CHAPTER 4-LECTURE NOTES

DEMAND, SUPPLY, AND MARKETS

INTRODUCTION
Chapter 4 introduces the concepts of demand and supply and shows how they interact in competitive
markets. Other major topics in this chapter include equilibrium, shifts in demand and supply, and
disequilibrium. Diagrams and graphs play a central role in this chapter, and most students will find it
helpful if your presentations and discussions of the material use a similar treatment. A thorough
understanding of demand and supply analysis is critical to the study of economics so this chapter may be
the most important in the textbook.

CHAPTER OUTLINE
I. Demand: A relation between the price of a good and the quantity that consumers are willing
and able to buy per period, other things constant.

A. Law of Demand
The Law of Demand states that the quantity of a good that consumers are willing and
able to buy per period varies inversely with its price, other things constant. More is
demanded when the price decreases. Less is demanded when the price increases.
1. Demand, Wants, and Needs: are not the same
2. The Substitution Effect of a Price Change: Caused by a change in the relative
price of a good. If the price of one good falls relative to the prices of other
goods, consumers tend to substitute the lower-priced good for the other goods.
3. The Income Effect of a Price Change: Caused by a change in a consumer's real
income. If the price of a good falls, other things constant, the consumer’s
purchasing power (real income) rises, increasing his ability to purchase all
goods.

B. Demand Schedule and Demand Curve

 Demand Schedule: Lists possible prices, along with the quantity demanded at each
price.
 Demand Curve: A plot of the demand schedule. It slopes downward, reflecting the
law of demand.
 Quantity demanded: The quantity consumers are willing and able to buy per period
at a particular price; reflected by a point on the demand curve.
 Movement along the demand curve: Reflects a change in quantity demanded caused
by a change in price.
 Individual Demand: The relation between the price and quantity demanded per
period, by an individual consumer, other things constant.
 Market Demand: The relation between the price and quantity demanded per period,
by all consumers, other things constant.

1
II. What Shifts a Demand Curve?
The demand curve isolates the relation between the price of a good and quantity demanded,
assuming other factors remain constant. Other variables that may affect demand are the money
income of consumers, prices of other goods, consumer expectations, number or composition of
consumers, and consumer tastes. Changes in these factors lead to shifts in the demand curve. An
increase in demand is represented by a rightward shift of the demand curve; consumers are
willing and able to buy more units at each price. A decrease in demand is represented by a
leftward shift of the demand curve; consumers are willing and able to buy fewer units at each
price.

A. Consumer Income
 Demand for normal goods increases as money income increases.
 Demand for inferior goods decreases as money income increases.

B. Prices of Other Goods

 Substitutes: Goods that are related in such a way that an increase in the price of
one increases demand for the other, shifting that demand curve rightward (example:
apples and pears).
 Complements: Goods that are related in such a way that an increase in the price of
one decreases demand for the other, shifting that demand curve leftward (example:
hot dogs and hot dog rolls).

C. Consumer Expectations
 Consumers expecting increased future income may increase their current demand
for a good.
 Consumers expecting a future price increase may increase their current demand for
the good.

D. Number or Composition of Consumers

Market demand is the sum of individual demands. If the number of consumers in the
market changes the demand curve will shift. Even if total population remains
unchanged, demand could shift with a change in the composition of the population.

E. Consumer Tastes:
 Tastes: Consumer preferences; likes and dislikes in consumption; a change in
consumer likes and dislikes for a particular good would shift that good’s demand
curve.

III. Supply: A relation between the price of a good and the quantity that producers are willing and
able to sell per period, other things constant.
 Law of supply: The amount of a good producers are willing and able to sell per period is
usually directly related to its price, other things constant. The lower the price, the smaller the
quantity supplied and the higher the price, the higher the quantity supplied. As the price of a
good increases, producers become more willing and able to supply the good. The higher
price provides producers with a profit incentive to shift some resources from lower-valued
uses to the higher-valued use. A higher price makes producers more willing and able to
increase quantity supplied of a good.

2
 A. The Supply Schedule and Supply Curve
 Supply Schedule: Lists possible prices, along with the quantity supplied at each
price.
 Supply Curve: A plot of the supply schedule. It slopes upward, reflecting the law of
supply.
 Quantity supplied: The quantity producers are willing and able to sell per period at
a particular price; reflected by a point on the supply curve.
 Movement along the supply curve: Reflects a change in quantity supplied caused by
a change in price.
 Individual Supply: The relation between the price of a good and the quantity an
individual producer is willing and able to sell per period, other things constant.
 Market Supply: The relation between the price of a good and the quantity all
producers are willing and able to sell per period, other things constant

IV. What Shifts a Supply Curve?

The supply curve isolates the relation between price and quantity supplied, assuming other
factors are held constant. Other variables that may affect supply include state of technology and
know-how, the prices of resources, the prices of other goods, producer expectations, and the
number of producers in the market. Changes in these factors lead to shifts in the supply curve.
An increase in supply is represented by a rightward shift of the supply curve; producers are
willing and able to sell more units at each price. A decrease in supply is represented by a
leftward shift of the supply curve; producers are willing and able to sell fewer units at each price.

A. State of Technology and Know-How

State of technology and know-how represents the economy’s knowledge about how to
combine resources efficiently. If a better technology or better production process is
discovered, production costs will fall. Quantity supplied at each price will increase, and
the supply curve will shift to the right.

B. Resource Prices
 Those resources employed in the production of the good.
 If the price of an important resource decreases, costs of production fall and the
supply curve shifts to the right.
 If the price of an important resource increases, costs of production increase and the
supply curve shifts to the left.

C. Prices of Other Goods

 Other goods: Those that use some of the same resources as are employed to
produce the good under consideration.
 A rise in the price of another good will cause the supply of the good in question to
decrease, or shift to the left because some producers will opt to produce the other
good.

3
 D. Producer Expectations
If a producer expects the future price of a good to be higher than today's price, she or he
may decrease or increase the current supply, depending on the good under
consideration.

E. Number of Producers in the Market

If the number of producers increases, supply will increase, or shift to the right.

V. Demand and Supply Create a Market

A. Markets: Arrangements made by individuals to buy and sell goods and services.
 Reduce the transaction costs of exchange.
 Coordinate the independent intentions of buyers and sellers through Adam Smith's
"invisible hand."

B. Market Equilibrium
 Surplus: Excess quantity supplied; puts downward pressure on the price.
 Shortage: Excess quantity demanded; puts upward pressure on the price.
 Equilibrium: Occurs when the quantity consumers are willing and able to buy
equals the quantity producers are willing and able to sell. There is no pressure to
change price or quantity.
o Impersonal market forces synchronize the personal and independent decisions
of many individual buyers and sellers to achieve equilibrium price and quantity.

VI. Changes in Equilibrium Price and Quantity

A. Shifts of the Demand Curve

 Given an upward-sloping supply curve, a rightward shift of the demand curve
increases both equilibrium price and quantity. Given an upward-sloping supply
curve, a leftward shift of the demand curve decreases both equilibrium price and
quantity.

B. Shifts of the Supply Curve

 Given a downward-sloping demand curve, a leftward shift of the supply curve
decreases equilibrium quantity but increases equilibrium price. Given a downward-
sloping demand curve, a rightward shift of the supply curve increases equilibrium
quantity but decreases equilibrium price.

C. Simultaneous Shifts of Demand and Supply Curves

 If both curves shift, the results are less obvious but can be approximated by drawing
the demand and supply diagram, shifting the curves appropriately, and interpreting
the new equilibrium point.

4
VII. Disequilibrium
Represent a temporary phase while the market seeks equilibrium. Sometimes, often as a result of
government intervention, disequilibrium can last a while.

A. Price Floor: A minimum legal selling price. To have an impact, the price floor must be
set above the equilibrium price. It creates a surplus.

B. Price Ceilings: A maximum legal selling price. To have an impact, the price ceiling
must be set below the equilibrium price. It creates a shortage.

VIII. Conclusion
Analysis of demand and supply is a foundation of economics. This text emphasizes the market
economy so a thorough understanding of the interaction of demand and supply is crucial.
Consumer sovereignty rules, deciding what gets produced. Those who don’t like the market
outcome usually look to government for a solution through price ceilings and price floors,
regulations, income redistribution, and public finance more generally. Limitations of market
economies are considered later in the text.

CHAPTER SUMMARY
Demand is a relationship between the price of a product and the quantity consumers are willing and able
to buy per period, other things constant. According to the law of demand, quantity demanded varies
negatively, or inversely, with the price, so the demand curve slopes downward.

A demand curve slopes downward for two reasons. A price decrease makes consumers (a) more willing
to substitute this good for other goods and (b) more able to buy the good because the lower price
increases real income.

Assumed constant along a demand curve are (a) money income, (b) prices of other goods, (c) consumer
expectations, (d) the number or composition of consumers in the market, and (e) consumer tastes. A
change in any of these will shift, or change, the demand curve.

Supply is a relationship between the price of a good and the quantity producers are willing and able to
sell per period, other things constant. According to the law of supply, price and quantity supplied are
usually positive, or directly, related, so the supply curve typically slopes upward.

The supply curve slopes upward because higher prices make producers (a) more willing to supply this
good rather than supply other goods that use the same resources and (b) more able to cover the higher
marginal cost associated with greater output rates.

Assumed to remain constant along a supply curve are (a) the state of technology, (b) the prices of
resources used to produce the good, (c) the prices of other goods that could be produced with these
resources, (d) supplier expectations, and (e) the number of producers in this market. A change in any of
these will shift, or change, the supply curve.

Demand and supply come together in the market for the good. A market provides information about the
price, quantity, and quality of the good. In doing so, a market reduces the transaction costs of exchange—
the costs of time and information required for buyers and sellers to make a deal. The interaction of
demand and supply guides resources and products to their highest-valued use.

5
Impersonal market forces reconcile the personal and independent plans of buyers and sellers. Market
equilibrium, once established, will continue unless there is a change in a determinant that shapes demand
or supply. Disequilibrium is usually temporary while markets seek equilibrium, but sometimes
disequilibrium lasts a while, such as when government regulates the price.

A price floor is the minimum legal price below which a particular good or service cannot be sold. The
federal government imposes price floors on some agricultural products to help farmers achieve a higher
and more stable income than would be possible with freer markets. If the floor price is set above the
market clearing price, quantity supplied exceeds quantity demanded. Policy makers must figure out some
way to prevent this surplus from pushing the price down.

A price ceiling is a maximum legal price above which a particular good or service cannot be sold.
Governments sometimes impose price ceilings to reduce the price of some consumer goods such as rental
housing. If the ceiling price is below the market clearing price, quantity demanded exceeds the quantity
supplied, creating a shortage. Because the price system is not allowed to clear the market, other
mechanisms arise to ration the product among demanders.