Dem&sup(1)

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R. Larry Reynolds © 1997
Principles of
Fall ‘ 97 slide 1
Microeconomics

Demand and Supply
· Markets as allocative mechanism require:
· nonattenuated property rights
[exclusive, enforceable, transferable]
· “voluntary” transactions
· Markets include all “potential buyers and
sellers”
· behavior of buyers is represented by “demand”
[benefits side of model]
· behavior of sellers is represented by “supply”
[cost side of model]
Principles of
Fall ‘ 97 slide 2
Microeconomics

Markets, Supply and Demand
· markets include all potential buyers
and sellers
· geographic boundaries of market
· markets defined by nature of product
and characteristics of buyers
· conditions of entry into market
· markets, competition and substitutes

Principles of
Fall ‘ 97 slide 3
Microeconomics

Demand
· Definition: “A schedule of the quantities
of a good that buyers are willing and able
to purchase at each possible price during a
period of time, ceteris paribus. [all other
things held constant]”
· Demand can also be perceived as a schedule
of the maximum prices buyers are willing
and able to pay for each unit of a good.

Principles of
Fall ‘ 97 slide 4
Microeconomics

Demand Function
· Is the functional relationship between the
price of the good and the quantity of that
good purchased in a given time period [UT],
income, other prices and preferences being
held constant.
· A change in income, prices of other goods
or preferences will alter [‘shift’] the
demand function.

Principles of
Fall ‘ 97 slide 5
Microeconomics

Quantity demanded
· A change in the price of the good under
consideration will change the “quantity demanded.”

· Q = f (P, holding M, Pr , preferences constant);
where: M = income
Pr = prices of related goods
• ∆P causes a change in X [∆Q], this is a “change in
quantity demanded”

Principles of
Fall ‘ 97 slide 6
Microeconomics

Change in demand
· If M, Pr, or preferences change, the demand
function [relationship between P and Q] will
change.
· These are sometimes called “demand shifters”
· Be sure to understand difference between a
“change in demand” and a “change in quantity
demanded”
· change in demand --- shift of the function
· change in quantity demanded --- move on the function

Principles of
Fall ‘ 97 slide 7
Microeconomics

“Law of Demand”
· Theory and empirical evidence
suggest that the relationship
between Price and Quantity is an
inverse or negative relationship
· At higher prices, quantity purchased
is smaller, or at lower prices the
quantity purchased is greater.

Principles of
Fall ‘ 97 slide 8
Microeconomics

An example of hot chocolate:
There is a coffee cart in the building that primarily serves the
individuals who work in the building. The market is defined to some
extent by the geography of the building. Individuals who buy the
hot chocolate rarely come from other buildings to purchase a cup.
During the time period [UT]under consideration [8:00-9:00am on
a week day ] the incomes and preferences of buyers are unlikely to
change. The prices of coffee, lattes, etc. can be controlled by the
vendor and the price of soft drinks from the machines remains
constant. The number of workers in the building remain at a
constant level.

Under these circumstances, we observe the number of cups of hot
chocolate [H] sold each morning as the price [P] is changed.
From these observations the demand relationship is estimated.

Principles of
Fall ‘ 97 slide 9
Microeconomics

Cups of Hot Chocolate [H] purchased
each day between 8 -9 am
price cups The demand relationship
per cup purchased can be demonstrated as a
table:
A 0 20 .

B $ .50 15 . Demand is a schedule of
quantities that will be
C $ .75 12 . 5 purchased at a schedule
∆P > 0 ∆Q < 0
D $ 1.00 [+.75] 10 . [-7.5] of prices during a given
time period, cet. par.
E $ 1 . 25 7.5
As the price is increased,
F
the quantity purchased
$ 1.50 5.

G $ 1 . 75 2.5 decreases.
H $ 2 .00 0

This demand relationship can be expressed as an equation:
P = 2 - .1Q or Q = 20 - 10P: [Q = f (P, . . .) but we graph P on
the Y axis and Q on the X axis.]
Principles of
Fall ‘ 97 slide 10
Microeconomics

The demand relationship can be expressed as a table
(previous slide) or an equation [either P = 2 - .1Q or Q = 20 - 10P]
The data from the table or equation can be graphed:
$
PRICE

P = $2, Then Q = 0 P = $1.75, then Q = 2.5

..
2.25
2.00
P = $1.50, then Q = 5

..
1.75
1.50 P = $1.25, Q = 7.5
1.25

..
1.00 P = $1, then Q = 10
.75 P = 0, then Q = 20
.50
.25 Demand

2 4 6 8 10 12 14 16 18 20 22 24
QUANTITY
The demand function can be represented as a table, {CUPS/UT}
an equation or a graph.
Principles of
Microeconomics

The demand equation P = 2 - .1Q was graphed
A change in “quantity demanded” is a movement on the demand
function caused by a change in the independent variable [ price].
PRICE

∆P from $1.50 to $1 causes ∆Q from 5 to 10 units
2.25

.
2.00
A change in quantity demanded is a move
1.75 A from point A to B “on the demand function”

.
1.50
caused by a change in the price!
1.25
Β
1.00
.75
.50 Demand [P = 2 - .1Q]
.25
QUANTITY
2 4 5 6 8 10 12 14 16 18 20 22 24
{CUPS/ UT}
Principles of
Microeconomics

The demand equation P = 2 - .1Q was graphed
A change in any of the parameters (income, price of related goods,
preferences, population of buyers, etc.) will cause a “shift of the
demand function.” In this example, the intercepts have changed,
the slope has remained constant
PRICE

2.50
2.25
2.00
1.75
an increase in demand
ad

1.50
D’ [ P’ = 2.5 - .1Q]
ec

1.25
re

1.00
as
ei

.75
nd

.50 Demand [P = 2 - .1Q]
em

.25
nda

2 4 6 8 10 12 14 16 18 20 22 24
QUANTITY
{CUPS/UT}
D`` [P`` = 1.5 - Principles of
.1Q]
Microeconomics

PRICE
2.50
2.25
2.00
1.75
buyers are more responsive to ∆P
1.50
1.25 P` = 2- .048076923Q
1.00
buyers
.75 a decrease in the
are less
slope
.50 responsive an increase in Demand [P = 2 - .1Q]
to ∆P the slope
.25
P = 2 - .25Q
2 4 6 8 10 12 14 16 18 20 22 24
QUANTITY
{CUPS/UT}

A change in the parameters [income, Pr, preferences, population,
etc.] might alter the relationship by changing the slope
A change in demand refers to a movement or shift of the entire
demand function

Principles of
Microeconomics

PRICE
2.50
An increase in demand
2.25
2.00 results in a larger quantity being
1.75 purchased at each price
increase
1.50
1.25
1.00 D2 [an increase in demand]
.75
.50
Demand [P = 2 - .1Q]
.25 Q = 7.5
2 4 6 8 10 12 14 16 18 20 22 24
QUANTITY
In this case, an increase in demand results {CUPS/UT}

in an increase in the amount that will be purchased at a price of
$1.25. At this price the Quantity purchased increases from 7.5
to 18. An increase in demand!

Principles of
Microeconomics

PRICE Effect of a change in the price of a
2.50
substitute
2.25 Dem
2.00 the and fo
pric r
1.75 e of steak
chic incre
1.50 ken as
incr es wh
eas e
es n
1.25
a
1.00 in dec
.75 fo th re
r e as
.50
s t de e
ea m Demand [P = 2 - .1Q]
k an
.25 d D2
2 4 6 8 10 12 14 16 18 20 22 24
QUANTITY
If the price of a substitute, like chicken, increases [steak /UT]
buyers will buy more steak at each price of steak
If the price of chicken decreases, the buyers will want less steak at
each possible price of steak; the demand for steak decreases!

Principles of
Microeconomics

Complementary goods
Two goods may be complimentary, i.e. the two goods are
“used together. [tennis rackets and tennis balls or CD’s
and CD Players]
An increase in the price of CD’s will tend to reduce the
demand [shift the demand function to the left] for CD Players
As people buy fewer
PCD’s Pplayers CD’s, the demand for
As the price of CD’s increases CD players decreases.
from P1 to P2, the quantity of At the same price,
CD’s decreases from Y1 Ppl , the demand
P2 to Y. Ppl is reduced
from Dto D’.
D’player
P1 Dcd Dplayer

Y Y1 CD’s/UT X X1 CD Players
Principles of per UT
Microeconomics

Compliments and
Substitutes
· Substitutes:
· if the price of a substitute increases, the
demand for the good increases.
· if the price of a substitute decreases, the
demand for the good decreases.
· Compliments:
· if the price of a compliment increases, the
demand for the good decreases.
· if the price of a compliment decreases, the
demand for the good increases.
Principles of
Microeconomics

Demand Summary
· “Law of Demand” holds that usually as the
price of a good increases, individuals will
buy less of it.
· The nature of this relationship is
influenced by a variety of other variables;
· income, preferences, prices of related
goods, and other circumstances
· as these circumstances change, the
demand relationship changes or “shifts.”
Principles of
Microeconomics

Demand Summary [cont. . . ]

· A “change in demand” means the relationship
between price and quantity was altered by a
change in some other variable [a demand “shifter”]
The demand “shifts.”
· A “change in quantity demanded” is a change in the
quantity bought that was caused by a change in
the price of the good. There is a movement on the
demand function.

Principles of
Microeconomics

Supply
· Supply is defined as a schedule of
quantities of a good that will be produced
and offered for sale at a schedule of
prices during a given time [UT], ceteris
paribus.
· Generally, producers are willing to offer
greater quantities of a good for sale at
higher prices; a positive relationship
between price and quantity supplied.
Principles of
Microeconomics

Supply Schedule

Observation Price Quantity
Supplied
The information can be represented
A $1 6
on a graph by plotting each
B $2 10 price quantity combination.
C $3 14

D $4 18

E
F $5 22

P
Both the graph and the table $5
.
represent a supply
relationship: Q = 2 + 4P
$4
$3
. . ppl
y

.
A supply schedule can be $2 su
displayed as a table. $1

Fall ‘ 97
Principles of 2 4 6 8 10 12 14
slide 22 Q
Microeconomics

Change in Quantity Supplied
· A change in the price of the good
causes a change in the “quantity
supplied.”
· The change in the price of the good
causes a “movement on the supply
function,” not a change or “shift of
the supply function.”

Principles of
Microeconomics

Supply Schedule

Supplied
A change in the price “causes” a
A $1
$1 6 change in the “quantity supplied.”
B $2 ∆P “CAUSES” ∆Q
10 This can be represented by a
C $3
$3 14 “movement” on the supply
D $4 18 function in the graph
E
F $5 22

This is a change in “quantity P
supplied.” Not to be $5 ∆P “causes” the quantity supplied
confused with a “change in to increase from 6 to 14.
$4
supply!”
ply
$3
∆P from $1 to $2 sup
$3
$1

Principles 2 4
of 6 8 10 12 14 16 Q
Fall ‘ 97 slide 24 /ut
Microeconomics

“Change in Supply”
· A change in supply [like a change in demand]
refers to a change in the relationship
between the price and quantity supplied.
· A change in supply is “caused” by a change
in any variable, other than price, that
influences supply
· A change in supply can be represented by a
shift of the supply function on a graph

Principles of
Microeconomics

“Change in Supply” [cont. . . ]

· There are many factors that infuence the
willingness of producers to supply a good.
· technology
· prices of inputs
· returns in alternative choices
· taxes, expectations, weather, number of
sellers, . . .
· Qs = fs (P, Pinputs, technology, . . .)

Principles of
Microeconomics

“Change in Supply” [cont. . . ]

· Qs = fs (P, Pinputs, technology, number of
sellers, taxes, . . .)
· A change in the price [P] causes a “change
in quantity supplied;”
· a change in any other variable causes a
“change in supply”

Principles of
Microeconomics

Supply Schedule
Given the supply schedule,
An increase in the prices Supplied
of inputs would make it A $1 46
more expensive to produce
B $2 810
each unit of output,
C $3 1214
therefore, the supply
decreases D $4 1618

E
F $5 20
22
P a shift to the left
ct
io n
$5 is a decrease in supply
n
fu

The decreased quantity
$4
pl y

in at each price “shifts” the
ply supply curve to the left!
an increase
p

$3
sup The development of a “new”
su

$2
w

supply
ne

technology that reduces the
$1
cost of production will “shift”
the supply function to the right
2 4 6 8 10 12 14 Q 16
Principles of
Microeconomics

Equilibrium
· Equilibrium: 1. a state of rest or balance due to
the equal action of opposing forces. 2. equal
balance between any powers, influences, [Webster’s
Encyclopedic Unabridged Dictionary of the English Language]
· In a market an equilibrium is said to exist when
the forces of supply [sellers] and demand [buyers] are
in balance: the actions of sellers and buyers are
coordinated. The quantity supplied equals the
quantity demanded!

Principles of
Microeconomics

[Price]
100
90 Given a demand
80 function [which
Px

$70
70 represents the
behavior or choices
60 of buyers,
50
40 and a supply function
30 that represents the
behavior of
20
sellers,
10

10 20 30 40 50 60 70 80 90 100 110 120 130
60 Qx/ UT

De
Where the quantity that people want to buy is equal to the quantity

ma
that the producers want to sell, there is an equilibrium quantity.

dn
The price that coordinates the preferences of the buyers and sellers
is the equilibrium price.
At the equilibrium price of $70, the quantity supplied is equal to
the quantity demanded. Principles of
Microeconomics

When the price is greater than the equilibrium price, the
amount that sellers want to sell at that price [quantity supplied]
exceeds the amount that buyers are willing to purchase [quantity
demanded] at that price. The price is “too high.”

p ly
At a Price of $90 the quantity supplied is 80, the quantity demanded is 35

Sup
surplus = 45

$90
equilibrium quantity At $90 there is a surplus
$70 of 45 units [80-35=45]

/
equilibrium price

0
13 x
12
0 Q
De
0
11
ma
0 0
nd
]

10 10
ce

90
i
Pr

90
[

80 80
70 70
Px

60
60 35 800
60 5
50 Principles of 40
Fall ‘ 97 40 slide 31
30
30 Microeconomics

surplus = 45

S
.
$90
lower At a price of $90 a surplus
price of 45 units exists
$70
Suppliers have more to sell than T
U
3 /
buyers will purchase at 1a0price of $90.
0thesexunsold
To get rid of 12 Q
units De 0
[inventory], the
11
Quantity
Quantity ma
10
0 demanded
supplied
0
nd
10 sellers lower
]

increases
the price.
e

decreases 90
90
ric

80
80
[P

70 70
Px

60
60 35 80
60 50
50
0 40
As the price4of the good is reduced, the quantity supplied decreases.
0 30
3
20 20
The quantity demanded increases as the price falls.
10
As the price moves10 toward equilibrium, quantity supplied and
quantity demanded are brought into equilibrium.

Principles of
. Microeconomics

[Price]
As a result of market forces

.
100 the market moves to
90 equilibrium
At a price below equilibrium the
80
the quantity demanded exceeds
Px

$70
70
the quantity supplied.
60 price
At a price of $30 the quantity
50 rises
demanded is 110. The quantity
40 supplied is 15.
$30
30 quantity quantity
20 supplied demanded
10
increases decreases
shortage = 95
10 1520 30 40 50 60 70 80 90 100 110 120 130
110
60 Qx/ UT

De
m
At a price of $30 the quantity demanded exceeds the quantity

and
supplied by 95 units [110 - 15 = 95]. This is a shortage.
Since the buyers cannot obtain all they want at a price of $30, some buyers will
offer to pay more. Some buyers will not pay the higher price, they buy less so the
quantity demanded decreases. At the higher price the quantity supplied increases

Principles of
.. Fall ‘ 97 slide 33
Microeconomics

Su
demand
increases
$89 The market for good X is
price
rises in equilibrium at Px = $70 T
$70 U
x/
30
Q
1
1 20
D
11 em
0
0 equilibrium 0 a nd D2
10 quantity 10
90 90
ric

increases
80 80
P [

70 70
Px

60 80 60
60 50
50
An increase in the price of a
0 40
4 The increase in the demand for
substitute [good Y] causes the 30
30
20
good X results in an increase in
demand for good X to increase.
20
10 both the equilibrium price and
As a result of the 0increased demand,
1 quantity.
market forces push Px up. Identify other factors that could
increase demand!
Principles of
Microeconomics

[Price]
100
90 Given a demand function,
80 an equilibrium is defined.
Px

70
$7 0
A decrease in demand,
60
establishes a new equilibrium
$50.89
50
at a lower price and
40
quantity.
30 D1
20
10

10 20 30 39.2 50 6 0 70 80 90 100 110 120 130
40 60
Qx/ UT

De
Demand might be reduced by: A change in the

ma
a decrease in the price of a substitute, price of the good

n
an increase in the price of a compliment, does not change

d
a change in income, demand! It changes
a change in the number of buyers the quantity
or their preferences, or, . . . demanded.
Principles of
. Microeconomics

Su
S2
UT
supply
$70
price falls
increases
x /
0 Q
13
$50 12
0
D
11 em
0
0
10
0 and
10
90
ice

90
80
Pr

80
[

70 70
Px

60 60
60 86
50
0
Given an equilibrium
5
40
condition in a 0
4 market, Quantity Identify factors that increase supply:
30 30
1. fall in price of inputs
an increase in supply will 20increases
20 2. improved technology
increase the equilibrium 10
10 3. increase in number of sellers
quantity and decrease 4. fall in return in alternative
equilibrium P. uses of inputs
5. or, . . .
Principles of
Microeconomics

A decrease in supply causes the equilibrium price to increase
and equilibrium quantity to decrease. What forces might cause the
supply to decrease?

ly
Supp
1. an increase in the prices
Px S1 of inputs
2. increase in returns from
100 alternative actions
decrease in supply
$90
90
3. problems in technology
[regulations, . . . ]
80 price rises
4. decrease in number of
70
$7 0 sellers or producers
60
50 quantity
40 decreases
30
20
10

35
10 20 30 40 50 6 0 70 80 90 100 110 120 130
60
Qx/ UT
De
ma
Principles of
n

Microeconomics
d

P100

upp
x
demand
S2 If both supply and

S
90 increases
and decrease
80 demand decrease,
price might price
70 +∆P and the ∆P will be
$7 0 go up or down increase indeterminate and
60 or stay the same -∆P price the equilibrium Q
increase
will decrease.
50 results in
increase
40 a market
D2
30 supply results to
force in De
increases aincrease Q ma
20 market
force to
nd
10 increase Q

10 20 30 40 50 6 0 70 80 90 100 110 120 130
60 100 Qx/ UT
When demand and supply both shift, the resultant effect on either
equilibrium price or quantity will be indeterminate.
Both the increase in demand and supply increase quantity; equilibrium Q increases.
The increase in demand pushes price up. The increase in supply pushes price down.
The change in price may be positive or negative, it depends on the magnitude
of the shifts in and slopes of demand and supply.
Principles of
Microeconomics

A decrease in supply tends to increase P and reduce Q.
An increase in demand tends to increase both P and Q.
Result is that Price will rise, Quantity may increase, decrease or stay the same

ly
depending on the magnitudes of the shifts and slopes of supply and demand.

Supp
In this example,
the price Price
increases to
$105
100
S1
$105. decrease in supply
to push
90
price up
When supply 80 pushes
increases and $70
70 price up
demand
decreases, 60
an increase in
the price will 50 demand tends D2
fall but the 40 reducesand
change in Q increase
quantity
30 Q
will be
20
indeterminate!
10

10 20 3035 49 60 70 80 90 100 110 120
40 50 60
Qx/ UT

De
the quantity decreases to 49
Principles of

ma
Microeconomics
n d

Supply and Demand Analysis
· Supply and demand is a simplistic model that
provides insights into the effects of events that
are related to a specific market.
· Whether an event will tend to cause the price of a
good to increase or decrease is of importance to
decision makers.
· To estimate the magnitude of price and quantity
changes more sophisticated models are needed.

Principles of
Microeconomics

Dem&sup(1)

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