Chapter 3

Demand, Supply, andMarket Equilibrium

Asst.Prof. Dr. Serdar AYAN

Law of Supply and Demand is the fundamental tool of economic analysis

In this presantation

we describe the rudiments of supply and demand analysis in steps

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Demand in Product/Output MarketsDemand in Product/Output Markets

A household’s decision about what quantity of a particular output, or product, to demand depends on a number of factors, including:

The price of the product in question. The income available to the household.

The household’s amount of accumulated wealth.

The prices of other products available to the household.

The household’s tastes and preferences. The household’s expectations about

future income, wealth, and prices.

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Demand in Product/Output MarketsDemand in Product/Output Markets

The most important relationship in individual The most important relationship in individual markets is that between market price and quantity markets is that between market price and quantity

demanded.demanded.

Changes in Quantity Demanded versus Changes in Demand

Changes in the price of a product affect the quantity demanded per period. Changes in any other factor, such as income or preferences, affect demand. Thus, we say that an increase in the price of Coca-Cola is likely to cause a decrease in the quantity of Coca-Cola demanded. However, we say that an increase in income is likely to cause an increase in the demand for most goods.

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Demand in Product/Output MarketsDemand in Product/Output Markets

income The sum of all a household’s wages, salaries, profits, interest payments, rents, and other forms of earnings in a given period of time. It is a flow measure.

Income And Wealth

wealth or net worth The total value of what a household owns minus what it owes. It is a stock measure.

Other Determinants of Household Demand

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normal goods Goods for which demand goes up when income is higher and for which demand goes down when income is lower.

inferior goods Goods for which demand tends to fall when income rises.

Demand in Product/Output MarketsDemand in Product/Output Markets

Income And Wealth

Other Determinants of Household Demand

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substitutes Goods that can serve as replacements for one another; when the price of one increases, demand for the other increases.

complements, complementary goods Goods that “go together”; a decrease in the price of one results in an increase in demand for the other and vice versa.

Demand in Product/Output MarketsDemand in Product/Output Markets

Prices of Other Goods and ServicesPrices of Other Goods and Services

Other Determinants of Household Demand

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Demand in Product/Output MarketsDemand in Product/Output Markets

Tastes and PreferencesTastes and Preferences

Other Determinants of Household Demand

Income, wealth, and prices of goods available are the three factors that determine the combinations of goods and services that a household is able to buy.

Changes in preferences can and do manifest themselves in market behavior.

Within the constraints of prices and incomes, preference shapes the demand curve, but it is difficult to generalize about tastes and preferences. First, they are volatile. Second, tastes are idiosyncratic.

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Demand in Product/Output MarketsDemand in Product/Output Markets

Other Determinants of Household Demand

ExpectationsExpectations

What you decide to buy today certainly depends on today’s prices and your current income and wealth.

There are many examples of the ways expectations affect demand.

Increasingly, economic theory has come to recognize the importance of expectations.

It is important to understand that demand depends on more than just current incomes, prices, and tastes.

The Quantity Demanded : It is the number of units consumers want to buy over a specified

period of time.

The Quantity Demanded of any product normally depends on its price. Quantity demanded also has a number of other determinants, including population size, consumer incomes, tastes and

the prices of other products.

Demand Schedule is a table showing how the quantity demanded of some product during a

specified period of time changes as the price of that product changes, holding all other

determinants of quantity demanded constant

Demand Schedule For Milk

Price Quantity Demanded Label in Figure 1

--------------------------------------------------------------------------------------------------

1.00 45 A

0.90 50 B

0.80 55 C

0.70 60 D

0.60 65 E

0.50 70 F

0.40 75 G

Demand Curve is a graphical depiction of a demand schedule. It shows how the quantity

demanded of some product during a specified period of time will change as the price of that

product changes, holding all other determinants of quantity demanded constant

As the price of an item rises, the quantity demanded normally falls. As the price falls, the

quantity demanded normally rises

Price 1.00 A 90 B 80 C 70 D 60 E 50 F 40 G 0 45 50 55 60 65 70 75 Quantity Demanded

The Quantity Supplied is the number of units sellers want to sell over a specified period of

time.

As the price of an item rises, the quantity supplied normally rises. As the price falls, the

quantity supplied normally falls

A supply schedule is a table showing how the quantity supplied of some product during a

specified period of time changes as the price of that product changes, holding all other

determinants of quantity supplied constant

Supply Schedule For Milk

Price Quantity Supplied Label İn Figure2.

------------------------------------------------------------------------------------

1.00 90 A

0.90 80 B

0.80 70 C

0.70 60 D

0.60 50 E

0.50 40 F

0.40 30 G

A Supply Curve is a graphical depiction of a supply schedule. It shows how the quantity supplied of some product during a specified period of time will change as the price of that

product changes, holding all other determinants of quantity supplied constant.

Price 1.00 A 0.90 B 0.80 C 0.70 D 0.60 E 0.50 F 0.40 G 0 30 40 50 60 70 80 90 Quantity Supplied

EQUILIBRIUM OF SUPPLY AND DEMAND

Shortage : is an excess of quantity demanded over quantity supplied. When there is a shortage, buyers can not purchase the

quantities they desire

Surplus : is an excess of quantity demanded. When there is surplus, sellers can not sell the

quantities they desire to supply

An Equilibrium : is a situation in which there are no inherent forces that produce change.

The law of supply and demand states that, in a free market, the forces of supply and demand generally push the price toward the price at

which quantity supplied and quantity demanded are equal

Determination of the Equilibrium Price And Quantity of Milk

Price Quantity D. Quantity S Surplus or Short. Price

--------------------------------------------------------------------------------------------------1.00 45 90 Surplus Fall

0.90 50 80 Suplus Fall

0.80 55 70 Suplus Fall 0.70 60 60 Neither SAME

0.60 65 50 Shortage Rise

0.50 70 40 Shortage Rise

0.40 75 30 Shortage Rise

Price 1.00 A 0.90 B 0.80 C 0.70 D 0.60 E 0.50 F 0.40 G 0 30 40 50 60 70 80 90 Quantity

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Demand in Product/Output MarketsDemand in Product/Output Markets

shift of a demand curve The change that takes place in a demand curve corresponding to a new relationship between quantity demanded of a good and price of that good. The shift is brought about by a change in the original conditions.

movement along a demand curve The change in quantity demanded brought about by a change in price.

Shift of Demand versus Movement Along a Demand Curve

Change in price of a good or service leads toChange in price of a good or service leads toChange in Change in quantity demandedquantity demanded (movement (movement

along the demand curve).along the demand curve).

Change in income, preferences, or prices of Change in income, preferences, or prices of other goods or services leads togoods or services leads to

Change in Change in demand demand (shift of the demand (shift of the demand curve).curve).

Shifts Of The Demand Curve

• Consumer Incomes : If average incomes increase, consumers may purchase more of

many goods.

Increases in income normally shift demand curves outward to the right.

D1 Price 1.00 A S 0.90 B D2 0.80 C 0.70 D 0.60 E 0.50 F D1 0.40 G D2 0 30 40 50 60 70 80 90 Quantity

Any factor that causes the demand curve to shift outward to the right or inward to the left does

not affect the supply curve, will raise the equilibrium price and the equilibrium quantity

•Population : Population growth should affect quantity demanded in more or less the same

way as increases in average incomes

• Consumer Prefences : A successfull advertising campaign etc....

• Prices and Availability of related goods: Increases in the prices of goods that are

substitutes ( Soda/milk ) move the demand curve to the right,

Increses in the prices of goods that are normally used together with ( tea/sugar) shift the demand

curve to the left.

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As with demand, it is very important to distinguish between movements along supply

curves (changes in quantity supplied) and shifts in supply curves (changes in supply):

Supply in Product/Output MarketsSupply in Product/Output Markets

Shift of Supply versus Movement Along a Supply Curve

Change in price of a good or service leads toChange in quantity supplied (movement

along a supply curve).

Change in income, preferences, or prices of other goods or services leads to

Change in supply (shift of a supply curve).

Shifts Of Supply Curve

• Size of Industry : For example if more milk producers enter the milk industry, the quantity

supplied at any given price probably will increase.

Any factor that shifts the supply curve outward to the right or inward to the left does not affect

the demand curve.

S1 Price 1.00 A 0.90 B 0.80 C S2 0.70 D 0.60 S1 E 0.50 F 0.40 G S2 0 30 40 50 60 70 80 90 Quantity

• Technological Progress : Cost-reducing technological progress shifts the supply curve

outward to the right

• Prices of Inputs : Increases in the prices of inputs that suppliers must buy will shift the

supply curve inward to the left.

• Prices of Related Outputs : A change in the price of one good produced by a multiproduct industry may be expected to shift the supply

curves of all the other goods produced by that industry