Economics - Demand and Supply

Economics: Demand & Supply

Chapter Outline

  • The demand side of the market.

  • The supply side of the market.

Our Model of a Market

  • To analyze markets, we use a model of how buyers and sellers behave.

  • Perfectly Competitive Market: A market with:

    • Many buyers and sellers.

    • All firms selling identical products.

    • No barriers to new firms entering the market.

  • This model is useful for analyzing many markets despite its restrictive assumptions.

3.1 The Demand Side of the Market

  • Focuses on how buyers behave.

  • Market Demand: The demand by all the consumers of a given good or service.

Demand Schedule and Demand Curve

  • Demand Schedule: A table showing the relationship between the price of a product and the quantity demanded.

  • Demand Curve: A curve illustrating the relationship between the price of a product and the quantity demanded.

  • Ceteris Paribus Condition: The requirement that when analyzing the relationship between two variables (like price and quantity demanded), other variables must be held constant.

  • Quantity Demanded: The amount of a good or service that a consumer is willing and able to purchase at a given price.

  • Law of Demand: Holding everything else constant:

    • When the price of a product falls, the quantity demanded of the product will increase.

    • When the price of a product rises, the quantity demanded of the product will decrease.

What Explains the Law of Demand?

  • When the price of a good falls, two effects take place:

    • Consumers substitute toward the newly less-expensive good.

    • Consumers have more purchasing power, which is like an increase in income.

  • Substitution Effect: The change in the quantity demanded of a good that results from a change in price, making the good more or less expensive relative to other goods that are substitutes.

  • Income Effect: The change in the quantity demanded of a good that results from the effect of a change in the good’s price on a consumers’ purchasing power.

Shifting the Demand Curve

  • A change in something other than price that affects demand causes the entire demand curve to shift.

  • A shift to the right is an increase in demand.

  • A shift to the left is a decrease in demand.

  • As the demand curve shifts, the quantity demanded will change, even if the price doesn’t change. The quantity demanded changes at every possible price.

Variables That Shift Market Demand

  • Income:

    • Increase in income increases demand if product is normal.

    • Decreases demand if product is inferior.

  • Prices of Related Goods:

    • Increase in price of related good increases demand if products are substitutes.

    • Decreases demand if products are complements.

  • Tastes: Changes in consumer preferences.

  • Population and Demographics: Changes in the size or composition of the population.

  • Expected Future Prices: Expectations about future prices.

Changes in Income of Consumers

  • Normal Goods: Goods for which the demand increases as income rises and decreases as income falls.

    • Examples: New clothes, restaurant meals, vacations.

  • Inferior Goods: Goods for which the demand increases as income falls and decreases as income rises.

    • Examples: Second-hand clothes, instant noodles.

Effects of Changes in Income

  • An increase in income would increase the demand for new clothes, ceteris paribus.

  • The same increase in income would likely decrease the demand for second-hand clothes.

Changes in the Price of Related Goods

  • Substitutes: Goods and services that can be used for the same purpose.

    • Examples: Big Mac and Whopper, Ford F-150 and Dodge Ram, Jeans and Khakis.

  • Complements: Goods and services that are used together.

    • Examples: Big Mac and McDonald’s fries, Hot dogs and hot dog buns, Left shoes and right shoes.

Effects of Changes in the Price of Related Goods

  • An increase in the price of a Big Mac would increase the demand for Whoppers.

  • The same increase in the price of a Big Mac would decrease the demand for McDonald’s fries.

Changes in Tastes

  • If consumers’ tastes change, they may buy more or less of the product.

  • Example: If consumers become more concerned about eating healthily, they might decrease their demand for fast food.

Changes in Population/Demographics

  • Demographics: The characteristics of a population with respect to age, race, and gender.

  • Increases in the number of people buying something will increase the amount demanded.

  • Example: An increase in the elderly population increases the demand for medical care.

Changes in Expectations About Future Prices

  • Consumers decide which products to buy and when to buy them.

  • Future products are substitutes for current products.

  • An expected increase in the price tomorrow increases demand today.

  • An expected decrease in the price tomorrow decreases demand today.

  • Example: If you found out the price of gasoline would go up tomorrow, you would increase your demand today.

Apple’s Policy on Product Speculation

  • Apple strongly discourages its employees from speculating about when a new model will appear.

  • If a customer learns that a new iPad model will be available next month:

    • The new model is a potential substitute for the current model.

    • The price of the current model will likely fall next month.

    • Both effects decrease current demand (bad for Apple!).

Change in Demand versus Change in Quantity Demanded

  • A change in the price of the product being examined causes a movement along the demand curve. This is a change in quantity demanded.

  • Any other change affecting demand causes the entire demand curve to shift. This is a change in demand.

3.2 The Supply Side of the Market

  • There are some similarities and some important differences between the demand and supply sides of the market.

  • Examines the market supply, i.e., the decisions of firms about how much of a product to provide at various prices.

Supply Schedule and Supply Curve

  • Supply Schedule: A table that shows the relationship between the price of a product and the quantity of the product supplied.

  • Supply Curve: A curve that shows the relationship between the price of a product and the quantity of the product supplied.

  • Quantity Supplied: The amount of a good or service that a firm is willing and able to supply at a given price.

  • Law of Supply: Holding everything else constant, increases in price cause increases in the quantity supplied, and decreases in price cause decreases in the quantity supplied.

Shifting the Supply Curve

  • A change in something other than price that affects supply causes the entire supply curve to shift.

  • A shift to the right is an increase in supply.

  • A shift to the left is a decrease in supply.

  • As the supply curve shifts, the quantity supplied will change, even if the price doesn’t change. The quantity supplied changes at every possible price.

What Factors Influence Market Supply?

  • Prices of inputs.

  • Technological change.

  • Prices of related goods in production.

  • Number of firms in the market.

  • Expected future prices.

Change in Prices of Inputs

  • Inputs: Things used in the production of a good or service.

  • Example: For an athletic shoe, inputs include the rubber, plastic, and labor.

  • An increase in the price of an input decreases the profitability of selling the good, causing a decrease in supply.

  • A decrease in the price of an input increases the profitability of selling the good, causing an increase in supply.

Technological Change

  • A firm may experience a positive or negative change in its ability to produce a given level of output with a given quantity of inputs. We call this a technological change.

  • Examples:

    • A new, more efficient way of producing shoes would increase their supply.

    • Governmental restrictions on how much workers are allowed to work might decrease the supply of athletic shoes.

Prices of Related Goods in Production

  • Many firms can produce and sell alternative products: substitutes in production.

  • Example: An Illinois farmer can plant corn or soybeans. If the price of soybeans rises, he will plant (supply) less corn.

  • Sometimes, two products are necessarily produced together: complements in production.

  • Example: Cattle provide both beef and leather. An increase in the price of beef encourages more cattle farming, and hence increase the supply of leather.

Number of Firms and Expected Future Prices

  • More firms in the market will result in more product available at a given price (greater supply).

  • Fewer firms → supply decreases.

  • If a firm anticipates the price of its product will be higher in the future, it might decrease its supply today in order to increase it in the future.

Fracking, the U.S. Oil Boom, and Expected Oil Prices

  • The development of hydraulic fracturing (fracking) disrupted the world oil market, propelling the U.S. to be the world’s largest oil producer.

  • In 2016, U.S. oil producers believed the price of oil was temporarily low. They reduced current production, intending to sell more later when prices recovered.

Change in Supply Versus a Change in Quantity Supplied

  • A change in the price of the product being examined causes a movement along the supply curve. This is a change in quantity supplied.

  • Any other change affecting supply causes the entire supply curve to shift. This is a change in supply.Econimics

3.1 The Demand Side of the Market

  • Focuses on how buyers behave.

  • Market Demand: The demand by all the consumers of a given good or service.

Demand Schedule and Demand Curve

  • Demand Schedule: A table showing the relationship between the price of a product and the quantity demanded.

  • Demand Curve: A curve illustrating the relationship between the price of a product and the quantity demanded.

  • Ceteris Paribus Condition: The requirement that when analyzing the relationship between two variables (like price and quantity demanded), other variables must be held constant.

  • Quantity Demanded: The amount of a good or service that a consumer is willing and able to purchase at a given price.

  • Law of Demand: Holding everything else constant:-

    • When the price of a product falls, the quantity demanded of the product will increase.

    • When the price of a product rises, the quantity demanded of the product will decrease.

What Explains the Law of Demand?

  • When the price of a good falls, two effects take place:-

    • Consumers substitute toward the newly less-expensive good.

    • Consumers have more purchasing power, which is like an increase in income.

  • Substitution Effect: The change in the quantity demanded of a good that results from a change in price, making the good more or less expensive relative to other goods that are substitutes.

  • Income Effect: The change in the quantity demanded of a good that results from the effect of a change in the good’s price on a consumers’ purchasing power.

Shifting the Demand Curve

  • A change in something other than price that affects demand causes the entire demand curve to shift.

  • A shift to the right is an increase in demand.

  • A shift to the left is a decrease in demand.

  • As the demand curve shifts, the quantity demanded will change, even if the price doesn’t change. The quantity demanded changes at every possible price.

Variables That Shift Market Demand

  • Income:-

    • Increase in income increases demand if product is normal.

    • Decreases demand if product is inferior.

  • Prices of Related Goods:-

    • Increase in price of related good increases demand if products are substitutes.

    • Decreases demand if products are complements.

  • Tastes: Changes in consumer preferences.

  • Population and Demographics: Changes in the size or composition of the population.

  • Expected Future Prices: Expectations about future prices.

Changes in Income of Consumers

  • Normal Goods: Goods for which the demand increases as income rises and decreases as income falls.-

    • Examples: New clothes, restaurant meals, vacations.

  • Inferior Goods: Goods for which the demand increases as income falls and decreases as income rises.-

    • Examples: Second-hand clothes, instant noodles.

Effects of Changes in Income

  • An increase in income would increase the demand for new clothes, ceteris paribus.

  • The same increase in income would likely decrease the demand for second-hand clothes.

Changes in the Price of Related Goods

  • Substitutes: Goods and services that can be used for the same purpose.-

    • Examples: Big Mac and Whopper, Ford F-150 and Dodge Ram, Jeans and Khakis.

  • Complements: Goods and services that are used together.-

    • Examples: Big Mac and McDonald’s fries, Hot dogs and hot dog buns, Left shoes and right shoes.

Effects of Changes in the Price of Related Goods

  • An increase in the price of a Big Mac would increase the demand for Whoppers.

  • The same increase in the price of a Big Mac would decrease the demand for McDonald’s fries.

Changes in Tastes

  • If consumers’ tastes change, they may buy more or less of the product.

  • Example: If consumers become more concerned about eating healthily, they might decrease their demand for fast food.

Changes in Population/Demographics

  • Demographics: The characteristics of a population with respect to age, race, and gender.

  • Increases in the number of people buying something will increase the amount demanded.

  • Example: An increase in the elderly population increases the demand for medical care.

Changes in Expectations About Future Prices

  • Consumers decide which products to buy and when to buy them.

  • Future products are substitutes for current products.

  • An expected increase in the price tomorrow increases demand today.

  • An expected decrease in the price tomorrow decreases demand today.

  • Example: If you found out the price of gasoline would go up tomorrow, you would increase your demand today.

Apple’s Policy on Product Speculation

  • Apple strongly discourages its employees from speculating about when a new model will appear.

  • If a customer learns that a new iPad model will be available next month:-

    • The new model is a potential substitute for the current model.

    • The price of the current model will likely fall next month.

    • Both effects decrease current demand (bad for Apple!).

Change in Demand versus Change in Quantity Demanded

  • A change in the price of the product being examined causes a movement along the demand curve. This is a change in quantity demanded.

  • Any other change affecting demand causes the entire demand curve to shift. This is a change in demand.

3.2 The Supply Side of the Market

  • There are some similarities and some important differences between the demand and supply sides of the market.

  • Examines the market supply, i.e., the decisions of firms about how much of a product to provide at various prices.

Supply Schedule and Supply Curve

  • Supply Schedule: A table that shows the relationship between the price of a product and the quantity of the product supplied.

  • Supply Curve: A curve that shows the relationship between the price of a product and the quantity of the product supplied.

  • Quantity Supplied: The amount of a good or service that a firm is willing and able to supply at a given price.

  • Law of Supply: Holding everything else constant, increases in price cause increases in the quantity supplied, and decreases in price cause decreases in the quantity supplied.

Shifting the Supply Curve

  • A change in something other than price that affects supply causes the entire supply curve to shift.

  • A shift to the right is an increase in supply.

  • A shift to the left is a decrease in supply.

  • As the supply curve shifts, the quantity supplied will change, even if the price doesn’t change. The quantity supplied changes at every possible price.

What Factors Influence Market Supply?

  • Prices of inputs.

  • Technological change.

  • Prices of related goods in production.

  • Number of firms in the market.

  • Expected future prices.

Change in Prices of Inputs

  • Inputs: Things used in the production of a good or service.

  • Example: For an athletic shoe, inputs include the rubber, plastic, and labor.

  • An increase in the price of an input decreases the profitability of selling the good, causing a decrease in supply.

  • A decrease in the price of an input increases the profitability of selling the good, causing an increase in supply.

Technological Change

  • A firm may experience a positive or negative change in its ability to produce a given level of output with a given quantity of inputs. We call this a technological change.

  • Examples:-

    • A new, more efficient way of producing shoes would increase their supply.

    • Governmental restrictions on how much workers are allowed to work might decrease the supply of athletic shoes.

Prices of Related Goods in Production

  • Many firms can produce and sell alternative products: substitutes in production.

  • Example: An Illinois farmer can plant corn or soybeans. If the price of soybeans rises, he will plant (supply) less corn.

  • Sometimes, two products are necessarily produced together: complements in production.

  • Example: Cattle provide both beef and leather. An increase in the price of beef encourages more cattle farming, and hence increase the supply of leather.

Number of Firms and Expected Future Prices

  • More firms in the market will result in more product available at a given price (greater supply).

  • Fewer firms → supply decreases.

  • If a firm anticipates the price of its product will be higher in the future, it might decrease its supply today in order to increase it in the future.

Fracking, the U.S. Oil Boom, and Expected Oil Prices

  • The development of hydraulic fracturing (fracking) disrupted the world oil market, propelling the U.S. to be the world’s largest oil producer.

  • In 2016, U.S. oil producers believed the price of oil was temporarily low. They reduced current production, intending to sell more later when prices recovered.

Change in Supply Versus a Change in Quantity Supplied

  • A change in the price of the product being examined causes a movement along the supply curve. This is a change in quantity supplied.

  • Any other change affecting supply causes the entire supply curve to shift. This is a change in supply.

Simple Explanation:

Demand: Think about what people want to buy.

  • If something gets cheaper, people want more of it.

  • If something gets more expensive, people want less of it.

  • If people's income increases, they buy more fancy stuff (normal goods) and less cheap stuff (inferior goods).

  • If the price of something similar goes up (like Coke when Pepsi is expensive), people buy more of the other thing.

Supply: Think about what companies want to sell.

  • If