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Chapter 3
Demand, Supply, and Market
Equilibrium

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 Chapter Contents
• Markets
• Demand
• Supply
• Market Equilibrium
• Changes in Supply, Demand, and Equilibrium
• Application: Government-Set Prices

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 Markets
Interaction between buyers and sellers.
Markets may be:
• Local.
• National.
• International.
Price is discovered in the interactions of buyers and
sellers.
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 Demand
A schedule or curve that shows the various amounts of a
product that consumers are willing and able to purchase at
each of a series of possible prices during specified periods of
time.
Demand schedule (table) or demand curve (graph)
Amount consumers are willing and able to purchase at a given
price assuming:
• Other things equal.
• Individual demand.
Market demand
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 Law of Demand
Law of demand: Other things equal, as price falls, the
quantity demanded rises, and as price rises, the
quantity demanded falls
Explanations:
• Price acts as an obstacle to buyers.
• Law of diminishing marginal utility.
• Income effect and substitution effect.
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 The Demand Curve
Individual demand
for gasoline
P Q sub d
$5 10

4 20

3 35

2 55

1 80

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 Market Demand

Market Demand for Gasoline, Three Buyers

Quantity Quantity Quantity
Price Demanded Demanded Demanded Total Q sub
per bushel Joe Jen Jay d per week
$5 10 12 8 30
4 20 23 17 60
3 35 39 26 100
2 55 60 39 154
1 80 87 54 221

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 Changes in Demand
Market Demand for Gasoline,
200 Buyers,(D sub 1)

P Q sub d
$5 2,000

4 4,000

3 7,000

2 11,000

1 16,000

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 Determinants of Demand (1 of 2)
Determinants of demand
Change in consumer tastes and preferences
Change in the number of buyers
Change in income:
• Normal goods.
• Inferior goods.
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 Determinants of Demand (2 of 2)
Change in prices of related goods
• Substitute good.
• Complementary good.
Change in consumer expectations
• Future prices.
• Future income.

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 Determinants of Demand: Factors that
Shift the Demand Curve
Determinant Examples
Change in buyers’ tastes Physical fitness rises in popularity, increasing the demand for jogging shoes and bicycles;
smartphone popularity rises, reducing the demand for landline phones.

Change in the number of A decline in the birthrate reduces the demand for children’s toys; an additional 600 million
buyers people on WhatsApp makes it a more attractive communications network; the migration of
Californians to Colorado increases the demand for housing in Denver.

Change in income A rise in incomes increases the demand for normal goods such as restaurant meals, sports
tickets, and smartphones while reducing the demand for inferior goods such as turnips, bus
passes and cheap wine.

Change in the prices of A reduction in airfares reduces the demand for train transportation (substitute goods); a decline
related goods in the price of printers increases the demand for ink cartridges (complementary goods).

Change in consumer Inclement weather in South America creates an expectation of higher future coffee bean prices,
expectations thereby increasing today’s demand for coffee beans. The expectation that other consumers will
rush to buy toilet paper next week as a hurricane approaches causes many consumers to
increase their purchases of toilet paper this week.

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 Supply
A schedule or curve that shows the various amounts of a
product that producers are willing and able to make
available for sale at each of a series of possible prices
during a specified period of time.
Supply schedule or a supply curve
Amount producers are willing and able to sell at a given
price
Individual supply
Market supply
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 Law of Supply
Law of supply: Other things equal, as the price rises,
the quantity supplied rises and as the price falls, the
quantity supplied falls.
Explanation:
• Price acts as an incentive to producers.
• At some point, costs will rise.

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 The Supply Curve

Supply of Gasoline
P Q sub s
$5 60
4 50
3 35
2 20
1 5

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 Changes in Supply

Market Supply of
Gasoline, 200
Producers (s sub 1)

P Q sub s
$5 12,000
4 10,000
3 7,000
2 4,000
1 1,000

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 Determinants of Supply
A change in resource prices
A change in technology
A change in taxes and subsidies
A change in prices of other goods
A change in producer expectations
A change in the number of sellers

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 Determinants of Supply: Factors that
Shift the Supply Curve (1 of 2)
Determinant Examples
Change in A decrease in the price of microchips increases the supply of computers; an increase in the price of
resource prices crude oil reduces the supply of gasoline.
Change in The development of lower-cost space-launch technology increases the supply of satellite broadband;
technology improvements in artificial intelligence increase the supply of customer-service chatbots.
Change in taxes An increase in the excise tax on cigarettes reduces the supply of cigarettes; a decline in subsidies to
or subsidies state universities reduces the supply of higher education; tax credits (subsidies) for child care
increase the number of daycare centers; a tax on indoor tanning reduces the number of tanning
salons.

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 Determinants of Supply: Factors that
Shift the Supply Curve (2 of 2)
Determinant Examples
Change in An increase in the price of cucumbers decreases the supply of watermelons; an increase in the price
prices of other of alcohol-based hand sanitizers causes a decrease in the supply of gin
goods
Change in An expectation of a substantial rise in future lumber prices decreases the supply of logs today; the
producer belief that gasoline prices will fall next year increases the supply of oil this year.
expectations
Change in the An increase in the number of tattoo parlors increases the supply of tattoos; the formation of
number of women’s professional basketball leagues increases the supply of women’s professional basketball
suppliers games.

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 Market Equilibrium
Equilibrium occurs where the demand curve and
supply curve intersect.
Equilibrium price and equilibrium quantity.
Surplus and shortage.
Rationing function of prices.
Efficient allocation.

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 Efficient Allocation
Productive efficiency
• Producing goods in the least costly way.
• Using the best technology.
• Using the right mix of resources.
Allocative efficiency
• Producing the right mix of goods.
• The combination of goods most highly valued by
society.
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 Equilibrium Price and Quantity

P Q sub d P Q sub s
$5 2,000 $5 12,000
4 4,000 4 10,000
3 7,000 3 7,000
2 11,000 2 4,000
1 16,000 1 1,000

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 Rationing Function of Prices
The ability of the competitive forces of demand and
supply to establish a price at which selling and buying
decisions are consistent.

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 Changes in Demand and Equilibrium

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 Changes in Supply and Equilibrium

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 Complex Cases
Effects of Changes in Both Supply and Demand
Effect on
Effect on Equilibrium
Change in Supply Change in Demand Equilibrium Price Quantity
1. Increase Decrease Decrease Indeterminate
2. Decrease Increase Increase Indeterminate
3. Increase Increase Indeterminate Increase
4. Decrease Decrease Indeterminate Decrease

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 Global Perspective 3.1
AVERAGE PRICE OF A LOAF OF WHITE BREAD, SELECTED NATIONS, 2020

The market equilibrium price of a 500 gram (1.1 pound) loaf of white bread differs substantially across
countries, reflecting local differences in supply and demand, as well as government interventions like
subsidies and price ceilings. Foreign prices were converted to U.S. dollars using current exchange rates.

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 Government Set Prices: Price Ceiling
Price ceiling:
• Set below equilibrium price.
• Rationing problem.
• Black markets.
Example is rent control.

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 Price Ceiling

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 Government Set Prices: Price Floor
Price floor:
• Prices are set above the market price.
• Chronic surpluses.
Example is the minimum wage law.

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 Price Floor

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 Last Word: Pandemic Prices (1 of 2)
The most obvious economic effect of the pandemic
initially was empty store shelves.
Consumers rushed to stock up on certain
commodities, causing shortages.
With retail prices remaining largely fixed, shortages
resulted as demand far exceeded supply.

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 Last Word: Pandemic Prices (2 of 2)
Pandemic economics also resulted in:
• A crash in stock prices.
• A spike in the price of used cars.
• Increased demand for housing in suburban and
rural areas.
• Widespread labor shortages.

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