Supply and Demand: Theory

The Market

Putting Supply and Demand Together

• If quantity supplied exceeds quantity demand a surplus or excess supply exists.

• In the following table a surplus exists at price…………………………..

• If quantity demanded exceeds quantity supplied a shortage or excess demand exists.

• In the following table a shortage exists at price…………………………….

• Equilibrium price: the price at which quantity demanded equals quantity supplied

• In the table the equilibrium price is:

• Equilibrium quantity is:

Price Quantity supplied Quantity demanded Condition

15 150 50

10 100 100

5 50 150

In brief:

If QS > QD Surplus

If QS < QD Shortage

If QS = QD Equilibrium

• What happens to price when there is a surplus?

 When there is a surplus, sellers lower their price. Price continues to fall as long as
surplus is greater than 0.
There is a tendency to price and quantity to fall until the surplus is disappeared.

• What happens to price when there is a shortage?

Some buyers will bid up the price to get sellers to sell to them.
Some sellers increase the price.
Therefore price goes up.
Increase in price decreases quantity demand and increase quantity supply.
This process continues as long as there is a shortage.

Price Quantity Quantity Condition What happens to price

supplied demanded
20 200 0
15 150 50

10 100 100

5 50 150

0 0 200

Graphical Presentation:

What can change equilibrium price and quantity?

Equilibrium price and quantity are determined by supply and demand. Whenever demand
changes, supply changes, or both change, equilibrium price and quantity change.

Price

Demand
Supply

Quantity

Demand Supply Equilibrium Price Equilibrium

Quantity
Falls Constant Falls Falls
Rises Constant Rises Rises
Constant Falls
Constant Rises
Falls Falls
Falls Rises
Rises Falls
Rises Rises
Supply and Demand: Theory

Equilibrium in terms consumers’ and producers’ surplus

Consumer surplus: difference between maximum buying price and the price paid by
the buyer

Consumer surplus = Maximum buying price – price paid

Example: suppose, highest price you would pay to see a movie is 100 Taka

You pay 40 Taka to see the movie.

Your surplus is (100 – 40 ) = 60 Taka

The higher the consumer surplus, the better the consumers are.

Producer surplus: difference between the price received by the producer and the
minimum selling price.

Producer surplus = Price received – Minimum selling price

Example: suppose, minimum price a producer wants for a good is 30 taka but from the
market he receives 40 taka.

His surplus is (40 – 30 ) = 10 Taka

The higher the producer surplus, the better the producers are.

Total surplus: Total surplus = consumer surplus + producer surplus

 Price Qd Qs Consumer surplus Producer surplus
10 0 6
9 1 5 9-7=2
8 2 4 8-7=1
7 3 3 7-7=0 7-7=0
6 4 2 7-6=1
5 5 1 7-5=2
4 6 0
3 7 0

Total consumer surplus=

Total producer surplus =

Total surplus=

Graphically:
Consumer surplus: region on and below the demand curve but above the equilibrium price
line

Producer surplus: region on and above the supply curve but below the price line
Another example of consumer and producer surplus

Price Qd Qs CS=consumer PS= producer

surplus surplus

20 0 8

18 1 7

16 2 6

14 3 5

12 4 4

10 5 3

8 6 2

6 7 1

4 8 0