1.2 Market Forces: Demand and Supply

What is market demand?

The total quantity of a good that all consumers are willing and able to purchase at various prices, holding other factors constant.

What is a market demand curve?

A curve showing the relationship between price and the total quantity demanded by all consumers, ceteris paribus.

How is market demand derived?

By horizontally summing individual demand curves of all consumers in the market.

What is the law of demand?

As the price of a good falls (rises), the quantity demanded increases (decreases), holding other factors constant.

Why does the demand curve slope downward?

Because consumers are willing to buy more at lower prices and less at higher prices.

What is a change in quantity demanded?

A movement along a given demand curve caused solely by a change in price.

What causes a change in quantity demanded?

A change in the price of the good itself.

What is a change in demand?

A shift of the entire demand curve caused by factors other than the good’s own price.

What causes a change in demand?

Changes in income, prices of related goods, advertising/tastes, population, or expectations.

How does income affect demand for normal goods?

An increase in income increases demand; a decrease in income decreases demand.

How does income affect demand for inferior goods?

An increase in income decreases demand; a decrease in income increases demand.

What are substitute goods?

Goods where an increase (decrease) in the price of one increases (decreases) demand for the other.

What are complementary goods?

Goods where an increase (decrease) in the price of one decreases (increases) demand for the other.

How does advertising affect demand?

Advertising can shift demand rightward by increasing awareness or altering consumer tastes.

What is informative advertising?

Advertising that provides information about product existence or quality.

What is persuasive advertising?

Advertising that changes consumer tastes or preferences.

How does population affect demand?

An increase in population increases demand; a decrease reduces demand.

How do consumer expectations affect demand?

Expecting higher future prices increases current demand; expecting lower prices reduces current demand.

What is a demand function?

A mathematical relationship showing how quantity demanded depends on price, income, prices of related goods, and other factors.

What is a linear demand function?

A demand function expressed as a straight-line equation relating quantity demanded to its determinants.

What does the price coefficient in a demand function indicate?

It shows how quantity demanded responds to a change in price and is negative by the law of demand.

How do coefficients indicate substitutes or complements?

A positive coefficient on another good’s price indicates substitutes; a negative coefficient indicates complements.

How do coefficients indicate normal vs inferior goods?

A positive income coefficient indicates a normal good; a negative income coefficient indicates an inferior good.

What is consumer surplus?

The difference between what consumers are willing to pay and what they actually pay.

What is total consumer value?

The total maximum willingness to pay for all units consumed.

Why does consumer surplus exist?

Because consumers pay the market price for all units even though they value some units more.

How is consumer surplus shown graphically?

As the area under the demand curve and above the market price.

What is market supply?

The total quantity all producers are willing and able to sell at various prices, holding other factors constant.

What is the law of supply?

As price rises (falls), quantity supplied rises (falls), holding other factors constant.

Why does the supply curve slope upward?

Higher prices incentivize producers to supply more output.

What is a change in quantity supplied?

A movement along a supply curve caused by a change in price.

What is a change in supply?

A shift of the entire supply curve caused by factors other than price.

How do input prices affect supply?

Higher input prices decrease supply; lower input prices increase supply.

How does technology affect supply?

Improved technology lowers costs and increases supply.

How do government regulations affect supply?

Regulations that increase costs decrease supply; deregulation increases supply.

How does the number of firms affect supply?

Entry increases supply; exit decreases supply.

What are substitutes in production?

Goods that can be produced using the same resources.

How do producer expectations affect supply?

Expecting higher future prices reduces current supply.

What is an excise tax?

A per-unit tax imposed on producers for each unit sold.

How does an excise tax affect supply?

It shifts the supply curve upward by the amount of the tax.

What is an ad valorem tax?

A percentage tax based on the value of the good.

How does an ad valorem tax affect supply?

It rotates the supply curve counterclockwise, making it steeper.

What is a supply function?

A mathematical relationship showing how quantity supplied depends on price, input prices, technology, and other factors.

What is a linear supply function?

A straight-line equation relating quantity supplied to its determinants.

What does the price coefficient in supply indicate?

It is positive, reflecting the law of supply.

What is producer surplus?

The amount producers receive beyond what is necessary to induce production.

Why does producer surplus exist?

Producers receive the market price even though some units would have been supplied at lower prices.

How is producer surplus shown graphically?

As the area above the supply curve and below the market price.

What is market equilibrium?

The point where quantity demanded equals quantity supplied.

What is equilibrium price?

The price at which quantity demanded equals quantity supplied.

What is equilibrium quantity?

The quantity traded at the equilibrium price.

What causes surplus?

A price above equilibrium.

What causes shortage?

A price below equilibrium.

How does the market return to equilibrium?

Through price adjustments driven by shortages and surpluses.

What is the price system?

A mechanism that allocates goods to those willing and able to pay.

What is a price ceiling?

A maximum legal price set below equilibrium.

What is the effect of a binding price ceiling?

Shortage and lost social welfare.

What is a price floor?

A minimum legal price set above equilibrium.

What is the effect of a binding price floor?

Surplus and inefficiency.

Movement vs shift (demand/supply)?

Price change causes movement; non-price factors cause shifts.

Normal vs inferior goods?

• Normal: income ↑ → demand ↑

• Inferior: income ↑ → demand ↓

Excise vs ad valorem tax?

Excise is per unit; ad valorem is percentage-based.