Unit 2 - Supply and Demand Guide

All the basics of Supply and Demand which are the foundation of the majority of concepts moving forward.

[[2.1 - 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: * 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 consumer’s income increases (ex. oreos)
Inferior good : increase in demand when consumer’s 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

Fig. 1 Demand curve

[[2.2 - 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@@

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

Fig. 2 Supply Curve

Shifters of supply :

1. 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

\ 2. 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)

\ 3. 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

\ 4. 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)

\ 5. 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)

\ 6. 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

[[2.3 - Price Elasticity of Demand[[

Equation : %∆Qd/%∆P * 0 = perfectly elastic,
Midpoint formula : Qd2-Qd1/(Q2d+Qd1)/2 , replace with Qd with price for price
Inelastic demand : TR correlates direct with price
Elastic demand = TR correlates inversely with price

@@Elasticity@@: how much the Q is affected by P. * Elastic demand means that the goods are subject to be affected by a change in price. * Inelastic demand means that goods are not subject to be affected by a change in price.

@@Characteristics of Elastic Demand@@: * Flat, quantity is sensitive to price change, substitutes, luxury items, large portion of income, not needed immediately. Is equal to >1.
@@Characteristics of Inelastic Demand:@@ * Steep, few substitutes, required now, small portion of income, is equal to <1

@@Shapes of elasticity/inelasticity@@ * Perfectly elastic: infinity * Relatively elastic: >1 * Unit elastic: 1 * Relatively inelastic: <1 * Perfectly inelastic: 0

[[2.4 - Price Elasticity of Supply[[

@@PES@@: measures how sensitive are sellers to price changes on goods * Equation : %∆Qs/%∆P * 0 = perfectly elastic, * Inelastic : unable to respond to price change * Elastic : short run * Extremely elastic : long run

@@Characteristics of inelastic Supply:@@ * Difficult production, high costs, hard to change to alternative, high barriers to entry, <1
@@Characteristics of Elastic Supply:@@ * Easy production, low cost, easy to switch to, low barriers to entry, >1

[[2.5 - Other Elasticities[[

@@Cross price elasticity of demand :@@ %∆Qd of Good A/%∆P of good B
Negative = compliments (inferior good), positive = substitutes (normal good)
Income elasticity of demand : %∆Qd/%∆income

> 1 = income elastic, <1 = income inelastic, negative = inferior, positive = normal

[[2.6 - Market Equilibrium, Consumer and Producer Surplus[[

@@Equilibrium@@ : occurs when no one is better off doing something else * Equilibrium = Qs=Qd * Price below the equilibrium is shortage
Consumer surplus : price consumers are willing to pay - actual price
Producer surplus : actual price -price the producer is willing to sell for

Fig. 4 Consumer and Producer Surplus

Demand increase : price and quantity increase
Demand decrease : price and quantity decrease

Supply increase : price decreases, quantity increases
Supply decrease : price increases, quantity decreases

@@Double shift@@ : either price or quantity will be unknown. This rule states that when there is a simultaneous shift in both demand and supply, either price or quantity would stay indeterminate
@@Deadweight loss (DWL)@@ : transactions that should occur, but don’t because of government intervention (calculate the area = triangle formula, ½(base x height)

Fig. 5 Deadweight loss

[[2.7 - Market Disequilibrium and Changes in Equilibrium[[

[[2.8 - Government Intervention in Markets[[

@@Market Disequilibrium:@@ * Shortage : Qs < Qd, price is lower than equilibrium * Surplus : Qs > Qd, price is above equilibrium

Price floor : minimum price a supplier can charge, price is set above equilibrium (causes shortage)

Fig. 6 Price Floor

Price ceiling : maximum price a supplier can charge, price is set below equilibrium (causes surplus)

Fig. 7 Price Ceiling

Quota : upper limit of a quantity that can be bought or sold (known as quantity control)
License : gives an owner the right to supply a good/service
Demand price : the price at which consumers will demand that quantity
Supply price : the price at which producers will supply that quantity

[[2.9 - International Trade and Public Policy[[

Quota rent : difference between demand price and supply price
Tariffs : tax placed on a good that is imported or exported
Import quota : restriction on the quantity of a good that can be imported

Fig. 8