Chapter 3: Demand, Supply, and Market Equilibrium

• Markets - Bring together buyers + sellers
  • Highly competitive markets have large #s of independently acting buyers + sellers of standardized products
• Demand - Schedule/curve showing various amounts of product that consumers willing + able to buy at several possible prices during a specific period of time
  • Statement of buyer’s plans/intentions of purchase of product
• Demand schedule - Illustrates quantity demanded of a good or service at different prices
• Law of demand - Other things equal, as price falls, the quantity demanded rises (and vice versa)
  • Inverse relationship
  • Diminishing marginal utility - Each successive unit of product consumed → Buyers get less satisfaction
  • Income effect - Lower price increases purchasing power of income → Buyer can purchase more of product than before (and vice versa)
  • Substitution effect - Buyer has incentive to substitute less expensive products for similar products that are relatively more expensive

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• Demand curve - Quantity demanded on horizontal axis, price on vertical axis; downward slope reflects law of demand
  • Increase in demand → Curve shifts right
  • Decrease in demand → Curve shifts left
• Add quantities demanded by all consumers at each possible price → Market demand

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• Determinants of demand - Other factors besides price that affect purchases; shifts the demand curve

  • Consumer preferences
  • Number of buyers
  • Consumer incomes
  • Normal goods - Rise in income causes increase in demand
  • Inferior goods - Rise in income causes decrease in demand
  • Prices of related goods
  • Substitute goods - Increase in price of one related good → Demand for other good increases
  • Complementary goods - Increase in price of one related good → Demand for other good decreases
  • Independent/unrelated goods
  • Consumer expectations

• Change in demand - Shift of demand curve to right/left

• Change in quantity demanded - Movement from one point to another on a fixed demand curve (the same demand curve)

  

• Supply - Schedule/curve showing various amounts of product that producers are willing + able to make available for sale at several possible prices during a specific period of time

• Supply schedule - Illustrates quantity supplied of a good or service at different prices

• Law of supply - Other things equal, as price rises, the quantity supplied rises (and vice versa)

• Supply curve - Upward sloping; reflects law of supply

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• Sum quantities supplied by each producer at each price → Market supply
• Determinants of supply - Other factors besides price that affect supply; shifts supply curve
  • Resource prices
  • Technology
  • Taxes and subsidies
  • Prices of other goods
  • Producer expectations
  • Number of sellers in the market
• Change in supply - Shift of supply curve to right/left
• Change in quantity supplied - Movement from one point to another on a fixed supply curve (the same supply curve)

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• Equilibrium price - Price where quantity demanded = quantity supplied
  • Intersection of supply + demand curve
• Equilibrium quantity - Quantity demanded and quantity supplied at the equilibrium price

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• Surplus - Quantity supplied exceeds quantity demanded; drives prices down
• Shortage - Quantity demanded exceeds quantity supplied; drives prices up
• Rationing function of prices - Competitive forces of supply + demand establish equilibrium price
• Productive efficiency - Production of a good in the least-costly way
• Allocative efficiency - Production of the particular mix of goods and services most highly valued by society
• Demand reflects marginal benefit, supply reflects marginal supply
  • MB = MC → Allocative efficiency
• Changes in supply + demand
  • Increase in demand → Increase in equilibrium price + equilibrium quantity
  • Increase in supply → Decrease in equilibrium price + increase in equilibrium quantity
  • Supply increase, demand decrease → Equilibrium price decrease, equilibrium quantity indeterminate
  • Supply decrease, demand increase → Equilibrium price increase, equilibrium quantity indeterminate
  • Supply increase, demand increase → Equilibrium price indeterminate, equilibrium quantity increase
  • Supply decrease, demand decrease → Equilibrium price indeterminate, equilibrium quantity decrease

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• Price ceiling - Maximum legal price a seller can charge for a good or service
  • Must be below equilibrium price to be binding
  • Shortage
  • Rationing problem - Gov’t must establish formal system of rationing in order to solve inequitable distribution of gasoline
  • Black markets - Goods illegally bought and sold at prices above the legal limits
  • Rent controls - Maximum rents established by law

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• Price floor - Minimum legal price a seller can charge for a good or service
  • Must be above equilibrium price to be binding
  • Surplus
  • Gov’t can solve surplus by either restricting supply or purchasing surplus output
  • Distorts resource allocation

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