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Understanding Demand, Supply, and Market Equilibrium: Key Concepts Explained

This chapter delves into the fundamentals of demand and supply, focusing on the quantity demanded (Qd) and quantity supplied (Qs) of goods and services in the market. It outlines the six key variables influencing demand and supply, including price, consumer income, and the number of consumers. The concept of market equilibrium, where Qd equals Qs, is crucial for understanding how markets function. The chapter includes graphical representations of demand and supply curves, illustrating changes in the market leading to shortages or surpluses, with real-world implications.

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Understanding Demand, Supply, and Market Equilibrium: Key Concepts Explained

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  1. Chapter 2 Demand, Supply, & Market Equilibrium

  2. Demand • Quantity demanded (Qd) • Amount of a good or service consumers are willing & able to purchase during a given period of time

  3. Demand • Six variables that influence Qd • Price of good or service (P) • Incomes of consumers (M) • Prices of related goods & services (PR) • Expected future price of product (Pe) • Number of consumers in market (N) • Generalized demand function

  4. Generalized Demand Function • b, c, d, e, f, & g are slope parameters • Measure effect on Qdof changing one of the variables while holding the others constant • Sign of parameter shows how variable is related to Qd • Positive sign indicates direct relationship • Negative sign indicates inverse relationship

  5. e = Qd/is positive Generalized Demand Function Inverse for complements P b = Qd/P is negative Inverse c = Qd/Mis positive Direct for normal goods M c = Qd/Mis negative Inverse for inferior goods d = Qd/PRis positive Direct for substitutes PR d = Qd/PRis negative Direct Pe f = Qd/Peis positive Direct N g = Qd/Nis positive Direct

  6. Demand Function • Demand function, or demand, shows relation between P & Qdwhen all other variables are held constant • Qd = f(P) • Law of Demand • Qdincreases when P falls & Qddecreases when P rises, all else constant • Qd/P must be negative

  7. Graphing Demand Curves • Traditionally price (P) is plotted on the vertical axis & quantity demanded (Qd) is plotted on the horizontal axis • The equation plotted is the inverse demand function • P = f(Qd)

  8. Graphing Demand Curves • A point on a demand curve shows either: • Maximum amount of a good that will be purchased for a given price • Maximum price consumers will pay for a specific amount of the good

  9. Graphing Demand Curves • Change in quantity demanded • Occurs when price changes • Movement along demand curve • Change in demand • Occurs when one of the other variables, or determinants of demand, changes • Demand curve shifts rightward or leftward

  10. P 80 D1 70 Price (dollars) Demand increase 60 D0 $50, 300 • • $50, 600 50 D2 • • 40 $40, 500 $40, 200 30 Demand decrease 20 10 Qd 900 1,300 300 100 700 1,500 500 1,100 0 Quantity Shifts in Demand (Figure 2.2)

  11. Supply • Quantity supplied (Qs) • Amount of a good or service offered for sale during a given period of time

  12. Supply • Six variables that influence Qs • Price of good or service (P) • Input prices (PI ) • Prices of goods related in production (Pr) • Technological advances (T) • Expected future price of product (Pe) • Number of firms producing product (F) • Generalized supply function

  13. Generalized Supply Function • k, l, m, n, r, & s are slope parameters • Measure effect on Qsof changing one of the variables while holding the others constant • Sign of parameter shows how variable is related to Qs • Positive sign indicates direct relationship • Negative sign indicates inverse relationship

  14. Generalized Supply Function Direct for complements P k = Qs/P is positive Direct PI l = Qs/PIis negative Inverse m = Qs/Pris negative Inverse for substitutes Pr m = Qs/Pris positive T n = Qs/Tis positive Direct Pe r = Qs/Peis negative Inverse F s = Qs/Fis positive Direct

  15. Supply Function - thurs • Supply function, or supply, shows relation between P & Qswhen all other variables are held constant • Qs = g(P)

  16. Graphing Supply Curves • A point on a supply curve shows either: • Maximum amount of a good that will be offered for sale at a given price • Minimum price necessary for producers to voluntarily offer a particular quantity for sale

  17. Graphing Supply Curves • Change in quantity supplied • Occurs when price changes • Movement along supply curve • Change in supply • Occurs when one of the other variables, or determinants of supply, changes • Supply curve shifts rightward or leftward

  18. S2 S0 S1 $60, 700 • $60, 400 • • • $40, 500 $40, 650 Supply increase Shifts in Supply (Figure 2.4) P 80 70 Price (dollars) 60 Supply decrease 50 40 30 20 10 Qs 900 300 100 700 500 0 Quantity

  19. Market Equilibrium • Equilibrium price & quantity are determined by the intersection of demand & supply curves • At the point of intersection, Qd = Qs • Consumers can purchase all they want & producers can sell all they want at the “market-clearing” price

  20. S0 • • • • • D0 Market Equilibrium (Figure 2.5) P 80 70 Price (dollars) 60 50 40 30 20 10 Qd , Qs 900 1,300 300 100 700 1,500 500 1,100 0 Quantity

  21. Shortage • When demand shifts outward, initially there will be what could be seen as a shortage of goods supplied at the original equilibrium price.

  22. S0 B • • • C • D1 D2 Demand Shifts (Supply Constant)(Figure 2.6) P 80 70 Price (dollars) 60 50 A • 40 30 20 10 D0 Qd , Qs 900 1,300 300 100 700 1,500 500 1,100 0 Quantity

  23. Surplus • When supply shifts out, it appears to be a surplus of goods at the old equilibrium price

  24. S2 S1 T • • • • S Supply Shifts (Demand Constant)(Figure 2.7) P S0 80 70 Price (dollars) 60 50 R • 40 30 20 10 D0 Qd , Qs 900 1,300 300 100 700 500 1,100 0 Quantity

  25. Simultaneous Shifts • When demand & supply shift simultaneously • Can predict either the direction in which price changes or the direction in which quantity changes, but not both • The change in equilibrium price or quantity is said to be indeterminate when the direction of change depends on the relative magnitudes by which demand & supply shift

  26. S S’ S’’ B • P’ • C P’’ D’ D Q’ Q’’ Simultaneous Shifts: (D, S) P A • P Q Q Price may rise or fall; Quantity rises

  27. S S’ S’’ B • P’ • C P’’ D’ D Q’ Q’’ Simultaneous Shifts: (D, S) P A • P Q Q Price falls; Quantity may rise or fall

  28. S’’ S • S’ C P’’ B • P’ D’ D Q’ Q’’ Simultaneous Shifts: (D, S) P A • P Q Q Price rises; Quantity may rise or fall

  29. S’’ S S’ • C P’’ • B P’ D’ D Q’’ Q’ Simultaneous Shifts: (D, S) P A • P Q Q Price may rise or fall; Quantity falls

  30. Ceiling & Floor Prices • Ceiling price • Maximum price government allows sellers to charge for a good • When ceiling price is below equilibrium, a shortage occurs • Floor price • Minimum price government allows sellers to charge for a good • When floor price is above equilibrium, a surplus occurs

  31. Sx 3 2 2 1 Dx 62 50 50 84 22 32 Panel B – Floor price Ceiling & Floor Prices (Figure 2.11) Px Px Price (dollars) Price (dollars) Sx Dx Qx Qx Quantity Quantity Panel A – Ceiling price

  32. Homework • Read Chapter 2 • Do Technical problems: 1, 2, 4, 6, 7, 9, 11, 12, 13, 14, 17 • Do Applied Problems: 1, 2, 5, 11, 13, 14, • Do Mathematical exercise : 2

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