Chapter 3 - Supply & demand
Buyers and sellers in markets
- Market: market for any good consists of all buyers and sellers of that good.
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- Demand curve: schedule/graph showing the quantity of a good that buyers wish to buy at each price.
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- Substitution effect: change in the quantity demanded of a good that results because buyers switch to or from substitutes when the price of the good changes.
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- Income effect: change in the quantity demanded of a good that results because a change in the price of a good changes the buyer's purchasing power.
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- Buyer's reservation price: the largest dollar amount the buyer would be willing to pay for good.
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- Supply curve: graph/schedule showing the quantity of a good that sellers wish to sell at each price.
- Seller's reservation price: the smallest dollar amount for which a seller would be willing to sell an additional unit, generally equal to marginal cost.
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Market equilibrium
- Equilibrium: balanced/unchanging situation in which all forces at work within a system are canceled by others.
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- Equilibrium price and equilibrium quantity: price and quantity at the intersection of the supply and demand curves for the good.
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- Market equilibrium occurs in a market when all buyers and sellers are satisfied with their respective quantities at the market price.
- Excess supply: amount by which quantity supplied exceeds quantity demanded when the price of a good exceeds the equilibrium price.
- Excess demand: amount by which quantity demanded exceeds quantity supplied when the price of a good lies below the equilibrium price.
Predicting and explaining changes in prices and quantities
- Change in the quantity demanded: movement along the demand curve that occurs in response to a change in price.
- Change in demand: shift of the entire demand curve.
- Change in the quantity supplied: movement along the supply curve that occurs in response to change in price
- Change in supply: shift of the entire supply curve.
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- Complements: 2 goods are complements in consumption if an increase in the price of one causes a leftward shift in the demand curve for the other (or if a decrease causes a rightward shift).
- Substitutes: 2 goods are substitutes in consumption if an increase in the price of one causes rightward shift in the demand curve for the other (or if a decrease causes a leftward shift).
- Normal good: good whose demand curve shifts rightward when the incomes of buyers increase and leftward when the Incomes of buyers decrease.
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- Inferior good: good whose demand curve shifts leftward when the incomes of buyers increase and rightward when the incomes of buyers decrease.
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- 4 simple rules:
- Factors that cause an increase (rightward/upward shift) in demand: * Decrease in the price of complements to the good/service * Increase in the price of substitutes for the good/service * Increase in income (for a normal good) * Increased preference by demanders for the good/service * Increase in the population of potential buyers * Expectation of higher prices in the future.
→ When these factors move in the opposite direction, demand will shift left.
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- Factors that cause an increase (rightward/downward shift) in supply: * Decrease in the cost of materials, labor or other inputs used in the production of the good/service * Improvement in technology that reduces the cost of producing the good/service * Improvement in the weather (especially for agricultural products) * Increase in the number of suppliers * Expectation of lower prices in the future.
→ When these factors move in the opposite direction, supply will shift left
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Efficiency and equilibrium
- Buyer's surplus: difference between the buyer's reservation price and the price he/she actually pays.
- Seller's surplus: difference between the price received by the seller and his/her reservation price.
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- Total surplus: difference between the buyer's reservation price and the seller's reservation price.
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- Cash on the table: economic metaphor for unexploited gains from exchange.
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- Socially optimal quantity: quantity of a good that results in the maximum possible economic surplus from producing and consuming the good.
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- Efficiency = economic efficiency: condition that occurs when all goods and services are produced and consumed at their respective socially optimal levels.
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