Economic Principles I

Lecture 3:
Demand and Supply: a First Look
The Nature of Markets
What is a market?
A market is a group of buyers and sellers of a particular
good or service
In most cases the buyers and sellers do not have to all
meet in the same place
In the E-economy individual buyers and sellers do not
have to meet at all
A competitive market is one with many buyers
and many sellers
No single buyer or seller can influence price
Types of Market
Economists define something called Perfect
Competition
The goods are the same (homogeneous)
Many buyers and sellers none can influence price
price takers
At the other extreme a Monopoly is a single seller
An Oligopoly has a small number of sellers firms
may compete or collude
The Demand Side
Individual demand is determined by
Price
The Law of Demand states that the quantity demanded is
negatively related to price
Income
If quantity demanded rises with income the good is normal; if
it falls with income the good is inferior
The Demand Side (continued)
Further, individual demand is also determined by
Price of related goods
When a fall in the price of one good reduces the quantity
demanded of another the two are called substitutes (e.g.
videos and DVDs)
When a fall in the price of one good increases the quantity
demand of another the two are called complements (e.g.
cars and tyres)
Tastes
Peoples preferences for goods and services change over time
with fashion
Expectations about the future
An Individual Demand Curve
Price of
CDs
Quantity
demanded
2.5 14
5 12
7.50 10
10 8
12.50 6
15 4
17.50 2
Note that we are holding
everything else constant. Ceteris
paribus, an increase in price
reduces the quantity demanded.
Quantity demanded
Price
17.5
15
12.5
10
7.5
5
0 2 4 8 6 10 12 14
20
2.5
16
A Market Demand Curve
10
8
price
quantity
Thomas
10
4
+
price
quantity
Richard =
10
12
quantity
price
Market
To obtain the market demand curve we sum the individual
quantities demanded horizontally
Shifts in the Demand Curve
D
2

D
3

Increase in
demand
Decrease in
demand
D
1

0
price
quantity
When anything other than
the (own) price of the good
changes the demand curve
shifts. For example:
D
2
: increase in income
D
3
: decrease in income
The Supply Side
Individual supply is determined by
Price
The Law of Supply states that the quantity supplied is
positively related to price
Input prices
If input prices rise, then it costs more to produce the good,
and the firm supplies less
Technology
If a new machine is invented that makes production cheaper,
then the firm supplies more
Expectations about the future
An Individual Supply Curve
Price of
CDs
Quantity
supplied
2.50 2
5 4
7.50 6
10 8
12.50 10
15 12
17.50 14
Note again that we are holding everything else
constant. Ceteris paribus, an increase in price
increases the quantity supplied.
Price
Quantity supplied
17.5
15
12.5
10
7.5
5
0
2 4 8 6 10 12 14
20
2.5
A Market Supply Curve
10
8
price
quantity
Sony
10
4
+
price
quantity
Philips =
10
12
quantity
price
Market
To obtain the market supply curve we sum the quantities
supplied by each firm horizontally
Shifts in the Supply Curve
S
3

Increase in
supply
decrease in
supply
S
2

S
1

0
price
quantity
When anything other than
the (own) price of the good
changes the supply curve
shifts. For example:
S
2
: decrease in input price
S
3
: increase in input price
The Concept of Equilibrium
Equilibrium means
a state of balance
In the case of a
market it means a
position where the
quantity buyers
demand equals
the amount sellers
wish to supply
price
quantity
0
S
D
Equilibrium
Equilibrium
quantity
Equilibrium
price
What if Prices are above
Equilibrium?
The quantity
supplied would
have been greater
than demand
price
quantity
0
D
S
p
Quantity
demanded
Quantity
supplied
surplus
A market surplus or
excess supply
Sellers would
observe unsold
goods and so cut
price to clear the
surplus stock
What if Prices are below
Equilibrium?
The quantity supplied
would have been less
than demand
price
quantity
0
D
S
p
Quantity
supplied
Quantity
demanded
shortage
A market shortage or
excess demand
Sellers would observe
queues for goods and
so raise price to
ration available
supplies
Conclusions
The demand curve shows the relationship between price
and the quantity the consumer or consumers wish to
demand, holding all other influences on demand constant.
The supply curve shows the relationship between price
and the quantity the firm or firms wish to supply holding
all other influences on supply constant.
Changes in (own) price cause movements along the
curves.
Changes in anything other than (own) price induce shifts
in the curves
A market shortage or surplus will send a signal to sellers
to change prices and restore market equilibrium
Next Lecture
Lecture 4 will show how changes in demand and
supply affect market equilibrium and explore the
concept of elasticity
Economic Principles I
Lecture 3:
Demand and Supply: a First Look