L3 Supply and Demand

Principles of Microeconomics: Supply and Demand

Topic Overview

• Focus on the mechanisms of exchange between buyers and sellers in markets, particularly how these interactions shape market dynamics.

• Understand the role of markets in allocating resources efficiently and transmitting information vital for economic decision-making.

• Develop a comprehensive terminology and foundational concepts essential to the field of economics, including supply, demand, equilibrium, and market efficiency.

Aims of Topic 1

• Introduce key concepts:

  • Supply: the quantity of a good or service that sellers are prepared to produce at various price levels, influenced by production costs, technology, and time.

  • Demand: the quantity of a good or service that buyers are willing to purchase at different price points, influenced by consumer preferences, income levels, and the prices of related goods.

• Understand market interactions for resource allocation: how supply and demand determine market prices and how prices influence producer and consumer behavior.

• Establish foundational knowledge to analyze market outcomes and understand the implications of market changes on the economy as a whole.

Aims of Lecture

• Learn fundamental principles of supply and demand:

  • Demand: defined as the buyer’s capacity and willingness to purchase goods and services at different prices; influenced by various determinants such as income, preferences, and the prices of related goods.

  • Supply: defined as the seller’s capacity and willingness to produce goods and services; affected by production costs, technology, and market entry barriers.

• Explore:

  • Determinants of supply and demand and their equations.

  • Impact of supply and demand on price formation in competitive markets.

  • Influence of demand knowledge on business pricing strategies and government price regulations, especially in instances of price ceilings and price floors.

Example of Supply and Demand Impact

• Case study regarding the rise in price due to the coronavirus outbreak, illustrating the drastic implications of sudden changes in supply and demand:

  • Price on 30/01/2020: £0.086/unit.

  • Price on 10/02/2020: £1.12/unit.

  • Observed price increase: 13 times over just 10 days, resulting from panic buying, supply shortages, and shifts in consumer demand towards essentials.

Lecture Outline

1. Law of Demand

2. Causes for Shifts in Demand

3. Law of Supply

4. Causes for Shifts in Supply

Reading Assignment

• Lipsey and Chrystal, 14th ed., ch. 2, pp 23-35 provides essential insights into the principles of supply and demand.

• Additional texts covering similar topics may include discussions on elasticities and government intervention in markets.

Assumptions in Buyer and Seller Behavior

• Buyers = Individuals; Sellers = Firms in product markets, and vice versa in factor markets

• Firms aim for profit maximization and operate as price takers, accepting market prices as given.

• Individuals seek maximum utility from consumption, influencing their purchasing decisions based on their willingness to pay, which varies with income and preferences.

Nature of Demand

• Demand is defined as the quantity consumers wish to purchase at a given price.

• Quantity Demanded: the desired quantity consumers intend to buy at specific prices, which may differ from actual purchases due to market dynamics.

• Inverse relationship with price: typically, as price increases, quantity demanded decreases, showcasing the law of demand.

• Factors influencing demand:

  • Income Effect: Higher prices reduce purchasing capacity, leading consumers to purchase less of the good.

  • Substitution Effect: Consumers will shift to alternative products when the price rises, demonstrating consumer responsiveness to price changes.

Demand Curve

• Movement along the demand curve represents changes in price affecting quantity demanded:

  • Law of Demand: Quantity demanded increases when prices fall, reflecting an inverse relationship.

Interpreting the Demand Curve

• Illustrates the relationship between price and quantity demanded, assuming other factors remain constant (ceteris paribus).

• Two interpretations:

  • Horizontal: Represents the quantity demanded at a specified price.

  • Vertical: Reflects the maximum price buyers are willing to pay for a given quantity.

Shifts in Demand

• Factors causing shifts in demand:

  • Income: For normal goods, demand shifts right with rising income, while for inferior goods, demand may shift left.

  • Prices of Related Goods:

    • Substitutes: Demand increases when prices of substitutes rise, leading consumers to replace the more expensive item.

    • Complements: Demand decreases when prices of complements rise, as these goods are often consumed together.

  • Tastes: Changing consumer preferences can lead to increased demand.

  • Number of Buyers: An increase in the number of buyers typically shifts demand to the right.

  • Future Expectations: Anticipated changes in income or prices can influence current purchasing decisions.

Nature of Supply

• Supply is defined as the quantity firms are willing to produce at a given price level.

• Quantity Supplied: the total amount that firms can offer for sale based on production costs and market conditions.

• Direct relationship: Quantity supplied generally rises as the price increases, showcasing producers’ higher inclination to supply at profitable price points.

Factors Affecting Supply:

• Scale Effects: Changes in production costs can influence overall supply levels.

• Entry Effects: Higher market prices can incentivize new firms to enter the market, increasing overall supply.

Supply Curve

• Movement along the supply curve is derived from changes in price:

  • Law of Supply: Quantity supplied increases as price rises, resulting in upward sloping supply curves.

Interpreting the Supply Curve

• The relationship between price and quantity supplied is illustrated as follows:

  • Horizontal: Shows quantity supplied at a specific price level.

  • Vertical: Indicates the minimum price sellers are willing to accept for specific quantities.

Shifts in Supply

• Factors causing shifts in supply:

  • Input Prices: Rising costs for inputs typically cause supply to shift leftward, indicating decreased supply at each price level.

  • Technology: Technological advancements often allow firms to produce more efficiently, shifting supply rightward.

  • Random Shocks: Unpredictable events such as natural disasters can decrease supply.

  • Number of Sellers: An increase in the number of sellers usually results in greater overall market supply.

Summary of Key Concepts

• Law of Demand: Quantity demanded typically decreases as price increases.

• Demand Curve: Reflects the relationship between price and quantity demanded, with shifts indicating changes in market conditions.

• Law of Supply: Quantity supplied tends to increase as price increases.

• Supply Curve: Illustrates the relationship between price and quantity supplied, and identifies factors that influence shifts.

Lecture Outcomes

• Ability to:

  • Explain the relationships between price and quantity.

  • Illustrate demand and supply relationships through graphical representations as curves.

  • Identify non-price factors that cause shifts in both demand and supply, understanding their broader implications in market dynamics.