Chapter 3: Demand, Supply, and Market Equilibrium

demand

a schedule or curve that shows the various amounts of a product that consumers are willing and able to purchase at each of a series of possible prices during a specified period of time

demand schedule

a table of numbers showing the amounts of a good or service buyers are willing and able to purchase at various prices over a specified period of time (doesn’t tell us what prices actually exist)

law of demand

the principle that, other things equal, an increase in a product’s price will reduce the quantity of it demanded, and conversely for a decrease in price

diminishing marginal utility

the principle that as a consumer increases the consumption of a good or service, the marginal utility obtained from each additional unit of the good or service decreases

income effect

a change in the quantity demanded of a product that results from the change in real income (purchasing power) caused by a change in the product’s price

• Ex: decrease in price of chicken will cause more people to buy it

substitution effect

A change in the quantity demanded of a consumer good that results from a change in its relative expensiveness caused by a change in the good’s own price

Ex: price of chicken is lower, will be a substitute for beef or pork

demand curve

a curve that illustrates the demand for a product by showing how each possible price (on the vertical axis) is associated with a specific quantity demanded (on the horizontal axis)

determinants of demand

factors other than price that determined the quantities demanded of a good or service: consumer preferences, number of buyers, income, prices of related goods, consumer expectations

network effect

value of product increases as more people use it

• Ex: iPhone use, increase in demand shifts curve to right

congestion effect

the value of a product decreases as more people use it 

• Ex: driving on highways

normal goods

a good or service whose consumption increases when income increases and falls when income decreases, other things equal

Ex: eating out when income increases

inferior goods

a good or service whose consumption declines as income rises, other things equal

Ex: buying store brand items when money is tight

substitute good

products or services that can be used in place of each other

• When the price of one falls, the demand for the other product falls; when the price of one product rises, the demand for the other product rises

• Ex: Ben and Jerry’s and Haagen Dazs ice cream are substitutes

complementary good

products and services that are used together

• When the price of one falls, the demand for the other increases (and conversely)

  • If the price of lettuce goes up, the demand for salad dressing will go down

unrelated goods

vast majority of goods are not related to one another and are called independent goods

consumer preferences

(demand)

A change that makes the product more or less desirable

• Ex: introduction of Instagram and Snapchat decreased the demand for Facebook among teens

number of buyers

(demand)

Increase of number of buyers → increase demand; Decrease in number of buyers → decrease demand

• Ex: Rising number of older people in the US has increased demand for motor homes, medical care, and retirement communities

income

(demand)

Rise in income → rise in demand; decrease in income → decrease in demand; income and substitution effects

prices of related goods

(demand) substitute goods, complementary goods

consumer expectations

(demand)

Changes in consumer expectations may shift demand

• Ex: A newly formed expectation of higher future prices may cause consumers to buy now in order to ‘beat’ the anticipated hike, thus increasing current demand

change in demand

a movement of an entire demand curve (or of the numerical entries in a demand schedule) such that the quantity demanded changes at every particular price; caused by a change in one of more of the determinants of demand

change in quantity demanded

a change in the quantity demanded along a fixed demand curve (or within a fixed demand schedule) as a result of a change in the price of the product

• Movement of one point to another point along the demand curve

supply

a schedule or curve that shows the various amounts of a product that producers are willing and able to make available for sale at each of a series of possible prices during a specified period of time

supply schedule

a table of numbers showing the amounts of a good or service producers are willing and able to make available for sale at each of a series of possible prices during a specified period of time

law of supply

the principle that, other things equal, an increase in the price of a product will increase the quantity of it supplied, and conversely for a price decrease

• The higher the price, the greater this incentive and the greater the quantity supplied

supply curve

a curve that illustrates the supply for a product by showing how each possible price ( on the vertical axis) is associated with a specific quantity supplied (on the horizontal axis)

market supply

To calculate market supply from individual supply, the quantities supplied by each producer are added together at each price

determinants of supply

factors other than price that determine the quantities supplied of a good or service: resource prices, technology, taxes & subsidies, prices of other goods, producer expectations, number of sellers

resource prices

(supply)

• Higher resource prices raise production costs and assuming a particular product price, squeeze profits

• Lower resource prices reduce production costs and increase profits → supply greater output at each product price

technology

Improvements in technology (techniques of production) enable firms to produce units of output with fewer resources

taxes & subsidies

(supply)

• Increase in sales or property taxes will increase production costs and reduce supply

• Subsidies lower the producer’s costs and increase supply

prices of other goods

(supply)

• Firms that produce a particular product can sometimes use their plant and equipment to produce alternative goods

• If the prices of those goods increase, they might switch to the production of the other goods to increase profits (and vice versa)

producer expectations

(supply)

Changes in expectations about the future price of a product may affect the producer’s current willingness to supply that product

number of sellers

(supply)

• The larger the number of suppliers, the greater the market supply; As more firms enter an industry, the supply curve shifts right

• The smaller the number of firms in the industry, the supply curve shifts left

change in supply

a movement of an entire supply curve (or of the numerical entries in a schedule) such that the quantity supplied changes at every particular price; caused by a change in one or more of the determinants of supply

change in quantity supplied

a change in the quantity supplied of a product along a fixed supply curve (or within a fixed supply schedule) as a result of a change in the product’s price

equilibrium price

the price in a competitive market at which the quantity demanded and the quantity supplied are equal, there is neither a shortage nor a surplus, and there is no tendency for price to rise or fall 

equilibrium quantity

the quantity at which the intentions of buyers and sellers in a particular market match at a particular price such that the quantity demanded and the quantity supplied are equal; the profit maximizing output of a firm

productive efficiency

the production of a good in the least costly way; occurs when production takes place at the output lvel at which per-unit production costs are minimized

allocative efficiency

the apportionment of resources among firms and industries to obtain the production of the products most wanted by society (consumers); the output of each product at which its marginal cost and marginal benefit are equal and at which the sum of consumer surplus and producer surplus is maximized

price ceiling

a legally established maximum price for a good, or service. Normally set at a price below the equilibrium price

rent control

a lawe that sets a maximum price on the rents that a landlord can legally charge tenants for renting an apartment or a house

price floor

a legally established minimum price for a good, or service. Normally set at a price above the equilibrium price