Chapter 3

Demand, Supply,
and Market
Equilibrium

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 Markets

Interaction between buyers and

sellers
Markets may be
Local
National
International
Price is discovered in the interactions
of buyers and sellers
LO 3-2
 Demand

Demand
Demand schedule or demand
curve
Amount consumers are willing and
able to purchase at a given price
Other things equal
Individual demand
Market demand
LO 3-3
 Law of Demand

Law of demand
Other things equal, as price falls, the
quantity demanded rises, and as price
rises, the quantity demanded falls
Explanations
Price acts as an obstacle to buyers
Law of diminishing marginal utility
Income effect and substitution effect

LO 3-4
 The Demand Curve
P
6

Price (per bushel)

5

P Qd
$5 10 4

4 20 3

3 35
2

2 55
1 D
1 80
0
10 20 30 40 50 60 70 80
Q

Quantity demanded (bushels per week)

LO 3-5
 Market Demand
Market Demand for Corn, Three Buyers

Quantity Demanded Total

Price Qd
per bushel Joe Jen Jay per week
$5 10 12 8 30
4 20 23 17 60
3 35 39 26 100
2 55 60 39 154
1 80 87 54 221

LO 3-6
 Changes in Demand

P6

Price (per bushel)

5
Increase
P Qd in
$5 2000 4 demand

4 4000 3

3 7000
2
D2
2 11,000
1 Decrease
D1
1 16,000 in demand
D3
0
Q
2 4 6 8 10 12 14 16 18
Quantity demanded (thousands of bushels p
LO 3-7
 Changes in Demand
P
6
Change in
demand
Price (per bushel)

4 Change in
quantity
3 demanded

2
D2
1
D1
D3
0
2 4 6 8 10 12 14 16 18 Q
Quantity demanded (thousands of bushels per week)

LO 3-8
 Determinants of Demand

Determinants of demand
Change in consumer tastes and
preferences
Change in the number of buyers
Change in income
Normal goods
Inferior goods

LO 3-9
 Determinants of Demand

Change in prices of related goods

Complementary good
Substitute good
Change in consumer expectations
Future prices
Future income

LO 3-10
 Determinants of Demand
Determinants of Demand: Factors That Shift the Demand Curve
Determinant
Change in buyers tastes
Change in the number of
buyers
Change in income
Change in the prices of related
goods
Change in consumer
Examples
Physical fitness rises in popularity, increasing
the demand for jogging shoes and bicycles;
cell phone popularity rises, reducing the
demand for land-line phones.
A decline in the birthrate reduces the demand
for childrens toys.
A rise in incomes increases the demand for
normal goods such as restaurant meals, sports
tickets, and necklaces while reducing the
demand for inferior goods such as cabbage,
turnips, and inexpensive wine.
A reduction in airfares reduces the demand for
bus transportation (substitute goods); a
decline in the price of DVD players increases
the demand for DVD movies (complementary
goods).
Inclement weather in South America creates 3-11
 Supply

Supply
Supply schedule or a supply
curve
Amount producers are willing and
able to sell at a given price
Individual supply
Market supply

LO 3-12
 Law of Supply

Law of supply
Other things equal, as the price rises,
the quantity supplied rises and as the
price falls, the quantity supplied falls
Explanation
Price acts as an incentive to
producers
At some point, costs will rise

LO 3-13
 The Supply Curve
P S1
5

Price (per bushel)

4
P Qs
$5 60 3

4 50
2
3 35
1
2 20
0
1 5
Q
10 20 30 40 50 60 70
Quantity supplied (bushels per week)

LO 3-14
 Changes in Supply
P
$6
S3 S1

5
Price (per bushel) Decrease
P Qs S2
in supply
$5 12,000
4
4 10,000
3
3 7000
2
2 4000
Increase
1 1000 1 in
supply
0 Q
2 4 6 8 10 12 14
Quantity supplied (thousands of bushels per we
LO 3-15
 Changes in Supply
P
$6 Change in
quantity suppliedS3 S1

5
Price (per bushel)

S2
4

1
Change in
supply
0
Q
2 4 6 8 10 12 14 16
Quantity supplied (thousands of bushels per week)
LO 3-16
 Determinants of Supply

Determinants of supply
A change in resource prices
A change in technology
A change in the number of sellers
A change in taxes and subsidies
A change in prices of other goods
A change in producer expectations

LO 3-17
 Determinants of Supply
Determinants of Supply: Factors That Shift the Supply Curve
Determinant
Change in resource prices
Change in technology
Change in taxes and subsidies
Change in prices of other goods
Change in producer expectations
Change in the number of suppliers
Examples
A decrease in the price of microchips increases the
supply of computers; an increase in the price of
crude oil reduces the supply of gasoline.
The development of more effective wireless
technology increases the supply of cell phones.
An increase in the excise tax on cigarettes reduces
the supply of cigarettes; a decline in subsidies to
state universities reduces the supply of higher
education.
An increase in the price of cucumbers decreases the
supply of watermelons.
An expectation of a substantial rise in future log
prices decreases the supply of logs today.
An increase in the number of tattoo parlors increases
the supply of tattoos; the formation of womens
professional basketball leagues increases the supply
of womens professional basketball games.
3-18
 Market Equilibrium

Equilibrium occurs where the

demand curve and supply curve
intersect
Equilibrium price and equilibrium
quantity
Surplus and shortage
Rationing function of prices
Efficient allocation
LO 3-19
 Efficient Allocation

Productive efficiency
Producing goods in the least costly way
Using the best technology
Using the right mix of resources
Allocative efficiency
Producing the right mix of goods
The combination of goods most highly
valued by society

LO 3-20
 Market Equilibrium

6,000 bushel S
5
Price (per bushel)

surplus
P Qd P Qs
$5 2000 4 $5 12,00
4 4000 4 0
3
3
3 7000 3 10,00
2 11,000 2 2 0
1 16,000 1 7000
1 7,000 bushel
shortage D 4000
0 1000
2 4 67 8 10 12 14 16 18

Bushels of corn (thousands per week)

LO 3-21
 Rationing Function of Prices

The ability of the competitive forces

of demand and supply to establish a
price at which selling and buying
decisions are consistent

LO 3-22
 Changes in Demand and
Equilibrium

D D
increase: decrease:
P, Q P, Q
P
P
S S

D2 D3

D1 D4

0 0

Increase in Decrease in
demand demand
LO 3-23
 Changes in Supply and
Equilibrium
S S
increase: decrease:
P, Q P, Q
P P
S1 S2 S4 S3

D
D

0 0

Increase in Decrease in
supply supply
LO 3-24
 Complex Cases
Effects of Changes in Both Supply and Demand
Effect on Effect on
Change in Change in Equilibrium Equilibrium
Supply Demand Price Quantity
1. Increase Decrease Decrease Indeterminate
2. Decrease Increase Increase Indeterminate
3. Increase Increase Indeterminate Increase
4. Decrease Decrease Indeterminate Decrease

LO 3-25
 Government Set Prices

Price ceiling
Set below equilibrium price
Rationing problem
Black markets
Example is rent control

LO 3-26
 Government Set Prices

P S

$3.5 P0 Ceilin
0 g
3.00 PC

D
Shorta
ge
Q
Qs Q0 Qd

LO 3-27
 Government Set Prices

Price floor
Prices are set above the market
price
Chronic surpluses
Example is the minimum wage law

LO 3-28
 Government Set Prices
P
S
Surplus
Floo
r
Pf
$3.0
0

2.00 P0

Q
Qd Q0 Qs
LO 3-29
 Legal Market for Human
Organs
What if we created a legal market for
human organs?
Positive effects
Increase the incentive to donate
Eliminate the persistent shortage
of eyes, livers, hearts, kidneys, etc.

3-30
 Legal Market for Human
Organs
Negative effects
Diminishes the special nature of
life by commercializing it
The market would leave out the
poor and uninsured
Increases the cost of medical care
Prohibition on market solution has
resulted in a $1 billion illegal market
3-31