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