2. Micro -- Markets: The Model of Supply and Demand -- Dunbar

Demand

The entire relationship between each possible price of a good and the corresponding quantity the consumer would be willing and able to purchase, "ceteris paribus."

Ceteris Paribus

Latin phrase, meaning "all else held constant" or "all else equal." This modeling assumption allows us to focus only on the relationship between the two variables of interest with all other factors not being allowed to change.

Law of Demand

If the price of an item falls (rises), then buyers are willing to buy more (less) of it, ceteris paribus. Graphically, this law means the Demand curve is negatively-sloped (with a few exceptions where the curve is vertical or horizontal).

The Income Effect

As the price of a good rises (falls), the purchasing power of your dollars of income falls (rises). This is one explanation of the "Law of Demand."

The Substitution Effect

As the price of a good rises (falls), that good becomes more (less) expensive relative to other goods, whose prices haven't changed. People will substitute toward relatively cheaper goods and away from relatively more expensive goods. This is one explanation of the "Law of Demand."

Marginal utility

The additional utility gained from consuming one additional unit of a good.

Law of Diminishing Marginal Utility

As additional units of a single good are consumed, eventually the additional/marginal utility derived from each additional unit of the good decreases. This is one explanation of the "Law of Demand."

Substitutes

Two goods/services that serve roughly the same purpose to buyers. (e.g. PDQ gas and Kwik Trip gas). If the price of one good/service rises (falls), the demand for the other good/service rises (falls).

Complements

Two goods/services which are often consumed together. (e.g. cars and gasoline). If the price of one good/service rises (falls), the demand for the other good/service falls (rises).

Inferior good

A good whose demand falls (rises) when buyers' incomes rise (fall). (e.g. Ramen noodles).

Normal good

A good whose demand rises (falls) when buyers' incomes rise (fall). (e.g. nice vacations).

"Increase in Quantity Demanded"

This happens ONLY when there is a decrease in the price of the good in question. Graphically, this shows as a movement down and to the right along a given demand curve to a larger quantity as the price goes down.

"Decrease in Quantity Demanded"

This happens ONLY when there is an increase in the price of the good in question. Graphically, this shows as a movement up and to the left along a given demand curve to a smaller quantity as the price goes up.

"Increase in Demand"

This happen when something other than the price of the good itself changes and causes people to be willing to buy more of the good at any given price. Graphically, this is shown as a SHIFT of the whole demand curve to the right. (see the class handouts for examples of what might cause this increase).

"Decrease in Demand"

This happen when something other than the price of the good itself changes and causes people to be willing to buy less of the good at any given price. Graphically, this is shown as a SHIFT of the whole demand curve to the left. (see the class handouts for examples of what might cause this increase).

Supply

The entire relationship between each possible selling price of a good and the corresponding quantity firms would be willing and able to produce for sale, "ceteris paribus."

Law of Supply

If the selling price of a good rises (falls), the firms/sellers are willing to sell more (less) of that good, ceteris paribus. Graphically, this means the Supply curve is positively-sloped (with a few exceptions where the curve is vertical or horizontal).

"Increase in the Quantity Supplied"

This happens ONLY when there is an increase in the selling price of the good in question. Graphically, this is shown as a movement up and to the right along a given supply curve to a larger quantity as the selling price goes up.

"Decrease in the Quantity Supplied"

This happens ONLY when there is a decrease in the selling price of the good in question. Graphically, this is shown as a movement down and to the left along a given supply curve to a smaller quantity as the selling price goes down.

"Increase in Supply"

This happen when something other than the selling price of the good itself changes and causes firms/suppliers to be willing to produce more of the good at any given selling price. Graphically, this is shown as a SHIFT of the whole supply curve to the right. (see the class handouts for examples of what might cause this increase).

"Decrease in Supply"

This happen when something other than the selling price of the good itself changes and causes firms/suppliers to be willing to produce less of the good at any given selling price. Graphically, this is shown as a SHIFT of the whole supply curve to the left. (see the class handouts for examples of what might cause this increase).

Subsidy

A payment given to firms or individuals when they undertake a particular activity or produce a particular product. This is the opposite of a tax.

Market

An institution or mechanism allowing buyers (demanders) and sellers (suppliers) to make exchanges.

Equilibrium Price and Equilibrium Quantity

The price and quantity of a good such that quantity demanded equals the quantity supplied. In equilibrium, there is NO shortage or surplus. Graphically, the market equilibrium price and quantity occur where the Supply and Demand curves cross each other.

Price floor

A minimum price allowed by law for a given good or service (e.g. minimum wage).

Price ceiling

A maximum price allowed by law for a given good or service (e.g. rent controls).

Shortage

When quantity demanded exceeds quantity supplied. This typically occurs when the existing price is "too low" (i.e. when the existing price is below the market equilibrium price).

Surplus

When quantity supplied exceeds quantity demanded. This typically occurs when the existing price is "too high" (i.e. when the existing price is above the market equilibrium price).