Chapter 3

Market demand and supply

Chapter summary
Demand and supply analysis is fundamental to an understanding of how a market economy works.
The law of demand states that there is an inverse relationship between the price of a good or service
and the quantity buyers are willing to purchase in a defined time period, ceteris paribus. This
indicates that the demand curve is downward-sloping from left to right. The market demand curve
is the horizontal summation of all individual demand curves in the market. Any price change will
cause a change in the quantity demanded and is reflected as a movement along the demand curve.
Whereas, if some non-price determinant of demand changes, this will cause a change in demand
that is reflected as a shift of the demand curve.
The law of supply is expressed as an upward-sloping curve from left to right. This is based
on the law of supply, which states that there is a direct relationship between the price of the good
and the quantity sellers are willing to offer for sale in a defined time period, ceteris paribus. The
market supply curve is the horizontal summation of all individual supply curves in the market. Any
price change will cause a change in the quantity supplied and is reflected as a movement along the
supply curve. Whereas, if some non-price determinant of supply changes, this will cause a change
in supply and is reflected as a shift of the supply curve.
When we bring demand and supply together we have a market. Equilibrium is shown at the
point of intersection between the demand and supply curves. Equilibrium exists at that price at
which the quantity demanded is just equal to the quantity supplied. At the equilibrium, neither a
surplus nor a shortage exists. If price is above equilibrium then a surplus is observed (the quantity
supplied exceeds the quantity demanded). Conversely, if the price is below equilibrium a shortage
will be observed. Surpluses cause prices to fall while shortages cause prices to rise.

New concepts introduced

• consumer sovereignty • change in demand
• substitute good • change in quantity supplied
• surplus • efficiency
• law of demand • normal good
• complementary good • change in supply
• shortage • price system
• change in quantity demanded • inferior good
• law of supply • market
• equilibrium

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22 Economics for Today Instructor’s Manual

Instructional objectives
After completing this chapter, students should be able to:
• describe the laws of demand and supply and express them graphically
• understand and distinguish the difference between a change in quantity demanded (supply)
from a change in demand (supply), and be able to illustrate these graphically (a change in the
quantity demanded (supplied) is reflected graphically as movement along a given demand
(supply) curve, whereas a change in demand (supply) is reflected as a complete shift of the
demand (supply) curve)
• express an increase in demand (supply) as a rightward shift and a decrease in demand (supply)
as a leftward shift of the demand (supply) curve
• identify the causes of an increase and a decrease in demand (supply)
• graphically express market equilibrium
• understand that equilibrium exists at that price at which the quantity demanded equals the
quantity supplied
• graphically express a surplus and a shortage
• understand that a surplus (shortage) exists whenever the price is above (below) equilibrium and
the quantity supplied exceeds (is less than) the quantity demanded
• explain why a surplus (shortage) will cause the price to fall (rise) in the market.

Chapter 3 outline
Introduction
The law of demand
Market demand
Exhibit 3.1 An individual buyer’s demand curve for compact discs
Exhibit 3.2 The market demand curve for compact discs
The distinction between changes in quantity demanded and changes in demand
Exhibit 3.3 Movement along a demand curve versus a shift in demand
Exhibit 3.4 Terminology for changes in price and non-price determinants of
demand
Non-price determinants of demand
Number of buyers
Tastes and preferences
Income
Expectations of buyers
Prices of related goods
You make the call: Can housing become an exception to the law of demand?
Exhibit 3.5 Summary of the impact of changes in non-price determinants of demand
on the demand curve
The law of supply
Exhibit 3.6 An individual seller’s supply curve for compact discs
Market supply
You make the call: Can the law of supply be applied to choice of university courses?
Exhibit 3.7 The market supply curve for compact discs
The distinction between changes in quantity supplied and changes in supply
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Exhibit 3.8 Movement along a supply curve versus a shift in supply

Exhibit 3.9 Terminology for changes in price and non-price determinants of supply
Non-price determinants of supply
Number of sellers
Technology
Input prices
Taxes and subsidies
Expectations of producers
Prices of other goods the firm could produce
Exhibit 3.10 Summary of the impact of changes in non-price determinants of supply
on the supply curve
Analyse the issue: Using the law of supply to help clean up the environment
A market supply and demand analysis
Exhibit 3.11 Demand, supply, and equilibrium for tennis shoes (pairs per year)
Equilibrium price and quantity
Exhibit 3.12 The supply and demand for tennis shoes
Analyse the issue: Should we adopt a market approach to organ shortages?
Key concepts
Summary
Study questions and problems
Online exercises
Answers to ‘You make the call’
Multiple-choice solutions

Hints for effective teaching

1 Spending some time on demand and supply analysis will pay off later. So don’t rush through
this material.
2 Use examples and diagrams as you go through demand and supply analysis.
3 Stress the distinction between a change in the quantity demanded (supplied) and demand
(supply). The best way to illustrate these points is to use diagrams. The distinction is made so
that we know whether, for example, people are buying more because the price went down
(increase in the quantity demanded) or because of some non-price factor (increase in demand).
Point out that in economics we are concerned with what causes what – with lines of causation.
If the lines of causation get tangled we get predictions that are useless.
4 Emphasise what is meant by an increase in demand (supply), as well as a decrease. For
example, note that an increase in demand means buyers will buy more at any given price – the
price hasn’t changed yet people are buying more. Show this graphically.
5 Have students think of some non-price determinants of demand or supply that are not
mentioned in the book, but which would result in an increase or decrease in supply – get the
students involved in the class.
6 Use diagrams as a visual aid but stress intuitive reasoning. For example, intuitively explain that
a surplus means more is put up for sale than buyers are willing to buy at that particular price.
Therefore, sellers are faced with unwanted inventories. They reduce their price – have a
clearance, or liquidation sale – to rid themselves of their excess stock. Likewise, a shortage

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24 Economics for Today Instructor’s Manual

means that some people will be willing and able to pay more just to get the item. In this way,
there is an inherent tendency for prices to move toward equilibrium.
7 Stress that a surplus will cause sellers to competitively bring down the price. A shortage will
cause buyers to competitively bid up the price (use petrol as an example).
8 It is usually a good idea to mention that demand and supply forces are at play in every market.
This stuff is not just an academic exercise. Mention that there are at least only three types of
markets:
a product markets (goods and services)
b resource markets (land, labour and capital)
c loanable funds markets.
Students may find it helpful to use demand and supply analysis in the labour or loanable funds
market. Mention that the only thing that changes is who is doing the demanding and who is
doing the supplying – all other analysis remains the same.

Solutions to text problems

Analyse the issue
Using the law of supply to help clean up the environment (pp 75-76)
1 The likely effect would be an increase in price resulting in a decrease in the quantity demanded.
2 Individuals’ attitudes may change as a result of a more environmentally friendly scheme.
Hence, demand for environmentally friendly products might increase as these individuals
support such a scheme, especially when environmental benefits become known.
3 Introduction of such a scheme would mean that the producers would face higher costs (e.g.
establishing collection points, hiring extra staff, etc.). This will lead to a reduction in supply of
bottled soft drinks and alcohol.

International focus
Should we adopt a market approach to organ shortages? (pp 80-81)
1 Draw a diagram similar to Exhibit 3.12. The information provided in the article (p.3) states that
‘compensating a supplier monetarily would encourage more people to offer their organs for
sale’. This implies that higher the price, higher would be the supply. However, at higher than
equilibrium prices few people would be able to afford organ transplants. Hence, there will be a
surplus of donors. On the other hand, at a lower price than equilibrium, there will be a shortage
of donors. Under the rationing system, where the price is zero there will be a huge excess
demand, as the diagram indicates. Under the price system, there would be more use of organ
transplants than under a rationing system – price will rise and so will quantity supplied as
compared with the rationing system.
2 The ethical issues that should be considered are many. They include respecting the rights of
religious and other groups, ensuring that the price system does not encourage people to kill
other people for their body parts and to ensure that there are alternatives to the price system so
that those who are unable to afford could also have a chance in obtaining an organ transplant.
Another ethical issue that should be considered is that poor people in developing countries are
not exploited.

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Study questions and problems solutions

(pp 84-85)
1 No, it does not. From a high-income earner’s perspective, a luxury good is just another normal
good. As more of that good is purchased, consumption of an extra unit of that good will result
in a fall in the high-income earner’s marginal utility. The consumer will; thus, buy less, but if
the price was to fall, this will encourage the consumer to purchase more of that good, which
indicates that the demand curve for it will be downward-sloping, left-to-right.
2 Figure 3A-1
a Decrease in the quantity demanded. b Decrease in demand.

The decrease in the quantity demanded is a response to an increase in the price from P1 to P2
per cut flower. The decrease in demand from D1 to D2 is caused by a change in a non-price
determinant, such as a decrease in the number of buyers. Note the difference in wording
‘decrease in quantity demanded’ and ‘decrease in demand’ (see Exhibit 3.3).
3 a The demand for cars will fall because petrol and cars are complementary goods.
b The demand for home insulation will rise (cheaper alternative) as, its substitute, oil heating
will become more expensive.
c The demand for coal will increase because it becomes a cheaper substitute.
d The demand for tyres will fall because tyres and cars are complements.

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26 Economics for Today Instructor’s Manual

4 Figure 3A-2
a Decrease in the quantity supplied b Decrease in supply

The decrease in the quantity supplied is a response to decrease in the price from P1 to P2 for
new houses. The decrease in supply from S1 to S2 is caused by a change in a non-price
determinant, such as a decrease in the number of sellers. Note the difference in wording
‘decrease in quantity supplied’ and ‘decrease in supply’ (see Exhibit 3.8).
5 The quantity of new word processing software exchanged in the market usually increases from
one year to the next in both demand and supply. Use a diagram to illustrate this point. Demand
increases due to the ever-increasing number of firms and students who require the use of such
software. Quantity supplied increases as there is the need to meet the increased demand.
Supply may also increase through other factors, such as technological breakthroughs (use
diagrams to show shifts in both demand and supply curves).
6 a Supply increases and price decreases.
b Demand decreases and price decreases.
c Demand increases and price increases.
d Demand increases and price increases.
e Demand decreases and price decreases.
f Demand decreases and price decreases.
g Supply increases and price decreases.
h Supply increases and price decreases.
7a Increase in population results in more consumers (increase in demand) and larger labour
force (increase in supply).
b The supply of good X falls as a result of rising cost of production.
c Supply of good Y increases.
d Demand for normal good X rises because consumer’s income increases.
e Demand for inferior good Y increases.
f Supply of brussels sprouts increases as farmers shift resources into their production.

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 Chapter 3: Market demand and supply 27

Diagrams for each part are shown below:

(a) (b) S1
P P
S S
S1

D1
D D
Q Q

P (c) P (d)
S S
S1

D1
D D
Q Q

P (e) P (f)
S S
S1

D1
D D
Q Q
8 The market price moves by trial and error toward the equilibrium price. If the market price is
above the equilibrium price, there will be a surplus. If the market price is below the equilibrium
price, there will be a shortage (use diagrams to illustrate this point).
9 a Supply of compact disc players will increase.
b Demand for compact disc players remains constant (only a movement along the demand
curve).
c The equilibrium price falls; the quantity of compact disc players increases.
d Demand for compact discs increases as compact discs and compact disc players are
complements.
10 The increased number of firms offering mail services reduces the price of this substitute
service. The effect will be a reduction of demand for services offered by Australia Post.
11 Shortages of tickets exist due to excess demand (i.e. shortage of supply – limited seatings). The
excess supply of tickets is due to the over-supply of seats or a lack of demand. In the case of
shortages the ticket price is below equilibrium; in the case of surpluses it is above equilibrium.
12 Higher market prices for good X discourage consumer purchases and encourage an increase in
the quantity of good X offered for sale. Lower market prices for good X encourage consumption
and discourage an increase in the quantity of good X offered for sale.

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28 Economics for Today Instructor’s Manual

Multiple-choice solutions
(pp 86–88)
1e a smaller quantity demanded for good X
2a the price of the good changes
3b a downward movement along the demand curve for tea
4b a change in the price of good X
5a shift to the left as consumers switch from beef to pork
6b a leftward shift in the demand curve for tea
7c increase the demand for oyster sauce
8b shift the demand curve for prawns to the left
9c shift the demand curve for an inferior good to the left
10b an increase in supply
11c a firm to supply a larger quantity at any given price
12c a leftward shift of the supply curve for bank services
13d a leftward shift in the supply curve for grapes
14d Qd is greater than Q
15c a shortage will cause the price to rise towards $10
16d $1.00, 200
17d a surplus of 200 units
18c downward pressure on price.

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