Supply and DemandMarket Price and Output

Lesson Objectives

• To understand and be able to illustrate a market

• To be able to illustrate and explain market equilibrium and how this changes

• To e able to explain disequilibrium and the concept of market forces and the price mechanism

• A market is defined as a place where buyers and sellers meet to exchange goods and services

• Examples of markets?• Markets are illustrated using supply and

demand curves together.

Equilibrium• When a market is in equilibrium it

means it is in a state of balance.• Market equilibrium occurs where supply

equals demand.• When planned supply meets planned

demand we can determine the equilibrium price (known as the ‘market price’) and the equilibrium quantity traded in a market.

S1

D1

Qe

PeE

Price

Quantity

Equilibrium Price= Pe (market price)Equilibrium Output= Qe

• Assuming markets are competitive and consumers and producers follow their self interests (utility and profit maximisers) then scarce resources can be allocated efficiently via the price mechanism

Disequilibrium

• When demand and supply are not equal a state of disequilibrium will occur

• Market forces (the ‘invisible hand’) should move price back to it’s equilibrium

S1

D1

Qe

PeE

Price

Quantity

P1

P2

Excess Supply

Excess Demand

• Excess supply- producers have to lower prices to sell output. This downward pressure on price is sometimes known as a ‘buyers market’

• Excess demand- prices are ‘bid up’- ‘sellers market’The price mechanism ensures that a free market (a market with no government intervention) will always end up in equilibrium

Read handoutThe Functions of Price and the Allocation of

Scarce Resources

Recall

• What factors cause a shift in demand?

• What factors cause a shift in supply?

Effect of an Increase in Demand

• Time periods–Momentary- supply is fixed– Short-run- the interval which must

elapse before more can be supplied with existing capacity. At least one factor of production will remain fixed

– Long run- the time interval long enough to change all factors of production

–Now illustrate on your handouts

Momentary Period- Supply is fixed

D1

Q1

P1

Price

Quantity

D2

Sm

Pm

Short run

S1

D1

Q1

P1

Price

Quantity

D2

P2

Q2

In the long run- new firms enter industry attracted by the new higher equilibrium price

S1

D1

Q1

P1

Price

Quantity

D2

Q2

S2

Effect of an increase in supply

• In the short run, ceteris paribus, an increase in supply will lower the price, this in turn will cause an extension in demand

• Illustrate using a diagram

S1

D1

Q2

P2

Price

Quantity

S2

P1

Q1

S1

D1

Q2

P2

Price

Quantity

S2

P1

Q1

S1

D1

Q2

P2

Price

Quantity

S2

P1

Q1

Price Elasticity of supply and demand

On your worksheet…• Illustrate- If Supply is inelastic what happens to

equilibrium price and quantity when there is an increase in demand? 

• Illustrate- If Supply is inelastic what happens to equilibrium price and quantity when there is an increase in demand?

• Illustrate- If Demand is inelastic what happens to equilibrium price and quantity when there is an increase in supply? 

• Illustrate- If Demand is elastic what happens to equilibrium price and quantity when there is an increase in supply?

Handout Activities…

• Multiple Choice Handout• Supply and Demand Worksheet 1• Supply and Demand Worksheet 2

Producer and Consumer Surplus

Illustrate on a diagram…

QuantityQ

Price

Producer Surplus

P

D

Consumer Surplus

E

S

A

B

S1

D1

Q1

P1

Price

Quantity

D2

P2

Q2