Chapter 2
Supply and Demand
Chapter Summary
This chapter covers all the basics of supply and demand analysis beginning with the
definition of a market. The example of the market for lobsters in Hyannis, Massachusetts, on
July 20, 2009, is used to make the discussion concrete. The chapter derives demand curves, and
supply curves, and presents the concept of an equilibrium price.
The section entitled "Some Welfare Properties of Equilibrium" develops the idea that if price
and quantity are not at the equilibrium values, resources could be allocated so as to make
everyone better off (the term "Pareto optimality" is not presented, but the discussion follows this
line of thought). Examples of denied airline boarding compensation and rent control are
presented to bolster the argument.
The section entitled "Determinants of Supply and Demand" discusses the factors that shift
demand curves and supply curves, and presents examples for each case. The following section
discusses price supports in detail. The chapter concludes with the algebra of supply and demand.
The appendix introduces the effects of a lump sum tax on either side of the market
concluding that the effects are the same whether the tax is put on the buyer or the seller. .
Chapter Outline
Chapter Preview
Supply and Demand Curves
Equilibrium Quantity and Price
Some Welfare Properties of Equilibrium
Free Market and the Poor
Price Supports
The Rationing and Allocative Function of Price
Determinants of Supply and Demand
Predicting and Explaining Changes in Quantity and Price
The Algebra of Supply and Demand
Summary
Appendix: How Do Taxes Affect Equilibrium Prices and Quantity?
Teaching Suggestions
1.
This chapter reviews and goes a bit beyond the supply and demand models that most
students will have had in principles of microeconomics. It might be helpful to list the supply
and demand curves in a slightly formal way. For example, list the demand curve as
Qx =
f(Px, Py, I, N, T, E), where Qx is the amount of
X consumed,
Px is the price of X, Py is the
price of an alternative good, I is income, N is the number of buyers, T is a lump sum sales
tax, and E is expectations. (If the appendix is omitted you may want to drop the T from the
equation.) Now ask the students to put + or - signs under each item in parentheses to show
what relationship they think exists between that item and the quantity variable.
The Px is an
easy minus, but the Py will be both signs depending on whether the alternative good is a
substitute or a complement. Income likewise has a + or - depending on whether a good is
normal or inferior. In this manner the student is then prepared for the next step. Since a
demand curve has only two axes, it can deal with only the Qx and Px. Thus movement along
a demand curve will relate to changes in Px only. All the other variables are held constant. If
one of them is changed while Px and all the others are held constant, then the curve shifts.
In
like manner, the supply variables can be dealt with.
For example, Qx = (Px, Pi, Te, T, E),
where Pi is the price of inputs, Te is the level of technology, T is a lump sum producer tax,
and E is again expectations.