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Chapter 4: Supply and Demand (Vocabulary Flashcards)

Demand

  • The law of demand states that the quantity of a good demanded is inversely related to the good’s price.

    • When the price falls, quantity demanded rises; when the price rises, quantity demanded falls.

    • This behavior exists because, as prices rise, people substitute away from the good toward other goods.

  • The demand concept is based on other things being constant (ceteris paribus).

The Demand Curve

  • A demand curve graphs price (P) on the vertical axis and quantity demanded (Qd) on the horizontal axis, showing the relationship between P and Qd.

  • The demand curve is downward sloping: as price increases, quantity demanded decreases.

    • Relationship is inverse:

    • Mathematically, the slope is negative:

Quantity Demanded: Movements Along a Demand Curve

  • Quantity demanded refers to a specific amount demanded per unit of time at a specific price, holding other things constant.

  • A change in price causes a change in quantity demanded and a movement along the demand curve (not a shift in the entire curve).

  • Thus, price changes are movements along the curve; non-price factors cause shifts of the entire demand curve.

Shifts in Demand vs Movements Along a Demand Curve

  • Demand (the schedule of quantities demanded at various prices, holding everything else constant) refers to the entire demand curve.

  • A change in anything other than price that affects demand shifts the entire demand curve to a new position.

    • This is a demand shift, not a movement along the curve.

  • Movement along a demand curve is caused by a price change alone.

Movement Along a Demand Curve (illustration)

  • Example representation where a price change moves you from one point to another on the same curve: a small downshift in price moves from higher P, lower Qd to lower P, higher Qd.

Shift in Demand (illustration)

  • A shift in the demand curve occurs when a non-price factor changes the quantity demanded at every price.

Factors in Demand Shift

  • Important non-price shift factors include:

    • Income

    • Prices of other goods

    • Tastes and Preference

    • Expectations

    • Taxes and subsidies

Application: Demand Shift (Income effect)

  • Example: If you win $1 million in the lottery, demand for Amedei chocolates would shift out to the right because income increased.

    • Demand1 vs Demand0 (shift to the right)

From a Demand Table to a Demand Curve

  • A demand table lists price-quantity demanded pairs; the curve is the graph of these data points.

  • Example (Movies): the data can be summarized as follows (illustrative data from the table):

    • At price 2.00, market demand = sum of individual demands (details below in Market Demand).

    • At price 4.00, market demand is reduced relative to 2.00.

    • At price 6.00, further reduction in market demand.

    • At price 8.00, even smaller market demand.

Market Demand: Price per Movie (example data)

  • Individual demands (examples from data) at various prices:

    • Price 2.00 ext{ }
      ightarrow ext{Ava} = 8, ext{ Batu} = 5, ext{ Carmen} = 1
      ightarrow ext{Market} = 14

    • Price 4.00 ext{ }
      ightarrow ext{Ava} = 6, ext{ Batu} = 3, ext{ Carmen} = 0
      ightarrow ext{Market} = 9

    • Price 6.00 ext{ }
      ightarrow ext{Ava} = 4, ext{ Batu} = 1, ext{ Carmen} = 0
      ightarrow ext{Market} = 5

    • Price 8.00 ext{ }
      ightarrow ext{Ava} = 2, ext{ Batu} = 0, ext{ Carmen} = 0
      ightarrow ext{Market} = 2

Market Demand Curve: Movies per Week

  • The market demand curve is the sum of all individual demand curves.

  • Using the illustrative data above, the market demand at each price level can be plotted to obtain the market curve.

  • Example aggregate points:

    • At 2.00: Market demand = 14

    • At 4.00: Market demand = 9

    • At 6.00: Market demand = 5

    • At 8.00: Market demand = 2

Individual and Market Demand Curves

  • The market demand curve is the horizontal summation of all individual demand curves.

  • The law of demand for the market arises from two phenomena:

    • At lower prices, existing demanders buy more.

    • At lower prices, new demanders enter the market.

Six Things to Remember About a Demand Curve

1) A demand curve follows the law of demand: When price rises, quantity demanded falls, and vice versa.
2) The horizontal axis (quantity) has a time dimension.
3) The quality of each unit is the same.
4) The vertical axis (price) assumes all other prices remain the same.
5) The demand curve assumes everything else is held constant.
6) Effects of price changes are shown by movements along the demand curve; effects of anything else on demand (shift factors) are shown by shifts of the entire demand curve.

Supply

  • The law of supply states that the quantity of a good supplied is directly related to the good’s price (ceteris paribus):

    • Quantity supplied rises as price rises; quantity supplied falls as price falls.

  • This occurs because:

    • When prices rise, firms substitute production of one good for another.

    • Assuming costs are constant, a higher price means higher profit.

The Supply Curve

  • A supply curve graphs price and quantity supplied; it is upward sloping.

  • As price increases, quantity supplied increases. This relationship illustrates the law of supply, which states that producers are willing to offer more of a good or service at higher prices.

Quantity Supplied

  • Quantity supplied refers to a specific amount that will be supplied per unit of time at a specific price, holding other things constant.

  • A change in price causes a movement along the supply curve.

Shifts in Supply vs Movements Along a Supply Curve

  • Supply is the schedule of quantities a seller is willing to sell at various prices, holding other things constant.

  • A change in anything other than price that affects the supply curve changes the entire supply curve, i.e., a shift in supply.

  • Movement along a supply curve is caused by a price change alone.

Movement Along a Supply Curve

  • A change in price causes a movement along the supply curve.

  • Example points (illustrative): as price changes from P0 to P1, quantity supplied changes from Q0 to Q1 along the same curve.

Shift in Supply

  • A shift in the supply curve occurs when a non-price determinant causes the quantity supplied at every price to change.

Factors in Supply Shift

  • Important shift factors of supply include:

    • Price of inputs

    • Technology

    • Expectations

    • Taxes and subsidies

Market Supply: Price per Movie (example data)

  • Individual supplies (examples from data):

    • Abeni, Benicio, Charlie contribute to market supply.

  • At prices:

    • Price 1.00: Total market supply = 1

    • Price 3.00: Total market supply = 5

    • Price 5.00: Total market supply = 9

    • Price 7.00: Total market supply = 14

Market Supply Curve: Movies per Week

  • The market supply curve is the sum of all individual supply curves.

  • Example summary points:

    • At 1.00: Market supply = 1

    • At 3.00: Market supply = 5

    • At 5.00: Market supply = 9

    • At 7.00: Market supply = 14

Six Things to Remember About a Supply Curve

1) A supply curve follows the law of supply: When price rises, quantity supplied increases, and vice versa.
2) The horizontal axis (quantity) has a time dimension.
3) The quality of each unit is the same.
4) The vertical axis (price) assumes all other prices remain constant.
5) The supply curve assumes everything else is constant.
6) Effects of price changes are shown by movements along the supply curve; effects of nonprice determinants of supply are shown by shifts of the entire supply curve.

Equilibrium

  • Equilibrium is a state where opposing dynamic forces cancel each other out.

  • In a free market, supply and demand interact to determine:

    • Equilibrium quantity: the amount bought and sold at the equilibrium price.

    • Equilibrium price: the price toward which the market tends to move (the price that clears the market).

The Interaction of Supply and Demand

  • If there is an excess supply (surplus), quantity supplied > quantity demanded.

  • If there is an excess demand (shortage), quantity demanded > quantity supplied.

  • Prices adjust and tend to rise when there is excess demand and fall when there is excess supply to reach an equilibrium.

Graphical Representation: Excess Pressure on Prices

  • Excess supply exerts downward pressure on price; excess demand exerts upward pressure on price.

  • At equilibrium, quantity supplied equals quantity demanded (Qs = Qd) at price P*.

Political and Social Forces and Equilibrium

  • Social and political forces can offset economic pressures.

    • Example: Social pressures may prevent unemployed individuals from accepting lower wages.

    • Renters may organize to pressure local governments to cap rents.

Shifts in Supply and Demand

  • Shifts in either the supply or the demand curve change the equilibrium price.

  • If demand increases or supply decreases: creates excess demand at the original equilibrium price; excess demand pushes price up until a new higher equilibrium price is reached.

  • If demand decreases or supply increases: creates excess supply at the original equilibrium price; excess supply pushes price down until a new lower equilibrium price is reached.

Applications: A Decrease in Supply

  • A decrease in supply generates excess demand.

  • Price will rise until a new, higher equilibrium price is reached.

  • Diagrammatic labels (from the figure): D0, S1, S0, Q, Q1, P1, P, P0 with explanations such as: excess demand.

Applications: A Decrease in Demand

  • A decrease in demand generates excess supply.

  • Price will fall until a new, lower equilibrium price is reached.

  • Diagrammatic labels (from the figure): D1, D0, S0, P, Q, Q0 with explanations such as: excess supply.

Limitations of Supply/Demand Analysis

  • Supply and demand are not always independent; they can be interdependent.

  • The "everything else held constant" assumption is often violated when goods constitute a large share of the economy.

  • The fallacy of composition: what is true for a part is not necessarily true for the whole.