Macroeconomics - Supply and Demand

Consumer Behavior and the Demand Curve

Consumers are limited by their income

Consumers look for ways to make themselves better off

Consumers respond to economic incentives

Law of Demand

As price decreases, the quantity demanded increases

Why is the Demand Curve negatively sloped?

Because of limited income

Producer Behavior and the Supply Curve

Producers are limited by scarcity

Producers look to maximize their profit

Producers respond to economic incentives

Law of Supply

Quantity supplied will increase as prices increase, and decrease as prices fall

Ceterus Parabus

All else remains the same

Combining Supply and Demand on 1 graph

The curves meet at the equilibrium point. This is where most consumers are willing and able to buy, and most suppliers are willing and able to produce

Market Price; Equilibrium

Qs=Qd. It is the most efficient point at which it is no longer possible to make someone better off without making someone else worse off.

Shortage

When price is set below Market Equilibrium, and Qs<Qd; or Qd>Qs

Surplus

When price is set above equilibrium, and Qs>Qd; or Qd<Qs

Change in Quantity Demanded (Qd)

Change in Quantity Demanded refers to a movement along the demand curve, this is caused by a change in price.

Change in Demand

Refers a shift of the Demand Curve not caused by price. Can either shift left or right

Causes for Change in Demand

• Change in Household income

• Change in population

• Change in Expectations

• Change in Tastes and Preferences

• Change in the price of related Goods and Services

Change in Quantity Supplied (Qs)

Refers to a movement along the Supply Curve that is a result of a change in price.

Change in Supply

Change in Supply refers to a shift of the Supply Curve that is not the result of a change in price.

Causes for Change in Supply

• Change in cost of production

• Change in Seller expectations

• Change in number of sellers

• Natural Conditions (i.e. Drought)

• Change in Technology

Related Goods and Services

Substitutes or Complements

Substitute Goods

Goods and Service purchased in place of others. Increase in the price of 1 would result in an increase in Demand of the other.

Complement Goods

Goods and Services purchased alongside other Goods and Services. Increase in the price of 1 would result in a decrease in Demand for the other.

Price Control

Legal minimums or maximums set by government with regards to price.

Price Floor

Results in an economic condition of Surplus, where Qs>Qd. To fill the gap, you must shift the Demand curve to the right.

Price Ceiling

Results in an economic condition of Shortage, where Qs<Qd. Only way to fix this problem is to shift Supply to the right.

Quota

A government can set a limit on how much product can be produced or imported.

Tariff

A government can impose a tax on imported goods as a means of price control.

Elasticity

Used to describe responsiveness in one variable with regards to another

Stages of Demand

• Perfectly inelastic

• Inelastic

• Unitary Elastic

• Elastic

• Perfectly Elastic

Perfectly Inelastic Demand

Demand is a straight vertical line

Applicable to necessities; markets with no substitutes

Inelastic Demand

Shift in price does not have a strong effect on Qd; Steep slope

Few substitutes

Unitary Elastic

Most goods fall in this category

Product Demand changes in a similar proportion to price

Elastic Demand

A lot of substitutes

Small changes in price lead to larger changes in Qd

Perfectly Elastic Demand

Straight horizontal line; No slope

Describes Agricultural Market

How to Calculate Price Elasticity

(Percent Change in Quantity)/(Percent Change in Price)

Midpoint Method

Percent change in demand formula with the denominator being the average of the new and old value.