Chapter 6: Supply and Demand

6.1 Demand

 

  • Demand curve: shows relationship between price and quantity demanded of a good during a certain period of time
    • Individual’s demand curve for a good reflects marginal utility received → marginal utility decreases as unit increases
    • Law of diminishing marginal utility: satisfaction decreases as additional units of a good is consumed within a given period
  • Law of demand: as the price of a good increases, the demand decreases
    • And vice versa: as price decreases, the demand increases

6.2 Supply

 

  • Supply curve: shows relationship between price and quantity supplied by a perfectly competitive firm during a certain period of time
  • Law of supply: as the price increases, the quantity of a good also increases
    • Marginal cost increases
    • Marginal cost: additional cost of producing another unit
  • Market supply curve: shows total quantities of a good that suppliers are willing able able to provide at various prices during a period of time
    • Horizontal summation of supply curves
  • Change in quantity supplied: change in price → sellers adjust quantity
  • Change in supply: change in overall supply

 

When is there an increase in supply?

  • Decrease in input costs
    • If wages, rents, etc. related to the good produced decrease
  • Improvement in technology
  • Expectations of lower prices in the future
  • Increase in number of sellers
    • More sellers = more supply curves added horizontally
  • Decrease in price of a substitution during production
    • Ex) Paper and lumber, milk and cheese
    • If cost for cheese decreases, more milk will be sold instead
  • Increase in price of joint product
    • Ex) Leather and beef
    • Production of one makes other available
    • If price of leather increases → more cows will be slaughtered → supply of beef will increase
  • Lower taxes
  • Higher subsidies
  • Lower regulations
  • Acronym

  ROTTEN

  Resource costs

  Other goods’ prices

  Taxes and subsidies

  Technology changes

  Expectations of suppliers

  Number of suppliers

  • Long-run average cost (LRAC): cost function that represents the average cost per unit for producing a good

  • Economies of scale

    • Long-run average cost curve has a negative slope → cost per unit decreases
    • Due to:
    • Use of equipment: robots, assembly lines, etc. that increase efficiency when handling large output
    • Cost of input that does not increase when output increases → spread out over large output
      • Long term
      • Ex) Copyright

  • Diseconomies of scale: exist over range of output when LRAC increases

  • Increasing returns (to scale): when output increases proportionately more than increases in all inputs

    • Ex) Doubling all inputs results in more than double the amount of output

  • Decreasing returns (to scale): when output increases proportionately less than increases in all inputs

  • Constant returns (to scale): increase in output is equal to increase in input

  • Diminishing (marginal) returns: additional unit of input increases total input less than the previous unit of input → holds all other inputs constant

  • Increasing cost firm: faces decreasing returns to scale

  • Decreasing cost firm: faces increasing returns to scale