Supply and Demand

Outcome 1

1. Economics Defined

  • Economics studies how consumers and producers make decisions with scarce income.

  • Investigates the outcomes of these decisions.

2. The Supply and Demand Model

2.1 Overview

  • Topics covered:

    • Questions that can be answered using the supply and demand model.

    • Assumptions and results of the model both abstractly and with hypothetical numbers.

    • Real-world applications of the framework.

    • Required outcomes for understanding the model.

2.2 Key Questions Addressed by the Model

  1. COVID-19 Impact: Why did the price of a ventilator rise substantially during the pandemic?

  2. Price Trends: What causes the price of computers to decline over time while most other goods see rising prices?

  3. Seasonal Pricing: Why do roses have a higher price on Valentine’s Day?

  • Understanding the model is essential for analyzing everyday market behaviors.

3. Demand in Economics

3.1 Definition of Demand

  • Demand: A relationship between price and the quantity demanded of a good.

  • Price: The amount one pays to obtain a good.

  • Quantity Demanded: The quantity of a good that people want to buy at a specified price during a specific timeframe.

3.2 Principle of Demand

  • Law of Demand: The quantity demanded of a good typically declines as its price rises.

    • A consistent demand curve must be downward sloping.

    • Price and demand are negatively related, indicating a downward trend in demand as price increases.

3.3 Violations of the Law of Demand

  • Veblen Goods: Goods for which demand increases as their price rises, due to status appeal (e.g., designer handbags, luxury cars).

  • Speculative Demand: Expectations of further price increases leading to higher current demand (e.g., cryptocurrency or housing market bubbles).

  • Giffen Goods: Instances where demand for staple goods increases as their prices rise due to income constraints of consumers (e.g., staples like bread during a depression).

3.4 Demand for Bicycles Example

  • Table 3.1: Demand for Bicycles (Millions Per Year)

    • Price ($140): Quantity Demanded (18)

    • Price ($160): Quantity Demanded (14)

    • Price ($180): Quantity Demanded (11)

    • Price ($200): Quantity Demanded (9)

    • Price ($220): Quantity Demanded (7)

    • Price ($240): Quantity Demanded (5)

    • Price ($260): Quantity Demanded (3)

    • Price ($280): Quantity Demanded (2)

    • Price ($300): Quantity Demanded (1)

3.5 Demand Curve

  • Illustrative Figure 3.2 shows the demand curve with quantities shifting downward as prices increase.

4. Factors Influencing Demand

4.1 Beyond Price: Shifts in Demand

  • Factors causing demand shifts include factors such as consumer preferences, number of consumers, consumers' information, consumers' income, future price expectations, and price of related goods (both substitutes and complements).

4.2 Demand Shift Illustration

  • Figure 3.3: Shifts the demand curve to the right indicating an increase in demand.

4.3 Movements Along vs Shifts of the Demand Curve

  • Figure 3.4: Clarifies movement along versus a shift of the demand curve:

    • Movement along the curve indicates a change resulting from price alterations.

    • Shifts in the curve indicate changes in demand due to external factors.

5. Supply in Economics

5.1 Definition of Supply

  • Supply: A relationship between price and the quantity supplied, assuming all other factors are constant.

  • Quantity Supplied: The quantity of a good that sellers are willing to provide at a specific price during a set timeframe.

5.2 Principle of Supply

  • Law of Supply: Quantity supplied of a good increases as price increases.

    • Supply curve must be upward sloping, demonstrating positive correlation between price and quantity supplied.

5.3 Violation of the Law of Supply

  • Backward-bending Labor Supply Curve: At high wages, some consumers may prefer more leisure time over supplying more labor, leading to decreased quantity of labor supplied despite rising wages.

5.4 Supply for Bicycles Example

  • Table 3.2: Supply for Bicycles (Millions Per Year)

    • Price ($140): Quantity Supplied (1)

    • Price ($160): Quantity Supplied (4)

    • Price ($180): Quantity Supplied (7)

    • Price ($200): Quantity Supplied (9)

    • Price ($220): Quantity Supplied (11)

    • Price ($240): Quantity Supplied (13)

    • Price ($260): Quantity Supplied (15)

    • Price ($280): Quantity Supplied (16)

    • Price ($300): Quantity Supplied (17)

5.5 Supply Curve

  • Figure 3.5: The supply curve illustrating the relationship between price and quantity supplied; upward slope indicating positive relationship.

6. Supply Curve Changes

6.1 Shifts in the Supply Curve

  • Factors that cause shifts:

    • Technology

    • Weather (agricultural impacts)

    • Number of firms in the market

    • Price of production inputs (e.g., labor, materials)

    • Future price expectations

    • Government policies (taxes, regulations, subsidies)

  • Figure 3.6: Shifts the supply curve to the right to indicate increased supply.

6.2 Movement Along vs Shifts of the Supply Curve

  • Figure 3.7: Highlights how an increase in price leads to an increase in quantity supplied versus how shifts reflect external influences on supply.

7. Market Equilibrium

7.1 Definitions

  • Equilibrium Price: Price where quantity supplied equals quantity demanded.

  • Equilibrium Quantity: The number of goods traded at the equilibrium price.

  • Market Equilibrium: Condition where price equals equilibrium and traded quantity matches equilibrium quantity.

7.2 Shortage and Surplus

  • Shortage (Excess Demand): When quantity demanded exceeds quantity supplied; occurs when the market price is below equilibrium.

  • Surplus (Excess Supply): When quantity supplied exceeds quantity demanded; occurs when market price is above equilibrium.

7.3 Finding Market Equilibrium Example

  • Table 3.3: Illustrates how to find equilibrium:

    • Price ($140): Quantity Demanded (18), Quantity Supplied (1) - Shortage = 17

    • Price ($160): … "Price rises."

    • Price ($200): Equilibrium with both Quantity Demanded and Supplied = 9.

7.4 Equilibrium Responses

  • Shortage triggers price rise until equilibrium is met; surplus triggers price fall.

8. Effects of Demand and Supply Shifts

8.1 Demand Shift Effects

  • Figure 3.10: Shows the impact on equilibrium price and quantity due to shifts in demand (increase results in higher price and quantity, decrease has opposite effect).

8.2 Supply Shift Effects

  • Figure 3.11: Details how shifts in supply result in changes to equilibrium price and subsequently, to equilibrium quantity.

9. Applications and Theoretical Frameworks

9.1 Real-World Application Examples

  • Increased understanding of dynamics in economic scenarios (e.g., COVID-19 ventilator shortages).

9.2 Vernon Smith Experiment Implications

  • Questions the validity and emergence of equilibrium with few traders.

  • Explores the effects of trading strategies and curve slopes on markets in a controlled experiment.

10. Key Outcomes and Summary

  • Remember assumptions of the model, definitions of demand and supply, their laws, and how to solve for equilibrium prices.

  • Analyze shifts in demand and supply and remember the outcomes of various examples discussed throughout the notes.

Conclusion

  • Study the implications on pricing behavior influenced by market conditions, leveraging real-life applications and experimental data for broader understanding.