The Market Forces of Supply and Demand
Market and Competition
A market is a group of buyers and sellers of a particular product
o The type of market can be determined by the number of buyers and sellers
A competitive market is one with many buyers and sellers, each has a negligible effect on price.
o Leads to many competitors within the marketplace
In a perfectly competitive market:
o All goods are exactly the same
o Buyers and sellers are so numerous that no one can affect market price – each is a
Price is manipulated by the buyer
In the real world there is relatively few perfectly competitive markets. Most goods come in lots
of different varieties- including ice-cream.
o There are many markets in which the number of firms is small enough that some of
them have the ability to affect the market price
In this chapter, we assume markets are perfectly competitive
Oligarchy: few sellers who work together in a group
o Price is relatively stable
The quantity demanded of any good is the amount of the good that buyers are willing and able
Law of demand: the claim that the quantity demanded of a good falls when the price of the
good rises, other things equal
o In the law of demand, we must make a strong assumption that in order for all the things
to be equal and work in linear fashion, thus price will be only affected by buyers
When price increase, demand falls
When price decreases, demand increases
o It is important to understand that that other things may affect the rise in demand other
Demand comes from the behaviour of buyers
The Demand Schedule
Demand schedule: A table that shows the relationship between the price of a good and the
o Ex. Helen’s demand for lattes
Price Quantity of lattes of lattes demanded $0.00 16
5.00 6 Notice that Helen’s preference’s obey
the law of demand
Helen’s Demand Schedule & Curve
Price of lattes Quantity of lattes demanded
At the beginning Price is an independent variable but later affected by p.
Market Demand vs. Individual Demand
It is possible to get market demand from the use of many buyers demand
The quantity demanded in the market is the sum of the quantities demanded by all buyers at
Suppose Helen and Ken are the only two buyers in the Latte market ( Q = quantity demanded)
Quantity – x-axis
Market quantity corresponds to a different price levels The Market Demand Curve for Lattes
P Q (Market)
Demand Curve Shifters
The demand curve shows how price effects quantity demanded, other things being equal.
These “other things” are non-price determinants of demand (i.e., things that determine buyers
demand for a good, other than the good’s price).
A demand curve shifter is any change that increases the quantity demanded at every price
o Ex. An imaginary discovery about the nutritional benefits of ice-cream will shift the
demand curve to the right which is called an increase in demand.
o Any change that reduces the quantity demanded at every price shifts the demand curve
to the left and is called a decrease in demand
Changes in them shift the D curve…
Demand Curve Shifters: Number of Buyers
Increase in the # of buyers increases quantity demanded at each price, shift D curve to the
Suppose the number of buyers increases.
Then, at each P, Q will increase (by 5 in this example) Demand Curve Shifters: Income
Demand for a normal good is positively related to income
o Increase in income causes increase in quantity demanded at each price, shift D
curve to the right
(Demand for an inferior good is negatively related to income. An increase in income shifts D
curve for inferior goods to the left
Normal goods: when your income increases, you would buy more of these kinds of products
Inferior goods: when your income increases you would buy more expensive version of these
Both normal goods and inferior goods are relative to the person being describes
Demand Curve Shifters: Prices of Related Goods
Two goods are substitutes if an increase in the price causes an increase in demand for
Ex: pizza and hamburgers. An increase in the price of pizza increase demand for
hamburgers, shafting hamburger demand curve to the right
o Other ex: Coke and Pepsi, laptops and desktop computers, CDs and music
Two goods are complements if an increase in the price of one causes a fall in demand
for the other.
o Ex: computers and software
If price of computer rises, people buy fewer computers and therefore
less software. Software demand curve shifts left.
o Other examples: college tuition and textbooks, bagels and cream cheese, eggs
o Other ex: camera and films: the decline in photographic film cameras has led to
a decline in the photographic film industry
Demand Curve Shifters: Tastes
Anything that causes a shift in tastes toward a good will increase demand for that good
and shift its D curve to right.
Ex. The Atkins diet that became popular in the 90s caused an increase in demand for
eggs, shifted the egg demand curve to the right
Demand Curve Shifter: Expectations
Expectation affect consumers’ buying decisions
o If people expect their incomes to rise, their demand for meals at expensive
restaurants may increase
o If the economy sours and people worry about their future job security,, demand
for new automobiles may fall
o Can also be used in relation to expectation of quality of goods i.e. Apple IPhone 5C: didn’t meet expectations which may result in a
decline in demand
Summary: Variables That Influence Buyers
It must be noted that Price only causes a movement along
the demand curve not a shift
If the variable that is causing demand to change is NOT
measured on either axis, the curve shifts
Active Learning #1: Demand Curve
Draw a demand curve for music downloads. What happens to it in each of the following
a. The price of iPods falls
Music download and iPods are
compliments of each other. A fall in price of iPods shifts the
demand curve for music downloads to the right.
The price of downloads is the
same, but the quantity demanded is now higher. At any given
point the quantity is higher than before
b. The price of music downloads falls
The D curve does not shift.
Move down along to a point with lower P, higher
c. The price of CD falls
CDs and music
downloads are substitutes A fall in price of CDs shifts demand for music downloads to the left
The quantity supplied of any good is the amount that sellers are willing and able to sell.
Law of supply: the claim that the quantity supplied of a good rises when the price of the good
rises, other things equal
o When price increases, quantity increases
o When prices falls, quantity supplied falls as well
This we say that quantity supplied is positively related to the price of the good
Supply comes from the behaviour of sellers
The Supply Schedule
Supply schedule: A table that shows the
relationship between the price of a good and
the quantity supplied.
Ex. Starbucks’ supply of lattes
o Notice that Starbucks’ supply schedule
obeys the Law of Supply
Starbucks’ Supply Schedule & Curve Market Supply vs. Individual Supply
The quantity supplied in the market is the sum of quantities supplied by all sellers at each price.
Suppose Starbucks and Jitters are the only sellers in this market (Q = quantity supplied)
The Markey Supply Curve
Supply Curve Shifters
The supply curve shows how price affects quantity supplied, other things being equal.
These “other things” are non-price determinants of supply.
A supply curve shifter is any change that increases the quantity supplied at every price
Changes in them shift the S curve…
Supply Curve Shifters: Input Prices Has direct impact of the price of the product
o i.e. if wages/materials, etc. increase, production price will increase as well
Ex. of input prices:
o Prices of raw materials
A fall in input prices makes production more profitable at each output price (the price of
the good that firms are producing and selling), so firms supply a larger quantity at each
price, and the S curve shifts to the right
Suppose the price of milk falls. At each price, the
quantity of lattes supplied will increase ( by 5 in this example)
Supply Curve Shifters: Technology
Technology determined how much inputs are required to produce a unit of output.
A cost-saving technological improvement has the same effect as a fall in input prices, shift
the S curve to the right
o More efficiency with productions
o Leads to more production at lower costs
Supply Curve Shifter: Number of Sellers
An increase in the number of sellers increases the quantity supplied at each price, shifts S
curve to the right.
Supply Curve Shifters: Expectations
o Events in the Middle East leads to Expectations of higher oil prices.
o In response owners of Texas oilfields reduce supply now, save some inventory to sell
later at the higher price.
o S curve shift left
In general, sellers may adjust supply (if good is not perishable) when their expectation of
suture prices change.
Summary: Variables that Influence Sellers
*memorise Active Learning 2: Supply Curve
Draw a supply curve for tax return preparation software like “TurboTax” and “Tax Cut”. What
happens to it in each of the following scenarios?
a) Retailers cut the price of software
S curve does not shift.
Move down along the curve to a lower P and lower Q
b) A technological advancement allows the software to be produced at lower cost.
S curve shifts to the right: at each Q increases.
c) Professional tax return preparers raise the price for the services they provide
This shifts the demand curve for tax preparation
software, not the supply curve.
Supply and Demand Together
Economy is a demand bound
o When there is demand, there will be
Equilibrium: P has reached the level
where quantity supplied equals quantity demanded
Equilibrium price: the price that equates quantity supplied with quantity demanded
To graph of Supply Demands Graph find the x and y intercepts +10
Q d (50, 0) Q s (10, 0)
(0, 25) (0, -5)
Equilibrium quantity: the quantity supplied and the quantity demanded at the equilibrium price
Surplus (a.k.a. excess supply): when quantity supplied is greater than quantity demanded
If P = $5
Q = 9 lattes
Q = 25 lattes
Resulting in a surplus of 16 lattes
Facing a surplus sellers try to increase sales by cutting price.
Q D to rise and Q to fall…
…which reduces the surplus Prices continue to fall until market reaches equilibrium
Shortage (a.k.a. excess demand): when quantity demanded is greater than quantity supplied
If P - $1
Q = 21 lattes
Q S = 5 lattes
Resulting in a shortage of 16 lattes
Facing a shortage sellers raise the price causing Q to fall
and Q to rise …
…which reduces the shortage
Prices continue to rise until market reaches equilibrium Three Steps to Analyzing Changes in Equilibrium
To determine the effects of any event,
1. Decide whether even shifts S curve D curve, or both.
2. Decide in which direction curve shifts.
3. Use supply-demand diagram to see shift changes eq’m P and Q
Example: The Market for Hybrid Cars
Hybrids are substitute traditional cars which are compliments of gas
Example 1: A Shift in Demand
EVENTS TO BE ANALYSED: Increase in price of gas
STEP 1: D curve shifts
STEP 2: D shifts right
STEP 3: D The shift causes an increase in price and quantity of
Notice: When P rises producers supply larger quantity of
hybrids, even though the S curve has not shifted.
*Note: Always be careful to distinguish between a shift in a
curve and a movement and the curve
Terms for Shift vs. Movement along Curve
Change in supply: a shift in the S curve occurs when a non-price determinant of supply changes
(like technology or costs)
Change in quantity supplied: a movement along a fixed S curve occurs when P changes
Change in demand: a shift in the D curve occurs when a non-price determinant of demand
changes ( like income or #of buyers)
Change in the quantity demanded: a movement along a fixed D curve occurs when P changes
Example 2: A Shift in Supply
EVENT: New technology reduces costs of producing hybrid cars
STEP 1: S curve shifts
STEP 2: S curve shifts right
STEP 3: The shift causes price to fall and quantity to rise Example 3: A Shift in Both Supply and Demand
EVENTS: price of gas rises AND new technology reduces
STEP 1: Both curves shift
STEP 2: Both curves shift to the right
STEP 3: Q rises, but effect on P is ambiguous: If demand
increases more that supply, P rises. But if supply increases
more than demand, P falls.
New market equilibrium is created from the intersection
between P and Q .
Demand is dominant in determining market equivalent
price. Change in supply has little effect on P
If demand is dominant P*Q* changes in the same direction.
If supply is dominant P*Q* changes in opposite directions
Active Learning 3: Shifts in supply and demand
Use the three-step method to analyse the effects of each event on the equilibrium price ad
quantity of music downloads.
Event A: A fall in the price of CDs
1. D curve shifts
2. D shifts left
3. P and Q both fall
Event B: Sellers of music downloads negotiate a reduction in royalties they
must pay for each song they sell
S curve shifts
S shifts right (Royalties are part of sellers’ costs)
P falls, Q rises
Sellers of music downloads negotiate a reduction in the royalties they
must pay for each song they sell. This event causes a fall in “costs of
production” for sellers of music downloads. Hence the S curve shifts to
*Note: royalties are considered sellers’ cost of production Event C: Event A and B both occur
Both curves shifts (see part A & B)
D shifts left, S shifts right
P unambiguously falls. Effect on Q is ambiguous: The fall in demand reduces Q, the increase is
supply increase Q.
Conclusion: How Prices Allocate Resources
One of the Ten Principles from Chapter 1: Markets are usually a good way to organise
In market economies, price adjusts to balance supply and demand. These equilibrium prices are
the signal that guide economic decisions and thereby allocate scarce resources
A competitive market has many buyers and sellers, each of whom has little or no influence on
the market price
Economist use the supply and demand model to analyse competitive markets
The downward-sloping demand curve reflects the Law of Demand, which states that the
quantity buyers demand of a good depends negatively on the good’s price.
Besides price, demand depends on buyers’ income, tastes, and expectations, the prices of
substitutes and complements, and number if buyers. If one of these factors changes, the D curve
The upward-sloping supply curve reflects the Law of Supply, which states that the quantity
sellers’ supply depends positively on the good’s price.
Other determinants of supply include input prices, technology, expectation and the # of sellers.
Changes in these factors shift the S curve
The intersection of S and D curves determines the market equilibrium. At the equilibrium price,
quantity supplied equals quantity demanded.
If the market price is above equilibrium, a surplus results, which causes the price to fall. If the
market price is below equilibrium, a shortage results, causing the price to rise.
We can use the supply-demand diagram to analyze the effects of any event on a market: First,
determine whether the event shifts one or both curves. Second, determine the direction of the
shifts. Third, compare the new equilibrium to the initial one.
In market economies, prices are the signals that guide economic decisions and allocate scarce
Basic Idea: Elasticity measures how one variable responds to changes in another variable o Scenario: You design websites for local businesses. You charge $200 per website, and
currently sell 12 websites per month.
o Your costs are rising (including the opportunity cost of your time), so you consider
raising the price to $250.
o The law of demand says that you won’t sell as many websites if you raise your price.
How many fewer websites? How much will your revenue fall, or might it increase?
One type of elasticity measures how much demand for your websites will fall if
you raise your price
Definition: Elasticity is a numerical measure of the responsiveness of Q or Q to one of its
o Measures the sensitivity of buyers in any change
o Buyers can react to income increase, expectation, price change of good etc.
Price Elasticity of Demand
Price elasticity of demand measures how much Q responds to a change in P
Loosely speaking, it measures the price-sensitivity of buyers’ demand
Price elasticity of demand equals
The percentage change in demand is always put in the numerator and the
percentage change in price in the denominator.
This is demand responds to a price change
Along a D curve, P and Q move in opposite direction, which would make
price elasticity negative.
We will drop the minus sign and report all price elasticities as positive numbers.
Calculating Percentage Changes
Standard method of computing the percentage (%) change:
Going from A to B, the % change in P:
o The standard method gives different answers
depending on where you start.
o From A to B,
o P rises 25%, Q falls 33%, elasticity = 33/25 = 1.33
o From B to A,
o P falls 20%, Q rises 50%, elasticity = 50/20 = 2.50
So we instead use the midpoint method: The midpoint is the number halfway between the start and end vales, the average of those
It doesn’t matter which values you use as the “start” and which as the “end” – you get the same
Using the midpoint method, the % change in P equals
The % change in Q equals
The price elasticity of demand equals
Active Learning 1: Calculate an elasticity
Use the following information to calculate the price elasticity of demand for hotel rooms:
if P = $70, d = 5000
if P =$90, Q = 3000
Use the midpoint method to calculate % change in Q d
%change in P
The price elasticity of demand equals
What determines price elasticity?
To learn the determinants of price elasticity, we look at a series of examples. Each compares two
In each example:
Suppose the prices of both goods rise by 20%
The good for which Q falls the most (in percent) has the highest price elasticity of demand.
Which good is it? Why?
What lesson does the example teach us about the determinants of the price elasticity of
Example 1: Breakfast cereal vs. Sunscreen d
The prices of both of these goods rise by 20%. For which does Q drop the most? Why? o Breakfast cereal has close substitutes (e.g., pancakes, Eggo waffles, leftover pizza),
so buyers can easily switch if the price rises.
o Sunscreen has no close substitutes, so consumers would probably not buy less if its
Lesson: Price elasticity is higher when close substitutes are available.
Example 2: “blue Jeans” vs. “Clothing”
The price of both goods rise by 20% for which good does Q drop the most? Why?
o For a narrowly defined good such as blue jeans, there are many substitutes (khakis,
o There a fewer substitutes available for broadly defined goods. (There aren’t too
many substitutes for clothing, other than living in a nudist colony.)
o In the first alternative there will be a percentage decrease in the quantity of blue
o In the second scenario, the price of all clothing rises by 20%, and observe almost no
percentage decrease in demand for all clothing.
Lesson: Price elasticity is higher for narrowly defined goods than broadly defined ones.
Example 3: Insulin vs. Caribbean Cruises
The prices of both of these goods rise by 20%. For which good does Q drop the most? Why?
o To millions of diabetics, insulin is necessity. A rise in its price would cause little or no
decrease in demand.
o A cruise is a luxury. If the prices rises, some people will forego it.
Lesson: Price elasticity is higher for luxuries than for necessities.
Example 4: Gasoline In the Short Run vs. Gasoline in the Long Run
The price of gasoline rises 20%. Does Q drop more in the short run or the long run? Why?
o There’s not much people can do in the short run, other than ride the bus or carpool.
o In the long run, people can buy smaller cars or live closer to where they work.
Lesson: Price elasticity is higher in the long run than the short run.
The Determinant of Price Elasticity: A Summary
The price elasticity of demand depends on:
The extent to which close substitutes are available
Whether the good is a necessity or luxury
How broadly or narrowly the good is defined
The time horizon- elasticity is higher in the long run than the short run
The Variety of Demand Curves
The price elasticity of demand is closely related to the slope of the demand curve.
Rule of thumb: The flatter the curve, the bigger the elasticity. The steeper the curve, the
smaller the elasticity.
Five different classifications of D curves.…
“Perfectly Inelastic Demand” (one extreme case) D curve:
Consumers’ price sensitivity:
The slope of this curve is the inverse of the slope in the
When you see a vertical demand curve price
elasticity equals zero
If Q doesn’t change, then the percentage change in Q equals zero, and this elasticity equals
o Ex. Insulin: a sufficiently large price will reduce demand for insulin a little,
particularly among people with v. low incomes and no health insurance.
o If elasticity is close v. close to zero, then demand curve is almost close to vertical
and we can call it “perfectly inelastic”
Consumers’ price sensitivity:
Price elasticity would be small, but not zero
At a high price some students would not buy
their books, but instead will share with a friend, or rather find
them in the library, or take copious notes in class
Ex. gas in the short run
“Unit elastic demand”
increase D curve:
Consumers’ price sensitivity:
1 is a threshold that can divide
between elastic and inelastic demand
The price change has no effect in the
Consumers’ price sensitivity:
Ex. breakfast cereal, or anything with readily available
its relatively flatter than an inelastic demand curve
“Perfectly elastic demand” (the other extreme)
Consumers’ price sensitivity:
“Extreme price sensitivity” means the tiniest price increase
causes demand to fall to zero.
“Q changes by any %” when the D curve is horizontal,
quantity cannot be determined from the price.
Consumers might demand Q1 units one month, Q2 units another month, and some other
quantity later. Q changes by any amount, but P always “changes by 0%” (i.e., doesn’t change). o Ex. a small family farm which grows wheat. The demand curve in this curve is
downward-slopping, and the market demand and supply curve determines the price of
wheat. Suppose that price is $5/bushel.
Now consider the demand curve facing you, the individual wheat farmer. If you charge