Lecture 3: Supply and Demand Analysis

Market

A group of buyers and sellers of a particular product

Competitive Market

A market with many buyers and sellers, each with no effect on price

What is true of a perfectly competitive market?

In a perfectly competitive market

• All goods are exactly the same

• There are so many so many buyers and sellers that no one can affect the market price, all of them are price takers

Quantity Demanded

The amount of the good that buyers are willing and able to purchase

Law of Demand

Law that states that the quantity demanded of a good falls when the price of a good rises

• As Price increases, the Quantity demanded of a good falls

Demand Schedule

Table that shows the relationship between the price of a good and the quantity demanded

How does the demand curve look like with price on y axis and quantity on the x?

Demand curve is downward sloping

• As price decreases, a higher quantity is demanded

What is the quantity demanded in the market?

The quantity demanded in a market is the sum of the quantities demanded by all buyers at each price

What are factors that cause a movement along the demand curve?

A change in the price of the good or service causes a movement along the demand curve

• Movement represents a change in quantity demanded

What are the factors that shift the demand curve?

Shifters of the demand curve include:

• Change in the number of buyers

• Change in Income

• Price of related goods, like substitutes and complements

• Change in tastes

• Expectations

How does a change in the number of buyers affect the demand curve?

Market demand= sum of individual demand

• Increase in the number of buyers increases the quantity demanded at each price, and shifts D curve to the right

How does a change in income shift the demand curve?

For a normal good, demand is positively related to income

• Increase in income → increase in QD at each price, and shift in D curve to the right

• Demand for an inferior good is negatively related to income, increase in income shifts D curve to the left

How does income shift demand curve for an inferior good?

Demand for an inferior good is negatively related to income

• An increase in income shifts the Demand curve for inferior goods to the left

How do you know if two goods are substitutes?

Two goods are substitutes if an increase in the price of one, causes an increase in demand for the other

• Substitutes= similar goods that can be used as replacements

How do you know if two goods are complements?

Two goods are complements if an increase in the price causes a decrease in the demand for the other

• Goods that are related to one another

Example of how complements affect the demand curve

For example, computers and software are complements

• If the price of computers rise, people buy less computers, and less software

• Demand curve for software decreases (shifts left)

How does a change in tastes affect the demand curve?

A shift in taste towards a good increases the demand for that good and shifts the demand curve to the right

• Shift away from a good does the opposite, decreases the demand and shifts the demand curve to the left

How do expectations affect the demand curve?

Expectations influence consumers’ buying decisions

• If economy is bad, demand for cars falls

Demand curve for music downloads. What happens to it in each of the following scenarios?

A) Price of smartphones falls

B) Price of music downloads falls

C) The price of compact discs falls

A) Price of smartphone falls and since music downloads and smartphones are complements, people buy more smartphones and more music downloads, shift in the demand curve right

B) Price of music downloads falls, since the price is lower, quantity demanded is higher, shift along the demand curve

C) Price of compact discs fall. Compact discs and music downloads are substitutes, so a decrease in the price of compact discs= more people buy compact discs, and a decrease in the quantity of music downloads at every price. Shift in the demand curve left

Quantity supplied

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

Law of supply

The claim that the quantity supplied of a good rises when the price of a good rises

• Price increases, so the quantity supplied increases

Supply Schedule

A table that shows the relationship between the price of a good and the quantity supplied

• As the price of a good increases, the QS increases

How does the demand curve look like?

The demand curve is upwards sloping with Q on the x axis and P on the y axis

What is the quantity supplied in the market?

The quantity supplied in the market is the sum of the quantities supplied by all sellers at each price

What causes a movement aong the supply curve?

A movement along the supply curve is caused by a change in the price of the good or service itself

What are factors that cause a shift in the demand curve?

Factors that shift the demand curve are:

• Input prices

• Technology

• Number of sellers

• Expectations

How do input prices affect the supply curve?

A fall in input prices makes production more profitable at each output price, so firms supply a larger quantity at each price, shift to the right for the supply curve

• Decrease in input prices → Profit per unit is higher → Firms supply more at each price

• Opposite if there is an increase in input prices

How does a change in technology shift the supply curve?

Technology determines how much inputs are required to produce a unit of output

• Increase in technology, increases per unit profit, shifts supply curve to the right

How does a change in the number of sellers affect the supply curve?

Increase in the number of sellers increases the quantity supplied at each price, shifts the Supply curve to the right

• Decrease in the number of sellers has the opposite effect, it decreases the Qs at each price and shifts S curve to left

How do changes in expectations affect the supply curve?

When there are expectations of higher prices, suppliers save some of the good to sell later at the higher price, S curve shifts left

• Opposite shift of the supply curve

If there is a supply curve for tax return software, what happens in each case?

A) Retailers cut the price of the software

B) Technology allows software to be made at a lower cost

C) Tax preparers increase price of the services provided

A) Decrease in price of the software→ less profit made→ decrease in quantity supplied of the software, movement along the supply curve left

B) Increase in technology→ more profit due to reduced costs→ increase in supply of software, shift right of the supply curve

C) Tex return preparers raise the price of the services they provide: Doesn’t affect supply, only demand

What is the equilibrium?

Equilibrium is where quantity supplied and quantity demanded are equal

Equilibrium Price

The price where where quantity supplied and quantity demanded are equal

Surplus

When the Quantity supplied (QS) is greater than the Quantity demanded (QD)

• Excess supply

What happens when there is a surplus?

When there is a surplus, the QD is greater than the QS, so sellers try to increase sales by decreasing price

• With decrease in price, QD rises and QS falls, which reduces the surplus

• Price continues to fall until the market reaches an equilibrium

What happens when there is a shortage?

When there is a shortage, QD is larger than the QS

• More demand than supply

• With a shortage, sellers raise the price, causing QD to fall and QS to rise

• Prices continue to rise, until the market reaches equilibrium

If there is a supply demand diagram for the market for hybrid cars. Price of hybrid cars on y and quantity of hybrid cars on x, how does an increase in the price of gas affect the market?

Gas is a subsitute for hybrid cars.

• Increase in the price of gas, decreases the demand for gas, increases demand for hybrid cars, shift right of demand curve for hybrid cars

• Increase in price and quantity of hybrid cars

If there is a supply demand diagram for the market for hybrid cars. Price of hybrid cars on y and quantity of hybrid cars on x, how does new technology that reduces the cost of making hybrid cars affect it?

New technology reduces the cost→ more profit → increase in the quantity of hybrid cars at every price

• Shift in the supply curve for hybrid cars right

If there is a supply demand diagram for the market for hybrid cars. Price of hybrid cars on y and quantity of hybrid cars on x, how does price of gas increasing and new technology reducing production costs affect it?

Price of gas increasing = Increase in demand for hybrid cars

New technology= Increase in supply for hybrid cars

• Shift in the demand and the supply curve right

• Q rises, but affect on P is ambigious, if demand increaes more than supply, then P rises

• But if supply increases more than demand, P falls