1. Chapter 3 Demand, Supply and the Market
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Key terms
Market: a set of arrangements by which buyers and sellers are in contact to exchange goods or services
Demand: the quantity of a good buyers wish to purchase at each conceivable price
Supply: the quantity of a good sellers wish to sell at each conceivable price
Equilibrium price: price at which quantity supplied = quantity demanded
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The demand curve shows the relation between price and quantity demanded holding other things constant
Price
Other things include:
The price of related goods
Consumer incomes
Consumer preferences D
Quantity
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The supply curve shows the relation between price and quantity demanded holding other things constant S
Price
Other things include:
Technology
Input costs
Government regulations
Quantity
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Market equilibrium S
Market equilibrium is at E0 where quantity demanded equals quantity supplied
with price P0 and
quantity Q0
P0 is the equilibrium price.
Price E0 P0 D Q0
Quantity
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6. A shift in demand D0 S D1 Q1 P1 Q0 P0 S If the price of a substitute
good decreases ...
less will be demanded at
each price.
Price D0 S
The demand curve shifts
from D0D0 to D1D1. D1 Q1 P1 E0 Q0 P0 E1
See Sections 3-4 and 3-5 in the main text.
If price stayed at P0 there
would be excess supply.
So the market moves to a
new equilibrium at E1. S
Quantity 6

7. A shift in supply S1 S1 S0 D Q1 P1 E2 P0 E0 D Q0 Suppose safety
The supply curve
shifts to S1S1
Suppose safety
regulations are tightened,
increasing producers’ costs S0 D
Price Q1 P1 E2
So the market moves to a
new equilibrium at E2 P0 E0
If price stayed at P0 there
would be excess demand
See Sections 3-6 and 3-7 in the main text. D Q0
Quantity 7

8. Two ways in which demand may increase (1)
Price
(1) A movement along the demand curve from A to B
represents consumer reaction to a price change
could follow a supply shift A P0 B P1 Q1
See Activity Box 3 in the main text. D Q0
Quantity 8

9. Two ways in which demand may increase (2)
(2) A movement of the demand curve from D0 to D1
leads to an increase in demand at each price
e.g., at P0 quantity demanded increases from Q0 to Q2: at P1 quantity demanded increases from Q1 to Q3
Price C D1 F Q2 Q3 P0 A P1 B
See Activity Box 3 in the main text. D0 Q0 Q1
Quantity 9

10. A market in disequilibrium
Price S
Suppose a disastrous harvest moves the supply curve to SS.
Government may try to protect the poor, setting a price ceiling at P1, which is below P0, the equilibrium price level.
The result is excess demand. D P2 E P0 A B P1
excess demand
You may wish to point out that:
1 Supply is actually reduced as a result of this policy;
2 There is a possible long-run effect on resource allocation arising because the incentives for producers are poor with prices held artificially low;
3 A price ceiling at P2 would be ineffective/irrelevant, given that the market could reach its equilibrium level.
See Section 3-8 in the main text. D S
RATIONING is needed to cope with the resulting excess demand. QS Q0 QD
Quantity 10

11. Price and quantity changes
In practice, we cannot plot ex ante demand curves and supply curves.
So we use historical data and the supposition that the observed values are equilibrium ones.
Since other things are often not constant, some detective work is required.
This is where our theory comes in useful.
See Box 3-4 in main text. 11

12. What, how and for whom The market:
decides how much of a good should be produced
by finding the price at which the quantity demanded equals the quantity supplied
tells us for whom the goods are produced
those consumers willing to pay the equilibrium price
determines what goods are being produced
there may be goods for which no consumer is prepared to pay a price at which firms would be willing to supply
See Section 3-9 in the main text. 12

13. Consumer & producer surplus
For a single consumer, the consumer surplus is the difference between the maximum price that she is willing to pay for a given amount of a good or service and the price she actually pays.
The producer surplus for sellers is the amount that sellers benefit by selling at a market price that is higher than they would be willing to sell for.
Price
Consumer
surplus S
P *
Producer
surplus D Q*
Quantity
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