03

Demand, Supply, and Market

Equilibrium

McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
 Markets
• Interaction between buyers and
sellers
• Markets may be:
• Local
• National
• International
• Price is discovered in the interactions
of buyers and sellers

LO1 3-2
 Demand

• Schedule or curve
• Amount consumers are willing and
able to purchase at a given price
• Other things equal
• Individual demand
• Market demand

LO1 3-3
 Law of Demand

• Other things equal, as price falls, the

quantity demanded rises, and as price
rises, the quantity demanded falls.
• Reasons:
• Common sense
• Law of diminishing marginal utility
• Income effect and substitution effects

LO1 3-4
 The Demand Curve

P
6

Price (per bushel)

P Qd
4
$5 10

4 20 3

3 35 2

2 55 1 D

1 80
0 10 20 30 40 50 60 70 80 Q
Quantity Demanded (bushels per week)

LO1 3-5
 Market Demand
Market Demand for Corn, Three Buyers
Quantity Demanded Total
Price Qd
per bushel Joe Jen Jay per week

$5 10 12 8 30

4 20 23 17 60

3 35 39 26 100

2 55 60 39 154

1 80 87 54 221

LO1 3-6
 Changes in Demand

P
6

5
Price (per bushel)

2
D2

1 D1
D3
0 Q
2 4 6 8 10 12 14 16 18
Quantity Demanded (bushels per week)

LO1 3-7
 Changes in Demand

P
6 Change in Demand

5
Price (per bushel)

4 Change in Quantity
Demanded
3

2
D2

1 D1
D3
0
2 4 6 8 10 12 14 16 18 Q
Quantity Demanded (bushels per week)

LO1 3-8
 Determinants of Demand

• Change in consumer tastes and

preferences
• Change in number of buyers
• Change in income
• Normal goods
• Inferior goods

LO1 3-9
 Determinants of Demand

• Change in prices of related goods

• Complements
• Substitutes
• Change in consumers’ expectations
• Future prices
• Future income

LO1 3-10
 Determinants of Demand
Table 3.1 Determinants of Demand: Factors That Shift the Demand Curve
Determinant Examples
Change in buyers’ tastes Physical fitness rises in popularity, increasing the
demand for jogging shoes and bicycles; cell phone
popularity rises, reducing the demand for land-line
phones.
Change in the number of buyers A decline in the birthrate reduces the demand for
children’s toys.
Change in income A rise in incomes increases the demand for normal
goods such as restaurant meals, sports tickets, and
necklaces while reducing the demand for inferior
goods such as cabbage, turnips, and inexpensive
wine.
Change in the prices of related A reduction in airfares reduces the demand for bus
goods transportation (substitute goods); a decline in the price
of DVD players increases the demand for DVD movies
(complementary goods).
Change in consumer expectations Inclement weather in South America creates an
expectation of higher future coffee bean prices,
thereby increasing today’s demand for coffee beans.
LO1 3-11
 Supply

• Schedule or curve
• Amount producers are willing and
able to sell at a given price
• Individual supply
• Market supply

LO2 3-12
 Law of Supply

• Other things equal, as the price rises,

the quantity supplied rises and as the
price falls, the quantity supplied falls.
• Reason:
• Price acts as an incentive to
producers
• At some point, costs will rise

LO2 3-13
 The Supply Curve

P
S
Supply of Corn 5

Price Qs
per 4
per
Bushel Week Price (per bushel)
3
$5 60
4 50 2
3 35
2 20 1

1 5
0
Q
10 20 30 40 50 60 70
Quantity supplied (bushels per week)

LO2 3-14
 Changes in Supply
P

$6 S3 S1

5
Decrease S2
4 in supply
Price (per bushel)

1 Increase
in supply
0
Q
2 4 6 8 10 12 14 16
Quantity supplied (thousands of bushels per week)

LO2 3-15
 Changes in Supply
P

$6
Change in Quantity
Supplied S3 S1

5
S2
4
Price (per bushel)

1 Change in Supply

0
Q
2 4 6 8 10 12 14 16
Quantity supplied (thousands of bushels per week)

LO2 3-16
 Determinants of Supply

• A change in resource prices

• A change in technology
• A change in the number of sellers
• A change in taxes and subsidies
• A change in prices of other goods
• A change in producer expectations

LO2 3-17
 Determinants of Supply
Table 3.2 Determinants of Supply: Factors That Shift the Supply Curve
Determinant Examples
Change in resource prices A decrease in the price of microchips increases the
supply of computers; an increase in the price of crude
oil reduces the supply of gasoline.
Change in technology The development of more effective wireless
technology increases the supply of cell phones.
Change in taxes and subsidies An increase in the excise tax on cigarettes reduces the
supply of cigarettes; a decline in subsidies to state
universities reduces the supply of higher education.
Change in prices of other goods An increase in the price of cucumbers decreases the
supply of watermelons.
Change in producer expectations An expectation of a substantial rise in future log prices
decreases the supply of logs today.
Change in the number of suppliers An increase in the number of tattoo parlors increases
the supply of tattoos; the formation of women’s
professional basketball leagues increases the supply
of women’s professional basketball games.

LO2 3-18
 Market Equilibrium

• Equilibrium occurs where the demand

curve and supply curve intersect.
• Surplus and shortage
• Rationing function of prices
• Efficient allocation
• Productive efficiency
• Allocative efficiency

LO3 3-19
 Market Equilibrium

6
6,000 Bushel S
5 Surplus
P Qd P Qs
Price (per bushel)

$5 2,000 4
$5 12,000
4 4,000 3 4 10,000
3 7,000 3 7,000
2 11,000 2
2 4,000
1 16,000 7,000 Bushel 1 1,000
1 D
Shortage

0 2 4 67 8 10 12 14 16 18
Bushels of Corn (thousands per week)

LO3 3-20
 Rationing Functions of Prices

• The ability of the competitive forces of

demand and supply to establish a
price at which selling and buying
decisions are consistent.

LO3 3-21
 Efficient Allocation

• Productive efficiency
• Producing goods in the least costly way
• Using the best technology
• Using the right mix of resources
• Allocative Efficiency
• Producing the right mix of goods
• The combination of goods most highly
valued by society

LO3 3-22
 Changes in Demand
`
and
Equilibrium
D increase: D decrease:
P, Q P, Q

P
P
S S

D2 D3

D1 D4

0 0

Increase in demand Decrease in demand

LO4 3-23
 Changes
Changesin
inDemand
`
Supply and
and
Equilibrium
S increase: S decrease:
P, Q P, Q

P P
S1 S2 S4 S3

D
D

0 0

Increase in supply Decrease in supply

LO4 3-24
 Complex Cases
TABLE 3.3 Effects of Changes in Both Supply and Demand

Effect on
Effect on Equilibrium
Change in Supply Change in Demand Equilibrium Price Quantity
1. Increase Decrease Decrease Indeterminate
2. Decrease Increase Increase Indeterminate
3. Increase Increase Indeterminate Increase
4. Decrease Decrease Indeterminate Decrease

LO4 3-25
 Government Set Prices

• Price Ceilings
• Set below equilibrium price
• Rationing problem
• Black markets
• Example: Rent control

LO5 3-26
 Government Set Prices

P
S

$3.50 P0 ceiling

3.00 PC

D
Shortage

Q
Qs Q0 Qd

LO5 3-27
 Government Set Prices

• Price Floors
• Prices are set above the market
price
• Chronic surpluses
• Example: Minimum wage laws

LO5 3-28
 Government Set Prices
P
S
Surplus
floor

$3.00 Pf

2.00 P0

Q
Qd Q0 Qs

LO5 3-29
Legal Market for Human Organs

• What if we created a legal market for

human organs?
• Positive effects
• Increase the incentive to donate
• Eliminate the persistent shortage of
eyes, livers, hearts, kidneys, etc.

3-30
Legal Market for Human Organs

• Negative effects
• Increases the cost of medical care
• Diminishes the special nature of life
by commercializing it

3-31