Lecture 1: Introduction to Supply,

Demand, Equilibrium, and Exchange

Tina Kao
Econ7073
Welcome to Econ7073
• Structure of the class this semester
– Lectures: pre-recorded and will be available
through Wattle
– one hour tutorial per week. Face to face/zoom
– one additional workshop/tutorial/drop in
session on Wednesday 2 -3 pm in Copland
lecture theatre.
• Please see instruction on Wattle site for
tutorial signup.

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Main references
• Principles of microeconomics. By Joshua Gans,
Stephen King, Martin Byford, and N. Gregory
Mankiw. 7th Asia-Pacific edition. Published by
Cengage Learning.
• Landsburg, Steven E. (2014). Price theory and
applications. Ninth edition. Published by
Cengage Learning.
• Varian, H. (2019) Intermediate Microeconomics
A modern approach. 9th edition, W. W. Norton.

3
 Assessment
• Mid-semester exam: 30% or 0% (week 6 or 7 TBC)
• 2 Quizzes/problem sets 10% or 0%.
– Due in week 4 and week 10.
• Final exam: min 60%, max 100%
• Both mid-semester exam and quizzes are optional and
fully redeemable against the final exam.
• Scaling, if applicable, will be order preserving,
and may go up or down

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Assessment example
• Alice got 75 in the mid term, 80 in quiz 1 and 60
in quiz 2. The mark for the quiz category is 70.
• If her final exam mark x is greater than 75, the
course mark will be equal to the final exam
mark.
• If 70<x<75, the final grade would be 30% mid
term + 70% final.
• If x < 70, the final grade would be 30% midterm
+ 10% quiz +60% final.

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Roadmap
• Preliminaries: supply, • Game theory
demand, equilibrium, – Strategic games,
gains from trade sequential games,
• Consumers: optimal oligopoly
choice, market • Welfare economics,
• Producers externality
– Profit, cost, perfect • Risk and uncertainty
competition, • Information
monopoly economics

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Supply, Demand, and Equilibrium

Reading: Gans et al. Chapter 4

Landsburg Chapter 1
Introduction
• The demand curve and the supply curve in
markets and the market equilibrium.
– Exogenous shocks and change in D, S and
equilibrium. [This week]
• Behind D: Consumers’ consumption
decision – utility maximisation
• Behind S: Producers’ supply decision –
profit maximisation.

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Demand
• Demand schedule lists the quantity demanded
corresponding to each (own) price.
• A change in price leads to a change in quantity
demanded.
• Demand curves plots the relationship between
quantity demanded for a good and the price of
the good
– For most goods, as price goes up, the
quantity demanded goes down, negatively
sloped

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Catherine’s demand schedule
Price of an Quantity of ice-
ice-cream creams
demanded
$0.00 12
0.50 10
1.00 8
1.50 6
2.00 4
2.50 2
3.0 0
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Demand curve
• Demand curve shows the relationship
between quantity demand for a good and
the good’s own price
• In drawing the demand curve, we hold all
other things equal.
– Prices of other goods, taste, income

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Catherine’s demand curve
Price of
ice-cream cone Price of an Quantity of ice-
$3.00 ice-cream creams
demanded
$0.00 12
2.50
0.50 10
1. A decrease 1.00 8
2.00
in price ... 1.50 6
2.00 4
1.50
2.50 2
3.0 0
1.00

0.50

0 1 2 3 4 5 6 7 8 9 10 11 12 Quantity of
ice-cream cones
2. ... increases quantity
of cones demanded.
Copyright © 2004 South-Western 12
Catherine’s demand curve –
continuous case
Price of
ice-cream cone Inverse demand curve:
$3.00 P=3–¼Q

2.50

1. A decrease
2.00
in price ...

1.50

1.00

0.50

0 1 2 3 4 5 6 7 8 9 10 11 12 Quantity of
ice-cream cones
2. ... increases quantity
of cones demanded.
13
 Market demand
• Aggregate all individual demand into
market demand
– In a more general setup, this would include
demand for intermediate input as well
• Shows the relationship between price and
quantity demanded in the market
• Horizontal summation of the individual
demand
– Given price, sum up the quantity demanded
by each individual
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 Individual demand

<Insert Figure 4.2 from Gans 5/e pg 70>

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 Market demand

<insert unlabelled market demand graph from

p71>

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Movement along the demand curve
and shifts of the demand curve

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 Movements along the
demand curve
• Change in quantity demanded
– Movement along the demand curve.
– Caused by a change in the price of the
product.

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Shifts in the demand curve
• Change in demand curve
– A shift in the demand curve, either to the
left or right.
– Caused by any change that alters the
quantity demanded at every price.

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 Shifts in the demand curve
Price of
ice-cream
cone

Increase
in demand

Decrease
in demand
Demand
curve, D2
Demand
curve, D1
Demand curve, D3
0 Quantity of
ice-cream cones
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Shifts in the demand curve
 Consumer income
 Prices of related goods
 Tastes
 Number of buyers

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Shifts in the demand curve –
income Suppose income
increases

Demand for Demand for

good rises good falls

Good is Good is
normal inferior

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 Normal goods

Goods whose market demand rises as income rises

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Inferior goods

<Insert shutterstock Image ID: 70432729 >

Depends on personal taste. Instant noodles may be inferior

goods for some people.
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Shifts in the demand curve
• Prices of related goods
– 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.

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SUBSTITUTES

<insert shutterstock Image

ID: 56242480 >

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complements

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Shifts in the demand curve –
tastes
• consumer’s preferences for goods and
services.
• Economists typically do not try to explain
tastes, but do consider what happens
when tastes change (for example, due to
advertising campaigns)
29
Supply
• Quantity supplied is the amount of a good that
the supplier will provide at a given price.
• Quantity supplied typically goes up when price
goes up
• Plots the relationship between quantity and own
price and hold all other things constant
– Input prices, technology
• Movement along the supply curve versus shifts
of the supply curve

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 supply schedule and
curve
Supply schedule Supply curve
(Discrete) (Continuous)

Table showing Graph showing

relationship between relationship between
the price of a good the price of a good
and the quantity and the quantity
supplied. supplied.

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 Tony’s supply schedule
Price of an ice- Quantity of ice-creams
cream supplied
$0.00 0
0.50 0
1.00 1
1.50 2
2.00 3
2.50 4
3.00 5

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 Tony’s supply curve
Price of
Ice-Cream
Cone
$3.00 Price of Quantity of
an ice- ice-creams
2.50 cream supplied
1. An $0.00 0
increase
2.00 0.50 0
in price ...
1.00 1

1.50 1.50 2
2.00 3
1.00 2.50 4
3.00 5
0.50

0 1 2 3 4 5 6 7 8 9 10 11 12 Quantity of
Ice-Cream Cones
2. ... increases quantity of cones supplied.
33
Copyright©2003 Southwestern/Thomson Learning
 Tony’s supply curve –
Price of
continuous case
Ice-Cream
Cone
$3.00 Inverse supply:
P = 0.5+ 0.5Q
2.50
1. An
increase
in price ... 2.00

1.50

1.00

0.50

0 1 2 3 4 5 6 7 8 9 10 11 12 Quantity of
Ice-Cream Cones
2. ... increases quantity of cones supplied.
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Copyright©2003 Southwestern/Thomson Learning
 Market supply versus
individual supply
• Market supply refers to the sum of all
individual supplies for all sellers of a
particular good or service.
• Graphically, individual supply curves are
summed horizontally to obtain the market
supply curve.

35
 Movements along the supply
curve
• Change in quantity supplied
– In response to own price changes.

36
 Shifts in the supply curve
• Change in supply
– A shift in the supply curve, either to the left or
right.
– Caused by a change in a determinant other
than its own price.
– A change in the good’s price represents a
movement along the supply curve, whereas a
change in one of the other variables shifts the
supply curve.

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 Shifts in the supply curve
Price of
ice-cream Supply curve, S3
Supply
cone
curve, S1
Supply
Decrease curve, S2
in supply

Increase
in supply

0 Quantity of
ice-cream cones
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Shifts in the supply curve
• Input prices
• Technology
• Number of sellers

39
40
Equilibrium
• Quantity demanded equals quantity supplied.
• Intersection of the market demand curve and the
market supply curve.
• A competitive market is a market in which there
are many buyers and sellers so that each has a
negligible impact on the market price.
• In equilibrium, all agents are doing as well as
they can given the market price.

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 Supply and demand
together
Demand schedule Supply schedule

At $2.00, the quantity demanded

is equal to the quantity supplied!
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 The equilibrium of supply and
Price of
demand
ice-cream
cone Supply

Equilibrium price Equilibrium

$2.00

Equilibrium Demand
quantity

0 1 2 3 4 5 6 7 8 9 10 11 12 13
Quantity of ice-cream cones
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Equilibrium
• Surplus
– When market price > equilibrium price, then
quantity supplied > quantity demanded.
• There is excess supply or a surplus.
• Suppliers will lower the price to increase sales,
thereby moving toward equilibrium.

44
 Markets not in equilibrium
(a) Excess supply
Price of
ice-cream Supply
cone Surplus
$2.50

2.00

Demand

0 4 7 10 Quantity of
Quantity Quantity ice-cream
demanded supplied cones

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Equilibrium
• Shortage
– When market price < equilibrium price, then
quantity demanded > the quantity supplied.
• There is excess demand or a shortage.
• Suppliers will raise the price due to too many
buyers chasing too few goods, thereby moving
toward equilibrium.

46
 Markets not in equilibrium
(b) Excess demand
Price of
ice-cream Supply
cone

$2.00

1.50
Shortage

Demand

0 4 7 10 Quantity of
Quantity Quantity ice-cream
supplied demanded cones

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Changes in the Equilibrium Point
• Equilibrium is affected by a shift in the
supply curve, the demand curve, or both.

48
 Three steps to analysing
changes in equilibrium
• Decide whether the event shifts the supply
or demand curve (or both).
• Decide whether the curve(s) shift(s) to the
left or to the right.
• Use the supply-and-demand diagram to
see how the shift affects equilibrium price
and quantity.

49
 An increase in demand
Price of
ice-cream 1. Hot weather increases
cone the demand for ice cream ...

Supply

$2.50 New equilibrium

2.00
2 ... resulting
Initial
in a higher equilibrium
price ...
D

0 7 10 Quantity of
3 ... and a higher ice-cream cones
quantity sold.
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Copyright©2003 Southwestern/Thomson Learning
 A decrease in supply
Price of
ice-cream 1. An increase in the
cone price of sugar reduces
the supply of ice cream ...
S2
S1

New
$2.50 equilibrium

2.00 Initial equilibrium

2. ... resulting
in a higher
price of ice
cream ... Demand

0 4 7 Quantity of
3. ... and a lower ice-cream cones
quantity sold.
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A decrease in supply and
increase in demand

<Insert Figure 4.12 from Gans 5/e pg 86>

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Summary
• Demand curve, movement along the curve
and shifts of the curve, individual demand
to market demand
– Substitutes and complements, normal goods
and inferior goods.
• Supply curve, movement along the curve
and shifts of the curve, individual supply to
market supply
• Equilibrium, change of equilibrium.

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Gains from Trade
Reading: Gans et al, Chapter 3.
Landsburg, Chapter 2.

Tina Kao
Econ7073
Source: RBA discussion paper, 2004-11
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Gains from Trade
• A person has an absolute advantage if that
person is more productive than others.
• A person has a comparative advantage in an
activity if that person can perform the activity at
a lower opportunity cost than anyone else.
– Opportunity cost: the best forgone opportunity
• Absolute advantage involves comparing
productivities while comparative advantage
involves comparing opportunity costs.

56
Imagine an economy with

57
 The PPF and CPF
• The production possibilities frontier (PPF)
gives the combinations of output that an
individual/economy can possibly produce
given
– the available factors of production; and
– the available production technology.
• The consumption possibility frontier (CPF)
gives the combination of goods that an
individual / economy can possibly
consume
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 The production technologies of
Cameron and Mitchell
Hours needed to Amount produced
make: in 12 hours:
1 meal 1 basket Meals Baskets

Cameron 2 4 6 3
Mitchell 1/2 3 24 4

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 The production opportunities
of Cameron and Mitchell

Cameron: 2 hours for one meal Mitchell: 0.5 hr for one meal and
and 4 hours for 1 laundry 3 hours for 1 laundry
Slope = -2. One laundry requires Slope = - 6. One laundry requires
4 hours which can be used to 3 hours which can be used to
produce 2 meals. product 6 meals.
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 Self-Sufficiency (Autarky)
• The production possibilities frontier is also
the consumption possibilities frontier.

61
 Absolute advantage
The producer that requires a smaller quantity
of inputs to produce a good is said to have an
absolute advantage in producing that good

Mitchell has an • Mitchell needs 3 hours to do

absolute a basket of laundry
advantage with
laundry • Cameron needs 4 hours.

Mitchell has an • Mitchell needs ½ hour to

absolute produce a meal
advantage with
meals • Cameron needs 2 hours

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Meals

24

PPF Mitchell

PPF
Cameron

3 4
Laundry

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 Comparative advantage
The producer that requires a smaller opportunity
cost of producing a good is said to have a
comparative advantage in producing that good

Mitchell has a • Mitchell’s opportunity cost of a

comparative meal is 1/6 of a basket of laundry
advantage • Cameron’s opportunity cost of a
with meals meal is ½ of a basket of laundry.

Cameron has • Cameron’s opportunity cost of a

a comparative basket of laundry is 2 meals
advantage • Mitchell’s opportunity cost of a
with laundry basket is 6 meals.

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Meals For Mitchell:
The opportunity cost of 1 laundry
is 6 meals.
Increasing laundry by 1
24 The O.C. of 1 meal is 1/6 laundry

Requires decreasing meals by 6

6 Slope = 24/4 = 6
PPF Mitchell

PPF
Cameron

3 4
Laundry
For Cameron:
The opportunity cost of 1 laundry
is 2 meals.
The O.C. of 1 meal is 1/2 laundry
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 1 meal 1 basket
Cameron 2 4
The gains from trade: Mitchell 1/2 3
An example
Production Gains
and from
consumption Production Trade Consumption trade
(No trade) (with trade) (with trade)
Cameron 4 meals 0 meals gets 5 5 meals 1 meal
meals

1 basket 3 baskets for 11⁄2 11⁄2 baskets 1⁄2 basket

baskets

Mitchell 12 meals 18 meals gives 5 13 meals 1 meal

meals

2 baskets 1 basket for 11⁄2 21⁄2 baskets 1⁄2 basket

baskets

66
The gains from trade: An example

67
 Comparative advantage and trade

• Comparative advantage and differences in

opportunity costs are the basis for
specialised production and trade.

68
 Constructing the PPF for the
economy
• How do we go from individuals’ PPFs to
the economy’s PPF?
• Defn of PPF
• Resources
• Technology

69
Meals Looking at Laundry production from 0 to 3. The most efficient way is to
make the person with least O.C to produce laundry first: Cameron. PPF
follows the shape of Cameron’s PPF

Mitchell completely specialises in

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mean and Cameron completely
specialises in laundry

24 After Cameron has completely specialised

in in laundry, to produce more laundry,
Mitchell needs to give up some meal
PPF Mitchell
making. The PPF follows the shape of
Mitchell’s PPF.

6 Both Cameron and Mitchell

devote all time to laundry

PPF
Cameron

3 4
7 Laundry

70
How about consumption points?

71
PPF when there are many individuals
in this economy?
Imagine many individuals producing
cola and pizza.

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 Increasing Opportunity Cost
Because resources
are not equally
productive in all
activities, the typical
PPF bows outward.
The outward bow of

the PPF means that

as the quantity
produced of each
good increases, so
does its opportunity
cost.
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 Using Resources Efficiently

As we move along

the PPF, the
opportunity cost of a
pizza increases.

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 Summary
• Absolute advantage
– lies with the person who can produce a good with
the least quantity of inputs.
• Comparative advantage
– lies with the person who can produce a good with
the smaller opportunity cost.

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Summary
• The gains from trade are based on
comparative advantage, not absolute
advantage.
• Trade makes everyone better off because
– people specialise in those activities in which they
have a comparative advantage.
• Constructing the economy’s PPF from
individuals’ PPFs
• The principle of comparative advantage
applies to countries as well as individuals.
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