E102

Introduction to Microeconomics
Dr Heba Youssef
[email protected]
 Chapter 3

Basic Elements of Supply and Demand

In this chapter:
• We will introduce (actually, recall!) the
notions of supply and demand
• We will show how they operate in competitive
markets for individual commodities.
• Using these basic tools, we will see how the
market price is determined
• We end the chapter with some examples of
how supply-and-demand analysis can be
applied in real life.
 A. THE DEMAND SCHEDULE
• Both common sense and careful scientific
observation show that
– the amount of a commodity people buy depends
on its price.
• The higher the price of a commodity, other
things held constant, the fewer units
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consumers are willing to buy.

• The lower its market price, the more units
consumers are willing to buy.
In other words,
• There exists a definite relationship between
the market price of a good and the quantity
demanded of that good, other things held
constant.
• This relationship between price and quantity
bought is called the demand schedule, or the
demand curve.
Example: Cornflakes
THE DEMAND CURVE
• The graphical representation of the demand
schedule is the demand curve .
The previous graph shows the following:
• The quantity of cornflakes demanded on the
horizontal axis and the price of cornflakes on
the vertical axis.
• Quantity and price are inversely related; that
is, Q goes up when P goes down.
• The curve slopes downward, going from
northwest to southeast.
• This important property is called the law of
downward-sloping demand.
Why does quantity demanded fall as price rises?
1. Substitution effect:
• When the price of a good rises, it becomes
relatively more expensive. I will thus substitute
goods B, C, D, . . . for it.
• For example, as the price of Pepsi rises, other
things being constant, I drink more Coke.
2. Income effect:
• When the price of a good goes up, I find myself
somewhat poorer than I was before.
• Example: If gasoline prices double, I have in effect
less real income, so I will reduce my consumption
of both gasoline and other goods.
Market Demand

• It represents the sum of all individual demands.

– The market demand curve is found by adding together
the quantities demanded by all individuals at each
price.
• The market demand is what is observable in the
real world.
• Does the market demand curve obey the law of
downward-sloping demand?
– It certainly does. If prices drop, new customers are
attracted through the substitution effect. In addition,
a price reduction will induce extra purchases by
existing consumers through both the income and
substitution effects.
Forces behind the Demand Curve
A number of factors influence how much will be
demanded at a given price
1. Average Income
• As people’s incomes rise, individuals tend to buy
more of almost everything
2. Size of market
• measured, by the population—clearly affects the
market demand curve.
3. Related Goods
• Substitutes and Complements.
4. Subjective Factors: Tastes and Preferences
• They represent culture/tradition, or religion
• Example: Eating pork is popular in European
countries but taboo in Muslim countries.
5. Special Influences
• Weather Conditions:
– The demand for umbrellas is high in rainy London but
low in sunny Cairo.
• Traffic Conditions
– demand for automobiles will be low in New York,
where public transportation is plentiful and parking is
a nightmare
Shifts in Demand
• What causes the demand curve to shift?
• A change in any of the previous factors other
than the good’s own price.
• Shifts can be rightward or leftward.
• Demand increases (or decreases) when the
quantity demanded at each price increases (or
decreases).
• Example: Will a heat wave shift the demand
curve for ice cream leftward or rightward?
Movements along Curves versus Shifts of Curves
• A change in demand (denoted by a shift of
the demand curve): occurs when one of the
elements underlying the demand curve shifts.
• A change in the quantity demanded (which
means moving along the demand curve):
occurs when the price of the commodity
changes.
 B. THE SUPPLY SCHEDULE
• We will now turn from demand to supply.
• It involves those who produce the commodity
• The supply schedule (or supply curve ) for a
commodity shows the relationship between
the market price and the amount of that
commodity that producers are willing to
produce and sell, other things held constant.
• We mean by other things held constant: input
prices, prices of related goods, and
government policies.
THE SUPPLY CURVE
The Previous graph shows the following:
• The Supply curve is upward sloping.
• One important reason for the upward slope is
“the law of diminishing returns”
Forces behind the Supply Curve
1. Cost of production:
• When production costs for a good are low
relative to the market price, it is profitable for
producers to supply a great deal.
A. Price of inputs: labor, machinery, energy
• What do you think are the consequences of the
recent fall in oil prices?
B. Technological advances: consist of changes that
lower the quantity of inputs needed to produce
the same quantity of output; scientific
breakthroughs.
2. Prices of related goods:
• Particularly goods that are alternative outputs
of the production process.
3. Government policy:
• Taxes and minimum-wage laws can
significantly affect input prices.
• Government trade policies have a major
impact upon supply.
4. Special Influences: weather conditions.
Shifts in Supply
• When changes in factors other than a good’s own price affect
supply, we call these changes shifts in supply.
• Supply increases (or decreases) when the amount supplied
increases (or decreases) at each market price.
 C. EQUILIBRIUM OF SUPPLY AND DEMAND
• Up to this point we have been considering
demand and supply in isolation.
• Supply and demand interact to produce an
equilibrium price and quantity; a market
equilibrium.
• The market equilibrium comes at that price and
quantity where the forces of supply and demand
are in balance
• The reason we call this an equilibrium is that,
when the forces of supply and demand are in
balance, there is no reason for price to rise or fall,
as long as other things remain unchanged.
Example to see how supply and demand
determine a market equilibrium
Effect of a Shift in Supply or Demand
Bread example:
• Suppose that a spell of bad weather reduces
the amount of wheat grown, a key ingredient
of bread.
• What will happen to the bread market?
I think this is enough for today!
Thank You