2.1 Supply & Demand

Market

is a mechanism that allows buyers and sells to meet and enables transactions between them.

Elements of Supply & Demand model

• Buyers (also known as consumers or customers)

• Sellers (also known as producers or firms)

• Market

In a perfectly competitive market

• There are many buyers and sellers

• Sellers offer the same goods or services

• No individual's actions have a noticeable effect on the price at which the good or service is sold

• Buyers and sellers are

Demand

represents the behavior of buyers.

Demand Curve

shows the quantity demanded at various prices.

Law of Demand

 states that, other things equal, the quantity demanded of a good fall when the price of the good rises. (assumption) (fix factors other constant)

Quantity demanded

the quantity that buyers are willing (and able) to purchase at a particular price. - the number of buyers at a given price (the point)

Consumer Surplus

the consumers gain from exchange; the difference between the maximum price a consumer is willing to pay for a certain quantity and the market price. (net gain)

Total Consumer Surplus

the area beneath the demand curve and above the price. (If you are lining up all the buyers according to their willingness to pay, then you will get a line of buyers' willingness)

increase in quantity demanded

means a movement down along the demand curve. Movement down the curve.

increase in demand

means a rightward shift of the demand curve. (rightward shift)

demand shifters

• changes in income

• inferior/normal good

• Changes in the prices of related goods or services.

• Substitutes/complements

• Changes in taste

• Changes in expectations'

• Changes in number of consumers

normal good

 when a rise in income increases the demand for a good. (Example big brands)

inferior good

when a rise in income decreases the demand for a good (ramen noodles)

substitutes

if a fall in the price of one of the goods makes consumers less willing to buy the other good (Coke vs. Pepsi)

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

Complements

If a fall in the price of one good makes people more willing to buy the other good (hot dogs and hot dog buns)

Two goods are complements if an increase in the price of one causes a fall in the demand for the other.

Supply

represents the behavior of sellers

Supply Curve

shows the quantity supplied at various prices

Quantity supplied

is the quantity that producers are willing and able to sell at a particular price. (one single point)

Supply schedule

shows how much of a good or service would be supplied at different prices

Law of Supply

the claim that the quantity supplied of a good rise when the price of the good rises, other things equal.

Producer Surplus

The producer’s gain from exchange, or the difference between the market price and the minimum price at which a producer would be willing to sell a particular quantity.

Total Producer Surplus

the area above the supply curve and below the price.

Supply Shifters

• Changes in input prices

  • An input is a good that is used to produce another good

• Changes in technology

• Changes in expectations

• Changes in related goods (substitutes in product, complements in production) (co-product and by-product)

• Changes in the number of producers

Equilibrium Price

the price that equates quantity supplied with quantity demanded

Equilibrium

in a competitive market occurs when:

Quantity supplied = Quantity demanded

Surplus

when the quantity supplied exceeds, the quantity demanded.

Occurs when the price is above its equilibrium level.

Shortage

when the quantity demanded exceeds, the quantity supplied.

Shortages occur when the price is below its equilibrium level.

Changes in Equilibrium

• Decide whether the events shift the supply, demand curve, or both

  • Shift of supply = increase/decrease in supply

  • Shift of demand = increase/decrease in demand

• Decide whether the curve(s) shift(s) to the left or to the right

• Use the demand-and-supply diagram to see how the shift affects equilibrium price and quantity.