Economics for Decision Makers

(Managerial Economics)
 Supply
• The quantity supplied of any good is the
amount that sellers are willing and able to sell.
• Law of supply: the claim that the quantity
supplied of a good rises when the price of the
good rises, other things equal

2
• A supply curve generally slopes upward,
indicating a positive or direct relationship
between the price of the product and the
quantity producers are willing to supply.

• A higher price typically gives producers an

incentive to increase the quantity supplied of
a particular product because higher
production is more profitable.
• Among the factors influencing the quantity
supplied of a product, the price of the product
itself is often the most important.
• Higher prices increase the quantity of output
producers want to bring to market.
• Higher prices allow firms to pay the higher
production costs that are sometimes associated
with expansions in output.
• Conversely, lower prices typically cause
producers to reduce the quantity supplied. At
the margin, lower prices can have the effect of
making previous levels of production
unprofitable.
 The Supply Schedule
Price Quantity
• Supply schedule:
of of lattes
A table that shows the lattes supplied
relationship between the
$0.00 0
price of a good and the
1.00 3
quantity supplied.
2.00 6
• Example: 3.00 9
Starbucks’ supply of lattes. 4.00 12
5.00 15
 Notice that Starbucks’ supply
6.00 18
schedule obeys the
Law of Supply.
6
 Starbucks’ Supply Schedule & Curve
Price Quantity
P of of lattes
$6.00 lattes supplied
$0.00 0
$5.00
1.00 3
$4.00
2.00 6
$3.00 3.00 9
$2.00 4.00 12
5.00 15
$1.00
6.00 18
$0.00 Q
0 5 10 15
7
 Market Supply versus Individual Supply
• The quantity supplied in the market is the sum of
the quantities supplied by all sellers at each price.
• Suppose Starbucks and Jitters are the only two sellers in
this market. (Qs = quantity supplied)
Price Starbucks Jitters 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 8
 The Market Supply Curve
QS
P
(Market)
P
$6.00 $0.00 0
1.00 5
$5.00
2.00 10
$4.00 3.00 15
$3.00 4.00 20
$2.00 5.00 25
6.00 30
$1.00

$0.00 Q
0 5 10 15 20 25 30 35
9
 Supply Curve Shifters
• 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

10
Supply Curve Shifters: Input Prices

• Examples of input prices:

wages, prices of raw materials.
• A fall in input prices makes production
more profitable at each output price,
so firms supply a larger quantity at each price,
and the S curve shifts to the right.

12
• A decrease in the price of any of the inputs of
production, which lowers the costs of
production and causes the supply curve to shift
to the right.

• Any increase in the price of inputs increases

the costs of production and causes the supply
curve of the product to shift to the left.
Supply Curve Shifters: Input Prices

P Suppose the
$6.00 price of milk falls.
At each price,
$5.00
the quantity of
$4.00 Lattes supplied
will increase
$3.00
(by 5 in this
$2.00 example).
$1.00

$0.00 Q
0 5 10 15 20 25 30 35
14
Supply Curve Shifters: Technology and
Government Regulations
• Technology is the state of knowledge concerning
how to combine resources to produce goods and
services.

• An improvement in technology generally results

in one or more of the inputs used in making the
good to be more productive. Increased
productivity allows firms to make more of a good
or service with the same amount of inputs or the
same output with fewer inputs.
• 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,
which shifts S curve to the right.
• Developing new technology typically causes
an increase in supply, or a rightward shift of
the supply curve, because technology changes
usually lower the costs of production.

16
• The cost of producing a given level of output falls
when firms use better technology, which would
lower the costs of production, increase profit,
and increase the supply of the good to the
market, all other things remaining the same.
Supply Curve Shifters: Number of Sellers or
Number of Firms
• An increase in the number of sellers or firms,
increases the quantity supplied at each price,
shifts S curve to the right.

• If the number of firms in the industry

increases or if the productive capacity of
existing firms increases, more of the good or
service will be supplied at each price.

20
• For example, the supply of air travel between
New York and Hong Kong increases when either
more airlines begin servicing this route or when
the firms currently servicing the route increase
their capacities to fly passengers by adding more
jets to service their New York–Hong Kong route.

• Conversely, a decrease in the number of firms in

the industry or a decrease in the productive
capacity of existing firms decreases the supply
of the good, all other things remaining constant.
• As another example, suppose a freeze in Florida
decreases the number of firms by destroying
entirely some citrus growers. Alternatively, it
might leave the number of growers unchanged
but decrease productive capacity by killing a
portion of each grower’s trees. In either
situation, the supply of fruit decreases. Thus
changes in the number of firms in the industry
or changes in the amount of productive capacity
shifts the whole S curve.
• An increase in the number of producers results
in a rightward shift of the supply curve, while a
decrease results in a leftward shift of the supply
curve.

• A given supply curve shows how prices induce

the current number of producers to change the
quantity supplied. Any change in the number of
producers in the market is represented by a shift
of the entire curve.
Supply Curve Shifters: Prices of Related Goods
• Changes in the prices of goods that are related
in production may affect producers in either
one of two ways, depending on whether the
goods are substitutes or complements in
production.

• Two goods, X and Y, are substitutes in

production if an increase in the price of good X
relative to good Y causes producers to increase
production of good X and decrease production
of good Y.
24
Substitutes
• For example, if the price of corn increases while
the price of wheat remains the same, some
farmers may change from growing wheat to
growing corn, and less wheat will be supplied.
In the case of manufactured goods, firms can
switch resources from the production of one
good to the production of a substitute (in
production) commodity when the price of the
substitute rises.

25
Complements
• Alternatively, two goods, X and Y, are complements in
production if an increase in the price of good X causes
producers to supply more of good Y.

• For example, crude oil and natural gas often occur in

the same oil field, making natural gas a by-product of
producing crude oil, or vice versa. If the price of crude
oil rises, petroleum firms produce more oil, so the
output of natural gas also increases.

• Other examples of complements in production include

nickel and copper (which occur in the same deposit),
beef and leather hides, and bacon and pork chops.
Supply Curve Shifters: Expectations

• A firm’s decision about its level of production

depends not only on the current price of the
good but also upon the firm’s expectation
about the future price of the good.

• If firms expect the price of a good they produce

to rise in the future, they may withhold some
of the good, thereby reducing supply of the
good in the current period.
Example:
– Events in the Middle East lead to expectations of
higher oil prices.
– In response, owners of Texas oilfields reduce supply
now, save some inventory to sell later at the higher
price.
– S curve shifts left.
In general, sellers may adjust supply* when their
expectations of future prices change.
(*If good not perishable)
29
• Producer expectations of lower prices cause
the supply curve of a good to shift to the
right. The supply increases in anticipation of
lower prices in the future.

• The opposite holds if producers expect

prices to increase. There would be a smaller
current supply than without those
expectations.
Supply Curve Shifters: Weather Conditions
• For some products, especially agricultural
products, weather can play an important role in
determining supply.

• Temperature, rainfall, and wind all influence

the quantity that can be supplied.

• Heavy rainfall in early spring, for example, can

delay or prevent the planting of crops,
significantly limiting supply.
Supply Curve Shifters: Weather Conditions

• Abundant rain during the growing season can

greatly increase the available supply at harvest
time.

• An early freeze that prevents full maturation or

heavy snow that limits harvesting activity can
reduce the supply of agricultural products.
Supply Curve Shifters: Taxes
 Summary: Variables that Influence Sellers
Variable A change in this variable…
Price …causes a movement along the S curve
Input Prices …shifts the S curve
Technology/ Government Regulation …shifts the S curve
Prices of Related Goods …shifts the S curve
Number of Sellers/Firms …shifts the S curve
Producer Expectations …shifts the S curve
Weather Conditions …shifts the S curve
Taxes …shifts the S curve
36
ACTIVE LEARNING 2
Supply Curve
Draw a supply curve for tax
return preparation software.
What happens to it in each
of the following scenarios?
A. Retailers cut the price of
the software.
B. A technological advance
allows the software to be
produced at lower cost.
C. Professional tax return preparers raise the price
of the services they provide.
37
 ACTIVE LEARNING 2
A. Fall in price of tax return software
Price of
tax return S curve does
S1
software not shift.
P1 Move down
along the curve
P2 to a lower P
and lower Q.

Q2 Q1 Quantity of tax
return software
38
 ACTIVE LEARNING 2
B. Fall in cost of producing the software
Price of
tax return S curve shifts
S1 S2
software to the right:
at each price,
P1
Q increases.

Q1 Q2 Quantity of tax
return software
39
 ACTIVE LEARNING 3
C. Professional preparers raise their price
Price of
tax return
S1 This shifts the
software
demand curve for
tax preparation
software, not the
supply curve.

Quantity of tax
return software
40
• The essential skill for doing demand and
supply analysis of real-world markets is the
ability to identify correctly all of the
underlying demand- and supply-shifters
that are working to cause market prices and
quantities to move higher or lower.
 Supply
• The quantity supplied of any good is the
amount that sellers are willing and able to sell.
• Law of supply: the claim that the quantity
supplied of a good rises when the price of the
good rises, other things equal

49
 SUPPLY FUNCTION
• The individual supply function shows, in
symbolic or mathematical terms, the variables
that influence an individual producer’s supply
of a product.

• The market supply function shows the

variables that influence the overall supply of a
product by all producers and is thus affected
by the number of producers in the market.
 SUPPLY FUNCTION
• The market supply function for a product is the
relation between the quantity supplied and all
factors affecting that amount.

• The generalized supply function expressed in

Equation (3.6) lists variables that influence
supply. As is true with the demand function, the
supply function must be made explicit to be
useful for managerial decision-making.
 SUPPLY FUNCTION

• This equation states that the number of new domestic automobiles

supplied during a given period (in millions), where Q, quantity
supplied is a linear function of
P - the average price of new domestic cars (in $);
Psuv - average price of new sport utility vehicles (SUVs) (in $),
W - average hourly price of labor (wages in $ per hour),
S - average cost of steel ($ per ton),
E - average cost of energy ($ per mcf natural gas), E
i - average interest rate (cost of capital in per cent)
• The terms b1, b2….b6 are the parameters of the supply function.
Note that no explicit term describes technology, or the method by
which inputs are combined to produce output. The current state of
technology is an underlying, or implicit, factor in the industry supply
function.
 SUPPLY FUNCTION

Equation (3.8) indicates that :

• The quantity of automobiles supplied Q increases by 2000 units for
each $1 increase in the average price charged;
• Q decreases by 500 units for each $1 increase in the average price
of new SUVs;
• It decreases by 100000 units for each $1 increase in wage rates,
including fringes;
• It decreases by 15000 units with each $1 increase in the average
cost of steel;
• It decreases by 125000 units with each $1 increase in the average
cost of energy; and
• It decreases by 1 million units if interest rates rise 1 per cent.

Thus, each parameter indicates the effect of the related factor on

supply from domestic manufacturers.
 SUPPLY FUNCTION
• To estimate the supply of automobiles during
the coming period, each parameter in
Equation (3.8) is multiplied by the value of its
respective variable and these products are
then summed.
• Table 3.2 illustrates this process, showing that
the supply of autos, assuming the stated
values of the independent variables, is 8
million units.
SUPPLY FUNCTION
 Industry Supply vs Firm Supply
Just as in the case of demand, supply functions can be
specified for an entire industry or an individual firm. Even though
factors affecting supply are often similar in industry supply versus firm
supply functions, the relative importance of such influences can differ
dramatically.

Firms within a given industry adopt somewhat different

production methods, use equipment of different vintage, and employ
labor of varying skill and compensation levels.

Individual firms supply output only when doing so is profitable.

When industry prices are high enough to cover the marginal costs of
increased production, individual firms expand output, thereby
increasing total profits, and the value of the firm. To the extent that
the economic capabilities of industry participants vary, so too does the
scale of output supplied by individual firms at various prices.
 Industry Supply vs Firm Supply
Similarly, supply is affected by production
technology. Firms operating with highly automated
facilities incur large fixed costs and relatively small
variable costs.

The supply of product from such firms is likely to

be relatively insensitive to price changes when compared
to less automated firms, for which variable production
costs are higher and thus more closely affected by
production levels. Relatively low-cost producers can and
do supply output at relatively low market prices. Of
course, both relatively low-cost and high-cost producers
are able to supply output profitably when market prices
are high.
 SUPPLY CURVE
• The supply curve expresses the relation between
the price charged and the quantity supplied,
holding constant the effects of all other variables.
• A supply curve generally slopes upward,
indicating a positive or direct relationship
between the price of the product and the
quantity producers are willing to supply.
• A higher price typically gives producers an
incentive to increase the quantity supplied of a
particular product because higher production is
more profitable.
 SUPPLY CURVE
• As is true with demand curves, supply curves
are often shown graphically, and all
independent variables in the supply function
except the price of the product itself are fixed
at specified levels.
• In the automobile supply function given in
Equation (3.8), for example,
 SUPPLY CURVE
It is important to hold constant the price of SUVs
and the prices of labor, steel, energy, and other
inputs to examine the relation between
automobile price and the quantity supplied.

• To illustrate the supply determination process,

consider the relation depicted in Equation (3.8).
Assuming that the price of trucks, the prices of
labor, steel, energy, and interest rates are all held
constant at their Table 3.2 values, the relation
between the quantity supplied and price is
 SUPPLY CURVE

Alternatively, when price is expressed as a function of

output, the industry supply curve [Equation (3.9)] can
be written
 SUPPLY CURVE
• Equations (3.9) and (3.10), which represent
the supply curve for domestically produced
automobiles given the specified values of all
other variables in the supply function, are
shown graphically in Figure 3.3.
• When the supply function is pictured with
price as a function of quantity, or as P = $26
000 + $0.0005Q, industry supply will rise by 4
million new domestic cars if average price
rises by $2000, or 1/0.0005.
 SUPPLY CURVE
• Industry supply increases by 2000 units with
each $1 increase in average price above the
$26 000 level. The $26 000 intercept in this
supply equation implies that the domestic car
industry would not supply any new cars at all
if the industry average price fell below
$26000.
 RELATION BETWEEN SUPPLY CURVE
AND SUPPLY FUNCTION
Like the relation between the demand curve and the demand
function, the relation between the supply curve and the supply
function is very important in managerial decision-making.

Figure 3.4 shows three supply curves for automobiles: S6%,

S8% and S10%. S8% is the same automobile supply curve determined
by Equations (3.9) and (3.10) and shown in Figure 3.3. If S8% is the
appropriate supply curve, then 8 million automobiles would be offered
for sale at an industry average price of $30 000. Only 4 million
automobiles would be offered for sale at an average price of $28000;
but industry supply would total 12 million automobiles at an average
price of $32000.

Such movements along a given supply curve reflect a change

in the quantity supplied. As average price rises from $28000 to
$30000 to $32000 along S8%, the quantity supplied increases from 4
million to 8 million to 12 million automobiles.
 RELATION BETWEEN SUPPLY CURVE
AND SUPPLY FUNCTION
Supply curves S6% and S10% are similar to S8%. The differences are
that S6% is based on a 6 per cent interest rate, whereas S10% assumes a 10
per cent interest rate. Recall that S8% is based on an interest rate assumption
of 8 percent.

Because the supply function interest rate parameter is -1,000,000, a

2 percent fall in interest rates leads to a 2 million-unit increase in automobile
supply at each automobile price level. This increase is described as a
downward or rightward shift in the original supply curve, S , to the new
supply curve S6%.

Conversely, a 2 per cent rise in interest rates leads to a 2 million-unit

decrease in automobile supply at each automobile price level. This reduction
is described as an upward or leftward shift in the original supply curve S8% to
the new supply curve S10%.
 RELATION BETWEEN SUPPLY CURVE
AND SUPPLY FUNCTION
• To avoid confusion, remember that S10% lies above S8% in
Figure 3.4, whereas D10% lies below D8% in Figure 3.2.

• Similarly, it is important to keep in mind that S6% lies below

S8% in Figure 3.4, but D6% lies above D% in Figure 3.2.

• These differences stem from the fact that a rise in demand

involves an upward shift in the demand curve, whereas a
fall in demand involves a downward shift in the demand
curve. Conversely, a rise in supply involves a downward
shift in the supply curve; a fall in supply involves an upward
shift in the supply curve.
 RELATION BETWEEN SUPPLY CURVE
AND SUPPLY FUNCTION
• At a price of $30 000, for example, a 2 per cent rise in interest
rates reduces automobile supply from 8 million units, the S8%
level, to 6 million units, the S10% level. This reduction in
supply reflects the fact that previously profitable production
no longer generates a profit because of the increase in capital
costs.

• At a price of $30000, a 2 per cent reduction in interest rates

increases automobile supply from 8 million units, the S8%
level, to 10 million units, the S6% level. Supply rises following
this decline in interest rates because, given a decline in capital
costs, producers find that they can profitably expand output at
the $30000 price level from 8 million to 10 million units.
 RELATION BETWEEN SUPPLY CURVE
AND SUPPLY FUNCTION
• A shift in supply, or a switch from one supply curve to another, indicates a
change in one or more of the non-price variables in the product supply
function.

• When automobile supply is inversely related to a factor such as SUV

prices, rising SUV prices lead to falling automobile supply, and falling SUV
prices lead to rising automobile supply. From the negative parameters for
the price of labor, steel, energy, and interest rates, it is also possible to
infer that automobile supply is inversely related to each of these factors.

• A change in interest rates is not the only factor that might be responsible
for a change in the supply curve from S8% to S6% or S10%. From the steel
cost parameter of -15000, it is possible to infer that supply and steel costs
are inversely related. Falling supply follows an increase in steel costs, and
rising supply follows a decrease in steel costs. The shift from S8% to S10%
in Figure 3.4, which reflects a decrease in supply, could have resulted from
a $133.33 per ton increase in steel costs rather than a 2 per cent increase
in interest rates.
RELATION BETWEEN SUPPLY CURVE
AND SUPPLY FUNCTION
For some products, a positive relation
between supply and other factors such as
weather is often evident. This is especially true
for agricultural products. If supply were positively
related to weather, perhaps measured in terms of
average temperature, then rising supply would
follow rising average temperature and falling
supply would accompany falling average
temperature.
Weather is not included in the automobile
supply function because there is no close relation
between automobile supply and weather.
 RELATION BETWEEN SUPPLY CURVE
AND SUPPLY FUNCTION
The distinction between changes in the
quantity supplied, which reflect movements along a
given supply curve, and a shift in supply, which
reflects movement from one supply curve to
another, is important, as was the distinction
between changes in the quantity demanded and a
shift in demand.
Because the prices of related products, input
prices, taxes, weather, and other factors affecting
supply can be expected to vary from one period to
the next, assessing the individual importance of
each factor becomes a challenging aspect of
managerial economics.
 MARKET EQUILIBRIUM
• When quantity demanded and quantity
supplied are in perfect balance at a given price
the product market is said to be in equilibrium
• The best way to understand equilibrium is to
consider what would happen if some price
other than the equilibrium price actually
existed in a market.
• Because there is an imbalance between quantity
demanded and quantity supplied at this price,
the situation is not stable.
• Some individuals are willing to pay more than
price P1, so they will start to bid the price up. A
higher price will cause producers to supply a
larger quantity.
• This adjustment process will continue until the
equilibrium price has been reached and quantity
demanded is equal to quantity supplied.
• At price P2, the quantity supplied, QS, is greater
than the quantity demanded, QD, at that price.
• This above-equilibrium price creates a surplus of
the good and sets into motion forces that will
cause the price to fall.
• As the price falls, the quantity demanded
increases and the quantity supplied decreases
until a balance between quantity demanded
and quantity supplied is restored at the
equilibrium price.
• Thus, the existence of either shortages or
surpluses of goods is an indication that a
market is not in equilibrium.
CHANGES IN DEMAND
 CHANGES IN DEMAND
• The original equilibrium price, P0, and quantity, Q0, arise from the
intersection of demand curve D0 and supply curve S0. An increase in demand
is shown by the rightward or outward shift of the demand curve from D0 to
D1.

• This increase in demand results in a new higher equilibrium price, P1, and a
new larger equilibrium quantity, Q1, or in the movement from point A to
point B.

• This change represents a movement along the supply curve or a change in

quantity supplied. Thus, a change in demand (a shift of the curve on one side of
the market) results in a change in quantity supplied (movement along the curve
on the other side of the market).

• The opposite result occurs for a decrease in demand. In this case, the
demand curve shifts from D0 to D2 and the equilibrium price and quantity
fall to P2 and Q2. This change in demand also causes a change in quantity
supplied, or a movement along the supply curve from point A to point C.
CHANGES IN SUPPLY
 CHANGES IN SUPPLY
• Starting with the original demand and supply curves,D0 and S0, and the
original equilibrium price and quantity, P0 and Q0, an increase in supply is
represented by the rightward or outward shift of the supply curve from S0
to S1.

• The result of this increase in supply is a new lower equilibrium price, P1,
and a larger equilibrium quantity, Q1. This change in supply results in a
movement along the demand curve or a change in quantity demanded
from point A to point B.

• The figure also shows the result of a decrease in supply. In this case, the
supply curve shifts leftward or inward from S0 to S2. This results in a new
higher equilibrium price, P2, and a smaller equilibrium quantity, Q2. This
decrease in supply results in a decrease in quantity demanded or a
movement along the demand curve from point A to point C.
CHANGES IN EQUILIBRIUM PRICES
AND QUANTITIES

If the decrease in
supply is less than
the increase in
demand, the
equilibrium
quantity will rise
 CHANGES IN EQUILIBRIUM PRICES
AND QUANTITIES

The equilibrium
quantity will fall if
the increase in
demand is less than
the decrease in
supply
 CHANGES IN EQUILIBRIUM PRICES
AND QUANTITIES
• The trends in equilibrium prices and quantities will depend on the size of the shifts
of the curves and the responsiveness of either quantity demanded or quantity
supplied to changes in prices.

• In some cases, we know the direction of the change in equilibrium price, but not
the equilibrium quantity. This result is illustrated in Figures 2.11 and 2.12, which
show a decrease in supply (the shift from point A to point B) combined with an
increase in demand (the shift from point B to point C).

• Both shifts cause the equilibrium price to rise from P0 to P2. However, the
direction of change for the equilibrium quantity (Q0 to Q2) depends on the
magnitude of the shifts in the curves. If the decrease in supply is less than the
increase in demand, the equilibrium quantity will rise, as shown in Figure 2.11.

• The equilibrium quantity will fall if the increase in demand is less than the
decrease in supply, as shown in Figure 2.12.
CHANGES IN EQUILIBRIUM PRICES
AND QUANTITIES

If the increase in
demand is less than
the increase in
supply, the
equilibrium price
will fall
 CHANGES IN EQUILIBRIUM PRICES
AND QUANTITIES
• In some cases, we know the direction of the change in equilibrium
price, but not the equilibrium quantity.

• This result is illustrated in Figures 2.11 and 2.12, which show a

decrease in supply (the shift from point A to point B) combined with
an increase in demand (the shift from point B to point C). Both
shifts cause the equilibrium price to rise from P0 to P2.

• However, the direction of change for the equilibrium quantity (Q0

to Q2) depends on the magnitude of the shifts in the curves.

• If the decrease in supply is less than the increase in demand, the

equilibrium quantity will rise, as shown in Figure 2.11.

• The equilibrium quantity will fall if the increase in demand is less

than the decrease in supply, as shown in Figure 2.12.
 CHANGES IN EQUILIBRIUM PRICES
AND QUANTITIES

The equilibrium
price will rise if the
increase in supply is
less than the
increase in demand
 CHANGES IN EQUILIBRIUM PRICES
AND QUANTITIES
• In other cases, we know the direction of the change in the equilibrium
quantity, but not the equilibrium price.

• Figures 2.13 and 2.14, which illustrate this situation, show an increase in
supply (from point A to point B) combined with an increase in demand
(from point B to point C).

• Both of these shifts in the curves result in a larger equilibrium quantity (an
increase from Q0 to Q2). However, the direction of the price change
depends on the magnitude of the shift in each curve.

• If the increase in demand is less than the increase in supply, the

equilibrium price will fall, as shown in Figure 2.13.

• The equilibrium price will rise if the increase in supply is less than the
increase in demand, as shown in Figure 2.14.
 MARKET EQUILIBRIUM
• When quantity demanded and quantity
supplied are in perfect balance at a given price
the product market is said to be in equilibrium
 SURPLUS AND SHORTAGE
A surplus is created when producers supply more of a product
at a given price than buyers demand. Surplus describes a condition of
excess supply.

Conversely, a shortage is created when buyers demand more

of a product at a given price than producers are willing to supply.
Shortage describes a condition of excess demand.

Neither surplus nor shortage will occur when a market is in

equilibrium, because equilibrium is defined as a condition in which the
quantities demanded and supplied are exactly in balance at the
current market price.

Surplus and shortage describe situations of market

disequilibrium because either will result in powerful market forces
being exerted to change the prices and quantities offered in the
market.
Shortage
Surplus
 SURPLUS AND SHORTAGE
What are the implications of a shortage?

Shortages exert a powerful upward force on both market prices and

output levels.

In this example, the demand curve indicates that with only 4 million
automobiles supplied, buyers would be willing to pay an industry average
price of $38 000 [=$46 000 - $0.002(4000000)].

Consumers would bid against one another for the limited supply of
automobiles and cause prices to rise.

The resulting increase in price would motivate manufacturers to

increase production while reducing the number of buyers willing and able to
purchase cars.

The resulting increase in the quantity supplied and reduction in

quantity demanded work together to eventually eliminate the shortage.
 SURPLUS AND SHORTAGE
• In summary:
– Surplus describes an excess in the quantity
supplied over the quantity demanded at a given
market price.
– A surplus results in downward pressure on both
market prices and industry output.
– Shortage describes an excess in the quantity
demanded over the quantity supplied at a given
market price.
 SURPLUS AND SHORTAGE
• In summary:
– A shortage results in upward pressure on both
market prices and industry output.

– Market equilibrium describes a condition of

perfect balance in the quantity demanded and the
quantity supplied at a given price. In equilibrium,
there is no tendency for change in either price or
quantity.