Lecture 6:

Supply & Demand II

Lecture Overview
• Firms’ supply decisions

• Market equilibrium
• how prices and market turnover are
determined

• Changes in equilibrium
• how prices and market turnover
change

Reading
Mankiw, Chapter 4

31 101 Economics I 2005-2006 Lecture 6 1

 Supply
• Price of good rises, quantity supplied
increases

• Low price - only profitable to use

cheap techniques - limits output

• Higher price - worth while to use more

expensive techniques - output higher

31 101 Economics I 2005-2006 Lecture 6 2

The supply of bottles of beer (weekly)

Price (£) Old Red Hobgoblin Market

supply supply supply
(000s)
1.25 75 50 20
2.00 100 80 35
2.50 140 105 40
3.00 180 130 50

£ per
bottle

3.00 Market Supply

curve
2.50
2.00

1.25

0 20 35 40 50 75
bottles
per week 000s

31 101 Economics I 2005-2006 Lecture 6 3

 Other determinants of supply

• Supply influenced by factors other than

price

• Costs of production
• higher costs (input prices etc) ⇒
less profit made

• Other factors influence costs

• e.g. taxes on inputs, new
technology, new management
techniques

• Number of sellers

• Profitability alternative products

• e.g. profitability of lager increases
• supply beer falls

• Profitability of goods in joint supply

• profitability gin increases
• supply of tonic increases

• Expectations
• e.g. if suppliers expect future prices for
their commodity to be higher
31 101 Economics I 2005-2006 Lecture 6 4
 Movements v Shifts
• Important distinction between

i. Movement along supply curve as price

changes

£ per
bottle new price

3.00

2.00
original
price

0 20 35 40 50 75
bottles
per week 000s

31 101 Economics I 2005-2006 Lecture 6 5

 ii. Shift in position as one of the non-price
determinants of supply changes

£ per old
bottle supply
curve
3.00

2.00 new
supply
curve

0 20 35 40 50 75
bottles
per week 000s

31 101 Economics I 2005-2006 Lecture 6 6

 Market Equilibrium:
Price and Output Determination
• Market demand and supply for beer
Price Market Market Excess Effect
(£) demand supply Demand on Price
(000s) (000s) (000s)
1.25 75 20 55 ↑
2.00 50 35 15 ↑
2.50 40 40 0 None
3.00 30 50 -20 ↓
• Shortage of beer
• demand > supply (positive excess
demand)
• price of beer rises
• reduces quantity demanded &
increases quantity supplied
• Surplus of beer
• demand < supply (negative excess
demand)
• price of beer falls
• increases quantity demanded &
reduces quantity supplied

31 101 Economics I 2005-2006 Lecture 6 7

 • Market equilibrium
• supply equals demand (zero excess
demand)
• all suppliers & consumers plans
fulfilled
• no price change

• Equilibrium “balance: the state of even

balance: a state in which opposing
forces or tendencies neutralise each
other”

Chambers English Dictionary

31 101 Economics I 2005-2006 Lecture 6 8

 Price Market Market Excess Effect
(£) demand supply Demand on Price
(000s) (000s) (000s)
1.25 75 20 55 ↑
2.00 50 35 15 ↑
2.50 40 40 0 None
3.00 30 50 -20 ↓

£ per
bottle surplus Supply
P falls
3.00 equilibrium
no change in P
2.50
2.00
shortage
1.25 P rises Demand

0 20 30 40 50 75
bottles
per week 000s

31 101 Economics I 2005-2006 Lecture 6 9

 Movement to a New Equilibrium:
steps for analysis
1. Describe the initial equilibrium

2. A determinant of demand or supply

will change: how does this affect the
position of the demand or supply
curve for the commodity you are
examining?

3. At the initial price level, what is the

situation in the market? Does supply
still equal demand?

4. How does the market price respond

to eliminate this excess supply or
demand and adjust to a new
equilibrium?

5. How do the new equilibrium market

price and quantity compare with the
original equilibrium values?

31 101 Economics I 2005-2006 Lecture 6 10

 EXAMPLES:
1. Suppose Glasgow hosts a
European cup game: what is
the likely impact on the
market for beer?

2. What is the likely impact on

the market for chips of an
increase in the price of
potatoes?

31 101 Economics I 2005-2006 Lecture 6 11

 Example 1:Glasgow hosts a European cup game -
demand for beer increases at all prices
1. Initially in equilibrium with P1 (£2.50) and Q1 (40
bottles)
2. A non-price determinant of demand (availability of
complement goods) has changed: the demand curve
shifts out from D0 to D1
3. At the initial price level there is excess demand with
quantity demanded rising above the quantity suppliers
are willing to supply at price P1 (£2.50)
4. The market price responds to excess demand by
increasing. This causes demand to contract again
(movement back up the demand curve), but also
supply to expand (movement down the supply curve)
5. The new equilibrium is reached where supply and
demand are equal at the higher price P2 (£3) and Q2
(50 bottles)
new
£ per equilibrium
bottle Supply

3.00 shortage
2.50 P rises
old
equilibrium
D1
D0
0 40 50 bottles per
week 000s

31 101 Economics I 2005-2006 Lecture 6 12