1. Chapter 2: Demand, Supply, and Market Equilibrium
McGraw-Hill/Irwin
Copyright © 2011 by the McGraw-Hill Companies, Inc. All rights reserved.

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

3. Definitions Demand function Direct demand Inverse demand Demand curve
Quantity demand as a function of the independent variables that influence the quantity demanded
Direct demand
The direct relationship between the quantity demanded and price (other independent variables held constant)
Inverse demand
The direct relationship between price and quantity demanded
Demand curve
A graphical presentation of inverse demand

4. General Demand Function
Six variables that influence Qd
Price of goods or service (P)
Incomes of consumers (M)
Prices of related goods & services (PR)
Taste patterns of consumers (T)
Expected future price of product (Pe)
Number of consumers in market (N)
General demand function
Qd = f(P, M, PR, T, Pe , N)

5. General Demand Function
Qd = a + bP + cM + dPR + eT + fPe + gN
b, c, d, e, f, & g are slope parameters
Measure effect on Qd of 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

6. General Demand Function
Price of goods or service (P)
Without price everything is unchanged.
Ex: if income or taste increases but price of goods increases, demand will increase and vice-versa. So, the relation is inverse and the parameter is negative.

7. So, there is a direct relationship.
Incomes of consumers (M)
In case of normal goods, if income of a person increases, demand of normal goods will be increased.
So, there is a direct relationship.
In case of inferior goods, if income increases, demand will decrease.
So, there is a inverse relationship.

8. Prices of related goods & services (PR)
In case of substitute (exam: tea and sugar), if the price of sugar increases, there will be same demand of tea. If price decreases, same will happened. So, positive relation.
In case of complements (exam: paper and pen), if the price of paper increases, the demand of pen will decrease and vise-versa. So, negative relation.

9. Taste patterns of consumers (T)
Say, a piece of Diamond or Jaguar. When the price of this product increases, the demand among the rich will increase.
So, positive relation.

10. Expected future price of product (Pe)
In the beginning of Holy Ramadan, prices of some goods increase. Then, the demand of the people increases as they think future price of those product will increase more….
So, there is a positive relation.

11. So, there is a positive relation.
Number of consumers in market (N)
If the consumers in market increases, demand will increase. Say, in a restaurant, if there are few customers, other customers will go. But there must be some customers.
So, there is a positive relation.

12. General Demand Function
Variable
Relation to Qd
Sign of Slope Parameter P
b = Qd/P is negative
Inverse
c = Qd/M is positive
Direct for normal goods M
c = Qd/M is negative
Inverse for inferior goods
d = Qd/PR is positive
Direct for substitutes PR
Inverse for complements
d = Qd/PR is negative T
Direct
e = Qd/T is positive Pe
f = Qd/Pe is positive
Direct N
g = Qd/N is positive
Direct

13. Direct Demand Function
Demand for Pork

14. Inverse Demand Function
How much consumers are willing to pay as a function of quantity

15. Direct Demand Function

16. Demand Schedule

17. A Demand Curve (Figure 2.1)

18. Three Demand Shifts

19. Shifts in Demand (Figure 2.2)

21. Let’s have some brainstorming
Part 1

22. Px & Py are
substitute, as if one is increase, other will decrease
As M= Income is negative
which indicates that if income decreases
there will be no chance to buy normal goods.
So, X is an inferior goods.

23. If

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

25. Supply Qs = f(P, PI, Pr, T, Pe, F) 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)
General supply function
Qs = f(P, PI, Pr, T, Pe, F)

26. General Supply Function
Variable
Relation to Qs
Sign of Slope Parameter P
k = Qs/P is positive
Direct PI
l = Qs/PI is negative
Inverse
m = Qs/Pr is negative
Inverse for substitutes Pr
Direct for complements
m = Qs/Pr is positive T
n = Qs/T is positive
Direct Pe
r = Qs/Pe is negative
Inverse F
s = Qs/F is positive
Direct

27. Direct Supply Function

28. Inverse Supply Function

29. Direct Supply Function

30. A Supply Curve (Figure 2.3)

31. Three Supply Functions

32. Shifts in Supply (Figure 2.4)

33. 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” or “equilibrium” price

34. Market Equilibrium

35. Market Equilibrium (Figure 2.5)

36. Market Equilibrium Excess demand (shortage) Excess supply (surplus)
Exists when quantity demanded exceeds quantity supplied
Excess supply (surplus)
Exists when quantity supplied exceeds quantity demanded

37. Brainstorming
Part 2

42. Measuring the Value of Market Exchange
Consumer surplus
Difference between the economic value of a good (its demand price) & the market price the consumer must pay
Producer surplus
For each unit supplied, difference between market price & the minimum price producers would accept to supply the unit (its supply price)
Social surplus
Sum of consumer & producer surplus
Area below demand & above supply over the relevant range of output

43. Measuring the Value of Market Exchange (Figure 2.6)

45. Brainstorming
Part 3

53. Ceiling & Floor Prices (Figure 2.12)Px Px
Price (dollars) Sx Dx 2 50
Panel B – Floor price Sx 3 32 84 2 50 1 62 22 Dx Qx Qx
Quantity
Quantity
Panel A – Ceiling price

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

56. Let’s Ready For First Term Exam
Based on Chapter 1 + Chapter 2

57. Any Queries?

58. “An increase in the demand for electricity will cause a shortage of electricity.”
An increase in the demand for electricity will not cause a shortage as long as the price of electricity is allowed to rise to the market clearing level.
Only if government places a ceiling price below the market clearing price can there be a shortage of electricity when demand increases.
Shortages are not caused by increases in demand.

59. “A decrease in the supply of crude oil will cause a shortage of crude oil.”

60. Changes in Market Equilibrium
Qualitative forecast
Predicts only the direction in which an economic variable will move
Quantitative forecast
Predicts both the direction and the magnitude of the change in an economic variable

61. Demand Shifts (Supply Constant) (Figure 2.7)

62. Supply Shifts (Demand Constant) (Figure 2.8)

63. 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

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

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

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

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