The Market Forces of Supply and Demand
Some important questions
• What factors affect buyers’ demand for goods?
• What factors affect sellers’ supply of goods?
• How do supply and demand determine the price of a good and the
quantity sold?
• How do changes in the factors that affect demand or supply affect
the market price and quantity of a good?
• How do markets allocate resources?
Markets and Competition
Market
– A group of buyers and sellers of a particular good or service.
– Buyers as a group
• Determine the demand for the product
– Sellers as a group
• Determine the supply of the product
Markets and Competition
• Competitive market
– Many buyers and many sellers, each has a negligible impact on
market price
• Perfectly competitive market
– All goods are exactly the same.
– Price takers: so many buyers and sellers that no one can affect
the market price.
– At the market price, buyers can buy all they want, and sellers
can sell all they want.
Demand
• Quantity demanded
– Amount of a good that buyers are willing and able to purchase
• Law of demand
– Other things equal
– When the price of a good rises, the quantity demanded of the
good falls
– When the price falls, the quantity demanded rises
Demand Schedule and Demand Curve
• Demand schedule:
− A table that shows the relationship between the price of a good
and the quantity demanded
• Demand curve
− A graph of the relationship between the price of a good and
the quantity demanded
EXAMPLE : Sofia’s demand for muffins
Sofia’s demand schedule for Price Quantity
of muffins of muffins demanded
muffins 0.00 16
1.00 14
− Notice that Sofia’s 2.00 12
preferences obey the law of 3.00 10
demand. 4.00 8
5.00 6
6.00 4
Quantity
Price of Price
of muffins
Muffins of muffins
demanded
$6.00
0.00 16
$5.00 1.00 14
$4.00 2.00 12
A decrease 3.00 10
$3.00
in price… 4.00 8
$2.00 5.00 6
$1.00 6.00 4
$0.00
Quantity of
0 5 10 15 Muffins
… increases the quantity of muffins demanded.
Market Demand
• Market demand
– Sum of all individual demands for a good or service
– Market demand curve: sum the individual demand curves
horizontally
• To find the total quantity demanded at any price, we add the
individual quantities
EXAMPLE : Market vs. individual demand
Suppose Sofia and Diego are the only two buyers in the
market for muffins. (Qd = quantity demanded)
Price Sofia’s Qd Diego’s Qd Market Qd
$0.00 16 + 8 = 24
1.00 14 + 7 = 21
2.00 12 + 6 = 18
3.00 10 + 5 = 15
4.00 8 + 4 = 12
5.00 6 + 3 = 9
6.00 4 + 2 = 6
EXAMPLE : Market demand curve for muffins
P
Qd
$6.00 P
(Market)
$5.00 $0.00 24
A movement 1.00 21
$4.00 along the
An increase demand curve 2.00 18
$3.00 in price…
3.00 15
$2.00 4.00 12
$1.00 5.00 9
6.00 6
$0.00
Q
0 5 10 15 20 25
… decreases the quantity of muffins demanded.
Shift vs. Movement Along Curve
• Change in demand:
– A shift in the demand curve
– Occurs when a non-price determinant of demand changes (like income or
number of buyers)
• Change in the quantity demanded:
– A movement along a fixed demand curve
– Occurs when the price changes
Demand Curve Shifters – 1
• The demand curve
– Shows how price affects quantity demanded, other
things being equal
• These “other things” are non-price determinants
of demand
– Things that determine buyers’ demand for a good,
other than the good’s price
• Changes in them shift the D curve
Demand Curve Shifters – 2
Shifts in the demand curve are caused by changes in:
– Number of buyers
– Income
– Prices of related goods
– Tastes
– Expectations
Changes in Number of Buyers
• Increase in number of buyers
– Increases the quantity demanded at each price
– Shifts the demand curve to the right
• Decrease in number of buyers
– Decreases the quantity demanded at each price
– Shifts the demand curve to the left
Changes in Income
• Normal good, other things constant
– An increase in income leads to an increase in demand
– Shifts the demand curve to the right
• Inferior good, other things constant
– An increase in income leads to a decrease in demand
– Shifts the demand curve to the left
Changes in Prices of Related Goods – 1
• Two goods are substitutes if:
– An increase in the price of one leads to an increase in the
demand for the other
• Example: pizza and hamburgers
– An increase in the price of pizza increases demand for
hamburgers, shifting hamburger demand curve to the right
• Other examples:
– Coke and Pepsi, laptops and tablets, movie streaming and
movie theater
Changes in Prices of Related Goods – 2
• Two goods are complements if:
– An increase in the price of one leads to a decrease in the
demand for the other
• Example: smartphones and apps
– If price of smartphones rises, people buy fewer smartphones,
and therefore fewer apps; App demand curve shifts to the left
• Other examples:
– College tuition and textbooks, bagels and cream cheese, milk
and cookies
Changes in Tastes & Expectations
Tastes
• Anything that causes a shift in tastes toward a good will increase demand for that
good and shift its demand curve to the right. Example: Increased demand for N95
masks, sanitizers, during pandemic due to its use in protection from the virus.
Expectations about the future
• People expect an increase in income: The current demand increases. . Example: If people
expect their incomes to rise (because they got a promotion at work), their demand for
meals at expensive restaurants may increase now
• People expect higher prices: The current demand increases
Summary: variables that influence buyers
Supply
• Quantity supplied
– Amount of a good
– Sellers are willing and able to sell
• Law of supply
– Other things equal
– When the price of a good rises, the quantity supplied of the
good rises
– When the price falls, the quantity supplied falls
Supply Schedule and Supply Curve
• Supply schedule:
− A table that shows the relationship between the price of a good
and the quantity supplied
• Supply curve
− A graph of the relationship between the price of a good and
the quantity supplied
EXAMPLE : Chaayos’ supply of muffins
Chaayos’ supply schedule of muffins Quantity
Price
of samosas
of samosas
− Notice that Chaayos’ supply supplied
schedule obeys the law of supply Rs. 0.00 0
1.00 3
2.00 6
3.00 9
4.00 12
5.00 15
6.00 18
EXAMPLE: Chaayos’ supply schedule and
supply curve
P Price Quantity
of of samosas
$6.00
samosas supplied
$5.00 $0.00 0
$4.00 1.00 3
2.00 6
$3.00
3.00 9
$2.00 4.00 12
$1.00 5.00 15
$0.00 6.00 18
Q
0 5 10 15
Market Supply vs. Individual Supply
• Market supply
– Sum of the supplies of all sellers of a good or service
– Market supply curve: sum of individual supply curves
horizontally
• To find the total quantity supplied at any price, we add the
individual quantities
EXAMPLE : Market vs. individual supply
Suppose Chaayos and Costa are the only two sellers in
this market. (Qs = quantity supplied)
Qs Qs
Price Chaayos Costa Market Qs
0.00 0 + 0 = 0
1.00 3 + 2 = 5
2.00 6 + 4 = 10
3.00 9 + 6 = 15
4.00 12 + 8 = 20
5.00 15 + 10 = 25
6.00 18 + 12 = 30
EXAMPLE : Market supply curve of muffins
P QS
P
$6.00 (Market)
$5.00 0.00 0
An increase 1.00 5
$4.00 in price… A movement
along the supply
2.00 10
$3.00 curve 3.00 15
$2.00 4.00 20
5.00 25
$1.00
6.00 30
$0.00
0 5 10 15 20 25 30 35 Q
… increases the quantity of muffins supplied.
Supply Curve Shifters – 1
• The supply curve
– Shows how price affects quantity supplied, other
things being equal
• These “other things”
– Are non-price determinants of supply
• Changes in them shift the S curve…
Supply Curve Shifters – 2
Shifts in the supply curve are caused by changes in:
– Input prices
– Technology
– Number of sellers
– Expectations about the future
Changes in Input Prices
• Examples of input prices
– Wages, prices of raw materials
• A fall in input prices
– Makes production more profitable at each output
price
– Firms supply a larger quantity at each price: the supply
curve shifts to the right
– Supply is negatively related to prices of inputs
EXAMPLE : Changes in input prices
P Suppose the price of
$6.00 oranges falls.
• At each price, the
$5.00
quantity of orange
$4.00 juice supplied will
increase (by 5 in
$3.00
this example).
$2.00 • The supply curve
$1.00 shifts to the right
$0.00
Q
0 5 10 15 20 25 30 35
Changes in Technology
• Technology
– Determines how much inputs are required to produce a unit of
output
• A cost-saving technological improvement
– Has the same effect as a fall in input prices
– Shifts the supply curve to the right
Changes in Number of Sellers
• An increase in the number of sellers
– Increases the quantity supplied at each price
– Shifts the supply curve to the right
• A decrease in the number of sellers
– Decreases the quantity supplied at each price
– Shifts the supply curve to the left
Expectations about Future
Sellers may adjust supply when their expectations of future prices
change
Example: Events in the Russian region led to expectations of higher
oil prices
– Owners of oil fields reduce supply now, save some inventory to
sell later at the higher price
– The supply curve shifts left
Shift vs. Movement Along the Supply
• Change in supply:
– A shift in the supply curve
– Occurs when a non-price determinant of supply changes (like
technology or costs)
• Change in the quantity supplied:
– A movement along a fixed supply curve
– Occurs when the price changes
Summary: variables that influence sellers
What is an equilibrium?
Supply and demand together
Equilibrium price: price where QS = QD = equilibrium Q
P D
S
$6.00 P QD QS
$5.00 $0 24 0
$4.00 1 21 5
2 18 10
$3.00
3 15 15
$2.00 4 12 20
$1.00 5 9 25
6 6 30
$0.00
Q
0 5 10 15 20 25 30 35
How do we reach an equilibrium?
Markets not in equilibrium: surplus
P
D S
$6.00 Surplus
$5.00
Surplus (excess supply):
$4.00
quantity supplied is
$3.00 greater than quantity
$2.00 demanded
$1.00
$0.00
Q
0 5 10 15 20 25 30 35
Markets not in equilibrium: surplus
P Facing a surplus, sellers
D S try to increase sales by
$6.00 Surplus cutting the price:
$5.00 – This causes QD to
rise
$4.00
– and QS to fall…
$3.00 – …which reduces
$2.00 the surplus.
– And so on… until
$1.00 market reaches
$0.00 equilibrium.
Q
0 5 10 15 20 25 30 35
Markets not in equilibrium: shortage
Shortage (excess demand):
P quantity demanded is greater
D S
$6.00 than quantity supplied
$5.00 If P = $1,
- then QD = 21 muffins
$4.00
- and QS = 5 muffins
$3.00 - Resulting in a shortage
of 16 muffins
$2.00
$1.00
$0.00 Shortage
Q
0 5 10 15 20 25 30 35
Supply and Demand Together
Three steps to analyzing changes in equilibrium:
1. Decide whether the event shifts the supply curve, the demand curve, or, in
some cases, both curves
2. Decide whether the curve(s) shifts to the right or to the left
3. Use the supply-and-demand diagram
• Compare the initial and the new equilibrium
• Effects on equilibrium price and quantity
EXAMPLE 3: The market for muffins
P
price of
S1
muffins
Market
P1 equilibrium
D1
Q
Q1
quantity of
muffins
EXAMPLE 3A: A shift in demand
EVENT A: Increase in the price of doughnuts.
P
STEP 1: D curve shifts
• muffins and doughnuts S1
are substitutes. P2
STEP 2: D shifts right
• Consumers will buy
fewer expensive doughnuts P1
and switch to muffins.
STEP 3: Increase in price
and quantity of muffins. D1 D2
Q
Q1 Q 2
EXAMPLE 3B: A shift in supply
EVENT B: New technology of producing muffins.
EXAMPLE 3C: A shift in both S and D
EVENTS: Price of doughnuts rises AND new technology
reduces production costs.
Shifts in supply and demand
Use the three-step method to analyze the effects of each
event on the equilibrium price and quantity of orange juice.
Event A: A fall in the price of apple juice
Event B: The price of oranges declines
because of an abundant orange crop.
Event C: Events A and B both occur
simultaneously.
How Prices Allocate Resources
“Markets are usually a good way to organize economic activity”
• In market economies, prices adjust to balance
supply and demand
• These equilibrium prices act as signals that guide
economic decisions and thereby allocate scarce
resources
