Supply and Demand Concepts

Supply and Demand Dynamics

Introduction to Supply Shift

  • Technological change allows producers to use fewer inputs (e.g., labor).

  • Result of technological change:

    • Costs decrease

    • Profits increase

    • Self-regulating market mechanisms in play.

Final Integration in Economics

  • The goal of economics: create models that explain real-world behaviors.

  • Economic models combine various economic factors much like parts of a car coming together to form a functional vehicle.

  • Aim: formulate a theory regarding equilibrium price and quantity.

Understanding Equilibrium Price and Quantity

  • Equilibrium price: the price at which quantity supplied equals quantity demanded.

  • The study of supply and demand assists in understanding price fluctuations:

    • Why prices increase.

    • Why prices decrease.

Visualization of Supply and Demand

  • Graphical presentation:

    • X-axis: Quantity of apples.

    • Y-axis: Price of apples.

  • Characteristics of curves:

    • Supply Curve: Upward sloping.

    • Demand Curve: Downward sloping.

Initial Scenario: Price Too High

  • Example with a price of $2 per pound:

    • Quantity demanded at $2 = 8,000,000 pounds.

    • Quantity supplied at $2 = 12,000,000 pounds.

  • Market condition:

    • Excess Supply (Surplus) occurs as quantity supplied exceeds quantity demanded.

    • Excess Supply formula: qs > qd .

Imbalance and Market Regulation

  • Consequence of excess supply:

    • Producers attempt to sell more apples than consumers are willing to buy.

    • Market correction occurs via price adjustments:

    • Auctioneer lowers the price, resulting in:

      • Increased quantity demanded.

      • Decreased quantity supplied.

  • Continuation of price reduction until excess supply is eliminated.

Scenario: Price Too Low

  • Example with a price of $1 per pound:

    • Quantity demanded = 12,000,000 pounds.

    • Quantity supplied = 7,000,000 pounds.

  • Market condition:

    • Excess Demand occurs as quantity demanded exceeds quantity supplied.

    • Excess Demand formula: qd > qs .

Regulating Excess Demand

  • Consequence of excess demand:

    • Auctioneer raises the price until equilibrium is restored.

    • The process of raising prices continues until excess demand disappears.

Concept of Equilibrium

  • Definition of Equilibrium: A state of balance in the market.

  • At equilibrium:

    • Quantity supplied equals quantity demanded.

    • No excess supply or excess demand.

  • Equilibrium is not necessarily a favorable condition; it simply indicates stability in the market price level.

  • Disequilibrium: Occurs when either excess supply or excess demand is present.

Price Flexibility and Rapid Adjustment

  • Markets are assumed to adjust quickly to reach equilibrium, with specific examples:

    • Stock market prices fluctuate rapidly based on buyer and seller dynamics.

    • Other markets, like supermarkets, witness slower price adjustments.

    • Example of wages: Typically adjusted annually, demonstrating much slower market responses.

Theory of Price Adjustment

  • Understanding how equilibrium prices change involves analyzing four cases:

Case 1: Increase in Demand

  • Scenario:

    • Original equilibrium: $1.50 per pound, quantity = 10,000,000 pounds.

    • Demand shifts right due to increased preference.

  • Result of increased demand:

    • Old price becomes untenable (excess demand occurs).

    • Auctioneer raises the price to restore equilibrium, leading to a price increase to, for example, $1.75.

    • Quantity also rises to accommodate higher demand.

Case 2: Decrease in Demand

  • Scenario:

    • Demand curve shifts to the left.

  • Result:

    • Leads to excess supply at the original equilibrium price ($1.50).

    • Auctioneer lowers the price to restore equilibrium; new price might be $1.25.

    • Quantity decreases from 10,000,000 to 9,000,000 pounds.

Case 3: Increase in Supply

  • Scenario:

    • Supply curve shifts to the right.

  • Result:

    • Excess supply at the old equilibrium price ($1.50).

    • Auctioneer lowers prices, causing a new equilibrium around a lower price while quantity increases.

  • Example: Price drops, say to $1.25 while quantity increases significantly.

Case 4: Decrease in Supply

  • Scenario:

    • Supply curve shifts to the left.

  • Result:

    • Excess demand is generated, requiring the auctioneer to raise prices.

    • Price increases, but quantity sold decreases due to higher prices.

Practical Applications of the Supply and Demand Model

  • Use the model to analyze various markets, including:

    • Fast food industry: Increased income boosts demand; prediction of higher prices and sales.

    • Automotive market: Increased wages for workers decreases supply, resulting in higher car prices.

    • Effects of external factors (e.g., pandemics) lead to temporary fluctuations in supply and demand.

Conclusion

  • The supply and demand framework provides valuable insights into pricing mechanisms and market equilibria, essential for understanding economic behaviors.