3: Supply & Demand

Demand

Quantity demanded: the amount of a good or service that consumers wish to purchase. How much they’re willing to purchase.

The Law of Demand: The price of a product and the quantity demanded are related negatively, ceterius paribus. The lower the price, the higher demand and vice versa.

    —- Alfred Marshall

Demand schedule: one way of showing the relationship between quantity demanded and the price of a product. The quantity demanded at various prices.

  • The demand curve is drawn through the points of the demand schedule.

    • The negative slope indicates that the quantity demanded increases when the price decreases. Inverse proportionality.

  • Demand function: the linear equation that results from your demand curve.

    • Qd = a - bP → you give me the price, and I’ll tell you how much I’m willing to buy. Must have direction of causation.

    • Inverse demand function where price is the y-var and quantity demanded is the x-var.

  • A change in any of the variables (other than the product’s own price) that will affect the quantity demanded will shift the demand curve to a new position.

    • Example: an increase in annual household income would increase the quantity demanded at each price.

  • Table: price & quantity demanded.

2 types of movement: from observation to observation, or a shift in the demand curve.

  • A change in quantity demanded: a change along the demand curve. → change price/exogenous.

  • A change in demand: a shift in the curve. → change y-int.

    • Increase in demand: away from origin.

    • Decrease in demand: shift in towards origin.

  • A desired quantity: the amount that consumers want to purchase when faced with a particular price of the product, other prices, their incomes, preferences, population, weather change.

    • Average income: if average income rises, consumers as a group desire more of most products. Increase in demand for normal goods.

      • Inferior goods: goods where demand falls when income rises.

    • Prices of other goods: substitutes in consumption occur, e.g. if apples are cheaper than oranges, people will buy more apples.

      • Compliments in consumption are the opposite, e.g., if cars are being sold, gas will increase too.

    • Population: an increase in population with purchasing power will result in an increasing demand for a product.

    • Weather: cold snaps will result in an increased demand for electricity.

    • Product’s own price: causes movement along the line.

    • Preferences and tastes

    • Income distribution: if I take money from one group and give it to another, income is redistributed

    • Expectations of the Future (biggest): people have expectations of the future, e.g. gas. e.g. toilet paper.

    • ALL OTHER FACTORS result in a shift in the line.

  • Can be referred to as a flow of purchases, e.g. a rate: 1 million units per day.

  • Ceterius Paribus: holding everything else equal across a theory.

Stock variable: a variable which has meaning at a particular period of time, e.g. 2000 eggs on September 3rd.

Quantity bought: used to refer to the total amount that is actually purchased.

Along the Curve vs. the Whole Curve

  • Increased coffee prices as a result of increased demand: a shift in the demand curve.

  • Decreased coffee demand as a result of higher prices: a movement along the demand curve in response to a change in price.

Change in demand: a change in the quantity demanded at every price.

Change in quantity demanded: a movement from one point on a demand curve to another point, either on the same curve or on a new one.

  • As a result, a change in quantity demanded can be resulted from:

    • a shift in the demand curve with a constant price

    • a movement along a given demand curve due to a change in the price

    • or a combination of both.

Supply

Quantity supplied: the amount of a good or service that firms wish to supply.

Supply schedule: shows the relationship between quantity supplied of a product and the price of the product, ceterius paribus.

  • Supply curve: a graphical representation of this. The relationship between quantity supplied and price.

  • Supply function: Qs(P) = c + dP

Conditions of supply apply to the entire supply curve, not a singular point.

  • Influenced by the product’s own price, the price of inputs, technology, government taxes or subsidies, prices of other products, significant changes in weather and the number of suppliers.

    • Price of inputs: all things that a firm uses to make products are called inputs. As these increase, less profit will be made. Therefore, the higher the price of any input, the less the firm will produce and offer for sale at any given price.

    • Product’s own price: directly results in a movement along the supply curve.

    • Technology: better methods of production result in more product being produced for cheaper, reducing the amount of inputs needed per unit of output.

    • Taxes & Subsidies: Excise taxes make production and sales of goods less profitable, therefore reducing supply. Subsidies are where the government pays a specific amount for each unit of goods. This makes them more profitable.

    • Price of other products: substitutes and compliments in the production process. If the price of oats fall, then the farmer will plant wheat instead. → production substitutes.

      • Production compliments: oil and natural gas. If the market price of oil rises, so will the supply of natural gas.

    • Weather: Changes in weather can lead to changes in supply. Drought, rain, etc, can reduce the supply of wheat and other crops.

    • Number of suppliers: More profitability results in more producers entering, producing more product and subsequently increases the supply.

The price of the product and the quantity supplied are positively related. The higher the product’s own price, the more its producers will supply; the lower the price, the less its producers will supply.

Be careful about the movement of the supply curve. Increasing supply results in a rightward shift. Not a change in the array of pricing — that’s an up and down shift.

Change in quantity supplied: a move along the line

Change in supply: the whole line has shifted left/right.

Price does not exist unless you have both supply and demand. The moment you agree on supply and demand is equilibrium. That is the price.

Supply refers to the entire relationship between the quantity supplied of a product and the price of that product.

Supply curve shifts

  • Right-ward shift: an increase in the quantity supplied

  • Left-ward shift: a decrease in the quantity supplied.

Change in supply: a shift of the whole supply curve; more supply at all pricepoints.

Change in quantity supplied: a movement from one point on a supply curve to another point.

A change in quantity supplied can result from:

  • a change in supply with a constant price

  • a movement along a supply curve because of a change in price

  • a combination.

These are called shocks in demand and supply.

Determination of Price

Market: any situation in which buyers and sellers negotiate the exchange of goods or services.

  • Perfectly competitive markets: markets in which the number of buyers and sellers is sufficiently large that no one of them has any appreciable influence on the market price.

Supply & Demand Curve

The equilibrium price corresponds to the intersection of the supply and demand curves. There is only one price where the quantity demanded equals the quantity supplied.

  • Excess demand: a situation in which there is too much demand and not enough supply to meet it.

    • Creates upward pressure on price.

  • Excess supply: a situation in which there is too much supply, and not enough demand to meet it.

    • Usually results in a cut in price to sell. Causes downward pressure on price.

Equilibrium occurs where Qd = Qs. The price at which quantity demanded of a good is exactly the amount of quantity supplied.

    Any price above the equilibrium point results in excess supply. We push the price down.

    Any price below the equilibrium point results in excess demand. We push the price up.

Price is on the y-axis because price does not exist without an agreeance between quantity supplied and demanded. Give me the quantity, I’ll give you the price.

The price at which the market demanded equals the quantity supplied is called the equilibrium price, or the market-clearing price.

Disequilibrium price: any price at which the market does not clear (quantity demanded does not equal supplied quantity). The market price will be changing.

Changes in any variables, other than price, quantity demanded, or quantity supplied, will cause a shift in the demand curve, the supply curve or both.

  • Comparative statics: the derivation of predictions by analyzing the effect of a change in a single exogenous variable on the equilibrium.

  • Increase in demand: an increase in both the equilibrium price and the equilibrium quantity exchanged.

    • Caused by a shortage at the initial equilibrium price, therefore the unsatisfied buyers bid up the price. Causes a larger quantity to be supplied, with the result that the new equilibrium is exchanged at a higher price.

  • Decrease in demand: a decrease in both the equilibrium price and the equilibrium quantity exchanged.

    • Creates a surplus at the initial equilibrium price and the sellers bid the price down. Less of the product is supplied. Lower than original.

  • Increase in supply: a decrease in the equilibrium price and an increase in the equilibrium quantity exchanged.

    • Creates a surplus at the initial equilibrium price. Unsuccessful sellers force the price down. The drop increases the quantity demanded and the new equilibrium is therefore at a lower price and a higher quantity exchanged.

  • Decrease in supply: an increase in the equilibrium price and a decrease in the equilibrium quantity exchanged.

    • Creates a shortage at the initial equilibrium price and causes the price to be bid up. Reduces the quantity demanded and the new equilibrium is at a higher price and a lower quantity exchanged.

Each modification to an exogenous variable causes a curve to shift and a movement occurs along another curve.

Absolute price: the amount of money that must be spent to acquire one unit of the product.

Relative price: the ratio of two absolute products, the price of one good in terms of another good.

When a change to the price of one product occurs, it is implied that it is a change in that product’s relative price — a change in the price of that product relative to the prices of all other goods.

Solving (grade 9 math)

Qd = Qs

a-bP = c+dP

+bP + a - bP = c+dP + bP

a - c = bP + dP + c - c

a - c = P(d+b)

(a - c) / (d+b) = P*

Take price, plug it in. Gives you quantity in equilibrium.

    p = a-b (a-c / b+d)

Difference between the y-intercepts of the demand and supply function, divided by the sum of the slopes.

This is called general theory.

(b+d)Qd = (ad+bc)

Qd = (ad + bc) / (b+d)

3 + (1/2)p = 5 - ¾p

Demand function: Qd = a - bP

Supply function: Qs = c + dP