Demand and Supply Notes

Demand and Supply in Macroeconomics

• Fundamental Economic Problem
  • Based on neoclassical assumptions:
  • Limited Resources
  • Unlimited Desires/Wants
  • Result: Scarcity, which is the fundamental economic problem.

Production Possibilities Model and PPF

• Production Possibilities Frontier (PPF)
  • The PPF model shows the potential output of an economy, revealing the trade-offs between different goods.
  • Example: Quantity of guns versus quantity of butter produced.
  • Societal Preference: Production ideally on the curve to ensure full employment and efficiency.

Characteristics of the PPF

• Points on the PPF:
  • Full Employment & Efficient Use of Resources
• Flexible Prices: Certainty that society will operate on the PPF without interference by government or monopolistic entities.

Points Inside the PPF

• Characteristics of Point A (Inside the PPF):
  • Indicates inefficiency and unemployment.
  • Results from imbalance between demand & supply, potentially caused by:
  • Prices being too high or too low
  • Adjustment: Impacts are typically temporary in a self-correcting capitalist economy.

Market Definitions

• Key Terms:
  • Consumer: Individual or household.
  • Producer: Entrepreneur or firm.
  • Market: Organized action between buyers and sellers of a commodity.

Types of Markets

1. Input Markets
   • Related to factors of production.
2. Output Markets
   • Concerned with goods and services.

Market Structures

• Classification based on the number of firms and control over price:
  1. Perfect Competition
  • Many firms, no price control
  1. Monopolistic Competition
  • Many firms, some control over price
  1. Oligopoly
  • Few firms, significant price control
  1. Monopoly
  • One producer, full price control

Characteristics of Perfect Competition

1. Many buyers and sellers, unable to influence market price.
2. Standardized production – similar products.
3. Perfect mobility of resources – easy market entry/exit.
4. Flexible prices without government or union interference.
5. Perfect knowledge of market conditions – consumers are informed.

Demand

Demand Schedule

• Table showing quantity demanded as price changes.
• Equation: Q_d = F(P) (ceteris paribus).

Demand Curve

• Graphical representation showing that for most goods, quantity demanded inversely relates to price (Law of Demand).

Demand Curve Characteristics

• 1. Downward sloping, showing inverse relation.
• 2. Pertains to a specific time period.
• 3. Influenced by constant variables (ceteris paribus):
  • Tastes, Income, Prices of related goods, Population.

Shifts in Demand Curve

• Changes due to:
  • Income: Increases move demand curve right for normal goods; decreases move it left.
  • Preferences: Increased preference shifts curve right; decreased shifts it left.

Supply

Supply Schedule

• Table showing quantity supplied as price changes, defined as:
  Q_s = F(P) (ceteris paribus).

Supply Curve

• Shows positive relation between price and quantity supplied (Law of Supply).

Characteristics of Supply Curve

• 1. Generally upward sloping.
• 2. Time specific.
• 3. Influenced by constant variables (ceteris paribus):
  • Size of the industry, Technology, Prices of inputs.

Shifts in Supply Curve

• Changes induced by:
  • Technology advancements: Can lead to increased production.
  • Input Prices: Increased costs shift supply curve left (less supply); decreased costs shift it right.

Market Equilibrium

Characteristics of Equilibrium

1. Quantity supplied equals quantity demanded.
2. No tendency to change at equilibrium price ($ P^* $).
3. Optimal consumption and production at minimal costs.

Adjustment Mechanism

• Imbalances are corrected through:

1. Shortages: Price below equilibrium; producers raise prices, consumers lower demand until equilibrium is restored.
2. Surpluses: Price above equilibrium; producers reduce prices, consumers increase demand until equilibrium is restored.

Conclusions

• Neoclassical Theory: Markets self-regulating; disequilibrium conditions like unemployment are temporary.
• Policy Approach: Laissez-faire, allowing the market to self-correct.
• Critiques exist on the practical applicability of these theories due to idealized conditions (e.g., perfect competition rarely exists).