Comprehensive Study Guide on Changes in Demand and Supply

Fundamental Concepts of Demand and Supply Changes

  • Changes Driven by Price vs. Non-Price Determinants:

    • Any change in PRICE will always cause a change in the QUANTITY demanded and supplied. This represents a movement along the Demand and Supply curves.

    • Non-price determinants of Demand and Supply are variables other than Price that can cause Demand or Supply to change. These changes are known as SHIFTS.

  • Market Disequilibrium Created by Price Movements:

    • An increase in Price from Equilibrium will create an excess of Supply, which is known as a Surplus.

    • A decrease in Price from Equilibrium will create an excess of Demand, which is known as a Shortage.

  • Directions of Curve Shifts:

    • An increase in Demand or Supply will shift the entire curve to the right.

    • A decrease in Demand or Supply will shift the entire curve to the left.

Shifters and Non-Price Determinants of Demand

Determinants of Demand

  • Income:

    • Consumers' income has a direct effect on Demand.

    • For Normal Goods, an increase in income will cause an increase in Demand (and vice versa).

    • For Inferior Goods, an increase in income will cause a decrease in Demand (and vice versa).

  • Preferences and Tastes:

    • This can be thought of as the popularity of a product.

    • Trendy things change over time (for example, hit songs or movies).

  • Prices of Substitute Goods:

    • Two goods are substitutes if they satisfy a similar need (for example, Coke and Pepsi).

    • If the price of Coke increases, the demand for Pepsi will increase (and vice versa).

    • As Coke becomes more expensive, more people will choose to buy Pepsi instead.

  • Prices of Complement Goods:

    • Two goods are complements if they tend to be used together (for example, bicycles and bike helmets).

    • If the price for bicycles goes down, the demand for helmets will go up.

    • If more people can afford to buy new bicycles, they will often require a new helmet too.

  • Population Changes (Changes in the Number of Buyers):

    • An increase in the number of buyers will increase the demand for a good (and vice versa).

    • Market demand is defined as the sum of all individual demands.

  • Expectations:

    • If a buyer expects the price of a good to go down in the future, he or she will hold off buying it in the present.

Shifters and Non-Price Determinants of Supply

Determinants of Supply

  • Costs of the Factors of Production:

    • The Factors of Production consist of Land, Labor, Capital, and Enterprise.

    • This is easy to understand by considering the cost to pay workers (Labor).

    • If the labor cost increases, the firm will become less profitable and produce less, causing the supply curve to shift to the left.

  • Technology:

    • New technology lowers the cost of production, making it more profitable.

    • As a result, Supply will increase and shift right.

  • Prices of Related Goods:

    • Competitive Supply (Substitutes in Production):

    • Refers to a situation where a firm can produce two products with the same resources.

    • Producing more of one product will result in producing less of the other.

    • Example: A farmer growing two crops will choose to grow the crop with the highest price; therefore, the Supply of the other crop will decrease.

    • Joint Supply (Complements in Production):

    • Refers to the production of two or more goods derived from a single product.

    • Example: Beef and leather, which both come from cows.

    • Mechanism: If the price of beef increases, it increases the quantity of beef supplied and also causes the supply of leather to shift right.

  • Taxes and Subsidies:

    • Taxes are considered costs of production. A new tax imposed would increase production costs, and therefore Supply will fall and shift left.

    • Subsidies are payments from the government to a firm and have the opposite effect of a tax. Supply will increase and shift right.

  • Number of Firms:

    • An increase in the number of firms producing a good will increase the supply.

  • Shocks:

    • Unforeseen factors such as natural disasters, wars, and weather conditions will cause the supply of a good to decrease.

  • Expectations:

    • If a firm expects the price of its product to rise in the future, it may withhold some production, causing current supply to decline and shift left (and vice versa).