Chapter 2

Remaining topics:
laissez-faire economy
Post hoc fallacy
Fallacy of composition
PPF
Visible hands of Government

Basic Elements
of Demand,
Supply

Chapter Objectives
Demand and its determinants
Supply and its determinants
Supply, demand, & market
equilibrium
Changes in supply and
demand
Government-set prices
3-2

A Market
Interaction between
buyers and sellers
Buyers demand goods
Sellers supply goods
Assumptions
Standardized good
Competitive market
3-3

Demand
Schedule or curve
Amount consumers willing
and able to purchase at a
given price in a specific
time
Other things equal
Individual demand
Market demand

3-4

Law of Demand
Other things equal, as
price falls quantity
demanded rises
Explanations:
Diminishing marginal
utility
Income effect
Substitution effect

3-5

Individual Demand
P6

P
Rs.5

Qd
10

20

35

55

80

Price (per bushel)

5
4
3
2
1
0

D
10

20

30

40

50

60

70

80

Quantity Demanded (bushels per week)

3-6

Determinants of Demand
Factors that shift the demand
curve
Cause more or less to be
bought at any possible price
Increase or decrease in
demand
Tastes
Number of buyers (Population)
3-7

Determinants of Demand
Income
Normal goods
Inferior goods

Price of related goods

Substitute good
Complementary good
Unrelated goods
3-8

Determinants of Demand

Tastes and preferences

Expectations of future prices
Advertising
Distribution of income

Consumer expectations

3-9

Types of Goods
Normal goods are those goods whose demand goes up
when the consumers income increases.
Inferior goods are those goods whose demand falls
when the consumers income increases. e.g. autotravel,
Petrol
Giffen goods are those goods whose demand moves in
same direction as price (demand decreases when price decreases)
the consumer spends saved amount on other goods
Snob or Veblen goods (position goods; like luxury cars,
designers good) are those goods whose demand falls when
price falls
Bandwagon When individuals make rational choices
based on the information they receive from others
3-10

Individual Demand
P6

P
$5

Qd
10

20

35

55

80

Price (per bushel)

5
4
3
2

D2

D1

D3
0

10

12

14

16

18 Q

Quantity Demanded (bushels per week)

3-11

Individual Demand
P6

Change in Demand

P
Rs.5

Qd
10

20

35

55

80

Price (per bushel)

5
4

Change in Quantity
Demanded

3
2

D2

D1

D3
0

10

12

14

16

18 Q

Quantity Demanded (bushels per week)

3-12

Supply
Schedule or curve
Amount producers willing and able to
sell at a given price in a specific time

Individual supply
Market supply

3-13

Law of Supply
Other things equal, as
price rises the quantity
supplied rises
Explanations:
Revenue implications
(effects)
Marginal cost
3-14

Individual Supply
P6

P Qs
Rs.5 60
4 50
3 35
2 20
1

S1

Price (per bushel)

Individual
Supply

4
3
2
1
0

10

20

30

40

50

60

70

Quantity Supplied (bushels per week)

3-15

Determinants of Supply

Resource prices
Technology
Taxes and subsidies
Prices of other goods
Producer expectations
Number of sellers
3-16

Individual Supply
P6

P Qs
Rs.5 60
4 50
3 35
2 20
1

S3
5

Price (per bushel)

Individual
Supply

S1
S2

4
3
2
1
0

10

20

30

40

50

60

70

Quantity Supplied (bushels per week)

3-17

Individual Supply
P6

P Qs
Rs.5 60
4 50
3 35
2 20
1

S3
5

Price (per bushel)

Individual
Supply

Change in Quantity
Supplied

S1
S2

4
3
2

Change in Supply

1
0

10

20

30

40

50

60

70

Quantity Supplied (bushels per week)

3-18

Market Equilibrium
Equilibrium price and quantity
Surplus and shortage
Rationing (Controlling) function of price
Efficient allocation
Productive efficiency
Allocative efficiency
3-19

Equilibrium in a Market
Demand

Price

Supply

800

$3,000

2,900

1,150

$2,500

2,550

1,500

$2,000

2,200

1,850

$1,500

1,850

2,200

$1,000

1,500

2,550

$500

1,150

2,900

$0

3-20

Alternative Price- Control

Mechanisms
A price ceiling is a maximum price that sellers may
charge for a good, usually set by government.
Example: rent control
A price floor is a price above equilibrium price that
the buyers have to pay.
Example : agricultural support price, minimum wages

3-21

Market Equilibrium
Market
Demand
200 Buyers

Qd

Rs.5

2,000

4,000

7,000

11,000

16,000

6,000 Bushel
Surplus

Price (per bushel)

Market
Supply
200 Sellers

Rs.4 Price Floor

Rs.5 12,000
4 10,000

3
3

Rs.2 Price Ceiling

7,000 Bushel
Shortage

1
0

Qs

6 7 8

10

7,000

4,000

1,000

D
12

14

16

18

Bushels of Corn (thousands per week)

3-22

Market Equilibrium
Change in demand
Shift of the demand curve

Change in supply
Shift of the supply curve

Change in equilibrium price and quantity

3-23

Market Equilibrium

Price

Supply increase;
Demand decrease
Supply decrease;
Demand increase

Key Terms

demand
demand schedule
law of demand
diminishing marginal utility
income effect
substitution effect
demand curve
determinants of demand
normal goods
inferior goods
substitute good
complementary good
change in demand
change in quantity
demanded

supply
supply schedule
law of supply
supply curve
determinants of
supply
change in supply
change in quantity
supplied
equilibrium price
equilibrium quantity
surplus
shortage
price ceiling
price floor
3-25