Economics

Chap 2 – Demand and Supply

Dr. Cansu Unver-Erbas

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[email protected]

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AIM OF THIS LECTURE

In this lecture, we will learn about: MARKET FORCES OF SUPPLY AND DEMAND

Following the lecture, you should be able to

1. What a competitive market is
2. What determines the demand for a good in a competitive market
3. What determines the supply of a good in a competitive market

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READING MATERIAL

Mankiw, G. and Taylor, M. (2017). Microeconomics. Cengage Learning.

Chapter 3: The Market Forces of Supply and Demand

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EXAMPLES OF THE WORKINGS OF SUPPLY AND DEMAND

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EXAMPLES OF THE WORKINGS OF SUPPLY AND DEMAND

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INTRODUCTION

Supply and Demand:

 Two words that economists use most often

 Forces that make market economies work

 Determine the quantity of each good produced and the price at which it is
sold

 If you want to know how an event or policy will affect the economy, you
must first think about how it will affect supply and demand

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INTRODUCTION

 Supply and demand refer to behavior of people as they interact with one
another in markets.

 Market: group of buyers and sellers of a particular good or service.

 Buyers determine the demand.

 Sellers determine the supply.

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INTRODUCTION

Competitive market: a market in which there are many buyers and many sellers
so that each has a negligible impact on the market price.

 E.g., competitive market: market for milk.

Each producer of milk has limited control over the price because other sellers
are offering almost identical milk.

 E.g., non competitive market: Netflix, Hulu, and Amazon for

online
streaming.
Small number of providers → each provider is big enough to affect market price.

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INTRODUCTION

Perfectly competitive markets have 2 characteristics:

1. Goods being offered for sale are identical for all sellers.
2. Buyers or sellers are so numerous that no single buyer or seller
can influence the market price (they are “price takers”).

Perfectly competitive markets are easiest to analyse.

 In most of this course, we will assume that the market is competitive, i.e.,
study how buyers and sellers interact in perfectly competitive markets.

 We will study how buyers and sellers interact in other types of markets (e.g.,
(monopolistically competitive, oligopolistic, monopolistic) in Chap 8.

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INTRODUCTION

Assume you are planning to go to the cinema next Friday.

 What is the maximum price you would be willing to pay for a ticket?

 Find 2 other elements besides the price that determine how often you go to
the cinema every month.

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DEMAND

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DEMAND

Individual Demand / Market Demand

People have unlimited needs/wishes for goods and services.

Demand reflects a decision about which needs/wishes to satisfy.

Individual demand is the amount of a good that an individual is willing and able
to purchase within a given time period.

Market demand is the amount of a good that all buyers are willing and able to
purchase within a given time period.

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DEMAND

Individual Demand

Consider your own demand for pizzas. What factors affect how many pizzas you
buy each month?

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DEMAND

Individual Demand

Consider your own demand for pizzas. What factors affect how many pizzas you
buy each month?

Factors affecting individual demand:

a) Price of the good
b) Income
c) Price of related goods
d) Tastes
e) Expectations
f) Advertising

b, c, d, e, f: Non price determinants of demand.

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DEMAND

Individual Demand

a) How does price affect individual demand?

 If price of pizza increases, you will buy less pizza.

 If price of pizza decreases, you will buy more pizza.

Law of demand: Other things being equal, the quantity demanded of a good
falls when the price of the good rises.

( = Quantity demanded is negatively related to the price.)

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DEMAND

Individual Demand

b) How does income affect individual demand?

 If your income increases, you will buy more pizza.

 If your income decreases, you will buy less pizza.

If the demand for a good increases when income increases, the good is called a
normal good.
Example: pizza.

If the demand for a good falls when income increases, the good is called an
inferior good.
Example: frozen pizza

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DEMAND

Individual Demand

c) How does the price of related goods affect individual demand?

Related goods: those consumed with pizza or instead of pizza

 If price of pasta increases, you will buy more pizza.

 If price of beer (or something that you usually consume with pizza)
increases, you will buy less pizza.

Substitutes: two goods for which an increase in the price for one good leads to
an increase in the demand for the other good.
Example: pizza and pasta

Complements: two goods for which an increase in the price for one good leads
to a decrease in the demand for the other good.
Example: pizza and beer, petrol and cars, bacon and eggs 17
DEMAND

Individual Demand

d) How do tastes affect individual demand?

If you like pizza, you buy more of it.

Economists do not try to explain people’s tastes, but they examine what
happens when tastes change.

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DEMAND

Individual Demand

d) How do expectations affect individual demand?

 If you expect to earn a higher income next month, you may save less this
month and buy more pizza.

 If you expect the price of pizza to be lower next week, you may be less willing
to buy a pizza at today’s price.

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DEMAND

Individual Demand

f) How does advertising affect individual demand?

If a firm is having an advertising campaign, the demand for the product will rise.

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DEMAND

Individual Demand

Many variables determine quantity of pizza a person demands.

Imagine all these variables except price are held constant.

Demand schedule: table that shows the relationship between the price of a
good and the quantity demanded, when all other variables affecting demand
are held constant.

Demand curve: graph of the relationship between the price of a good and the
quantity demanded, when all other variables affecting demand are held
constant.

Example : Sabine’s ice cream demand schedule/curve.

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DEMAND

Individual Demand

Ex: Sabine’s demand schedule (ice-cream cones per month).

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DEMAND

Individual Demand

Sabine’s demand curve

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DEMAND

Market Demand

Market demand is the sum of all the individual demands for a particular good or
service.

Factors which determine market demand:

 factors which determine individual demand
 number of buyers

The market demand is found by adding horizontally the individual demand

curves.

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DEMAND

Market Demand

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DEMAND

Market Demand

Example: market demand 𝑄𝐷𝑀 for pizza when there are 3

consumers:
𝑝=£2.0 → 𝑄𝐷𝑀 =0+2+3=5

𝑝=£1.5 → 𝑄𝐷𝑀 =1+2+5=8

… for all prices

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DEMAND

Demand Changes

Important:

When the price changes, the quantity demanded changes. This is a movement
along the demand curve.

When a non price determinant changes, the demand schedule/curve change.

This is a shift of the demand curve.

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DEMAND

Demand Changes

Variables that influence buyers:

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DEMAND

Demand Changes

 Example 1: changes in demand for ice cream cones.

 Example 2: changes in demand for pizza.

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DEMAND

Demand Changes: Example 1

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DEMAND

Demand Changes: Example 1

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DEMAND

Demand Changes: Example 1

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DEMAND

Demand Changes: Example 1

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DEMAND

Demand Changes: Example 2 (changes in demand for pizza).

Suppose that the European Medical Association announces a new discovery:

people who regularly eat pizzas live shorter and less healthy lives.

How does this discovery affect market for pizza?

Which determinant of demand is affected by this discovery?

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DEMAND

Demand Changes: Example 2

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DEMAND

Finding price and quantity using algebra

Linear equation for a demand curve:

Qd = 1800 – 30p

 What will the quantity demanded be if

 the price is £5: Q = 1800 – 30*5 = 1650
 the price is £ 20: Q = 1800 – 30*20 = 1200

 If we know the quantity demanded is 1500 how much will the price then be?
1500 = 1800 – 30*P => -300 = -30P => P= 10

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DEMAND

Finding price and quantity using algebra

Exercise: Qd = -80P + 1600

Calculate Qd when the price is €10 and €15. Plot the demand curve.

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DEMAND

Finding price and quantity using algebra

Exercise: Qd = -80P + 1600

Calculate Qd when the price is €10 and €15. Plot the demand curve.

P=10: Q = -80*10 + 1600 = 800

P=15: Q = -80*15 + 1600 = 400

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DEMAND

Finding price and quantity using algebra

Exercise: Qd = -80P + 1600

Calculate Qd when the price is €10 and €15. Plot the demand curve.

P=10: Q = -80*10 + 1600 = 800

P=15: Q = -80*15 + 1600 = 400

Intercept vertical axis:

0 = -80P + 1600 => 80P = 1600 => P = 20

Intercept horizontal axis:

Q = -80*0 + 1600 => Q = 1600
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DEMAND

Finding price and quantity using algebra

P=10: Q = -80*10 + 1600 = 800

P=15: Q = -80*15 + 1600 = 400
Intercept vertical axis: 0 = -80P + 1600 => 80P = 1600 => P = 20
Intercept horizontal axis: Q = -80*0 + 1600 => Q = 1600

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SUPPLY

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SUPPLY

Individual Supply

The quantity supplied of any good or service is the amount that sellers are
willing and able to sell.

Individual supply: the amount that one particular firm is willing and able to sell.

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SUPPLY

Individual Supply

What determines the supply of pizza?

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SUPPLY

Individual Supply

What determines the supply of pizza?

Factors affecting individual supply:

a) Price of the good
b) Input Prices
c) Technology
d) Expectations
e) Natural/social factors
f) Profitability of other goods in production and prices of goods in joint
supply

b, c, d, e, f: Non price determinants of supply.

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SUPPLY

Individual Supply

a) How does price affect individual supply of a firm?

 If the price of pizza is high, producing pizzas is profitable, so the firm

should produce and sell many pizzas.
 If the price of pizza is low, producing pizzas is not that profitable, so the
firm should produce and sell few pizzas.

Law of supply: Other things being equal, the quantity supplied of a good rises
when the price of the good rises.

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SUPPLY

Individual Supply

b) How do input prices affect individual supply?

Input prices for producing pizza: price of tomatoes, ham, mozzarella, oven, etc.

When the price of one or more inputs rises, producing pizza becomes less
profitable so the firm should produce less pizzas.

The quantity supplied of a good is negatively related to the price of inputs used
to make that good.

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SUPPLY

Individual Supply

c) How does technology affect individual supply?

An advancement in technology that reduces firms’ cost (e.g., less workers

needed to produce same number of pizzas) will make producing pizzas more
profitable and thus raise the quantity of pizza supplied.

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SUPPLY

Individual Supply

d) How do expectations affect individual supply?

If the firm expects the price of pizza to increase in the future, it will put some of
its current production into storage and supply less to the market today.

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SUPPLY

Individual Supply

e) How do natural/social factors affect individual supply?

Examples:
 flood or drought reduces agricultural production.
 Impact Covid-crisis on cinemas

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SUPPLY

Individual Supply

e) How do the profitability of other goods in production and prices of goods in

joint supply affect individual supply?

Firms have some flexibility in their supply and can sometimes switch production
to other goods that might be more profitable.

Sometimes goods are in joint supply – e.g. lamb and wool

An increase in the supply of lamb will also lead to an increase in the supply of
wool

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SUPPLY

Individual Supply

 Many variables determine quantity of pizza a firm supplies.

 Imagine all these variables except price are held constant.

 The supply schedule is a table that shows the relationship between the price
of the good and the quantity supplied when all other variables affecting
supply are held constant

 Supply curve: graph of the relationship between the price of a good and the
quantity supplied when all other variables affecting supply are held constant.

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SUPPLY

Individual Supply

Ex: Häagen’s Supply Schedule

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SUPPLY

Individual Supply

Häagen’s Supply curve

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SUPPLY

Market Supply

Market Supply is the sum of all the individual supplies for a particular good or
service.

The market supply is found by adding horizontally the individual supply curves.

It shows how the total quantity supplied of a good varies as the price of the
good varies.

Market supply depends on:

 factors that determine individual supply
 number of sellers

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SUPPLY

Market Supply

Example: market supply schedule of pizzas when there are 3 suppliers

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SUPPLY

Supply Changes

Important:

When the price changes, the quantity supplied changes. This is a movement
along the supply curve.

When a non price determinant changes, supply changes. This is a shift of the
supply curve.

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SUPPLY

Supply Changes

Variables that influence supply:

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SUPPLY

Supply Changes

 Example 1: changes in supply for ice-cream cones.

 Example 2: changes in supply for pizza.

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SUPPLY

Supply Changes: Example 1

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SUPPLY

Supply Changes: Example 1

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SUPPLY

Supply Changes: Example 2

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SUPPLY

The algebra of Supply

Linear equation for a supply curve:

Qs = -150 + 50P

 How much is the supplied quantity if the price is

 the price is £10:
 the price is £15:

 Intercept horizontal axis:

 Intercept vertical axis:

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SUPPLY

The algebra of Supply

Linear equation for a supply curve:

Qs = -150 + 50P

 How much is the supplied quantity if the price is

 the price is £10: Q = -150 + 50*10 = 350
 the price is £15: Q = -150 + 50*15 = 600

 Intercept horizontal axis:

Q = -150 + 50*0 = -150

 Intercept vertical axis:

0 = -150 + 50P => P = 3
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SUPPLY

 Intercept horizontal axis:

Q = -150 + 50*0 = -150
 Intercept vertical axis:
0 = -150 + 50P => P = 3

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SUMMARY

 The demand curve shows how the quantity of a good depends on the price.
 According to the law of demand, as the price of a good falls, the
quantity demanded rises. Therefore, the demand curve slopes
downward.
 In addition to price, other determinants of how much consumers want
to buy include income, the prices of complements and substitutes,
tastes, expectations, advertising and the number of buyers. If one of
these factors changes, the demand curve shifts.

 The supply curve shows how the quantity of a good supplied depends on the
price.
 According to the law of supply, as the price of a good rises, the quantity
supplied rises. Therefore, the supply curve slopes upward.
 In addition to price, other determinants of how much producers want to
sell include input prices, technology, expectations, … and the number of
sellers. If one of these factors changes, the supply curve shifts. 65