Supply and demand

Eco 2301: Supply and Demand (Fall 2024)

Paradox of Value

  • Introduction to Value

    • Miss Diamond: Costs $1,000,000 for a small bit.

    • Mr. Water: Costs $1 a bottle.

    • Market Price Equation:

    • Market Price = Want/Need + Scarcity

Introduction to Demand and Supply

  • Concepts Defined:

    • Want/Need: Basis for consumer demand.

    • Demand: Represents the quantity of a good consumers are willing to purchase.

    • Scarcity: Limited availability of resources affecting supply.

    • Supply: Amount of a good that sellers are willing to produce.

    • Buyers and Sellers:

    • 1. Buyers have money and seek products.

    • 2. Sellers have products and desire money.

    • 3. ???

    • 4. Profit

    • Markets function to 'clear' all goods.

Consumer Behavior

  • Buying Scenario:

    • When purchasing, consumers have finite resources (e.g., a $5 limit at Braum's for ice cream).

    • Consumers have a maximum price they are willing to pay based on budget constraints.

Examples of Pricing and Demand: Ice Cream

  • Scenario 1:

    • Going to Braum’s with $5, the maximum price for 1 scoop of ice cream would be $5.

  • Scenario 2 - Ice Cream Day (3rd Sunday in July):

    • Special price: $2.50 per scoop.

    • Maximum scoops purchased: rac52.50=2rac{5}{2.50} = 2 scoops.

  • Scenario 3 - 2068 Anniversary Special:

    • Special price: $1.25 per scoop.

    • Maximum scoops purchased: rac51.25=4rac{5}{1.25} = 4 scoops.

Demand Curve and Demand Schedule

  • Demand Schedule Example:

    • Price per bottle vs. quantity demanded:

    • $30: 3 bottles

    • $30: 25 bottles

    • $20: 5 bottles

    • $10: 10 bottles

    • Visual: Demand curve slopes downward, indicating that as prices fall, quantity demanded increases.

Family Demand Schedules

  • Smith Family Babysitting Demand Schedule:

    • Price per hour and hours demanded per month.

    • $4.00: 55 hours

    • $5.00: 45 hours

    • $10.00: 20 hours.

Law of Demand

  • Definition:

    • Economic law stating that when the price of a product increases, the quantity demanded generally decreases and vice versa (ceteris paribus).

  • Exceptions:

    • Veblen Goods: High-quality goods viewed as status symbols.

    • Giffen Goods: Inverse relationship where demand increases as price rises for basic survival goods.

Factors Influencing the Law of Demand

  • Total Effect: The change in quantity demanded due to price changes.

  • Substitution Effect: Consumers substitute towards a less expensive good as its price decreases.

  • Income Effect: Changes in purchasing power relative to price changes.

Ceteris Paribus Condition

  • Refers to analyzing the effect of price changes while holding all other variables constant, essential to constructing accurate demand curves.

Shifts in Demand

  • Variables that Shift Demand:

    • Changes in consumer income

    • Prices of related goods (substitutes and complements)

    • Consumer preferences and tastes

    • Population demographics

    • Expected future prices

    • Natural disasters and pandemics.

Practical Example Effects on Demand

  • Example 1: If Pepsi lowers prices, demand for Coca-Cola decreases as consumers switch.

  • Example 2: During a recession, decreased consumer income leads to decreased demand for non-essential goods.

  • Example 3: Celebrity endorsements (e.g., Taylor Swift for Diet Coke) can increase demand due to heightened interest.

Changes in Demand vs Quantity Demanded

  • Change in Demand: A shift in the entire demand curve due to external factors.

  • Change in Quantity Demanded: Movement along the demand curve caused by price changes only.

Sellers and Supply

  • Supply Concept: The quantity of a good that a seller is willing to offer at a given price.

  • Price and Profit: Higher prices result in increased supply due to higher profitability incentives.

Supply Schedules and Supply Curves

  • Example Supply Schedule (Water Bottles):

    Price per Bottle

    Quantity Supplied (millions per week)

    $30

    7

    $20

    5

    $10

    10

  • Law of Supply: Increases in price lead to an increase in quantity supplied and vice versa.

Shifts in Supply Curve

  • Factors that Shift Supply:

    • Input price changes

    • Technology advancements

    • Number of suppliers entering the market

    • Expected future prices

    • Effects of natural disasters.

Market Equilibrium

  • Definition: Intersection point where quantity supplied equals quantity demanded.

  • Market Surplus: Occurs when the price is too high, leading to excess supply.

  • Market Shortage: Occurs when the price is too low, leading to excess demand.

  • Equilibrium Price: Price at which the market clears (quantity supplied equals quantity demanded).

Income and Demand Changes

  • Engel's Law: Demonstrates the relationship between income levels and consumption expenditure, particularly on food.

  • Normal Goods: Demand increases with income (e.g., cars, movie tickets).

  • Inferior Goods: Demand decreases with rising income (e.g., ramen noodles, public transport).

Complements and Substitutes

  • Substitutes: Goods that fulfill similar roles (e.g., Coke and Pepsi).

  • Complements: Goods that are frequently used together (e.g., peanut butter and jelly).

  • Effects on Demand: Price changes in one good affect the demand for the other.

Economic Profit and Market Structure

  • Economic Profit Definition: Total revenue minus total costs, accounting for both explicit and implicit costs.

  • Accounting Profit vs Economic Profit:

    • Accounting Profit = Total Revenue - Explicit Costs;

    • Economic Profit = Total Revenue - (Explicit Costs + Implicit Costs).

  • Example: A bakery's revenue and profits calculated from explicit and implicit costs defining profit success.

Different Market Structures

  • Overview: Markets can differ vastly in terms of the number of sellers, products offered, and competition dynamics:

    • Perfect Competition: Many firms, homogeneous products, free entry/exit, price takers.

    • Monopoly: Single firm dominates with unique products, price setting power, barriers to entry.

Perfect Competition Characteristics

  1. Large number of buyers and sellers.

  2. Homogeneous products.

  3. Perfect information flows.

  4. Freedom of market entry and exit.

  5. Price taking behavior.

Monopoly Characteristics

  1. Single seller controls entire market supply.

  2. Absence of close substitutes.

  3. High barriers prevent new entrants.

  4. Price setting abilities, leading to potential market inefficiencies.

Marginal Concepts in Economics

  • Marginal Costs (MC): Additional costs incurred by producing one more unit.

  • Marginal Revenue (MR): Additional revenue gained from selling one more unit.

  • Optimal Production Rule for Monopolists: Produces where MR = MC to maximize profit.

Conclusion on Market Dynamics

  • Monopolists generally charge higher prices and produce less compared to perfectly competitive markets, emphasizing the impact of market structure on consumer choices and resource allocation.

Real-World Examples

  1. OPEC's Oil Market Manipulation: Market impacts from supply changes can drastically shift pricing.

  2. Pharmaceutical Industry Decisions: Production cuts significantly affect supply and demand and ultimately price points.

Summary of Effects

  • Demand changes due to external factors can increase consumption while supply adjustments, such as production cuts, can raise market prices, illustrating the dynamic interaction of supply and demand in economics.