Demand and Supply: Basics

September 9, 2009

Demand

Ceteris Paribus “all else remaining the same” or “other things

being equal” Relative prices and Money Prices

Money Price is the price that is observed in terms of today’s dollars.

Relative price is the price of good or service in terms of another. It is the money price of one commodity divided by the money price of another; the number of units of one commodity that must be sacrificed to purchase one unit of another commodity.

Demand

Demand

The money prices of both commodities has fallen from last year to this year.

The relative price of 4-Gigabite flash memory drives has fallen, whereas the relative price of rewritable DVDs has risen.

When evaluating the effects of price changes, we must always compare price per constant-quality unit.

Demand

In a market economy, the price of a good is determined by the interaction of demand and supply.

All the analysis about demand and supply in this chapter will be in the competitive market.

Competitive Market: a market that has many buyers and many sellers so no single buyer or seller can influence the price.

Demand

Demand is the relationship between the price of a good and the quantity of the good demanded at each price. The various combinations of price and

quantity demanded can be reported in a demand schedule.

Each individual in a market has a demand schedule since each person has different preference over the products.

Demand

The law of demand: The greater the price the lower the quantity demanded, other things being equal.

This is the result of two effects: Substitution Effect: The tendency for

people to substitute in favor of cheaper goods and away from more expensive ones.

Income Effect: The change in people’s purchasing power when the price of one of the goods they buy changes.

Demand

The good with an upward demand curve is called “Giffen Good”, but it rarely exits in the real world.

Discussion: Whether luxury goods are Giffen Goods?

Some people say that in certain circumstances, only when the prices of some goods, such as luxury goods, are high, they tend to be willing to buy it. When the prices are low, they will not buy it.

Demand

Market Demand: the total quantity demanded in the market equals the sum of the quantities demanded by each person in the market at a given price.

The law of demand also holds for market demand.

Demand

Demand schedules in the Market for Chewing Gum

PriceQuantity Demanded by Total

Quantity Demanded

Person 1 Person 2 Person 3 Person 4

$0.01 10 17 13 20 60

$0.10 7 16 10 17 50

$0.20 5 15 5 15 40

$0.30 4 8 4 14 30

$0.40 2 6 3 9 20

$0.50 1 3 1 5 10

Demand

A simple demand curve

Demand

Distinction between Quantity Demanded and Demand Demand: The overall relationship

between price and quantity demanded. Quantity Demanded: The amount that

would be purchased at a given price. A change in demand is not the same

as a change in the quantity demanded.

Demand

A change in demand indicates a shift of the demand curve.

A change in the quantity demanded is represented by the movement long the demand curve, when there is a change of the own price.

Demand

A change in the quantity demanded versus a change in demand

A change in demand – shift of

demand curve

A change in demand – shift of

demand curve

A change in the quantity changed – movement

along the same demand curve

A change in the quantity changed – movement

along the same demand curve

Demand

Determinants of Demand ( other than own price) Changes in the prices of related goods The disposable income of consumers Expected future prices and future

income The number of demanders in the

market(market size) Tastes and Preferences

Demand

Changes in the prices of related goods Substitutes: Goods that can replace

each other in consumption. Complements: Goods that are used in

conjunction with each other. When the price of a substitute increases,

ceteris paribus, the demand for the good in focus will increase. When the price of a complement increases, the demand for the product in focus will decline.

Demand

The disposable income of consumers Normal goods: Demand increases after

an increase in income. Inferior goods: Demand decreases after

an increase in income.

Demand Expected future prices and future income If a sufficient number of demanders expect the

price of the good to increase in the future, these people will increase their demand for the product today in order to stock up on the good and avoid the higher price in the future. If a sufficient number of demanders think the price will decline tomorrow, the demand today will decrease.

Expectation of a rise in income may cause consumers to purchase more of normal goods today at current prices.

Demand

The number of demanders in the market(market size)

As the number of demanders in the market or population increases, the demand for the good increases.

Tastes and Preferences If the taste or preference increases, then the

demand for that product will increase, and vice versa.

Economists tend to think that preferences change slowly over time and therefore this influence on demand is relatively minor.

Supply

Supply is the relationship between the price of a good and the quantity supplied by producers.

A market supply is found by adding up individual producer supply schedules. Summing the quantity supplied at each price by each producer (horizontal summing of the individual supply curves) derives the market supply curve.

Supply

The law of supply: The higher the price of a good, the greater the quantity supplied, other things being equal.

The law of supply is the result of the law of increasing cost. As the quantity of a good rises, the

marginal opportunity cost rises. Sellers will only produce and sell additional

unit of a good if the price rises above the marginal opportunity cost of producing additional unit.

Supply

Supply Schedules in the Market for Chewing Gum

PriceQuantity Supplied by Total

Quantity Supplied

Firm 1 Firm 2 Firm 3

$0.01 10 15 0 25

$0.10 20 25 5 50

$0.20 30 35 10 75

$0.30 40 45 15 100

$0.40 50 55 20 125

$0.50 60 65 25 150

Supply

A simple supply curve

Supply

A change in supply indicates a shift of the supply curve.

A change in the quantity supplied is represented by the movement long the supply curve, when there is a change of the own price.

Supply

Determinants of Supply (other than own price) The prices of factors of production The price of related goods: substitutes and

complements in the production process. Expected future prices Number of suppliers Technology Taxes and subsidies The state of nature

Demand and Supply

Market Equilibrium Equilibrium is a situation in which

opposing forces balance each other.

In the supply and demand model, the equilibrium occurs when there is neither a shortage nor a surplus in the market.

Demand and Supply

Supply and demand diagram

SurplusSurplus

Shortage

Shortage

Demand and Supply

Equilibrium Price is the price at which the quantity demanded equals the quantity supplied.

Equilibrium Quantity is the quantity bought and sold at the equilibrium price.

Demand and Supply

Changes in demand and Supply does not change Increase in demand leads to a rise in the

equilibrium price and quantity. Decrease in demand leads to a fall in

the equilibrium price and quantity.

Demand and Supply

Changes in demand

Demand and Supply

Changes in supply and demand does not change Increase in supply leads to a fall of

equilibrium price and quantity. Decrease in supply leads to a rise of

equilibrium price and quantity.

Demand and Supply

Changes in supply

Demand and Supply

Changes in supply and demand(in the same direction) If both the demand and the supply of a good

or service increase, both the demand and supply curves shift rightward. The quantity unambiguously increases but the effect on the price is ambiguous. If the increase in demand is greater than the increase

in supply, the price rises. If the increase in demand is the same size as the

increase in supply, the price does not change. If the increase in demand is less than the increase in

supply, the price falls.

Demand and Supply

If both the demand and the supply of a good or service decrease, both the demand and supply curves shift leftward. The quantity unambiguously decreases but the effect on the price is ambiguous. If the decrease in demand is greater than the

decrease in supply, the price falls. If the decrease in demand is the same size as

the decrease in supply, the price does not change.

If the decrease in demand is less than the decrease in supply, the price rises.

Demand and Supply

Increase in both demand and supply

Demand and Supply

Changes in supply and demand(in the opposite direction) If the demand increases and the supply

decreases, the demand curve shifts rightward and the supply curve shifts leftward. The price unambiguously rises but the effect on the quantity is ambiguous. If the increase in demand is greater than the

decrease in supply, the quantity increases. If the increase in demand is the same size as the

decrease in supply, the quantity does not change. If the increase in demand is less than the decrease

in supply, the quantity decreases.

Demand and Supply

If the demand decreases and the supply increases, the demand curve shifts leftward and the supply curves shifts rightward. The price unambiguously falls but the effect on the quantity is ambiguous. If the decrease in demand is greater than the

increase in supply, the quantity decreases. If the decrease in demand is the same size as

the increase in supply, the quantity does not change.

If the decrease in demand is less than the increase in supply, the quantity increases.

Demand and Supply

Increase in supply and a decrease in demand