CHAPTER 2: SUPPLY, DEMAND, AND that a single consumer is willing to

MARKET EQUILIBRIUM buy, or quantity demanded.

The Model of Supply and Demand

 The purpose of the model of supply
and demand is to predict changes in
market quantity and price based on
changes in supply and demand
conditions.
 The supply and demand model is
used to explain how a perfectly The Individual Demand Curve and The Law
competitive market operates. of Demand

The Demand Curve

 Market demand shows how much of
a particular product are consumers
willing to buy during a particular
time period, all else being equal.

Variables Affecting Demand

The main determinants of demand includes:  The negative slope of the individual
demand curve reflects the law of
 The price of the product demand.
 Consumer income  Law Of Demand: The higher the
 The price of related goods- price, the smaller the quantity
substitutes and complements demanded, ceteris paribus.
 The number of consumers
 Consumer preferences- tastes and
advertising The “Ceteris Paribus” Assumption
 Consumer expectations about future
prices
The Individual Demand Curve
 It shows the relationship between
the price of a good and the quantity
  The lower the price of a good, the
smaller the sacrifice associated with
 To obtain various points on the
consumption of good.
individual demand curve for pizzas
we assume that only the price of the The Income Effect
pizzas changes, while other
 It describes the change of
determinants of the demand for
consumption resulting from an
pizzas (income, tastes and
increase in the consumer’s real
preferences, the price of related
income, or the income in terms of
goods, etc.) remain constant, or
the goods the money can buy.
ceteris paribus.
 Real income is the consumer’s
income measured in terms of
the goods it can buy.

A Change in Quantity Demanded

 It is caused by a change in the price
of the good, which causes a
movement along the demand curve.

From Individual to Market Demand

Income and Substitution Effect

 Market Demand Curve: A curve
 The reason why the slope of the showing the relationship between
individual demand curve is negative, price and quantity demanded by all
involves the substitution and income consumers together, ceteris paribus.
effects.  Market demand is the sum of the
 The substitution effect describes a quantities demanded by all
change in consumption resulting consumers in the market, or the
from a change in the price of one sum of individual demand curves.
good relative to the price of other
The Market Demand Curve and The Law of
goods.
Demand
  Since the slope of the individual  The decision to produce a given
curve is negative, it follows that the quantity of output is based on the
marginal principle.
 Marginal Principle: Increase the level
of an activity if its marginal benefit
exceeds its marginal cost, but
reduce the level if the marginal cost
exceeds the marginal benefit. If
possible, pick the level at which the
marginal benefit equals the marginal
cost.
 The optimal quantity of output is the
one that satisfies the marginal
slope of the market demand curve is principle- where marginal cost
also negative, reflecting the law of
demand.

Market Supply
 The supply curve shows the
relationship between the price and
quantity that producers are willing
to sell during a particular time
period, all else being equal. equals marginal benefit.
 As price rises, marginal benefit
Variables Affecting Supply intersects marginal cost at a higher
The main determinants of supply include: output level.

 The price of the product

 The cost of inputs
 The state of production technology
 The number of producers Individual Supply and The Law of
Supply
 Producer expectations about future
prices
 Taxes or subsidies from the
government
The Marginal Principle and the Output
Decision
  The market supply curve is positively
sloped, reflecting the law of supply.
 Supply Schedule id a table of
The higher the price, the larger the
numbers that shows the relationship
quantity supplied, ceteris paribus.
between price and quantity
supplied, ceteris paribus.
 The Individual Supply Curve shows
Market Equilibrium
the relationship between the price
and the quantity supplied by a single
firm, ceteris paribus.
 The positive is slope of the curve
reflects the law of supply.
 Law of Supply: The higher the price,
the larger the quantity supplied,
ceteris paribus.
Individual Supply to Market Supply

 It is a situation in which, at the

current market price, quantity
supplied equals quantity demanded.
 When the market is in equilibrium,
there is no tendency for the price to
increase or decrease.

Shortage: excess quantity demanded

 Excess Demand (Shortage): A
 The market supply curve for a
situation in which consumers are
particular good shows the
relationship between the price of
the good and the quantity that all
producers together are willing to
sell, ceteris paribus.
Market Supply and the Law of Supply

willing to buy more than producers

 are willing to sell. It occurs when a
market price is lower than
equilibrium price.
 An increase in the price eliminates
the shortage by changing both
quantity demanded and quantity
supplied until the original
equilibrium is established.
A Change in Demand
It is a change in the amount of good
demanded resulting from change in
something other than the price of the good,
which causes a shift of the entire demand
curve.
An increase in demand (rightward shift)
results in higher quantity demanded at each
Surplus: excess quantity supplied price level.
 Excess Supply (Surplus): A situation
in which producers are willing to sell
more than consumers are willing to
buy. It occurs when market price is
above equilibrium price.
 A decrease in the price eliminates
excess supply by changing both
quantity demanded and quantity
supplied until the original
equilibrium is established.
Shifting the Demand Curve
Changes in determinants of demand other
than price cause the demand curve to shift.
A rightward shift shows an increase in
demand and leftward shift a decrease in
demand.
Equilibrium and Disequilibria
  An increase in the price of
complementary good
 Less preference for the good in
question
 An expectation of lower future
prices
 A decrease in the number of
Causes of an Increase in Demand consumers
 An increase in income (normal Normal Versus Inferior Goods
goods) and a decrease in income
 A normal good is a good for which
(inferior goods)
the demand increases as real
 An increase in the price of a
income rises.
substitute good
 An inferior good is a good for which
 A decrease in price of a
demand decreases as real income
complimentary good
rises.
 Higher preference for the good in
 For normal goods, the law of
question
demand makes sense because the
 Favorable advertising
substitution and income effects
 An increase in the number of
reinforce each other. Lower prices
consumers (population)
result in higher quantity demanded.
 And expectation of higher future
 For inferior goods, the substitution
prices
and income effects conflict with
each other, blurring the law of
demand.
Market Effects of A Change in Demand
 The substitution effect tends to
increase consumption while the
income effect tends to decrease it.
The law of demand is correct only as
long as the substitution effect
outweighs the income effect.

Causes of a Decrease in Demand

A Change In Quantity Supplied
 A decrease in income (normal
goods) or an increase in income
(inferior goods)
 A decrease in the price of substitute
good
It is caused by a change in the price of the  Subsidies
good, which causes a movement along the  An increase in the number of
supply curve. producers (firms)
A Change in Supply Causes of a Decrease in Supply

 An increase in the cost of inputs

 A loss of technology
 A decrease in the number of
producers (firms)
 Higher future prices than anticipated
 Higher taxes imposed on the
producers of the good in question
A change in supply is caused by a change in
something other than the price of the good,
which causes a shift of the entire supply Market Effects of Simultaneous Changes in
curve. Supply and Demand
An increase in supply results in higher
quantity supplied at each price level.
Shifting the Supply Curve

When the magnitude of an increase in

demand is a smaller than the magnitude of
an increase in supply, equilibrium quantity
Changes in determinants of supply other increases and market price decreases.
than price cause the supply curve to shift. Market Effects of A Change in Supply
A rightward shift shows an increase in
supply and a leftward shift decrease in
supply
Causes of an Increase in Supply

 A decrease in the cause of inputs

 A technological improvement that
decreases cost of production
 Lower future prices than anticipated Market Effects of Simultaneous Changes in
Supply and Demand
When the magnitude of an increase in
demand is larger than the magnitude of an
increase in supply, equilibrium quantity
increases and market price increases.

Market Equilibrium, The Invisible Hand,

and Efficiency
 The "invisible hand" describes how
the action of individual buyers and
sellers, each acting on their own self
interest, leads to a market
Equilibrium.
 But does this market equilibrium
promote the social interest, or could
society do better?
 Four conditions must be met in
order to promote the social interest:
1. Buyers and sellers must have
enough information to make
informed decision.
2. The market must be perfectly
competitive.
3. There must be no spillover
benefits.
4. There must be no spillover cost.