Chapter_2
Chapter_2
Chapter 2
Demand, Supply, and
Market Equilibrium
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No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education.
Learning Objectives
Identify demand functions and distinguish between a
change in demand and a change in quantity demanded.
Identify supply functions and distinguish between a
change in supply and a change in quantity supplied.
Explain why market equilibrium occurs at the price for
which quantity demanded equals quantity supplied.
Measure gains from market exchange using consumer
surplus, producer surplus, and social surplus.
Predict the impact on equilibrium price and quantity of
shifts in demand or supply.
Examine the impact of government imposed price ceilings
and price floors.
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Demand
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General Demand Function
Six variables that influence Qd
• Price of good or service (P)
• Incomes of consumers (M)
• Prices of related goods & services (PR)
• Taste patterns of consumers (T)
• Expected future price of product (PE)
• Number of consumers in market (N)
General demand function:
Qd = f(P, M, PR, T, PE , N)
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Slope Parameters
Qd = a + bP + cM + dPR + eT + fPE + gN
b, c, d, e, f, & g are slope parameters
• Measure effect on Qd of changing one of the variables
while holding the others constant
Sign of parameter shows how variable is
related to Qd
• Positive sign indicates direct relationship
• Negative sign indicates inverse relationship
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Normal vs. Inferior Goods
Normal good
• A good or service for which an increase
(decrease) in income causes consumers to
demand more (less) of the good, holding all other
variables in the general demand function constant.
Inferior good
• A good or service for which an increase
(decrease) in income causes consumers to
demand less (more) of the good, all other factors
held constant.
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Substitute vs. Complement Goods
Substitutes
• Two goods are substitutes if an increase
(decrease) in the price of one good causes
consumers to demand more (less) of the other
good, holding all other factors constant.
Complements
• Two goods are complements if an increase
(decrease) in the price of one good causes
consumers to demand less (more) of the other
good, all other things held constant.
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Table 2.1: Summary of the General (Linear)
Demand Function
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Direct Demand Function
The direct demand function, or simply
demand, shows how quantity demanded,
Qd , is related to product price, P, when all
other variables are held constant:
Qd = f(P)
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Demand Curve
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Figure 2.1: A Demand Curve,
Qd = 1,400 – 10P
Figure 2.1
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Inverse Demand Function
Traditionally, price (P) is plotted on the vertical
axis & quantity demanded (Qd) is plotted on
the horizontal axis
• The equation plotted is the inverse demand
function, P = f(Qd)
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Graphing Demand Curves
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Table 2.3: Three Demand Schedules
Table 2.3
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Figure 2.2: Shifts in Demand
Figure 2.2
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Table 2.4: Summary of Demand Shifts
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Supply
Quantity supplied (Qs)
• Amount of a good or service offered for
sale during a given period of time
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General Supply Function
Six variables that influence Qs
• Price of good or service (P)
• Input prices (P )
I
• Prices of goods related in production (P )
r
• Technological advances (T)
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Table 2.5: Summary of the General (Linear)
Supply Function
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Direct Supply Function
The direct supply function, or simply supply,
shows how quantity supplied, Qs , is related to
product price, P, when all other variables are
held constant:
Qs = f(P)
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Table 2.6: The Supply Schedule for the Supply
Function S0: Qs = –400 + 20P
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Supply Curve
Figure 2.3
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Inverse Supply Function
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Graphing Supply Curves
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Table 2.7: Three Supply Schedules
Table 2.7
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Figure 2.4: Shifts in Supply
Figure 2.4
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Table 2.8: Summary of Supply Shifts
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Market Equilibrium
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Table 2.9: Market Equilibrium
Table 2.9
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Figure 2.5: Market Equilibrium
Figure 2.5
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Excess Supply and Excess Demand
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Value of Market Exchange
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Measuring the Value of Market Exchange
Consumer suplus
• Difference between the economic value of a good (its
demand price) & the market price the consumer must pay
Producer surplus
• For each unit supplied, difference between market price &
the minimum price producers would accept to supply the
unit (its supply price)
Social surplus
• Sum of consumer & producer surplus
• Area below demand & above supply over the relevant range
of output
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Figure 2.6: Measuring the Value of Market
Exchange
Figure 2.6
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Changes in Market Equilibrium
Qualitative forecast
• Predicts only the direction in which an
economic variable will move
Quantitative forecast
• Predicts both the direction and the
magnitude of the change in an economic
variable
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Figure 2.7: Demand Shifts (Supply Constant)
Figure 2.7
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Figure 2.8: Supply Shifts (Demand Constant)
Figure 2.8
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Simultaneous Shifts
When demand & supply shift simultaneously
• We can predict either the direction in which
price changes or the direction in which
quantity changes, but not both.
• The change in equilibrium price or quantity is
said to be indeterminate when the direction of
change depends on the relative magnitudes
by which demand and supply shift.
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Figure 2.9: Shifts in Both Demand and Supply,
Demand and Supply Both Increase
Figure 2.9
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Figure 2.10: Summary of Simultaneous Shifts in
Demand and Supply, The Four Possible Cases
Figure 2.10
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Figure 2.11: Demand and Supply for Air Travel
Figure 2.11
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Ceiling and Floor Prices
Ceiling price
• Maximum price government permits sellers to
charge for a good
• When ceiling price is below equilibrium, a
shortage occurs
Floor price
• Minimum price government permits sellers to
charge for a good
• When floor price is above equilibrium, a surplus
occurs
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Figure 2.12: Ceiling and Floor Prices
Figure 2.12
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Summary (1 of 2)
• Six variables influence demand: good’s price, income, prices of
related goods, consumers’ tastes, expected future price, and
number of consumers.
• Law of demand states that quantity demanded increases
(decreases) when price falls (rises), all else constant.
• Six variables influence supply: good’s price, input prices, prices
of goods related in production, producers’ expectation of future
price, number of firms.
• Equilibrium price and quantity are determined by intersection of
supply and demand curves.
• Consumer surplus arises because the equilibrium price
consumers pay is less than the value they place on the units
they purchase.
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Summary (2 of 2)
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No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education.