Theory of Supply and Demand

1. Theory of Supply and Demand

How does supply and demand
determine the price of a good and the
quantity sold in the market?
Used to help determine the role of
prices and in allocating resources in the
market economy
By: Cherpakov Michail Evgenevich

2. Demand

the desire to own something and the
ability to pay for it
Price changes always affect the quantity
demanded;
Law of Demand: When a good’s price is lower,
consumers will buy more of it and when the price is
higher people will buy less of it

3. Law of Demand

Other things equal, the quantity
demanded of a good falls when the
price of the good rises.
Quantity demanded is the amount of
the good that buyers are willing to
purchase

4. Types of markets

Market is a group of buyers and sellers of a
particular good or service
Buyers determine the demand for a product and
sellers determine the supply of the product
Competitive market is a market in which there
are many buyers and many sellers in the market
so that each has a negligible impact on the
market price

5. Types of Markets

Competitive markets
Goods being sold are all relatively the same
Sometimes there is better marketing or other factors that lead a
company to be more successful
Examples?
Monopoly is characterized by:
One seller and many buyers
Seller sets the price
One company controls market
Oligopoly is characterized by
Few sellers without rigorous competition (few sellers
control market)
The sellers get together to set a price (collusion)
Monopolistic competition is characterized by
Many sellers, each selling a differentiated product
Sellers have some ability to set the price for their own
product

6.

There are 2 behaviors economists look at to
study demand
Substitution Effect
Takes place when a consumer reacts to a rise in the
price of one good by consuming less of that good and
more of a substitute good
Example: What happens when an item becomes too
expensive for you to purchase? You look for something
else
Income Effect
The change in consumption that results when a price
increase causes real income to decline
Your income dictates what you can or can not buy
If the price of a good you normally buy drops then you now
have money to buy other things
If the price of something you buy goes up you either have to
adjust other things that you buy or not buy the item
Price will dictate how much of the item you will buy also

7. Demand Schedule

Demand Schedule
It is a table that lists the quantity of a good that a
person will purchase at various prices in the
market
Market Demand Schedule
Shows quantities demanded at various prices by
all consumers in the market
Used to predict how much of an item is needed to
sell to maximize profit and not create waste
Chart on page 71 figure 3.1

8.

Law of Demand with Pizza

9. Determinants of Demand

Determinants of quantity demanded:
Income (normal, inferior)
Prices of related goods (substitutes,
complements)
Tastes/preferences
Expectations
Number of buyers (Market demand curve)
Demand schedule and Demand curve
Demand schedule is a table that shows the
relationship between the price of a good and
the quantity demanded
Demand curve graphs the demand schedule.
The demand curve slopes downward

10. Market Versus Individual Demand

Market demand is the horizontal sum of
all individual demands for a particular
good or service
Market demand is derived from
individual demands and thus depends on
all those factors that determine individual
demand (income, expectations, etc)
In our case, market demand curve shows
the variations in the quantity demanded
of a good as price changes

11. Shifts Versus Movements Along the Demand Curve

Any change that varies the quantity that buyers
wish to buy at a given price shifts the demand
curve
Changes in price that varies the quantity that
buyers wish to buy is represented as a
movement along the demand curve
To summarize: Demand curve shows what
happens to the quantity demanded of a good
when its price varies, holding constant all other
determinants of quantity demanded. When one
of these determinants changes, the demand
curve shifts.

12. Application of law of Demand: Policy to Reduce Smoking

Raise prices of cigarettes by putting a
tax on them
Introduce a public awareness program
regarding ill effects of smoking
(effect?)
Other examples
Put a tax on soda to increase revenue
Deter people from buying it

13. SUPPLY

Quantity supplied of any good is the
amount that sellers are willing to
sell in the market
Determinants of supply:
Price
Input prices
Technology
Expectations
Number of sellers (Market supply
curve)

14. Law of Supply

Other things equal, the quantity
supplied of a good rises when the price
of the good rises.
Quantity supplied is positively related
to the price of the good
Supply schedule is a table that shows
the relationship between the price of a
good and the quantity supplied
Supply curve graphs the supply
schedule. It is upward sloping

15. Market Versus Individual Supply

Market supply is derived by horizontally
summing the individual supply curves
Market supply curve shows how the quantity
supplied varies as the price of the good
varies
Any change that varies the quantity supplied
at a given price shifts the supply curve
Changes in price that varies the quantity
supplied in the market is represented as a
movement along the supply curve

16. SUPPLY AND DEMAND

How do supply and demand combined
together determine the quantity and price
of a good sold in the market?
Supply and demand curves intersect. At this
equilibrium price quantity supplied equals
quantity demanded
Equilibrium is a situation in which supply
equals demand
Equilibrium price is also called as the
market clearing price as quantity supplied
equals quantity demanded

17. SUPPLY AND DEMAND

What happens when market price is
not equal to the equilibrium price?
Excess supply- surplus in the market
Excess demand- shortage in the market
Free markets reach equilibrium through
the interaction of buyers and sellers and
price is the tool through which the
market is cleared

18. LAW OF SUPPLY AND DEMAND

Other things remaining same, the price of
any good adjusts to bring the supply and
demand for that good into balance.
Shifts versus movements along curves
Change in quantity supplied and change in
quantity demanded is represented as a
movement along the fixed supply and demand
curves respectively
Change in supply and change in demand is
represented as shifts in supply and demand
curves respectively

19. Analyzing Changes in Equilibrium: Application

1. Change in demand- shifts in the
demand curve
2. Change in supply- shifts in the supply
curve
3. Changes in both supply and demandChange in equilibrium quantity and
price
A simple application

20. Analyzing Changes in Equilibrium: Summary

DEMAND/
SUPPLY
No change in
demand
No change in Increase in
Supply
supply
Decrease in
supply
Increase in
demand
P same
Q same
P up
Q up
P up
Q down
P up
Q ambiguous
Decrease in
demand
P down
Q down
P down
Q up
P
ambiguous
Q up
P down
Q
ambiguous
P ambiguous
Q down

21. How Prices allocate Resources

Prices act as signals that guide the
allocation of scarce resources in a
market economy
Prices in turn are determined by forces
of supply and demand