Chapter: 3

Demand, Supply , and Equilibrium:

An Overview
 Demand
If you demand something, then you
Want it,
Can afford it, and
Have made a definite plan to buy it.
Wants are the unlimited desires or wishes
people have for goods and services.
Demand reflects a decision about which
wants to satisfy.
 The individual’s demand for a
commodity
The quantity of a commodity that an individual is
willing to purchase over a specified time period
depends on many factors such as:
 Price of the commodity and expected future price
 The person’s monthly income and expected
future income
 The prices of substitutes and compliments, and
 Individual’s tastes and preferences.
Qd = f (Px, M, Po, T, S)
 Individual’s demand schedule
By varying the price of the commodity and keeping other factors
unchanged (ceteris paribus) we get the individual’s demand
schedule for the commodity.
Price Quantity demanded
(Rs. per bar) (millions of bars per week)
A 0.50 22
B 1.00 15
C 1.50 10
D 2.00 7
E 2.50 5
 The individual’s demand curve

Price
Demand curve is downward sloping
3.00
2.50 E
2.00 D
1.50 C
1.00 B
0.50 A
0 5 10 15 20 25
Quantity demanded
 The law of demand

Other things remaining unchanged, the lower

the price of good X, the greater the quantity
of X demanded by the individual and higher
the price of the good X, the lower the quantity
of X demanded. In other words, there is an
inverse relationship between the price and
quantity demanded.
The law of demand results from:
 Substitution effect
 Income effect
Substitution effect:
When the relative price (opportunity cost) of a good
or service rises, people seek substitutes for it, so the
quantity demanded of the good or service
decreases.
Income effect:
When the price of a good or service rises relative to
income, people cannot afford all the things they
previously bought, so the quantity demanded of the
good or service decreases.
Shift in the individual’s demand curve
When any of the ceteris paribus conditions
changes, with price remaining the same, the
entire demand curve shifts. This is referred to
as a change in demand as opposed to change
in the quantity demanded, which is movement
along the same demand curve.
 Demand
Six main factors that change demand are:
 The prices of related goods
 Expected future prices
 Income
 Expected future income
 Population
 Seasonal and individual preferences
 Demand
Prices of Related Goods
A substitute is a good that can be used in place of
another good.
A complement is a good that is used in
conjunction with another good.
When the price of substitute for an energy bar
rises or when the price of a complement of an
energy bar falls, the demand for energy bars
increases.
 Demand
Expected Future Prices
If the price of a good is expected to rise in the future,
current demand for the good increases and the
demand curve shifts rightward.
Income
When income increases, consumers buy more of most
goods and the demand curve shifts rightward. A
normal good is one for which demand increases as
income increases. An inferior good (Giffen good) is a
good for which demand decreases as income
increases.
 Demand
Expected Future Income
When income is expected to increase in the
future, the demand might increase now.
Population
The larger the population, the greater is the
demand for all goods.
Preferences
People with the same income have different
demands if they have different preferences.
 Demand
A Change in the Quantity
Demanded Versus a
Change in Demand
Figure illustrates the distinction between a
change in demand and a change in the quantity
demanded.
 Demand
A Movement along
the Demand Curve
When the price of
the good changes
and everything else
remains the same,
the quantity
demanded changes
and there is a
movement along the
demand curve.
 Change or shift in the demand curve

A Shift of the Demand

Curve
If the price remains the
same but one of the
other influences on
buyers’ plans changes,
demand changes and the
demand curve shifts.
The Market Demand For a Commodity
 The market or aggregate demand for a commodity
gives the alternative amounts of the commodity
demanded per time period, at various alternative
prices, by all individuals in the market.
 The market demand for a commodity thus depends on
all the factors that determine individual’s demand, and
 On the number of buyers of the commodity in the
market
 Geometrically, the market demand curve is the
horizontal summation of all the individuals’ demand
curves for the commodity.
 Market demand schedule
Price DX1 DX2 DX
A 0.50 22 22 44
B 1.00 18 18 36
C 1.50 15 15 30
D 2.00 10 10 20
E 2.50 5 5 10
 Market Demand Curve

PX(Rs) PX(Rs) PX(Rs)

d1 1.50 d2 1.50 dx=dx1+dx2

0 15 Qd1 0 15 Qd2 0 30 Qdx

 Supply
The Single Producer’s Supply of a Commodity:
If a firm supplies a good or service, then the firm:
 Has the resources and the technology to produce
it,
 Can profit from producing it, and
 Has made a definite plan to produce and sell it.
The quantity supplied of a good or service is the
amount that producers plan to sell during a given
time period at a particular price.
In order to get a producer’s supply schedule and
supply curve of a commodity, certain factors
which influence costs of production must be
held constant (other factors remaining
constant) .
 Factors that change the supply
The main factors that change supply of a good are:
 The prices of inputs
 The prices of related goods produced
 Expected future prices
 The number of suppliers
 Technology
Government fiscal policy such as business tax rate
Central Bank’s monetary policy affecting market
interest rate
In case of agricultural commodities, weather.
Prices of Productive Resources (inputs)
If the price of resource used to produce a
good rises, the minimum price that a
supplier is willing to accept for producing
each quantity of that good also rises.
So a rise in the price of productive
resources decreases supply and shifts the
supply curve leftward.
Prices of Related Goods Produced
A substitute in production for a good is another
good that can be produced using the same
resources.
The supply of a good increases if the price of a
substitute in production falls.
Goods are complements in production if they
must be produced together.
The supply of a good increases if the price of a
complement in production rises.
Expected Future Prices
If the price of a good is expected to rise in the
future, supply of the good today decreases and
the supply curve shifts leftward.
The Number of Suppliers
The larger the number of suppliers of a good, the
greater is the supply of the good. An increase in
the number of suppliers shifts the supply curve
rightward.
Technology
Advances in technology create new
products and lower the cost of producing
existing products, so advances in
technology increase supply and shift the
supply curve rightward.
A natural disaster is a negative technology
change, which decreases supply and shifts
the supply curve leftward.
 Supply schedule and supply curve
By keeping all the above factors constant while
varying the price of the commodity, we get
the individual producer’s supply schedule and
supply curve:

In simple mathematical language:

Qsx = f (Px, Tech, Ps , Fn …..)
 Price Quantity supplied
(Rs. per bar (million of bars per week)
A 0.50 0 Supply curve is upward sloping
B 1.00 6 (Rs.)
C 1.50 10 3.00 E
D 2.00 13 2.50 D
E 2.50 15 2.00 C
1.50 B
1.00 A
0.50
0 6 10 13 15
 Market supply
Price SX1 SX2 SX
A 0.50 0 0 0
B 1.00 6 6 12
C 1.50 15 15 30
D 2.00 20 20 40
E 2.50 25 25 50
 law of Supply
In the supply schedule, we see that the lower
the price of X, the smaller the quantity of X
offered by the supplier and vice versa. This
direct relationship between price and quantity
is reflected in the positive slope of the supply
curve
Change or shift in the supply curve
When the factors that we kept constant (i.e.
other than the price) change, the entire
supply curve shifts. S”
Px(Rs) S
S’

0 Qsx
 Equilibrium
Equilibrium is a situation in which opposing
forces balance each other. Equilibrium in a
market occurs when the price balances the
plans of buyers and sellers.
The equilibrium price is the price at which the
quantity demanded equals the quantity
supplied.
The equilibrium quantity is the quantity
bought and sold at the equilibrium price.
 Price regulates buying and selling plans.
 Price adjusts when plans don’t match.
 Market Equilibrium
Px (Rs) QDx QSx Price (Px)
0.50 44 0 Sx
1.00 36 12 surplus
1.50 30 30 1.50
2.00 20 40 shortage Dx
2.50 10 50
0 30 Qx
Equilibrium means quantity demanded is equal to
quantity supplied at one price, so:
Qdx = Qsx Qdx = 42 - 8PX
42 – 8PX = 21 + 6PX Qdx = 42 – 8(1.5)
- 8PX – 6PX = 21 – 42 Qdx = 42 - 12
8PX + 6PX = -21 +42 Qdx = 30
14PX = 21
PX = 21/14
PX = 1.5
 Shifts in demand and supply, and
equilibrium
If the market demand curve, the market supply
curve, or both shift, the equilibrium point will
change.
Problem: Draw various equilibrium situations:
 Shifting demand curve keeping supply curve
unchanged.
 Shifting supply curve keeping demand curve
unchanged.
 Shifting both supply and demand curves.
See page 75 of Parkin for various combinations
 Review Quiz
1. What is the equilibrium price of a good or service?
2. When surplus or shortage of a good occurs in the market?
3. What happens to the price when there is a surplus or
shortage of a good in the market?
4. Why is the equilibrium price the best deal available for
both buyers and sellers?
5. What is the law of demand and how do we illustrate it?
6. What is the law of supply and how do we illustrate it?
7. List all the influences on buying plans that change
demand, and for each influence, say whether it increases
or decreases demand.
 Review Quiz
1. List all the influences on selling plans, and for
each influence, say whether it changes
supply.
2. From the following equation find the
equilibrium price and quantity of a good.
QDx = 800 – 2PD
QSx = 200 + 1PS
 Problems
Solve problems (Parkin 8th edition, Page 81)
1, 2, 3, 5, 6, 7, and 8