Chapter 3 Supply and Demand

Chapter 3
Supply and
Demand
Chapter Outline
• Market demand
• Market supply
• Market equilibrium
• Comparative statics analysis
• Supply, demand, and price
Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-2

Learning Objectives
• Define supply, demand, and equilibrium price

• List and provide specific examples of the non-price
determinants of supply and demand
• Distinguish between the short-run rationing
function and long-run guiding function of price
• Illustrate how the concepts of supply and demand
can be used in management decisions about price
and allocations of resources.
• Use supply and demand diagrams to determine
price in the short and long run

Market Demand
• The demand for a good or service is defined

as:
– Quantities of a good or service that people are
ready, willing and able to buy at various prices
within some given time period. (Other factors
besides price held constant.)

Market Demand
• “Ready” implies that consumers are

prepared to buy a good or service both
because they are:
– Willing: Consumers have a preference for it.
– Able: Consumers have the income to support this

preference.

Market Demand
Market demand is the sum of all the individual

demands.
• Individuals may have distinct demand curves,
and they sum to the overall demand in the
market.
Example: demand for pizza

Market Demand
There is an inverse
relationship between
price and the quantity
demanded of a good or
service.
This is called the Law

of Demand.
Thus, the demand

curve is downward
sloping.
Market Demand
• Graphical
Representation of
Demand
• Algebraic
Representation of
Demand
Qd=700-100P

Market Demand
• Changes in price result in changes in the

quantity demanded
– This is shown as movement along the demand

curve.
• Changes in non-price factors result in

changes in demand
– This is shown as a shift in the demand curve.

Market Demand

Market Demand
• Non-price determinants of demand-result is

a shift in the demand curve.
– tastes and preferences

– income
– prices of related products
– future expectations
– number of buyers

Market Supply
• The supply of a good or service is defined as

quantities that people are ready to sell at
various prices within some given time period
(Other factors besides price held constant)

Market Supply
• Changes in price result in changes in the

quantity supplied
– shown as movement along the supply curve
• Changes in non-price determinants result in

changes in supply
– shown as a shift in the supply curve

Market Supply

Market Supply
• Non-price determinants of supply-results in

a shift in the supply curve.
– costs and technology

– prices of other goods or services offered by the
seller
– future expectations
– number of sellers
– weather conditions

Market Equilibrium
• Equilibrium price: the price that equates

the quantity demanded with the quantity
supplied
• Equilibrium quantity: the amount that

people are willing to buy and sellers are
willing to offer at the equilibrium price level

Market Equilibrium
• Shortage: a market situation in which the

quantity demanded exceeds the quantity
supplied
– shortage occurs at a price below the equilibrium
level
• Surplus: a market situation in which the

quantity supplied exceeds the quantity
demanded
– surplus occurs at a price above the equilibrium
level
Market Equilibrium

Comparative Statics Analysis
• Comparative statics is a form of

sensitivity (or what-if) analysis
– Commonly used method in economic analysis

• Process of comparative statics analysis:

– state all the assumptions needed to construct the
model
– begin by assuming that the model is in
equilibrium
– introduce a change in the model, so a condition
of disequilibrium is created
– find the new point of equilibrium
– compare the new equilibrium point with the
original one

Step 1
• assume all factors
except the price of
pizza are constant
• buyers’ demand and

sellers’ supply are
represented by lines
shown

Step 2
• begin the analysis
in equilibrium as
shown by Q1 and P1

Step 3
• assume that a new
study shows pizza
to be the most
nutritious of all fast
foods
• consumers increase
their demand for
pizza as a result

Step 4
• the shift in demand
results in a new
equilibrium price
(P2)
• and a new
equilibrium quantity
(Q2)

Step 5
• comparing the
new equilibrium
point with the
original one, we
see that both
equilibrium price
and quantity have
increased

• The short run is the period of time in

which:
– sellers already in the market respond to a

change in equilibrium price by adjusting variable
inputs
– buyers already in the market respond to changes

in equilibrium price by adjusting the quantity
demanded for the good or service

• Short run changes show the rationing

function of price
– The rationing function of price is the change in

market price to eliminate the imbalance between
quantities supplied and demanded.

Comparative Static Analysis:
Short-run
• an increase in
demand causes
equilibrium price and
quantity to rise

Short-run
• a decrease in demand
causes equilibrium
price and quantity to
fall

Short-run
• an increase in
supply causes
equilibrium price
to fall and
equilibrium
quantity to rise

Short-run
• a decrease in
supply causes
equilibrium price
to rise and
equilibrium
quantity to fall

Long-run
• The long run is the period of time in which:

– new sellers may enter a market
– existing sellers may exit from a market
– existing sellers may adjust fixed factors of
production
– buyers may react to a change in equilibrium
price by changing their tastes and preferences

Long-run
• Long run changes show the allocating

function of price
• The guiding or allocating function of

price is the movement of resources into or
out of markets in response to a change in
the equilibrium price.

Long-run
• initial change: decrease in
demand from D1 to D2
• result: reduction in
quantity (to P2, Q2)
• follow-on adjustment:
– movement of resources out
of the market
– leftward shift in the supply
curve to S2
– equilibrium price and

Long-run Analysis
• initial change: increase in

demand from D1 to D2
• result: increase in
• follow-on adjustment:
– movement of resources
into the market
– rightward shift in the
supply curve to S2
– equilibrium price and
Summary: Short-Run and Long-Run
Changes in the Market

Supply, Demand, and Price
• In the extreme case, the forces of supply

and demand are the sole determinants of
the market price, not any single firm.
– this type of market is ‘perfect competition’
• In many cases, individual firms can exert

market power over price because of their:
– dominant size
– ability to differentiate their product through
advertising, brand name, features, or services

Supply, Demand, and Price
• Discussion of changes in the computer

industry
– Makers of PCs, notebooks and jump drives are

facing slower growth in the demand for their
products as technology is changing.
– What impact do you think cloud computing will

have on the demand for stand-alone applications
such as Microsoft Office or storage devices for
computers?

Global Application
What are the implications of rising demand for

oil among developing counties?

Global Application

Global Application

Summary
• The law of demand states that, other factors

held constant, the quantity demanded is
inversely related to price.
• The law of supply states that, other factors
held constant, the quantity supplied is
directly related to price.
• Non-price factors may shift the curves.
• Price serves a short-run rationing function
and a long-run guiding function in the
marketplace.

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Chapter 3

Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-2

• Define supply, demand, and equilibrium price

Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-3

• The demand for a good or service is defined

Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-4

• “Ready” implies that consumers are

– Willing: Consumers have a preference for it.

– Able: Consumers have the income to support this

Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-5

Market demand is the sum of all the individual

Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-6

This is called the Law

Thus, the demand

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• Changes in price result in changes in the

– This is shown as movement along the demand

• Changes in non-price factors result in

– This is shown as a shift in the demand curve.

Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-9

Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-10

• Non-price determinants of demand-result is

– tastes and preferences

Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-11

• The supply of a good or service is defined as

(Other factors besides price held constant)

Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-12

• Changes in price result in changes in the

– shown as movement along the supply curve

• Changes in non-price determinants result in

– shown as a shift in the supply curve

Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-13

Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-14

• Non-price determinants of supply-results in

– costs and technology

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• Equilibrium price: the price that equates

• Equilibrium quantity: the amount that

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• Shortage: a market situation in which the

• Surplus: a market situation in which the

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• Comparative statics is a form of

– Commonly used method in economic analysis

Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-19

• Process of comparative statics analysis:

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• buyers’ demand and

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• The short run is the period of time in

– sellers already in the market respond to a

– buyers already in the market respond to changes

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• Short run changes show the rationing

– The rationing function of price is the change in

Copyright ©2014 Pearson Education, Inc. All rights reserved. 3-27