2/20/2017

CHAPTER
2

The Market Forces of

Demand and Supply

D
Ph
Arjun Madan Ph D

Managerial / Micro Economics

a n
ad

look for the answers to these questions:

M
un

 What factors affect buyers’ demand for goods?

 What factors affect sellers’ supply of goods?
rj

 How do supply and demand determine the price

of a good and the quantity sold?
A

 How do changes in the factors that affect demand

or supply affect the market price and quantity of
a good?
 How do markets allocate resources?
1
1

1
 2/20/2017

Markets and Competition

 A market is a group of buyers and sellers of a
particular product.
 A competitive market is one with many buyers
and sellers, each has a negligible effect on price.
 In a perfectly competitive market:

D
 All goods exactly the same
 Buyers & sellers so numerous that no one can affect

Ph
market price – each is a “price taker”
 In this chapter, we assume markets are perfectly
competitive.
a n 2
ad

Markets and Competition

M

 Markets as allocative mechanism require:

 Nonattenuated [exclusive, enforceable, transferable]
un

property rights, and

 “voluntary” transactions
rj

 Markets include all “potential buyers and sellers”

A

 behavior of buyers is represented by “demand”

[benefits side of model]

 behavior of sellers is represented by “supply” [cost

side of model]
3

2
 2/20/2017

Demand
 “A schedule of the quantities of a good that buyers
are willing and able to purchase at each possible
price during a period of time, ceteris paribus. [all
other things held constant]”

D
 Law of demand
 “Other things being equal, the higher the price of

Ph
the commodity, less is the quantity demanded and
lower the price, more is the quantity demanded.”

a n 4
ad

Demand
M
un

Demand may be viewed as ex-ante, i.e.

intended demand (potential demand) or ex-
post, i.e. which is already purchased (actual
rj

demand).
A

3
 2/20/2017

Types of Demand
 Direct / Autonomous Demand
 Demand for goods meant for final consumption

 Derived Demand
 Demand is derived from the demand for final

D
commodity

Ph
 Recurring and Replacement Demand
 Consumer goods and Durables

a n 6
ad

Types of Demand
M

 Competitive Demand
 Demand for substitutes
un

 Joint or Complementary Demand

 Two or more goods consumed together
rj

 Composite Demand
A

 Commodities which have several uses

4
 2/20/2017

The Demand Schedule

Price Quantity
 Demand schedule: of of coffee
a table that shows the coffee demanded
relationship between the
$0.00 16
price of a good and the
quantity demanded 1.00 14

D
2.00 12
 Example: 3.00 10
Hiten’s demand for coffee.
4.00 8

Ph
5.00 6
 Notice that Hiten’s preferences 6.00 4
obey the Law of Demand.

a n 8
ad

Hiten’s Demand Schedule & Curve

M

Price of Price Quantity

Coffee of of coffee
coffee demanded
un

$6.00
$0.00 16
$5.00
1.00 14
$4.00
rj

2.00 12
$3.00 3.00 10
A

$2.00 4.00 8
5.00 6
$1.00
6.00 4
$0.00
Quantity
0 5 10 15 of Coffee

5
 2/20/2017

Market Demand versus Individual Demand

 The quantity demanded in the market is the sum of
the quantities demanded by all buyers at each price.
 Suppose Hiten and Ketan are the only two buyers in
the Coffee market. (Qd = quantity demanded)
Price Hiten’s Qd Ketan’s Qd Market Qd

D
$0.00 16 + 8 = 24
1.00 14 + 7 = 21

Ph
2.00 12 + 6 = 18
3.00 10 + 5 = 15
4.00 8 + 4 = 12
5.00 6 + 3 = 9
6.00 4
a +
n 2 = 6
10
ad

The Market Demand Curve for Coffee

M

Qd
P P
(Market)
un

$6.00
$0.00 24
$5.00 1.00 21
$4.00 2.00 18
rj

3.00 15
$3.00
A

4.00 12
$2.00
5.00 9
$1.00 6.00 6
$0.00 Q
0 5 10 15 20 25

11

6
 2/20/2017

Demand Function
 Is the functional relationship between the price of
the good and the quantity of that good purchased in
a given time period. [UT], income, other prices and
preferences being held constant

 Individual demand function can be expressed as:

D
 Qd = f (PX, I, Pr , P, A); alternatively:

Ph
 Qd= f (PX, holding I, Pr , P, A, etc. constant);
 Thus, an individual demand function would be:
Qd = f (PX)
a n 12
ad

Linear Demand Function

M

 The individual demand function does not show

how much qty demanded will change following a
un

unit change in price. We need a specific form of

demand function.
rj

 Generally demand function is considered to be of a

A

linear form. This is written as:

Qd = a – b Px
Where,
a is a constant intercept term
b is the coefficient showing the slope of demand curve.
13

7
 2/20/2017

Linear Demand Function

 However, demand function must be stated in
explicit form showing the precise effect on demand
of changes in various individual variables. Thus,

D
Qd = a + b1Px+b2P1+b3P2+b4I+b5A+b6…

 The coefficient b1,b2,b3,b4,b5,b6 shows the changes in

Ph
qty demanded caused by one unit change in the
associates variables.

a n
ad
M

Linear Demand Function: An Example

 Thus, annual demand for sugar at various price

un

may be Qd = 70 – 5P

 Interpreted as a one rupee fall in price of sugar

rj

will cause its qty to increase by 5 units.

A

 5 is the demand multiplier for change in demand

corresponding to a unit change in price.

15

8
 2/20/2017

An Inverse Demand Function

 If an inverse demand function is given as
 P = 300 - 2Q
 Where P is the negative function of quantity (p =
d(Q)

D
 What is the demand equation?
 2Q = 300 – P

Ph
300 – P
Q=
2

 Q = 150 - 0 .5P
a n 16
ad

An Inverse Demand Function

M

 Qd = 100 – 0.5P
 Where Q is the negative function of price q= D(p)
un

 What is the inverse demand equation?

 100 – Qd = 0.5P
rj

200 – Qd
=P
A

0.5

 200 – 2Qd = P
 P = 200 – 2Qd

17

9
 2/20/2017

An example of hot chocolate:

There is a coffee cart in the building that primarily serves the
individuals who work in the building. The market is defined to
some extent by the geography of the building. Individuals who
buy the hot chocolate rarely come from other buildings to
purchase a cup. During the time period [UT] under
consideration [8:00-9:00am on a week day ] the incomes and
preferences of buyers are unlikely to change. The prices of

D
coffee, lattes, etc. can be controlled by the vendor and the
price of soft drinks from the machines remains constant. The
number of workers in the building remain at a constant level.

Ph
Under these circumstances, we observe the number of cups
of hot chocolate [H] sold each morning as the price [P] is
changed.
From these observations the demand relationship is
estimated. a n 18
ad

Cups of Hot Chocolate [H] purchased

M

eachday between8-9am
price cups The demand relationship
per cup purchased can be demonstrated as a
table:
un

A 0 20 .

B $ . 50 15 . Demand is a schedule of
quantities
C $ . 75 12 . 5 that will be
DP > 0 DQ < 0 purchased
rj

D $ 1. 00 [+.75] 10 . [-7.5]
at a schedule
E $ 1. 25 7.5 of prices during a given
time period, cet. par.
A

F $ 1. 50 5.

G $ 1. 75 2.5
As the price is increased,
the quantity purchased
H $ 2 . 00 0 decreases.

This demand relationship can be expressed as an equation: = axis.]

Q = 20 - 10P
19

10
 2/20/2017

The demand relationship can be expressed as a table

(previous slide) or an equation Q = 20 - 10P] [either P = 2 - .1Q or
PRICE The data from the table or equation can be graphed:
$

2.25
P = $2, Then Q = 0 P = $1.75, then Q = 2.5
2.00
1.75 . . P = $1.50, then Q = 5
1.50
. . P = $1.25, Q = 7.5

D
1.25
P = $1, then Q = 10

..
1.00
.75 P = 0, then Q = 20

Ph
.50
.25 Demand

2 4 6 8 10 12 14 16 18 20 22 24 QUANTITY
The demand function can be represented as a table, {CUPS/UT}
an equation or a graph.
a n 20
ad

Market Demand Function

M

 Mathematically, market demand function can be

expressed in general form as:
un

 Qd = f (PX, I, Pr , P, A, N);
 And in specific form as:
rj

 Qd = C + b1Px+b2I+b3PY+b4T+b5A+b6N
A

 C is a constant term showing the intercept of

market demand curve
 The coefficient b1,b2,b3,b4,b5,b6 shows the
quantitative relationship of various independent
variables.

11
 2/20/2017

An Illustration

 A fruit seller want to sell 20 kgs of apples. He

want to fix a price. There are three customers and
their individual demand function is as follows:

D
D1 = 25 – 1.0P

D2 = 20 – 0.5P

Ph
D3 = 15 – 0.5P

 Determine market demand equation, and selling

price a n 22
ad

Solution
M

 Market demand is the sum of individual demands:

 Dm = (25 – 1.0P)+(20 – 0.5P)+(15 – 0.5P)
un

 Dm = 60 – 2.0P
 Quantity to be sold 20 kgs, so the price should be
rj

set such that demand is for 20 kgs

Dm = 60 – 2.0P
A

20 = 60 – 2.0P
P = 20
 Thus, demand by each buyer would be
D1 = 5 , D2 = 10 and D3 = 5
23

12
 2/20/2017

Practice Problem
 Suppose the estimated demand function for shirts
in a departmental store is as follows:

Q = 300 – 1.5 P

D
 What would be the demand for shirts at Rs 90,
and at Rs 100.

Ph
 At what price demand would be zero?

a n
ad

Practice Problem 1
M

 At Rs 90, the demand for shirt is estimated to be:

Q = 300 – 1.5 (90)
= 300 – 135
un

= 165 shirts
• At Rs. 100, then the demand would be:
Q = 300 – 1.5 (100)
rj

= 300 – 150
= 150 shirts
A

• At what price demand would be zero?

Qd = 300 – 1.5P
let us put Qd = 0
300 – 1.5P = 0
1.5P = 300
P = 300 / 1.5 = Rs. 200

13
 2/20/2017

Practice Problem 2

 The demand function for beer in the city is

Qd = 400 – 4 P

 Qd = quantity of beer (in ‘000 bottles per week)

D
a) Construct a demand curve assuming price Rs. 10,
12, 15, 20 and 25 per bottle.

Ph
b) At what price the demand would be zero?
c) If the producer want to sell 3,80,000 bottles per
week, what price should he charge ?
a n
ad
M

Practice Problem

 a)
un

 P = 10: Qd = 400 - 4 x 10 = 360

 P = 12: Qd = 400 – 4 X 12 = 352
rj

 P = 15: Qd = 400 – 4 X 15 = 340

A

 P = 20: Qd = 400 – 4 X 20 = 320

 P = 25: Q = 400 – 4 X 25 = 300

14
 2/20/2017

Practice Problem
b) Qd = 400 – 4 P, c) Qd = 400 - 4P
let us put Qd = 0 Let Qd = 380
400 – 4P = 0
380 = 400 – 4 P
4P = 400
By manipulation

D
P = 400 / 4 = 100
4P = 400 – 380 = 20
At price Rs 100 per P = 20 / 4 = 5

Ph
bottle, the demand will be To sell 3,80,000 he
zero should charge Rs 5 per
bottle
a n
ad

Illustration
M

 Demand for a goods is given by the equation:

 DX = 1500 - 10PX + 4Y – 15PY.
un

 Find the demand equation for good X in terms of

price for P(PX) when
rj

 Y = 500, and
 PY = 60
A

Solution !
• DX = 1500 - 10PX+ 4Y – 15PY
• 1500 – 10PX + 4(500) – 15(60)
= 2600 – 10PX
29

15
 2/20/2017

Illustration
 Truett and Ruett (1980) described the following demand function for
a brand X of microwave ovens
 Qx = f (Px, Pz, Nw, Y, A)
 Where Qx = quantity demanded per year for brand X of microwave
ovens in a city,
 Px = price of X brand
 Pz = price of Z brand

D
 Nw= number of working women
 Y = mean annual household income

Ph
 A = annual advertising expenditure
 Assuming hypothetical data, we may state the demand estimation
as under :
 Qx = 11,93,200 – 100Px + 20 Pz + 0.002 Nw + 1.8Y + 0.3A

city, Y = 100,000 A = 60,000

a n
 On this basis, given that Px = 8000, Pz = 9000, Nw = 800,000 in a
30
ad

Solution
M

 Qx = 11,93,200 – (100 x 8000) + (20 x 9000) +

(0.002 x 800,000) + (1.8 x 100,000) + (0.3 x 60,000)
un

 = 11,93,200 – (800,000 + 180,000 + 1600 + 180,000

+ 18000)
 = 11,93,200 –11,79,600
rj

 = 13,600
A

31

16
 2/20/2017

Determinants of Demand
 Price of the Product
 Income
 Consumer tastes, preferences, needs, etc.
 Availability and Price of related goods

D
 substitutes and compliments
 Fashion

Ph
 Advertisements
 Population- size, composition, density, and Income
distribution,
 Future expectations of consumers
a n
ad

Exceptions
M

1. Giffen Goods (Inferior Goods)

un

2. Prestige Goods/Articles of Snob Appeal

Also called the Veblen Effect

rj

(named after the American economist Thorstein Veblen)

3. Speculation/Future Expectation
A

4. Consumer’s Psychological Bias

5. Ignorance on part of consumers

17
 2/20/2017

Two Rules for Movements vs. Shifts

 Rule One
 When an independent variable changes and that
variable does not appear on the graph, the curve on
the graph will shift.

D
 Rule Two

Ph
 When an independent variable does appear on the
graph, a movement along the existing curve will
occur.
a n
ad

Change in Quantity Demanded versus

M

Change in Demand
un

Change in Quantity Demanded

 Movement along the demand curve.
rj

 Caused by a change in the price of

A

the product.

18
 2/20/2017

Changes in Quantity Demanded

Price of
Cigarettes
per Pack
A tax that raises the price
of cigarettes results in a
B movement along the
4.00
demand curve.

D
Ph
2.00 A

D1

0
12
a n 20 Number of Cigarettes
Smoked per Day
ad

Change in Quantity Demanded versus

M

Change in Demand
un

Change in Demand
 A shift in the demand curve, either to the
rj

left or right.
 Caused by a change in a determinant other
A

than the price.

19
 2/20/2017

Consumer Income
Normal Good
Price of Ice-
Cream Cone

$3.00 An increase
2.50 in income...
Increase

D
in demand
2.00

1.50

Ph
1.00

D2
0.50
D1

0 1
n
2 3 4 5 6 7 8 9 10 11 12
a Quantity of
Ice-Cream
Cones
ad

Consumer Income
M

Inferior Good
Price of Bus
ticket
un

$3.00

2.50 An increase
rj

2.00
A1
A in income...
A

1.50

1.00
Decrease
0.50 in demand

D2 D1
Quantity of
0 1 2 3 4 5 6 7 8 9 10 11 12 Bus rides

20
 2/20/2017

Summary: Variables That Influence Buyers

Variable A change in this variable…

Price …causes a movement

along the D curve
# of buyers …shifts the D curve

D
Income …shifts the D curve
Price of

Ph
related goods …shifts the D curve
Tastes …shifts the D curve
Expectations …shifts the D curve
a n 40
ad

Supply
M

 The quantity supplied of any good is the amount

that sellers are willing and able to sell.
un

 Law of supply: the claim that the quantity

supplied of a good rises when the price of the good
rises, other things equal
rj
A

41

21
 2/20/2017

The Supply Schedule

 Supply schedule: Price Quantity
of of coffee
A table that shows the
coffee supplied
relationship between the
price of a good and the $0.00 0
quantity supplied. 1.00 3

D
2.00 6
 Example:
3.00 9
Starbucks’ supply of coffee.
4.00 12

Ph
5.00 15
 Notice that Starbucks’
6.00 18
supply schedule obeys the
Law of Supply.
a n 42
ad

Starbucks’ Supply Schedule & Curve

M

Price Quantity
P of of coffees
coffee upplied
un

$6.00
$0.00 0
$5.00
1.00 3
$4.00
rj

2.00 6
$3.00 3.00 9
A

$2.00 4.00 12
5.00 15
$1.00
6.00 18
$0.00 Q
0 5 10 15

43

22
 2/20/2017

Market Supply versus Individual Supply

 The quantity supplied in the market is the sum of
the quantities supplied by all sellers at each price.
 Suppose Starbucks and Jitters are the only two
sellers in this market. (Qs = quantity supplied)
Price Starbucks Jitters Market Qs

D
$0.00 0 + 0 = 0
1.00 3 + 2 = 5

Ph
2.00 6 + 4 = 10
3.00 9 + 6 = 15
4.00 12 + 8 = 20
5.00 15 + 10 = 25
6.00 18
a +
n 12 = 30 44
44
ad

The Market Supply Curve

M

QS
P
(Market)
P
$0.00 0
un

$6.00
1.00 5
$5.00
2.00 10
rj

$4.00 3.00 15
$3.00 4.00 20
A

$2.00 5.00 25
6.00 30
$1.00
$0.00 Q
0 5 10 15 20 25 30 35

45

23
 2/20/2017

Determinants of Supply
 Price of the commodity
 Cost of production
 State of technology

D
 Number of firms

Ph
 Government policies

a n 46
ad

Supply Function
M

Sx = f(Px, C, T, G, N)
 Px, = price of the product
un

 C, = cost of production
 T, = state of technology
rj

 G, = government policies
 N = number of firms
A

 Holding other factors constant, supply function

would be : Sx = f(P)

 A linear supply function would be:

Qs = c + dP 47

24
 2/20/2017

Supply Schedule
Observation Price Quantity
Supplied
The information can be represented
A $1 6
on a graph by plotting each
B $2 10 price quantity combination.
C $3 14
D $4 18

E
F $5 22

D
P
Both the graph and the table $5
.
represent a supply $4
.

Ph
.
relationship: Q = 2 + 4P $3
A supply schedule can be $2
displayed as a table or a curve.$1 .
a n 2 4 6 8 10 12 14 Q
48
ad
M

Change in Quantity Supplied

 A change in the price of the good causes a

un

change in the “quantity supplied.”

 It signify a “movement on the supply function,”

rj

and not a “shift of the supply function.”

A

49

25
 2/20/2017

Supply Schedule

Observation Price Quantity

Supplied
A change in the price “causes” a
A $1
$1 6change in the “quantity supplied.”
B $2 DP “CAUSES”
10 DQThis can be represented by a
C $3
$3 14 “movement” on the supply
D $4 18 function in the graph
E
F $5 22

D
This is a change in “quantity P
supplied.” Not to be $5 DP “causes” the quantity supplied
confused with a “change in to increase from 6 to 14.
$4

Ph
supply!”
$3
DP from $1 to $2
$3
$1

a n
2 4 6 8 10 12 14 16 Q
/ut
50
ad
M

“Change in Supply”
 A change in supply is “caused” by a change in any
un

variable, other than price, that influences supply.

 A change in supply can be represented by a shift of

rj

the supply function on a graph.

A

51

26
 2/20/2017

Supply Schedule
Given the supply schedule,
Observation Price Quantity
An increase in the prices Supplied
of inputs would make it A $1 46
more expensive to produce
B $2 810
each unit of output,
C $3 1214
therefore, the supply
decreases D $4 1618

E
F $5 20
22
P

D
a shift to the left
$5 is a decrease in supply
The decreased quantity
$4
at each price “shifts” the

Ph
$3 supply curve to the left!
$2 The development of a “new”
technology that reduces the
$1
cost of production will “shift”
the supply function to the right
2 4 6 8 10 a 12 14 16

n Q
52
ad

Change in Quantity Supplied

M

versus Change in Supply

un

Variables that
Affect Quantity Supplied A Change in This Variable . . .
Price Represents a movement along
rj

the supply curve

Input prices Shifts the supply curve
A

Technology Shifts the supply curve

Expectations Shifts the supply curve
Number of sellers Shifts the supply curve

27
 2/20/2017

Equilibrium
 A state of rest or balance due to the equal action of
opposing forces.
 Equal balance between any power or influence [Webster’s
Encyclopedic Unabridged Dictionary of the English Language]

 In a market an equilibrium is said to exist when

D
the forces of supply [sellers] and demand [buyers]
are in balance: the actions of sellers and buyers are

Ph
coordinated.
 The quantity supplied equals the quantity
demanded!
a n
ad

Market Equilibrium
M

Market for Denim Jeans

un

Price of Denim Jeans Quantity Demanded Quantity Supplied

per month per month
(No. of pairs) (No. of pairs)
0 8 0
rj

50 7 1
Equilibrium
Price=200 100 6 2
150 5 3
A

200 4 4
250 3 5
300 2 6
350 1 7
400 0 8

Equilibrium Quantity=4

28
 2/20/2017

What would happen if the market

D
equilibrium is disturbed?

Ph
a n 6–56
ad

Market Equilibrium
M

 At prices above the equilibrium price, quantity

supplied is greater than quantity demanded,
resulting in a temporary surplus.
un

 In a surplus situation, producers will try to reduce price to

entice consumers to buy more denim jeans. Actions by
rj

both producers and the public will wipe out the temporary
surplus.
A

 At prices below the equilibrium price, consumers

desire to buy more denim jeans than are available,
creating a temporary shortage.
 Consumers will try to outbid each other, thus pushing up
the price. As price rises, firms increase their production
while some consumers reduce their purchases.

29
 2/20/2017

100
90 Given a demand
80 function [which
$70
70 represents the
behavior or choices
60 of buyers,
50 and a supply function
40 that represents the
30 behavior of
20 sellers,

D
10

10 20 30 40 50 60
60 70 80 90 100 110 120 130
Qx/ UT

Ph
Where the quantity that people want to buy is equal to the quantity
that the producers want to sell, there is an equilibrium quantity.
The price that coordinates the preferences of the buyers and sellers
is the equilibrium price.
At the equilibrium price of $70, the quantity supplied is equal to
the quantity demanded.
a n
ad

When the price is greater than the equilibrium price, the

[quantity supplied] exceeds the [quantity demanded] at that price.
M

The price is “too high.”

At a Price of $90 the quantity supplied is 80, the quantity demanded is 35

un

surplus = 45
100
$90
90
At $90 there is a surplus
rj

80
equilibrium price of 45 units [80-35=45]
$70
70
equilibrium quantity

60
A

50
40
30
20
10

10 20 30 3540 50 60 808090 100 110 120 130

60 70
Qx/ UT

30
 2/20/2017

surplus = 45
100
$90
90
80
$70
70
60
lower
price
. At a price of $90 a surplus
of 45 units exists
Suppliers have more to sell than
buyers will purchase at a price of $90.
50 To get rid of these unsold
40 Quantity units [inventory], the
Quantity
30
demanded
supplied sellers lower
increases
20
decreases the price.

D
10

10 20 30 35
40 50 60
60 70 8090
80 100 110 120 130
Qx/ UT

Ph
As the price of the good is reduced, the quantity supplied decreases.
The quantity demanded increases as the price falls.
As the price moves toward equilibrium, quantity supplied and
quantity demanded are brought into equilibrium.

.
a n
ad

As a result of market forces

100 the market moves to equilibrium
M

90
80
$70
70 . At a price below equilibrium the
the quantity demanded exceeds
the quantity supplied.
un

60 price
At a price of $30 the quantity
50 rises
demanded is 110.The quantity
40 supplied is 15.
$30
30 quantity quantity
20 supplied
rj

demanded
10
increases decreases
shortage = 95
90 100 110 110
A

10 1520 30 40 50 60
60 70 80 120 130
Qx/ UT
At a price of $30 the quantity demanded exceeds the quantity
supplied by 95 units [110 - 15 = 95]. This is a shortage.

Since the buyers cannot obtain all they want at a price of $30, some buyers will
offer to pay more. Some buyers will not pay the higher price, they buy less so the
quantity demanded decreases.
At the higher price the quantity supplied increases

31
 2/20/2017

• Shift in Demand and Supply Function

D
Ph
a n 6–62
ad

100 demand
M

increases
90
$89 The market for good X is
80 price in equilibrium at Px = $70
rises
$70
70
un

60
50
40
30 equilibrium
quantity
20
rj

increases
10
A

10 20 30 40 50 60
60 70 808090 100 110 120 130 Qx/ UT
An increase in the price of a
substitute [good Y] causes the The increase in the demand for
demand for good X to increase. good X results in an increase in
both the equilibrium price and
As a result of the increased demand, quantity.
market forces push Px up.

32
 2/20/2017

100
90 Given a demand function,
80 an equilibrium is defined.
$70
70
A decrease in demand,
60
establishes a new equilibrium
$50.89
50
at a lower price and
40
quantity.
30
20

D
10

10 20 30 40 6 070 80 90 100 110 120 130

39.250 60 Qx/ UT

Ph
Demand might be reduced by: A change in the
a decrease in the price of a substitute, price of the good
an increase in the price of a compliment, does not change
a change in income, demand! It changes
a change in the number of buyers the quantity
or their preferences, or, . . . demanded.

.
a n
ad

100
M

90 S2
80 supply
$70
70 increases
price
60 falls
un

50
$50
40
30
20
rj

10
A

6070 80 86
10 20 30 40 50 60 90 100 110 120 130
Qx/ UT
Given an equilibrium
condition in a market, Quantity Identify factors that increase supply:
1. fall in price of inputs
an increase in supply will increases 2. improved technology
increase the equilibrium 3. increase in number of sellers
quantity and decrease 4. fall in return in alternative
equilibrium P. uses of inputs
5. or, . . .

33
 2/20/2017

A decrease in supply causes the equilibrium price to increase

and equilibrium quantity to decrease.
What forces might cause the
supply to decrease?
1. an increase in the prices
S1 of inputs
2. increase in returns from
100 alternative actions
decrease in supply 3. problems in technology
$9090
[regulations, . . . ]
80 price rises
4. decrease in number of
$70

D
70 sellers or producers
60
50 quantity
40 decreases

Ph
30
20
10

10 20 3035 6 070 80 90 100 110 120 130

40 50 60
Qx/ UT
a n
ad

demand
M

100
increases S2If both supply and
90 and decrease
80 demand decrease,
price might price
+DP and the DP will be
$70
70 go up or down increase indeterminate and
-DP price
un

60 or stay the same increase

the equilibrium Q
will decrease.
50 results in
increase
a market
40
supply force to
results in
D2
30
increases aincrease
market Q
rj

20
force to
10 increase Q
A

10 20 30 40 50 60 6 070 80 90 100100 110 120 130 Qx UT /

When demand and supply both shift, the resultant effect on either
equilibrium price or quantity will be indeterminate.
Both the increase in demand and supply increase quantity; equilibrium Q increases.
The increase in demand pushes price up. The increase in supply pushes price down.
The change in price may be positive or negative, it depends on the magnitude
of the shifts in and slopes of demand and supply.

34
 2/20/2017

A decrease in supply tends to increase P and reduce Q.

An increase in demand tends to increase both P and Q.
Result is that Price will rise, Quantity may increase, decrease or stay the same
depending on the magnitudes of the shifts and slopes of supply and demand.
In this example,
the price Price
increases to $105100
S1
$105. decrease in supply
to push
90
price up
When supply 80 pushes

D
increases and $70
70 price up
demand
decreases, 60
an increase in
the price will 50 demand tends D2

Ph
fall but the 40 reduces and
change in Q quantity increase
30 Q
will be
20
indeterminate!
10

10 20 30 3540 49
50 60
60 70 80 90 100 110 120 Qx/ UT

n
the quantity decreases to 49
a
ad

Illustration
M

 Demand for wrist watches by Beyond Time Ltd.

for the year 2012 was given by
un

 Qd = 1000 – P and
 supply is given by : Qs = 100 +4P
rj

 What is the equilibrium price?

 What is the excess demand or supply if the price
A

is:
 a) Rs 500
 b) Rs100

69

35
 2/20/2017

Solution
 At equilibrium quantity Qd = quantity supplied Qs
 Therefore, 1000 – P = 100 + 4P
 5P = 1000 – 100
 P = 180
 A) when price is Rs 500

D
 Qd = 1000 – 500 = 500,
 Qs = 100 + 4(500) = 2100

Ph
 Therefore, excess supply = 2100 – 500 = 1600
 B) when price is Rs 100
 Qd = 1000 – 100 = 900


Qs = 100 + 4(100) = 500

n
Excess demand is 900 – 500 = 400
a 70
ad

Illustration
M

 Demand for X is given as

 Dx = 1500 – 10Px + 4Y – 15Py
un

 Where Y = consumers income, and

 Py is the price of related goods
rj

 Find demand equation for X in terms of price of X

A

(Px) when Y is Rs 500 and Py is Rs 60.

 Supply function is given by the equation –
 Sx = 800 + 2Px
 Find equilibrium price and quantity.

36
 2/20/2017

Solution
 Demand function by substituting the values of Y and Py
 Dx = 1500 – 10Px + 4Y – 15Py
 1500 – 10Px + 4 (500) – 15 (60) = 2600 – 10Px
 Given the supply function:
 Sx = 800 + 2Px equilibrium will occur when Dx = Sx

D
 2600 – 10Px = 800 + 2Px
 12Px = 2600 – 800

Ph
 Px = 150
 Equilibrium quantity is Dx = 2600 – 10Px
 2600 – 10 (150)
 Dx = 1100 a n 72
ad
M
un
rj
A

37