Chapter 3: Supply, Demand, and Market Equilibrium

ECO 112 Principles of Macroeconomics

Today’s Roadmap

Key Concepts

  • The law of demand and what the demand curve shows
  • The determinants that shift the whole demand curve
  • The law of supply and what the supply curve shows
  • The determinants that shift the whole supply curve
  • Market equilibrium: where supply meets demand
  • Shortages and surpluses when price is away from equilibrium
  • How a shift in supply or demand changes equilibrium price and quantity

Demand

The Law of Demand

Demand describes how much of a good buyers are willing and able to purchase at each possible price, holding everything else constant.

Law of demand:

  • As the price of a good rises
    • The quantity demanded falls
  • As price falls
    • The quantity demanded rises

Why?

  1. Higher price makes a good less attractive relative to substitutes
  2. Higher price lowers the real purchasing power of a buyer’s income

Both effects reduce quantity demanded.

How is this different from inflation? The law of demand describes what happens when one good’s price changes while everything else, including other prices and income, stays the same.

The Demand Curve

Price Quantity Demanded
$7.20 10
$7.00 15
$6.80 20
$6.60 25
$6.40 30
$6.20 35

Price per bushel, quantity in thousands of bushels of soybeans.

Plotting each price/quantity pair traces out the demand curve, downward sloping because of the law of demand.

Movement Along vs. a Shift In

It matters which kind of change is happening.

  • A change in quantity demanded is a movement along a fixed demand curve, caused only by a change in the good’s own price
  • A change in demand is a shift of the entire curve, caused by anything other than the good’s own price

Consider the market for new textbooks at a college bookstore. Which kind of change is each event?

  1. The price of new textbooks rises.
  2. Enrollment falls, so fewer students are shopping for textbooks at all.
  3. Students increasingly prefer buying used books instead of new ones.

Event 1 is a movement along the demand curve. Events 2 and 3 are shifts of the whole curve, since neither one is a change in the textbook’s own price.

What Shifts Demand

Determinants That Shift Demand

  1. Income: for a normal good, quantity demanded at every price rises as income rises. For an inferior good, it falls as income rises.
  2. Tastes and preferences: a good becoming more or less fashionable or desirable shifts demand at every price.
  3. Prices of related goods: an increase in the price of a substitute raises demand for this good; an increase in the price of a complement lowers demand for this good.
  4. Expectations: if buyers expect a higher price later, demand now tends to rise, as people buy sooner rather than pay more later.
  5. Number of buyers: more buyers in the market raises demand at every price; fewer buyers lowers it.

Example: Income Shifts Demand

Suppose consumer income rises, and a toy hoop is a normal good. At every price, buyers now want more of it than before.

Price Old Qd New Qd
$10 10 15
$8 14 19
$6 18 23
$4 22 27

Quantity demanded rises by 5 units at every price.

An increase in demand shifts the whole curve to the right. A decrease in demand, from an event like a recession or a fading fad, shifts it to the left.

Supply

The Law of Supply

Supply describes how much of a good sellers are willing and able to offer for sale at each possible price, holding everything else constant.

Law of supply:

  • As the price of a good rises
    • The quantity supplied rises
  • As price falls
    • The quantity supplied falls

Price and quantity supplied move in the same direction.

Why?

  1. Higher price makes producing the good more profitable
  2. Higher price helps cover the rising marginal cost firms typically face as they push output higher

Both effects increase quantity supplied.

The Supply Curve

Price Quantity Supplied
$7.20 40
$7.00 35
$6.80 30
$6.60 25
$6.40 20
$6.20 15

Same soybean market, price per bushel, quantity in thousands of bushels.

The supply curve is upward sloping: a higher price draws out a larger quantity supplied.

What Shifts Supply

Determinants That Shift Supply

  1. Technology: a better production method lets firms produce more at the same cost, raising supply.
  2. Input (resource) prices: a higher cost for labor, materials, or other inputs makes production less profitable, lowering supply.
  3. Number of sellers: more firms in the market raises supply at every price; fewer firms lowers it.
  4. Expectations: if sellers expect a higher price later, they may hold output back now, lowering current supply.
  5. Weather and nature: especially important for agricultural goods, a drought, hurricane, or disease can destroy output and sharply reduce supply.

Notice these are exactly parallel to the demand-side list, just from the seller’s side of the market instead of the buyer’s.

Real-World Example: The Florida Orange Crop

A Wall Street Journal article from September 2025 reported that Florida’s orange output for the 2024 to 2025 marketing year fell to 12.2 million boxes, down from 18 million boxes the year before, the lowest total since the Great Depression.

  • Citrus greening disease, spread by an insect, which has no cure and produces smaller, unusable fruit
  • Storm damage, especially from Hurricane Milton, concentrated in the handful of counties that grow most of Florida’s oranges

Retail orange juice prices reached $11.80 per gallon, up nearly 20 percent from a year earlier.

Market Equilibrium

Where Supply Meets Demand

Put the demand curve and the supply curve on the same graph, and they cross at exactly one point:

  • Market equilibrium
    • Price and quantity where quantity demanded equals quantity supplied.

At the equilibrium price, there is no built-in tendency for price to rise or fall. Buyers are willing to buy exactly the amount sellers are willing to sell.

Example: Finding Equilibrium

Price Qd Qs
$7.20 10 40
$7.00 15 35
$6.80 20 30
$6.60 25 25
$6.40 30 20
$6.20 35 15

At what price does quantity demanded equal quantity supplied?

Equilibrium price is $6.60 per bushel, equilibrium quantity is 25,000 bushels, the only row where quantity demanded and quantity supplied are equal.

Shortages and Surpluses

Away from equilibrium, the market does not clear.

  • Surplus:
    • Price is above equilibrium
    • Quantity supplied exceeds quantity demanded
    • Unsold goods pile up, pushing price back down.
  • Shortage:
    • Price is below equilibrium
    • Quantity demanded exceeds quantity supplied
    • Competition among buyers pushes price back up.

Suppose the federal government set a price floor of $7.00 per bushel of soybeans, above the $6.60 equilibrium.

At $7.00: quantity demanded is 15,000 bushels, but quantity supplied is 35,000 bushels. That is a surplus of 20,000 bushels, since suppliers want to sell far more than buyers want to purchase at that price.

Example: Solving Equilibrium Algebraically

Demand and supply can also be written as equations. Suppose:

\[ Q_d = 50 - 2P \qquad Q_s = 10 + 3P \]

At equilibrium, quantity demanded equals quantity supplied, so set the two equations equal and solve for \(P\).

\[ Q_d = Q_s \quad \Rightarrow \quad 50 - 2P = 10 + 3P \] \[ 40 = 5P \quad \Rightarrow \quad P^{*} = 8 \]

Substitute \(P^{*} = 8\) back into either equation: \(Q^{*} = 50 - 2(8) = 34\).

Equilibrium price is $8, equilibrium quantity is 34 units.

Example: The T-Shirt Market

The demand and supply for t-shirts in a college town are given by:

\[ Q_d = 24{,}000 - 500P \qquad Q_s = 6{,}000 + 1{,}000P \]

where \(P\) is the price in dollars and \(Q\) is the number of t-shirts sold per year.

  1. Find the equilibrium price and quantity.
  2. If price is $18, is there a surplus or a shortage? By how much?
  3. If price is $6, is there a surplus or a shortage? By how much?

The T-Shirt Market: Review

Part a. Set \(Q_d = Q_s\): \(24{,}000 - 500P = 6{,}000 + 1{,}000P\), so \(18{,}000 = 1{,}500P\), giving \(P^{*} = \$12\) and \(Q^{*} = 24{,}000 - 500(12) = 18{,}000\) t-shirts.

Part b. At \(P = 18\): \(Q_d = 24{,}000 - 9{,}000 = 15{,}000\); \(Q_s = 6{,}000 + 18{,}000 = 24{,}000\). Since \(Q_s > Q_d\), that is a surplus of 9,000 t-shirts.

Part c. At \(P = 6\): \(Q_d = 24{,}000 - 3{,}000 = 21{,}000\); \(Q_s = 6{,}000 + 6{,}000 = 12{,}000\). Since \(Q_d > Q_s\), that is a shortage of 9,000 t-shirts.

Price above equilibrium creates a surplus, price below equilibrium creates a shortage, exactly as the graph would show.

How Shifts Change Equilibrium

When Demand Shifts

If demand increases (shifts right) while supply stays the same, the new intersection point moves up and to the right along the fixed supply curve.

An increase in demand raises both equilibrium price and equilibrium quantity. A decrease in demand lowers both.

When Supply Shifts

If supply decreases (shifts left) while demand stays the same, equilibrium moves up and to the left along the fixed demand curve.

A decrease in supply raises price but lowers quantity. An increase in supply does the opposite: price falls and quantity rises.

Worked Example: Predicting a Shift

Consumer income rises, and a toy hoop is a normal good. What happens to the equilibrium price and quantity of hoops?

  1. Income is a determinant of demand, not supply. The supply curve does not move.
  1. Since the hoop is a normal good, higher income increases demand: the demand curve shifts right.
  1. Sliding along the fixed supply curve to the new intersection point, both equilibrium price and equilibrium quantity rise.

Harder Problem: The Florida Orange Shortage

Recall the Wall Street Journal numbers from earlier: citrus greening disease and hurricane damage cut Florida’s orange output from 18 million boxes to 12.2 million boxes in a single year, a 32 percent decline.

Using a supply and demand diagram for the market for oranges (or orange juice):

  1. Which curve shifts, demand or supply? Which direction?
  2. What happens to the equilibrium price?
  3. What happens to the equilibrium quantity?

The Orange Shortage: Review

Part a. Disease and storm damage are supply-side events, they reduce the quantity growers can bring to market at every price. The supply curve shifts left.

Part b. With demand unchanged and supply shifted left, the new equilibrium sits higher on the demand curve: price rises. This matches the article: retail orange juice hit $11.80 per gallon, up nearly 20 percent.

Part c. Sliding up the fixed demand curve to the new, higher price, buyers purchase less: equilibrium quantity falls. This matches the reported drop from 18 million to 12.2 million boxes.

A real supply shock, a crop disease with no cure, plus hurricane damage, produces exactly the textbook prediction: price up, quantity down.

Real Data: Supply and Demand in the Egg Market

Egg Prices Move With Supply and Demand Shocks

Series APU0000708111

  1. In 2022 and 2023, avian flu outbreaks forced farms to cull millions of egg-laying hens. Is that a demand shock or a supply shock?

Answer: a supply shock. Fewer hens means fewer eggs can be produced at any price, so the supply curve shifts left, raising price.

  1. Every November and December, egg prices tend to rise as households buy more eggs for holiday baking. Is that a demand shock or a supply shock?

Answer: a demand shock. More buyers want eggs at every price, shifting the demand curve right and pulling price up even though the number of hens has not changed.

  1. If you saw a sudden price spike on this graph with no other information, could you tell from price alone whether it was a demand shift or a supply shift?

Answer: not from price alone. A price increase is consistent with either an increase in demand or a decrease in supply, you need quantity data or outside context (like a news event) to tell them apart.

Wrap Up: Supply, Demand, and Market Equilibrium

  • The law of demand: price and quantity demanded move in opposite directions, tracing out a downward-sloping demand curve
  • The law of supply: price and quantity supplied move in the same direction, tracing out an upward-sloping supply curve
  • A change in the good’s own price moves you along a curve; a change in anything else shifts the whole curve
  • Market equilibrium is where the demand and supply curves cross, the only price with no shortage and no surplus
  • A shift in demand moves price and quantity in the same direction; a shift in supply moves them in opposite directions