Demand and Supply
The foundation of many economic concepts
The Demand and Supply model is the most used model in economics!
Its main purpose is to show how a competitive market works. That is, it illustrates how buyers
(Demanders) and sellers (Suppliers) come together for the purpose of establishing a price at
which to exchange goods and services.
It was developed in the late 1800’s by a Scottish economist named Alfred Marshall
2 assumptions of the D/S model…
(a) Many buyers and sellers. Firms produce identical (standardized) goods, and each firm
produces only a small percentage of total output. As a result, no one firm can control market
price, and each firm must take market price as given. A competitive market exists.
(b) Only one factor affecting demand is assumed to change at a time (Ceteris Paribus
assumption). The same applies to supply.
The Demand/Supply model deals with what economists call relative prices
Money price vs. Relative Price
Money price=accounting cost, and is the amount of money given up to purchase a good or
Relative price, in contrast, is the ratio of one good’s money price to another good’s money price.
It measures the opportunity cost
Example…Suppose a TTC metropass currently costs $98, while a movie costs $14. If Ps
represents the money price of the metropass, while Pm represents the price of the movie, then
the relative price of the metropass to the movie is (Ps/Pm)=7/1. The opportunity cost of
purchasing an additional metropass is seven (7) movies.
First, we consider the buyer’s side of the market…Demand
What factors will affect the amount of a good or service a consumer will want to purchase?
(a) The price of the good itself (P)
(b) Prices of related goods and services (Pr)—in particular, substitutes and complements
(c) Consumer incomes (y)
(d) Expected future prices [E(P)] (e) Tastes and Preferences (Tp)
(f) Population and demographics (P0)
amount of a good or service that consumers will want to purchase
In general, economists consider the price of the good itself to be the most important factor
affecting purchases. So, we consider this first…
Some basic definitions…
Economists say that there is a demand for a good if…(a) there is a want for it, (b) there is an
ability to pay for it, and (c) there is a definite plan to purchase it
The quantity demanded (Qd) of some good or service is the amount that consumers are willing
and able to purchase, at a given price (P), over a given period of time (t)
Law of Demand: As the price of a good (P) increases, all else equal, the quantity demanded (Qd)
of the good will decrease.
Likewise, as P decreases (all else equal) the quantity demanded (Qd) of the good will increase.
There is an inverse relationship between P and Qd
Because of…(a) the Substitution effect: As the price of a good increases, all else equal, its
relative price increases. As a result, consumers substitute away from the good toward cheaper
substitutes, and Qd decreases. Example When the price of Coca Cola increases, all else equal,
people will purchase more Pepsi.
And (b) the Income Effect—As the price of good increases, all else equal (including income)
people will not be able to purchase as much of the good. Their purchases of other goods may
decrease as well. Economists say that people’s purchasing power is reduced by the price
increase. As a result, as P increases, all else equal, Qd will decrease.
The Law of Demand can be illustrated in one of two ways…(a) By a demand schedule that
illustrates the quantities demanded at various prices by an individual consumer or market
(b) Graphically, by means of a demand curve.
Both these methods will be illustrated in a class handout with all the diagrams.
Note that, in general, the Law of Demand is shown by a movement along the Demand Curve. As
the price of the good itself ↑, all else equal, the quantity demanded of the good ↓ and there is
an upward movement along the demand curve from one point to another. As the price of the good itself ↓, the opposite occurs, and there is a downward movement along the demand
curve, with Qd ↑
If some factor other than the price of the good itself (P) changes, then the demand curve shifts
either rightward (for ↑demand) or leftward (for ↓ demand)
Any factor that causes the demand curve to shift (change position) is called a Demand Shifter
The Demand Shifters***
(a) Changes in Prices of Related Goods—(i) Substitutes—Goods that have a similar function, or
Tea and coffee, golf and tennis, Nike® and Reebok® running shoes, etc.
If the price of Burger King’s Whoppers (a substitute for Big Macs ) increases, all else equal, th