Demand and Supply

Markets
In economic theory a market is where buyers and sellers come together to
carry out an economic transaction.
physical places on-line markets

factor markets product markets

financial markets stock markets

At the core of market theory

are the concepts of demand and supply.
Demand
Demand is the quantity of a good or service that consumers
are willing and able to purchase at a given price in a
given time period.

effective demand
Law of demand

“as the price of a product falls, the quantity demanded

of the product will usually increase, ceteris paribus”.

It is sometimes expressed even more simply as “the

demand curve normally slopes downwards”.
Law of demand

Price of soft drinks (Eur) Quantity demanded of soft drinks (cans)

2,00 100

1,20 150

0,80 225

0,40 400

Table illustrates the effective demand for soft drinks

at a sports event
Law of demand

The increase in
Price of softdrinks (eur) 2,00 demand is for
1,50 two reasons:
1,00
1/ Income effect
2/ Substitution
0,50
D Demand effect
100 200 300 400
Quantity of softdrinks (units)
Law of demand
The non-price determinants of demand
Income
• Normal goods - for most
goods, as income rises,

Price of airtravel (eur)

the demand for the
product will also rise.
• Inferior goods - demand p

for the product will fall as

income rises and the D
consumer starts to buy Q1 Q2
higher priced substitutes Quantity of airmiles

in place of the inferior

good Demand for air travel
Law of demand
The non-price determinants of demand
The price of other
products
• Substitutes

Price (eur)

Price (eur)
P P
If products are P1
substitutes for each
other, then a change in D D1
D
the price of one of the
products will lead to a Q Q1 Q1 Q

change in the demand Quantity (kg) Quantity (kg)

for the other product.
Demand for chicken Demand for beef
Law of demand
The non-price determinants of demand
The price of other
products
• Complements

Price (eur)

Price (eur)
P P
Complements are products
that are often purchased P1

together, such as printers D1

and ink cartridges. If D D
products are complements Q Q1 Q Q1
to each other, then a
change in the price of one Quantity Quantity
of the products will lead to
a change in the demand Demand for DVD players Demand for DVD
for the other product.
Law of demand
The non-price determinants of demand
The price of other products
• Unrelated goods
If products are unrelated, then a change in the price of one
product will have no effect upon the demand for the other
product
Law of demand
The non-price determinants of demand
Testes/

Price of skateboards (eur)

preferences
marketing may alter
tastes and firms
attempt to influence p

tastes so that they

can shift the demand D D1
curve for their Q Q1
product to the right Quantity of skateboards

Demand for skateboards

Law of demand
The non-price determinants of demand
Other factors
• The size of the population
• Changes in the age structure of the population
(demographic factors)
• Changes in income distribution
• Government policy changes
• Seasonal changes
Law of demand

The distinction between a movement along a demand curve

and a shift of the demand curve
A change in the price of the good itself leads to a movement
along the existing demand curve, since the price of the good is
on one of the axes.
A change in any of the other determinants of demand will
always lead to a shift of the demand curve to either the left or
the right.
Supply

Supply is the willingness and ability of

producers to produce a quantity of a good or
service at a given price in a given time period.

effective supply
Law of Supply

states that “as the price of a product rises, the

quantity supplied of the product will usually
increase, ceteris paribus”.

It is sometimes expressed even more simply as

“the supply curve normally slopes upwards”.
Law of Supply

Quantity supplied of frozen pizzas

Price of frozen pizzas (Eur) (per week)
3,50 4400
3,00 4000
2,50 3500
2,00 2750
1,50 1750
Table illustrates the effective supply for frozen pizzas in a small town
Law of Supply

a change in the S Supply

price of the 3,50
product itself will
Price of frozen pizzas (eur)
lead to a change 3,00
in the quantity 2,50
supplied of the 2,00
product (a
movement along 1,50
the existing supply 1,00
curve)
1000 2000 3000 4000
Quantity of frozen pizzas

Supply curve for frozen pizzas

Law of Supply
The non-price determinants of supply
The costs of factors of S1 S

production

Price of textiles (eur)

If there is an increase in the cost of a P
factor of production, such as a wage
increase in a firm producing textiles
which is labour intensive, then this
will increase the firm’s costs,
meaning that they can supply less,
shifting the supply curve to the left.
0 Q1 Q
A fall in the cost of factors of Quantity of textiles
production will enable firms to
increase their supply, shifting the
supply curve to the right. Supply of textiles
Law of Supply
The non-price determinants of supply
The price of other
products, which S1 S

the producer could S

produce instead of P1 P

Price (eur)

Price (eur)
the existing P
product
Often, producers have a
choice as to what they are 0 Q Q1 0 Q1 Q
going to produce. Quantity
Quantity

Supply of skateboards Supply of roller skates

Law of Supply
The non-price determinants of supply
• The state of technology (Improvements in the state of
technology in a firm or an industry should lead to an
increase in supply and thus a shift of the supply curve
to the right)
• Expectations Producers make decisions about what to
supply based on their expectations of future prices.
Law of Supply
The non-price determinants of supply
Government intervention. The two most common
ways are indirect taxes and subsidies.
Indirect taxes (expenditure taxes) are taxes on goods and services that are
added to the price of a product. Because these taxes force up the price of the
product, they have the effect of shifting the supply curve upwards by the
amount of the indirect tax.
Subsidies are payments made by the government to firms that will, in effect,
reduce their costs. This then has the effect of shifting the supply curve
downwards by the amount of the subsidy.
Law of Supply
The distinction between a movement
along a supply curve and a shift of the S1 S
supply curve S
A change in the price of the good itself P

Price (eur)
P

Price (eur)
leads to a movement along the existing
supply curve, since the price of the good P1
is on one of the axes.
A change in any of the other
determinants of supply will always lead
to a shift of the supply curve to either the 0 Q1 Q 0 Q1 Q
left or the right. Quantity
Quantity

Supply of soccer boots Supply of cars

Market equilibrium, the price
mechanism, and market
efficiency
Equilibrium
Equilibrium may be defined as “a state of rest, self-
perpetuating in the absence of any outside
disturbance”.

For example, a book is in equilibrium if it is lying on a

desk. Unless someone comes along and moves it (an
“outside disturbance”), then it will continue to lie there
(“a state of rest”). If someone does move it, then it is in
disequilibrium until it is put down somewhere else, at
which time it is in a new equilibrium situation.
Equilibrium
In Figure, both the demand and supply .
curves for coffee are in the same diagram S
D
and we see that, at the
price Pe,

Price of coffee (eur)

the quantity Qe is both Pe

demanded and supplied.

The price Pe is sometimes

known
as the market-clearing price, Qe
Quantity of coffee (kg)
since everything produced in the market
will be sold.
The market for coffee
Equilibrium

What will happen if the

producers try to raise D Excess supply S

the equilibrium price?

Price of coffee (eur)

P1

Pe

0 Q1 Qe Q2
Quantity of coffee (kg)

The market for coffee

Equilibrium

What will happen if the

producers try to lower D S

the equilibrium price?

Price of coffee (eur)

Pe

P2

Excess demand

0 Q3 Qe Q4

Quantity of coffee (kg)

The market for coffee

The effect of changes in demand and supply upon
the equilibrium
the equilibrium may be
moved by any “outside
disturbance”.

Price of holidays (eur)

D1 S
In the case of demand D

and supply, this would be Pe1

a change in one of the Pe
determinants of demand Excess demand
or supply, other than the
price of the product, 0 Qe Qe1 Q2
which would lead to a Quantity of holidays (days)

shift of either of the

curves The market for foreign holidays
The role of the price mechanism
price mechanism – it is how the forces of supply and
demand move markets to equilibrium.
price mechanism helps to allocate scarce resources.
Resources are allocated, and re-allocated, in response
to changes in price.
If there is an increase in the price of a good, due to an
increase in demand for the good, then this gives a
“signal” to producers that consumers wish to buy this
good.
Market efficiency
Consumer and producer surplus
S
20

Price of thingies(eur)
15

10

D
0 5 10 15 20
Quantity of thingies

The market for thinges

Market efficiency
Consumer and producer surplus
consumer 20 Consumer
S At the
surplus is surplus equilibrium
defined as the 15 point, there
extra
Price of thingies(eur)
satisfaction (or are some
utility) gained 10 consumers
by consumers who would
5
from paying a have been
price that is D prepared to
lower than that 0 5 10 15 20 pay a higher
which they are Quantity of thingies
price for their
prepared to
pay. thingies.
The market for thinges
Market efficiency
Consumer and producer surplus
the concept of Consumer S
producer 20 surplus at the
surplus equilibrium
Price of thingies(eur)
15
is defined as the point, some
excess of actual 10
Producer production of
earnings that a
producer makes surplus thingies would
5
from a given take place at a
quantity of output, D
price lower
over and above the 0 5 10 15 20
amount the Quantity of thingies
than $10
producer would be
prepared to accept
for that output. The market for thinges
Allocative efficiency

The sum of 20
Consumer S = Marginal At the
surplus
consumer social cost
curve (MSC)
equilibrium,

Price of thingies(eur)
and producer 15 where demand
surplus is 10
Producer
is equal to
known as supply,
surplus
community 5 community
surplus is
surplus; this D = Marginal
maximised. This
0 5 10 15 20social benefit
is the total Quantity of thingies curve (MBC) is the point of
benefit to allocative
society. The market for thinges efficiency.
Allocative efficiency
The supply curve for a market is largely determined by
Consumer S = Marginal the industry’s costs of production. When we assume that
20 surplus social cost
the costs of the industry are equal to the costs to society
then the supply curve represents the social cost curve.
curve (MSC)
Price of thingies(eur)

15 In efficiency analysis we call this the marginal social

cost curve (MSC).
The demand curve is determined by the utility, or
10 benefits, that the consumption of a good or service
Producer
brings to the consumers. If we assume that the benefits
surplus
5 in the market are equivalent to the benefits to society,
then the demand curve represents the social benefits.
D = Marginal In efficiency analysis we refer to the demand curve as
the marginal social benefit curve (MSB).
0 5 10 15 20social benefit Free market leads to allocative efficiency. Community
Quantity of thingies curve (MBC) surplus is maximised, so it is the optimum allocation of
resources from society’s point of view. This occurs
where demand is equal to supply, or, where marginal
The market for thinges social benefit is equal to marginal social cost.