Demand, supply and the

market

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 Some key terms
• Market
– a set of arrangements by which buyers and sellers are
in contact to exchange goods or services
• Demand
– the quantity of a good buyers wish to purchase at each
conceivable price
• Supply
– the quantity of a good sellers wish to sell at each
conceivable price
• Equilibrium price
– price at which quantity supplied = quantity demanded
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©KHALID AZIZ 2011
 Catherine’s Demand Schedule
The demand schedule is a table that shows the relationship

between the price of the good and the quantity demanded.

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Figure 1 Catherine’s Demand Schedule and Demand Curve
(The demand curve is a graph of the relationship between the price of a good
and the quantity demanded.)

Price of
Ice-Cream Cone
$3.00

2.50

1. A decrease
2.00
in price ...

1.50

1.00

0.50

0 1 2 3 4 5 6 7 8 9 10 11 12 Quantity of
Ice-Cream Cones
2. ... increases quantity
of cones demanded.
©KHALID AZIZ 2011
Copyright © 2004 South-Western
 Changes in Quantity Demanded
Movement along the demand curve caused by a change
in the price of the product.
Price of Ice-
Cream A tax that raises the price
Cones
of ice-cream cones results
B in a movement along the
$2.00 demand curve.

1.00 A

D
0 4 8 Quantity of Ice-Cream Cones
©KHALID AZIZ 2011
 Market Demand versus
Individual Demand

• Market demand refers to the sum of all

individual demands for a particular good
or service.
• Graphically, individual demand curves
are summed horizontally to obtain the
market demand curve.

©KHALID AZIZ 2011

 The Demand curve shows the relation
between price and quantity demanded
holding other things constant
Price

• “Other things” include:

– the price of related
goods
– consumer incomes
– consumer preferences
• Changes in these other
D things affect the position
of the demand curve

Quantity

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©KHALID AZIZ 2011
 Prices of related goods and Effect on
Demand
Substitute Goods:
coffee for tea; train ride for driving your own auto; coal
for natural gas

If Price of coffee increases then Demand for tea increases

Complimentary Goods:
tea and sugar; coffee and milk; gas and car; coal and
coal heaters

If Price of gas increases, then Demand for automobiles

decreases

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©KHALID AZIZ 2011
Effect of Consumer Income on Demand:
Normal Goods versus Inferior Goods
Normal Goods:
For normal goods, demand increases when consumer
income increases.

Most goods are normal goods.

Inferior Goods:
For inferior goods, demand decreases when consumer
income increases.

Second-hand cars, second-hand clothing, bus rides

(versus driving your own auto or cab rides)

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©KHALID AZIZ 2011
 Ben’s Supply Schedule
(The supply schedule is a table that shows the relationship
between the price of the good and the quantity supplied.)

©KHALID AZIZ 2011

 Figure 5 Ben’s Supply Schedule and Supply Curve
(The supply curve is the graph of the relationship between the price of a good
and the quantity supplied.)

Price of
Ice-Cream
Cone
$3.00

2.50
1. An
increase
in price ... 2.00

1.50

1.00

0.50

0 1 2 3 4 5 6 7 8 9 10 11 12 Quantity of
Ice-Cream Cones
2. ... increases quantity of cones supplied. ©KHALID AZIZ 2011
Copyright©2003 Southwestern/Thomson Learning
 Market Supply versus
Individual Supply
• Market supply refers to the sum of all
individual supplies for all sellers of a
particular good or service.
• Graphically, individual supply curves are
summed horizontally to obtain the
market supply curve.

©KHALID AZIZ 2011

 The Supply curve shows the relation
between price and quantity supplied
holding other things constant

• “Other things” include:

Price

S
– technology
– input costs
– government
regulations
• Changes in these other
things affect the position
of the demand curve

Quantity

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©KHALID AZIZ 2011
 SUPPLY AND DEMAND
TOGETHER
Demand Schedule Supply Schedule

At $2.00, the quantity demanded

is equal to the quantity supplied!
©KHALID AZIZ 2011
 Market equilibrium (1)

D0 S
• Market equilibrium is at
E0 where quantity
demanded equals
P0  E0 quantity supplied
– with price P0 and
quantity Q0

S D0
Q0 Quantity

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©KHALID AZIZ 2011
 Market equilibrium and
disequilibrium
• If price were below P0
S there would be excess
excess demand
D
supply
– consumers wish to
P1   purchase more than
producers wish to
E
P0  supply
• If price were above P0
P2   there would be excess
excess supply
S demand D – producers wish to
supply more than
Q0 Quantity consumers wish to
purchase
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©KHALID AZIZ 2011
 A shift in demand
If the price of a substitute
D0 S good decreases ...
D1
less will be demanded at
P0 each price.
E0
P1 E1 The demand curve shifts
from D0D0 to D1D1.

If price stayed at P0 there

D0 would be excess supply.
S D1
So the market moves to a
Q1 Q0 new equilibrium at E1.
Quantity

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©KHALID AZIZ 2011
 A shift in supply
S1 Suppose safety
S0 regulations are tightened,
D increasing producers’ costs

E2 The supply curve

P1 shifts to S1S1
P0 E0
If price stayed at P0 there
would be excess demand
S1
S0 D So the market moves to a
new equilibrium at E2
Q1 Q0 Quantity

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©KHALID AZIZ 2011
 Two ways in which demand may
increase (1)

• (1) A movement along

the demand curve from A
A to B
P0 • represents consumer
B reaction to a price
P1 change
• could follow a supply
D shift

Q0 Q1 Quantity

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©KHALID AZIZ 2011
 Two ways in which demand may
increase (2)

• (2) A movement of the

demand curve from D0 to
D1
• leads to an increase in
demand at each price
P0 C
A • e.g. at P0 quantity
P1 F demanded increases
B from Q0 to Q2: at P1
quantity demanded
D0 D1 increases from Q1 to Q3

Q0 Q1 Q2 Q3
Quantity

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©KHALID AZIZ 2011
A market in disequilibrium
• Suppose a disastrous
S harvest moves the supply
D
curve to SS
P2 • government may try to
E protect the poor, setting
P0 a price ceiling at P1
A B • which is below P0, the
P1 equilibrium price level
• The result is excess
excess D demand
demand
S RATIONING is needed to
cope with the resulting
QS Q0 QD Quantity excess demand

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©KHALID AZIZ 2011
 Price and quantity changes
• In practice, we cannot plot ex ante demand
curves and supply curves
• So we use historical data and the supposition
that the observed values are equilibrium ones
• Since other things are often not constant,
some detective work is required
• This is where our theory comes in useful

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©KHALID AZIZ 2011
 What, how and for whom
• The market:
– decides how much of a good should be produced
• by finding the price at which the quantity demanded
equals the quantity supplied
– tells us for whom the goods are produced
• those consumers willing to pay the equilibrium price
– determines what goods are being produced
• there may be goods for which no consumer is prepared
to pay a price at which firms would be willing to supply

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 JOIN KHALID AZIZ
• ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
• FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP
MODULE B, B.COM, BBA, MBA & PIPFA.
• COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE
D, BBA, MBA & PIPFA.

• CONTACT:
• 0322-3385752
• 0312-2302870
• 0300-2540827
• R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA,
KARACHI, PAKISTAN.

©KHALID AZIZ 2011