1. Chapter 4
Demand, Supply, and Markets

2. The Law of Demand
 Law of Demand: the inverse ( or negative)
relationship between the price of a good
and the quantity consumers are willing to
purchase, other things held constant
(ceteris paribus).
 As the price of a good rises, consumers
buy less.

3. The Law of Demand
 The demand curve allows you to find the
quantity demanded by a buyer at
different selling prices by moving along
the curve

4. The Substitution Effect of a
Price Change
 What explains this “Law of Demand?”
 Lower Price= Greater Amount Consumer…
Why?
 Substitution effect: The consumer will
substitute a cheaper good for a more
expensive good.

5. The Income Effect of a Price
Change
 IncomeEffect: A fall in the price of the
good increases the consumers purchasing
power.
 The consumer can now buy more with NO
change in their income level.

6. The Demand Schedule and
Demand Curve
 Demand: a curve or schedule showing
the various quantities of a product
consumers are willing to purchase at
possible prices during a specific period of
time, other things held constant.
 Demand is the quantity consumers are both
willing and able to buy at each possible
price.

7. Market Demand Schedule
A demand schedule is simply a table
listing the various quantities of something
consumers are willing to purchase prices
 Example of the demand schedule

8. Example of a Market Schedule
 Demand of Hula Hoops
Price (in Dollars) Quantity Demanded
(Hula Hoops)
$10.00 0
8.00 10
6.00 20
4.00 30
2.00 40

9. The Demand Curve Using the
Schedule
 The demand curve is the plots of this table
 Example of demand curve using the
demand schedule

10. Demand Curve of Hula Hoops
Price of
the
Hula
Hoops
(measu
red in
dollars)
Quantity Demanded
of Hula Hoops

11. Market Demand
 The transition from the individual to the
market demand curve is done by totaling
or summing the individual demand
schedules (this is known as the horizontal
summation of demand).
 Example of horizontal summation

12. Horizontal Summation of
Demand
+
= Market Demand
of Hula Hoops

13. Market Demand of Hula
Hoops
 Themarket demand of hula hoops, is the
horizontal summation of the two
individuals demand for hula hoops (i.e.
the summation of quantity demanded at
each individual price).

14. Market Demand of Hula Hoops
Price
(measured
in dollars)
Quantity Demanded of Hula Hoops

15. Changes in demand vs. changes
in quantity demanded
A movement along the curve- CHANGES
IN PRICE ONLY
 Changes in quantity demanded
 Example of movement

16. Movement along the Curve
A movement from $8 to
$6 represents an
increase in quantity
demanded
A movement
from $8 to $10
represents an
decrease in
quantity
demanded

18. The distinction between changes in Quantity
Demanded and Changes in Demand
 Remember that price and quantity
variables in our model are subject to the
ceteris paribus assumption (other things
held constant).
 IT IS VERY IMPORTANT TO REMEMBER THE
FOLLOWING:
 If you are dealing with price of the item it is
a movement along the curve, a change in
quantity demanded not DEMAND, NO
SHIFT!!!!!!

19. Shifts of the Demand Curve:
1) Changes in consumer income
 Normal goods
 Inferior goods
2) Changes in the price of a related good
 Substitutes
 Complements
3) Changes in expectations- prices, income, or
availability of goods.
4) Changes in the number of consumers in the
market
5) Changes in consumer tastes and preferences

20. Examples
 Income
 Normal goods: direct relationship
 Inferior goods: inverse relationship

21. Changes in Demand
 Most of us would consider steak to be a
normal good. Since, steak is a more
expensive meat as income increases then
more consumption of steak should occur.
 Thus, when consumer income increases,
the demand for steak increases.

22. Normal Good
D2
D1

23. Inferior Goods
 However, we could argue that Ramon
Noodles would be an inferior good,
meaning as income increases then the
demand for Ramon Noodles would
decline.
 Thus, when income increases, then the
demand of Ramon Noodles will decrease.
 This would be a leftward shift of the
demand curve

24. Examples
 Related goods
 Substitute good: if the price of the
substitutable good decreases, then
demand decreases for the good of interest
 Complementary good: if the price of the
complement good increases, then demand
decreases for the good of interest.

25. Substitute goods
 Let’s assume that Pepsi and Coke are
substitute goods for one another.
 If the price of Pepsi increases, then what
happens to the demand of Coke?
 The demand for Coke will increase,
because now consumers will substitute
Coke for Pepsi

26. Graph of Coke
Price
(measured
in dollars)
D2
D1
Quantity
Demanded
of Coke (in
millions)

27. Complementary Goods
 Complementary goods are goods that
we buy together, I think it is safe to say
that peanut butter and jelly are bought
together.
 Thus, what would happen to the demand
of jelly, if the price of peanut butter
increased?
 The demand for jelly would decrease.
 This is a leftward shift of the demand curve

28. Demand for Jelly
D1
D2

29. Supply
 Supply indicates how much producers are
willing and able to offer for sale per
period at each possible price, other things
held constant.

30. Law of Supply
 There is a direct (positive) relationship
between the price of a good or service
and the amount of it that suppliers are
willing to produce.
 Example of the supply curve
 When price increases, then the amount
supplied will increase.
 Why are sellers willing to sell more at a
higher price? Does this make sense?

31. Market Supply
 Again,it is the horizontal summation of the
quantity produced by the sellers
 Example of Horizontal Summation

32. Changes in Supply VS.
Changes in Quantity Supplies
 Increase or decrease in the price of the
good is a movement along the curve
 This is a change in “quantity supplied”
 Example here

33. Shifts of the Supply Curve
1) Changes in Technology
2) Changes in the Prices of Relevant resources
 Inputs into production.
3) Changes in the Price of Alternative Goods
 Other goods that the producer could
produce
3) Changes in Producer Expectations
4) Changes in the Number of Producers

34. Markets
A market is any arrangement in which
buyers and sellers interact to determine
the price and quantity of goods and
services exchanged.
 Markets reduce transaction costs

35. Market Equilibrium
 The market is where the buyers and sellers
come together
 Equilibrium is no conflict between
demand and supply
 Quantity supplied= Quantity demand
 Example of the equilibrium
 This
is the theory of how the price system
operates and it is the cornerstone of
microeconomic analysis

36. Equilibrium in the Pizza Market
(a) Market schedules
Millions of pizzas per Week
Price per Quantity Quantity Surplus or
pizza Demanded Supplied Shortage Effect on Price
$15 8 28 Surplus of 20 Falls
12 14 24 Surplus of 10 Falls
9 20 20 Equilibrium Remains the same
6 26 16 Shortage of 10 Rises
3 32 12 Shortage of 20 Rises

37. Equilibrium in the Pizza Market
(b) Market curves
S
Market equilibrium occurs at:
$15 Surplus Price where QD=QS; Point c
12 Above the equilibrium price:
Price per pizza
QS>QD;
9 c Surplus;
Downward pressure on P
6
Below the equilibrium price:
3 Shortage D
QD>QS;
Shortage;
Upward pressure on P
0 14 16 20 24 26
Millions of pizzas per week

38. Economic Efficiency
 When a market reaches equilibrium, all
the gains from trade between the buyer
and seller have been fully realized and
Economic efficiency is met

39. Prices and Market order
 Prices communicate information to
decision makers
 Prices coordinate the actions of the
market participants
 Prices motivate economic players

40. Invisible Hand Principle
 The tendency of market forces to channel
the actions of self-interest individuals into
activities that promote the general
betterment of society
 The key to economic progress

41.  What is this all about
 Price System?? What is that?

43. Shifts of the Demand Curve
 Increase in demand
 Rightward shift of D curve
 Shortage; Upward pressure on P
 QD decreases; Qs increase
 New equilibrium: Increase in P and Q
 Decrease in demand
 Surplus; Downward pressure on P
 New equilibrium: Decrease in P and Q

44. Exhibit 6
Effects of an Increase in Demand
S
Increase in demand:
Rightward shift to D’
$12 g At P=$9: QD>QS; shortage
Price per pizza
c Upward pressure on P
9 QD decreases
QS increases
D’ New equilibrium g
Higher P
D Higher Q
0 20 24 30
Millions of pizzas per week

45. Shifts in the Supply Curve
 Increase in supply
 Rightward shift of S curve
 Surplus; Downward pressure on P
 QD increases; QS decreases
 New equilibrium:
 P decreases; Q increases
 Decrease in supply
 New equilibrium:
 P increase; Q decreases

46. Effects of an Increase
in Supply
S
Increase in supply:
Rightward shift to S’
Price per pizza
S’ At P=$9: QS>QD; surplus
c
$9 Downward pressure on P
QD increases
QS decreases
6 d
Exhibit 7
New equilibrium d
Higher Q
D Lower P
0 20 26 30
Millions of pizzas per week

47. Simultaneous Shifts of
D and S curves
 Both S and D increase;
 Q increases
 D shifts more: P increases
 S shifts more: P decreases
 Both S and D decrease:
 Q decreases
 D shifts more: P decreases
 S Shifts more: P increases

48. Exhibit 8
Indeterminate Effect of an Increase in Both
Demand and Supply
(a) Shift of D dominates (b) Shift of S dominates
S S
Price
Price
S’
S’’
p’ b
a a
p p
D’
p’’ c
D’’
D D
0 Q Q’ 0 Q Q’’
Units per period Units per period

49. Disequilibrium
 Surplus
 Downward pressure on P
 Shortage
 Upward pressure on P
 Disequilibrium
 Temporary, or
 Result of government
intervention
 Price floors
 Price ceilings

50. Disequilibrium
 Price Floors
 Set above equilibrium P
 Minimum selling P
 Surplus
 Distort markets
 Reduce economic
welfare

51. Disequilibrium
 Price Ceilings
 Set below the equilibrium P
 Maximum selling P
 Shortage
 Distort markets
 Reduce economic welfare

52. Exhibit 11
Price Floors and Price Ceilings
(a) Price floor for milk (b) Price ceiling for rent
S
S
Surplus
Price per gallon
Monthly rental price
$2.50
$1,000
1.90
600
Shortage
D
D
0 14 19 24 0 40 50 60
Millions of gallons per month Thousands of rental units per month
No effect if price floor is No effect if price ceiling is
set at or below equilibrium P set at or above equilibrium P