65
The Market Forces
of Supply and
Demand
W
hen a cold snap hits Florida, the price of orange juice rises in supermarkets
throughout the country. When the weather turns warm in New England
every summer, the price of hotel rooms in the Caribbean plummets. When
a war breaks out in the Middle East, the price of gasoline in the United States rises
and the price of a used Cadillac falls. What do these events have in common?
They all show the workings of supply and demand.
Supply and demand are the two words economists use most often—and for good
reason. Supply and demand are the forces that make market economies work.
They determine the quantity of each good produced and the price at which it
is sold. If you want to know how any event or policy will affect the economy,
you must think first about how it will affect supply and demand.
This chapter introduces the theory of supply and demand. It considers
how buyers and sellers behave and how they interact with one another.
Chapter
4
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66	 PART II	 HOW MARKETS WORK
It shows how supply and demand determine prices in a market economy and
how prices, in turn, allocate the economy’s scarce resources.
4-1 Markets and Competition
The terms supply and demand refer to the behavior of people as they interact with
one another in competitive markets. Before discussing how buyers and sellers
behave, let’s first consider more fully what we mean by the terms market and
competition.
4-1a What Is a Market?
A market is a group of buyers and sellers of a particular good or service. The buyers
as a group determine the demand for the product, and the sellers as a group
determine the supply of the product.
Markets take many forms. Some markets are highly organized, such as the
markets for many agricultural commodities. In these markets, buyers and sellers
meet at a specific time and place where an auctioneer helps set prices and arrange
sales.
More often, markets are less organized. For example, consider the market for
ice cream in a particular town. Buyers of ice cream do not meet together at any one
time. The sellers of ice cream are in different locations and offer somewhat different
products. There is no auctioneer calling out the price of ice cream. Each seller posts
a price for an ice-cream cone, and each buyer decides how much ice cream to buy
at each store. Nonetheless, these consumers and producers of ice cream are closely
connected. The ice-cream buyers are choosing from the various ice-cream sellers to
satisfy their cravings, and the ice-cream sellers are all trying to appeal to the same
ice-cream buyers to make their businesses successful. Even though it is not as organized,
the group of ice-cream buyers and ice-cream sellers forms a market.
4-1b What Is Competition?
The market for ice cream, like most markets in the economy, is highly competitive.
Each buyer knows that there are several sellers from which to choose, and
each seller is aware that his product is similar to that offered by other sellers. As a
result, the price and quantity of ice cream sold are not determined by any single
buyer or seller. Rather, price and quantity are determined by all buyers and sellers
as they interact in the marketplace.
Economists use the term competitive market to describe a market in which
there are so many buyers and so many sellers that each has a negligible impact
on the market price. Each seller of ice cream has limited control over the price because
other sellers are offering similar products. A seller has little reason to charge
less than the going price, and if he charges more, buyers will make their purchases
elsewhere. Similarly, no single buyer of ice cream can influence the price of
ice cream because each buyer purchases only a small amount.
In this chapter, we assume that markets are perfectly competitive. To reach this
highest form of competition, a market must have two characteristics: (1) The
goods offered for sale are all exactly the same, and (2) the buyers and sellers are
so numerous that no single buyer or seller has any influence over the market
price. Because buyers and sellers in perfectly competitive markets must accept the
price the market determines, they are said to be price takers. At the market price,
buyers can buy all they want, and sellers can sell all they want.
market
a group of buyers and
sellers of a particular
good or service
competitive market
a market in which there
are many buyers and
many sellers so that each
has a negligible impact
on the market price
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	 CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 67
There are some markets in which the assumption of perfect competition applies
perfectly. In the wheat market, for example, there are thousands of farmers
who sell wheat and millions of consumers who use wheat and wheat products.
Because no single buyer or seller can influence the price of wheat, each takes the
market price as given.
Not all goods and services, however, are sold in perfectly competitive markets.
Some markets have only one seller, and this seller sets the price. Such a seller is
called a monopoly. Your local cable television company, for instance, may be a monopoly.
Residents of your town probably have only one company from which to
buy cable service. Still other markets fall between the extremes of perfect competition
and monopoly.
Despite the diversity of market types we find in the world, assuming
perfect competition is a useful simplification and, therefore, a natural place to
start. Perfectly competitive markets are the easiest to analyze because everyone
participating in the market takes the price as given by market conditions.
Moreover, because some degree of competition is present in most markets, many
of the lessons that we learn by studying supply and demand under perfect competition
apply in more complicated markets as well.
Quick Quiz  What is a market? • What are the characteristics of a perfectly competitive
market?
4-2 Demand
We begin our study of markets by examining the behavior of buyers. To focus our
thinking, let’s keep in mind a particular good—ice cream.
4-2a The Demand Curve: The Relationship
between Price and Quantity Demanded
The quantity demanded of any good is the amount of the good that buyers are
willing and able to purchase. As we will see, many things determine the quantity
demanded of any good, but in our analysis of how markets work, one determinant
plays a central role—the price of the good. If the price of ice cream rose to
$20 per scoop, you would buy less ice cream. You might buy frozen yogurt instead.
If the price of ice cream fell to $0.20 per scoop, you would buy more. This
relationship between price and quantity demanded is true for most goods in the
economy and, in fact, is so pervasive that economists call it the law of demand:
Other things being equal, when the price of a good rises, the quantity demanded
of the good falls, and when the price falls, the quantity demanded rises.
The table in Figure 1 shows how many ice-cream cones Catherine buys each
month at different prices of ice cream. If ice cream is free, Catherine eats 12 cones
per month. At $0.50 per cone, Catherine buys 10 cones each month. As the price
rises further, she buys fewer and fewer cones. When the price reaches $3.00,
Catherine doesn’t buy any cones at all. This table is a demand schedule, a
table that shows the relationship between the price of a good and the quantity
demanded, holding constant everything else that influences how much of the
good consumers want to buy.
The graph in Figure 1 uses the numbers from the table to illustrate the law
of demand. By convention, the price of ice cream is on the vertical axis, and the
quantity demanded
the amount of a good that
buyers are willing and
able to purchase
law of demand
the claim that, other
things being equal, the
quantity demanded of a
good falls when the price
of the good rises
demand schedule
a table that shows the
relationship between the
price of a good and the
quantity demanded
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68	 PART II	 HOW MARKETS WORK
FIGURE 1 The demand schedule is a table that shows the quantity demanded at each price.
The ­demand curve, which graphs the demand schedule, illustrates how the quantity
demanded of the good changes as its price varies. Because a lower price increases the
quantity demanded, the demand curve slopes downward.
Catherine’s Demand Schedule
and Demand Curve
Price of
Ice-Cream Cone
Quantity of
Cones Demanded
$0.00 12 cones
0.50 10
1.00 8
1.50 6
2.00 4
2.50 2
3.00 0
Price of
Ice-Cream Cone
0
2.50
2.00
1.50
1.00
0.50
1 2 3 4 5 6 7 8 9 10 11 Quantity of
Ice-Cream Cones
$3.00
12
1. A decrease in
price . . .
2. . . . increases quantity of
cones demanded.
Demand curve
quantity of ice cream demanded is on the horizontal axis. The line relating price
and quantity demanded is called the demand curve. The demand curve slopes
downward because, other things being equal, a lower price means a greater quantity
demanded.
4-2b Market Demand versus Individual Demand
The demand curve in Figure 1 shows an individual’s demand for a product.
To analyze how markets work, we need to determine the market demand, the sum
of all the individual demands for a particular good or service.
The table in Figure 2 shows the demand schedules for ice cream of the two
individuals in this market—Catherine and Nicholas. At any price, Catherine’s demand
schedule tells us how much ice cream she buys, and Nicholas’s demand
schedule tells us how much ice cream he buys. The market demand at each price
is the sum of the two individual demands.
The graph in Figure 2 shows the demand curves that correspond to these demand
schedules. Notice that we sum the individual demand curves horizontally
to obtain the market demand curve. That is, to find the total quantity demanded
at any price, we add the individual quantities, which are found on the horizontal
axis of the individual demand curves. Because we are interested in analyzing how
markets function, we work most often with the market demand curve. The market
demand curve shows how the total quantity demanded of a good varies as the
price of the good varies, while all the other factors that affect how much consumers
want to buy are held constant.
demand curve
a graph of the
relationship between the
price of a good and
the quantity demanded
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	 CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 69
4-2c Shifts in the Demand Curve
Because the market demand curve holds other things constant, it need not be stable
over time. If something happens to alter the quantity demanded at any given
price, the demand curve shifts. For example, suppose the American ­Medical
­Association discovered that people who regularly eat ice cream live longer,
healthier lives. The discovery would raise the demand for ice cream. At any given
price, buyers would now want to purchase a larger quantity of ice cream, and the
demand curve for ice cream would shift.
Figure 3 illustrates shifts in demand. Any change that increases the quantity
demanded at every price, such as our imaginary discovery by the American
­Medical Association, shifts the demand curve to the right and is called an increase
in demand. Any change that reduces the quantity demanded at every price shifts
the demand curve to the left and is called a decrease in demand.
There are many variables that can shift the demand curve. Here are the most
important.
Income  What would happen to your demand for ice cream if you lost your
job one summer? Most likely, it would fall. A lower income means that you have
FIGURE 2The quantity demanded in a market is the sum of the quantities demanded by all the buyers
at each price. Thus, the market demand curve is found by adding horizontally the individual
demand curves. At a price of $2.00, Catherine demands 4 ice-cream cones and Nicholas demands
3 ice-cream cones. The quantity demanded in the market at this price is 7 cones.
Market Demand as the Sum of
Individual Demands
Price of Ice-Cream Cone Catherine Nicholas Market
$0.00 12 + 7 = 19 cones
0.50 10 6 16
1.00 8 5 13
1.50 6 4 10
2.00 4 3 7
2.50 2 2 4
3.00 0 1 1
Price of
Ice-Cream
Cone
Price of
Ice-Cream
Cone
Price of
Ice-Cream
Cone
$3.00
2.50
2.00
1.50
1.00
0.50
0 1 2 3 4 5 6
Quantity of Ice-Cream Cones
DCatherine
7 8 9 10 11 12
Catherine’s Demand Nicholas’s Demand Market Demand+ =
$3.00
2.50
2.00
1.50
1.00
0.50
0 1 2 3 4 5 6
Quantity of Ice-Cream Cones
7 8 9 10 11 12
$3.00
2.50
2.00
1.50
1.00
0.50
0 2 4 6
Quantity of Ice-Cream Cones
8 10 12 14 16 18
DNicholas
DMarket
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70	 PART II	 HOW MARKETS WORK
less to spend in total, so you would have to spend less on some—and probably
most—goods. If the demand for a good falls when income falls, the good is called
a normal good.
Not all goods are normal goods. If the demand for a good rises when income
falls, the good is called an inferior good. An example of an inferior good might be
bus rides. As your income falls, you are less likely to buy a car or take a cab and
more likely to ride a bus.
Prices of Related Goods  Suppose that the price of frozen yogurt falls. The law
of demand says that you will buy more frozen yogurt. At the same time, you will
probably buy less ice cream. Because ice cream and frozen yogurt are both cold,
sweet, creamy desserts, they satisfy similar desires. When a fall in the price of one
good reduces the demand for another good, the two goods are called ­substitutes.
Substitutes are often pairs of goods that are used in place of each other, such
as hot dogs and hamburgers, sweaters and sweatshirts, and movie tickets and
DVD ­rentals.
Now suppose that the price of hot fudge falls. According to the law of demand,
you will buy more hot fudge. Yet in this case, you will likely buy more ice cream
as well because ice cream and hot fudge are often used together. When a fall in the
price of one good raises the demand for another good, the two goods are called
complements. Complements are often pairs of goods that are used together, such
as gasoline and automobiles, computers and software, and peanut butter and jelly.
Tastes  The most obvious determinant of your demand is your tastes. If you like
ice cream, you buy more of it. Economists normally do not try to explain people’s
tastes because tastes are based on historical and psychological forces that are beyond
the realm of economics. Economists do, however, examine what happens
when tastes change.
Expectations  Your expectations about the future may affect your demand for a
good or service today. If you expect to earn a higher income next month, you may
FIGURE 3
Shifts in the Demand Curve
Any change that raises the quantity
that buyers wish to purchase at any
given price shifts the demand curve to
the right. Any change that lowers the
quantity that buyers wish to purchase
at any given price shifts the demand
curve to the left.
Price of
Ice-Cream
Cone
Quantity of
Ice-Cream Cones
Increase
in demand
Decrease
in demand
Demand curve, D3
Demand
curve, D1
Demand
curve, D2
0
normal good
a good for which, other
things being equal, an
increase in income leads
to an increase in demand
inferior good
a good for which, other
things being equal, an
increase in income leads
to a decrease in demand
substitutes
two goods for which an
increase in the price of
one leads to an increase
in the demand for the
other
complements
two goods for which an
increase in the price of
one leads to a decrease
in the demand for the
other
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	 CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 71
choose to save less now and spend more of your current income buying ice cream.
If you expect the price of ice cream to fall tomorrow, you may be less willing to buy
an ice-cream cone at today’s price.
Number of Buyers  In addition to the preceding factors, which influence the
behavior of individual buyers, market demand depends on the number of these
buyers. If Peter were to join Catherine and Nicholas as another consumer of ice
cream, the quantity demanded in the market would be higher at every price, and
market demand would increase.
Summary  The demand curve shows what happens to the quantity demanded
of a good when its price varies, holding constant all the other variables that influence
buyers. When one of these other variables changes, the demand curve shifts.
Table 1 lists the variables that influence how much of a good consumers choose
to buy.
If you have trouble remembering whether you need to shift or move along the
demand curve, it helps to recall a lesson from the appendix to Chapter 2. A curve
shifts when there is a change in a relevant variable that is not measured on either
axis. Because the price is on the vertical axis, a change in price represents a movement
along the demand curve. By contrast, income, the prices of related goods,
tastes, expectations, and the number of buyers are not measured on either axis, so
a change in one of these variables shifts the demand curve.
Variables That Influence Buyers
This table lists the variables that affect
how much consumers choose to buy of any
good. Notice the special role that the price
of the good plays: A change in the good’s
price represents a movement along the
demand curve, whereas a change in one of
the other variables shifts the demand curve.
Table 1Variable A Change in This Variable . . .
Price of the good itself Represents a movement along the
demand curve
Income Shifts the demand curve
Prices of related goods Shifts the demand curve
Tastes Shifts the demand curve
Expectations Shifts the demand curve
Number of buyers Shifts the demand curve
Two Ways to Reduce the Quantity of Smoking Demanded
Public policymakers often want to reduce the amount that people
smoke because of smoking’s adverse health effects. There are two ways
that policy can attempt to achieve this goal.
One way to reduce smoking is to shift the demand curve for cigarettes and
other tobacco products. Public service announcements, mandatory health warnings
on cigarette packages, and the prohibition of cigarette advertising on television
are all policies aimed at reducing the quantity of cigarettes demanded at any
given price. If successful, these policies shift the demand curve for cigarettes to
the left, as in panel (a) of Figure 4.
case
study
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72	 PART II	 HOW MARKETS WORK
FIGURE 4 If warnings on cigarette packages convince smokers to smoke less, the demand curve
for cigarettes shifts to the left. In panel (a), the demand curve shifts from D1
to D2
. At a
price of $2.00 per pack, the quantity demanded falls from 20 to 10 cigarettes per day,
as reflected by the shift from point A to point B. By contrast, if a tax raises the price of
cigarettes, the demand curve does not shift. Instead, we observe a movement to a different
point on the demand curve. In panel (b), when the price rises from $2.00 to $4.00, the
quantity demanded falls from 20 to 12 cigarettes per day, as reflected by the movement
from point A to point C.
Shifts in the Demand Curve
versus Movements along the
Demand Curve
D2
D1
0 10 20
$2.00
B A
(a) A Shift in the Demand Curve
A policy to discourage
smoking shifts the
demand curve to the left.
Number of Cigarettes Smoked per Day
Price of
Cigarettes,
per Pack
D1
0 12 20
2.00
$4.00 C
A
(b) A Movement along the Demand Curve
Number of Cigarettes Smoked per Day
Price of
Cigarettes,
per Pack
A tax that raises the price
of cigarettes results in a
movement along the
demand curve.
Alternatively, policymakers can try to raise the price of cigarettes. If the government
taxes the manufacture of cigarettes, for example, cigarette companies
pass much of this tax on to consumers in the form of higher prices. A higher price
encourages smokers to reduce the numbers of cigarettes they smoke. In this case,
the reduced amount of smoking does not represent a shift in the demand curve.
Instead, it represents a movement along the same demand curve to a point with a
higher price and lower quantity, as in panel (b) of Figure 4.
How much does the amount of smoking respond to changes in the price of
cigarettes? Economists have attempted to answer this question by studying what
happens when the tax on cigarettes changes. They have found that a 10 percent
increase in the price causes a 4 percent reduction in the quantity demanded. Teenagers
are especially sensitive to the price of cigarettes: A 10 percent increase in the
price causes a 12 percent drop in teenage smoking.
A related question is how the price of cigarettes affects the demand for illicit
drugs, such as marijuana. Opponents of cigarette taxes often argue that tobacco
and marijuana are substitutes so that high cigarette prices encourage marijuana
use. By contrast, many experts on substance abuse view tobacco as a “gateway
drug” leading the young to experiment with other harmful substances. Most
studies of the data are consistent with this latter view: They find that lower cigarette
prices are associated with greater use of marijuana. In other words, tobacco
and marijuana appear to be complements rather than substitutes.
“What is the best way to
stop this?”
EdytaPawlowska/Shutterstock.com
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	 CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 73
4-3 Supply
We now turn to the other side of the market and examine the behavior of sellers.
Once again, to focus our thinking, let’s consider the market for ice cream.
4-3a The Supply Curve: The Relationship
between Price and Quantity Supplied
The quantity supplied of any good or service is the amount that sellers are willing
and able to sell. There are many determinants of quantity supplied, but once
again, price plays a special role in our analysis. When the price of ice cream is
high, selling ice cream is profitable, and so the quantity supplied is large. Sellers
of ice cream work long hours, buy many ice-cream machines, and hire many
workers. By contrast, when the price of ice cream is low, the business is less profitable,
so sellers produce less ice cream. At a low price, some sellers may even
choose to shut down, and their quantity supplied falls to zero. This relationship
between price and quantity supplied is called the law of supply: Other things being
equal, when the price of a good rises, the quantity supplied of the good also
rises, and when the price falls, the quantity supplied falls as well.
The table in Figure 5 shows the quantity of ice-cream cones supplied each
month by Ben, an ice-cream seller, at various prices of ice cream. At a price below
Quick Quiz  Make up an example of a monthly demand schedule for pizza and graph the
implied demand curve. Give an example of something that would shift this demand curve, and
briefly explain your reasoning. Would a change in the price of pizza shift this demand curve?
quantity supplied
the amount of a good that
sellers are willing and
able to sell
law of supply
the claim that, other
things being equal, the
quantity supplied of a
good rises when the price
of the good rises
FIGURE 5The supply schedule is a table that shows the quantity supplied at each price. This supply
curve, which graphs the supply schedule, illustrates how the quantity supplied of the good
changes as its price varies. Because a higher price increases the quantity supplied, the supply
curve slopes upward.
Ben’s Supply Schedule and 	
Supply Curve
Price of
Ice-Cream Cone
Quantity of
Cones Supplied
$0.00 0 cones
0.50 0
1.00 1
1.50 2
2.00 3
2.50 4
3.00 5
Price of
Ice-Cream
Cone
0
2.50
2.00
1.50
1.00
1 2 3 4 5 6 7 8 9 10 11 Quantity of
Ice-Cream Cones
$3.00
12
0.50
1. An
increase
in price ...
2. ... increases quantity of cones supplied.
Supply curve
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74	 PART II	 HOW MARKETS WORK
$1.00, Ben does not supply any ice cream at all. As the price rises, he supplies
a greater and greater quantity. This is the supply schedule, a table that shows
the relationship between the price of a good and the quantity supplied, holding
constant everything else that influences how much producers of the good want
to sell.
The graph in Figure 5 uses the numbers from the table to illustrate the law of
supply. The curve relating price and quantity supplied is called the supply curve.
The supply curve slopes upward because, other things being equal, a higher price
means a greater quantity supplied.
4-3b Market Supply versus Individual Supply
Just as market demand is the sum of the demands of all buyers, market supply
is the sum of the supplies of all sellers. The table in Figure 6 shows the supply
schedules for the two ice-cream producers in the market—Ben and Jerry. At any
price, Ben’s supply schedule tells us the quantity of ice cream that Ben supplies,
supply schedule
a table that shows the
relationship between the
price of a good and the
quantity supplied
supply curve
a graph of the
relationship between the
price of a good and the
quantity supplied
FIGURE 6 The quantity supplied in a market is the sum of the quantities supplied by all the
­sellers at each price. Thus, the market supply curve is found by adding horizontally
the individual supply curves. At a price of $2.00, Ben supplies 3 ice-cream cones and
Jerry supplies 4 ice-cream cones. The quantity supplied in the market at this price is
7 cones.
Market Supply as the Sum of
Individual Supplies
Price of Ice-Cream Cone Ben Jerry Market
$0.00 0 + 0 = 0 cones
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
$3.00
2.50
2.00
1.50
1.00
0.50
0 1 2 3 4 5 6
Quantity of Ice-Cream Cones
7 8 9 10 11 12
Ben’s Supply Jerry’s Supply Market Supply+ =
Price of
Ice-Cream
Cone
Price of
Ice-Cream
Cone
Price of
Ice-Cream
Cone
$3.00
2.50
2.00
1.50
1.00
0.50
0 1 2 3 4 5 6
Quantity of Ice-Cream Cones
7 8 9 10 11 12
$3.00
2.50
2.00
1.50
1.00
0.50
0 1 2 3 4 5 6
Quantity of Ice-Cream Cones
7 8 9 10 11 12
SBen SJerry
SMarket
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Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.
	 CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 75
and Jerry’s supply schedule tells us the quantity of ice cream that Jerry supplies.
The market supply is the sum of the two individual supplies.
The graph in Figure 6 shows the supply curves that correspond to the supply
schedules. As with demand curves, we sum the individual supply curves
­horizontally to obtain the market supply curve. That is, to find the total quantity
supplied at any price, we add the individual quantities, which are found on the
horizontal axis of the individual supply curves. The market supply curve shows
how the total quantity supplied varies as the price of the good varies, holding
constant all the other factors beyond price that influence producers’ decisions
about how much to sell.
4-3c Shifts in the Supply Curve
Because the market supply curve is drawn holding other things constant, when
one of these factors changes, the supply curve shifts. For example, suppose the
price of sugar falls. Sugar is an input into the production of ice cream, so the fall in
the price of sugar makes selling ice cream more profitable. This raises the supply
of ice cream: At any given price, sellers are now willing to produce a larger quantity.
The supply curve for ice cream shifts to the right.
Figure 7 illustrates shifts in supply. Any change that raises quantity supplied at
every price, such as a fall in the price of sugar, shifts the supply curve to the right
and is called an increase in supply. Similarly, any change that reduces the quantity
supplied at every price shifts the supply curve to the left and is called a decrease in
supply.
There are many variables that can shift the supply curve. Here are some of the
most important.
Input Prices  To produce their output of ice cream, sellers use various inputs:
cream, sugar, flavoring, ice-cream machines, the buildings in which the ice cream
is made, and the labor of workers to mix the ingredients and operate the machines.
When the price of one or more of these inputs rises, producing ice cream is less
profitable, and firms supply less ice cream. If input prices rise substantially, a firm
FIGURE 7
Shifts in the Supply Curve
Any change that raises the quantity
that sellers wish to produce at any
given price shifts the supply curve to
the right. Any change that lowers the
quantity that sellers wish to produce
at any given price shifts the supply
curve to the left.
Price of
Ice-Cream
Cone
Quantity of
Ice-Cream Cones
0
Increase
in supply
Decrease
in supply
Supply curve, S3
Supply
curve, S1
Supply
curve, S2
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76	 PART II	 HOW MARKETS WORK
might shut down and supply no ice cream at all. Thus, the supply of a good is
negatively related to the price of the inputs used to make the good.
Technology  The technology for turning inputs into ice cream is another determinant
of supply. The invention of the mechanized ice-cream machine, for example,
reduced the amount of labor necessary to make ice cream. By reducing firms’
costs, the advance in technology raised the supply of ice cream.
Expectations  The amount of ice cream a firm supplies today may depend on its
expectations about the future. For example, if a firm expects the price of ice cream
to rise in the future, it will put some of its current production into storage and supply
less to the market today.
Number of Sellers  In addition to the preceding factors, which influence the
behavior of individual sellers, market supply depends on the number of these
sellers. If Ben or Jerry were to retire from the ice-cream business, the supply in the
market would fall.
Summary  The supply curve shows what happens to the quantity supplied of
a good when its price varies, holding constant all the other variables that influence
sellers. When one of these other variables changes, the supply curve shifts.
Table 2 lists the variables that influence how much producers choose to sell of
a good.
Once again, to remember whether you need to shift or move along the supply
curve, keep in mind that a curve shifts only when there is a change in a
relevant variable that is not named on either axis. The price is on the vertical
axis, so a change in price represents a movement along the supply curve. By
contrast, because input prices, technology, expectations, and the number of sellers
are not measured on either axis, a change in one of these variables shifts the
supply curve.
Variables That Influence Sellers
This table lists the variables that
affect how much producers choose
to sell of any good. Notice the
special role that the price of the
good plays: A change in the good’s
price represents a movement along
the supply curve, whereas a change
in one of the other variables shifts
the supply curve.
Table 2 Variable A Change in This Variable . . .
Price of the good itself Represents a movement along the supply curve
Input prices Shifts the supply curve
Technology Shifts the supply curve
Expectations Shifts the supply curve
Number of sellers Shifts the supply curve
Quick Quiz  Make up an example of a monthly supply schedule for pizza, and graph
the implied supply curve. Give an example of something that would shift this supply curve,
and briefly explain your reasoning. Would a change in the price of pizza shift this supply
curve?
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	 CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 77
4-4 Supply and Demand Together
Having analyzed supply and demand separately, we now combine them to see
how they determine the price and quantity of a good sold in a market.
4-4a Equilibrium
Figure 8 shows the market supply curve and market demand curve together. Notice
that there is one point at which the supply and demand curves intersect. This
point is called the market’s equilibrium. The price at this intersection is called the
equilibrium price, and the quantity is called the equilibrium quantity. Here the
equilibrium price is $2.00 per cone, and the equilibrium quantity is 7 ice-cream
cones.
The dictionary defines the word equilibrium as a situation in which various
forces are in balance—and this also describes a market’s equilibrium. At the equilibrium
price, the quantity of the good that buyers are willing and able to buy exactly
balances the quantity that sellers are willing and able to sell. The equilibrium price is
sometimes called the market-clearing price because, at this price, everyone in the
market has been satisfied: Buyers have bought all they want to buy, and sellers
have sold all they want to sell.
The actions of buyers and sellers naturally move markets toward the equilibrium
of supply and demand. To see why, consider what happens when the market
price is not equal to the equilibrium price.
Suppose first that the market price is above the equilibrium price, as in panel (a)
of Figure 9. At a price of $2.50 per cone, the quantity of the good supplied
(10 cones) exceeds the quantity demanded (4 cones). There is a surplus of the
good: Suppliers are unable to sell all they want at the going price. A surplus is
sometimes called a situation of excess supply. When there is a surplus in the icecream
market, sellers of ice cream find their freezers increasingly full of ice cream
they would like to sell but cannot. They respond to the surplus by cutting their
FIGURE 8
The Equilibrium of Supply
and Demand
The equilibrium is found
where the supply and demand
curves intersect. At
the equilibrium price, the
quantity supplied equals the
quantity demanded. Here the
equilibrium price is $2.00:
At this price, 7 ice-cream
cones are supplied and 7 icecream
cones are demanded.
Price of
Ice-Cream
Cone
$2.00
0 1 2 3 4 5 6 7 8 9 10 11 12
Quantity of Ice-Cream Cones
13
Equilibrium
quantity
Equilibrium
price
Equilibrium
Supply
Demand
equilibrium
a situation in which the
market price has reached
the level at which
quantity supplied equals
quantity demanded
equilibrium price
the price that balances
quantity supplied and
quantity demanded
equilibrium quantity
the quantity supplied and
the quantity demanded at
the equilibrium price
surplus
a situation in which
quantity supplied is
greater than quantity
demanded
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78	 PART II	 HOW MARKETS WORK
prices. Falling prices, in turn, increase the quantity demanded and decrease the
quantity supplied. These changes represent movements along the supply and
demand curves, not shifts in the curves. Prices continue to fall until the market
reaches the equilibrium.
Suppose now that the market price is below the equilibrium price, as in panel (b)
of Figure 9. In this case, the price is $1.50 per cone, and the quantity of the good
demanded exceeds the quantity supplied. There is a shortage of the good:
­Demanders are unable to buy all they want at the going price. A shortage is sometimes
called a situation of excess demand. When a shortage occurs in the ice-cream
market, buyers have to wait in long lines for a chance to buy one of the few cones
available. With too many buyers chasing too few goods, sellers can respond to the
shortage by raising their prices without losing sales. These price increases cause
the quantity demanded to fall and the quantity supplied to rise. Once again, these
changes represent movements along the supply and demand curves, and they
move the market toward the equilibrium.
Thus, regardless of whether the price starts off too high or too low, the activities
of the many buyers and sellers automatically push the market price toward
the equilibrium price. Once the market reaches its equilibrium, all buyers and
sellers are satisfied, and there is no upward or downward pressure on the price.
How quickly equilibrium is reached varies from market to market depending
on how quickly prices adjust. In most free markets, surpluses and shortages are
FIGURE 9 In panel (a), there is a surplus. Because the market price of $2.50 is above the equilibrium
price, the quantity supplied (10 cones) exceeds the quantity demanded (4 cones). Suppliers
try to increase sales by cutting the price of a cone, and this moves the price toward its equilibrium
level. In panel (b), there is a shortage. Because the market price of $1.50 is below
the equilibrium price, the quantity demanded (10 cones) exceeds the quantity supplied
(4 cones). With too many buyers chasing too few goods, suppliers can take advantage of the
shortage by raising the price. Hence, in both cases, the price adjustment moves the market
toward the equilibrium of supply and demand.
Markets Not in Equilibrium
Price of
Ice-Cream
Cone
Price of
Ice-Cream
Cone
2.00
$2.50
0 4 7 10
Supply
Demand
(a) Excess Supply
Quantity
demanded
Quantity
supplied
Surplus
$2.00
1.50
0 4 7 10Quantity of
Ice-Cream
Cones
Quantity of
Ice-Cream
Cones
Supply
Demand
(b) Excess Demand
Quantity
supplied
Quantity
demanded
Shortage
shortage
a situation in which
quantity demanded is
greater than quantity
supplied
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	 CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 79
only temporary because prices eventually move toward their equilibrium levels.
­Indeed, this phenomenon is so pervasive that it is called the law of supply and
demand: The price of any good adjusts to bring the quantity supplied and quantity
demanded for that good into balance.
4-4b Three Steps to Analyzing Changes
in Equilibrium
So far, we have seen how supply and demand together determine a market’s equilibrium,
which in turn determines the price and quantity of the good that buyers
purchase and sellers produce. The equilibrium price and quantity depend on the
position of the supply and demand curves. When some event shifts one of these
curves, the equilibrium in the market changes, resulting in a new price and a new
quantity exchanged between buyers and sellers.
When analyzing how some event affects the equilibrium in a market, we proceed
in three steps. First, we decide whether the event shifts the supply curve,
the demand curve, or, in some cases, both curves. Second, we decide whether the
curve shifts to the right or to the left. Third, we use the supply-and-demand diagram
to compare the initial and the new equilibrium, which shows how the shift
affects the equilibrium price and quantity. Table 3 summarizes these three steps.
To see how this recipe is used, let’s consider various events that might affect the
market for ice cream.
Example: A Change in Market Equilibrium Due to a Shift in Demand Suppose
that one summer the weather is very hot. How does this event affect the
market for ice cream? To answer this question, let’s follow our three steps.
1.	The hot weather affects the demand curve by changing people’s taste for
ice cream. That is, the weather changes the amount of ice cream that people
want to buy at any given price. The supply curve is unchanged because the
weather does not directly affect the firms that sell ice cream.
2.	Because hot weather makes people want to eat more ice cream, the demand
curve shifts to the right. Figure 10 shows this increase in demand as a shift
in the demand curve from D1
to D2
. This shift indicates that the quantity of
ice cream demanded is higher at every price.
3.	At the old price of $2, there is now an excess demand for ice cream, and this
shortage induces firms to raise the price. As Figure 10 shows, the increase
in demand raises the equilibrium price from $2.00 to $2.50 and the equilibrium
quantity from 7 to 10 cones. In other words, the hot weather increases
the price of ice cream and the quantity of ice cream sold.
law of supply and demand
the claim that the price
of any good adjusts
to bring the quantity
supplied and the quantity
demanded for that good
into balance
NONSEQUITUR©WileyMiller.Dist.By
UNIVERSALPRESSSYNDICATE.Reprinted
withpermission.Allrightsreserved.
Three Steps for Analyzing
Changes in Equilibrium
Table 3
1.	Decide whether the
event shifts the supply
or demand curve
(or ­perhaps both).
2.	Decide in which
­direction the curve
shifts.
3.	Use the supply-anddemand
diagram to see
how the shift changes
the equilibrium price
and quantity.
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80	 PART II	 HOW MARKETS WORK
Shifts in Curves versus Movements along Curves  Notice that when hot
weather increases the demand for ice cream and drives up the price, the quantity
of ice cream that firms supply rises, even though the supply curve remains the
same. In this case, economists say there has been an increase in “quantity supplied”
but no change in “supply.”
Supply refers to the position of the supply curve, whereas the quantity supplied
refers to the amount suppliers wish to sell. In this example, supply does not change
because the weather does not alter firms’ desire to sell at any given price. Instead,
the hot weather alters consumers’ desire to buy at any given price and thereby
shifts the demand curve to the right. The increase in demand causes the equilibrium
price to rise. When the price rises, the quantity supplied rises. This increase
in quantity supplied is represented by the movement along the supply curve.
To summarize, a shift in the supply curve is called a “change in supply,” and
a shift in the demand curve is called a “change in demand.” A movement along a
fixed supply curve is called a “change in the quantity supplied,” and a movement
along a fixed demand curve is called a “change in the quantity demanded.”
Example: A Change in Market Equilibrium Due to a Shift in Supply 
Suppose that during another summer, a hurricane destroys part of the sugarcane
crop and drives up the price of sugar. How does this event affect the market for ice
cream? Once again, to answer this question, we follow our three steps.
1.	 The change in the price of sugar, an input for making ice cream, affects the
supply curve. By raising the costs of production, it reduces the amount of
ice cream that firms produce and sell at any given price. The demand curve
does not change because the higher cost of inputs does not directly affect the
amount of ice cream households wish to buy.
FIGURE 10
How an Increase in Demand
­Affects the Equilibrium
An event that raises quantity
­demanded at any given price
shifts the demand curve to the
right. The equilibrium price
and the equilibrium quantity
both rise. Here an abnormally
hot summer causes buyers to
demand more ice cream. The
demand curve shifts from D1
to
D2
, which causes the equilibrium
price to rise from $2.00
to $2.50 and the equilibrium
quantity to rise from 7 to
10 cones.
Price of
Ice-Cream
Cone
2.00
$2.50
0 7 10 Quantity of
Ice-Cream Cones
Supply
New equilibrium
Initial
equilibrium
D1
D2
3. . . . and a higher
quantity sold.
2. . . . resulting
in a higher
price . . .
1. Hot weather increases the
demand for ice cream . . .
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	 CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 81
2.	 The supply curve shifts to the left because, at every price, the total amount
that firms are willing and able to sell is reduced. Figure 11 illustrates this decrease
in supply as a shift in the supply curve from S1 to S2.
3.	 At the old price of $2, there is now an excess demand for ice cream, and this
shortage causes firms to raise the price. As Figure 11 shows, the shift in the
supply curve raises the equilibrium price from $2.00 to $2.50 and lowers the
equilibrium quantity from 7 to 4 cones. As a result of the sugar price increase,
the price of ice cream rises, and the quantity of ice cream sold falls.
Example: Shifts in Both Supply and Demand  Now suppose that a heat wave
and a hurricane occur during the same summer. To analyze this combination of
events, we again follow our three steps.
1.	 We determine that both curves must shift. The hot weather affects the demand
curve because it alters the amount of ice cream that households want
to buy at any given price. At the same time, when the hurricane drives up
sugar prices, it alters the supply curve for ice cream because it changes the
amount of ice cream that firms want to sell at any given price.
2.	 The curves shift in the same directions as they did in our previous analysis:
The demand curve shifts to the right, and the supply curve shifts to the left.
Figure 12 illustrates these shifts.
3.	 As Figure 12 shows, two possible outcomes might result depending on the relative
size of the demand and supply shifts. In both cases, the equilibrium price
rises. In panel (a), where demand increases substantially while supply falls just
a little, the equilibrium quantity also rises. By contrast, in panel (b), where supply
falls substantially while demand rises just a little, the equilibrium quantity
falls. Thus, these events certainly raise the price of ice cream, but their impact
on the amount of ice cream sold is ambiguous (that is, it could go either way).
FIGURE 11
How a Decrease in Supply Affects
the Equilibrium
An event that reduces quantity supplied
at any given price shifts the
supply curve to the left. The equilibrium
price rises, and the equilibrium
quantity falls. Here an increase in
the price of sugar (an input) causes
sellers to supply less ice cream. The
supply curve shifts from S1 to S2,
which causes the equilibrium price
of ice cream to rise from $2.00 to
$2.50 and the equilibrium quantity
to fall from 7 to 4 cones.
Price of
Ice-Cream
Cone
2.00
$2.50
0 4 7 Quantity of
Ice-Cream Cones
Demand
New
equilibrium
Initial equilibrium
S1
S2
2. . . . resulting
in a higher
price of ice
cream . . .
1. An increase in the price of
sugar reduces the supply of
ice cream . . .
3. . . . and a lower
quantity sold.
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82	 PART II	 HOW MARKETS WORK
Summary  We have just seen three examples of how to use supply and demand
curves to analyze a change in equilibrium. Whenever an event shifts the supply
curve, the demand curve, or perhaps both curves, you can use these tools to predict
how the event will alter the price and quantity sold in equilibrium. Table 4
shows the predicted outcome for any combination of shifts in the two curves. To
make sure you understand how to use the tools of supply and demand, pick a few
FIGURE 12 Here we observe a simultaneous increase in demand and decrease in supply. Two outcomes
are possible. In panel (a), the equilibrium price rises from P1
to P2
and the equilibrium
quantity rises from Q1
to Q2
. In panel (b), the equilibrium price again rises from P1
to
P2
but the equilibrium quantity falls from Q1
to Q2
.
A Shift in Both Supply and
Demand
(b) Price Rises, Quantity Falls
0
New
equilibrium
Initial
equilibrium
(a) Price Rises, Quantity Rises
Quantity of
Ice-Cream Cones
Quantity of
Ice-Cream Cones
0
New
equilibrium
Initial equilibrium
S1
S1
D1
D1
D2
D2
S2
S2
Q1 Q2Q2 Q1
P2
P1
P2
P1
Large
increase in
demand
Small
decrease
in supply
Small
increase in
demand
Large
decrease
in supply
Price of
Ice-Cream
Cone
Price of
Ice-Cream
Cone
What Happens to Price and Quantity
When Supply or Demand Shifts?
As a quick quiz, make sure you can
explain at least a few of the entries in
this table using a supply-and-demand
diagram.
Table 4   No Change
in Supply
An Increase
in Supply
A Decrease
in Supply
No Change
in Demand
P same
Q same
P down
Q up
P up
Q down
An Increase
in Demand
P up
Q up
P ambiguous
Q up
P up
Q ambiguous
A Decrease
in Demand
P down
Q down
P down
Q ambiguous
P ambiguous
Q down
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	 CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 83
Quick Quiz  On the appropriate diagram, show what happens to the market for pizza if
the price of tomatoes rises. • On a separate diagram, show what happens to the market for
pizza if the price of hamburgers falls.
entries in this table and make sure you can explain to yourself why the table contains
the prediction that it does.
4-5 Conclusion: How Prices Allocate Resources
This chapter has analyzed supply and demand in a single market. Although our
discussion has centered on the market for ice cream, the lessons learned here apply
in most other markets as well. Whenever you go to a store to buy something,
you are contributing to the demand for that item. Whenever you look for a job,
you are contributing to the supply of labor services. Because supply and demand
are such pervasive economic phenomena, the model of supply and demand is a
powerful tool for analysis. We will be using this model repeatedly in the following
chapters.
One of the Ten Principles of Economics discussed in Chapter 1 is that markets are
usually a good way to organize economic activity. Although it is still too early to
judge whether market outcomes are good or bad, in this chapter we have begun
to see how markets work. In any economic system, scarce resources have to be
allocated among competing uses. Market economies harness the forces of supply
and demand to serve that end. Supply and demand together determine the prices
of the economy’s many different goods and services; prices in turn are the signals
that guide the allocation of resources.
For example, consider the allocation of beachfront land. Because the amount of
this land is limited, not everyone can enjoy the luxury of living by the beach. Who
gets this resource? The answer is whoever is willing and able to pay the price.
The price of beachfront land adjusts until the quantity of land demanded exactly
balances the quantity supplied. Thus, in market economies, prices are the mechanism
for rationing scarce resources.
Similarly, prices determine who produces each good and how much is produced.
For instance, consider farming. Because we need food to survive, it is
crucial that some people work on farms. What determines who is a farmer and
who is not? In a free society, there is no government planning agency making
this decision and ensuring an adequate supply of food. Instead, the allocation of
workers to farms is based on the job decisions of millions of workers. This decentralized
system works well because these decisions depend on prices. The prices
of food and the wages of farmworkers (the price of their labor) adjust to ensure
that enough people choose to be farmers.
If a person had never seen a market economy in action, the whole idea might
seem preposterous. Economies are enormous groups of people engaged in a multitude
of interdependent activities. What prevents decentralized decision making
from degenerating into chaos? What coordinates the actions of the millions of
people with their varying abilities and desires? What ensures that what needs to
be done is in fact done? The answer, in a word, is prices. If an invisible hand guides
market economies, as Adam Smith famously suggested, then the price system is
the baton that the invisible hand uses to conduct the economic orchestra.
©RobertJ.Day/TheNewYorker
Collection/www.cartoonbank.com
“Two dollars”
“—and seventy-five cents.”
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84	 PART II	 HOW MARKETS WORK
Price Increases after
Disasters
When a disaster such as a hurricane strikes a region, many goods
experience an increase in demand or a decrease in supply, putting
upward pressure on prices. Policymakers often object to these price
hikes, but this opinion piece endorses the market’s natural response.
In the News
Is Price Gouging
Reverse Looting?
By John Carney
Four dollars for a can of coke. Five hundred
dollars a night for a hotel in downtown
Brooklyn. A pair of D-batteries for $6.99.
These are just a few of the examples of
price hikes I or friends of mine have personally
come across in the run-up and aftermath
of hurricane Sandy. Price gouging, as this is
often called, is a common occurrence during
emergencies.
Price gouging around natural disasters is
one of the things politicians on the left and
right agree is a terrible, no good, very bad thing.
New York Attorney General Eric Schneiderman
sent out a press release warning “against
price inflation of necessary goods and services
during hurricane Sandy.” New Jersey Governor
Chris Christie issued a “forceful reminder” that
price gouging “will result in significant penalties.”
Hotlines have been established to allow
consumers to report gouging.
New Jersey’s law is very specific. Price
increases of more than 10 percent during a
declared state of emergency are considered
excessive. A New Jersey gas station paid a
$50,000 fine last year for hiking gasoline
prices by 16 percent during tropical storm
Irene.
New York’s law may be even stricter.
­According to AG Schneiderman’s release,
all price increases on “necessary goods and
items” count as gouging.
“General Business Law prohibits such
increase in costs of essential items like
food, water, gas, generators, batteries and
flashlights, and services like transportation,
during natural disasters or other events that
disrupt the market,” the NY AG release said.
These laws are built on the quite conventional
view that it is unethical for a business
to take advantage of a disaster in pursuit
of profits. It just seems wrong for business
owners to make money on the misery of their
neighbors. Merchants earning larger profits
because of a disaster seem to be rewarded for
doing nothing more than raising their prices.
“It’s reverse looting,” a neighbor of mine
in Brooklyn said about the price of batteries
at a local electronic store.
Unfortunately, ethics runs into economics
in a way that can make these laws positively
harmful. Price gouging can occur only when
there is a shortage of the goods in demand.
If there were no shortage, normal market processes
would prevent sudden price spikes.
A deli owner charging $4 for a can of Pepsi
would discover he was just driving customers
to the deli a block away, which charges a buck.
But when everyone suddenly starts buying
batteries or bottles of water for fear of
a blackout, shortages can arise. Sometimes
•	 Economists use the model of supply and demand to
analyze competitive markets. In a competitive market,
there are many buyers and sellers, each of whom has
little or no influence on the market price.
•	 The demand curve shows how the quantity of a good
demanded depends on the price. According to the law
of demand, as the price of a good falls, the quantity
demanded rises. Therefore, the demand curve slopes
downward.
•	 In addition to price, other determinants of how much
consumers want to buy include income, the prices of
substitutes and complements, tastes, expectations, and
the number of buyers. If one of these factors changes,
the demand curve shifts.
•	 The supply curve shows how the quantity of a good
supplied depends on the price. According to the law
of supply, as the price of a good rises, the quantity supplied
rises. Therefore, the supply curve slopes upward.
•	 In addition to price, other determinants of how much
producers want to sell include input prices, technology,
expectations, and the number of sellers. If one of
these factors changes, the supply curve shifts.
•	 The intersection of the supply and demand curves
­determines the market equilibrium. At the equilibrium
Summary
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	 CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 85
there simply is not enough of a particular
good to satisfy a sharp spike in demand.
And so the question arises: how do we decide
which customers get the batteries, the groceries,
the gasoline?
We could hold a lottery. Perhaps people
could receive a ticket at the grocery store. Winners
would get to shop at the usual prices. Losers
would just go hungry. Or, more likely, they
would be forced to buy the food away from the
lottery winners—at elevated prices no doubt,
since no one would buy food just to sell it at
the same price. So the gouging would just pass
from merchant to lottery winning customer.
We could have some sort of rationing program.
Each person could be assigned a portion
of the necessary goods according to their
household need. This is something the U.S.
resorted to during World War II. The problem
is that rationing requires an immense amount
of planning—and an impossible level of
knowledge. The rationing bureaucrat would
have to know precisely how much of each
good was available in a given area and how
many people would need it. Good luck getting
that in place as a hurricane bears down on
your city.
We could simply sell goods on a first
come, first serve basis. This is, in fact, what
anti-gouging laws encourage. The result is
all too familiar. People hoard goods. Store
shelves are emptied. And you have to wonder,
why is a first to the register race a fairer
system than the alternative of market prices?
Speed seems a poor proxy for justice.
Allowing prices to rise at times of extreme
demand discourages overconsumption. People
consider their purchases more carefully.
Instead of buying a dozen batteries (or bottles
of water or gallons of gas), perhaps they buy
half that. The result is that goods under extreme
demand are available to more customers.
The market process actually results in
a more equitable distribution than the antigouging
laws.
Once we understand this, it’s easy to see
that merchants aren’t really profiting from disaster.
They are profiting from managing their
prices, which has the socially beneficial effect
of broadening distribution and discouraging
hoarding. In short, they are being justly
rewarded for performing an important public
service.
One objection is that a system of freefloating,
legal gouging would allow the
wealthy to buy everything and leave the poor
out altogether. But this concern is overrated.
For the most part, price hikes during disasters
do not actually put necessary goods and services
out of reach of even the poorest people.
They just put the budgets of the poor under
additional strain. This is a problem better resolved
through transfer payments to alleviate
the household budgetary effects of the prices
after the fact, rather than trying to control the
price in the first place….
Instead of cracking down on price gougers,
we should be using our experience of shortages
during this time of crisis to spark a reform of
our counter-productive laws. Next time disaster
strikes, we should hope for a bit more gouging
and a lot fewer empty store shelves.Would you pay $4 for this?
Source: Courtesy of CNBC.
price, the quantity demanded equals the quantity
supplied.
•	 The behavior of buyers and sellers naturally drives
markets toward their equilibrium. When the market
price is above the equilibrium price, there is a surplus
of the good, which causes the market price to fall.
When the market price is below the equilibrium price,
there is a shortage, which causes the market price to
rise.
•	 To analyze how any event influences a market, we use
the supply-and-demand diagram to examine how the
event affects the equilibrium price and quantity. To do
this, we follow three steps. First, we decide whether
the event shifts the supply curve or the demand curve
(or both). Second, we decide in which direction the
curve shifts. Third, we compare the new equilibrium
with the initial equilibrium.
•	 In market economies, prices are the signals that guide
economic decisions and thereby allocate scarce resources.
For every good in the economy, the price
ensures that supply and demand are in balance. The
equilibrium price then determines how much of the
good buyers choose to consume and how much sellers
choose to produce.
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Copyright 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).
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86	 PART II	 HOW MARKETS WORK
  1.	 A change in which of the following will NOT shift the
demand curve for hamburgers?
a.	 the price of hot dogs
b.	 the price of hamburgers
c.	 the price of hamburger buns
d.	 the income of hamburger consumers
  2.	 An increase in ________ will cause a movement along
a given demand curve, which is called a change in
________.
a.	 supply, demand
b.	 supply, quantity demanded
c.	 demand, supply
d.	 demand, quantity supplied
  3.	 Movie tickets and DVDs are substitutes. If the price
of DVDs increases, what happens in the market for
movie tickets?
a.	 The supply curve shifts to the left.
b.	 The supply curve shifts to the right.
c.	 The demand curve shifts to the left.
d.	 The demand curve shifts to the right.
  4.	 The discovery of a large new reserve of crude oil will
shift the ________ curve for gasoline, leading to a
________ equilibrium price.
a.	 supply, higher
b.	 supply, lower
c.	 demand, higher
d.	 demand, lower
  5.	 If the economy goes into a recession and incomes fall,
what happens in the markets for inferior goods?
a.	 Prices and quantities both rise.
b.	 Prices and quantities both fall.
c.	 Prices rise, quantities fall.
d.	 Prices fall, quantities rise.
  6.	 Which of the following might lead to an increase in the
equilibrium price of jelly and a decrease in the equilibrium
quantity of jelly sold?
a.	 an increase in the price of peanut better, a complement
to jelly
b.	 an increase in the price of Marshmallow Fluff, a
substitute for jelly
c.	 an increase in the price of grapes, an input into jelly
d.	 an increase in consumers’ incomes, as long as jelly
is a normal good
Quick Check Multiple Choice
market, p. 66
competitive market, p. 66
quantity demanded, p. 67
law of demand, p. 67
demand schedule, p. 67
demand curve, p. 68
normal good, p. 70
inferior good, p. 70
substitutes, p. 70
complements, p. 70
quantity supplied, p. 73
law of supply, p. 73
supply schedule, p. 74
supply curve, p. 74
equilibrium, p. 77
equilibrium price, p. 77
equilibrium quantity, p. 77
surplus, p. 77
shortage, p. 78
law of supply and demand, p. 79
Key Concepts
  1.	 What is a competitive market? Briefly describe a type
of market that is not perfectly competitive.
  2.	 What are the demand schedule and the demand
curve, and how are they related? Why does the demand
curve slope downward?
  3.	 Does a change in consumers’ tastes lead to a movement
along the demand curve or a shift in the demand
curve? Does a change in price lead to a movement
along the demand curve or a shift in the demand
curve? Explain your answers.
  4.	 Popeye’s income declines, and as a result, he buys
more spinach. Is spinach an inferior or a normal
good? What happens to Popeye’s demand curve for
spinach?
  5.	 What are the supply schedule and the supply curve,
and how are they related? Why does the supply curve
slope upward?
  6.	 Does a change in producers’ technology lead to a
movement along the supply curve or a shift in the supply
curve? Does a change in price lead to a movement
along the supply curve or a shift in the supply curve?
  7.	 Define the equilibrium of a market. Describe the forces
that move a market toward its equilibrium.
  8.	 Beer and pizza are complements because they are often
enjoyed together. When the price of beer rises, what
happens to the supply, demand, quantity supplied,
quantity demanded, and price in the market for pizza?
  9.	 Describe the role of prices in market economies.
Questions for Review
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	 CHAPTER 4 THE MARKET FORCES OF SUPPLY AND DEMAND 87
  1.	 Explain each of the following statements using supply-and-demand
diagrams.
a.	 “When a cold snap hits Florida, the price of orange
juice rises in supermarkets throughout the country.”
b.	 “When the weather turns warm in New ­England
every summer, the price of hotel rooms in
­Caribbean resorts plummets.”
c.	 “When a war breaks out in the Middle East, the
price of gasoline rises and the price of a used
Cadillac falls.”
  2.	 “An increase in the demand for notebooks raises the
quantity of notebooks demanded but not the quantity
supplied.” Is this statement true or false? Explain.
  3.	 Consider the market for minivans. For each of the
events listed here, identify which of the determinants
of demand or supply are affected. Also indicate
whether demand or supply increases or decreases.
Then draw a diagram to show the effect on the price
and quantity of minivans.
a.	 People decide to have more children.
b.	 A strike by steelworkers raises steel prices.
c.	 Engineers develop new automated machinery for
the production of minivans.
d.	 The price of sports utility vehicles rises.
e.	 A stock market crash lowers people’s wealth.
  4.	 Consider the markets for DVDs, TV screens, and
­tickets at movie theaters.
a.	 For each pair, identify whether they are
­complements or substitutes:
•	 DVDs and TV screens
•	 DVDs and movie tickets
•	 TV screens and movie tickets
b.	 Suppose a technological advance reduces the cost
of manufacturing TV screens. Draw a diagram to
show what happens in the market for TV screens.
c.	 Draw two more diagrams to show how the change
in the market for TV screens affects the markets for
DVDs and movie tickets.
  5.	 Over the past 30 years, technological advances have
reduced the cost of computer chips. How do you think
this has affected the market for computers? For computer
software? For typewriters?
  6.	 Using supply-and-demand diagrams, show the effect
of the following events on the market for sweatshirts.
a.	 A hurricane in South Carolina damages the cotton
crop.
b.	 The price of leather jackets falls.
c.	 All colleges require morning exercise in appropriate
attire.
d.	 New knitting machines are invented.
  7.	 Ketchup is a complement (as well as a condiment) for
hot dogs. If the price of hot dogs rises, what happens
to the market for ketchup? For tomatoes? For tomato
juice? For orange juice?
  8.	 The market for pizza has the following demand and
supply schedules:
Price Quantity Demanded Quantity Supplied
$4 135 pizzas 26 pizzas
5 104 53
6 81 81
7 68 98
8 53 110
9 39 121
a.	 Graph the demand and supply curves. What is the
equilibrium price and quantity in this market?
b.	 If the actual price in this market were above the
equilibrium price, what would drive the market
toward the equilibrium?
c.	 If the actual price in this market were below the
equilibrium price, what would drive the market
toward the equilibrium?
  9.	 Consider the following events: Scientists reveal that
eating oranges decreases the risk of diabetes, and
at the same time, farmers use a new fertilizer that
makes orange trees produce more oranges. Illustrate
and explain what effect these changes have on the
­equilibrium price and quantity of oranges.
10.	 Because bagels and cream cheese are often eaten
­together, they are complements.
a.	 We observe that both the equilibrium price of cream
cheese and the equilibrium quantity of ­bagels have
risen. What could be responsible for this pattern—a
fall in the price of flour or a fall in the price of milk?
Illustrate and explain your answer.
b.	 Suppose instead that the equilibrium price of
cream cheese has risen but the equilibrium quantity
of bagels has fallen. What could be responsible
for this pattern—a rise in the price of flour or a rise
in the price of milk? Illustrate and explain your
answer.
Problems and Applications
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88	 PART II	 HOW MARKETS WORK
11.	 Suppose that the price of basketball tickets at your
college is determined by market forces. Currently, the
demand and supply schedules are as follows:
Price Quantity Demanded Quantity Supplied
$4 10,000 tickets 8,000 tickets
8 8,000 8,000
12 6,000 8,000
16 4,000 8,000
20 2,000 8,000
a.	 Draw the demand and supply curves. What is
unusual about this supply curve? Why might this
be true?
b.	 What are the equilibrium price and quantity of
tickets?
c.	 Your college plans to increase total enrollment next
year by 5,000 students. The additional students will
have the following demand schedule:
Price Quantity Demanded
$4 4,000 tickets
8 3,000
12 2,000
16 1,000
20 0
	 Now add the old demand schedule and the
­demand schedule for the new students to ­calculate
the new demand schedule for the entire ­college.
What will be the new equilibrium price and
quantity?
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Copyright 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s).
Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.