Supply, Demand, and Equilibrium

Competitive market - many buyers and sellers for the same good or service

• Behavior is described by the supply and demand model \n

Six Key Elements of the Supply and Demand Model

• The demand curve
• Set factors that cause demand to shift
• The supply curve
• Set factors that cause supply to shift
• Market equilibrium - includes equilibrium price and quantity
• Way equilibrium curve changes based on supply and demand curve shifts

Demand:

Demand Curve

• Determined by consumers/buyers
• Buyers have a desire to purchase a good
• Quantity demanded and price are inversely related
• The higher the price of an item, the less of that item people will be willing to purchase, and vice versa

Demand Schedule - table that shows how much of a certain good consumers are willing to buy at different prices

• Quantity Demanded - actual amount consumers are willing and able to buy at a certain price
• Demand - how much people want at every pricepoint \n

Demand Curve - graphical representation of a demand schedule

• Shows the relationship between quantity demanded and price \n

Law of Demand - the higher price of a good or service leads to less quantity demanded of that good or service, all other things being equal

• Demand curves are shifted due to population growth
• Shift in the demand curve (TRIBE factors, no change in price of THE good) ≠ movement along the demand curve (price change)
• Increase in demand = rightward shift in the curve
• Decrease in demand = leftward shift in the curve

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Five Principle Factors that shift the demand curve (Determinants) (TRIBE)

• Changes in:
  • Taste - how people feel about a product
• Related goods or services
  • Substitutes in consumption - two goods for which a rise in the price of one of the goods leads to an increase in demand for the other good (example: Beef and Pork)
  • Complements in consumption - two goods that are used together. The rise in the price of one good leads to a decrease in demand for the other good (example: Beef and Potatoes)
• Income
  • Normal goods - a rise in income increases the demand (example: Butcher meat)
  • Inferior goods - a rise in income decreases the demand, mostly due to better, more expensive options (example: Spam, which is lower quality meat)
• Buyers (number of) (example: More parents = more baby supplies)
• Expectations (future price) (example: Buying large amounts of gasoline because of expectation of prices rising)

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Individual Demand Curve - shows quantity demanded and price for a single customer

Market Demand Curve - combined quantity demanded of all consumers determined by the market price of a good

• Horizontal sum - individual demand curves of all consumers in a market
• Demand = is the curve
• Quantity Demanded = point on the curve

Supply:

Quantity Supplied - amount producers are willing to produce and sell

Supply Schedule - table that shows how much of a good or service produced will affect prices

• Supply Curve - shows the relationship between quantity supplied and price
• Price and quantity supplied are directly proportional
• Up and Down graphical movement

Law of Supply - the price and quantity supplied are directly related

• Movement along the supply curve is not the same as a shift in the supply curve
• Increase in supply = downward shift
• Decrease in supply = upward shift

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Five Factors that Shift Supply Curve (IRENT)

• Input prices
  • Input - any good or service that is used to produce another good or service
  • Examples of input prices for producing donuts: Ingredients, Oven, Labor, Utility, and Rent
  • An increase in input costs leads to a decrease in supply
  • A decrease in input costs leads to an increase in supply
• Related goods or services
  • Substitutes in production (Example: Coke and BodyArmor)
  • Complements in production (Example: Cow skin and beef)
• Expectations (future price)
• Number of sellers (more sellers, more supply)
• Technology (new and better technology becomes available, leading to increase in supply)

Equilibrium

• Equilibrium: an economic condition where no individual would be better off with any alternative
• Achieved in a competitive market when quantity demanded is equal to quantity supplied (This is called the equilibrium price or market price)
• Equilibrium Quantity - quantity bought and sold at the equilibrium price
• Equilibrium can be calculated by bringing supply and demand curves together on one graph and finding where they intersect \n

Surplus - excess supply

Shortage - excess demand

• Market price always moves toward equilibrium
• When demand for a good/service increases, the equilibrium price and quantity both rise
• When supply for a good/service decreases, the equilibrium price rises, but the equilibrium quantity falls
• When both curves shift, the curve with the greatest magnitude of shift will control the equilibrium price and quantity

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Price Controls - restrictions on how high or low a market price can go

• Price ceiling - the highest a price can be
  • Price ceilings above the equilibrium will not have any effect
  • This can lead to shortages
  • Wasted Resources - a form of inefficiency where people expend money, effort, and time to cope with the shortcomings experienced by a price ceiling
  • Inefficiently low quality - sellers sell lower quality goods at a lower price
  • Sparks the emergence of black markets
• Price floor - lowest a price can be
  • Price floors below the equilibrium will not have any effect
  • Includes minimum wage
  • Can lead to surpluses
  • Inefficiently low quantity
  • Inefficiently high quality \n

Quantity Controls - also known as a quota; an upper limit on the amount of a good that can be bought or sold

• Government can limit quantity by requiring licenses to produce certain products
• These create wedges in the graph, where the quantity does not meet the equilibrium point
  • This is called the quota rent
• The cost of these wedges is known as deadweight loss, or the triangle created between the wedge and equilibrium point