PRICE DETERMINATION

• DEMAND
• AND
• SUPPLY
• MARKETS
• Supply and demand are the two words that
economists use most often.
• Supply and demand are the forces that
make market economies work.
• Modern microeconomics is about supply,
demand, and market equilibrium.
Markets and competition
• A market is a group of buyers and sellers of
a particular good or service.

• The terms supply and demand refer to the

behavior of people . . . as they interact with
one another in markets.
Markets and competition
• Buyers determine demand.

• Sellers determine supply

Competitive Markets

• A competitive market is a market in which

there are many buyers and sellers so that
each has a negligible impact on the market
price.
Competition: Perfect and
Otherwise
• Perfect competition
• Products are the same
• Numerous buyers and sellers so that each has
no influence over price
• Buyers and sellers are price takers
• Monopoly
• One seller, and seller controls price
Competition: Perfect and
Otherwise
• Oligopoly
• Few sellers
• Not always aggressive competition
• Monopolistic competition
• Many sellers
• Slightly differentiated products
• Each seller may set price for its own product
DEMAND
• Quantity demanded is the amount of a
good that buyers are willing and able to
purchase.
• Law of Demand
• The law of demand states that, other things
equal, the quantity demanded of a good falls
when the price of the good rises.
Demand curve: relationship between
price and quantity demanded
• Demand schedule
• The demand schedule is a table that shows the
relationship between the price of the good and
the quantity demanded.
Catherine’s Demand Schedule
Demand curve: relationship between
price and quantity demanded
• Demand Curve
• The demand curve is a graph of the
relationship between the price of a good and
the quantity demanded.
Figure 1 Catherine’s Demand Schedule and
Demand Curve

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.
Copyright © 2004 South-Western
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.
Shifts in the Demand Curve

• Change in Quantity Demanded

• Movement along the demand curve.
• Caused by a change in the price of the
product.
Changes in Quantity
Demanded
Price of Ice-
Cream A tax that raises the
Cones
price of ice-cream
B cones results in a
$2.00
movement along the
demand curve.

1.00 A

D
0 4 8 Quantity of Ice-Cream Cones
Shifts in the Demand Curve
• Consumer income
• Prices of related goods
• Tastes
• Expectations
• Number of buyers
• Weather
Shifts in the Demand Curve

• Change in Demand
• A shift in the demand curve, either to the left or
right.
• Caused by any change that alters the quantity
demanded at every price.
 Figure 3 Shifts in the Demand Curve

Price of
Ice-Cream
Cone

Increase
in demand

Decrease
in demand
Demand
curve, D2
Demand
curve, D1
Demand curve, D3
0 Quantity of
Ice-Cream Cones
Copyright©2003 Southwestern/Thomson Learning
Shifts in the Demand Curve

• Consumer Income
• As income increases the demand for a normal
good will increase.
• As income increases the demand for an
inferior good will decrease.
Consumer Income
Normal Good
Price of Ice-
Cream Cone
$3.00 An increase
2.50 in income...
Increase
2.00 in demand

1.50

1.00

0.50
D2
D1 Quantity of
Ice-Cream
0 1 2 3 4 5 6 7 8 9 10 11 12 Cones
Consumer Income
Inferior Good
Price of Ice-
Cream Cone
$3.00

2.50 An increase
2.00
in income...
Decrease
1.50 in demand
1.00

0.50

D2 D1 Quantity of
Ice-Cream
0 1 2 3 4 5 6 7 8 9 10 11 12 Cones
Shifts in the Demand Curve

• Prices of Related Goods

• When a fall in the price of one good reduces
the demand for another good, the two goods
are called substitutes.
• When a fall in the price of one good increases
the demand for another good, the two goods
are called complements.
Variables That Influence Buyers

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SUPPLY
• Quantity supplied is the amount of a good
that sellers are willing and able to sell.
• Law of Supply
• The law of supply states that, other things
equal, the quantity supplied of a good rises
when the price of the good rises.
The Supply Curve: The Relationship
between Price and Quantity Supplied
• Supply Schedule
• The supply schedule is a table that shows the
relationship between the price of the good and
the quantity supplied.
Ben’s Supply Schedule
The Supply Curve: The Relationship
between Price and Quantity Supplied
• Supply Curve
• The supply curve is the graph of the
relationship between the price of a good and
the quantity supplied.
 Ben’s Supply Schedule and Supply Curve

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
2. ... increases quantity of cones Cones
supplied.
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.
Shifts in the Supply Curve

• Input prices
• Technology
• Expectations
• Number of sellers
Shifts in the Supply Curve

• Change in Quantity Supplied

• Movement along the supply curve.
• Caused by a change in anything that alters the
quantity supplied at each price.
Change in Quantity Supplied
Price of Ice-
Cream S
Cone
C
$3.00
A rise in the price
of ice cream
cones results in a
movement along
A the supply curve.
1.00

Quantity of
Ice-Cream
0 1 5 Cones
Shifts in the Supply Curve

• Change in Supply
• A shift in the supply curve, either to the left or
right.
• Caused by a change in a determinant other
than price.
 Shifts in the Supply Curve

Price of
Ice-Cream Supply curve, S3
Supply
Cone
curve, S1
Supply
Decreas curve, S2
ein supply

Increase
in supply

0 Quantity of
Ice-Cream Cones
Copyright©2003 Southwestern/Thomson Learning
Variables That Influence Sellers

Copyright©2004 South-Western
SUPPLY AND DEMAND
TOGETHER
• Equilibrium refers to a situation in which the
price has reached the level where quantity
supplied equals quantity demanded.
SUPPLY AND DEMAND
TOGETHER
• Equilibrium Price
• The price that balances quantity supplied and
quantity demanded.
• On a graph, it is the price at which the supply
and demand curves intersect.
• Equilibrium Quantity
• The quantity supplied and the quantity
demanded at the equilibrium price.
• On a graph it is the quantity at which the
supply and demand curves intersect.
SUPPLY AND DEMAND
TOGETHER
Demand Schedule Supply Schedule

At $2.00, the quantity demanded

is equal to the quantity supplied!
 The Equilibrium of Supply and Demand

Price of
Ice-Cream
Cone Supply

Equilibrium price Equilibrium

$2.00

Equilibrium Demand
quantity

0 1 2 3 4 5 6 7 8 9 10 11 12 13
Quantity of Ice-Cream Cones
Copyright©2003 Southwestern/Thomson Learning
 Markets Not in Equilibrium

(a) Excess Supply

Price of
Ice-Cream Supply
Cone Surplus
$2.50

2.00

Demand

0 4 7 10 Quantity of
Quantity Quantity Ice-Cream
demande supplied Cones
d
Copyright©2003 Southwestern/Thomson Learning
Equilibrium

• Surplus
• When price > equilibrium price, then quantity
supplied > quantity demanded.
• There is excess supply or a surplus.
• Suppliers will lower the price to increase sales,
thereby moving toward equilibrium.
Equilibrium

• Shortage
• When price < equilibrium price, then quantity
demanded > the quantity supplied.
• There is excess demand or a shortage.
• Suppliers will raise the price due to too many
buyers chasing too few goods, thereby moving
toward equilibrium.
Markets Not in Equilibrium

(b) Excess
Price of Demand
Ice- Suppl
Cream Cone y

$2.00

1.50
Shortage

Demand

0 4 7 10 Quantity of
Quantity Quantity Ice-
supplied demanded Cream Cones

Copyright©2003 Southwestern/Thomson Learning

Equilibrium

• Law of supply and demand

• The claim that the price of any good adjusts to
bring the quantity supplied and the quantity
demanded for that good into balance.
Three Steps to Analyzing
Changes in Equilibrium
• Decide whether the event shifts the supply
or demand curve (or both).
• Decide whether the curve(s) shift(s) to the
left or to the right.
• Use the supply-and-demand diagram to
see how the shift affects equilibrium price
and quantity.
 How an Increase in Demand Affects Equilibrium
Price of
Ice-Cream 1. Hot weather
Cone increases
the demand for ice cream . . .

Supply

$2.50 New
equilibrium
2.00
2. . . . resulting
Initial
in a higher equilibrium
price . . .
D

0 7 10 Quantity of
3. . . . and a higher Ice-Cream Cones
quantity sold.
Copyright©2003 Southwestern/Thomson Learning
Three Steps to Analyzing Changes in
Equilibrium
• Shifts in Curves versus Movements along
Curves
• A shift in the supply curve is called a change in
supply.
• A movement along a fixed supply curve is
called a change in quantity supplied.
• A shift in the demand curve is called a change
in demand.
• A movement along a fixed demand curve is
called a change in quantity demanded.
 How a Decrease in Supply Affects Equilibrium

Price of
Ice-Cream 1. An increase in
Cone the
price of sugar
reduces
the supply of ice cream. . .
S2
S1

Ne
$2.50 w
equilibriu
m
2.00 Initial
equilibrium
2. . . . resulting
in a higher
price of ice
cream . . . Demand

0 4 7 Quantity of
3. . . . and a lower Ice-Cream Cones
quantity sold.
Copyright©2003 Southwestern/Thomson Learning
What Happens to Price and Quantity
When Supply or Demand Shifts?

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Summary
• Economists use the model of supply and
demand to analyze competitive markets.
• In a competitive market, there are many
buyers and sellers, each of whom has little
or no influence on the market price.
Summary
• The demand curve shows how the quantity of a
good depends upon the price.
• According to the law of demand, as the price of a good
falls, the quantity demanded rises. Therefore, the
demand curve slopes downward.
• In addition to price, other determinants of how much
consumers want to buy include income, the prices of
complements and substitutes, tastes, expectations,
and the number of buyers.
• If one of these factors changes, the demand curve
shifts.
Summary
• The supply curve shows how the quantity
of a good supplied depends upon the price.
• According to the law of supply, as the price of
a good rises, the quantity supplied rises.
Therefore, the supply curve slopes upward.
• In addition to price, other determinants of how
much producers want to sell include input
prices, technology, expectations, and the
number of sellers.
• If one of these factors changes, the supply
curve shifts.
Summary
• Market equilibrium is determined by the
intersection of the supply and demand
curves.
• At the equilibrium price, the quantity
demanded equals the quantity supplied.
• The behavior of buyers and sellers
naturally drives markets toward their
equilibrium.
Summary
• To analyze how any event influences a
market, we use the supply-and-demand
diagram to examine how the even affects
the equilibrium price and quantity.
• In market economies, prices are the signals
that guide economic decisions and thereby
allocate resources.