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R. Larry Reynolds 

Fall ‘ 97 Principles of Microeconomics slide 1
 Demand and Supply
· Markets as allocative mechanism require:
· nonattenuated property rights
[exclusive, enforceable, transferable]
· “voluntary” transactions
· Markets include all “potential buyers and
sellers”
· behavior of buyers is represented by “demand”
[benefits side of model]
· behavior of sellers is represented by “supply”
[cost side of model]

Fall ‘ 97 Principles of Microeconomics slide 2

Markets, Supply and Demand
· markets include all potential buyers
and sellers
· geographic boundaries of market
· markets defined by nature of product
and characteristics of buyers
· conditions of entry into market
· markets, competition and substitutes

Fall ‘ 97 Principles of Microeconomics slide 3

 Demand
· Definition: “A schedule of the quantities
of a good that buyers are willing and able
to purchase at each possible price during a
period of time, ceteris paribus. [all other
things held constant]”
· Demand can also be perceived as a schedule
of the maximum prices buyers are willing
and able to pay for each unit of a good.

Fall ‘ 97 Principles of Microeconomics slide 4

 Demand Function
· Is the functional relationship between the
price of the good and the quantity of that
good purchased in a given time period [UT],
income, other prices and preferences being
held constant.
· A change in income, prices of other goods
or preferences will alter [‘shift’] the
demand function.

Fall ‘ 97 Principles of Microeconomics slide 5

 Quantity demanded
· A change in the price of the good under
consideration will change the “quantity demanded.”
· Q = f (P, holding M, Pr , preferences constant);
where: M = income
Pr = prices of related goods
 DP causes a change in X [DQ], this is a “change in
quantity demanded”

Fall ‘ 97 Principles of Microeconomics slide 6

 Change in demand
· If M, Pr, or preferences change, the demand
function [relationship between P and Q] will
change.
· These are sometimes called “demand shifters”
· Be sure to understand difference between a
“change in demand” and a “change in quantity
demanded”
· change in demand --- shift of the function
· change in quantity demanded --- move on the function

Fall ‘ 97 Principles of Microeconomics slide 7

 “Law of Demand”
· Theory and empirical evidence
suggest that the relationship between
Price and Quantity is an inverse or
negative relationship
· At higher prices, quantity purchased
is smaller, or at lower prices the
quantity purchased is greater.

Fall ‘ 97 Principles of Microeconomics slide 8

An example of hot chocolate:
There is a coffee cart in the building that primarily serves the
individuals who work in the building. The market is defined to some
extent by the geography of the building. Individuals who buy the
hot chocolate rarely come from other buildings to purchase a cup.
During the time period [UT]under consideration [8:00-9:00am on
a week day ] the incomes and preferences of buyers are unlikely to
change. The prices of coffee, lattes, etc. can be controlled by the
vendor and the price of soft drinks from the machines remains
constant. The number of workers in the building remain at a
constant level.

Under these circumstances, we observe the number of cups of hot

chocolate [H] sold each morning as the price [P] is changed.
From these observations the demand relationship is estimated.

Fall ‘ 97 Principles of Microeconomics slide 9

 Cupsof Hot Chocolate[H] purchased
eachdaybetween8-9am
price cups
The demand relationship
per cup purchased can be demonstrated as a
table:
A 0 20 .

B $ . 50 15 . Demand is a schedule of
quantities that will be
C $ . 75 12 . 5 purchased at a schedule
DP > 0 DQ < 0
D $ 1. 00 [+.75] 10 . [-7.5] of prices during a given
time period, cet. par.
E $ 1. 25 7.5
As the price is increased,
F $ 1. 50 5.
the quantity purchased
G $ 1. 75 2.5 decreases.
H $ 2 . 00 0

This demand relationship can be expressed as an equation:

P = 2 - .1Q or Q = 20 - 10P: [Q = f (P, . . .) but we graph P on
the Y axis and Q on the X axis.]
Fall ‘ 97 Principles of Microeconomics slide 10
The demand relationship can be expressed as a table
(previous slide) or an equation [either P = 2 - .1Q or Q = 20 - 10P]
The data from the table or equation can be graphed:
$
PRICE

P = $2, Then Q = 0 P = $1.75, then Q = 2.5

..
2.25
2.00
P = $1.50, then Q = 5

..
1.75
1.50 P = $1.25, Q = 7.5
1.25

..
1.00 P = $1, then Q = 10
.75 P = 0, then Q = 20
.50
.25 Demand

2 4 6 8 10 12 14 16 18 20
QUANTITY 22 24
The demand function can be represented as a table, {CUPS/UT}
an equation or a graph.
Fall ‘ 97 Principles of Microeconomics slide 11
The demand equation P = 2 - .1Q was graphed
A change in “quantity demanded” is a movement on the demand
function caused by a change in the independent variable [ price].
PRICE

DP from $1.50 to $1 causes DQ from 5 to 10 units

2.25

.
2.00
A change in quantity demanded is a move
1.75 A from point A to B “on the demand function”

.
1.50
caused by a change in the price!
1.25
B
1.00
.75
.50 Demand [P = 2 - .1Q]
.25
QUANTITY
2 4 5 6 8 10 12 14 16 18 20 22 24
{CUPS/ UT}

Fall ‘ 97 Principles of Microeconomics slide 12

 The demand equation P = 2 - .1Q was graphed
A change in any of the parameters (income, price of related goods,
preferences, population of buyers, etc.) will cause a “shift of the
demand function.” In this example, the intercepts have changed,
the slope has remained constant
PRICE

2.50
2.25
2.00
1.75
an increase in demand
1.50
D’ [ P’ = 2.5 - .1Q]
1.25
1.00
.75
.50 Demand [P = 2 - .1Q]
.25

2 4 6 8 10 12 14 16 18 20 22 24
QUANTITY
{CUPS/UT}
D`` [P`` = 1.5 -
Fall ‘ 97
.1Q]
Principles of Microeconomics slide 13
PRICE
2.50
2.25
2.00
1.75
buyers are more responsive to DP
1.50
1.25 P` = 2- .048076923Q
1.00
buyers
.75 a decrease in the
are less
slope
.50 responsive an increase in Demand [P = 2 - .1Q]
to DP the slope
.25
P = 2 - .25Q
2 4 6 8 10 12 14 16 18 20 22 24
QUANTITY
{CUPS/UT}

A change in the parameters [income, Pr, preferences, population,

etc.] might alter the relationship by changing the slope
A change in demand refers to a movement or shift of the entire
demand function

Fall ‘ 97 Principles of Microeconomics slide 14

PRICE
2.50
An increase in demand
2.25
2.00 results in a larger quantity being
1.75 purchased at each price
increase
1.50
1.25
1.00 D2 [an increase in demand]
.75
.50
Demand [P = 2 - .1Q]
.25 Q = 7.5
2 4 6 8 10 12 14 16 18 20 22 24
QUANTITY
In this case, an increase in demand results {CUPS/UT}

in an increase in the amount that will be purchased at a price of

$1.25. At this price the Quantity purchased increases from 7.5
to 18. An increase in demand!

Fall ‘ 97 Principles of Microeconomics slide 15

PRICE Effect of a change in the price of a
2.50
substitute
2.25
2.00
1.75
1.50
1.25
1.00
.75
.50 Demand [P = 2 - .1Q]
.25 D2
2 4 6 8 10 12 14 16 18 20 22 24
QUANTITY
If the price of a substitute, like chicken, increases [steak /UT]
buyers will buy more steak at each price of steak
If the price of chicken decreases, the buyers will want less steak at
each possible price of steak; the demand for steak decreases!

Fall ‘ 97 Principles of Microeconomics slide 16

 Complementary goods
Two goods may be complimentary, i.e. the two goods are
“used together. [tennis rackets and tennis balls or CD’s
and CD Players]
An increase in the price of CD’s will tend to reduce the
demand [shift the demand function to the left] for CD Players
As people buy fewer
PCD’s Pplayers CD’s, the demand for
As the price of CD’s increases CD players decreases.
from P1 to P2, the quantity of At the same price,
CD’s decreases from Y1 Ppl , the demand
P2 to Y. Ppl is reduced
from Dto D’.
D’player
P1 Dcd Dplayer

Y Y1 CD’s/UT X X1 CD Players
Fall ‘ 97 Principles of Microeconomics per UT17
slide
Compliments and Substitutes
· Substitutes:
· if the price of a substitute increases, the
demand for the good increases.
· if the price of a substitute decreases, the
demand for the good decreases.
· Compliments:
· if the price of a compliment increases, the
demand for the good decreases.
· if the price of a compliment decreases, the
demand for the good increases.
Fall ‘ 97 Principles of Microeconomics slide 18
 Demand Summary
· “Law of Demand” holds that usually as the
price of a good increases, individuals will
buy less of it.
· The nature of this relationship is
influenced by a variety of other variables;
· income, preferences, prices of related
goods, and other circumstances
· as these circumstances change, the
demand relationship changes or “shifts.”
Fall ‘ 97 Principles of Microeconomics slide 19
 Demand Summary [cont. . . ]
· A “change in demand” means the relationship
between price and quantity was altered by a
change in some other variable [a demand “shifter”]
The demand “shifts.”
· A “change in quantity demanded” is a change in the
quantity bought that was caused by a change in
the price of the good. There is a movement on the
demand function.

Fall ‘ 97 Principles of Microeconomics slide 20

 Supply
· Supply is defined as a schedule of
quantities of a good that will be produced
and offered for sale at a schedule of
prices during a given time [UT], ceteris
paribus.
· Generally, producers are willing to offer
greater quantities of a good for sale at
higher prices; a positive relationship
between price and quantity supplied.
Fall ‘ 97 Principles of Microeconomics slide 21
 Supply Schedule
Observation Price Quantity
Supplied
The information can be represented
A $1 6
on a graph by plotting each
B $2 10 price quantity combination.
C $3 14
D $4 18

E
F $5 22

P
$5
.
.
Both the graph and the table
represent a supply $4

.
relationship: Q = 2 + 4P $3
A supply schedule can be
displayed as a table.
$2
$1 .
Fall ‘ 97
2 4
Principles of Microeconomics
6 8 10 12 14
slide 22
Q
 Change in Quantity Supplied
· A change in the price of the good
causes a change in the “quantity
supplied.”
· The change in the price of the good
causes a “movement on the supply
function,” not a change or “shift of
the supply function.”

Fall ‘ 97 Principles of Microeconomics slide 23

 Supply Schedule
Observation Price Quantity
Supplied
A change in the price “causes” a
A $1
$1 6 change in the “quantity supplied.”
B $2 DP “CAUSES”
10 DQThis can be represented by a
C $3
$3 14 “movement” on the supply
D $4 18 function in the graph
E
F $5 22

This is a change in “quantity P

supplied.” Not to be $5 DP “causes” the quantity supplied
confused with a “change in to increase from 6 to 14.
$4
supply!”
$3
DP from $1 to $2
$3
$1

2 4 6 8 10 12 14 16 Q
Fall ‘ 97 Principles of Microeconomics
/ut
slide 24
 “Change in Supply”
· A change in supply [like a change in demand]
refers to a change in the relationship
between the price and quantity supplied.
· A change in supply is “caused” by a change
in any variable, other than price, that
influences supply
· A change in supply can be represented by a
shift of the supply function on a graph

Fall ‘ 97 Principles of Microeconomics slide 25

 “Change in Supply” [cont. . . ]
· There are many factors that infuence the
willingness of producers to supply a good.
· technology
· prices of inputs
· returns in alternative choices
· taxes, expectations, weather, number of
sellers, . . .
· Qs = fs (P, Pinputs, technology, . . .)

Fall ‘ 97 Principles of Microeconomics slide 26

 “Change in Supply” [cont. . . ]
· Qs = fs (P, Pinputs, technology, number of
sellers, taxes, . . .)
· A change in the price [P] causes a “change
in quantity supplied;”
· a change in any other variable causes a
“change in supply”

Fall ‘ 97 Principles of Microeconomics slide 27

 Supply Schedule
Given the supply schedule,
Observation Price Quantity
An increase in the prices Supplied
of inputs would make it A $1 46
more expensive to produce
B $2 810
each unit of output,
C $3 1214
therefore, the supply
decreases D $4 1618

E
F $5 20
22
P a shift to the left
$5 is a decrease in supply
The decreased quantity
$4
at each price “shifts” the
$3 supply curve to the left!
$2 The development of a “new”
technology that reduces the
$1
cost of production will “shift”
the supply function to the right
2 4 6 8 10 12 14 16 Q
Fall ‘ 97 Principles of Microeconomics slide 28
 Equilibrium
· Equilibrium: 1. a state of rest or balance due to
the equal action of opposing forces. 2. equal
balance between any powers, influences, [Webster’s
Encyclopedic Unabridged Dictionary of the English Language]
· In a market an equilibrium is said to exist when
the forces of supply [sellers] and demand [buyers] are
in balance: the actions of sellers and buyers are
coordinated. The quantity supplied equals the
quantity demanded!

Fall ‘ 97 Principles of Microeconomics slide 29

 100
90 Given a demand
80 function [which
$70
70 represents the
behavior or choices
60 of buyers,
50
40 and a supply function
30 that represents the
behavior of
20
sellers,
10

Qx/ UT
10 20 30 40 50 60 70 80 90 100 110 120 130
60
Where the quantity that people want to buy is equal to the quantity
that the producers want to sell, there is an equilibrium quantity.
The price that coordinates the preferences of the buyers and sellers
is the equilibrium price.
At the equilibrium price of $70, the quantity supplied is equal to
the quantity demanded.
Fall ‘ 97 Principles of Microeconomics slide 30
When the price is greater than the equilibrium price, the
amount that sellers want to sell at that price [quantity supplied]
exceeds the amount that buyers are willing to purchase [quantity
demanded] at that price. The price is “too high.”

At a Price of $90 the quantity supplied is 80, the quantity demanded is 35

surplus = 45
100
$90
90
80 At $90 there is a surplus
equilibrium price
$70
70 of 45 units [80-35=45]

equilibrium quantity
60
50
40
30
20
10

10 20 303540 50 60
60 70 80
80 90 100 110 120 130

Fall ‘ 97 Principles of Microeconomics

Qx/ UT
slide 31
 surplus = 45

.
100
$90
90
lower At a price of $90 a surplus
80
price of 45 units exists
$70
70
Suppliers have more to sell than
60 buyers will purchase at a price of $90.
50 To get rid of these unsold
40 Quantity units [inventory], the
Quantity
30
demanded
supplied sellers lower
increases
20
decreases the price.

10

10 20 303540 50 60
60 70 80
80 90 100 110 120 130
Qx/ UT
As the price of the good is reduced, the quantity supplied decreases.
The quantity demanded increases as the price falls.
As the price moves toward equilibrium, quantity supplied and
quantity demanded are brought into equilibrium.

Fall ‘ 97 Principles of Microeconomics

.
slide 32
 As a result of market forces

.
100 the market moves to
90 equilibrium
At a price below equilibrium the
80
the quantity demanded exceeds
$70
70
the quantity supplied.
60 price
At a price of $30 the quantity
50 rises
demanded is 110. The quantity
40 supplied is 15.
$30
30 quantity quantity
20 supplied demanded
10
increases decreases
shortage = 95
10 1520 30 40 50 60 70 80 110 120 130
90 100 110
60 Qx/ UT
At a price of $30 the quantity demanded exceeds the quantity
supplied by 95 units [110 - 15 = 95]. This is a shortage.
Since the buyers cannot obtain all they want at a price of $30, some buyers will
offer to pay more. Some buyers will not pay the higher price, they buy less so the
quantity demanded decreases. At the higher price the quantity supplied increases

.. Fall ‘ 97 Principles of Microeconomics slide 33

 100 demand
increases
90
$89 The market for good X is
price
80
rises in equilibrium at Px = $70
$70
70
60
50
40
30 equilibrium
quantity
20 increases
10

10 20 30 40 50 60
60 70 80
80 90 100 110 120 130
An increase in the price of a
substitute [good Y] causes the
demand for good X to increase.
As a result of the increased demand,
market forces push Px up.
Qx/ UT
The increase in the demand for
good X results in an increase in
both the equilibrium price and
quantity.
Identify other factors that could
increase demand!

Fall ‘ 97 Principles of Microeconomics slide 34

 100
90 Given a demand function,
80 an equilibrium is defined.
70
$70
A decrease in demand,
60
establishes a new equilibrium
$50.89
50 at a lower price and
40 quantity.
30
20
10

Qx/ UT
10 20 30 39.2
40 50 660
0 70 80 90 100 110 120 130
Demand might be reduced by: A change in the
a decrease in the price of a substitute, price of the good
an increase in the price of a compliment, does not change
a change in income, demand! It changes
a change in the number of buyers the quantity
or their preferences, or, . . . demanded.
Fall ‘ 97 Principles of Microeconomics slide 35
.
 100
90 S2
80
supply
$70
70 increases
price
60 falls

$50
50
40
30
20
10

60 70 8086
Qx/ UT
10 20 30 40 50 60 90 100 110 120 130
Given an equilibrium
condition in a market, Quantity Identify factors that increase supply:
1. fall in price of inputs
an increase in supply will increases
2. improved technology
increase the equilibrium 3. increase in number of sellers
quantity and decrease 4. fall in return in alternative
equilibrium P. uses of inputs
5. or, . . .

Fall ‘ 97 Principles of Microeconomics slide 36

A decrease in supply causes the equilibrium price to increase
and equilibrium quantity to decrease. What forces might cause the
supply to decrease?
1. an increase in the prices
S1 of inputs
2. increase in returns from
100 alternative actions
decrease in supply
$90
90
3. problems in technology
[regulations, . . . ]
80 price rises
4. decrease in number of
70
$70 sellers or producers
60
50 quantity
40 decreases
30
20
10

10 20 3035
Qx/ UT
40 50 6
600 70 80 90 100 110 120 130

Fall ‘ 97 Principles of Microeconomics slide 37

 100 demand
increases S2 If both supply and
90 and decrease
80 demand decrease,
price might price
+DP and the DP will be
70
$70 go up or down increase indeterminate and
60 or stay the same -DP price the equilibrium Q
increase
will decrease.
50 results in
increase
40
supply
a market
force to
results in
D2
30
increases a market Q
increase
20
force to
10 increase Q

10 20 30 40 50 660
0 70 80 90 100
100 110 120 130 Qx/ UT
When demand and supply both shift, the resultant effect on either
equilibrium price or quantity will be indeterminate.
Both the increase in demand and supply increase quantity; equilibrium Q increases.
The increase in demand pushes price up. The increase in supply pushes price down.
The change in price may be positive or negative, it depends on the magnitude
of the shifts in and slopes of demand and supply.
Fall ‘ 97 Principles of Microeconomics slide 38
A decrease in supply tends to increase P and reduce Q.

An increase in demand tends to increase both P and Q.

Result is that Price will rise, Quantity may increase, decrease or stay the same
depending on the magnitudes of the shifts and slopes of supply and demand.
In this example,
the price Price
increases to
$105
100
S1
$105. decrease in supply
to push
90
price up
When supply 80 pushes
increases and $70
70 price up
demand
decreases, 60
an increase in
the price will 50 demand tends D2
fall but the 40 reducesand
change in Q quantityincrease
30 Q
will be
20
indeterminate!
10

10 20 303540 49
50 60
60 70 80 90 100 110 120
Qx/ UT
the quantity decreases to 49
Fall ‘ 97 Principles of Microeconomics slide 39
 Supply and Demand Analysis
· Supply and demand is a simplistic model that
provides insights into the effects of events that
are related to a specific market.
· Whether an event will tend to cause the price of a
good to increase or decrease is of importance to
decision makers.
· To estimate the magnitude of price and quantity
changes more sophisticated models are needed.

Fall ‘ 97 Principles of Microeconomics slide 40