Microeconomics (Supply and Demand)

Assumptions of demand

• Perfectly competitive market - many buyers and sellers

• A price enterprise system exists where economic decisions are made through the market mechanism

What is market mechanism

• Prices goes up

  • Consumers buy less which tells suppliers that the price is too high

• Prices goes down

  • Consumers buy more which tells suppliers that the price is too low

1. How does market prices bring order by

1. Information

2. Incentives

What is a demand curve

• The demand curve refers to the entire relationship between price and demand

• Demand curve shows how quantity demanded is affected by only price

What is quantity demanded

A single point on the demand curve is the quantity demanded at that price

What is the law of demand

• Ceteris Perebis

• There is an inverse relationship between the price of a product and the quantity demanded

• If price increases, quantity demanded decreases

• If price decreases, quantity demanded increases

What are the justification for the law of demand

1. Common sense

2. Diminishing marginal utility

3. The substitution effect

4. The real income effect

Common sense - lod

• Price is an obstacle

Diminishing marginal utility - lod

• Consumption is subject to the law of diminishing marginal utility which is:

  • Each buyer of a product derives less and less utility (benefit or satisfaction) from each successive unit consumed

  • Therefore: more is consumed only if price falls

The substitution effect - lod

• A change in quantity demanded resulting from substitution one good for another

  • For example, if the price of apples decreases, some buyers will switch from other relatively more expensive fruit

• Therefore, quantity of apples demanded increase

  • If the price of apples increases, buyers will switch to a relatively less expensive fruit

• Therefore, quantity demanded decrease

The real income effect - lod

• A change in quantity demanded resulting from a change in purchasing power of real income

• For instance, if the price of apples decreases, while your real money income and the price of all other products remain constant, then your ability to purchase apples increases, and quantity demanded of apples goes up, your income goes up

What are the factors of quantity demanded

• Price

• Non-price determinants

What are the non proce determinants of quantity demanded

1. Change in real income

2. Change in population

3. Change in preferences/tastes

4. Change in future expectations

5. Change in related goods (complement/substitute)

What are the assumptions of law of supply

• Perfectly competitive market (many buyers and sellers)

• Producers are of a constant quality

• Short run analysis

What is the law of supply 

• other things being equal (CP), there is a direct relationship between price and the quantity supplied if price increases, quantity supplied increases or if price decreases, quantity supplied decreases  

Supply curve

• shows the entire relationship between price and quantity supplied

What is a single point on the supply called

It refers to the quantity supplied at that price

What are the non price determinants of supply

1. Cost of resources inputs

2. Technology

3. Prices of related goods

4. Subsidies and taxes

5. Expectations

6. Number of sellers

Cost of resources input

• If the price of a resource input falls, production costs fall

• Causes a change in supply (curve shifts a supply increases favorably)

Technology

• Technological advance - firms allowed to produce each unit of output more efficiently (less resource inputs required)

• Production costs fall

• Supply increases favorably

Prices of related goods

a. Substitute in production

• Goods that can be produced as Substitutes using the same resources efficiently

b. Complement in production

• The production of one good ideas to the automatic output of the other (by product)

• Thus the supply of one is directly related to the price the supplier can get for the other product in the market

Taxes

• Treated as costs borne by the producer

• They will be absorbed into the prices

• It unfavorably impacts the entire supply curve as the seller knows that often the entire amount of the tax cannot be passed on to the consumer

Subsidies

• Are treated as gifts from the government for the seller (producer)

• Allows firms to decrease their production costs

• Favorably impacting their ability to supply output

• Expectations

• Difficult to predict

• Farmers (suppliers) might withhold some of their current crop in anticipation of a higher price they might receive in the future

• Particularly true in agriculture if there is a bumper crop (lots grown in one season)

Number of sellers

• Over a longer period of time, firms in an industry can hire more workers and expand their investment in capital and allow other firms to freely enter the industry to compete