Econ 2113: Principles of
Microeconomics
Spring 2009
ECU
Chapter 3
Demand, Supply and
Equilibrium
Demand
 
You demand something if
  You
want it.
  You can afford it.
  You have a definite plan to buy it.
Demand
 
Quantity demanded: the amount consumers demand
at a particular price.
 
Demand: the entire relationship between price and
quantity demanded.
 
The Law of Demand: All else equal, the higher is the
price of a good, the smaller is the quantity
demanded.
Law of Demand
 
Example: How much would you pay for
an A in this class?
Price
$500
$200
$100
$50
$0.01
Quantity
2
10
30
60
100
The Demand Curve
Interpretation of Demand
(ways to read the demand curve)
 
Horizontal interpretation
 
 
Quantity demanded at a given price
Vertical interpretation
 
Reservation price of the marginal buyer (or
marginal unit)
 
Buyer’s reservation price: the largest dollar
amount the buyer would be willing to pay for a
good (benefit the buyer receives from the good)
Why is the demand curve
downward sloping?
 
The substitution effect: the change in the
quantity demanded of a good that results from
buyers substituting into other goods when the
price of that good changes.
 
The income effect: the change in the quantity
demanded of a good that results from the
reduction in purchasing power when the price of
a good increases.
Change in quantity demanded vs.
a change in demand
 
Change in quantity demanded
  Movement
along the demand curve that
occurs in response to a change in price
 
Change in demand
  A
shift of the entire demand curve
Change in Demand
 
Change in the entire relationship between price and
quantity demanded.
 
An increase in demand means that the quantity
demanded is higher at every price.
 
A decrease in demand means that the quantity
demanded is lower at every price
Movements along the curve vs.
shifts in the curve
Factors that lead to changes (shifts)
in demand
 
 
 
 
 
 
Prices of related goods
Expected future prices
Income
Expected future income
Population
Preferences
Changes in the price of related
products: substitutes
 
If the price of a substitute good goes up, then
demand will go up.
 
Two goods are substitutes in consumption if an
increase in the price of one causes an increase in the
demand for the other
 
 
Red Bull vs. Monster
Overnight letter delivery service and Internet access
Change in Demand: Decrease in the Price of a
Substitute
Price
D0 to D1: Decrease in Demand
7
D0
D1
10
15
Quantity
Changes in the price of related
products: complements
 
If the price of a complementary good goes up, then
demand will go down.
 
Two goods are complements in consumption if an
increase in the price of one causes a decrease in the
demand for the other
 
 
Hot dogs and hot dog buns
Tennis balls and court rental fees
Changes in income
 
Normal goods: If income increases, demand for
normal goods increases.
 
 
A normal good is one whose demand increases when the
incomes of buyers increase
Inferior goods: If income increases, demand for
inferior goods decreases.
 
An inferior good is one whose demand decreases when the
incomes of buyers increase
Change in Demand: Increase in Income (Normal
Good)
Price
D0 to D1: Increase in Demand
6
D1
D0
7
13
Quantity
Supply
 
A firm will supply a good if it:
 
has the resources and technology to produce it
 
can profit from producing it
 
has made a definite plan to produce and sell it
Law of Supply
 
Other things remaining the same, the higher
the price of a good, the greater is the quantity
supplied
 
Sellers must receive a higher price to produce
additional units of a product to cover higher
opportunity costs of each additional unit
 
Supply curve is upward-sloping
Principle of “low-hanging fruit”
  Increasing opportunity costs
 
Interpretation of Supply
 
Horizontal interpretation
 
 
Quantity produced/supplied at a given price
Vertical interpretation
 
Shows the marginal cost for producing each
additional unit - or reservation price of the
marginal seller
 
Seller’s reservation price: the smallest dollar
amount for which a seller would be willing to sell
an additional unit (equal to marginal cost)
The Supply Curve
Change in Supply
 
Change in the entire relationship between price and
quantity supplied.
 
An increase in supply means that the quantity
supplied is higher at every price.
 
A decrease in supply means that the quantity
supplied is lower at every price
Movements along the curve vs.
shifts in the curve
Supply
 The
five main factors that change
supply of a good are
  The
prices of productive resources
  Expected
  The
future prices
number of suppliers
  Technology
Supply
  Prices
of Productive Resources
  If the price of resource used to produce a
good rises, the minimum price that a supplier is
willing to accept for producing each quantity of
that good rises.
  So a rise in the price of productive resources
decreases supply and shifts the supply curve
leftward.
Supply
  Expected
Future Prices
  If the price of a good is expected to rise in the
future, supply of the good today decreases and
the supply curve shifts leftward.
  The
Number of Suppliers
  The larger the number of suppliers of a good,
the greater is the supply of the good. An
increase in the number of suppliers shifts the
supply curve rightward.
Change in Supply from Entry of
New Firms
S0 to S1: Increase in supply
Price
S0
S1
8
6
5
7
Quantity
Supply
  Technology
  Advances
in technology create new products
and lower the cost of producing existing
products, so advances in technology increase
supply and shift the supply curve rightward.
  A natural disaster is a negative technology
change, which decreases supply and shifts the
supply curve leftward.
Market Equilibrium
 
In equilibrium, price equates the quantity supplied
and the quantity demanded.
 
Equilibrium price (P*): the price at which quantity
supplied = quantity demanded.
 
Equilibrium quantity (Q*): the quantity bought and
sold at the equilibrium price.
Putting it all together
 
Market equilibrium: buyers and sellers
are satisfied with the price.
  ‘satisfied’:
buyers are buying the amount
they want to buy & sellers are selling the
amount they want to sell, at that price
Equilibrium
Market Equilibrium
 
Equilibrium: balance
 
Equilibrium in the market occurs when
supply equals demand
QxS = Qxd
 
At that point there are no forces on the
price in either direction
If price is too low:
Price
S
7
6
5
D
Shortage
12 - 6 = 6
6
12
Quantity
If price is too high:
Surplus
14 - 6 = 8
Price
S
9
8
7
D
6
8
14
Quantity
Predicting changes in equilibrium
price and quantity
•  Changes in demand an supply will cause
changes in the equilibrium price and
quantity
Four Rules Governing the Effects
of Supply And Demand Shifts
An increase in demand will lead to an increase
in both the equilibrium price and quantity
Price
S
P’
P
D
Q
Q’
D’
Quantity
Four Rules Governing the Effects
of Supply And Demand Shifts
A decrease in demand will lead to a decrease
in both the equilibrium price and quantity
Price
S
P
P’
D’
Q’
Q
D
Quantity
Four Rules Governing the Effects
of Supply And Demand Shifts
An increase in supply will lead to a
decrease in the equilibrium price
and an increase in the equilibrium quantity
Price
S
S’
P
P’
D
Q
Q’
Quantity
Four Rules Governing the Effects
of Supply And Demand Shifts
An decrease in supply will lead to
an increase in the equilibrium price
and a decrease in the equilibrium quantity
Price
S’
S
P’
P
D
Q’
Q
Quantity
The Effects Of Simultaneous
Shifts In Supply And Demand
The Market for Corn Tortilla Chips
Price
($/bag)
S
S’
P
S’ after reduction in price of
corn harvesting equipment
D’ after discovery that oils are
harmful to people’s health
P’
D
D’
Q’
Q
Millions of bags
per month
Mathematically finding
equilibrium price and quantity
QD=1000-5P, QS=100+4P
BLACKBOARD: Graph these supply
and demand curves and find the
equilibrium price and quantity