Lecture 2

Elements of Demand, Supply, and Equilibrium

Price System under Market and Mixed

Economic System
Resource Allocation
Consumers / Buyers

Producers / Sellers

Demand

Supply
Equilibrium

Price System

Govt Intervention

Equilibrium Price

Price Ceiling

Equilibrium Quantity

Price Floor

Demand vs Quantity Demanded

Demand refers to the number or amount of goods and
services that consumers are willing and able to purchase at
various prices.
Quantity Demanded refers to the number or amount of
goods and services that consumers are willing and able to
purchase at a given price.

Law of Demand
Law of Demand states that, the quantity demanded of
a product falls when the price of that product rises, ceteris
paribus, and vice-versa.

Law of Demand: Justifications

1.

Law of Diminishing Marginal Utility

It states that as a person uses more and more units of a

good to satisfy a given want, the intensity of that want, and
the utility derived from further satisfying that want,
diminishes.
2.
3.

Income Effect
Substitution Effect

Demand Schedule and Demand Curve

Demand Schedule for Ball pen
Price (P)

Demand Curve for Ball pen

Qd (No. of units)

16

14

100

12

200

10

300

400

500

600

700

800

Qd = 800 50P

Non-Price Determinants of Demand

Taste and preference
Income
Price of related goods
Product quality
Advertisements
Expectations regarding future prices

1.
2.
3.
4.
5.
6.

Change in Qd vs Change in Demand

Demand Schedule for Ball pen
Price
(P)

Qd (original)

16

14

100

200

12

200

400

10

300

400

800

500

1,000

600

1,200

700

1,400

800

1,600

Qd (new)

Shift in Demand Curve for Ball pen

Qd1 = 800 50P
Qd2 = 1,600 1000P

600

Change in Qd vs Change in Demand

Change in Quantity Demanded

Change in Demand

Supply vs Quantity Supplied

Supply refers to the number or amount of goods and
services that sellers are willing and able to sell at various
prices.
Quantity Supplied refers to the number or amount of
goods and services that sellers are willing and able to sell
at a given price.

Law of Supply
Law of Supply states that, the quantity supplied of a
product increases when the price of that product rises,
ceteris paribus, and vice-versa.

Supply Schedule and Supply Curve

Supply Schedule for Ball pen
Price (P)

Qs (No. of units)

16

1,200

14

1,000

12

800

10

600

400

200

-200

-400

Supply Curve for Ball pen

Qs = -400 + 100P

Non-Price Determinants of Supply

Cost of production
Technology
Taxes
Government Subsidies
Price of other Goods
Expectations regarding future prices

1.
2.
3.
4.
5.
6.

Change in Qs vs Change in Supply

Supply Schedule for Ball pen
Price
(P)

Qs (original)

Qs (new)

16

1,200

3,000

14

1,000

2,600

12

800

2,200

10

600

1,000

400

1,400

200

1,000

600

-200

200

-400

-200

Shift in Supply Curve for Ball pen

Qs1 = -400 + 100P

Qs2 = -200 + 200P

Change in Qs vs Change in Supply

Change in Quantity Supplied

Change in Supply

Market Mechanism
The Market Mechanism is the tendency in a free market
for price to change until the market clears.
Markets clear when quantity demanded equals quantity
supplied at the prevailing price.
Market clearing price is the price at which markets clear.

Market Mechanism

Market
Equilibrium

Market Mechanism
Demand and Supply Schedule
for Ball pen
Price (P)

Qd

Qs

16

1,200

14

100

1,000

12

200

800

10

300

600

400

400

500

200

600

700

-200

800

-400

Market Equilibrium

E
Qd = 800 50P
Qs = -400 + 100P

Market Mechanism
Demand and Supply interact to determine the marketclearing price.
When not in equilibrium, the market will adjust to
alleviate a shortage or surplus and return the market to
equilibrium.
Markets must be competitive for the mechanism to be
efficient.

Market Mechanism
Market
Disequilibrium:
Surplus

Market Mechanism
Market
Disequilibrium:
Shortage

Changes in Market Equilibrium

Equilibrium prices are determined by the relative level of
demand and supply.
Changes in demand and or supply will cause changes in
the equilibrium price and or quantity in a free market.

Changes in Market Equilibrium

Increase in
Demand

Changes in Market Equilibrium

Increase in
Supply

Government Intervention
Markets are rarely free of government intervention.
Imposed taxes and granted subsidies
Price controls
Price controls usually hold the price above or below the
equilibrium price that will result to either of the following
situations:
Shortage
Surplus

Price Controls
Price Ceiling is the legal maximum price a seller may
charge for a product.
Price Floor is the legal minimum price a seller may
charge for a product.

Price Controls

Price
Ceiling

Price Controls

Price
Floor