Supply and Demand

Introduction

Supply and demand are fundamental concepts in economics that explain how prices and quantities of goods are determined in markets. These principles form the basis for understanding market equilibrium, price changes, and the effects of various economic events.

Markets and Competition

Market Structure

• Market: A group of buyers and sellers of a particular product.

• Competitive Market: Many buyers and sellers, each with negligible effect on price.

• Perfectly Competitive Market:

  • All goods are identical.

  • Buyers and sellers are so numerous that no one can affect market price; each is a price taker.

Demand

Quantity Demanded and Law of Demand

• Quantity Demanded: The amount of a good that buyers are willing and able to purchase.

• Law of Demand: The quantity demanded of a good falls when the price of the good rises, ceteris paribus (other things equal).

Demand Curves

The demand curve shows the relationship between the price of a good and the quantity demanded.

• Downward sloping: As price decreases, quantity demanded increases.

Why Do Demand Curves Slope Down?

• At high prices, only high-value uses are satisfied.

• As price falls, lower-value uses are also satisfied, increasing quantity demanded.

Demand Curve Shifters

Non-price determinants shift the demand curve:

• Number of Buyers: More buyers increase demand at each price.

• Income:

  • Normal Good: Demand rises as income rises.

  • Inferior Good: Demand falls as income rises.

• Prices of Related Goods:

  • Substitutes: Increase in price of one increases demand for the other.

  • Complements: Increase in price of one decreases demand for the other.

• Tastes

• Expectations

Example: Demand Curve Shifter - Number of Buyers

Greater willingness to pay and greater quantity demanded at the same price when the number of buyers increases.

Active Learning: Demand Curve for Music Downloads

• Scenario A: Price of AirPods falls.

  • Music downloads and AirPods are complements. A fall in AirPods' price shifts the demand curve for music downloads to the right.

• Scenario B: Price of music downloads falls.

  • The demand curve does not shift; instead, there is a movement along the curve, increasing quantity demanded.

Supply

Quantity Supplied and Law of Supply

• Quantity Supplied: The amount of a good that sellers are willing and able to sell.

• Law of Supply: The quantity supplied of a good rises when the price of the good rises, ceteris paribus.

Supply Curves

The supply curve shows the relationship between the price of a good and the quantity supplied.

• Upward sloping: As price increases, quantity supplied increases.

Why Do Supply Curves Slope Up?

• At low prices, only low-cost suppliers produce.

• As price rises, higher-cost suppliers enter the market, increasing quantity supplied.

Supply Curve Shifters

Non-price determinants shift the supply curve:

• Input Prices: Lower input prices increase supply.

• Technology: Advances increase supply.

• Number of Sellers: More sellers increase supply.

• Expectations: Future price expectations can affect current supply.

Example: Supply Curve Shifter - Input Prices

If wages of oil rig workers fall, quantity supplied increases at each price.

Active Learning: Supply Curve for Tax Return Software

• Scenario A: Technological advance lowers production cost.

  • Supply curve shifts right; at each price, quantity supplied increases.

• Scenario B: Professional preparers raise their price.

  • Supply curve for software may shift right as demand for alternatives increases.

Market Equilibrium

Equilibrium Price and Quantity

• Equilibrium: The point where quantity supplied equals quantity demanded.

• Equilibrium Price (): The price at which the market clears.

• Equilibrium Quantity (): The quantity bought and sold at equilibrium price.

Surplus and Shortage

• Surplus (Excess Supply): Quantity supplied > quantity demanded.

  • Sellers cut prices, increasing quantity demanded and reducing quantity supplied until equilibrium is reached.

• Shortage (Excess Demand): Quantity demanded > quantity supplied.

  • Sellers raise prices, decreasing quantity demanded and increasing quantity supplied until equilibrium is reached.

Analyzing Changes in Equilibrium

Three-Step Process

1. Decide whether the event shifts the supply curve, demand curve, or both.

2. Determine the direction of the shift.

3. Use the supply-demand diagram to analyze changes in equilibrium price and quantity.

Examples

• Shift in Demand: Increase in price of gas increases demand for electric cars, raising both price and quantity.

• Shift in Supply: Technological advance reduces production cost, increasing supply, lowering price, and raising quantity.

• Shift in Both: If both demand and supply increase, quantity rises; price may rise or fall depending on the relative magnitude of shifts.

Key Equations

• Demand Function:

• Supply Function:

• Equilibrium Condition:

Summary Table: Demand and Supply Shifters

Additional info: These notes expand on the original slides and text, providing definitions, examples, and tables for clarity and completeness.