UNIT 2

Demand, Supply
and Markets
 Demand, Supply and Markets

❑ The terms supply and demand refer to the behavior of

people . . . as they interact with one another in markets.
❑ Buyers determine demand and Sellers determine
supply.
❑ A market is a group of buyers and sellers of a particular
good or service.
❑ The market price of a good or service is determined by
both the supply and demand for it.
3

Markets

An institution or mechanism that brings together buyers

and sellers of particular goods and services.

This chapter focuses on competitive markets. What is a

competitive market?

❑ Competitive market
– a market that has many buyers and many sellers
– no single buyer or seller can influence the price.
 Demand
❑ A schedule or a curve that shows the various amounts
consumers are willing and able to purchase at each of a
series of possible prices, during some specified period of
time
❑ Quantity demanded of a good or service
– the amount that consumers plan to buy during a particular
time period at a particular price.
❑ The Law of Demand
– Other things remaining the same, the higher the price of a
good, the smaller is the quantity demanded.
– The law of demand results from
• diminishing marginal utility
• a substitution effect
• an income effect
4
 Demand Function

❑ Is the functional relationship between the price of the good and the
quantity of that good purchased in a given time period [UT], income,
other prices and preferences being held constant.
❑ A change in income, prices of other goods or preferences will alter
[‘shift’] the demand function.
 Demand

Price
❑ This figure shows a
demand curve for
gasoline
❑ A rise in the price,
ceteris paribus,
brings a decrease in
the QD and a D
movement along
the demand curve.
# gallons per week
 Demand

A D-curve is also Price

– Willingness-to-pay
curve.
– Willingness to pay
measures marginal
benefit.

# gallons per week

 Demand

❑ A Change in Demand
▪ The quantity of the good that people plan to buy
changes at each and every price, so there is a
new demand curve.
▪ When demand increases,
• QD increases at each and every price
• the demand curve shifts rightward.
▪ When demand decreases,
• QD decreases at each and every price
• the demand curve shifts leftward.
Demand

Change in Demand vs. Change in Quantity Demanded

 Law of Demand

o Theory and empirical evidence suggest that the relationship between

Price and Quantity is an inverse or negative relationship
o At higher prices, quantity purchased is smaller, or at lower prices the
quantity purchased is greater.
o As the price is increased, the quantity purchased decreases.
o This demand relationship can be expressed as an equation: P = 2 - 0.1Q : [Q
= f (P, . . .) but we graph P on the Y axis and Q on the X axis.]

The demand
function can be
represented as a
table, an
equation or a
graph
 Factors that change demand

1. Prices of related goods

▪ substitute in consumption
▪ complement in consumption
2. Income
▪ Normal good
▪ Inferior good
▪ Luxury good
3. Expected future prices
4. Population
5. Taxes on buyers
6. Consumer preferences
 Factors Affecting Demand

o A change in any of the parameters (income, price of related

goods, preferences, population of buyers, etc.) will cause a
“shift of the demand function.
o Rising incomes tend to increase demand for normal economic
goods, as people are willing to spend more.
o The availability of close substitute products that compete with
a given economic good will tend to reduce demand for that
good, since they can satisfy the same kinds of consumer
wants and needs.
o The availability of closely complementary goods will tend to
increase demand for an economic good, because the use of
two goods together can be even more valuable to consumers
than using them separately.
o Other factors such as future expectations, changes in
environmental conditions, Population can change the demand.
 Change in Income

❑ An Increase in income causes a positive change in demand for

normal goods, and a negative change occurs in the case of
inferior goods.
❑ If the incomes of the consumers increase, it is expected that
the demand will increase for normal goods.
❑ It must be noted that there is no change in demand for the
necessity goods with increase or decrease in income.
 Effect of a change in the price of a
substitute
❑ If the price of a substitute, like chicken, increases buyers will
buy more steak at each price of steak.
❑ If the price of chicken decreases, the buyers will want less
steak at each possible price of steak; the demand for steak
decreases!
 Complementary goods

o Two goods may be complimentary, i.e. the two goods are

“used together. [bread and Butter or CD’s and CD Players]
o As the price of Bread increases from P1 to P2, the quantity
of Bread decreases from Q1 to Q2
o As people buy fewer Bread, the demand for Butter decreases.
o At the same price, P1 , the demand is reduced from Q1 to Q2
 Compliments and Substitutes

Substitutes:
❑ If the price of a substitute increases, the
demand for the good increases.
❑ If the price of a substitute decreases, the
demand for the good decreases.
Complements:
❑ If the price of a compliment increases, the
demand for the good decreases.
❑ If the price of a compliment decreases, the
demand for the good increases.
 Review Questions

1. Use supply aid demand curves to illustrate how each of the following events
would affect the price of butter and the quantity of butter bought and sold:
(a) an increase in the price of margarine;
(b) an increase in the price of milk;
(c) a decrease in average income levels.

2. What is the difference between change in demand and Change in quantity

demanded?
3. Describe when demand increases (shifts right) or decreases (shifts left).
4. What does law of demand states?
5. Suppose that unusually hot weather causes the demand curve for ice cream
to shift to the right. Why will the price of ice cream rise to a new market-clearing
level?
6. In December, the price of Christmas trees rises and the number of trees sold
also rises. Is this a violation of the law of demand?
 Supply

❑ A schedule or a curve showing the amounts

that producers are willing and able to make
available for sale at each of a series of possible
prices, during some specified period of time.
❑ Generally, producers are willing to offer greater
quantities of a good for sale at higher prices; a
positive relationship between price and quantity
supplied.
❑ The information can be represented on a graph
by plotting each price quantity combination.
1
9
Change in Quantity Supplied

❑ A change in the price of the good causes a change in

the “quantity supplied.”
❑ The change in the price of the good causes a
“movement on the supply function,” not a change or
“shift of the supply function.”
❑ This is a change in “quantity supplied.” Not to be
confused with a “change in supply!”

A change in the price “causes” a change in

the “quantity supplied.” This can be
represented by a “movement” on the
supply function in the graph
 Determinants of Supply

Changes in any of these determinants will

cause the supply curve to shift:
 factor prices
 technology
 taxes & subsidies
 prices of other goods
 producer expectations
 number of sellers

let’s examine these more closely…

20
 Change in Supply

❑ Qs = fs (P, Price of inputs, technology, number of sellers, taxes, . . .)

❑ A change in the price [P] causes a “change in quantity supplied;”
❑ A change in any other variable causes a “change in supply”
❑ An increase in the prices of inputs would make it more expensive to
produce each unit of output, therefore, the supply decreases
❑ The decreased quantity at each price “shifts” the supply curve to the left
❑ However, the development of a “new” technology that reduces the cost of
production will “shift” the supply function to the right.
 Market supply and individual
supplies

Quantity Supplied

Price of ice-cream cone Ben Jerry Market

$0.00 0 + 0 = 0
0.50 0 0 0
1.00 1 0 1
1.50 2 2 4
2.00 3 4 7
2.50 4 6 10
3.00 5 8 13
 Market supply and individual
supplies

Ben’s Jerry’s Market

supply + supply = supply
Price of Price of Price of
Ice Ice Ice
Cream Cream Cream
Cones SBen Cones Cones
$3.00 $3.00 $3.00 SMarket
SJerry
2.50 2.50 2.50

2.00 2.00 2.00

1.50 1.50 1.50

1.00 1.00 1.00

0.50 0.50 0.50

0 1 2 3 4 5 6 7 8 9 10 11 12 0 1 2 3 4 5 6 7 0 2 4 6 8 10 12 14 16 18
Quantity of Ice-Cream Cones Quantity of Quantity of Ice-Cream Cones
Ice-Cream Cones
 Law of Supply

❑ States that, ceteris paribus, as price rises, the

quantity supplied rises (& vice-versa)

❑ why?
– price is revenue to suppliers
– higher price is necessary to induce higher supply,
to cover higher costs of production

24
 Market Equilibrium

o In a market, an equilibrium is said to exist when the forces of supply [sellers]

and demand [buyers] are in balance: the actions of sellers and buyers are
coordinated.
o The quantity supplied equals the quantity demanded given a demand function
[which represents the behavior or choices of buyers and a supply function that
represents the behavior of sellers
o Equilibrium price will be established where the supply decisions of producers
and the demand decisions of buyers are mutually consistent

Where the quantity that people want to buy is equal to

the quantity that the producers want to sell, there is an
equilibrium quantity(Q*)

The price that coordinates the preferences of the buyers and

sellers is the equilibrium price

At the equilibrium price of P*, the quantity supplied is

equal to the quantity demanded.
2
6

Equilibrium price & quantity

Demand Schedule Supply Schedule

At $2.00, the quantity demanded is

equal to the quantity supplied!
2
7

Equilibrium price & quantity

Price of
Ice-Cream
Cones Supply
$3.00

2.50 Equilibrium
price Equilibrium
2.00
1.50

1.00
Equilibrium Demand
0.50 quantity

0 1 2 3 4 5 6 7 8 9 10 11 12
Quantity of Ice-Cream Cones

27
2
8

SURPLUS AND SHORTAGES

▪ When markets are not in equilibrium, we are likely to

have shortages or surpluses exist?

❑ Surplus
– When the price exceeds equilibrium
price, the quantity supplied exceeds
the quantity demanded
• This is called excess supply or a
surplus
• Suppliers will be forced to cut their
prices, thereby moving closer to
equilibrium
2
9

SURPLUS AND SHORTAGES

• Shortage
– When the price is less than the
equilibrium price, the quantity demanded
exceeds the quantity supplied
• This is called excess demand or a
shortage
• Suppliers will raise the price, because too
many buyers are chasing too few goods,
thereby moving closer to equilibrium
3
0

SURPLUS AND SHORTAGES

o When the price is greater than the equilibrium price, the amount that sellers
want to sell at that price [quantity supplied] exceeds the amount that buyers
are willing to purchase [quantity demanded] at that price. The price is “too
high.”
❑ At $5 there is a surplus of 50 units [60-10=50)
❑ At $2 there is a shortage of 10 units [40-30=10)

What is the equilibrium price and

quantity?
3
1

SURPLUS AND SHORTAGES

❑ At $5 there is a surplus of 50 units [60-10=50), Suppliers have more to sell
than buyers will purchase at a price of $5.
❑ To get rid of these unsold units [inventory], the sellers lower the price
❑ As the price of the good is reduced, the quantity supplied decreases
❑ The quantity demanded increases as the price falls
❑ As the price moves toward equilibrium, quantity supplied and quantity
demanded are brought into equilibrium.
❑ At $2 there is a shortage of 10 units [40-30=10)

As a result of market forces

the market moves to
equilibrium

Who can explain the transmission mechanism at $2?

There is a shortage of 10 units [40-30=10)
3
2

Let’s make some predictions

❑ We have seen some of the factors that shift the

demand and supply curves
❑ Such shifts change the equilibrium outcome
❑ Using the supply-demand theory we can try to
predict the consequences of
– alternative policy proposals, and
– events outside our control that we need to be
ready for
 How an Increase in Demand Affects the
Equilibrium

Lets try to predict the Effects of hot weather patterns

1. Hot weather increases

the demand for ice cream . . .
Price
of Ice-Cream Cones

Supply Practice Questions

$2.50 New equilibrium ❑ Can you now try to predict the

consequences of unusually
cold weather?
2.00
2. . . . resulting
Initial ❑ Can you use this graph to
in a higher equilibrium predict the effect on the
price . . . market for rice if there is an
D increase in the price of
wheat?
D

0 7 10 Quantity of Ice-Cream Cones

3. . . . and a higher
quantity sold.
 How a Decrease in Supply
Affects the Equilibrium
What is likely to happen if there is an increase in the price of sugar?

1. An increase in the
price of sugar reduces
Price the supply of ice cream. . .
of Ice-Cream Cones S2
S1

Practice Questions
New
▪ Can you now predict
$2.50 equilibrium
the consequences of a
decrease in the price of
2.00 Initial equilibrium sugar?
2. . . . resulting
▪ Can you use this graph
in a higher
price of ice
to predict the effect on
cream . . . the market for rice if
Demand
there is a drought in
our rice-growing areas?

0 4 7 Quantity of Ice-Cream Cones

3. . . . and a lower
quantity sold.
 SIMULTANEOUS SHIFT IN
SUPPLY AND DEMAND CURVES
What happens when supply and demand shifted
simultaneously?
❑ When either the demand or the supply curve shifts, we know
what will happen to both equilibrium price and equilibrium
quantity, so long as we know whether demand or supply
increased or decreased.
❑ However, in practice, several events may occur at around the
same time that cause both the demand and supply curves to
shift.
❑ To figure out what happens to equilibrium price and
equilibrium quantity, we must:
▪ know not only in which direction the demand and
supply curves have shifted
▪ know the relative amount by which each curve shifts.
 SIMULTANEOUS SHIFT IN
SUPPLY AND DEMAND CURVES
Example
Suppose that there is a decrease in demand for coffee,
caused perhaps by a decrease in the price of a substitute
good, tea and a simultaneous decrease in the supply of coffee
caused perhaps by bad weather.

❑ Since reductions in demand and supply, considered separately,

each cause the equilibrium quantity to fall,
❑ The impact of both curves shifting simultaneously to the left
means that the new equilibrium quantity of coffee is less than the
old equilibrium quantity.
❑ The effect on the equilibrium price, though, is ambiguous.
whether the equilibrium price is higher, lower, or unchanged
depends on the extent to which each curve shifts.
SIMULTANEOUS SHIFT IN
SUPPLY AND DEMAND CURVES
• In Panel (a), the demand
curve shifts farther to the left
than does the supply curve,
so equilibrium price falls.

• In Panel (b), the supply

curve shifts farther to the left
than does the demand curve,
so the equilibrium price
rises.

• In Panel (c), both curves

shift to the left by the same
amount, so equilibrium price
stays the same.
SIMULTANEOUS SHIFT IN
SUPPLY AND DEMAND CURVES
 Supply, Demand and Market
Efficiency
Consumer Surplus The difference between the maximum amount a person is willing to
pay for a good and its current market price

 FIGURE 4.6 (a), some consumers (see point A) are willing to pay as much as $5.00 each for hamburgers.
Since the market price is just $2.50, they receive a consumer surplus of $2.50 for each hamburger that they
consume. Others (see point B) are willing to pay something less than $5.00 and receive a slightly smaller
surplus. Since the market price of hamburgers is just $2.50, the area of the shaded triangle in Figure 4.6(b) is
equal to total consumer surplus.
 Supply, Demand and Market
Efficiency
Producer Surplus: The difference between the current market price and the full cost
of production for the firm.

 FIGURE 4.7 (a), some producers are willing to produce hamburgers for a price of $0.75 each.
Since they are paid $2.50, they earn a producer surplus equal to $1.75. Other producers are willing
to supply hamburgers at a price of $1.00; they receive a producer surplus equal to $1.50. Since the
market price of hamburgers is $2.50, the area of the shaded triangle in Figure 4.7(b) is equal to total
producer surplus.
 Supply, Demand and Market
Efficiency
Total Sum of Producer and Consumer Surplus

 FIGURE 4.8 Total Producer and Consumer Surplus

Total producer and consumer surplus is greatest where supply and demand curves intersect at
equilibrium.
 Supply, Demand and Market
Efficiency
deadweight loss The net loss of producer and consumer surplus from
underproduction or overproduction.

 FIGURE 4.9 (a) shows the consequences of producing 4 million hamburgers per month instead of 7 million
hamburgers per month. Total producer and consumer surplus is reduced by the area of triangle ABC shaded in yellow.
This is called the deadweight loss from underproduction. (b) shows the consequences of producing 10 million
hamburgers per month instead of 7 million hamburgers per month. As production increases from 7 million to 10 million
hamburgers, the full cost of production rises above consumers’ willingness to pay, resulting in a deadweight loss equal
to the area of triangle ABC.
 Supply, Demand and Market
Efficiency

Potential Causes of Deadweight Loss From Under-

and Overproduction

When supply and demand interact freely, competitive markets produce

what people want at least cost, that is, they are efficient.

There are a number of naturally occurring sources of market failure.

Monopoly power gives firms the incentive to underproduce and
overprice, taxes and subsidies may distort consumer choices, external
costs such as pollution and congestion may lead to over- or
underproduction of some goods, and artificial price floors and price
ceilings may have the same effects.
4
4
Demand, Supply Analysis
and Applications

❑ On occasion, both governments and private firms decide to use

some mechanism other than the market system to ration an
item for which there is excess demand at the current price.

❑ Regardless of the rationale, two things are clear:

▪ Attempts to bypass price rationing in the market and to use alternative
rationing devices are much more difficult and costly than they would seem
at first glance.
▪ Very often, such attempts distribute costs and benefits among households
in unintended ways.
 Price Ceilings

❑ A price ceiling establishes a maximum price that sellers

are legally permitted to charge. Example: rent control
❑ When a price ceiling keeps the price of a good below
market equilibrium, there will be both direct and indirect
effects.
– (Direct effect) Shortage: the quantity demanded will exceed
the quantity supplied. Waiting lines may develop.
– (Indirect effects) Quality deterioration and changes in other
non-price factors favorable to sellers and unfavorable to
buyers are likely to occur.
❑ The quantity exchanged will fall and the gains from trade
will be less than if the good were allocated by markets.
 Impact of a Price Ceiling

• Consider the rental housing

market where the price (rent) P0 Price Rental housing
(rent) market
would bring the quantity of rental S
units demanded into balance with
the quantity supplied.
• A price ceiling like P1 imposes a
price below market equilibrium
causing quantity demanded QD to P0
exceed quantity supplied QS
resulting in a shortage.
• Because prices are not allowed to
Price
direct the market to equilibrium, P1 ceiling
non-price factors will become more Shortage
important in determining where the D
scarce goods go.
Quantity of
QS QD housing units
 Effects of Price Ceiling

❑ Shortages and black markets will develop.

❑ The future supply of housing will decline.
❑ The quality of housing will deteriorate.
❑ Non-price methods of rationing will increase
in importance.
❑ Inefficient use of housing will result.
❑ Long-term renters will benefit at the expense
of newcomers.
 Price Floor

❑ A price floor establishes a minimum legal price for the

good or service. Example: minimum wage
❑ When a price floor keeps the price of a good above
market equilibrium, it will lead to both direct and indirect
effects.
– (Direct effect) Surplus: sellers will want to supply a larger
quantity than buyers are willing to purchase.
– (Indirect effects) Changes in non-price factors favorable to
buyers and unfavorable to sellers.
– The quantity exchanged will fall and the gains from trade will
be less than if the good were allocated by markets.
 Impact of a Price Floor

Price
•A price floor like P1 imposes a S
price above market equilibrium Surplus
causing quantity supplied Qs to Price
P1
exceed quantity demanded QD floor
resulting in a surplus.
P0
•Because prices are not allowed
to direct the market to
equilibrium, non-price factors
will become more important in
the allocation of the good.

D
Quantity
QD QS
 Minimum Wage:
An Example of a Price Floor

❑ When the minimum wage is set above the market

equilibrium for low-skill labor, the following will
occur:
– Direct effect:
• Reduces employment of low-skilled labor.
– Indirect effects:
• Reduction in the non-wage components of
compensation
• Less on-the-job training
• May encourage students to drop out of school
 Employment and the Minimum
Wage

•Consider the market for Price Low-skill

low-skill labor where a price (wage) labor market
(wage) of $7 could bring the S
Excess Supply
quantity of labor demanded
into balance with the $10.00 Minimum
wage
quantity supplied. level
•A minimum wage (price $7.00
floor) of $10 would increase
the wages of low-skill labor,
but employment will decline
from E0 to E1.
•Those who lose their jobs
will be pushed into either D
unemployment or less Quantity
E1 E0 (low-skill
preferred employment. employment)
 Tax Incidence

❑ The legal assignment of who pays a tax is called the

statutory incidence.
– The actual burden of a tax (actual incidence)
may differ substantially.
• The actual burden does not depend on who
legally pays the tax (statutory incidence).
 Impact of a Tax Imposed on Sellers
• Consider the used car market
where a price of $7,000 would bring
the quantity of used cars
Pric
e S plus tax
demanded into balance with the
quantity supplied. S
• When a $1,000 tax is imposed on
the sellers of used cars, the supply
curve shifts vertically upward by the
$7,400
amount of the tax.
• The new price for used cars is $7,000 $1,000 tax
$7,400, sellers netting $6,400
($7,400 - $1000 tax).
$6,400
• Consumers end up paying $7,400
instead of $7,000 and bear $400 D
of the tax burden.
• Sellers end up receiving $6,400 # of used cars
500 750 per month
(after taxes) instead of $7000 (in thousands)
and bear $600 of the tax burden.
 Impact of a Tax Imposed on Sellers

• The new quantity of used cars that

clear the market is 500,000. Pric
e S plus tax
• Consumers bear $400 of the tax Tax revenue
burden and, as there are 500,000 from consumers S
units sold per month, tax revenues
derived from consumers (cross-
hatched red area) = $200,000,000.
• Sellers bear $600 of the tax burden $7,400
and so, as there are 500,000 units Deadweight
sold per month, tax revenues $7,000 Loss due to
derived from the sellers (cross- reduced trades
hatched blue area) = $300,000,000.
• As only 500,000 cars are sold after $6,400
the tax (instead of 750,000), the
yellow area above the old supply Tax revenue
from sellers D
curve and below the demand curve
represents the consumer and # of used cars
producer surplus lost from the 500 750 per month
levying of the tax, called the (in thousands)
deadweight loss to society.
 Impact of a Tax Imposed on Buyers
• Suppose the $1,000 tax was
levied on buyers rather than the Pric
e
sellers.
• When a $1,000 tax is imposed on S
buyers of used cars, the demand
curve shifts vertically downward
by the amount of the tax.
$7,40
• The new price for used cars is 0
$6,400. $7,00 $1,000
• Buyers then pay taxes of $1,000 0 tax
making the after tax price $7,400.
$6,40
• Consumers end up paying 0
$7,400 (after taxes) instead of D
$7,000 and bear $400 of the tax D minus tax
burden. # of used cars
500 750 per month
• Sellers end up receiving $6,400 (in thousands)

instead of $7,000 and bear $600

of the tax burden.
 Impact of a Tax Imposed on Buyers

• The new quantity of used cars

that clears the market is 500,000.
• Consumers bear $400 of the tax Pric
e
burden and, as there are 500,000
units sold per month, tax revenues Tax revenue
from consumers S
derived from consumers (cross-
hatched red area) = $200,000,000.
• Sellers bear $600 of the tax burden
and, as there are 500,000 units sold $7,40
per month, tax revenues derived 0
from the sellers (cross-hatched blue Deadweight
$7,00 Loss due to
area) = $300,000,000. reduced trades
0
• The yellow area above the supply
curve and below the old demand $6,40 Tax revenue
from sellers
curve represents consumer & 0
producer surplus lost due to the tax
– the deadweight loss to society. D
D minus tax
• The incidence of the tax is the # of used cars
same regardless of whether it is 500 750 per month
(in thousands)
imposed on buyers or sellers.
 Deadweight Loss

❑ The deadweight loss of taxation is the loss of

the gains from trade as a result of the imposition
of a tax.
– It imposes a burden of taxation over and
above the burden of transferring revenues to
the government.
– It is composed of losses to both buyers and
sellers.
– The deadweight loss of taxation is sometimes
referred to as the “excess burden of the tax.”
 Impact of a Subsidy

❑ A subsidy is a payment to either the buyer or seller of a

good, usually on a per unit basis.
❑ The supply & demand framework can be used to analyze
the impact of a subsidy as it was used to analyze the
impact of a tax.
❑ As in the case of a tax, the division of the benefit from a
subsidy is determined by the relative elasticities of
demand & supply rather than to whom the subsidy is
actually paid.
– When supply is highly inelastic relative to demand, sellers
will derive most of the benefits of a subsidy.
– When demand is highly inelastic relative to supply, the
buyers will reap most of the benefits of a subsidy.
 Impact of a Subsidy Granted to
Buyers
• Who benefits when government
subsidizes college students – the Price
student or the college? new $4,000 subsidy
gross
• When a $4,000 per year tuition price
subsidy is granted to students, the S
demand for college shifts vertically
by the amount of the subsidy.
P2 = $12.000
• The equilibrium price for college rises
from P1 = $10,000 to P2 = $12,000
(the new gross price for students). P1 = $10,00 D2
0 (D1 plus
• With the $4,000 subsidy, the net subsidy)
price paid by the subsidized students $8,000
is $8,000 per year (a gain of $2,000
for them). D11
new
• Colleges also benefit from the tuition net # Full-time
price
subsidy through higher prices for Q1 Q2 Students
their services (P2 is $2,000 higher per year
than before the subsidy).
 Real World Subsidy Programs

❑ Two examples:
– Subsidies to college students:
Grants and loans to college students have grown
substantially in recent decades. While these
subsidies have helped students pay for college,
they have also driven up the cost of college.
– Health care subsidies:
Subsidies to health care consumers have driven up
the cost of health care. Health care prices have
risen at twice the rate of other prices since the
passage of Medicare and Medicaid.
6
1
Mathematics of Market
Equilibrium
1. The market supply and demand are given by
Qs = 128 + 8P
Qd = 478 - 6P

Calculate the equilibrium quantity & price

❑ Step 1: Set the right hand side of both equations to equal on another & solve for Q*
(Q*= Qd = Qs in equilibrium)
❑ Step 2: Substitute Q* into either equation & solve for P* (P*=P in equilibrium)

Solution
Qs = QD
128 + 8P = 478 – 6P 128 + 8 (25) = Q
128 – 478 = -6P – 8P 128 + 200 = Q
- 350 = - 14 P 328units = Q
25units = P

25units = P and 328units = Q

6
2
Mathematics of Market
Equilibrium

2. The market supply and demand are given by2.

P = 100 - 0.5 Qd
P = 5 + 0.5 Qs

Calculate the equilibrium quantity & price

❑ Step 1: Set the right hand side of both equations to equal on

another & solve for Q* (Q*= Qd = Qs in equilibrium)
❑ Step 2: Substitute Q* into either equation & solve for P* (P*=P in
equilibrium)
 Questions for Thought:

3. Several cities and states have recently increased

the taxes they levy on cigarettes by a dollar or
more per pack. How will these taxes affect:
(a) the quantity of cigarettes sold in the city or state,
(b)the tax revenues collected from the tax,
(c) the incidence of smoking?
 Questions for Thought:

4. The price of a ticket to the Super Bowl typically averages

approximately $2,500. Seeking to make the tickets more
affordable for ordinary Americans, suppose the
government provides a $2,000 subsidy to the ticket
purchasers.
(a) What impact will the subsidy have on the price of the
tickets?
(b) Who will be the major beneficiary of this subsidy?
Practice Questions