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The Market
The Demand Side
The Supply Side
Market Equilibrium
Shocks to the Equilibrium
The Market
In the most basic supply and demand model, we start with the most
restrictive market (lots of assumptions).
Competitive Market
• Large number of buyers
• Large number of sellers
• Everyone is a price-taker.
• Standardized Product
• No Barriers to Entry
P 0.75
Change in Quantity Demanded = Change in own price only
0.25
Example: “Coca-Cola”
0.20 As coke prices increases,
Consumers respond by buying less.
0 28 40 44 160 Q
Determinants of Demand
Price of the product. (-) related
Information (expectations)
Price of related product (substitutes or complements) (+) or (-) related
Preferences (tastes)
Income (normal or inferior product) (+) or (-) related
Government rules/regulations (taxes) (+) or (-) related
P D2, Pepsi
D1, Pepsi
40¢ per $50¢ per can
can Effect of a 10¢ New* relationship
increase in the price between prices and
of Pepsi quantity demanded.
0.25 At every price level, the
consumer buys more coke
0 40 40.1 Q (millions)
Econ 300: Microeconomics Yang Fan
Intro and The Market Shocks to the Equilibrium
Demand
Supply Supply and Demand
Market Equilibrium
𝑄𝑑 = 𝐷(𝑝, 𝑝𝑝, 𝑌)
𝑄𝑑 = 𝐷 𝑝, 𝑝𝑟 , 𝑌 = 𝑎 − 𝑏𝑝 + 𝑐𝑝𝑟 + 𝑑𝑌
𝑄𝑑 = 𝐷 𝑝, 𝑝𝑟 , 𝑌 = 𝑎 − 𝑏𝑝 + 𝑐𝑝𝑟 + 𝑑𝑌
𝜕D(p,𝑝𝑟 , Y)
o >0 Substitutes
𝜕 𝑝𝑟
𝜕D(p,𝑝𝑟 , Y)
o <0 Complements
𝜕 𝑝𝑟
𝜕D(p,𝑝𝑟 , Y)
o =0 Not related
𝜕 𝑝𝑟
𝑄𝑑 = 𝐷 𝑝, 𝑝𝑟 , 𝑌 = 𝑎 − 𝑏𝑝 + 𝑐𝑝𝑟 + 𝑑𝑌
𝜕D(p,𝑝𝑝 , Y)
o >0 Normal Good
𝜕𝑌
𝜕D(p,𝑝𝑝 , Y)
o <0 Inferior Good
𝜕𝑌
𝜕D(p,𝑝𝑝 , Y)
o =0 Not related to income
𝜕𝑌
𝑄𝑑 = 60 − 80𝑝
𝑄𝑑 = 𝐷(𝑝) = 𝑎– 𝑏𝑝
𝑃 𝑄𝑑 𝑎 1
𝑎 Inverse Demand Function: 𝑃 𝑄𝑑 = − 𝑄𝑑
“Choke” 𝑏 𝑏
𝑏
3 1
𝑃= – 𝑄
4 80 𝑑
Δ𝑝 1
𝑆𝑙𝑜𝑝𝑒 = =−
Δ𝑄 𝑏
Inverse Demand D
𝑄𝑑
𝑎
Econ 300: Microeconomics Yang Fan
Intro and The Market Shocks to the Equilibrium
Demand
Supply Supply and Demand
Market Equilibrium
0 40 55 Q (millions)
Econ 300: Microeconomics Yang Fan
Intro and The Market Shocks to the Equilibrium
Demand
Supply Supply and Demand
Market Equilibrium
Determinants of Supply
Price of the product. (Quantity Supplied) (+) related
Cost of resources or inputs (-) related
Price of other product produced (-) related
Government rules/regulations (taxes) (+) or (-) related
0 20 40 Q (millions)
Econ 300: Microeconomics Yang Fan
Intro and The Market Shocks to the Equilibrium
Demand
Supply Supply and Demand
Market Equilibrium
𝑄𝑠 = 𝑆(𝑝, 𝑝𝑎)
The supply for coke is affected by it’s own price and price of
it’s inputs used for production.
𝜕S(p, 𝑝𝑐 )
o >0 Law of Supply
𝜕𝑝
𝜕S(p, 𝑝𝑐 )
o <0 As costs increase, supply decreases (all else equal)
𝜕𝑝𝑐
𝜕S(p, 𝑝𝑎 )
o = −2 < 0 As the price of a an input increases, the quantity
𝜕𝑝𝑎 supplied of Coke decreases.
𝑄𝑠 = 35 + 20𝑝
• Given some price of the input, the general supply curve is:
𝑄𝑠 = 𝑆(𝑝) = 𝑔 + ℎ𝑝
𝑔 1
Inverse Supply Function: 𝑃 𝑄𝑠 = − 𝑄
ℎ ℎ 𝑠
𝑔 1
Inverse Supply Function: 𝑃 𝑄𝑠 = − 𝑄𝑠
𝑃 𝑄𝑠 ℎ ℎ
Inverse Supply S
1
𝑆𝑙𝑜𝑝𝑒 = −
ℎ
1 7
𝑃 𝑄𝑠 = 𝑄 −
𝑔 20 𝑠 4
ℎ
𝑄𝑠
Econ 300: Microeconomics Yang Fan
Intro and The Market Shocks to the Equilibrium
Demand
Supply Supply and Demand
Market Equilibrium
Market Equilibrium
𝑄𝑠 = 𝑄𝑑 = 𝑄∗
Market Equilibrium
𝑄𝑠 = 𝑄𝑑 = 𝑄∗
P
Excess supply = 5 S
Market equilibrium,
0.30
𝑃∗ , 𝑄∗
0.25
0.20
Excess demand = 5
D
0 36 39 40 41 44 Q
0.30
𝑄𝑠 > 𝑄𝑑
0.25
0 36 40 41 Q
Econ 300: Microeconomics Yang Fan
Intro and The Market Shocks to the Equilibrium
Demand
Supply Supply and Demand
Market Equilibrium
Excess Supply
𝑄𝑠 > 𝑄𝑑
Excess Supply
𝑄𝑠 > 𝑄𝑑
𝑄𝑑 = 60 − 80𝑝
𝑄𝑠 = 𝑄𝑑 = 𝑄∗ 𝑄𝑠 = 35 + 20𝑝
P S 𝑃𝑎 = $10
0.25
D 𝑃𝑝 = $0.4, 𝑌 = $4000
0 40 Q
Now suppose a supply shock occurs. The price of aluminum per lb. increases to
$20 from $10. What effect does this have on the equilibrium?
Benchmark
𝑃∗ = 0.25 S’, Aluminum/lb
𝑄∗ = 40 $20
Demand
P S, Aluminum/lb
0.60 $10
𝑃∗ = 0.40
0.45
𝑄∗ = 43
0.25
Supply
𝑃∗ = 0.45 D’, Y=$5,500
𝑄∗ = 24
D, Y=$4,000
Dual Shock
𝑃∗ = 0.60 0 24 27 40 Q
𝑄∗ = 27