Ecion chapter 4

What do supply and demand determine in a market economy?

The quantity of each good produced and the price at which it is sold.

How do supply and demand affect the economy?

They determine how much of a good is produced and what the price will be, and they allocate the economy’s scarce resources.

What is the basic concept behind the law of demand?

When the price of a good rises, the quantity demanded falls, and when the price falls, the quantity demanded rises, assuming all other factors are constant.

What is a market?

A market is a group of buyers and sellers of a particular good or service, where buyers determine the demand, and sellers determine the supply.

How can markets be organized?

Some markets are highly organized (like commodity markets with auctions), while others, like the ice cream market, are less organized with various sellers in different locations.

What is competition in a market?

Competition occurs when there are many buyers and sellers, and no single participant has control over the market price.

What does a competitive market mean?

A competitive market is one in which many buyers and sellers exist, and each has a negligible impact on the market price.

What does it mean when buyers and sellers are 'price takers'?

Price takers accept the market price because they cannot influence it, either due to competition or the market being highly competitive.

What is a monopoly?

A monopoly is a market with only one seller, who controls the price of a good or service.

What are the two characteristics of a perfectly competitive market?

1. All goods offered for sale are identical. 2. There are so many buyers and sellers that no single participant can influence the price.

What is the primary benefit of assuming a perfectly competitive market in economic analysis?

It simplifies the analysis because participants cannot influence the market price, making it easier to understand how supply and demand function.

What is the law of demand?

The claim that when the price of a good rises, the quantity demanded of that good falls, and when the price falls, the quantity demanded rises, holding all else equal.

What is a demand schedule?

A demand schedule is a table that shows the relationship between the price of a good and the quantity demanded, holding all other factors constant.

What is a demand curve?

A demand curve is a graph of the relationship between the price of a good and the quantity demanded, typically sloping downward.

What does the downward slope of the demand curve represent?

It represents that as the price of a good decreases, the quantity demanded increases.

How is market demand different from individual demand?

Market demand is the total quantity of a good demanded by all buyers at each price, whereas individual demand refers to the quantity demanded by one consumer.

How do you calculate market demand from individual demand schedules?

To calculate market demand, add the quantities demanded by all individuals at each price point.

What happens when individual demand schedules are summed?

The sum of individual demand schedules at each price gives the market demand curve.

What happens when the demand curve shifts to the right?

The demand for the good increases, meaning consumers are willing to buy more at each price.

What causes the demand curve to shift to the left?

A decrease in demand, meaning consumers are willing to buy less at each price.

What factors can shift the demand curve?

Changes in income, the prices of related goods, tastes, expectations, and the number of buyers can all shift the demand curve.

How does a change in income affect demand for normal goods?

For normal goods, an increase in income increases demand, and a decrease in income decreases demand.

What is an inferior good?

An inferior good is one for which demand increases as income falls (e.g., bus rides when income decreases).

What are substitutes?

Substitutes are goods that can replace each other. A decrease in the price of one increases the demand for the other (e.g., ice cream and frozen yogurt).

What are complements?

Complements are goods that are often used together. A decrease in the price of one increases the demand for the other (e.g., ice cream and hot fudge).

How do tastes influence demand?

If tastes change, it can affect the quantity of a good demanded, such as preferring one dessert over another.

How do expectations about the future affect current demand?

If consumers expect higher future income, they may increase current demand. If they expect prices to drop, they may decrease current demand.

How does the number of buyers affect market demand?

An increase in the number of buyers increases the total market demand for a good at every price.

What is the general rule for shifting the demand curve?

If a variable that affects demand changes, the demand curve will shift. If only the price changes, it results in movement along the curve.

What does Table 1 in the chapter outline?

It outlines the variables that influence how much of a good consumers are willing to buy, such as price, income, related goods, tastes, expectations, and the number of buyers.

What is a movement along the demand curve versus a shift of the demand curve?

A movement along the demand curve occurs when the price of the good changes, while a shift in the demand curve occurs when any factor other than the price (like income or the number of buyers) changes.

What happens to the demand curve when the price of the good changes?

A change in the price leads to a movement along the demand curve, rather than a shift of the curve.

What role does the price of related goods play in shifting the demand curve?

If the price of a related good (substitute or complement) changes, it can either increase or decrease the demand for a good, shifting the demand curve.

Income

Shifts the demand curve

Prices of related goods

Shifts the demand curve

Tastes

Shifts the demand curve

Expectations

Shifts the demand curve

Number of buyers

Shifts the demand curve

Policy approach: Advertising, warnings, banning TV ads

Shifts the demand curve for cigarettes to the left (less demanded at every price)

Policy approach: Taxes on cigarettes

Raises price, causing movement along the demand curve (less demanded due to higher price)

Shift in demand vs. movement along the curve

Shift = demand changes at all prices; movement = change in quantity demanded due to price change

Example: $4/pack to 10/day -> 20/day

Shift from point A to point B (leftward shift in demand)

Example: $4 to $8 per pack, 20 to 12/day

Movement from point A to point C (up along same demand curve)

10% price increase on cigarettes

Leads to 4% reduction in quantity demanded

10% price increase on cigarettes (teenagers)

Leads to 12% drop in teenage smoking

Tobacco and marijuana relationship

Complementary goods (lower tobacco prices → higher marijuana use)

Quantity supplied

The amount of a good sellers are willing and able to sell

Law of supply

When price rises, quantity supplied rises (all else equal); when price falls, quantity supplied falls

Supply schedule

Table showing relationship between price and quantity supplied

Supply curve

Graph showing the supply schedule (price vs. quantity supplied)

Why the supply curve slopes upward

Higher prices make production more profitable, so sellers supply more

Market supply

Sum of all individual sellers’ supplies at each price

How to find market supply

Add quantities supplied by each individual seller horizontally at each price

Input prices

When input prices fall, supply increases (shifts right); when input prices rise, supply decreases (shifts left)

Technology

Improved technology increases supply (shifts supply curve right)

Expectations (supply side)

If sellers expect higher future prices, they reduce supply today (shift supply curve left)

Number of sellers

More sellers increase market supply (shift right); fewer sellers reduce supply (shift left)

Change in price

Leads to a movement along the supply curve, not a shift

Equilibrium price

The price at which quantity supplied equals quantity demanded

Equilibrium quantity

The quantity bought and sold at equilibrium price

Surplus

When quantity supplied > quantity demanded (price is above equilibrium)

How markets correct surplus

Sellers lower prices → demand increases, supply decreases → equilibrium restored

Shortage

When quantity demanded > quantity supplied (price is below equilibrium)

How markets correct shortage

Sellers raise prices → demand decreases, supply increases → equilibrium restored

Law of supply and demand

Price adjusts to bring quantity supplied and demanded into balance

Three steps to analyzing equilibrium changes

1) Decide which curve shifts. 2) Decide direction of shift. 3) Use graph to see effect on price & quantity

"Market Adjustment Toward Equilibrium"

"When too many buyers chase too few goods, a shortage occurs. Suppliers respond to shortages by raising prices. When there’s a surplus (more goods than buyers), sellers lower prices to sell excess stock. In both cases, price adjustments move the market toward equilibrium."

"Excess Supply (Surplus)"

"At price $2.50, quantity supplied is 10 cones, quantity demanded is 4 cones, resulting in a surplus of 6 cones. Sellers lower the price to eliminate the surplus."

"Excess Demand (Shortage)"

"At price $1.50, quantity supplied is 4 cones, quantity demanded is 10 cones, resulting in a shortage of 6 cones. Sellers raise the price to eliminate the shortage."

"Three Steps to Analyze Equilibrium Changes"

"1. Decide which curve shifts (supply, demand, or both). 2. Determine the direction of the shift (right or left). 3. Use a diagram to compare the initial and new equilibrium."

"Hot Weather Increases Demand for Ice Cream"

"Hot weather shifts the demand curve to the right because people want more ice cream at every price, while supply remains unchanged."

"Effect of Hot Weather on Market"

"Demand curve shifts right, increasing equilibrium price from $2.00 to $2.50 and quantity from 7 to 10 cones due to excess demand at old price."

"Change in Supply vs Change in Quantity Supplied"

"Change in supply refers to a shift of the supply curve, while change in quantity supplied is a movement along the curve due to price change."

"Change in Demand vs Change in Quantity Demanded"

"Change in demand refers to a shift of the demand curve, while change in quantity demanded is a movement along the curve due to price change."

"Hurricane Increases Sugar Prices → Decrease in Ice Cream Supply"

"Higher sugar prices shift the supply curve left because production costs increase, reducing the quantity supplied at every price; demand stays the same."

"Effect of Hurricane on Market"

"Supply curve shifts left, increasing equilibrium price from $2.00 to $2.50 and decreasing quantity from 7 to 4 cones due to excess demand at old price."

"Hot Weather + Hurricane Occur Together"

"Demand curve shifts right due to hot weather, supply curve shifts left due to hurricane; equilibrium price rises but quantity change depends on relative size of shifts."

"When Demand Increases More Than Supply Decreases"

"Equilibrium price rises and quantity rises."

"When Supply Decreases More Than Demand Increases"

"Equilibrium price rises but quantity falls."

"Summary of Shifts in Supply and Demand"

"Whenever supply or demand shifts, use supply-and-demand diagrams to predict changes in equilibrium price and quantity."

A Shift in Both Supply and Demand

Here we observe a simultaneous increase in demand and decrease in supply. Two outcomes are possible. In panel (a), the equilibrium price rises from P1 to P2, and the equilibrium quantity rises from Q1 to Q2. In panel (b), the equilibrium price again rises from P1 to P2, but the equilibrium quantity falls from Q1 to Q2.

(a) Price Rises, Quantity Rises

Graph shows a large increase in demand and a small decrease in supply, resulting in both price and quantity increasing from initial equilibrium to new equilibrium.

(b) Price Rises, Quantity Falls

Graph shows a small increase in demand and a large decrease in supply, resulting in price rising but quantity falling from initial equilibrium to new equilibrium.

TABLE 4: What Happens to Price and Quantity When Supply or Demand Shifts?

A quick quiz to explain entries in the table using supply-and-demand diagrams.