Demand, Supply and Market Equilibrium

Demand
Demand means the willingness and ability to buy. Demand is the amount of a product that people are willing and able to purchase at each possible price during a given period of time. The quantity demand is the amount of a product that people are willing and able to purchase at one, specific price.

The Law of Demand

Law of demand there is an inverse relationship between price and quantity demanded (ceteris paribus).
Quantity demanded rises as price falls, other things constant. Quantity demanded falls as prices rise, other things constant. Why?

From a Demand Table to a Demand Curve

A Demand Table
Price per DVDs (in dollars) Price per DVD rentals cassette demanded per week $6.00 5.00 4.00 3.50 3.00 2.00 E D G C F B A 1 2 3 4 5 6 7 8 9 10 11 12 13 Quantity of DVDs demanded (per week) Demand for DVDs

A Demand Curve

A B C D E

$0.50 1.00 2.00 3.00 4.00

9 8 6 4 2

1.00 .50 0

Change in Quantity Demanded

Price (per unit)

$2

B Change in quantity demanded (a movement along the curve)

$1

D1 0 100 200 Quantity demanded (per unit of time)

Change in Demand

Price (per unit)

$2

Change in demand (a shift of the curve)

$1

A D0 D1

250 100 200 Quantity demanded (per unit of time)

Shift Factors of Demand

Income The prices of other goods Tastes Expectations Number of Buyers

Consumer Income
Normal Good
Price of Ice-Cream Cone

$3.00
2.50 2.00 1.50 1.00 0.50 Increase in demand

An increase in income...

D1
0 1 2 3 4 5 6 7 8 9 10 11 12

D2
Quantity of Ice-Cream Cones

Consumer Income
Inferior Good
Price of Ice-Cream Cone

$3.00
2.50 2.00 1.50 1.00 0.50 Decrease in demand

An increase in income...

D2
0 1

D1

2 3 4 5 6 7 8 9 10 11 12

Quantity of Ice-Cream Cones

Prices of Related Goods

Substitutes & Complements

When a fall in the price of one good reduces the demand for another good, the two goods are called substitutes. When a fall in the price of one good increases the demand for another good, the two goods are called complements.

Consumer Taste
If there is a change in taste in favor of a commodity, the demand for that commodity will increase and demand curve will shift to the right, and vice versa. A taste can be affected by advertisement - Informative Advertisement - Persuasive Advertisement

Expectation and Population

If consumer expect that prices will rise in future, the current demand will increase . The market demand for a product is also influenced by changes in the size and composition of the population. Other Factors - Weather - Health Scares

Individual and Market Demand Curves

A market demand curve is the horizontal sum of all individual demand curves.
This is determined by adding the individual demand curves of all the demanders.

From Individual Demands to a Market Demand Curve

Price per cassette (in dollars)

(1) (2) (3) Price per Alices Bruces cassette demand demand

(2) Cathys demand

(3) Market demand

$4.00 3.50 3.00 2.50 2.00 1.50 1.00 0.50 0

G F

A $0.50 B 1.00 C 1.50 D 2.00 E 2.50 F 3.00 G 3.50 H 4.00

9 8 7 6 5 4 3 2

6 5 4 3 2 1 0 0

1 1 0 0 0 0 0 0

16 14 11 9 7 5 3 2

E
D C B A
Cathy Bruce Alice Market demand

8 10 12 14 16

Quantity of cassettes demanded per week

Supply Quantity supplied is the amount of a good that sellers are willing and able to sell.

The Law of Supply

There is a direct relationship between price and quantity supplied (ceteris paribus).
Quantity supplied rises as price rises, other things constant. Quantity supplied falls as price falls, other things constant.

Supply Curve
Price of Ice-Cream Cone

$3.00
2.50 2.00 1.50 1.00 0.50
Quantity of Ice-Cream Cones

1 2 3 4 5 6 7 8 9 10 11 12

Shifts in Supply Versus Movements Along a Supply Curve Quantity supplied refers to a specific amount that will be supplied at a specific price. Changes in price causes changes in quantity supplied represented by a movement along a supply curve. A movement along a supply curve the graphic representation of the effect of a change in price on the quantity supplied.

Change in Quantity Supplied

Price of Ice-Cream Cone

S
C A rise in the price of ice cream cones results in a movement along the supply curve.

$3.00

1.00

Quantity of Ice-Cream Cones

Shifts in Supply Versus Movements Along a Supply Curve If the amount supplied is affected by anything other than a change in price, there will be a shift in supply. Shift in supply the graphic representation of the effect of a change in a factor other than price on supply

Change in Supply
Price of Ice-Cream Cone

S3
Decrease in Supply Increase in Supply

S1

S2

Quantity of Ice-Cream Cones

Shift Factors of Supply

Other factors besides price affect how much will be supplied:
Prices of Resources Prices of Other Goods Technology Suppliers expectations Government Regulations Number of Suppliers

From Individual Supplies to a Market Supply

(1) (2) (3) (4) (5) Quantities Price Ann's Barry's Charlie's Market Supplied (per DVD) Supply Supply Supply Supply A B C D E F G H I $0.00 0.50 1.00 1.50 2.00 2.50 3.00 3.50 4.00 0 1 2 3 4 5 6 7 8 0 0 1 2 3 4 5 5 5 0 0 0 0 0 0 0 2 2 0 1 3 5 7 9 11 14 15

From Individual Supplies to a Market Supply

$4.00 3.50
Price per DVD

Charlie

Barry

Ann

Market Supply H G F

3.00 2.50 2.00 1.50 1.00 0.50 0 A B D

E C
CA
Quantity of DVDs supplied (per week)

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16

Equilibrium
Equilibrium is a concept in which opposing dynamic forces cancel each other out. In a free market, the forces of supply and demand interact to determine equilibrium quantity and equilibrium price. When the market is not in equilibrium, you get either excess supply or excess demand, and a tendency for price to change.

Excess Supply, Excess Demand Excess supply a surplus, the quantity supplied is greater than quantity demanded Prices tend to fall. Excess demand a shortage, the quantity demanded is greater than quantity supplied Prices tend to rise.

Price Adjusts
The greater the difference between quantity supplied and quantity demanded, the more pressure there is for prices to rise or fall.

When quantity demanded equals quantity supplied, prices have no tendency to change.

The Interaction of Demand and Supply

Price (per DVD) $3.50 $2.50 $1.50

Quantity Supplied 7 5 3

Quantity Demanded 3 5 7

Surplus (+) Shortage (-) +4 0 -4

The Interaction of Demand and Supply

$5.00 4.00 Price per DVD 3.50 3.00 2.50 2.00 1.50 1.00 1 Excess demand A Excess supply

E
C

2 3 4 5 6 7 8 9 10 11 12 Quantity of DVDs supplied and demanded

Shifts in Supply and Demand

Shifts in either supply or demand change equilibrium price and quantity. An increase in demand creates excess demand at the original equilibrium price.

The excess demand pushes price upward until a new higher price and quantity are reached.

Increase in Demand

S0
B $2.50 2.25 D0 0 D1 A Excess demand

8 9 10 Quantity of DVDs (per week)

Decrease in Supply
A decrease in supply creates excess demand at the original equilibrium price. The excess demand pushes price upward until a new higher price and lower quantity are reached.

Decrease in Supply

S1
C $2.50 2.25 S0 Excess demand A D0 0 8 9 10 Quantity of DVDs (per week)

Price Ceiling

Price Floor

The Demand Function

A general equation representing the demand curve Qxd = f(Px , PY , M, H) Qxd = quantity demand of good X. Px = price of good X. PY = price of a related good Y. Substitute good. Complement good. M = income. Normal good. Inferior good. H = any other variable affecting demand.

Inverse Demand Function

Price as a function of quantity demanded. Example: Demand Function Qxd = 10 2Px Inverse Demand Function: 2Px = 10 Qxd Px = 5 0.5Qxd

The Supply Function

An equation representing the supply curve:

Qxs = f(Px , PR ,W, H,)

QxS = quantity supplied of good X. Px = price of good X. PR = price of a production substitute. W = price of inputs (e.g., wages). H = other variable affecting supply.

Inverse Supply Function

Price as a function of quantity supplied.

Example: Supply Function Qxs= -10 + 2Px

Inverse Supply Function: 2Px = 10 + Qxs Px = 5 + 0.5Qxs

Market Equilibrium
Demand Function Q = 10 2P Supply Function Q = -5 + 3P What is Equilibrium P and Q ?

Market Equilibrium
Demand Function Qd = 10 2P Supply Function Qs = -5 + 3P Equilibrium P and Q ? P = 3 and Q = 4