Economics: by John B. Taylor Stanford University

Copyright 2001 by Houghton
Mifflin Company. All rights reserved.

1
Economics
THIRD EDITION

By John B. Taylor
Stanford University
2
Chapter 3
The Supply and
Demand Model
3
Overview

The supply and demand model is fundamental to
economics. Supply and demand are discussed as
representing the interests of sellers and buyers,
respectively. Next, supply and demand curves are
shown. Shifts of the curves compared to
movements along the curves are discussed. The
model is then used to show the determination of
price. The causes of shortages and surpluses are
explained. Finally, market interference is
discussed within the issues of price ceiling and
price floors.

4
Teaching Objectives
1. Develop the demand curve. Differentiate
between changes in demand and changes in
quantity demanded.
2. Develop the supply curve. Differentiate between
changes in supply and changes in quantity
supplied. List the factors that shift the supply
curve.
3. Show how the interaction of supply and demand
determines the equilibrium price.

5
Teaching Objectives (Cont.)
4. Use supply and demand analysis to
explain things students are interested in.
5. Show how price controls interfere with the
market and create surpluses or shortages.
6. Discuss how shifts in the demand and/or
the supply curve will change the
equilibrium price. Shift curves
simultaneously. Again, the "shifts" versus
"movements along" distinction is very
important but difficult for some students.

6
Demand
1a. Demand is a relation between the price
of a good or service and the quantity of that
good or service consumers are willing to
buy at that price per unit of time, ceteris
paribus. Demand curves relate price and
quantity demanded
7
Demand
1b. The law of demand states that price and
quantity demanded are negatively related.

Price is the independent variable and
quantity demanded is the dependent
variable. Price determines quantity.

8
Figure 3.1
The Demand Curve
9
Demand
1c. Demand is shown graphically by the
demand curve see Figure 3.1.
We relate the negative slope to the inverse
relationship in the law of demand.

1d. Price affects quantity because changes
in price create an incentive to substitute.

10
Shifts in the Demand Curve
1e. Demand curves shift around, indicating
changes in other variables. A shift is called
a change in demand. See Figure 3.2.

1e.1. The main determinants of demand are
consumer preferences, information, income,
price expectations, population, and the
prices of related goods.

11
Figure 3.2
A Shift in the
Demand Curve
12
Shifts versus movements
1e.2. It is important to distinguish between shifts
of the demand curve and movements along the
demand curve. Use Figure 3.3.

Note: Changes in a variable not identified on the
vertical axis shift the function, whereas changes in
the listed variable cause movement along the
given function.

13
Figure 3.3
Shifts versus
Movements Along
the Demand Curve
14
2. Supply
2a. Supply is a relation between the price of
a good or service and the quantity of the
good or service a supplier is willing to sell
at that price, ceteris paribus.

2b. The law of supply states that price and
quantity supplied are positively related.
This is shown in Table 3.2.

15
Figure 3.4
The Supply Curve
16
Supply

2c. As with demand, price creates an incentive
to increase the quantity supplied as price
increases.

Again, price is the independent variable and
quantity supplied is the dependent variable. Relate
this to the issue of causality discussed earlier.
Figure 3.4 gives the supply curve

The positive slope is due to the positive
relationship in the law of supply.

17
Shifts in Supply Curve
2d. Supply curves shift around, indicating changes
in other variables. See Figure 3.5. A shift is called
a change in supply.

2d.1. The principal determinants of supply are the
state of technology, the price of inputs, price
expectations, the number of sellers, and other
things that affect costs such as taxes, subsidies,
and regulations.

18
Figure 3.5
A Shift in the Supply
Curve
19
Shifts versus Movements
2e. Figure 3.6 to shows the difference
between movements along the supply curve
and shifts in it.

Movements are due to changes in non-price
determinants of supply while movements
are due to price changes (variable on the
vertical axis).

20
Figure 3.6
Shifts versus Movements
Along the Supply Curve
21
Figure 3.7
Overview of
Supply and
Demand
22
3. Market Equilibrium: Combining Supply and Demand

3a. The model of supply and demand is used to
explain the determination of market price. Use
Table 3.3 and Figure 3.7.

3b. Price adjusts to differences in quantity
demanded and quantity supplied. A shortage
indicates a willingness on the part of consumers to
pay sellers higher prices. A surplus indicates a
willingness on the part of sellers to lower prices.

3c. Price reaches equilibrium when quantity
demanded equals quantity supplied, ceteris
paribus.
23
Figure 3.8
Equilibrium Price and
Equilibrium Quantity
24
Equilibrium
Note: Price adjustment represents
movements along the curves and not shifts
of the curves.

3d. Shifts in the demand and/or the supply
curve may result in a price adjustment.
Figures 3.8 and 3.9 will be useful.

25
4. Using the Supply and Demand Model: A Case Study

4a. Figures 3.11, 3.12, and 3.13 show the
effects of shifts in the demand and supply of
peanuts on the price of peanuts. This
example shows the confusion between
movements along the demand curve and
shifts in the demand curve. See Figure 3.10.

26
Figure 3.9
Effects of a Shift in
Demand
27
Figure 3.10
Effects of a Shift in Supply
28
5. Interference with Market Prices
5a. One form of government interference with the
market process is the use of price controls. Price
ceilings keep prices from rising, whereas price floors
keep prices from falling.

5b. Price ceilings are always associated with shortages
because the ceiling keeps the price from rising to
equilibrium. Thus, the quantity demanded always
exceeds the quantity supplied. Rent controls are a
classic example. Black markets usually develop. Use
Figure 3.14.

5c. Price floors are associated with surpluses. Use
Figure 3.15. Governments must purchase the surplus
to support the price.
29
Figure 3.11
Peanut Production in the United States
30
Figure 3.12
Supply and Demand for
Peanuts
31
Figure 3.13
Effects of a Drought in the
Southeast
32
Figure 3.14
Predicted Effects of an
Increase in the Peanut
Quota

Economics: by John B. Taylor Stanford University

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Copyright 2001 by Houghton

Mifflin Company. All rights reserved.

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