Getting Acquainted with Economics

This chapter is an introduction to the basic analytical structure of markets through the use of the demand-supply diagram. It then indicates what sorts of problems arise when the government interferes with freely functioning markets.

Demand and Quantity Demanded

If we demand a good or service, it is obvious that we want it, we can affort it and that we have definitely decided to buy it. Wants are unlimited desires or wishes that people have for goods and services. Scarcity guarantees that most of our wants will never be satisfied. Demand reflects a decision about which wants to satisfy.

Quantity demanded

The quantity demanded of a good or service is the amount consumers are willing and able to buy in a given period of time at a particular price. Note that we say willing and able because willingness alone is not effective in the market. I may be willing to buy a Ferrari but if this willingness is not backed up by the ability to buy - the necessary amount of money - it will not be effective and, thus, not reflected in the market. In Table 5-1 in the textbook, if the price of milk in the market happened to be $1.50 per quart, consumers would be willing and able to buy 45 billions of quarts per year; if it were $1.40 per quart, they would be willing and able to buy 50 billions of quarts per year, and so forth. Quantity demanded is measured as an amount per unit of time. For example, the quantity of hot dogs that you demand can be expressed as 1 unit per day, or 7 units per week, 30 units per month or 365 units per year. Omitting the time variable is vague and meaningless.For example, being told that that the quantity of new cars demanded in the U.S. is 1,000,000 means nothing unless you include the time variable. One million cars per day would be an enormous rate of demand while one million per year would be a very small rate.

The amount of any particular good or service that consumers are willing and able to buy is influenced by the following important variables:

We will not be able to determine the separate influence of each of the above variables if we try to consider what happens when everything changes at once. Instead, we consider the influence of the variables one at a time. To do this, we hold all but one of them constant. Then we let that one selected variable vary and study how it affects quantity demanded. We can do the same for each of the other variables in turn and in this way we can come to understand the importance of each. As you might have guessed by now, this is an important application of the "other things equal" assumption. We are interested in explaining how goods and services are priced. To do this, we need to study the relationship between quantity demanded and the price of the good or service. To study this relationship, we hold constant all other influences on consumers' planned purchases and ask: "How does the quantity demanded of a good (in our case, milk) vary as its price varies, other things equal?

The Law of Demand

The law of demand states that the higher the price of a good, the smaller is the quantity demanded, other things remaining the same. Stated differently, there is an inverse (or negative) relationship between price and quantity demanded. Although there are many levels on which to support this law, it is sufficient to rest the case on common sense and simple observation. People ordinarily do buy more of a given good or service at a low price than they do at a higher price. (You would, normally, consume more pizza or more hamburgers or more hot dogs or buy more jeans if their price were lower). To consumers, price is an obstacle which deters them from buying.The higher the price obstacle, the less quantity they buy; the lower the price obstacle, the more they will buy. The existence of sales in the stores during specified time periods is more than adequate evidence on the belief of businesses in the law of demand. "Special offers" and "bargain days" are based on the law of demand.

Demand schedule and demand curve

We are about to study one of the two most used curves in economics: the demand curve. And we will encounter one of the most critical distinctions in economics: the distinction between demand and quantity demanded. 

The term demand refers to the entire relationship between quantity demanded and the price of a good or service and is illustrated by the demand schedule and the demand curve. The term quantity demanded refers to a point on the demand curve (for example point B in Fig. 5-1 in the textbook), that is, the quantity demanded at a particular price.

The demand schedule is one way of showing the relationship between quantity and price. It is a numerical tabulation showing the quantity demanded at each different price, other things remaining the same. Table 5-1 in the textbook is an example of a demand schedule.

The demand curve is a second method of showing the relationship between quantity demanded and price. It is a graphical representation of the demand schedule showing the quantity demanded at each different price, other things remaining the same. The seven price-quantity combinations shown in Table 5-1 are plotted on the graph shown in Fig. 5-1. Price is plotted on the vertical axis and quantity demanded on the horizontal axis. The points on the curve labelled A through H represent the rows of the demand schedule. The smooth curve drawn through these points is the demand curve. The negative slope of the curve, downward to the right, indicates that quantity demanded increases as price falls. Figure 1 below shows step-by-step the construction of the demand curve shown in Fig 5-1 in the textbook.

Figure 1

Shifts in the demand curve

The demand schedule is constructed and the demand curve plotted on the "other things equal" assumption. But what if other things change, as surely they must? What if, for example, consumers find themselves with more income? If they spend their extra income, they will buy additional quantities of many goods and services even though their prices are unchanged.

The demand curve shifts so that there is a change in demand when some influences other than the price of the good itself changes, Factors that cause a shift in a good's demand curve are:

Figure 2 below shows how the demand curve shifts rightward or leftward. At point C₁, following the rightward shift to demand curve D₁, more is demanded (approximately 65 billions of quarts per year) at the initial price of $1.30 per quart. At point C₂,  following the leftward shift to demand curve D₂, less is demanded (approximately 45 billions of quarts per year) at the initial price of $ 1.30 per quart. You can observe that consumers buy additional quantities of milk even though the price has not changed.

Figure 2

Movement along the demand curve versus shifts of the whole curve

The distinction between a " change in the quantity demanded" and a "change in demand" is crucial. A change in the quantity demanded is simply a movement along the demand curve and occurs when the price of the good changes. A change in demand refers to a shift in the entire curve either to the right to the left and occurs when the price of the good remains constant but some other influences on byuers' plans for that good change (income, population, tastes and preferences, prices of related goods). Figure 3 below gives the details of that important distinction:

Figure 3

If the price of a good changes but everything else remains the same, there is a movement along the demand curve. In terms of the above figure, if the price of a good rises when everything else remains the same, the quantity demanded of that good decreases and there is a movement up the demand curve D as indicated by the upward facing black arrow. In contrast, if the price of the good falls when everything else remains the same, the quantity demanded of that good increases and there is a movement down the demand curve D as indicated by the downward facing black arrow.

When any other influence on buying plan changes, other than the price of the good, the demand curve shifts and there is a change (increase or decrease) in demand. A rise in incomes, population, in the price of a substitute, a fall in the price of a complement, or a favorable consumer preference towards a good shifts the demand rightward from D to D₁ as indicated by the rightward yellow arrow. This represents an increase in demand. A fall in incomes, population, in the price of a substitute, a rise in the price of a complement, or an unfavorable consumer preference towards a good shifts the demand curve leftward from D to D₂ as indicated by the leftward yellow arrow. This represents a decrease in demand. Table 1 below summarizes the influences on demand and the direction of those influences.

Table 1

Supply and Quantity Supplied

If a firm supplies a good or service, it follows that the firm has the resources and technology to produce it, can make a profit from the production of the good or service and has definitely decided to produce it.

Many useful goods and services, limited only by the resources and the technology, can be produced but they are not produced unless it is profitable to do so. Supply reflects a decision about which technologically feasible goods and services to produce.

Quantity supplied

The quantity supplied of a good or service is the amount producers are willing and able to produce and make available for sale in the market in a given period of time at a particular price. Note that we say willing and able because willingness alone is not effective in the market. I may be willing to produce a space satelite  but if this willingness is not backed up by the ability to produce - the necessary resources and technology - it will not be effective and, thus, not reflected in the market. In Table 5-2 in the textbook, if the price of milk in the market happened to be $1.50 per quart, producers would be willing and able to produce 90 billions of quarts per year; if it were $1.40 per quart, they would be willing and able to produce 80 billions of quarts per year, and so forth. Quantity supplied is measured as an amount per unit of time. For example, Sony produces 1000 DVDs a day. The quantity of DVDs supplied by Sony can be expresses as 1000 per day or 7000 per week or 30000 per month or 365000 per year. Omitting the time variable is vague and meaningless. Without the time dimension we cannot tell whether a particular number is large or small.

The amount of any particular good or service that consumers are willing and able to produce is influenced by the following important variables:

As with demand, we will not be able to determine the separate influence of each of the above variables if we try to consider what happens when everything changes at once. Instead, we consider the influence of the variables one at a time. To do this, we hold all but one of them constant. Then we let that one selected variable vary and study how it affects quantity demanded. We can do the same for each of the other variables in turn and in this way we can come to understand the importance of each. As you might have guessed by now, this is an important application of the "other things equal" assumption. We are interested in explaining how goods and services are priced. To do this, we need to study the relationship between quantity supplied and the price of the good or service. To study this relationship, we hold constant all other influences on producers planned sales and ask: "How does the quantity supplied of a good (in our case, milk) vary as its price varies, other things equal?

The Law of Supply

The law of supply states that the higher the price of a good, the higher is the quantity supplied, other things remaining the same. Stated differently, there is direct (or positive) relationship between price and quantity supplied. This is due to the principle of opportunity cost. As the quantity produced a good increases, the opportunity cost of producing the good increases. It is never worth producing a good if the price received for it does not at least cover opportunity cost. So when the price of a good rises, other things equal, producers are willing to incur the higher opportunity cost and increase production. The higher price brings forth an increase in the quantity supplied. Additionally, the law of supply can be explained in terms of common sense although it is a simplified expression of the above explanation: price is a deterrent from the consumer's standpoint. The obstacles of a high price means that the consumer, being on the paying end of this price, will buy a relatively small amount of the good or service; the lower the price obstacle, the more the consumer will buy. The producer, on the other hand, is on the receiving end of the good's price. To him, price is an inducement or incentive to produce and sell a good or service. The higher the price of the good or service, the greater the incentive to produce and offer it on the market. You would, normally, as a college graduate and a supplier of skilled labor, would enter a market where jobs are highly paid; you wouldn't supply your labor to a market where wages are low.

Supply schedule and supply curve

As with demand, the term supply refers to the entire relationship between quantity supplied and the price of a good or service and is illustrated by the supply schedule and the supply curve. The term quantity supplied refers to a point on the supply curve (for example point c in Fig. 5-4 in the textbook), that is, the quantity supplied at a particular price.

The supply schedule is one way of showing the relationship between quantity and price. It is a numerical tabulation showing the quantity supplied at each different price, other things remaining the same. Table 5-2 in the textbook is an example of a supply schedule.

The supply curve is a second method of showing the relationship between quantity supplied and price. It is a graphical representation of the supply schedule showing the quantity supplied at each different price, other things remaining the same. The seven price-quantity combinations shown in Table 5-2 are plotted on the graph shown in Fig. 5-4. Price is plotted on the vertical axis and quantity supplied on the horizontal axis. The points on the curve labelled a through s represent the rows of the supply schedule. The smooth curve drawn through these points is the supply curve. The positive slope of the curve, upward to the right, indicates that quantity supplied increases as price rises. Figure 1 below shows step-by-step the construction of the supply curve shown in Fig 5-4 in the textbook.

Figure 4

Shifts of the supply curve

The supply schedule is constructed and the supply curve plotted on the "other things equal" assumption. But what if other things change, as surely they must? What if, for example, the number of the producers of a good increases? Additional quantities of that good will be supplied in the market even though its price is unchanged.

The supply curve shifts so that there is a change in supply when some influences other than the price of the good itself changes, Factors that cause a shift in a good's supply curve are:

Figure 5 below shows how the supply curve shifts rightward or leftward. At point C₁, following the rightward shift of the supply curve S₁, more is supplied (approximately 90 billions of quarts per year) at the initial price of $1.30 per quart. At point C₂,  following the leftward shift of the supply curve S₂, less is demanded (approximately 50 billions of quarts per year) at the initial price of $ 1.30 per quart. You can observe that producers supply additional quantities of milk even though the price has not changed.

Figure 5

Movement along the supply curve versus shifts of the whole curve

The distinction between a " change in the quantity supplied" and a "change in supply" is, again, crucial. A change in the quantity supplied is simply a movement along the supply curve and occurs when the price of the good changes. A change in supply refers to a shift in the entire curve either to the right to the left and occurs when the price of the good remains constant but some other influences on producers' plans for that good change (size of industry, thechnological progress, prices of inputs, prices of related outputs). Figure 6 below gives the details of that important distinction:

Figure 6

If the price of a good changes but everything else remains the same, there is a movement along the supply curve. In terms of the above figure, if the price of a good rises when everything else remains the same, the quantity supplied of that good increases and there is a movement up the supply curve S as indicated by the upward facing black arrow. In contrast, if the price of the good falls when everything else remains the same, the quantity supplied of that good falls and there is a movement down the supply curve S as indicated by the downward facing black arrow.

When any other influence on producing plans changes, other than the price of the good, the supply curve shifts and there is a change (increase or decrease) in supply. A rise in the number of the producers of a good, a technological improvement, a fall in the prices of inputs, a rise in the price of a complement in production and a fall in the price of a substitute in production shifts the supply rightward from S to S₁ as indicated by the rightward yellow arrow. This represents an increase in supply. A fall in the number of the producers of a good, a deterioration in technology, a rise in the prices of inputs, a fall in the price of a  complement in production and a rise in the price of a substitute in production shifts the supply curve leftward from S to S₂ as indicated by the leftward yellow arrow. This represents a decrease in supply. Table 2 below summarizes the influences on supply and the direction of those influences.

Table 2

Supply and Demand Equilibrium

We may now bring the concepts of supply and demand together to see how the interaction of the buying decisions of consumers and the selling decisons of producers will determine the price of a good or service and the quantity which is actually bought and sold in the market. Table 5-3 in the textbook brings together the demand and supply schedules from Tables 5-1 and 5-2. 

There is only one price, $1.20 per quart, at which the quantity of milk demanded equals the quantity supplied. At prices of less that $1.20 per quart there is a shortage of milk because the quantity demanded exceeds the quantity supplied. This is often called a situation of excess demand. At prices greater than $1.20 per quart there is a surplus of milk because the quantity supplied exceeds the quantity demanded. This is called a situation of excess supply.

To discuss the determination of market price, suppose first that the price is $1.40 per quart. At this price, 80 billions of quarts would be offered for sale, but only 50 billions of quarts would be demanded. There would be an excess supply of 30 billions of quarts per year. The surplus of milk would prompt competing producers to bid down the price in order to encourage buyers to take this surplus off their hands. In other words, excess supply causes a downward pressure on price. 

Next, consider the price of $0.90 per quart. It is evident that at this price quantity demanded is in excess of quantity supplied by 45 billions of quarts per year. This relatively low price discourages producers from devoting their resources to milk production; the same low price encourages consumers to attempt to buy more milk than would otherwise be the case. Milk is a "good buy" when the price is relatively low. In short, there is 45 billions of quarts shortage of milk. Can this price of $0.90 per quart persist as the market price? No. Competition among buyers will bid up the price as many potential consumers, in order to ensure that they will not have to do without, will express a willingness to pay a price in excess of $0.90 to ensure getting some of the available milk. In other words, excess demand causes an upward pressure on price.

Finally, consider a price of $1.20 per quart. At this price, producers wish to sell 60 billions of quarts per year and consumers wish to buy that quantity. There is neither a shortage nor a surplus of milk. There are no unsatisfied buyers to bid the price up nor are there unsatisfied producers to force the price down. Once the price of $1.20 per quart has been reached, therefore, there will be no tendency for it to change. In economics we call the price of $1.20 the equilibrium price and the quantity of 60 billions of quarts the equilibrium quantity. Equilibrium means "in balance" or "at rest" describing a situation in which opposing forces balance each other.

A graphic analysis, as in Fig 5-7 in the textbook, would yield the same conclusions. Figure 7 below illustrates the equilibrium process.

Figure 7

The intersection of the demand curve DD and the supply curve SS indicates the equilibrium price, P, and quantity, Q, at point E where quantity demanded equals quantity supplied. At the price P₁ quantity demanded is Q₁ and quantity supplied is Q₂. The resulting surplus (excess supply) is Q₂ - Q₁ exerts a downward pressure on price, as indicated by the downward black arrow, so as to increase the quantity demanded and reduce the quantity supplied until equilibrium is achieved.  At the price P₁ quantity demanded is Q₂ and quantity supplied is Q₁. The resulting shortage (excess demand) is Q₂ - Q₁ exerts an upward pressure on price, as indicated by the upward black arrow, so as to increase quantity supplied and reduce quantity demanded until equilibrium is reached.

Effects of demand and supply shifts on supply-demand equilibrium

The demand and supply theory provides us with powerful ways of analyzing influences on prices and the quantities bought and sold. According to the theory, a change in price stems from either a change in demand or a change in supply or a change in both. Let's have a look first at the effects of a change in demand:

Change in demand

To islotate the effects of a change in demand, we assume, for now, that supply remains constant. A rightward shift of the demand (increase in demand) as a result of a rise in incomes, population, in the price of a substitute, a fall in the price of a complement, or a favorable consumer preference towards a good brings about a rise in price and an increase in quantity as Figure 5-8(a) in textbook shows. Note that the increase in demand has also caused an increase in the quantity supplied but no change in supply - a movement along, but no shift of, the supply curve.

Alternatively, a leftward shift of the demand (decrease in demand) as a result of a fall in incomes, population, in the price of a substitute, a rise in the price of a complement, or an unfavorable consumer preference towards a good causes a fall in price and a decrease in quantity as Figure 5-8(b) in the textbook shows. Note, again, that the decrease in demand has also brought about a decrease in the quantity supplied but no change in supply - a movement along, but no shift, of the supply curve.

Change in supply

Again, to isolate the effects of a change in supply, we assume that demand remains constant. A rightward shift of the supply curve (increase in supply) as a result of a rise in the number of the producers of a good, a technological improvement, a fall in the prices of inputs, a rise in the price of a complement in production and a fall in the price of a substitute in production causes the price to fall and the quantity to increase as Figure 5-9(a) in the textbook shows. Note that the increase in supply has also brought about a decrease in the quantity demanded but no change in demand - a movement along, but no shift of, the demand curve.

In contrast, a leftward shift of the supply (decrease in supply) as a result of a fall in the number of the producers of a good, a deterioration in technology, a rise in the prices of inputs, a fall in the price of a  complement in production and a rise in the price of a substitute in production brings about a rise in price and a decrease in quantity as Figure 5-9(b) in the textbook shows. Note, again, that the decrease in supply has also caused an increase in the quantity demanded but no change in demand - a movement along, but no shift of, the demand curve.

To summarize:

Change in both supply and demand

Until now we were able to predict the effects of a change in either demand or supply on the price and quantity. But what happens if both demand and supply change together as, indeed, they do in the real world?

Let's first see what happens if demand and supply change in the same direction - either both increase or both decrease. We know that an increase in demand increases both price and quantity while an increase in supply lowers price and increases quantity. Alternatively, a decrease in demand decreases both price and quantity whereas a decrease in supply raises price and decreases quantity. Thus, if both demand and supply increase, we can predict with certainty that quantity will increase (the combined effect of an increase in demand and supply) but the effect on price is uncertain and will depend on the relative magnitudes of the shifts. In other words, if the rightward shift in the demand curve is larger than the rightward shift of the supply curve, the demand effect will prevail: an increase in quantity and an increase in price. If the rightward shift in the demand curve is smaller than the rightward shift of the supply curve, the supply effect will prevail: an increase in quantity and a fall in price. If both shifts are of equal magnitude, no effect will prevail: an increase in quantity with no change in price. The opposite holds true in the case of a leftward shift in both curves.

Now, let's see what happens when demand and supply change together but move in opposite directions. If demand decreases and supply increases, we can predict with certaintly that price will fall (the combined effect of a decrease in demand and an increase in supply) but the effect on price is uncertain and will depend on the relative magnitudes of the shifts. In other words, if the leftward shift in the demand curve is larger than the rightward shift of the supply curve, the demand effect will prevail: a fall in price and a decrease in quantity. If the leftward shift in the demand curve is smaller than the rightward shift of the supply curve, the supply effect will dominate: a fall in price and an increase in quantity. If both shifts are of equal magnitude, no effect will prevail: a fall in price with no change in quantity. In contrast, if demand increases and supply decreases, we can safely predict that price rises (the combined effect of an increase in demand and a fall in supply) but the effect on quantity is uncertain and will depend on the relative magnitudes of the shifts. That is, if the rightward shift in the demand curve is larger than the leftward shift of the supply curve, the demand effect will dominate: a rise in price and an increase in quantity. Alternatively, if the rightward shift in the demand curve is smaller than the leftward shift of the supply curve, the supply effect will dominate: a rise in price and a fall in the quantity. A shift of equal magnitude in both curves will cause a rise in price with no change in quantity.

To summarize:

In the Figure below you can see four cases of simoultaneous demand and supply shifts. Figure 8(a) depicts an increase in both demand and supply where the demand effect prevails, i.e., the rightward shift of the demand curve from DD to D₁D₁ is larger than the rightward shift of the supply curve from SS to S₁S₁. The net result is a rise in price and an unambiguous increase in quantity as shown by the blue arrows. Figure 8(b) shows a decrease in both demand and supply where the supply effect prevails, i.e., the leftward shift of the demand curve from DD to D₁D₁ is smaller than the leftward shift of the supply curve from SS to S₁S₁. The net result is a rise in price and an unambigous quantity decrease. The third diagram, Figure 8(c), represents an increase in demand and a decrease in supply. Since the rightward shift in the demand curve from DD to D₁D₁ is smaller than the leftward shift of the supply curve from SS to S₁S₁, the supply effect is dominant; we have an unabiguous rise in price and a decrease in quantity. Last, Figure 8(d) illustrates a decrease in demand and an increase in supply where the demand effect prevails. In this case, price unambiguously falls and quantity decreases. There are more cases of simultaneously changes in demand and supply but they can be useful food for thought in classroom discussions and assignments.

Figure 8

The Market Strikes Back

Equilibrium in a free market occurs when quantity demanded equals the quantity supplied. Government price control policies are designed to hold the actual price at some equilibrium value that could not be maintained in the absence of the government's intervention. Some price control policies hold the market price below equilibrium. In so doing they cause quantity demanded to exceed quantity supplied at the controlled price, creating shortages. Other price control policies are designed to hold prices above equilibrium. In so doing they cause quantity supplied to exceed quantity demanded at the control price, creating surpluses.

Price ceilings

The government sometimes establishes the highest permissible that producers may legally charge. Rent control is a well known example. This maximum is oftern called a price ceiling. If the ceiling is set above the equilibrium price, it has no effect, since equilibrium can be attained. If, however, the ceiling is set below the equilibrium price, the ceiling is binding or effective. Price ceilings create the potential for a black market because a profit can be made by buying at the controlled price and selling at the black market price. Figure 9 below explains the effects of a price ceiling. The free-market equilibrium is at E with price P and quantity Q. If a price ceiling is set at P₁, the quantity demanded will also rise to Q₁ and the quantity supplied will fall to Q₂. Quantity actually exchanged will be Q₂. Although excess demand is Q₂Q₁, price may not rise legally to restore equilibrium.

Figure 9

Price floors

The government occasionally establishes a minimum price, or price floor, for a good or service. Minimum wages for labor and guaranteed prices for some agricultural commodities are well-known examples. A price floor that is set at or below equilibrium has no effect because equilibrium can be attained. If, however, the price floor is set above equilibrium price, it is binding or effective. Price floors lead to excess supply. Either an unsold surplus will exist or someone must step in and buy the excess production. The consequences of excess supply will differ from commodity to commodity. If the commodity is labor, subject to a minimum wage, excess supply translates into people without jobs. If the commodity is, say, corn, and more is produced than can be sold, the surplus corn must accumulate in government warehouses. Figure 10 below explains the effects of price floors. The free-market equilibrium is at E with price P and quantity Q. If the government makes it illegal for the price to fall below P₁, it has established an effective price floor. Quantity supplied will exceed quantity demanded by Q₁Q₂. This excess supply will either go to waste or accumulate in inventories. If the government buys the excess supply, sellers will get rid of the full quantity they wish to produce, Q₂, but the government will have the quantity Q₁Q₂ to store or dispose of.

Figure 10

The Mathematics of Demand, Supply and Equilibrium

It is important that you understand the simple mathematics (Math 101 material) of the demand and supply curves and how equilibrium is represented mathematically. Don't be alarmed, you will not be tested but, nevertheless, it is good for you to know. For simplicity, we will assume a linear relationship, that is, we assume that the demand and supply curves are straight lines as in Figure 11 below.

Figure 11

The equation describing the demand curve is Qd = a - bP where Qd is quantity demanded, P is price, a and b are constants. The above equation tells us the following:

The equation describing the supply curve is Qs = c + dP where Qs is quantity supplied, P is price, c and d are constants. The equation tells us the following:

Graphically, equilibrium is achieved at the point where the demand and supply curves intersect. The equations above can be used to find equilibrium price and quantity. The price of a good will adjust until quantity demanded is equal to quantity supplied. In other words, we can let Qe = Qd = Qs and rewrite the model as follows:

A couple of numerical examples would help you understand it better:

Example 1

The equation Qd = 12 - 2P is a specific functional relationship which indicates precicely how quantity demanded (Qd) depends on price P. That is, by substituting various prices of the good into this specific demand function, we get the particular quantity of a good demanded by consumers per unit of time at these various prices. The demand schedule corresponding to the above equation is:

Remember: we substitute various prices into the specific equation. For example, how did we get Qd = 8? If we substitute P = 2 into the above equation, we have Qd = 12 - 2(2) = 12 - 4 = 8.

Example 2

The demand for VCRs is

Qd = 800 - 4P

The supply of VCRs is

Qs = 200 - 2P

The price of a VCR is expressed in dollars and the quantities are expressed in units per day.

We let Qe = Qd = Qs and rewrite the model as

Qe = 800 - 4P

Qe = 200 - 2P

Combining the two equations we get

800 - 4P = 200 - 2P

Solving for P we get the equilibrium price

800 - 200 = 4P - 2P

600 = 2P

Pe = 300

Substituting for P in either the demand or supply equation

Qe = 800 - 2(300)

Qe = 200

The equilibrium price is $300 per unit and the equilibrium quantity is 200 units per day. (The numbers in the example are arbitrary).

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