ECO101: Introduction to
Microeconomics
Lectures 3-5
Markets
A system where consumers and
producers meet to exchange
goods and services
Competitive Markets: a market
structure that allocates and
distributes goods and services to
their most efficient use.
To understand how markets
work, we need to turn to our
model of supply & demand.
What is an economic model?
An economic model is essentially a description of the relationship
between two or more economic variables.
Economic models rely on simplifying assumptions to help us get a
simplified description of complex processes.
A model of supply & demand
Variables: quantity, price
A Demand & Supply Model
Explains and analyzes as a competitive market for a
good/service.
Consider a market for cheeseburgers:
On the x-axis, we have the quantity of cheeseburgers
and on the y-axis, we have the price for
cheeseburgers.
The downward sloping line is the demand curve
which shows the relationship between the price of
cheeseburgers and the quantity demanded.
The upward sloping line is the supply curve which
shows the relationship between the price of
cheeseburgers and the quantity supplied.
A Demand & Supply Model
Key Assumptions:
Demand for a good/service declines as price
increases
Supply for a good/service increases as price
increases
Market clears i.e. reaches its equilibrium position at
the price where demand equals supply
A Demand & Supply Model
There is a new burger joint in town called Boss
Burgers. What happens to the market for
cheeseburgers?
Price of pizzas across the country are on the rise.
How do consumers of fast food react?
Demand
If you demand something, then you:
• Want it
• Can afford it
• Plan to buy it
The quantity demanded of a good or service is the amount that consumers plan to
buy during a given time period at a particular price.
Law of demand:
Ceteris paribus, a rise in the price of a good or a service will lead to a fall in the
quantity demanded of that good or service, vice versa.
Demand
Why does higher price lead to lower quantity demanded for a good?
Two reasons:
1. Substitution effect: All other things remaining the same, when the price
of a good rises, its relative price or opportunity cost rises. The quantity
demanded for the good falls as people seek substitutes for it.
e.g. if price of tea increases, people buy more coffee
2. Income effect: When price of a good rises relative to income, people can
afford less of the goods they previously bought. So, quantity demanded of
the good decreases.
Demand Schedule & Demand Curve
Movements along the demand curve are only
brought about by changes in price, all other things
remaining the same.
Factors affecting demand
When a factor other than price changes, there is a change in the demand i.e. shift of the
demand curve.
What factors affect your demand
for coffee?
Factors affecting demand
1. Price of related goods
2. Expected future prices
3. Income
4. Expected future income
5. Population
6. Preferences
Factors affecting demand
1. Price of related goods
Substitutes: A substitute is a good that
can be used in place of another good.
Complements: A complement is a good
that is used in conjunction with another
good.
Factors affecting demand
2. Expected future prices
If the price of a good is expected to rise in the future, current demand
for the good increases.
3. Income
When income increases, consumers buy more of most goods
Normal goods: A good for which demand increases as income increases.
Inferior goods: A good for which demand decreases as income
increases.
Factors affecting demand
4. Expected future income
When income is expected to increase in the future, demand might
increase today.
5. Population
When population size increases, demand for all goods and services
increases.
6. Preferences
Preferences are an individual’s attitude towards certain goods and
services. If preferences change, demand changes.
Factors affecting demand
Example:
Sunsilk and Pantene are leading
shampoo brands which are also
great substitutes.
The curve on the right represents
the demand for Sunsilk.
Suppose there is a BDT 5 increase
in the price of a sachet of Pantene.
What happens to the demand for
Sunsilk?
Factors affecting demand
Example:
Demand for sunsilk increases, so
the demand curve shifts rightwards.
At a price BDT 1.50, demand for
sunsilk shampoo increases from 4
sachets (point C on the old demand
curve) to 8 sachets (point C’ on the
new demand curve)
At the same price level, the
quantity demanded has increased.
Supply
If a firm supplies a good/service, the firm:
• Has the resources and technology to produce it
• Can profit from producing it
• Plans to produce and sell it
The quantity supplied of a good or service is the amount that producers plan to sell
during a given time period at a particular price.
Law of supply:
Ceteris paribus, a rise in the price of a good or a service will lead to an increase in
the quantity supplied of that good or service, vice versa.
Supply
As price rises, consumers demand less (substitution and income
effect), but producers produce more.
When price level changes, profit margin changes. Suppliers
respond to increased profit margins through increasing their
production.
Supply Schedule & Supply Curve
Movements along the supply curve are only
brought about by changes in price, all other things
remaining the same.
When the price of the good changes,
there is a movement along the
supply curve and a change in the
quantity supplied, shown by the blue
arrows on supply curve S0.
When there is any change in the
factors affecting supply, there is a
shift of the supply curve and a
change in supply.
An increase in supply shifts the
supply curve rightward (from S0 to
S1), and a decrease in supply shifts
the supply curve leftward (from S0
to S2)
Factors affecting supply
When a factor other than price changes, there is a change in the
supply i.e. shift of the supply curve.
Factors:
1. Price of factors of production
2. Price of related goods produced
3. Expected future prices
4. Number of suppliers
5. Technology
Factors affecting supply
1. Price of factors of production
What are the main factors of production?
Land – earns rent
Labor – earns wage
Capital - earns interest
Entrepreneurship – earns profits
When costs associated with these factors of production go up, it
becomes costlier to produce the goods/services. Hence, supply
decreases.
Factors affecting supply
Why are garment
manufacturers
unhappy about the
rise in minimum
wage for workers?
Factors affecting supply
2. Price of related goods produced
Substitutes: substitutes in production are goods that can be produced using
the same raw materials
Rise in price of substitutes will lead to a fall in the supply for a good.
e.g. cookies and cupcakes at a bakery
Complements: complements in production are goods that must be produced
together.
Rise in price of complements will lead to an increase in the supply for a
good.
e.g. schools and training programs for teachers
Factors affecting supply
3. Expected future prices
If the price of a good is expected to rise in the future, suppliers will get
higher returns from selling the good in the future than they get today.
Supply decreases today and increases in the future.
4. Number of suppliers
Larger the number of firms producing a good, the greater the supply for
that good.
5. Technology
Advances in technology expand the production possibilities frontier for an
economy. Thus, advancements in technology lead to increase in supply.
Recall, our Demand & Supply model
Market Equilibrium:
Demand for a good/service declines as price
increases
Supply for a good/service increases as price
increases
Market clears i.e. reaches its equilibrium position at
the price where demand equals supply
The equilibrium price (P*) is the price at which the
quantity demanded equals quantity supplied (Q*)
Through interactions between the two economic
agents i.e. producers and consumers, the market
reaches a point where there is no tendency for
prices to change further.
Market Equilibrium
Price
Consider a market for blue pens.
At equilibrium, Qd = Qs
What is P*? What is Q*?
Quantity
Market Equilibrium
Price
surplus
shortage
At a price of $1.00 per pen, there is a demand for 6 million
pens, but quantity supplied is only 3 million. This creates a
shortage of 3 million pens and pushes price upwards.
Similarly, at a price of $ 2.00 per pen, there is a demand for Quantity
3 million pens, but supply is 5 million. Therefore, there is a
surplus of 2 million pens which pushes prices downwards.
Market Equilibrium
Price Adjustments
Price
If price is below the equilibrium, there is a
shortage and prices are forced upwards.
If price is above the equilibrium, there is a surplus
surplus and prices are bid down.
At the equilibrium price, quantity demanded
equals quantity supplied and consumers and
producers do not have any incentives to
shortage
change prices.
Quantity
Predicting changes using the Model
Suppose there is a market for
Price
cheeseburgers.
Supply
At equilibrium, price of cheeseburgers is $
25 and quantity is 150
e1
Price of pizzas increases. 25
What happens to the market for
cheeseburgers? Demand
150 Quantity
Predicting changes using the Model
Since there is an increase in the price of its substitutes,
Price
S
demand for cheeseburgers increases.
This causes demand curve to shift rightwards from D1 to
D2
e2
30
At the original price $25, quantity supplied is 150 but e1
quantity demanded is 260, so there is a shortage of 110 25
cheeseburgers.
This shortage pushes price upwards. D2
Suppliers are willing to produce more only at a higher D1
price – therefore, there is a movement along the supply
curve from e1 to e2. Consumers also want more
cheeseburgers than they wanted before but not as much
150 200 260 Quantity
as they would have wanted if price remained unchanged.
At the new equilibrium, price is $ 30 and quantity is 200
cheeseburgers.
Predicting changes using the Model
Price
At equilibrium, price of cheeseburgers is $ Supply
25 and quantity is 150 e2
Suppose, there is a new tax imposed on e1
cheese imports. Hence cheese becomes 25
more expensive.
What happens to the market for Demand
cheeseburgers?
Represent the changes graphically
How does this outcome differ from the 150 Quantity
outcome in the previous case?
Mathematical Equations for Demand & Supply
When the demand curve is a straight line, the following linear equation describes it:
𝑃 = 𝑎 − 𝑏𝑄𝐷
where P is the price and 𝑄𝐷 is the quantity demanded. The a and b are positive constants.
When the supply curve is a straight line, the following linear equation describes it:
𝑃 = 𝑐 + 𝑑𝑄𝑠
where P is the price and 𝑄𝑠 the quantity supplied. The c and d are positive constants.
At equilibrium, the two curves intersect and we get the equilibrium price P* and equilibrium quantity Q*. To
find the equilibrium price and quantity, we set the two equations equal to each other.
𝑎 − 𝑏𝑄 = 𝑐 + 𝑑𝑄
At equilibrium 𝑄𝑠 = 𝑄𝑑 = 𝑄∗
Solving the equations gives us:
𝑎−𝑐 𝑎𝑑+𝑏𝑐
𝑄∗ = 𝑏+𝑑
𝑃∗ = 𝑏+𝑑
Example
Suppose the demand and supply functions for ice-cream are given by:
𝑃 = 400 − 2𝑄𝑑
𝑃 = 100 + 1𝑄𝑠
1. What is the minimum price needed for suppliers to be willing to sell ice-cream?
2. Find the equilibrium price and quantity.
3. If government regulates the market for ice-cream and fixes price at TK 150, will there be a
shortage or surplus in the market?
4. Calculate the amount of surplus/shortage
Example
Load shedding is back in Bangladesh, with its cascading effects. It is not a
result of power- generation-capacity shortage. Bangladesh Power
Development Board (BPDB) has power plants in the country with installed
capacity to generate 25,500 megawatts. But the primary fuel (natural gas,
oil and coal) shortages has compelled BPDB to restrict power generation and
supply. The power plants are suffering from primary energy shortages as the
Russia-Ukraine war pushed up energy prices on the international market. At
the same time, the months of February through June see heightened
demand for electricity given the summer heat.
Using a supply-demand diagram, show what happens to the equilibrium
price and quantity of electricity in Bangladesh.
