Chapter 2.

Demand, Supply and

Equilibrium prices

1.Basic theory of demand and supply

Markets and Competition
▪ Market – a group of buyers and sellers of
a particular good or service
▪ Competitive market – a market in which
there are many buyers and many sellers
so that each has a negligible [neglɪʤəbl]
impact on the
market price
 Competition: Perfect and
Otherwise
▪ Characteristics of a perfectly competitive market
▪ The goods being offered for sale are all the same
▪ The buyers and sellers are so numerous that none can influence the
market price
▪ Because buyers and sellers must accept the market price as given,
they are often called “price takers.”
▪ Not all goods are sold in a perfectly competitive market
▪ A market with only one seller is called a monopoly market
▪ seller controls price
▪ A market with only a few sellers is called an oligopoly
▪ Not always aggressive competition
▪ A market with a large number of sellers, each selling a product that is
slightly different from its competitor’s products, is called monopolistic
competition
▪ We will start by studying perfect competition
 Demand

▪ Demand comes from the behavior of buyers.

▪ The demand curve: the relationship between price and
quantity demanded
▪ Quantity demanded – the amount of a good that
buyers are willing and able to purchase
▪ One important determinant of quantity demanded is the
price of the product
▪ Quantity demanded is negatively related to price. This
implies that the demand curve is downward sloping
▪ Law of demand – the claim that, other things equal,
the quantity demanded of a good falls when the price
of the good rises.
 Demand Schedule
▪ A table that shows the Price Quantity
relationship between the of of lattes
price of a good and the lattes demanded
quantity demanded
$0.00 16
▪ Example:
Helen’s demand for 1.00 14
lattes. 2.00 12
▪ Notice that Helen’s 3.00 10
preferences obey the 4.00 8
Law of Demand.
5.00 6
6.00 4
Price of Demand Curve
Lattes
$6.00
▪ A graph of the
$5.00 relationship between the
price of a good and the
$4.00 quantity demanded
$3.00 ▪ Price is generally drawn
on the vertical axis
$2.00
▪ Quantity demanded is
$1.00 represented on the
horizontal axis
$0.00
Quantity
0 5 10 15 of Lattes
 Helen’s Demand Schedule
& Curve
Price of Quantity
Price
Lattes of lattes
of lattes
$6.00 demanded
$0.00 16
$5.00
1.00 14
$4.00
2.00 12
$3.00
3.00 10
$2.00 4.00 8
$1.00 5.00 6
$0.00 6.00 4
Quantity
0 5 10 15 of Lattes
 Why the demand curve
slopes downward?
▪ What causes the inverse relationship between
price and quantity demanded? Move along the
line/curve
▪ Law of Diminishing Marginal Utility
▪ Income Effect – a lower price has the effect of
increasing money income => buy more of other
things
▪ Substitution Effect–a lower price causes people
to switch to the purchase of the “better deal”
▪ Common sense – buy more if price is lower
 Utility
▪ Utility measures the want-satisfying power of a good or
service. Subjective notion
▪ Marginal utility is the additional or incremental satisfaction
(utility) a consumer receives from acquiring one additional
unit of a product.
▪ Total utility: the total amount of satisfaction or pleasure a
person derives from consuming some quantity.
▪ Disutility results when total satisfaction decreases with the
consumption of an additional unit.
▪ A person can eat only so many hot dogs before they get sick.
▪ A potato chip company had an ad that said "I bet you can't eat
one." The idea was that utility went up and you had to eat more
than one chip.
▪ A utility is a fictitious measure of satisfaction. Two utils have twice
the satisfaction of one utility.
 Law of Diminishing
Marginal Utility
▪ A law of economics stating that
as a person increases
consumption of a product - while
keeping consumption of other
products constant - there is a
decline in the marginal utility that
person derives from consuming
each additional unit of that
product.
▪ The more a good, a consumer
already has, the lower the extra
(marginal) utility (satisfaction) ▪ When total utility is at its peak, marginal
provided by each extra unit utility becomes zero. MU reflects the
change in total utility so it is negative
▪ A util = a unit of satisfaction when total utility declines
 Law of Diminishing
Marginal Utility
•Consumers want:
•1)To maximize their total utility
•2) The most for their money, most
“bang for their bucks”

3)

4)

In other words, whatever combination of

two goods that meets this condition with
the available income will maximize the
consumer’s total utility.
 Market Demand Versus
Individual Demand
▪ The market demand is the sum of all of the
individual demands for a particular good or
service
▪ The demand curves are summed horizontally –
meaning that the quantities demanded are
added up for each level of price
▪ The market demand curve shows how the total
quantity demanded of a good varies with the
price of the good, holding constant all other
factors that affect how much consumers want to
buy
 Shifts in the Demand Curve
▪ The demand curve shows how much
consumers want to buy at any price, holding
constant the many other factors that influence
buying decisions
▪ If any of these other factors change, the
demand curve will shift
▪ An increase in demand can be represented by a
shift of the demand curve to the right
▪ A decrease in demand can be represented by a
shift of the demand curve to the left
 Shifts in the Demand Curve
▪ Income
▪ The relationship between income and quantity
demanded depends on what type of good the
product is
▪ Normal good – a good for which, other things equal,
an increase in income leads to a increase in
demand
▪ Demand for a normal good is positively related to
income.
▪ Inferior good – a good for which, other things equal,
an increase in income leads to a decrease in
demand
▪ Demand for an inferior good is negatively related to
income.
 Shifts in the Demand Curve
▪ Prices of related goods
▪ Substitutes – two goods for which an increase in
the price of one good leads to an increase in the
demand for the other
▪ Example: hot dogs and hamburgers.
An increase in the price of hot dogs
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
▪ Complements – two goods for which an increase
in the price of one good leads to a decrease in the
demand for the other
▪ Example: computers and software.
If price of computers rises, people buy fewer
computers, and therefore less software.
Software demand curve shifts left.
▪ Other examples: college tuition and textbooks,
bagels and cream cheese, eggs and bacon
 Supply

▪ Supply comes from the behavior of sellers.

▪ The Supply Curve: The Relationship between
Price and Quantity Supplied
▪ Quantity Supplied – the amount of a good
that sellers are willing and able to sell
▪ Quantity supplied is positively related to price
▪ Law of supply – the claim that, other things
equal, the quantity supplied of a good rises when
the price of the good rises
 Supply Schedule
▪ Supply schedule – a table
that shows the Quantity
Price
relationship between the of lattes
of lattes
price of a good and the supplied
quantity supplied $0.00 0
▪ Example: 1.00 3
Starbucks’ supply of 2.00 6
lattes.
3.00 9
▪ Notice that Starbucks’
supply schedule obeys 4.00 12
the 5.00 15
Law of Supply.
6.00 18
 Supply Curve
P
$6.00
▪ Supply curve – a
$5.00 graph of the
$4.00 relationship between
the price of a good
$3.00
and the quantity
$2.00 supplied
$1.00
$0.00 Q
0 5 10 15
 Supply Curve
▪ Change in price causes a
change in quantity
▪ At X the price is P1 and
quantity is Q1.
▪ An increase in price
increases the quantity
supplied
▪ Moving to point Y where
price is P2 and quantity is
Q2.
 Starbucks’ Supply Schedule &
Curve Price Quantity
P of of lattes
$6.00 lattes supplied
$5.00 $0.00 0
$4.00 1.00 3
$3.00
2.00 6
3.00 9
$2.00
4.00 12
$1.00
5.00 15
$0.00 Q 6.00 18
0 5 10 15
 Market Supply vs.
Individual Supply
▪ The market supply curve can be found by
summing individual supply curves
▪ Individual supply curves are summed
horizontally at every price
▪ The market supply curve shows how the
total quantity supplied varies as the price
of the good varies
Shifts in the Supply Curve
▪ The supply curve shows how much producers
offer for sale at any given price, holding
constant all other factors that may influence
producers’ decisions about how much to sell
▪ When any of these factors change, the supply
curve will shift
▪ An increase in supply can be represented by a shift
of the supply curve to the right
▪ A decrease in supply can be represented by a shift
of the supply curve to the left
 Shifts in the Supply Curve
▪ Input prices/Resource(factor) 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.

▪ Technology
▪ Technology determines how much inputs
are required to produce a unit of output.
▪ A cost-saving technological improvement
has same effect as a fall in input prices,
shifts the S curve to the right.
 Supply Curve Shifters: input
prices
P Suppose the
$6.00 price of milk falls.
At each price,
$5.00
the quantity of
$4.00 Lattes supplied
will increase
$3.00
(by 5 in this
$2.00 example).
$1.00
$0.00 Q
0 5 10 15 20 25 30 35
Shifts in the Supply Curve
▪ Expectations
▪ Suppose a firm expects the price of the good it sells
to rise in the future.
▪ The firm may reduce supply now, to save some of
its inventory to sell later at the higher price.
▪ This would shift the S curve leftward.
▪ Number of sellers
▪ An increase in the number of sellers increases the
quantity supplied at each price, shifts the S curve to
the right.
 Shifts in the Supply Curve
▪ Taxes/subsidies
▪ When a tax is added to a
good the supply will
decrease, when a subsidy is
added to a good the supply
will increase.
▪ Price of other goods =>
production substitution
▪ Example: Corn syrup
cheaper than sugar. Coca-
Cola replaces sugar with
corn syrup and increases
the supply.
 Supply and Demand
Together
▪ Equilibrium
▪ The point where the supply and
demand curves intersect is called the
market’s equilibrium
▪ Equilibrium – a situation in which the
price has reached the level where
quantity supplied equals quantity
demanded
▪ Equilibrium price – the price that
balances quantity supplied and
quantity demanded
▪ the equilibrium price is often called the
“market-clearing” price because both
buyers and sellers are satisfied at this
price
▪ Equilibrium quantity – the quantity
supplied and the quantity demanded at
the equilibrium price
 Supply and Demand
Together
P Equilibrium:
$6.00 D S
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
 Equilibrium
__________ _____
price:
The price that equates quantity supplied
with quantity demanded
P
$6.00 D S
P QD QS
$5.00 $0 24 0
$4.00 1 21 5
$3.00 2 18 10
$2.00 3 15 15
$1.00 4 12 20
$0.00
5 9 25
Q
0 5 10 15 20 25 30 35 6 6 30
 Equilibrium
__________ ________
quantity:
The quantity supplied and quantity demanded
at the equilibrium price
P
$6.00 D S
P QD QS
$5.00 $0 24 0
$4.00 1 21 5
$3.00 2 18 10
$2.00 3 15 15
$1.00 4 12 20
$0.00
5 9 25
Q
0 5 10 15 20 25 30 35 6 6 30
 Supply and Demand
Together
▪ If the actual market price is
higher than the equilibrium
price, there will be a surplus
of the good
▪ Surplus – a situation in
which quantity supplied is
greater than quantity
demanded
▪ To eliminate the surplus,
producers will lower the
price until the market
reaches equilibrium
 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
 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
 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
 Supply and Demand
Together
▪ If the actual price is lower than the equilibrium
price, there will be a shortage of the good
▪ Shortage – a situation in which quantity
demanded is greater than quantity supplied.
▪ Sellers will respond to the shortage by raising
the price of the good until the market reaches
equilibrium
▪ Law of supply and demand – the claim that
the price of any good adjusts to bring the
supply and demand for that good into balance
 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
 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
 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
Three steps to analyzing
changes in equilibrium
▪ Decide whether the event shifts the supply or demand
curve
▪ Decide in which direction the curve shifts
▪ Use the supply-and-demand diagram to see how the
shift changes the equilibrium price and quantity
▪ A shift in the demand curve is called a “change in demand.” A
shift in the supply curve is called a “change is supply.”
▪ A movement along a fixed demand curve is called a “change in
quantity demanded.” A movement along a fixed supply curve is
called a “change in quantity supplied.”
 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 demand
changes (like income or # of buyers)
▪ Change in the quantity demanded:
a movement along a fixed D curve
▪ occurs when P changes
 CONCLUSION:
How Prices Allocate
Resources
▪ One of the Ten Principles from Chapter
1: Markets are usually a good way
to organize economic activity.
▪ In market economies, prices adjust to
balance supply and demand. These
equilibrium prices are the signals that
guide economic decisions and thereby
allocate scarce resources.
Crossword
Puzzle
 True/False
Demand
1. The law of demand states that, if nothing else changes, as the price of a
good rises, the quantity demanded decreases.
2. A decrease in income decreases the demand for all products.
3. “An increase in demand” means a movement down and rightward along a
demand curve.
4. New technology for manufacturing computer chips shifts the demand
curve for computer chips.

Supply
5. A supply curve shows the maximum price required in order to have the
last unit of output produced.
6. A rise in the price of chicken feed decreases the supply of chickens.
7. A rise in the price of orange juice shifts the supply curve of orange juice
rightward.
8. A good with a high relative price must have a low opportunity cost.
9. A product’s relative price can fall even though its money price rises.
 True/False Answers

Demand
1. T The law of demand points out the negative relationship between a product’s price
and the quantity demanded.
2. F Demand decreases for normal goods but increases for inferior goods.
3. F The term “increase in demand” refers to a rightward shift in the demand curve.
4. F Changes in technology are not a factor that shifts the demand curve. (Changes in
technology will shift the supply curve.)

Supply
5. F The supply curve shows the minimum price that suppliers must receive in order to
produce the last unit supplied.
6. T Chicken feed is a resource used to produce chickens, so a rise in its price shifts the
supply curve of chickens leftward.
7. F The rise in the price of orange juice creates a movement along the supply curve to
a larger quantity supplied (that is, upward and rightward), but it does not shift the
supply curve.
11. F A product’s relative price is its opportunity cost.
12. T A good’s relative price will fall if its money price rises less than the money prices
of other goods.
TASK No. 1. HOW MANY JUICE BOXES WILL BE SOLD.
If the price of tangerine juice 5,5 RMB. for 1 pack net sales amounted to 180
packages per day. How many packets of juice will be sold at a price of 7.2
RMB., if:

DECISION:
Let's use the formula of arc elasticity, as the prices differ from each other by
more than 10%:

Express from here

(since the price and volume are inversely related coefficient of elasticity-the
value is negative and equal to -1,2).

So, for the price of the 7.2 RMB will be sold …. packages of juice.