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The Basics of Demand,

Supply, and Equilibrium





Demand
A relation showing how
much of a good
consumers are willing and
able to buy at each
possible price during a
given period of time,
other things held constant
Law of Demand
A decrease in the price of a good, all other
things held constant, will cause an
increase in the quantity demanded of the
good.
An increase in the price of a good, all
other things held constant, will cause a
decrease in the quantity demanded of the
good.

Demand schedule Demand curve
Price
Quantity
Demanded
1.25 $ 8
1.00 $ 14
0.75 $ 20
0.50 $ 26
0.25 $ 32
$-
$0.25
$0.50
$0.75
$1.00
$1.25
2 8 14 20 26 32
Quantity
P
r
i
c
e
D
The Demand Curve
The demand curve
slopes downward
because of the law
of demand
Change in Quantity
Demanded
Quantity
Price
P
0

Q
0

P
1

Q
1

An increase in price
causes a decrease in
quantity demanded.
Change in Quantity
Demanded
Quantity
Price
P
0

Q
0

P
1

Q
1

A decrease in price
causes an increase
in quantity
demanded.
Changes in Quantity Demanded
(Increases and Decreases)
Q
P
D
decrease in
quantity demanded
increase in quantity
demanded
Changes in Demand
1. Changes in demand can
be caused by changes in,
1. Consumer Income
2. The prices of related
goods
Substitute Goods
Complementary Goods
Consumer expectations
The number of
consumers in the
market
Consumer taste
Change in Demand
Quantity
Price
P
0

Q
0
Q
1

An increase in demand
refers to a rightward
shift in the market
demand curve.
Change in Demand
Quantity
Price
P
0

Q
1
Q
0

A decrease in demand
refers to a leftward shift
in the market demand
curve.
Supply
A relation showing how much of a
good producers are willing and able
to sell at each possible price during a
given period of time, other things
held constant
The Law of Supply
1. The quantity of a good supplied
is directly related to its price,
other things constant
Law of Supply
A decrease in the price of a good, all other
things held constant, will cause a decrease
in the quantity supplied of the good.
An increase in the price of a good, all
other things held constant, will cause an
increase in the quantity supplied of the
good.
The Supply Curve
Supply schedule Supply curve
Price
Quantity
Supplied
1.25 $ 28
1.00 $ 24
0.75 $ 20
0.50 $ 16
0.25 $ 12
$-
$0.25
$0.50
$0.75
$1.00
$1.25
8 12 16 20 24 28
Quantity
P
r
i
c
e
S
The supply curve
slopes upward
because of the law
of supply
Change in Quantity
Supplied
Quantity
Price
P
1

Q
1

P
0

Q
0

A decrease in price
causes a decrease in
quantity supplied.
Change in Quantity
Supplied
Quantity
Price
P
0

Q
0

P
1

Q
1

An increase in price
causes an increase
in quantity
supplied.
Changes in Quantity Supplied
(Increases and Decreases)
Q
P
S
decrease in
quantity supplied
increase in
quantity supplied
Changes in Supply
Changes in supply can be caused by
changes in,
Production Technology
The prices of inputs/resources used in
production
The prices of alternative goods
Producer expectations
The number of producers
Change in Supply
Quantity
Price
P
0

Q
1
Q
0

An increase in supply
refers to a rightward shift
in the market supply
curve.
Change in Supply
Quantity
Price
P
0

Q
1
Q
0

An increase in supply
refers to a rightward shift
in the market supply
curve.
Change in Supply
Quantity
Price
P
0

Q
1
Q
0

An increase in supply
refers to a rightward shift
in the market supply
curve.
Market equilibrium
In equilibrium, the plans
of buyers match the
plans of sellers
Q
P
S D
Q
e
P
e
Market Schedules and
Equilibrium
Market schedules
Price
Quantity
Supplied
Quantity
Demanded
Surplus or
Shortage Price
1.25 $ 28 8 Surplus of 20 Fall
1.00 $ 24 14 Surplus of 10 Fall
0.75 $ 20 20 Equilibrium Remain the same
0.50 $ 16 26 Shortage of 10 Rise
0.25 $ 12 32 Shortage of 20 Rise
Markets move toward equilibrium.
An economic situation is in equilibrium when
no individual would be better off doing something
different.
Anytime there is a change, the economy will
move to a new equilibrium.
Ex.: What happens when a new checkout line
opens at a busy supermarket?
Equilibrium and Changes in
Demand
Q
P
S
D
Q
e
P
e
D
Q
e
P
e
Equilibrium and Changes in
Supply
Q
P
S
D
Q
e
P
e
Q
e
P
e
S
Effects of Changes in Both Supply
& Demand
Demand increases Demand decreases
Supply
increases
Equilibrium price change is
indeterminate.
Equilibrium quantity increases.
Equilibrium price falls.
Equilibrium quantity change is
indeterminate.
Supply
decreases
Equilibrium price rises.
Equilibrium quantity change is
indeterminate.
Equilibrium price change is
indeterminate.
Equilibrium quantity decreases.
Demand & Supply in Currency Markets
Foreign Exchange Rate
Price of a foreign currency in terms of the domestic
currency
Depreciation of the Domestic
Currency
Increase in the price of a foreign currency relative to
the domestic currency
Appreciation of the Domestic
Currency
Decrease in the price of a foreign currency relative to
the domestic currency
Demand for Dollars
Supply of Dollars
R = Exchange Rate = Rupee Price of Dollar
R = Rs/$
Million $ per day
Demand & Supply in Currency Markets
Market Check:

A convenient way to test whether a product
is in the same market as another one is to ask
the following question:

Are there either demand substitutes or
supply substitutes to this product?
Demand Substitutes If the price of good A rises substantially
(holding all else constant), will a significant number of buyers of
good A instead purchase good B?

Supply Substitutes If the price of good A rises substantially
(holding all else constant), will a significant number of producers of
good B decide to produce good A instead?
Consumer Surplus
The Consumer Surplus is the gains from trade for
a Consumer by purchasing a product. This is
measured as the difference between what the
consumer is actually paying and what the
consumer is willing to pay.
Total Consumer Surplus in market = Sum of
individual consumer surpluses
= area below the market demand curve but
above the price.
Producer Surplus
It is the gains from trade for a producer
measured as difference in the actual price
received by him/her and the price at
which he/she is willing to sell the product
(minimum price = cost of producing the
good)
Total Producer Surplus in a market = Sum
of individual producer surpluses = Area
above the supply curve but below the
price.