Ch 4 - Demand and Supply: The Basics

(Microeconomics)

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@@Demand and the Law of Demand@@
  • ^^Demand^^ for a product is the quantity the customers are willing and able to pay for each and every price
  • The ^^law of demand^^ states that as price increases, demand for that product decreases (inverse the relationship). When the price of a product increases, the quantity demanded decreases (all other things remain unchanged) and vice versa.   * The curve also helps identify what price the customers would be willing to pay

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@@Reasons for the Law of Demand@@
  1. ^^Income effect:^^ when prices are low, people are easily able to afford it since their budget would allow it    * As prices increase, people’s budget would tend to become tighter, as they wouldn’t be willing to spend more on a product
  2. ^^Substitution effect:^^ when products price increase, they tend to increase in relative to other products    * If product A were to become expensive, product B would most likely be cheaper than A    * Due to the existence of substitutes, customers immediately leave product A for B
  3. ^^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

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@@Change in Quantity Demanded vs. Change in Demand@@
  • ^^Quantity Demanded^^: Has an inverse relationship with changes in the price of a particular good.   * Change in the quantity demanded only occurs due to change in price-movement along the curve
  • If product A would become expensive(P2 to P1), the quantity demanded would fall (D2 toD1)

   Fig. 1 Change in Quantity Demanded

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  • Changes in demand are when the entire curve would shift upwards or downwards

 Fig. 2 Shifts in Demand

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@@Determinants of Demand@@
  • ^^Determinants of Demand:^^ the factors that cause consumers to buy more or less at the same price; these are substitutes, preferences, population, income, complements, and expectations   * These are the determinants of demand which are variables causing consumers to buy more or less of a product, irrespective of the price
  1. ^^Substitutes Available^^    * Two goods would be considered substitutes if an increase in the price of one good causes an increase in demand for the other good

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  1. ^^Population preference^^    * This is the consumer’s taste for a product at any point    * If consumers like a product, the demand curve for that product shifts upwards and vice versa if they dislike it    * A good example is when the trend of vegetarianism hit the public, the consumption of plant-based food drastically increased

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  1. ^^Population/number of consumers^^    * The bigger the market for a product, the more likely the demand curve would shift upwards    * If country A has a low birth rate in a particular year, the demand curve for baby-related products would shift downwards

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  1. ^^Income^^    * Goods are usually categorized into 2 types, inferior and normal    * Demand tends to decline (shift downwards) for inferior goods with an increase in consumer income    * Demand for normal goods increases (shifts upwards) with an increase in consumer income

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  1. ^^Complementary good^^    * These goods are purchased separately but used together. The relation here is inverse of that of substitute goods    * If two products are substitutes, an increase in the price of one good causes demand for the other good to decline as well

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  1. ^^Expectation^^    * Consumer expectation pays a major role in the determination of the price    * if consumers expect that the price of something would increase in the future, they would buy the product at a larger scale leading to the demand curve shifting upwards    * A good example would be when government warns of the possible chances of future inflation, leading to people stocking up on goods at their homes

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@@Supply and the Law of Supply@@
  • ^^Quantity Supplied^^: has a direct relationship with changes in the price of a particular good   * Since price has a different impact on both buyers and sellers, the supply curve is different than a demand curve   * The market supply shows the quantity a supplier is willing and able to offer at various prices at a given time
  • The ^^law of supply^^ states that when prices increase, the supply increases as well (direct relation)

\  Fig. 3 The Supply Curve

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@@Reasons for the Law of Supply@@
  1. Rising prices give greater opportunities to suppliers to earn a profit
  2. 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

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@@Change in Quantity Supplied vs. Change in Supply@@

\  Fig. 4 A Change in Quantity Supplied

  • Change in quantity supplied only takes place when price change takes place
  • As price increases (P1-P2), the quantity supplied also increases from Q1 to Q2. The change occurs along the supply curve

 Fig. 5 Shifts in Supply

  • Shift in supply is due to the determinants of supply
  • Determinants of supply are the factors that influence the supplier to offer more or fewer goods at the same price

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@@DETERMINANTS 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

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  1. ^^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

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  1. ^^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

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  1. ^^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)

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  1. ^^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)

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  1. ^^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

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@@MARKET EQUILIBRIUM: SUPPLY AND DEMAND TOGETHER@@
  • ^^The market equilibrium^^ price is that price which the market sets, where buyers buy the exact amount which the sellers are willing to produce. It’s also known as market-clearing price
  • ^^The Equilibrium Price:^^ price at which quantity supplied equals quantity demanded   * A surplus would only exist when the quantity supplied is greater than the quantity demanded   * A shortage would only exist when the quantity demanded is greater than the quantity supplied
  • In a competitive market where a surplus exists, prices eventually fall back to the equilibrium   * In a competitive market where a shortage exists, prices eventually get pulled back up to equilibrium. This is because the shortage creates more demand from buyers   * The suppliers utilize this and supply more at higher prices, thus bringing prices back up
  • ^^Disequilibrium^^:This occurs when there is a shortage or surplus in the market. This surplus is what creates market disequilibrium

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@@Changes in Equilibrium@@
  • Supply increases towards the right and decreases towards left
  • Demand increases towards the right (moves upwards) and decreases towards the left (moves downwards)
  • Just shift it, noting your new equilibrium price and quantity   * General Rules:     * When supply is constant and only demand increases, equilibrium price and quantity increases     * When supply is constant and only demand decreases, equilibrium price and quantity decreases     * When demand is constant and only supply increases, equilibrium price and quantity decreases     * When demand is constant and only supply decreases, equilibrium price and quantity increases

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@@The Double-Shift Rule@@
  • ^^Double-shift rule:^^ This rule states that when there is a simultaneous shift in both demand and supply, either price or quantity would stay indeterminate

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