Chapter 5 – Supply & Demand Analysis

Any device/arrangement that brings buyers (actual or potential) into voluntary exchange with sellers (actual or potential).
Analysis proceeds in two stages:
- Examine buyers while ignoring sellers (demand side).
- Examine sellers while ignoring buyers (supply side).
- Merge both to explain price formation.

Short form: D = f(\text{factors that influence buyers})
Expanded form:
- D = f(\text{Price of the product},\ \text{Tastes \/ Preferences},\ \text{Product uses (final vs. derived)},\ \text{Number of buyers},
  \text{Product qualities (real/perceived)},\ \text{Advertising},\ \text{Buyer incomes (inferior, normal, superior)},
  \text{Prices of substitutes},\ \text{Prices of complements},\ \text{Time period},\ \text{Expectations},\ \text{Speculation},
  \text{Misc. factors – seasonality, fads, fashion})
All non-price elements are shift factors; if they change, the whole demand curve moves.

Plots quantity demanded vs. own price, holding other factors constant (ceteris paribus).
Opposite approach mutatis mutandis: study everything changing at once; abandoned in economics for tractability.

Substitute: Price↓ of other good ⇒ Demand↓ for our good; Price↑ ⇒ Demand↑.
- e.g. White vs. coloured T-shirts.
Complement: Price↓ of other good ⇒ Demand↑ for our good; Price↑ ⇒ Demand↓.
- e.g. Printers & ink, cameras & film, gasoline & large cars.
Relationship is economic, not physical; gasoline can be both complement (big cars) and catalyst for substitute purchases (small cars).

If buyers expect future price ↑ ⇒ Current demand ↑.
When expectations dominate → speculative market:
- Prices become highly volatile; bubbles fueled by self-reinforcing expectation of gains.
- Bubble bursts with slightest doubt, causing price collapse.

Statement: Ceteris paribus, buyers purchase more at lower prices and less at higher prices.
Negative slope of demand curve explained by:
1. Substitution Effect
- Price↓ ⇒ Good becomes cheaper relative to substitutes ⇒ Buyers switch toward it.
1. Income Effect
- Price↓ ⇒ Real purchasing power ↑ ⇒ Buyers can afford more.
1. Law of Diminishing Marginal Utility (LDMU)
- Consuming additional units yields declining marginal utility; only lower prices justify additional purchases.

Hot day choice: ice-cream or beer (mutually exclusive each round).
- 1st ice-cream: utility 9; 2nd: 8; further units decline; may even turn negative.
- Beer path: 1st: 11; 2nd: 12 (still rising); 3rd: 8; 4th: 6; 5th: ? (led to blackout).
Declining marginal enjoyment ⇒ demand curve must slope downward.

Price-as-Quality Signals
- Rarely purchased goods where buyers use price to judge quality (diamonds, live Maine lobster ▸ sold better at \$30 than \$15).
Snob/Status Goods (Veblen goods)
- Demand driven by exclusivity/high price (designer dresses, Rolex, Gucci bags).

Key rules:

Short form: S = g(\text{profits})
- Sellers act to cover costs & earn profit (Smithian self-interest).
Expanded form:
- S = g(\text{Price of product},\ \text{Prices of other products},\ \text{Input prices},\ \text{Productivity},\ \text{Number of sellers},
  \text{Technology \/ technological change},\ \text{Extra production factors (e.g., COVID-19)})

Plots quantity supplied vs. own price; other factors constant.
Shift factors (input costs, technology, # of sellers, etc.) move curve right (↑ supply) or left (↓ supply).

Ceteris paribus, sellers offer more at higher prices and less at lower prices.
Positive slope explained by profit motive: higher price ⇒ higher potential profit ⇒ more willingness to supply.

Change in Supply = shift of entire curve due to non-price shifter.
Change in Quantity Supplied = movement along the curve caused solely by own-price change.
Same terminology for demand side (change in demand vs. change in quantity demanded).

Combine demand & supply curves.
Example (hypothetical numbers from text):
- At P = \$60 ⇒ (QD = 100,\ QS = 200) ⇒ surplus 100 units.
- Seller competition → price ↓ until surplus gone.
- At P = \$20 ⇒ (QD = 200,\ QS = 100) ⇒ shortage 100 units.
- Buyer competition → price ↑ until shortage gone.
- Equilibrium at P = \$40 and Q = 150 ⇒ QD = QS.
Surplus: excess supply, sellers drop price to avoid unsold inventory & cash-flow problems.
Shortage: excess demand, buyers bid price up to secure product.
Equilibrium is positive, not normative; simply where an unregulated market tends to settle.

Any shift in supply or demand creates a new intersection (new P^, Q^).
Figures referenced (1–6) illustrate:
- Pure supply shift (right/left).
- Pure demand shift.
- Demand shift under two different supply elasticities.
- Simultaneous shifts (various combinations) → ambiguous predictions without magnitude info.

Identifying substitutes and complements crucial for pricing, bundling, and antitrust market-definition.
Complementary pricing strategy: lower price of complement (film, ink) to boost primary good (camera, printer) sales.
Monitoring expectations essential; speculative bubbles (housing, crypto) show how demand can become price driven.
Recognize when products exhibit Veblen or quality-signaling traits; optimal pricing may be above cost-plus.
Ceteris paribus simplifies analysis; be cautious when real-world situations are mutatis mutandis (multiple factors shifting).
COVID-19 cited as a supply-side shock example; demonstrates importance of exogenous events in shifting curves.