The Basics of
Supply and
Demand
Topics to Be Discussed
Supply and Demand
The Market Mechanism
Changes in Market Equilibrium
Elasticities of Supply and Demand
Short-Run Versus Long-Run Elasticities
Qs QS (P )
Quantity
P2
The supply curve slopes
P1 upward demonstrating that
at higher prices firms
will increase output
Q1 Q2 Quantity
At P2, produce Q1 P1
Supply curve shifts right
to S P2
More produced at any
price on S than on S
Q0 Q1 Q2 Q
QD QD(P)
Chapter 2: The Basics of Supply and Slide
Supply and Demand
Price
($ per unit)
Quantity
Quantity
Consumer Tastes
Price of Related Goods
Substitutes
Complements
At P2, produce Q1
Demand Curve shifts right P1
More purchased at any
price on D than on D
Q0 Q1 Q2 Q
Q0 Quantity
Q0 Quantity
Q1 Q3 Q2 Quantity
Q1 Q3 Q2 Quantity
Q1 Q3 Q2 Q
Income Increases P D D S
Demand shifts to D1
Shortage @ P1 of Q1, Q2 P3
P1
Equilibrium @ P3 , Q 3
Q2 Q1 Q3 Q
P
Income Increases & D D S S
raw material prices fall
The increase in D is
greater than the P2
increase in S P1
Q1 Q2 Q
S1998
$0.61
$0.26
D1970
D1998
5,300 5,500 Q (million dozens)
$2,530
D1995
D1970
Long-Run Path of
Price and Consumption
EP (%Q)/(%P)
Q/Q P Q
EP
P/P Q P
Price
EP - The lower portion of
4 a downward sloping
demand curve is less elastic
Q = 8 - 2P than the upper portion.
Ep = -1
2
Linear Demand Curve
Q = a - bP
Q = 8 - 2P
Ep = 0
4 8 Q
Price
Infinitely Elastic Demand
P* D
EP -
Quantity
EP 0
Q* Quantity
Q/Q I Q
EI
I/I Q I
Qb/Qb Pm Qb
EQbPm
Pm/Pm Qb Pm
Equilibrium: Q S = Q D
P 3.46 / bushel
Q 1,800 (240)(3.46) 2,630 million bushels
P QD 3.46
E
D
P (2.66) .035 Inelastic
Q P 2,630
P QS 3.46
E S
P (2.40) .032 Inelastic
Q P 2,630
4.00
Q D
P ( 266) 0.43
2,486
People tend to
drive smaller and
more fuel efficient
cars in the long-run
Gasoline DLR
Quantity
Automobiles DSR
Quantity
Gasoline
The long-run price and income elasticities
are larger than the short-run elasticities.
Automobiles
The long-run price and income elasticities
are smaller than the short-run elasticities.
Elasticity 1 2 3 4 5 6
Elasticity 1 2 3 4 5 6
Data Explains:
1) Why the price of oil did not continue to
rise above $30/barrel even though it
rose very rapidly in the early 1970s.
2) Why automobile sales are so sensitive
to the business cycle.
SLR
Due to limited
capacity, firms
are limited by
output constraints
in the short-run.
In the long-run, they
can expand.
Quantity
Price increases
provide an incentive
to convert scrap
copper into new supply.
In the long-run, this
stock of scrap copper
begins to fall.
Quantity
P0
Short-Run
1) Supply is completely inelastic
2) Demand is relatively inelastic
3) Very large change in price
Q1 Q0 Quantity
P2
P0
Intermediate-Run
1) Supply and demand are
more elastic
2) Price falls back to P2.
3) Quantity falls to Q2
Q2 Q0 Quantity
P0 S
Q0 Quantity
Available Data
Equilibrium Price, P*
Equilibrium Quantity, Q*
Priceelasticity of supply, ES, and
demand, ED.
Price
Supply: Q = c + dP
a/b
ED = -bP*/Q*
P* ES = dP*/Q*
-c/d Demand: Q = a - bP
Q* Quantity
Demand: QD = a - bP
Supply: QS = c + dP
We must choose numbers for a, b, c,
and d.
Step 1:
Recall:
E (P/Q)( Q/P)
ED - b(P * /Q*)
ES d(P * /Q*)
Es = d(P*/Q*) Ed = -b(P*/Q*)
1.6 = d(75/7.5) -0.8 = -b(.75/7.5)
= 0.1d = -0.1b
d = 1.6/0.1 = 16 b = 0.8/0.1 = 8
p = 18/24 = .75
Price
Supply: QS = -4.5 + 16P
a/b
.75
7.5 Mmt/yr
Q a bP fI
E ( I / Q)(Q / I )
and
f Q / I
Chapter 2: The Basics of Supply and Slide
Understanding and Predicting the Effects
of Changing Market Conditions
1.3 = (1.0/7.5)f
f = (1.3)(7.5)/1.0 = 9.75
a = 3.75
Q = 13.5 - 8P
Q = (0.80)(13.5 - 8P)
Q = 10.8 - 6.4P
Recall the equation for supply:
Q = -4.5 + 16P
P = 15.3/22.4
P = 68.3 cents/pound
Short-Run Long-Run
Demand = Supply
P = 41.08
Price 45
($ per Short-Run
barrel) 40 Effect
35
30
25
20
18
15
10
5 Quantity
0 5 10 15 20 23 25 30 35 (billions barrels/yr)
P = 21.75
SC ST ST Long-run Effect
Price 45
D
($ per
barrel) 40
35 Due to the elasticity
of the long-run
30 supply and demand
curves, the long-run
25 effect of a cut
in production is
20 much less.
18
15
10
5 Quantity
(billions barrels/yr)
0 5 10 15 20 23 25 30 35
If price is regulated to
be no higher than Pmax,
quantity supplied falls
P0 to Q1 and quantity
demanded increases to
Q2. A shortage results
Pmax
D
Excess demand
Q0 Quantity
PES 0.2
Cross elasticity of supply for oil 0.1
D
PE 0.5
Cross elasticity of demand for oil 1.5
Supply : Q 14 2 PG .25 PO
Demand : Q 5 PG 3.75 PO
Supply Demand @ $2/TcF
Chapter 2: The Basics of Supply and Slide
Price Controls and
Natural Gas Shortages
The
TheData:
Data: Natural
NaturalGas
Gas
At $1.00/TcF
QS 18 TcF and Q 25 TcF
Shortage 7 TcF/yr