The Basics of Demand,

Supply, and Equilibrium

Demand

A relation showing how

much of a good
consumers are willing and
able to buy at each
possible price during a
given period of time,
other things held constant

Law of Demand
A decrease in the price of a good, all
other things held constant, will cause
an increase in the quantity
demanded of the good.
An increase in the price of a good, all
other things held constant, will cause
a decrease in the quantity demanded
of the good.

The Demand Curve

The
Thedemand
demandcurve
curve
slopes
slopesdownward
downward
because
becauseof
ofthe
thelaw
law
of
ofdemand
demand

Demand curve
$1.25
$1.00

Price

Demand schedule
Quantity
Price Demanded
$ 1.25
8
$ 1.00
14
$ 0.75
20
$ 0.50
26
$ 0.25
32

$0.75
$0.50

D
$0.25
$2

14

20

Quantity

26

32

Change in Quantity
Demanded
Price

An increase in price
causes a decrease in
quantity demanded.

P1
P0

Q1

Q0

Quantity

Change in Quantity
Demanded
Price

A decrease in price
causes an increase
in quantity
demanded.

P0
P1
Q0

Q1

Quantity

Changes in Quantity
Demanded (Increases and
Decreases)
P

decrease
decreasein
in
quantity
quantitydemanded
demanded

increase
increasein
inquantity
quantity
demanded
demanded

Changes in Demand
1.

Changes in demand can be

caused by changes in,
1. Consumer Income
2. The prices of related
goods

Substitute Goods
Complementary Goods

Consumer expectations
The number of
consumers in the market
Consumer taste

Change in Demand
An increase in demand
refers to a rightward
shift in the market
demand curve.

Price

P0

Q0

Q1

Quantity

Change in Demand
A decrease in demand
refers to a leftward shift
in the market demand
curve.

Price

P0

Q1

Q0

Quantity

Supply

A relation showing how much of

a good producers are willing and
able to sell at each possible
price during a given period of
time, other things held constant

The Law of Supply

1.

The quantity of a good

supplied is directly related
to its price, other things
constant

Law of Supply
A decrease in the price of a good, all
other things held constant, will cause
a decrease in the quantity supplied
of the good.
An increase in the price of a good, all
other things held constant, will cause
an increase in the quantity supplied
of the good.

The Supply Curve

The
Thesupply
supplycurve
curve
slopes
slopesupward
upward
because
becauseof
ofthe
thelaw
law
of
ofsupply
supply

Supply curve
$1.25

$1.00

Price

Supply schedule
Quantity
Price
Supplied
$ 1.25
28
$ 1.00
24
$ 0.75
20
$ 0.50
16
$ 0.25
12

$0.75
$0.50
$0.25
$8

12

16

20

Quantity

24

28

Change in Quantity
Supplied
A decrease in price
causes a decrease in
quantity supplied.

Price

P0
P1

Q1

Q0

Quantity

Change in Quantity
Supplied
An increase in price
causes an increase
in quantity
supplied.

Price

P1
P0

Q0

Q1

Quantity

Changes in Quantity
Supplied (Increases and
Decreases)
P

decrease
decreasein
in
quantity
quantitysupplied
supplied

increase
increasein
in
quantity
quantitysupplied
supplied

Changes in Supply

Changes in supply can be

caused by changes in,

Production Technology
The prices of inputs/resources
used in production
The prices of alternative goods
Producer expectations
The number of producers

Change in Supply
An increase in supply
refers to a rightward shift
in the market supply
curve.

Price

P0

Q0

Q1

Quantity

Change in Supply
An increase in supply
refers to a rightward shift
in the market supply
curve.

Price

P0

Q0

Q1

Quantity

Change in Supply
An increase in supply
refers to a rightward shift
in the market supply
curve.

Price

P0

Q0

Q1

Quantity

Market equilibrium
P

In
Inequilibrium,
equilibrium,the
theplans
plans
of
ofbuyers
buyersmatch
matchthe
the
plans
plansof
ofsellers
sellers

Pe

Qe

Market Schedules and

Equilibrium
Price
$ 1.25
$ 1.00
$ 0.75
$ 0.50
$ 0.25

Quantity
Supplied
28
24
20
16
12

Market schedules
Quantity
Surplus or
Demanded
Shortage
8
Surplus of 20
14
Surplus of 10
20
Equilibrium
26
Shortage of 10
32
Shortage of 20

Price
Fall
Fall
Remain the same
Rise
Rise

Markets move toward

equilibrium.
An

economic situation is in equilibrium

when no individual would be better off
doing something different.
Anytime there is a change, the economy
will move to a new equilibrium.
Ex.: What happens when a new checkout
line opens at a busy supermarket?

Equilibrium and Changes in

Demand
P

D
D

Pe
Pe

Qe

Qe

Equilibrium and Changes in

Supply
P

Pe
Pe

Qe

Qe

Effects of Changes in Both

Supply & Demand
Demand increases
Equilibrium price change is
Supply
indeterminate.
increases
Equilibrium quantity increases.
Equilibrium price rises.
Supply
Equilibrium quantity change is
decreases
indeterminate.

Demand decreases
Equilibrium price falls.
Equilibrium quantity change is
indeterminate.
Equilibrium price change is
indeterminate.
Equilibrium quantity decreases.

Demand & Supply in Currency

Markets
Foreign Exchange Rate
Price of a foreign currency in terms of the
domestic currency

Depreciation of the Domestic

Currency
Increase in the price of a foreign currency
relative to the domestic currency

Appreciation of the Domestic

Currency
Decrease in the price of a foreign currency
relative to the domestic currency

Demand & Supply in Currency

Markets
R = Exchange Rate = Rupee Price of Dollar

R = Rs/$

Supply of Dollars

Demand for Dollars

Million $ per day

Market Check:
A convenient way to test whether a
product is in the same market as another
one is to ask the following question:
Are there either demand
substitutes or supply substitutes to
this product?

Demand Substitutes If the price of good A rises

substantially (holding all else constant), will a significant
number of buyers of good A instead purchase good B?

Supply Substitutes If the price of good A rises

substantially (holding all else constant), will a significant
number of producers of good B decide to produce good A

Consumer Surplus
The Consumer Surplus is the gains from
trade for a Consumer by purchasing a
product. This is measured as the difference
between what the consumer is actually
paying and what the consumer is willing to
pay.
Total Consumer Surplus in market = Sum of
individual consumer surpluses
= area below the market demand curve but
above the price.

Producer Surplus

It is the gains from trade for a producer

measured as difference in the actual price
received by him/her and the price at which
he/she is willing to sell the product
(minimum price = cost of producing the
good)
Total Producer Surplus in a market = Sum of
individual producer surpluses = Area above
the supply curve but below the price.