Ch 4 - Demand and Supply: The Basics

(Microeconomics)

@@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

@@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

@@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)

  

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

  

@@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

2. ^^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

3. ^^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

4. ^^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

5. ^^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

6. ^^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

@@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)

  

@@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

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

• 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

  

• 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

@@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

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

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

@@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

@@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

@@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