Supply, Demand, and Market Equilibrium

Supply, Demand, and Market Equilibrium Handout

A. Demand

1. Def: Demand is the relationship between price and quantity that consumers are willing and able to purchase.

-If someone does not have the ability or is not really in the market for a good they are not included

2. Demand Schedule: a table showing the actual quantities that are demanded at each price.

Ex: Table 1

Note: The table could be much longer (i.e. continue on showing each relationship at each price) or could be on a different scale.

3. Law of Demand: As the price of a good goes up, all else constant, the quantity demanded goes down or the other way around (i.e. price down è Qd up). This is intuitive since it basically states the relationship that consumers like lower prices.

4. Graphically:

Note: This is an individual demand curve. To get the market demand curve you simply horizontally sum all the individual demand curves to get the market totals.

5. Mathematically: Generally it can be represented in a simple linear function of the form: Qd = b – a P

a = slope; note it is negative which is consistent with a downward sloping demand curve

b = P – intercept; where the Demand Curve hits the p-axis

6. Determinants of Demand: Recall from the math/stat primer, there are many things that we know affect certain variables. Determinants of demand are all the main things that we have found affect the amount of demand for a particular good. The main determinant is price, this is why we primarily look at the way price affects Qd. Other determinants of demand are level of income, personal tastes/preferences, the price of related goods, the population (or also called market size), and expectations. If we go back to the math stat primer we can note that:

Movers: P and Qd

Shifters: Income (I), Tastes/Preferences (T), Price of related goods (substitutes and complementsè Pr ), Population (N), and price expectations (Pexp ).

B. Supply

1. Def: Supply is the relationship between price and quantity that suppliers are willing and able to supply at each price.

-If someone does not have the ability or is not really in the market for a good they are not included

2. Supply Schedule: a table showing the actual quantities that are supplied at each price.

Ex: Table 2

Note: the table could be much longer (i.e. continue on showing each relationship at each price) or could be on a different scale.

3. Law of Supply: As the price of a good goes up, all else constant, the quantity supplied goes up or the other way around (i.e. price up è Qs up). In general it states that suppliers like higher prices.

4. Graphically:

Note: Just as in the case of demand, to get the market supply you must horizontally sum the supply curves to get the market supply.

5. Mathematically: Generally it can be represented in a simple linear function of the form: Qs = d + c P

c = slope; note it is positive which is consistent with a upward sloping supply curve

d = P – intercept; where the supply curve hits the p-axis when Qs= 0

6. Determinants of Supply: Recall from the math/stat primer, there are things that we know affect certain variables. Determinants of supply are all the things that we have found affect the amount of supply for a particular good. The main determinant is price, this is why we primarily look at the way price affects Qs. Other determinants of supply are unit costs of production, profitability of alternate activities, nature, and expectations of future prices. If we go back to the math/stat primer we can note that:

Movers: P and Qs

Shifters: Unit Costs, Profitability of Alt. Activities, Nature, Technology, Number of Sellers and Price Expectations.

C. Market Equilibrium:

1. Def: This is where the supply and demand curve meet each other. At this price, all that is supplied is demanded è at this pint the market clears.

2. Graphically:

3. Using a table

Note: It is clear from the table above that the price where Qd=Qs is at a price of 10. At this price all that is supplied is demanded.

D. Practice Problems

1. Illustrate and define what would happen to P and Q if there is a shift inward of Supply. Does this always occur? What could cause Supply to shift inward?

2. Illustrate and define what would happen to P and Q if there is a shift inward of Supply and shift inward of Demand. Does this always occur? Make sure and explain fully your results. What are some things that can cause Demand to shift inward?

3. Given the following equations find equilibrium price and quantity? Graph your solutions.

Qd= 40-5p

Qs= 25+5p

Suppose that you have the supply equation change to Qs= 35+5p. What is the new equilibrium? Show your results on the graph.

Illustration of Horizontal Summation to get Market

As an exercise you should graph each of the demand curves and then the market, noting that the market is just the horizontal sum of the 4 demand curves. This is shown in the table with the horizontal sum (i.e. we add across to get market) of each demand curve to get the market. This illustration is the very reason that population is a determinant of demand. If we have more demand curves then, the market demand would go up.

4