2 How Market Works:

Demand and Supply

Outline

v Describe a market
v Demand and Supply
v Definition of Demand and Supply
v Distinguish Demand(Supply) and Quantity demanded
(Supplied).
v Explain the influences on Demand and Supply

v How Demand and Supply determine market outcome

v Use the demand and supply model to make predictions

about changes in prices and quantities
Market

A market consists of a group of buyers and sellers of a

particular good or service.
Two examples of
market
Example 1:Competitive market

Competitive market: a market that has many buyers and

many sellers so that each has a negligible impact on the
market price
Example 1:Pefectly competitive market

Ø Conditions for perfect competition:

Ø Many buyers and sellers ---- Price taker
Ø Exactly the same products ---- Homogeneous products
Ø Perfect information
Ø No transaction cost (people and goods move freely)
Ø Free entry and exit

e.g. the market for fruits

Example 2: Monopoly

Monopoly: the only one seller in the market.

Anti-trust law:
“trust” means big
business
Demand
and
Supply
Demand

If you demand something, then you

1. Want it,
2. Can afford it
3. Have made a definite plan to buy it.
Wants are the unlimited desires or wishes people have for
goods and services.
Demand reflects a decision about which wants to satisfy.
Definition of Demand

Demand: the entire relationship between the price of the

good and quantity demanded of the good during a
particular time period

Quantity demanded: the amount that buyers are willing

and able to purchase at a particular price during a
particular time period
How to express Demand ?

v Demand schedule (table)

v Demand curve

v Demand function
Demand Schedule (Table)

Demand schedule (table): a table (schedule) that shows

the relationship between the quantity demanded of a good
and its price when all other influences on consumers’
planned purchases remain the same.
Demand Curve

Demand curve: a curve that shows the relationship

between the quantity demanded of a good and its price
when all other influences on consumers’ planned
purchases remain the same.
Demand Curve

Example : an demand curve that is not a straight line

Demand Curve & Willingness-to-Pay Curve

Willingness to Pay
A demand curve is also a
willingness-to-pay curve.
The smaller the quantity
available, the higher is the
price that someone is willing
to pay for another unit.
Willingness to pay
measures marginal benefit.
Demand Function

Demand function: a function that shows the relationship

between the quantity demanded of a good and its price
when all other influences on consumers’ planned purchases
remain the same.

Example:

Q(p) = 12 - 4p
Market Demand and Individual Demand

Market Demand: the sum of Individual Demands

Market Demand and Individual Demand

Market Demand: the sum of Individual Demands

Law of Demand

Law of demand:
Other things remaining the same, the higher the price of
a good, the smaller is the quantity demanded; and the
lower the price of a good, the larger is the quantity
demanded.
Effect of A Change in Price

A change in price changes the quantity demanded, but

not the demand. Why?
Substitution Effect

When the relative price (opportunity cost) of a good or service

rises, people seek substitutes for it, so the quantity demanded
of the good or service decreases.
Income Effect
When the price of a good or service rises relative to income,
people cannot afford all the things they previously bought, so
the quantity demanded of the good or service decreases.
Change in Quantity Demanded

A rise in the price, other

things remaining the
same, brings a decrease
in the quantity demanded
and a movement up along
the demand curve.
A fall in the price, other
things remaining the
same, brings an increase
in the quantity demanded
and a movement down
along the demand curve.
Change in Demand

When some influence on buying plans other than the price

of the good changes, there is a change in demand for
that good.
----- a new demand curve.
Change in Demand

When demand increases, the demand curve shifts

rightward.
When demand decreases, the demand curve shifts
leftward.
Factors that affect Demand

Six main factors that change demand are

▪ number of buyers
▪ prices of related goods
▪ income
▪ preference/tastes
▪expected future income
▪ expected future price
Shift in Demand Curve: Number of
Buyers
The larger the number of buyers, the greater is the
demand
Example: Chinese Dama refers to a group of Chinese
middle-aged women who rushed to purchase gold as an
investment in the year 2013 when the gold price plunged
greatly.
Shift in Demand Curve: Price of Related
Goods
A substitute is a good that can be used in place of
another good.

A complement is a good that is used in conjunction with

another good.
Substitute

When the price of a substitute increase, demand

increases.

1. Pepsi and Sprite are substitutes

2. Pepsi/Sprite and “Jinglongyu” are not substitutes
Bus and MRT, Apple and Huawei, Didi and Taxi
 Complement

When the price of a complement increase, demand decreases.

Other examples: computer and software, coffee and coffee

maker
Shift in Demand Curve: Income

When income increases, demand curve shifts.

A normal good is one for which demand increases as
income increases.
An inferior good is a good for which demand decreases
as income increases.
Shift in Demand Curve: Tastes

Increased tastes for a good will increase the demand for

that good.
e.g., foot soaking bath basin
Shift in Demand Curve: Expectation

Expected Future Income

When income is expected to increase in the future, the
demand might increase now.

Expected Future Prices

If the price of a good is expected to rise in the future,
current demand for the good increases and the demand
curve shifts rightward.
Supply

If a firm supplies a good or service, then the firm

1. Has the resources and the technology to produce it,
2. Can profit from producing it, and
3. Has made a definite plan to produce and sell it.

Resources and technology determine what it is possible

to produce.
Definition of Supply

Supply: the entire relationship between the price of the

good and quantity supplied during a particular time
period

Quantity supplied: the amount that producers plan to

sell at a particular price during a particular time period
How to express Supply ?

1. Supply schedule (table)

2. Supply curve
3. Supply function
Market Supply & Individual Supply
Law of Supply

The Law of Supply

Other things remaining the same, the higher the price of a
good, the greater is the quantity supplied; and the lower
the price of a good, the smaller is the quantity supplied.
Change in Quantity supplied

A movement along the

Supply Curve
If other things remain the
same, a change in price will
result in a movement along
the supply curve.
Change in Supply

When some influence on selling plans other than the price

of the good changes, there is a change in supply of that
good.
-------a new supply curve.

A Shift of the Supply Curve

When supply increases, the
supply curve shifts rightwards.
When supply decreases, the
supply curve shifts leftwards.
Factors that affect Supply

The four main factors that change supply of a good are

▪ The number of supplier
▪ Prices of production factors/inputs
▪ Technology
▪ Expectation
Shift in Supply Curve

The Number of Suppliers

The larger the number of suppliers of a good, the greater
is the supply of the good.
An increase in the number of suppliers shifts the supply
curve rightwards.
Shift in Supply curve

Prices of Production Factors

If the price of a factor of production used to produce a
good rises, the minimum price that a supplier is willing to
accept for producing each quantity of that good rises.
So a rise in the price of a factor of production decreases
supply and shifts the supply curve leftwards.
Shift in Supply curve

Technology
Advances in technology create new products and lower
the cost of producing existing products.
So advances in technology increase supply and shift the
supply curve rightwards.
Shift in Supply Curve

Expected Future Prices

If the price of a good is expected to rise in the future,
supply of the good today decreases and the supply curve
shifts leftward.
Market Equilibrium
Market Equilibrium

Equilibrium is a situation in which the market price has

reached the level at which quantity supplied equals
quantity demanded

Equilibrium price is the price at which the quantity

demanded equals the quantity supplied.

Equilibrium quantity is the quantity supplied and

demanded at the equilibrium price.
Example
Surplus: excess supply
Surplus: a situation in which quantity supplied is greater than quantity
demanded

If the price is $2.00/bar, the quantity

supplied exceeds the quantity
demanded.
There is a surplus of 8 million energy
bars.
Shortage: excess demand
Shortage: a situation in which quantity demanded is greater than
quantity supplied

If the price is $1.00/ bar, the quantity

demanded exceeds the quantity
supplied.
A shortage of 9 million bars.
Price adjustment

v If the price is above the

equilibrium price, a surplus
forces the price down.
v If the price is below the
equilibrium price, a
shortage forces the price
up.
At the equilibrium price,
buyers’ plans and sellers’
plans agree and the price
doesn’t change until an event
changes demand or supply.
Predicting Changes in Equilibrium Price
and Quantity
An Increase in Demand
When demand increases
the demand curve shifts
rightwards.
At the original price, there
is now a shortage.
The price rises, and the
quantity supplied
increases along the
supply curve.
Predicting Changes in Equilibrium Price
and Quantity
A Decrease in Demand
When demand decreases
the demand curve shifts
leftward.
At the original price, there
is now a surplus.
The price falls, and the
quantity supplied
decreases along the
supply curve.
 Predicting Changes in Equilibrium Price
and Quantity
An Increase in Supply
When supply increases
the supply curve shifts
rightward.
At the original price, there
is now a surplus.
The price falls, and the
quantity demanded
increases along the
demand curve.
Predicting Changes in Equilibrium Price
and Quantity
A Decrease in Supply
When supply decreases
the supply curve shifts
leftwards.
At the original price, there
is now a shortage.
The price rises, and the
quantity demanded
decreases along the
demand curve.
Predicting Changes in Equilibrium Price
and Quantity

Changes in Both
Demand and Supply
A change in both demand
and supply may change
the equilibrium price and
the equilibrium quantity.
Predicting Changes in Equilibrium Price
and Quantity
Both Demand and Supply
Change in the Same
Direction
An increase in demand and
an increase in supply
increase the equilibrium
quantity.
The change in equilibrium
price is uncertain because
the increase in demand
raises the price and the
increase in supply lowers it.
Predicting Changes in Equilibrium Price
and Quantity
A decrease in both
demand and supply
decreases the equilibrium
quantity.
The change in equilibrium
price is uncertain because
the decrease in demand
lowers the price and the
decrease in supply raises
the price.
Predicting Changes in Equilibrium Price
and Quantity
Both Demand and Supply
Change in Opposite
Directions
A decrease in demand and
an increase in supply lowers
the equilibrium price.
The change in equilibrium
quantity is uncertain
because the decrease in
demand decreases the
quantity and the increase
in supply increases it.
Predicting Changes in Equilibrium Price
and Quantity
An increase in demand
and a decrease in supply
raises the equilibrium
price.
The change in equilibrium
quantity is uncertain
because the increase in
demand increases the
quantity and the decrease
in supply decreases it.
Homework (Due on Oct 12)
(1) Read Chapter 4 of Mankiw’s book
(2) Chapter quick quiz on Page 85-86 of Mankiw’s book
(3) On Page 87 -88 of Mankiw’s book (8th edition), 1(a), 2, 4, 10, 11
(4) As shown in the following figure, pork price rises in July. What are
the possible reasons behind this price rise?