LN03 Keat020827 07 Me LN03

Supply and Demand
Chapter Outline
 Market demand
 Market supply
 Market equilibrium
 Comparative statics analysis
 Supply, demand, and price
Learning Objectives
 Define supply, demand, and equilibrium price

 List and provide specific examples of the non-
price determinants of supply and demand
 Distinguish between the short-run rationing
function and long-run guiding function of
price
 Illustrate how the concepts of supply and
demand can be used in management decisions
about price and allocations of resources.
 Use supply and demand diagrams to
determine price in the short and long run
Market Demand
 The demand for a good or service is defined as:

 Quantities of a good or service that people are ready,
willing and able to buy at various prices within some given
time period. (Other factors besides price held constant.)
Market Demand
 “Ready” implies that consumers are prepared to buy a

good or service both because they are:
 Willing: Consumers have a preference for it.
 Able: Consumers have the income to support this

preference.
Market Demand
Market demand is the sum of all the

individual demands.
• Individuals may have distinct demand curves, and they sum
to the overall demand in the market.
Example: demand for pizza
Market Demand
There is an inverse
relationship between
price and the quantity
demanded of a good or
service.
This is called the Law of

Demand.
Thus, the demand curve

is downward sloping.
Market Demand
 Graphical
Representation
of Demand
 Algebraic
Representation
of Demand
Qd=700-100P
Market Demand
 Changes in price result in changes in the quantity

demanded
 This is shown as movement along the demand curve.
 Changes in non-price factors result in changes in

demand
 This is shown as a shift in the demand curve.

Market Demand
Market Demand
 Non-price determinants of demand-result is a shift in

the demand curve.
 tastes and preferences

 income
 prices of related products
 future expectations
 number of buyers
Market Supply
 The supply of a good or service is defined as quantities

that people are ready to sell at various prices within
some given time period
(Other factors besides price held constant)

Market Supply
 Changes in price result in changes in the quantity

supplied
 shown as movement along the supply curve
 Changes in non-price determinants result in changes in

supply
 shown as a shift in the supply curve

Market Supply
Market Supply
 Non-price determinants of supply-results in a shift in

the supply curve.
 costs and technology

 prices of other goods or services offered by the seller
 future expectations
 number of sellers
 weather conditions
Market Equilibrium
 Equilibrium price: the price that equates the quantity

demanded with the quantity supplied
 Equilibrium quantity: the amount that people are

willing to buy and sellers are willing to offer at the
equilibrium price level
Market Equilibrium
 Shortage: a market situation in which the quantity

demanded exceeds the quantity supplied
 shortage occurs at a price below the equilibrium level
 Surplus: a market situation in which the quantity

supplied exceeds the quantity demanded
 surplus occurs at a price above the equilibrium level
Market Equilibrium
Comparative Statics Analysis
 Comparative statics is a form of sensitivity (or what-if)

analysis
 Commonly used method in economic analysis

 Process of comparative statics analysis:

 state all the assumptions needed to construct the model
 begin by assuming that the model is in equilibrium
 introduce a change in the model, so a condition of
disequilibrium is created
 find the new point of equilibrium
 compare the new equilibrium point with the original one
Step 1
 assume all factors
except the price of
pizza are constant
 buyers’ demand and

sellers’ supply are
represented by lines
shown
Step 2
 begin the analysis in equilibrium
as shown by Q1 and P1
Step 3
 assume that a new study shows
pizza to be the most nutritious of
all fast foods
 consumers increase their

demand for pizza as a result
Step 4
 the shift in demand results in a
new equilibrium price (P2)
 and a new equilibrium quantity

(Q2)
Step 5
 comparing the new equilibrium
point with the original one, we
see that both equilibrium price
and quantity have increased
 The short run is the period of time in which:
 sellers already in the market respond to a change in

equilibrium price by adjusting variable inputs
 buyers already in the market respond to changes in

equilibrium price by adjusting the quantity demanded for
the good or service
 Short run changes show the rationing function of price
 The rationing function of price is the change in market

price to eliminate the imbalance between quantities
supplied and demanded.
Comparative Static Analysis:
Short-run
an increase in demand
causes equilibrium
price and quantity to
rise
Short-run
a decrease in demand
causes equilibrium price
and quantity to fall
Short-run
an increase in
supply causes
equilibrium price
to fall and
equilibrium
quantity to rise
Short-run
a decrease in
supply causes
equilibrium price
to rise and
equilibrium
quantity to fall
Long-run
 The long run is the period of time in which:
 new sellers may enter a market
 existing sellers may exit from a market
 existing sellers may adjust fixed factors of production
 buyers may react to a change in equilibrium price by
changing their tastes and preferences
Long-run
 Long run changes show the allocating function of price
 The guiding or allocating function of price is the

movement of resources into or out of markets in
response to a change in the equilibrium price.
Long-run
initial change: decrease in
demand from D1 to D2
 result: reduction in
equilibrium price and
quantity (to P2, Q2)
 follow-on adjustment:
 movement of resources out of
the market
 leftward shift in the supply
curve to S2
 equilibrium price and quantity
(to P3, Q3)
Long-run Analysis
 initial change: increase in
demand from D1 to D2
 result: increase in
equilibrium price and
quantity (to P2, Q2)
 follow-on adjustment:
– movement of resources into the
market
– rightward shift in the supply curve to
S2
– equilibrium price and quantity (to P3,
Q3)
Summary: Short-Run and Long-Run
Changes in the Market
Supply, Demand, and Price
 In the extreme case, the forces of supply and demand

are the sole determinants of the market price, not any
single firm.
 this type of market is ‘perfect competition’
 In many cases, individual firms can exert market power

over price because of their:
 dominant size
 ability to differentiate their product through advertising,
brand name, features, or services
Supply, Demand, and Price
 Discussion of changes in the computer industry
 Makers of PCs, notebooks and jump drives are facing

slower growth in the demand for their products as
technology is changing.
 What impact do you think cloud computing will have on

the demand for stand-alone applications such as Microsoft
Office or storage devices for computers?
Global Application
What are the implications of rising demand for oil among

developing counties?
Global Application
Global Application
Summary
 The law of demand states that, other factors held

constant, the quantity demanded is inversely related to
price.
 The law of supply states that, other factors held
constant, the quantity supplied is directly related to
price.
 Non-price factors may shift the curves.
 Price serves a short-run rationing function and a long-
run guiding function in the marketplace.

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Supply and Demand

 Define supply, demand, and equilibrium price

 The demand for a good or service is defined as:

 “Ready” implies that consumers are prepared to buy a

 Willing: Consumers have a preference for it.

 Able: Consumers have the income to support this

Market demand is the sum of all the

This is called the Law of

Thus, the demand curve

 Changes in price result in changes in the quantity

 This is shown as movement along the demand curve.

 Changes in non-price factors result in changes in

 This is shown as a shift in the demand curve.

 Non-price determinants of demand-result is a shift in

 tastes and preferences

 The supply of a good or service is defined as quantities

(Other factors besides price held constant)

 Changes in price result in changes in the quantity

 shown as movement along the supply curve

 Changes in non-price determinants result in changes in

 shown as a shift in the supply curve

 Non-price determinants of supply-results in a shift in

 costs and technology

 Equilibrium price: the price that equates the quantity

 Equilibrium quantity: the amount that people are

 Shortage: a market situation in which the quantity

 Surplus: a market situation in which the quantity

 Comparative statics is a form of sensitivity (or what-if)

 Commonly used method in economic analysis

 Process of comparative statics analysis:

 buyers’ demand and

 consumers increase their

 and a new equilibrium quantity

 The short run is the period of time in which:

 sellers already in the market respond to a change in

 buyers already in the market respond to changes in

 Short run changes show the rationing function of price

 The rationing function of price is the change in market

 The guiding or allocating function of price is the

 In the extreme case, the forces of supply and demand

 In many cases, individual firms can exert market power

 Discussion of changes in the computer industry

 Makers of PCs, notebooks and jump drives are facing

 What impact do you think cloud computing will have on

What are the implications of rising demand for oil among

 The law of demand states that, other factors held

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