Lecture 3 (Chapter 3) Slides

Chapter 3
Demand, supply, and the

market
Economics, 12e
Key concepts in the study of markets
• Market: a set of arrangements by which buyers and sellers are in

contact to exchange goods or services.
• Demand: the quantity of a good buyers wish to purchase at each
conceivable price.
• Supply: the quantity of a good sellers wish to sell at each
conceivable price.
• Equilibrium price: price at which quantity supplied = quantity
demanded.
The demand curve shows the relation between price
and quantity supplied holding other things constant
Other things include:
• Price of related goods

Price
• Income of consumers
• Consumers’ tastes
D
• Consumers’ Expectations
Quantity
The supply curve shows the relation between price and quantity
demanded holding other things constant
S
Price
Other things include:
• Technology
• Input costs
• Government regulations
• Business expectations
Quantity
Market equilibrium
S Market equilibrium is at E0
Price
where quantity demanded

equals quantity supplied.
P0 E0 The equilibrium price is P0
and quantity Q0
Q0
Quantity
Behind the demand curve
• It is important to distinguish between movements (or shifts) in the

demand curve and movements along the demand curve.
• Movements along the demand curve result from changes in the price
of the good itself.
Movements along the demand curve
Price
• A movement along the

A demand curve from A to B
P0 occurs when price falls.
B • Here all other determinants
P1
of demand remain constant.
Q0 Q1 Quantity
Behind the demand curve
Movements (or shifts) in the demand curves are caused by:

 Changes in the price of related goods – either substitutes or
complements
Changes in consumer incomes
Changes in tastes
Expectations over future price changes.
Income changes and demand
• The influence of changes in income on demand depends

on whether the good is:
 a normal good or
 an inferior good.
Movements of or shifts in the demand curve
• A movement (or shift) of the

Price
demand curve from D0 to

D1leads to an increase in
demand at each and every
P0 C price.
A
P1 F
B • e.g., at P0 quantity demanded
increases from Q0 to Q2: at P1
quantity demanded increases
from Q1 to Q3.
Q0 Q1 Q2 Q3
Quantity
A shift in demand
If the price of a substitute

good decreases, then
Price
D0 less will be demanded at

D1 each price.
The demand curve shifts

P0 E0 from D0D0 to D1D1.
P1 E1
If price stayed at P0 the
resultant glut would put
downward pressure on the
D0 price.
D1
Demand would rise and
Q1 Q0 supply fall until equilibrium is
Quantity
restored at E1.
Behind the supply curve (1)
• It is important to distinguish between movements (or

shifts) in the supply curve and movements along the
supply curve.
• Movements along the supply curve result from changes

in the price of the good itself.
Behind the supply curve (2)
Movements (or shifts) in the supply curves are caused by:

 Changes in technology
 Changes in input costs
 Changes in government regulations
 Business expectations.
A shift in supply
S1
S0 Suppose safety
regulations are tightened,
Price
D
increasing producers’ costs.
E2 The supply curve
P1 shifts to S1S1.
P0 E0
If price stayed at P0, then there
would be excess demand and
upward pressure on price.
S0 D Demand would fall and supply
increase until market
Q1 Q0 Quantity equilibrium is restored.
Consumer and producer surplus(1)
• The difference between what a consumer is willing to pay for a

good and the price actually paid is a measure of the consumer’s
surplus.
• Total consumer surplus in a market is the sum of all the surpluses
enjoyed by all consumers.
Consumer and producer surplus (2)
• The difference between the price at which a firm would be willing

to supply a good and the price actually received by the firm is a
measure of its producer surplus.
• Total producer surplus in a market is the sum of all the surpluses
enjoyed by all producers.
Consumer and producer surplus (3)
For a single consumer, the

consumer surplus is the
difference between the
maximum price that she is
Price
Consumer willing to pay for a given

surplus amount of a good or service
and the price she actually
pays.
P*
Producer
surplus The producer surplus for
sellers is the amount that
sellers benefit by selling at a
market price that is higher than
they would be willing to sell for.
Q* Quantity
Consumer and producer surplus and the gains from trade
• The economic surplus in a market (sum of consumer and

producer surplus) is a measure of the benefits firms and
consumers derive from trade.
• It is maximized at the equilibrium price.
• Only at this price are all the benefits from exchange exhausted.
What, how and for whom
The market:
• decides how much of a good should be produced:
• by finding the price at which the quantity demanded equals the
quantity supplied.
• tells us for whom the goods are produced:
• those consumers willing to pay the equilibrium price.
• determines what goods are being produced:
• there may be goods for which no consumer is prepared to pay a
price at which firms would be willing to supply.
Free markets and price controls: a market in disequilibrium
• Suppose a disastrous harvest

Price
S moves the supply curve to SS.

• The resulting market clearing or
P2 equilibrium price is P0.
P0 E • Government may try to protect

the poor, setting a price ceiling
P1 A B at P1.
excess
• The result is excess demand.
demand
S RATIONING is needed to cope
with the resulting excess
QS Q0 QD Quantity demand.
Free markets and price controls: a market in disequilibrium
• Minimum wages are an example of a price floor and can result in

unemployment.
• Rent caps are an example of a price ceiling and can result in
shortages in rental markets.
Uncovering demand and supply curves
It is important to understand that demand and supply curves are not

physical objects that can be seen or touched.
Rather they are relationships revealed through the appropriate use

of statistical analyses undertaken by skilled econometricians.
Uncovering supply and demand
We cannot plot ex ante (forecast) demand curves and supply

curves.
So we use historical data and the supposition that the observed
values are equilibrium ones.
Since other things are often not constant, careful use of statistical
techniques is required to isolate the parameters of a demand or
supply curve.
Concluding comments (1)
Demand is the quantity that buyers wish to buy at each price.

Supply is the quantity of a good sellers wish to sell at each price.
The market clears, or is in equilibrium, when the price equates the
quantity supplied and the quantity demanded, and there are no
shortages or surpluses.
An increase in the price of a substitute good (or decrease in the
price of a complementary good) will raise the quantity demanded at
each price.
Concluding comments (2)
• The consumer surplus is measured by the area below the

market demand and above the equilibrium price.
• The producer surplus is measured by the area above the market
supply and below the equilibrium price.
• To be effective, a price ceiling must be imposed below the free
market equilibrium price.
• An effective price floor must be imposed above the free market
equilibrium price.

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Chapter 3

Demand, supply, and the

• Market: a set of arrangements by which buyers and sellers are in

Other things include:

• Price of related goods

Other things include:

where quantity demanded

• It is important to distinguish between movements (or shifts) in the

• A movement along the

Movements (or shifts) in the demand curves are caused by:

• The influence of changes in income on demand depends

• A movement (or shift) of the

demand curve from D0 to

If the price of a substitute

D0 less will be demanded at

The demand curve shifts

• It is important to distinguish between movements (or

• Movements along the supply curve result from changes

Movements (or shifts) in the supply curves are caused by:

• The difference between what a consumer is willing to pay for a

• The difference between the price at which a firm would be willing

For a single consumer, the

Consumer willing to pay for a given

• The economic surplus in a market (sum of consumer and

• Suppose a disastrous harvest

S moves the supply curve to SS.

P0 E • Government may try to protect

• Minimum wages are an example of a price floor and can result in

It is important to understand that demand and supply curves are not

Rather they are relationships revealed through the appropriate use

We cannot plot ex ante (forecast) demand curves and supply

Demand is the quantity that buyers wish to buy at each price.

• The consumer surplus is measured by the area below the

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