Chapter 3

Supply and
Demand
d

Chapter Outline

Market demand
Market supply
Market equilibrium
Comparative statics analysis
pp y demand, and price
p
Supply,

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3-2

Learning Objectives
Define supply, demand, and equilibrium price
List and
d provide
d specific
f examples
l off the
h non-price
determinants of supply and demand
Distinguish between the short
short-run
run rationing
function and long-run guiding function of price
Illustrate how the concepts of supply and demand
can be used in management decisions about price
and allocations of resources.
Use supply and demand diagrams to determine
price in the short and long run

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3-3

Market Demand
The demand for a good or service is defined
as:
Quantities of a good or service that people are
ready willing and able to buy at various prices
ready,
within some given time period. (Other factors
besides price held constant.)

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Market Demand
Ready implies that consumers are
prepared
d to b
buy a good
d or service b
both
h
because they are:
Willing: Consumers have a preference for it.
Able: Consumers have the income to support this
preference.

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3-5

Market Demand
Market demand is the sum of all the individual
demands.
demands
Individuals may have distinct demand curves,
y sum to the overall demand in the
and they
market.
Example: demand for pizza

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Market Demand
There is an inverse
relationship between
price and the quantity
demanded of a good or
service.
This is
Thi
i called
ll d th
the Law
L
of Demand.
Thus, the demand
curve is downward
sloping.
l i
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3-7

Market Demand
Graphical
R
Representation
t ti
off
Demand
Algebraic
Representation
ep ese tat o of
o
Demand
Qd=700-100P

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3-8

Market Demand
Changes in price result in changes in the
quantity demanded
d
d d
This is shown as movement along the demand
curve.

Changes in non-price factors result in

changes in demand
This is shown as a shift in the demand curve.
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Market Demand

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Market Demand
Non-price determinants of demand-result is
a shift
h f in the
h demand
d
d curve.

tastes and preferences

income
prices of related products
future expectations
number of buyers

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3-11

Market Supply
The supply of a good or service is defined as
quantities that
h people
l are ready
d to sell
ll at
various prices within some given time period
(Other factors besides price held constant)

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Market Supply
Changes in price result in changes in the
quantity supplied
l d
shown as movement along the supply curve

Ch
Changes iin non-price
i d
determinants
t
i
t result
lt in
i
changes in supply
shown as a shift in the supply curve

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Market Supply

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Market Supply
Non-price determinants of supply-results in
a shift
h f in the
h supply
l curve.
costs and technology
prices of other goods or services offered by the
seller
future expectations
number of sellers
weather conditions

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3-15

Market Equilibrium
Equilibrium price: the price that equates
the
h quantity demanded
d
d d with
h the
h quantity
supplied
Equilibrium quantity: the amount that
people are willing to buy and sellers are
willing to offer at the equilibrium price level

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Market Equilibrium
Shortage: a market situation in which the
quantity demanded
d
d d exceeds
d the
h quantity
supplied
shortage occurs at a price below the equilibrium
level

Surplus: a market situation in which the

quantity
q
y supplied
pp
exceeds the quantity
q
y
demanded
surplus occurs at a price above the equilibrium
l
level
l
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Market Equilibrium

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3-18

Comparative Statics Analysis

Comparative statics is a form of
sensitivity (or
( what-if)
h
f) analysis
l
Commonly used method in economic analysis

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3-19

Comparative Statics Analysis

Process of comparative statics analysis:
state all the assumptions needed to construct the
model
begin by assuming that the model is in
equilibrium
g in the model, so a condition
introduce a change
of disequilibrium is created
find the new point of equilibrium
compare the
th new equilibrium
ilib i
point
i t with
ith the
th
original one

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Comparative Statics Analysis

Step 1
assume all factors
except the price of
pizza are constant
buyers
y
demand and
sellers supply are
represented by lines
shown

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Comparative Statics Analysis

Step 2
begin the analysis
in equilibrium as
shown
h
by
b Q1 and
d P1

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Comparative Statics Analysis

Step 3
assume that a new
study shows pizza
t be
to
b the
th mostt
nutritious of all fast
foods
consumers increase
their demand for
pizza as a result
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3-23

Comparative Statics Analysis

Step 4
the shift in demand
results in a new
equilibrium
ilib i
price
i
(P2)
and a new
equilibrium quantity
(Q2)

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3-24

Comparative Statics Analysis

Step 5
comparing the
new equilibrium
point
i t with
ith the
th
original one, we
see that both
equilibrium price
and q
quantity
y have
increased

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Comparative Statics Analysis

The short run is the period of time in
which:
h h
sellers already in the market respond to a
change in equilibrium price by adjusting variable
inputs
buyers already in the market respond to changes
in equilibrium price by adjusting the quantity
demanded for the good or service

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Comparative Statics Analysis

Short run changes show the rationing
f
function
i
off price
i
The rationing function of price is the change in
market price to eliminate the imbalance between
quantities supplied and demanded.

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Comparative Static Analysis:

S o
Short-run
u
an increase in
demand causes
equilibrium price and
quantity to rise

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Comparative Static Analysis:

S o
Short-run
u
a decrease in demand
causes equilibrium
price and quantity to
fall

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Comparative Static Analysis:

S o
Short-run
u
an increase in
supply causes
equilibrium price
to fall and
equilibrium
ilib i
quantity to rise

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Comparative Static Analysis:

S o
Short-run
u
a decrease in
supply causes
equilibrium price
to rise and
equilibrium
ilib i
quantity to fall

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Comparative Static Analysis:

o g u
Long-run
The long run is the period of time in which:
new sellers may enter a market
existing sellers may exit from a market
existing
i ti
sellers
ll
may adjust
dj t fi
fixed
d factors
f t
off
production
buyers may react to a change in equilibrium
price by changing their tastes and preferences

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Comparative Static Analysis:

o g u
Long-run
Long run changes show the allocating
f
function
off price
The guiding or allocating function of
price is the movement of resources into or
out of markets in response to a change in
the equilibrium price.

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Comparative Static Analysis:

o g u
Long-run
initial change: decrease in
demand from D1 to D2
result: reduction in
q
price and
p
equilibrium
quantity (to P2, Q2)
follow-on adjustment:
movement off resources out
of the market
leftward shift in the supply
curve to S2
equilibrium price and
quantity (to P3, Q3)

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Long-run Analysis
initial change: increase in
demand from D1 to D2
result: increase in
equilibrium price and
quantity (to P2, Q2)
follow-on adjustment:
movement of resources
into the market
rightward shift in the
supply curve to S2
equilibrium
q
price and
p
quantity (to P3, Q3)
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Summary: Short-Run and Long-Run

Changes
g
in the Market

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Supply, Demand, and Price

In the extreme case, the forces of supply
and
dd
demand
d are the
h sole
l d
determinants off
the market price, not any single firm.
this type of market is perfect competition

IIn many cases, individual

i di id l firms
fi
can exertt
market power over price because of their:
dominant size
ability to differentiate their product through
advertising, brand name, features, or services
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Supply, Demand, and Price

Discussion of changes in the computer
industry
d
Makers of PCs, notebooks and jump drives are
facing slower growth in the demand for their
products as technology is changing.
What impact do you think cloud computing will
have on the demand for stand-alone applications
such as Microsoft Office or storage devices for
computers?
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Global Application
What are the implications of rising demand for
oill among d
developing
l
counties?

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Global Application

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Global Application

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Summary
The law of demand states that, other factors
h ld constant, the
held
h quantity d
demanded
d d is
inversely related to price.
The
Th llaw off supply
l states
t t th
that,
t other
th ffactors
t
held constant, the quantity supplied is
directly related to price.
price
Non-price factors may shift the curves.
Price serves a short-run
short run rationing function
and a long-run guiding function in the
marketplace.
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