THE BASICS

OF DEMAND
& SUPPLY
Demand
1. Key definitions
2. The law of demand
3. Illustrating demand
4. Distinguishing moving along demand
curve and demand shifting
5. Determinants of demand
Cherry freedom
Supply and demand model
 Thesupply and demand model is a
model of how a competitive market
works.

 Five key elements:

◦ Demand curve
◦ Supply curve
◦ Demand and supply curve shifts
◦ Market equilibrium
◦ Changes in the market equilibrium
 Demand
1. Key Definitions
- Demand illustrates the amounts of
commodity that buyers are willing and
can afford to buy at different prices in a
certain period of time given everything
else held constant.
✓ Demand versus Need?
- Quantity demanded is the amount of
commodity that buyers are willing and can
afford to buy at a certain price during a period
of time given everything else held constant.
- Individual demand: the demand of a single
consumer.
- Market demand: the sum of the quantity
demanded for each individual buyer at each
price
DEMAND
2. The law of demand
Given everything else held constant, the
quantity demanded of a good will increase
when the price decreases, and vice versa.

Ceteris Paribus
P  QD
P  QD
3. Illustrating demand
- Demand schedule
- Demand curve
- Demand function
 1
Catherine’s demand schedule and demand curve
Price of
Ice-Cream
Cones
1. A decrease
$3.00 in price . . .
Price of Quantity of 2.50
Ice-cream cone Cones demanded
2. . . . increases quantity
$0.00 12 cones 2.00
of cones demanded.
0.50 10 1.50
1.00 8
1.50 6 1.00 Demand curve
2.00 4
2.50 2 0.50
3.00 0
0 1 2 3 4 5 6 7 8 9 10 11 12
Quantity of Ice-Cream Cones

The demand schedule is a table that shows the quantity demanded at each price.
The demand curve, which graphs the demand schedule, illustrates how the quantity
demanded of the good changes as its price varies. Because a lower price increases
10
the quantity demanded, the demand curve slopes downward.
- Demand function is a mathematical
representation of the relationship between
quantity demanded and demand determinants.
QD = f( P, Py, I, T, E, N)
Where
QD : Quantity demanded
P : Price of the commodity
Py : Price of related commodities
I : Income
T : Taste
E : Expectations
N : Number of buyers
Demand function
Other things being equal, the demand
function can be simplified as follows:
Q = f (P)
If the relationship between quantity
demanded and price is linear:
Q = aP + b ( a<0)
 A change in quantity demanded vs. a
change in demand
 When price changes, P
quantity demanded will
change sequentially.
P1 A
 However demand, as
the relationship between P2 B
D
price and quantity
demanded, will not
change.
0 Q1 Q2 Q
 Thus the demand curve
remains at the same
position.
What Causes a Demand Curve to
Shift?
Changes in the non-price factors (exogenous
factors): price of related goods, income,
expectation, taste, number of buyers ➔ the
whole demand function changes
DETERMINANTS CAUSING SHIFTS OF
DEMAND

Price of Substitute
 Two commodities are substitutes if we can
use either of them to achieve the same
purpose.
 Impact of the price of substitutes on
demand?
PY↑ ➔ QDY↓➔ DX ↑
PY↓➔ QDY ↑ ➔ DX ↓
Shifts of the Demand Curve
A “decrease
An “increase
in demand”
in
Price demand”
means a leftward
means shift
a of
the demand
rightward shiftcurve:
of the
atdemand
any given price,
curve:
Increase
in consumers
at any givendemand
price, a
demand
smaller quantity
consumers demand thana
larger before.
quantity than
(D1→D2)
(D1→D3)
before.
Decrease
in demand

D D D
3 1 2

Quantity
 DETERMINANTS OF DEMAND

Price of Complement
 Two goods are complements if they are
necessarily consumed together to
guarantee their usefulness.
 Impact
PZ ↑ ➔ QDz↓➔ DX ↓
Pz↓➔ QDz↑ ➔ DX ↑
DETERMINANTS OF DEMAND
Income
 Normal goods
I↑ ➔ D ↑
I↓ ➔ D ↓
 Inferior goods
I↑ ➔ D ↓
I↓ ➔ D ↑
 ErnstEngel : At different income levels,
consumers have different perspectives
toward the same goods.
I

I2 Inferior goods
I0
I1
Normal goods

0 Q2 Q1 Q0 Q
 Determinants of demand
Tastes
 Tastes are consumers’ preferences towards
goods.
 Tastes depend on:
❖Age
❖Gender
❖Convention and customs
❖Time
 Determinants of Demand
Expectations
Expectations about future income or prices will
affect the demand for a good today
 Expectation of an increase in price => Current
Demand Increases.
 Expectation of an decrease in price => Current
Demand Decreases.
 Expectation of an increase in income ➔ Current
demand increases in case of normal goods.
DETERMINANTS OF DEMAND

Number of buyers
N↑ ➔ D ↑
N↓ ➔ D ↓
Supply
1. Key definitions
2. The law of supply
3. Illustrating supply
4. Distinguishing a movement and a shift
of the supply curve
5. Determinants of supply
Key definitions
 Supply shows the amounts of commodity
that sellers are willing and able to sell at
different prices in a certain period of time
given everything else held constant.
 Quantity supplied is the amount of
commodity that sellers are willing and
able to sell at a given price in a certain
period of time given everything else held
constant.
 THE LAW OF SUPPLY
 CETERIS PARIBUS

P -Þ Qs -

P ¯Þ Qs ¯
Illustrating supply
 Supply schedule
 Supply curve
 Supply function
 5
Ben’s supply schedule and supply curve
Price of
Ice-Cream
Cones Supply curve
$3.00
Price of Quantity of 2.50 1. An increase
Ice-cream cone Cones supplied in price . . .
$0.00 0 cones 2.00
0.50 0 1.50
1.00 1 2. . . . increases quantity
1.50 2 1.00 of cones supplied.
2.00 3
2.50 4 0.50
3.00 5
0 1 2 3 4 5 6 7 8 9 10 11 12
Quantity of Ice-Cream Cones

The supply schedule is a table that shows the quantity supplied at each price. This
supply curve, which graphs the supply schedule, illustrates how the quantity supplied
Of the good changes as its price varies. Because a higher price increases the
29
quantity supplied, the supply curve slopes upward.
Supply function
QS = g ( Px, Pi, G, Tec, E, N)
Where
❖Pi : price of inputs
❖G: Government policies
❖Tec: Technology
❖E: Expectations of sellers
❖N: number of sellers
Supply function
 Ceteris paribus
QS = g ( P)
If supply curve is linear:
QS = cP + d (c>0)
 Shifts of the Supply Curve
Any
Any “decrease
“increase in in
Pric
e
supply”
supply” means a
S
3
S
1
S
2
rightward
leftward shift
shiftofofthe
the
supply curve:
Increase
in supply
at
at any
any given
given price,
price,
there is an a decrease
increase in in
the quantity supplied.
(S1→ S
(S1→ S2)
3)

Decrease
in supply

Quantity
Determinants causing shifts of
supply curve
Price of inputs (Pi)
◦ If Pi increases, Cost of production increases
◦ The business become less profitable
◦ Firms sell less
◦ Supply – negatively related to prices of inputs
 Determinants causing shifts of supply curve

 The government St
P
imposes tax of P2
$t/unit: Supply curve t S
shifts upward by a
distance of t P1

 For the same quantity

supplied, producers
ask for a price which
0 Q1 Q
is $t higher than the
initial price.
Determinants causing shifts of supply curve

Government Policies
 Tax (specific/ ad volarem): Firms sell less
➔ The Supply curve shifts leftwards
 Subsidy: Firms sell more ➔ The Supply
curve shifts rightwards.
Determinants causing shifts of supply curve

 Eg: Q = 3P- 5
Q (tons), P ( $/kg)
t = $0.5/ kg.
Derive the new supply function.
 Determinants of supply
 Supply without tax
𝑄+5
P without tax=
3
 Supply with tax
P with tax = P without tax + tax
𝑄+5
P with tax = + 0.5
3
𝑄+6,5
P with tax =
3
➔Q = 3P – 6.5
* P with subsidy = P without subsidy - subsidy
Determinants causing shifts of supply

Technology
Advance in technology
 Higher productivity
 Higher profitability
 Supply increases.
Determinants of supply

Expectations of sellers
Expectation of a decrease in price ➔
Increase in current supply

Expectation of an increase in price ➔

Decrease in current supply
Determinants of supply

Number of sellers

Number of sellers increases ➔ Increase in

supply

Number of sellers decreases ➔ Decrease

in supply
Market equilibrium
 Equilibrium in a market: when the
quantity demanded of a good equals the
quantity supplied of that good

 Theprice at which this takes place is the

equilibrium price (or market-clearing
price)
◦ The quantity of the good bought and sold at
that price is the equilibrium quantity.
 8
The equilibrium of supply and demand
Price of
Ice-Cream
Cones Supply
$3.00

2.50 Equilibrium
price Equilibrium
2.00

1.50

1.00
Equilibrium Demand
0.50 quantity

0 1 2 3 4 5 6 7 8 9 10 11 12
Quantity of Ice-Cream Cones
The equilibrium is found where the supply and demand curves intersect. At the
equilibrium price, the quantity supplied equals the quantity demanded. Here the
equilibrium price is $2.00: At this price, 7 ice-cream cones are supplied, and 7 ice-
43
cream cones are demanded.
 9
Markets not in equilibrium
(a) Excess Supply (b) Excess demand
Price of Price of
Ice Ice
Cream Supply Supply
Surplus Cream
Cones Cones

$2.50

2.00 $2.00

1.50
Demand Demand
Quantity Quantity Quantity Quantity
demanded supplied supplied Shortage
demanded
0 4 7 10 0 4 7 10
Quantity of Ice-Cream Cones Quantity of Ice-Cream Cones
In panel (a), there is a surplus. Because the market price of $2.50 is above the equilibrium price,
the quantity supplied (10 cones) exceeds the quantity demanded (4 cones). Suppliers try to
increase sales by cutting the price of a cone, and this moves the price toward its equilibrium level.
In panel (b), there is a shortage. Because the market price of $1.50 is below the equilibrium price,
the quantity demanded (10 cones) exceeds the quantity supplied (4 cones). With too many buyers
chasing too few goods, suppliers can take advantage of the shortage by raising the price. Hence, in
44
both cases, the price adjustment moves the market toward the equilibrium of supply and demand
Supply and Demand Together
 Surplus
◦ Quantity supplied > quantity demanded
◦ Excess supply
◦ Downward pressure on price
 Shortage
◦ Quantity demanded > quantity supplied
◦ Excess demand
◦ Upward pressure on price

45
 The market for good X has demand and supply
are given by
Q = 4000 – 5P
Q = P - 200
(P: $/ton, Q: tons)
a. Determine the equilibrium price and
quantity.
b. If the Government levies a tax of 30$/ton on
sellers, what are new price and quantity?

46
 Equilibrium and Shifts of the Demand Curve
Price

An increase
in Supply
demand…
… leads to a higher
E
2
equilibrium price and
P
2
higher equilibrium
Price quantity.
rises E
1
P
1

D
2

D1

Q Q
1 2 Quantity
Quantity
rises
Equilibrium and Shifts of the Supply Curve
An increase in supply S1 … leads to a lower equilibrium
Price …
price and higher equilibrium
quantity.
S2

E1
P1
Price
falls E2
P2

Demand

Q1 Q2 Quantity
Quantity increases
Equilibrium and Shifts of the Demand Curve
Price

A decrease
in Supply
demand…
… leads to a lower
equilibrium price and
lower equilibrium quantity.
E
1
P
1
P2
E
2

D1

D
2

Q Q
2 1 Quantity
Equilibrium and Shifts of the Supply
An decrease in
Curve supply …
S2 … leads to a higher equilibrium
Price price and lower equilibrium
quantity.
S1

E2
P2

P1 E1

Demand

Q2 Q1 Quantity
Simultaneous Shifts of Supply and
Demand
Four possibilities:
(1) Supply increases, Demand increases
(2) Supply increases, Demand decreases
(3) Supply decreases, Demand decreases
(4) Supply decreases, Demand increases
Simultaneous Shifts of Supply and Demand
(a) One Possible Outcome: Price Rises, Quantity Rises

Small
Price
decrease in
supply S S
2 1

E
2
P The
Twoincrease in demand
opposing forces
2
dominates the decrease
determining the
in supply.
equilibrium quantity.
E
1
P
1

D
D 2
1
Large increase in
demand
Q Q2 Quantity
1
Simultaneous Shifts of Supply and Demand
(b) Another Possible Outcome: Price Rises, Quantity Falls
Price
Large
decrease
S
in supply 2

S
1
The
Twodecrease
opposinginforces
supply
E dominates
determining
the increase
the
2
P equilibrium
in demand.
quantity.
2

E
1 Small
P increase in
1
demand

D
2
D
1

Q Q Quantity
2 1
Simultaneous Shifts of Supply and Demand
(c) Another Possible Outcome: Price Rises, Quantity remains unchanged

Price
decrease
in supply
S
2

S
1 Two opposing forces
determining the
E
2
equilibrium quantity.
P
2
E
1 increase in
P demand
1

D
2
D
1

Q1= Q2 Quantity
Why Governments Control Prices
 The market price moves to the level at which
the quantity supplied equals the quantity
demanded. But, this equilibrium price does
not necessarily please either buyers or sellers.

 Therefore, the government intervenes to

regulate prices by imposing price controls,
which are legal restrictions on how high or
low a market price may go.
Price controls
 How price ceilings affect market outcomes
◦ Price ceiling
 Legal maximum on the price at which a good can be
sold
 Not binding
 Above the equilibrium price
 No effect
 Binding constraint
 Below the equilibrium price
 Shortage
 Sellers must ration the scarce goods

57
 1
A market with a price ceiling
(a) A price ceiling that is not binding (b) A price ceiling that is binding
Price of Price of
Ice Ice
Cream Supply Cream Supply
Cones Cones
Price ceiling
$4
Equilibrium
price
3 $3
Equilibrium
price Price ceiling
2
Demand
Demand
Shortage

Equilibrium Quantity Quantity

quantity supplied demanded

0 100 0 75 125
Quantity of Ice-Cream Cones Quantity of Ice-Cream Cones

58
60
Price controls
 How price floors affect market outcomes
◦ Price floor
 Legal minimum on the price at which a good can be
sold
 Not binding
 Below the equilibrium price
 No effect
 Binding constraint
 Above the equilibrium price
 Surplus
 Some seller are unable to sell what they want

61
SUMMARY
1.The supply and demand model illustrates
how a competitive market, one with many
buyers and sellers, none of whom can influence
the market price, works.

2.The demand schedule shows the quantity

demanded at each price and is represented
graphically by a demand curve.

The law of demand says that demand curves

slope downward; that is, a higher price for a
good or service leads people to demand a
smaller quantity, other things equal.
 4
A market with a price floor
(a) A price floor that is not binding (b) A price floor that is binding
Price of Price of
Ice Ice
Cream Supply Cream Surplus
Supply
Cone Cone
$4
Price floor
$3 3
Equilibrium Equilibrium
price price
Price floor
2

Demand Demand

Equilibrium Quantity Quantity

quantity demanded supplied

0 100 0 80 120
Quantity of Ice-Cream Cones Quantity of Ice-Cream Cones
In panel (a), the government imposes a price floor of $2. Because this is below the equilibrium
price of $3, the price floor has no effect. The market price adjusts to balance supply and
demand. At the equilibrium, quantity supplied and quantity demanded both equal 100 cones. In
panel (b), the government imposes a price floor of $4, which is above the equilibrium price of
$3. Therefore, the market price equals $4. Because 120 cones are supplied at this price and 63
only 80 are demanded, there is a surplus of 40 cones.
 5
How the minimum wage affects the labor market
(a) A free labor market (b) A Labor Market with a
Binding Minimum Wage
Wage Wage

Labor Labor
supply Labor surplus supply
(unemployment)

Minimum
wage
Equilibrium
wage
Labor Labor
demand demand

0 Equilibrium Quantity 0 Quantity Quantity Quantity

employment of Labor demanded supplied of Labor

Panel (a) shows a labor market in which the wage adjusts to balance labor supply and labor
demand. Panel (b) shows the impact of a binding minimum wage. Because the minimum wage is
a price floor, it causes a surplus: The quantity of labor supplied exceeds the quantity demanded. 64
The result is unemployment.
SUMMARY
3. A movement along the demand curve
occurs when a price change leads to a
change in the quantity demanded.

When economists talk of increasing or

decreasing demand, they mean shifts of the
demand curve—a change in the quantity
demanded at any given price.

An increase in demand causes a rightward

shift of the demand curve. A decrease in
demand causes a leftward shift.
SUMMARY
4. There are five main factors that shift the
demand curve:
• A change in the prices of related goods or
services, such as substitutes or
complements
• A change in income: when income rises,
the demand for normal goods increases and
the demand for inferior goods decreases.
• A change in tastes
• A change in expectations
• A change in the number of consumers
SUMMARY
5. The market demand curve for a good or
service is the horizontal sum of the
individual demand curves of all consumers
in the market.

6. The supply schedule shows the quantity

supplied at each price and is represented
graphically by a supply curve. Supply
curves usually slope upward.
SUMMARY
7. A movement along the supply curve
occurs when a price change leads to a
change in the quantity supplied.

When economists talk of increasing or

decreasing supply, they mean shifts of the
supply curve—a change in the quantity
supplied at any given price.

An increase in supply causes a rightward

shift of the supply curve. A decrease in
supply causes a leftward shift.
SUMMARY
8. There are main factors that shift the supply
curve:
• A change in input prices
• A change in technology
• A change in expectations
• A change in the number of producers

9. The market supply curve for a good or

service is the horizontal sum of the
individual supply curves of all producers in
the market.
SUMMARY
11. An
increase in demand increases both the
equilibrium price and the equilibrium
quantity; a decrease in demand has the
opposite effect.

An increase in supply reduces the

equilibrium price and increases the
equilibrium quantity; a decrease in supply
has the opposite effect.
SUMMARY
10. Thesupply and demand model is based on
the principle that the price in a market
moves to its equilibrium price, or market-
clearing price, the price at which the
quantity demanded is equal to the quantity
supplied. This quantity is the equilibrium
quantity.

When the price is above its market-clearing

level, there is a surplus that pushes the price
down.
SUMMARY
12. Shifts
of the demand curve and the supply
curve can happen simultaneously.

When they shift in opposite directions, the

change in equilibrium price is predictable but
the change in equilibrium quantity is not.

When they shift in the same direction, the

change in equilibrium quantity is predictable
but the change in equilibrium price is not.

In general, the curve that shifts the greater

KEY TERMS
 Competitive market  Quantity supplied
 Supply and demand model  Supply schedule
 Demand schedule  Supply curve
 Quantity demanded  Shift of the supply curve
 Demand curve  Movement along the supply
 Law of demand curve
 Shift of the demand curve  Input
 Movement along the  Individual supply curve
demand curve  Equilibrium price
 Substitutes  Equilibrium quantity
 Complements  Market-clearing price
 Normal good  Surplus
 Inferior good  Shortage
 Individual demand curve
 Consider the market for good X:
 P = 100 – 0.1Q
 P = 10 + 0.1Q
 (P: $/kg, Q: ton)
 a. Determine the market equilibrium.
 b. If the Government imposes a price ceiling of 42$/kg and
supplies the shortage amount, determine the price and
quantity.
 c. If the Government doesn’t want to impose price ceiling
but still desires the same outcome as (b), should the Gov
impose tax or subsidize producers? Determine that subsidy
or tax.
 A market demand curve
A. is derived by a vertical summation of
individual demand curves.
B. is derived by a horizontal summation of
individual demand curves.
C. will shift in response to a change in the
price of the good.
D. is always steeper than an individual
demand curve.
 If buyers today become more willing and able than before
to purchase larger quantities of Vanilla Coke at each price
of Vanilla Coke,
A. we will observe a movement downward along the demand
curve for Vanilla Coke.
b. we will observe a movement upward along the demand
curve for Vanilla Coke.
c. the demand curve for Vanilla Coke will shift to the right.
d. the demand curve for Vanilla Coke will shift to the left.
 During the last decade, we observe that the
price of laptop has fallen sharply while the
quantity has increased. This fact can be
explained by which of the following events?
a. The introduction of tablet
b. Financial crisis
c. Technological advance in laptop
production
d. Higher income
 What will happen if the price of Urban
Station coffee goes up?
a. Demand curve for Urban shift rightward
b. Demand curve for Urban shift leftward
c. Demand curve for The coffee Inn shift
rightward
d. Demand curve for The Coffee Inn shift
leftward
 An increase in the price of oranges would
lead to
a. an increased supply of oranges.
b. a reduction in the prices of inputs used in
orange production.
c. an increased demand for oranges.
d. a movement up and to the right along the
supply curve for oranges
 Another term for equilibrium price is
a. dynamic price.
b. market-clearing price.
c. quantity-defining price.
d. satisfactory price.
 If at the current price, there is a shortage
of a good,
a. sellers are producing more than buyers
wish to buy.
b. the market must be in equilibrium.
c. the price is below the equilibrium price.
d. quantity demanded equals quantity
supplied.
 A weaker demand together with a stronger
supply would necessarily result in
a. a lower price.
b. a higher price.
c. an increase in equilibrium quantity.
d. a decrease in equilibrium quantity.