ECON 211- Microeconomics

Chapter 3: Supply and Demand

Concepts Covered:

 Market/Market Participants  Law of Demand/Supply

 Factor/Product Market  Market Equilibrium/Disequilibrium
 Demand/Supply  Shortage/Surplus
 Quantity Demanded/Supplied  Price Controls: Floor/Ceiling
 Substitution Effect and Income Effect

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The second chapter to be covered in this course is Supply and Demand. Before getting into that,
we need to study the Market and know what it is.

The Market is any place where goods and services are bought and sold. It can be a physical
space such as a supermarket or online such as Amazon, or both at the same time.

There are different Market Participants, those who are involved in the market.

 Consumers/households: want to maximize their own happiness

 Producers/businesses: want to maximize their profits
 Government: want to maximize social welfare

We have 2 markets known as the Factor Market and the Product Market. The factor market is
any place where the factors of production are bought and sold. The households sell their
resources (land owners, laborers, entrepreneurship abilities and capital) to businesses (firms)
and the businesses buy them.

Next we have the product market which is any place where finished goods and services are
bought and sold. The firms sell their products to households (consumers).

We also have 2 market participants who are the Households and Businesses. As we mentioned,
households sell factors of production to businesses and buy products from them. Businesses
buy factors of production from households and sell products to them.

The two sides of each market transaction are called supply and demand. We are supplying
resources to the market when we offer a job. We are demanding goods from the market when
we shop in a supermarket. Businesses can supply goods and services to the product market and
at the same time demand factors of production from the factor market

Fill in the blanks:

Households: ………………………….. (supply/demand) products

…………………………... (supply/demand) factors of production

Businesses: ………………………….. (supply/demand) products

………………………….. (supply/demand) factors of production

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DEMAND

For Demand to be counted in economics, the following 3 criteria must be met:

1. We must want the product

2. We can afford it
3. We actually plan to buy it

So it is not enough to say we like something, but that we actually plan on buying it.

The Quantity Demanded is the amount of a good or service that people are willing and able to
buy at a given time period at a particular price.

So what affects the quantity demanded of a product? Its price.

How does the price of a product, affect the quantity demanded for it?

The Law of Demand: ceteris paribus (other things remaining the same), the higher the price of
a good or service, the smaller is the quantity demanded; and the lower the price of a good or
service, the greater the quantity demanded.

This happens for 2 reasons: (when higher price of x reduces the quantity demanded of x)

1. Substitution Effect
2. Income Effect

1) Substitution Effect: when prices rise, consumers will replace more expensive items with less
costly alternatives.

For example: - if the price of pepsi rises from $3-$6, people will substitute it for coke (if it is
cheaper).

- if the price of pepsi drops from $3-$1.50, people will substitute coke for pepsi

2) Income Effect: if the price of pepsi increases, it is as if income dropped (purchasing power of
fixed income), so the Qd will drop.

Exceptions to the law of demand:

 Giffen goods: products people continue to buy even at high prices because there is a
lack of cheaper substitute products (such as rice, potato).
 Veblen effect: people tend to buy expensive goods to show off their status, ie. brand
names

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  Snob effect: some buyers have a desire to own unique products to show that they are
different than others.
 Bandwagon effect: preference for a good increases as the number of buyers purchasing
it increases (popularity).

Demand Curve and Demand Schedule

Demand: refers to the entire relationship between the price of a good and the quantity
demanded of the good. Demand is seen through the demand curve and demand schedule.
When we say quantity demanded, we refer to a particular point on the demand curve at a
particular price.

Demand Schedule: a table that shows the relationship between the price of a good and the
quantity demanded of the good.

Demand Curve: a graph that shows the relationship between the price of a good and the
quantity demanded of the good.

Let us take the following example which looks at the relationship between the price of energy
bars per dollar and the quantity demanded in millions of bars per week.

We can see that the demand curve slopes downward since it has a negative (inverse)
relationship with price. We can see that as price increases, the quantity demanded decreases.

A Change in Demand

When any factor, other than price, influences buying plans and decisions, we say that there is a
change in Demand. When demand increases, the demand curve will shift to the right and the
quantity demanded at each price increases; when demand decreases, the demand curve will
shift to the left and the quantity demanded at each price will decrease.

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There are 6 factors that cause a change in Demand:

1. Prices of related goods (substitutes and complements)

2. Expected future price of the good
3. Income
4. Expected future income
5. Population
6. Preferences/tastes

1. Prices of Related Goods: when we speak of related goods, we mean substitutes and
complements. Substitutes are goods that are used instead of each other while
complements are goods that are used with each other.
a. If the price of a substitute increases, people will demand less of that product and
more of another product to be used instead of it and if the price of the substitute
falls, people will demand more of it and less of the other product. For example:
pepsi and coke
b. If the price of a complement increases, the demand for it and the other
complementary good decreases. If the price of a complement decreases, the
demand for it and the complementary good both increase. For example play
station and play station games
2. Expected Future Prices: if the future price of something is expected to rise, demand for
it now will increase and if the future price is expected to drop, demand will drop now
and rise later. For example, the price of gas is expected to rise, we will demand more gas
and go and fill up our gas tanks, yet if it is expected to drop, our demand for it now will
drop as well and we will wait until its price drops to fill up.
3. Income: if income rises, consumers will demand more of most goods. Here we need to
differentiate between a normal good and an inferior good. A normal good is when
demand for the good increases as income increases whereas an inferior good is one
which demand drops as income increases. For example, with more income, people will
choose to travel more by airplane than long-distance bus trips (inferior good).
4. Expected Future Income: if income is expected to increase in the future, demand will
increase now and if it is expected to decrease, demand will drop now. For example, if
you are expecting a raise at work at the end of the month, you will increase your
demand now.
5. Population: the larger the population, the greater is the demand. For example, the
demand for parking spaces is higher in cities like Beirut than they are in Kelhat.
6. Preferences/Tastes: depends on things such as weather, fashion and information. For
example, health awareness has increased and the demand for healthy food has
increased as well.

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 Difference between a MOVEMENT ALONG THE CURVE and MOVEMENT OF THE CURVE.

These 6 factors cause a change in DEMAND (of the curve), NOT IN QUANTITY DEMANDED. Only
a change in the PRICE of the good itself causes a CHANGE IN QUANTITY DEMANDED (along the
curve). These factors only cause a change in demand and they will shift the demand curve
either to the right (increase) or the left (decrease). Whereas an increase in the price of a good
or service causes an upward movement along the demand curve whereas a decrease in the
price of a good or service causes a downward movement along the demand curve.

Now let us take the same example as before and suppose that our income has increased. What
affect will this have on demand, assuming that energy bars are a normal good? What will
happen to the demand curve? Demand for energy bars will increase and the demand curve will
shift to the right. We now have higher quantities of energy bars yet price remains the same.

SUPPLY

For Supply to be counted in economics, the following 3 criteria must be met:

1. Have the resources and technology to produce it

2. Can profit from producing it
3. Plan to produce and sell it

The Quantity Supplied is the amount of a good or service that producers are willing and able to
sell at a given time period at a particular price.

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The Law of Supply: ceteris paribus (other things remaining the same), the higher the price of a
good or service, the greater is the quantity supplied; and the lower the price of a good or
service, the lower is the quantity supplied.

Supply Curve and Supply Schedule

Supply: refers to the entire relationship between the price of a good and the quantity supplied
of the good. Supply is seen through the supply curve and supply schedule. When we say
quantity supplied, we refer to a particular point on the supply curve at a particular price.

Supply Schedule: a table that shows the relationship between the price of a good and the
quantity supplied of that good.

Supply Curve: a graph that shows the relationship between the price of a good and the quantity
supplied of that good.

Let us take the following example which looks at the relationship between the price of energy
bars per dollar and the quantity supplied in millions of bars per week.

We can see that the supply curve slopes upward since it has a positive (direct) relationship with
price. We can see that as price increases, the quantity supply increases.

A Change in Supply

When any factor, other than price, influences selling plans and decisions, we say that there is a
change in Supply. When supply increases, the supply curve will shift to the right and the
quantity supplied increases; when supply decreases, the supply curve will shift to the left and
the quantity supplied will decrease.

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There are 6 factors that cause a change in Supply:

1. Cost of production (prices of the factors of production used to make the

good/service)
2. Prices of related goods produced (substitutes and complements in production)
3. Expected future price of the good
4. Number of suppliers
5. Technology
6. Nature

1. Cost of production: here we mean the prices of factors of production that were used to
produce the good or service; not the prices of all the factors of production. If the price of
a factor of production used increases, the supply for that good/service will drop and if
the price of the factor of production used drops, then supply will increase. For example
if the wages paid to bakers increases, less bread will be supplied since the producer now
has higher costs and would not hire as many workers than if their wages were lower,
which might increase supply of bread.
2. Prices of related goods in production : here we also need to look at whether the good or
service if a substitute or a complement. The condition is that the same company
produces the 2 goods that are either substitutes or complements.
a. If the price of a substitute in production increases, less of the original good will be
supplied, and if the price of the substitute good drops, more of the original good will be
produced. For example if I supply both 7up and Pepsi, and the price of Pepsi increases,
as a supplier, I will produce less 7up and more Pepsi because they are substitutes.
b. If the price of a complement in production increases, I will supply more of the original
good yet if its price drops, I will supply less of it. For example if I am producing hot dogs
and hot dog buns and the price of hot dogs increases, I will supply more hot dog buns.
3. Expected future price of the good: if the price of a good or service is expected to
increase, suppliers will choose to supply less of it now and more of it later at a higher
price. Whereas if the price is expected to drop in the future, suppliers will supply more
of it now. For example gas stations.
4. Number of suppliers: if the number of suppliers of the particular good or service
increases, the higher is the supply of that good/service and the lower the number of
suppliers, the less if the supply. For example if Starbucks opens 20 new stores, more
coffee will be supplied and if it closes 20 stores, less coffee will be supplied.
5. Technology: the way in which factors of production are used to make a good/service. If
there is a positive technological change, supply will increase. If there is a negative
technological change, supply will decrease.

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 6. Nature: we mean all the natural forces that influence production including the weather
and the natural environment. For example, bad weather or floods will affect the corn
crops, wheat etc. and this will cause supply to decrease.

Difference between a MOVEMENT ALONG THE CURVE and MOVEMENT OF THE CURVE.

These 6 factors cause a change in SUPPLY (of the curve), NOT IN QUANTITY SUPPLIED. Only a
change in PRICE of the good itself causes a CHANGE IN QUANTITY SUPPLIED (along the curve).
These factors only cause a change in supply and they will shift the supply curve either to the
right (increase) or the left (decrease). An increase in the price of a good or service causes an
upward movement along the supply curve whereas a decrease in the price of a good or service
causes a downward movement along the supply curve.

Now we will take the same example yet consider that technology has improved. What will
happen to supply? How will the supply curve shift?

MARKET EQUILIBRIUM

Market Equilibrium is reached when Supply meets Demand. The equilibrium price (market
clearing price) is the price at which quantity demanded is equal to quantity supplied and the
equilibrium quantity is the quantity bought and sold at the equilibrium price.
We can get the equilibrium in 3 ways: graphically (intersection), table (Qd=Qs) or algebraically:
setting Qs to equal to Qd and solving for P, then replacing P into any of the equations. There are
some cases of disequilibrium: shortages and surpluses.

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Let us see this with the example we had before:

So a shortage is when the quantity demanded is more than the quantity supplied and this
happens at low prices since consumers are willing to buy more at low prices yet suppliers are
not willing to supply that quantity.
A surplus is when the quantity supplied is more than the quantity demanded and this happens
at high prices since suppliers are willing to provide more at higher prices yet consumers are
willing to buy less at these prices.
- When there is a shortage, consumers are willing to buy more than what is available so
producers will raise their prices to reach equilibrium and thus reducing the shortage.
- When there is a surplus, producers are providing more than what consumers are demanding
and thus must encourage consumers to buy more so they lower their prices, which will
decrease the quantity supplied and thus reducing the surplus.
- At market equilibrium, buyers pay the highest price they are willing to pay and sellers are
receiving the lowest price they are willing to accept for that good or service.

Changes in Market Equilibrium:

1. Decide whether the event shifts the supply or demand curve, or both
2. Decide in which direction the curve shifts
3. Use the supply and demand diagram to see how the shift changes the equilibrium price
and quantity

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Government interference in the market

Price Controls
This is when the government intervenes in the market by either setting a price ceiling or a price
floor.
1. Price Ceiling: when the government sees that free-market price (equilibrium price) is too
high and it wants to help consumers, a price ceiling is imposed by the government when it
believes that the equilibrium price is too high and thus sets a maximum price at which the
product can be sold in order to help consumers. There will be excess demand, resulting in a
shortage since Qd is higher than Qs. People will want to buy more of the good, resulting in
queuing and the black market.
* case of medicine: results in a shortage, Qd>Qs, no adjustment can be made because it is a
legal price. The government will step in and supply the medicine or pay the difference to
the suppliers.

2. Price Floor: when the government sees that the equilibrium price is too low, a price floor is
imposed by the government when it believes that the equilibrium price is too low and
therefore sets a minimum price that the good cannot be sold under. This will result in a
surplus because Qs will exceed Qd. The government will have to buy this surplus.
* Agricultural product A is set at $2, the government imposes a price floor= $4, to help
farmers. This will result in a surplus; consumers are not willing to buy as much as the
farmers are offering. The government will have to buy this surplus.

Show graphical illustration of each.

Algebraic calculation of Market Equilibrium

Explain this by doing problem 10 on page 11, to calculate Qe and P.

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