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The Laws of Demand and
SupplyShifts, Movements, and Elasticity and
Equilibrium
Demand represents the actions of the buyers in the market.
As such you need to thinkthink like a buyer.
If the price of gum were to double you may cut back on your gum consumption.
By the same token if the price of gum were to drop considerably you may be inclined to
buy gum rather than mints.
Price increase = demand decrease
Price decrease = demand increase
As such demand appears on a graph as a downward sloping curve (or line)
Therefore the law of demand states:
As the price of a product changes the demand will change in an inverse direction
(that is, in the opposite direction)
Basic Demand Curve
P
Q
D
Q = Quantity
P = price
D = Demand
Basic Demand Curve
P
Q
D
As the price of a product increases the demand for that product will decrease. At the same
time as the price declines the demand increases. Thus an INVERSE RELATIONSHIP
Demand for Widgets
P
Q
D
P1
Q1
•A
•BP2
Q2To move from A to B is called a MOVEMENT ALONG the demand curve. This occurs when the price of the object presented (widgets) has changed resulting in a change in DEMAND.
Demand for Widgets
P
Q
D
P1
Q1
•A
•BP2
Q2
As the price of Widgets increased (from P1 to P2) the demand for Widgets decreased from Q1 to Q2).
Demand for Widgets
P
Q
D1
P1
Q1
•A
D2
•B
However, sometimes something other than the price of widgets can affect its demand. This is called a change in the QUANTITY DEMANDED. At the same price the demand for widgets has increased. This is a SHIFT in the Demand Curve.
Q2
Demand for Widgets
P
Q
D1
P1
Q1
•A
D2
•B
Q2
This may have occurred due to a increase in the price of a substitute for widgets or simply a general increase in the popularity of widgets.
Demand for Widgets
P
Q
D1
P1
Q1
•A
D2
•B
Q2
The same would be true for a decrease in the QUANTITY DEMANDED.
Demand for Widgets
P
Q
D1
P1
Q1
•A
D2
•B
Q2Here the price of a substitute may have
decreased causing fewer people to demand widgets at a given price. Or, the general widget
fad may have started to decline.
WHAT FACTORS MIGHT AFFECT
DEMAND?Factors affecting demand may include but are not limited to:
price
tastes
trends
incomes
needs
Practice exercise1. Use the following Demand Schedule
to create a fully labelled graph illustrating the demand for shoes.
PriceQuantity
Demanded
$5 50
$10 45
$15 40
$20 35
$25 30
2. What happens when the price for a pair of shoes falls from $20 to $15?
3. What is this change called?
4. What might happen with the coming of Spring and the end of boot weather?
5. Indicate this change on your graph.
6. What is this change called?
Ok... so now we can move on to SUPPLY and find that it is the same
but opposite (if that makes any sense)
Supply represents the actions of the sellers in the market. As such you need to thinkthink like a seller
(manufacture.If the price of gum were to double there would be
a resulting increase in the supply of gum
By the same token if the price of gum were to drop considerably there would be a
decrease in the amount of gum supplies.
Price increase = supply increase
Price decrease = supply decrease
WHY?
WHY?
As such supply appears on a graph as an upward sloping curve (or line)
Therefore the law of supply states:
As the price of a product changes the supply will change in the same direction
(this is called a direct relationship)
Basic Supply Curve
P
Q
S
Q = Quantity
P = price
Basic Supply Curve
P
Q
S
As the price of a product increases the supply of that product will also increase. At the same
time as the price of a product decreases its supply decreases. Thus a DIRECT
RELATIONSHIP
Supply for Widgets
P
Q
S
P1
Q1
•A
•BP2
Q2To move from A to B is called a MOVEMENT ALONG the supply curve. This occurs when the price of the object presented (widgets) has changed resulting in a change in SUPPLY.
Supply for Widgets
P
Q
S
P1
Q1
•A
•BP2
Q2
As the price of Widgets increased (from P1 to P2) the supply of Widgets increased from Q1 to Q2).
Supply for Widgets
P
Q
S2
P1
Q1
•A •B
However, sometimes something other than the price of widgets can affect its Supply. This is called a change in the QUANTITY SUPPLIED. At the same price the supply for widgets has increased. This is a SHIFT in the Supply Curve.
S1
Q2
Supply for Widgets
P
Q
S2
P1
Q1
•A •B
This may have occurred due to a decrease in the price of an input into the production of widgets or because of improved technology in production (can now make more goods cheaper).
S1
Q2
Supply for Widgets
P
Q
S2
P1
Q1
•A•B
The same would be true for a DECREASE in the Quantity Supplied.
S1
Q2
Supply for Widgets
P
Q
S2
P1
Q1
•A•B
Here the price of inputs may have increased resulting in producers suppling fewer goods at the
same price.
S1
Q2
WHAT FACTORS MIGHT AFFECT
SUPPLY?Factors affecting supply may include but are not limited to:
price
cost of production
technological change
weather
government regulations
Referred to as
“Techniques of
Production.”
Practice exercise1. Use the following Supply Schedule
to create a fully labelled graph illustrating the supply for shoes.
PriceQuantity Supplied
$5 30
$10 35
$15 40
$20 45
$25 50
2. What happens when the price for a pair of shoes falls from $20 to $15?
3. What is this change called?
4. What might happen if contract negotiations resulted in increased pay for shoe manufacturers?
5. Indicate this change on your graph.
6. What is this change called?
EQUILIBRIUMPutting Demand and Supply together
Equilibrium - is also known as the “market clearing” price.
the point where supply and demand meet.
markets have a tendency to move toward this point - but seldom reach it.
Equilibrium
P
Q
S
D
Q1
•eP1
At P1 both the Quantity Demanded and the Quantity Supplied is Q1.
In actual fact both curves are always present in each graph - we just have not included them yet so that we could concentrate on just Demand or
just Supply
As a result it is still possible to have movements and shifts occur to the
Demand or Supply curves.
Here, for example, the demand curve has shifted to the right - perhaps due to the product becoming more popular. As a result of this increased demand both equilibrium supply and price ultimately increase.
Shoes
What has happened
here?
Shoes
Here Supply has decreased -
perhaps due to a decreased
availability of resources and this has resulted in a price increase in
demand decrease.
Shoes
Two important scenarios of equilibrium we will be
concentrating on involve only movements along the supply and
demand curves.
Price Ceilings is a gov’t-
mandated maximum price that a seller can
charge for a product of service.
may be placed on such things as food or fuel
during a time of war or rents when affordable
housing is not available.
Rent Controls most common example of Price Ceilings
used in economics
put in place on certain units to ensure affordable housing is available to people
who can’t otherwise afford to live in a community.
rental prices are artificially held at a level below market equilibrium.
Rent Controls
P
Q
S
D
Q1
•eP1
Here Price = rent charged to tenants and Q = the amount of available rental
units
Rent Controls
P
Q
S
D
Q1
•eP1
If the government determines this market equilibrium price is too high they will insist prices be kept below
this level.
Rent Controls
P
Q
S
D
Q1
•eP1
This new level is seen at Prc. As a result of the new, lower price the
Supply of rental units (Qs ) will decrease while the Demand (Qd)
will increase.
Prc
QdQs
Rent Controls
P
Q
S
D
Q1
•eP1
This will result in a shortage of apartments as new spaces are not made available. As the same time more people are looking to rent.
Prc
QdQs
Price Floors is a gov’t-
mandated minimum price that a seller can
charge for a product of service.
The most common example of a price floor is minimum
wage legislation. The market equilibrium is too low so the
government imposed a minimum price for labour.
Minimum Wage
P
Q
S
D
Q1
•eP1
Here Price = the amount paid for wages and Q = the labour force.
Minimum Wage
P
Q
S
D
Q1
•eP1
Setting a minimum wage at P2 means that wages cannot go below this point -
hence a PRICE FLOOR.
Minimum Wage
P
Q
S
D
Q1
•eP1
This new level is seen at Pmw. As a result of the new, higher price of labour
the Supply of people looking to work (Qs ) will increase while the Demand for
workers (Qd) will decrease.
Qs
Pmw
Qd
Minimum Wage
P
Q
S
D
Q1
•eP1
This will result in a surplus as more people will be looking for work but fewer
employers will be looking to hire.
Qs
Pmw
Qd
To sum up... a Price Ceiling results in a Shortage and a Price Floor results in a
Surplus.
Think of the equilibrium graph as an upside down room.
The Floor is on the top (above equilibrium) and the ceiling is on the bottom (below
equilibrium).
Elasticityof Supply and Demand
Elasticity of Demand
The degree to which the demand for any good changes in relation to changes in price.
A product is:
ELASTIC - if price changes cause large variations in the quantity
demanded.
INELASTIC - if price changes cause have little effect on the
quantity demanded.
UNIT-ELASTIC - if a percentage change in price causes an equal percent change in the quantity
demanded.
Elastic DemandGoods with an elastic demand tend to be those which are:
luxury items
use a very small portion of ones incomenon-necessities
easily substituted
Examples of Elastic goods:
ballpoint pens
one particular brand of a product (i.e. Nikes over Adidas)
chicken wings
OR...anything in the long run
The “long run” is a period of time in which everything is changeable.
Over time goods become more and more elastic as substitutes are created.
Or...as John Maynard Keynes said... “In the long run we’re all dead.”
Inelastic DemandGoods which are inelastic tend to be:
not easily replaced
necessary or essential
large ticket items
items difficult to replace in the short term.
Examples of inelastic goods:
automobiles in general
public transit
gasoline - in the short run
insulin for a diabetic
staple foods
The key is to determine the degree to which something will be elastic or inelastic.
will a given price increase still allow a companies revenues to increase?
if no - the demand is elastic
if yes - the demand is inelastic
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