S121 ECO504 BUSINESS ECONOMICS
roy robin 
Session-02-handouts.pdf
1
The Market Forces
of Supply and Demand
Markets and Competition
• Supply and demand
– Words economists use most often
– The forces that make market economies
work
– Refer to the behavior of people as they
interact with one another in competitive
markets
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
2
Markets and Competition
• Markets take many forms
– Highly organized
• Markets for many agricultural commodities
– Less organized
• Market for ice cream or perfume in a
particular town
Markets and Competition
• Competitive market
– Market in which there are many buyers
and many sellers
– Each has a negligible impact on market
price
– Price and quantity are determined by all
buyers and sellers
• As they interact in the marketplace
Markets and Competition
• Perfectly competitive market
– Goods offered for sale are all exactly the
same
– Buyers and sellers are so numerous
• No single buyer or seller has any influence
over the market price
• Price takers
– At the market price
• Buyers can buy all they want
• Sellers can sell all they want
3
Markets and Competition
• Monopoly
– The only seller in the market
– Sets the price
• Other markets
– Between perfect competition and
monopoly
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 also rises
– When the price falls, the quantity supplied
falls as well
Supply
• Supply
– Relationship between the price of a good
and the quantity supplied
– Supply schedule: a table
– Supply curve: a graph
• Price on the vertical axis
• Quantity on the horizontal axis
• Individual supply
– A seller’s individual supply
4
Ben’s Supply Schedule and Supply Curve
Price of
Ice-cream
Cone
Quantity
Of Cones
Supplied
$0.00
0.50
1.00
1.50
2.00
2.50
3.00
0 cones
0
1
2
3
4
5
Supply curve
The supply schedule is a table that shows the quantity supplied at each price. This supply curve,
which graphs the supply schedule, illustrates how the quantity supplied of the good changes as
its price varies. Because a higher price increases the quantity supplied, the supply curve slopes
upward.
0 12 10 11 9 1 2 3 4 5 6 7 8
Quantity of Ice-Cream Cones
$3.00
2.50
2.00
1.50
1.00
0.50
Price of Ice-Cream Cones
1. An increase
in price . . .
2. . . . increases
quantity of cones
supplied.
Supply
• Market supply
– Sum of the supplies of all sellers for a
good or service
• Market supply curve
– Sum of individual supply curves
horizontally
– Total quantity supplied of a good varies
• As the price of the good varies
• All other factors that affect how much
suppliers want to sell are held constant
Market Supply as the Sum of Individual Supplies
The quantity supplied in a market is the sum of the quantities supplied by all the
sellers at each price. Thus, the market supply curve is found by adding horizontally
the individual supply curves. At a price of $2.00, Ben supplies 3 ice-cream cones,
and Jerry supplies 4 ice-cream cones. The quantity supplied in the market at this
price is 7 cones.
5
Market Supply as the Sum of Individual Supplies
SBen
0 1 2 3 4 5 6 7
Quantity of
Ice-Cream Cones
$3.00
2.50
2.00
1.50
1.00
0.50
Price of
Ice-Cream
Cones
Ben’s supply
SJerry
0 1 2 3 4 5 6 7
Quantity of
Ice-Cream Cones
$3.00
2.50
2.00
1.50
1.00
0.50
Price of
Ice-Cream
Cones
Jerry’s supply + =
SMarket
0 18 2 4 6 8 10 12 14 16
Quantity of
Ice-Cream Cones
$3.00
2.50
2.00
1.50
1.00
0.50
Price of
Ice-Cream
Cones
Market supply
Supply
• Shifts in supply
– Increase in supply
• Any change that increases the quantity
supplied at every price
• Supply curve shifts right
– Decrease in supply
• Any change that decreases the quantity
supplied at every price
• Supply curve shifts left
Shifts in the Supply Curve
Price of
Ice-Cream
Cones
Quantity of Ice-Cream Cones 0
Supply
curve, S1
Supply
curve, S3 Supply
curve, S2
Increase in
Supply
Decrease
In supply
Any change that raises the quantity that sellers wish to produce at any given price
shifts the supply curve to the right. Any change that lowers the quantity that sellers
wish to produce at any given price shifts the supply curve to the left.
6
Supply
• Variables that can shift the supply curve
– Input prices
– Technology
– Expectations about future
– Number of sellers
– Natural/Social factors
Variables That Influence Sellers
This table lists the variables that affect how much producers choose to sell of any
good. Notice the special role that the price of the good plays: A change in the good’s
price represents a movement along the supply curve, whereas a change in one of the
other variables shifts the supply curve.
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
7
Demand
• Demand
– Relationship between the price of a good
and quantity demanded
– Demand schedule: a table
– Demand curve: a graph
• Price on the vertical axis
• Quantity on the horizontal axis
• Individual demand
– An individual’s demand for a product
Catherine’s Demand Schedule and Demand Curve
Demand curve
The demand schedule is a table that shows the quantity demanded at each price. The demand
curve, which graphs the demand schedule, illustrates how the quantity demanded of the good
changes as its price varies. Because a lower price increases the quantity demanded, the
demand curve slopes downward.
Price of
Ice-Cream
Cone
Quantity of
Cones
Demanded
$0.00
0.50
1.00
1.50
2.00
2.50
3.00
12 cones
10
8
6
4
2
0
0 12 10 11 9 1 2 3 4 5 6 7 8
Quantity of Ice-Cream Cones
$3.00
2.50
2.00
1.50
1.00
0.50
Price of Ice-Cream Cones
1. A decrease
in price . . .
2. . . . increases quantity
of cones demanded.
Demand
• Market demand
– Sum of all individual demands for a good
or service
• Market demand curve
– Sum the individual demand curves
horizontally
– Total quantity demanded of a good varies
• As the price of the good varies
• Other things constant
8
Market Demand as the Sum of Individual Demands
The quantity demanded in a market is the sum of the quantities demanded by all the
buyers at each price. Thus, the market demand curve is found by adding horizontally
the individual demand curves. At a price of $2.00, Catherine demands 4 ice-cream
cones, and Nicholas demands 3 ice-cream cones. The quantity demanded in the
market at this price is 7 cones.
Market Demand as the Sum of Individual Demands
DCatherine
0 12 10 11 9 1 2 3 4 5 6 7 8
Quantity of Ice-Cream Cones
$3.00
2.50
2.00
1.50
1.00
0.50
Price of
Ice-Cream
Cones
Catherine’s demand
DNicholas
0 1 2 3 4 5 6 7
Quantity of Ice-Cream Cones
$3.00
2.50
2.00
1.50
1.00
0.50
Price of
Ice-Cream
Cones
Nicholas’s demand + =
DMarket
0 18 2 4 6 8 10 12 14 16
Quantity of Ice-Cream Cones
$3.00
2.50
2.00
1.50
1.00
0.50
Price of
Ice-Cream
Cones
Market demand
Demand
• Shifts in the demand curve
– Increase in demand
• Any change that increases the quantity
demanded at every price
• Demand curve shifts right
– Decrease in demand
• Any change that decreases the quantity
demanded at every price
• Demand curve shifts left
9
Shifts in the Demand Curve
Price of
Ice-Cream
Cones
Quantity of Ice-Cream Cones 0
Demand
curve, D1 Demand
curve, D3
Demand
curve, D2
Increase in
Demand
Decrease in
Demand
Any change that raises the quantity that buyers wish to purchase at any given price
shifts the demand curve to the right. Any change that lowers the quantity that buyers
wish to purchase at any given price shifts the demand curve to the left.
Demand
• Variables that can shift the demand curve
– Income
– Prices of related goods (substitutes and
complements)
– Tastes
– Expectations
– Number of buyers
•26
Variables That Influence Buyers
This table lists the variables that affect how much consumers choose to buy of any
good. Notice the special role that the price of the good plays: A change in the good’s
price represents a movement along the demand curve, whereas a change in one of
the other variables shifts the demand curve.
10
Two ways to reduce the quantity of smoking
demanded
1. Shift the demand curve for cigarettes and
other tobacco products
2. Try to raise the price of cigarettes
“What is the best way to
stop this?”
Shifts in the Demand Curve versus Movements along the Demand Curve
Price of Cigarettes, per Pack
Number of Cigarettes Smoked per Day 0
D1 D2
A policy to discourage
smoking shifts the
demand curve to the left
10 20
$2.00 B A
(a) A Shift in the Demand Curve
If warnings on cigarette packages convince smokers to smoke less, the demand curve for cigarettes shifts to the
left. In panel (a), the demand curve shifts from D1 to D2. At a price of $2.00 per pack, the quantity demanded falls
from 20 to 10 cigarettes per day, as reflected by the shift from point A to point B. By contrast, if a tax raises the
price of cigarettes, the demand curve does not shift. Instead, we observe a movement to a different point on the
demand curve. In panel (b), when the price rises from $2.00 to $4.00, the quantity demanded falls from 20 to 12
cigarettes per day, as reflected by the movement from point A to point C.
Price of Cigarettes, per Pack
Number of Cigarettes Smoked per Day 0
D1
A tax that raises the
price of cigarettes
results in a movement
along the demand curve
12 20
2.00
C
A
(b) A Movement along the Demand Curve
$4.00
Supply and Demand Together
• Equilibrium
– Various forces are in balance
– A situation in which market price has
reached the level where
• Quantity supplied = quantity demanded
– Supply and demand curves intersect
11
Supply and Demand Together
• Equilibrium price
– Balances quantity supplied and quantity
demanded
– Market-clearing price
• Equilibrium quantity
– Quantity supplied and quantity demanded
at the equilibrium price
The Equilibrium of Supply and Demand
Supply
0 12 10 11 9 1 2 3 4 5 6 7 8
Quantity of Ice-Cream Cones
$3.00
2.50
2.00
1.50
1.00
0.50
Price of
Ice-Cream
Cones Equilibrium
Demand
Equilibrium
price Equilibrium
quantity
The equilibrium is found where the supply and demand curves intersect. At the
equilibrium price, the quantity supplied equals the quantity demanded. Here the
equilibrium price is $2.00: At this price, 7 ice-cream cones are supplied, and 7 ice-
cream cones are demanded.
Markets Not in Equilibrium Price of
Ice-Cream
Cones
Quantity of Ice-Cream Cones 0
Demand
7
$2.50
(a) Excess Supply
In panel (a), there is a surplus. Because the market price of $2.50 is above the equilibrium price, the
quantity supplied (10 cones) exceeds the quantity demanded (4 cones). Suppliers try to increase sales by
cutting the price of a cone, and this moves the price toward its equilibrium level. In panel (b), there is a
shortage. Because the market price of $1.50 is below the equilibrium price, the quantity demanded (10
cones) exceeds the quantity supplied (4 cones). With too many buyers chasing too few goods, suppliers
can take advantage of the shortage by raising the price. Hence, in both cases, the price adjustment moves
the market toward the equilibrium of supply and demand
(b) Excess demand
2.00
Supply Surplus
4
Quantity
demanded
10
Quantity
supplied
Price of
Ice-Cream
Cones
Quantity of Ice-Cream Cones 0
Demand
7
1.50
$2.00
Supply
Shortage
4
Quantity
supplied
10
Quantity
demanded
12
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
Supply and Demand Together
• A change in market equilibrium due to a
shift in demand
– One summer, very hot weather
– Effect on the market for ice cream?
1. Hot weather: shifts the demand curve
(tastes )
2. Demand curve shifts to the right
3. Higher equilibrium price; higher
equilibrium quantity
How an increase in demand affects the equilibrium
Supply
New equilibrium
D2
An event that raises quantity demanded at any given price shifts the demand curve to the right.
The equilibrium price and the equilibrium quantity both rise. Here an abnormally hot summer
causes buyers to demand more ice cream. The demand curve shifts from D1 to D2, which causes
the equilibrium price to rise from $2.00 to $2.50 and the equilibrium quantity to rise from 7 to 10
cones.
Price of
Ice-Cream
Cones
Quantity of Ice-Cream Cones 0 7
$2.50
2.00
10
D1
Initial equilibrium
1. Hot weather increases the
demand for ice cream . . .
2. …resulting in
a higher price . . .
3. …and a higher
quantity sold.
13
How a Decrease in Supply Affects the Equilibrium
S1
New equilibrium S2
An event that reduces quantity supplied at any given price shifts the supply curve to the left.
The equilibrium price rises, and the equilibrium quantity falls. Here an increase in the price of
sugar (an input) causes sellers to supply less ice cream. The supply curve shifts from S1 to S2,
which causes the equilibrium price of ice cream to rise from $2.00 to $2.50 and the equilibrium
quantity to fall from 7 to 4 cones.
Price of
Ice-Cream
Cones
Quantity of Ice-Cream Cones 0 7
$2.50
2.00
4
Demand
Initial equilibrium
1. An increase in the price of sugar reduces
the supply of ice cream . . .
2. …resulting in
a higher price . . .
3. …and a lower
quantity sold.
A Shift in Both Supply and Demand
Price of
Ice-Cream
Cones
Quantity of Ice-Cream Cones
0
D1
P2
(a) Price Rises, Quantity Rises
Here we observe a simultaneous increase in demand and decrease in supply. Two outcomes
are possible. In panel (a), the equilibrium price rises from P1 to P2, and the equilibrium quantity
rises from Q1 to Q2. In panel (b), the equilibrium price again rises from P1 to P2, but the
equilibrium quantity falls from Q1 to Q2.
(b) Price Rises, Quantity Falls
P1
S1
Q1 Q2
D2
S2
Initial equilibrium
New
equilibrium
Small
decrease
in supply
Large increase
in demand
Price of
Ice-Cream
Cones
Quantity of Ice-Cream Cones
0
D1 P2
P1
S1
Q1 Q2
D2 S2
Initial
equilibrium
New
equilibrium
Large decrease
in supply
Small increase
in demand
How Prices Allocate Resources
• Supply and demand together
– Determine the prices of the economy’s
many different goods and services
“Two dollars” “—and seventy-five
cents.”
