The Market Forces of Supply and De-

mand

WEEK 2 & 3

1
 Markets and Competition
 A market is a group of buyers and sellers of a
particular product.
 A competitive market is one with many buyers
and sellers, each has a negligible effect on price.
 A perfectly competitive market:
• all goods exactly the same
• buyers & sellers so numerous that no one can
affect market price – each is a “price taker”
 In this chapter, we assume markets are perfectly
competitive.
CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 2
 Demand
 Demand comes from the behavior of buyers.
 The quantity demanded of any good is the
amount of the good that buyers are willing and
able to purchase.
 Law of demand: the claim that the quantity
demanded of a good falls when the price of the
good rises, keeping other things equal

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 3

 Demand Curve Shifters
 The demand curve shows how price affects
quantity demanded, other things being equal.
 These “other things” are non-price determinants
of demand (i.e., things that determine buyers’
demand for a good, other than the good’s price).

 Changes in them shift the D curve…

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 4

Demand Curve Shifters: # of buyers
 An increase in the number of buyers causes
an increase in quantity demanded at each price,
which shifts the demand curve to the right.

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 5

 Demand Curve Shifters: # of buyers

P Suppose the number

$6.00 of buyers increases.
Then, at each price,
$5.00
quantity demanded
$4.00 will increase
$3.00 (by 5 in this example).

$2.00
$1.00

$0.00 Q
0 5 10 15 20 25 30
CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 6
Demand Curve Shifters: income
 Demand for a normal good is positively related
to income.
• An increase in income causes increase
in quantity demanded at each price, shifting
the D curve to the right.
(Demand for an inferior good is negatively re-
lated to income. An increase in income shifts D
curves for inferior goods to the left.)

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 7

Demand Curve Shifters: prices of
related goods
 Two goods are substitutes if
an increase in the price of one causes
an increase in demand for the other.
 Example: pizza and hamburgers.
An increase in the price of pizza
increases demand for hamburgers,
shifting hamburger demand curve to the right.
 Other examples: Coke and Pepsi,
laptops and desktop computers,
compact discs and music downloads
CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 8
Demand Curve Shifters: prices of
related goods
 Two goods are complements if
an increase in the price of one causes
a fall in demand for the other.
 Example: computers and software.
If price of computers rises, people buy fewer com-
puters, and therefore less software.
Software demand curve shifts left.

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 9

Demand Curve Shifters: expecta-
tions
 Expectations affect consumers’ buying deci-
sions.
 Examples:
• If people expect their incomes to rise,
their demand for meals at expensive restau-
rants may increase now.
• If the economy turns bad and people worry
about their future job security, demand for
new autos may fall now.

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 10

Summary: Variables That Affect Demand

Variable A change in this variable…

Price …causes a movement
along the D curve
No. of buyers …shifts the D curve
Income …shifts the D curve
Price of
related goods …shifts the D curve
Tastes …shifts the D curve
Expectations …shifts the D curve

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 11

A C T I V E L E A R N I N G 1:
Demand curve
Draw a demand curve for music downloads.
What happens to it in each of the following sce-
narios? Why?
A. The price of iPods
falls
B. The price of music
downloads falls
C. The price of com-
pact discs falls

12
A C T I V E L E A R N I N G 1:
A. price of iPods falls
Music
Music downloads
downloads
Price of
music and
and iPods
iPods are are
down- complements.
complements.
loads AA fall
fall in
in price
price of
of
iPods
iPods shifts
shifts the
the
P1
demand
demand curve curve for
for
music
music downloads
downloads
to
to the
the right.
right.
D1 D2

Q1 Q2 Quantity of
music downloads
13
A C T I V E L E A R N I N G 1:
B. price of music downloads falls

Price of
music
down- The
The D
D curve
curve
loads does
does not
not shift.
shift.
P1
Move
Move down
down along
along
curve
curve to
to aa point
point with
with
P2 lower
lower P,
P, higher
higher Q.
Q.

D1

Q1 Q2 Quantity of
music downloads
14
A C T I V E L E A R N I N G 1:
C. price of CDs falls

Price of CDs
CDs andand
music music
music downloads
downloads
down-
are
are substitutes.
substitutes.
loads
AA fall
fall in
in price
price of
of CDs
CDs
P1 shifts
shifts demand
demand forfor
music
music downloads
downloads
to
to the
the left.
left.

D2 D1

Q2 Q1 Quantity of
music downloads
15
 Supply
 Supply comes from the behavior of sellers.
 The quantity supplied of any good is the
amount that sellers are willing and able to sell.
 Law of supply: the claim that the quantity sup-
plied of a good rises when the price of the good
rises, other things equal

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 16

 Starbucks’ Supply Schedule & Curve
Price Quantity
P of lat- of lattes
$6.00 tes supplied
$0.00 0
$5.00
1.00 3
$4.00
2.00 6
$3.00 3.00 9
$2.00 4.00 12
5.00 15
$1.00
6.00 18
$0.00 Q
0 5 10 15
CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 17
 Supply Curve Shifters
 The supply curve shows how price affects quan-
tity supplied, other things being equal.
 These “other things” are non-price determinants
of supply.
 Changes in them shift the S curve…

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 18

Supply Curve Shifters: input prices
 Examples of input prices:
wages, prices of raw materials.
 A fall in input prices makes production
more profitable at each output price,
so firms supply a larger quantity at each price,
and the S curve shifts to the right.

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 19

 Supply Curve Shifters: input prices

P Suppose the
$6.00 price of milk falls.

$5.00
At each price,
$4.00 the quantity of
$3.00
Lattes supplied
will increase
$2.00 (by 5 in this ex-
$1.00 ample).

$0.00 Q
0 5 10 15 20 25 30 35
CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 20
Summary: Variables That Affect Sup-
ply
Variable A change in this variable…
Price …causes a movement
along the S curve
Input prices …shifts the S curve
Technology …shifts the S curve
No. of sellers …shifts the S curve
Expectations …shifts the S curve

CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 21

 Supply and Demand Together

P
$6.00 D S Equilibrium:
P has reached
$5.00
the level where
$4.00 quantity supplied
$3.00 equals
quantity demanded
$2.00
$1.00

$0.00 Q
0 5 10 15 20 25 30 35
CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 22
 Equilibrium price:
The price that equates quantity supplied
with quantity demanded
P
$6.00 D S
$5.00
$4.00

$3.00

$2.00
$1.00

$0.00 Q
0 5 10 15 20 25 30 35
CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 23
 Equilibrium quantity:
The quantity supplied and quantity demanded
at the equilibrium price
P
$6.00 D S
$5.00
$4.00

$3.00

$2.00
$1.00

$0.00 Q
0 5 10 15 20 25 30 35
CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 24
 Surplus:
when quantity supplied is greater than
quantity demanded
P
$6.00 D Surplus S Example:
If P = $5,
$5.00
then
$4.00 QD = 9 lattes
$3.00 and
$2.00 QS = 25 lattes

$1.00
resulting in a surplus
of 16 lattes
$0.00 Q
0 5 10 15 20 25 30 35
CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 25
 Surplus:
when quantity supplied is greater than
quantity demanded
P
$6.00 D Surplus S Facing a surplus,
sellers try to increase
$5.00 sales by cutting the price.
$4.00 This causes
$3.00 QD to rise and QS to fall…

$2.00 …which reduces the

surplus.
$1.00

$0.00 Q
0 5 10 15 20 25 30 35
CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 26
 Surplus:
when quantity supplied is greater than
quantity demanded
P
$6.00 D Surplus S Facing a surplus,
sellers try to increase
$5.00 sales by cutting the price.
$4.00 Falling prices cause
$3.00 QD to rise and QS to fall.

$2.00 Prices continue to fall until

market reaches equilibrium.
$1.00

$0.00 Q
0 5 10 15 20 25 30 35
CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 27
 Shortage:
when quantity demanded is greater than
quantity supplied
P
$6.00 D S Example:
If P = $1,
$5.00
then
$4.00 QD = 21 lattes
$3.00 and
QS = 5 lattes
$2.00
resulting in a
$1.00 shortage of 16 lattes
$0.00 Shortage Q
0 5 10 15 20 25 30 35
CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 28
 Shortage:
when quantity demanded is greater than
quantity supplied
P
$6.00 D S Facing a shortage,
sellers raise the price,
$5.00
causing QD to fall
$4.00 and QS to rise,
$3.00 …which reduces the
shortage.
$2.00
$1.00
Shortage
$0.00 Q
0 5 10 15 20 25 30 35
CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 29
 Shortage:
when quantity demanded is greater than
quantity supplied
P
$6.00 D S Facing a shortage,
sellers raise the price,
$5.00
causing QD to fall
$4.00 and QS to rise.
$3.00 Prices continue to rise
$2.00
until market reaches
equilibrium.
$1.00
Shortage
$0.00 Q
0 5 10 15 20 25 30 35
CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 30
 Terms for Shift vs. Movement Along
Curve
 Change in supply: a shift in the S curve
• occurs when a non-price determinant of supply
changes (like technology or costs)
 Change in the quantity supplied:
a movement along a fixed S curve
• occurs when P changes
 Change in demand: a shift in the D curve
• occurs when a non-price determinant of de-
mand changes (like income or # of buyers)
 Change in the quantity demanded:
a movement along a fixed D curve
• occurs when P changes