Microeconomics - Demand and Supply
Markets and Prices
A market is an arrangement where buyers and sellers exchange information and conduct business.
A competitive market has many buyers and sellers, so no single participant can influence the price.
Money price is the amount of money needed to buy a good.
Relative price is the ratio of a good's money price to the money price of the next best alternative (opportunity cost).
Demand
Demand consists of:
Wanting the good or service
Being able to afford it
Having a definite plan to buy it
Wants are unlimited desires for goods and services.
Demand reflects decisions about which wants to satisfy.
Quantity demanded is the amount consumers plan to buy during a specific time period at a particular price.
The Law of Demand
The law of demand states that if other factors remain constant:
The higher the price of a good, the smaller the quantity demanded.
The lower the price of a good, the larger the quantity demanded.
Reasons for the inverse relationship between price and quantity demanded:
Substitution effect: As the relative price of a good rises, people seek substitutes, decreasing the quantity demanded of the original good.
Income effect: As the price of a good rises relative to income, people cannot afford as much, decreasing the quantity demanded.
Demand Curve and Demand Schedule
Demand refers to the entire relationship between the price of a good and the quantity demanded.
A demand curve illustrates the relationship between the quantity demanded and its price, assuming all other influences remain constant.
Movement along the demand curve:
A rise in price leads to a decrease in quantity demanded (movement up the curve).
A fall in price leads to an increase in quantity demanded (movement down the curve).
A demand curve is also a willingness-and-ability-to-pay curve.
The smaller the quantity available, the higher the price someone is willing to pay for another unit.
Willingness to pay measures marginal benefit.
Changes in Demand
A change in demand occurs when factors other than the price of the good change, affecting buying plans.
This results in a shift of the entire demand curve.
Increase in demand: demand curve shifts rightward.
Decrease in demand: demand curve shifts leftward.
Factors That Change Demand
Prices of related goods
Expected future prices
Income
Expected future income and credit
Population
Preferences
Prices of Related Goods
Substitute: A good used in place of another.
Complement: A good used in conjunction with another.
If the price of a substitute rises, the demand for the original good increases.
If the price of a complement falls, the demand for the original good increases.
Expected Future Prices
If the price of a good is expected to rise in the future, current demand increases, and the demand curve shifts rightward.
Income
When income increases, consumers buy more of most goods, and the demand curve shifts rightward.
Normal good: A good for which demand increases as income increases.
Inferior good: A good for which demand decreases as income increases.
Expected Future Income and Credit
If income is expected to increase or credit becomes easily accessible, demand may increase.
Population
A larger population generally leads to a greater demand for all goods.
Preferences
Differences in preferences among people with the same income lead to different demands.
Change in Quantity Demanded vs. Change in Demand
Change in quantity demanded: Movement along the demand curve due to a change in the price of the good.
Change in demand: Shift of the entire demand curve due to changes in other influences on buyers' plans.
Supply
Supply conditions:
Having the resources and technology to produce it.
Being able to profit from producing it.
Having a definite plan to produce and sell it.
Resources and technology determine production possibilities.
Supply reflects decisions about which technologically feasible items to produce.
Quantity supplied is the amount producers plan to sell during a given time period at a specific price.
The Law of Supply
The law of supply states that if other factors remain constant:
The higher the price of a good, the greater the quantity supplied.
The lower the price of a good, the smaller the quantity supplied.
The law of supply is based on the tendency for the marginal cost of production to increase as quantity produced increases.
Producers supply a good only if they can cover their marginal cost of production.
Supply Curve and Supply Schedule
Supply refers to the entire relationship between the quantity supplied and the price of a good.
The supply curve shows the relationship between the quantity supplied and its price, assuming all other influences remain constant.
A rise in price leads to an increase in the quantity supplied.
A supply curve is also a minimum-supply-price curve.
As quantity produced increases, marginal cost increases.
The lowest price at which someone is willing to sell an additional unit is marginal cost.
Changes in Supply
A change in supply occurs when factors other than the price of the good change, influencing selling plans.
This results in a shift of the entire supply curve.
Increase in supply: the supply curve shifts rightward.
Decrease in supply: the supply curve shifts leftward.
Factors That Change Supply
Prices of factors of production
Prices of related goods produced
Expected future prices
Number of suppliers
Technology
State of nature
Prices of Factors of Production
If the price of a factor of production rises, the minimum price a supplier is willing to accept for producing each quantity rises.
A rise in the price of a factor of production decreases supply and shifts the supply curve leftward.
Prices of Related Goods Produced
Substitute in production: Another good that can be produced using the same resources.
Complements in production: Goods that must be produced together.
The supply of a good increases if the price of a substitute in production falls.
The supply of a good increases if the price of a complement in production rises.
Expected Future Prices
If the price of a good is expected to rise in the future, the supply of the good today decreases, and the supply curve shifts leftward.
Number of Suppliers
The larger the number of suppliers, the greater the supply of the good.
An increase in the number of suppliers shifts the supply curve rightward.
Technology
Advances in technology create new products and lower the cost of producing existing products.
Advances in technology increase supply and shift the supply curve rightward.
State of Nature
The state of nature includes natural forces that influence production (e.g., weather).
A natural disaster decreases supply and shifts the supply curve leftward.
Change in Quantity Supplied vs. Change in Supply
Change in quantity supplied: Movement along the supply curve due to a change in the price of the good.
Change in supply: Shift of the entire supply curve due to changes in other influences on sellers' plans.
Market Equilibrium
Equilibrium is a situation in which opposing forces balance each other.
Market equilibrium occurs when the price balances the plans of buyers and sellers.
The equilibrium price is the price at which quantity demanded equals quantity supplied.
The equilibrium quantity is the quantity bought and sold at the equilibrium price.
Price regulates buying and selling plans.
Price adjusts when plans don’t match.
Price as a Regulator
If the price is above the equilibrium price, the quantity supplied exceeds the quantity demanded, resulting in a surplus.
If the price is below the equilibrium price, the quantity demanded exceeds the quantity supplied, resulting in a shortage.
At the equilibrium price, the quantity supplied equals the quantity demanded there is no shortage or surplus.
Price Adjustments
At prices above the equilibrium price, a surplus forces the price down.
At prices below the equilibrium price, a shortage forces the price up.
At the equilibrium price, buyers’ and sellers’ plans agree, and the price doesn’t change until an event changes demand or supply.
Predicting Changes in Price and Quantity
When demand increases, the demand curve shifts rightward. At the original price, there is a shortage, the price rises, and the quantity supplied increases along the supply curve.
When demand decreases, the demand curve shifts leftward. At the original price, there is a surplus, the price falls, and the quantity supplied decreases along the supply curve.
When supply increases, the supply curve shifts rightward. At the original price, there is a surplus, the price falls, and the quantity demanded increases along the demand curve.
When supply decreases, the supply curve shifts leftward. At the original price, there is a shortage, the price rises, and the quantity demanded decreases along the demand curve.
Changes in Both Demand and Supply
A change in both demand and supply changes the equilibrium price and the equilibrium quantity.
When both demand and supply change in the same direction:
An increase in demand and an increase in supply increase the equilibrium quantity.
The change in equilibrium price is uncertain because the increase in demand raises the price and the increase in supply lowers it.
A decrease in demand and a decrease in supply decreases the equilibrium quantity.
The change in equilibrium price is uncertain because the decrease in demand lowers the price and the decrease in supply raises the price.
When both demand and supply change in opposite directions:
A decrease in demand and an increase in supply lowers the equilibrium price.
The change in equilibrium quantity is uncertain because the decrease in demand decreases the quantity and the increase in supply increases it.
An increase in demand and a decrease in supply raises the equilibrium price.
The change in equilibrium quantity is uncertain because the increase in demand increases the quantity and the decrease in supply decreases it.