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CHAPTER 4 Demand and Supply Analysis
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CHAPTER CHECKLIST

1. Distinguish between quantity demanded and demand
   and explain what determines demand.
2. Distinguish between quantity supplied and supply
   and explain what determines supply.
3. Explain how demand and supply determine price and
   quantity in a market and explain the effects of
   changes in demand and supply.
4. Explain how price ceilings, price floors, and
   sticky prices cause shortages, surpluses, and
   unemployment.

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LECTURE TOPICS

• Demand
• Supply
• Market Equilibrium
• Price Rigidities

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MARKETS

• A market is any arrangement that bring buyers and
  sellers together.

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MARKETS

• In this chapter, we study a simple model of a
  market a market that has so many buyers, all
  small relative to the size of the market, and so
  many sellers, all small relative to the size of
  the market, that no individual buyer or seller
  can influence the price by their individual
  actions.
• This is called a perfectly competitive market.
• Very few real world markets fully fit the
  assumptions of the perfectly competitive market,
  but it is a good and useful model as an
  approximation of many real markets.

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4.1 DEMAND

• Quantity demanded
• The amount of a good, service, or resource that
  people are willing and able to buy during a
  specified period at a specified price.
• The quantity demanded is an amount per unit of
  time. For example, the amount per day or per
  month.
• How much people want to buy, given the price, is
  what the jargon calls quantity demanded.

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4.1 DEMAND

• The Law of Demand
• Other things remaining the same, ceteris
  paribus
• If the price of a good rises, the quantity
  demanded of that good decreases.
• If the price of a good falls, the quantity
  demanded of that good increases.
• I.e., if something becomes more expensive, people
  want to buy less of it if it becomes cheaper,
  people want to buy more of it.

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4.1 DEMAND

• Demand Schedule and Demand Curve
• Demand
• The relationship between the quantity demanded
  and the price of a good when all other influences
  on buying plans remain the same.
• Demand is a list of quantities at different
  prices and is illustrated by the demand curve.
• Demand means all the amounts people will want
  to buy at all possible different prices,
  everything else unchanged it is the relationship
  between price and how much people want to buy.

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4.1 DEMAND

• Demand schedule
• A list of the quantities demanded at each
  different price when all the other influences on
  buying plans remain the same.
• Demand curve
• A graph cartoon of the relationship between
  the quantity demanded of a good and its price
  when all other influences on buying plans remain
  the same i.e. the graph of the goods own-price
  and how much people want to buy at each
  own-price.

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4.1 DEMAND
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Economists have their own traditions .

• It is usual in most disciplines math, physics,
  etc to draw graphs with the dependent variable
  on the y (vertical) axis and the independent
  variable on the x (horizontal) axis
• Economics does it the other way round in demand
  and supply diagrams -- own-price determines the
  amount buyers want to buy, but own-price is on
  the vertical y axis.

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Why?

• Economists started drawing and publishing in
  books supply and demand diagrams in the 19th
  century, before the standard y f(x) convention
  was strongly established
• The standard supply and demand diagrams are so
  firmly established, nobody dares try to change
  them to conform to what is standard in math,
  science, and engineering

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4.1 DEMAND

• Changes in Demand
• Change in the quantity demanded
• A change in the quantity of a good that people
  plan to buy that results from a change in the
  price of the good.
• Change in demand
• A change in the quantities that people plan to
  buy at various prices when any influence other
  than the own-price of the good changes. In other
  words, a shift or change in the relationship
  between the price of the good and how much of it
  people want to buy.

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4.1 DEMAND

• When demand
• changes, the
• demand curve shifts.

1. When demand decreases, the demand curve shifts
leftward from D0 to D1.

• 2. When demand increases, the demand curve shifts
  rightward from D0 to D2.

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4.1 DEMAND

• The main influences on buying plans that change
  demand are
• Prices of related goods
• Income
• Expectations
• Number of buyers
• Preferences

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Make a Mnemonic to remember

• Economists use Y for income a lot so
• Prices of related goods
• Y -- income of potential buyers
• Number of potential buyers
• Tastes preferences of potential buyers
• Expectations about the future

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4.1 DEMAND

• Prices of Related Goods
• Substitute
• A good that can be consumed in place of another
  good. For example, apples and oranges.
• The demand for a good increases, if the price of
  one of its substitutes rises.
• The demand for a good decreases, if the price of
  one of its substitutes falls.

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4.1 DEMAND

• Complement
• A good that is consumed with another good. For
• example, ice cream and fudge sauce.
• The demand for a good increases, if the price of
• one of its complements falls.
• The demand for a good decreases, if the price of
• one of its complements rises.

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4.1 DEMAND

• Income
• The demand for a normal good increases if income
  increases.
• The demand for an inferior good decreases if
  income increases.

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4.1 DEMAND

• Expectations
• Expected future income and expected future prices
  influence demand today.
• For example, if the price of a computer is
  expected to fall next month, the demand for
  computers today decreases.
• Number of Buyers
• The greater the number of buyers in a market, the
  larger is the demand for any good.

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4.1 DEMAND

• Preferences
• When preferences tastes change, the demand for
  one item increases and the demand for another
  item (or items) decreases.
• Preferences change when
• People become better informed, or new
  information becomes available.
• New goods become available.
• Fashions opinions shift for some reason.
• Advertisers succeed in influencing tastes.

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4.1 DEMAND

• Demand A Summary

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4.2 SUPPLY

• Quantity supplied
• The amount of a good, service, or resource that
  people are willing and able to sell during a
  specified period at a specified price how much
  people want to sell at the given price.
• The Law of Supply
• Other things remaining the same,
• If the price of a good rises, the quantity
  supplied of that good increases. When price
  rises, people will want to sell more.
• If the price of a good falls, the quantity
  supplied of that good decreases. If the goods
  price falls, people will want to sell less.

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4.2 SUPPLY

• Supply Schedule and Supply Curve
• Supply
• The relationship between the quantity supplied of
  a good and the price of the good when all other
  influences on selling plans remain the same.
• Supply is a list of quantities at different
  prices and is illustrated by the supply curve,
  just like demand and the demand curve.

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4.2 SUPPLY

• Supply schedule
• A list of the quantities supplied at each
  different price when all other influences on
  selling plans remains the same.
• Supply curve
• A graph of the relationship between the quantity
  supplied and the goods own-price when all other
  influences on selling plans remain the same. As
  with demand, this is the relationship between the
  amounts sellers will want to sell and the price
  of the good, other things constant.

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4.2 SUPPLY
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4.2 SUPPLY

• Changes in Supply
• Change in quantity supplied
• A change in the quantity of a good that suppliers
  plan to sell that results from a change in the
  price of the good.
• Change in supply
• A change in the quantities that suppliers plan to
  sell at all different prices when any influence
  on selling plans other than the own-price of the
  good changes i.e. a change in the relationship
  between own-price and how much sellers want to
  sell caused by some change in something other
  than the goods price.

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4.2 SUPPLY
4.2 SUPPLY
When supply changes, the supply curve shifts.
1. When supply decreases, the supply curve shifts
leftward from S0 to S1.
2. When supply increases, the supply curve shifts
rightward from S0 to S2.
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4.2 SUPPLY

• The main influences on selling plans that change
  supply are
• Prices of related goods
• Prices of resources and other Inputs
• Expectations
• Number of sellers
• Productivity

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Things that shift supply ..

• Prices of inputs used to make the good and of
  related outputs
• Expectations about future prices
• Supplier numbers
• Technology, which determines productivity to a
  large extent

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4.2 SUPPLY

• Prices of Related Goods
• A change in the price of one good can bring a
  change in the supply of another good.
• Substitute in production
• A good that can be produced in place of another
  good. For example, a truck and an SUV in an auto
  factory.
• The supply of a good increases if the price of
  one of its substitutes in production falls.
• The supply a good decreases if the price of one
  of its substitutes in production rises.

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4.2 SUPPLY

• Complement in production
• A good that is produced along with another good.
  For example, straw is a complement in production
  of wheat. Manufacturing examples are hard to
  find except in things like metal-refining.
• The supply of a good increases if the price of
  one of its complements in production rises.
• The supply a good decreases if the price of one
  of its complements in production falls.

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4.2 SUPPLY

• Prices of Resources and Other Inputs
• Resource and input prices influence the cost of
  production. And the more it costs to produce a
  good, the smaller will be supply of that good.
• Expectations
• Expectations about future prices influence
  supply.
• Expectations of future input prices also
  influence supply.

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4.2 SUPPLY

• Number of Sellers
• The greater the number of sellers in a market,
  the larger is supply.
• Productivity
• Productivity is output per unit of input it
  depends on technology and organization.
• An increase in productivity lowers costs and
  increases supply.

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4.2 SUPPLY

• Supply A Summary

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Supply and Market Structure

• Remember, we ONLY talked about markets where
  there are many suppliers, all small compared to
  the market
• With other market structures, there may not be a
  supply curve in a meaningful sense ECO 2023
  deals with those cases

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4.3 MARKET EQUILIBRIUM

• Market equilibrium
• When the quantity demanded equals the quantity
  suppliedwhen buyers and sellers plans are
  consistent.
• Equilibrium price
• The price at which the quantity demanded equals
  the quantity supplied.
• Equilibrium quantity
• The quantity bought and sold at the equilibrium
  price.

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4.3 MARKET EQUILIBRIUM

• Figure 4.5 shows the
• equilibrium price and
• equilibrium quantity.

• 1. Market equilibrium is at the intersection of
  the demand curve and the supply curve.

• 2. The equilibrium price is 1 a bottle.

• 3. The equilibrium quantity is 10 million bottles
  a day.

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4.3 MARKET EQUILIBRIUM

• Price A Markets Automatic Regulator
• Law of market forces
• When there is a shortage, the price tends to
  rise.
• When there is a surplus, the price tends to fall.
• Surplus or Excess Supply
• The quantity supplied exceeds the quantity
  demanded.
• Shortage or Excess Demand
• The quantity demanded exceeds the quantity
  supplied.

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4.3 MARKET EQUILIBRIUM

• Figure 4.6(a) market
• achieves equilibrium.

At 1.50 a bottle 1. Quantity supplied is 11
bottles.
2. Quantity demanded is 9 bottles.
3. There is a surplus.
4. Price falls until the market is in
equilibrium.
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4.3 MARKET EQUILIBRIUM

• Figure 4.6(b) market
• achieves equilibrium.

At 75 cents a bottle 5. Quantity demanded is 11
bottles.
6. Quantity supplied is 9 bottles.
7. There is a shortage.
8. Price rises until the market is in
equilibrium.
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4.3 MARKET EQUILIBRIUM

• Figure 4.7(a) shows the
• effects of an increase in
• demand.

• 1. An increase in demand shifts the demand curve
  rightward.

• 2. The price rises to restore market equilibrium.

• 3. Quantity supplied increases along the supply
  curve.

• 4. Equilibrium quantity increases.

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4.3 MARKET EQUILIBRIUM

• Figure 4.7(b) shows the
• effects of a decrease in
• demand.

• 1. A decrease in demand shifts the demand curve
  leftward.

• 2. The price falls to restore market equilibrium.

• 3. Quantity supplied decreases along the supply
  curve.

• 4. Equilibrium quantity decreases.

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4.3 MARKET EQUILIBRIUM

• Effects of Changes in Demand
• When demand changes
• The supply curve does not shift.
• But there is a change in the quantity supplied
  sellers change how much they want to sell,
  because price changes.
• Price and quantity change in the same direction
  as the change in demand.

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4.3 MARKET EQUILIBRIUM

• Figure 4.8(a) shows the
• effects of an increase in
• supply.

• 1. An increase in supply shifts the supply curve
  rightward.

• 2. The price falls to restore market equilibrium.

• 3. Quantity demanded increases along the demand
  curve.

• 4. Equilibrium quantity increases.

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4.3 MARKET EQUILIBRIUM

• Figure 4.8(b) shows the
• effects of a decrease in supply.

• 1. A decrease in supply shifts the supply curve
  leftward.

• 2. The price rises to restore market equilibrium.

• 3. Quantity demanded decreases along the demand
  curve.

• 4. Equilibrium quantity decreases.

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4.3 MARKET EQUILIBRIUM

• Effects of Changes in Supply
• When supply changes
• The demand curve does not shift.
• But there is a change in the quantity demanded
  buyers change how much they want to buy, because
  the price changes.
• Price changes in the same direction as the change
  in supply.
• Quantity changes in the opposite direction to the
  change in supply.

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4.3 MARKET EQUILIBRIUM

• Figure 4.9(a) shows the
• effects of an increase in
• both demand and supply.

• An increase in demand
• shifts the demand curve
• rightward and an increase
• in supply shifts the supply
• curve rightward.

1. Quantity increases.

• 2. Price might rise or fall.

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4.3 MARKET EQUILIBRIUM

• Increase in Both Demand and Supply
• Increases the equilibrium quantity.
• The change in the equilibrium price is ambiguous
  because the
• Increase in demand raises the price.
• Increase in supply lowers the price.

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4.3 MARKET EQUILIBRIUM

• Figure 4.9(b) shows the
• effects of a decrease in
• both demand and supply.

• A decrease in demand
• shifts the demand curve
• leftward and a decrease in
• supply shifts the supply
• curve leftward.

3. Quantity decreases.

• 4. Price might rise or fall.

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4.3 MARKET EQUILIBRIUM

• Decrease in Both Demand and Supply
• Decreases the equilibrium quantity.
• The change in the equilibrium price is ambiguous
  because the
• Decrease in demand lowers the price
• Decrease in supply raises the price.

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4.3 MARKET EQUILIBRIUM

• Figure 4.10(a) shows the
• effects of an increase in
• demand and a decrease in
• supply.

• An increase in demand
• shifts the demand curve
• rightward, and a decrease
• in supply shifts the supply
• curve leftward.

1. Price rises.

• 2. Quantity might increase, decrease, or not
  change.

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4.3 MARKET EQUILIBRIUM

• Increase in Demand and Decrease in Supply
• Raises the equilibrium price.
• The change in the equilibrium quantity is
  ambiguous because the
• Increase in demand increases the quantity.
• Decrease in supply decreases the quantity.

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4.3 MARKET EQUILIBRIUM

• Figure 4.10(b) shows the
• effects of a decrease in
• demand and an increase
• in supply.

• A decrease in demand
• shifts the demand curve
• leftward, and an increase
• in supply shifts the supply
• curve rightward.

3. Price falls.

• 2. Quantity might increase, decrease, or not
  change.

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4.3 MARKET EQUILIBRIUM

• Decrease in Demand and Increase in Supply
• Lowers the equilibrium price.
• The change in the equilibrium quantity is
  ambiguous because the
• Decrease in demand decreases the quantity.
• Increase in supply increases the quantity.

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Kinds of Equilibrium
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Market Equilibrium

• One of the neat things about the market is that
  the Demand and Supply model shows that market
  equilibrium is generally stable
• I.e., it is like
• If the ball moves a little, it will go back where
  it started if conditions dont change, but price
  is perturbed moved a little from equilibrium,
  it will go back where it started.

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4.4 PRICE RIGIDITIES

• Price adjustments bring market equilibrium.
• But sometimes prices do not adjust. What happens
  then?
• Three reasons why price adjustment might not
  occur are
• Price ceiling
• Price floor
• Sticky price

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4.4 PRICE RIGIDITIES

• Price Ceiling
• Price Ceiling
• The highest price at which it is legal to trade a
  particular good, service, or factor of
  production.
• Rent Ceiling
• A law that makes it illegal for landlords to
  charge a rent that exceeds a set limit.

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4.4 PRICE RIGIDITIES
Figure 4.11 shows a rental apartment market.
1. Market equilibrium is determined by demand and
supply.
2. The equilibrium rent is 550 a month.
3. The equilibrium quantity is 4,000 apartments.
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4.4 PRICE RIDIGITIES
Figure 4.12 shows a rental apartment market.
The rent ceiling is introduced below the
equilibrium rent at 400 a month.
The quantity of apartments supplied decreases to
3,000.
The quantity for apartments demanded increases to
6,000.
There is a shortage of 3,000 apartments.
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4.4 PRICE RIGIDITIES

• Price Floor
• Price floor
• The lowest price at which it is legal to trade a
  particular good, service, or factor of
  production.
• Minimum wage law
• A government regulation that makes hiring labor
  for less than a specified wage illegal.

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4.4 PRICE RIGIDITIES
Figure 4.13 shows a market for fast food servers.
1. Market equilibrium is determined by demand and
supply.
2. The equilibrium wage rate is 5 an hour.
3. The equilibrium quantity is 5,000 servers.
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4.4 PRICE RIGIDITIES
Figure 4.14 shows how a minimum wage creates
unemployment.
The minimum wage rate is set at 7 an hour.
1. The quantity demanded decreases to 3,000
workers.
2. The quantity supplied increases to 7,000
workers.
3. A surplus of workers occurs and 4,000 are
unemployed.
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4.4 PRICE RIGIDITIES

• Sticky Price
• In most markets, a law does not restrict the
  price.
• But in some markets, either the buyer and seller
  agree on a price for a fixed period or the seller
  sets a price that changes infrequently.
• In these markets, prices adjust slowly and not
  quickly enough to avoid shortages and surpluses.

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Methodology

• How to use Demand and Supply
• Identify the Ceteris Paribus variable(s) that
  changed.
• Shift the Demand and/or Supply curve Draw
  yourself a small sketch diagram (cartoon).
• Find the new Equilibrium.
• Make your prediction.
• It will be qualitative direction of changes,
  not how much.