Chapter 3: Demand, Supply, and Market Equilibrium

Honors Econ

Demand

The quantities consumers are willing and able to buy at different prices during a specified period

Law of demand

Other things equal, price rises → quantity demanded falls; price falls → quantity demanded rises

Supply

The quantities producers are willing to sell at different prices during a specified period.

Law of supply

Other things equal price rises → quantity supplied rises; price falls → quantity supplied falls

Change in demand vs. change in quantity demanded

A non-price determinant shifts the entire demand curve. The good’s own price causes movement along the existing curve

Change in supply vs change in quantity supplied

A non-price determinant shifts the entire supply curve, The good’s own price causes movement along the existing curve.

Demand determinants

Tastes, number of buyers, income, prices of related goods, and consumer expectations

Normal good

Higher income increases demand

Inferior good

Higher income decreases demand

Substitutes

Goods used in place of each other. A rise in B’s price increases demand for A.

Complements

Goods used together. A rise B’s price decreases demand for A.

Supply determinants

Input prices, technology, taxes/subsidies, number of sellers, prices of alternative outputs, expectations, and natural conditions

Production costs and supply

Lower costs increase supply, shifting it right. Higher costs decrease supply, shifting it left.

Production taxes and subsidies

Raises costs and decreases supply. A subsidy lowers effective costs and increases supply.

Market equilibrium

The price and quantity demanded equal quantity supplied: Q_d = Q_s.

Surplus

Quantity supplied exceeds quantity demanded. Surplus = Q_s - Q_d ; it creates downward price pressure

Shortage

Quantity demanded exceeds quantity supplied. Shortage = Q_d - Q_s ; ir creates upward price pressure

Rationing function of prices

Prices coordinate buying and selling and allocate available goods among buyers

Market demand and supply aggregation

Add individuals’ quantities horizontally at the same price

Demand increases; supply unchanged

Equilibrium price rises and equilibrium quantity rises

Demand decreases; supply unchanged

Equilibrium price falls and equilibrium quantity falls

Supply increases; demand unchanged

Equilibrium price rises and equilibrium quantity rises

Supply decreases; demand unchanged

Equilibrium price rises and equilibrium quantity falls

Demand and supply both increase

Quantity definitely rises; the price change is ambiguous

Demand and supply both decrease

Quantity definitely falls; the price change is ambiguous.

Demand increases and supply decreases

Price definitely rises; the quantity change is ambiguous

Demand decreases and supply increases

Price definitely falls; the quantity change is ambiguous.

Ambiguous equilibrium change

The direction depends on the relative sizes of the demand and supply shifts

Four steps for a market-change problem

Identify the market → identify D or S → determine shift direction → read the new equilibrium

Price ceiling

A legal maximum price. It is binding above equilibrium and creates a surplus.

Nonbinding price control

A ceiling at or above equilibrium, or a floor at or below equilibrium, does not change the market outcome

Price floor

A legal minimum price. It is binding above equilibrium and creates a surplus

Quantity traded under a binding control

Without government purchases, trades cannot exceed the smaller of Q_d and Q_s: usually Q_s under a ceiling and Q_d under a floor in the market.

Possible consequences of price ceilings

Shortages, queues, nonprice rationing, black markets, and reduced quality,

Ways to support a price floor

Government purchases of excess supply, restrictions on production, or measures that increase demand

Solving equilibrium from equations

Set Q_d equal to Q_s, solve for price, then substitute that price into either equation to find quantity