Supply and Demand

INTRODUCTION
• This chapter describes supply and demand, which are the driving forces behind the
market economies that exist around the globe. As suggested in this chapter’s opening
headline, supply and demand analysis is a tool that managers can use to visualize the
“big picture.”
• Supply and demand analysis is a qualitative tool which, like the above genie,
empowers managers by enabling them to see the “big picture.” It is a qualitative
forecasting tool you can use to predict trends in competitive markets, including changes
in the prices of your firm’s products, related products (both substitutes and
complements), and the prices of inputs (such as labor services) that are necessary for
your operations.

Law of Demand
• The ‘Law of Demand’ states that there is an inverse relationship between quantity
demanded of a commodity and its price, other factors being constant. In other words,
higher the price, lower the demand and vice versa, other things remaining constant
• The quantity demanded is the amount of a good that consumers are willing to buy at a
given price, holding constant the other factors that influence purchases
.
Demand Curve
• A ‘Demand Curve’ is a diagrammatic
representation of Demand Schedule.
• It is a graphical representation of price
quantity relationship.
• The individual demand curve shows the
highest price which an individual is
willing to pay for different quantities of
the commodity.
DEMAND
FACTORS OF DEMAND
• Factors of Demand: Own Price
- Economists focus most on how a good’s own price affects the quantity
demanded
- To determine how a change in price affects the quantity demanded, economists
ask what happens to quantity when price changes and other factors are held
constant
• Factors of Demand: Income
- When a consumer’s income rises that consumer will often buy more of many
goods
• Factors of Demand: Price of Related Goods
- Substitute: different brands of essentially the same good are close substitutes
- Complement: a good that is used with the good under consideration
• Factors of Demand: Tastes and Information
- Consumers do not purchase goods they dislike. Firms devote significant
resources to trying to change consumer tastes through advertising.
- Information about characteristics and the effects of a good has an impact on
consumer decisions
• Factors of Demand: Government Regulations
- Governments may ban, restrict, tax, or subsidize goods or services.

EFFECTS OF A PRICE CHANGE ON THE QUANTITY DEMANDED

• Law of Demand: consumers demand more of a good if its price is lower or less when
its price is higher.
• The law of demand assumes income, the prices of other goods, tastes, and other factors
that influence the amount they want to consume are constant
• The law of demand is an empirical claim— a claim about what actually happens
.
• According to the law of demand, demand curves slope downward.
CHANGES IN QUANTITY DEMANDED
• The demand curve is a concise summary of the answer to the question: What happens
to the quantity demanded as the price changes, when all other factors are held constant?
• Changes in the quantity demanded in response to changes in price are movements
along the demand curve
.

Law of Supply
• The ‘Law of Supply’ states that there is a direct relationship between quantity
supplied of a commodity and its price, other factors being constant. In other words,
higher the price, higher the supply and vice versa, other things remaining constant.
• The quantity supplied is the amount of a good that firms want to sell at a given price,
holding constant other factors that influence firms’ supply decisions, such as costs and
government actions.
.

Supply Curve
• A ‘Supply Curve’ is a diagrammatic
representation of Supply Schedule.
• It is a graphical representation of
price quantity relationship.

Supply
FACTORS OF SUPPLY
• Factors of Supply: Own Price
- Usually, we expect firms to supply more quantity at a higher price.
• Other Factors of Supply
- These other factors include costs of production, technological change,
government regulations, and other factors.
• Factors of Supply: Costs of Production
- The costs of labor, machinery, fuel, and other costs affect how much of a
product firms want to sell.
- As a firm’s cost falls, it is usually willing to supply more, holding price and
other factors constant. Conversely, a cost increase will often reduce a firm’s
willingness to produce.
• Factors of Supply: Technological Change
- If a technological advance allows a firm to produce its good at lower cost, the
firm supplies more of that good at any given price, holding other factors
constant.
• Factors of Supply: Government Regulations
- Government rules and regulations can affect supply directly without working
through costs.
- For example, in some parts of the world, retailers may not sell most goods and
services on particular days of religious significance

EFFECTS OF PRICE ON SUPPLY

- The supply curve is usually upward sloping. There is no “Law of Supply”
stating that the supply curve slopes upward.
- We observe supply curves that are vertical, horizontal, or downward sloping in
particular situations. However, supply curves are commonly upward sloping
- Along an upward-sloping supply curve a higher price leads to more output
being offered for sale, holding other factors constant

CHANGES IN QUANTITY SUPPLIED

- An increase in the price of avocados causes a movement along the supply curve,
resulting in more avocados being supplied.
 - As the price increases, firms supply more
- In the supply curve, if the price rises from $2 per lb to $3 per lb, the quantity
supplied rises from 80 million lbs per month to 95 million lbs per month
.
MARKET EQUILIBRIUM
• The S and D curves jointly determine the p and q at which a good or service is bought
and sold.
• The market is in equilibrium when all market participants are able to buy or sell as
much as they want (no participant wants to change its behavior).
• The p at which consumers can buy as much as they want, and sellers can sell as much
as they want is an equilibrium price.
• The resulting q is the equilibrium quantity because the quantity demanded equals the
quantity supplied

MARKET EQUILIBRIUM
Using a Graph to Determine the
Equilibrium

• In a graph, the market equilibrium is the

point at which the demand and supply curves
cross each other. This point gives the q and p
of equilibrium.

Graphical Presentation

• Figure 2.5 shows the supply curve, S,and

demand curve, D, for avocados.

• The D and S curves intersect at point e, the

market equilibrium.

• The equilibrium price is $2 per lb, and the

equilibrium quantity is 80 million lbs per
month, which is the quantity firms want to
sell and the quantity consumers want to buy.

EFFECTS OF GOVERNMENT
INTERVENTION
• Policies that Shift Curves: Limits on Who can Buy
 - For example, governments usually forbid selling cigarettes or alcohol to
children. This decreases the quantity demanded for those goods at each price
and thereby shifts their demand curves to the left.
• Policies that Shift Curves: Restriction of Imports
- The effect of this governmental restriction is to decrease the quantity supplied of
imported goods at each price and shifts the importing country’s supply curve to
the left.
• Policies that Shift Curves: Start buying a good
- The effect of governments starting to buy goods is to increase the quantity
demanded at each price for the good and shifts the demand curve to the right.
• Price Controls: Price Ceiling
• Price Controls: Price Floor
- When the government sets a price floor below the unregulated equilibrium
price, the price that is actually observed in the market is the price floor.
• Why Supply Need Not Equal Demand
- The theory says that the price and quantity in a market are determined by the
intersection of the supply curve and the demand curve and the market clears if
the government does not intervene.
- However, the theory also tells us that government intervention can prevent
market-clearing.
- The price ceiling and price floor examples show that the quantity supplied does
not necessarily equal the quantity demanded in a supply-and-demand model.
- The quantity that sellers want to sell and the quantity that buyers want to buy at
a given price need not equal the actual quantity that is bought and sold.
• Sales Taxes
- The specific sales tax causes the equilibrium price consumers pay to rise, the
equilibrium quantity that firms receive to fall, and the equilibrium quantity to
fall.
- Although the consumers and producers are worse off because of the tax, the
government acquires new tax revenue.
• Tax Collected from Firms or Consumers
- It doesn’t matter whether the specific tax is collected from firms or consumers.
- The market outcome is the same regardless of who is taxed.
• Common Belief: Taxes are Fully Passed to Consumers
- This belief is not true in general. Full pass-through can occur but partial
passthrough is more common.
- The degree of the pass through depends on the shapes of the S and D curves.

WHEN TO USE THE SUPPLY AND-DEMAND MODEL

• S-D model and Real-World Events
- The S-D model can help us to understand and predict real-world events in many
markets. Like a map, it need not be perfect to be useful.
- The model is useful if the market to be analyzed is ‘competitive enough.’
- It is reliable in markets, such as those for agriculture, financial products, labor,
construction, many services, real estate, wholesale trade, and retail trade.
• S-D model is Accurate for Perfectly Competitive Markets
- It is precisely accurate in perfectly competitive markets, which are markets in
which all firms and consumers are price takers (no market participant can affect
the market price).
• S-D Model not Accurate for Non-Competitive Markets
- In markets with price setters, the market price is usually higher than that
predicted by the S-D model.
- Monopoly or oligopoly markets have one or very few sellers, respectively.
• Five Characteristics of a Perfect Competitive Market
- Many buyers and sellers, all relatively small with respect to the size of the
market.
- - Consumers believe all firms produce identical products, so they only care
about price.
- All market participants have full information about price and product
characteristics, so no participant can take advantage of each other.
- Transaction costs (expenses over and above the price) are negligible.
- Firms can easily enter and exit the market over time, so competition is very
high.