Chapter 2

Supply and
Demand
 Topics

1. Demand.
2. Supply.
3. Market Equilibrium.
4. Shocking the Equilibrium.
5. Effects of Government Interventions.
6. When to Use the Supply-and-Demand
Model.

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 Demand: Determinants of Demand

• The following factors determine the

demand for a good:
 Price of the good
 Tastes
 Information
 Prices of other goods
• Complements and substitutes
 Income
 Government rules and regulations
 Other factors

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 Demand: The Demand Curve

• Quantity demanded - the amount of a

good that consumers are willing to buy at
a given price, holding constant the other
factors that influence purchases.
• Demand curve - the quantity demanded
at each possible price, holding constant
the other factors that influence purchases

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 Figure 2.1 A Demand Curve

Law of Demand
p, $ per kg

14.30
consumers demand more
of a good the lower its
Demand curve for pork, D1
price, holding constant all
other factors that
influence consumption

4.30
3.30
2.30

0 200 220 240 286

Q, Million kg of pork per year

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 Figure 2.2 A Shift of the
p, $ per kg
Demand Curve

Effect of a 60¢ increase in the price of beef

3.30

D2
D1

0 176 220 232

Q, Million kg of pork per year

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 The Demand Function

• The processed pork demand function is:

Q = D(p, pb, pc, Y)

 where Q is the quantity of pork demanded

 p is the price of pork (dollars per kg)
 pb is the price of beef (dollars per kg)
 pc is the price of chicken (dollars per kg)
 Y is the income of consumers (thousand
dollars)
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 From the Demand Function to the
Demand Curve
• Estimated demand function for pork:

Q = 171−20p + 20pb + 3pc + 2Y

• Using the values pb = 4, pc = 3.33 and Y =

12.5, we have
Q = 286−20p

 which is the linear demand function for pork.

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 From the Demand Function to the
Demand Curve (cont.)
Q = 286−20p
p, $ per kg

14.30
If pp = $3.30 then,
InIfgeneral,
If Ifp pincreases
= 0, then
decreases by $1by
Q = 220 (to $2.30) then,
Demand curve for pork, D 1 DQQQ=$1
=
= 240
286
-20 D
(to $4.30)
p
then,
= slope D p
Q = 200
4.30
3.30
2.30

0 200 220 240 286

Q , Million kg of pork per year

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 Solved Problem 2.1

• How much would the price have to fall for

consumers to be willing to buy 1 million
more kg of pork per year?

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 Solved Problem 2.1

1. Express the price that consumers are

willing to pay as a function of quantity.

Q = 286−20p

20p = 286 - Q

p = 14.30 − 0.05Q

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 Solved Problem 2.1

2. Use the inverse demand curve to determine

how much the price must change for
consumers to buy 1 million more kg of pork
per year.

Δp = p2 − p1
= (14.30 − 0.05Q2) − (14.30 − 0.05Q1)
= –0.05(Q2 − Q1)
= –0.05ΔQ.

 The change in quantity is ΔQ = Q2 − Q1 = (Q1 +

1)−Q1 = 1, so the change in price is Δp = –0.05.

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 Summing Demand Curves

• The total demand shows the total quantity

demanded at each price
• The total quantity demanded at a given
price is the sum of the quantity each
consumer demands at that price
• Q = Q1 + Q2 = D1(p) + D2(p)

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 Application Aggregating the Demand
for Broadband Service

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 Supply: Determinants of Supply

• The following factors determine the supply

for a good:
 Price of the good
 Costs
 Government rules and regulations

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 Supply: The Supply Curve

• Quantity supplied - the amount of a

good that firms want to sell at a given
price, holding constant other factors that
influence firms’ supply decisions, such as
costs and government actions
• Supply curve - the quantity supplied at
each possible price, holding constant the
other factors that influence firms’ supply
decisions
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 Figure 2.3 A Supply Curve
An increase in the price…
p, $ per kg

5.30 Supply cu rve, S 1

3.30

causes a movement
along the curve….

0 176 220 300

and a decrease in the Q, Million kg of pork per year
quantity supplied….

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 Figure 2.4 A Shift of a Supply Curve
p, $ per kg A $0.25 increase in
the price of hogs….. shifts the supply
curve to the left

S2
S1

3.30

reducing the
quantity supplied at
the previous price.

0 176 205 220

Q , Million kg of po rk per year

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 The Supply Function

• The processed pork supply function is:

Q = S(p, ph)

 where Q is the quantity of pork supplied

 p is the price of pork (dollars per kg)
 ph is the price of a hog (dollars per kg)

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 From the Supply Function to the Supply
Curve
• Estimated demand function for pork:

Q = 178 + 40p−60ph

• Using the values ph = $1.50 per kg

Q = 88 + 40p.

• What happens to the quantity supplied if the

price of processed pork increases by Δp =
p2−p1?

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 Summing Supply Curves

• The total supply curve shows the total

quantity produced by all suppliers at each
price
• Horizontal sum of each producer’s supply
curve
 Sum of all quantities supplied at a given price

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 Figure 2.5 Total Supply: The Sum of
Domestic and Foreign Supply

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 Solved Problem 2.2

• How does a quota set by the United

States on foreign steel imports of Q affect
the total American supply curve for steel
given the domestic supply, Sd in panel a of
the graph, and foreign supply, Sf in panel
b?

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 Solved Problem 2.2

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 Market Equilibrium

• Equilibrium - a situation in which no one

wants to change his or her behavior
 equilibrium price is the price at which
consumers can buy as much as they want
and sellers can sell as much as they want
 equilibrium quantity is the quantity bought
and sold at the equilibrium price

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 Market Equilibrium (cont.)

• Excess demand the amount by which the

quantity demanded exceeds the quantity
supplied at a specified price.
• Excess supply the amount by which the
quantity supplied is greater than the
quantity demanded at a specified price

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 Figure 2.6 Market Equilibrium
Above the Market equilibrium point!
p, $ per kg

equilibrium price….
Excess supply = 39

S
3.95
e
3.30

2.65

Excess demand = 39
Below the D
equilibrium is below the
is below the
price…. quantity
quantity supplied
demanded

0 176 194 207 220 233 246

Q, Million kg of por k per year
the quantity supplied…. the quantity demanded….
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 Using Math to Determine the Equilibrium

• Demand: Qd = 286 − 20p

• Supply: Qs = 88 + 40p
• Equilibrium:
Qd = Qs
286 − 20p = 88 + 40p
60p = 198
P = $3.30
Q = 286 – 20(3.3) = 220
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 Equilibrium: Practice Problem

• The demand function for a good is

Q = a−bp, and the supply function is
Q = c + ep, where a, b, c, and e are
positive constants. Solve for the
equilibrium price and quantity in terms
of these four constants.

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 Shocking the Equilibrium

The equilibrium changes only if a shock

occurs that shifts the demand curve or the
supply curve. These curves shift if one of
the variables we were holding constant
changes.

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 Figure 2.7a Equilibrium Effects of a
Shift of a Demand Curve

p, $ per kg
A $0.60 increase in the price
of beef shifts demand outward
Which puts an upward
pressure on the price to
a new equilibrium.

e2 S
3.50
3.30 D2
e1

D1
At the original price
Excess demand = 12 there is now excess
demand….

0 176 220 228 232

Q, Million kg of pork per year

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 Figure 2.7b Equilibrium Effects of a
Shift of a Supply Curve
A $0.25 increase in the price of hogs

p , $ per kg
shifts the supply curve to the left

Which puts an upward

pressure on the price to a
new equilibrium.
S2
e2
3.55 S1
3.30
e1
D

At the original
Excess demand = 15
price there is now
excess demand….
0 176 205 215 220
Q, Million kg of pork per year

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 Solved Problem 2.3

• Mathematically, how does the equilibrium

price of pork vary as the price of hogs
changes if the variables that affect
demand are held constant at their typical
values?

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 Solved Problem 2.3
1. Solve for the equilibrium price of pork in
terms of the price of hogs.
Qd = 286−20p
Qs = 178 + 40p−60ph
286−20p = 178 + 40p−60ph
-60p = 108 – 60ph
-p = 1.8 – ph

2. Show how the equilibrium price of pork varies

with the price of hogs.
 Since Δp = Δph, any increase in the price of hogs
causes an equal increase in the price of
processed pork.

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 Equilibrium Effects of Government
Interventions
• Government action can cause
 a shift in the supply curve, the demand curve,
or both
 the quantity demanded to be different from
quantity supplied

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 Equilibrium Effects of Government
Interventions (cont.)
• Policies that shift supply curves
 Licensing laws, quotas
• Policies that cause demand to differ from
supply
 Price ceilings, price floors

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 Figure 2.8 A Ban on Rice Imports
Raises the Price in Japan
p, Price of rice per pound
–
S (ban) A ban on rice imports
shifts the total supply
of rice in Japan… S (no ban)

p2 e2

which causes the

p1 e1 equilibrium to change
and the price to increase.

D
Q2 Q1 Q, Tons of rice per year

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 Solved Problem 2.4

• What is the effect of a United States quota

on sugar of Q on the equilibrium in the
U.S. sugar market? Hint: The answer
depends on whether the quota binds (is
low enough to affect the equilibrium).

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 Solved Problem 2.4

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 Figure 2.9 Price Ceiling on Gasoline
p, $ per gallon
Supply shifts to the S1
left….

but gas stations must

continue to charge a
price of p1…..

e1
p1 = –p Price ceiling

Qs Q1= Q d
which creates excess
demand. Q, Gallons of gasoline per month
Excess demand

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 Solved Problem 2.5

• Suppose that there is a single labor market in

which everyone is paid the same wage. If a
binding minimum wage, w, is imposed, what
happens to the equilibrium in this market?
• Answer:
 Show the initial equilibrium before the minimum wage
is imposed.
 Draw a horizontal line at the minimum wage, and
show how the market equilibrium changes.

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 Figure 2.10 Minimum Wage

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 Why Supply Need Not Equal Demand

• The quantity that firms want to sell and

the quantity that consumers want to buy
at a given price need not equal the actual
quantity that is bought and sold.
 Example: price ceiling.

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 Perfectly Competitive Markets

• Everyone is a price taker.

• Firms sell identical products.

• Everyone has full information about the

price and quality of goods.

• Costs of trading are low.

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 Figure 2A.1 Regression

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