Lecture 2:

Supply, Demand &

Market Equilibrium

ECONOMICS
MICROECONOMICS MACROECONOMICS
• Basic Economic concepts • National Income accounting
• Supply, Demand and Market • ASAD
• Elasticity • Inflation and Unemployment
• Supply, Demand & Government • Financial, Monetary and
Policies Banking system
• Production and Cost • Macroeconomics Policies
• Market structures

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 SUPPLY, DEMAND AND MARKET EQUILIBRIUM
• Demand and quantity demanded
• Supply and quantity supplied
• Change in Demand and change in Quantity Demanded
• Change in Supply and change in Quantity Supplied
• Shortage and Surplus
• Price Ceiling, Price Floor
• Welfare economics

Market Interactions

Foreign market
Product
participants markets

Households Governments Business firms

Factor
Foreign market markets
participants

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 Supply and Demand
• The two sides of each market transaction are called
supply and demand.
• Demand: The ability and willingness to buy specific
quantities of a good at alternative prices in a given time
period, ceteris paribus.
• Supply: The ability and willingness to sell (produce)
specific quantities of a good at alternative prices in a
given time period, ceteris paribus.

Maslow’s Hierarchy of Needs

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Demand
• Law of demand
• The quantity of a good demanded in a given time
period increases as its price falls, ceteris paribus.
• Determinants of demand
• Tastes (desire for this and other goods)
• Income (of the consumer)
• Other goods (their availability and price)
• Expectations (for income, prices, tastes)
• Number of buyers
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The Demand Curve Changes in quantity
P demanded
Q d
$6.00 Movements along a given
P
(Market) demand curve in response to
$5.00 price changes of the good.
$0.00 24
1.00 21 $4.00
2.00 18 $3.00
3.00 15
$2.00
4.00 12
5.00 9 $1.00

6.00 6 $0.00
Q
0 5 10 15 20 25

Demand Curve Shifters

P Changes in demand: Shifts of the
$6.00 demand curve due to changes in non-
price determinants of demand
$5.00
• income,
$4.00
• prices of substitutes and
$3.00 complements,
$2.00 • tastes,
$1.00 • expectations,
$0.00
• number of buyers.
Q
0 5 10 15 20 25 30

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 Determinants of demand

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Change in quantity demanded

• The D curve does not shift.
Price • Move down along curve to
a point with lower P, higher
Q.
PRICE
P1

P2

D1

Q1 Q2 Quantity

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 • income,
Change in Demand • prices of substitutes
Non-price and complements,
• tastes,
Price Price • expectations,
• number of buyers.

P1 P1

D2 D1 D1 D2

Q2 Q1 Quantity Q1 Q2 Quantity

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1. If equilibrium moves from point a to 2. If equilibrium moves from point a to point

point b, the only market experiencing b, the only market experiencing an increase
an increase in demand is shown in: in quantity demanded is shown in:
(a) Panel A. (a) Panel A.
(b) Panel B. (b) Panel B.
(c) Panel C. (c) Panel C.
(d) Panel D. (d) Panel D.

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 3. Lobster is a normal good and peanut butter is an inferior good. If your
income rises, you will probably consume:
a. more of both goods.
b. less of both goods.
c. more peanut butter and less lobster.
d. more lobster and less peanut butter.
4. Which of the following demonstrates the law of demand?
a. Relative to last month, Jason buys more KitKats at $1.50 per KitKat since he got a
raise at work this month.
b. Chanel buys fewer cupcakes at $0.75 per cupcake than at $1 per cupcake, other
things equal.
c. John buys more donuts at $0.25 per donut than at $0.50 per donut, other things
equal.
d. Rica buys fewer Snickers at $0.60 per Snicker since the price of Milky Ways fell to
$0.50 per Milky Way.

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Supply

• The total quantities of a good that sellers are willing and able
to sell at alternative prices in a given time period, ceteris
paribus.
• Market supply is an expression of sellers’ intentions, of the
ability and willingness to sell, not a statement of actual sales.
• Law of supply:
• The quantity of a good supplied in a given time period increases as its
price increases, ceteris paribus.
• Larger quantities will be offered at higher prices.

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 Supply Schedule and Supply Curve
Changes in a quantity supplied: Movement along a given supply curve.
P
$6.00 Price Quantity
$5.00 $0.00 0
1.00 3
$4.00
2.00 6
$3.00 3.00 9
$2.00 4.00 12
5.00 15
$1.00
6.00 18
$0.00
Q
0 5 10 15

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Supply Curve Shifters .

P Changes in supply: Shifts due

$6.00 to some change in a
$5.00 determinant of supply
$4.00
• input prices,
• technology,
$3.00
• expectations,
$2.00 • number of sellers
$1.00

$0.00
Q
0 5 10 15 20 25 30 35

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 Determinants of Supply

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5. An increase in the price of oranges would lead to

a. an increased supply of oranges.
b. a reduction in the prices of inputs used in orange production.
c. a movement up and to the right along the supply curve for oranges.
d. an increased demand for oranges.

6. Workers at a bicycle assembly plant currently earn the mandatory minimum

wage. If the government increases the minimum wage by $1.00 an hour, it is likely
that the
a. demand for bicycle assembly workers will increase.
b. supply of bicycles will shift to the right.
c. supply of bicycles will shift to the left.
d. firm must increase output to maintain profit levels.

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 7. If equilibrium moves from point a to 8. If equilibrium moves from point a to
point b, the only market experiencing point b, the only market experiencing
an decrease in quantity supplied is an decrease in supply is shown in:
shown in: (a) Panel A.
(a) Panel A. (b) Panel B.
(b) Panel B. (c) Panel C.
(c) Panel C. (d) Panel D.
(d) Panel D.

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Supply and Demand Together

P D
$6.00 S
P QD QS Equilibrium price:
$5.00 $0 24 0 price where Q
1 21 5 supplied = Q
$4.00
2 18 10 demanded
$3.00
3 15 15 Equilibrium quantity:
$2.00
4 12 20 Q supplied and
$1.00 5 9 25 demanded at the
$0.00 6 6 30 equilibrium price
Q
0 5 10 15 20 25 30 35
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Markets Not in Equilibrium: Surplus
P D S
$6.00 Surplus Surplus (excess supply):
$5.00
quantity supplied is greater than
quantity demanded
$4.00

$3.00 Example: if P = $5,

$2.00
then QD = 9
and QS = 25
$1.00
resulting in a surplus of 16 lattes
$0.00
Q
0 5 10 15 20 25 30 35

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Markets Not in Equilibrium: Surplus

P D S
Facing a surplus,
$6.00 Surplus
$5.00 sellers try to increase
$4.00 sales by cutting price.
$3.00 This causes QD to rise
$2.00 and QS to fall…
$1.00
…which reduces the
$0.00 surplus.
Q
0 5 10 15 20 25 30 35

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 Markets Not in Equilibrium: Surplus
Facing a surplus,
P
$6.00
D
Surplus
S sellers try to increase
$5.00 sales by cutting price.
$4.00
This causes QD to rise
$3.00
and QS to fall…
$2.00
$1.00 Prices continue to fall
until market reaches
$0.00
Q equilibrium.
0 5 10 15 20 25 30 35

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Markets Not in Equilibrium: Shortage

Shortage (excess demand):
P D S
$6.00 quantity demanded is
greater than quantity
$5.00
supplied
$4.00

$3.00 Example: if P = $1,

then QD = 21
$2.00
and QS = 5
$1.00
$0.00 Shortage resulting in a shortage of 16
Q
0 5 10 15 20 25 30 35

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 Market dynamics: Hybrid car market
EVENT: Increase in the price of gas. P
STEP 1: D curve shifts S1
because price of gas affects demand for
P2
hybrids. (S curve does not shift, because price
of gas does not affect cost of producing
hybrids) P1
STEP 2: D shifts right
•because high gas price makes hybrids more D2
D1
attractive relative to other cars.
Q
STEP 3: The shift causes an increase in price Q1 Q2
and quantity of hybrid cars.

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A Shift in Supply
P
EVENT: New technology reduces cost of S1 S2
producing hybrid cars.
STEP 1: S curve shifts
because event affects cost of production. (D curve
does not shift, because production technology is P1
not one of the factors that affect demand) P2
STEP 2: S shifts right
because event reduces cost, makes production D1
more profitable at any given price. Q
Q1 Q2
STEP 3: The shift causes price to fall and quantity
to rise.

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 A Shift in Both Supply and Demand
EVENTS: Prie of gas rises AND new P
technology reduces production costs S1 S2

STEP 1: Both curves shift. P2

STEP 2: Both shift to the right. P1

STEP 3: Q rises, but the effect on P is

ambiguous: D1 D2
Q
Q1 Q2
If demand increases more than
supply, P rises.

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A Shift in Both Supply and Demand

EVENTS: Price of gas rises AND P

new technology reduces S1 S2
production costs

P1
STEP 3: Q rises, but the effect on P2
P is ambiguous:
D1 D2
But if supply increases more than Q1 Q2
Q
demand, P falls.

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 9. Equilibrium market price will definitely rise when:
a. demand decreases, with supply constant.
b. supply increases, with demand constant.
c. demand decreases and supply increases.
d. supply decreases and demand increases.

10. Beef is a normal good. You observe that both the equilibrium price and
quantity of beef have fallen over time. Which of the following explanations
would be most consistent with this observation?
a. Consumers have experienced an increase in income and beef-production
technology has improved.
b. The price of chicken has risen and the price of steak sauce has fallen.
c. New medical evidence has been released that indicates a negative correlation
between a person’s beef consumption and his or her longevity.
d. The demand curve for beef must be positively sloped.

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11. Suppose the number of buyers in a market increases and a technological advancement
occurs also. What would we expect to happen in the market?
a. Equilibrium price would decrease, but the impact on equilibrium quantity would be ambiguous.
b. Equilibrium price would increase, but the impact on equilibrium quantity would be ambiguous.
c. Equilibrium quantity would decrease, but the impact on equilibrium price would be ambiguous.
d. Equilibrium quantity would increase, but the impact on equilibrium price would be ambiguous.

12. Equilibrium price will unambiguously increase when

a. demand increases and supply does not change, when demand does not change and supply
decreases, and when demand decreases and supply increases simultaneously.
b. demand increases and supply does not change, when demand does not change and supply
decreases, and when demand increases and supply decreases simultaneously.
c. demand decreases and supply does not change, when demand does not change and supply
increases, and when demand decreases and supply increases simultaneously.
d. demand decreases and supply does not change, when demand does not change and supply
increases, and when demand increases and supply decreases simultaneously.

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