Chapter 2: Supply and Demand

Before using the Supply and Demand Model, determine

1. Buyers behavior
2. Sellers behavior
3. Their interactions
Demand: the quantity of a good or service that consumers demand depends on price and other
factors such as consumers income and the prices of related goods.
Supply: the quantity of a good or service that firms supply depends on price and other factors
such as the cost of inputs that firms use to produce the goods or service.
Market Equilibrium: the interaction between consumers demand curve and firms supply
curve determines the market price and quantity of a good or service that is bought and sold.
Shocking the Equilibrium: Comparative Statics. changes in a factor that affect demand (such
as consumers income), supply (such as a rise in the price of inputs) or a new govnt policy (syc
as a new tax) , alter the market or equilibrium price and quantity of a good.
Elasticities: Given estimates of summary statistics called elasticities, economists can forecast the
effects of changes in taxes and other factors on market price and quantity.
Effects of a Sales Tax: how a sales tax increase affects the price and quantity of a good, and
whether the tax falls more heavily on consumers or on suppliers, depend on the supply and
demand curves.
Quantity supplied Need not Equal Quantity Demanded: if the government regulates the price
in market, the quantity supplied might not equal the quantity demanded.
When to Use the Supply-and-Demand Model: The supply-and-demand model applies to
competitive markets only.
2.1 Demand
Quantity demanded: the amount of a good that consumers are willing to buy at a given price
during specified period, holding constant the other factors that influence purchases.
Factors that influence Consumers purchase
1. Information and misinformation
2. Prices of other goods (substitutes & complements)
3. Peoples income
4. Govt rules and regulations
The Demand Function: describes the mathematical relationship between quantity demanded
(Qd), price (p) and other factors that influence purchases:
Q=D( p , ps , p c Y )
p = per unit price of the food or service

ps = per unit price of a substitute good

pc = per unit price of a complementary good

Y = consumers income
- Changes in the price of the goods causes movement along the demand curve

Law of Demand: consumers demand more of a good the lower its price, holding
others factors constant. Derivative is negative higher price results in lower
quantity demanded.
- the derivative of the demand function with respect to price shows the movements along the
demand curve
Q=17120 p+20 pb +3 pc +2 Y
Qd =quantity of pork demanded
p= price of pork
pb= price of beef [$4]
pc = price of chicken [$3.33]
Y =consumers ' income [$12.5]
( Q/ p)=20
Derivative =
Slope = 1/( Q/ p)=(1/2)0=0.05
- Changes in price causes movement along the curve
- Changes in any other factors, causes shift of the demand curve.
Quantity supplied: the amount of good that firms want to sell during a given period at a given
price, holding other factor constant.
Factors that influence the Supply function
1. Production cost
2. Government rules and regulations
Supply function: the relationship between quantity supplied, price, and other factors that
influence the number of units offered for sale.
-There is NO law of supply, the curve can be upwards, vertical, horizontal, or upward/downward
sloping.
Equilibrium: situation in which no participant wants to change its behavior.
Equilibrium price (Market clearing price): consumers want to buy the same quantity that
firms want to sell.
Equilibrium quantity: quantity that is bought and sold at the equilibrium price.
Comparative statistics: the method economists use to analyze how variable controlled by
consumers, and firms, price and quantity react to a change in environmental variables
(exogenous variables).
- Includes prices of:
- Substitutes
- Complement
- Consumer income level
- Price of inputs
Comparative Statistics with Small Changes
Demand Function: Q = D(p)
Supply Function: Q = S(p, a)
a environmental variable.

Demand Elasticity
Price elasticity of demand:

Percentage change in quantity demanded

Percentage change in price
Elasticity along the Demand Curve
- The higher the price the more negative the elasticity of the demand.
= 0 perfectly inelastic (eg. vertical demand curve)
- -1 < < 0 inelastic
< -1 elastic
Income Elasticity: percentage change in quantity demanded in response to % change in income.

= % change in quantity demanded =

% change in income
Cross price elasticity: percentage change in the quantity demanded in response to a given
percentage change in the price of another good.
= % change in quantity demanded =
% change in price of another good
- CPE = (-) good is complements
- CPE = (+) good is substitutes
Supply Elasticity
% change in quantity supplied in response in response to a given percentage change in price.
= % change in quantity supplied =
% change in price

= supply curve slopes downwards

+
= supply curve slopes upwards
- Vertical supply curve perfectly inelastic =0
- Horizontal supply curve perfectly elastic =
0<<1 inelastic
Effects of Sales tax
- How much a tax affects the equilibrium price and quantity and how much tax fall
on consumers depends on the elasticities of demand and supply.
- 2 different taxes:
- Sales tax
- Unit tax (gasoline)
Price ceiling: legally limits the amount that can be charged for a product.
- Causes excess in demand leading to shortage
- (eg. Oil price on gasoline, charged less than what it really was thus supplying less
but higher demand)

Price Floor: legally impose a price control that limits how low a price is charged on a product.
- Causes an excess supply or persistent surplus
- (eg. Minimum wage on employees forced employers to lay off worker resulting in
high unemployment)