Demand and

supply in action
Learning Unit 5: Chapter 5
Test 1 …
• How was test 1?

• Any surprises?

• Challenges?

• Suggestions?

• Problems?
 Tips?
o Self-driven: you are expected to manage your own workload, attendance, and
engagement
o Have a schedule (especially a study timetable/plan) – you don’t always have to
adhere to it, but it gives you control
o Reading is NOT studying –

o Space out your studying – review immediately after lectures, the next day, 3 days
after and 1 week later, 2 weeks later
o Study groups help, but rely on yourself
Source: Ohio University www.ohio.edu/university-college/first-year-student-transitions/study-strategies
Why you should care about your grade (mark)?

• Lifetime earnings correlated - 8% higher salaries with increase in

grade point (e.g., B to A, C to B etc.)
• Employers - Most companies only take students with 65% or more –
the top ones only consider 70% or more
• Sense of accomplishment, self-confidence
• Scholarships, opportunities

• Signal that you can get things done

• Getting the most from your investment (education)

Questions?
Learning Content
• Explain, with the aid of a diagram, how a change in either demand or
supply will affect the equilibrium price and quantity in the market
• Explain, with the aid of a diagram, how simultaneous changes in demand
and supply will affect the equilibrium price and quantity in the market
• Explain, with the aid of a diagram, how changes in one market can affect
the equilibrium position in a related market
• Understand the role of government intervention
• Explain, with the aid of a diagram, the impact of government intervention
in the form of minimum and maximum price setting
• Understand the welfare cost of maximum and minimum price setting
Introduction

Equilibrium price:
The price for a good or service at which the quantity
demanded equals the quantity supplied (market
equilibrium).
At any other price there is disequilibrium - excess demand
or excess supply.

Equilibrium quantity:
The quantity of a good or service bought and sold at the
equilibrium price.
Changes in Demand - Increase
Changes in Demand - Decrease
Changes in Demand
– Graphical
An increase in demand is
illustrated.
The demand curve shifts from DD
to D1D1 and as a result the
equilibrium price increases from P0
to P1, while the equilibrium
quantity increases from Q0 to Q1.
There is an upward movement
along the supply curve from E to E1.
Changes in Demand –
Graphical
A decrease in demand, illustrated by
a shift of the demand curve from DD
to D2D2.
Both the equilibrium price and the
equilibrium quantity fall, to P2 and
Q2 respectively.
There is a downward movement
along the supply curve from E to E2.
Example of
Demand changes
– study all of
them

Practise the
determinants of
demand and how
they affect
equilibrium price
and quantity?

You must be able

to explain using a
graph and words!
Changes in Supply - Increase
Changes in Supply - Decrease
 Changes in Supply

We show an increase in supply,

illustrated by the shift of the supply
curve from SS to S1S1.
The equilibrium price falls to P1
and the equilibrium quantity
increases to Q1.
There is a downward movement
along the demand curve from E to
E1.
 Changes in Supply

A decrease in supply is illustrated in (b) by a

shift of the supply curve from SS to S2S2.

The equilibrium price increases to P2 while

the equilibrium quantity falls to Q2.

In this case there is an upward movement

along the demand curve from E to E2.
Know how to explain
such changes in
Supply – in words but
also drawing a graph
Simultaneous changes in demand and supply
What happens when we have a simultaneous increase in
demand and decrease in supply?
To a large extent, the effect is determined by the relative
magnitude of the changes - how big the changes are
across demand and supply relative to one another. In this
diagram, the original demand, supply, equilibrium price
and equilibrium and equilibrium quantity are
represented by DD, SS, P0 and Q0. Let’s look at some
examples.
A simultaneous increase in demand
and decrease in supply
• The original demand, supply, equilibrium price and
equilibrium quantity are represented by DD, SS, P0 and Q0
• A simultaneous increase in demand (illustrated by a
rightward shift of the demand curve) and decrease in
supply (illustrated by a leftward shift of the supply curve)
raises the price of the product
• The impact on the equilibrium quantity depends on the
relative magnitude of the changes.
• In (a) the quantity remains unchanged at Q0.
• In (b) it falls to Q2 and in (c) it increases to Q3.

This is how you answer – practise!

A simultaneous increase in demand
and decrease in supply
• The original demand, supply, equilibrium price and
equilibrium quantity are represented by DD, SS, P0 and
Q0
• A simultaneous increase in demand (illustrated by a
rightward shift of the demand curve) and decrease in
supply (leftward shift of the supply curve) raises the price
of the product
• The impact on the equilibrium quantity depends on the
relative magnitude of the changes
• In (a) the quantity remains unchanged at Q0
• In (b) it falls to Q2 and in (c) it increases to Q3
This is how you answer – practise!
A simultaneous increase in demand
and decrease in supply
The original demand, supply, equilibrium price and
equilibrium quantity are represented by DD, SS, P0 and
Q0
A simultaneous increase in demand (rightward shift of
the demand curve) and decrease in supply (illustrated
by a leftward shift of the supply curve) raises the price
of the product
The impact on the equilibrium quantity depends on the
relative magnitude of the changes.
In (a) the quantity remains unchanged at Q0
In (b) it falls to Q2 and in (c) it increases to Q3
This is how you answer – practise!
Interaction betw related markets – Fish & Meat
Interaction between related markets – Explanation
The markets for fish and meat are illustrated in (a) and (b) respectively.
The original demand and supply curves are DD and SS and the equilibrium prices and quantities are P0
and Q0 respectively.
In (a) the decrease in the demand for fish is illustrated by the leftward (downward) shift of the demand
curve from DD to D1D1
The equilibrium price of fish declines from P0 to P1 and the weekly quantity traded falls from Q0 to
Q1.
In (b) the increase in the demand for meat is illustrated by the rightward (upward) shift of the demand
curve from DD to D1D1.
The equilibrium price of meat increases from P0 to P1 and the equilibrium quantity traded rises from
Q0 to Q1.
Interaction between markets for motorcars and
tyres
 Interaction between markets for motorcars
and tyres - Explanation
• The markets for motorcars and tyres are illustrated in (a) and (b) respectively. The original
demand and supply curves are DD and SS and the equilibrium prices and quantities P0 and Q0
respectively
• In (a) the impact of an increase in the costs of producing motorcars is illustrated by the leftward
(upward) shift of the supply curve from SS to S1S1. The equilibrium price of motorcars increases
from P0 to P1 and the equilibrium quantity falls from Q0 to Q1
• In (b) the consequent decrease in the demand for tyres is illustrated by a leftward (downward)
shift of the demand curve from DD to D1D1
• The equilibrium price of tyres falls from P0 to P1 and the equilibrium quantity also decreases
from Q0 to Q1
Government
Intervention
Government Intervention
 Maximum prices (price ceilings, price
control)
Maximum prices (price ceilings): A government regulation that makes it illegal to charge a
price higher than a specific level for a specific good.

Governments set maximum prices to:

• keep the prices of basic foodstuffs low, as part of a policy to assist the poor
• avoid the exploitation of consumers by producers, that is, to avoid “unfair” prices
• combat inflation
• limit the production of certain goods and services (e.g., in wartime)
Maximum prices
If the government sets a maximum
price of Pm below the equilibrium
price of P0

This results in an excess demand

of Q2 – Q1
(or ab).
Practise explaining using graphs and words
 Black Markets
Fixing prices below the equilibrium (or market-clearing) price thus
• creates shortages (or excess demand)
• prevents the market mechanism from allocating the available
quantity among consumers
• stimulates black market activity by providing an incentive for people
to obtain the good and resell it at a higher
• price to those consumers who are willing to pay higher prices to
obtain it
 Prices – Functions of prices
Rationing: The rationing function of prices is a natural market force which
addresses excess demand. However, if this rationing function is limited by external
forces (government price control), formal or informal rationing systems arise to
manage the excess demand.
Rent control: When government intervenes in the rental market, by setting a
maximum prices
Administered prices: Government department or public entity determined prices
for a range of goods and services (including the prices for medical services, petrol
and diesel, communication services, electricity and education as well as public
transport services, water and licences).
The welfare costs of maximum
price fixing
• Prior to price fixing, the equilibrium price is P1 and
the equilibrium quantity Q1
• Government then fixes a maximum price Pm below
the equilibrium price
• The quantity exchanged falls to Qm from Q1
• Rectangle B is transferred from the producer
surplus to the consumer surplus
• Triangle A, which used to be part of the consumer
surplus, and triangle C, which used to be part of the
producer surplus, both disappear
• The total deadweight loss to society is equal to A
plus C
Homework: Redraw the effect of maximum price fixing and explain the welfare losses
Definitions – must know
Welfare costs: A cost to society created by market inefficiency when market
equilibrium for a good is not achieved, as a result of an external intervention (min.,
max. prices, import tariffs, subsidies etc).
• Too much or little of the good is subsequently produced or consumed
• A part of the consumer and producer surplus is lost, and this inefficiency costs
society at large
Deadweight loss: A cost to society created by market inefficiency. As a result of
intervention external to the market (price ceilings and price floors), parts of the
consumer surplus and producer surplus are lost, resulting in inefficiency. Too much
or too little of a good is produced, this output level is inefficient, and society is
worse off as a result of the interference in the market system
Minimum prices (price supports,
price floors)

1
DD and SS represent the
demand and supply of beef.
9–4=5
2 The equilibrium price is R30
per kg and the equilibrium
quantity is 7 million kg.
3 The introduction of a
minimum price of R40 per kg
results in a market surplus of 5
million kg (represented by ab).
The welfare costs of minimum price fixing
• Initial equilibrium price is P1 and the equilibrium
quantity Q1
• Government then fixes a minimum price Pm above
the equilibrium price
• If producers respond to actual demand, the quantity
supplied falls to Qm
• Rectangle A is transferred from the consumer surplus
to the producer surplus
• Triangle B, which used to be part of the consumer
surplus, and triangle C, which used to be part of the
producer surplus, both disappear
• The total deadweight loss to society is equal to B plus
C
Setting minimum prices above equilibrium prices is a highly
inefficient way of assisting small or poorer producers, since
• All consumers (incl. the poor) pay artificially high prices
• Benefit accrues to large producers
• Inefficient producers are protected
• Disposal of the market surpluses  welfare losses to society
 Subsidies

Subsidies: An type of government aid in the form of an amount paid to or a

tax benefit for producers in an industry or consumers to remove some or
other burden (ensuring that the price remains competitive or income remains
stable), as an alternative to setting minimum or maximum prices.
• Has the advantage of not interfering with the market's natural pricing
mechanism, while protecting the consumer and producer from price
changes that would adversely affect them
• In addition, the cost of the subsidy is explicit (and not hidden as with price
controls)
Burden of excise tax – who pays it?
 Agricultural Products Market

Agricultural prices: The prices for agricultural products (e.g. maize, wheat,
vegetables, meat, etc.).
• The prices of agricultural products generally fluctuate more than the prices of
manufactured goods, as while demand remains steady, supply varies as a result of
seasonal changes, weather patterns, disease and the perishable nature of
agricultural goods
• As supply varies, prices vary, even if demand conditions remain unchanged
Agricultural Products Market
• DD represents the demand for potatoes and
S1S1 the supply of potatoes in Year 1 (when the
harvest was bad)
• The equilibrium price and quantity are P1 and
Q1 respectively
• Farmers expect prices to be high in Year 2 as well
and plant more potatoes
• S2S2 represents the supply of potatoes in Year 2
• The equilibrium quantity increases to Q2 but the
price falls to P2
• Farmers’ total income from potatoes in Year 2
(0P2E2Q2) is lower than in Year 1 (0P1E1Q1)
 Must know
• All Determinants of supply and demand – explain and show using graph
• How changes in supply and demand affect equilibrium prices and quantity - explain and show
using graph
• Effect of Maximum prices, Minimum Prices
o Explain using graphs and words
o Equilibrium price, quantity, volume and deadweight loss, revenue
o When is a max or min price ineffective
• Practise everything -
 ICE Task
• Complete: Chapter 5 Test Bank – Questions only document
and,
Complete Questions 2 – 4 in the workbook (page 27 -33)
• We will randomly pick one of the above as your ICE
• If you don’t complete your ICE tasks, you will be penalized
• Also, the entire class will be penalized if you don’t pull your weight
 Important Concepts
• Change in demand • Deadweight loss
• Change in supply • Welfare costs
• Market shortage (excess • Administered prices
demand) • Subsidies
• Market surplus (excess • Taxes
supply) • Quotas
• Maximum prices (price • Import tariffs
ceilings)
• Agricultural prices
• Minimum prices (price
• Speculative markets
floors)
• Self-fulfilling expectations
• Rationing