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Mankiw et al.: Principles of Microeconomics, 2nd Canadian edition. Chapter 4: Page 1

Demand and
Supply :
How Markets
Work
In this chapter you will…
•• Examine
Examine whatwhat determines
determines the the demand
demand for
for
aa good
good inin aa competitive
competitive market.
market.
•• Examine
Examine whatwhat determines
determines the the supply
supply of
of aa
good
good inin aa competitive
competitive market.
market.
•• See
See how
how supply
supply and
and demand
demand together
together set
set
the
the price
price ofof aa good
good and
and the
the quantity
quantity sold.
sold.
•• Consider
Consider the the key
key role
role of
of prices
prices in
in
allocating
allocating scarce
scarce resources.
resources.

Mankiw et al.: Principles of Microeconomics, 2nd Canadian edition. Chapter 4: Page 3

 THE MARKET FORCES OF
SUPPLY AND DEMAND
•• Demand
Demand andand Supply
Supply are
are the
the two
two
words
words that
that economists
economists use
use most
most
often.
often.
•• Demand
Demand andand Supply
Supply are
are the
the forces
forces
that
that make
make market
market economies
economies work!
work!
•• Modern
Modern microeconomics
microeconomics is is about
about
supply,
supply, demand,
demand, and
and market
market
equilibrium.
equilibrium.

Mankiw et al.: Principles of Microeconomics, 2nd Canadian edition. Chapter 4: Page 4

 MARKETS AND COMPETITION

•• The
The terms
terms Demand
Demand and and Supply
Supply refer
refer
to
to thethe behaviour
behaviour of of people.
people. .. ..
•• .. .. .as
.as they
they interact
interact with
with one
one another
another
in
in markets.
markets.
•• AA market
market is is aa group
group of
of buyers
buyers and
and sellers
sellers
of
of aa particular
particular good
good or
or service.
service.
–– Buyers
Buyers determine
determine demand...
demand...
–– Sellers
Sellers determine
determine supply…
supply…

Mankiw et al.: Principles of Microeconomics, 2nd Canadian edition. Chapter 4: Page 5

 Demand Function

Qdx
Qdx == F(Px,M,Po,T,Pop,S)
F(Px,M,Po,T,Pop,S)
Where
Where
Qdx
Qdx == Quantity
Quantity Demand
Demand of
of XX
Px
Px==Price
Priceof
ofXX
MM ==Money
Moneyincome
income
Po
Po==Price
Priceof
ofother
othergoods
goods
TT ==Test
Test
Pop=
Pop=Size
Sizeof
ofpopulation
population
S=
S= Special
Special Influence
Influenceor
orsituation
situation

Mankiw et al.: Principles of Microeconomics, 2nd Canadian edition. Chapter 4: Page 6

 DEMAND

•• Quantity
Quantity Demanded
Demanded refersrefers to
to the
the
amount
amount (quantity)
(quantity) of
of aa good
good that
that
buyers
buyers are
are willing
willing to
to purchase
purchase at at
different
different prices
prices for
for aa given
given period.
period.

Mankiw et al.: Principles of Microeconomics, 2nd Canadian edition. Chapter 4: Page 7

 Determinants of Demand
•• What
What factors
factors determine
determine how
how much
much ice
ice
cream
cream youyou will
will buy?
buy?
•• What
What factors
factors determine
determine how
how much
much you
you
will
will really
really purchase?
purchase?
1)
1) Product’s
Product’sOwnOwnPrice
Price
2)
2) Consumer
ConsumerIncome
Income
3)
3) Prices
PricesofofRelated
RelatedGoods
Goods
4)
4) Tastes
Tastes
5)
5) Expectations
Expectations
6)
6) Number
Numberof ofConsumers
Consumers

Mankiw et al.: Principles of Microeconomics, 2nd Canadian edition. Chapter 4: Page 8

1) Price

Law
Law of
of Demand
Demand
–– The
The law
law of
of demand
demand states
states that,
that,
other
other things
things equal,
equal, the
the quantity
quantity
demanded
demanded of of aa good
good falls
falls when
when
the
the price
price of
of the
the good
good rises.
rises.

Mankiw et al.: Principles of Microeconomics, 2nd Canadian edition. Chapter 4: Page 9

2) Income

•• As
As income
income increases
increases thethe
demand
demand for
for aa normal
normal good
good will
will
increase.
increase.
•• As
As income
income increases
increases thethe
demand
demand for
for an
an inferior
inferior good
good will
will
decrease.
decrease.

Mankiw et al.: Principles of Microeconomics, 2nd Canadian edition. Chapter 4: Page 10

3) Prices of Related Goods

Prices
Prices of
of Related
Related Goods
Goods
–– When
When aa fall
fall in
in the
the price
price of
of one
one
good
good reduces
reduces the the demand
demand forfor
another
another good,
good, the the two
two goods
goods are
are
called
called substitutes.
substitutes.
–– When
When aa fall
fall in
in the
the price
price of
of one
one
good
good increases
increases the the demand
demand forfor
another
another good,
good, the the two
two goods
goods are
are
called
called complements.
complements.
Mankiw et al.: Principles of Microeconomics, 2nd Canadian edition. Chapter 4: Page 11
4) Others
•• Tastes
Tastes
•• Expectations
Expectations
•• Number
Number ofof Consumers
Consumers
•• Special
Special situation
situation

Mankiw et al.: Principles of Microeconomics, 2nd Canadian edition. Chapter 4: Page 12

 The Demand Schedule and the
Demand Curve
 The
The demand
demand schedule
schedule is is aa table
table that
that
shows
shows the
the relationship
relationship between
between the the
price
price of
of the
the good
good and
and the
the quantity
quantity
demanded.
demanded.
 The
The demand
demand curve
curve is
is aa graph
graph of of the
the
relationship
relationship between
between thethe price
price of
of aa
good
good and
and the
the quantity
quantity demanded.
demanded.
 Ceteris
Ceteris Paribus:
Paribus: “Other
“Other thing
thing being
being
equal”
equal”

Mankiw et al.: Principles of Microeconomics, 2nd Canadian edition. Chapter 4: Page 13

Table 4-1: Catherine’s Demand Schedule

Price of Ice-cream Quantity of cones

Cone ($) Demanded
0.00 12
0.50 10
1.00 8
1.50 6
2.00 4
2.50 2
3.00 0

Mankiw et al.: Principles of Microeconomics, 2nd Canadian edition. Chapter 4: Page 14

 Figure 4-1: Catherine’s Demand Curve
Price of Ice-
Cream
Cone

$3.00

2.50

2.00

1.50

1.00

0.50

0 2 4 6 8 10 12 Quantity of
Ice-Cream
Cones
Mankiw et al.: Principles of Microeconomics, 2nd Canadian edition. Chapter 4: Page 15
 Market Demand Schedule

•• Market
Market demand
demand is is the
the sum
sum of
of all
all individual
individual
demands
demands atat each
each possible
possible price.
price.
•• Graphically,
Graphically, individual
individual demand
demand curves
curves are
are
summed
summed horizontally
horizontally to to obtain
obtain the
the market
market
demand
demand curve.
curve.
•• Assume
Assume the
the ice
ice cream
cream market
market has
has two
two
buyers
buyers as
as follows…
follows…

Mankiw et al.: Principles of Microeconomics, 2nd Canadian edition. Chapter 4: Page 16

 Table 4-2: Market demand as the Sum of
Individual Demands
Price of Ice-cream
Catherine Nicholas Market
Cone ($)

0.00 12 + 7 = 19
0.50 10 6 16
1.00 8 5 13
1.50 6 4 10
2.00 4 3 7
2.50 2 2 4
3.00 0 1 1

Mankiw et al.: Principles of Microeconomics, 2nd Canadian edition. Chapter 4: Page 17

 Figure 4-3: Shifts in the Demand Curve
Price of Ice-
Cream
Cone

Increase
in demand

Decrease
in demand

D2
D1

D3
Quantity of
Ice-Cream
Cones
Mankiw et al.: Principles of Microeconomics, 2nd Canadian edition. Chapter 4: Page 18
Table 4-3: The Determinants of Quantity
Demanded

Mankiw et al.: Principles of Microeconomics, 2nd Canadian edition. Chapter 4: Page 19

Shifts in the Demand Curve versus
Movements Along the Demand
Curve

Change
Changein
inDemand:-
Demand:-Shifts
Shifts
Change
Changein
inquantity
quantityDemand:-Movement
Demand:-Movement
 Qdx = F(Px,M,Po,Pop,T,S)
•• Other
Other than
than price(Px),when
price(Px),when any
any of
of the
the
factors
factors change
change then
then only
only demand
demand
will
will be
be change
change is
is called
called Shifts
Shifts of
of the
the
Demand
Demand Curve
Curve

•• When
When only
only price
price (Px)
(Px) change,
change, allall
other
other factors
factors remaining
remaining constant
constant
then
then quantity
quantity demand
demand will
will be
be change
change
is
is called
called Movement
Movement along
along the
the
Demand
Demand Curve
Curve

Mankiw et al.: Principles of Microeconomics, 2nd Canadian edition. Chapter 4: Page 21

 Figure 4-4 a): A Shifts in the Demand Curve
Price of
Cigarettes,
per Pack.
A policy to discourage
smoking shifts the demand
curve to the left.

B A
$2.00

D1

D2
0 10 20 Number of Cigarettes
Smoked per Day

Mankiw et al.: Principles of Microeconomics, 2nd Canadian edition. Chapter 4: Page 22

 Figure 4-4 b): A Movement Along the
Demand Curve
Price of
Cigarettes,
per Pack.
C A tax that raises the price
of cigarettes results in a
$4.00 movements along the
demand curve.

A
$2.00

D1

0 12 20 Number of Cigarettes
Smoked per Day

Mankiw et al.: Principles of Microeconomics, 2nd Canadian edition. Chapter 4: Page 23

 SUPPLY

•• Quantity
Quantity Supplied
Supplied refers
refers to
to the
the
amount
amount (quantity)
(quantity) ofof aa good
good that
that
sellers
sellers are
are willing
willing to
to make
make available
available
for
for sale
sale at
at alternative
alternative prices
prices for
for aa
given
given period.
period.

Mankiw et al.: Principles of Microeconomics, 2nd Canadian edition. Chapter 4: Page 24

 Supply Function

QSx
QSx == F(Px,Pi,T,W,G)
F(Px,Pi,T,W,G)
Where
Where
Qsx
Qsx == Quantity
Quantity Supply
Supply of
of XX
Px
Px==Price
Priceof
ofXX
Po
Po==Price
Priceof
ofinputs
inputs
TT ==Technology
Technology
WW == Weather
Weather
GG ==Government
GovernmentPolicy
Policy

Mankiw et al.: Principles of Microeconomics, 2nd Canadian edition. Chapter 4: Page 25

 Determinants of Supply

•• What
What factors
factors determine
determine how
how much
much
ice
ice cream
cream youyou are
are willing
willing to
to offer
offer or
or
produce?
produce?
1)
1)Product’s
Product’s Own
Own Price
Price
2)
2)Input
Input prices
prices
3)
3)Technology
Technology
4)
4)Expectations
Expectations
5)
5)Number
Number ofof sellers
sellers

Mankiw et al.: Principles of Microeconomics, 2nd Canadian edition. Chapter 4: Page 26

1) Price

Law
Law of
of Supply
Supply
–– The
The law
law ofof supply
supply states
states that,
that,
other
other things
things equal,
equal, the
the quantity
quantity
supplied
supplied of of aa good
good rises
rises when
when the
the
price
price of
of the
the good
good rises.
rises.

Mankiw et al.: Principles of Microeconomics, 2nd Canadian edition. Chapter 4: Page 27

 The Supply Schedule and the
Supply Curve
 The
The supply
supply schedule
schedule is is aa table
table that
that
shows
shows the
the relationship
relationship between
between the the
price
price of
of the
the good
good and
and thethe quantity
quantity
supplied.
supplied.
 The
The supply
supply curve
curve is
is aa graph
graph ofof the
the
relationship
relationship between
between the the price
price of
of aa
good
good and
and the
the quantity
quantity supplied.
supplied.
 Ceteris
Ceteris Paribus:
Paribus: “Other
“Other thing
thing being
being
equal”
equal”

Mankiw et al.: Principles of Microeconomics, 2nd Canadian edition. Chapter 4: Page 28

Table 4-4: Ben’s Supply Schedule

Price of Ice-cream Quantity of cones

Cone ($) Supplied
0.00 0
0.50 0
1.00 1
1.50 2
2.00 3
2.50 4
3.00 5

Mankiw et al.: Principles of Microeconomics, 2nd Canadian edition. Chapter 4: Page 29

 Figure 4-5: Ben’s Supply Curve
Price of Ice-
Cream
Cone

$3.00

2.50

2.00

1.50

1.00

0.50

0 1 2 3 4 5 6 8 10 12 Quantity of
Ice-Cream
Cones
Mankiw et al.: Principles of Microeconomics, 2nd Canadian edition. Chapter 4: Page 30
 Market Supply Schedule

•• Market
Market supply
supply isis the
the sum
sum ofof all
all individual
individual
supplies
supplies at
at each
each possible
possible price.
price.
•• Graphically,
Graphically, individual
individual supply
supply curves
curves are
are
summed
summed horizontally
horizontally to to obtain
obtain thethe market
market
demand
demand curve.
curve.
•• Assume
Assume the
the ice
ice cream
cream market
market has has two
two
suppliers
suppliers as
as follows…
follows…

Mankiw et al.: Principles of Microeconomics, 2nd Canadian edition. Chapter 4: Page 31

 Table 4-5: Market supply as the Sum of
Individual Supplies
Price of Ice-cream
Ben Nicholas Market
Cone ($)

0.00 0 + 0 = 0
0.50 0 0 0
1.00 1 0 1
1.50 2 2 4
2.00 3 4 7
2.50 4 6 10
3.00 5 8 13

Mankiw et al.: Principles of Microeconomics, 2nd Canadian edition. Chapter 4: Page 32

Table 4-6: The Determinants of Quantity
Supplied

Mankiw et al.: Principles of Microeconomics, 2nd Canadian edition. Chapter 4: Page 33

Shifts in the Supply Curve versus
Movements Along the supply
Curve

Change
Changein
inSupply:-
Supply:-Shifts
Shifts
Change
Changein
inquantity
quantitySupply
Supply:-Movement
:-Movement
 QSx = F(Px,Pi,T,W,G)
•• Other
Other than
than price(Px),when
price(Px),when anyany ofof the
the
factors
factors change
change then
then only
only supply
supply will
will
be
be change
change isis called
called Shifts
Shifts of
of the
the
supply
supply Curve
Curve

•• When
When only
only price
price (Px)
(Px) change,
change, all
all
other
other factors
factors remaining
remaining constant
constant
then
then quantity
quantity supply
supply will
will be
be change
change
is
is called
called Movement
Movement along
along the
the supply
supply
Curve
Curve

Mankiw et al.: Principles of Microeconomics, 2nd Canadian edition. Chapter 4: Page 35

 Figure 4-7: Shifts in the Supply Curve
Price of Ice- S3
Cream
Cone
S1 S2

Decrease
in supply

Increase
in supply

Quantity of
Ice-Cream
Cones
Mankiw et al.: Principles of Microeconomics, 2nd Canadian edition. Chapter 4: Page 36
 SUPPLY AND DEMAND
TOGETHER

•• Equilibrium
Equilibrium refers
refers to
to aa situation
situation in
in which
which
the
the price
price has
has reached
reached the
the level
level where
where
quantity
quantity supplied
supplied equals
equals quantity
quantity
demanded.
demanded.

Mankiw et al.: Principles of Microeconomics, 2nd Canadian edition. Chapter 4: Page 37

 Equilibrium
•• Equilibrium
EquilibriumPrice
Price
–– The
Theprice
pricethat
thatbalances
balancesquantity
quantitysupplied
suppliedand
and
quantity
quantitydemanded.
demanded.
–– On
Onaagraph,
graph, ititis
isthe
theprice
priceatatwhich
whichthethesupply
supply
and
anddemand
demandcurves
curvesintersect.
intersect.
•• Equilibrium
EquilibriumQuantity
Quantity
–– The
Thequantity
quantitysupplied
suppliedandandthe
thequantity
quantity
demanded
demandedat atthetheequilibrium
equilibriumprice.
price.
–– On
Onaagraph
graphititisisthe
thequantity
quantityatatwhich
whichthe
the
supply
supplyand
anddemand
demandcurvescurvesintersect.
intersect.

Mankiw et al.: Principles of Microeconomics, 2nd Canadian edition. Chapter 4: Page 38

 Equilibrium

Demand Supply
Schedule Schedule

At $2.00, the quantity demanded

is equal to the quantity supplied!
Mankiw et al.: Principles of Microeconomics, 2nd Canadian edition. Chapter 4: Page 39
 Figure 4-8: The Equilibrium of Supply and
Demand
Price of
Ice-Cream
Cone

Supply

Equilibrium price Equilibrium

$2.00

Demand

Equilibrium quantity

0 1 2 3 4 5 6 7 8 9 10 11 Quantity of Ice-
Cream Cones

Mankiw et al.: Principles of Microeconomics, 2nd Canadian edition. Chapter 4: Page 40

 Equilibrium
•• Surplus
Surplus
–– When
Whenprice
price>>equilibrium
equilibriumprice,
price, then
thenquantity
quantity
supplied
supplied>>quantity
quantitydemanded.
demanded.
•• There
Thereis
isexcess
excesssupply
supplyor
oraasurplus.
surplus.
•• Suppliers
Supplierswill
willlower
lowerthe
theprice
priceto
toincrease
increasesales,
sales,
thereby
therebymoving
movingtoward
towardequilibrium.
equilibrium.
•• Shortage
Shortage
–– When
Whenprice
price<<equilibrium
equilibriumprice,
price, then
thenquantity
quantity
demanded
demanded>> the
thequantity
quantitysupplied.
supplied.
•• There
Thereisisexcess
excessdemand
demandor oraashortage.
shortage.
•• Suppliers
Supplierswill
willraise
raisethe
theprice
pricedue
dueto
totoo
toomany
manybuyers
buyers
chasing
chasingtoo
toofew
fewgoods,
goods,thereby
therebymoving
movingtoward
toward
equilibrium.
equilibrium.
Mankiw et al.: Principles of Microeconomics, 2nd Canadian edition. Chapter 4: Page 41
 Figure 4-9 a): Excess Supply
Price of
Ice-Cream
Cone
Surplus
Supply
$2.50

$2.00

Demand

0 1 2 3 4 5 6 7 8 9 10 11 Quantity of Ice-
Cream Cones
Quantity Quantity
Demanded Supplied

Mankiw et al.: Principles of Microeconomics, 2nd Canadian edition. Chapter 4: Page 42

 Figure 4-9 b): Excess Demand
Price of
Ice-Cream
Cone

Supply

$2.00

$1.50

Shortage
Demand

0 1 2 3 4 5 6 7 8 9 10 11 Quantity of Ice-
Cream Cone
Quantity Quantity
Supplied Demanded

Mankiw et al.: Principles of Microeconomics, 2nd Canadian edition. Chapter 4: Page 43

Concluding Remarks…

•• Market
Market economies
economies harness
harness thethe
forces
forces of
of supply
supply andand demand.
demand. .. ..
•• Supply
Supply and
and Demand
Demand together
together
determine
determine the the prices
prices ofof the
the
economy’s
economy’s different
different goods
goods andand
services.
services. .. ..
•• Prices
Prices in
in turn
turn are
are the
the signals
signals that
that
guide
guide the
the allocation
allocation ofof resources.
resources.

Mankiw et al.: Principles of Microeconomics, 2nd Canadian edition. Chapter 4: Page 44

Summary

•• Economists
Economists use use the
the model
model ofof supply
supply and
and
demand
demand to to analyze
analyze competitive
competitive markets.
markets.
•• In
In aa competitive
competitive market,
market, there
there are
are many
many
buyers
buyers andand sellers,
sellers, each
each of
of whom
whom hashas little
little
or
or no
no influence
influence on
on the
the market
market price.
price.

Mankiw et al.: Principles of Microeconomics, 2nd Canadian edition. Chapter 4: Page 45

Summary
•• The
The demand
demand curve
curve shows
shows how
how the
the
quantity
quantity of
of aa good
good depends
depends upon
upon the
the
price.
price.
–– According
Accordingto tothe
thelawlaw of
ofdemand,
demand, asasthe
theprice
price
of
ofaagood
goodfalls,
falls, the
thequantity
quantitydemanded
demandedrises.
rises.
Therefore,
Therefore, the
thedemand
demandcurvecurveslopes
slopes
downward.
downward.
–– In
Inaddition
additiontotoprice,
price, other
otherdeterminants
determinantsof ofhow
how
much
muchconsumers
consumerswant wanttotobuy
buyinclude
includeincome,
income,
the
theprices
pricesofofcomplements
complementsand andsubstitutes,
substitutes,
tastes,
tastes, expectations,
expectations, andandthe
thenumber
numberof of
buyers.
buyers.
–– IfIfone
oneofofthese
thesefactors
factorschanges,
changes, the
thedemand
demand
curve
curveshifts.
shifts.
Mankiw et al.: Principles of Microeconomics, 2nd Canadian edition. Chapter 4: Page 46
Summary
•• The
Thesupply
supplycurve
curveshows
showshowhow the
thequantity
quantityofofaa
good
goodsupplied
supplieddepends
dependsuponuponthe
theprice.
price.
–– According
Accordingto tothe
thelaw
law of
ofsupply,
supply, asasthe
theprice
priceof
of
aagood
goodrises,
rises, the
thequantity
quantitysupplied
suppliedrises.
rises.
Therefore,
Therefore, the
thesupply
supplycurve
curveslopes
slopesupward.
upward.
–– In
Inaddition
additiontotoprice,
price, other
otherdeterminants
determinantsof ofhow
how
much
muchproducers
producerswant wanttotosell
sell include
includeinput
input
prices,
prices, technology,
technology, expectations,
expectations, andandthe
the
number
numberof ofsellers.
sellers.
–– IfIfone
oneof
ofthese
thesefactors
factorschanges,
changes, thethesupply
supply
curve
curveshifts.
shifts.

Mankiw et al.: Principles of Microeconomics, 2nd Canadian edition. Chapter 4: Page 47

Summary
•• Market
Market equilibrium
equilibrium is is determined
determined by by the
the
intersection
intersection ofof the
the supply
supply and
and demand
demand
curves.
curves.
•• At
At the
the equilibrium
equilibrium price,
price, the
the quantity
quantity
demanded
demanded equals
equals thethe quantity
quantity supplied.
supplied.
•• The
The behavior
behavior of
of buyers
buyers and
and sellers
sellers
naturally
naturally drives
drives markets
markets toward
toward their
their
equilibrium.
equilibrium.

Mankiw et al.: Principles of Microeconomics, 2nd Canadian edition. Chapter 4: Page 48

The End

Mankiw et al.: Principles of Microeconomics, 2nd Canadian edition. Chapter 4: Page 49