity change is indeterminate.

Supplydecreases

Equilibrium price rises.

Equilibrium quantity change is indeterminate.

Equilibrium price change is indeterminate.

Equilibrium quantity decreases.

Change in demandC

ha

nge

in s

up

ply

Disequilibrium

• Surplus– downward pressure on P

• Shortage– upward pressure on P

• Disequilibrium– Temporary, or

– Result of government intervention • Price floors• Price ceilings

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Disequilibrium

• Price Floors– minimum price below which the market

price cannot fall

– creates a surplus

– distort markets

– reduce economic welfare

How do we allocate scarce resources?

Unintended consequences!!17

Disequilibrium

• Price Ceilings – maximum price above which the market

price cannot rise

– creates a shortage

– distort markets

– reduce economic welfare

How do we allocate scarce resources??

Unintended consequences!!18