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: Qd=F(P)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:
    Qs=F(P)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).