Chapter IVSupply and

Demand

I. THE MARKET FORCES OF SUPPLY AND DEMAND

• SupplySupply and Demand are the two words that economists use most often.• Supply and Demand are the forces that

make market economies work!• Modern economics is about supply,

demand, and market equilibrium.

MARKETS AND COMPETITION• The terms supply and demand refer to

the behaviour of people as they interact with one another in markets.• A market is a group of buyers and sellers of

a particular good or service.Buyers determine demand...Sellers determine supply…

Private parties (individuals or businesses) own vast majority of land, factories, and other

economic resources

Demand

Quantity of a good or service that buyers are

willing to purchase at a specific selling price

Market Economy

Supply

Quantity of a good or service that producers are willing to provide at a specific selling

price

I.1. What is Demand?In everyday language, demand

includes needs ands wants of consumers.

In economics, demand refers to how much (quantity) of a product or service is desired by buyers

I.2. What is Quantity Demanded?= amount of goods and services that

consumers are willing and able to purchase at conceivable prices or in a range of prices

A demand schedule shows how much of a good or service consumers will want to buy at different prices

Demand Schedule for TicketsPrice ($ per ticket)

Quantity demanded (tickets)

350 5,000

300 6,000

250 8,000

200 11,000

150 15,000

100 20,000

I. 3. I. 3. Demand Schedule

The quantity demanded is the actual amount consumers want to buy at some specific price. If the scalpers are charging $250 per ticket,8,000 tickets will be

purchased

8,000

That is, 8,000 is the quantity demanded at a price of $250

A demand curve is the graphical representation of the demand schedule; it shows how much of a good or service consumers want to buy at any given price.

The law of demand says that a higher price for a good, other things equal, leads people to demand a smaller quantity of the good If the price drops to $100,20,000 fans want to

buy tickets

At $250, only 8,000 tickets are demanded

The law of demand points to the inverse relationship between price and the quantity demanded.

Note that the demand curve slopes downward

This reflects the This reflects the general proposition general proposition that a higher price that a higher price reduces the number of reduces the number of people willing to buy a people willing to buy a goodgood

Relation between price and quantity demanded

I.4. The Law of DemandStates that when the price of a good rises and

everything else remains the same, the quantity of the good demanded will fall (e.g., air travel, magazines, education, etc)The words, “everything else remains the same” are

important In the real world many variables change simultaneously However, in order to understand the economy we must

first understand each variable separately Thus we assume that, “everything else remains the

same,” in order to understand how demand reacts to price

I.4. Law of Demand (Cont’d)

Price Quantity demandedTry to economize to useFind out the substitute

Price Quantity demanded Afford more products

Substitute to others at high prices

I.5. Graphing Demand Curve

Graphing Demand Curve

II. 1.What is Supply?In daily language, supply is the ability that

sellers and producers can satisfy consumers’ needs and wants

In economics, supply refers to the desire and ability that sellers and producers can satisfy consumers’ demand

II. 2. What is quantity supplied?

The amount of goods and services which are offered for sale at conceivable prices or

in a range of pricesRelation between price and quantity

suppliedPrice (dollar) Quantity supplied

1 102 203 304 40

A supply schedule shows how much of a good or service would be supplied at different prices

Supply Schedule for TicketsPrice ($ per ticket)

Quantity supplied (tickets)

350 8,800300 8,500250 8,000200 7,000150 5,000

100 2,000

II.3. II.3. Supply Schedule

Just as demand curves normally slope downwards, supply curves normally slope upwards

The higher the price being offered, the more people will be willing to part with their hockey tickets…

A supply curve shows graphically how much of a good or service people are willing to sell at any given price.

II.4.The Law of SupplyStates that when the price of a good rises

and everything else remains the same, the quantity of the good supplied will riseThe words, “everything else remains the same”

are important In the real world many variables change

simultaneously However, in order to understand the economy we

must first understand each variable separately We assume “everything else remains the same” in

order to understand how supply reacts to price

II.4. Law of SupplyPrice Quantity supplied

Try to produce more to gain more profitMore and more producers join the market

Price Quantity supplied Minimize production to reduce loss

Some producers change their production to other goods

II.5. Graphing Supply CurvePrice

(dollar)

Quantity supplied

1 102 203 304 40

III. What is market price?1. Market price vs Prices in the market

Different sellers in the market give consumers different prices of the product

Market price is the one at which the quantity demanded is equal to the quantity supplied. E.g. It satisfies both seller and consumers

III. 2. Graphing market price

III. 3. Finding the Equilibrium Price and Quantity

Let’s put the supply curve and the demand curve for that market on the same diagram

Market equilibrium occurs at point E, where the supply curve and the demand curve intersect

In equilibrium the quantity demanded is equal to the quantity supplied

In this market the equilibrium price is $250 And the equilibrium quantity is 8,000 tickets

SUPPLY AND DEMAND TOGETHER

Equilibrium refers to a situation in which the price has reached the level where quantity supplied equals quantity demanded.

EquilibriumEquilibrium Price

The price that balances quantity supplied and quantity demanded.

On a graph, it is the price at which the supply and demand curves intersect.

Equilibrium QuantityThe quantity supplied and the quantity demanded at the

equilibrium price. On a graph it is the quantity at which the supply and

demand curves intersect.

At $2.00, the quantity demanded is equal to the quantity supplied!

Demand Schedule

Supply Schedule

Equilibrium

Equilibrium price

Demand

Supply

$2.00

6 8 100

Equilibrium

Equilibrium quantity

Quantity of Ice-Cream Cones

Price of Ice-Cream

Cone

421 3 5 7 9 11

Figure : The Equilibrium of Supply and Demand

III.4. Surplus vs ShortageSurplus

When price > equilibrium price, then quantity supplied > quantity demanded. There is excess supply or a surplus. Suppliers will lower the price to increase sales, thereby

moving toward equilibrium.Shortage

When price < equilibrium price, then quantity demanded > the quantity supplied. There is excess demand or a shortage. Suppliers will raise the price due to too many buyers

chasing too few goods, thereby moving toward equilibrium.

Demand

Supply

$2.00

6 8 100 Quantity of Ice-Cream Cones

Price of Ice-Cream

Cone

421 3 5 7 9 11

$2.50

Surplus

Quantity Demanded

Quantity Supplied

Figure 4-9 a): Excess Supply

Let’s say the market price of $350 is above the equilibrium price of $250This creates a surplusThis surplus will push the price down until it reaches the equilibrium price of $250

Why Does the Market Price Fall if It Is Above the Equilibrium Price?

There is a surplus of a good when the quantity supplied exceeds the quantity demanded. Surpluses occur when the price is above its equilibrium level.

Why Does the Market Price Rise if It Is Below the Equilibrium Price?

There is a shortage of a good when the quantity demanded exceeds the quantity supplied. Shortages occur when the price is below its equilibrium level.

Let’s say the market price of $150 is below the equilibrium price of $250This creates a shortageThis shortage will push the price up until it reaches the equilibrium price of $250

Demand

Supply

$2.00

6 8 100 Quantity of Ice-Cream Cone

Price of Ice-Cream

Cone

421 3 5 7 9 11

$1.50

Shortage

Quantity Supplied

Quantity Demanded

Figure 4-9 b): Excess Demand

IV. Changes in demand and supply affect price

IV.1. Changes in demandQuantity demanded Price

Not enough goods to satisfy consumers’ demand

(Excess demand)

Quantity demanded Price Sellers reduce prices to attract consumers

Otherwise they have a lot of inventories, lack of capital for further investment

Exess demand

IV.2. Changes in supplyQuantity supplied Price

Sellers reduce prices to attract consumers (excess supply)

Otherwise they have a lot of inventories, lack of capital for further investment

Quantity supplied Price Too few goods to satisfy all consumers’

demand

Exess Supply

V. Prices important in market economy

1. Act as signals to buyers and sellers Price Purchasing signal to buyers

+ Purchase more to store for future use

+ to substitute goods at high pricesPrice Selling signal to sellers

+ sell more to gain more profit+ more producers and sellers join the

market

Roles of prices (Cont’d)2. Encourage efficient production

Price producers gain more profit- Invest more into their production such as new

assembly lines, machinery.- Invest more into entrepreneurship- Invest more into human resources such as training

and retraining* Making their production more and more efficient

Roles of prices (Cont’d)3. Determine who will receive the things

produced- If the price is too high, only rich

consumers can purchase.- If the price is too low, everyone seems

to be affordable but creating the anxiety and suspicion.

- The price must be set in accordance with the producers’, sellers’ and consumers’ demand.