micro economics - market supply and demand
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Market Supply and Demand
• Key Concepts• Summary• Practice Quiz
What is theLaw of Demand?
The principle that there is an inverse relationship between the price of a good and the quantity buyers are willing to purchase in a defined time period, ceteris paribus
What does “ceteris paribus” mean?
All else remains the same
What is a demand curve?
Depicts the relationship between price and quantity demanded
Rs20
Rs15
Rs10
Rs5
4 8 12 16
A
B
C
D
Individual’s Demand Curve for Compact Discs
Demand Curve
P
Q
7
A Rs 20 4
B Rs 15 6
C Rs 10 10
D Rs 5 16
Point Price Quantity demandedper compact disk (per year)
Individuals Buyer’s Demand Schedule for Compact Discs
Why do demand curves have a negative slope?
At a higher price consumers will buy fewer units, and at a lower price they will buy more units
What is ademand schedule?
Shows the specific quantity of a good or service that people are willing and able to buy at different prices
What is market demand?
The summation of the individual demand schedules
IMPORTANT
KNOW THE DIFFERENCE BETWEEN A CHANGE IN THE QUANTITY DEMANDED AND A CHANGE IN DEMAND
When price changes - what happens?
The curve does not shift - there is a change in the
quantity demanded
Decrease in Price
Increase in Quantity
Demanded
Rs20
Rs15
Rs10
Rs5
1 2 3 4
P
Q5 6 7 8 9
Rahul’s Demand Curve
D1
Rs20
Rs15
Rs10
Rs5
1 2 3 4
P
Q5 6 7 8 9
Mohan’s Demand Curve
D2
Rs20
Rs15
Rs10
Rs5
3 4 5 6
P
Q7 8 9 1011
Market Demand Curve
D3
12
12
Rs20
Rs15
Rs10
Rs5
1 2 3 4
P
Q5 6 7 8 9
Rahul’s Demand Curve
D113
Rs20
Rs15
Rs10
Rs5
1 2 3 4
P
Q5 6 7 8 9
Mohan’s Demand Curve
D2
14
Rs20
Rs15
Rs10
Rs5
3 4 5 6
P
Q7 8 9 1011
Market Demand Curve
D3
12
Rs25 1 + 0 = 1
Rs20 2 1 3
Rs15 3 3 6
Rs10 4 5 9
Rs5 5 7 12
Price Fred Mary Total Demanded
Market Demand Schedule for Compact Discs
Rs20
Rs15
Rs10
Rs5
10 20 30 40
AB
A change in price causes a change in the quantity
demanded
D
P
Q50
When something changes other than price, what
happens?The whole curve
shifts,there is a change in demand
Rs20
Rs15
Rs10
Rs5
10 20 30 40
D1
D2
P
50
A
When the ceteris paribus assumption is relaxed, the whole curve can shift
Q
B
Change innonprice
determinant
Increase in demand
What can cause a shift in a demand curve?
• Tastes and preferences• Number of buyers in the market• Income• Expectations of consumers• Prices of related goods
Price increases
Upward movement along the
demand curve
Decrease in quantity
demanded
Price decreases
Downward movement along the
demand curve
Increase in quantity
demanded
Nonprice determinant
Leftward or rightward shift in
the demand curve
Decrease or increase in
demand
What is a normal good?
Any good for which there is a direct relationship between changes in income and its demand curve
What is aninferior good?
Any good for which there is an inverse relationship between changes in income and its demand curve
What aresubstitute goods?
Goods that compete with one another for consumer purchases
What happens when the price increases for a good
that has a substitute?
The demand curve for the substitute good increases
What happens when the price decreases for a good
that has a substitute?
The demand curve for the substitute good decreases
What does a direct relationship between
price and quantity mean?
The two move in the same direction
What are complementary goods?
Goods that are jointly consumed with another good
What happens when the price increases for a good that has a complement?
The demand curve for the complements good decreases
What happens when the price decreases for a good
that has a complement?
The demand curve for the complements good increases
What does an inverse relationship between price
& quantity mean? It means that the two
move in opposite directions
What is thelaw of supply?
The principle that there is a direct relationship between the price of a good and the quantity sellers are willing to offer for sale in a defined time period, ceteris paribus
Why do supply curves have a positive slope?
Only at a higher price will it be profitable for sellers to incur the higher opportunity cost associated with supplying a larger quantity
Rs20
Rs15
Rs10
Rs5
10 20 30 40
A
BC
Supply CurveA company’s Supply Curve for Compact Discs
P
Q
A Rs20 40
B 10 30
C 6 20
Point Price Quantity
An Individual Seller’s Supply for Compact Discs
What is a market?Any arrangement in which
buyers and sellers interact to determine the price and quantity of goods and services exchanged
What is market supply?
The horizontal summation of all the quantities supplied at various prices that might prevail in the market
Rs25
Rs20
Rs15
Rs10
40
P
Q45 55
Market Supply Curve
60
S total
Rs 25
Rs20
Rs15
Rs10
10
P
Q15 20
Super Sound Supply Curve
S1
25
Rs25
Rs20
Rs15
Rs10
20
P
Q25 30
High Vibes Supply Curve
S2
35
Rs25 25 + 35 = 60
Rs20 20 30 50
Rs15 15 25 40
Rs10 10 20 30
Rs5 5 15 20
Price Super Sound High Vibes Total
Market Supply Schedule for Compact Discs
IMPORTANT
KNOW THE DIFFERENCE BETWEEN A CHANGE IN THE QUANTITY SUPPLIED AND A CHANGE IN SUPPLY
When price changes, what happens?
The curve does not shift - there is a change in the
quantity supplied
Rs20
Rs15
Rs10
Rs5
10 20 30 40
A
BC
Supply CurveA change in price causes a change
in the quantity supplied
P
Q
Increase in Price
Increase in Quantity Supplied
When something changes other than price, what
happens?The whole curve shifts - there
is a change in supply
Rs20
Rs15
Rs10
Rs5
10 20 30 40
S1S2
When the ceteris paribus assumption is relaxed, the
whole curve can shiftP
Q
Change innonprice
determinant
Increase in supply
What can cause a shift in a supply curve?
1. Number of sellers in the market 2. Technology 3. Resource prices 4. Taxes and subsidies 5. Expectations of producers 6. Prices of other goods the firm
could produce
Rs1200
Rs900
Rs600
Rs300
1,000 2,000 3,000 4,000
D
S
The Supply & Demand for Tennis ShoesP
Q
Surplus
Shortage
What is an equilibrium?
A market condition that occurs at any price for which the quantity demanded and the quantity supplied are equal
What is the price system?
A mechanism that uses the forces of supply and demand to create an equilibrium through rising and falling prices
• Suppose that the Intel microprocessor chips (Pentium, etc.) increases in price by about 10%. What will happen to Microsoft software?
• If the price of one product rises and the quantity demanded of another product falls, then we say the products are complements.
Cross Price Elasticity
• Suppose that Coca-Cola raises its price by 10%.
• What happens to sales of Pepsi?
• If the price of one product rises and the quantity demanded of another product rises, we say the products are substitutes.
Cross Price Elasticity
Utility Max: Marginal• Suppose you could measure happiness
from consumption of apples, then, suppose that the following situation exists:
• Unit 1 = 8 units of happiness
• Unit 2 = 6 units of happiness
• Unit 3 = 4 units of happiness
• Unit 4 = 2 units of happiness
Utility Max: Marginal• The total amount of happiness depends on
how much of the good we have.
Units Total Happiness
Unit 1 6 units of happiness
Unit 2 14
Unit 3 18
Unit 4 20
Utility Max: Marginal
The total amount of happiness depends on how much of the good we have.
Units Total Happiness Marginal
Unit 1 6 6
Unit 2 14 8
Unit 3 18 4
Unit 4 20 2
10 8 6 4 2
20
15
10
5
Total utility
MU
Quantity of Good or Activity1 2 3 4 5 6
The first Unit gives us 6 units of happiness
10 8 6 4 2
20
15
10
5
Total utility
MU
Quantity of Good or Activity1 2 3 4 5 6
The second unit gives us 8 units of happiness
The first two units then are providing a total of 14 units of happiness
10 8 6 4 2
15
10
5
Total utility
MU
Quantity of Good or Activity1 2 3 4 5 6
Even though MU is falling, total utility continues to rise until .....
10 8 6 4 2
15
10
5
MU reaches zero. Zero MU means MAX Total Utility. Any more consumption and MU is negative so total utility declines
Total utility
MU
Quantity of Good or Activity1 2 3 4 5 6
Key Concepts
• What is the law of demand?• What is a demand curve?• Why do demand curves have a negative slope?• When price changes, what happens?• When something changes other than price, what
happens?• What can cause a shift in a demand curve?
Key Concepts
Key Concepts cont.
• What is the law of supply?• Why do supply curves have a positive slope?• When price changes, what happens?• When something changes other than price, what
happens?• What can cause a shift in a supply curve?• What is a market?• What is an equilibrium?
68
Summary
69
The law of demand states there is an inverse relationship between the price and the quantity demanded, ceteris paribus. A market demand curve is the horizontal summation of individual demand curves.
Rs20
Rs15
Rs10
Rs5
4 8 12 16
A
B
C
D
Individual’s Demand Curve for Compact Discs
Demand Curve
P
Q
7
A Rs 20 4
B Rs 15 6
C Rs 10 10
D Rs 5 16
Point Price Quantity demandedper compact disk (per year)
Individuals Buyer’s Demand Schedule for Compact Discs
71
A change in quantity demanded is a movement along a stationary demand curve caused by a change in price. When any of the nonprice determinants of demand changes, the demand curve responds by shifting. An increase in demand (rightward shift) or a decrease in demand (leftward shift) is caused by a change in one of the nonprice determinants.
Rs20
Rs15
Rs10
Rs5
10 20 30 40
D1
D2
P
50
A
When the ceteris paribus assumption is relaxed, the whole curve can shift
Q
B
73
Nonprice determinants of demand:
a. the number of buyers,
b. tastes and preferences.
c. income (normal and inferior).
d. expectations of future p;rice and income changes, and
e. prices of related goods (substitutes and complements)
74
The law of supply states there is a direst relationship between the price and the quantity supplied, ceteris paribus. The market supply curve is the horizontal summation of individual supply curves.
75
A change in quantity supplied is a movement along a stationary supply curve caused by a change in price. When any of the nonprice determinants of supply changes, the supply curve responds by shifting. An increase in supply (rightward shift) or a decrease in supply (leftward shift) is caused by a change in one of the nonprice determinants.
Rs20
Rs15
Rs10
Rs5
10 20 30 40
A
BC
Supply CurveA company’s Supply Curve for Compact Discs
P
Q
Rs20
Rs15
Rs10
Rs5
10 20 30 40
S1S2
When the ceteris paribus assumption is relaxed, the whole
curve can shift
P
Q
78
Nonprice determinants of supply:a. the number of sellers.b. technologyc. resource prices. d. taxes and subsidies.e. expectations of future price changes, f. prices of other goods.
79
A surplus or shortage exists at any price where the quantity demanded and the quantity supplied are not equal. When the price of a good is greater than the equilibrium price, there is an excess quantity supplied called a surplus. When the price is less than the equilibrium price, there is an excess quantity demanded called a shortage.
80
Equilibrium is the unique price and quantity established at the intersection of the supply and the demand curves. Only at equilibrium does quantity demanded equal quantity supplied.
Rs120
Rs90
Rs60
Rs30
1,000 2,000 3,000 4,000
D
S
The Supply & Demand for Tennis ShoesP
Q
Surplus
Shortage
82
The price system is the supply and demand mechanism that establishes equilibrium through the ability of prices to rise or fall.
Quiz that all of you love
1. If the demand curve for good X is downward-sloping, this means that an increase in the price will result in
a. an increase in the demand for good X.b. a decrease in the demand for good X.c. no change in the quantity demanded for
good X.d. a larger quantity demanded for good X.e. a smaller quantity demanded for good X.
Answer 1
E. When price changes there is a opposite change in the quantity demanded as measured on the horizontal axis.
2. The law of demand states that the quantity demanded of a good changes, other things being equal, when
a. the price of the good changes.b. consumer income changes.c. the prices of other goods change.d. a change occurs in the quantities of other
goods purchased.
Answer 2
A. A “change in demand” means that the whole curve shifts, but a “change in the quantity demanded” means that there is movement along a stationary curve.
3. Which of the following is the result of a decrease in the price of tea, other things being equal?
a. A leftward shift in the demand curve for tea.
b. A downward movement along the demand curve for tea.
c. A rightward shift in the demand curve for tea.
d. An upward movement along the demand curve for tea.
Answer 3
B. Because demand curves have a negative slope, as the price declines, the quantity demanded will increase.
4. Which of the following will cause a movement along the demand curve for X?
a. A change in the price of a close substitute.
b. A change in the price of good X.c. A change in consumer tastes and
preferences for good X.d. A change in consumer income.
Answer 4
Answer 4
B. Movement along a given demand curve always occurs when
the price changes, if anything other than price changes, then the
whole curve will shift.
5. Assuming that beef and chicken are substitutes, a decrease in the price of chicken will cause the demand curve for beef toa. shift to the left as consumers switch
from chicken to beef.b. shift to the right as consumers switch
from chicken to beef.c. remain unchanged, since beef and
chicken are sold in separate markets.d. none of the above.
Answer 5
A. With a decrease in the price of chicken people will want to buy more chicken; because beef and chicken are substitutes, they will buy less beef.
6. Assuming that coffee and tea are substitutes, a decrease in the price of coffee, other things being equal, results in a (an)a. downward movement along the demand
curve for tea.b. leftward shift in the demand curve for tea.c. upward movement along the demand curve
for tea.d. rightward shift in the demand curve for tea.
Answer 6
B. With a decrease in the price of coffee people will want to buy more coffee; because coffee and tea are substitutes, they will buy less at possible prices for tea.
7. Assuming steak and potatoes are complements, a decrease in the price of steak will
a. decrease the demand for steak.b. increase the demand for steak.c. increase the demand for potatoes.d. decrease the demand for potatoes.
Answer 7
C. With a decrease in the price of steak people will want to buy more steak; because steak and potatoes are complements, they will buy more potatoes as well.
8. Assuming that steak is a normal good, a decrease in consumer income, other things being equal, willa. cause a downward movement along the
demand curve for steak.b. shift the demand curve for steak to the
left.c. cause an upward movement along the
demand curve for steak.d. shift the demand curve for steak to the
right.
Answer 8
B. Normal goods are goods that people will buy more of as their incomes increase and less of as their income decreases.
9. An increase in consumer income, other things being equal, will
a. shift the supply curve for a normal good to the right.
b. cause an upward movement along the demand curve for an inferior good.
c. shift the demand curve for an inferior good to the left.
d. cause a downward movement along the supply curve for a normal good.
Answer 9
C. Inferior goods are goods that people will buy less of at possible prices as their income increases.
10. Yesterday, seller A supplied 400 units of a good X at Rs10 per unit. Today, seller A supplies the same quantity of units at Rs5 per unit. Based on this evidence, seller A has experienced a (an)
a. decrease in supply.b. increase in supply.c. increase in the quantity supplied.d. decrease in the quantity supplied.e. increase in demand.
Answer 10
B. A shift to the right of a supply curve along a stationary demand curve will result in a lower price as illustrated on the next page.
Rs20
Rs15
Rs10
Rs5
10 20 30 40
S1S2
When the ceteris paribus assumption is relaxed, the
whole curve can shiftP
Q
11. An improvement technology causes a (an)a. leftward shift of the supply curve.b. upward movement along the supply
curve.c. firm to supply a larger quantity at any
given price.d. downward movement along the supply
curve.
Answer 11
C. When price changes, the supply curve itself does not change, but when other things change, the whole curve will shift. A change in technology is an example of what can cause the supply curve to shift.
12. Suppose auto workers receive a substantial wage increase. Other things being equal, the price of autos will rise because of a (an)a. increase in the demand for autos.b. rightward shift of the supply curve for
autos.c. leftward shift of the supply curve for
autos.d. reduction in the demand for autos.
Answer 12
C. A change in costs for a business is a factor that will shift the supply curve. If costs go up, as in the case of having to pay higher wages, the supplier has less of an ability to supply cars.
13. Assuming that soybeans and tobacco can both be grown on the same land, an increase in the price of tobacco, other things being equal, causes a (an)a. upward movement along the supply curve for
soybeans.b. downward movement along the supply curve
for soybeans.c. rightward shift in the supply for soybeans.d. leftward shift in the supply for soybeans.
Answer 13
D. With an increase in the price of tobacco farmers will want to grow more tobacco to take advantage of the higher price. Farmers will therefore plant soybeans on land they used to use for tobacco.
14. If Qd = quantity demanded and Qs = quantity supplied at a given price, a shortage in the market results whena. Qd is greater than Qs.b. Qs equals Qd. c. Qs is less than or equal to Qd. d. Qs is greater than or equal to Qd.
Answer 14
A. When there are more units of something being demanded than being supplied, a shortage will result.
15. Assume that the equilibrium price for a good is Rs10. If the market price is Rs5, a a. shortage will cause the price to remain at
Rs5.b. surplus will cause the price to remain at Rs5.c. shortage will cause the price to rise toward
Rs10.d. surplus will cause the price to rise toward
Rs10.
Answer 15
C. When the price of a good is below the market price, there are less units being supplied than being demanded. The result is a shortage and consumers will bid the price up toward the equilibrium price.
100 200 300 400
D
SSupply & Demand ExhibitP
Q
Rs2.00
Rs1.50
Rs1.00
Rs.50
16. In the market shown in the previous graph, the equilibrium price and quantity of good X are
a. Rs0.50, 200.b. Rs1.50, 300c. Rs2.00, 100d. Rs1.00, 200
Previous graph
Answer 16
D. The equilibrium price and equilibrium quantity are at the point where the quantity demanded equals the quantity supplied. This is the price toward which the economy tends.
17. In the previous graph, at a price of Rs2.00, the market for good X will experience a a. shortage of 150 units.b. surplus of 100 units.c. shortage of 100 units.d. surplus of 200 units.
Previous graph
Answer 17
D. At a price of Rs2.00 the quantity demanded is 100 and the quantity supplied is 300; 300 units minus 100 equals 200 units.
18. In the previous graph, if the price of good X moves from Rs1.00 to Rs2.00, the new market condition will put a. upward pressure on price.b. no pressure on price to change.c. downward pressure on price.d. upward pressure on price.
Previous graph
Answer 18
C. Anytime the price is above the equilibrium price a surplus will result. Suppliers will therefore lower price to get rid of the surplus.
END
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