Topic 1 and 2

Supply and Demand

(Chapter 2)
Ratna K. Shrestha
2
The Market Forces of
Supply and Demand
Supply and Demand are the forces that
make market economies work!
This model allows managers to predict
changes in market outcomes caused by
changes in economic situations such as new
taxes, prices of inputs, and income.
For example, it can predict what happens to
the demand for online music when the price
of iPod goes down?
3
2.1 The Demand Curve
D
The Effect of Price:
The demand curve slopes
downward demonstrating
that consumers are willing
to buy more at a lower price,
given that other factors such
as income doesnt change.
Quantity
Price
($ per unit)
P
2

Q
1

P
1

Q
2

4
The Demand Curve
Variables (Other than Price) Affecting Demand
Income: Increases in income allow
consumers to purchase more at all prices,
shifting the demand curve to the right.
Consumer Tastes: Advertisement can
affect peoples taste.
Price of Related Goods
Substitutes and Complements
5
The Demand Curve
When the fall in price of one good reduces
the demand for another good (shift of demand
curve to the left), the two goods are
substitutes. Examples: Pepsi and Coke, butter
and margarine, etc..
When the fall in the price of one good
increases (shifts right) the demand for
another good, the two goods are
complements. e.g., computer and software.
6
The Demand Curve
Population
Consumer Expectations: If the consumers
expect the price of autos to be higher next
year, its demand today will increase (shifting
the curve to the right).
Govt. rules and regulations: If the city bans the
use of skateboards on its street, the demand
for skateboards falls (shift left). Sales taxes
can decrease the demand for goods (shift left).
7
D
P
Q
D
Q
1
P
2
Q
0
P
1
Q
2
Change (Shift) in Demand
With an increase
in income, demand
increases from Q
1

to Q
2
at P
1
and as a
result demand
curve shifts right.
This good is a
Normal good.
Examples
Melbourne newspaper
reports that local book
retailers are faring better
this Christmas (2008)
than last. So the income
elasticity seems to be
helping out here.
Possibly books are
inferior goods.
8
9
The Demand Curve
Changes in quantity demanded
Movements along the demand curve
caused by a change in the price of the
good itself.
Changes in demand (shift)
A shift of the entire demand curve caused
by something other than price, such as
income, preference, expectation etc...
10
The Demand Function
Estimated demand function for pork in
Canada
Q
D
= 171-20P+20P
b
+3P
C
+2Y,
where P
b
= Price of beef; P
C
= Price of chicken
and Y = income.
For given P
b
= $4, P
C
= $3.33 and Y = 12.5,
Q
D
= 286 20P.
In this case, Q
D
/ P = - 20. A 1$ increase in
P decreases Q
D
by 20 units (Law of demand).

11
The Demand Function
We can also analyze the effects of other
factors: Q
D
= 171 - 20P + 20P
b
+ 3P
C
+ 2Y.
Q
D
/P
b
= 20. A 1$ increase in P
b
increases
pork demand by 20 units, implying that pork
and beef are substitute goods.
Q
D
/ Y = 2 >0. When incomes increases,
pork demand also increases, implying that
pork is a normal good.

12
Market Or Industry Demand
Market Demand Curve
The sum of all the individual demand
curves in the market.
It is the horizontal summation of all the
individual demand curves.
For example, at P = $3, if D
A
= 2 and D
B
=6,
the total demand = 8 as given by the market
demand curve in the next slide.
13
Summing to Obtain a
Market Demand Curve
Quantity
1
2
3
4
Price
0
5
5 10 15 20 25 30
D
B
Market Demand
D
A
If Q
A
= 8 - 2P and Q
B
= 12 2P, then
market Q = Q
A
+ Q
B
= 20 4P.
6
14
2.2 The Supply Curve
S
Effect of Price
The supply curve slopes
upward demonstrating that
at higher prices firms are
willing to supply more.

Mathematically: dQ
s
/dP > 0.
Quantity
Price
($ per unit)
P
1

Q
1

P
2

Q
2

15
The Supply Curve
Other Variables (except Price) Affecting
Supply
Costs of Production: Labor, Capital, Raw
Materials:
Lower costs of production allow a firm to
produce more at each price level (and vice
versa) and shift the supply curve to the
right. Thus the decrease in the prices of
factors of production shift supply curve to
the right.
16
The Supply Curve
Weather pattern especially in the case of
agricultural products
Technology
Government regulation (taxes): excise tax on
production (tax on per unit production) make
it more expensive to produce and shifts
supply curve to the left.
Expectations about future prices
Number of producers
17
Change (or Shift) in Supply
Initially, produced
Q
1
at P
1

After the cost of raw
materials falls,
produce Q
2
at P
1
.
Supply curve
shifts right to S
P
S
Q
P
1
Q
1
S
Q
2
18
The Supply Curve
Change in Quantity Supplied
Movement along the curve caused by a
change in price of the good itself.
Change in Supply (shift)
Shift of the curve caused by a change in
something other than price of the good
itself such as changes in costs of
production.
19
Supply Function
Pork supply function:
Q
S
= 178 + 40P - 60P
h
.
where P
h
= Price of hog.
For given P
h
= $1.5, supply Q
S
= 88 + 40P.
In this case, Q
S
/ P = 40. Q
S
increase as its
market P increases (the law of supply).
Q
S
/ P
h
= - 60, implying that when the price
of hog goes up, supply decreases (shifts left).

20
2.3 The Market Equilibrium
D
S
The market
equilibrium is
determined by
the interactions
of S and D. At
the market-
clearing price P
0
,
Q
D
= Q
S
.
P
0
Q
0
Quantity
Price
($ per unit)
21
The Market Equilibrium
D
S
P
0
Q
0
1. If price is above
the market
clearing price
,
Q
S
> Q
D
2. Price falls to
the market-
clearing price
3. Market adjusts
to equilibrium
P
1
Surplus
Quantity
Price
($ per unit)
Q
S
Q
D
22
The Market Equilibrium
D
Q
S
Q
D
P
2
Quantity
Price
($ per unit)
1. If price is below
the market
clearing price
,
Q
D
> Q
S
2. Price rises to
the market-
clearing price
3. Market adjusts
to equilibrium.
Q
3
P
3
Shortage
23
Finding Market Equilibrium
Pork supply and demand functions:
Q
S
= 88 + 40p
Q
D
= 286 20p
At equilibrium, Q
D
= Q
S

286 20p = 88 + 40p
Solving for p, p = $ 3.3. Substituting p = 3.3
in either equation, Q = 220.

24
2.4 Shocks to Equilibrium
What happens to the price of Pork when the
price of hog (input) goes up?
Q
S
= 178+ 40p 60p
h

Q
D
= 286 20p
At equilibrium, Q
D
= Q
S

286 20p = 178 + 40p 60p
h
.
Or, p = 1.8 + p
h

Differentiating, p/ p
h
= 1, when p
h
goes
up by $1, p increases by $1 as well.

25
S
Shocks to Equilibrium
When the price
of hog goes up
(shifting S curve
to the left), the
price of pork
goes up as well.
P
Q
S
D
P
1
Q
1
Q
2
P
2
26
D
S
D
Q
3

P
3
Changes In Market Equilibrium
When income
Increases
Demand shifts to D
Shortage at P
1
of Q
2

Q
1

Shortage drives P up
Equilibrium at P
3
, Q
3

P
Q
Q
1
P
1
Q
2
27
Application: Market for a College
Education
Q (millions enrolled)
P
D
1970
S
1970
S
2010
D
2010
$6,000
13
$2,600
9
28
Application: BC Cranberry
After the discovery of beneficial health effect
of Cranberry in 1996 (Harvard Study), BC
cranberry farmers expected its demand and
hence price to go up. But to their dismay,
the price fell instead.
Analyze what might have caused this
unexpected result??