Demand & Supply

Demand

• Demand: the quantity which a consumer/buyer are willing and able to buy at different prices

  • Movement on the graph: downward sloping

  • Demand slopes down on the graph due to:

  1. Income effect

  2. Substitution effect

  3. law of diminishing marginal utility

• Law of Demand: As price increases, demand decreases, and as price decreases, demand increases

• Determinants of demand:

  • TRIBE

    • Taste and preferences

    • Related goods

    • Income

    • Buyers

    • Expectation of failure

• Substitutes : good/service that can be used in place of another, when price of one increases, consumers will buy more of the other (ex. coffee and tea)

  • Substitution effect: as the price of a good increases, consumers substitute the good with another that is cheaper

• Complements : goods/services that are consumed together (ex. hamburgers and buns)

• Income effect: as income increases, people will buy more of normal goods, and less of inferior goods

• Normal good : increase in demand when consumers income increases (ex. oreos)

• Inferior good : increase in demand when consumers income decreases (ex. off brand oreos)

• Diminishing marginal utility: As more units of a product are consumed, the satisfaction/utility it provides tends to decline

  • Apple users would purchase at maximum, a limited phones-they wouldn’t purchase a new iPhone every month since that extra phone would offer them no utility or not as much

  

Supply

• Supply: different quantities of goods/services which sellers are willing and able to produce at a given price

• Law of supply: as price increases, quantity supplied also increases, this is a direct relation.

• The market supply shows the quantity a supplier is willing and able to offer at various prices at a given time

Reasons for the Law of Supply

1. Rising prices give greater opportunities to suppliers to earn a profit

2. With every additional unit, suppliers face an increase in the marginal cost of production

   • Charging higher prices provides them with the easiest way to cover the cost

     • The vice versa is also true; lower prices wouldn’t provide the incentive to motivate the supplier and thus reduces the quantity of product

   • The supply curve shifts upward, and the movement along the supply curve indicates a change in price

   

Shifters of supply

• Resource costs and availability

  • The cost of production (land, labor, capital) has an inverse impact on the supply

  • When the cost of these increases, the supplier decides to produce less of the products since he is unable to afford the production cost

• Other goods and services

  • Suppliers who produce more than one product (profit-maximizing firms) have an easier time switching to the production of another product if issues do arise in prices

  • E.g. A farmer has land where he is able to produce corn and earn a profit

  • If his land is capable to produce wheat as well, in case the price of wheat increases to that of corn, he would switch to wheat production to earn better

  • The supply curve in this situation for wheat would shift outwards(more supply) and vice versa for corn(reduced supply)

• Technology

  • Newer technology causes the cost of production to decline and helps improve the efficiency of the supplier

  • This allows the supplier to produce more, shifting the supply curve outwards(toward right)

    • E.g. machines on the production line help reduce unit costs due to which more products are affordable by the supplier

• Taxes and Subsidies

  • Taxes are added up to the unit cost of production, thus making it more expensive

  • Due to this, heavily taxed products are produced in less quantity by suppliers(supply curve shifts towards left)

  • Subsidies are the opposite of taxes and help reduce price per unit

  • This allows suppliers to produce more of the product(supply curve shifts towards the right)

• Expectation

  • If suppliers expect prices to increase in the future, they would hold back supply for the current time with the future goal of earning more profit later (and vice versa)

• Number of sellers

  • As the number of sellers increases in the market, the supply automatically increases

  • This allows consumers more choices at a lower price due to an increase in competition