Chapter IV Supply and Demand

I. THE MARKET FORCES OF SUPPLY

AND DEMAND
Supply and Demand are the two words that

economists use most often. Supply and Demand are the forces that make market economies work! Modern economics is about supply, demand, and market equilibrium.

MARKETS AND COMPETITION

The terms supply and demand refer to the

behaviour of people as they interact with one another in markets. A market is a group of buyers and sellers of a
particular good or service.
Buyers determine demand...

Sellers determine supply

Market Economy Private parties (individuals or businesses) own vast

majority of land, factories, and other economic resources
Supply
Quantity of a good or service that producers are willing to provide at a specific selling price

Demand
Quantity of a good or service that buyers are willing to purchase at a specific selling price

I.1. What is Demand?

In everyday language, demand includes

needs ands wants of consumers. In economics, demand refers to how much (quantity) of a product or service is desired by buyers

I.2. What is Quantity Demanded?

= amount of goods and services that consumers are willing and able to purchase at conceivable prices or in a range of prices

I. 3. Demand Schedule
A demand schedule shows how much of a good or service consumers will want to buy at different prices Demand Schedule for Tickets
Price ($ per ticket) 350 300 250 200 Quantity demanded (tickets) 5,000 6,000 8,000 11,000

150
100

15,000
20,000

The quantity demanded is the actual amount consumers want to buy at some specific price.
If the scalpers are charging $250 per ticket, 8,000 tickets will be purchased

8,000

That is, 8,000 is the quantity demanded at a price of $250

A demand curve is the graphical representation of the demand schedule; it shows how much of a good or service consumers want to buy at any given price.

The law of demand says that a higher price for a good, other things equal, leads people to demand a smaller quantity of the good
If the price drops to $100, 20,000 fans want to buy tickets
At $250, only 8,000

tickets are demanded

This The reflects law of the demand general Note to that the demand points proposition the that inverse a higher curve slopes downward price reduces relationship between the number price and of people the quantity willing to buy a demanded. good

Relation between price and quantity demanded

I.4. The Law of Demand

States that when the price of a good rises and everything else

remains the same, the quantity of the good demanded will fall (e.g., air travel, magazines, education, etc)
The words, everything else remains the same are important

In the real world many variables change simultaneously However, in order to understand the economy we must first understand each variable separately Thus we assume that, everything else remains the same, in order to understand how demand reacts to price

I.4. Law of Demand (Contd)

Price Quantity demanded Try to economize to use Find out the substitute
Price Quantity demanded Afford more products Substitute to others at high prices

I.5. Graphing Demand Curve

Graphing Demand Curve

II. 1.What is Supply?

In daily language, supply is the ability that sellers and

producers can satisfy consumers needs and wants In economics, supply refers to the desire and ability that sellers and producers can satisfy consumers demand

II. 2. What is quantity supplied?

The amount of goods and services which are offered for sale at conceivable prices or in a range of prices Relation between price and quantity supplied
Price (dollar)
1 2 3 4

Quantity supplied
10 20 30 40

II.3. Supply Schedule

A supply schedule shows how much of a good or service would be supplied at different prices

Supply Schedule for Tickets

Price ($ per ticket) 350 300 250 200 150 100 Quantity supplied (tickets) 8,800 8,500 8,000 7,000 5,000 2,000

A supply curve shows graphically how much of a good or service people are willing to sell at any given price.

The the Just higher as demand price being curves normally offered, the more slope downwards, people will be supply curves willing to slope part with normally their hockey upwards tickets

II.4.The Law of Supply

States that when the price of a good rises and

everything else remains the same, the quantity of the good supplied will rise
The words, everything else remains the same are

important

In the real world many variables change simultaneously However, in order to understand the economy we must first understand each variable separately We assume everything else remains the same in order to understand how supply reacts to price

II.4. Law of Supply

Price Quantity supplied Try to produce more to gain more profit More and more producers join the market
Price Quantity supplied Minimize production to reduce loss Some producers change their production to other goods

II.5. Graphing Supply Curve

Price (dollar) 1 2 3 4 Quantity supplied 10 20 30 40

III. What is market price?

1. Market

price vs Prices in the market

Different sellers in the market give consumers different prices of the product Market price is the one at which the quantity demanded is equal to the quantity supplied. E.g. It satisfies both seller and consumers

III. 2. Graphing market price

III. 3. Finding the Equilibrium Price and Quantity

In this market the Market equilibrium equilibrium price Lets put the supply In equilibrium the is occurs atdemanded point E, is $250 quantity curve and the demand where the supply curve equal to the quantity curve for that market And the equilibrium and the demand curve supplied on the same diagram quantity is 8,000 intersect

tickets

SUPPLY AND DEMAND TOGETHER

Equilibrium refers to a situation in which the price

has reached the level where quantity supplied equals quantity demanded.

Equilibrium
Equilibrium Price The price that balances quantity supplied and quantity demanded. On a graph, it is the price at which the supply and demand curves intersect. Equilibrium Quantity The quantity supplied and the quantity demanded at the equilibrium price. On a graph it is the quantity at which the supply and demand curves intersect.

Equilibrium Demand Schedule

Supply Schedule

At $2.00, the quantity demanded is equal to the quantity supplied!

Figure : The Equilibrium of Supply and Demand

Price of Ice-Cream Cone

Supply

Equilibrium price

Equilibrium

$2.00

Demand
Equilibrium quantity

10

11

Quantity of IceCream Cones

III.4. Surplus vs Shortage

Surplus When price > equilibrium price, then quantity supplied > quantity demanded.

There is excess supply or a surplus. Suppliers will lower the price to increase sales, thereby moving toward equilibrium.

Shortage When price < equilibrium price, then quantity demanded > the quantity supplied.

There is excess demand or a shortage. Suppliers will raise the price due to too many buyers chasing too few goods, thereby moving toward equilibrium.

Figure 4-9 a): Excess Supply

Price of Ice-Cream Cone

Surplus
$2.50

Supply

$2.00

Demand

4
Quantity Demanded

10
Quantity Supplied

11

Quantity of IceCream Cones

Why Does the Market Price Fall if It Is Above the Equilibrium Price?
Lets say the market price of $350 is above the equilibrium price of $250
This creates a surplus This surplus will push the price down until it reaches the equilibrium price of $250

There is a surplus of a good when the quantity supplied exceeds the quantity demanded. Surpluses occur when the price is above its equilibrium level.

Why Does the Market Price Rise if It Is Below the Equilibrium Price?
Lets say the market price of $150 is below the equilibrium price of $250 This creates a shortage This shortage will push the price up until it reaches the equilibrium price of $250

There is a shortage of a good when the quantity demanded exceeds the quantity supplied. Shortages occur when the price is below its equilibrium level.

Figure 4-9 b): Excess Demand

Price of Ice-Cream Cone

Supply

$2.00

$1.50

Shortage

Demand

4
Quantity Supplied

10

11

Quantity of IceCream Cone

Quantity Demanded

IV. Changes in demand and supply affect price

IV.1. Changes in demand
Quantity demanded Price Not enough goods to satisfy consumers demand (Excess demand)
Quantity demanded Price Sellers reduce prices to attract consumers Otherwise they have a lot of inventories, lack of capital for further investment

Exess demand

IV.2. Changes in supply

Quantity supplied Price Sellers reduce prices to attract consumers (excess supply) Otherwise they have a lot of inventories, lack of capital for further investment
Quantity supplied Price Too few goods to satisfy all consumers demand

Exess Supply

V. Prices important in market economy

1.

Act as signals to buyers and sellers

Price Purchasing signal to buyers + Purchase more to store for future use + to substitute goods at high prices Price Selling signal to sellers + sell more to gain more profit + more producers and sellers join the market

Roles of prices (Contd)

2. Encourage efficient production
Price producers gain more profit - Invest more into their production such as new assembly lines, machinery. - Invest more into entrepreneurship - Invest more into human resources such as training and retraining * Making their production more and more efficient

Roles of prices (Contd)

3. Determine who will receive the things produced - If the price is too high, only rich consumers can purchase. - If the price is too low, everyone seems to be affordable but creating the anxiety and suspicion. - The price must be set in accordance with the producers, sellers and consumers demand.