Demand, Supply, and Market Equilibrium Study Notes

Demand, Supply, and Market Equilibrium

The Basic Decision-Making Units

  • Firms: Organizations that transform resources (inputs) into products (outputs). They are the primary producing units in a market economy.

  • Entrepreneurs: Individuals who organize, manage, and assume risks of a firm, turning new ideas or products into successful businesses.

  • Households: The consuming units in an economy.

The Circular Flow of Economic Activity

  • Represents the connections between firms and households in both input and output markets, highlighting the flow of resources and payments.

Input Markets and Output Markets

  • Output Markets: Where goods and services are exchanged.

  • Input Markets: Where resources such as labor, capital, and land are exchanged for production.

  • Payments flow counterclockwise, opposite to the physical flow of resources, goods, and services.

Input Markets

  • Labor Market: Households supply labor for wages; firms demand labor.

  • Capital Market: Households supply savings for interest or profit claims; firms demand funds for capital goods.

  • Land Market: Households supply land or real property for rent.

Determinants of Household Demand

  • Factors influencing demand include:

    • Price of the product.

    • Income available to the household.

    • Accumulated wealth.

    • Prices of related products.

    • Tastes and preferences.

    • Expectations regarding future income, wealth, and prices.

Quantity Demanded

  • Definition: The quantity demanded is the amount of a product a household is willing to buy within a specific time at the current market price.

Demand in Output Markets

  • Demand Schedule: A table that shows how much of a product a household would be willing to buy at various prices.

  • Example of Demand Schedule:

    • Price (per call) vs. Quantity Demanded (calls per month)

    • $0, 30

    • $0.50, 25

    • $3.50, 7

    • $7.00, 3

    • $10.00, 1

    • $15.00, 0

The Demand Curve

  • Definition: A graph showing the amount of a product a household is willing to buy at different prices.

  • Visual Representation: A downward slope indicating an inverse relationship between price and quantity demanded.

The Law of Demand

  • Statement: There is a negative, or inverse, relationship between price and quantity demanded, resulting in demand curves that slope downward.

Other Properties of Demand Curves

  • Demand curves intersect the quantity (X-axis) due to time limitations and diminishing marginal utility.

  • They also intersect the Y-axis due to limited incomes and wealth.

Income and Wealth

  • Income: Total earnings of a household including wages, salaries, profits, rents, etc., measured over a specific period (flow measure).

  • Wealth: The total value of what a household owns minus liabilities (stock measure).

Related Goods and Services

  • Normal Goods: Goods for which demand increases with higher income.

  • Inferior Goods: Goods for which demand decreases as income rises.

Substitute and Complement Goods

  • Substitutes: Goods that can replace each other; demand for one increases if the price of the other rises.

  • Complements: Goods that are consumed together; demand for one rises when the price of the other falls.

The Ceteris Paribus Assumption

  • Definition: Assumption that no other relevant economic factors change except for the price when analyzing demand or supply curves.

  • Meaning: Latin phrase meaning "other things being equal."

Shifts in Demand and Supply Lines

  • Factors that Shift Demand Curves: Changes in determinants such as income, preferences, or prices of related goods can shift the demand curve from D0 to D1.

  • Changes in price lead only to movement along the demand curve, not a shift.

A Change in Demand vs. A Change in Quantity Demanded

  • Definition of Change in Demand: Changes in factors, other than price, that lead to a shift of the entire demand curve.

  • Movement Along the Curve: A change in price causes movement along the demand curve.

The Impact of Changes in Income

  • Higher income causes:

    • Increased demand for normal goods.

    • Decreased demand for inferior goods.

The Impact of Changes in Prices of Related Goods

  • When the price of a complement good (e.g., ketchup) rises, its demand decreases.

  • When the price of a substitute good (e.g., chicken) rises, its demand increases.

From Household to Market Demand

  • Definition of Market Demand: The total quantity demanded by all households in the market for a good or service over a period.

  • Calculation: Market demand is the summation of individual household demands.

Factors Affecting Demand Curve Shifts: Visual Representation

  • Illustrations show various potential shifts in demand caused by:

    • Changes in the price of complements and substitutes.

    • Changes in income affecting normal and inferior goods.

    • Population growth and changes in consumer expectations.

Supply in Output Markets

  • Supply Schedule: A table illustrating how much product firms will supply at different prices.

  • Quantity Supplied: Amount a firm is willing to sell at a specific price during a given time.

  • Example of Supply Schedule:

    • Price (per bushel) vs. Quantity Supplied (thousands per year)

    • $2, 0

    • $1.75, 10

    • $2.25, 20

    • $3.00, 30

    • $4.00, 45

    • $5.00, 45

The Supply Curve

  • Definition: A graph that shows the quantity of a product a firm will supply at different price levels, typically sloping upward.

The Law of Supply

  • Statement: There is a positive relationship between price and quantity supplied, leading to a positively sloped supply curve.

Determinants of Supply

  • Factors affecting supply include:

    • The price of the good.

    • Costs of production (influence of input prices).

    • Technologies used in manufacturing.

    • Prices of related products.

Factors That Shift Supply Curves

  • A range of factors can cause shifts in supply including changes in input costs, technology, and market conditions.

A Change in Supply vs. A Change in Quantity Supplied

  • Distinction between:

    • Change in Supply: Caused by shifts of the supply curve due to changes in determinants other than price.

    • Change in Quantity Supplied: Movement caused specifically by changes in the price of the good.

Market Supply Definition

  • The total quantity supplied by all firms in a market, obtained by horizontal summation of individual supply curves.

Factors That Shift The Supply Curve: Visual Representation

  • Illustrations demonstrating:

    • Effects of improved technology

    • Changing firm numbers in the market

    • Expectations of shifts in price

    • Weather conditions on agricultural supply.

Market Equilibrium

  • Definition: The point where quantity supplied equals quantity demanded, maintaining a stable market price.

  • Non-equilibrium Conditions: Prices at which demands and supplies do not coincide lead to excess demand (shortages) or excess supply (surpluses).

Market Disequilibria

  • Excess Demand (Shortage): Occurs when quantity demanded exceeds quantity supplied at the current price, leading to upward price movement until equilibrium is restored.

  • Excess Supply (Surplus): Occurs when quantity supplied exceeds quantity demanded at the current price, leading to downward price pressure until equilibrium is restored.

Increases in Demand and Supply Effects

  • Higher Demand: Leads to an increase in both equilibrium price and quantity.

  • Higher Supply: Leads to a decrease in equilibrium price but an increase in equilibrium quantity.

Decreases in Demand and Supply Effects

  • Lower Demand: Results in a decrease in price and quantity exchanged.

  • Lower Supply: Results in higher prices but lower quantity exchanged.

Relative Magnitudes of Change Effects

  • The outcomes of simultaneous increases or decreases in supply and demand are influenced by the relative magnitudes of those changes impacting price and quantity.

References

  1. Principles of Economics, Updated Edition (6th Edition) by Karl E. Case, Ray C. Case, Ray C. Fair

  2. Link: https://pressbooks.oer.hawaii.edu/principlesofmicroeconomics/chapter/3-2-shifts-in-demand-and-supply-for-goods-and-services/

Next Meeting Topics

  • Engel's Law

  • Bennett's Law

  • Giffen Goods

  • Veblen Goods