Demand and Supply

© Peter Berck 2012

Lecture Outline

• Goods• People Demand Goods;

– Shift in demand

• Firms Supply Goods; • Keep Supply and Demand Separate• Demand and Supply intersect at the equilibrium price and

quantity– Shift and movement

• Horizontal Addition

Goods

• A particular thing in a particular place at a particular time.– Coal today and coal tomorrow are not the same

good.– A rotten peach and a yummy peach are not the

same good.– Wheat in Minneapolis and wheat in Iowa are

not the same good.

Demand Curve

• Quantity that will be purchased as a function of price.– Is a function: Q=D(P)

• To economists, Demand is synonymous with demand curve.

Price-Demand or Inverse Demand Curve

• Diagram: P on vertical and Q on horizontal• D(p) is the demand curve. It associates a quantity with

every price.• D-1(Q) is the inverse- (or price-) demand curve. It

associates a price with every quantity.

Q

P

D-1(Q)

D-1(Q)

• The price that consumers will pay if Q units of the good are available.

Shifting the Demand Curve

• Qown = D(pown,pother,y)

• If the price of the other good goes up and the demand curve shifts in, the goods are complements.

• If it shifts out, they are substitutes. • Give examples.

P

Q

D-1

Shifting the Demand Curve: y

• Qown = D(pown,pother,y)

• If income goes up and the demand curve shifts out, the good is a normal good.

• If it shifts in, it is an

inferior good.

P

Q

D-1

Supply

• Q= S(pout , pin , x)– pout is the price of the product the firm makes

(an output).– pin are the prices of the inputs the firm uses to

make the output.– x are exogenous factors, like the weather.– slope up or flat (assumed for this course) in pout.

– shift in with increased price of input

Inverse Supply curve diagram

• Price on input goes up, how does the inverse supply curve shift?

Q

Pout

S-1

On Notation

• We blithely write and say D or S when we mean inverse demand or inverse supply.

Equilibrium

• The equilibrium price and quantity are the coordinates of the point where the supply and demand curve intersect.

• The equilibrium price is the price where quantity supplied and quantity demanded are equal.

• Equilibrium quantity is the quantity supplied and demanded at the equilibrium price.

One observes only this equilibrium price and quantity in

the market.

• We use supply and demand to find out how the equilibrium changes when other things change. E.g. what happens when income goes up? An input price goes down, etc.

Example of equilibrium

0

0.5

1

1.5

2

2.5

3

0 2 4 6 8 10

Q

P

SD

Algebraic Example

• Q = 3 p is S(p)• Q = 12 - 4p is D(p)• (graph using y = mx + b)

– ps = Q/3 slope 1/3 intercept zero– pd = 3 - Q/4 slope - ¼ intercept 3

• Equilibrium: p = ps=pd : Q/3=3-Q/4– Q= 36/7; p= 12/7

Out of Equilibrium

• Excess supply: supply – demand• Price above equilibrium causes excess

supply.• How do you think the system would adjust

if there were excess supply? • Is it reasonable that we think economic

forces will drive us toward equilibrium?

Excess S or D

Suppose P is 2.5. Suppose P is 1

Suppose Q = 2Suppose Q = 8

0

0.5

1

1.5

2

2.5

3

0 2 4 6 8 10

Q

P

SD

Example:

• A fast food chain undercooks its burgers and makes people sick. What happens to price and quantity?

• http://www.nytimes.com/1993/02/06/business/company-news-jack-in-the-box-s-worst-nightmare.html?pagewanted=all&src=pm

E Coli Burgers

Which curve shifted? Where was there a movement along a curve? What points are observed?

0

0.5

1

1.5

2

2.5

3

0 2 4 6 8 10

Q

P

SDD'

Example:

• The United States offered to buy grain at above the equilibrium price.– The mechanics were that they loaned the farmer

money for his grain at a “loan rate”, a price above equilibrium. When it came time to repay, the former could give the government the grain instead of paying off the loan.

– Government either stored or gave away excess.

Ag. Programs: Loan rate of PL • : How much does the gov’t buy and store?

Are consumers better off? producers better off?

0

0.5

1

1.5

2

2.5

3

0 2 4 6 8 10

Q

P

SD

Rent Control

• Excess demand for housing– lines– bribes

• When rent control ends can students be worse off?

Price is set as 1: excess demand

0

0.5

1

1.5

2

2.5

3

0 2 4 6 8 10

Q

P

SD

Getting market demand as sum of demands of people or groups

• D1(p) is the first person’s demand

• D2(p) is the second person’s demand

• Dtotal = D1(p)+ D2(p)

In a graph it is Horizontal Addition

P

Q

demand from developed world

from less developed world

Total Demand

Pinhead’s View of Hunger

P

Q

demand from developed world

from less developed world

Total DemandSupply

QE

Supply*

$2.74

Key Concepts

• Demand and inverse demand– Shifts: Complements, substitutes, normal,

inferior

• Supply and inverse supply– Shifts

• Equilibrium– Shift and movement. Excess supply/demand