Chapter 3_The Market forces of Supply and Demand

Part 2
THE THEORY OF COMPETITIVE MARKETS
FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION

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3
THE MARKET FORCES OF SUPPLY AND
DEMAND

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I. Market Forces Of Supply And
Demand

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Introduction to supply and demand
o Supply and demand are the forces that make
market economies work.
o Supply and demand determine prices in a market
economy and how prices, in turn, allocate the
economy’s scarce resources.
o The model of the market based on supply and
demand, like any other model, is based on a series
of assumptions.

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II. The Assumptions Of The
Market Model

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Supply and Demand
The terms supply and demand refer to the behaviour of
people as they interact with one another in markets.
A market is a group of buyers and sellers of a

particular good or service.
A competitive market is a market in which there are

many buyers and sellers so that each has a negligible
impact on the market price.

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Assumption for Efficient Outcomes
o The model of supply and demand which leads
to this ‘efficient’ outcome is based on the
following:
o Many buyers and sellers.
o Perfect information for all buyers and sellers.
o Freedom of entry and exit.
o Identical goods.
o Buyers and sellers act in self interest.
o Clearly defined property rights.

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Competitive Markets
A market in which there are many buyers and many
sellers so that each has a negligible impact on the
market price.
Characteristics of a perfectly competitive market:
o All goods for sale are the same.
o No buyer or seller can influence market price on their
own.
Because buyers and sellers must accept the market
price as given, they are often called "price takers."

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The Demand Curve: The Relationship
between Price and Quantity demanded
Quantity demanded is the amount of a good that
buyers are willing and able to purchase.
Law of Demand is the claim that, other things equal,

the quantity demanded of a good falls when the price
of the good rises.
Demand schedule is a table that shows the

relationship between the price of the good and the
quantity demanded.

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The Demand Curve: The Relationship between
Price and Quantity Demanded
Price of milk per litre (€) Quantity of milk demanded
Table 1. (litres per month)
Rachel’s
0.00 20
Demand
Schedule 0.10 18
0.20 16
0.30 14
0.40 12
0.50 10
0.60 8
0.70 6
0.80 4
0.90 2

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Figure 1. Rachel’s Demand Schedule and Demand Curve
The demand
curve is a graph
of the relationship
between the price
of a good and the
quantity
demanded. FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION
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Market Demand Versus Individual Demand
Market demand refers to the sum of all individual
demands for a particular good or service.
Graphically, individual demand curves are summed

horizontally to obtain the market demand curve.

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III. Shifts Versus Movements
Along The Demand Curve

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Introduction to shifts and movements
o Ceteris paribus - other factors affecting demand are held
constant so that we can analyze the effect of a change in price
on demand.
o A shift in the demand curve is caused by a factor affecting
demand other than a change in price.
o Movement along the demand curve.
o Caused by a change in the price of the product.

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Figure 2. Changes In Quantity Demanded
Price of milk
A tax that raises the price of milk
results in a movement along the
demand curve.
B
€1.20
A
€0.60
D
0 4 8 Quantity of milk
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Movement Along the Demand Curve
Assume the price of milk falls.
o More will be demanded because of the income and
substitution effects.
o The income effect. Assume that incomes remain
constant. A fall in the price of milk means that
consumers can now afford to buy more with their
income.
o The substitution effect. Milk is lower in price compared to
other similar products, so some consumers will choose to
substitute the more expensive drinks with the now
cheaper milk.

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A Shift in the Demand Curve
o A shift in the demand curve, to the left or right.
o Caused by any change that alters the quantity demanded at every
given price.
o Shifts caused by factors other than price.
1) Prices of related goods (substitutes and complements).
o Substitutes: two goods for which an increase in the price of
one good leads to an increase in the demand for the other.
o Complements: two goods for which an increase in the price of
one good leads to a decrease in the demand for the other.
Continued on next slide

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A Shift in the Demand Curve
2) Income
o A lower income means that you have less to spend in total, so you
would have to spend less on some – and probably most – goods.
o If the demand for a good falls when income falls or rises, as income rises,
the good is called a normal good.
o If the demand for a good rises when income falls, the good is called an
inferior good.
3) Tastes. More people may like something.
4) Number of buyers (population).
5) Advertising.
6) Expectations of consumers where demand is influenced by expectations
of future income and future prices.

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Figure 3 Shifts in the Demand Curve
Price of
milk
Increase
in demand
Decrease
in demand
Demand
curve, D2
Demand
curve, D1
Demand curve, D3
0 Quantity of milk
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Figure 4 Consumer Income Normal Good
Price of milk
€
1.20
An increase
in income...
1.0
Increase
0.8 in demand
0.6
0.4
0.2
D2
D1 Quantity
of milk
0 1 2 3 4 5 6 7 8 9 10 11 12
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Figure 5. Consumer Income Inferior Good
Price inferior
good € 1.50
An increase
1.00
in income...
Decrease
in demand
0.50
D2 D1 Quantity of
inferior
0 1 2 3 4 5 6 7 8 9 10 11 12 good

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IV. Supply

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Supply
Quantity supplied is the amount of a good that sellers are willing
and able to sell.
Law of supply is the claim that, other things equal, the quantity
supplied of a good rises when the price of the good rises.

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The Supply Curve: The Relationship between
Price and Quantity Supplied
Quantity supplied is the amount of a good that sellers

are willing and able to sell.
Law of supply is the claim that, other things equal, the

quantity supplied of a good rises when the price of the
good rises.
The supply schedule is a table that shows the

relationship between the price of the good and the
quantity supplied.

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Price of milk per litre (€) Quantity of milk supplied
(litres per month)
Table 2: 0.00 0
Richard’s 0.10 0
Supply 0.20 2
Schedule 0.30 4
0.40 6
0.50 8
0.60 10
0.70 12
0.80 14
0.90 16
1.00 18

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The supply curve is the graph of the relationship

between the price of a good and the quantity supplied.

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Figure 6. Richard’s Supply Curve

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Table 3. Market Supply Versus Individual Supply
Market supply refers to the sum of all individual

supplies for all sellers of a particular good or service.

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Figure 7. The Market Supply
Graphically, individual supply curves are summed
horizontally to obtain the market supply curve.

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Figure 8. Supply schedule
Price of
milk S
C
€1.50
A rise in the price of
milk results in a
movement along the
supply curve.
€0.6
A
0
Quantity of
milk
0 1 5

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Shifts in the Supply Curve
o The supply curve shows how much producers offer for
sale at any given price, holding constant all other factors
that may influence producers’ decisions about how much
to sell.
o When any of these other factors change, the supply curve
will shift.
o These are shown on the next slide.

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① Profitability of other goods in production and prices of goods
in joint supply.
② Technology.
③ Natural/Social Factors such as the weather and changing

attitudes.
④ Input prices – the prices of the factors of production.
⑤ Expectations of producers about the future state of the

market.
⑥ A change in the number of sellers in the market.

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Change in Supply
o A shift in the supply curve, either to the left or
right.
o Caused by a change in a determinant other than
price.

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Figure 9. Shifts in the Supply Curve
Price of
milk Supply curve, S3
Supply
curve, S1
Supply
Decrease curve, S2
in supply
Increase
in supply
0 Quantity of milk
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V. Supply And Demand
Together

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Equilibrium
Equilibrium Price
o The price that balances quantity supplied and quantity demanded.
o On a graph, it is the price at which the supply and demand curves
intersect.
Equilibrium Quantity
o The quantity supplied and the quantity demanded at the equilibrium
price.
o On a graph it is the quantity at which the supply and demand curves
intersect.

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Table 3. Equilibrium
Demand Schedule Supply Schedule
price quantity price quantity
At €2.00, the quantity demanded is equal to the quantity

supplied in this example.

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Figure 10. The Equilibrium of Supply and Demand

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Figure 11. Markets Not in Equilibrium
(a) Excess Supply
Price
of milk Supply
Surplus
€ 0.70
0.60
Demand
0 4 7 10 Quantity of milk
Quantity Quantity
demanded supplied
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Equilibrium
Surplus
o When price > equilibrium price, then quantity supplied > quantity
demanded.
o There is excess supply or a surplus.
o Suppliers will lower the price to increase sales, thereby moving toward
equilibrium.
Shortage
o When price < equilibrium price, then quantity demanded > the
quantity supplied.
o There is excess demand or a shortage.
o Suppliers will raise the price due to too many buyers chasing too few goods,
thereby moving toward equilibrium.

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Figure 12. Markets Not in Equilibrium
(b) Excess Demand

Price of
Ice-Cream Supply
Cones
€ 2.00
1.50
Shortage
Demand
0 4 7 10 Quantity of
Quantity Quantity Ice-Cream
supplied demanded Cones
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Equilibrium
Law of supply and demand
o The claim that the price of any good adjusts to bring the
quantity supplied and the quantity demanded for that good
into balance.

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VI. Prices as signals

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Prices as signals to buyers and sellers
The main function of price in a free market is to act
as a signal to both buyers and sellers.
o For buyers, price tells them something about what they have to
give up (usually an amount of money) to acquire the benefits.
o Price rise changes the nature of the trade-off buyers face.
o For sellers, price acts as a signal in relation to the profitability of
production.
o Price rises for sellers indicates a shortage so will increase
production.

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VII. Analyzing Changes in Equilibrium

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Three Steps to Analyzing Changes in
Equilibrium
Shifts in Curves versus Movements along Curves.
o A shift in the supply curve is called a change in supply.
o A movement along a fixed supply curve is called a change in
quantity supplied.
o A shift in the demand curve is called a change in demand.
o A movement along a fixed demand curve is called a change
in quantity demanded.

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Three Steps to Analyzing Changes in
Equilibrium
① Decide whether the event shifts the supply or
demand curve (or both).
② Decide whether the curve(s) shift(s) to the left or to

the right.
③ Use the supply and demand diagram to see how

the shift affects equilibrium price and quantity.

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Figure 13. How an Increase in Demand Affects the Equilibrium
Price
of milk 1. Hot weather increases
the demand for milk. . .
Supply
€ 0.80 New equilibrium
0.60
2. . . . resulting Initial
in a higher
equilibrium
price . . .
D
0 7 10 Quantity of
3. . . . and a higher milk
quantity sold.
Figure 14. How a Decrease in Supply Affects the Equilibrium
Price of
milk 1. An increase in the
animal feed reduces
the supply of milk. .
S2
S1
New
€ 0.80 equilibrium
0.60 Initial equilibrium
2. . . . resulting
in a higher
price of milk
Demand
0 4 7 Quantity of milk
3. . . . and a lower
quantity sold.
Table 4: What Happens to Price and Quantity When
Supply or Demand Shifts?

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VIII. Elasticity

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Elasticity: An Introduction
Elasticity:
o Allows us to analyze supply and demand with
greater precision.
o Is a measure of how much buyers and sellers
respond to changes in market conditions.

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IX. The Price Elasticity of Demand

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The Price Elasticity of Demand and its
Determinants
Price elasticity of demand is a Determinants of price elasticity

measure of how much the of demand include:
quantity demanded of a good
responds to a change in the o Availability of close
price of that good. substitutes.
Price elasticity of demand is the o Necessities versus luxuries.

percentage change in quantity
demanded given a one percent o Proportion of income
change in the price. devoted to the product.
o Time horizon.

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The Price Elasticity of Demand and its
Determinants
Demand tends to be more elastic:
o the larger the number of close substitutes.
o if the good is a luxury.
o the more narrowly defined the market.
o the longer the time period.

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Computing the Price Elasticity of Demand
The price elasticity of demand is the percentage change in
the quantity demanded divided by the percentage change in
price.
oExample: The price of breakfast cereal rises by 10% and

quantity demanded falls by 20%.
Price elasticity of demand = (20%)/(10%) = 2

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Calculating Price elasticity
The midpoint method is preferable when calculating the price
elasticity of demand because it gives the same answer regardless
of the direction of the change.
(Q 2 − Q1 ) / [(Q 2 + Q1 ) / 2]
Price elasticity of demand =
(P2 − P1 ) / [(P2 + P1 ) / 2]
o Example: the price rises from €4 to €6 and quantity
demanded falls from 120 to 80.
o % change in price = (6 - 4)/5 × 100% = 40%
o % change in quantity demanded = (120-80)/100 = 40%
o price elasticity of demand = 40/40 = 1

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Calculating Price elasticity
The point elasticity of demand method measures elasticity at a
particular point on the demand curve.

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The Variety of Demand Curves
Price Inelastic Demand
o Quantity demanded does not respond strongly to price changes.
o Price elasticity of demand is less than one.
Price Elastic Demand

o Quantity demanded responds strongly to changes in price.
o Price elasticity of demand is greater than one.

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The Variety of Demand Curves
1. Perfectly Price Inelastic
o Quantity demanded does not respond to price changes.
2. Perfectly Price Elastic
o Quantity demanded changes infinitely with any change in price.
3. Unit Price Elastic
o Quantity demanded changes by the same percentage as the price.
Because the price elasticity of demand measures how much
quantity demanded responds to the price, it is closely related to the
slope of the demand curve.
o This is shown in the next few slides.

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Figure 15 a Perfectly Price Inelastic Demand: Elasticity Equals 0
Price
Demand
€5
4
1. An
increase
in price . . .
0 100 Quantity
2. . . . leaves the quantity demanded unchanged.

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Figure 15 (b) Price Inelastic Demand: Elasticity Is Less Than 1
Price
€5
4
1. A 22% Demand
increase
in price . . .
0 90 100 Quantity
2. . . . leads to an 11% decrease in quantity demanded.

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Figure 15 c. Unit Elastic Demand: Elasticity Equals 1
Price
€5
4
1. A 22% Demand
increase
in price . . .
0 80 100 Quantity
2. . . . leads to a 22% decrease in quantity demanded.

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Figure 15d. Price Elastic Demand: Elasticity Is Greater Than 1
Price
€5
4 Demand
1. A 22%
increase
in price . . .
0 50 100 Quantity
2. . . . leads to a 67% decrease in quantity demanded.

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Figure 15e. Perfectly Price Elastic Demand: Elasticity Equals Infinity
Price
1. At any price
above €4, quantity
demanded is zero.
€4 Demand
2. At exactly €4,
consumers will
buy any quantity.
0 Quantity
3. At a price below €4,
quantity demanded is infinite.

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Total Expenditure, Total Revenue and the Price
Elasticity of Demand
Total revenue is the amount paid by buyers and
received by sellers of a good.
Computed as the price of the good times the quantity

sold.
TR = P x Q

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Figure 16. Total Revenue
Price
€4
P × Q = €400
P
(revenue) Demand
0 100 Quantity
Q FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 5TH EDITION
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Price Elasticity and Total Revenue along a
Linear Demand Curve
With a price inelastic demand curve:
o An increase in price….
o …leads to a decrease in quantity that is proportionately
smaller.
o Thus, total revenue increases.

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Figure 17. Total Revenue Changes When Price Changes: Price
Inelastic Demand
Price Price
An Increase in price from €1 … leads to an Increase in
to €3 … total revenue from €100 to
€240
€3
Revenue = €240
€1
Revenue = €100 Demand Demand
0 100 Quantity 0 80 Quantity

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Figure 18. How Total Revenue Changes When Price Changes: Price
Elastic Demand
Price Price
An Increase in price from €4 … leads to a decrease in

to €5 … total revenue from €200 to
€100
€5
€4
Demand
Demand
Revenue = €200 Revenue = €100
0 50 Quantity 0 20 Quantity

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Table 5. Elasticity and Total Revenue along a
Linear Demand Curve
o At points with a low price and a high quantity, demand is inelastic.
o At points with a high price and a low quantity, demand is elastic.

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X. Other Demand Elasticities

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Income Elasticity of Demand
Income elasticity of demand measures how much the quantity
demanded of a good responds to a change in consumers’ income.
It is computed as the percentage change in the quantity

demanded divided by the percentage change in income.
Percentage change
in quantity demanded
Income elasticity of demand =
Percentage change
in income
Higher income raises the quantity demanded for normal goods but
lowers the quantity demanded for inferior goods.

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Income Elasticity of Demand
Demand for goods consumers regard as necessities
tends to be income inelastic.
o Examples include food, fuel, clothing, utilities, and medical
services.
Demand for goods consumers regard as luxuries tends

to be income elastic.
o Examples include sports cars, furs, and expensive foods.

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Cross Elasticity of Demand
The cross-price elasticity of demand measures how much
the quantity demanded of one good responds to a change
in the price of another good.
It is computed as the percentage change in quantity

demanded of the first good, divided by the percentage
change in the price of the second good.
o Substitutes have positive cross-price elasticities.
o Complements have negative cross-price elasticities.

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XI. The Price elasticity of Supply

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The Price Elasticity of Supply and its
Determinants
Price elasticity of supply is a measure of how much the quantity
supplied of a good responds to a change in the price of that good.
Price elasticity of supply is the percentage change in quantity

supplied, resulting from a one percent change in price.
Determinants:
o Time period. Supply is more price elastic in the long run.
o Productive capacity and the ability of sellers to change the amount of
the good they produce.
o Size of the firm or industry.
o Mobility of the factors of production.

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Computing the Price Elasticity of Supply
The price elasticity of supply is computed as the percentage
change in the quantity supplied divided by the percentage change
in price.
Example:
A rise in price of bicycles of 10 per cent increases supply by 15 per cent.
Price elasticity of supply = (15%)/(10%) = 1.5

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Computing the Price Elasticity of Supply
The midpoint method measures the price elasticity of supply
between two points, denoted (Q1, P1) and (Q2, P2):
The point elasticity of supply method measures elasticity at a particular

point on the supply curve.

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The Variety of Supply Curves
In general, the flatter the slope of the supply curve that
passes through a given point, the more elastic the supply.
This is best shown diagrammatically as in the next few

slides.

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Figure 19 a. Perfectly Priced Inelastic Supply: Elasticity Equals 0
Price
Supply
€5
4
1. An
increase
in price . . .
0 100 Quantity
2. . . . leaves the quantity supplied unchanged.

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Figure 19 b. Price Inelastic Supply: Elasticity Is Less Than 1
Price
Supply
€5
4
1. A 22%
increase
in price . . .
0 100 110 Quantity
2. . . . leads to a 10% increase in quantity supplied.

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Figure 19c. Unit Elastic Supply: Elasticity Equals 1
Price
Supply
€5
4
1. A 22%
increase
in price . . .
0 100 125 Quantity


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Figure 19d. Price Elastic Supply: Elasticity Is Greater Than 1
Price
Supply
€5
4
1. A 22%
increase
in price . . .
0 100 200 Quantity

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Figure 19e. Perfectly Price Elastic Supply: Elasticity Equals Infinity
Price
1. At any price
above €4, quantity
supplied is infinite.
€4 Supply
2. At exactly €4,
producers will
supply any quantity.
0 Quantity
3. At a price below €4,
quantity supplied is zero.
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Total Revenue and the Price elasticity of
Supply (Figure 20)
When studying changes
in supply in a market, we
are often interested in the
resulting changes in the
total revenue received
by producers.
Total revenue received by

sellers is P × Q, the price
of the good times the
quantity of the good sold.

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XII. Applications of Supply and
Demand elasticity

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Why does the Price of Train travel Vary at
Different Times of the Day?
o Figure 21 Panel a) Peak time travel: Demand is price inelastic, so tickets
are expensive.
o Figure 21 Panel b) Off peak time travel: Demand is price elastic, so to
maximize revenues ticket prices are lowered.

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Why Have Farmers’ Incomes Fallen
Despite Increases in Productivity?
Figure 22: Increased

productivity in farming
has lead to…
• Considerable rise in
supply S1 to S2, but
only a small rise in
demand from D1 to D2
• Result = lower prices
for farmers.

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Useful Advice
① Examine whether the supply or demand curve shifts.
② Determine the direction of the shift of the curve.
③ Use the supply and demand diagram to see how the market
equilibrium changes.

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Summary
① Economists use the model of supply and demand to analyze
competitive markets.
② In a competitive market, there are many buyers and sellers,

each of whom has little or no influence on the market price.
③ The demand curve shows how the quantity of a good depends

upon the price.
④ The supply curve shows how the quantity of a good supplied

depends upon the price.

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Summary
⑤ Market equilibrium is determined by the intersection of the
supply and demand curves.
⑥ At the equilibrium price, the quantity demanded equals the

quantity supplied.
⑧ The behaviour of buyers and sellers naturally drives markets

toward their equilibrium. To analyze how any event influences
a market, we use the supply and demand diagram to examine
how the even affects the equilibrium price and quantity.
⑨ In market economies, prices are the signals that guide

economic decisions and thereby allocate resources.

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Summary
⑩ Price elasticity of demand measures how much the quantity
demanded responds to changes in the price.
⑪ Price elasticity of demand is calculated as the percentage

change in quantity demanded divided by the percentage
change in price.
⑫ If a demand curve is elastic, total revenue falls when the price

rises.
⑬ If it is inelastic, total revenue rises as the price rises.
⑭ The income elasticity of demand measures how much the

quantity demanded responds to changes in consumers’
income.
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Summary
⑮ The cross-price elasticity of demand measures how much the quantity
demanded of one good responds to the price of another good.
⑯ The price elasticity of supply measures how much the quantity

supplied responds to changes in the price.
⑰ In most markets, supply is more price elastic in the long run than in
the short run.
⑱ The price elasticity of supply is calculated as the percentage change

in quantity supplied divided by the percentage change in price.
⑲ The tools of supply and demand can be applied in many different

types of markets.

9781473768543 © CENGAGE EMEA 2020

Chapter 3_The Market forces of Supply and Demand

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Chapter 3_The Market forces of Supply and Demand

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Part 2

THE THEORY OF COMPETITIVE MARKETS

FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION

FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 5TH EDITION

FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 5TH EDITION

FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 5TH EDITION

FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 5TH EDITION

A market is a group of buyers and sellers of a

A competitive market is a market in which there are

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FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 5TH EDITION

FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 5TH EDITION

Law of Demand is the claim that, other things equal,

Demand schedule is a table that shows the

FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 5TH EDITION

FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 5TH EDITION

Graphically, individual demand curves are summed

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FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 5TH EDITION

FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 5TH EDITION

FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 5TH EDITION

Continued on next slide

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FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 5TH EDITION

FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 5TH EDITION

FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 5TH EDITION

FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 5TH EDITION

Quantity supplied is the amount of a good that sellers

Law of supply is the claim that, other things equal, the

The supply schedule is a table that shows the

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FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 5TH EDITION

The supply curve is the graph of the relationship

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FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 5TH EDITION

Market supply refers to the sum of all individual

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FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 5TH EDITION

FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 5TH EDITION

FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 5TH EDITION

③ Natural/Social Factors such as the weather and changing

④ Input prices – the prices of the factors of production.

⑤ Expectations of producers about the future state of the

⑥ A change in the number of sellers in the market.

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FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 5TH EDITION

FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 5TH EDITION

At €2.00, the quantity demanded is equal to the quantity

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FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 5TH EDITION

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(b) Excess Demand

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FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 5TH EDITION

② Decide whether the curve(s) shift(s) to the left or to

③ Use the supply and demand diagram to see how

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