PMIC02-5

Topic 2
Outline
• Once you have studied this topic you should be able to
• explain the most important determinants of the quantity demanded
• differentiate between a movement along a demand curve and a shift
of the curve
• explain the determinants of the quantity supplied
• distinguish between a movement along a supply curve and a shift of
the curve
• explain how the equilibrium price and quantity are determined
• explain the consumer surplus and the producer surplus.
Outline continued….

• explain how a change in demand affects the equilibrium price and

quantity in the market
• explain how a change in supply affects the equilibrium price and
quantity in the market
• predict the effects of simultaneous changes in demand and supply
• analyse the interaction between related markets
• show what happens if the government interferes in the price
mechanism by setting minimum or maximum prices.
 DEMAND AND SUPPLY: AN INTRODUCTORY OVERVIEW

Figure 3-1 The interaction between households and firms

DEMAND

• Demand – quantities of a good or service that the potential

buyers are willing and able to buy

• Market demand – the combined demand for all the households

in a particular market
 DEMAND

Determinants of demand
Let Qd = quantity of good demanded in a particular period
Px = price of good
Pg = prices of related goods
Y = households’ income during the period
T = taste of the consumers concerned
N = number of consumers in the market concerned
… = allowance for other possible influences

The law of demand states:

Other things being equal (ie ceteris paribus), the higher the price of a good, the lower
the quantity demanded.
 DEMAND

Various ways to express demand and the law of demand

• Using words
• Using numbers: the demand schedule

TABLE 3-1 A demand schedule for tomatoes

 DEMAND

• Using graphs: the demand curve

Figure 3-2 Consumers’ weekly demand for tomatoes

 DEMAND

• Using symbols: the demand equation

 Movements along and shifts of the demand curve

• It is very important to distinguish between a movement along in a demand

curve and a shift of the demand curve
• A movement along the curve IS ON THE SAME DEMAND curve
• A shift of the curve relates to A CHANGE TO A NEW DEMAND curve.
• An easy way to remember the difference is if there is a change IN PRICE,
there will be movement along the curve, changes in all other variables will
cause a shift of the curve.
 DEMAND
Movements along the curve vs. shifts of the curve
Movement along the curve (change in the quantity demanded)
relates to the slope of the curve

Figure 3-3 A movement along

a demand curve
 DEMAND

Shift of the curve (a change in demand) relates to the

position or intercept of the curve

Figure 3-4 Two substitutes: butter and margarine

 A change in the price of related goods (𝑷𝒈 )
Substitutes like
coffee and tea
A substitute is a good that can be
used in place of another good to Demand for tea Demand for coffee
satisfy a consumer’s want.

Price

Price
Tea can be used as a substitute for
coffee, if people cannot afford
coffee, they will buy tea instead. 𝑃1
Hence, a decrease in the price of 𝑃𝑎
tea (movement along the tea
demand curve) will cause a 𝑃𝑏
decrease in the demand for
coffee.
𝐷𝑡𝑒𝑎
The more tea is demanded, the 𝐷2 𝐷1
less coffee will be demanded, this
will cause a shift to the left for the 𝑄𝑎 𝑄𝑏
demand of coffee tins. Quantity 𝑄2 𝑄1 Quantity

*Note that the price of coffee remains constant while the decrease in demand causes the quantity
demanded of coffee to decrease as well.
 DEMAND

Determinants which will cause the demand curve to shift

• A change in the price of a related good
– Substitutes (Figure 3.4)
– Complements (Figure 3.5)
• A change in the income of consumers
• A change in consumers’ tastes or preference
• A change in populations
• Other influences on demand
– A change in expected future prices
– The distribution of income
 DEMAND

Demand: a summary
TABLE 3-2 The market demand curve: a summary
 DEMAND
TABLE 3-2 The market demand curve: a summary continued
 DEMAND

Figure 3-6 A change in the quantity demanded versus a change in demand

SUPPLY

• Supply – the quantities of a good or service that producers

plan to sell at each possible price during a certain period

• They must be willing AND able to sell

• It can also be expressed in words, schedules (numbers),

curves (graphs) or equations (symbols).

• The law of supply – other things equal (ceteris paribus), the

higher the price of a good, the higher the quantity supplied
 SUPPLY

Market supply
Determinants of market supply
• The price of the product
• The price of alternative products
• Prices of factors of production and other inputs
• Expected future prices
• The state of technology

The quantity of a good supplied in a particular period is a function

of the price of the good, the prices of alternative outputs, the
prices of the factors of production, the expected future prices of
the good and the state of technology.
 SUPPLY

Various ways to express supply and the law of supply

• Using words
• Using numbers: the supply schedule

TABLE 3-3 A supply schedule of tomatoes

 SUPPLY

• Using graphs: the supply curve

Figure 3-7 Firms’ weekly supply of tomatoes

 SUPPLY

• Using symbols: the supply equation

 SUPPLY

See Box 3-1: Other possible determinants of supply (page 72)

• Government policy
• Unexpected events
• Joint products and by-products
• Productivity
 SUPPLY

Movements along the supply curve and shifts of

the curve
Movement along the supply curve

Figure 3-8 A movement

along a supply curve: a
change in the quantity
supplied
 SUPPLY

Shift of the supply curve

Figure 3-9 Shifts of the supply curve: changes in supply

 SUPPLY

Possible causes of change in supply:

TABLE 3-4 The market supply curve: a summary

 SUPPLY
TABLE 3-4 The market supply curve: a summary continued
 SUPPLY
TABLE 3-4 The market supply curve: a summary continued
MARKET EQUILIBRIUM

• Equilibrium (quantity demanded = quantity supplied)

• Excess demand (market shortage)

• Excess supply (market surplus)

 MARKET EQUILIBRIUM

TABLE 3-5 The demand and supply of tomatoes in a market on a particular day
 MARKET EQUILIBRIUM

Figure 3-10 Demand, supply and market equilibrium

Market equilibrium – Numerical
example
• Given supply and demand functions,
Qs = 30 + 55 P
Qd = 230 – 45 P
• Calculate equilibrium price (Pe) from the quantity demanded
equals quantity supplied equilibrium condition,
Q s = Qd
30 + 55 P = 230 – 45 P
100 P = 200
P=2
• Use P to get equilibrium quantity, Qe
Qe = 230 – (45 x 2) = 230 –90 = 140
CONSUMER SURPLUS AND
PRODUCER SURPLUS

• Consumer surplus – the difference between what consumers

pay and the value that they receive
 CONSUMER SURPLUS AND PRODUCER SURPLUS

Figure 3-11 The consumer surplus

 CONSUMER SURPLUS AND PRODUCER SURPLUS

• Producer surplus – the difference between the lowest price

producers are willing to accept and the price they actually
receive

Figure 3-12 The producer surplus

 CONSUMER SURPLUS AND PRODUCER SURPLUS

• Consumer surplus and producer surplus

Figure 3-13 Consumer surplus and producer surplus at market equilibrium

CHANGES IN DEMAND

An increase in
demand
• Increase in the price
of the product
• Increase in the
quantity exchanged

Figure 4-1(a) Changes in demand

 CHANGES IN DEMAND

A decrease in demand
• Decrease in the price of the product
• Decrease in the
quantity exchanged

Figure 4-1(b) Changes in demand

CHANGES IN SUPPLY

An increase in supply
• Decrease in the price
of the product
• Increase in the
quantity exchanged

Figure 4-2 Changes in supply

 CHANGES IN SUPPLY

A decrease in supply
• Increase in the price of the product
• Decrease in the quantity
exchanged

Figure 4-2 Changes in supply

SIMULTANEOUS CHANGES IN
DEMAND AND SUPPLY
•

TABLE 4-1 Change in demand or change in supply

 SIMULTANEOUS CHANGES IN DEMAND AND SUPPLY

TABLE 4-2 Simultaneous changes in demand and supply

SIMULTANEOUS CHANGES IN DEMAND AND SUPPLY

Figure 4-3 A simultaneous

increase in demand and
decrease in supply
INTERACTION BETWEEN RELATED
MARKETS

Case studies:
Fish and meat

Motorcars and tyres

 INTERACTION BETWEEN RELATED MARKETS

Fish and meat

Figure 4-4 Interaction between the markets for fish and meat
 INTERACTION BETWEEN RELATED MARKETS

Motorcars and tyres

Figure 4-5 Interaction between the markets for motorcars and tyres
4.5 GOVERNMENT INTERVENTION

Maximum prices (price ceilings, price control)

See Box 4-1: Rent control (page 96)

See Box 4-2: Administered prices (page 98)

 GOVERNMENT INTERVENTION
Maximum prices (price ceilings, price control)

Figure 4-6 Maximum prices

 GOVERNMENT INTERVENTION
Maximum prices (price ceilings, price control)

The welfare costs of maximum price fixing

Figure 4-7 The welfare costs of maximum price fixing

Prior to price fixing, the equilibrium price is P1
and the equilibrium quantity Q1.

Government then fixes a maximum price Pm

below the equilibrium price.

The quantity exchanged falls to Qm. Rectangle

B is transferred from the producer surplus to the
consumer surplus. Triangle A, which used to be
part of the consumer surplus, and triangle C,
which used to be part of the producer surplus,
both disappear. The total deadweight loss to
society is equal to A plus C.
 GOVERNMENT INTERVENTION

Minimum prices (price supports, price floors)

Figure 4-8 A minimum price
 GOVERNMENT INTERVENTION
Minimum prices (price supports, price floors)

The welfare costs of minimum price fixing

Figure 4-9 The welfare costs of minimum price fixing