Demand, Supply and

Market Equilibrium
Demand
Demand:
Quantity demanded: is the amount
of a good or a service that a
consumer is willing and able to
purchase during a specified period of
time (one week, one month, .....).
Factors affecting demand: six factors
are considered sufficiently important
to be included in most studies of
market demand:
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Factors affecting
demand:
1. Price of the good or service/own price (P).
2. Income of the consumer (Y).
3. Prices of related goods or services (PR).
4. Taste or preference pattern of the
consumer (T).
5. Expected prices of the product in the
future (PE ).
6. Number of consumers in the market (N).

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Demand function:
There are two types of demand functions:
1. Generalized (multivariate) demand
function: relates quantity demanded to
all factors affecting demand.
Qd = F(P, Y, PR , T , PE , N)
2. Univariate demand function: shows the
relationship between quantity demanded
of a product and price of the product
holding all other factors constant.
Qd = F(P) 5
The generalized demand function can be
expressed in a linear functional form as foll0ws:

Qd = α0 + α1 P + α2 Y + α3 PR + α4 T + α5 PE
+ α6N

Where: α0 , α1 , α2 , α3 , α4 , α5, α6 are

parameters.
α : is the intercept parameter. It shows the
0
quantity demanded when all other
parameters are zero.
The other parameters are slope parameters.

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• A slope parameter measures the effect on the
amount of the good purchased (Q d) of
changing one of the variables (P, Y, T, …)
while holding all the others constant.
• For example: α1 = dQ/dP
• This measures the change in quantity
demanded per unit change in price holding
(Y, PR , T , PE , N) constant.
• When the slope parameter change of a
specific variable is positive (negative) in sign,
Qd is directly (inversely) related to that
variable.
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 Table(1): Summary of Parameters of the
Generalized Demand Function
Variable Relation to Qd Sign of the slope parameter

P Inverse α1 = dQ/dP (negative)

Y Direct for α2 = dQ/dY (positive)
normal goods;
Inverse for α2 = dQ/dY (negative)
inferior goods
PR Direct for α3 = dQ/dPR (positive)
substitutes;
Inverse for α3 = dQ/dPR (negative)
complements (α3 = 0 for independent products)
T Direct α4 = dQ/dT (positive)
PE Direct α5 = dQ/dPE (positive)
N Direct α6 = dQ/dN (positive)
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In the remainder of the discussion
analysis will be restricted to three
variables only: P, Y and PR
Consequently, the demand function
is given by:
Qd = F(P, Y, PR)
Qd = α0 + α1P + α2Y + α3 PR

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Demand Function
Derivation:
 Qd = F(P)
Here the demand function expresses the quantity
demanded as a function of product price only.
The demand function is derived from the
generalized demand function by holding all variables
except price constant.
The demand function, whether expressed as an
equation, graph or table, shows the quantity
demanded at various price levels holding constant
the effects of other factors.
To illustrate the derivation consider the following
example:
Qd = 1800 - 20 P + 0.6 Y - 50 PR
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• Qd = 1800 - 20 P + 0.6 Y - 50 PR
• To derive the demand function (Qd = F(P)),
the variables Y and PR should be held
constant by assigning them fixed values.
• Suppose the consumer’s income is $20,000
and the price of the related good is $250. To
find the demand function, substitute the
values of Y and PR
Qd = 1800 - 20 P + 0.6 (20000) - 50 (250)
Qd = 1800 - 20 P + 12000 - 12500
Qd = 1300 - 20 P
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Qd = 1300 - 20 P
The intercept parameter = 1300. This is
the value of Qd when P = 0 (the maximum
amount taken by the consumer when the
product is free of charge).
The slope of the demand function is α1 =
dQ/dP = - 20. It indicates that a one pound
increase in price will lead to reduction in
quantity demanded by 20 units.
If the price is $50, then the quantity
demanded is
Qd = 1300 - 20 P = 1300 - 20 (50) = 1300 -
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Graphical Representation of the
Demand Function:
Qd = 1300 - 20 P
To allocate points on the XY-axis:
Let Qd =0, then P= 65
P
and the point is (0, 65).
(0, 65)
When P = 0, Qd = 1300
Qd = 1300 - 20 P
and the point is (1300, 0).
Connecting the two points together
we get the demand curve. 0
(1300, 0)
Q
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Inverse Demand Function:
If Qd = 1300 - 20 P, then
Qd + 20 P = 1300
or
20 P = 1300 - Qd
P = (65 - Qd / 20)
or
P = 65 - 1/20 Qd - Inverse Demand Function.
The inverse demand function expresses price in terms of
quantity demanded. i.e.
P = F(Qd )
The significance of the inverse demand function is that
sometimes managers want to know the maximum price that
could be charged given a specific amount demanded.

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Shift in Demand:
A shift in demand occurs when factors affecting demand
other than own price change.
Example: Qd = F (P, Y, PR)
where Qd = 1800 - 20 P + 0.6 Y - 50 PR
If the consumer’s income increases from $20000 to 20500
and PR = $250 as before, then the shift in demand can be
shown mathematically and graphically as follows:
Substitute for Y and PR in the equation above:
when Y= 20,000; Qd = 1800 - 20 P + 0.6 (20,000) - 50 (250)
then Qd = 1300 - 20 P
when Y = 20500, Qd = 1800 - 20 P + 0.6 (20500) - 50 (250)
then Qd = 1600 - 20 P

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Graphical Representation of a Shift
in Demand:
Qd = 1300 - 20 P (1)
Qd = 1600 - 20 P (2)
To allocate the new points on the XY-axis:
Let Qd =0, then P= 80 P
(0,80)
and the point is (0, 80).
When P = 0, Qd = 1600 (0, 65) Qd = 1300 - 20 P

and the point is (1600, 0).

Connecting the two points
together we get the new higher0 Q
(1300, 0) (1600, 0)
demand curve.
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Supply
Supply:
• Supply function (curve) represents quantity supplied
at different prices during a specific period of time.
• The quantity supplied is a function of:
P : Price of the product
C : Cost of production or cost of inputs (prices of
inputs)
PR: Prices of related goods (complements or substitutes)
T : Technology level
PE: Expected future prices of the product.
F: Number of firms or companies in the market

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Generalized Supply
Function:
• The generalized supply function is given by:
Qs = β0 + β 1 P+β 2 C+β 3 PR + β 4 T+β 5 PE + β 6 F

 Signs of parameters depend on the relationship

between the quantity supplied and the specific factor
affecting supply .
 β0 : intercept parameter. It shows quantity supplied
when all other variables are zero.
Signs of β1 , β2 , β3 , …. are shown in the following
table :

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 Table(2): Summary of Parameters of the
Generalized Supply Function
Variable Relation to Qs Sign of the slope parameter

P Direct β1 = dQ/dP (positive)

C Inverse β2 = dQ/dC (negative)

PR Inverse for β3 = dQ/dPR (negative)

substitutes; β3 = dQ/dPR (positive)
direct for
complements
T Direct β4 = dQ/dT (positive)

PE Inverse β5 = dQ/dPE (negative)

F Direct β6 = dQ/dF (positive)

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(cont.)
We will focus for the remainder of the
discussion on three variables only (P, C and
F).
Consequently,
Qs = β0 + β 1 P + β 2 C + β 3 F

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Example of a Supply Function:
Consider the following supply function:
Qs = - 150 + 10 P - 8 C + 5 F
Given the cost of production = 50 units and the number of
firms = 90 firms;
Derive the supply curve?
Solution:
The first step is to find the equation of the supply curve from
the
generalized equation: Qs = - 150 + 10 P - 8 C + 5 F
By substituting C = 50 and F = 90 in the above equation:
Qs = -150 + 10 P - 8 (50) + 5 (90)
Qs = -150 + 10 P - 400 + 450
Qs = - 100 + 10 P

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(cont.)
Qs = -100 + 10 P

Graphically:
Let P = 0; this gives the point of intersection with the X-axis.
Qs = -100 + 0, then Qs = -100 and the point is (-100, 0)
Let Qs = 0; then 0 = -100 + 10P, and P = 10, and
the point is (0, 10) on the Y-axis.
The slope is (+ 10) = dQ/dP . This means when market
price increases by one unit, the quantity supplied will
increase by 10 units.
An intercept = – 100 means quantity supplied does not exist.

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Graphical Representation of the
Supply Curve:

Qs = -100 + 10 P

(0,10)

(- 100, 0)

Generally the negative part of the supply curve is

ignored. It is meaningless.
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 P

Qs = -100 + 10P

10
0
Qs

(by ignoring the negative part of the supply curve)

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The Inverse Supply
Function:
• Rather than having Qs as the dependent variable the
inverse supply function expresses price in terms of the
quantity supplied:
• Qs = -100 + 10 P, or
10 P = Qs + 100
Then P = 10 + (1/10)Qs. This is the inverse supply
function.
 The economic importance of this equation is that when the
firm has market power (can set market price), then it can
determine the price according to quantity supplied (i.e.
production level).
 The price in this case is not given (set by market forces) but
rather a dependent variable (i.e. the firm can change it).
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Market Equilibrium
Demand = supply
Market equilibrium:
 A market equilibrium takes place when demand equals
supply.
 Qd = Q s
 In this case there is no excess demand (Q d > Qs ) nor excess
supply (Qs > Qd).
 The market clearing price is the price that equates Q d with
Qs .
 It is unique (i.e. only one price level clears the market ).
Example:
Qs = -70 + 3P
Qd = 130 - 2 P
The equilibrium price and quantity are given by:
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(cont.)
At equilibrium: Qs = Qd
- 70 + 3P = 130 - 2 P
3P + 2P = 130 + 70 , then 5P = 200
P = $ 40
To find the equilibrium quantity, substitute P = 40 in Q s or
Q d.
Qs = -70 + 3P , Qs = - 70 + 3 x 40 = -70 + 120 = 50 units
Qs = Qd = 50 units.
Apart from P= 40 and Q = 50, Q s will not be the same as Qd.
P = 40 = market clearing price
Q = 50 = equilibrium quantity
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(cont.)

E*
P*

Q*

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