The Market Forces

of Supply and Demand

Look for the answers to these questions
• What factors affect buyers’ demand for
goods?
• What factors affect sellers’ supply of goods?
• How do supply and demand determine the
price of a good and the quantity sold?
• How do changes in the factors that affect
demand or supply affect the market price
and quantity of a good?
• How do markets allocate resources?
 Markets and Competition
• Market
– A group of buyers and sellers of a
particular good or service
– Buyers as a group
• Determine the demand for the product
– Sellers as a group
• Determine the supply of the product
 Markets and Competition
• Competitive market
– Many buyers and many sellers, each has
a negligible impact on market price
• Perfectly competitive market
– All goods are exactly the same
– Buyers and sellers are so numerous that
no one can affect the market price, “Price
takers”
 Demand
• Quantity demanded
– Amount of a good that buyers are willing
and able to purchase
• Law of demand
– Other things equal
– When the price of a good rises, the
quantity demanded of the good falls
– When the price falls, the quantity
demanded rises
Sam’s Demand Schedule
Demand schedule: Quantity
Price
− A table, shows the of lattes
of lattes
relationship between the demanded
price of a good and the $0.00 16
quantity demanded 1.00 14
− Example: Sam’s demand 2.00 12
3.00 10
for lattes
− Notice that Sam’s 4.00 8
5.00 6
preferences obey the law
6.00 4
of demand.
Sam’s Demand Schedule and Demand Curve
Quantity
Price of Price
of lattes
Lattes of lattes
demanded
$6.00 $0.00 16
$5.00 1.00 14
2.00 12
$4.00
3.00 10
$3.00 4.00 8
$2.00 5.00 6
6.00 4
$1.00
$0.00 Quantity of
0 5 10 15 Lattes
 Demand
• Market demand
– Sum of all individual demands for a good
or service
– Market demand curve: sum the individual
demand curves horizontally
• To find the total quantity demanded at any
price, we add the individual quantities
Market Demand versus Individual Demand
Suppose Sam and Dean are the only two buyers in
the market for lattes. (Qd = quantity demanded)

Price Sam’s Qd Dean’s Qd Market Qd

$0.00 16 + 8 = 24
1.00 14 + 7 = 21
2.00 12 + 6 = 18
3.00 10 + 5 = 15
4.00 8 + 4 = 12
5.00 6 + 3 = 9
6.00 4 + 2 = 6
The Market Demand Curve for Lattes

P Qd
P
(Market)
$6.00
$0.00 24
$5.00
1.00 21
$4.00 2.00 18
$3.00 3.00 15
4.00 12
$2.00
5.00 9
$1.00
6.00 6
$0.00
Q
0 5 10 15 20 25
 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
– Things that determine buyers’ demand for
a good, other than the good’s price
• Changes in them shift the D curve…
 Demand Curve Shifters
• Number of buyers
– Increase in # of buyers
• Increases quantity demanded at each price
• Shifts D curve to the right
– Decrease in # of buyers
• Decreases quantity demanded at each price
• Shifts D curve to the left
Demand Curve Shifters: # of Buyers

P Suppose the number

$6.00 of buyers increases.
Then, at each P, Qd
$5.00
will increase (by 5 in
$4.00 this example).
$3.00
$2.00
$1.00
$0.00
Q
0 5 10 15 20 25 30
 Demand Curve Shifters
• Income
– Normal good, other things constant
• An increase in income leads to an increase in
demand: Shifts D curve to the right
– Inferior good, other things constant
• An increase in income leads to a decrease in
demand: Shifts D curve to the left
 Demand Curve Shifters
• Prices of related goods, substitutes
– Two goods are substitutes if
• An increase in the price of one leads to an
increase in the 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 tablets, music CDs
and music downloads
 Demand Curve Shifters
• Prices of related goods, complements
– Two goods are complements if
• An increase in the price of one 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
 Demand Curve Shifters
• Tastes
– Anything that causes a shift in tastes
toward a good will increase demand for
that good and shift its D curve to the right
– Example:
• The Atkins diet became popular in the ’90s,
caused an increase in demand for eggs,
shifted the egg demand curve to the right
 Demand Curve Shifters
• Expectations about the future
– Expect an increase in income, increase in
current demand
– Expect higher prices, increase in current
demand
– Example:
• If people expect their incomes to rise, their D
for meals at expensive restaurants may
increase now
Summary: Variables That Influence Buyers
Active Learning 1 Demand
curve
• Draw a demand curve for music downloads
• What happens to it in each of the following
scenarios?
• Why?

A. The price of iPods falls

B. The price of music
downloads falls
C. The price of music CDs falls
Active Learning 1 A. The price of iPods falls

Music downloads and

Price of iPods are complements.
music
down-
A fall in price of iPods
loads
shifts the demand curve
P1 for music downloads to
the right.

D1 D2

Q1 Q2 Quantity of
music downloads
Active Learning 1 B. The price of music downloads falls

The D curve does not shift.

Price of
music
down- Move down along curve to a
loads point with lower P, higher Q.

P1

P2

D1

Q1 Q2 Quantity of
music downloads
Active Learning 1 C. The price of music CDs falls
Music CDs and music
Price of downloads are substitutes.
music
down- A fall in the price of music
loads
CDs shifts demand for
P1
music downloads to the left.

D2 D1

Q2 Q1 Quantity of
music downloads
 Supply
• Quantity supplied
– Amount of a good
– Sellers are willing and able to sell
• Law of supply
– Other things equal
– When the price of a good rises, the
quantity supplied of the good rises
– When the price falls, the quantity supplied
falls
Starbucks’ Supply Schedule
Supply schedule: Price Quantity
− A table, shows the of of lattes
relationship between the lattes supplied
price of a good and the $0.00 0
quantity supplied. 1.00 3
− Example: Starbucks’ 2.00 6
supply of lattes 3.00 9
− Notice that Starbucks’ 4.00 12
supply schedule obeys 5.00 15
the law of supply 6.00 18
Starbucks’ Supply Schedule and Supply Curve

Price Quantity
P of of lattes
$6.00 lattes supplied
$0.00 0
$5.00
1.00 3
$4.00 2.00 6
$3.00 3.00 9
4.00 12
$2.00
5.00 15
$1.00 6.00 18
$0.00
Q
0 5 10 15
 Market Supply vs. Individual Supply
• Market supply
– Sum of the supplies of all sellers of a good
or service
– Market supply curve: sum of individual
supply curves horizontally
• To find the total quantity supplied at any price,
we add the individual quantities
Market Supply vs. Individual Supply

Suppose Starbucks and Peet’s are the only two

sellers in this market. (Qs = quantity supplied)
Qs Qs
Price Starbucks Peet’s Market Qs
$0.00 0 + 0 = 0
1.00 3 + 2 = 5
2.00 6 + 4 = 10
3.00 9 + 6 = 15
4.00 12 + 8 = 20
5.00 15 + 10 = 25
6.00 18 + 12 = 30
The Market Supply Curve
QS
P P
(Market)
$6.00
$0.00 0
$5.00 1.00 5
$4.00 2.00 10
3.00 15
$3.00
4.00 20
$2.00
5.00 25
$1.00 6.00 30
$0.00
0 5 10 15 20 25 30 35 Q
 Supply Curve Shifters
• The supply curve
– Shows how price affects quantity supplied,
other things being equal
• These “other things”
– Are non-price determinants of supply
• Changes in them shift the S curve…
 Supply Curve Shifters
• Input prices
– Supply is negatively related to prices of
inputs
– Examples of input prices: wages, prices
of raw materials
– A fall in input prices makes production
more profitable at each output price
• Firms supply a larger quantity at each price
• The S curve shifts to the right
Supply Curve Shifters: Input Prices
P
$6.00 Suppose the price
$5.00 of milk falls.

$4.00 At each price, the

$3.00 quantity of lattes
supplied will
$2.00 increase (by 5 in
$1.00 this example).

$0.00
0 5 10 15 20 25 30 35
Q
 Supply Curve Shifters
• Technology
• Determines how much inputs are required to
produce a unit of output
– A cost-saving technological improvement
has the same effect as a fall in input
prices, shifts S curve to the right
• Number of sellers
– An increase in the number of sellers
• Increases the quantity supplied at each price
• Shifts S curve to the right
 Supply Curve Shifters
• Expectations about future
– Example: Events in the Middle East lead
to expectations of higher oil prices
• Owners of Texas oilfields reduce supply now,
save some inventory to sell later at the higher
price
• S curve shifts left
– Sellers may adjust supply* when their
expectations of future prices change
(*If good not perishable)
Summary: Variables That Influence Sellers
 Active Learning 2 Supply
curve
Draw a supply curve for tax return preparation
software. What happens to it in each of the
following scenarios?
A. Retailers cut the price of the software.
B. A technological advance allows the
software to be produced at lower cost.
C. Professional tax return
preparers raise the price of
the services they provide.
Active Learning 2 A. Fall in price of tax return software

Price of S curve does not shift.

tax return
S1
software
Move down along the
P1
curve to a lower P and
lower Q.
P2

Q2 Q1 Quantity of tax
return software
 Active Learning 2 B. Fall in cost of producing software

Price of
S curve shifts to the
tax return right:
S1 S2
software
at each price, Q
P1 increases.

Q1 Q2 Quantity of tax
return software
Active Learning 2 C. Professional preparers raise
their price
Price of Trick question:
tax return
S1
software
This shifts the demand
curve for tax
preparation software,
not the supply curve.

Quantity of tax
return software
Supply and Demand Together
P
Equilibrium: D
$6.00 S
Price has
$5.00
reached the
level where $4.00

quantity $3.00
supplied equals $2.00
quantity $1.00
demanded
$0.00
Q
0 5 10 15 20 25 30 35
Supply and Demand Together
Equilibrium price: price where Q supplied = Q demanded
Equilibrium quantity: Q supplied and demanded at the
equilibrium price
P D S
$6.00 P QD QS
$5.00 $0 24 0
$4.00 1 21 5
2 18 10
$3.00
3 15 15
$2.00 4 12 20
$1.00 5 9 25
$0.00 6 6 30
Q
0 5 10 15 20 25 30 35
ASK THE EXPERTS
Price Gouging
“Connecticut should pass its Senate Bill 60, which
states that during a ‘severe weather event emergency,
no person within the chain of distribution of
consumer goods and services shall sell or offer to sell
consumer goods or services for a price that is
unconscionably excessive.’”
Markets Not in Equilibrium: Surplus
Surplus (excess supply):
quantity supplied is
P greater than quantity
D S
$6.00 Surplus demanded
$5.00
Example: if P = $5,
$4.00 then QD = 9 lattes
$3.00 and QS = 25 lattes
$2.00
resulting in a surplus of
$1.00 16 lattes
$0.00
Q
0 5 10 15 20 25 30 35
Markets Not in Equilibrium: Surplus
Facing a surplus,
sellers try to increase
P sales by cutting price.
D S
$6.00 Surplus
$5.00 This causes QD to rise
$4.00
and QS to fall…
$3.00

$2.00 …which reduces the

$1.00 surplus.
$0.00
Q
0 5 10 15 20 25 30 35
Markets Not in Equilibrium: Surplus
Facing a surplus,
sellers try to increase
P sales by cutting price.
D S
$6.00 Surplus
$5.00 This causes QD to rise
$4.00
and QS to fall…
$3.00
Prices continue to fall
$2.00 until market reaches
$1.00 equilibrium.
$0.00
Q
0 5 10 15 20 25 30 35
Markets Not in Equilibrium: Shortage
Shortage (excess demand):
quantity demanded is
greater than quantity
P D Ssupplied
$6.00

$5.00 Example: if P = $1,

$4.00 then QD = 21 lattes
and QS = 5 lattes
$3.00

$2.00 resulting in a shortage of 16

$1.00 lattes

$0.00 Shortage
Q
0 5 10 15 20 25 30 35
Markets Not in Equilibrium: Shortage
Facing a shortage,
sellers raise the price,
P D S causing QD to fall
$6.00

$5.00 and QS to rise,

$4.00

$3.00
…which reduces the
shortage.
$2.00
$1.00
Shortage
$0.00
Q
0 5 10 15 20 25 30 35
Markets Not in Equilibrium: Shortage
Facing a shortage,
sellers raise the price,
P D S causing QD to fall
$6.00

$5.00 and QS to rise,

$4.00

$3.00
…which reduces the
shortage.
$2.00 Prices continue to rise
$1.00 until market reaches
Shortage
$0.00
equilibrium.
Q
0 5 10 15 20 25 30 35
 Supply and Demand Together
Three steps to analyzing changes in equilibrium
1. Decide whether the event shifts the
supply curve, the demand curve, or, in
some cases, both curves
2. Decide whether the curve shifts to the
right or to the left
3. Use the supply-and-demand diagram
• Compare the initial and the new equilibrium
• Effects on equilibrium price and quantity
EXAMPLE: The Market for Hybrid Cars
P
price of
S1
hybrid cars

P1

D1
Q
Q1
quantity of
hybrid cars
EXAMPLE 1: A Shift in Demand
EVENT TO BE ANALYZED:
Increase in the price of gas.
P
STEP 1: D curve shifts
because price of gas affects S1
demand for hybrids. (S curve P
2
does not shift, because price of
gas does not affect cost of
producing hybrids) P1
STEP 2: D shifts right
because high gas price makes
hybrids more attractive relative to D1 D2
other cars.
Q
STEP 3: The shift causes an Q1 Q2
increase in price and quantity of
hybrid cars.
 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
 Shift vs. Movement Along Curve
• 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
EXAMPLE 2: A Shift in Supply
EVENT: New technology
reduces cost of producing hybrid P
cars.
S1 S2
STEP 1: S curve shifts
because event affects cost of
production. (D curve does not
shift, because production
P1
technology is not one of the
factors that affect demand) P2
STEP 2: S shifts right
because event reduces cost, D1
makes production more Q
profitable at any given price. Q1 Q2
STEP 3: The shift causes price
to fall and quantity to rise.
EXAMPLE 3: A Shift in Both Supply and Demand

EVENTS: Price of gas

rises AND new technology P
reduces production costs S1 S2

STEP 1: Both curves shift. P

2
STEP 2: Both shift to the
P1
right.

STEP 3: Q rises, but the

D1 D2
effect on P is ambiguous:
Q
Q1 Q2
If demand increases more
than supply, P rises.
EXAMPLE 3: A Shift in Both Supply and Demand

EVENTS: Price of gas

rises AND new technology P
reduces production costs S1 S2

P1
P2
STEP 3: Q rises, but the
D1 D2
effect on P is ambiguous:
Q
Q1 Q2
But if supply increases
more than demand, P falls.
Active Learning 3 Shifts in supply and
demand
Use the three-step method to analyze the
effects of each event on the equilibrium price
and quantity of music downloads.
Event A: A fall in the price of music CDs
Event B: Sellers of music downloads
negotiate a reduction in the
royalties they must pay for each
song they sell.
Event C: Events A and B both occur.
Active Learning 3 A. A fall in the price of music CDs
The market for
STEPS: P music downloads
S1
1. D curve shifts
P1

2. D curve shifts left P2

3. P and Q both fall

D2 D1
Q
Q2 Q1
Active Learning 3 B. Fall in cost of royalties

STEPS: The market for

P music downloads
1. S curve shifts S1 S2
(Royalties are part of
P1
sellers’ costs)
P2
2. S curve shifts right

3. P falls, Q rises D1
Q
Q1 Q2
Active Learning 3 C. Fall in price of music CDs
and fall in cost of royalties
STEPS:
1. Both curves shift (see parts A & B)

2. D shifts left, S shifts right

3. P falls.
Effect on Q is ambiguous:
- the fall in demand reduces Q,
- the increase in supply increases Q.
 How Prices Allocate Resources
• “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
 Summary
• Economists use the model of supply and demand
to analyze competitive markets.
– Many buyers and sellers, all are price takers
• The demand curve shows how the quantity of a
good demanded depends on the price.
– Law of demand: as the price of a good falls, the
quantity demanded rises; the D curve slopes
downward
– Other determinants of demand: income, prices of
substitutes and complements, tastes, expectations,
and number of buyers.
– If one of these factors changes, the D curve shifts
 Summary
• The supply curve shows how the quantity of a
good supplied depends on the price.
– Law of supply: as the price of a good rises, the
quantity supplied rises; the S curve slopes upward.
• Other determinants of supply: input prices,
technology, expectations, and number of sellers.
– If one of these factors changes, supply curve shifts.
• The intersection of the supply and demand curves
determines the market equilibrium.
– At the equilibrium price, quantity demanded =
quantity supplied
 Summary
• The behavior of buyers and sellers naturally drives
markets toward their equilibrium.
– When the market price is above the equilibrium
price, there is a surplus of the good, which
causes the market price to fall.
– When the market price is below the equilibrium
price, there is a shortage, which causes the
market price to rise.
 Summary
• To analyze how any event influences a market, we
use the supply-and-demand diagram to examine
how the event affects the equilibrium price and
quantity.
1. Decide whether the event shifts the supply curve
or the demand curve (or both).
2. Decide in which direction the curve shifts.
3. Compare the new equilibrium with the initial one.
• In market economies, prices are the signals that
guide economic decisions and thereby allocate
scarce resources.