Demand, Supply and Market
Equilibrium
z Firms and Households
Chapter 4
1
The Basic Decision-Making Units in
the Economy:
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Firms and Households
The Entrepreneur
z A firm is an organization that transforms
resources (inputs) into products (outputs).
Firms are the primary producing units in a
market economy.
z Households are the consuming unit in the
economy.
z The entrepreneur is the person who organizes,
manages, and assumes the risks of a firm,
taking a new idea or a new product and turning
it into a successful business.
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Markets
Labour Markets
z Product or output markets are the markets in
which goods and services are exchanged.
z Input or factor markets are the markets in
which resources used to produce products are
exchanged
z Labour markets are the input/factor markets in
which households supply work for wages to
firms that demand labour.
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Capital Markets
Land Markets
z Capital markets are the input/factor markets in
which households supply their savings, for
interest or for claims to future profits, to firms
that demand funds in order to buy capital
goods.
z Land markets are the input/factor markets in
which households supply land or other real
property in exchange for rent.
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Factors of Production
The Circular Flow
z The inputs into the production process. Land,
labour, and capital are the three key factors of
production.
z A circular flow diagram describes the interaction
of firms and households in markets for outputs
and inputs.
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The Circular Flow of Economic
Activity (Figure 4.1)
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Determinants of Household Demand:
z
z
z
z
z
z
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The price of the product in question
The income available to the household
The households amount of accumulated wealth
The prices of other products available
Tastes and preferences
Expectations about future income, wealth, and
prices
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Changes in Quantity Demanded vs.
Changes in Demand
Quantity Demanded
z The quantity demanded represents the amount
(number of units) of a product that a household
would buy in a given period if it could buy all it
wanted at the current market price.
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z Changes in the price of a product affect the
quantity demanded per period. Changes in any
other factor, such as income or preferences,
affect demand. An increase in income, for
instance, tends to increase demand. While a
drop in prices will increase the quantity
demanded.
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The Demand Schedule
The Demand Curve
z A demand schedule is a table or chart showing
how much of a given product a household
would be willing to buy at different prices.
z The demand curve is a graph illustrating how
much of a given product a household would be
willing to buy at different prices.
z Demand curves are usually derived from
demand schedules.
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The Demand Curve
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The Law of Demand
P
z The negative relationship between price and
quantity demanded. As price rises, quantity
demanded decreases. As price falls, quantity
demanded increases
z This is why we observe a negative slope in
demand curves.
D
0
17
Q
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3
Anna’s Demand Schedule for
Telephone Calls (Table 4.1)
Anna’s Demand Curve
Price
Price per call
0
0.50
3.50
7.00
10.00
15.00
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Other Determinants of Household
Demand
z Income and Wealth
y Income: The total of all earnings received by a
household in a given period of time
y Wealth: The total value of what a household owns
less what it owes
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$15.00
Quantity Demanded in
calls per month
30
25
7
3
1
0
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$10.00
$7.50
$3.50
$ .50
01
3 7
25 30
Quantity demanded
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Income as a Determinant of Demand
z Normal Goods: Goods for which demand goes
up when income is higher and for which
demand goes down when income is lower.
z Inferior Goods: Goods for which demand falls
when income rises.
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Prices of Other Goods and Services
as Determinants of Demand
Other Determinants of Household
Demand:
z Substitutes: Goods that can serve as
replacements for one another; when the price of
one increases, demand for the other goes up.
z Tastes and Preferences - These are quite
subjective and tend to change over time.
y Perfect substitutes are identical products.
z Complements: Goods that “go together”; when
the price of one increases, demand for the other
goes down, and vice versa.
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z Expectations - With respect to future income,
wealth, prices, and availability.
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Shift of Demand vs. Movement Along
Demand Curve
Anna’s Demand for Telephone Calls A Change in Quantity Demanded
Price
z Shift of a demand curve is the change that
takes place in a demand curve when a new
relationship between the quantity demanded of
a good and the price of that good is brought
about by a change in the original conditions.
z Movement along the demand curve is what
happens when a change in price causes quantity
demanded to change.
$15.00
z The graph shows a
shift in quantity
demanded from 3 to
7 caused by a change
in price from $7.50 to
$3.50.
$10.00
$7.50
$3.50
$ .50
01 3
7
25 30
Quantity demanded
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Anna’s Demand for Telephone Calls A Change in Demand
$15.00
$7.50
$3.50
D1
$ .50
01
3 7
25 30
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Changes in Demand
Prices of Related Goods
P
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Changes in Demand
Income Changes
z When any factor
except price
changes the
relationship
between price and
quantity is
different; there is a
of the
D2 shift
demand curve, in
this case from D1
to D2.
$10.00
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Income Rises
P
P
D2
Demand for inferior good
shifts left
28
D1
Q
D1
Demand for normal good
shifts right
D2
Q
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From Household to Market Demand
Price of
hamburger rises
z Demand for a good or service can be defined for
an individual household, or for a group of
households that make up a market.
P
P
Q
D1
D2
Demand for complement
good (ketchup) shifts left
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Q
Quantity of
hamburger
demanded
falls
D1 D2
Demand for substitute
good (chicken) shifts right
Q
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Market Demand Defined
Deriving market demand from the
individual demand curves:
P
z Market demand may be defined as the sum of
all the quantities of a good or service demanded
per period by all the households buying in the
market for that good or service.
P
$3.50
DA
$1.50
0
P
$3.50
DB
4
8 Qd
DC
$3.50
$1.50
$1.50
0
3
Price
Qd
0
4
9
Qd
Market Demand
$3.50
$1.50
0
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8
20
Qd
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Supply
Quantity Supplied
z A firm’s decision about what quantity of product
to supply depends on:
z The amount of a particular product that a firm
would be willing and able to offer for sale at a
particular price during a given time period.
y The price of the good or service
y The cost of producing the product which depends on:
x The price of required inputs (land, labour , capital)
x The technologies to be used to produce the product
y The prices of related products
y A firm’s expectations about future prices and costs
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The Supply Schedule and Supply
Curve
The Law of Supply
z The positive relationship between price and
quantity of a good supplied. An increase in
market price will lead to an increase in quantity
supplied, and a decrease in market price will
lead to a decrease in quantity supplied.
35
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z A supply schedule is a table, or chart, showing
how much of a product firms will supply at
different prices.
z A supply curve is a graph illustrating how much
of a product a firm will supply at different
prices.
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Clarence Brown’s Supply Schedule
for Soybeans (Table 4.3)
Price (per tonne)
37
75
Quantity Supplied
(tonnes per year)
0
85
115
150
400
600
800
200
250
1200
1200
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Changes in Quantity Supplied vs.
Changes in Supply:
Clarence Brown’s Soybean
Supply Curve (Figure 4.6)
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A Change in the Quantity Supplied of
Clarence Brown’s Soybeans (Figure 4.6)
z Change in quantity
supplied from 600
to 800 tonnes per
year due to an
increase in price
from $115 to $150
per tonne.
z Causes movement
along supply
curve.
z Changes in quantity supplied imply movement
along a supply curve.
z Changes in supply imply a shift in the entire
supply curve.
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Shift Of Supply Curve for Soybeans
Following Development of New Strain
(Figure 4.7)
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Changes in Quantity Supplied vs.
Changes in Supply:
P
S
P
S1
Q
An increase in the
quantity supplied
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An increase in supply
S2
Q
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From Individual Firm to Market
Supply
Market Supply
z The supply of a good or service can be defined
for an individual firm, or for a group of firms
that make up a market or an industry.
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From Individual Firm to Market
Supply (Figure 4.8)
z The sum of all the quantities of a good or
service supplied per period by all the firms
selling in the market for that good or service.
z As with market demand, market supply is the
horizontal summation of the individual firms’
supply curves.
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Market Equilibrium
z The operation of the market depends on the
interaction between suppliers and demanders.
z An equilibrium is the condition that exists when
quantity supplied and quantity demanded are
equal.
z At equilibrium, there is no tendency for the
price to change.
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P
P
S
$ per
tonne
S
125
E
D
QE
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The market for soybeans in
equilibrium:
Market Equilibrium
PE
46
D
Q
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0
48
3500
Tonnes of Soybeans
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Excess Demand
Excess Demand (Figure 4.9c)
z Excess Demand is the condition that exists
when quantity demanded exceeds quantity
supplied at the current price.
z At $85 per tonne
quantity
demanded
exceeds quantity
supplied by 2500
tonnes.
z Excess demand
tends to lead to
an increase in
prices.
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Excess Supply
Excess Supply
z Excess supply is the condition that exists when
quantity supplied exceeds quantity demanded at
the current price.
z At $150, quantity
supplied exceeds
the quantity
demanded by
2000 tonnes.
z This causes prices
to fall
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Changes in Equilibrium:
Demand Shifts/Supply is Constant
P
P2
D2
D1
Q1
Q2
Increase in Demand
53
Q
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P
S
S1
S2
P1
P1
P1
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Changes in Equilibrium:
Supply Shifts/Demand is Constant
P
S
(Figure 4.10)
P2
D1
Q2
Q1
D
Q
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S1
P2
P2
D2
Decrease in Demand
S2
P
Q1
Q2
Increase in Supply
54
Q
P1
D
Q2
Q1
Q
Decrease in Supply
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Changes in Equilibrium:Demand & Supply
Move Opposite
Changes in Equilibrium: Supply &
Demand both Increase (or Decrease)
P
S1
P
S2
P=?
S1
D2
P=?
D1
D1
Q1
Q2
P
S2
Q2
Increase in Demand
& Supply
Q1
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factors of production
firm
households
income
inferior goods
input or factor markets
labour market
land market
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D1
P2
D2
Q
Q=?
Demand Increases &
Supply Decreases
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z
z
z
z
z
z
z
z
S2
D1
Q= ?
Q
Review Terms & Concepts
S1
D2
P1
Decrease in Demand &
Supply
55
S1
P
P1
P2
D2
Q
z capital market
z complements,
complementary goods
z demand curve
z demand schedule
z entrepreneur
z equilibrium
z excess demand
z excess supply
S2
Q
Demand Decreases &
Supply Increases
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Review Terms & Concepts
(continued)
law of demand
law of supply
market demand
market supply
movement along a
demand curve
z normal goods
z perfect substitutes
z product or output
markets
z
z
z
z
z
58
z
z
z
z
z
z
z
z
profit
quantity demanded
quantity supplied
shift of a demand curve
substitutes
supply curve
supply schedule
wealth or net worth
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