McGraw-Hill/Irwin

Copyright 2010 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter 3:
Demand, Supply,
and Market
Equilibrium
Markets
Markets bring together buyers
(demanders) and sellers (suppliers).
Some markets are local while others
are national or international.
Markets help to determine the prices
and quantities bought and sold of
millions of goods and services.

LO: 3-1
3-2
Demand
Demand is a schedule or curve that
shows the various amounts of a product
that consumers will buy at each of a series
of possible prices during a specific period.
The Law of Demand states that, all else
equal, as price falls, the quantity
demanded rises, and vice versa.


LO: 3-1
3-3
Demand Curve
6

5

4

3

2

1

0
10 20 30 40 50 60 70 80
Quantity Demanded (lattes per month)
P
r
i
c
e

(
p
e
r

l
a
t
t
e
)

P Q
d
$5
4
3
2
1
10
20
35
55
80
P
Q
D
LO: 3-1
3-4
Market Demand
Individual demand is the demand schedule or
curve of a single consumer.
Market demand is the sum of all the individual
demands.
Market demand is determined by:
Consumers tastes (preferences)
The number of consumers in the market
Consumers incomes
The prices of related goods
Expected prices

LO: 3-1
3-5
Demand Can Increase
or Decrease
6

5

4

3

2

1

0
Quantity Demanded (lattes per month)
P
r
i
c
e

(
p
e
r

l
a
t
t
e
)

P
Q
D
1
2 4 6 8 10 12 14 16 18
D
2
D
3
Shifts of the
demand
curve are
changes in
demand
LO: 3-1
3-6
Demand Can Increase
or Decrease
6

5

4

3

2

1

0
Quantity Demanded (lattes per month)
P
r
i
c
e

(
p
e
r

l
a
t
t
e
)

P
Q
D
1
2 4 6 8 10 12 14 16 18
D
2
D
3
Change in Demand
Change in Quantity
Demanded
Movements
along the
demand
curves are
changes in
quantity
demanded
LO: 3-1
3-7
Supply
Supply is a schedule or curve showing the
amounts of a product that producers will make
available for sale at each of a series of
possible prices during a specific period.
The Law of Supply states that, all else equal,
as price rises, the quantity supplied rises, and
vice versa.
Shifts of the supply curve are changes in
supply.
Movements along the supply curve are
changes in quantity supplied.
LO: 3-2
3-8
Supply Curve
6

5

4

3

2

1

0
Quantity Supplied (lattes per month)
P
r
i
c
e

(
p
e
r

l
a
t
t
e
)

P Q
s
$5
4
3
2
1
60
50
35
20
5
P
Q
S

10 20 30 40 50 60 70
LO: 3-2
3-9
Market Supply
Market supply is derived from individual
supply by horizontally adding the supply
curves of the individual producers.
Market supply is determined by:
Resource prices
Technology
Taxes and subsidies
Prices of other goods
Expected price
The number of sellers in the market
LO: 3-2
3-10
Market Equilibrium
In a competitive market neither buyers nor
sellers can set the price.
Intersection of demand and supply curves
determine equilibrium price and equilibrium
quantity.
Equilibrium price in
the competitive market
is the price at which
quantity supplied is
equal to quantity
demanded.
Equilibrium quantity
is the quantity
demanded and quantity
supplied that occur at
equilibrium price in the
competitive market.
LO: 3-2
3-11
Market Equilibrium
Any price above the equilibrium price would create
a surplus, or excess supply.
Surpluses drive prices down to equilibrium: as prices fall,
the incentive to produce declines and the incentive for
consumers to buy increases.
Any price below the equilibrium price would create
a shortage, or excess demand.
Shortages push prices up equilibrium: as prices rise, the
incentive to produce increases and the incentive for
consumers to buy decreases.

Excess supply is a
situation when quantity
supplied exceeds
quantity demanded.
Excess demand is a
situation when quantity
demanded exceeds
quantity supplied.
LO: 3-3
3-12
Government-Set Prices
Government occasionally concludes that market prices
are unfairly high to buyers or unfairly low to sellers.
Government may then place legal limits on how high or
low a price or prices may go, creating price ceilings or
price floors.
A price ceiling limits price increase and thus creates a
shortage of the product.
A price floor limits price decrease and thus creates
surplus of the product.
Government-controlled prices distort resource
allocations and cause negative side effects.
LO: 3-5
3-13
Market Equilibrium
6

5

4

3

2

1

0
2 4 6 8 10 12 14 16 18
Cups of latte (thousands per month)
P
r
i
c
e

(
p
e
r

l
a
t
t
e
)

P Q
d
$5
4
3
2
1
2,000
4,000
7,000
11,000
16,000
P Q
s
$5
4
3
2
1
12,000
10,000
7,000
4,000
1,000
7
3
D
S
$4 Price Floor
6,000 Cups
Surplus
$2 Price Ceiling
7,000 Cups
Shortage
Market
demand
Market
supply
LO: 3-3
3-14
Changes in Demand, Supply,
and Equilibrium
Changes in demand when supply is constant:
An increase in demand will result in a higher
equilibrium price and quantity;
A decline in demand will result in a lower
equilibrium price and quantity.
Changes in supply when demand is constant:
An increase in supply will result in a lower
equilibrium price and a higher equilibrium
quantity;
A decline in supply will result in a higher
equilibrium price and a lower equilibrium
quantity.
LO: 3-4
3-15
When Demand and Supply
Both Change
Supply increases;
Demand decreases
Supply decreases;
Demand increases
Supply increases;
Demand increases
Supply decreases;
Demand decreases
Price Quantity
?
?
?
?
LO: 3-4
3-16