ECON 101 - Chapter 3 Flashcards

Where Prices Come From: The Interaction of Demand and Supply

Introduction

• Focus on demand schedule, demand curve, law of demand, supply schedule, supply curve, law of supply, market equilibrium, and equilibrium price/quantity

Learning Objectives

1. Define and discuss demand schedule, demand curve, law of demand, and factors influencing demand.

2. Define and discuss supply schedule, supply curve, law of supply, and factors influencing supply.

3. Illustrate market equilibrium using demand and supply curves.

4. Solve for equilibrium price and quantity using demand and supply equations.

5. Use demand and supply graphs to predict changes in prices and quantities due to changes in demand/supply determinants.

The Demand Side of the Market

Demand Schedule

• A demand schedule is a table showing the relationship between the price of a product and the quantity demanded.

Quantity Demanded

• Quantity demanded is the amount of a good or service that consumers are willing and able to purchase at a specific price.

Demand Curve

• A demand curve is a graphical representation illustrating the relationship between the price of a product and the quantity demanded.

Market Demand

• Market demand represents the total demand for a good or service among all consumers.

Demand Schedule and Demand Curve Illustration

• A table or graph shows that as the price of energy drinks falls, the quantity demanded increases.

  • Example:

    • Price = $3.00 → Quantity Demanded = 60 million cans/day

    • Price = $2.50 → Quantity Demanded = 70 million cans/day

  • Conclusion: Demand curve for energy drinks is downward sloping.

Law of Demand

• The law of demand states that, keeping other factors constant, a decrease in price leads to an increase in quantity demanded and vice versa.

Effects on Demand

• Substitution Effect:

  • The change in quantity demanded due to a price change affecting the product's relative affordability compared to substitute goods.

• Income Effect:

  • The change in quantity demanded resulting from a price change that alters consumers' purchasing power.

Ceteris Paribus Condition

• “Ceteris paribus” means holding other variables constant when examining the relationship between price and quantity demanded.

Shifting the Demand Curve

Demand Shift Explanation

• When consumers demand more of a product at a given price, the demand curve shifts right (from D1 to D2).

• Conversely, a decrease in demand shifts the curve left (from D1 to D3).

Types of Goods

• Normal Good: Demand rises as income increases.

  • Example: Clothing

• Inferior Good: Demand increases as income decreases.

  • Example: Used cars

Variables that Shift Market Demand

1. Income:

   • Change in consumer income affects demand for goods (normal vs. inferior).

2. Prices of Related Goods:

   • Substitutes: Goods that can be used for the same purpose; an increase in one causes an increase in demand for the other.

   • Complements: Goods that are used together; an increase in the price of one decreases demand for the other.

3. Tastes and Preferences:

   • Influenced by advertising and social factors.

4. Population and Demographics:

   • Changes in population characteristics can shift demand.

5. Expected Future Prices:

   • Demand can shift based on anticipated price changes in the future.

The Change in Demand vs. Change in Quantity Demanded

• A change in quantity demanded occurs due to a price change along the demand curve (e.g., from $3.00 to $2.50 results in increase from 60 million to 70 million).

• A change in demand shifts the curve itself (e.g., increasing demand at all price levels).

The Supply Side of the Market

Supply Schedule

• A supply schedule indicates the relationship between the price of a product and the quantity supplied.

Quantity Supplied

• Quantity supplied is the amount of a good or service that firms are willing and able to sell at a specific price.

Supply Curve

• A supply curve graphically represents the relationship between price and quantity supplied.

Supply Schedule and Supply Curve Illustration

• Supply schedules and curves indicate that as prices rise, firms increase quantity supplied.

  • Example:

    • Price = $2.50 → Quantity Supplied = 90 million cans

    • Price = $3.00 → Quantity Supplied = 100 million cans

Law of Supply

• The law of supply states that keeping other factors constant, increases in price result in increases in quantity supplied, while decreases in price cause decreases in quantity supplied.

Shifting the Supply Curve

• When firms increase the quantity supplied at a given price, the supply curve shifts right.

• A decrease in quantity supplied shifts the curve left.

Variables that Shift Market Supply

1. Price of Inputs:

   • Changes in input prices significantly affect supply.

2. Technological Change:

   • Enhancements or limitations in the production process impact output.

3. Prices of Substitutes in Production:

   • Firms may shift production based on relative prices of different products.

4. Number of Firms in the Market:

   • An increase in firms results in a higher supply at every price point.

5. Expected Future Prices:

   • Anticipating higher future prices can decrease current supply.

Market Equilibrium

Definition

• Market Equilibrium: A situation where the quantity demanded equals the quantity supplied.

• Competitive Market Equilibrium: Many buyers and sellers interacting.

Surplus and Shortage

• Surplus: Occurs when quantity supplied exceeds quantity demanded.

• Shortage: Occurs when quantity demanded exceeds quantity supplied.

Effects of Surpluses and Shortages on Market Price

• If market price is above equilibrium (e.g., $3.00), quantity supplied exceeds quantity demanded.

• Surplus prompts price adjustments downward towards equilibrium (e.g., from $3.00 to $2.00).

• If market price is below equilibrium (e.g., $0.50), quantity demanded exceeds quantity supplied.

• Shortage encourages firms to raise prices towards equilibrium.

Demand and Supply Interactions

• Interaction between demand and supply establishes the equilibrium price.

• Neither consumers nor firms can single-handedly dictate equilibrium.

• Buyers need sellers to complete transactions, and vice versa.

Solving for Market Equilibrium

Equations

• Given:

  • Demand: Q_d = 50 - 5P

  • Supply: Q_s = 5 + 10P

Finding Equilibrium

• Set Qd = Qs to find price and quantity equations.

Effects of Shifts in Supply and Demand on Equilibrium

Shift Effects

1. Shifts in Supply:

   • Entry of firms reduces equilibrium price and increases quantity.

   • Example: Coca-Cola entering energy drinks market changes equilibrium scenarios.

2. Shifts in Demand:

   • Increase in income raises equilibrium price and quantity, illustrating demand shift effects.

Time Effects on Shifts

• Permutation of demand and supply shifts over time influences equilibrium price stability.

Summary of Shifts Effects

Conclusion

• Understanding demand and supply fosters insight into market operation, equilibrium determination, and price mechanism.