Chapter 3: Supply and Demand

Change in demand

A shift of the entire demand curve

Change in supply

A shift of the entire supply curve

Suppliers are willing to sell (more, less) at higher pricews

More

Market equilibrium

Occurs in a market when all buyers and sellers are satisfied with their respective quantities at the market price

Economists usually put (price, quantity) on the vertical axis of a graph

Price

Economists usually put (price, quantity) on the horizontal axis of a graph

Quantity

What does the fact that the demand curve for a good is downward-sloping reflect about the reservation price

Reflects the fact that the reservation price of the marginal buyer declines as the quantity of the good bought increases

When there's excess demand for a product, its price tends to (rise, fall)

Rise

Why is the supply curve upward sloping

Sellers differ with respect to their opportunity cost of supplying, for example, pizza. For those with limited education and work experience, the OC of selling pizza is relatively low. For others, the OC of selling pizza is of moderate value, and for others (like rock stars and athletes) it is high. The fact that the supply curve slopes upward may be seen as a consequence of the Low-Hanging-Fruit Principle. This principle tells us that as we expand the production of pizza, we turn first to those whose OC of producing pizza is lowest, and only then to others with a higher OC.

What is the vertical interpretation of the demand curve

Start with the quantity on the horizontal axis and then read the marginal buyer's reservation price on the vertical axis

Excess demand

The amount by which quantity demanded exceeds quantity supplied when the price of a good lies below the equilibrium price

Excess supply

The amount by which quantity supplied exceeds quantity demanded when the price of a good exceeds the equilibrium price

Equilibrium

A balanced or unchanging situation in which all forces at work within a system are canceled by others. In economics, a market is said to be in equilibrium when no participant in the market has any reason to alter his or her behavior, so that there is no tendency for production or prices in that market to change

What will a decrease in demand lead to

A decrease in both the equilibrium price and quantity

What will an increase in supply lead to

A decrease in the equilibrium price and an increase in the equilibrium quantity

Price ceiling

A maximum allowable price, specified by law

What will an increase in demand lead to

An increase in both the equilibrium price and quantity

What factors cause a decrease (leftward or upward shift) in supply

An increase in the cost of materials, labor, or other inputs used in the production of the good or service. Technology that increases the cost of producing the good or service. Worsening of weather (especially for agricultural products). A decrease in the number of suppliers. An expectation of higher prices in the future.

Any given buyer is willing to purchase a product if his reservation price for it exceeds what

Its market price

Equilibrium price

The price at the intersection off the supply and demand curves for the good

Change in the quantity demanded

A movement along the demand curve that occurs in response to a change in price

Income effect

The change in the quantity demanded of a good that results because a change in the price of a good changes the buyer's purchasing power

Equilibrium quantity

The quantity at the intersection of the supply and demand curves for the good

Complements

Two goods are complements in consumption if an increase in the price of one causes a leftward shift in the demand curve for the other (or if a decrease causes a rightward shift)

What factors cause an increase (rightward or downward shift) in supply

A decrease in the cost of materials, labor, or other inputs used in the production of the good or service. An improvement in technology that reduces the cost of producing the good or service. An improvement in the weather (especially for agricultural products). An increase in the number of suppliers. AN expectation of lower prices in the future

What factors cause an increase (rightward or upward shift) in demand

A decrease in the price of complements to the good or service. An increase in the price of substitutes for the good or service. An increase in income (for a normal good). An increased preference by demanders for the good or service. An increase in the population of potential buyers. An expectation of higher prices in the future

Inferior good

A good whose demand curve shifts leftward when the incomes of buyers increase and rightward when the incomes of buyers decrease

Normal good

A good whose demand curve shifts rightward when the incomes of buyers increase and leftward when the incomes of buyers decrease

Supply curve

A graph or schedule showing the quantity of a good that sellers wish to sell at each price

Change in the quantity supplied

A movement along the supply curve that occurs in response to a change in price

Demand curve

A schedule or graph showing the quantity of a good that buyers wish to buy at each price

What will a decrease in supply lead to

An increase in the equilibrium price and a decrease in the equilibrium quantity

What factors cause a decrease (leftward or downward shift) in demand

An increase in the price of complements to the good or service. A decrease in the price of substitutes of the good or service. A decrease in income (for a normal good). A decreased preference by demanders for the good or service. A decrease in the population of potential buyers. An expectation of lower prices in the future.

Substitution effect

The change in the quantity demanded of a good that results because buyers switch to or from substitutes when the price of the good changes

Why does the demand curve slope downward

The demand curve slopes downward for multiple reasons. Some have to do with the individual consumer's reactions to price changes. Thus, for example, as pizza becomes more expensive, a consumer may switch to chicken sandwiches, hamburgers, or other foods that substitute for pizza. This is called the substitution effect. In addition, a price increase reduces the quantity demanded because it reduces purchasing power. A consumer simply can't afford to buy as many slices of pizza at higher prices as at lower prices. This is called the income effect of a price change. Another reason the demand curve slopes downward is that consumers differ in terms of how much they're willing to pay for the good. The Cost-Benefit Principle tells us that a given person will buy the good if the benefit he expects to receive from it exceeds its cost. The benefit is the buyer's reservation price.

Buyer's reservation price

The largest dollar amount the buyer would be willing to pay for a good

What does the market for any good consist of

The market for any good consists of all buyers and sellers of that good. So, for example, the market for pizza on a given day in a given place is just the set of people (or other economic actors such as firms) potentially able to buy or sell pizza at that time and location

Seller's reservation price

The smallest dollar amount for which a seller would be willing to sell an additional unit, generally equal to marginal cost

True/False: In most markets, different buyers have different reservation prices. So, when the good sells for a high price, it will satisfy the cost-benefit test for fewer buyers than when it sells for a lower price

True

Substitutes

Two goods are substitutes in consumption if an increase in the price of one causes a rightward shift in the demand curve for the other (or if a decrease causes a leftward shift)

What is the horizontal interpretation of the demand curve

We defined the demand curve for any good as a schedule telling how much of it consumers wish to purchase at various prices. Using the horizontal interpretation, we start with price on the vertical axis and read the corresponding quantity demanded on the horizontal axis.