Demand, Supply and Market Equilibrium MB Chp: 3 - PowerPoint PPT Presentation


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Demand, Supply and Market Equilibrium MB Chp: 3


Demand, Supply and Market Equilibrium MB Chp: 3 Lecture: 3 Chapter Objectives Demand and its determinants Supply and its determinants Supply, demand, & market ... – PowerPoint PPT presentation

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Title: Demand, Supply and Market Equilibrium MB Chp: 3

Demand, Supply and Market EquilibriumMB Chp 3
  • Lecture 3

Chapter Objectives
  • Demand and its determinants
  • Supply and its determinants
  • Supply, demand, market equilibrium
  • Changes in supply and demand
  • Government-set prices

  • A market is an institution or mechanism that
    brings together buyers (demanders) and sellers
    (suppliers) of particular goods and services
  • This chapter concerns purely competitive markets
    with a large number of independent buyers and

  • Demand is a schedule or a curve that shows the
    various amounts of a product consumers are
    willing and able to buy at each specific price in
    a series of possible prices during a specified
    time period
  • Demand is simply a statement of a buyers' plans,
    or intentions
  • Price will be determined by interaction of demand
    and supply

Individual Demand
Individual Demand
5 4 3 2 1
10 20 35 55 80
Law of Demand
  • Law of Demand is a fundamental characteristic of
    demand behavior
  • All else equal, as price falls, the quantity
    demanded rises, and as price rises, the quantity
    demanded falls there is an inverse (or
    negative) relationship between price and quantity
  • All else equal implies that tastes, income,
    price of substitutes etc are constant
  • This inverse r/s is the law of demand

Explanation behind the Law of Demand
  • 1. Diminishing marginal utility the decrease in
    added satisfaction that results as one consumers
    additional units of a good or services i.e the
    second Big Mac yields less satisfaction (or
    utility) than the first. Thus you will only buy
    additional units if price is reduced
  • 2. Income effect A lower price increases the
    purchasing power of money income enabling the
    consumer to buy more of the product than before
    (or less at a higher price)
  • 3.Substitution effect A lower price (of good X),
    gives the incentive to substitute (or buy more of
    good X) the lower- priced good for now relatively
    higher-priced goods

Market Demand Curve
  • By adding the quantities demanded by all
    consumers at each of the various possible prices,
    we can get a market demand schedule from
    individual demands
  • It is the horizontal sum of individual curves

Change in Demand
  • There are several determinants of demand or the
    other things besides price , which affect
  • Changes in these determinants cause the demand
    schedule to shift graphically
  • This is called a change in demand
  • A change in quantity demanded comes from price
    changes and it is a movement ALONG demand
    schedule (with no shifts involved)

Determinants of Demand
  • 1. Tastes
  • Favorable change leads to increase in demand ,
    unfavorable change to decrease
  • 2. Number of buyers
  • An increase in the number of buyers in a market
    will result in increase in product demand
  • 3. Income
  • As income increases, demand for normal (or
    superior) goods varies directly. However, demand
    for inferior goods decreases as income increases
    (used cars, clothing etc)

Determinants of Demand
  • 4. Price of related goods
  • Substitute good is one that can be used in place
    of another good. An increase in price of a
    substitute will increase the demand for actual
    good (direct R/s)
  • Complementary good is one that is used together
    with another good. The goods have a joint demand
    An increase in price of comp. good will decrease
    the demand for the other good (inverse R/s)
  • 5.Consumer Expectations
  • Consumers views about future prices, product
    availability and income can shift demand

  • A change in demand must not be confused with a
    change in quantity demanded
  • A change is demand is a shift of the demand curve
  • Occurs due to one or more of the determinants of
    demand altering
  • A change in quantity demanded is a movement from
    one point to another point
  • Cause of such a change is the increase or
    decrease in price

  • Supply is a schedule or curve showing the various
    amounts of a product that producers are willing
    and able to make available for a sale at each of
    a series of possible prices during a specific

Individual Supply
  • Supply is a schedule or curve showing the various
    amounts of a product that producers are willing
    and able to make available for a sale at each of
    a series of possible prices during a specific

6 5 4 3 2 1 0
Individual Supply
5 4 3 2 1
60 50 35 20 5
Price (per bushel)
10 20 30 40 50
60 70
Quantity Supplied (bushels per week)
Law of Supply
  • Law of Supply
  • As price increases, quantity supplied will also
    increase. There is a direct relationship between
    price and supplied qty.
  • Explanations
  • 1. Revenue implications
  • Given product costs, a higher price means
    greater profits and thus an incentive to increase
    the qty supplied
  • 2. Marginal cost
  • Beyond some production level, producers usually
    encounter increasing costs per added unit of
  • Market supply is derived by horizontally adding
    the supply curves of individual producers

Determinants of Supply
  • Changes in any of the determinants cause shifts
    in the supply curve
  • 1. Resource prices
  • A rise in resource prices will cause a decrease
    in supply or leftward shift
  • 2. Technology
  • Technological improvements leading to efficient
    production and lower costs can increase supply
  • 3. Taxes and Subsidies
  • Tax is treated as cost, subsidy lowers cost and
    increases supply

Determinants of Supply
  • 4. Price of related goods
  • If price of substitute good increases, prod.
    might shift production to that good
  • 5.Expectations about future price of product
  • Can lead to increases or decreases in supply
  • 6. Number of sellers
  • Larger number of sellers lead to greater supply

Market Equilibrium
  • Equilibrium price and quantity
  • Where qty demanded and supplied equals
  • Can any other price exist?
  • Surplus and shortage

Rationing function of price
  • Ability of competitive forces of supply and
    demand to establish a price at which selling and
    buying decisions are consistent
  • At equilibrium price, no surplus or shortage
    remains market clearing price

Efficient allocation
  • Competitive markets ensure
  • Productive efficiency
  • Production of any particular good in the least
    costly way
  • Allocative efficiency
  • The particular mix of goods and services most
    highly valued by society
  • At the intersection of D and S therefore, MB MC
    and there is neither an underallocation of an
    overallocation of resources to a particular

Market Equilibrium
  • Change in demand
  • Shift of the demand curve
  • Change in supply
  • Shift of the supply curve
  • Change in equilibrium price and quantity

Complex cases
  • Supply increase Demand decrease
  • Supply decrease Demand increase
  • Supply increase Demand increase
  • Supply decrease Demand decrease

Price Floors
  • A price floor is a minimum price fixed by the
    government. A price at or above the price floor
    is legal, a price below is not.
  • Support prices for wheat, minimum wages for labor
    are good examples
  • Price floors result in excess supply

Price Floors contd.
  • Govt. has to either restrict supply by giving
    permits to certain farmers to produce OR
  • Increase demand by finding new uses for the
  • Govt. has to buy the excess output (store or
    destroy it)
  • PF lead to distorted allocation of scarce
    resources allocative inefficiency
  • Consumers pay higher prices
  • Tax money wasted on purchasing excess output

Price Ceilings
  • A price ceiling sets the maximum legal price a
    seller can charge for a product or service. A
    price at or below the ceiling is legal, a price
    above it not.
  • Price Ceiling results in excess demand which will
    cause problems
  • 1. Rationing Problem
  • How will the available amount be apportioned
    among consumers who demand a higher amount?
  • coupons
  • 2. Black Market
  • Many buyers are willing to pay a higher price and
    it therefore profitable for producers to sell to
    these customers
  • A black market will flourish where the product is
    bought and sold at a higher price

Market Equilibrium
200 Buyers 200 Sellers
Market Supply 200 Sellers
Market Demand 200 Buyers
6 5 4 3 2 1 0
6,000 Bushel Surplus
4 Price Floor
5 4 3 2 1
2,000 4,000 7,000 11,000 16,000
5 4 3 2 1
12,000 10,000 7,000 4,000 1,000
Price (per bushel)
2 Price Ceiling
7,000 Bushel Shortage
2 4 6 8 10 12 14
16 18
Bushels of Corn (thousands per week)