The Market Forces of Supply and Demand
The Market Forces of Supply and Demand
Demand
Definition of Quantity Demanded (Q_d):
The amount of a good that buyers are willing and able to purchase at a certain price.
Represented by a single point on the demand curve.
If the price is increased, Q_d will be decreased.
Law of Demand:
The claim that the quantity demanded of a good falls when the price of the good rises, other things equal (ceteris paribus).
Definition of Demand:
The sum of consumers' preferences for goods or services at specific intervals of price.
Describes how consumers' willingness to purchase changes as a function of price, representing the entire demand curve.
The Demand Schedule:
A table that shows the relationship between the price of a good and the quantity demanded.
Example: Helen's demand for lattes
Price of lattes () | Quantity of lattes demanded (Q_d)
--- | ---
0.00 | 16
1.00 | 14
2.00 | 12
3.00 | 10
4.00 | 8
5.00 | 6
6.00 | 4
This example demonstrates Helen's preferences obeying the Law of Demand.
Market Demand versus Individual Demand:
The quantity demanded in the market is the sum of the quantities demanded by all buyers at each price.
Example: Helen and Ken's market demand for lattes
Price () | Helen's Qd | Ken's Qd | Market Q_d
--- | --- | --- | ---
0.00 | 16 | 8 | 24
1.00 | 14 | 7 | 21
2.00 | 12 | 6 | 18
3.00 | 10 | 5 | 15
4.00 | 8 | 4 | 12
5.00 | 6 | 3 | 9
6.00 | 4 | 2 | 6
Demand Curve Shifters (Non-Price Determinants of Demand)
The demand curve shows how price affects quantity demanded, other things being equal. These "other things" are factors that determine buyers' demand for a good, other than its price.
A change in any of these factors shifts the entire demand curve.
1. Number of Buyers (Population):
An increase in the number of buyers increases quantity demanded at each price, shifting the Demand (D) curve to the right.
Example: If the number of buyers increases, at each price (P), Q_d will increase (e.g., by 5 units in the example given).
2. Income:
Normal Good: Demand for a normal good is positively related to income. An increase in income causes an increase in quantity demanded at each price, shifting the D curve to the right.
Inferior Good: Demand for an inferior good is negatively related to income. An increase in income shifts the D curve for inferior goods to the left.
3. Prices of Related Goods:
Substitutes: Two goods are substitutes if an increase in the price of one causes an increase in demand for the other.
Example: Pizza and hamburgers. An increase in the price of pizza increases demand for hamburgers, shifting the hamburger D curve to the right.
Other Examples: Coke and Pepsi, laptops and desktop computers, compact discs and music downloads.
Complements: Two goods are complements if an increase in the price of one causes a fall in demand for the other.
Example: Computers and software. If the price of computers rises, people buy fewer computers, and therefore less software. The software D curve shifts left.
Other Examples: College tuition and textbooks, bagels and cream cheese, eggs and bacon.
4. Consumer Tastes/Preferences:
Anything that causes a shift in tastes toward a good will increase demand for that good and shift its D curve to the right.
Example: The Atkins diet in the '90s caused an increase in demand for eggs, shifting the egg D curve to the right.
5. Consumer Expectations:
Expectations about future income or prices affect consumers' buying decisions today.
Examples:
If people expect their incomes to rise, their demand for meals at expensive restaurants may increase now.
If the economy worsens and people worry about job security, demand for new autos may fall now.
6. Taxes: Taxes can influence demand by changing perceived prices or disposable income, potentially shifting the demand curve to reflect these changes if directly impacting consumer willingness to buy at a given price.
Summary of Variables Affecting Demand
Variable: Price
A change in price causes a movement along the D curve.
Variable: No. of buyers
A change in the number of buyers shifts the D curve.
Variable: Income
A change in income shifts the D curve.
Variable: Price of related goods
A change in the price of related goods shifts the D curve.
Variable: Tastes
A change in tastes shifts the D curve.
Variable: Expectations
A change in expectations shifts the D curve.
Special Cases: Giffen and Veblen Goods
Giffen Good:
A good which people consume more of as its price rises, violating the Law of Demand.
Reason for Higher Demand at Higher Price: In normal situations, the substitution effect encourages consumers to buy less of a good and more of its substitutes when its price rises. However, for Giffen goods, cheaper close substitutes are unavailable. Due to a strong income effect, low-income consumers rely heavily on this staple good; when its price rises, they must cut other goods from their budget and purchase more of the staple to meet basic needs, leading to increased demand despite the price increase.
Type of Good: Typically a staple necessity with no close substitutes (e.g., rice, bread, potatoes in poor communities).
Income Group Affected: Usually affects low-income consumers.
Effect of Price Fall: If the price falls, demand may decrease as people buy less of the staple good and switch to preferred, better quality foods.
Veblen Good (Luxury Good):
A commodity for which people's preference for buying increases as a direct function of its price, as a higher price confers greater status, thus violating the Law of Demand. A Veblen good is often also a positional good.
Reason for Higher Demand at Higher Price: Consumers value exclusivity; a higher price signals luxury and status, making the good more desirable. Decreasing the price of such goods can reduce people's preference for buying them because they are no longer perceived as exclusive or high-status products.
Type of Good: Typically a luxury good (e.g., Rolex watches, designer handbags, luxury cars, high-end wines).
Income Group Affected: Usually affects high-income/status-seeking consumers.
Effect of Price Fall: If the price falls, demand may decrease because the good loses its exclusivity and status appeal.
Active Learning Example 1: Demand Curve for Music Downloads
Scenario A: The price of iPods falls.
Analysis: Music downloads and iPods are complements. A fall in the price of iPods makes them more affordable, which generally leads to an increase in their quantity demanded. This, in turn, increases the demand for their complements (music downloads).
Effect: The demand curve for music downloads shifts to the right, leading to an increase in both equilibrium price and quantity of music downloads.
Scenario B: The price of music downloads falls.
Analysis: This is a change in the price of the good itself, not a non-price determinant of demand.
Effect: The demand curve does not shift. Instead, there is a movement down along the existing demand curve to a point with a lower price and higher quantity demanded.
Scenario C: The price of compact discs falls.
Analysis: Compact discs (CDs) and music downloads are substitutes. A fall in the price of CDs makes them relatively more attractive, thus decreasing the demand for their substitutes (music downloads).
Effect: The demand curve for music downloads shifts to the left, leading to a decrease in both equilibrium price and quantity of music downloads.
Supply
Definition of Quantity Supplied (Q_s):
The amount of a good that sellers are willing and able to sell at a certain price.
Law of Supply:
The claim that the quantity supplied of a good rises when the price of the good rises, other things equal (ceteris paribus).
The Supply Schedule:
A table that shows the relationship between the price of a good and the quantity supplied.
Example: Starbucks' supply of lattes
Price of lattes () | Quantity of lattes supplied (Q_s)
--- | ---
0.00 | 0
1.00 | 3
2.00 | 6
3.00 | 9
4.00 | 12
5.00 | 15
6.00 | 18
This example demonstrates Starbucks' supply schedule obeying the Law of Supply.
Market Supply versus Individual Supply:
The quantity supplied in the market is the sum of the quantities supplied by all sellers at each price.
Example: Starbucks and Jitters' market supply for lattes
Price () | Starbucks Qs | Jitters Qs | Market Q_s
--- | --- | --- | ---
0.00 | 0 | 0 | 0
1.00 | 3 | 2 | 5
2.00 | 6 | 4 | 10
3.00 | 9 | 6 | 15
4.00 | 12 | 8 | 20
5.00 | 15 | 10 | 25
6.00 | 18 | 12 | 30
Supply Curve Shifters (Non-Price Determinants of Supply)
The supply curve shows how price affects quantity supplied, other things being equal (ceteris paribus). These "other things" (non-price determinants of supply) shift the entire Supply (S) curve.
1. Input Prices (Production Cost):
Examples of input prices: wages, prices of raw materials. A fall in input prices makes production more profitable at each output price.
Effect: Firms supply a larger quantity at each price, and the S curve shifts to the right.
Example: If the price of milk (an input for lattes) falls, the quantity of lattes supplied will increase at each price, shifting the S curve to the right (e.g., by 5 units).
2. Technology:
Technology determines how much input is required to produce a unit of output.
Effect: A cost-saving technological improvement has the same effect as a fall in input prices, shifting the S curve to the right.
3. Number of Sellers/Producers:
Effect: An increase in the number of sellers increases the quantity supplied at each price, shifting the S curve to the right.
4. Producer Expectations:
Sellers may adjust current supply based on their expectations of future prices, provided the good is not perishable or can be stored.
Example: If events in the Middle East lead to expectations of higher oil prices in the future, owners of Texas oilfields might reduce current supply (stockpiling inventory) to sell later at the higher price. This shifts the current S curve to the left.
Summary of Variables Affecting Supply
Variable: Price
A change in price causes a movement along the S curve.
Variable: Input prices
A change in input prices shifts the S curve.
Variable: Technology
A change in technology shifts the S curve.
Variable: No. of sellers
A change in the number of sellers shifts the S curve.
Variable: Expectations
A change in expectations shifts the S curve.
Active Learning Example 2: Supply Curve for Tax Return Preparation Software
Scenario A: Retailers cut the price of the software.
Analysis: This is a change in the price of the good itself, not a non-price determinant of supply.
Effect: The S curve does not shift. There is a movement down along the existing curve to a lower price and lower quantity supplied.
Scenario B: A technological advance allows the software to be produced at lower cost.
Analysis: This is a change in technology, a non-price determinant of supply.
Effect: The S curve shifts to the right because at each price, the quantity supplied increases due to lower production costs. This leads to a fall in equilibrium price and a rise in equilibrium quantity.
Scenario C: Professional tax return preparers raise the price of the services they provide.
Analysis: This affects the demand for tax preparation software (as it's a substitute service), not the cost of producing the software itself. It is a determinant of demand.
Effect: This shifts the demand curve for tax preparation software, not the supply curve. The S curve remains unchanged.
Supply and Demand Together: Market Equilibrium
Equilibrium:
The state where the market price has reached the level where quantity supplied equals quantity demanded (QS = QD).
Equilibrium Price:
The price that equates quantity supplied with quantity demanded. In the market latte example, the equilibrium price is 3.00 (where QD = 15 and QS = 15).
Equilibrium Quantity:
The quantity supplied and quantity demanded at the equilibrium price. In the market latte example, the equilibrium quantity is 15 lattes.
Surplus (Excess Supply):
Occurs when quantity supplied is greater than quantity demanded (QS > QD). This typically happens when the market price is above the equilibrium price (sometimes seen in