Supply And Demand

Perloff 2.1-4, 2.6. WB 1 and 2.

We review the supply-and-demand model. You will learn why equilibrium happens; how to compute the equilibrium; and how the equilibrium moves with market conditions.

Gans' quizzes on Supply and Demand shifters (in the "More resources" section, below) are a quick way of testing yourself. However, keep in mind that an "increase/decrease in Demand/Supply" is not an up/down shift, but right/left.

Graphing

• What are on the axes?
• What do the curves represent?
• S is the quantity suppliers want to supply, for every price.
• D is the quantity consumers want to buy, for every price.
• What do the formulas represent?
• QS is how much suppliers want to supply at a particular price.
• QD is how much consumers want to buy at a particular price.
• Why does S slope up? It does not have to.
• Why does D slope down? The Law of Demand.
• Use demand and supply schedules to graph the curves, marking axes and points.
• Use the formulas to graph the curves, marking axes and intercepts.

Equilibrium

An equilibrium in the supply-and-demand model is an equilibrium price P* and an equilibrium quantity Q*, at which the quantity demanded equals the quantity supplied: QD = QS = Q*.

Price-taking assumption

We assume that buyers and sellers take prices as given when making decisions.1 This is why we say that quantities demanded and supplied respond to price.

Other key assumptions are discussed in Perloff 2.6 and the next topic.

Computing the equilibrium

• Given formulas for supply QS and demand QD, compute the equilibrium (P*,Q*).

Moving the equilibrium

Changes in market conditions are represented by “shifts” in the supply and/or demand curves. The idea here is that if the curves shift, we can predict where the new equilibrium price and quantity will be.

This before-and-after comparison of equilibria is called comparative statics.

Demand shifters

• What factors shift Demand, and which direction?
• When Demand increases/decreases, how does the curve move?

Supply shifters

• What factors shift Supply, and which direction?
• When Supply increases/decreases, how does the curve move?

Shifting the curves

• In which direction does the equilibrium (P,Q) move after Demand/Supply increases/decreases?
• In which direction does the equilibrium (P,Q) move after two shifts?
• Illustrate your answers with a graph.

Out of equilibrium

A market is out of equilibrium if, at the current price, the quantity supplied QS is not equal to the quantity demanded QD. There are two cases:

• Excess demand or shortage QD>QS2
• Excess supply or surplus QS>QD

In the short run — after a shift, but before the price adjusts to it — the market may be out of equilibrium.

• Why will equilibrium be restored in this case? (See Perloff p28)
• At a price above/below the equilibrium price, is there excess demand or excess supply?
• Which way will the price move when there is excess supply/demand?

See Applying Supply and Demand for other reasons why a market might be out of equilibrium.