Market Forces of Supply and Demand - Chapter 4

Demand

  • Definition: Demand comes from buyers; the quantity demanded $Q_d$ is how much buyers are willing and able to buy.
  • Law of Demand: holding all else constant, as price rises, quantity demanded falls. Expressed as \frac{\partial Q_d}{\partial P} < 0.
  • Demand Schedule & Curve: a table/graph showing the relationship between price ($P$) and quantity demanded ($Q_d$).
  • Market vs. Individual Demand: market demand is the sum of all buyers’ quantities at each price.
  • Demand Shifters (non-price determinants): income, prices of related goods (substitutes & complements), tastes/preferences, expectations, number of buyers.
  • Normal vs. Inferior Goods:
    • Normal goods: income up ⇒ demand up (shift right).
    • Inferior goods: income up ⇒ demand down (shift left).
  • Substitutes & Complements (prices of related goods):
    • Substitutes: price of substitute up ⇒ demand for the good up (shift right).
    • Complements: price of complement up ⇒ demand for the good down (shift left).
  • Movement vs. Shift:
    • Change in price causes a movement along the demand curve (quantity demanded changes, not the curve).
    • Changes in non-price determinants shift the entire demand curve.
  • Quick recap concept: the demand curve shows how $Q_d$ responds to $P$ when other determinants are held constant.

Supply

  • Definition: Supply comes from sellers; the quantity supplied $Q_s$ is how much sellers are willing and able to sell.
  • Law of Supply: holding all else constant, as price rises, quantity supplied rises. Expressed as \frac{\partial Q_s}{\partial P} > 0.
  • Supply Schedule & Curve: a table/graph showing the relationship between price ($P$) and quantity supplied ($Q_s$).
  • Market vs. Individual Supply: market supply is the sum of all sellers’ quantities at each price.
  • Supply Shifters (non-price determinants): input costs (including wages), technology, weather/seasonality, taxes/subsidies, expectations about future prices, number of sellers.
  • Movement vs. Shift:
    • Change in price causes a movement along the supply curve (quantity supplied changes, not the curve).
    • Changes in non-price determinants shift the entire supply curve.
  • Good weather/tech improvements reduce production costs and shift the supply curve right (increase in supply).

Equilibrium and Market Clearing

  • Equilibrium: intersection of demand and supply curves where quantity supplied equals quantity demanded.
    • Qd = Qs\quad\text{at }P^, Q^
  • Surplus: when quantity supplied > quantity demanded (QS > QD). Prices tend to fall to clear surplus.
  • Shortage: when quantity demanded > quantity supplied (QD > QS). Prices tend to rise to clear shortage.
  • Market adjustments: price movements ensure market moves toward equilibrium over time.

Shifts vs Movements (Summary)

  • Demand:
    • Shift: a non-price determinant changes, moving the curve from $D$ to $D'$.
    • Movement: price change causes movement along the same curve (QD changes).
  • Supply:
    • Shift: a non-price determinant changes, moving the curve from $S$ to $S'$.
    • Movement: price change causes movement along the same curve (QS changes).

Price as a Signal and Resource Allocation

  • Prices act as signals that guide decision making in a market economy.
  • Equilibrium prices allocate scarce resources efficiently in competitive markets.

Quick Visual Summary (Key Formulas)

  • Demand slope: \frac{\partial Q_d}{\partial P} < 0
  • Supply slope: \frac{\partial Q_s}{\partial P} > 0
  • Equilibrium condition: Qd = Qs, \quad P^, Q^
  • Surplus: Qs > Qd
  • Shortage: Qd > Qs
  • Shifts vs Movements: non-price determinants shift curves; price changes move along curves