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Market equilibrium (a
mathematical approach)
(Chapter 2: 2.1-2.4)

The Demand Function

The quantity of a good or service that consumers demand
depends on price and other factors such as consumers’
incomes and the prices of related goods.
The demand function describes the mathematical
relationship between quantity demanded (Qd), price (p)
and other factors that influence purchases:

𝑄𝑑 = 𝐷(𝑝, 𝑝𝑠 , 𝑝𝑐 , 𝑌)

◦ p = per unit price of the good or service

◦ ps = per unit price of a substitute good
◦ pc = per unit price of a complementary good
◦ Y = consumers’ income

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The Supply Function

The quantity of a good or service that firms supply depends
on price and other factors such as the cost of inputs that
firms use to produce the good or service.
The supply function describes the mathematical
relationship between quantity supplied (Qs), price (p) and
other factors that influence the number of units offered for
sale:
𝑄𝑠 = 𝑆(𝑝, 𝑝ℎ )

◦ p = per unit price of the good or service

◦ ph = per unit price of other production factors

Equilibrium Price
Under perfect competition, the market price is independent of any one
agent’s actions: it is the actions of all the agents (buyers and sellers)
together that determine the market price
The equilibrium price of a good is that price where the quantity
supplied of the good equals to the quantity demanded.
If we let D(p) be the market demand curve and S(p) the market supply
curve, the equilibrium price is the price 𝑝∗ that solves the equation:
𝐷 𝑝∗ = S(𝑝∗ )

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Inverse Demand and Supply Curves

As indicated earlier, individual demand (supply) curves are often viewed as
giving the quantities demanded (supplied) as a function of price charged
◦ We can view them as “inverse demand functions” that measure the price someone
is willing to pay in order to acquire some given amount of a good (and similarly for
supply curves)

Thus if we let 𝑃𝑠 (𝑞 ∗) be the inverse supply function and 𝑃𝐷 (𝑞 ∗) be the inverse

demand function, equilibrium is determined by the condition
𝑃𝑠 (𝑞 ∗ ) =𝑃𝐷 (𝑞 ∗ )

◦ Interpretation: equilibrium is determined by finding that quantity at which the

amount of the buyers are willing to pay to consume that quantity is the same as the
price that sellers must receive to sell that quantity

Example 1: Equilibrium with

Linear Demand and Supply Curves
Suppose that both the demand and supply curves are linear and take
the forms:
𝐷 𝑝 = 𝑎 − 𝑏𝑝
𝑆 𝑝 = 𝑐 + 𝑑𝑝
◦ The coefficients (a,b,c,d) are the parameters that determine the intercepts
and slopes of these linear curves.

The equilibrium price can be found by equating D(p) and S(p) and
solving the equation in terms of price (𝑝∗ ):

𝐷 𝑝 = 𝑎 − 𝑏𝑝 = 𝑐 + 𝑑𝑝 = 𝑆(𝑝)
𝑎−𝑐
𝑝∗ =
𝑑+𝑏

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Example 1: Equilibrium with Linear

Demand and Supply Curves (cont.)
We can check the equilibrium quantity demanded=quantity supplied by
substituting the equilibrium price into the demand and supply function:
The equilibrium quantity demanded is:

𝐷 𝑝∗ = 𝑎 − 𝑏𝑝∗
(𝑎−𝑐)
=𝑎−𝑏
(𝑏+𝑑)

𝑎𝑑 + 𝑏𝑐
=
(𝑏 + 𝑑)
And similarly for the equilibrium quantity supplied

Example: Equilibrium with Linear

Demand and Supply Curves (cont.)
We can also solve this problem by using the inverse demand and supply curves.
First, we need to find the inverse demand curve. At what price is some quantity
demanded?
◦ Substitute q for D(p) and solve for p. We have:
𝑞 = 𝑎 − 𝑏𝑝 (initial demand function), so
(𝑎 − 𝑞)
𝑃𝐷 𝑞 =
𝑏
In the same manner we find
(𝑞 − 𝑐)
𝑃𝑠 𝑞 =
𝑑
Setting the demand price equal to the supply price and solving for the equilibrium
quantity we have:
(𝑎 − 𝑞) (𝑞 − 𝑐)
𝑃𝐷 𝑞 = = = 𝑃𝑆 𝑞
𝑏 𝑑
(𝑎𝑑 + 𝑏𝑐)
𝑞∗ =
𝑏+𝑑

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A Numerical Example:
Canadian Pork: Demand
Example: estimated demand function for pork in Canada.

• Qd = quantity of pork demanded (million kg per year)

• p = price of pork (in Canadian dollars per kg)
• pb = price of beef, a substitute good (in Canadian dollars per kg)
• pc = price of chicken, another substitute (in Canadian dollars per kg)
• Y = consumers’ income (in Canadian dollars per year)

Graphically, we can only depict the relationship between Qd and p, so

we hold the other factors constant.

A Numerical Example: Canadian Pork: Demand

(cont.)

Assumptions about pb, pc, and Y

to simplify equation
◦ pb = $4/kg
◦ pc = $3.33/kg
◦ Y = $12.5 thousand

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A Numerical Example: Canadian Pork: Demand (cont.)

◦ Changing the own-price of
pork simply moves us along an
existing demand curve.

◦ Changing one of the things

held constant (e.g. pb, pc, and
Y) shifts the entire demand
curve.

A Numerical Example:
Canadian Pork: Supply
We often work with a linear supply function.
Example: estimated supply function for pork in Canada.

◦ Qs = quantity of pork supplied (million kg per year)

◦ p = price of pork (in Canadian dollars per kg)
◦ ph = price of hogs, an input (in Canadian dollars per kg)

Graphically, we can only depict the relationship between Qs and

p, so we hold the other factors constant.

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A Numerical Example: Canadian Pork: Supply (cont.)

◦ Assumption about ph to
simplify equation
◦ ph = $1.50/kg
◦ The supply function:

dQs dp 1
 40   slope
dp dQs 40

A Numerical Example: Canadian Pork: Supply

(cont.)
◦ Changing the own-price of pork
simply moves us along an
existing supply curve.

◦ Changing one of the things held

constant (e.g. ph) shifts the entire
supply curve.

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A Numerical Example: Canadian

Pork: The Equilibrium
The interaction between consumers’ demand curve
and firms’ supply curve determines the market price
and quantity of a good or service that is bought and
sold.
Mathematically, we find the price that equates the
quantity demanded, Qd, and the quantity supplied, Qs:
• Given Qd  286  20 p and Qs  88  40 p , find p such
that Qd = Qs:
286  20 p  88  40 p
p* = $3.30

A Numerical Example: Canadian Pork:

The Equilibrium (cont.)
Graphically, market equilibrium occurs where the demand and
supply curves intersect.
• At any other price, excess supply or excess demand results.
• Natural market forces push toward equilibrium Q and p.

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Shocking the Equilibrium:

Comparative Statics
Changes in a factor that affects demand, supply, or a new
government policy alters the market price and quantity of a
good or service.
Changes in demand and supply factors can be analyzed
graphically and/or mathematically.
• Graphical analysis should be familiar from your introductory
microeconomics course.
• Mathematical analysis simply utilizes demand and supply
functions to solve for a new market equilibrium.
Changes in demand and supply factors can be large or small.
• Small changes are analyzed with calculus.

Shocking the Equilibrium: Comparative Statics in

general demand and supply functions
Demand and supply functions are written as general
functions of the price of the good, holding all else constant:

• Supply is also a function of some exogenous (not in firms’

control) variable, a:
Because the intersection of demand and supply determines
the price, p, we can write the price as an implicit function
of the supply-shifter, a:
Q  S  p(a), a 
In equilibrium:

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Shocking the Equilibrium: Comparative Statics in

general demand and supply functions (cont.)
Given the equilibrium condition
, we differentiate with respect to a using the
chain rule to determine how equilibrium is affected by a
small change in a:

Rearranging:

Comparative Statics: When demand

and supply curves are linear
◦ Suppose the linear demand curve shifts to the right in a
parallel way: some fixed amount more is demand at every
price, the equilibrium price and quantity must both rise
◦ We can check that by the previous example of linear
demand and supply curves:
𝑎−𝑐 (𝑎𝑑+𝑏𝑐)
𝑝∗ = 𝑑+𝑏, 𝑞∗ = 𝑏+𝑑
◦ The equilibrium price and quantity are both increasing in
a.

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Question: The local lemon market has the following

supply and demand relationships:
QD = 100 - 5p - po + 2I
QS = 4p
where p:price of lemons (per pound), Q:quantity of lemons in pounds
I:average consumer income, and po: price per pound of oranges.

Derive the equilibrium price and quantity of lemons as functions

of the price of oranges and average consumer income. Use the
calculus method of comparative statics to compute the effects
of income and the price of oranges on the equilibrium price and
quantity of lemons.

Answer: Find equilibrium price by setting supply and demand equal:

100 - 5p - po + 2I = 4p
Solving for p:
p = 11.11 - .11po + .22I
To find Q, plug the equilibrium price into either supply or demand:
Q = 44.44 - .44po + .89I
The comparative statics w.r.t. the price of oranges are:
∂p/∂po = -.11
∂Q/∂po = -.44 (oranges and lemons are complements:-/)
The comparative statics with respect to income are:
∂p/∂I = .22
∂Q/∂I = .89 (lemons are normal goods.)

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Unit Taxes
Consider the imposition of a unit tax. In the first case, we suppose the
supplier is required to pay the tax. Then the amount the supplier
actually gets after paying the tax will be the amount the buyers pay
minus the tax
This gives the two equation:
𝐷(𝑃𝐷 )= S(𝑃𝑆 )
𝑃𝑆 =𝑃𝐷 − 𝑡
Substituting the second equation into the first we have the equilibrium
condition:
𝐷(𝑃𝐷 )= S(𝑃𝐷 − 𝑡)

Unit Taxes
Now suppose that instead of the sellers paying the tax, the buyer has to
pay the tax, the amount they are willing to pay the sellers at each
quantity is deducted by the amount of the unit tax, we have:
𝐷(𝑃𝐷 )= S(𝑃𝑆 )
𝑃𝐷 = 𝑃𝑆 + 𝑡 ⇒ 𝑃𝑆 =𝑃𝐷 − 𝑡 (same condition as before!)
Conclusion: it does not matter which party actually pays the tax in
terms of determining equilibrium quantity and what the sellers (buyers)
actually receive (pay)

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Example: Taxation with Linear

Demand and Supply
Suppose that the demand and supply curves are both linear. If a unit tax is
imposed, the equilibrium is determined by the equations:
𝑎 − 𝑏𝑝𝐷 = 𝑐 + 𝑑𝑝𝑆
𝑝𝐷 = 𝑝𝑆 + 𝑡
Substituting from the second equation into the first, we have:
𝑎 − 𝑏(𝑝𝑆 +𝑡) = 𝑐 + 𝑑𝑝𝑆
Solving for the equilibrium supply price,𝑝𝑆∗ , gives

𝑎 − 𝑐 − 𝑏𝑡
𝑝𝑆∗ =
𝑑+𝑏

𝑎 − 𝑐 − 𝑏𝑡 𝑎 − 𝑐 + 𝑑𝑡
𝑝𝐷∗ = +𝑡 =
𝑑+𝑏 𝑑+𝑏

Question:
What is the equilibrium 𝑝𝑆∗ and 𝑝𝐷∗ if supply is
perfectly inelastic?

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